**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, 2006


**or**


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





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







**DELTA
      FINANCIAL CORPORATION**


(Exact
      name of registrant as specified in its charter)





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





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


(Address
      of principal executive offices) (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 Section 15(d) of the 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 Exchange Act).


Yes
      [
      ]  No [ x
      ]





As
      of
      June 30, 2006, the aggregate market value of the voting stock held by
      non-affiliates of the Registrant, based on the closing price of $9.85 for such
      stock on that date, was approximately $161.5 million.





As
      of
      March 2, 2007, 23,495,411 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, 2006.








**Delta
                Financial Corporation****Table
                of Contents****Part
              I**Item
                1.
            Business
            1Item
                1A.
            Risk
                Factors
            23Item
                1B.
            Unresolved
                Staff
                Comments
            39Item
                2.
            Properties
            39Item
                3.
            Legal
                Proceedings
            40Item
                4.
            Submission
                of Matters to a Vote of
                Security Holders
            42**Part
                II**Item
                5.
            Market
                for the Registrant’s Common Equity, Related Stockholder Mattersand
                Issuer Purchases of Equity Securities
            43Item
                6.
            Selected
                Financial Data
            44Item
                7.
            Management’s
                Discussion and Analysis of
                Financial Condition and Results of Operations
            47Item
                7A.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            77Item
                8.
            Financial
                Statements and Supplementary
                Data
            79Item
                9.
            Changes
                in and Disagreements with
                Accountants on Accounting and Financial Disclosure
            116Item
                9A.
            Controls
                and Procedures
            116Item
                9B.
            Other
                Information
            117**Part
                III**Item
                10.
            Directors,
                Executive Officers and Corporate
                Governance
            117Item
                11.
            Executive
                Compensation
            117Item
                12.
            Security
                Ownership of Certain Beneficial Owners and
                Management and Related Stockholder Matters
            117Item
                13.
            Certain
                Relationships and Related Transactions, and
                Director Independence
            117Item
                14.
            Principal
                Accountant Fees and
                Services
            117**Part
                IV**Item
                15.
            Exhibits
                and Financial Statement
                Schedules
            117**Signatures**
            119








**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” on page 22 and “Risk Factors” on page 23 for a description of
      some of these uncertainties.*





**Description
      of Our Business**





Delta
      Financial Corporation (and collectively with its subsidiaries, the “Company,”
“we” or “us” and on a stand-alone basis “Delta Financial” or the “Holding
      Company”) is a specialty consumer finance company that originates, securitizes
      and sells non-conforming mortgage loans. We were incorporated in 1996 as a
      Delaware corporation. We were initially organized in 1982 as Delta Funding
      Corporation, a New York corporation. Our corporate offices are located at 1000
      Woodbury Road, Suite 200, 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, as soon as reasonably practicable
      after such material is electronically filed with or presented to the SEC.
      Information appearing on our website will not be deemed to be part of this
      report.





Our
      loans
      are primarily fixed rate and secured by first mortgages on one- to four-family
      residential properties. Throughout our 25-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
      2006, our average loan size was approximately $154,000 and, at the time of
      origination, the weighted average interest rate was 8.9%, the weighted average
      combined loan-to-value (“CLTV”) ratio was 78.0% and the weighted average credit
      score of the underlying borrowers was approximately 618. Since 2001, at least
      35% of our annual loan production has been related to borrowers located in
      New
      York, New Jersey and 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 good faith exercise 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
                origination 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 credit facilities 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 asset-backed 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 reserves.





**1**


**Origination
      of Mortgage Loans**





We
      originate mortgage loans through two distribution channels, wholesale and
      retail. The majority of the mortgage loans we originate occur in 34 states.
      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; and Dallas, Texas. We also purchase closed loans on
      a
      limited basis. (See “-Wholesale Loan Channel”).





For
      the
      year ended December 31, 2006, we originated $4.0 billion of loans, an increase
      of $195.8 million, or 5.1%, over the $3.8 billion of loans originated in the
      year ended December 31, 2005. The amount originated in 2006 included
      approximately $2.1 billion of wholesale loans, representing 51.4% of total
      loan
      production, and $1.9 billion of retail loans, representing 48.6% of total loan
      production, compared to $2.0 billion of wholesale loans, or 53.9% of total
      loan
      production, and $1.8 billion of retail loans, or 46.1% of total loan production,
      during the year ended December 31, 2005.


**2**


The
      following table shows certain data regarding our loan originations, presented
      by
      channel of loan origination, for the years ended December 31, 2006, 2005 and
      2004:





**For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**
              
              **2004****Wholesale:**Number
                  of loans
              
              
              11,104
              
              
              10,982
              
              
              8,434Principal
                  balance
              
              $
              2,073,124
              
              $
              2,065,638
              
              $
              1,497,743Average
                  principal balance per loan
              
              
              187
              
              
              188
              
              
              178Weighted
                  average initial LTV/CLTV ratio(1)
              
              
              76.6
              %
              
              77.5
              %
              
              76.5
              %Weighted
                  average interest rate
              
              
              8.7
              %
              
              7.7
              %
              
              7.7
              %Weighted
                  average credit score
              
              
              606
              
              
              618
              
              
              623**Retail:**Number
                  of loans
              
              
              15,135
              
              
              13,927
              
              
              9,259Principal
                  balance
              
              $
              1,958,302
              
              $
              1,770,007
              
              $
              1,113,783Average
                  principal balance per loan
              
              
              129
              
              
              127
              
              
              120Weighted
                  average initial LTV/CLTV ratio(1)
              
              
              79.5
              %
              
              80.2
              %
              
              80.0
              %Weighted
                  average interest rate
              
              
              9.0
              %
              
              8.3
              %
              
              8.1
              %Weighted
                  average credit score
              
              
              630
              
              
              639
              
              
              640**Total
                  Wholesale and Retail:**Number
                  of loans
              
              
              26,239
              
              
              24,909
              
              
              17,693Principal
                  balance
              
              $
              4,031,426
              
              $
              3,835,645
              
              $
              2,611,526Average
                  principal balance per loan
              
              
              154
              
              
              154
              
              
              148Weighted
                  average initial LTV/CLTV ratio(1)
              
              
              78.0
              %
              
              78.8
              %
              
              78.0
              %Weighted
                  average interest rate
              
              
              8.9
              %
              
              8.0
              %
              
              7.9
              %Weighted
                  average credit score
              
              
              618
              
              
              628
              
              
              630**Percentage
                  of Loans Secured by:**First
                  mortgages
              
              
              95.4
              %
              
              97.8
              %
              
              97.7
              %Second
                  mortgages
              
              
              4.6
              %
              
              2.2
              %
              
              2.3
              %**Loan
                  Type:**Fixed
                  rate mortgages
              
              
              87.1
              %
              
              79.5
              %
              
              78.4
              %Adjustable-rate
                  mortgages
              
              
              12.9
              %
              
              20.5
              %
              
              21.6
              %





*(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, 2006, 2005 and
      2004:





**For
                the Year Ended December 31,****2006**
            
            **2005**
            
            **2004****First
                Mortgage:**Weighted
                average initial LTV ratio(1)
            
            
            77.8
            %
            
            78.7
            %
            
            78.0
            %Weighted
                average interest rate
            
            
            8.8
            %
            
            7.9
            %
            
            7.8
            %**Second
                Mortgage:**Weighted
                average initial CLTV ratio(1)
            
            
            82.4
            %
            
            80.2
            %
            
            80.1
            %Weighted
                average interest rate
            
            
            10.6
            %
            
            9.3
            %
            
            9.1
            %





*(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, 2006, 2005 and 2004:





**For
                the Year Ended December 31,****2006**
            
            **2005**
            
            **2004****Percentage**
            
            **Amount**
            
            **Percentage**
            
            **Amount**
            
            **Percentage**
            
            **Amount****Region:**
            
            
            
            
            *(Dollars
                in millions*)New
                York, New Jerseyand
                Pennsylvania
            
            35.4
            %
            $
            1,426.7
            
            
            37.7
            %
            $
            1,447.6
            
            
            41.5
            %
            $
            1,083.3Southeast
            
            17.7
            
            
            713.1
            
            
            15.5
            
            
            595.6
            
            
            10.1
            
            
            264.1Mid-Atlantic(1)
            
            14.5
            
            
            583.1
            
            
            14.4
            
            
            552.7
            
            
            15.3
            
            
            400.7Midwest
            
            14.3
            
            
            575.0
            
            
            16.0
            
            
            612.7
            
            
            17.8
            
            
            463.8West
            
            11.0
            
            
            445.5
            
            
            8.8
            
            
            336.2
            
            
            4.7
            
            
            121.9New
                England
            
            7.1
            
            
            288.0
            
            
            7.6
            
            
            290.8
            
            
            10.6
            
            
            277.7Total
            
            100.0
            %
            $
            4,031.4
            
            
            100.0
            %
            $
            3,835.6
            
            
            100.0
            %
            $
            2,611.5





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





***Wholesale
      Loan Channel.*** Through
      our wholesale loan 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 our wholesale loans
      through a network of approximately 3,200 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. Because 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 wholesale 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, 2006, we employed 125 account executives focused exclusively on
      the
      wholesale market. For the year ended December 31, 2006, our wholesale network
      accounted for $2.1 billion, or 51.4% of our loan originations, compared to
      $2.1
      billion, or 53.9%, of our loan originations for the year ended December 31,
      2005
      and $1.5 billion, or 57.4%, of our loan originations for the year ended December
      31, 2004. No single broker contributed more than 4.8%,  5.3%
      or
      5.9% of our total loan production in the years ended December 31, 2006, 2005
      and
      2004, respectively.





**4**


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





Typically,
      we initiate contact with brokers through our Business Development Department,
      supervised by a senior officer with over 24 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 wholesale 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
      an independent mortgage broker becomes part of our network, the broker must
      go
      through our approval process. Once approved, the broker may begin submitting
      applications 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 wholesale 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 Click & Close
        (“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 key factors that generally 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 10 origination centers located in
        nine
        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. T he
        retail
        channel accounted for $1.9 billion, or 48.6%, of our loan originations for
        the
        year ended December 31, 2006, compared to $1.8 billion, or 46.1%, of our
        loan
        originations for the year ended December 31, 2005 and $1.1 billion, or 42.6%,
        of
        our loan originations for the year ended December 31, 2004.
 
 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, 2006, we
        employed 464 mortgage analysts, representing a 12.3% increase over the 413
        mortgage analysts employed at December 31, 2005.
 
 ***Loan
        Underwriting***
 
 *Underwriting
        Guidelines.* We
        maintain written underwriting guidelines that are utilized by all of our
        employees associated with the underwriting process. Throughout our 25-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 (specifically the borrower’s Fair, Isaac & Co. (“FICO”) score,
                  which measures an individual’s record in using
                  credit);
 
 **6**
 §
              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.
 
 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 each of those classifications (referred to as the
        “credit grade”). 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 rolling 30-day late payments in the last
                    12
                    months.
                
                Up
                    to a maximum of one rolling 60-day late payment in the last 12
                    months.
                
                Up
                    to a maximum of one 90-day late payment in the last 12
                    months.
                
                Up
                    to a maximum of one 120-day late payment in the last 12 months.
                    Case by
                    case open foreclosures considered.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 525.Bankruptcy
                    Filings
                Generally,
                    Ch. 7 discharged or Ch. 13 filed more than two years prior to
                    closing.
                    Open Ch. 13 considered.
                
                Generally,
                    Ch. 7 discharged or Ch. 13 filed more than one year prior to
                    closing. Open
                    Ch. 13 is considered.
                
                Generally,
                    Ch. 7 must be discharged prior to closing. 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 600 credit score for full income check loans if
                    mortgage is no worse than 1x60 rolling within the last 12 months
                    (maximum
                    of 3 consecutive months).
                
                Up
                    to 80% LTV with a 550 credit score for full income check loans
                    if 1x90
                    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 660 credit score for full income check loans
                    if mortgage
                    is no worse than 1x30 rolling within the last 12 months.
                
                Up
                    to 80% LTV with a 580 credit score for full income check loans if
                    mortgage is no worse than 0x60 within the last 12 months.
                
                Not
                      available.
                
                Not
                    available.
 
  
 **7**
 *(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, “1x30”
means one payment late by 30 days; “0x60” means no payments late by 60 days,
“1x60” means one payment late by 60 days, “0x90” means no payments late by 90
        days, “1x90” means one payment late by 90 days and “1x120” means one payment
        late by 120 days).*
 
 *Underwriting
        Exceptions.* We use
        these underwriting classifications 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 grade of our originations along with
        the
        weighted average coupon and weighted average LTV/CLTV, for the years ended
        December 31, 2006, 2005 and 2004:
 *(Dollars
                        in thousands)***For
                        the Year Ended**
                    
                    **Credit
                        Grade**
                    
                    **Total
                        Originations**
                    
                    **Percent
                        of Total Originations**
                    
                    **Weighted
                        Average**
                      **Coupon**
                    
                    **Weighted
                        Average LTV/CLTV****December
                        31, 2006**
                    
                    A
                    
                    $3,555,222
                    
                    88.2%
                    
                    8.7%
                    
                    79.7%B
                    
                    258,227
                    
                    6.4
                    
                    9.4
                    
                    69.1C
                    
                    120,296
                    
                    3.0
                    
                    9.9
                    
                    65.4D
                    
                    97,681
                    
                    2.4
                    
                    10.3
                    
                    57.2Total/Average
                    
                    
                    
                    $                             
                        4,031,426
                    
                    100.0%
                    
                    8.9%
                    
                    78.0%**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%
  **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 a period of
        time
        (two to three years) and then adjust every six months thereafter. We also 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 stepped fixed-rate mortgage loan’s term, the
        fixed monthly payment is based on either a 40-year or (commencing in late
        December 2006) a 50-year amortization, after which the fixed monthly payment
        is
        adjusted based on a 20-year amortization during the remaining 20 years of
        the
        term. Both the initial monthly mortgage payments (for the first 10 years
        of the
        loan) and the subsequent monthly mortgage payments over the next 20 years
        are
        known by the borrower upfront at closing.
 
 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 $1.2
        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.
 
 We
        periodically review the loan products we offer to determine the need for
        changes
        to or elimination of a product. While interest-only mortgage loans represented
        less than 1% of our annual 2006 loan origination volume, we stopped offering
        this product altogether in the fourth quarter of 2006 because of our view
        of the
        product’s diminished risk adjusted return. Additionally, during the fourth
        quarter of 2005 we ceased originating 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: 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:
 
 **9**
 ·
              job
                  position;
 
 ·
              length
                  of time on job; and
 
 ·
              current
                  salary.
 
 The
        job
        letter should be on the employer’s letterhead and include the telephone number
        and signature of the individual completing the letter on behalf of the
        employer.
 
 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, to better credit quality
        borrowers where employment can be verified by an underwriter via telephone.
        We
        usually require lower combined LTV ratios with respect to loans made under
        programs other than our 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 25-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 92 underwriters, averaging nine years of non-conforming lending
        experience and averaging six years working for us. All underwriting functions
        for broker originations are conducted in our Woodbury, New York headquarters,
        and our regional offices in Jacksonville, Florida; 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/valuation review is conducted by our
                  underwriters and/or appraisal review department, except where an
                  appraisal is not centrally ordered by us or when 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 all federal and state regulations were properly complied
                  with.
 
 **10**
 When
        we
        utilize appraisals, we require that they be performed by third-party, fee-based
        appraisers. 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 also access alternate
        sources to validate sales data used in the appraisals to determine market
        value.
        These alternate 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.
 
 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.
        Our underwriters conduct limited reviews of the appraisals centrally ordered
        by
        us and the AVMs utilized in order to determine that the appraisal/AVM meets
        our
        guidelines.
 
 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.
        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 the design of their
        model. 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
        to
        mitigate one of the weaknesses in using an AVM to value a property - the
        lack of
        a physical exterior or interior inspection of the property. For each AVM
        considered for use, we therefore require a property condition report which 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 years ended December
        31,
        2006 and 2005, we utilized an Insured AVM for approximately 12% and 11%,
        respectively, of the loans we originated and those loans had a weighted average
        LTV of 76% and 77%, respectively, and a weighted average credit score of
        680 and
        689, respectively.
 
 At
        the
        closing of a loan, where an AVM is used, we will purchase insurance, from
        a
        company that meets our minimum requirements ( *i.e.* ,
        A.M.
        Best insurer rating of A+), 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 either the losses we incurred from the
        disposal of the property or the difference between the 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 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 to insure 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.
 
 **11**
 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.
 
 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 department 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, geographic areas or other third parties)
                  or products
                  (perceived riskier products and/or newly offered
                  products).
 
 If
        any
        discrepancies are discovered during the quality control 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 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,
                  including
                  closing documents; and
 
 §
              easy,
                  real-time supervisory oversights to ensure that 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.
 
 **12**
 ***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
        credit
        facility 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 credit facility for only a limited time - generally, not
        more
        than three months - long enough to enable us to either securitize or sell
        the
        loans. During the time we hold the loans prior to securitization or whole-loan
        sale, we earn interest income from the borrower. The income is partially
        offset
        by any interest we pay to our warehouse creditors for providing us with
        financing. Additionally, we pay a third-party servicer a sub-servicing fee
        to
        perform the servicing of the mortgage loans during this pre-securitization
        or
        pre-sale holding period.
 
 ***Securitizations
        and Whole-Loan Sales.***  As
        a
        fundamental part of our business and financing strategy, we securitize a
        substantial portion of the mortgage loans we originate. We also sell a portion
        of our loans as whole-loans. We
        select
        the outlet (securitization or whole-loan sale) depending on market conditions,
        relative profitability and cash flows.  In
        the
        years ended December 31, 2006 and 2005, whole-loan sales comprised approximately 18.7%
        and
        14.9% ,
        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, 2006
        and
        2005:
 
 **For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Loan
                  securitizations - portfolio based
              
              $
              3,149,976
              
              $
              3,199,997Whole-loan
                  sales
              
              
              725,112
              
              
              561,487Total
                  securitizations and whole-loan sales
              
              $
              3,875,088
              
              $
              3,761,484
 
 We
        apply
        the net proceeds from securitizations and whole-loan sales to pay down our
        warehouse lines of credit - in order to make available capacity under these
        facilities for future funding of mortgage loans - and utilize any additional
        funds for working capital.
 
 ***Securitizations.***  In
        a
        securitization, we pool together loans, typically each quarter, and convey
        these
        loans to a newly formed securitization trust. These trusts are established
        for
        the limited purpose of receiving our mortgage loans and are bankruptcy remote
        -
        meaning that purchasers of asset-backed securities may rely on the cash flows
        generated from the assets held by the securitization trust for payment and
        not
        upon us for payment; likewise, the assets held by the securitization trust
        are
        not available to our general creditors, despite carrying the securitized
        loans
        and securitization financing on our consolidated financial statements. 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. Furthermore, we provide no guarantees to
        investors with respect to the cash flow or performance of these
        trusts.
 
 **13**
 The
        following table sets forth information about our securitized mortgage loan
        portfolio and the corresponding securitization debt balance, for each
        asset-backed security series, at December 31, 2006:
 
 *(Dollars
                  in thousands*)
              
              **Issue
                  Date**
              
              **Current
                  Loan Principal Balance****(1)**
              
              **Total
                  Securitization Debt Balance****(2)**Asset-backed
                  Security Series:2004-1
              
              March
                  30, 2004
              
              $     
                                                                      
                  199,796
              
              $                                                          
                  192,3052004-2
              
              June
                  29, 2004
              
              231,836
              
              215,6742004-3
              
              September
                  29, 2004
              
              276,600
              
              259,9612004-4
              
              December
                  29, 2004
              
              318,167
              
              301,2402005-1
              
              March
                  31, 2005
              
              441,285
              
              418,9972005-2
              
              June
                  29, 2005
              
              492,547
              
              473,9052005-3
              
              September
                  29, 2005
              
              587,594
              
              567,7312005-4
              
              December
                  30, 2005
              
              678,338
              
              660,4282006-1
              
              March
                  30, 2006
              
              739,566
              
              729,3982006-2
              
              June
                  29, 2006
              
              760,753
              
              758,0552006-3
              
              September
                  29, 2006
              
              808,693
              
              813,4902006-4
              
              December
                  29, 2006
              
              624,999
              
              633,038Total
              
              
              
              $                                                       
                  6,160,174
              
              $                                                      
                   6,024,222
 
 *(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 $6.3 million at December 31,
        2006.*
 
 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 2006, 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 certificates or
        notes
        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
        of
        the securitizations includes a series of asset-backed securities with various
        credit ratings, maturities and interest rates. The combined weighted average
        interest rate of the asset-backed securities in each securitization generally
        will 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, 2006 and 2005, we issued four securitizations
        totaling $3.1 billion in collateral and four securitizations totaling $3.2
        billion in collateral, respectively. All of our 2006 and 2005 securitizations
        received ratings from a combination of several rating agencies. The ratings
        received on the various classes of securities issued ranged from AAA to BBB-
        rated by Standard & Poor's Ratings Services (“S&P”) or Fitch Ratings,
        Inc. (“Fitch”), Aaa to Ba1 rated by Moody's Investors Service, Inc (“Moody’s”),
        and AAA to BBB (low) rated by Dominion
        Bond Rating Service, Inc. (“DBRS”).
 
  **14**
 The
        following table sets forth information with respect to our 2006, 2005 and
        2004
        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)***2006-1**
              
              March
                  30, 2006
              
              $                         
                   848.3
              
              $                         
                   875.0
              
              5.88
              %
              Senior/Sub**2006-2**
              
              June
                  29, 2006
              
              801.1
              
              825.0
              
              6.04
              
              Senior/Sub**2006-3**
              
              September
                  29, 2006
              
              800.3
              
              825.0
              
              5.90
              
              Senior/Sub**2006-4**
              
              December
                  29, 2006
              
              608.4
              
              625.0
              
              5.60
              
              Senior/Sub$                      
                   3,058.1
              
              $                        3,150.0**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
                  30, 2004
              
              $                         
                   542.3
              
              $                         
                   550.0
              
              1.71
              %
              Senior/Sub**2004-2**
              
              June
                  29, 2004
              
              504.4
              
              520.0
              
              4.44
              
              Senior/Sub**2004-3**
              
              September
                  29, 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
 
 Each
        of
        our securitizations of mortgage loans during 2006, 2005 and 2004 were structured
        and accounted for as secured financings. 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,
        comprised of “senior and subordinate notes” and net interest margin (“NIM”)
        notes or Class N Notes. 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 financing on mortgage loans held for investment.
        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. 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 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 (senior and subordinate note portions only). 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 (senior and subordinate note portions) totaling
        approximately 96.7% to 98.9% 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 (senior and subordinate note
        portions).
 
 **15**
 The
        O/C
        is generally expressed as a percentage of the initial mortgage loan or
        collateral principal balance sold to the securitization trust to the amount
        of
        senior and subordinate notes issued. The required O/C is initially determined
        by
        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 (*i.e.,*issuing BBB- certificates creates greater credit enhancement in
                  the
                  securitization transaction, which generally results in a lower
                  O/C).
 
 During
        2006 and 2005, our securitizations required a range of O/C from
        2.7%
        to 3.1% and 2.8% to 3.3%, respectively, of the initial mortgage loans held
        as
        collateral by 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
        (defined as the funds available for distribution after all principal, interest
        and hedging related payments are made in full on the senior, subordinate,
        and
        NIM notes or Class N notes)  generated from the securitizations are
        distributed to us after all other distributions are made in accordance with
        the
“waterfall” described below.
 
 Each
        month we are entitled to receive payment only after all required payments
        have
        been made on all the other securities issued by the securitization trust,
        because our right of payment is subordinate to all other securities issued
        by
        the securitization trust. In addition, before we receive any payments, the
        excess cash flows are generally 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
                  above, 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 securities to absorb losses and a monoline
        insurance company that guarantees timely principal and interest payments
        with
        respect to the senior securities.
 
 In
        2002
        through 2004, we utilized a securitization structure in which we completed
        a
        concurrent NIM transaction. In a NIM transaction, the excess cash flows (the
        rights to receive excess cash flows are referred to as the “excess cashflow
        certificates” or “owner trust certificates”) are 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). Commencing
        in
        2005, we began issuing the NIM note(s) through the securitization trust
        (referred to as “Class N Notes”) as opposed to issuing them through a NIM
        trust.
 
 **16**
 The
        NIM
        note(s), or Class N Notes, entitles the holder to be paid a specified interest
        rate, and further provides for all cash flows generated by the excess cashflow
        or owner trust certificates to be used to pay all principal and interest
        on the
        NIM note(s), or Class N Notes, until paid in full, which typically occurs
        approximately 18 to 24 months from the date the NIM note(s), or Class N Notes,
        were issued. We ultimately will hold the excess cashflow or owner trust
        certificates after the holder of the NIM note(s), or Class N Notes, 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), or Class N Notes, 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 2006 and
        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, or Class N 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.
 
 ***Securitizations
        Structured as a Financing*** *.* All of
        the securitization transactions completed in 2006 and 2005 were structured
        and
        accounted for as secured financings. We refer to recordation of these
        transactions as “portfolio accounting,” and intend to utilize this structure in
        the foreseeable future. The securitizations were structured for accounting
        purposes as secured financings under SFAS No. 140. The 2006 and 2005
        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 option to either contribute a derivative instrument
        into the trust or purchase
        up to 1% of the mortgage loans contained in the securitization mortgage
        pool .
        Securitization transactions consummated prior to 2004 met the QSPE criteria
        under SFAS No. 140 and were accounted for, recognized and recorded as
        sales.
 
 With
        portfolio accounting, (1) the mortgage loans we originate remain on our
        consolidated balance sheet as loans held for investment; (2) the securitization
        debt replaces the warehouse debt associated with the securitized mortgage
        loans;
        and (3) we record interest income on the mortgage loans and interest expense
        on
        the securities issued in the securitization over the life of the securitization,
        instead of recognizing a gain or loss upon completion of the
        securitization.
 
 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, 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,
        on a homogeneous pool basis, 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 (“MSRs”), which results in a
        discount to the mortgage loans held for investment. The fair value of the
        mortgage servicing rights 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,
        generally results in a discount being created on the loan retained in the
        securitization. The MSRs generally are sold to a third-party servicer. The
        resulting discount is accreted to interest income on a level-yield basis
        over
        the estimated life of the related loans, on a pool-by-pool basis, using the
        interest method calculation.
 
 **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,
        2006,
        2005 and 2004 as compared to pre-2004 historical 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.***  Prior
        to
        2004, we structured our securitizations to be accounted for as sales under
        SFAS No. 140 ,
        which
        is known as “gain-on-sale accounting.” In
        a
        securitization structured as a sale, or off-balance sheet, we sold a pool
        of
        loans to a trust for a cash purchase price and a certificate (specifically
        an
        excess cashflow certificate) evidencing our ownership in the distributions
        from
        the trust. With
        gain-on-sale accounting, we recorded an upfront gain at the time of
        securitization and recorded the fair value of the excess cashflow certificates
        on our balance sheet. 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. The
        excess cashflow certificates are trading securities and are carried at their
        fair value.
 
 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 of our excess cashflow certificates
        are reasonable, there can be no assurance as to the accuracy of the assumptions
        or estimates.
 
 ***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 December 31, 2006
        and
        2005, we sold whole loans without recourse to third-party purchasers (with
        the
        exception of a premium recapture and secondary marketing reserves described
        below) on a servicing-released basis of $725.1 million and $561.5 million,
        respectively. The average gross premium we received for the whole loans sold
        during the year ended December 31, 2006 was 3.7%, compared to 3.9% for
        the year ended December 31, 2005. The gross premium paid to us by
        third-party purchasers in whole-loan sale transactions does not take into
        account premiums we pay to originate the mortgage loans, the origination
        fees we
        collect (whether deferred or not), premium recapture reserves or secondary
        marketing reserves - each of which are components of the gain on sale
        calculation.
 
 We
        maintain a premium recapture reserve related to our contractual obligation
        to
        rebate a portion of any premium paid by a purchaser when a borrower prepays
        a
        sold loan within an agreed period of time. The premium recapture reserve
        is
        established at the time of the whole-loan sale through a provision, which
        is
        reflected as a reduction of the gain on sale of mortgage loans. During the
        years
        ended December 31, 2006, 2005 and 2004, we recorded a premium recapture reserve
        provision of $1.1 million, $1.1 million and $309,000, respectively. The premium
        recapture reserve is recorded as a liability on the consolidated balance
        sheet.
        We estimate recapture based primarily upon historical premium recaptures
        and by
        reviewing the types of loan products, interest rates, borrower prepayment
        fees,
        if any, and an estimate of the impact of future interest rate changes may
        have
        on early repayments. The premium recapture reserve totaled $958,000 and $619,000
        at December 31, 2006 and 2005, respectively.
 
 We
        also
        maintain a secondary market reserve related to our estimated exposure to
        losses
        arising from loan repurchases, or the net settlement, related to representation
        and warranty claims by investors. During the year ended December 31, 2006,
        we
        recorded a secondary market reserve provision of $780,000 for losses that
        arise
        in connection with loans that we may be required to repurchase from whole-loan
        sale investors. No such provision was recorded during the years ended December
        31, 2005 or 2004. We estimate the exposure primarily based upon historical
        repurchases and we estimate losses using a detailed analysis of historical
        loan
        performance by product type and origination year, similar to the analysis
        performed for the allowance for loan losses related to our mortgage loans
        held
        for investment portfolio. The secondary market reserve totaled $512,000 at
        December 31, 2006. We had no such reserve at December 31, 2005.
 
 **18**
 ***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, gains from the sale of MSRs and 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 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.
 
 Currently,
        we sell the MSRs 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 MSRs to another third-party servicer,
        Ocwen Loan Servicing, LLC will then, on our behalf, transfer the mortgage
        loans
        electronically 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 MSRs to on a securitization by securitization basis. We
        also
        employ several employees whose job functions are to monitor servicers with
        regards to delinquent and defaulted loans, as well as aid us in our portfolio
        retention efforts.
 
 **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, and have a lower cost of funds and a more established
        market presence than we have. Our competition varies by origination channel,
        delivery system and geographic region. Some of our competitors originate
        mortgage loans primarily through the wholesale channel, while others primarily
        originate directly to the consumer through a retail operation; some deliver
        their services exclusively via the Internet while others exclusively through
        “brick and mortar” offices. Additionally, some of our competitors offer products
        that we do not offer, such as negative amortization loans.
 
 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. 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.
 
 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
        competitive pricing, quality of service, diversification of products offered,
        use of technology 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.
 
 **19**
 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.
 
 The
        sub-prime mortgage industry has undergone rapid consolidation in recent months.
        Several of our peer competitors have been acquired by large investment banks
        or
        other mortgage companies. In order to compete effectively in this business,
        we
        must maintain a high level of operational, technological and managerial
        expertise. The impact of these consolidations on our business has not been
        significant to date, but it is uncertain whether and to what extent we will
        be
        harmed or benefit from this industry consolidation over the long term.
        Additionally, 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 markets. 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.
 
 **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 (“FCRA”);
 
 § 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.
 
 **20**
 *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.
  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 Office of Thrift Supervision (“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. There can be no assurance that other federal regulations
        promulgated in the future will not contain similar provisions that give
        federally-regulated entities greater rights than state-chartered financial
        institutions and mortgage bankers, such as us.
 
 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.
 
 **21**
 **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, 2006, Delta Financial Corporation had two wholly-owned direct
        subsidiaries, Delta Funding Corporation and DFC Financial Corporation. The
        following is a summary of each of these subsidiaries activities at December
        31,
        2006:
 
 *Delta
        Funding Corporation* -
        Originates mortgage loans through two distribution channels. The majority
        of
        these originations occur in 34 states. In the wholesale channel, Delta Funding
        Corporation originates mortgage loans indirectly through a network of 3,200
        independent mortgage brokers and other real estate professionals who submit
        loan
        applications on behalf of borrowers. Through its retail operating division
        -
        Fidelity Mortgage - Delta Funding Corporation originates mortgage loans directly
        with borrowers who submit loan applications. Fidelity Mortgage develops loan
        leads primarily through a telemarketing system, and also through Internet
        leads,
        direct mail and a network of 10 origination centers located in nine states.
        Additionally, Delta Funding Corporation has 17 wholly owned direct and indirect
        subsidiaries.
 
 *DFC
        Financial Corporation* - Holds
        certain trademark rights for both Fidelity Mortgage Inc. and Delta Funding
        Corporation.
 
 **Employees**
 
 As
        of
        December 31, 2006 and 2005, we had a total of 1,395 and 1,327 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,” “project,” “should,” “target,” “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 future originations volume,
        the size of our loan portfolio, the impact of changes in interest rates,
        our
        future hedging strategy, the adequacy of our allowance for loan losses and
        other
        reserves, 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.
 
 **22**
 These
        risks and uncertainties 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. 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 during
        the past several years. We
        utilize cash proceeds from our securitizations, including NIM transactions,
        as
        well as cash generated from our whole-loan sales, to help offset the costs
        to
        originate our loans. 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,
        Class N 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 our loans.
        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 in the future.
 
 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, 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.
 
 **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, 2006 and 2005, 51.4% and 53.9%, respectively, of our loan originations
        were
        originated through approximately 3,200 and 3,000 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, savings banks, 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 securities market have generally
        created a desire for even larger transactions, giving companies with greater
        volumes of originations a competitive advantage.
 
 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 reduce our profitability or the likelihood that our loans will be repaid.
        Any expansion of our marketing efforts could result in higher
        costs.
 
 **23**
 **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
        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.
 
 **We
        may be required to repurchase mortgage loans or indemnify investors if we
        breach
        representations and warranties in our mortgage loan sales
        agreements.**
 
 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 securitizing, selling or re-selling
        these
        loans. We also create allowances in our financial statements to provide for
        defective loans. However, 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.
 
 **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 that the loan
        is
        outstanding. 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.
 
 **24**
 **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, finance and underwriting
        loans. 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.
 
 **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.
 
 **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,
        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.
 
 **25**
 **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.
 
 **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 approximately 12% and 11% of our total loan production in 2006
        and
        2005, respectively). 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 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.
 
 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, which would affect the interest income we earn from
        such
        trust.
 
 **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 increase our expenses,
        or
        harm our results of operations, financial condition and business
        prospects.
  **26**
  **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. 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. 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.
 
 **If
        any of our assumptions used to determine the fair value of our stock-based
        awards change significantly, future share-based compensation expense may
        differ
        materially from that recorded currently.**
 
 In
        2006
        we adopted SFAS No. 123(R), “Share-Based Payment,” which required us to measure
        compensation cost for stock awards at fair value and recognize compensation
        over
        the service period the awards are expected to vest. The determination of
        compensation cost requires us to make many assumptions regarding volatility,
        expected option life and forfeiture rates. In addition, changes in our stock
        price or prevailing interest rates will also impact the determination of
        fair
        value and compensation cost. If any of our assumptions used to determine
        fair
        value change significantly, future share-based compensation expense may differ
        materially from the amounts currently recorded.
 
 **We
        are subject to certain risks in connection with the level of our allowance
        for
        loan losses.**
 
 A
        variety
        of factors could cause our borrowers to default on their loan payments and
        the
        collateral securing such loans to be insufficient to pay any remaining
        indebtedness. In such an event, we could experience significant loan losses,
        which could have a material adverse effect on our financial condition and
        results of operations.
 
 In
        the
        process of originating a loan, we make various assumptions and judgments
        about
        the ability of the borrower to repay it, based on the creditworthiness of
        the
        borrower, and the value of the real estate, among other factors.  We
        establish an allowance for loan losses through an assessment of probable
        losses
        in our loan portfolio. Several factors are considered in this process, including
        historical and projected default rates and loss severities. If our assumptions
        and judgments regarding such matters prove to be incorrect, our allowance
        for
        loan losses might not be sufficient, and additional loan loss provisions
        might
        need to be made. Depending on the amount of such loan loss provisions, the
        adverse impact on our earnings could be material. See “Part II. - Item 7.
        Management’s Discussion and Analysis of Financial Condition and Results of
        Operations - Summary of Critical Accounting Policies - Allowance
        for Loan Losses on Mortgage Loans Held for Investment ”
for
        a
        discussion of the procedures we follow in establishing our loan loss
        allowance.
 
 **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 2006, 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.
 
 **27**
 As
        a
        result of these changes, our results of operations in 2006, 2005 and 2004
        were
        recorded on a basis that is substantially different from years prior to 2004.
        We
        have recorded increased quarterly income during 2006, as compared to the
        same
        quarter in 2005. The increasing trend in same quarter over same quarter income
        we have experienced from the first quarter of 2004 through the fourth quarter
        of
        2006 largely 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, and to a
        certain
        extent in 2004 and 2005 when we started building up our loan portfolio, will
        be
        of limited use to you in evaluating our performance in future
        periods.
 
 **Risks
        Related to Our Financing Activities**
 
 **We
        depend on third-party financing sources, which may be unavailable to us in
        the
        future.**
 
 To
        accumulate loans for securitization or sale, we borrow money on a short-term
        basis through warehouse credit facilities. We have relied upon a limited
        number
        of lenders to provide the primary credit facilities for our loan originations.
        As of December 31, 2006, we had five warehouse credit facilities for this
        purpose, each from a different lender. These facilities are due to expire
        between May 2007 and November 2007. We may not be able to renew or replace
        these
        warehouse facilities at their respective maturities, at terms satisfactory
        to us
        or at all.
 
 Any
        failure to renew or obtain adequate funding under these warehouse credit
        facilities or other financing arrangements, or any reduction in the size
        of, or
        increase in the cost of, these types of facilities could increase our interest
        expense or reduce the number of loans that we can originate. 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.
 
 **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, such as selling new
        types of loan products.
 
 **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 credit facilities 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.
 
 **28**
 **Our
        inability to access the securitization market or 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
        may
        not 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.
 
 Additionally,
        we may not receive premiums on our future whole-loan sales transactions,
        and may
        sell loans at a discount, affecting the amount of cash proceeds we realize.
        If
        we are unable to originate loans at a cost lower than the cash proceeds realized
        from securitizations and loan sales, our ability to operate our business
        profitably will be impaired.
 
 **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, credit unions, savings and loans, savings banks, and government-sponsored
        entities. 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 sale
        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. In addition, any deterioration of prevailing economic conditions,
        such as higher unemployment rates, may further increase the risks inherent
        in
        making loans to these types of borrowers.
 
 **29**
 **We
        are exposed to contingent risks and liabilities related to all of the loans
        we
        originate and either securitize or sell.**
 
 We
        have
        the following contingent risks with respect to loans that we originate and
        either securitize or 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 value of our loans to potential
                  purchasers.
 
 ·
              Our
                  securitizations generally require the use of the excess cash flow
                  distributions related to the owner trust 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
                  O/C
                  limit instead of being distributed to us as the holder of the owner
                  trust
                  certificate, which would reduce 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 commercial banks, consumer finance companies 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, 2006, we had reserved $81,000 in potential
                  losses against $387,000 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 terminated its
        banking subsidiary’s status as a federal savings bank under supervision of the
        OTS and Federal Deposit Insurance Corporation (“FDIC”) and has obtained
        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**
 **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.**
 
 One
        of
        our primary market risks 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 the 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 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 originated;
 
 ·
              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 credit financings or other corporate
                  borrowings, which may result in a reduced spread between the rate
                  of
                  interest we receive on loans and the 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 long-term 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 over time. 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.
 
 **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, decreasing real estate values and increasing
        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. 
More detailed delinquency information regarding the loans collateralizing
        each
        of our securitizations (which comprise our mortgage loans held for investment
        -
        securitized portfolio) is available on our website at
        www.deltafinancial.com/regAB.htm.
 
 **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 adverse
        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.
 
 **32**
 **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 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.
 
 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 servicers’ 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.
 
 **33**
 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 fines 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, interest
        rate, 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.
 
 We
        have
        decided not to originate loans that exceed the interest rate, 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 interest rate, 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.
 
 **34**
 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, charging improper fees and making firm
        offers under the fair credit reporting act. These actions generally seek
        unspecified compensatory damages, statutory 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.
 
 **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.
 
 **35**
 **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 through which we source mortgage loans have
        legal
        obligations to which they are subject. These laws may not explicitly hold
        the
        originating lenders responsible for the legal violations of mortgage brokers,
        federal and state agencies have increasingly 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.
 
 **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 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.
 
 **36**
 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 of damages, which may be
        costly.
 
 **Our
        inability to comply with REIT qualification tests for our REIT subsidiary
        may
        result in our securitization trusts being taxed as a taxable mortgage pool,
        which would reduce our earnings and cash flow.**
 
 Our
        inability to comply with REIT qualification tests for our REIT subsidiary
        (Renaissance REIT Investment Corp.) 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, 2006, members of the Miller family
        (considered one stockholder under the attribution rule applicable to the
        ownership of REIT stock) own approximately 33.6% of the common stock (including
        employee stock options as required by the Internal Revenue Code of 1986,
        as
        amended (the “Code”), and related rules and regulations). There can be no
        assurance that we will be able to comply with these tests or remain
        compliant.
 
 Failure
        to remain compliant would result in the imposition of a tax upon our
        securitization trusts and would reduce the 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.
 
 **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
        and make it more difficult for us to attract directors, officers and other
        personnel.**
 
 The
        Sarbanes-Oxley Act of 2002, and the related regulations of the SEC and U.S.
        stock exchanges, has 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, 2007, our principal stockholders, members of the Miller family,
        beneficially owned approximately 33.1% 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).
 
 **37**
 **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.
 
 Our
        common stock commenced trading on the American Stock Exchange (“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 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 may be dilutive to 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.
 
 **38**
 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, 2006, we had
        approximately 1.8 million shares of our common stock issuable upon exercise
        of
        options, approximately 1.3 million of which were currently exercisable, and
        203,775 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.
 
 **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 $2.7 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 10 retail mortgage origination centers located
        in
        Arizona, Illinois, Missouri, Nevada, New York, North Carolina, Ohio,
        Pennsylvania (2) and Texas. 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 2012 (see “Part II, Item 8. - Financial Statements and Supplementary
        Data - Note 13 - Commitments and Contingencies - Operating Lease Obligations” in
        our audited consolidated financial statements).  We
        consider our leased properties adequate for our current needs. 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.
 
 **39**
 **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,
                  the federalTruth-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 District Court’s
                  request in or about April 2004. In August 2004, the District Court
                  conditionally approved the settlement, subject to our submitting
                  supplemental documentation regarding a change in the settlement
                  agreement
                  and proposed supplemental notices to be sent to those borrowers
                  who either
                  opted out or objected. We, plaintiffs and certain objectors submitted
                  our
                  respective supplemental submissions in August 2004 and the District
                  Court
                  granted its final approval to the settlement in January 2005. In
                  February
                  2005, certain objectors filed a notice of appeal. The objectors
                  filed
                  their appellate brief in July 2005. We filed our appellate papers
                  in
                  opposition in September 2005, and the objectors filed their reply
                  papers
                  in September 2005. In February 2006, the Appellate Court vacated
                  the
                  District Court’s decision to approve the settlement, not based on the
                  merits of the settlement, but because a motion to intervene was
                  decided by
                  the District Court Magistrate Judge and not the District Court
                  Judge. The
                  Appellate Court instructed the District Court Judge to rule on
                  the motion
                  to intervene and, until then, it cannot be determined if the District
                  Court Judge will also have to rule on the fairness of the settlement,
                  or
                  if that issue will have to return to the Appellate Court. Briefing
                  on the
                  intervention motion was re-submitted to the District Court Judge
                  in July
                  2006, and the motion was denied in November 2006. In January 2007,
                  we
                  executed a proposed amendment to the settlement with the plaintiffs.
                  The
                  settlement amount did not increase, but the Court scheduled a fairness
                  hearing for April 2007. 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.
 
 ·
              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 continued in the lower
                  Court.
                  In October 2006, 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 Court preliminarily approved the settlement
                  and
                  scheduled a fairness hearing in March 2007,  at which the Court
                  granted final approval of the settlement
                  agreement.
 
 **40**
 ·
              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.
                  In or about October 2004, the LLC commenced an action against KPMG
                  LLP,
                  our independent public accountants at that time, based upon similar
                  allegations as asserted in this action. In September 2005, it was
                  agreed
                  that the action against KPMG LLP would be joined with this action.
                  In the
                  countersuit, the LLC was granted permission to serve an amended
                  complaint,
                  which it did in November 2005. The amended complaint included two
                  additional causes of action alleging breach of fiduciary duty owed
                  to the
                  LLC, one against us and the other against several of our officers
                  and
                  directors. In December 2005, we filed a motion to amend our complaint
                  to
                  add claims (both individually and as a member of the LLC) against
                  Mr.
                  Morrison arising from the same and/or similar facts and circumstances,
                  seeking recovery for waste, for improper personal benefit, for
                  breach of
                  fiduciary duty (beyond those already alleged in the complaint)
                  and for a
                  material misstatement in the LLC’s financial statements. In April 2006,
                  the Supreme Court dismissed our motion to amend and granted us
                  permission
                  to revise the motion and re-file it. In July 2006, we re-filed
                  our motion
                  to amend our complaint, which motion was opposed. In November 2006,
                  the
                  Court denied our motion. Discovery is proceeding. 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.
 
 ·
              In
                  or about December 2003, we received a notice that we had been named
                  in two
                  lawsuits filed by the same plaintiff in the Circuit Court, Third
                  Judicial
                  Circuit in Madison County, Illinois. One alleged that we had improperly
                  charged certain borrowers fax fees, and one alleged that we improperly
                  retained extra per diem interest when loans were satisfied. The
                  complaints
                  seek (a) certification of a class of plaintiffs, (b) direction
                  to return
                  fax fees charged to borrowers, and (c) unspecified compensatory
                  and
                  statutory damages, including prejudgment and post judgment interest
                  and
                  attorneys’ fees, based upon alleged (1) breach of contract, (2) statutory
                  fraud and (3) unjust enrichment. In February 2004, we filed a motion
                  to
                  dismiss the case pertaining to fax fees claims. The plaintiff was
                  granted
                  leave to file a motion to amend his complaint in the fax fee case,
                  which
                  rendered our February 2004 motion to dismiss moot. The plaintiff
                  filed an
                  amended complaint in July 2004 and we filed a new motion to dismiss
                  in
                  August 2004, which the court denied in January 2005, and we have
                  since
                  filed an answer in that case. In March 2004, we filed a motion
                  to dismiss
                  the case pertaining to per diem interest claims, which the court
                  denied in
                  September 2004. We have since filed an answer in that case and
                  plaintiffs
                  filed a motion to dismiss our affirmative defenses, which the Circuit
                  Court granted, permitting us leave to replead the defenses with
                  more
                  particularity, which we have done. Discovery has commenced in both
                  cases.
                  In June 2005, we filed opposition papers to the plaintiff’s motion for
                  class certification in the case pertaining to fax fee claims. In
                  June
                  2006, we filed a motion for summary judgment in the case pertaining
                  to the
                  per diem interest and in July 2006 we filed a motion for summary
                  judgment
                  in the case pertaining to fax fees claims. In December 2006, both
                  of these
                  matters were settled on an individual
                  basis.
 
 **41**
 ·
              In
                  or about November 2004, we received notice that we have been named
                  in a
                  lawsuit styled as a collective action filed in the United States
                  District
                  Court of the Western District of Pennsylvania, alleging that our
                  subsidiary, Fidelity Mortgage Inc. (“Fidelity”, now a division of our
                  other subsidiary, Delta Funding Corporation), did not pay its loan
                  officers overtime compensation and/or minimum wage in violation
                  of the
                  Federal Fair Labor Standards Act. The complaint seeks: (1) an amount
                  equal
                  to the unpaid wages at the applicable overtime rate, (2) an amount
                  equal
                  to the minimum wages at the applicable minimum wage, (3) an equal
                  amount
                  as liquidated damages, (4) costs and attorneys’ fees, (5) leave to add
                  additional plaintiffs, and (6) leave to amend to add claims under
                  applicable state laws. We filed an answer and discovery has commenced.
                  In
                  April 2005, the plaintiff filed his motion for conditional class
                  certification and in May 2005, Fidelity filed its opposition to
                  that
                  motion. In June 2005, the Magistrate Judge issued a Report and
                  Recommendation, recommending that the plaintiff’s motion for conditional
                  class certification be granted, and that plaintiff’s motion to authorize
                  judicial notice be granted (subject to revision and final approval
                  by the
                  District Court). In July 2005, Fidelity filed with the District
                  Court its
                  objections to the Magistrate Judge’s Report and Recommendation and the
                  plaintiff filed its opposition to our objections. In July 2005,
                  the
                  District Court upheld the Magistrate Judge’s Report and Recommendation.
                  Any potential class members who desired to join the collective
                  action were
                  provided an opportunity to do so during an “opt-in” period that ended in
                  October 2005. Approximately 180 individuals, virtually all of whom
                  are
                  former employees, are plaintiffs in the collective action. In April
                  2006,
                  the plaintiffs filed a motion for summary judgment. By agreement
                  in June
                  2006, the Court stayed the action while the parties engaged in
                  non-binding
                  mediation, and plaintiffs’ motion for summary judgment was withdrawn
                  without prejudice to it being re-filed. The matter was not resolved
                  through mediation, the stay was lifted in August 2006, the plaintiffs’
                  motion was re-filed and we filed our opposition to the motion and
                  a
                  cross-motion for partial summary judgment. In September 2006, the
                  plaintiffs filed their papers in response to our opposition to
                  their
                  motion and replied to our cross-motion. In October 2006, we filed
                  our
                  reply papers to the plaintiffs’ opposition to our cross-motion. We believe
                  that we have meritorious defenses and intend to vigorously defend
                  this
                  suit, but cannot estimate with any certainty our ultimate legal
                  or
                  financial liability, if any, with respect to the alleged
                  claims.
 
 ·
              In
                  or about February 2007, we received notice that we had been named
                  in a
                  lawsuit filed in the United States District Court for the Northern
                  District of Illinois, Eastern Division, alleging that we had accessed
                  certain consumers' credit reports without a permissible purpose
                  under the
                  FCRA and sent improper prescreening offers in Illinois. The complaint
                  seeks: (a) certification of a class of plaintiffs, (b) injunctive
                  relief
                  against further violations, (c) statutory damages and general and
                  other
                  damages, and (d) attorneys’ fees, costs and litigation expenses, based
                  upon alleged (i) violations of the FCRA, (ii) common law invasion
                  of
                  privacy and (iii) consumer fraud/unfair acts and practices. We
                  have not
                  yet filed an answer to the complaint. We believe that we have meritorious
                  defenses and intend to vigorously defend this suit, but at this
                  early
                  stage of the litigation, we cannot estimate with any certainty
                  our
                  ultimate legal or financial liability, if any, with respect to
                  the alleged
                  claims.
 
 **Item
        4. Submission of Matters to a Vote of
        Security Holders.**
 
 None.
  **42**
 **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****2006**First
                  Quarter
              
              $
              10.00
              
              $
              8.30Second
                  Quarter
              
              
              10.08
              
              
              8.81Third
                  Quarter
              
              
              9.97
              
              
              8.97Fourth
                  Quarter
              
              
              10.40
              
              
              9.19**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
 
 **Holders**
 
 On
        March
        7, 2007, we had approximately 455 stockholders of record. This number does
        not
        include beneficial owners holding shares through nominee or “street”
names.
 
 **Dividends**
 
 The
        following table indicates the quarterly dividends declared during the years
        ended December 31, 2006 and 2005:
 *(Dollars
                      in thousands, except per share amounts)***Quarter**
                  
                  **Record
                      Date**
                  
                  **Payment
                      Date**
                  
                  **Dividend****Per****Share**
                  
                  **Total
                      Dividends Paid****(1)****2006**First
                  
                  March
                      31, 2006
                  
                  April
                      14, 2006
                  
                  $                                     
                       0.05
                  
                  $                                   
                       1,038Second
                  
                  June
                      23, 2006
                  
                  July
                      6, 2006
                  
                  0.05
                  
                  1,168Third
                  
                  September
                      25, 2006
                  
                  October
                      4, 2006
                  
                  0.05
                  
                  1,169Fourth
                  
                  December
                      26, 2006
                  
                  January
                      5, 2007
                  
                  0.05
                  
                  1,174**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
 
 *(1)*  *Total
        dividends paid for the four quarters of 2006 includes approximately $34,000
        of
        dividends (approximately $8,000 per quarter for the first three quarters
        and
        approximately $10,000 for the fourth quarter) paid on shares of granted but
        unvested restricted common stock awards. 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.*
 **43**
 Any
        decision to declare and pay dividends in the future will be made at the
        discretion of our Bard of Directors and will depend on, among other things,
        our
        results of operations, cash requirements, financial condition, contractual
        restrictions and other factors our Board of Directors may deem
        relevant.
 
 **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, 2006:
 
 **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****(1)**
              
              **Number
                  of Securities Remaining Available for Future Issuance Under Equity
                  Compensation**
                **Plans****(2)**Approved
                  by security holders
              
              
              1,781,750
              
              $
              3.23
              
              
              203,775
              
              $
              8.05
              
              
              1,687,475Not
                  approved by security holders
              
              
              N/A
              
              
              N/A
              
              
              N/A
              
              
              N/A
              
              
              N/ATotal
              
              
              1,781,750
              
              $
              3.23
              
              
              203,775
              
              $
              8.05
              
              
              1,687,475
 
 *(1)*  *The
        weighted average price of outstanding common stock awards represents the
        average
        price of the outstanding restricted stock grants on the date of the
        grant.*
 
 *(2)*  *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.*
 
 **Item
        6. Selected Financial
        Data.**
 
 The
        following selected financial information for the years ended December 31,
        2006,
        2005, and 2004, and as of December 31, 2006 and 2005, has been derived from
        our
        audited consolidated financial statements included elsewhere in this report.
        The
        financial information for the years ended December 31, 2003 and 2002 and
        as of
        December 31, 2004, 2003 and 2002 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, particularly for the period prior
        to
        January 1, 2004, 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.”
 
 **44**
 **At
                  or For the Year Ended December 31,***(Dollars
                  in thousands, except share and per share data)*
              
              **2006**
              
              **2005**
              
              **2004**
              
              **2003**
              
              **2002**Interest
                  income(1)
              
              $
              467,330
              
              $
              290,829
              
              $
              100,105
              
              $
              14,386
              
              $
              12,058Interest
                  expense(2)
              
              
              319,600
              
              
              167,792
              
              
              39,782
              
              
              5,509
              
              
              5,273Net
                  interest income
              
              
              147,730
              
              
              123,037
              
              
              60,323
              
              
              8,877
              
              
              6,785Provision
                  for loan losses
              
              
              29,085
              
              
              28,592
              
              
              10,443
              
              
              --
              
              
              --Net
                  interest income after provisionfor
                  loan losses
              
              
              118,645
              
              
              94,445
              
              
              49,880
              
              
              8,877
              
              
              6,785Non-interest
                  income:Net
                  gain on sale of mortgage loans
              
              
              33,558
              
              
              27,193
              
              
              16,057
              
              
              94,782
              
              
              57,974Other
                  income
              
              
              11,214
              
              
              14,674
              
              
              1,722
              
              
              1,000
              
              
              2,999Total
                  non-interest income
              
              
              44,772
              
              
              41,867
              
              
              17,779
              
              
              95,782
              
              
              60,973Non-interest
                  expense:Payroll
                  and related costs
              
              
              67,436
              
              
              63,524
              
              
              52,005
              
              
              39,147
              
              
              27,120General
                  and administrative
              
              
              47,427
              
              
              42,467
              
              
              30,152
              
              
              23,460
              
              
              22,685Other(3)
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              2,085(Gain)
                  loss on derivative instruments(2)
              
              
              (147
              )
              
              908
              
              
              100
              
              
              --
              
              
              --Total
                  non-interest expense
              
              
              114,716
              
              
              106,899
              
              
              82,257
              
              
              62,607
              
              
              51,890Income
                  (loss) before income taxexpense
                  (benefit)
              
              
              48,701
              
              
              29,413
              
              
              (14,598
              )
              
              42,052
              
              
              15,868Provision
                  for income tax expense(benefit)
              
              
              18,936
              
              
              11,458
              
              
              (5,249
              )
              
              (25,354
              )
              
              (1,769
              )Net
                  income (loss)
              
              $
              29,765
              
              $
              17,955
              
              $
              (9,349
              )
              $
              67,406
              
              $
              17,637**Comprehensive
                  Income (Loss)**:Other
                  comprehensive (loss) income
              
              
              (4,040
              )
              
              4,743
              
              
              (2,207
              )
              
              --
              
              
              --Comprehensive
                  income (loss), net
              
              $
              25,725
              
              $
              22,698
              
              $
              (11,556
              )
              $
              67,406
              
              $
              17,637
  **45**
  
 **At
                  or For the Year Ended December 31,***(Dollars
                  in thousands, except share and**per
                  share data)*
              
              **2006**
              
              **2005**
              
              **2004**
              
              **2003**
              
              **2002****Per
                  Share Data:**Basic
                  - weighted average number ofshares
                  outstanding
              
              
              22,477,213
              
              
              20,349,515
              
              
              18,375,864
              
              
              16,308,561
              
              
              15,894,913Diluted
                  - weighted average numberof
                  shares outstanding(4)
              
              
              23,278,375
              
              
              21,283,220
              
              
              18,375,864
              
              
              18,407,249
              
              
              16,971,028Net
                  income (loss) applicable tocommon
                  shares
              
              $
              29,765
              
              $
              17,955
              
              $
              (9,349
              )
              $
              66,015
              
              $
              17,637Basic
                  earnings per share - netincome
                  (loss)
              
              $
              1.32
              
              $
              0.88
              
              $
              (0.51
              )
              $
              4.05
              
              $
              1.11Diluted
                  earnings per share - netincome
                  (loss)(4)
              
              $
              1.28
              
              $
              0.84
              
              $
              (0.51
              )
              $
              3.59
              
              $
              1.04Dividends
                  per common share
              
              $
              0.20
              
              $
              0.20
              
              $
              0.15
              
              $
              --
              
              $
              --**Selected
                  Balance Sheet Data:**Cash
                  and cash equivalents
              
              $
              5,741
              
              $
              4,673
              
              $
              5,187
              
              $
              4,576
              
              $
              3,405Mortgage
                  loans held for sale, net
              
              
              --
              
              
              --
              
              
              --
              
              
              190,524
              
              
              33,945Mortgage
                  loans held for investment, net
              
              
              6,358,377
              
              
              4,626,830
              
              
              2,340,994
              
              
              --
              
              
              --Excess
                  cashflow certificates
              
              
              1,209
              
              
              7,789
              
              
              14,933
              
              
              19,853
              
              
              24,565Trustee
                  receivable
              
              
              73,361
              
              
              56,164
              
              
              32,915
              
              
              --
              
              
              --Deferred
                  tax asset, net
              
              
              45,760
              
              
              54,875
              
              
              50,326
              
              
              31,184
              
              
              5,600Other
                  assets
              
              
              104,679
              
              
              69,271
              
              
              46,438
              
              
              10,854
              
              
              6,029Total
                  assets
              
              $
              6,589,127
              
              $
              4,819,602
              
              $
              2,490,793
              
              $
              256,991
              
              $
              73,544Warehouse
                  financing
              
              $
              335,865
              
              $
              222,843
              
              $
              135,653
              
              $
              144,826
              
              $
              13,757Financing
                  on mortgage loans held forinvestment,
                  net
              
              
              6,017,947
              
              
              4,436,938
              
              
              2,236,215
              
              
              --
              
              
              --Senior
                  notes
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              10,844Other
                  liabilities
              
              
              85,739
              
              
              53,039
              
              
              31,745
              
              
              16,212
              
              
              19,446Total
                  liabilities
              
              $
              6,439,551
              
              $
              4,712,820
              
              $
              2,403,613
              
              $
              161,038
              
              $
              44,047Total
                  stockholders’ equity
              
              $
              149,576
              
              $
              106,782
              
              $
              87,180
              
              $
              95,953
              
              $
              29,497
 
 *(1)*  *During
        the year ended December 31, 2005, we recorded $324,000 of interest 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.*
 
 *(4)*  *For
        the year ended December 31, 2004, approximately 1.0 million in-the-money
        stock
        options are excluded from the calculation of diluted earnings per share because
        their effect was anti-dilutive in a year where losses are
        reported.*
 
 **46**
 **Item
        7. Management’s Discussion and Analysis of
        Financial Condition and Results of Operations.**
 
 *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 non-conforming mortgage loans. Our loans are primarily fixed rate and
        secured by first mortgages on one- to four-family residential properties.
        Throughout our 25-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 whole-loan
        sales transactions .  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
        2007, as compared to 2006, 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. The accounting policies outlined below are deemed to be
        “critical” because they can materially affect our income, as these policies may
        require management to make difficult and subjective judgments regarding
        uncertainties, and as a result, these estimates may significantly impact
        our
        financial results. The accuracy of these estimates and the likelihood of
        future
        changes depend on a range of possible outcomes and a number of underlying
        variables, many of which are beyond our control, and there can be no assurance
        that our estimates are accurate.
 
 **Accounting
        for Hedging Activities.** We
        regularly issue securitization asset-backed securities, backed by fixed-
        and
        adjustable-rate mortgage loans. As a result of this activity, we are exposed
        to
        interest rate risk beginning when our mortgage loans close and are recorded
        as
        assets until permanent financing is arranged, such as when the asset-backed
        securities are issued. Our strategy is to use interest rate swap contracts
        in an
        effort to lock in a pre-determined base interest rate on designated portions
        of
        our prospective future securitization financing. At times, we also use corridors
        ( corresponding
        purchase and sale of interest rate caps with similar notional balances at
        different strike prices )
        and/or
        amortizing notional balance interest rate swaps that are designed to limit
        our
        financing costs within the securitization to maintain minimum margins, with
        the
        possibility of allowing us to increase margins in lower than anticipated
        interest rate environments. Both the interest rate swaps and corridors are
        derivative instruments that trade in liquid markets, and we do not use either
        of
        them for speculative purposes.
 
 In
        accordance with SFAS No. 133 ,
        “Accounting for Derivative Instruments and Hedging Activities,” we
        record
        all of our derivatives on our consolidated balance sheet at fair value. For
        derivative financial instruments not designated as hedging instruments, gains
        or
        losses resulting from a change in fair value are recognized in current period
        earnings. When derivatives are used as hedges, hedge accounting is permitted
        only if we document the hedging relationship and its effectiveness at the
        time
        we designate the derivative as a hedge instrument. If we meet certain
        requirements under SFAS No. 133, we may account for the hedge instrument
        as a
        cash flow hedge.
 
 **47**
 Cash
        flow
        hedge accounting is appropriate for hedges of uncertain cash flows associated
        with future periods - whether as a consequence of interest to be received
        or
        paid on existing variable rate assets or liabilities or in connection with
        intended purchases or sales.
 
 Under
        cash
        flow hedge accounting treatment, the changes in the fair value of the derivative
        instruments are divided into two portions, “effective” and “ineffective.” The
        effective portion of the derivative's gain or loss initially is reported
        as a
        component of OCI and subsequently reclassified into earnings when the forecasted
        transaction affects earnings. The ineffective portion of the gain or loss
        is
        reported in earnings immediately.
 
 To
        qualify for cash flow hedge accounting treatment:
 
 ·
              hedges
                  must be documented, with the objective and strategy stated, along
                  with an
                  explicit description of the methodology used to assess and measure
                  hedge
                  effectiveness;
 
 ·
              dates
                  (or periods) for the expected forecasted events and the nature
                  of the
                  exposure involved (including quantitative measures of the size
                  of the
                  exposure) must be explicitly
                  documented;
 
 ·
              hedges
                  must be expected to be “highly effective,” both at the inception of the
                  hedge and on an ongoing basis. Effectiveness measures must relate
                  the
                  gains or losses of the derivative to changes in the cash flow associated
                  with the hedged item;
 
 ·
              forecasted
                  transactions must be probable; and
 
 ·
              forecasted
                  transactions must be made with different counterparties other than
                  the
                  reporting entity.
 
 If
        a
        hedge fails the assessment of hedge effectiveness test (the ratio of the
        outstanding balance of the hedged item (debt) to the notional amount of the
        hedge exceeds 125% or falls below 80%, since the notional amount varies)
        at any
        time, and therefore is not expected to be “highly effective” at achieving
        offsetting changes in cash flows, the hedge ceases to qualify for cash flow
        hedge accounting. An
        assessment analysis is then prepared by management to determine the subsequent
        treatment of the hedges that failed the retrospective test to determine if
        any
        portion of the hedge may still qualify for cash flow hedge accounting treatment.
        If the analysis indicates future effectiveness for a portion of the hedge,
        the
        original hedge will effectively be allocated into two pieces, a trading security
        (ineffective portion) and “new hedge relationship” (effective
        portion).
 
 The
“new
        hedge relationship” is determined by re-aligning the hedge with the projected
        remaining bond balances (debt) as of the date the original hedge became
        retrospectively ineffective. The ratio of the outstanding balance of the
        debt to
        notional size of the revised hedge will then be 100% as of the re-alignment
        date. The expected repayment pattern of the debt associated to the original
        hedge is used as the basis to establish the “new hedge relationship” future
        repayment pattern. The difference between the fair value of the original
        hedge
        and the “new hedge relationship” hedge on the re-alignment date is classified as
        a trading security. Once classified as a trading security, any changes in
        the
        fair value are recorded directly to the income statement as a component of
        gain
        or loss on derivative instruments.
 
 **Accounting
        for Income Taxes.** Significant management judgment is required in developing our provision for
        income taxes, including the determination of deferred tax assets and liabilities
        and any valuation allowances that might be required against the deferred
        tax
        asset. Management
        needs to consider the relative impact of negative and positive evidence related
        to the ability to recognize a deferred tax asset. This evaluation takes into
        consideration our recent earnings history, current tax position and estimates
        of
        taxable income in the near term. If actual results differ from these estimates,
        we may be required to record a valuation allowance on our deferred tax assets,
        which could negatively impact our consolidated financial position and results
        from operations. We recognize all of our deferred tax assets if we believe,
        on a
        more likely than not basis, that all of the benefits of the deferred tax
        assets
        will be realized. Management believes that, based upon on the available
        evidence, it is more likely than not that the
        results of future operations will generate sufficient taxable income to realize
        the deferred tax assets. Therefore, at December 31, 2006, we did not maintain a valuation allowance
        against our deferred tax assets. Additionally, in July 2006, the FASB issued
        FASB Interpretation (“FIN”) No. 48, *“* Accounting
        for Uncertainty in Income Taxes - an interpretation of FASB Statement No.
        109.”
FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized
        in  an
        enterprise’s financial statements in accordance with SFAS No. 109. The adoption
        of FIN No. 48 on January 1, 2007 did not have a material effect on our
        consolidated balance sheet, statement of operations or statement of cash
        flows.
 
 **48**
 **Allowance
        for
        Loan Losses on Mortgage Loans Held for Investment.** In
        connection with our mortgage loans held for investment, excluding those loans
        which meet the criteria for specific review under SFAS
        No.
        114, “Accounting by Creditors for Impairment of a Loan - an amendment of FASB
        Statement No. 5 and 15,” we
        established an allowance for loan losses based on our estimate of losses
        to be
        incurred in the foreseeable future. Provisions for loan losses are made for
        loans to the extent that we bear probable losses on these loans. Provision
        amounts are charged as a current period expense to operations. We charge-off
        uncollectible loans at the time we deem they are not probable of being
        collected.
 
 In
        order to
        estimate an appropriate allowance for losses on mortgage loans held for
        investment, we estimate losses using a detailed analysis of historical mortgage
        loan performance data. This data is analyzed for loss performance and prepayment
        performance by product type, origination year and securitization issuance.
        The
        results of that analysis are then applied to the current long-term mortgage
        portfolio held for investment, excluding those loans which meet the criteria
        for
        specific review under SFAS
        No.
        114, and
        an
        estimate is created. In accordance with SFAS No. 5, “ Accounting
        for Contingencies,” we
        believe that pooling of mortgages with similar characteristics is an appropriate
        methodology with which to calculate or estimate the allowance for loan losses.
        The results of that analysis are then applied to the current long-term mortgage
        portfolio and an allowance for loan losses estimate is created to take into
        account both known and inherent losses in the loan portfolio. Losses incurred
        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 borrowers’ ability to pay,
        changes in the market value of the collateral, political factors and the
        general
        economic environment. As these factors and estimates are influenced by factors
        outside of our control and are inherently uncertain, it is reasonably possible
        that they could change. In particular, if conditions were such that we were
        required to increase the provision for loan losses, our income for that period
        would decrease.
 
 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
        in 2005
        on a portion of our mortgage loans held for investment portfolio, management
        identified certain loans located in Federal Emergency Management Agency (“FEMA”)
        declared disaster areas as meeting the criteria under SFAS No. 114, thereby,
        requiring a separate loan impairment review. Based upon the analysis performed,
        we identified specific mortgage loans in which the borrowers’ abilities to repay
        the loans in accordance with their contractual terms was impaired. We assessed
        the extent of damage to the underlying collateral and the extent to which
        damaged collateral is not covered by insurance in determining the amount
        of
        specific reserves needed. We established specific reserves for these affected
        mortgage loans based upon estimates of loss exposure. As additional information
        is obtained and processed over the coming months and quarters, we will continue
        to assess the need for any adjustments to our estimates and the specific
        reserves related to the mortgage loans in the affected areas.
 
 **Amortization
        of Deferred Loan Origination Fees and Costs.** Interest
        income is recorded on our mortgage loans held for investment portfolio based
        upon a combination of interest accruals based on the outstanding balance
        and
        contractual terms of the mortgage loans, adjusted by the amortization of
        net
        deferred origination fees or costs accounted for in accordance with SFAS
        No. 91.
        Our net deferred origination fees/costs consist principally of origination
        fees,
        discount points, broker premiums, and payroll and commissions associated
        with
        originating our mortgage loans. For our loans held for investment, these
        net
        deferred fees or costs are accreted or amortized as adjustments to interest
        income over the estimated lives of the loans using the interest method. Our
        portfolio of mortgage loans held for investment is comprised of a large number
        of homogeneous loans for which we believe prepayments are probable. The periodic
        amortization of our deferred origination fees or costs is based on a model
        that
        considers actual prepayment experience to date as well as forecasted prepayments
        based on the contractual interest rate on the mortgage loans, loan age, loan
        type and prepayment fee coverage, among other factors. Mortgage prepayments
        are
        affected by the terms and credit grades of the loans, conditions in the housing
        and financial markets and general economic conditions. Prepayment assumptions
        are reviewed regularly to ensure that our actual experience, as well as industry
        data, is supportive of the prepayment assumptions used in our model. Any
        changes
        to these estimates are applied as if the revised estimates had been in place
        since the origination of the loans, and current period amortization is adjusted
        to reflect the effect of the changes.
 
 **49**
 During
        the year ended December 31, 2005, we recorded $324,000 of income in interest
        income that was 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.
 
 **Amortization
        of Deferred Debt Issue Discounts and Transaction Costs.** Interest
        expense on our securitization financing is comprised of the accrual of interest
        based on the contractual terms, cash receipts and amortization related to
        our
        cash flow hedges (interest rate swaps and corridors), the amortization of
        deferred debt issue discounts and transaction costs. The deferred debt issue
        discounts and transaction costs are amortized as an adjustment to interest
        expense over the estimated lives of the related debt using the interest method
        and take into account the effect of estimated prepayments. Any changes made
        to
        these estimates are applied as if the revised estimates had been in place
        since
        the issuance of the related debt, and result in adjustments to the period
        amortization recorded to interest expense.
 
 **Excess
        Cashflow Certificates.** In
        securitization transactions structured to be accounted for as a sale (prior
        to
        2004), the excess cash flow certificates represent one or all of the following
        assets:
 
 ·
              BIO
                  certificate, which represents a subordinate right to receive excess
                  cash
                  flows, if any, generated by the related securitization
                  pool.
 
 ·
              P
                  certificate, which represents a right to receive prepayment penalties
                  on
                  the mortgage loans sold to the securitization
                  trust.
 
 ·
              Cash
                  flows from corridors - we receive payments on corridors (corresponding
                  purchase and sale of interest rate caps with similar notional balances
                  at
                  different strike prices) from third-party cap providers through
                  the
                  securitization trusts (which, when we sell NIM notes, are received
                  only
                  after the NIM notes are paid in
                  full).
 
 The
        valuation of our excess cashflow certificates is highly dependent upon the
        reasonableness of our assumptions and the predictiveness of the relationships
        that drive the results of our valuation model. The assumptions we utilize,
        described below, are complex as we must make judgments about the effects
        of
        matters that are inherently uncertain. As the number of variables and
        assumptions affecting the possible future resolution of the uncertainties
        increase, those judgments become even more complex. Management uses internal,
        historical mortgage loan performance data and forward LIBOR interest rate
        curves
        to value future expected excess cash flows. The amount recorded for the excess
        cashflow certificates is subsequently reduced for cash distributions we receive,
        increased for the expected return and adjusted for changes in fair value
        of
        these excess cashflow certificates.
 
 We
        believe that our assumptions used to determine fair value are reasonable
        based
        upon the estimates using our historical loan performance and the performance
        of
        similar mortgage pools from other lenders - in addition to accessing other
        public information about market factors such as interest rates, inflation,
        recession, unemployment and real estate market values, among other things.
        However, these are only estimates and it is virtually impossible to predict
        the
        actual level of prepayments and losses, which also are driven by consumer
        behavior, and as such there can be no assurance as to the accuracy of the
        assumptions or estimates.
 
 In
        volatile markets, like those we have experienced over the past several years,
        there is increased risk that our actual results may vary significantly from
        our
        assumed results. The longer the time period over which the uncertainties
        exist,
        the greater the potential for volatility in our valuation assumptions, which
        may
        impact the fair value of our excess cashflow certificates. The fair value
        of
        each excess cashflow certificate represents the present value of the cash
        flows
        we expect to receive in the future based upon our best estimates.
 
 **50**
 The
        assumptions used to determine fair value are the following:
 
 A.  *Prepayments.* We base
        our prepayment rate assumptions on our ongoing analysis of the performance
        of
        the mortgage pools we previously securitized and the performance of similar
        pools of mortgage loans securitized by others in the industry. We apply
        different prepayment speed assumptions to different loan product types based
        on
        our experience with different loan product types exhibiting different prepayment
        patterns. Generally, our mortgage loans can be grouped into two loan products
        -
        fixed-rate loans and adjustable-rate loans. With fixed-rate loans, an underlying
        borrower’s interest rate remains fixed throughout the life of the loan. Our
        adjustable-rate loans are a “hybrid” between fixed- and adjustable-rate loans,
        in that the interest rate generally remains fixed, typically for the first
        two
        or three years of the loan, and then adjusts based on a spread over the
        six-month LIBOR, typically every six months thereafter. We also take into
        account within each product type factors other than interest rates that can
        affect our prepayment rate assumptions.
  We
        have
        found that the rate at which borrowers prepay their loans tends to fluctuate.
        In
        general, prepayment speeds are lowest in the first month after origination.
        Thereafter, prepayment speeds generally increase until a peak speed is reached.
        Generally, loans will continue to prepay at the peak speed for some period
        of
        time, and then prepayment speeds typically begin to decline. We use prepayment
        assumptions that reflect these tendencies. The following table shows our
        assumptions related to the excess cashflow certificates held at December
        31,
        2006 regarding the percentage of loans that will be prepaid during the first
        month following the closing of a loan, peak speed over the life of a loan
        and
        the peak speed from December 31, 2006 forward:
 
 **Loan
                  Type**
              
              **Month
                  One**
              
              **Peak
                  Speed**
                **Over
                  the Life**
              
              **Peak
                  Speed from**
                **December
                  31, 2006 Forward**Fixed
                  rate
              
              4.0%
              
              45.0%
              
              35.0%Adjustable-rate
              
              4.0%
              
              75.0%
              
              35.0%
                  to 75.0%
 
 We
        revised our peak speed over the life assumption as of September 30, 2005
        to
        reflect the prepayment trend experienced within the loan pools, which has
        remained consistent through December 31, 2006. Our assumption regarding the
        peak
        speed over the life ranged from 35.0% to 40.0% for fixed rate loans and was
        75.0% for adjustable-rate loans prior to September 30, 2005.
 
 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. Conversely, if mortgage loans prepay at a slower rate than
        anticipated, we generally earn more income and more excess cash flow in the
        future, subject to other factors that can affect the cash flow from, and
        our
        valuation of, the excess cashflow certificates.
 
 B.  *Default
        Rate.* The
        default rate is the percentage of estimated total loss of principal, interest
        and related advances that will take place over the life of the mortgage loans
        within a loan pool compared to the total original principal balance of the
        mortgage loans in the pool. A default rate is determined for each securitization
        reflecting the overall credit scores, average loan sizes and layered risks
        on
        the fixed- and adjustable-rate loans comprising each securitization trust.
        We
        apply a default or loss rate to the excess cashflow certificate because it
        is
        the “first-loss” piece and is subordinated in right of payment to all other
        securities issued by the securitization trust. If defaults are higher than
        we
        anticipate, we will receive less income and less excess cash flow than expected
        in the future. Conversely, if defaults are lower than we expected, we will
        receive more income and more excess cash flow than expected in the future,
        subject to the other factors that can affect the cash flow from, and our
        valuation of, the excess cashflow certificates. We revised our estimated
        default
        rates at September 30, 2005 to reflect the better-than-expected pool performance
        on our underlying securitizations. The current default rate, which is consistent
        with the revised rate at September 30, 2005, applied on the excess cashflow
        certificates held at December 31, 2006 is 4.0%. Prior to September 30, 2005,
        our
        default rate assumption on the same excess cashflow certificates held at
        December 31, 2006 was 4.5%.
 
 C.  *Forward
        LIBOR Curve.* The
        forward LIBOR curve is used to project future interest rates, which affects
        both
        the rate to the floating-rate asset-backed security investors (primarily
        indexed
        off the one-month LIBOR) and the adjustable-rate mortgage loans sold to the
        securitization trust (a fixed rate of interest for either the first 24 or
        36
        months and a variable rate of interest thereafter indexed off the six-month
        LIBOR). Most of our loans are fixed-rate mortgages and a significant amount
        of
        the securities sold by the securitization trust are floating-rate securities
        (the interest rate adjusts based upon an index, such as one-month LIBOR).
        As a
        result, our excess cashflow certificates are subject to significant basis
        risk
        and a change in LIBOR will impact our excess spread. If LIBOR is lower than
        anticipated, we generally will receive more income and more excess cash flow
        than expected in the future, subject to the other factors that can affect
        the
        cash flow from, and our valuation of, the excess cashflow certificates.
        Conversely, if LIBOR is higher than expected, we generally will receive less
        income and less excess cash flow than expected in the future. In each of
        our
        securitizations in which we sold NIM note(s), we purchased an interest rate
        cap,
        which helps mitigate the basis risk for the approximate time that the NIM
        notes
        are outstanding. We have adjusted the valuation of each excess cashflow
        certificate to use a forward interest rate curve that represents both today’s
        rates and the expectation for rates in the future.
 
 **51**
 D.  *Discount
        Rate.* We use a
        discount rate that we believe reflects the risks associated with our excess
        cashflow certificates. Due to the unavailability of quoted market prices
        on
        comparable excess cashflow certificates, we compare our valuation assumptions
        and performance experience to our competitors in the non-conforming mortgage
        industry. Our discount rate takes into account the asset quality and the
        performance of our securitized mortgage loans compared to that of the industry
        and other characteristics of our securitized loans. We quantify the risks
        associated with our excess cashflow certificates by comparing the asset quality
        and payment and loss performance experience of the underlying securitized
        mortgage pools to comparable industry performance. The discount rate we use
        to
        determine the present value of the cash flow from excess cashflow certificates
        reflects increased uncertainty surrounding current and future market conditions,
        including, without limitation, uncertainty concerning inflation, recession,
        home
        prices, interest rates and conditions in the equity markets.
 
 We
        utilized a discount rate of 18% at December 31, 2006 and 2005 on all excess
        cashflow certificates (a discount rate of 15% was utilized prior to September
        30, 2005).
 
 ***Stock-Based
        Compensation Expense.*** Effective January 1, 2006, we account for stock-based compensation costs
        in
        accordance with SFAS No. 123(R), which requires the measurement and recognition
        of compensation expense for all stock-based payment awards made to our employees
        and directors. Under the fair value recognition provisions of SFAS No. 123(R),
        stock-based compensation cost is measured at the grant date based on the
        fair
        value of the award and is recognized as expense over the vesting period.
        Determining the fair value of stock-based awards at the grant date requires
        considerable judgment, including estimating expected volatility, expected
        term
        and risk-free rate. Our expected volatility is based upon the historical
        volatility of our common stock. The expected term of the stock options is
        based
        on factors including historical observations of employee exercise patterns
        and
        expectations of employee exercise behavior in the future, giving consideration
        to the contractual terms of the stock-based awards. The risk-free interest
        rate
        assumption is based on the yield at the time of grant of a U.S. Treasury
        security with an equivalent remaining term. If factors change and we employ
        different assumptions, stock-based compensation expense may differ significantly
        from the amounts we have recorded or reported in the past.
 
 **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 2004 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 2006, we do
        not
        expect to be subject to the AMT.
 
 **52**
 ***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 that our subsidiary Delta Funding
        Corporation receives from Renaissance REIT Investment Corp. (described below)
        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 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.
 
 ***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 U.S generally accepted accounting principles ("GAAP") 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 ofat
                  least 90% of its annual REIT taxable income to stockholders (comprised
                  of
                  common and preferred 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 there be at least 100 shareholders
                  and 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) 0.178% of capital allocable
        to New York State, or (c) a fixed amount up to a maximum of $1,500. 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.  However, if the franchise tax paid to New York State
        is based on entire net income, then that District surcharge is equal to 17%
        of
        the franchise tax calculated using a 9% rate.  The District tax
        surcharge 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.
  **53**
  **Results
        of Operations**
 
 **Year
        Ended December 31, 2006 Compared to the Year Ended December 31,
        2005**
 
 **General**
 
 Our
        net
        income for the year ended December 31, 2006 was $29.8 million, or $1.32 per
        share basic and $1.28 per share diluted, compared to net income of $18.0
        million, or $0.88 per share basic and $0.84 per share diluted, for the year
        ended December 31, 2005. As described in more detail below, the primary drivers
        of the increase in net income recorded during the year ended December 31,
        2006
        were:
 
 (1)
              An
                  increase in net interest income after provision for loan losses
                  of $24.2
                  million, or 25.6%, from $94.4 million in the same period in 2005.
                  The
                  increase in net interest income after provision for loan losses
                  reflects
                  the net effect of recognizing interest income on a 37.4% larger
                  amount of
                  mortgage loans held for investment, net and interest expense on
                  a 36.4%
                  larger amount of mortgage loan related financing. Our net interest
                  income,
                  which has continued to grow sinceour
                  change from gain-on-sale accounting to portfolio accounting in
                  the first
                  quarter of 2004, represented 72.6%of
                  our net revenue for the year end December 31, 2006, compared to
                  69.3% for
                  the year ended December 31, 2005; and
 
 (2)
              An
                  increase in net gain on sale of mortgage loans of $6.4 million,
                  or 23.4%,
                  to $33.6 million on the sale of $725.1 million of mortgage loans
                  on a
                  whole-loan basis, from a $27.2 million gain during the same period
                  in 2005
                  on sales on a whole-loan basis of $561.5 million of mortgage loans.
                  Theincrease in the gains recorded from our whole-loan sales relates
                  to the
                  29.1% increase in the volume of sales, partially offset by a 29
                  basis
                  point decrease in the average whole-loan sale premium received,
                  during the
                  year ended December 31, 2006 compared to the year ended December
                  31,
                  2005.
 
 These
        increases were partially offset by (1) a $7.8 million increase to non-interest
        expense primarily related to payroll expense and general and administrative
        expenses associated with a year-over year increase of 5.1% in loan originations
        and personnel, and increased REO related expenses; and (2) a $3.5 million
        decrease in other income, primarily relating to the $3.7 million decrease
        in the
        amount of fair value change recorded on our excess cashflow certificates
        for the
        year ended December 31, 2006 compared to the same period in 2005.
 
 We
        originated $4.0 billion of mortgage loans during the year ended December
        31,
        2006, representing a $195.8 million, or 5.1%, increase from $3.8 billion
        of
        mortgage loans originated during the year ended December 31, 2005. We
        securitized and/or sold $3.9 billion of loans during the year ended December
        31,
        2006, compared to $3.8 billion of loans during the year ended December 31,
        2005.
 
 **Net
        Interest Income**
 
 We
        recorded net interest income of $147.7 million during the year ended December
        31, 2006, an increase of $24.7 million, or 20.1%, from the $123.0 million
        recorded during the year ended December 31, 2005. The increase in net interest
        income primarily reflects the net effect of the higher average balance of
        mortgage loans held for investment and the related financing, coupled with
        the
        net changes in the interest rate earned or incurred on those balances, during
        the year ended December 31, 2006 compared to the year ended December 31,
        2005.
        Net interest income represents the difference between our interest income
        and
        our interest expense, each of which is described in the following
        paragraphs.
 
 ***Interest
        Income.*** Interest
        income increased $176.5 million, or 60.7%, to $467.3 million for the year
        ended
        December 31, 2006, from $290.8 million for the year ended December
        31, 2005. The increase is primarily due to (1) a $168.0 million increase in
        interest income earned on our loans held for investment - securitized, which
        totaled $6.1 billion at December 31, 2006 as compared to $4.4 billion at
        December 31, 2005; coupled with a 42 basis point increase in the average
        interest rate over the same period, (2) a $5.7 million increase in interest
        income on mortgage loans held for investment - pre-securitized due to an
        increase in the average amount of mortgage loans we originated and held pending
        securitization or sale during the year ended December 31, 2006 compared to
        the
        same period in 2005; 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, 2006, compared to the asset-backed securities
        issued during the year ended December 31, 2005. These increases were partly
        offset by a decrease in interest income earned on our excess cashflow
        certificates due to the lower average balance of the excess cashflow
        certificates during the year ended December 31, 2006, compared to the year
        ended
        December 31, 2005.
 
 **54**
 The
        following table is a summary of interest income:
 
 **For
                  the Year Ended****December
                  31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Interest
                  income on mortgage loans held for investment - securitized, net(1)
              
              $
              418,817
              
              $
              250,841Interest
                  income on mortgage loans held for investment - pre-securitization,
                  net
              
              
              36,230
              
              
              30,494Securitization
                  pass-through interest
              
              
              11,775
              
              
              7,886Interest
                  income on excess cashflow certificates
              
              
              452
              
              
              1,593Miscellaneous
                  interest income
              
              
              56
              
              
              15Total
                  interest income
              
              $
              467,330
              
              $
              290,829
 
 *(1)
        The amounts for the year ended December 31, 2006 and 2005 include $21.5 million
        and $13.8 million, respectively, of prepayment penalty fees.*
 
 ***Interest
        Expense.*** Interest
        expense increased by $151.8 million, or 90.5%, to $319.6 million for the
        year
        ended December 31, 2006, from $167.8 million for the year ended December
        31,
        2005. 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, 2006 on our warehouse
        facilities, compared to the same year ended December 31, 2005. The weighted
        average cost of our mortgage loans held for investment financing increased
        by 68
        basis points during 2006, reaching 5.60% at December 31, 2006, compared to
        4.92%
        at December 31, 2005. To a lesser extent, the increase in interest expense
        was
        also caused by 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 index rate increased 171 basis points to an average of
        5.10%
        for the year ended December 31, 2006, compared to an average of 3.39% for
        the
        year ended December 31, 2005.
 
 The
        following is a summary of the components of interest expense:
 
 **For
                  the Year Ended****December
                  31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Interest
                  expense on mortgage loans held for investment financing(1)
              
              $
              288,342
              
              $
              145,431Interest
                  expense on warehouse financing
              
              
              30,593
              
              
              22,075Interest
                  expense on other borrowings
              
              
              430
              
              
              286Other
                  interest expense
              
              
              235
              
              
              --Total
                  interest expense
              
              $
              319,600
              
              $
              167,792
 
 *(1)*  *The
        amounts for the year ended December 31, 2006 and 2005 include $2.3 million
        and
        $6.3 million, respectively, of deferred securitization debt issuance expenses
        and trustee expenses recognized during the period, net of hedge
        amortization.*
 
 **Provision
        for Loan Losses**
 
 A
        provision for loan losses on mortgage loans held for investment is recorded
        to
        maintain the related allowance for loan losses at an appropriate level for
        currently existing probable losses of principal. We recorded a provision
        for
        loan losses of $29.1 million (including a recovery of $377,000 of a specific
        provision related to impaired loans)
        and $28.6 million (including a $1.7 million specific provision related to impaired loans)
        for the years ended December 31, 2006 and 2005, respectively, related to
        mortgage loans held for investment. The increase in the amount of the provision
        for loan losses, excluding the specific provision related to impaired loans,
        corresponds to the performance and seasoning of our mortgage loans held for
        investment during the respective period.
 
 During
        the fourth quarter of 2005, we established a $1.7 million specific allowance
        for
        loan losses related to certain loans deemed to be impaired by the effects
        of
        Hurricanes Katrina and Rita. Our
        specific 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.
        During the year ended December 31, 2006, as additional information was obtained,
        we adjusted the portion of the specific allowance related to impaired loans
        for
        the mortgage loans in the Hurricanes
        Katrina and Rita affected
        areas by recording a recovery to the specific allowance provision of
        $716,000.
 
 **55**
 **Non-Interest
        Income**
 
 Total
        non-interest income increased by $2.9 million, or 6.9%, to $44.8 million
        for the
        year ended December 31, 2006, from $41.9 million for the year ended December
        31,
        2005. The increase in non-interest income resulted from a $6.4 million increase
        in the net gain on sale of mortgage loans, partially offset by a decrease
        of
        $3.7 million in the amount of fair value gains recorded on our excess cashflow
        certificates during the year ended December 31, 2006 as compared to the year
        ended December 31, 2005.
 
 ***Net
        Gain on
        Sale of Mortgage Loans.*** Net gain
        on sale of mortgage loans for the years ended December 31, 2006 and 2005
        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 and secondary
        marketing reserves. During the year ended December 31, 2006, the net gain
        on the
        sale of mortgage loans increased $6.4 million, or 23.4%, to $33.6 million
        on the
        sale of $725.1 million of mortgage loans on a whole-loan basis, from the
        $27.2
        million gain recorded during the year ended December 31, 2005 on of the sale
        of
        $561.5 million of mortgage loans on a whole-loan basis.
 
 The
        following table is a summary of our net gain on sale of mortgage loans for
        the
        years ended December 31, 2006 and 2005:
 
 **For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Net
                  Gain on Sale of Mortgage Loans:Loans
                  sold
              
              $
              725,112
              
              $
              561,487Gain
                  on whole-loan sales
              
              $
              26,595
              
              $
              21,862Premium
                  recapture reserve
              
              
              (1,057
              )
              
              (1,077
              )Secondary
                  marketing (indemnification) reserve
              
              
              (780
              )
              
              --Net
                  loan origination fees
              
              
              8,800
              
              
              6,408Net
                  gain on sale recorded
              
              $
              33,558
              
              $
              27,193Average
                  whole-loan sales premium, net of reserves
              
              
              3.41
              %
              
              3.70
              %Average
                  net gain on sale ratio
              
              
              4.63
              %
              
              4.84
              %
 
 During
        the year ended December 31, 2006, we recorded a secondary market reserve
        provision of $780,000 as a reduction of our gain on sale of mortgage loans.
        The
        secondary market reserve covers our estimated exposure to losses arising
        from
        loan repurchases, or the net settlement, related to representation and warranty
        claims by investors. We had no such reserve at December 31, 2005.
 
 The
        average whole-loan sales premium, net of reserves, for the years ended December
        31, 2006 and 2005 was 3.41% and 3.70%, respectively. The average whole-loan
        sales premium, net of reserves is calculated by dividing the gain on whole-loan
        sales, net of premium recapture and secondary marketing reserves, by the
        total
        amount of loans sold. The average net gain on sale ratio for the years ended
        December 31, 2006 and 2005 was 4.63% and 4.84%, respectively. The average
        net
        gain on sale ratio is calculated by dividing the net gain on sale by the
        total
        amount of loans sold.
 
 ***Other
        Income.*** Other
        income decreased $3.5 million, or 23.6%, to $11.2 million for the year ended
        December 31, 2006, from $14.7 million for the year ended December 31, 2005.
        The
        decrease in other income primarily relates to a $3.7 million, or 26.0%, decline
        in the amount of the fair value change recorded on our excess cashflow
        certificates year over year. During the year ended December 31, 2006, we
        recorded a fair value adjustment gain of $10.7 million for the year ended
        December 31, 2006, compared to a $14.4 million fair value adjustment gain
        for
        the year ended December 31, 2005. The
        decrease in the amount of fair value adjustment gains recorded related to
        our
        excess cashflow certificates was primarily driven by the amount of excess
        cashflow certificates that we held throughout the year ended December 31,
        2006.
        These certificates represent the right to receive cash flows from securitization
        trusts. As the cash flows are received, the value of the excess cashflow
        certificates declines. The decrease in the amount of fair value adjustment
        gains
        recorded during the year ended December 31, 2006 was directly impacted by
        the
        cash flows received from our excess cashflow certificates during the year
        ended
        December 31, 2006, which reduced the fair value of the remaining excess cashflow
        certificates. The primary driver of the fair value changes recorded during
        the
        years ended December 31, 2006 and 2005 was the better-than-expected performance
        of our excess cashflow certificates, which resulted from lower than anticipated
        losses on the underlying loans. Additionally contributing to the fair value
        change was the impact of our revised assumptions made during the third quarter
        of 2005, when we lowered the expected losses for most of the underlying
        securitizations and changed the shape of the loss curve to reflect losses
        occurring at a later date ( *i.e.,* the
        timing of losses) than originally anticipated.
 
 **56**
 Also
        included in other income are the gains recognized on the sale of MSRs. During
        the year ended December 31, 2006 we recorded a gain of $381,000 on the sale
        of
        our MSRs to a third-party, an increase of $224,000 over the amount recognized
        during the year ended December 31, 2005. The increase in the gain on sale
        of
        MSRs is due to changes in the composition of the relative fair values of
        the
        MSRs and the related mortgage loans used in the gain calculation during 2006
        as
        compared to 2005.
 
 **Non-interest
        Expense**
 
 Total
        non-interest expense increased by $7.8 million, or 7.3%, to $114.7 million
        for
        the year ended December 31, 2006, from $106.9 million for the comparable
        period
        in 2005. The increase primarily is due to an increase in payroll and related
        costs associated with a 5.1% increase in our mortgage loan production and
        personnel, coupled with an increase in general and administrative expenses
        principally due to other mortgage loan production and REO related expenses.
        Partially offsetting the increase in non-interest expense was a $1.1 million
        decrease in the loss on derivative instruments recorded year over year. During
        the year ended December 31, 2006, we recorded a $147,000 gain on derivative
        instruments relating to the ineffective portion of our derivatives that is
        recognized through current earnings, as compared to a $908,000 loss recorded
        during the year ended December 31, 2005.
 
 ***Payroll
        and
        Related Costs.***  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. Payroll
        and related costs increased by $3.9 million, or 6.2%, to $67.4 million for
        the
        year ended December 31, 2006, from $63.5 million for the year ended December
        31,
        2005. The increase was primarily the result of higher compensation and related
        payroll cost associated with an increase in our staff. As of December 31,
        2006,
        we employed 1,395 full- and part-time employees, an increase of 5.1% over
        our
        1,327 full- and part-time employees as of December 31, 2005. Additionally,
        payroll and related costs, specifically for loan production related personnel,
        were higher due to the 5.1% increase in loan production during the year ended
        December 31, 2006 compared to the year ended December 31, 2005.
 
 Also
        contributing to the increase in payroll and related costs during the year
        ended
        December 31, 2006 was the $842,000 increase in stock-based compensation expense,
        primarily due to the expensing of stock options under SFAS No. 123(R) commencing
        in 2006.
 
 ***General
        and Administrative Expenses.***  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,
        REO
        related expenses and the provision for recourse loans. General and
        administrative expenses increased $4.9 million, or 11.7%, to $47.4 million
        for
        the year ended December 31, 2006, from $42.5 million for the year ended December
        31, 2005. The
        increase primarily was due to an increase in expenses associated with a 5.1%
        increase in loan production during the year ended December 31, 2006, compared
        to
        the year ended December 31, 2005 (which includes slightly higher non-deferrable
        fees, telephone, advertising, and promotional and marketing expenses), the
        consequent 5.1% increase in personnel related to our ongoing expansion of
        our
        wholesale and retail divisions (which resulted in a $3.1 million increase
        in
        rent and depreciation expenses), a $1.0 million increase in legal expenses
        and
        consulting fees and the impact of a $2.3 million increase in REO related
        expenses. These increases were partially offset by a $2.4 million decrease
        in
        accounting expenses, primarily related to a reduction in SOX related
        costs.
 
 The
        increase in REO related expenses in 2006 was due to the expected increase
        in REO
        activity that occurred during 2006. As the mortgage loan portfolio becomes
        more
        seasoned, the portfolio of REO properties will generally increase, resulting
        in
        an increase in the expenses incurred related to the operation and disposal
        of
        those properties.
 
 **57**
 ***(Gain)***  ***Loss
        on Derivative Instruments.*** The gain
        or loss on derivative instruments recorded during the years ended December
        31,
        2006 and 2005 represented 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, 2006, we recorded a gain on derivative instruments
        of $147,000, as compared to a net loss on derivatives of $908,000 during
        the
        year ended December 31, 2005. During the year ended December 31, 2006, we
        recorded a gain of $8,000 on the ineffective portion of corridors and interest
        rate swaps, compared to a loss of $1.5 million recorded on the ineffective
        portion of corridors and interest rate swaps during the year ended December
        31,
        2005. Additionally, at
        December 31, 2006 and 2005, we held $227,000 and $1.7 million, respectively,
        of
        corridors classified as trading securities in prepaid and other assets as
        these
        corridors were no longer deemed “highly effective.” During the years ended
        December 31, 2006 and 2005, gains of $139,000 and $545,000, respectively,
        were
        recorded to earnings for the change in the fair value of the corridors held
        as
        trading securities.
 
 **Provision
        for Income Tax Expense**
 
 We
        recorded an income tax expense of $18.9 million for the year ended December
        31,
        2006 due to the pre-tax income of $48.7 million recorded for the year (utilizing
        an effective tax rate of approximately 38.9%). 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%).
 
 **Year
        Ended December 31, 2005 Compared to the Year Ended December 31,
        2004**
 
 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.
 
 **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 year ended December 31, 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 year ended December 31, 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 year ended December 31, 2004.
 
 **58**
 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.
 
 **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 year ended December 31, 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 year ended December 31,
        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 during
        the
        year ended December 31, 2004. Additionally contributing to the increase in
        interest income was a 42 basis point increase in the weighted-average interest
        rate on the mortgage loans held for investment - securitized portfolio to
        8.19%
        at December 31, 2006 from 7.77% at December 31, 2005.
 
 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 - securitized, net(1)
              
              
              250,841
              
              
              75,469Interest
                  income on mortgage loans held for investment - pre-securitization,
                  net
              
              
              30,494
              
              
              5,531Securitization
                  pass-through interest
              
              
              7,886
              
              
              4,116Interest
                  income on excess cashflow certificates
              
              
              1,593
              
              
              2,073Miscellaneous
                  interest income
              
              
              15
              
              
              115Total
                  interest income
              
              $
              290,829
              
              $
              100,105
 
 *(1)*  *The
        amounts for the year ended December 31, 2005 and 2004 include $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 year ended December 31, 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 year ended December 31, 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 year ended December 31, 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 year ended December 31,
        2004.
 
 **59**
 The
        following table presents the components of interest expense:
 
 **For
                  the Year Ended****December
                  31,***(Dollars
                  in thousands)*
              
              **2005**
              
              **2004**Interest
                  expense on mortgage loans held for investment financing(1)
              
              $
              145,431
              
              $
              31,480Interest
                  expense on warehouse financing
              
              
              22,075
              
              
              8,006Interest
                  expense on other borrowings
              
              
              286
              
              
              296Total
                  interest expense
              
              $
              167,792
              
              $
              39,782
 
 *(1)*  *The
        amounts for the year ended December 31, 2005 and 2004 include $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.*
 
 **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 year ended December 31,
        2004. The increase in non-interest income primarily resulted from an $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, the net gain on the sale of mortgage loans
        increased $11.1 million, or 69.4%, to $27.2 million on the sale of $561.5
        million of mortgage loans on a whole-loan basis, from $16.1 million during
        the
        year ended December 31, 2004 on sale of $283.3 million of mortgage loans
        on a
        whole-loan basis, or through a securitization structured to be accounted
        for as
        a sale. Additionally, the gain on sale of mortgage loans amount of $16.1
        million
        recorded for the year ended December 31, 2004 includes a $6.6 million net
        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:
 
 **60**
 (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 MSRs; 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.
  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
              
              $
              283,253Gain
                  on whole-loan sales
              
              $
              21,862
              
              $
              7,716Premium
                  recapture reserve
              
              
              (1,077
              )
              
              (308
              )Net
                  loan origination fees
              
              
              6,408
              
              
              2,468NIM
                  proceeds, net
              
              
              --
              
              
              4,712Interest-only
                  security proceeds
              
              
              --
              
              
              1,292Mortgage
                  servicing rights(2)
              
              
              --
              
              
              661Securitization
                  transaction costs
              
              
              --
              
              
              (484
              )Net
                  gain on sale recorded
              
              $
              27,193
              
              $
              16,057Average
                  whole-loan sales premium, net of reserves(3)
              
              
              3.70
              %
              
              4.37
              %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.*
 
 *(3)*  *For
        the year ended December 31, 2004, the average whole-loan sales premium, net
        of
        reserves calculation is based upon the $7.7 million of gains recorded on
        the
        sale of $169.3 million of loans sold on a whole-loan basis, net of the $308,000
        of premium recapture reserves recorded.*
 
 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
        average whole-loan sales premium, net of reserves, for the years ended December
        31, 2005 and 2004 was 3.70% and 4.37%, respectively. The average whole-loan
        sales premium, net of reserves is calculated by dividing the gain on whole-loan
        sales, net of premium recapture and secondary marketing reserves, by the
        total
        amount of loans sold. The average net gain on sale ratio for the years ended
        December 31, 2005 and 2004 was 4.84% and 5.67%, respectively. The average
        net
        gain on sale ratio is calculated by dividing the net gain on sale by the
        total
        amount of loans securitized and sold.
 
 **61**
 ***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 year ended December 31, 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.
 
 **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 year ended December
        31, 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 year ended
        December 31, 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 year ended December 31,
        2004.
 
 ***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.
 
 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.
 
 **62**
 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.
 
 **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%).
 
 **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, 2006
        and
        2005.
  **Financial
        Condition**
 
 ***December
        31, 2006 compared to December 31, 2005***
 
 **Cash
        and cash
        equivalents** .
        Cash
        and cash equivalents increased $1.0 million, or 22.9%, to $5.7 million at
        December 31, 2006, from $4.7 million at December 31, 2005. This increase
        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 $1.8 billion, or 37.4%,
        to
        $6.4 billion at December 31, 2006, from $4.6 billion at December 31, 2005.
        This
        account represents our basis in the mortgage loans that were either delivered
        to
        the securitization trusts (recorded as mortgage loans held for investment
        -
        securitized) or are pending delivery into future securitizations or sale
        on a
        whole-loan basis (recorded 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)*
              
              **2006**
              
              **2005**Mortgage
                  loans held for investment - securitized
              
              $
              6,051,996
              
              $
              4,430,775Mortgage
                  loans held for investment - pre-securitization(1)
              
              
              417,818
              
              
              270,372Discounts
                  (MSR related)
              
              
              (36,933
              )
              
              (26,750
              )Net
                  deferred origination fees
              
              
              (19,194
              )
              
              (10,735
              )Allowance
                  for loan losses
              
              
              (55,310
              )
              
              (36,832
              )Mortgage
                  loans held for investment, net
              
              $
              6,358,377
              
              $
              4,626,830
 
 *(1)*  *Included
        in our mortgage loans held for investment - pre-securitization at December
        31,
        2006 and 2005, was approximately $335.9 million and $222.8 million,
        respectively, of mortgage loans that were pledged as collateral for our
        warehouse financings at December 31, 2006 and 2005,
        respectively.*
 
 During
        the year ended December 31, 2006, we originated $4.0 billion of mortgage
        loans
        and sold $725.1 million of loans on a whole-loan basis. The increase in mortgage
        loans held for investment is driven by the volume of our originations, net
        of
        principal repayments and whole-loan sales for the year. The
        increase in the mortgage loans held for investment - pre-securitization was
        impacted by our year-end 2006 decision to carry additional loans into the
        first
        quarter of 2007, and finance the loans through our warehouse credit facilities
        rather than through securitization debt. Additionally
        contributing to the decision to carry additional loans was our historical
        experience of receiving more
        advantageous securitization pricing in the first quarter of the year than
        in the
        fourth quarter of the year.
 
 **63**
 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, 2006 and 2005, we
        established an allowance for loan losses totaling $55.3 million and $36.8
        million, respectively, based upon our analysis of the mortgage loans held
        for
        investment portfolio, including a $1.0 million and $1.7 million, respectively,
        reserve for probable loan losses on impaired mortgage loans. 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,
        2006.
 
 The
        following table sets forth a summary of the activity in the allowance for
        loan
        losses for the years ended December 31, 2006 and 2005:
 
 **For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Allowance
                  for loan losses - beginning of year
              
              $
              36,832
              
              $
              10,278Provision
                  for loan losses(1)
              
              
              29,085
              
              
              28,592Charge-offs(2)
              
              
              (10,607
              )
              
              (2,038
              )Allowance
                  for loan losses - end of year(3)
              
              $
              55,310
              
              $
              36,832
 
 *(1)*  *The
        provision for loan losses for the years ended December 31, 2006 and 2005
        includes a specific provision which consisted of a $377,000 recovery and
        a $1.7
        million provision, respectively. The specific provisions* *relates
        to probable losses attributable to impaired loans for each
        year.*
 
 *(2)*  *The
        charge-offs for the years ended December 31, 2006 and 2005 includes a $342,000
        (net of $10,000 of recoveries) and $3,000, respectively, in charge-offs against
        the specific allowance for loan losses attributable to impaired loans primarily
        related to loans located in Hurricanes Katrina and Rita disaster
        areas.*
 
 *(3)*  *The
        allowance for loan losses at December 31, 2006 and 2005 includes a specific
        allowance for impaired loans of $1.0 million and $1.7 million, respectively.
        The
        majority of the specific allowance, or $675,000, relates to impaired loans
        located in Hurricanes Katrina and Rita disaster areas at December 31, 2006
        and
        all of the specific allowance at December 31, 2005 related to those
        loans.*
 
 Our
        specific allowance for loan losses at December 31, 2006 and 2005 is based
        upon
        our probable loss exposure attributable to 17 and 35 properties, respectively,
        securing a total unpaid principal balance (impaired loans) of $2.5 million
        and
        $3.9 million, respectively. The impaired loan totals at December 31, 2006
        and
        2005 include approximately $1.3 million (of which $226,000 are
        pre-securitization loans) and $3.9 million (of which $798,000 are
        pre-securitization loans), respectively, of mortgage loans held for investment
        located in the Hurricanes Katrina and Rita disaster areas designated by FEMA. As
        additional information is obtained we will continue to assess the need for
        any
        adjustments to our specific reserves related to our
        impaired loans.
 
 ***Trustee
        Receivable.*** Trustee
        receivable increased $17.2 million, or 30.6%, to $73.4 million at December
        31,
        2006 from $56.2 million at December 31, 2005. Trustee receivable principally
        represents any un-remitted principal and interest payments collected by the
        securitization trust’s third-party loan servicer subsequent to the monthly
        remittance cut-off date on our mortgage loans held for investment - securitized
        portfolio. The unscheduled principal payments and prepaid loan payments received
        after the remittance cut-off date as of December 31, 2006 and 2005 totaled
        $67.0
        million and $50.7 million, respectively, relating to the securitizations
        accounted for as secured financings. The trustee is expected to remit these
        amounts on the following month’s scheduled remittance date, at which time they
        mainly will be used to pay down principal on the related financing on mortgage
        loans held for investment, net. 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 2006
        remittance cut-off date will be remitted to us in January
        2007).
  **64**
  ***Accrued
        Interest Receivable.*** Accrued
        interest receivable increased $14.7 million, or 54.7%, to $41.7 million at
        December 31, 2006, from $27.0 million at December 31, 2005. The increase
        is due
        to (1) the 36.6% increase in mortgage loans held for investment - securitized
        from December 31, 2005, (2) the 54.5% increase in mortgage loans held for
        investment - pre-securitization during the same period, and (3) the effect
        of an
        increase in the weighted-average interest rates on the mortgage loans held
        for
        investment - securitized and mortgage loans held for investment -
        pre-securitization of 42 basis points and 38 basis points, respectively,
        from
        December 31, 2005 to December 31, 2006. Additionally contributing to the
        increase in the accrued interest receivable balance is the increase in the
        amount of accrued interest owed relating to loans that are 30 to 89 days
        past
        due in
        accordance with contractual terms of the mortgage at December 31, 2006 as
        compared to December 31, 2005.
 
 ***Excess
        Cashflow Certificates*** **.** The
        following table presents the activity related to our excess cashflow
        certificates for the years ended December 31, 2006 and 2005:
 
 **For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Balance,
                  beginning of year
              
              $
              7,789
              
              $
              14,933Excess
                  cashflow certificates sold
              
              
              (1,500
              )
              
              --Accretion
              
              
              452
              
              
              1,593Cash
                  receipts
              
              
              (16,198
              )
              
              (23,146
              )Net
                  change in fair value
              
              
              10,666
              
              
              14,409Balance,
                  end of year
              
              $
              1,209
              
              $
              7,789
 
 Since
        we
        began structuring our securitizations in 2004 to be accounted for as secured
        financings, we no longer record excess cashflow certificates (but rather
        the
        underlying mortgage loans) on our consolidated balance sheet for our newly
        issued securitizations. During the year ended December 31, 2006, we sold
        at fair
        value $1.5 million of excess cashflow certificates to a third-party without
        recourse. We did not sell any excess cashflow certificates during the year
        ended
        December 31, 2005.
 
 The
        decrease in the fair value of our excess cashflow certificates for the year
        ended December 31, 2006, as compared to the same period in 2005, is primarily
        due to the timing of cash receipts and losses on the underlying loans, coupled
        with the change in the amount of remaining residual cash flows. Actual losses
        for the year ended December 31, 2006 were lower than anticipated, 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 than expected on the excess cashflow certificates
        during the year ended December 31, 2006.
 
 ***Equipment,
        Net*** **.** Equipment, net, increased $1.6 million, or 23.9%, to $8.3 million at December
        31, 2006, from $6.7 million at December 31, 2005. This increase is primarily
        due
        to purchases of computer equipment, leasehold improvements and office
        furnishings during the year ended December 31, 2006, which is consistent
        with
        the 5.1% increase in employees compared to December 31, 2005 and the effect
        of
        our office expansions. The computer equipment and office furnishings purchased
        during 2006 are being depreciated over a three- to five-year period from
        the
        date acquired, while the leasehold improvements will be depreciated generally
        over the shorter of the life of the lease or the estimated useful
        life.
 
 ***Accounts
        Receivable.***  Accounts
        receivable decreased $251,000, or 4.9%, to $4.9 million at December 31, 2006,
        from $5.1 million at December 31, 2005. This
        decrease primarily is due to a decrease in amounts of principal, interest
        and
        escrow advances related to recourse loans and a decrease in servicer
        receivables. The decrease in recourse loan related advances was primarily
        due to
        the $374,000, or 49.1%, decrease in recourse loans from December 31, 2005
        to
        December 31, 2006. Under the terms of the recourse agreements, we are required
        to make advances to the recourse loan investors in the event the underlying
        loan’s borrower fails to make their payment. The decrease in servicer
        receivables relates to a decrease in loan payments received by our third-party
        loan servicer related to our mortgage loans held for investment -
        pre-securitization portfolio at December 31, 2006. The decreases were partially
        offset by a $649,000 increase in current tax assets from December 31, 2005
        to
        December 31, 2006.
 
 **65**
 ***Prepaid
        and Other Assets.*** Prepaid
        and other assets increased $19.3 million, or 63.4%, to $49.8 million at December
        31, 2006, from $30.5 million at December 31, 2005. The increase primarily
        is due
        to the (1) $25.2 million increase in REO properties due to the expected
        seasoning of the loan portfolio, and (2) $2.4 million net increase in deferred
        securitization debt issuance costs that are recognized over the estimated
        life
        of the securitization debt as a yield adjustment to interest expense. These
        increases were partially offset by an $8.3 million net decrease in the fair
        value of our derivative instruments used to hedge our securitization debt
        during
        the year ended December 31, 2006.
 
 At
        December 31, 2006 and 2005, we held $29.6 million and $4.4 million,
        respectively, of REO properties, which we carry at the lower of cost or fair
        value less estimated selling costs.  A
        provision of $1.5 million and $213,000 was made during the years ended December
        31, 2006 and 2005, respectively, for decreases in the fair value of the REO
        properties.
 
 ***Deferred
        Tax Asset.***  The
        deferred tax asset decreased by $9.1 million, or 16.6%, to $45.8 million
        at
        December 31, 2006, from $54.9 million at December 31, 2005. The decrease
        primarily relates to (1) gain-on-sale accounting versus REMIC tax accounting
        for
        securitizations entered into prior to 2004, our 2004 securitizations which
        were
        accounted for as secured financings, and for tax purposes were accounted
        for as
        REMIC transactions and were treated as sales, (2) realized gains and losses
        on
        derivatives (interest rate swaps) associated with hedging the securitization
        debt issuance (financing costs), (3) capitalized origination fees and related
        costs, and (4) the timing of dividends from our REIT subsidiary. These decreases
        were partially offset by increased deferred tax assets related to the timing
        of
        loan losses (allowance for loan losses) and non-accrual interest, coupled
        with a
        $2.6 million increase in deferred taxes related to the fair value of the
        hedge
        instruments within accumulated other comprehensive income.
 
 Commencing
        in the first quarter of 2005, we began issuing our securitizations from a
        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 decreased $364,000, or 18.9%, to $1.6 million at December 31, 2006,
        from
        $1.9 million at December 31, 2005. 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 $113.0 million, or 50.7%, to $335.9 million
        at
        December 31, 2006, from $222.8 million at December 31, 2005. The increase
        was
        primarily due to a $147.4 million increase in the amount of mortgage loans
        held
        for investment - pre-securitization. The increase in warehouse financing
        relates
        to our year-end 2006 decision to carry additional loans into the first quarter
        of 2007, and finance the loans through our warehouse credit facilites rather
        than through securitization debt. Additionally impacting the amount of
        outstanding borrowings under our warehouse credit facilities was the increase
        in
        the amount of self-funded loans from December 31, 2005 to December 31, 2006.
        At
        December 31, 2006, we self-funded $82.0 million of these mortgage loans,
        as
        compared to $47.5 million at December 31, 2005.
 
 ***Financing
        on Mortgage Loans Held for Investment, Net.*** Our
        financing on mortgage loans held for investment, net increased $1.6 billion,
        or
        35.6%, to $6.0 billion at December 31, 2006, from $4.4 billion at December
        31,
        2005. This increase in the issuance of asset-backed securities corresponds
        to
        the increase in loans held for investment - securitized during the year ended
        December 31, 2006. The balance of this account will generally increase or
        decrease in proportion to the change in the balance of our mortgage loans
        held
        for investment - securitized.
 
 ***Other
        Borrowings.***  Other
        borrowings increased $1.2 million, or 24.8%, to $6.0 million at December
        31,
        2006, from $4.8 million at December 31, 2005. The increase in other borrowings
        was due to an increase in the amount of financed equipment during the year
        ended
        December 31, 2006. The increase in the need for equipment, and the resultant
        financing thereon, was due to the 5.1% increase in personnel, expansion of
        several of our mortgage origination offices during 2006 and our continued
        investment in technology.
  **66**
  The
        following table summarizes certain information regarding other borrowings
        at
        December 31, 2006 and 2005:
 
 *(Dollars
                  in thousands*)
              
              **Range
                  of Interest Rates**
              
              **Balance
                  at December 31,**
              
              **Range
                  of Expiration Dates**Equipment
                  financing - 2006
              
              6.26%
                  to 8.95%
              
              $                                                    
                   5,970
              
              January
                  2007 to November 2009Equipment
                  financing - 2005
              
              3.29%
                  to 12.45%
              
              $                                                    
                   4,785
              
              January
                  2006 to December 2008
 
 ***Accrued
        Interest Payable.*** Accrued
        interest payable increased $12.0 million, or 91.4%, to $25.1 million at December
        31, 2006, from $13.1 million at December 31, 2005. The increase was primarily
        related to (1) the 35.6% increase in financing on mortgage loans held for
        investment, net, (2) the 50.7% increase in warehouse financing, and (3) the
        impact of the 68 basis point (5.60% at December 31, 2006 from 4.92% at December
        31, 2005) increase in the weighted average cost on mortgage loans held for
        investment financing, coupled with a 93 basis point increase in the index
        utilized to calculate the interest expense on our warehouse
        financing.
 
 Additionally
        contributing to the increase in accrued interest payable related to warehouse
        financing was the change in the interest settlement process for two of our
        warehouse credit facilities. The change, from settling interest on the date
        the
        loans are securitized or sold to a mid-month date, will result in our carrying
        higher accrued interest payable balances at month end when we utilize the
        warehouse facilities with this provision.
 
 ***Accounts
        Payable and Other Liabilities.*** Accounts
        payable and other liabilities increased $20.0 million, or 59.9%, to $53.2
        million at December 31, 2006, from $33.2 million at December 31, 2005. The
        increase was primarily due to (1) a $20.0 million increase in accrued servicer
        payables related primarily to our growth in our mortgage loans held for
        investment portfolio, (2) a $1.6 million increase in rent abatement and lease
        termination related accruals, (3) a $458,000 increase in payroll accruals
        for
        payroll related items ( *i.e.* ,
        salary
        and commissions) due primarily to the 5.1% increase in personnel, (4) a $316,000
        increase in accrued professional fees, primarily related to timing of payments,
        and (5) a $622,000 increase in reserves associated with whole-loan sales
        ( *i.e.,* secondary marketing and premium recapture reserves). These increases were
        partially offset by a $3.8 million decrease in current taxes payable during
        the
        same period.
 
 ***Stockholders’
        Equity.*** Stockholders’ equity increased $42.8 million, or 40.1%, to $149.6 million at
        December 31, 2006 from $106.8 million at December 31, 2005. This increase
        is
        primarily due to (1) the recording of $29.8 million in net income for the
        year
        ended December 31, 2006, (2) the $19.3 million of net proceeds we received
        from
        the issuance of 2.5 million shares of common stock in a private placement
        in
        April 2006, (3) the $346,000 of proceeds and $1.0 million of excess tax benefits
        we received from the exercise of 321,000 stock options from authorized but
        unissued shares during the same period, and (4) the $889,000 impact of the
        stock-based compensation recorded during the period. These increases were
        offset
        by decreases of $4.0 million, net of tax, in the accumulated OCI related
        to the
        net unrealized losses from derivatives, the payment of $3.3 million in common
        stock dividends, and the accrual of $1.2 million in common stock dividends
        that
        were declared on December 26, 2006 and paid on January 5, 2007.
 
 Additionally
        increasing stockholders’ equity was the effect of the adoption of SFAS No.
        123(R), which removed from stockholders’ equity the unearned common stock held
        by the 2005 Stock Incentive Plan (“SIP”) on January 1, 2006. During the fourth
        quarter of 2005, we contributed 157,275 shares, or $1.2 million, of our common
        stock to the SIP, which represented deferred compensation and was initially
        recorded as a component of stockholders’ equity.
  **67**
  **Contractual
        Obligations**
 
 The
        following table summarizes our material contractual obligations as of December
        31, 2006:
 *(Dollars
                    in thousands)*
                
                **Total**
                
                **Less
                    than**
                  **One
                    Year**
                
                **One
                    to**
                  **Three
                    Years**
                
                **Three
                    to**
                  **Five
                    Years**
                
                **More
                    than**
                  **Five
                    Years**Financing
                    on mortgage loansheld
                    for investment, net(1)
                    (2)
                
                $
                6,017,947
                
                $
                2,289,883
                
                $
                2,247,178
                
                $
                820,585
                
                $
                660,301Operating
                    leases(2)
                
                $
                22,649
                
                $
                6,897
                
                $
                9,653
                
                $
                6,040
                
                $
                59Equipment
                    financing(2)
                
                $
                5,970
                
                $
                257
                
                $
                5,713
                
                $
                --
                
                $
                --
 *(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.*
 
 *(2)*  *The
        amounts shown do not include interest.*
 
 During
        the year ended December 31, 2006, we entered into a non-cancelable operating
        sublease with a third-party to rent space in a location previously utilized
        by
        us as retail mortgage origination center. We expect to receive rental payments
        totaling $236,000 over the next 1.8 years related to the sublease. We had
        no
        sublease arrangements prior to 2006.
 
 **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, 2006 and 2005, we had outstanding origination
        commitments to fund approximately $117.1 million and $104.8 million,
        respectively, in mortgage loans.
 
 **Off-Balance
        Sheet Trusts**
 
 Our
        off-balance sheet arrangements primarily 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 $457.6 million and $843.2 million
        in
        collateral (primarily mortgage loans) owned by off-balance sheet trusts as
        of
        December 31, 2006 and 2005, respectively. These trusts have issued asset-backed
        securities secured by these mortgage loans. We have no obligation to provide
        funding support to either the third-party investors or the off-balance sheet
        trusts. The third-party investors or the trusts have no recourse to our assets
        or us and have no ability to require us to repurchase their loans other than
        for
        non-credit-related recourse that can arise under standard representations
        and
        warranties. See “Part I - Item 1. - Business - Securitizations. -
        Securitizations Structured as a Sale - Off-Balance Sheet
        Arrangements.”
  **68**
 Cash
        Flows
  The
        following table summarizes our historical cash flows for the years ended
        December 31, 2006, 2005 and 2004:
 **For
                    the Year Ended December 31,***(Dollars
                    in thousands)*
                
                **2006**
                
                **2005**
                
                **2004**Net
                    cash provided by (used in):Operating
                    activities
                
                $
                16,219
                
                $
                2,735
                
                $
                122,738Investing
                    activities
                
                $
                (1,724,938
                )
                $
                (2,293,521
                )
                $
                (2,349,928
                )Financing
                    activities
                
                $
                1,709,787
                
                $
                2,290,272
                
                $
                2,227,801
  *Operating
        Activities* -
        The
        net ** cash
        provided by operating activities was $16.2 million for the year ended December
        31, 2006, compared to $2.7 million for the year ended December 31, 2005.
        The
        increase for the year ended December 31, 2006 primarily reflects the net
        impact
        of the $31.2 million increase in accrued interest payable, accounts payable
        and
        other liabilities, the $29.8 million of net income recorded, the $29.1 million
        of provision for loan losses, the $24.4 million of proceeds received from
        the
        sale of MSRs, the $15.7 million of cash received related to our excess cashflow
        certificates and the $11.7 million of deferred tax expense accrued. Partially
        offsetting these increases was the impact of the $57.7 million increase in
        trustee receivable, accrued interest receivable and prepaid and other assets,
        the $34.3 million of gains recorded on mortgage loan sales, the $12.9 million
        of
        deferred cost amortization related to bond securitizations and $10.7 million
        of
        gains on the change in fair value of excess cashflow certificates.
 
 *Investing
        Activities -* The
        net
        cash used in investing activities was $1.7 billion for the year ended December
        31, 2006, compared to $2.3 billion for the year ended December 31, 2005.
        The net
        cash used in investing activities in the year ended December 31, 2006 primarily
        reflects the $2.5 billion of net originations of mortgage loans held for
        investment offset by the $759.5 million of proceeds received from the sale
        of
        mortgage loans.
 
 *Financing
        Activities* - The net
        cash provided by financing activities was $1.7 billion for the year ended
        December 31, 2006, compared to $2.3 billion for the year ended December 31,
        2005. The net cash provided during the year ended December 31, 2006 primarily
        related to the $1.6 billion in the proceeds received from the financing on
        mortgage loans held for investment, the $113.0 million of proceeds from
        warehouse financing and the $19.3 million of net proceeds received from the
        common stock issued in our secondary offering. These cash inflows were partially
        offset by cash payments for common stock dividends of $4.4 million during
        the
        year ended December 31, 2006.
 
 **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, including
        NIM transactions and the sale of MSRs. Our current cost structure has many
        embedded fixed costs, which are not likely to be significantly affected by
        a
        relatively substantial change in our loan origination volume. If we can continue
        to originate a sufficient amount of mortgage loans and continue our practice
        of
        securitizations, we expect to generate sufficient cash proceeds from our
        securitization financings, whole-loan sales and the cash flows from our growing
        portfolio of mortgage loans held for investment to largely offset our current
        cost structure and cash uses. However, we may choose to not sell MSRs or
        to
        reduce the amount of securitization debt we issue, which will negatively
        impact
        our cash flow in any period in which this occurs. Additionally, although
        we
        believe our strategy to hedge our exposure to rising interest rates in an
        effort
        to “lock in” our spread (as discussed in more detail in “Summary of Critical
        Accounting Policies - Accounting for Hedging Activities” and "Market Risk -
        Hedging”) to be appropriate, decreasing interest rates could adversely impact
        our cash flow in future periods.
 
 **69**
 We
        believe we must generate sufficient cash from the following in order to sustain
        our current level of working capital:
 
 ·
              the
                  proceeds we receive from selling or financing asset-backed securities
                  (including NIMs or Class N Notes) in connection with our
                  securitizations;
 
 ·
              the
                  proceeds from the sale of MSRs to a third-party mortgage
                  servicer;
 
 ·
              the
                  premiums we receive from selling whole-loans on a servicing-released
                  basis;
 
 ·
              origination
                  fees collected on newly closed
                  loans;
 
 ·
              the
                  cash flow from corridors and interest rate
                  swaps;
 
 ·
              excess
                  cashflow certificates we retained in connection with our securitizations
                  prior to 2004; and
 
 ·
              principal
                  and interest payments we receive on our loans held for
                  investment.
 
 Currently,
        our primary uses of cash include the funding of:
 
 ·
              mortgage
                  loans held for investment -
                  pre-securitization;
 
 ·
              interest
                  expense on warehouse financings, financing of mortgage loans held
                  for
                  investment, interest rate swap payments and other
                  financings;
 
 ·
              scheduled
                  principal pay-downs on financing of mortgage loans held for investment,
                  warehouse credit financings and other
                  financings;
 
 ·
              transaction
                  costs, derivative costs and credit enhancement (O/C) in connection
                  with
                  our securitizations;
 
 ·
              general
                  ongoing administrative and operating expenses, including the cost
                  to
                  originate loans;
 
 ·
              tax
                  payments, including those on excess inclusion income generated
                  from our
                  excess cashflow certificates and all, or a portion, of the dividends
                  received from our REIT subsidiary;
                  and
 
 ·
              common
                  stock dividends.
 
 Historically,
        we have financed our operations utilizing securitization financings, various
        secured credit financing facilities, issuance of corporate debt, issuances
        of
        equity, and MSRs sold in conjunction with each of our securitizations to
        support
        our originations, securitizations, and general operating expenses.
 
 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 to a lesser
                  extent,
 
 ·
              cash
                  flows from retained excess cashflow
                  certificates.
 
 Additionally,
        from time to time we may raise capital from the sale of common stock. On
        April
        10, 2006, we closed a private placement of 2,500,000 newly issued shares, from
        authorized but unissued shares, of our
        common stock at a price of $8.25 per share to a combination of new and existing
        institutional investors. We received proceeds of approximately $19.3 million,
        after deducting expenses payable in connection with this offering. The
        proceeds were used to repay warehouse financings and originate mortgage
        loans.
 
 **70**
 We
        have
        repurchase agreements with institutions that purchased mortgage loans from
        us
        several years ago. 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 is still outstanding
        totaled $387,000 and $762,000 at December 31, 2006 and 2005, respectively.
        Included in “accounts payable and other liabilities” is an allowance for
        recourse loans related to those loans sold with recourse of $81,000 and $310,000
        at December 31, 2006 and 2005.
  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, Part 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
        credit 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
        Credit Facilities***
 
 To
        originate and accumulate loans for securitization, we borrow money on a
        short-term basis primarily through committed secured warehouse credit
        facilities. Throughout each quarter as we amass loans for inclusion in each
        quarter’s securitization, a significant portion of our total warehouse financing
        facilities may be utilized to fund loans. The
        majority of the loans collateralizing warehouse borrowings are held for a
        period
        of up to 120 days, at which point they are securitized or sold. We
        had
        the following warehouse credit facilities in place at December 31, 2006 and
        2005:
  *(Dollars
                  in thousands)*
              
              **Facility**
              
              
              
              **At
                  December 31,****Warehouse
                  Credit Facility**
              
              **Amount****(1)**
              
              **Interest
                  Rate**
              
              **2006**
              
              **2005**
              
              **Expiration
                  Date**Citigroup
              
              $              
                   350,000
              
              Margin
                  over LIBOR
              
              $                
                  234,578
              
              $               
                   144,912
              
              May
                  2007Bank
                  of America
              
              350,000
              
              Margin
                  over LIBOR
              
              76,717
              
              --
              
              August
                  2007RBS
                  Greenwich Capital
              
              350,000
              
              Margin
                  over LIBOR
              
              24,570
              
              77,931
              
              November
                  2007JPMorgan
                  Chase
              
              350,000
              
              Margin
                  over LIBOR
              
              --
              
              --
              
              May
                  2007Deutsche
                  Bank
              
              350,000
              
              Margin
                  over LIBOR
              
              --
              
              --
              
              October
                  2007Total
              
              $            
                   1,750,000
              
              
              
              $               
                   335,865
              
              $                 222,843
 
 *(1)*  *The
        warehouse facility amounts shown are as of December 31, 2006 only. The warehouse
        facility amounts totaled $1.25 billion as of December 31,
        2005.*
 
 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, 2006.
 
 During
        the year ended December 31, 2006, we entered into a two new $350.0 million
        warehouse credit facilities with JPMorgan Chase and Deutsche Bank and allowed
        our $200.0 million warehouse credit facility with Friedman, Billings, Ramsey
        to
        expire. The JPMorgan Chase and Deutsche Bank credit facilities amounts are
        each
        comprised of a $200.0 million committed line and a $150.0 million uncommitted
        line. These credit facilities provide us with the ability to borrow against
        first and second lien loans and wet collateral. The interest and fees that
        we
        pay in connection with these facilities are similar to the interest rates
        and
        fees that we pay to our other warehouse credit facility lenders. The JPMorgan
        Chase and Deutsche Bank facilities will expire in May 2007 and October 2007,
        respectively. As of December 31, 2006, we had no balance outstanding under
        either credit facility.
 
 **71**
 Additionally,
        during the year ended December 31, 2006, upon renewal of our warehouse credit
        facilities with RBS Greenwich Capital and Bank of America, we altered the
        warehouse credit facility from a $350.0 million committed line on both to
        a
        $200.0 million and $175.0 million, respectively, committed line and a $150.0
        million and $175.0 million, respectively, uncommitted line. All other terms
        of
        the warehouse credit facilities remained consistent with their respective
        prior
        agreements.
 
 **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
        2006, the yield curve was flat to inverted. A flat or inverted yield curve
        occurs when short-term interest rates increase 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, 2006, the interest rate on all of our warehouse financing
        arrangements and a portion of our securitization debt adjust daily or monthly.
        On the other hand, most of the mortgage loans we own are fixed-rate; the
        remainder contains features where rates are fixed for some period of time
        and
        then adjust frequently thereafter (primarily every six months). 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 represented 72.6% and 69.3%
        of our
        net revenues (net interest income and non-interest income, less provision
        for
        loan loss) during the years ended December 31, 2006 and 2005, respectively.
        Accordingly, the interest rate environment has a substantial impact on our
        earnings. Our balance sheet is currently liability sensitive. A company with
        a
        liability sensitive balance sheet generally experiences reduced net interest
        income in a rising or increasing rate environment, while earnings are enhanced
        in a sustained decreasing rate cycle. The impact of 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 (primarily comprised of
        mortgage loans held for investment) and interest-bearing liabilities (primarily
        comprised of the securitization and warehouse financing related to our mortgage
        loans and any hedging instruments related thereto) 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, 2006:
 
 *(Dollars
                  in thousands)*
              
              **Base
                  Case**
              
              **Up
                  100 Basis Points**
              
              **Up
                  200 Basis Points**
              
              **Down
                  100 Basis Points**
              
              **Down
                  200 Basis Points*****One
                  Year Projection:***Net
                  interest income(1)(2)
              
              $
              135,037
              
              $
              131,160
              
              $
              129,717
              
              $
              139,177
              
              $
              144,042Percentage
                  change from base
              
              
              
              
              
              (2.9
              )%
              
              (3.9
              )%
              
              3.1
              %
              
              6.7
              %***Three
                  Year Projection:***Net
                  interest income(1)(2)
              
              $
              268,620
              
              $
              261,775
              
              $
              259,070
              
              $
              275,559
              
              $
              283,221Percentage
                  change from base
              
              
              
              
              
              (2.6
              )%
              
              (3.6
              )%
              
              2.6
              %
              
              5.4
              %
 
 *(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
        interest expense on warehouse financings through March 31,
        2007.*
 
 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.
 
 **74**
 ***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.
 
 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
        and interest rate swaps are legal contracts between us and a third-party
        firm or
“counterparty.” In a corridor contract, 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. An interest rate swap is
        a
        contractual arrangement between two counterparties who agree to exchange
        interest payments on a defined principal amount for a fixed period of time.
        The
        principal amount is never exchanged, and therefore is referred to as a notional
        principal amount. The payments on interest rate swaps are a function of the
        notional principal amount, interest rates and time. Generally, our 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**
  **Credit
        Risk**
 
 Credit
        risk generally represents the risk of potential loss that may result from
        the
        failure of a borrower or an institution to honor its contractual obligations
        to
        us. We actively manage credit risk to maintain credit losses within levels
        that
        achieve our profitability and return on capital objectives.
 
 In
        our
        mortgage lending activities, we manage our credit risk through our established
        credit policies, as well as through our underwriting, quality control and
        monitoring activities. Our mortgage loans are generally pooled and securitized
        into asset-backed securities. These securitizations involve some form of
        credit
        enhancement, such as senior/subordinated structures, overcollateralization
        or
        monoline insurance. Securitizations that involve senior/subordinated structures
        contain asset-backed securities that assume varying levels of credit risk.
        The
        holders of the subordinated securities assume more credit risk than the senior
        securities and generally receive a higher yield as a result of assuming that
        higher credit risk. We sell the subordinated securities created in connection
        with our securitizations and thereby transfer the related credit risk to
        the
        holders, subject to standard representations and warranties we make when
        the
        loans are securitized.
 
 We
        also
        sell our mortgage loans on a non-recourse basis, as whole-loan sales. We
        have a
        potential liability under the standard representations and warranties we
        make to
        purchasers of the loans. In the event of a breach of such representations
        and
        warranties, we may be required to either repurchase the mortgage loans with
        the
        identified defects or indemnify the investor. In such cases, we bear any
        subsequent credit loss on the mortgage loans. We have established a secondary
        marketing reserve to cover potential losses arising from the repurchase or
        net
        settlement of loans previously sold.
 
 **Legal
        and Regulatory Risk**
 
 We
        are
        subject to extensive and evolving regulation in jurisdictions across the
        United
        States. Substantial legal liability or a significant regulatory action against
        us could have material adverse financial effects or cause significant
        reputational harm to us, which in turn could seriously harm our business
        prospects. Companies in the financial services industry, like ours, have
        been
        operating in a difficult regulatory environment. We face significant legal
        risks
        in our businesses, and the volume of claims and amount of damages and penalties
        claimed in litigation can be substantial.
 
 **Maturity
        and Repricing Information**
 
 The
        following table summarizes the notional amount, expected maturities and weighted
        average strike price or rate for corridors (caps bought and caps sold) and
        amortizing notional balance interest rate swaps that we held as of December
        31,
        2006:
 
 *(Dollars
                  in thousands)*
              
              **Total**
              
              **One**
                **Year**
              
              **Two**
                **Years**
              
              **Three
                  Years**
              
              **Four**
                **Years**
              
              **Five
                  Years & Thereafter**Caps
                  bought - notional
              
              $
              954,101
              
              $
              600,811
              
              $
              204,667
              
              $
              37,086
              
              $
              28,288
              
              $
              83,249Weighted
                  average strikeprice
              
              
              6.93
              %
              
              6.53
              %
              
              7.31
              %
              
              7.47
              %
              
              7.45
              %
              
              7.42
              %Caps
                  sold - notional
              
              $
              954,101
              
              $
              600,811
              
              $
              204,667
              
              $
              37,086
              
              $
              28,288
              
              $
              83,249Weighted
                  average strikeprice
              
              
              9.15
              %
              
              9.03
              %
              
              9.30
              %
              
              9.27
              %
              
              9.28
              %
              
              9.31
              %Amortizing
                  notional balance interest rate swaps:Notional
              
              $
              274,727
              
              $
              114,547
              
              $
              104,735
              
              $
              55,445
              
              $
              --
              
              $
              --Weighted
                  average rate
              
              
              5.15
              %
              
              5.17
              %
              
              5.14
              %
              
              5.10
              %
              
              --
              
              
              --
 
 The
        notional amount of the corridors totaled $2.5 billion and $1.9 billion at
        December 31, 2005 and 2004, respectively. We held no amortizing notional
        balance
        interest rate swaps prior to 2006.
  **76**
  **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
        2(t)
        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 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.
 
 The
        following table demonstrates the sensitivity, at December 31, 2006, of the
        estimated fair value of our excess cashflow certificates caused by an immediate
        10% and 20%, respectively, adverse change in the key assumptions we use to
        estimate the fair value:
  **77**
  **Fair
                  Value of**
                **Excess
                  Cashflow**
                **Certificates**
              
              **Increase
                  (Decrease)**
                **To
                  Earnings**
                **(pre-tax
                  basis)***(Dollars
                  in thousands)*Fair
                  value as of December 31, 2006
              
              $
              1,20910%
                  increase in prepayment speed
              
              
              1,233
              
              $
              2420%
                  increase in prepayment speed
              
              
              1,259
              
              
              5010%
                  increase in credit losses
              
              
              1,154
              
              
              (55
              )20%
                  increase in credit losses
              
              
              1,096
              
              
              (113
              )10%
                  increase in discount rates
              
              
              1,209
              
              
              --20%
                  increase in discount rates
              
              
              1,206
              
              
              (3
              )10%
                  increase in one and six month LIBOR
              
              
              1,222
              
              
              1320%
                  increase in one and six month LIBOR
              
              
              1,287
              
              
              78
 
 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
        pass-through certificates 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” ).
        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 7. - Management's Discussion
        and Analysis of Financial Condition and Results of Operations - Market Risk
        - Interest Rate Risk,” “Part I., Item 1. - Forward Looking Statements and
        Risk Factors” and “Part I. Item 1A. - Risk Factors”).
  **78**
  **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, BDO Seidman, 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, 2006. Our management’s
        assessment of the effectiveness of our internal control over financial reporting
        as of December 31, 2006 has been audited by BDO Seidman, LLP, an independent
        registered public accounting firm, as stated in their report which is included
        herein.
  **79**
  **Report
        of Independent Registered Public Accounting Firm**
 
 Board
        of
        Directors and Shareholders
 Delta
        Financial Corporation
 Woodbury,
        New York
  We
        have
        audited management’s assessment, included in the accompanying “Item 9A, Controls
        and Procedures - 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, 2006,
        based on criteria established in *Internal
        Control - Integrated Framework* issued
        by the Committee of Sponsoring Organizations of the Treadway Commission (the
        COSO criteria). 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
        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, 2006, is fairly stated,
        in
        all material respects, based on the COSO criteria. Also in our opinion, the
        Company maintained, in all material respects, effective internal control
        over
        financial reporting as of December 31, 2006, based on the COSO
        criteria.
  We
        have also
        audited, in accordance with the standards of the Public Company Accounting
        Oversight Board (United States), the consolidated balance sheet of Delta
        Financial Corporation and subsidiaries as of December 31, 2006 and the related
        consolidated statement of operations, changes in stockholders’ equity, and cash
        flows for the year then ended and our report dated March 9, 2007 expressed
        an
        unqualified opinion thereon.
 
  New
        York,
        New York
 March
        9,
        2007
  **80**
  **Report
        of Independent Registered Public Accounting Firm**
   Board
        of
        Directors and Stockholders
 Delta
        Financial Corporation
 Woodbury,
        New York
 
 We
        have
        audited the accompanying consolidated balance sheet of Delta Financial
        Corporation and subsidiaries (the “Company”) as of December 31, 2006 and the
        related consolidated statements of operations, changes in stockholders’ equity,
        and cash flows for the year then ended. These 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
        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 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, assessing the accounting principles used and significant estimates
        made by management, as well as evaluating the overall financial statement
        presentation. We believe that our audit provides 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 at December 31, 2006, and the results of its operations
        and its
        cash flows for the year then ended **,** in
        conformity with accounting principles generally accepted in the United States
        of
        America.
  We
        also have
        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, 2006, 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 9, 2007 expressed an unqualified opinion
        thereon.
  As
        discussed in Note 2 to the consolidated financial
        statements, in 2006 the Company changed its method of accounting for stock-based
        compensation to conform to FASB Statement No. 123(R),  
*Share-Based Payment*.
 
  New
        York,
        New York
 March
        9,
        2007
  **81**
  
 **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 sheet of Delta Financial
        Corporation and subsidiaries (the “Company”) as of December 31, 2005, and the
        related consolidated statements of operations, changes in stockholders’ equity,
        and cash flows for each of the years in the two-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 the results of its operations
        and
        its cash flows for each of the years in the two-year period ended December
        31,
        2005, in conformity with U.S. generally accepted accounting
        principles.
 
 
  New
        York,
        New York
 March
        9,
        2007  **82**
 **DELTA
        FINANCIAL CORPORATION AND SUBSIDIARIES**
 **CONSOLIDATED
        BALANCE SHEETS**
 *(Dollars
        in thousands, except for share data)*
 
 **At
                  December 31,****2006**
              
              **2005****Assets:**Cash
                  and cash equivalents
              
              $
              5,741
              
              $
              4,673Mortgage
                  loans held for investment, net of discounts and deferredorigination
                  fees
              
              
              6,413,687
              
              
              4,663,662Less:
                  Allowance for loan losses
              
              
              (55,310
              )
              
              (36,832
              )Mortgage
                  loans held for investment, net
              
              
              6,358,377
              
              
              4,626,830Trustee
                  receivable
              
              
              73,361
              
              
              56,164Accrued
                  interest receivable
              
              
              41,684
              
              
              26,952Excess
                  cashflow certificates
              
              
              1,209
              
              
              7,789Equipment,
                  net
              
              
              8,287
              
              
              6,688Accounts
                  receivable
              
              
              4,872
              
              
              5,123Prepaid
                  and other assets
              
              
              49,836
              
              
              30,508Deferred
                  tax asset
              
              
              45,760
              
              
              54,875Total
                  assets
              
              $
              6,589,127
              
              $
              4,819,602**Liabilities
                  and Stockholders’ Equity****Liabilities:**Bank
                  payable
              
              $
              1,557
              
              $
              1,921Warehouse
                  financing
              
              
              335,865
              
              
              222,843Financing
                  on mortgage loans held for investment, net
              
              
              6,017,947
              
              
              4,436,938Other
                  borrowings
              
              
              5,970
              
              
              4,785Accrued
                  interest payable
              
              
              25,052
              
              
              13,091Accounts
                  payable and other liabilities
              
              
              53,160
              
              
              33,242Total
                  liabilities
              
              
              6,439,551
              
              
              4,712,820**Stockholders’
                  Equity:**Common
                  stock, $.01 par value. Authorized 49,000,000 shares;23,607,612
                  and 20,736,362 shares issued and 23,490,812 and
                20,619,562
                  shares outstanding at December 31, 2006 and 2005,respectively
              
              
              234
              
              
              207Additional
                  paid-in capital
              
              
              141,984
              
              
              121,561Retained
                  earnings (accumulated deficit)
              
              
              10,180
              
              
              (15,077
              )Accumulated
                  other comprehensive (loss) income
              
              
              (1,504
              )
              
              2,536Unearned
                  common stock held by stock incentive plan
              
              
              --
              
              
              (1,127
              )Treasury
                  stock, at cost (116,800 shares)
              
              
              (1,318
              )
              
              (1,318
              )Total
                  stockholders’ equity
              
              
              149,576
              
              
              106,782Total
                  liabilities and stockholders’ equity
              
              $
              6,589,127
              
              $
              4,819,602
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
  **83**
  **DELTA
        FINANCIAL CORPORATION AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF OPERATIONS**
 *(Dollars
        in thousands, except share and per share data)*
  **For
                    the Year Ended December 31,****2006**
                
                **2005**
                
                **2004**Interest
                    income
                
                $
                467,330
                
                $
                290,829
                
                $
                100,105Interest
                    expense
                
                
                319,600
                
                
                167,792
                
                
                39,782Net
                    interest income
                
                
                147,730
                
                
                123,037
                
                
                60,323Provision
                    for loan losses
                
                
                29,085
                
                
                28,592
                
                
                10,443Net
                    interest income after provision for loan losses
                
                
                118,645
                
                
                94,445
                
                
                49,880Non-interest
                    income:Net
                    gain on sale of mortgage loans
                
                
                33,558
                
                
                27,193
                
                
                16,057Other
                    income
                
                
                11,214
                
                
                14,674
                
                
                1,722Total
                    non-interest income
                
                
                44,772
                
                
                41,867
                
                
                17,779Non-interest
                    expense:Payroll
                    and related costs
                
                
                67,436
                
                
                63,524
                
                
                52,005General
                    and administrative
                
                
                47,427
                
                
                42,467
                
                
                30,152(Gain)
                    loss on derivative instruments
                
                
                (147
                )
                
                908
                
                
                100Total
                    non-interest expense
                
                
                114,716
                
                
                106,899
                
                
                82,257Income
                    (loss) before income tax expense (benefit)
                
                
                48,701
                
                
                29,413
                
                
                (14,598
                )Provision
                    for income tax expense (benefit)
                
                
                18,936
                
                
                11,458
                
                
                (5,249
                )Net
                    income (loss)
                
                $
                29,765
                
                $
                17,955
                
                $
                (9,349
                )**Comprehensive
                    Income (Loss):**Other
                    comprehensive (loss) income, net of tax
                
                
                (4,040
                )
                
                4,743
                
                
                (2,207
                )Comprehensive
                    income (loss)
                
                $
                25,725
                
                $
                22,698
                
                $
                (11,556
                )**Per
                    Share Data:**Basic
                    - weighted average number of shares outstanding
                
                
                22,477,213
                
                
                20,349,515
                
                
                18,375,864Diluted
                    - weighted average number of shares outstanding
                
                
                23,278,375
                
                
                21,283,220
                
                
                18,375,864Net
                    income (loss) applicable to common shares
                
                $
                29,765
                
                $
                17,955
                
                $
                (9,349
                )Basic
                    earnings per share - net income (loss)
                
                $
                1.32
                
                $
                0.88
                
                $
                (0.51
                )Diluted
                    earnings per share - net income (loss)
                
                $
                1.28
                
                $
                0.84
                
                $
                (0.51
                )
  
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
 
  **84**
  **DELTA
        FINANCIAL CORPORATION AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY**
 **For
        the Years Ended December 31, 2006, 2005 and 2004**
 *(Dollars
        in thousands)*
 
 
 **Preferred
                  Stock**
              
              **Common
                  Stock**
              
              **Additional**
                **Paid-in
                  Capital**
              
              **Retained
                  Earnings (Accumulated Deficit)**
              
              **Accumulated
                  Other Comprehensive (Loss) Income**
              
              **Unearned
                  Common Stock Held by Stock Incentive Plan**
              
              **Treasury
                  Stock**
              
              **Total**Balance
                  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
                  declared and 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
                  declared and 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
              )
              $
              106,782Stock
                  options exercised
              
              
              --
              
              
              3
              
              
              343
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              346Excess
                  tax benefit related to share-based compensation
              
              
              --
              
              
              --
              
              
              1,013
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              1,013Share-based
                  compensation expense
              
              
              --
              
              
              --
              
              
              889
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              889Reversal
                  of unearned common stock held by stock
                incentive plan
              
              
              --
              
              
              (1
              )
              
              (1,126
              )
              
              --
              
              
              --
              
              
              1,127
              
              
              --
              
              
              --Shares
                  issued in secondary offering
              
              
              
              
              
              25
              
              
              19,304
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              19,329Dividends
                  declared and paid on common stock
              
              
              --
              
              
              --
              
              
              --
              
              
              (3,344
              )
              
              --
              
              
              --
              
              
              --
              
              
              (3,344
              )Dividend
                  declared and payable
              
              
              --
              
              
              --
              
              
              --
              
              
              (1,164
              )
              
              --
              
              
              --
              
              
              --
              
              
              (1,164
              )Net
                  unrealized losses from derivatives, net of tax
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              (4,040
              )
              
              --
              
              
              --
              
              
              (4,040
              )Net
                  income
              
              
              --
              
              
              --
              
              
              --
              
              
              29,765
              
              
              --
              
              
              --
              
              
              --
              
              
              29,765Balance
                  at December 31, 2006
              
              $
              --
              
              $
              234
              
              $
              141,984
              
              $
              10,180
              
              $
              (1,504
              )
              $
              --
              
              $
              (1,318
              )
              $
              149,576
 
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
  **85**
  **DELTA
        FINANCIAL CORPORATION AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 *(Dollars
        in thousands)*
 
 **For
                  the Year Ended December 31,****2006**
              
              **2005**
              
              **2004**Cash
                  flows from operating activities:Net
                  income (loss)
              
              $
              29,765
              
              $
              17,955
              
              $
              (9,349
              )Adjustments
                  to reconcile net income (loss) to net cash provided byoperating
                  activities:Provision
                  for loan losses
              
              
              29,085
              
              
              28,592
              
              
              10,443Provision
                  for (recovery of) recourse loans and secondary marketing
                  losses
              
              
              780
              
              
              (380
              )
              
              (50
              )Depreciation
                  and amortization
              
              
              3,516
              
              
              2,381
              
              
              1,940Deferred
                  tax expense (benefit)
              
              
              11,698
              
              
              (7,581
              )
              
              (17,731
              )Deferred
                  origination income
              
              
              (16,653
              )
              
              (10,666
              )
              
              (3,113
              )Gain
                  on change in fair value of excess cashflow certificates
              
              
              (10,666
              )
              
              (14,409
              )
              
              (1,366
              )Gain
                  on sale of mortgage loans, net
              
              
              (34,338
              )
              
              (27,193
              )
              
              (16,057
              )Gain
                  on sale of mortgage servicing rights
              
              
              (381
              )
              
              (157
              )
              
              --Amortization
                  of deferred debt issuance costs and premiums
              
              
              (12,867
              )
              
              (4,340
              )
              
              (1,838
              )Cash
                  flows received from excess cashflow certificates, net of
                  accretion
              
              
              15,746
              
              
              21,553
              
              
              6,286Proceeds
                  on sale of excess cashflow certificates
              
              
              1,500
              
              
              --
              
              
              --Proceeds
                  from sale of mortgage servicing rights, net
              
              
              24,404
              
              
              22,449
              
              
              16,920Share-based
                  compensation expense
              
              
              889
              
              
              46
              
              
              --Changes
                  in operating assets and liabilities:Decrease
                  (increase) in accounts receivable
              
              
              251
              
              
              (1,388
              )
              
              (842
              )Decrease
                  in mortgage loans held for sale, net
              
              
              --
              
              
              --
              
              
              190,524Increase
                  in trustee receivable
              
              
              (17,197
              )
              
              (23,249
              )
              
              (32,915
              )Increase
                  in accrued interest receivable
              
              
              (14,693
              )
              
              (14,691
              )
              
              (12,676
              )Increase
                  in prepaid and other assets
              
              
              (25,794
              )
              
              (5,535
              )
              
              (22,222
              )Increase
                  in accrued interest payable
              
              
              11,961
              
              
              8,809
              
              
              4,220Increase
                  in accounts payable and other liabilities
              
              
              19,213
              
              
              10,539
              
              
              10,564Net
                  cash provided by operating activities
              
              
              16,219
              
              
              2,735
              
              
              122,738Cash
                  flows from investing activities:Origination
                  of mortgage loans held for investment, net of repayments
              
              
              (2,479,273
              )
              
              (2,877,430
              )
              
              (2,532,220
              )Proceeds
                  from sale of mortgage loans
              
              
              759,450
              
              
              588,680
              
              
              185,383Purchase
                  of equipment
              
              
              (5,115
              )
              
              (4,771
              )
              
              (3,091
              )Net
                  cash used in investing activities
              
              
              (1,724,938
              )
              
              (2,293,521
              )
              
              (2,349,928
              )Cash
                  flows from financing activities:Proceeds
                  from (repayment of) warehouse financing, net
              
              
              113,022
              
              
              87,190
              
              
              (9,173
              )Proceeds
                  from financing on mortgage loans held for investment, net
              
              
              1,579,629
              
              
              2,203,942
              
              
              2,233,392Proceeds
                  from other borrowings, net
              
              
              1,185
              
              
              1,455
              
              
              968(Decrease)
                  increase in bank payable
              
              
              (364
              )
              
              811
              
              
              (1,182
              )Redemption
                  of preferred stock
              
              
              --
              
              
              --
              
              
              (13,916
              )Cash
                  dividends paid on common stock
              
              
              (4,373
              )
              
              (4,066
              )
              
              (1,860
              )Excess
                  tax benefit related to share-based compensation
              
              
              1,013
              
              
              --
              
              
              --Net
                  proceeds from issuance of common stock in secondary
                  offering
              
              
              19,329
              
              
              --
              
              
              18,741Proceeds
                  from exercise of stock options
              
              
              346
              
              
              940
              
              
              831Net
                  cash provided by financing activities
              
              
              1,709,787
              
              
              2,290,272
              
              
              2,227,801Net
                  increase (decrease) in cash and cash equivalents
              
              
              1,068
              
              
              (514
              )
              
              611Cash
                  and cash equivalents at beginning of year
              
              
              4,673
              
              
              5,187
              
              
              4,576Cash
                  and cash equivalents at end of year
              
              $
              5,741
              
              $
              4,673
              
              $
              5,187
  **86**
  
 **For
                  the Year Ended December 31,****2006**
              
              **2005**
              
              **2004**Supplemental
                  information:Cash
                  paid during the year for:Interest
              
              $
              306,182
              
              $
              153,608
              
              $
              33,869Income
                  taxes
              
              $
              10,699
              
              $
              21,975
              
              $
              6,424Non
                  cash transactions:Transfer
                  of mortgage loans held for investment to REO, net
              
              $
              34,726
              
              $
              5,541
              
              $
              578Dividends
                  payable
              
              $
              1,164
              
              $
              1,030
              
              $
              1,013
 
 
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
 
  **87**
  **DELTA
        FINANCIAL CORPORATION AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2006, 2005 and 2004**
 
 **(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. In
        April
        2006, we sold 2,500,000 newly issued shares of common stock, from
        authorized but unissued shares, in a
        private placement, at a price of $8.25 per share.
 
 We
        are a
        national specialty consumer finance company that originates, securitizes
        and
        sells non-conforming mortgage loans. We originate primarily fixed rate 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 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 year 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 $5.2 million and $6,000 of interest-bearing deposits with
        select financial institutions at December 31, 2006 and 2005,
        respectively.
 
 Additionally,
        cash and cash equivalents as of December 31, 2006 and 2005, included restricted
        cash held for various reserve accounts totaling $91,000 and $29,000,
        respectively.
 
 **88**
 ***(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 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 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 per securitization trust 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 borrowers’
financial condition, evaluating and recording collateral and security
        arrangements, negotiating loan terms, processing loan documents and closing
        the
        loan. Management believes these estimates reflect an accurate cost structure
        related to successful loan origination efforts. Management periodically reviews
        its time and cost estimates to determine if updates and refinements to the
        deferral amounts are necessary.
 
 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, net. 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, net.
 
 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 earn the coupon rate of interest paid by the borrower
        and
        pay interest to the lenders that provide our warehouse financing, to the
        extent
        that we utilized such financing. We also pay a sub-servicing fee to a
        third-party during the period the loans are held pending securitization or
        whole-loan sale. Any gains or losses on sales of mortgage loans are recognized
        based upon the difference between the selling price and the carrying value
        of
        the related mortgage loans sold.
 
 **89**
 ***(c)
        Allowance and Provision for Loan Losses***
 
 In
        connection with our mortgage loans held for investment, excluding those loans
        which meet the criteria for specific review under SFAS
        No.
        114, “Accounting by Creditors for Impairment of a Loan - an amendment of FASB
        Statement No. 5 and 15,” we
        established an allowance for loan losses based on our estimate of losses
        to be
        incurred in the foreseeable future. Provisions for loan losses are made for
        loans to the extent that we bear probable losses on these loans. Provision
        amounts are charged as a current period expense to operations. We charge-off
        uncollectible loans at the time we deem they are not probable of being
        collected. In order to estimate an appropriate allowance for loan losses
        on
        mortgage loans held for investment, we estimate losses using a detailed analysis
        of historical loan performance by product type, origination year and
        securitization issuance. We
        stratify the loans held for investment into separately identified loan pools
        based upon seasoning criteria. In
        accordance with SFAS No. 5, “Accounting for Contingencies,” we believe that
        pooling of mortgages with similar characteristics is an appropriate methodology
        with which to calculate or estimate the allowance for loan losses. The results
        of that analysis are then applied to the current long-term mortgage portfolio
        and an allowance for loan losses estimate is created to take into account
        both
        known and inherent losses in the loan portfolio. Losses incurred are written-off
        against the allowance for loan losses.
 
 In
        evaluating
        the adequacy of this allowance, there are qualitative factors and estimates
        that
        must be taken into consideration when evaluating and measuring potential
        expected losses on mortgage loans. These items include, but are not limited
        to,
        current performance of the loans, economic indicators that may affect the
        borrowers’ ability to pay, changes in the market value of the collateral,
        political factors and the general economic environment. As these factors
        and
        estimates are influenced by factors outside of our control and are inherently
        uncertain, it is reasonably possible that they could change. In particular,
        if
        conditions were such that we were required to increase the provision for
        loan
        losses, our income for that period would decrease. Management considers the
        current allowance for loan losses 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 mortgage loan
        agreement. Due to the significant effects of Hurricanes Katrina and Rita
        in 2005
        on a portion of our mortgage loans held for investment portfolio, management
        identified certain loans located in Federal Emergency Management Agency (“FEMA”)
        declared disaster areas as meeting the criteria under SFAS No. 114, thereby,
        requiring a separate loan impairment review. Based upon the analysis performed,
        we identified 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
        during the year ended December 31, 2005 for these affected loans based upon
        estimates of loss exposure. At December 31, 2006, we have a specific reserve
        of
        $675,000 (which is included in the $1.0 million in specific reserves on impaired
        loans) for these affected loans based upon estimates of loss exposure. As
        additional information is obtained and processed over the coming months and
        quarters, we will continue to assess the need for any adjustments to our
        estimates and the specific reserves related to the mortgage loans in the
        affected areas.
 
 ***(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 sheets. 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.
  **90**
  ***(e)
        Excess Cashflow Certificates***
 
 Prior
        to
        2004, we structured our securitization transactions to be accounted for as
        sales. In these transactions the excess cashflow 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 estimated fair value. The amount recorded for the excess
        cashflow certificates is reduced by cash distributions received, and is adjusted
        for income accretion and subsequent changes in the fair value. Any changes
        in
        fair value are recorded as a component of “other income” in our consolidated
        statements 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 our assumptions as deemed
        necessary.
 
 The
        Emerging Issues Task Force (“EITF”) issued EITF 99-20, “Recognition of Interest
        and Impairment on Purchased and Retained Beneficial Interests in Securitized
        Financial Assets,” which provides
        guidance on expected return (interest income) recognition and fair value
        measurement for interests, such as excess cashflow certificates, retained
        in a
        securitization transaction accounted for as a sale. In order
        to determine
        whether there has been a favorable change (increase to earnings) or an adverse
        change (decrease to earnings) in excess
        cashflow certificates, a comparison is made between (1) the present value
        of the
        excess cash flows at period end, and (2) the estimated carrying value at
        period
        end - which is based on the change from the beginning period (specifically
        the
        cash receipts) 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 the end of the period, 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 $3.5 million, $2.4 million and $1.9 million, respectively,
        for the
        years ended December 31, 2006, 2005, and 2004. Accumulated depreciation and
        amortization totaled $16.0 million and $12.5 million, respectively, at December
        31, 2006 and 2005.
 
 ***(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.
 
 **91**
 In
        accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
        Long-Lived Assets,” we classify our REO as “held for sale” at the date of
        foreclosure. The REO properties held are actively marketed for sale by our
        third-party servicer at a price that is deemed reasonable in relation to
        the
        properties’ current fair values. We generally expect the REO properties to be
        disposed of within six months to one year after being acquired.
 
 The
        balance of REO is included in “prepaid expenses and other assets” on the
        consolidated balance sheets. We had $29.6 million and $4.4 million of REO
        properties as of December 31, 2006 and 2005, respectively. A provision of
        $1.5
        million and $213,000 was recognized during the years ended December 31, 2006
        and
        2005, respectively, for the decrease in the fair value of the REO properties
        in
“general and administrative expenses.” No provision was 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. During the years ended December
        31,
        2006 and 2005, we sold $8.8 million and $1.5 million, respectively, of REO
        properties.
 
 ***(h)
        Warehouse Financing***
 
 Warehouse
        financing represents the outstanding balance of our borrowings collateralized
        by
        mortgage loans held pending securitization. Generally, warehouse financing
        facilities are used as interim, short-term financing which bears interest
        at a
        fixed margin over an index, such as LIBOR. The outstanding balance of our
        warehouse financings will fluctuate based on our lending volume, cash flows
        from
        operations, other financing activities and equity transactions. Any commitment
        fees paid to obtain the warehouse financing are capitalized and amortized
        to
        expense as a component of “non-interest expense - general and administrative”
over the term of the warehouse agreement, normally a 12 month
        period.
 
 ***(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 consolidated balance sheets. 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.
 
 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(q) - “Derivative Instruments” and Note 9 - “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.
 
 **92**
 ***(j)***  ***Interest
        Income***
 
 Interest
        income primarily represents the sum of (a) the gross interest, net of servicing
        fee, we earn on mortgage loans held for investment - securitized; (b) the
        gross
        interest we earn on mortgage loans held for investment - pre-securitization;
        (c)
        securitization accrued bond interest (income received from the securitization
        trust for fixed-rate asset-backed securities at the time of securitization
        settlement); (d) excess cashflow certificate income; (e) interest earned
        on bank
        accounts; (f) prepayment penalty fees, and (g) amortized discounts, deferred
        costs and fees recognized on a level-yield basis.
 
 Interest
        on mortgage loans is recognized as revenue when earned according to the
        contractual terms of the mortgages and when, in the opinion of management,
        it is
        deemed collectible. Mortgage loans are placed on non-accrual status generally
        when the loan becomes 90 days past due, or earlier when concern exists as
        to the
        ultimate collectability of principal or interest ( *i.e.,* an
        impaired loan), in accordance with the contractual terms of the mortgage.
        A
        non-accrual loan will be returned to accrual status when principal and interest
        payments are no longer three months past due, 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.
 
 ***(k)
        Interest Expense***
 
 Interest
        expense primarily represents the borrowing costs under (a) our warehouse
        credit
        facilities to finance loan originations; (b) securitization debt; and (c)
        equipment financing. Interest expense also reflects the impact of hedge
        amortization and the amortization of discounts and deferred costs on a
        level-yield basis.
 
 ***(l)
        Gain on Sale of Mortgage Loans***
 
 Gains
        and
        losses on the sale of mortgage loans are recognized at settlement date and
        are
        determined by the difference between the selling price and the carrying value
        of
        the 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
        to
        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 premium recapture 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. We also establish a secondary marketing reserve based
        upon our estimated exposure to losses arising from loan repurchases, or the
        net
        settlement, related to representation and warranty claims made by whole-loan
        sale investors. The
        premium recapture and secondary marketing reserves are recorded as liabilities
        on our consolidated balance sheets when the mortgage loans are sold, based
        on
        our historical experience. The
        provisions recorded for the premium recapture and secondary marketing reserves
        are recognized at the date of sale and are 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, 2006
        and
        2005, we received $24.4 million and $22.4 million, respectively, from a
        third-party servicer for the right to service the mortgage loans collateralizing
        our securitizations that were structured and accounted for as secured
        financings.
 
 **93**
 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.
 
 ***(n)
        Advertising Expense***
 
 In
        accordance with American Institute of Certified Public Accountants (“AICPA”)
        Statement of Position (“SOP”) No. 93-7, “Reporting on Advertising Costs,” we
        expense advertising costs as incurred. We account for our advertising costs
        as
        non-direct response advertising. During the years ended December 31, 2006,
        2005
        and 2004, we recorded advertising and promotional expenses of $1.8 million,
        $796,000 and $986,000, respectively, in non-interest expense - general and
        administrative.
 
 ***(o)*** ***Stock-Based
        Compensation***
 
 We
        have
        various stock-based compensation plans for employees and outside directors,
        which are described more fully in Note 14 “Stock-Based Incentive Plans.”
Effective January 1, 2006, we adopted the fair value recognition provisions
        of
        SFAS No. 123(R), “Share-Based Payment,” using the modified-prospective adoption
        method. Under that method of adoption, the provisions of SFAS No. 123(R)
        generally are applied only to share-based awards granted subsequent to adoption.
        The consolidated financial statements for periods prior to adoption are not
        restated for the effects of adopting SFAS No. 123(R). Additionally, under
        this
        method, compensation cost recognized for year ended December 31, 2006 includes
        compensation cost for all options granted prior to, but not yet vested as
        of
        January 1, 2006, and all options granted subsequent to January 1, 2006, based
        on
        the grant date fair value estimated in accordance with the provisions of
        SFAS
        No. 123(R).
 
 Prior
        to
        January 1, 2006, employee stock options were accounted for under the intrinsic
        value method in accordance with Accounting Principles Board (“APB”) Opinion No.
        25, “Accounting for Stock Issued to Employees,” and its related interpretations,
        including FASB Interpretation (“FIN”) No. 44, “Accounting for Certain
        Transactions Involving Stock Compensation, an Interpretation of APB Opinion
        No.
        25,” as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” No
        stock option compensation cost was recognized in our consolidated statement
        of
        operations prior to January 1, 2006, as all options granted had an exercise
        price equal to the market value of the underlying common stock on the grant
        date. Additionally, the adoption of SFAS No. 123(R) did not have a material
        impact on our statement of operations related to restricted stock awards.
        Prior
        to the adoption of SFAS No. 123(R), compensation expense was being recognized
        over the restricted stock award’s vesting period, which is in accordance with
        how such expense is being recognized under SFAS No. 123(R).
 
 For
        purposes of calculating the pool of excess tax benefits available to absorb
        tax
        deficiencies recognized subsequent to the adoption of SFAS No. 123(R) (“APIC
        Pool”), we determined the net excess tax benefits that would have qualified as
        such had we adopted SFAS No. 123 for recognition purposes for all of our
        stock-based award grants made after December 31, 1994.
 
 ***(p)
        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.
 
 **94**
 ***(q)
        Derivative Instruments***
 
 We
        regularly issue securitization asset-backed securities collateralized by
        fixed-
        and variable-rate mortgage loans. As a result of this activity, we are exposed
        to interest rate risk beginning when our mortgage loans close and are recorded
        as assets, until permanent financing is arranged, such as when asset-backed
        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 future 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.
 
 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 derivative 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).
 
 **95**
 The
“new
        hedge relationship” is determined by re-aligning the hedge with the projected
        remaining securitization 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.
 
 ***(r)*** **** ***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.
 
 ***(s)
        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.
 
 ***(t)
        Recent Accounting Pronouncements***
 
 *Fair
        Value Option for Financial Assets and Financial Liabilities* .
        In
        February 2007, ** the
        Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “The Fair
        Value Option for Financial Assets and Financial Liabilities - Including an
        amendment of FASB Statement No. 115,” which permits entities to choose to
        measure many financial instruments and certain other items at fair value
        that
        are not currently required to be measured at fair value. The objective is
        to
        improve financial reporting by providing entities with the opportunity to
        mitigate volatility in reported earnings caused by measuring related assets
        and
        liabilities differently without having to apply complex hedge accounting
        provisions. SFAS No. 159 also establishes presentation and disclosure
        requirements designed to facilitate comparisons between entities that choose
        different measurement attributes for similar types of assets and liabilities.
        SFAS No. 159 does not affect any existing accounting literature that requires
        certain assets and liabilities to be carried at fair value, nor eliminate
        disclosure requirements included in other accounting standards, including
        requirements for disclosures about fair value measurements included in SFAS
        No.
        157, “Fair Value Measurements,” and SFAS No. 107, “Disclosures about Fair Value
        of Financial Instruments.” ** SFAS
        No.
        159 is effective for our fiscal year beginning after November 15, 2007. We
        do
        not expect that the adoption of SFAS No. 159 during the first quarter of
        2008
        will have a material impact on our financial condition or results of operations,
        but we
        are
        currently in the process of assessing the impact that the adoption of SFAS
        No.
        159 will have on our consolidated financial statements.
 
 *Fair
        Value Measurements.* In
        September 2006, ** the
        FASB
        issued SFAS No. 157, which defines fair value, establishes a framework for
        measuring fair value in GAAP, and expands disclosures about fair value
        measurements. SFAS No. 157 is effective for financial statements issued for
        fiscal years beginning after November 15, 2007, and interim periods within
        those
        fiscal years. We do not expect that the adoption of SFAS No. 157 during the
        first quarter of 2008 will have a material impact on our financial condition
        or
        results of operations, but we
        are
        currently in the process of assessing the impact that the adoption of SFAS
        No.
        157 will have on our consolidated financial statements.
 
 **96**
 *Prior
        Year Misstatements.* In
        September 2006, the Securities and Exchange Commission (“SEC”) Staff issued
        Staff Accounting Bulletin (“SAB”) No. 108, "Considering the Effects of Prior
        Year Misstatements when Quantifying Misstatements in Current Year Financial
        Statements," which addresses how the effects of prior year uncorrected
        misstatements should be considered when quantifying misstatements in current
        year financial statements. SAB No. 108 requires registrants to quantify
        misstatements using both the balance sheet and income-statement approaches
        and
        to evaluate whether either approach results in quantifying an error that
        is
        material in light of relevant quantitative and qualitative factors. When
        the
        effect of initial adoption is determined to be material, SAB No. 108 allows
        registrants to record that effect as a cumulative effect adjustment to beginning
        retained earnings. The requirements became effective for annual financial
        statements covering the first fiscal year ending after November 15, 2006.
        SAB
        No. 108 did not change the requirements within SFAS No. 154 *,
        “* Accounting
        Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB
        Statement No. 3,” ** for
        the
        correction of an error in financial statements. We have not encountered any
        uncorrected prior year misstatements requiring an analysis under SAB No.
        108.
 
 *Accounting
        for Uncertainty in Income Taxes.* In
        June
        2006, ** the
        FASB
        issued FIN
        No.
        48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB
        Statement No. 109.” FIN No.
        48 clarifies the accounting for uncertainty in income taxes recognized
        in  an
        enterprise’s financial statements in accordance with SFAS No. 109. Only tax
        positions meeting a “more-likely-than-not” threshold of being sustained are
        recognized under FIN No. 48. FIN No. 48 also provides guidance on derecognition,
        classification of interest and penalties and accounting and disclosures for
        annual and interim financial statements. FIN No. 48 is effective for fiscal
        years beginning after December 15, 2006. The cumulative effect of the changes
        arising from the initial application of FIN No. 48 is required to be reported
        as
        an adjustment to the opening balance of retained earnings in the period of
        adoption. The adoption of FIN No. 48 on January 1, 2007 did not have a material
        effect on our financial statements.
 
 *Accounting
        for Servicing of Financial Assets.* In
        March
        2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
        Assets - an Amendment of FASB Statement No. 140.” SFAS No. 156 amends SFAS No.
        140 with respect to the  accounting
        for separately recognized servicing assets and servicing liabilities. SFAS
        No.
        156 requires, among other things, that (1) an entity recognize a servicing
        asset
        or servicing liability each time it undertakes an obligation to service a
        financial asset by entering into a servicing contract under certain situations;
        and (2) all separately recognized servicing assets and servicing liabilities
        initially be measured at fair value, if practicable.
 
 SFAS
        No.
        156 also permits an entity to choose its measurement methods for each class
        of
        separately recognized servicing assets and servicing liabilities. At the
        date
        SFAS No. 156 is initially adopted, an entity with recognized servicing rights
        is
        permitted a one-time reclassification of available-for-sale securities to
        trading securities, without calling into question the treatment of other
        available-for-sale securities under SFAS No. 115, provided that the
        available-for-sale securities are identified in some manner as offsetting
        the
        entity’s exposure to changes in fair value of servicing assets or servicing
        liabilities that a servicer elects to subsequently measure at fair
        value.
 
 Additionally
        required by SFAS No. 156 is the separate presentation of servicing assets
        and
        servicing liabilities subsequently measured at fair value in the statement
        of
        financial position and additional disclosures for all separately recognized
        servicing assets and servicing liabilities.
 
 An
        entity
        should adopt SFAS No. 156 as of the beginning of its first fiscal year that
        begins after September 15, 2006. Earlier adoption is permitted as of the
        beginning of an entity’s fiscal year, provided the entity has not yet issued
        financial statements, including interim financial statements, for any period
        of
        that fiscal year. An entity should apply the requirements for recognition
        and
        initial measurement of servicing assets and servicing liabilities prospectively
        to all transactions after the effective date of SFAS No. 156. We adopted
        the
        provisions of SFAS No. 156 on January 1, 2007, which had no impact on our
        financial condition or results of operations.
 
 *Accounting
        for Certain Hybrid Financial Instruments.* In
        February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
        Financial Instruments, an amendment of FASB Statements No. 133 and 140,” which
        amends SFAS No. 133 and No. 140. SFAS No. 155, among other things, permits
        fair
        value re-measurement for any hybrid financial instrument that contains an
        embedded derivative that otherwise would require bifurcation and clarifies
        which
        interest-only strips and principal-only strips are not subject to the
        requirements of SFAS No. 133. Additionally, SFAS No. 155 establishes a
        requirement to evaluate interests in securitized financial assets to identify
        interests that are freestanding derivatives or that are hybrid financial
        instruments that contain an embedded derivative requiring bifurcation and
        clarifies that concentrations of credit risk in the form of subordination
        are
        not embedded derivatives. SFAS No. 155 amends SFAS No. 140 to eliminate the
        prohibition on a QSPE from holding a derivative financial instrument that
        pertains to a beneficial interest other than another derivative financial
        instrument. SFAS No. 155 is effective for all financial instruments acquired
        or
        issued after the beginning of an entity’s first fiscal year that begins after
        September 15, 2006. We adopted the provisions of SFAS No. 155 on January
        1,
        2007, which did not have a material impact on our financial condition or
        results
        of operations.
 
 **97**
 **(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 certain 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 to the whole-loan
        sale investor within a
        specified period of time. At December 31, 2006 and 2005, mortgage loans held
        for
        investment - pre-securitization included approximately $764,000 and $723,000,
        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, 2006,
        approximately 24% and 13%, based upon principal balance, of the mortgage
        loans
        we originated were on properties located in New York and Florida, respectively,
        with no other state representing more than 6% of the originations.
 
 **(4)**  **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.
 
 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, 2006 and 2005, we closed four
        securitization transactions totaling $3.1 billion and $3.1 billion,
        respectively, which were structured to be accounted for as a secured financing
        and which were collateralized by $3.1 billion and $3.2 billion, respectively,
        of
        mortgage loans held for investment - securitized. Mortgage loans held for
        investment - securitized had a weighted-average interest rate of 8.19% and
        7.77%
        per annum at December 31, 2006 and 2005, respectively.
 
 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, 2006 and 2005, was approximately $335.9 million and $222.8 million,
        respectively, of these mortgages that were pledged as collateral for our
        warehouse financings at December 31, 2006 and 2005, respectively. Mortgage
        loans
        held for investment - pre-securitization had a weighted-average interest
        rate of
        8.73% and 8.35% per annum at December 31, 2006 and 2005,
        respectively.
 **98**
 
 The
        following table presents a summary of mortgage loans held for investment,
        net at
        December 31, 2006 and 2005:
 
 **At
                  December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Mortgage
                  loans held for investment - securitized(1)
              
              $
              6,051,996
              
              $
              4,430,775Mortgage
                  loans held for investment - pre-securitization(2)
              
              
              417,818
              
              
              270,372Discounts
                  (MSR related)
              
              
              (36,933
              )
              
              (26,750
              )Net
                  deferred origination fees
              
              
              (19,194
              )
              
              (10,735
              )Allowance
                  for loan losses
              
              
              (55,310
              )
              
              (36,832
              )Mortgage
                  loans held for investment, net
              
              $
              6,358,377
              
              $
              4,626,830
 
 *(1)*  *Included
        in the* *outstanding balance of the mortgage loans held for investment - securitized
        at
        December 31, 2006 and 2005 were $1.1 million and $3.1 million, respectively,
        of
        impaired loans. The majority of the impaired loans held at December 31, 2006
        and
        all of the impaired loans held at December 31, 2005 were loans located in
        the
        Hurricanes Katrina and Rita disaster areas designated by the Federal Emergency
        Management Agency (“FEMA”).*
 
 *(2)*  *Included
        in the* *outstanding balance of the mortgage loans held for investment - pre-securitized
        at December 31, 2006 and 2005 were $1.5 million and $798,000, respectively,
        of
        impaired loans. The majority of the impaired loans held at December 31, 2006
        and
        all of the impaired loans held at December 31, 2005 were loans located in
        the
        Hurricanes Katrina and Rita disaster areas designated by the
        FEMA.*
 
 For
        the
        years ended December 31, 2006, 2005 and 2004, we recorded interest income
        related to our mortgage loans held for investment - securitized of $418.8
        million, $250.8 million and $75.5 million, respectively. For the years ended
        December 31, 2006, 2005 and 2004, we recorded interest income related to
        our
        mortgage loans held for investment - pre-securitization of $36.2 million,
        $30.5
        million and $18.3 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, 2006 and 2005:
 
 **For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Beginning
                  balance
              
              $
              36,832
              
              $
              10,278Provision(1)
              
              
              29,085
              
              
              28,592Charge-offs(2)
              
              
              (10,607
              )
              
              (2,038
              )Ending
                  balance
              
              $
              55,310
              
              $
              36,832
 
 *(1)*  *The
        provision for loan losses for the year ended December 31, 2006 and 2005 includes
        a recovery of specific provision of $377,000 and a specific provision of
        $1.7
        million, respectively,* *related
        to probable losses attributable to impaired loans.*
 
 *(2)*  *The
        charge-offs for the year ended December 31, 2006 and 2005 includes $342,000
        (net
        of $10,000 of recoveries) and $3,000, respectively, of charge-offs against
        the
        specific allowance for loan losses attributable to impaired
        loans.*
 
 During
        the fourth quarter of 2005, we established a $1.7 million specific allowance
        for
        loan losses related to certain loans deemed to be impaired by the effects
        of
        Hurricanes Katrina and Rita. Our
        specific 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.
        During the year ended December 31, 2006 as additional information was obtained,
        we adjusted the portion of the specific allowance related to impaired loans
        for
        the mortgage loans in the Hurricanes
        Katrina and Rita affected
        areas by recording a recovery of $716,000. During the year ended December
        31,
        2006 and 2005, we charged-off $342,000 and $3,000 of impaired loans, all
        of
        which were mortgage loans in the Hurricanes
        Katrina and Rita affected
        areas.
 
 As
        of
        December 31, 2006, 2005 and 2004, we had $324.1 million (including $1.3 million
        of loans located in Hurricanes Katrina and Rita disaster areas designated
        by
        FEMA and $1.2 million of mortgage loans held for investment -
        pre-securitization), $123.0 million (including $6.1 million of loans located
        in
        Hurricanes Katrina and Rita disaster areas designated by FEMA) and $18.9
        million, respectively, of mortgage loans held for investment that were 90
        days
        or more delinquent under their payment terms, all of which were on non-accrual
        status. If the non-accrual mortgage loans held for investment at December
        31,
        2006, 2005 and 2004 performed in accordance with their contractual loan terms,
        we would have recognized an additional $12.1 million, $5.9 million and $920,000
        of interest income during the years ended December 31, 2006, 2005 and 2004,
        respectively. We
        expect
        the amounts of non-accrual mortgage loans to change over time depending on
        a
        number of factors, such as the growth or decline in the size of our mortgage
        loans held for investment portfolio, the maturity of the loan portfolio,
        the
        number and dollar value of problem loans that are recognized and resolved
        through collection efforts made by our third-party servicer, and the amount
        of
        charge-offs. Additionally, the performance of our mortgage loans can be affected
        by external factors, such as economic and employment conditions, or other
        factors related to the individual borrower.
 **99**
 Our
        recorded investment in impaired loans at December 31, 2006 and 2005 was $2.5
        million and $3.9 million, respectively. We have a related specific allowance
        for
        these impaired loans totaling $1.0 million and $1.7 million at December 31,
        2006
        and 2005, respectively. The average recorded investment in impaired loans
        for
        the years ended December 31, 2006 and 2005 was $3.2 million and $324,000,
        respectively. We recorded $216,000 of interest income on impaired loans during
        the year ended December 31, 2006. We recorded no interest income on impaired
        loans during the years ended December 31, 2005 and 2004.
 
 **(5)** **Excess
        Cashflow Certificates**
 
 The
        following table presents the activity related to our excess cashflow
        certificates for the years ended December 31, 2006 and 2005:
 
 **For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Balance,
                  beginning of year
              
              $
              7,789
              
              $
              14,933Excess
                  cashflow certificates sold
              
              
              (1,500
              )
              
              --Accretion
              
              
              452
              
              
              1,593Cash
                  receipts
              
              
              (16,198
              )
              
              (23,146
              )Net
                  change in fair value
              
              
              10,666
              
              
              14,409Balance,
                  end of period
              
              $
              1,209
              
              $
              7,789
 
 In
        accordance with EITF 99-20, we regularly analyze and review our assumptions
        to
        determine that the actual rate of return (interest income) on our excess
        cashflow certificates is within our expected rate of return. The expected
        rate
        of return is recorded as a component of interest income. Any return that
        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, 2006,
        2005 and 2004, we recorded interest income related to our excess cashflow
        certificates of $452,000, $1.6 million and $2.1 million, respectively. For
        the
        years ended December 31, 2006, 2005 and 2004, we recorded fair value gain
        in
        income related to our excess cashflow certificates of $10.7 million, $14.4
        million and $1.4 million, respectively. Additionally, during the year ended
        December 31, 2006, we sold at fair value $1.5 million of excess cashflow
        certificates to a third-party without recourse. No such sales occurred during
        the years ended December 31, 2005 or 2004.
 
 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 volatility for our valuation assumptions and the fair value of our excess
        cashflow certificates.
 
 **(6)**  **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, 2006 and 2005 totaled $1.6 million and $1.9 million, respectively,
        and represented the checks outstanding at those respective dates to be paid
        in
        this manner.
 
 **100**
 **(7)**  **Warehouse
        Financing**
 
 Our
        warehouse credit facilities are collateralized by specific mortgage loans
        held
        for investment - pre-securitization at December 31, 2006 and 2005, the balances
        of which are equal to or greater than the outstanding balances under the
        warehouse credit facility at any point in time. The amounts available under
        these warehouse credit facilities are based on the amount of the collateral
        pledged. The amount we have outstanding on our committed facilities at any
        period end generally is 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 our warehouse credit facilities
        at December 31, 2006 and 2005:
  *(Dollars
                    in thousands)*
                
                **Facility**
                
                
                
                **At
                    December 31,****Warehouse
                    Credit Facility**
                
                **Amount**(1)
                
                **Interest
                    Rate**
                
                **2006**
                
                **2005**
                
                **Expiration
                    Date**Citigroup
                
                $                      
                    350,000
                
                Margin
                    over LIBOR
                
                $               
                     234,578
                
                $               
                     144,912
                
                May
                    2007Bank
                    of America(2)
                
                350,000
                
                Margin
                    over LIBOR
                
                76,717
                
                --
                
                August
                    2007RBS
                    Greenwich Capital(3)
                
                350,000
                
                Margin
                    over LIBOR
                
                24,570
                
                77,931
                
                November
                    2007JPMorgan
                    Chase(4)
                
                350,000
                
                Margin
                    over LIBOR
                
                --
                
                --
                
                May
                    2007Deutsche
                    Bank(5)
                
                350,000
                
                Margin
                    over LIBOR
                
                --
                
                --
                
                October
                    2007Total
                
                $                  
                     1,750,000
                
                
                
                $               
                     335,865
                
                $               
                     222,843
 *(1)*  *The
        warehouse facility amount shown is as of December 31, 2006 only. The warehouse
        facility amount totaled $1.25 billion as of December 31, 2005.*
 
 *(2)*  *In
        August 2006, we extended our warehouse financing facility with Bank of America.
        As part of the extension, the facility amount remained the same but the
        committed portion of the facility changed from $350.0 million to $175.0
        million.*
 
 *(3)*  *In
        November 2006, we extended our warehouse financing facility with RBS Greenwich
        Capital. As part of that extension, the facility amount remained the same
        but
        the committed portion of the facility changed from $350.0 million to $200.0
        million.*
 
 *(4)*  *In
        May 2006, we entered into a new warehouse financing facility with JPMorgan
        Chase. The JPMorgan Chase warehouse facility amount is comprised of a $200.0
        million committed line and a $150.0 million uncommitted line.*
 
 *(5)*  *In
        October 2006, we entered into a new warehouse financing facility with Deutsche
        Bank. The Deutsche Bank warehouse facility amount is comprised of a $200.0
        million committed line and a $150.0 million uncommitted line.*
 
 As
        securitization transactions are completed, a substantial portion of the proceeds
        from the long-term debt issued in the securitization is used to pay down
        our
        warehouse credit facilities. Therefore, the outstanding amount of warehouse
        financing will fluctuate from quarter to quarter, and could be significantly
        higher or lower than the $335.9 million outstanding at December 31, 2006,
        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 171 basis points to an average of 5.10% for the
        year
        ended December 31, 2006, compared to an average of 3.39% for the same period
        in
        2005. Partially offsetting the increase in the benchmark rate was a decrease
        in
        the average margin charged by our warehouse creditors during the same period.
        For the years ended December 31, 2006, 2005 and 2004, we recorded interest
        expense related to our warehouse financing of $30.6 million, $22.1 million
        and
        $8.0 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,
        2006.
  **101**
  **(8)**  **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.”
 
 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.
 
 At
        December 31, 2006 and 2005, the outstanding financing on mortgage loans held
        for
        investment, net consisted of $6.0 billion and $4.4 billion, respectively.
        The
        weighted-average interest rate of our financing on mortgage loans held for
        investment, net increased 68 basis points to 5.60% at December 31, 2006 from
        4.92% at December 31, 2005.
 
 The
        following table summarizes the expected maturities on our secured financings
        at
        December 31, 2006:
 
 *(Dollars
                  in thousands)*
              
              **Total**
              
              **Less
                  than**
                **One
                  Year**
              
              **One
                  to**
                **Three
                  Years**
              
              **Three
                  to**
                **Five
                  Years**
              
              **More
                  than**
                **Five
                  Years**Financing
                  on mortgage loans held for investment, net(1)
              
              $
              6,017,947
              
              $
              2,289,883
              
              $
              2,247,178
              
              $
              820,585
              
              $
              660,301
 
 *(1)*  *The
        amounts in the table do not include interest.*
 
 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, 2006, 2005 and 2004, we recorded interest expense
        related to our securitization debt of $288.3 million, $145.4 million and
        $31.5
        million, respectively. Included in financing on mortgage loans held for
        investment, net at December 31, 2006 and 2005 are $6.3 million and $5.3 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.
  **(9)**  **Derivative
        Instruments**
 
 We
        account for our derivative financial instruments such as corridors and interest
        rate swaps (including amortizing notional balance interest rate swaps) as
        cash
        flow hedges. We utilize both corridors and amortizing notional balance interest
        rate swaps to hedge our interest payments on securitization variable-rate
        debt,
        while we utilize interest rate swaps to hedge estimated cash flows associated
        with future securitization financing. At December 31, 2006 and 2005, the
        fair
        value of our corridors totaled $2.5 million and $11.7 million, respectively,
        and
        the fair value of our interest rate swaps (including amortizing notional
        balance
        interest rate swaps) totaled gains of $942,000 and losses of $210,000,
        respectively. The fair value of our corridors and interest rate swaps are
        recorded as a component of prepaid and other assets or accounts payable and
        other liabilities.
 
 As
        of
        December 31, 2006, the effective portion of the changes in fair value of
        the
        corridors and interest rate swaps and any losses on terminated swaps are
        recorded as components of accumulated other comprehensive loss, and total,
        net
        of tax, losses of $155,000 and gains of $575,000 and losses of $1.9 million,
        respectively. As of December 31, 2005, the effective portion of the changes
        in
        fair value of the corridors and interest rate swaps and any gains on terminated
        swaps 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. 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 $7,000 gain, $1.5 million loss and $277,000
        gain for the years ended December 31, 2006, 2005 and 2004,
        respectively.
 
 **102**
 The
        estimated amortization of the accumulated other comprehensive loss at December
        31, 2006 related to derivative instruments into earnings for the next twelve
        months is approximately $820,000 of additional expense (pre-tax), depending
        on
        future performance.
 
 If
        a
        hedge fails the assessment of hedge effectiveness test (the ratio of the
        outstanding balance of the hedged item (debt) to the notional amount of the
        hedge exceeds 125% or falls below 80%, since the notional amount varies)
        at any
        time, and therefore is not expected to be “highly effective” at achieving
        offsetting changes in cash flows, the hedge ceases to qualify for hedge
        accounting. At December 31, 2006 and 2005, we classified $227,000 and $1.7
        million, respectively, of derivative instruments (specifically corridors)
        as
        trading securities in prepaid and other assets as these instruments were
        no
        longer deemed highly effective. During the years ended December 31, 2006
        and
        2005, a gain of $139,000 and $545,000, respectively, was recorded to earnings
        on
        the changes in fair value of the hedges held as trading securities. None
        of the
        hedges held during the year ended December 31, 2004 were classified as trading
        securities.
 
 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 or rate for the corridors (caps bough and caps
        sold) and amortizing notional balance interest rate swaps that we held as
        of
        December 31, 2006:
 
 *(Dollars
                  in thousands)*
              
              **Total**
              
              **One**
                **Year**
              
              **Two
                  Years**
              
              **Three
                  Years**
              
              **Four
                  Years**
              
              **Five
                  Years & Thereafter**Caps
                  bought - notional
              
              $
              954,101
              
              $
              600,811
              
              $
              204,667
              
              $
              37,086
              
              $
              28,288
              
              $
              83,249Weighted
                  averagestrike
                  price
              
              
              6.93
              %
              
              6.53
              %
              
              7.31
              %
              
              7.47
              %
              
              7.45
              %
              
              7.42
              %Caps
                  sold - notional
              
              $
              954,101
              
              $
              600,811
              
              $
              204,667
              
              $
              37,086
              
              $
              28,288
              
              $
              83,249Weighted
                  averagestrike
                  price
              
              
              9.15
              %
              
              9.03
              %
              
              9.30
              %
              
              9.27
              %
              
              9.28
              %
              
              9.31
              %Amortizing
                  notional balance interest rate swaps:Notional
              
              $
              274,727
              
              $
              114,547
              
              $
              104,735
              
              $
              55,445
              
              $
              --
              
              $
              --Weighted
                  average rate
              
              
              5.15
              %
              
              5.17
              %
              
              5.14
              %
              
              5.10
              %
              
              --
              
              
              --
 
 The
        notional amount of the corridors totaled $2.5 billion at December 31, 2005.
        We
        had no amortizing notional balance interest rate swaps at December 31, 2005.
        The
        original stated maturities of our corridors on the date of purchase ranged
        from
        a low of 1.3 years to a maximum of 8.3 years. The original stated maturities
        of
        our amortizing interest rate swaps on the date of purchase ranged from a
        low of
        3.0 years to a maximum of 3.1 years.
 
 **(10)
        Other Borrowings**
 
 Other
        borrowings represent capital leases and other arrangements related to our
        equipment financing. The
        following table summarizes certain information regarding other borrowings
        at
        December 31, 2006 and 2005:
 
 *(Dollars
                  in thousands)*
              
              **Range
                  of Interest Rates**
              
              **Balance
                  at December 31,**
              
              **Range
                  of Expiration Dates**Equipment
                  financing - 2006
              
              6.26%
                  to 8.95%
              
              $                                       
                   5,970
              
              January
                  2007 to November 2009Equipment
                  financing - 2005
              
              3.29%
                  to 12.45%
              
              $                                       
                   4,785
              
              January
                  2006 to December 2008
 
 For
        the
        years ended December 31, 2006, 2005 and 2004, we recorded interest expense
        related to our other borrowings of $430,000, $286,000 and $296,000,
        respectively.
 
 **(11)**  **Stockholders’
        Equity**
 
 **Stock
        Offering.**  On
        April
        10, 2006, we closed a private placement of 2,500,000 newly issued shares, from
        authorized but unissued shares, of our
        common stock at a price of $8.25 per share to a combination of new and existing
        institutional investors. We received proceeds of approximately $19.3 million,
        after deducting expenses payable in connection with this offering. We utilized
        the proceeds to repay warehouse financings and originate mortgage
        loans.
 
 **Unearned
        Common Stock Held by Stock 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 initially in 2005 as a reduction of stockholders' equity
        (specifically recorded as unearned common stock held by stock incentive plan)
        and represents the closing market price of our common stock on the date the
        shares were contributed to the 2005 Plan. In accordance with SFAS 123(R),
        which
        we adopted on January 1, 2006, we removed from stockholders’ equity the unearned
        common stock held by the stock incentive plan.
 
 **103**
 **Other
        Comprehensive (Loss) Income.** In
        accordance with SFAS No. 130, “Reporting Comprehensive Income,” the components
        of OCI for the years ended December 31, 2006, 2005 and 2004 is as
        follows:
  *(Dollars
                  in thousands)*
              
              **Before
                  Tax Amount**
              
              **Tax
                  (Expense) Benefit**
              
              **After
                  Tax Amount**For
                  the year ended December 31, 2006:Net
                  unrealized holding gains on derivatives arising during the
                  year
              
              $
              1,876
              
              $
              (732
              )
              $
              1,144Reclassification
                  adjustment for losses on derivatives included in net income
              
              
              (8,499
              )
              
              3,315
              
              
              (5,184
              )Other
                  comprehensive loss
              
              $
              (6,623
              )
              $
              2,583
              
              $
              (4,040
              )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 income
              
              $
              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
              )
 
 **(12)**  **Employee
        Benefit Plans**
 
 We
        sponsor a 401(k) Retirement Savings Plan (the “401(k) Plan”). Substantially all
        of our full-time employees who are at least 21 years old are eligible to
        participate in the 401(k) Plan after completing one year of service.
        Contributions are made from employees’ elected salary deferrals. We elected to
        make discretionary matching contributions to the 401(k) Plan of $1.4 million,
        $1.3 million and $916,000 for the years ended December 31, 2006, 2005 and
        2004,
        respectively. The discretionary matching contributions are included as a
        component of “payroll and related costs” in the consolidated statements of
        operations. Our discretionary matching contribution vests
        ratably based on an employee’s years of service, and fully vests after five
        years.
  **104**
  **(13)**  **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. We
        quote
        interest rates to customers, which are generally subject to change by us.
        Although we typically honor these interest rate quotes, the quotes do not
        constitute future cash requirements, minimizing the potential interest rate
        risk
        exposure. We do not believe these non-conforming mortgage loan commitments
        meet
        the definition of a derivative under GAAP. Accordingly, they are not recorded
        in
        the consolidated financial statements. At December 31, 2006 and 2005, we
        had
        outstanding origination commitments to fund approximately $117.1 million
        and
        $104.8 million, respectively, in mortgage loans.
 
 **Off-Balance
        Sheet Arrangements.** Our
        off-balance sheet arrangements primarily 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 $457.6 million and $843.2 million
        in
        collateral (primarily mortgage loans) owned by off-balance sheet trusts as
        of
        December 31, 2006 and 2005, respectively. 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,
        2006:
  *(Dollars
                    in thousands)*
                
                **Total**
                
                **Less
                    than One Year**
                
                **One
                    to Three Years**
                
                **Three
                    to Five Years**
                
                **More
                    than Five Years**Financing
                    on mortgage loansheld
                    for investment, net(1)
                    (2)
                
                $
                6,017,947
                
                $
                2,289,883
                
                $
                2,247,178
                
                $
                820,585
                
                $
                660,301Operating
                    leases(2)
                
                $
                22,649
                
                $
                6,897
                
                $
                9,653
                
                $
                6,040
                
                $
                59Equipment
                    financing(2)
                
                $
                5,970
                
                $
                257
                
                $
                5,713
                
                $
                --
                
                $
                --
  *(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.*
 
 *(2)*  *The
        amounts in the table do not include interest.*
 
 **Repurchase
        Obligations.** We have
        repurchase agreements with several of the institutions to which 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 $387,000 and $762,000 at December 31, 2006
        and
        2005. Included in “accounts payable and other liabilities” is an allowance for
        recourse loans related to those loans sold with recourse of $81,000 and $310,000
        at December 31, 2006 and 2005, respectively.
 
 We
        did
        not record a provision for recourse loans for the year ended December 31,
        2006.
        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. 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.
 **Whole-Loan
        Sales Related Reserves.** During
        the years ended December 31, 2006 and 2005, we sold $725.1 million and $561.5
        million, respectively, of whole-loans on a non-recourse basis. We sold these
        loans without recourse, except that we provide standard representations and
        warranties to the purchasers of such loans. In accordance with those
        representations and warranties we establish certain reserves as denoted
        below:
 
 **105**
 *Premium
        Recapture Reserve* - 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
        sheets.
        We estimate recapture losses primarily based upon historical premium recaptures
        and by reviewing the types of loan products, interest rates, borrower prepayment
        fees, if any, and an estimate of the impact of future interest rate changes
        may
        have on early repayments. The premium recapture reserve totaled $958,000
        and
        $619,000 at December 31, 2006 and 2005, respectively. We
        recorded a provision, net of reversals, for premium recapture of $1.1 million,
        $1.1 million and $309,000 for the years ended December 31, 2006, 2005 and
        2004,
        respectively. We recorded refunds related to premium recapture of $718,000,
        $718,000 and $126,000 for the years ended December 31, 2006, 2005 and 2004,
        respectively.
 
 *Secondary
        Marketing Reserve* - We
        maintain a secondary marketing reserve related to our
        estimated exposure to losses arising from loan repurchases, or the net
        settlement, related to representation and warranty claims by investors. We
        estimate the exposure primarily based upon historical repurchases and estimate
        losses using a detailed analysis of historical loan performance by product
        type
        and origination year, similar to the analysis performed for the allowance
        for
        loan losses related to our mortgage loans held for investment portfolio.
        The
        secondary market reserve totaled $512,000 at December 31, 2006. We had no
        such
        reserve at December 31, 2005. During the year ended December 31, 2006, we
        recorded a secondary market reserve provision of $780,000 for losses that
        arise
        in connection with loans that we may be required to repurchase from whole-loan
        sale investors. No secondary market reserve provision was recorded during
        the
        years ended December 31, 2005 and 2004. During the years ended December 31,
        2006
        and 2005, we repurchased or net settled $2.3 million and $723,000, respectively,
        of loans under certain repurchase provisions related to whole-loan sales. We
        incurred $268,000 of losses related to loan repurchases or net settlements,
        which were charged to the secondary marketing reserve, during the year ended
        December 31, 2006. No losses were incurred related to the loans repurchased
        during the year ended December 31, 2005.
 
 **Operating
        Lease Obligations.** Our
        rental expense, net of sublease income, for the years ended December 31,
        2006,
        2005 and 2004 amounted to $8.6 million, $6.7 million and $5.1 million,
        respectively. At
        December 31, 2006, we were obligated under 25 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. We account for operating leases
        with
        scheduled rent increases during the lease term in accordance with SFAS No.
        13,
“Accounting for Leases,” and as further clarified by FASB Technical Bulletin
        (“FTB”) No. 85-3, “Accounting for Operating Leases with Scheduled Rent
        Increases,” which requires that rental payments that are not made on a
        straight-line basis be recognized on a straight-line basis. Any rent escalations
        and rent
        holidays in our operating leases are recognized on a straight-line basis
        over
        the lease term (including any rent holiday period).
 
 Additionally, in
        accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or
        Disposal Activities,” we record a liability for leases where we have ceased
        using the space and concluded that we will not derive any future economic
        benefit. The amount of the liability is based on the remaining lease rentals
        reduced by any potential or existing sublease rentals. Costs to terminate
        a
        lease before the end of its term are recognized and measured at fair value
        upon
        termination.
 
 The
        minimum future rentals under non-cancelable operating leases as of December
        31,
        2006 are as follows:
 
 *(Dollars
                  in thousands)*
              
              **Amount**For
                  the year ended December 31,:2007
              
              $
              6,8972008
              
              
              5,2592009
              
              
              4,3942010
              
              
              3,7472011
              
              
              2,2932012
                  and thereafter
              
              
              59$
              22,649
 
 During
        the year ended December 31, 2006, we entered into a non-cancelable operating
        sublease with a third-party to rent space in a location previously utilized
        by
        us as retail mortgage origination center. We expect to receive rental payments
        totaling $236,000 over the next 1.8 years related to the sublease. We had
        no
        sublease arrangements prior to 2006.
 
 **106**
 **Insured
        AVM.**  We
        use
        Insured AVMs in lieu of appraisals for certain mortgage loan originations
        (totaling approximately 12% and 11% of our 2006 and 2005, respectively, total
        loan production) in order to determine the value of a properties collateralizing those loans. An
        Insured AVM is
        the
        coupling of a third-party valuation estimate and insurance on that value. At
        the
        closing of a loan, when an AVM is used we will purchase insurance, from a
        company that meets our minimum requirements ( *i.e.* ,
        A.M.
        Best insurer rating of A+), that will insure the value 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. 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. There
        can
        be no assurance, however, that we will be able to collect any insurance in
        the
        event of a loss.
 
 **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.
 
 **(14)**  **Stock
        Based Incentive Plans**
 
 We
        have
        three stock benefit plans outstanding, of which two may still issue awards,
        the
        2005 Stock Incentive Plan (“2005 Plan” or “SIP”) and the 2001 Stock Option Plan
        (the “2001 Plan”). The 2005 provides for the granting of stock options,
        restricted stock, restricted stock units, stock appreciation rights and dividend
        equivalent rights (collectively referred to as “awards”). A total of 1,000,000
        shares of our common stock are reserved for issuance under the 2005 Plan,
        subject to adjustment only in the event of a stock split, stock or other
        extraordinary dividend, or other similar change in our common stock or capital
        structure. Incentive stock options may be granted only to employees. Awards
        other than incentive stock options may be granted to employees, directors
        and
        consultants. The term of any award granted under the 2005 Plan may not be
        for
        more than 10 years (or five years in the case of an incentive stock option
        granted to any participant who owns stock representing more than 10% of the
        combined voting power of our company or any parent or subsidiary of ours),
        excluding any period for which the participant has elected to defer the receipt
        of the shares or cash issuable pursuant to the award.
 
 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.
 
 In
        addition to the 2005 Plan, we have one other outstanding stock benefit plan,
        the
        2001 Plan. The 2001 Plan authorized the reserve of 1,500,000 shares of unissued
        common stock for issuance. We also have options outstanding from our 1996
        Stock
        Option Plan (the “1996 Plan” and collectively with the 2001 Plan, the “Option
        Plans”). At December 31, 2006, we have approximately 1.7 million shares
        available for grant under the outstanding stock benefit plans (2001 Plan
        and
        2005 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.
  **107**
  
 The
        following table summarizes certain information regarding the Option
        Plans:
 
 **For
                  the Year Ended December 31,****2006**
              
              **2005**
              
              **2004****Number
                  of Options**
              
              **Weighted
                  Average Exercise Price**
              
              **Number
                  of Options**
              
              **Weighted
                  Average Exercise Price**
              
              **Number
                  of Options**
              
              **Weighted
                  Average Exercise Price**January
                  1stbalance
              
              
              2,174,300
              
              $
              2.87
              
              
              2,091,500
              
              $
              2.23
              
              
              2,234,450
              
              $
              2.00Options
                  granted
              
              
              55,000
              
              
              9.51
              
              
              281,500
              
              
              8.14
              
              
              165,000
              
              
              7.64Options
                  exercised
              
              
              (321,000
              )
              
              1.08
              
              
              (175,900
              )
              
              3.33
              
              
              (233,750
              )
              
              1.18Options
                  canceled
              
              
              (126,550
              )
              
              5.27
              
              
              (22,800
              )
              
              5.24
              
              
              (74,200
              )
              
              10.65December
                  31stbalance
              
              
              1,781,750
              
              $
              3.23
              
              
              2,174,300
              
              $
              2.87
              
              
              2,091,500
              
              $
              2.23Options
                  exercisable
              
              
              1,319,317
              
              $
              2.07
              
              
              1,321,973
              
              $
              1.79
              
              
              944,780
              
              $
              2.01
 
 The
        following table summarizes information about stock options outstanding and
        exercisable at December 31, 2006:
 
 **At
                  December 31, 2006****Outstanding**
              
              **Exercisable****Range
                  of Exercise Prices**
              
              **Number**
                **of
                  Options**
              
              **Weighted
                  Average Remaining Contractual Life (Years)**
              
              **Weighted
                  Average Exercise Price**
              
              **Number
                  of Options**
              
              **Weighted
                  Average Exercise Price**$0.50
                  - $2.00
              
              
              1,108,450
              
              
              1.75
              
              $
              0.89
              
              
              1,017,800
              
              $
              0.81$2.50
                  - $3.00
              
              
              100,000
              
              
              2.16
              
              
              2.75
              
              
              80,000
              
              
              2.75$4.60
                  - $5.94
              
              
              57,500
              
              
              3.59
              
              
              5.79
              
              
              34,100
              
              
              5.80$6.67
                  - $8.20
              
              
              390,800
              
              
              4.93
              
              
              7.62
              
              
              165,167
              
              
              7.73$9.12
                  - $10.30
              
              
              125,000
              
              
              5.76
              
              
              9.48
              
              
              22,250
              
              
              9.591,781,750
              
              
              2.81
              
              $
              3.23
              
              
              1,319,317
              
              $
              2.07
 
 In
        accordance with SFAS No. 123(R), our income before income tax expense and
        net
        income for the year ended December 31, 2006 included stock option compensation
        cost (recorded as a component of non-interest expense - payroll and related
        costs) of $516,000 and $315,000, respectively, which reduced by $0.01 our
        basic
        and diluted earnings per share for the year.
 
 The
        fair
        value of each option award is estimated on the date of grant using the Black
        Scholes Merton option pricing model. For options granted prior to January
        1,
        2006, the fair value was calculated for purposes of the SFAS No. 123 pro
        forma
        disclosures only. The weighted average assumptions used in the valuations
        are
        summarized as follows:
  **108**
  
 **For
                  the Year Ended December 31,****2006**
              
              **2005**
              
              **2004**Expected
                  dividend yield
              2.1%
              
              2.5%
              
              0.9%Expected
                  volatility
              51.1%
              
              48.2%
              
              67.4%Risk-free
                  interest rate
              4.8%
              
              4.2%
              
              3.5%Expected
                  life
              3.7
                  years
              
              3.8
                  years
              
              3.7
                  yearsAnnual
                  forfeiture rate
              7.9%
              
              n/a
              
              n/a
  The
        weighted average grant date fair value of the stock options granted during
        the
        years ended December 31, 2006, 2005 and 2004 was $3.58, $3.11 and $4.48,
        respectively, per option. Under the Black Scholes Merton option pricing model,
        the expected term of the options is estimated based on historical option
        exercise activity and represents the period of time that options granted
        are
        expected to be outstanding. The expected volatility is based on the historical
        volatility of our common stock. The risk-free interest rate for periods within
        the contractual life of the option is based on the U.S. Treasury yield curve
        in
        effect at the time of grant.
 
 The
        following table summarizes the option activity regarding the Option Plans
        for
        the year ended December 31, 2006:
 
 (*Dollars
                  in thousands, except weighted average exercise price*)
              
              **Number
                  of Options**
              
              **Weighted
                  Average Exercise Price**
              
              **Weighted
                  Average Remaining Contractual Term**
              
              **Aggregate
                  Intrinsic Value**January
                  1, 2006 balance
              
              
              2,174,300
              
              $
              2.87Options
                  granted
              
              
              55,000
              
              
              9.51Options
                  exercised
              
              
              (321,000
              )
              
              1.08Options
                  expired
              
              
              (107,000
              )
              
              5.68Options
                  forfeited
              
              
              (19,550
              )
              
              3.07December
                  31, 2006 balance
              
              
              1,781,750
              
              $
              3.23
              
              
              2.8
                  years
              
              $
              12,296Options
                  fully vested and exercisable
              
              
              1,319,317
              
              $
              2.07
              
              
              2.2
                  years
              
              $
              10,637
 
 The
        intrinsic value of a stock option is the amount by which the fair value of
        the
        underlying stock exceeds the exercise price of the option. The total intrinsic
        value of the stock options exercised during the years ended December 31,
        2006
        and 2005 was $2.6 million and $1.2 million, respectively. As
        of
        December 31, 2006, there was $812,000 of total unrecognized compensation
        cost,
        net of estimated forfeitures, related to non-vested options under the Option
        Plans. The unrecognized compensation cost at December 31, 2006 is expected
        to be
        recognized over a weighted average period of 2.40 years.
 
 Cash
        received from option exercises under the Option Plans for the years ended
        December 31, 2006 and 2005 was $346,000 and $585,000, respectively. The actual
        tax benefit for the tax deductions from option exercises totaled $1.0 million
        and $354,000 for the years ended December 31, 2006 and 2005, respectively.
        The
        fair value of the shares that vested during the years ended December 31,
        2006
        and 2005 totaled $566,000 and $526,000, respectively.
 
 Prior
        to
        the adoption of SFAS No. 123(R), unearned compensation for grants of restricted
        stock equivalent to the fair value of the shares at the date of grant was
        recorded as unearned common stock held by stock incentive plan, a separate
        component of stockholders’ equity. The unearned compensation was amortized to
        compensation expense over the restricted stock award’s vesting period. In
        accordance with the
        adoption of SFAS No. 123(R) on January 1, 2006, we reclassified the unearned
        compensation from unearned common stock held by the SIP to
        additional paid-in-capital within stockholders’ equity.
 
 **109**
 Our
        income before income tax expense and net income for the year ended December
        31,
        2006 included a restricted stock award compensation cost (recorded as a
        component of non-interest expense - payroll and related costs) of $372,000
        and
        $227,000, respectively, which reduced by $0.01 our basic and diluted earnings
        per share for the year. Our income before income tax expense and net income
        for
        the year ended December 31, 2005 included restricted stock award compensation
        cost of $46,000 and $28,000, respectively, which had no impact on basic earnings
        per share and diluted earnings per share for the year. No restricted stock
        awards were outstanding during the year ended December 31, 2004. The adoption
        of
        SFAS No. 123(R) did not have a material impact on our statement of operations
        related to restricted stock awards. The status of our non-vested restricted
        stock awards as of December 31, 2006 and 2005, and changes during the years
        ended December 31, 2006 and 2005 are set forth in the following
        table:
 
 **For
                  the Year Ended December 31,****2006**
              
              **2005****Number
                  of Shares**
              
              **Weighted-Average
                  Grant Date Fair Value Per Share**
              
              **Number
                  of Shares**
              
              **Weighted-Average
                  Grant Date Fair Value Per Share**Non-vested
                  restricted stock awards at beginning of year
              
              
              157,275
              
              $
              7.46
              
              
              --
              
              $
              --Granted
              
              
              57,500
              
              
              9.66
              
              
              157,275
              
              
              7.46Vested
              
              
              (3,750
              )
              
              9.39
              
              
              --
              
              
              --Forfeited
              
              
              (7,250
              )
              
              7.46
              
              
              --
              
              
              --Non-vested
                  restricted stock awards at end of year
              
              
              203,775
              
              $
              8.05
              
              
              157,275
              
              $
              7.46
  The
        grants issued during the year ended December 31, 2006 primarily vested over
        a 3
        to 5 year period (either 100% vest in year 3, vested 25% upon grant and 25%
        per
        year over the next 3 years or 50% vest in year 3, 25% vest in year 4 and
        25%
        vest in year 5). The grants issued during the year ended December 31, 2005
        vested over a 5 year period on a prorated basis (50% vest in year 3, 25%
        vest in
        year 4 and 25% vest in year 5). As of December 31, 2006, there was $1.3 million
        of total unrecognized compensation costs related to non-vested restricted
        stock
        awards granted under the 2005 Plan. The unrecognized compensation cost at
        December 31, 2006 is expected to be recognized over a weighted average period
        of
        2.77 years.
 
 Share-based
        employee awards granted for the year ended December 31, 2005 and prior years
        were accounted for under the intrinsic-value-based method prescribed by APB
        Opinion No. 25, as permitted by SFAS No. 123. Therefore, no compensation
        expense
        was recognized for unmodified stock options issued for years prior to 2006
        that
        had no intrinsic value on the date of grant.
 
 SFAS
        No.
        123(R) requires the disclosure of pro-forma information for periods prior
        to
        adoption. The
        following table illustrates the pro forma net income for the years ended
        December 31, 2005 and 2004 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**Net
                  income (loss), as reported
              
              $
              17,955
              
              $
              (9,349
              )Deduct
                  total stock-based employee compensation expense determined under
fair
                  value-based method for all awards net of tax
              
              
              (413
              )
              
              (285
              )Pro
                  forma net income (loss) applicable to common shares
              
              $
              17,542
              
              $
              (9,634
              )**Earnings
                  per share:**Basic
                  - as reported
              
              $
              0.88
              
              $
              (0.51
              )Basic
                  - pro forma
              
              $
              0.86
              
              $
              (0.52
              )Diluted
                  - as reported
              
              $
              0.84
              
              $
              (0.51
              )Diluted
                  - pro forma
              
              $
              0.82
              
              $
              (0.52
              )
 
 **110**
 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.
 
 **(15)
        Income Taxes**
 
 The
        provision (benefit) for income taxes for the years ended December 31, 2006,
        2005
        and 2004 is as follows:
 
 **For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**
              
              **2004**Current
                  income taxes:Federal
              
              $
              6,076
              
              $
              16,211
              
              $
              10,606State
                  and local
              
              
              1,162
              
              
              2,828
              
              
              1,876Total
                  current income taxes
              
              
              7,238
              
              
              19,039
              
              
              12,482Deferred
                  income taxes:Federal
              
              
              9,852
              
              
              (6,385
              )
              
              (14,933
              )State
                  and local
              
              
              1,846
              
              
              (1,196
              )
              
              (2,798
              )Total
                  deferred income taxes
              
              
              11,698
              
              
              (7,581
              )
              
              (17,731
              )Total
                  provision (benefit) for income taxes
              
              $
              18,936
              
              $
              11,458
              
              $
              (5,249
              )
 
 The
        tax
        effect of significant temporary differences comprising our net deferred tax
        asset as of December 31, 2006 and 2005 were as follows:
 
 **At
                  December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005****Deferred
                  tax assets:**Allowance
                  for loan losses
              
              $
              21,571
              
              $
              14,364Excess
                  cashflow certificates
              
              
              12,512
              
              
              21,795Mortgage
                  loans held for investment
              
              
              5,960
              
              
              8,353Capitalized
                  origination fees and related costs, net
              
              
              2,614
              
              
              9,528Accrued
                  interest receivable
              
              
              2,233
              
              
              --Accrued
                  expenses
              
              
              1,930
              
              
              1,667Other
                  comprehensive income
              
              
              962
              
              
              --Stock-based
                  compensation expense
              
              
              348
              
              
              --Accumulated
                  depreciation
              
              
              46
              
              
              --Deferred
                  hedge gain
              
              
              --
              
              
              1,039Deferred
                  tax assets
              
              
              48,176
              
              
              56,746**Deferred
                  tax liabilities:**REIT
                  dividends
              
              
              (1,473
              )
              
              --Deferred
                  hedge loss
              
              
              (943
              )
              
              --Other
                  comprehensive income
              
              
              --
              
              
              (1,621
              )Accumulated
                  depreciation
              
              
              --
              
              
              (250
              )Deferred
                  tax liabilities
              
              
              (2,416
              )
              
              (1,871
              )Total
                  deferred tax asset
              
              $
              45,760
              
              $
              54,875
 
 We
        had no
        valuation allowances at December 31, 2006 and 2005.
 
 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.
 
 **111**
 At
        December 31, 2006 and 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, 2006,
        2005
        and 2004 is as follows:
 
 **For
                  the Year Ended December 31,****2006**
              
              **2005**
              
              **2004**Statutory
                  tax rate
              
              
              35.0
              %
              
              35.0
              %
              
              (35.0
              )%State
                  and local taxes, net of federal benefit
              
              
              4.0
              
              
              3.6
              
              
              (4.1
              )Non-deductible
                  expenses and other(1)
              
              
              (0.1
              )
              
              0.4
              
              
              3.1Total
                  tax rate
              
              
              38.9
              %
              
              39.0
              %
              
              (36.0
              )%
 
 *(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).*
 
 **(16)**  **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)*
              
              **2006**
              
              **2005**
              
              **2004**Net
                  income (loss), as reported
              
              $
              29,765
              
              $
              17,955
              
              $
              (9,349
              )Less:
                  preferred stock dividends
              
              
              --
              
              
              --
              
              
              --Net
                  income (loss) available to common shareholders
              
              $
              29,765
              
              $
              17,955
              
              $
              (9,349
              )Basic
                  - weighted-average shares
              
              
              22,477,213
              
              
              20,349,515
              
              
              18,375,864Basic
                  EPS
              
              $
              1.32
              
              $
              0.88
              
              $
              (0.51
              )Basic
                  - weighted-average shares
              
              
              22,477,213
              
              
              20,349,515
              
              
              18,375,864Incremental
                  shares-options(1)(2)(3)
              
              
              801,162
              
              
              933,705
              
              
              --Diluted
                  - weighted-average shares
              
              
              23,278,375
              
              
              21,283,220
              
              
              18,375,864Diluted
                  EPS
              
              $
              1.28
              
              $
              0.84
              
              $
              (0.51
              )
 
 *(1)*  *For
        the year ended December 31, 2006, the weighted average of approximately 204,000
        unvested restricted stock awards (including approximately 58,000 restricted
        stock awards granted during the fourth quarter of 2006) are included in the
        calculation of diluted earnings per share. Also, for the year ended December
        31,
        2006, approximately 29,000 out-of-the-money employee stock options, 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, 2005, the weighted average of approximately 157,000
        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 options, 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, 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 options, on
        a
        weighted average basis, were excluded from the calculation of diluted earnings
        per share since their effect is anti-dilutive.*
 
 On
        April
        10, 2006, we closed a private placement of 2,500,000 newly issued shares, from
        authorized but unissued shares, of our
        common stock at a price of $8.25 per share to a combination of new and existing
        institutional investors. We received proceeds of approximately $19.3 million,
        after deducting expenses payable in connection with this offering. The
        proceeds were used to repay warehouse financings and originate mortgage
        loans.
 
 **112**
 **(17)**  **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, 2006 and
        2005:
 
 **At
                  December 31, 2006**
              
              **At
                  December 31, 2005***(Dollars
                  in thousands)*
              
              **Carrying
                  Amount**
              
              **Estimated
                  Fair Value**
              
              **Carrying
                  Amount**
              
              **Estimated
                  Fair Value****Financial
                  Assets:**Cash
                  and cash equivalents
              
              $
              5,741
              
              $
              5,741
              
              $
              4,673
              
              $
              4,673Mortgage
                  loans held for investment, net
              
              
              6,358,377
              
              
              6,511,754
              
              
              4,626,830
              
              
              4,718,788Trustee
                  receivable
              
              
              73,361
              
              
              73,361
              
              
              56,164
              
              
              56,164Accrued
                  interest receivable
              
              
              41,684
              
              
              41,684
              
              
              26,952
              
              
              26,952Excess
                  cashflow certificates
              
              
              1,209
              
              
              1,209
              
              
              7,789
              
              
              7,789Derivative
                  assets
              
              
              3,426
              
              
              3,426
              
              
              11,744
              
              
              11,744**Financial
                  Liabilities:**Bank
                  payable
              
              
              1,557
              
              
              1,557
              
              
              1,921
              
              
              1,921Warehouse
                  financing
              
              
              335,865
              
              
              335,865
              
              
              222,843
              
              
              222,843Financing
                  on mortgage loans heldfor
                  investment, net
              
              
              6,017,947
              
              
              5,976,072
              
              
              4,436,938
              
              
              4,388,118Other
                  borrowings
              
              
              5,970
              
              
              5,970
              
              
              4,785
              
              
              4,785Accrued
                  interest payable
              
              
              25,052
              
              
              25,052
              
              
              13,091
              
              
              13,091Derivative
                  liabilities
              
              
              12
              
              
              12
              
              
              210
              
              
              210
 
 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.
 
 ***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.
 
 **113**
 ***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.
 
 ***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, 2006
        and
        2005 because there are no interest rate-lock commitments on the mortgage
        loans.
        We had no forward sale commitments as of December 31, 2006 and
        2005.
 
 **(18)**  **General
        and Administrative Expenses**
 
 The
        following table is a summary of general and administrative
        expenses:
 
 **For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**
              
              **2004**General
                  and administrative expenses:Rent
                  and occupancy
              
              $
              9,028
              
              $
              7,102
              
              $
              5,444Advertising,
                  promotional and marketing
              
              
              6,274
              
              
              6,080
              
              
              1,987Professional
                  fees
              
              
              5,538
              
              
              6,886
              
              
              2,745Telephone
              
              
              3,871
              
              
              3,801
              
              
              3,193Depreciation
                  and amortization
              
              
              3,516
              
              
              2,381
              
              
              1,940Fees
                  and licenses
              
              
              3,046
              
              
              2,738
              
              
              2,058REO
                  related expenses and losses
              
              
              2,621
              
              
              336
              
              
              --Travel
                  and entertainment
              
              
              2,359
              
              
              2,267
              
              
              1,341Non-deferrable
                  loan origination expenses(1)
              
              
              2,008
              
              
              1,880
              
              
              1,581Computer
                  expenses
              
              
              1,190
              
              
              1,059
              
              
              1,827Management
                  and consulting
              
              
              1,314
              
              
              701
              
              
              1,647Other
                  administrative expenses
              
              
              6,662
              
              
              7,236
              
              
              6,389Total
                  general and administrative expenses
              
              $
              47,427
              
              $
              42,467
              
              $
              30,152
 
 *(1)*  *Non-deferrable
        loan origination expenses is comprised of credit report and appraisal expenses
        related to loan applications that did not result in a closed
        loan.*
  **114**
  **Condensed
        Quarterly Financial Data (Unaudited)**
 
 The
        following table is a summary of financial data by quarter for the years ended
        December 31, 2006 and 2005:
 
 **For
                  the 2006 Quarters Ended***(Dollars
                  in thousands)*
              
              **March
                  31**
              
              **June
                  30**
              
              **September
                  30**
              
              **December
                  31**Net
                  interest income
              
              $
              34,707
              
              $
              36,442
              
              $
              37,579
              
              $
              39,002Provision
                  for loan losses
              
              
              6,404
              
              
              6,998
              
              
              6,874
              
              
              8,809Net
                  interest income after provisionfor
                  loan losses
              
              
              28,303
              
              
              29,444
              
              
              30,705
              
              
              30,193Net
                  gain on sale of mortgages
              
              
              7,061
              
              
              7,039
              
              
              9,501
              
              
              9,957Other
                  income
              
              
              3,376
              
              
              4,256
              
              
              1,815
              
              
              1,767Non-interest
                  expense
              
              
              27,917
              
              
              28,837
              
              
              29,157
              
              
              28,805Income
                  before income tax expense
              
              
              10,823
              
              
              11,902
              
              
              12,864
              
              
              13,112Income
                  tax expense
              
              
              4,237
              
              
              4,661
              
              
              4,904
              
              
              5,134Net
                  income
              
              $
              6,586
              
              $
              7,241
              
              $
              7,960
              
              $
              7,978Basic
                  earnings per share(1)
              
              $
              0.32
              
              $
              0.32
              
              $
              0.34
              
              $
              0.34Diluted
                  earnings per share(1)
              
              $
              0.31
              
              $
              0.31
              
              $
              0.33
              
              $
              0.33
 
 **For
                  the 2005 Quarters Ended***(Dollars
                  in thousands)*
              
              **March
                  31**
              
              **June
                  30**
              
              **September
                  30**
              
              **December
                  31**Net
                  interest income(2)(3)
              
              $
              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(3)
              
              
              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(1)
              
              $
              0.10
              
              $
              0.18
              
              $
              0.33
              
              $
              0.28Diluted
                  earnings per share(1)
              
              $
              0.10
              
              $
              0.17
              
              $
              0.31
              
              $
              0.27
 
 *(1)*  *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.*
 
 *(2)*  *During
        the quarter ended December 31, 2005, we recorded $803,000 of interest 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.*
 
 *(3)*  *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.”*
  **115**
 **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, 2006, 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, 2006, 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, 2006, 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, 2006, has been audited by BDO Seidman,
        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, 2006.
  *Changes
        in Internal Control over Financial Reporting* *.* During
        the fourth 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.
  **116**
  **Item
        9B. Other Information.**
 
 None.
 
 **PART
        III**
 
 **Item
        10.****Directors,
        Executive Officers and Corporate Governance.**
 
 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, 2006.
 
 **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, 2006.
 **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, 2006.
 
 **Items
        13.****Certain
        Relationships and Related Transactions, and Director
        Independence.**
 
 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, 2006.
 
 **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, 2006.
 
 **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**Reports
                  of Independent Registered Public Accounting Firm
              80Consolidated
                  Balance Sheets - At December 31, 2006 and 2005
              83Consolidated
                  Statements of Operations - Years ended December 31, 2006, 2005
                  and
                  2004
              84Consolidated
                  Statement of Changes in Stockholders’ Equity - Years ended December 31,
                  2006,2005
                  and 2004
              85Consolidated
                  Statements of Cash Flows - Years ended December 31, 2006, 2005
                  and
                  2004
              86Notes
                  to Consolidated Financial Statements
              88
 
 **117**
 *(b)
        Exhibits:*
 
 **Exhibit
                  No.**
              
              **Filed**
              
              **Description**3.1
              
              (a)
              
              Certificate
                  of Incorporation of Delta Financial Corporation3.2
              
              (b)
              
              Second
                  Amended Bylaws 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 October 12, 2006 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 Company(assumed
                  byLake
                  Park 1000 Woodbury LLC and CLK HP 1000 Woodbury LLC in
                  2006)10.9
              
              (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 Firm23.2
              
              (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 Current Report on Form 8-K (File No. 1-12109), filed
        with
        the Commission on October 13, 2006.
 (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.
 
 **118**
  
 **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)
 
 Dated:
        March 9,
        2007 By: /s/
        HUGH MILLER
 Hugh Miller
 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
                    9, 2007/s/
                    HUGH MILLER
                  Hugh
                    Miller
                
                President,
                    Chief Executive Officer and Director
                  (Principal
                    Executive Officer)
                
                March
                    9, 2007/s/
                    RICHARD BLASS
                  Richard
                    Blass
                
                Executive
                    Vice President, Chief Financial Officer and Director
                  (Principal
                    Financial Officer)
                
                March
                    9, 2007/s/
                    MARTIN D. PAYSON
                  Martin
                    D. Payson
                
                Director
                
                March
                    9, 2007/s/
                    ARNOLD B. POLLARD
                  Arnold
                    B. Pollard
                
                Director
                
                March
                    9, 2007/s/
                    MARGARET A. WILLIAMS
                  Margaret
                    A. Williams
                
                Director
                
                March
                    9, 2007/s/
                    JOHN ADAMOVICH, JR.
                  John
                    Adamovich, Jr.
                
                Director
                
                March
                    9, 2007/s/
                    WILLIAM ADDAS
                  William
                    Addas
                
                Director
                
                March
                    9, 2007
   **119**