______________________________________________________________________________





**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


_____________________


**FORM
      10-Q**





x Quarterly
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934


For
      the
      Quarterly Period Ended September 30, 2005


or


o  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 001-32447


_____________________





**SAXON
      CAPITAL, INC.**


(Exact
      Name of Registrant as Specified in Its Charter)





Maryland
            30-0228584(State
                or Other Jurisdiction of Incorporation)
            (I.R.S.
                Employer Identification No.)4860
                Cox Road
              Suite
                300
              Glen
                Allen, Virginia 23060
            23060(Address
                of Principal Executive Offices)
            (Zip
                Code)





Registrant’s
      Telephone Number, Including Area Code: (804) 967-7400.


_____________________





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
            o





Indicate
      by check mark whether the registrant is an accelerated filer (as defined in
      Rule
      12b-2 of the Exchange Act).





Yes
            x
            No
            o





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).





Yes
            o
            No
            x





As
      of
      November 3, 2005 there were 49,980,135 shares of our common stock, par value
      $0.01 per share, outstanding.











**TABLE
                OF CONTENTS****Page****Part
                I**
            **Financial
                Information**Item
                1.
            Financial
                StatementsUnaudited
                Consolidated Balance Sheets at September 30, 2005 and December 31,
                2004
            1Unaudited
                Consolidated Statements of Operations for the three and nine months
                ended
                September 30, 2005 and September 30, 2004
            2Unaudited
                Consolidated Statement of Shareholders’ Equity for the nine months ended
                September 30, 2005
            3Unaudited
                Consolidated Statements of Cash Flows for the nine months ended September
                30, 2005 and September 30, 2004
            4Notes
                to Unaudited Consolidated Financial Statements
            5Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            22Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            61Item
                4.
            Controls
                and Procedures
            65**Part
                II**
            **Other
                Information**Item
                1.
            Legal
                Proceedings
            66Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            67Item
                3.
            Defaults
                Upon Senior Securities
            67Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            67Item
                5.
            Other
                Information
            67Item
                6.
            Exhibits
            67








**Part
      I.**  **Financial
      Information**


**Item
      1.**  **Financial
      Statements**





**Saxon
                Capital, Inc.****Consolidated
                Balance Sheets****($
                in thousands, except per share data)****(unaudited)****September
                30,**
              **2005**
            **December
                31,**
              **2004****Assets:**Cash
            $9,493
            $12,852Accrued
                interest receivable
            56,784
            56,132Trustee
                receivable
            130,117
            112,062Mortgage
                loan portfolio
            6,270,256
            6,027,620Allowance
                for loan loss
            (49,175)
            (37,310)Net
                mortgage loan portfolio
            6,221,081
            5,990,310Restricted
                cash
            142,233
            1,495Servicing
                related advances
            155,812
            113,129Mortgage
                servicing rights, net
            138,943
            98,995Real
                estate owned
            26,654
            24,860Derivative
                assets
            33,919
            11,801Deferred
                tax asset
            56,767
            27,825Other
                assets
            65,787
            89,670Total
                assets
            $7,037,590
            $6,539,131**Liabilities
                and shareholders’ equity:****Liabilities:**Accrued
                interest payable
            $7,044
            $8,045Dividends
                payable
            —
            28,909Warehouse
                financing
            144,100
            600,646Securitization
                financing
            6,195,417
            5,258,344Derivative
                liabilities
            5,262
            1,809Other
                liabilities
            25,493
            22,449Total
                liabilities
            6,377,316
            5,920,202Commitments
                and contingencies - Note 9**Shareholders’
                equity:**Common
                stock, $0.01 par value per share, 100,000,000 shares authorized;
                shares
                issued and outstanding: 49,980,135 and 49,849,386 as of September
                30, 2005
                and December 31, 2004, respectively
            501
            498Additional
                paid-in capital
            632,702
            625,123Accumulated
                other comprehensive income (loss), net of tax effect of $2,705 and
                $2,446
            22,932
            (3,842)Net
                retained earnings (accumulated deficit):Cumulative
                dividends declared
            (170,395)
            (114,641)Retained
                earnings
            174,534
            111,791Net
                retained earnings (accumulated deficit)
            4,139
            (2,850)Total
                shareholders’ equity
            660,274
            618,929Total
                liabilities and shareholders’ equity
            $7,037,590
            $6,539,131





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




1





**Saxon
                Capital, Inc.****Consolidated
                Statements of Operations****(in
                thousands, except per share data)****(unaudited)****Three
                Months Ended September 30,**
            **Nine
                Months Ended September 30,****2005**
            **2004**
            **2005**
            **2004****Revenues:**Interest
                income
            $115,685
            $99,657
            $341,386
            $289,707Interest
                expense
            (69,075)
            (37,933)
            (185,815)
            (107,145)Net
                interest income
            46,610
            61,724
            155,571
            182,562Provision
                for mortgage loan losses
            (19,369)
            (14,730)
            (38,551)
            (28,768)Net
                interest income after provisionfor
                mortgage loan losses
            27,241
            46,994
            117,020
            153,794Servicing
                income, net of amortization and impairment
            19,064
            8,371
            49,853
            20,194Gain
                on sale of assets
            44
            220
            2,451
            3,079Total
                net revenues
            46,349
            55,585
            169,324
            177,067**Expenses:**Payroll
                and related expenses
            21,324
            19,662
            59,330
            52,860General
                and administrative expenses
            16,918
            14,311
            48,277
            40,437Depreciation
            1,558
            1,393
            4,401
            4,462Other
                expense
            1,253
            978
            2,547
            3,368Total
                expenses
            41,053
            36,344
            114,555
            101,127Income
                before taxes
            5,296
            19,241
            54,769
            75,940Income
                tax expense (benefit)
            (6,314)
            (19,044)
            (7,943)
            515**Net
                income before cumulative effect of change in accounting principle
                (SFAS
                123(R))**
            $11,610
            $38,285
            $62,712
            $75,425Cumulative
                effect of change in accounting principle (SFAS 123(R))
            —
            —
            31
            —**Net
                income**
            $11,610
            $38,285
            $62,743
            $75,425**Earnings
                per share:**Average
                shares - basic
            49,942
            31,525
            49,892
            29,637Average
                shares - diluted
            50,726
            33,565
            50,647
            32,064Basic
                earnings per share
            $0.23
            $1.21
            $1.26
            $2.54Diluted
                earnings per share
            $0.23
            $1.14
            $1.24
            $2.35Dividends
                declared per share
            $0.55
            —
            $1.10
            —







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




2





**Saxon
                Capital, Inc.****Consolidated
                Statement of Shareholders’ Equity****($
                in thousands)****(unaudited)****Common
                Shares Outstanding**
            **Common**
              **Stock**
            **Additional**
              **Paid-in
                Capital**
            **Accumulated**
              **Other**
              **Comprehensive**
              **Income**
            **Cumulative
                Dividends Declared**
            **Retained**
              **Earnings**
            **Total****Balance
                as of January 1, 2005**
            49,849,386
            $498
            $625,123
            $(3,842)
            $(114,641)
            $111,791
            $618,929Issuance
                of common stock
            130,749
            2
            2,013
            —
            —
            —
            2,015Compensation
                expense
            —
            1
            2,061
            —
            —
            —
            2,062Share-based
                compensation tax benefit
            —
            —
            3,536
            —
            —
            —
            3,536Cumulative
                effect of change in
              accounting
                principle (SFAS 123(R))
            —
            —
            (31)
            —
            —
            —
            (31)Dividends
                declared ($1.10 per share)
            —
            —
            —
            —
            (55,754)
            —
            (55,754)**Comprehensive
                income:**
              Net
                income
            —
            —
            —
            —
            —
            62,743Mortgage
                bonds:Change
                in unrealized loss
            —
            —
            —
            (161)
            —
            —Reclassification
                adjustment
            —
            —
            —
            346
            —
            —Tax
                effect
            —
            —
            —
            7
            —
            —Cash
                flow hedging instruments:Change
                in unrealized gain
            —
            —
            —
            25,151
            —
            —Reclassification
                adjustment
            —
            —
            —
            1,179
            —
            —Tax
                effect
            —
            —
            —
            252
            —
            —**Total
                comprehensive income**
            —
            —
            —
            26,774
            —
            62,743
            89,517**Balance
                as of September 30, 2005**
            49,980,135
            $501
            $632,702
            $22,932
            $(170,395)
            $174,534
            $660,274







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




3





**Saxon
                Capital, Inc.****Consolidated
                Statements of Cash Flows****($
                in thousands)****(unaudited)****Nine
                Months Ended September 30,****2005**
            **2004****Operating
                Activities:**Net
                income from operations
            $62,743
            $75,425Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            66,200
            28,009Deferred
                income taxes
            (17,549)
            (9,914)Impairment
                of assets
            6,812
            9,485Gain
                from sale of assets
            (2,451)
            (3,079)Provision
                for mortgage loan losses
            38,551
            28,768Compensation
                expense recognized under share-based compensation plans
            2,061
            3,880Provision
                for (recovery of) advanced interest losses
            34
            (1,067)Cumulative
                effect of change in accounting principle
            (31)
            —Increase
                in servicing related advances
            (42,683)
            (12,832)Increase
                in accrued interest receivable
            (652)
            (2,687)(Decrease)
                increase in accrued interest payable
            (1,001)
            514Increase
                in trustee receivable
            (18,055)
            (24,990)Net
                change in other assets and other liabilities
            16,398
            11,332Net
                cash provided by operating activities
            110,377
            102,844**Investing
                Activities:**Purchase
                and origination of mortgage loans
            (2,470,538)
            (2,763,453)Principal
                payments received on mortgage loan portfolio
            1,889,215
            1,521,305Proceeds
                from the sale of mortgage loans
            251,264
            205,214Proceeds
                from the sale of real estate owned
            41,792
            42,347(Increase)
                decrease in restricted cash
            (140,738)
            202Principal
                payments received on mortgage bonds
            —
            3,584Acquisition
                of mortgage servicing rights
            (78,727)
            (52,315)Capital
                expenditures
            (9,100)
            (5,332)Net
                cash used in investing activities
            (516,832)
            (1,048,448)**Financing
                Activities:**Proceeds
                from issuance of securitization financing
            3,017,620
            2,328,185Debt
                issuance costs
            (11,056)
            (25,420)Principal
                payments on securitization financing
            (2,073,236)
            (1,582,395)(Repayment)
                borrowings of warehouse financing, net
            (456,546)
            212,811Proceeds
                from (purchases of) derivative instruments
            8,962
            (6,245)Proceeds
                received from issuance of stock
            2,015
            426,786Payment
                of expenses related to REIT conversion and stock issuance
            —
            (30,621)Payment
                of merger consideration
            —
            (131,376)Repayment
                of note payable
            —
            (25,000)Payment
                of dividends
            (84,663)
            —Net
                cash provided by financing activities
            403,096
            1,167,166Net
                (decrease) increase in cash
            (3,359)
            221,562Cash
                at beginning of period
            12,852
            5,245Cash
                at end of period
            $9,493
            $226,807**Supplemental
                Cash Flow Information:**Cash
                paid for interest
            $(210,190)
            $(128,163)Cash
                received (paid) for taxes
            $7,143
            $(32,673)**Non-Cash
                Financing Activities:**Transfer
                of mortgage loans to real estate owned
            $63,143
            $69,864




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


4


**Notes
      to Unaudited Consolidated Financial Statements**





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




**(a)**  **The
      Company and Principles of Consolidation**




The
      accompanying unaudited consolidated financial statements have been prepared
      in
      conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of
      Regulation S-X for interim financial statements. Accordingly, they do not
      include all of the information and footnotes required by accounting principles
      generally accepted in the United States of America, or GAAP, for complete
      financial statements.





In
      the
      opinion of management, the accompanying unaudited consolidated financial
      statements contain all adjustments, consisting of normal recurring accruals,
      necessary for a fair presentation. The results of operations and other data
      for
      the three and nine months ended September 30, 2005 are not necessarily
      indicative of the results that may be expected for any other interim periods
      or
      the entire year ending December 31, 2005. Certain information and footnote
      disclosures normally included in the audited consolidated financial statements
      prepared in accordance with GAAP have been omitted. The unaudited consolidated
      financial statements presented herein should be read in conjunction with the
      audited consolidated financial statements and related notes thereto included
      in
      Saxon Capital, Inc.’s Annual Report on Form 10-K for the year ended December 31,
      2004, filed with the Securities and Exchange Commission. Use of the term
“Company” throughout these Notes to Unaudited Consolidated Financial Statements
      shall be deemed to refer to or include the applicable subsidiaries of the
      Company.  The
      unaudited consolidated financial statements of the Company include the accounts
      of all wholly owned subsidiaries. All inter-company balances and transactions
      have been eliminated in consolidation.





Saxon
      Capital, Inc., a Delaware corporation (“Old Saxon”) was formed on April 23, 2001
      and acquired all of the issued and outstanding capital stock of SCI Services,
      Inc. from Dominion Capital, Inc., a wholly owned subsidiary of Dominion
      Resources, Inc., on July 6, 2001. Saxon Capital, Inc., a Maryland corporation
      (formerly known as Saxon REIT, Inc.) (“New Saxon,” and together with Old Saxon,
      referred to herein as “Saxon” or the “Company”) (NYSE: SAX), was formed on
      February 5, 2004 for the purpose of effecting Old Saxon’s conversion to a real
      estate investment trust, or REIT. The REIT conversion was completed on September
      24, 2004.





During
      the third quarter of 2005, the Company recorded a cumulative adjustment to
      increase income tax benefit and increase deferred tax asset of approximately
      $3.7 million to correct the amortization of the net prepaid liability created
      by
      the tax on intercompany gains and losses related to the sales of mortgage loans
      and servicing advance receivables from the taxable REIT subsidiary to the
      qualified REIT subsidiary. The Company does not believe that the impact of
      the
      correction for the adjustment is material to the financial statements as of
      and
      for the quarters ended September 30, 2004; December 31, 2004; March 31, 2005;
      and June 30, 2005; as of and for the year ended December 31, 2004; nor is the
      cumulative adjustment recorded in the third
      quarter of 2005 expected to be material, in the aggregate, to the financial
      statements as of and for the year ending December 31, 2005. The adjustment
      had
      no impact on cash flows, taxable income or the amount of dividends declared
      for
      any of these periods.


5




**(b)**  **Use
      of Estimates**




The
      preparation of financial statements in conformity with GAAP requires management
      to make estimates and assumptions that affect the reported amounts of assets
      and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amount of revenues and expenses during
      the reporting period. Actual results could differ from those estimates. The
      recorded balances most affected by the use of estimates are amortization of
      yield adjustments to net interest income, the allowance for loan loss, valuation
      of servicing rights, hedging activities, deferral of certain direct loan
      origination costs, and income taxes.





The
      Company recorded $1.2 million of expense during the third quarter of 2005
      relating to a change in accounting estimate for its deferral of certain direct
      loan origination costs. This change in estimate decreased net income by $1.2
      million and reduced basic and diluted earnings per share by $0.02.




**(c)**  **Stock
        Options**


The
      Company adopted SFAS 123(R) *Share
      Based Payment* on April
      1, 2005 to account for its two share-based compensation plans, namely its Stock
      Incentive Plan and its Employee Stock Purchase Plan. The effect of this change
      from applying the original provisions of SFAS 123 had an immaterial effect
      on
      income before income taxes, net income, and earnings per share, as described
      in
      further detail in Note 10. The effect of this change from applying the original
      provisions of SFAS 123 had no effect on cash flow from operations and financing
      activities. The Company recorded a cumulative effect of change in accounting
      principle in the amount of $31.0 thousand as of April 1, 2005 to reflect the
      change in accounting for forfeitures. Pro forma calculations for prior periods
      for the cumulative effect of change in accounting principle are not required
      as
      the change in accounting for forfeitures related to restricted stock units
      granted during the first quarter of 2005.




In
      prior
      periods, the Company had elected to follow the intrinsic value method in
      accounting for stock options issued to employees and non-employee directors. Effective
      September 13, 2004, upon approval by Old Saxon’s shareholders of the merger
      agreement in connection with the REIT conversion, all then-outstanding stock
      options and restricted stock units immediately vested and were expensed at
      that
      time. The
      following table illustrates the effect on net income and earnings per share
      as
      if the Company had applied the fair value method to options granted to employees
      prior to September 30, 2004 using the Black-Scholes option-pricing model.




6







**Three
                Months Ended**
            **Nine
                Months Ended****September
                30, 2004**($
                in thousands, except per share data)Net
                income, as reported
            $38,285
            $75,425Add:
                stock-based compensation expense included in reported net income,
                net of
                related tax effects
            199
            199Deduct:
                total share-based compensation expense determined under fair value
                based
                method for all awards,
              net
                of related tax effects
            (2,918)
            (4,194)Pro
                forma net income
            $35,566
            $71,430Earnings
                per share:Basic
                - as reported
            $1.21
            $2.54Basic
                - pro forma
            $1.11
            $2.40Diluted
                - as reported
            $1.14
            $2.35Diluted
                - pro forma
            $1.05
            $2.22




7


**(d)**  **Reclassifications**




Certain amounts
      for 2004 have been reclassified to conform to presentations adopted in
      2005.




**(2)**  **Subsequent
      Events**




On
      October 12, 2005, a matter was filed in the Common Pleas Court for Cuyahoga
      County, Ohio as Jumar
      Hooks and Diane Felder, et al., v. Saxon Mortgage, Inc. ,
      Case
      No. CV 05 574577. The plaintiffs filed this case as a class action, alleging,
      on
      behalf of themselves and similarly situated Ohio borrowers, that the Company’s
      subsidiary engaged in unlawful practices in originating and servicing the
      plaintiffs’ loans. As with other pending litigation, if a class is certified and
      there is an adverse outcome or we do not otherwise prevail in the matter, we
      could suffer material losses, although we intend to vigorously defend this
      lawsuit. At the present time, we cannot predict the outcome of this case.





On
      October 27, 2005 the Company entered into a new $300.0 million repurchase
      facility with Greenwich Capital Financial Products, Inc. due to expire on
      September 28, 2006. The new facility provides the Company with the ability
      to
      finance first and second lien mortgage loans and to finance mortgage bonds.
      In
      conjunction with the new facility, the existing $150.0 million and $175.0
      million facilities with Greenwich Capital Financial Products, Inc. were both
      terminated.







On
      October 18, 2005, the Company granted 70,000 restricted stock units to some
      of
      the Company’s employees. The restricted stock units will vest on the fifth
      anniversary of the date of grant. The grantees of the restricted stock units
      will be entitled to receive all dividends and other distributions paid with
      respect to the common shares of the Company underlying such restricted stock
      units at the time such dividends or distributions are paid to holders of common
      shares.




On
      October 18, 2005, the Company declared a quarterly dividend of $0.50 per share
      of common stock payable on November 10, 2005 to shareholders of record as of
      the
      close of business on October 28, 2005.




**(3)**  **Earnings
      Per Share**




Basic
      earnings per share is based on the weighted average number of shares
      outstanding, excluding any dilutive effects of options, warrants, or restricted
      stock units. Diluted earnings per share is based on the weighted average number
      of shares, dilutive stock options, dilutive stock warrants, and dilutive
      restricted stock units outstanding during the year. Computations of earnings
      per
      share were as follows:




8







**Three
                Months Ended September 30,**
            **Nine
                Months Ended September 30,****2005**
            **2004**
            **2005**
            **2004**(in
                thousands, except per share data)**Basic:**Net
                income
            $11,610
            $38,285
            $62,743
            $75,425Weighted
                average shares outstanding
            49,942
            31,525
            49,892
            29,637Earnings
                per share
            $0.23
            $1.21
            $1.26
            $2.54**Diluted:**Net
                income
            $11,610
            $38,285
            $62,743
            $75,425Weighted
                average shares outstanding
            49,942
            31,525
            49,892
            29,637Dilutive
                effect of stock options, warrants and restricted stock
                units
            784
            2,040
            755
            2,427Weighted
                average shares outstanding - diluted
            50,726
            33,565
            50,647
            32,064Earnings
                per share
            $0.23
            $1.14
            $1.24
            $2.35





**(4)**  **Mortgage
      Loan Portfolio**




Mortgage
      loans reflected on the Company’s consolidated balance sheets as of September 30,
      2005 and December 31, 2004 were comprised of the following:




**September
                30, 2005**
            **December
                31, 2004**($
                in thousands)Securitized
                mortgage loans - principal balance
            $5,928,360
            $5,123,071Unsecuritized
                mortgage loans - principal balance
            212,630
            782,716Premiums,
                net of discounts
            88,953
            75,562Hedge
                basis adjustments
            25,055
            30,245Deferred
                origination costs, net of deferred fees
            12,342
            11,288Purchase
                accounting fair value adjustments
            2,916
            4,738Total
            $6,270,256
            $6,027,620






During
      the three months ended September 30, 2005, the Company completed the final
      funding of SAST 2005-2 ($203.0 million in principal balances and $2.8 million
      in
      unamortized basis adjustments) and the initial funding of SAST 2005-3 ($759.4
      million in principal balances and $9.2 million in unamortized basis
      adjustments).





From
      time
      to time, the Company’s subsidiaries may choose to sell certain mortgage loans
      rather than securitize them. The following chart summarizes the Company’s
      activity with respect to mortgage loans sold during the periods
      presented.


9





**Three
                Months Ended**
              **September
                30,**
            **Nine
                Months Ended**
              **September
                30,****2005**
            **2004**
            **2005**
            **2004**($
                in thousands)Performing
                mortgage loans sold:Non
                conforming first lien mortgages
            $3⁄4
            $3⁄4
            $98,786
            $69,274Conforming
                first lien mortgages (1)
            12,758
            1,270
            52,845
            2,205Second
                lien mortgages
            21,636
            42,312
            85,871
            94,584Delinquent
                mortgage loans (2)
            3⁄4
            10,142
            8,812
            34,607Total
                mortgage loans sold
            34,394
            53,724
            246,314
            200,670Plus
                basis adjustments
            426
            579
            2,521
            1,496Less:
                cash received
            (34,867)
            (54,523)
            (251,263)
            (205,214)Gain
                on sale of mortgage loans (2)(3)
            $47
            $220
            $2,428
            $3,048


___________


(1)
            Loans
                that generally meet the underwriting guidelines of one of the
                government-sponsored entities such as Freddie Mac, Fannie Mae, and
                Ginnie
                Mae.


(2)
            Includes
                real estate owned, or REO, that was part of a delinquent loan
                sale.


(3)
            Total
                gain on sale of assets of $44 thousand, $2.5 million, and $3.1 million
                on
                the consolidated statements of operations for the three months ended
                September 30, 2005 and for the nine months ended September 30, 2005
                and
                2004, respectively, includes the gain (loss) recognized on sale of
                other
                assets.





**(5)**  **Allowance
      for Loan Loss**




The
      Company is exposed to risk of loss from its mortgage loan portfolio and
      establishes the allowance for loan loss taking into account a variety of
      criteria including contractual delinquency status, historical loss experience,
      and catastrophic environmental influences or natural disasters - see Note 9
      for
      further details. The allowance for loan loss is evaluated monthly and adjusted
      based on this evaluation.





Activity
      related to the allowance for loan loss for the mortgage loan portfolio for
      the
      three and nine months ended September 30, 2005 and 2004 is as
      follows:








**Three
                Months Ended September 30,**
            **Nine
                Months Ended September 30,****2005**
            **2004**
            **2005**
            **2004**($
                in thousands)Beginning
                balance
            $36,278
            $34,032
            $37,310
            $43,369Provision
                for mortgage loan losses (1) (2)
            21,515
            14,192
            38,585
            27,702Charge-offs
            (8,618)
            (11,908)
            (26,720)
            (34,755)Ending
                balance
            $49,175
            $36,316
            $49,175
            $36,316


________________


(1)
            Includes
                $2.1 million and $(0.5) million for the three months ended September
                30,
                2005 and 2004, respectively, and $34 thousand and $(1.1) million
                for the
                nine months ended September 30, 2005 and 2004, respectively, related
                to
                the provision/(recovery) of the allowance for advanced interest paid
                to
                securitization trusts. This amount is included as a component of
                interest
                income in the consolidated statements of operations.


(2)
            Includes
                $6.8 million for the three and nine months ended September 30, 2005
                with
                respect to probable losses incurred due to Hurricane Katrina.


10


**(6)**  **Mortgage
      Servicing Rights**





As
      of
      September 30, 2005, the aggregate fair value of the mortgage servicing rights
      (MSRs) was $171.0 million, compared to $155.1 million as of December 31, 2004. The
      Company recognized a permanent impairment during the first nine months of 2005
      due to significant prepayment experience in certain underlying loans and
      recognized a temporary impairment relating to lower valuations of MSRs in the
      marketplace. The Company also recognized temporary impairments during the three
      months ended September 30, 2005 relating to hurricane-related factors - see
      Note
      9 for further details. The
      following table summarizes activity in mortgage servicing rights and its related
      valuation allowance for the three and nine months ended September 30, 2005
      and
      2004:





**Three
                Months Ended September 30,**
            **Nine
                Months Ended September 30,****2005**
            **2004**
            **2005**
            **2004**($
                in thousands)Beginning
                balance of MSRs, gross
            $135,122
            $50,035
            $106,619
            $41,942Purchased
            26,729
            37,489
            78,727
            52,315Amortization
            (13,410)
            (5,139)
            (33,931)
            (11,872)Charge-offs
            (419)
            (755)
            (3,393)
            (755)Ending
                balance of MSRs, gross
            $148,022
            $81,630
            $148,022
            $81,630Beginning
                balance of valuation allowance
            (6,083)
            (5,337)
            (7,624)
            (687)Impairment
            (3,415)
            (2,113)
            (4,848)
            (6,763)Charge-offs
            419
            755
            3,393
            755Ending
                balance of valuation allowance
            $(9,079)
            $(6,695)
            $(9,079)
            $(6,695)MSRs,
                net
            $138,943
            $74,935
            $138,943
            $74,935





As
      of
      September 30, 2005, the following table summarizes the remaining estimated
      projected amortization expense for the carrying value of the mortgage servicing
      rights for each of the five succeeding years and thereafter:





**Years
                Ending**
              **December
                31,**($
                in thousands)October
                2005 through December 2005
            $13,8552006
            49,9942007
            30,6132008
            19,3712009
            12,329Thereafter
            21,860Total
            $148,022







**(7)**  **Warehouse
      and Securitization Financing**




A
      summary
      of the amounts outstanding under these agreements as of September 30, 2005
      and
      December 31, 2004 is as follows:


11





**September
                30, 2005**
            **December
                31, 2004**($
                in thousands)**Debt
                Outstanding**Warehouse
                financing - loans and servicing advances
            $122,473
            $282,092Repurchase
                agreements - loans and mortgage bonds (1)(2)
            21,627
            318,554Securitization
                financing - servicing advances
            165,147
            117,988Securitization
                financing - loans and real estate owned
            6,030,270
            5,125,572Securitization
                financing - net interest margin
            3⁄4
            14,784Total
            $6,339,517
            $5,858,990


___________________  (1)
              Repurchase
                  agreements are included as part of warehouse financing on the consolidated
                  balance sheets.


(2)
            As
                of September 30, 2005 and December 31, 2004, amounts outstanding
                of $1.0
                million and $1.1 million were borrowed against an uncommitted
                facility.






The
      following table summarizes the Company’s contractual obligations with respect to
      these facilities as of September 30, 2005:




**As
                of September 30, 2005**
            **Total**
            **Less
                than 1 year**
            **1-3
                years**
            **3-5
                years**
            **After
                5 years**($
                in thousands)Warehouse
                financing - loans and servicing advances
            $122,473
            $122,473
            $—
            $—
            $—Repurchase
                agreements - loans and mortgage bonds (1)
            21,627
            21,627
            —
            —
            —Securitization
                financing - servicing advances
            165,147
            25,147
            55,000
            85,000
            —Securitization
                financing - loans and real estate owned (2)
            6,030,270
            2,400,559
            3,003,763
            536,782
            89,166Total
                contractual cash obligations
            $6,339,517
            $2,569,806
            $3,058,763
            $621,782
            $89,166


________________


(1)
            Repurchase
                agreements are included as part of warehouse financing on the consolidated
                balance sheets.


(2)
            Amounts
                shown are estimated debt payments based on anticipated receipt of
                principal and interest on underlying mortgage loan collateral using
                historical prepayment speeds.




A
      summary
      of interest expense and the weighted average cost of funds is as
      follows:





**Three
                Months Ended September 30,**
            **Nine
                Months Ended September 30,****2005**
            **2004**
            **2005**
            **2004**($
                in thousands)**Interest
                Expense**Warehouse
                financing
            $126
            $1,099
            $2,307
            $2,309Repurchase
                agreements
            3,258
            2,354
            7,357
            5,676Securitization
                financing
            64,594
            32,820
            172,949
            94,805Note
                payable
            —
            448
            —
            1,443Other
            1,098
            1,212
            3,202
            2,912Total
            $69,075
            $37,933
            $185,815
            $107,145**Weighted
                Average Cost of Funds**Warehouse
                financing
            0.28%
            2.10%
            1.70%
            1.92%Repurchase
                agreements
            4.22%
            2.35%
            3.80%
            2.01%Securitization
                financing
            4.50%
            2.60%
            4.03%
            2.67%Note
                payable
            —
            8.00%
            —
            8.00%Total
            4.44%
            2.68%
            4.02%
            2.71%





12


Under
      its
      borrowing agreements, the Company is subject to certain debt covenants and
      is
      required to maintain or satisfy specified financial ratios and tests, as well
      as
      other customary covenants, representations and warranties. In the event of
      default, the Company may be prohibited from paying dividends and making
      distributions under certain of its financing facilities without the prior
      approval of its lenders. As of September 30, 2005, the Company was in compliance
      with all covenants under the respective borrowing agreements.





**(8)**  **Derivatives**





The
      Company accounts for the majority of its existing derivative financial
      instruments as cash flow hedges, which hedge the Company’s variable rate debt.
      As of September 30, 2005 and December 31, 2004, the net fair value of the
      Company’s derivatives totaled $28.7 million and $10.0 million, respectively. As
      of September 30, 2005 and December 31, 2004, the mark to market adjustment
      on
      effective hedges recorded in accumulated other comprehensive income (loss)
      was
      $20.5 million with a tax benefit of $2.7 million and $(5.8) million with a
      tax
      benefit of $2.3 million, respectively. Accumulated other comprehensive income
      (loss) related to cash flow hedging is accreted (amortized) into earnings
      through interest expense as the hedged item affects earnings. The effect of
      net
      amortization of the accumulated other comprehensive income on earnings for
      the
      next twelve months is expected to be $9.6 million of income, depending on future
      repayment of debt and future changes in hedge values. The maximum term over
      which the Company is hedging its exposure for forecasted transactions is 60
      months. Hedge ineffectiveness resulted in $105.4 thousand of income and $105.2
      thousand of expense for the three months ended September 30, 2005 and 2004,
      respectively. Hedge ineffectiveness resulted in $134.1 thousand of expense
      and
      $113.6 thousand of expense for the nine months ended September 30, 2005 and
      2004, respectively. These ineffective portions are included as part of other
      expense on the consolidated statements of operations.




In
      addition, as of September 30, 2005, the Company had fourteen derivative
      contracts included in the net fair value of the Company’s derivatives in the
      amount of $0.3 million that did not qualify for hedge treatment. The
      changes in fair value of these contracts offset one another; therefore, they
      had
      no net impact on the statement of operations.




As
      of
      September 30, 2005 and December 31, 2004, the Company had $25.1 million and
      $30.2 million, respectively, of basis adjustments on mortgage loans related
      to
      previous fair value hedging activity. These basis adjustments are amortized
      into
      earnings through interest income as a yield adjustment of the previously hedged
      loans.




**(9)**  **Commitments
      and Contingencies**




13


*Mortgage
      Loans*




As
      of
      September 30, 2005 and December 31, 2004, the Company’s subsidiaries had
      commitments to fund mortgage loans with agreed-upon rates of approximately
      $261.8 million and $240.3 million, respectively. These amounts do not
      necessarily represent future cash requirements, as some portion of the
      commitments are likely to expire without being drawn upon or may be subsequently
      declined for credit or other reasons.





In
      connection with the approximately $433.6 million of mortgage loans securitized
      in off-balance sheet transactions from May 1996 to July 5, 2001 which are still
      outstanding as of September 30, 2005, and in connection with the sales of
      mortgage loans to nonaffiliated parties, the Company’s subsidiaries made
      representations and warranties about certain characteristics of the loans,
      the
      borrowers, and the underlying properties. In the event of a breach of these
      representations and warranties, those subsidiaries may be required to remove
      loans from a securitization and replace them with cash or substitute loans,
      and
      to indemnify parties for any losses related to such breach. As of September
      30,
      2005 those subsidiaries neither had nor expect to incur any material obligation
      to remove any such loans, or to provide any such indemnification.





*Mortgage
      Servicing Rights*





The
      Company has committed to purchase the rights to service an additional
      unpaid principal balance of $1.1 billion of third party mortgage loans during
      the fourth quarter of 2005, of which $0.2 billion has been purchased during
      October 2005 for approximately $1.1 million.





*Impact
      of Hurricane Katrina*





In
      August
      2005, Hurricane Katrina made landfall in the U.S. Gulf Coast region. The
      Company is in the process of evaluating its mortgage loan portfolio in the
      affected areas for collectibility and evaluating its MSRs and real estate owned
      for impairment. The percentage of our mortgage loan portfolio and our loans
      underlying the MSRs in the federally declared disaster areas is 2% and 1%,
      respectively. Assessing the extent to which insurance coverage exists may be
      challenging. Also, many insurance policies exclude coverage for flood damage.
      Therefore, claims for insurance recoveries may be disputed if insured parties
      and their insurers disagree in their assessments of how much of the damage
      was
      due to wind versus flooding. Estimates of the full extent of real estate losses
      may take some time to tally. Furthermore, the Company believes that the impact
      of the hurricane may pose additional risks and uncertainties for its servicing
      and portfolio business segments, including: increase in tax and insurance
      advance costs; conflicts of claim management between homeowners insurance and
      flood policy insurance; delinquency and foreclosure advance costs on losses
      on
      mortgage loans secured by homes that might be damaged beyond repair; and an
      increase in non-payment of mortgage loans due to the displacement of homeowners
      and their inability to make their mortgage payments. The collectibility of
      the
      Company’s mortgage loan portfolio and valuation of the Company’s MSRs and real
      estate owned may be impacted by this exposure due to higher delinquency and
      foreclosure rates,


14


increased
      servicer advances due to non-payment of mortgage loans, increased loss
      severities, and added servicing costs needed to effectively and efficiently
      service these loans as these loans will require increased contact with the
      borrower to ensure that timely payments are rendered. Foreclosure timelines
      are
      likely to lengthen as a result of increased conflict between insurers and
      homeowners relating to coverage under applicable flood or homeowners insurance
      policies.





While
      the
      ultimate impact of Hurricane Katrina on the Company’s business is uncertain, it
      could result in a material adverse effect on the Company’s financial position
      and results of operations. As of September 30, 2005, the total recorded
      investment in impaired loans within our mortgage loan portfolio related to
      Hurricane Katrina is $114.2 million. The Company has recorded accruals for
      losses that it considers to be probable and that can be reasonably estimated.
      During the third quarter of 2005, the Company recorded a reserve of $6.8 million
      in connection with estimated losses in its mortgage loan portfolio due to
      Hurricane Katrina. This amount was determined based on an analysis of the
      specific pool of mortgage loans within the federally declared disaster areas
      segmented into categories based on an estimation of the extent of flooding
      in
      each such area. The pool was further segmented to exclude loans for properties
      covered by flood insurance and loans for which the Company had received
      correspondence from the borrower and/or actual property inspection reports
      indicating damage was less severe than expected. The remaining pool of loans’
      unpaid principal balances and their associated basis adjustments, advances
      and
      accrued interest were accumulated and a range of estimated percentage of loss
      severity was applied using different insurance coverage scenarios. This analysis
      yielded a range of possible loss estimates from $1.4 million to $9.4 million,
      with a best estimate of $6.8 million calculated using what the Company believes
      is the most probable loss severity and insurance coverage scenarios. This
      estimate is imprecise, and if different loss severities had been applied or
      if
      estimates of the extent of flooding had been altered, numerous different
      estimates may have been obtained. As additional information is obtained and
      processed over the coming months and quarters, this reserve will be revised
      accordingly.





The
      Company has also recorded an additional MSR impairment related to the foregoing
      matter of $0.4 million. This amount was determined based on an analysis of
      the
      specific pool of serviced mortgage loans within the federally declared disaster
      areas segmented into categories based on an estimation of the extent of flooding
      in each such area. The pool of serviced loans’ unpaid principal balances were
      accumulated and a percentage of loss was then applied to each segment to
      determine the amount of loan principal at risk. The resulting amount of loan
      principal at risk was then applied to the total MSR balance to determine the
      impact of impairment. This analysis yielded a range of possible loss estimates
      from $0.4 million to $0.5 million, with the lowest end of the range representing
      what the Company believes is the best estimate within the range, given the
      uncertain nature of the final outcome. This estimate is imprecise, and if
      different loss severities had been applied or if estimates of the extent of
      flooding had been altered, numerous different estimates may have been obtained.
      As additional information is obtained and processed over the coming months
      and
      quarters, this estimate will be revised accordingly.


15


No
      specific provision was recorded for the Company’s real estate owned properties
      as the Company’s analysis indicated that none of these properties are in
      the flooded areas.




*Legal
      Matters*




Because
      the business of the Company’s subsidiaries involves the collection of numerous
      accounts as well as the validity of liens and compliance with various state
      and
      federal lending laws, the Company and its subsidiaries are subject to various
      legal proceedings in the normal course of business. In management’s opinion, the
      resolution of these lawsuits will not have a material adverse effect on the
      financial position or the results of operations of the Company.





Bauer,
      et al., v. Dean Morris, L.L.P., et al., and Patterson,
      et al., v. Dean Morris, et al., are
      successor matters to Bauer,
      et al., v. Saxon Mortgage Services, Inc., et al., previously described in Part I, Item 3 of the Company’s 2004 Form 10-K. On
      January 26, 2005, the plaintiffs in Bauer,
      et al., v. Saxon Mortgage Services, Inc., et al. filed a
      motion to dismiss the case without prejudice, and the court entered an order
      dismissing the case on January 31, 2005. On February 17, 2005, the plaintiffs
      re-filed the case as two separate class action lawsuits, Bauer,
      et al., vs. Dean Morris, et al. ,
      filed
      as Case No. 05-2173 in the Civil District Court for the Parish of Orleans,
      State
      of Louisiana, and Patterson
      et al., v. Dean Morris, et al. ,
      filed
      as Case No. 05-2174 in the Civil District Court for the Parish of Orleans,
      State
      of Louisiana. There were no material developments in this legal proceeding
      during the quarter ended September 30, 2005. At this time, the Company cannot
      predict the outcome of this matter and cannot reasonably estimate a range of
      possible loss given the current status of the litigation; accordingly, no
      amounts have been accrued in the Company’s accompanying consolidated financial
      statements.





Cechini,
      et al., v. America’s MoneyLine, Inc .
      is a
      matter filed on August 10, 2005 in the United States District Court for the
      Northern District of Illinois, Eastern Division, as Case No. 05C 4570. The
      Plaintiff filed the case as a class action, alleging violation of the Fair
      Credit Reporting Act in connection with the use of pre-approved offers of credit
      by the Company’s subsidiary, America’s MoneyLine, Inc. At this time, the Company
      cannot predict the outcome of this matter and cannot reasonably estimate a
      range
      of possible loss given the current status of the litigation; accordingly, no
      amounts have been accrued in the Company’s accompanying consolidated financial
      statements.





The
      Company is also subject to other legal proceedings arising in the normal course
      of business. In the opinion of management, the resolution of these other
      proceedings is not expected to have a material adverse effect on the Company’s
      financial position or results of operations.


16








**(10)**  **Share-Based
      Compensation Plans**




Compensation
      cost that has been charged against income for the Company’s share-based
      compensation plans was $1.5
      million and $3.6 million for the three months ended September 30, 2005 and
      2004,
      respectively, and $3.1 million and $4.9 million for the nine months ended
      September 30, 2005 and 2004, respectively.





*Stock
      Incentive Plan* -
      Pursuant to the merger agreement in connection with the REIT conversion, the
      Company assumed the Saxon Capital, Inc. 2001 Stock Incentive Plan (the “Stock
      Incentive Plan”), which provides for the issuance of restricted common stock,
      stock appreciation rights, dividend equivalent rights, stock options, or unit
      awards based on the value of the Company’s common stock to eligible employees
      and other eligible participants. The maximum number of shares or other awards
      authorized for issuance under the Stock Incentive Plan is reset as of January
      1
      of each year at the greater of (i) 2,998,556; (ii) 10.69% of the total number
      of
      then outstanding shares of common stock of the Company as of January 1 of each
      year; or (iii) the maximum number that has been previously awarded or granted
      under the Stock Incentive Plan, provided that the total number of shares
      authorized to be issued under the Stock Incentive Plan may not exceed 6,000,000
      shares. The Compensation Committee of the Board of Directors administers the
      Stock Incentive Plan, and has full authority to select the recipients of awards,
      to decide when awards are to be made, to determine the type and number of
      awards, and to establish the vesting requirements as well as other features
      and
      conditions of each award.





All
      options granted under the Company’s Stock Incentive Plan were expensed as a
      result of the Company’s conversion to a REIT in the third quarter of 2004, and
      the Company has not granted any additional options in 2005. Accordingly, no
      additional expense was recorded for these options as a result of the adoption
      of
      SFAS 123(R).




The
      following table summarizes the transactions relating to the Company’s stock
      options for the nine months ended September 30, 2005.







**Number
                of**
              **Options**
            **Weighted
                Average**
              **Exercise
                Price**Options
                outstanding, December 31, 2004 (includes 11,000 options with a remaining
                contractual life of 6.8 years currently exercisable under the Stock
                Incentive Plan)
            11,000
            $10.10Options
                granted
            —
            $—Options
                exercised
            (5,000)
            $10.10Options
                cancelled
            —
            $—Options
                outstanding, September 30, 2005 (includes 6,000 options with a remaining
                contractual life of 6.1 years currently exercisable under the Stock
                Incentive Plan)
            6,000
            $10.10





17





Cash
      received from options exercised under all share-based payment arrangements
      for
      the nine months ended September 30, 2005 and 2004, was $50.5 thousand and $39.6
      million, respectively. The actual tax benefit realized for the tax deductions
      from option exercises under share-based payment arrangements totaled $1.3
      thousand and $19.7 million, respectively for the nine months ended September
      30,
      2005 and 2004. The total intrinsic value of options exercised during the first
      nine months of 2005 and 2004 was $34.7 thousand and $69.9 million,
      respectively.





*Restricted
      Stock Units -* In
      the
      first quarter of 2005, the Company granted an aggregate of 789,500 restricted
      stock units to some of the Company’s employees, including each executive
      officer. The restricted stock units will vest on the fifth anniversary of the
      date of grant. In addition, the Company granted an aggregate of 80,000
      restricted stock units to its four non-employee directors. The restricted stock
      units related to the non-employee directors will vest in four equal annual
      installments on each of the four anniversaries of the date of grant. The
      grantees of the restricted stock units are entitled to receive all dividends
      and
      other distributions paid with respect to the common shares of the Company
      underlying such restricted stock units at the time such dividends or
      distributions are paid to holders of common shares.




The
      Company recognizes compensation expense for outstanding restricted stock units
      over their vesting periods for an amount equal to the fair value of the
      restricted stock units at grant date. Fair value is determined by the price
      of
      the common shares underlying the restricted stock units on the grant date. As
      of
      September 30, 2005, there was $12.1 million of total unrecognized compensation
      cost related to nonvested restricted stock units granted under the Stock
      Incentive Plan. That cost is expected to be recognized over a weighted-average
      period of 4.1 years.




The
        Company recorded $0.5 million in reduction of expense during the third quarter
        of 2005 related to a change in the accounting for forfeitures of restricted
        stock units following the Company’s adoption of SFAS 123(R).


A
      summary
      of the status of the Company’s nonvested restricted stock units as of September
      30, 2005, and changes during the nine months ended September 30, 2005, is
      presented below:




**Number
                of Restricted**
              **Stock
                Units**
            **Weighted
                Average**
              **Grant-Date
                Fair Value**Non-vested
                at January 1, 2005
            —
            $—Granted
            869,500
            $21.50Vested
            (50,000)
            $21.50Forfeited
            (64,500)
            $21.50Non-vested
                at September 30, 2005
            755,000
            $21.50





** *Warrants*  **-** ****** In
      connection with the Company’s private offering in 2001, the Company granted
      warrants to Friedman, Billings, Ramsey & Co., Inc. (“FBR”) to




18


purchase
      an aggregate of 1,200,000 shares of our common stock, of which 1,192,000 have
      been exercised as of September 30, 2005. The 8,000 remaining warrants have
      an
      exercise price of $10.00 per share and are exercisable until they expire on
      July
      6, 2006.




*Employee
      Stock Purchase Plan* - The
      Company’s Employee Stock Purchase Plan authorizes the issuance of up to a total
      of 1,000,000 shares of common stock to participating employees. The 1,000,000
      share aggregate limitation will be adjusted proportionately for any increase
      or
      decrease in the number of outstanding shares of the stock. Under the terms
      of
      the Employee Stock Purchase Plan, eligible employees may have up to 15% of
      eligible compensation deducted from their pay during each offering period to
      purchase common stock. Purchases are made on the last trading day of the
      offering period. The per share purchase price is 85% of the last transaction
      price per share of the Company’s common stock on the last trading day of the
      offering period. The C ompany
      recognizes compensation expense for its Employee Stock Purchase Plan for an
      amount equal to the difference between the fair value and the sales price of
      the
      shares on the date of purchase.





The
      C ompany
      began recognizing compensation expense for its Employee Stock Purchase Plan
      with
      the adoption of SFAS 123(R) for an amount equal to the difference between the
      fair value and the sales price of the shares on the date of purchase, as a
      result of which the Company incurred $49.1 thousand of expense during the third
      quarter 2005.





Activity
      related to the Company’s Employee Stock Purchase Plan for the periods presented
      is as follows:





**Shares
                Issued**
            **Issuance
                Price**
            **Proceeds**(amounts
                in thousands, except issuance price)**For
                the Nine Months Ended September 30, 2005:**March
                31, 2005
            29.7
            $14.62
            $433.5June
                30, 2005
            18.5
            $14.51
            $267.9September
                30, 2005
            27.6
            $10.07
            $278.3




**(11)**  **Segments**




The
      operating segments reported below are the segments of the Company for which
      separate financial information is available and for which amounts are evaluated
      regularly by management in deciding how to allocate resources and in assessing
      performance. The Company’s segment information for the three and nine months
      ended September 30, 2004 has been restated to reflect a change in the
      composition of its reportable segments.





The
      portfolio segment uses the Company’s equity capital and borrowed funds to invest
      in its mortgage loan portfolio, thereby producing net interest income. The
      portfolio segment also records servicing expense associated with servicing
      its
      mortgage loan portfolio. The
      mortgage loan production segment purchases and originates non-conforming
      residential mortgage loans through relationships with various mortgage
      companies, mortgage brokers, and correspondent lenders, and directly to
      borrowers through its nine branch


19


offices.
      The mortgage loan production segment also records interest income, interest
      expense, servicing expense, and provision for mortgage loan losses on the
      mortgage loans it holds prior to selling its loans to the portfolio segment.
      This segment also collects revenues such as origination and underwriting fees
      and certain other nonrefundable fees that are deferred and recognized over
      the
      life of the loan as an adjustment to interest income recorded in the portfolio
      segment. The servicing segment services loans, seeking to ensure that loans
      are
      repaid in accordance with their terms.




**Three
                Months Ended September 30, 2005****Qualified
                REIT Subsidiary**
            **Taxable
                REIT Subsidiary**
            **Taxable
                REIT**
              **Subsidiary****Portfolio**
            **Mortgage
                Loan**
              **Production**
            **Servicing**
            **Eliminations**
            **Total**($
                in thousands)Interest
                income
            $107,482
            $4,075
            $(17)
            $4,145
            $115,685Interest
                expense
            (68,044)
            (2,371)
            —
            1,340
            (69,075)Net
                intercompany interest
            (500)
            829
            (329)
            —
            —Net
                interest income
            38,938
            2,533
            (346)
            5,485
            46,610Provision
                for mortgage loan losses
            (18,900)
            (469)
            —
            —
            (19,369)Net
                interest income after provision for mortgage loan losses
            20,038
            2,064
            (346)
            5,485
            27,241Servicing
                income, net of amortization and impairment
            —
            —
            26,321
            (7,257)
            19,064Gain
                (loss) on sale of mortgage assets
            3
            15,214
            (5,277)
            (9,896)
            44Total
                net revenues
            20,041
            17,278
            20,698
            (11,668)
            46,349Operating
                expenses
            12,859
            23,848
            12,375
            (9,282)
            39,800Other
                expense (income)
            985
            (1,655)
            305
            1,618
            1,253Income
                (loss) before taxes
            6,197
            (4,915)
            8,018
            (4,004)
            5,296Income
                tax expense (benefit)
            255
            (2,002)
            3,266
            (7,833)
            (6,314)**Net
                income (loss) before cumulative effect of change in accounting
                principle**
            $5,942
            $(2,913)
            $4,752
            $3,829
            $11,610








**Three
                Months Ended September 30, 2004****Portfolio**
            **Mortgage
                Loan**
              **Production**
            **Servicing**
            **Eliminations**
            **Total**($
                in thousands)Interest
                income
            $91,720
            $9,838
            $—
            $(1,901)
            $99,657Interest
                expense
            (35,022)
            (3,108)
            (113)
            310
            (37,933)Net
                intercompany interest
            775
            (1,871)
            1,096
            —
            —Net
                interest income
            57,473
            4,859
            983
            (1,591)
            61,724Provision
                for mortgage loan losses
            (13,639)
            (1,091)
            —
            —
            (14,730)Net
                interest income after provision for mortgage loan losses
            43,834
            3,768
            983
            (1,591)
            46,994Servicing
                income, net of amortization and impairment
            —
            —
            11,431
            (3,060)
            8,371Gain
                (loss) on sale of mortgage assets
            (4,940)
            9,992
            (3,543)
            (1,289)
            220Total
                net revenues
            38,894
            13,760
            8,871
            (5,940)
            55,585Operating
                expenses
            19,187
            16,993
            9,741
            (10,555)
            35,366Other
                expense (income)
            1,618
            (735)
            192
            (97)
            978Income
                (loss) before taxes
            18,089
            (2,498)
            (1,062)
            4,712
            19,241Income
                tax expense (benefit)
            (19,503)
            (993)
            (422)
            1,874
            (19,044)**Net
                income (loss)**
            $37,592
            $(1,505)
            $(640)
            $2,838
            $38,285





20




**Nine
                Months Ended September 30, 2005****Qualified
                REIT Subsidiary**
            **Taxable
                REIT Subsidiary**
            **Taxable
                REIT Subsidiary****Portfolio**
            **Mortgage
                Loan**
              **Production**
            **Servicing**
            **Eliminations**
            **Total**($
                in thousands)Interest
                income
            $316,147
            $14,388
            $(39)
            $10,890
            $341,386Interest
                expense
            (181,180)
            (7,287)
            —
            2,652
            (185,815)Net
                intercompany interest
            (561)
            991
            (430)
            —
            —Net
                interest income
            134,406
            8,092
            (469)
            13,542
            155,571Provision
                for mortgage loan losses
            (37,925)
            (626)
            —
            —
            (38,551)Net
                interest income after provision for mortgage loan losses
            96,481
            7,466
            (469)
            13,542
            117,020Servicing
                income, net of amortization and impairment
            —
            —
            70,622
            (20,769)
            49,853Gain
                (loss) on sale of mortgage assets
            55
            53,275
            (12,719)
            (38,160)
            2,451Total
                net revenues
            96,536
            60,741
            57,434
            (45,387)
            169,324Operating
                expenses
            34,249
            65,125
            35,220
            (22,586)
            112,008Other
                expense (income)
            2,028
            (2,404)
            620
            2,303
            2,547Income
                (loss) before taxes
            60,259
            (1,980)
            21,594
            (25,104)
            54,769Income
                tax (benefit) expense
            1,880
            (806)
            8,795
            (17,812)
            (7,943)**Net
                income (loss) before cumulative effect of change in accounting
                principle**
            $58,379
            $(1,174)
            $12,799
            $(7,292)
            $62,712





**Nine
                Months Ended September 30, 2004****Portfolio**
            **Mortgage
                Loan**
              **Production**
            **Servicing**
            **Eliminations**
            **Total**($
                in thousands)Interest
                income
            $260,380
            $31,217
            $11
            $(1,901)
            $289,707Interest
                expense
            (95,973)
            (9,957)
            (1,889)
            674
            (107,145)Net
                intercompany interest
            (1,680)
            (1,724)
            3,404
            —
            —Net
                interest income
            162,727
            19,536
            1,526
            (1,227)
            182,562Provision
                for mortgage loan losses
            (26,351)
            (2,417)
            —
            —
            (28,768)Net
                interest income after provision for mortgage loan losses
            136,376
            17,119
            1,526
            (1,227)
            153,794Servicing
                income, net of amortization and impairment
            —
            —
            34,287
            (14,093)
            20,194Gain
                (loss) on sale of mortgage assets
            (21,588)
            29,468
            (3,512)
            (1,289)
            3,079Total
                net revenues
            114,788
            46,587
            32,301
            (16,609)
            177,067Operating
                expenses
            55,588
            48,454
            24,010
            (30,293)
            97,759Other
                expense(income)
            2,987
            (50)
            703
            (272)
            3,368Income
                (loss) before taxes
            56,213
            (1,817)
            7,588
            13,956
            75,940Income
                tax expense (benefit)
            (7,330)
            (723)
            3,018
            5,550
            515**Net
                income (loss)**
            $63,543
            $(1,094)
            $4,570
            $8,406
            $75,425








21





Management
      evaluates assets only for the servicing and portfolio segments, and not for
      the
      production segment. Assets not identifiable to an individual segment are
      corporate assets, which are comprised of cash and other assets.





**September
                30, 2005**
            **December
                31, 2004****Segment
                Assets:**Portfolio
            $6,576,869
            $6,184,859Servicing
            294,755
            212,124Total
                segment assets
            $6,871,624
            $6,396,983Corporate
                assets
            165,966
            142,148Total
                assets
            $7,037,590
            $6,539,131





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




This
      discussion should be read in conjunction with the unaudited consolidated
      financial statements, notes and tables included elsewhere in this report and
      in
      the Saxon Capital, Inc. Annual Report on Form 10-K for the year ended December
      31, 2004, or the 2004 Form 10-K, filed with the Securities and Exchange
      Commission. Certain information contained in this Report constitutes
      forward-looking statements within the meaning of Section 27A of the Securities
      Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Generally,
      forward-looking statements can be identified by the use of forward-looking
      terminology including, but not limited to, “may,”“will,” “expect,”“intend,”“should,”“anticipate,”“estimate,”“is
      likely to,”“could,”“are confident that,” or “believe” or comparable terminology.
      All statements contained in this item as well as those discussed elsewhere
      in
      this report addressing our operating performance, events, or developments that
      we expect or anticipate will occur in the future, including statements relating
      to net interest income growth, earnings or earnings per share growth, and market
      share, as well as statements expressing optimism or pessimism about future
      operating results, are forward-looking statements. 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 dates of such statements. By their nature, all
      forward-looking statements involve risk and uncertainties. Actual results may
      differ materially from those contemplated by the forward-looking statements
      for
      a number of reasons. Factors that might cause actual results to differ from
      our
      plans and expectations and which could have a material adverse affect on our
      operations and future prospects include, but are not limited to:





·
            changes
                in overall economic conditions or changes in interest
                rates;





·
            our
                ability to successfully implement our growth
                strategy;





·
            greater
                than expected declines in consumer demand for residential mortgage
                loans,
                particularly non-conforming loans;





·
            our
                ability to sustain loan origination growth at levels sufficient to
                absorb
                costs of production and operational
                costs;




·
              continued availability of financing facilities
                and access
                to the securitization markets or other funding
                sources;


·
              our
                ability to complete securitizations of our loans at favorable financing
                rates;




·
            deterioration
                in the credit quality of our loan portfolio and the loan portfolios
                of
                others serviced by us;





·
            lack
                of access to the capital markets for additional
                funding;





·
            challenges
                in successfully expanding our servicing platform and technological
                capabilities;





·
            changes
                to the rating of our servicing
                operation;





·
            difficulty
                in satisfying complex rules in order for us to maintain qualification
                as a
                real estate investment trust, or REIT, for federal income tax
                purposes;





·
            the
                ability of certain of our subsidiaries to qualify as qualified REIT
                subsidiaries for federal income tax
                purposes;


22


·
            our
                ability and the ability of our subsidiaries to operate effectively
                within
                the limitations imposed by the federal income tax laws and regulations
                applicable to REITs;





·
            changes
                in federal income tax laws and regulations applicable to
                REITs;





·
            increasingly
                stringent servicing termination trigger
                events;





·
            increased
                prepayment speeds;





·
            decreased
                valuations of our mortgage loan portfolio and MSRs due to catastrophic
                environmental influences or natural disasters such as hurricanes,
                tornados
                and earthquakes;





·
            future
                litigation developments or regulatory or enforcement actions;
                and





·
            increased
                competitive conditions or changes in the legal and regulatory environment
                in our industry.





These
      risks and uncertainties should be considered in evaluating forward-looking
      statements, and undue reliance should not be placed on such statements. We
      undertake no obligation to update publicly any of these statements in light
      of
      future events except as required in subsequent periodic reports we file with
      the
      Securities and Exchange Commission.





The
      following sets forth the table of contents for this management’s discussion and
      analysis of financial condition and results of operations.






**Table
                of Contents**
            **Page**Executive
                Summary
            23Description
                of Other Data
            272005
                Events and Outlook
            28Critical
                Accounting Policies
            29Consolidated
                Results
            35Business
                Segment Results
            48Financial
                Condition
            53Liquidity
                and Capital Resources
            55Off
                Balance Sheet Items and Contractual Obligations
            60







**Executive
      Summary**




23


*Company
      Overview*




We
      are in
      the business of originating, securitizing, and servicing non-conforming mortgage
      loans, including sub-prime residential mortgage loans. We operate through three
      business segments. These segments are:





·
            Portfolio
                Management, or our portfolio
                segment;





·
            Mortgage
                Loan Servicing, or our servicing
                segment;





·
            Mortgage
                Loan Operations, or our mortgage loan production
                segment;





Through
      our taxable REIT subsidiary, Saxon Capital Holdings, Inc., and its subsidiaries,
      which we refer to collectively as our taxable REIT subsidiaries, we originate
      or
      purchase mortgage loans for our portfolio segment through our wholesale, retail,
      and correspondent channels, which we refer to collectively as our “mortgage loan
      production segment.” We earn most of our revenues from the interest income from
      those mortgages through our portfolio segment and from servicing loans for
      other
      companies through our servicing segment. We also earn revenues through whole
      loan sales of some of our mortgage loans. We pay interest to finance our
      mortgage loan portfolio and servicing advances and incur general and
      administrative expenses to operate our business. We maintain a provision for
      mortgage loan losses that may occur from impaired mortgage loans that are in
      our
      portfolio. We initially fund our mortgage loan originations through short-term
      warehouse lines of credit and through repurchase facilities. These short-term
      facilities are replaced by permanent financing when we securitize the loans.
      When our qualified REIT subsidiaries securitize our mortgage loans, they
      structure those transactions as financing transactions. As such, the mortgage
      loans and related debt to finance those loans remain on our balance sheet.




In
      general, the primary factors in our business that affect our revenues are
      changes in interest rates and changes in the size of our mortgage loan portfolio
      and servicing portfolio. Decreases in interest rates generally result in a
      decrease in the interest rates we charge on the mortgage loans we originate,
      but
      also may result in growth in our mortgage loan portfolio. Decreases also lead
      to
      increases in loan prepayments, which result in increases in prepayment penalty
      income, but decrease servicing income. In addition, decreases in interest rates
      reduce our cost to borrow, but generally lead to increases in our borrowings
      because loan originations tend to rise during periods of decreased interest
      rates.




Conversely,
      increases in interest rates generally result in an increase in the interest
      rates we charge on the mortgage loans we originate. Increases in interest rates
      also generally lead to decreases in loan prepayments, reducing prepayment
      penalty income, but increasing servicing income. In addition, increases in
      interest rates increase our cost to borrow but generally lead to decreases
      in
      our borrowings because loan originations tend to decline during periods of
      increased interest rates.


24




In
      general, the primary factors in our business that lead to increased expenses
      are
      the volume and credit mix of mortgage loans we originate or purchase, the number
      of retail branches and centralized origination and back-end operations platforms
      we operate, the number of sales representatives we employ, the volume of third
      party servicing we acquire, the costs to comply with governmental regulations,
      and the costs of being a public company. As our loan production increases and
      our loan portfolio grows, we would generally expect to hire additional employees
      and we would also expect our variable expenses to increase. Also, we may incur
      additional marketing and advertising expenses in order to achieve our production
      goals. There are also increased cash requirements that are associated with
      being
      a public company, such as investor relations’ responsibilities and expending the
      resources necessary to ensure that we have met the requirements set forth by
      the
      Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission and others,
      by hiring outside consultants and additional employees when required. From
      time
      to time, we may also be required to upgrade existing computer systems and focus
      on other beneficial projects, and during those periods we will experience
      increased expenses.




For
      the
      three months ended September 30, 2005 and 2004 we originated, purchased, or
      called approximately $0.8 billion and $1.0 billion, respectively, and
      securitized approximately $1.0 billion and $1.2 billion, respectively, of
      residential mortgage loans. For the nine months ended September 30, 2005 and
      2004 we originated, purchased, or called approximately $2.4 billion and $2.7
      billion, respectively, and securitized approximately $2.7 billion and $2.3
      billion, respectively, of residential mortgage loans. Called loans occur upon
      exercise of the clean-up call option by our taxable REIT subsidiaries, which
      serve as servicer or master servicer of various securitized pools within our
      mortgage loan servicing portfolio. A clean-up call option is an option to
      acquire all remaining mortgage loans, and any real estate owned, referred to
      as
      REO, in a securitized pool that arises at the time the aggregate unpaid
      scheduled principal balance of the loans declines to an amount that is less
      than
      10% of the aggregate unpaid scheduled principal balance of the total pool at
      the
      time of securitization. We did not exercise any clean-up call options during
      the
      first nine months of 2005.




We
      intend
      to continue accessing the asset-backed securitization market to provide
      long-term financing for our mortgage loans. We finance the loans initially
      using
      one of several different secured and committed warehouse financing facilities.
      These loans are subsequently financed using asset-backed securities issued
      through securitization trusts. From May 1996 to September 30, 2005, we
      securitized approximately $21.8 billion in mortgage loans. Since July 6, 2001,
      we have structured our securitizations as financing transactions for financial
      reporting purposes under accounting principles generally accepted in the United
      States of America, or GAAP. Accordingly, following a securitization, (1) the
      mortgage loans we originate or purchase remain on our consolidated balance
      sheet; (2) the securitization indebtedness 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.
      This accounting treatment more closely matches the recognition of income with
      the receipt of cash payments on the individual loans than does gain on sale
      accounting, which we used prior to July 6, 2001.


25




*Industry
      Overview and Prospective Trends*




Described
      below are some of the marketplace conditions and prospective trends that may
      impact our future results of operations.




According
      to the Mortgage Bankers Association of America website as of October 12, 2005,
      lenders in the United States originated $2.6 trillion in single-family mortgage
      loans in 2004. Approximately 44% of the loan originations in 2004 were
      attributable to mortgage loan refinancings by customers taking advantage of
      the
      decline in interest rates. As of October 12, 2005, lenders in the United States
      are expected to originate approximately $2.9 trillion in single-family mortgage
      loans in 2005. Generally, we believe sub-prime borrowers are not solely
      motivated by fluctuations in interest rates. We experienced a decrease of $151.8
      million, or 15%, in our production volume to $847.8 million for the third
      quarter of 2005 compared to $999.6 million for the third quarter of 2004.
      Similarly, we experienced a decrease of $0.3 billion, or 11%, in our production
      volume to $2.4 billion for the first nine months of 2005 compared to $2.7
      billion for the first nine months of 2004. Our production levels during the
      first nine months of 2005 were negatively impacted by the closing and/or
      divestiture of several of our retail branches, intense pricing competition
      existing in the marketplace throughout the first nine months of 2005 and the
      introduction of new products to the marketplace by our competitors.




The
      non-conforming, residential mortgage industry has become increasingly
      competitive in recent years. Today the industry is dominated by a small number
      of large companies. According to the B & C Lending Survey, the top three
      mortgage lenders controlled a combined 30% of the mortgage origination market
      as
      of June 30, 2005, up from 27% as of December 31, 2003, and up from 15% as of
      December 31, 1997. This market share domination has led to intense competition
      within the industry and has negatively impacted our profitability. Specifically,
      lenders in the industry have not raised interest rates in line with increases
      in
      market interest rates, which has reduced our net interest margin and negatively
      impacted our liquidity. Also, the introduction and concentration of
      interest-only products in 2004 and 40-year products in 2005 have negatively
      impacted spreads in the industry. We expect these trends to continue throughout
      2005. To compete effectively, we will be required to achieve and maintain a
      high
      level of operational, technological and managerial expertise and efficiencies,
      as well as an ability to attract capital at a competitive cost.




The
      non-conforming, residential mortgage industry is subject to extensive
      regulation, supervision and licensing by federal, state and local governmental
      authorities and our business is subject to various laws and judicial and
      administrative decisions imposing requirements and restrictions on a substantial
      portion of our operations. Changes to laws, regulations or regulatory policies
      can have a significant adverse effect on our operations and profitability.
      For
      example, proposed state and federal legislation targeted at predatory


26




lending
      could have the unintended consequence of raising the cost or otherwise reducing
      the availability of mortgage credit for non-prime borrowers. This could result
      in a reduction of otherwise legitimate non-prime lending opportunities and
      is
      likely to increase our legal and compliance costs.




Over
      the
      last several years, the housing price index has increased faster than the
      consumer price index and growth in personal income. We expect that this trend
      may slow in the coming years. Over the long term, however, we anticipate that
      housing appreciation will be positively correlated with both consumer price
      inflation and growth in personal income. Rising housing values point to healthy
      demand for purchase-money mortgage financing, increased average loan balances
      and a reduction in the risk of loss on sale of foreclosed real estate in the
      event a loan defaults. However, as housing values appreciate, prepayments of
      existing mortgages tend to increase as borrowers look to realize the additional
      equity in their homes. If housing prices should fall significantly, our future
      results of operations would be adversely affected.




**Description
      of Other Data**




In
      this
      Management's Discussion and Analysis of Financial Condition and Results of
      Operations, we present certain data that we consider helpful in understanding
      our financial condition and results of operations. Descriptions of these
      financial measures are set forth below.




*Net
      interest margin.* Net
      interest margin is calculated as the difference between our interest income
      and
      interest expense divided by our average interest-earning assets. Average
      interest-earning assets are calculated using a daily average balance over the
      time period indicated.




*Reconciliation
      of net losses on liquidated loans and charge-offs.* We
      present a reconciliation of net losses on liquidated loans and charge-offs
      because management believes that it is meaningful to show both measures of
      losses since it is a widely accepted industry practice to evaluate net losses
      on
      liquidated loans and the information is provided on a monthly basis to the
      investors in each securitization. GAAP requires losses to be recognized
      immediately upon a loan being transferred to REO, whereas net losses on
      liquidated loans do not recognize a loss on REO until the loan is sold. This
      causes a timing difference between charge-offs and net losses on liquidated
      loans. In addition, the net losses on liquidated loans exclude losses resulting
      from delinquent loan sales.




*Working
      capital.* It is
      common business practice to define working capital as current assets less
      current liabilities. We do not have a classified balance sheet and therefore
      calculate our working capital using our own internally defined formula, which
      is
      generally calculated as unrestricted cash and investments as well as
      unencumbered


27




assets
      that can be pledged against existing committed facilities and converted to
      cash
      in five days or less.





*Reconciliation
      of GAAP net income to estimated tax net income.* To
      maintain our status as a REIT, we are required to distribute at least 90% of
      our
      REIT taxable income each year to our shareholders. REIT taxable income is
      calculated under federal tax laws in a manner that, in certain respects, differs
      from the calculation of consolidated net income pursuant to GAAP. We expect
      that
      our consolidated GAAP net income may differ from our REIT taxable income for
      many reasons, including the following:




·
            the
              provision for mortgage loan loss expense recognized for GAAP purposes
              is
              based upon our estimate of probable loan losses inherent in our current
              portfolio of loans held for investment, for which we have not yet recorded
              a charge-off (tax accounting rules allow a deduction for loan losses
              only
              in the period when a charge-off occurs);




·
            there are several differences between
              GAAP
              and tax methodologies for capitalization of origination expenses;
              and


·
              income of a taxable REIT subsidiary
                is
                generally included in the REIT’s earnings for consolidated GAAP purposes,
                but is not recognized in REIT taxable
                income.








We
      expect
      that our REIT taxable income will continue to differ from our GAAP consolidated
      income, particularly during the period in which we build our mortgage loan
      portfolio.




Estimated
      REIT taxable income is a non-GAAP financial measure within the meaning of
      Regulation G promulgated by the Securities and Exchange Commission. Management
      believes that the presentation of REIT taxable income provides useful
      information to investors regarding our estimated annual distributions to our
      investors. The presentation of REIT taxable income is not to be considered
      in
      isolation or as a substitute for financial results prepared in accordance with
      GAAP.




Descriptions
      of certain components of our revenues and expenses are set forth in more detail
      in our 2004 Form 10-K.







**2005
      Events and Outlook**




During
      the third quarter of 2005, we made significant progress in increasing our
      staffing levels within our strategically located retail mortgage branches.
      Also,
      we have already begun to experience efficiencies and increased productivity
      from
      centralizing our wholesale and retail back-end operations during the first
      half
      of 2005 and expect this to continue in the future.





In
      the
      third quarter of 2005, we continued to experience an increase in short-term
      borrowing interest rates and faster prepayment speeds due to the popularity
      of
      interest-


28


only
      and
      other longer amortization products in the marketplace, and we continued to
      see a
      marked increase in competitive pricing, product, and credit exception practices
      within our industry. We also experienced an increase in the 2/3 year swap curve
      and six-month LIBOR curve, which positively impacted our hedge values. We
      anticipate these trends to continue through the remainder of the year.





During
      the third quarter of 2005, whole loan sale premiums continued to decline. If
      this trend continues, we may not utilize whole loan sales as a strategy for
      disposing of non-portfolio assets until the whole loan sale market provides
      economically attractive terms. In the meantime, we seek to avoid originating
      mortgage loans that are not suitable for our portfolio.





In
      August
      2005, Hurricane Katrina made landfall in the U.S. Gulf Coast region. We could
      incur significant losses as a result of this hurricane, which could have a
      material adverse effect on our financial position, results of operations and
      liquidity. Further details are discussed in “-- Consolidated
      Results.”





In
      addition, we intend to continue to grow our mortgage loan portfolio and
      servicing portfolio in order to produce higher levels of net interest income,
      and produce higher levels of servicing income. Management’s continued analysis
      and examination of our cost structure has resulted in a focus on controlling
      our
      general and administrative expenses while growing our mortgage loan portfolio
      and servicing portfolio in 2005.







**Critical
      Accounting Policies**




Management’s
      Discussion and Analysis of Financial Condition and Results of Operations
      discusses our consolidated financial statements, which have been prepared in
      accordance with GAAP. The preparation of these consolidated financial statements
      requires management to make estimates and assumptions that affect the reported
      amounts of assets and liabilities and the disclosure of contingent assets and
      liabilities as of the date of the consolidated financial statements and the
      reported amounts of revenues and expenses during the reporting period. On an
      on-going basis, management evaluates its estimates and judgments. Management
      bases its estimates and judgments on historical experience and on various other
      factors that are believed to be reasonable under the circumstances, the results
      of which form the basis for making judgments about the carrying values of assets
      and liabilities that are not readily apparent from other sources. Actual results
      may differ from these estimates and the estimates will change under different
      assumptions or conditions.





Critical
      accounting estimates are defined as those that reflect significant judgments
      and
      uncertainties and potentially result in materially different outcomes under
      different assumptions and conditions. Our critical accounting estimates are
      discussed below and consist of:





·
            amortization
                of yield adjustments to net interest
                income;




29


·
            allowance
                for loan loss;




·
            mortgage
                servicing rights;




·
            accounting
                for hedging activities;




·
            deferral
                of direct loan origination costs;
                and




·
            accounting
                for income taxes.





*Amortization
      of Yield Adjustments to Net Interest Income*




Net
      interest income is calculated as the difference between our interest income
      and
      interest expense. Interest income on our mortgage loan portfolio is a
      combination of accruing interest based on the outstanding balance and
      contractual terms of the mortgage loans and the amortization of yield
      adjustments using the interest method, principally the amortization of premiums,
      discounts, and other net capitalized fees or costs associated with originating
      our mortgage loans. These yield adjustments are amortized against interest
      income over the lives of the assets using the interest method adjusted for
      the
      effects of estimated prepayments. Management does not currently use the payment
      terms of each loan contract in the calculation of amortization. Because we
      hold
      a large number of similar loans for which prepayments are probable, we currently
      use a prepayment model to project loan prepayment activity based upon loan
      age,
      loan type and remaining prepayment penalty coverage. Estimating prepayments
      and
      estimating the remaining lives of our mortgage loan portfolio requires
      management judgment, which involves consideration of possible future interest
      rate environments and an estimate of how borrowers will behave in those
      environments. Reasonableness tests are performed against past history, mortgage
      asset pool specific events, current economic outlook and loan age to verify
      the
      overall prepayment projection. If these mortgage loans prepay at an actual
      speed
      that differs from the projections used in our estimates, GAAP requires us to
      adjust the remaining capitalized yield adjustments accordingly on a prospective
      and retrospective basis.




Mortgage
      prepayments generally increase on our adjustable rate mortgages when fixed
      mortgage interest rates fall below the then-current interest rates on
      outstanding adjustable rate mortgage loans. Prepayments on mortgage loans are
      also affected by the terms and credit grades of the loans, conditions in the
      housing and financial markets and general economic conditions. We have sought
      to
      minimize the effects caused by faster than anticipated prepayment rates by
      lowering premiums paid to acquire mortgage loans, which decreases the balance
      of
      premiums to be amortized, and by purchasing and originating mortgage loans
      with
      prepayment penalties. Those penalties typically expire two to three years from
      origination. As of September 30, 2005, approximately 74% of our mortgage loan
      portfolio had active prepayment penalty features. We anticipate that prepayment
      rates on a significant portion of our adjustable rate mortgage portfolio will
      increase as these adjustable rate loans reach their initial adjustments during
      2005 and 2006, due to the high concentration of two to three year hybrid loans
      we originated or purchased during 2002 and 2003. However, management expects
      that the amendments to government regulations related to the Alternative
      Mortgage Transactions Parity Act, which restricted the ability of
      state-chartered mortgage lenders to charge prepayment penalties on certain
      types


30


of
      mortgage loans, effective July 1, 2003, could reduce the percentage of our
      loans
      with active prepayment penalty features in future periods. The constant
      prepayment rate, or CPR, currently used to project cash flows is 35% over twelve
      months. Actual
      prepayment penalty income is recorded when the cash is collected and is not
      recorded based on CPR assumptions. Therefore, in instances where our CPR
      increases, we anticipate also having an increase in prepayment penalty
      income.




Interest
      expense on our warehouse and securitization financings is a combination of
      accruing interest based on the contractual terms of the financing arrangements
      and the amortization of premiums, discounts, debt issuance costs, and
      accumulated other comprehensive income relating to cash flow hedging. These
      yield adjustments are amortized against interest expense over the life of the
      debt, in a manner similar to that described above, using the interest method
      based on the estimated payments on the debt.







*Allowance
      for Loan Loss*





The
      allowance for loan loss is established through the provision for mortgage loan
      losses, which is charged to earnings on a monthly basis. The accounting estimate
      of the allowance for loan loss is considered critical as significant changes
      in
      the mortgage loan portfolio, which includes both securitized and unsecuritized
      mortgage loans, and/or economic conditions may affect the allowance for loan
      loss and our results of operations. The assumptions used by management regarding
      these key estimates are highly uncertain and involve a great deal of judgment.





Provisions
      are made to the allowance for loan loss for currently impaired loans in the
      outstanding mortgage loan portfolio. We define a mortgage loan as impaired
      at
      the time the loan becomes 30 days delinquent under its payment terms.
      Charge-offs to the allowance are recorded at the time of liquidation or at
      the
      time the loan is transferred to real estate owned (REO) status. The allowance
      for loan loss is regularly evaluated by management for propriety by taking
      into
      consideration factors such as: changes in the nature and volume of the loan
      portfolio; trends in actual and forecasted portfolio performance and credit
      quality, including delinquency, charge-off and bankruptcy rates; and current
      economic conditions that may affect a borrower’s ability to pay and the
      underlying value of the collateral. An internally developed roll rate analysis,
      static pool analysis and historical losses are the primary tools used in
      analyzing our allowance for loan loss. Our roll rate analysis is defined as
      the
      historical progression of our loans through the various delinquency statuses.
      Our static pool analysis provides data on individual pools of loans based on
      year of origination. These tools take into consideration historical information
      regarding delinquency and loss severity experience and apply that information
      to
      the portfolio and the portfolio’s basis adjustments. Loss severity is defined as
      the total loss amount divided by the actual unpaid principal balance at the
      time
      of liquidation. Total loss amounts include all accrued interest, fees, principal
      balances, all costs of liquidating and all other servicing advances for taxes,
      property insurance, and other servicing costs incurred and invoiced to us within
      90 days following the liquidation date. If actual results differ from our
      estimates, we will adjust our provision accordingly. Likewise, the use of
      different estimates or assumptions could produce different provisions for loan
      losses.


31


During
      the third quarter of 2005, we recorded a reserve of $6.8 million in connection
      with estimated losses in our mortgage loan portfolio due to Hurricane Katrina.
      This amount was determined based on an analysis of the specific pool of mortgage
      loans within the federally declared disaster areas segmented into categories
      based on an estimation of the extent of flooding in each such area. The pool
      was
      further segmented to exclude loans for properties covered by flood insurance
      and
      loans for which we had received correspondence from the borrower and/or actual
      property inspection reports indicating damage was less severe than expected.
      The
      remaining pool of loans’ unpaid principal balances and their associated basis
      adjustments, advances and accrued interest were accumulated and a range of
      estimated percentage of loss severity was applied using different insurance
      coverage scenarios. This analysis yielded a range of possible loss estimates
      from $1.4 million to $9.4 million, with a best estimate of $6.8 million,
      calculated using what we believe to be the most probable loss severity and
      insurance coverage scenarios. This estimate is imprecise, and if different
      loss
      severities had been applied or if estimates of the extent of flooding had been
      altered, numerous different estimates may have been obtained. As additional
      information is obtained and processed over the coming months and quarters,
      this
      reserve will be revised accordingly.





*Mortgage
      Servicing Rights*





The
      valuation of mortgage servicing rights, or MSRs, requires that we make estimates
      of numerous market assumptions. Interest rates, prepayment speeds, servicing
      costs, discount rates, and the payment performance of the underlying loans
      significantly affect the fair value and the rate of amortization of MSRs.
      Increasing prepayments attributable to increased mortgage refinancing activity
      result in a decline in the value of MSRs.





The
      carrying values of the MSRs are amortized in proportion to, and over the period
      of, the anticipated net servicing income. MSRs are assessed periodically to
      determine if there has been any impairment to the carrying value, based on
      the
      fair value as of the date of the assessment and by stratifying the MSRs based
      on
      underlying loan characteristics, including the date of the related
      securitization. We obtain quarterly independent valuations for our
      MSRs.




Due
      to
      subsequent changes in economic and other relevant conditions, the actual rates
      of prepayments and defaults and the value of collateral generally differ from
      our initial estimates, and these differences are sometimes material. If actual
      prepayment and default rates were higher than those assumed, we would earn
      less
      mortgage servicing income, which would adversely affect the value of the MSRs.
      Significant changes in prepayment speeds, delinquencies, and losses may result
      in impairment of most of our MSRs. On a quarterly basis, we perform an
      impairment analysis using independent valuations that we obtain each quarter,
      and considering estimates of numerous market assumptions, changes in interest
      rates, prepayment speeds, servicing costs, discount rates, and the payment
      performance of the underlying loans, all of which could significantly affect
      the
      fair value and the rate of amortization of MSRs. If we determine that a pool
      of
      MSRs is impaired, we analyze certain attributes of that pool to assess whether
      the impairment
      is temporary or permanent. If we conclude that the impairment is temporary,
      we
      establish a valuation allowance and record an expense. Charge-offs to the
      valuation allowance are recorded if we conclude that the impairment is
      permanent.


32





During
      the third quarter of 2005, we recorded an additional MSR impairment related
      to
      the damage caused by Hurricane Katrina of $0.4 million. This amount was
      determined based on an analysis of the specific pool of serviced mortgage loans
      within the federally declared disaster areas segmented into categories based
      on
      an estimation of the extent of flooding in each such area. The pool of serviced
      loans’ unpaid principal balances were accumulated and a percentage of loss was
      then applied to each segment to determine the amount of loan principal at risk.
      The resulting amount of loan principal at risk was then applied to the total
      MSR
      balance to determine the impact of impairment. This analysis yielded a range
      of
      possible loss estimates from $0.4 million to $0.5 million, with the lowest
      end
      of the range representing what we believe is the best estimate within the range,
      given the uncertain nature of the final outcome. This estimate is imprecise,
      and
      if different loss severities had been applied or if estimates of the extent
      of
      flooding had been altered, numerous different estimates may have been obtained.
      As additional information is obtained and processed over the coming months
      and
      quarters, this estimate will be revised accordingly.





*Accounting
      for Hedging Activities*




We
      incorporate the use of derivative instruments to manage certain risks associated
      with changes in interest rates. We have qualified certain derivative instruments
      to be accounted for as cash flow hedges. A key element to qualify for hedge
      accounting is the maintenance of adequate documentation of the hedging
      relationship and our risk management objective and strategy for undertaking
      the
      hedge. To qualify, on the date a derivative instrument agreement is entered
      into, we designate the derivative as a hedge of a forecasted transaction or
      as a
      hedge of the variability of cash flows to be paid related to a recognized
      liability. Our forecasted transaction is an asset-backed securitization, an
      essential element in our business model. Historically, we have completed an
      asset-backed securitization approximately three to four times a year. The
      asset-backed market utilizes the swap curve as base interest rates when pricing
      the type of debt securities we issue. As a result, we utilize swaps or
      instruments that emulate swaps to minimize the interest rate risk over the
      life
      of the mortgage financing cycle.





To
      qualify for hedge accounting, we must demonstrate initially, and on an ongoing
      basis, that our derivative instruments are expected and have demonstrated
      themselves to be highly effective at offsetting the designated risk. The
      determination of effectiveness is the primary assumption and estimate used
      in
      accounting for our hedge transactions. We consider the swap rate and Eurodollar
      prices used in our assessment and measurement of effectiveness to be the most
      appropriate data points to use given the characteristics of the derivative
      and
      hedged item. In instances where we use swaps as a hedge, the swap rate is fixed
      and compared monthly to the one-month London Inter-Bank Offered Rate, or LIBOR,
      index. The payment of interest on our debt issued in a securitization
      transaction is also based on one-month LIBOR. Because our swaps and debt
      payments are based upon the same index on the same reset day, the change in
      the
      cash flows of the swaps are assumed by us to equal the change in cash flows
      of
      the hedged item. Likewise, when we use options,


33


such
      as
      caps and floors, as a hedge, the change in the cash flows of the options are
      assumed to equal the change in cash flows of the hedged item, to the extent
      of
      the effective notional balance of the hedge, because these options are
      based on the LIBOR index. In the case where we may use Eurodollar futures,
      the
      correlation calculation is calculated by capturing historic swap rates and
      the
      corresponding Eurodollar prices, and then calculating a financing rate, for
      the
      maturity deemed necessary. The impact of market changes on the hedged item
      and
      the derivative are recorded over the relevant hedging periods and correlation
      statistics are evaluated by performing a regression analysis on a quarterly
      basis. Quarterly data points are selected and used in the regression analysis
      to
      determine a correlation percentage. The difference between a 100% correlation
      result (slope) and our actual correlation percentage is used to calculate the
      ineffective portion related to the Eurodollar futures, which is recorded as
      other expense in the Statement of Operations.





If
      we
      have been unable to qualify certain of our interest rate risk management
      activities for hedge accounting, then the change in fair value of the associated
      derivative financial instruments is reflected in current period earnings, but
      the impact from the change in anticipated cash flows of the related liability
      is
      not, which creates an earnings mismatch. During the first nine months of 2005,
      certain of our derivative instruments did not qualify for hedge treatment. The
      changes in fair value of these contracts offset one another; therefore, they
      had
      no net impact on our earnings.







*Deferral
      of Direct Loan Origination Costs*





We
      incur
      certain direct loan origination costs in connection with our loan origination
      activities. Such amounts are recognized over the life of the related loans
      as an
      adjustment of yield, as discussed above in the section relating to our critical
      accounting estimate with respect to accounting for net interest
      income.





We
      determine the amount of direct loan origination costs to be deferred based
      on an
      estimate of the standard cost per loan originated. The standard cost per loan
      is
      based on the amount of time spent and costs incurred by loan origination
      personnel in the performance of certain activities directly related to the
      origination of funded mortgage loans. These activities include evaluating the
      prospective borrower’s financial condition, evaluating and recording collateral
      and security arrangements, negotiating loan terms, processing loan documents
      and
      closing the loan. Management believes these estimates reflect an accurate cost
      estimate related to successful loan origination efforts for the three and nine
      months ended September 30, 2005 as defined by GAAP. Management evaluates its
      time and cost estimates quarterly to determine if updates and refinements to
      the
      deferral amounts are necessary. Updates would be considered necessary if it
      was
      determined that the time spent and/or costs incurred related to performing
      the
      above activities had significantly changed from the previous period. This
      estimate is made for all loans originated by our wholesale and retail channels.
      Correspondent production is not included, as we purchase these loans as closed
      loans and therefore, loan origination costs related to these purchases are
      recorded as incurred.


34


*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.
      As
      of September 30, 2005, we had not recorded a valuation allowance on our deferred
      tax assets based on management’s belief that operating income will, more likely
      than not, be sufficient to realize the benefit of these assets over time. The
      evaluation of the need for a valuation allowance takes into consideration our
      taxable income, current tax position, and estimates of taxable income in the
      near term. The tax character (ordinary versus capital) and the carryforward
      periods of certain tax attributes such as capital losses and tax credits must
      also be considered. Significant judgment is required in considering the relative
      impact of negative and positive evidence related to the ability to realize
      deferred tax assets. In the event that actual results differ from these
      estimates or if our current trend of positive taxable income changes, we may
      be
      required to record a valuation allowance on our deferred tax assets, which
      could
      have a material adverse effect on our consolidated financial condition and
      results of operations. We recognize deferred tax assets if we believe that
      it is
      more likely than not, given all available evidence, that all 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 we will realize the benefit from our deferred tax
      assets.





We
      have
      sought to comply with the REIT provisions of the Internal Revenue Code for
      the
      nine months ended September 30, 2005 and intend to continue to do so.
      Accordingly, we expect to not be subject to federal or state income tax on
      net
      income that is distributed to shareholders to the extent that our annual
      distributions to shareholders are equal to at least 90% of our REIT taxable
      income (determined without regard to the deduction for dividends paid and by
      excluding any net capital gain) **** for
      a
      given year and as long as certain asset, income and stock ownership tests are
      met. In the event that we do not qualify as a REIT in any year, we will be
      subject to federal income tax as a domestic corporation and the amount of our
      after-tax cash available for distribution to our shareholders will be reduced.
      However, our taxable REIT subsidiaries will be subject to federal and state
      income tax and we intend to continue to employ the accounting policy described
      above with respect to our taxable REIT subsidiaries.





For
      further information about our critical accounting policies, refer to our 2004
      Form 10-K.




**Consolidated
      Results**





*Three
      and Nine Months Ended September 30, 2005 versus Three and Nine Months Ended
      September 30, 2004*





*Overview.* Net
      income decreased $26.7 million, or 70%, to $11.6 million for the three months
      ended September 30, 2005 from $38.3 million for the three months ended September
      30, 2004. Net income decreased $12.7 million, or 17%, to $62.7 million for
      the
      nine months ended September 30, 2005 from $75.4 million for the nine months
      ended September 30, 2004.




35


The
      decrease was primarily the result of a decrease in our net interest income
      after
      provision for mortgage loan losses and an increase in our total expenses. This
      decrease was partially offset by increases in servicing income. Overall, our
      net
      income was positively impacted by the growth in our mortgage loan and servicing
      portfolios and was negatively affected by an increase in one-month LIBOR rates,
      which significantly increased our borrowing costs while intense price
      competition has severely limited our ability to increase the interest rates
      we
      charge on our mortgage loans. To the extent that we continue to grow our
      mortgage loan and servicing portfolios, we would expect an increase in interest
      income and servicing income. However, if one-month LIBOR rates continue to
      rise
      and pricing pressures impede our ability to increase the interest rates we
      charge on our mortgage loans accordingly, the increased interest income would
      be
      offset by higher interest expense. Also, our ability to grow our mortgage loan
      portfolio could be negatively impacted by the intense pricing pressures
      currently being experienced in our industry.




**Revenues**





*Total
      Net Revenues.* Total
      net revenues decreased $9.3 million, or 17%, to $46.3 million for the three
      months ended September 30, 2005 from $55.6 million for the three months ended
      September 30, 2004. Total net revenues decreased $7.8 million, or 4%, to $169.3
      million for the nine months ended September 30, 2005 from $177.1 million for
      the
      nine months ended September 30, 2004. The decrease in total net revenues was
      due
      primarily to a decrease in our net interest income relating to increased
      borrowing costs, and an increase in our provision for mortgage loan losses.
      These decreases were partially offset by an increase in our servicing income,
      net of amortization and impairment. During the last year, our interest income
      has not grown at the same rate as our interest expense. This lack of growth
      is
      due to the intense pricing competition affecting the sub-prime residential
      mortgage loan industry as well as the lowering of accretion on our hedges as
      they were negatively impacted by the flattening of the 2/3 year swap curve
      during the first half of 2005. However, this curve increased overall
      during
      the third quarter, positively impacting our hedge values.




*Interest
      Income* .
      Interest income increased $16.0 million, or 16%, to $115.7 million for the
      three
      months ended September 30, 2005, from $99.7 million for the three months ended
      September 30, 2004. Interest income increased $51.7 million, or 18%, to $341.4
      million for the nine months ended September 30, 2005, from $289.7 million for
      the nine months ended September 30, 2004. The increase in interest income was
      due primarily to growth in our mortgage loan portfolio, as well as decreased
      amortization of our yield adjustments and our fair value hedges. This increase
      was partially offset by (1) the impact of lower weighted-average coupon rates
      (WAC) on our mortgage loans and (2) a decrease in prepayment penalty income.
      The
      WAC on our production for 2004 and for the first nine months of 2005, which
      represents 96% of our owned portfolio, was negatively impacted by prepayments
      on
      higher WAC loans, the resetting of adjustable rate mortgage loans in our
      portfolio as well as the intense pricing competition affecting the sub-prime
      residential mortgage loan industry. Competition had less of an effect on the
      WAC
      on our mortgage loans during the first nine months of 2004 compared to the
intensely
      competitive environment we are currently experiencing in 2005. The components
      of
      these decreases are discussed in more detail below.


36





*Rate/Volume
      Table For the Three and Nine Months Ended September 30, 2005 Compared to the
      Three and Nine Months Ended September 30, 2004*





As
      shown
      in the table below, compared to the three and nine months ended September 30,
      2004, our interest income increased $13.1 million and $54.0 million for the
      three and nine months ended September 30, 2005, respectively, due to an increase
      in the size of our mortgage loan portfolio, and increased $3.1 million and
      $0.3
      million for the three and nine months ended September 30, 2005, respectively,
      due to an increase in the WAC, net of amortization, on our mortgage loan
      portfolio.







**Three
                Months Ended September 30, 2005**
              **Compared
                to**
              **Three
                Months Ended September 30, 2004**
            **Nine
                Months Ended September 30, 2005**
              **Compared
                to**
              **Nine
                Months Ended September 30, 2004******
            **Change
                in Rate**
            **Change
                in Volume**
            **Total
                Change in Interest Income**
            **Change
                in Rate**
            **Change
                in Volume**
            **Total
                Change in Interest Income**(in
                thousands)Securitized
                loans
            $3,078
            $15,294
            $18,372
            $(2,106)
            $58,431
            $56,325Warehouse
                loans
            (143)
            (2,157)
            (2,300)
            1,810
            (4,537)
            (2,727)Mortgage
                bonds
            179
            14
            193
            546
            144
            690Other
            —
            (27)
            (27)
            —
            (36)
            (36)Total
            $3,114
            $13,124
            $16,238
            $250
            $54,002
            $54,252Prepayment
                penalty income
            —
            —
            (210)
            —
            —
            (2,573)$16,028
            
            
            $51,679





*Interest
      Income Yield Analysis For the Three and Nine Months Ended September 30, 2005
      and
      2004*




The
      following table presents the average yield on our interest-earning assets for
      the three and nine months ended September 30, 2005 and 2004.





**Three
                Months Ended September 30, 2005**
            **Three
                Months Ended September 30, 2004******
            **Average**
              **Balance**
            **Interest**
              **Income**
            **Average**
              **Yield**
            **Average**
              **Balance**
            **Interest**
              **Income**
            **Average**
              **Yield**($
                in thousands)Gross
            $6,132,934
            $110,727
            7.22%
            $5,375,840
            $98,572
            7.33%Less
                amortization of yield adjustments (1)
            —
            (3,420)
            (0.22)%
            —
            (5,202)
            (0.39)%Less
                amortization of fair value hedges
            —
            (693)
            (0.05)%
            —
            (3,039)
            (0.23)%$6,132,934
            $106,614
            6.95%
            $5,375,840
            $90,331
            6.71%Add
                prepayment penalty income
            —
            9,071
            0.59%
            —
            9,326
            0.69%**Total
                interest-earning assets**
            $6,132,934
            $115,685
            7.54%
            $5,375,840
            $99,657
            7.40%





**Nine
                months ended September 30, 2005**
            **Nine
                months ended September 30, 2004******
            **Average**
              **Balance**
            **Interest**
              **Income**
            **Average**
              **Yield**
            **Average
                Balance**
            **Interest**
              **Income**
            **Average**
              **Yield**($
                in thousands)Gross
            $6,070,007
            $338,448
            7.43%
            $5,029,513
            $294,881
            7.82%Less
                amortization of yield adjustments (1)
            —
            (16,284)
            (0.36)%
            —
            (18,316)
            (0.49)%Less
                amortization of fair value hedges
            —
            (5,189)
            (0.11)%
            —
            (13,887)
            (0.37)%$6,070,007
            $316,975
            6.96%
            $5,029,513
            $262,678
            6.96%Add
                prepayment penalty income
            —
            24,411
            0.54%
            —
            27,029
            0.72%**Total
                interest-earning assets**
            $6,070,007
            $341,386
            7.50%
            $5,029,513
            $289,707
            7.68%


_______________


(1)  Yield
      adjustments include premiums, discounts, net deferred origination costs and
      nonrefundable fees.





37


The
      increase in gross interest income is consistent with the growth of our mortgage
      loan portfolio. Our gross mortgage loan portfolio increased $0.7 billion, or
      13%, to $6.3 billion as of September 30, 2005 from $5.6 billion as of September
      30, 2004. However, this growth was offset partially by the 39 basis point
      decrease in gross WAC for the nine months ended September 30, 2005 as compared
      to the nine months ended September 30, 2004 due to intense pricing competition,
      the liquidation of higher WAC loans, and the increase in the credit quality
      of
      our mortgage loan portfolio. We anticipate that our gross interest income in
      dollars will continue to grow as our mortgage loan portfolio grows and as the
      adjustable rate mortgage loans in our portfolio reset. This growth could be
      negatively impacted by continuation of the intense pricing pressures we are
      currently experiencing.





Amortization
      expense of yield adjustments decreased $1.8 million, or 35%, to $3.4 million
      for
      the three months ended September 30, 2005 from $5.2 million for the three months
      ended September 30, 2004, and decreased $2.0 million, or 11%, to $16.3 for
      the
      nine months ended September 30, 2005 from $18.3 million for the nine months
      ended September 30, 2004. During the three and nine months ended September
      30,
      2005, the decrease in amortization expense of yield adjustments was due to
      a
      significant increase in the projected forward 6-month LIBOR curve.




The
      amortization expense of fair value hedges decreased $2.3 million, or 77%, to
      $0.7 million for the three months ended September 30, 2005 from $3.0 million
      for
      the three months ended September 30, 2004, and decreased $8.7 million, or 63%,
      to $5.2 million for the nine months ended September 30, 2005 from $13.9 million
      for the nine months ended September 30, 2004. The balance of our fair value
      hedges as of September 30, 2004 was $32.2 million compared to our balance of
      $25.1 million as of September 30, 2005. We expect amortization of fair value
      hedges to continue to decline in future years as we now use cash flow hedging
      for all hedging transactions that qualify for hedge accounting and, as a result,
      we expect that the balance of fair value hedges being amortized, which was
      $25.1
      million at September 30, 2005, will continue to decrease.





Prepayment
      penalty income decreased $0.2 million, or 2%, to $9.1 million for the three
      months ended September 30, 2005 from $9.3 million for the three months ended
      September 30, 2004, and decreased $2.6 million, or 10%, to $24.4 million for
      the
      nine months ended September 30, 2005 from $27.0 million for the nine months
      ended September 30, 2004. Despite
      the return of faster prepayment speeds during the third quarter of 2005, we
      were
      unable to collect prepayment penalty income on a portion of our prepaid loans
      due to the amendment of government regulations related to the Alternative
      Mortgage Transactions Parity Act. We expect that these amendments could continue
      to reduce our prepayment penalty income in future periods.





*Securitized
      Mortgage Loan Coupon and Prepayment Penalty Coverage*


38


Our
      WAC
      on our securitizations has decreased since 2001 due to (1) our origination
      of
      higher credit grade mortgage loans from 2001 through the third quarter of 2005,
      (2) the prepayments of higher WAC loans; and (3) recent intense pricing
      competition. The WAC on future production could be negatively impacted by the
      intense pricing pressures and flattened yield curve if the current environment
      persists.





Our
      loan
      principal balance was composed of 68% adjustable rate loans and 32% fixed rate
      loans at September 30, 2005. The percentage of our adjustable rate loans in
      their reset period was 12% at September 30, 2005. The following tables set
      forth
      information about our securitized mortgage loan portfolio including those loans
      associated with our securitized REO properties as of September 30, 2005 and
      December 31, 2004.





**Issue
                Date**
            **Original
                Loan Principal Balance**
            **Current
                Loan Principal Balance**
            **Fixed
                Current Loan Principal Balance**
            **Arm
                Current Loan Principal Balance**
            **Percentage**
              **of
                Portfolio**
            **Percentage**
              **of****Original**
              **Remaining**
            **Remaining**
              **WAC****Fixed**
            **Remaining**
              **WAC
                Arm**($
                in thousands)September
                30, 2005SAST
                2001-2
            8/2/2001
            $650,410
            $104,500
            $74,028
            $30,472
            2%
            16%
            9.22%
            10.17%SAST
                2001-3
            10/11/2001
            $699,999
            $94,606
            $40,245
            $54,361
            2%
            14%
            9.93%
            9.86%SAST
                2002-1
            3/14/2002
            $899,995
            $160,066
            $86,651
            $73,415
            3%
            18%
            8.88%
            9.44%SAST
                2002-2
            7/10/2002
            $605,000
            $117,792
            $52,002
            $65,790
            2%
            19%
            8.95%
            9.47%SAST
                2002-3
            11/8/2002
            $999,999
            $229,180
            $99,708
            $129,472
            4%
            23%
            8.33%
            8.87%SAST
                2003-1
            3/6/2003
            $749,996
            $221,300
            $134,549
            $86,751
            4%
            30%
            7.39%
            8.66%SAST
                2003-2
            5/29/2003
            $599,989
            $181,103
            $95,691
            $85,412
            3%
            30%
            7.23%
            7.94%SAST
                2003-3
            9/16/2003
            $1,000,000
            $406,334
            $212,097
            $194,237
            7%
            41%
            7.19%
            7.85%SAST
                2004-1
            2/19/2004
            $1,099,999
            $558,433
            $171,116
            $387,317
            9%
            51%
            7.82%
            7.40%SAST
                2004-2
            7/27/2004
            $1,199,994
            $787,680
            $418,958
            $368,722
            13%
            66%
            6.97%
            6.68%SAST
                2004-3
            10/27/2004
            $899,956
            $639,496
            $111,511
            $527,985
            11%
            71%
            7.80%
            7.06%SAST
                2005-1
            1/25/2005
            $999,972
            $808,574
            $113,536
            $695,038
            14%
            81%
            7.39%
            6.78%SAST
                2005-2
            6//07/2005
            $979,990
            $906,830
            $140,295
            $766,535
            15%
            93%
            7.51%
            7.18%SAST
                2005-3
            9/29/2005
            $759,446
            $756,074
            $152,072
            $604,002
            13%
            100%
            7.19%
            7.29%Total
            
            $12,144,745
            $5,971,968
            $1,902,459
            $4,069,509Less:
                unpaid principal balance of securitized
              REO
                properties
            (43,608)Total
                securitized loans
            $5,928,360December
                31, 2004SAST
                2001-2
            8/2/2001
            $650,410
            $142,563
            $98,239
            $44,324
            3%
            22%
            9.35%
            9.85%SAST
                2001-3
            10/11/2001
            $699,999
            $141,710
            $54,027
            $87,683
            3%
            20%
            10.01%
            9.60%SAST
                2002-1
            3/14/2002
            $899,995
            $247,779
            $118,020
            $129,759
            5%
            28%
            8.87%
            9.01%SAST
                2002-2
            7/10/2002
            $605,000
            $192,448
            $74,037
            $118,411
            4%
            32%
            8.87%
            9.16%SAST
                2002-3
            11/8/2002
            $999,999
            $352,051
            $133,009
            $219,042
            7%
            35%
            8.34%
            8.31%SAST
                2003-1
            3/6/2003
            $749,996
            $344,066
            $178,206
            $165,860
            7%
            46%
            7.45%
            8.09%SAST
                2003-2
            5/29/2003
            $599,989
            $317,171
            $132,299
            $184,872
            6%
            53%
            7.30%
            7.41%SAST
                2003-3
            9/16/2003
            $1,000,000
            $616,099
            $280,365
            $335,734
            12%
            62%
            7.23%
            7.52%SAST
                2004-1
            2/19/2004
            $1,099,999
            $835,925
            $226,877
            $609,048
            16%
            76%
            7.85%
            7.39%SAST
                2004-2
            7/27/2004
            $1,199,994
            $1,097,890
            $532,313
            $565,577
            21%
            91%
            7.02%
            6.74%SAST
                2004-3
            10/27/2004
            $899,956
            $877,628
            $133,122
            $744,506
            17%
            98%
            7.87%
            7.11%Total
            $9,405,337
            $5,165,330
            $1,960,514
            $3,204,816Less:
                unpaid principal balance of securitized
              REO
                properties
            (42,259)Total
                securitized loans
            $5,123,071


39


Borrowers
      who accept a prepayment penalty receive a lower interest rate on their mortgage
      loan. A number of states restrict our ability to charge prepayment penalties
      on
      mortgage loans made to borrowers in such states. Borrowers always retain the
      right to refinance their loan, but may have to pay a fee of up to six-months
      interest on 80% of the remaining principal when prepaying their loans. If the
      mortgage loan prepays within the prepayment penalty coverage period, we will
      record revenue from collection of a prepayment penalty. We report prepayment
      penalties when we collect such fees in interest income. In addition, if a loan
      prepays we fully expense any related deferred costs for that loan upon
      prepayment. We reflect the amortization of deferred costs in interest
      income.





We
      experienced an increase in prepayments of our mortgage loans during the third
      quarter of 2005 compared to the first and second quarters of 2005 and the fourth
      quarter of 2004. Refinancing activity continues to be strong due to an elevated
      home price index allowing borrowers to access the equity in their homes in
      the
      form of cash and also with the popularity of interest-only products. We expect
      our prepayment speeds to continue at generally the same levels in future periods
      if refinancing activity continues to be strong, particularly in light of the
      popularity of interest-only and longer amortization products in the
      marketplace.





**12
                Month Constant**
              **Prepayment
                Rate**
              **(Annual
                Percent)**
            **Life-to-date
                Constant**
              **Prepayment
                Rate**
              **(Annual
                Percent)******
            **Issue
                Date**
            **Percent
                with**
              **Prepayment
                Penalty**
            **Fixed**
            **Arm**
            **Fixed**
            **Arm**September
                30, 2005SAST
                2001-2
            8/2/2001
            50.50%
            30.58%
            41.98%
            30.48%
            42.36%SAST
                2001-3
            10/11/2001
            29.58%
            33.82%
            49.04%
            34.96%
            43.47%SAST
                2002-1
            3/14/2002
            35.74%
            33.50%
            51.26%
            31.88%
            43.83%SAST
                2002-2
            7/10/2002
            14.98%
            35.30%
            50.12%
            33.67%
            43.45%SAST
                2002-3
            11/8/2002
            45.66%
            32.77%
            53.05%
            30.73%
            43.66%SAST
                2003-1
            3/6/2003
            61.13%
            31.62%
            57.37%
            27.90%
            46.33%SAST
                2003-2
            5/29/2003
            55.55%
            35.48%
            59.73%
            28.72%
            47.71%SAST
                2003-3
            9/16/2003
            61.98%
            31.56%
            50.20%
            23.88%
            40.95%SAST
                2004-1
            2/19/2004
            64.00%
            29.91%
            43.80%
            24.77%
            38.06%SAST
                2004-2
            7/27/2004
            62.53%
            22.51%
            39.81%
            21.62%
            37.24%SAST
                2004-3
            10/27/2004
            58.69%
            —
            —
            16.13%
            33.62%SAST
                2005-1
            1/25/2005
            60.55%
            —
            —
            14.95%
            29.55%SAST
                2005-2
            6/07/2005
            57.25%
            —
            —
            7.75%
            24.03%SAST
                2005-3
            9/29/2005
            63.88%
            —
            —
            —
            —December
                31, 2004SAST
                2001-2
            8/2/2001
            48.42%
            36.11%
            52.36%
            30.75%
            42.96%SAST
                2001-3
            10/11/2001
            25.67%
            41.45%
            50.46%
            35.79%
            42.73%SAST
                2002-1
            3/14/2002
            68.44%
            34.12%
            49.03%
            31.29%
            40.97%SAST
                2002-2
            7/10/2002
            60.73%
            36.03%
            47.77%
            32.90%
            39.90%SAST
                2002-3
            11/8/2002
            57.17%
            38.17%
            51.72%
            30.56%
            41.09%SAST
                2003-1
            3/6/2003
            75.10%
            34.98%
            49.58%
            26.83%
            40.17%SAST
                2003-2
            5/29/2003
            76.57%
            31.87%
            44.93%
            25.88%
            37.15%SAST
                2003-3
            9/16/2003
            71.35%
            24.44%
            41.52%
            20.23%
            35.48%SAST
                2004-1
            2/19/2004
            64.45%
            —
            —
            18.89%
            30.77%SAST
                2004-2
            7/27/2004
            62.73%
            —
            —
            12.37%
            22.62%SAST
                2004-3
            10/27/2004
            55.86%
            —
            —
            1.77%
            21.59%





*Interest
      Expense* .
      Interest expense increased $31.2 million, or 82%, to $69.1 million for the
      three
      months ended September 30, 2005 from $37.9 million for the three


40


months
      ended September 30, 2004, and increased $78.7 million, or 73%, to $185.8 million
      for the nine months ended September 30, 2005 from $107.1 million for the nine
      months ended September 30, 2004. The table below presents the total change
      in
      interest expense for the three and nine months ended September 30, 2005 compared
      to the three and nine months ended September 30, 2004, and the amount of the
      total change that is attributable to increasing interest rates and an increase
      in our outstanding debt. Compared to the three and nine months ended September
      30, 2004, our interest expense increased $27.4 million and $58.7 million for
      the
      three and nine months ended September 30, 2005, respectively, as a result of
      higher interest rates on our interest bearing liabilities and increased $3.8
      million and $20.0 million for the three and nine months ended September 30,
      2005, respectively, due to an increase in our borrowings.





*Rate/Volume
      Table For the Three and Nine Months Ended September 30, 2005 Compared to the
      Three and Nine Months Ended September 30, 2004*




**Three
                Months Ended September 30, 2005 Compared to**
              **Three
                Months Ended September 30, 2004**
            **Nine
                Months Ended September 30, 2005 Compared to**
              **Nine
                Months Ended September 30, 2004******
            **Change
                in Rate**
            **Change
                in Volume**
            **Total
                Change in Interest Expense**
            **Change
                in Rate**
            **Change
                in Volume**
            **Total
                Change in Interest Expense**(in
                thousands)Securitization
                financing
            $26,683
            $5,091
            $31,774
            $55,106
            $23,039
            $78,145Warehouse
                financing:Lines
                of credit
            (840)
            (135)
            (975)
            (292)
            289
            (3)Repurchase
                agreements
            1,537
            (633)
            904
            3,871
            (2,190)
            1,681Other
            —
            (561)
            (561)
            —
            (1,153)
            (1,153)Total
            $27,380
            $3,762
            $31,142
            $58,685
            $19,985
            $78,670




*Interest
      Expense Yield Analysis For the Three and Nine Months Ended September 30, 2005
      and 2004*





As
      seen
      in the table below, our increase in interest expense was due primarily to the
      increase in the average yield on interest-bearing liabilities of 176 basis
      points and 131 basis points for the three and nine months ended September 30,
      2005, respectively. One-month LIBOR rates increased 202 basis points from
      September 30, 2004 to September 30, 2005. Our average balance of borrowings
      increased $0.5 billion, or 9%, to $6.2 billion for the three months ended
      September 30, 2005 from $5.7 billion for the three months ended September 30,
      2004, and increased $0.9 billion, or 17%, to $6.2 billion for the nine months
      ended September 30, 2005 from $5.3 billion for the nine months ended September
      30, 2004 as a result of the growth in our mortgage loan portfolio. Our amortization
      of yield adjustments increased $10.9 million, or 151%, to $3.7 million net
      amortization for the three months ended September 30, 2005 from $(7.2) million
      net accretion for the three months ended September 30, 2004, and increased
      $27.6
      million, or 138%, to $7.6 million net amortization for the nine months ended
      September 30, 2005 from $(20.0) million net accretion for the nine months ended
      September 30, 2004. Specifically, our amortization of debt issuance costs
      increased $4.5 million due to the issuance of new securitization debt in
      January, June, and September 2005. In addition, the
      accretion of premium on the interest only classes of certain of our bonds
      decreased$23.1
      million due to the repayment of such bonds, partially offset by a decrease
      of
      $0.4 million in our amortization of bond discount.




41







**Three
                Months Ended September 30, 2005**
            **Three
                Months Ended September 30, 2004****Average**
              **Balance**
            **Interest**
              **Expense**
            **Average**
              **Yield**
            **Average**
              **Balance**
            **Interest**
              **Expense**
            **Average**
              **Yield**($
                in thousands)**Warehouse
                financing**
            $175,874
            $1,465
            3.26%
            $204,261
            $1,384
            2.65%Less
                compensating balance credits (1)
            —
            (1,339)
            (2.98)%
            —
            (285)
            (0.55)%**Net
                warehouse financing**
            175,874
            126
            0.28%
            204,261
            1,099
            2.10%**Repurchase
                agreements**
            302,438
            3,258
            4.22%
            392,017
            2,354
            2.35%**Securitization
                financing:**Gross
            5,745,518
            61,038
            4.25%
            5,044,790
            41,511
            3.29%Plus
                (less) net amortization (accretion) of yield adjustments
                (2)
            —
            3,735
            0.26%
            —
            (7,165)
            (0.57)%Plus
                (less) amortization (accretion) of cash flow hedges (3)
            —
            (180)
            (0.01)%
            —
            (1,526)
            (0.12)%**Net
                securitization financing:**
            5,745,518
            64,593
            4.50%
            5,044,790
            32,820
            2.60%**Notes
                payable**
            —
            —
            —
            22,043
            448
            8.00%**Other
                expenses**
            —
            1,098
            —
            —
            1,212
            —**Total
                interest-bearing liabilities**
            $6,223,830
            $69,075
            4.44%
            $5,663,111
            $37,933
            2.68%**Nine
                Months Ended September 30, 2005**
            **Nine
                Months Ended September 30, 2004******
            **Average**
              **Balance**
            **Interest**
              **Expense**
            **Average**
              **Yield**
            **Average**
              **Balance**
            **Interest**
              **Expense**
            **Average**
              **Yield**($
                in thousands)**Warehouse
                financing**
            $179,333
            $4,961
            3.65%
            $158,219
            $2,958
            2.46%Less
                compensating balance credits (1)
            —
            (2,654)
            (1.95)%
            —
            (649)
            (0.54)%**Net
                warehouse financing**
            $179,333
            $2,307
            1.70%
            $158,219
            $2,309
            1.92%**Repurchase
                agreements**
            $255,098
            $7,357
            3.80%
            $371,511
            $5,676
            2.01%**Securitization
                financing:**Gross
            5,725,673
            166,556
            3.88%
            4,726,198
            116,345
            3.28%Plus
                (less) net amortization (accretion) of yield adjustments
                (2)
            —
            7,572
            0.18%
            —
            (20,044)
            (0.57)%Plus
                (less) amortization (accretion) of cash flow hedges (3)
            —
            (1,179)
            (0.03)%
            —
            (1,496)
            (0.04)%**Net
                securitization financing:**
            $5,725,673
            $172,949
            4.03%
            $4,726,198
            $94,805
            2.67%**Notes
                payable**
            —
            —
            —
            24,014
            1,443
            8.00%**Other
                expenses**
            —
            3,202
            —
            —
            2,912
            —**Total
                interest-bearing liabilities**
            $6,160,104
            $185,815
            4.02%
            $5,279,942
            $107,145
            2.71%







(1)
            Compensating
                balance credits represent the amount of credits against interest
                expense
                placed on the value of balances held by our financial
                institutions.




(2)
            Yield
                adjustments include premiums, discounts, and debt issuance costs
                related
                to our debt.




(3)
            Yield
                adjustments include accumulated other comprehensive income relating
                to
                cash flow hedging of our debt.







*Net
      Interest Margin* .
      Our net
      interest margin decreased to 3.0% for the three months ended September 30,
      2005,
      from 4.6% for the three months ended September 30, 2004,




42
 and
        decreased to 3.4% for the nine months ended September 30, 2005, from 4.8%
        for
        the nine months ended September 30, 2004. The decline in our net interest
        margin
        was primarily attributable to an increase in the cost of our borrowings due
        to
        an increase in one-month LIBOR, competitive pricing pressures, as well as
        our
        shift in credit mix to loans with lower WACs and prepayments of higher WAC
        loans. While there is an immediate impact on our net interest margin due
        to
        changes in one-month LIBOR, the impact of the anticipated changes in cash
        flows
        from our hedges is included in accumulated other comprehensive income, net
        of
        tax effect in shareholders’ equity on our consolidated balance sheets and is
        recognized into earnings over the expected life of the variable rate debt.
        This
        may result in short-term mismatches between the changes in our borrowing
        costs
        and the effect of our hedges, but over the term of the debt, we believe the
        hedges should effectively protect the interest margin. In the third quarter
        of
        2005, our hedges positively impacted our net interest margin by one basis
        point
        as compared to twelve basis points in the third quarter of 2004.




The
      following table sets forth information about our securitized mortgage loan
      portfolio and our securitization financing as of September 30, 2005 and December
      31, 2004.




**September
                30, 2005**
            **December
                31, 2004**(in
                thousands)Collateral:Fixed
            $1,902,459
            $1,960,514Arm
            4,069,509
            3,204,816Total
            $5,971,968
            $5,165,330Financing:Fixed
            $695,109
            $921,745Arm
            5,336,311
            4,212,421Total
            $6,031,420
            $5,134,166







*Provision
      for Mortgage Loan Losses* .
      Provision for mortgage loan losses increased $4.7 million, or 32%, to $19.4
      million for the three months ended September 30, 2005, from $14.7 million for
      the three months ended September 30, 2004, and increased $9.8 million, or 34%,
      to $38.6 million for the nine months ended September 30, 2005, from $28.8
      million for the nine months ended September 30, 2004. We did not make any
      significant changes in our reserve methodologies or assumptions during the
      nine
      months ended September 30, 2005.




During
      the third quarter of 2005, we recorded a reserve of $6.8 million in connection
      with estimated losses in our mortgage loan portfolio due to the damage
      caused by Hurricane Katrina during August 2005. This amount was determined
      based
      on an analysis of the specific pool of mortgage loans within the federally
      declared disaster areas segmented into categories based on an estimation of
      the
      extent of flooding in each such area. The pool was further segmented to exclude
      loans for properties covered by flood insurance and loans for which we had
      received correspondence from the borrower and/or actual property inspection
      reports indicating damage was less severe than expected. The remaining pool
      of
      loans’ unpaid principal balances and their associated basis adjustments,
      advances and accrued interest were accumulated and a range of estimated
      percentage of loss severity was
      applied using different insurance coverage scenarios. This analysis yielded
      a
      range of possible loss estimates from $1.4 million to $9.4 million, with a
      best
      estimate of $6.8 million calculated using the most probable loss severity
      and insurance coverage scenarios. This estimate is imprecise, and if different
      loss severities had been applied or if estimates of the extent of flooding
      had
      been altered, numerous different estimates may have been obtained. As additional
      information is obtained and processed over the coming months and quarters,
      this
      reserve will be revised accordingly.


43





The
      increase in the provision for the nine months ended September 30, 2005 as
      compared to the nine months ended September 30, 2004 was also attributable
      to an
      increase in delinquencies in the 30-59 day delinquent category of $0.1 million,
      or 21%. Serious delinquencies remained relatively constant over this time period
      even as the mortgage loan portfolio continues to season. Also, by looking at
      the
      portfolio on a static pool basis, or each year’s production over time, we are
      experiencing a decrease in overall losses on our 2005, 2004 and 2003 production
      as compared to our 2002 and 2001 production, as losses from production in the
      earlier years were charged-off and replaced with loans of higher credit quality.
      We saw a decrease in serious delinquency rates and loss severities in our owned
      portfolio in the first nine months of 2005 compared to the first nine months
      of
      2004. We believe this decrease was the result of the improved credit quality
      of
      our portfolio.




Two
      widely accepted methodologies of reporting delinquency data are the Mortgage
      Bankers Association (MBA) and the Office of Thrift Supervision (OTS) methods.
      The MBA methodology reports delinquencies as of month-end while the OTS
      methodology reports delinquencies as of the first day of the following month
      after payment is due. We believe the MBA method is more commonly used in
      conforming and jumbo mortgage markets while the OTS method is more commonly
      used
      in non-conforming and subprime mortgage markets. Reporting delinquencies as
      of
      the first of the month makes OTS reported loans appear one delinquency category
      better than the MBA method of reporting delinquencies as of month-end;
      therefore, we consider the MBA method to be a more conservative approach. The
      following table sets forth information about the delinquency and loss experience
      of our owned servicing portfolio using the MBA method and is followed by a
      reconciliation between net losses on liquidated loans and charge-offs. (See
      footnote (4) below the table for disclosure of seriously delinquent data using
      the OTS method.)




*Delinquency
      and Loss Experience Of Our Owned Portfolio*




September
                  30,2005
              2004Total
                  Delinquencies and Loss Experience
              ($
                  in thousands)Total
                  outstanding principal balance (at period end)
              $6,185,969
              $5,575,386Delinquency
                  (at period end):30-59
                  days:Principal
                  balance
              $357,960
              $295,202Delinquency
                  percentage
              5.79%
              5.29%60-89
                  days:Principal
                  balance
              $85,159
              $81,062Delinquency
                  percentage
              1.38%
              1.45%90
                  days or more:Principal
                  balance
              $40,316
              $34,515Delinquency
                  percentage
              0.65%
              0.62%Bankruptcies
                  (1):Principal
                  balance
              $125,780
              $101,492Delinquency
                  percentage
              2.03%
              1.82%Foreclosures:Principal
                  balance
              $128,253
              $122,074Delinquency
                  percentage
              2.07%
              2.19%Real
                  estate owned (2):Principal
                  balance
              $46,310
              $48,295Delinquency
                  percentage
              0.75%
              0.87%Total
                  seriously delinquent including real estate owned (3)(4)
              $393,843
              $369,488Total
                  seriously delinquent including real estate owned (3)(4)
              6.37%
              6.63%Total
                  seriously delinquent excluding real estate owned (4)
              $347,533
              $321,193Total
                  seriously delinquent excluding real estate owned (4)
              5.62%
              5.76%Net
                  losses on liquidated loans - quarter ended
              $9,496
              $10,862Charge-offs
                  - quarter ended (5)
              $8,618
              $11,908Percentage
                  of net losses on liquidated loans (6)
              0.61%
              0.78%Percentage
                  of charge-offs on liquidated loans (6)
              0.56%
              0.85%Loss
                  severity on liquidated loans (7)
              37.32%
              40.47%
 ________________


(1)
            Bankruptcies
                include both non-performing and performing loans in which the related
                borrower is in bankruptcy. Amounts included for contractually current
                bankruptcies for the owned portfolio for September 30, 2005 and 2004
                are
                $24.5 million and $13.6 million, respectively.


(2)
            When
                a loan is deemed to be uncollectible and the property is foreclosed,
                it is
                transferred to REO at net realizable value and periodically evaluated
                for
                additional impairments. Net realizable value is defined as the property’s
                fair value less estimated costs to sell. Costs of holding this real
                estate
                and related gains and losses on disposition are credited or charged
                to
                operations as incurred; and therefore, are not included as part of
                our
                allowance for loan loss.


(3)
            Seriously
                delinquent is defined as loans that are 60 or more days delinquent,
                foreclosed, REO, or held by a borrower who has declared bankruptcy
                and is
                60 or more days contractually
                delinquent.


(4)
            Total
                seriously delinquent including REO using the OTS method would be
                $303.3
                million, or 4.90% as of September 30, 2005 and $289.4 million, or
                5.19% as
                of September 30, 2004. Total seriously delinquent excluding REO using
                the
                OTS method would be $257.0 million, or 4.16% as of September 30,
                2005, and
                $243.1 million, or 4.36% as of September 30,
                2004.


(5)
            Charge-offs
                represent the losses recognized in our financial statements in accordance
                with GAAP. See reconciliation of net losses on liquidated loans to
                charge-offs below.


(6)
            Annualized.


(7)
            Loss
                severity is defined as the total loss amount divided by the actual
                unpaid
                principal balance at the time of liquidation. Total loss amounts
                include
                all accrued interest and interest advances, fees, principal balances,
                all
                costs of liquidating and all other servicing advances for taxes,
                property
                insurance, and other servicing costs incurred and invoiced to us
                within 90
                days following the liquidation date.




44


*Reconciliation
      of Net Losses on Liquidated Loans and Charge-offs*







**For
                the Three Months Ended September 30,******
            **2005**
            **2004**(in
                thousands)Net
                losses on liquidated loans
            $9,496
            $10,862Loan
                transfers to real estate owned
            7,772
            10,420Realized
                losses on real estate owned
            (7,789)
            (9,139)Timing
                differences between liquidation and claims processing
            (258)
            (496)Interest
                not advanced on warehouse
            (157)
            (78)Other
            (446)
            339Charge-offs
                (1)
            $8,618
            $11,908


________________


(1)  Charge-offs
      represent the losses recognized in our financial statements in accordance with
      GAAP.






The
      table
      below shows seriously delinquent outstanding principal balances and cumulative
      charge-offs by securitization.




**September
                30,**
              **2005**
            **September
                30,**
              **2004**
            **September
                30,**
              **2005**
            **September
                30,**
              **2004**
            **September
                30,**
              **2005**
            **September
                30,**
              **2004******
            **Seriously
                Delinquent**
              **Outstanding
                Principal Balance (1)**
            **Seriously
                Delinquent Percentage (1)**
            **Cumulative
                Charge-Offs**($
                in thousands)2001
                Securitizations
            $55,056
            $84,200
            27.65%
            25.59%
            $52,006
            $40,7642002
                Securitizations
            89,513
            133,014
            17.65%
            14.29%
            38,848
            26,8962003
                Securitizations
            77,780
            96,925
            9.62%
            6.55%
            14,277
            5,2142004
                Securitizations
            111,326
            43,757
            5.61%
            2.10%
            5,907
            1712005
                Securitizations
            51,380
            —
            2.08%
            —
            506
            —Warehouse
            8,788
            11,592
            4.11%
            1.54%
            5,332
            4,909Total
            $393,843
            $369,488
            6.37%
            6.63%
            $116,876
            $77,954


________________


(1)
            Seriously
                delinquent is defined as loans that are 60 or more days delinquent,
                foreclosed, REO, or held by a borrower who has declared bankruptcy
                and is
                60 or more days contractually delinquent.







**  *Servicing
      Income, Net of Amortization and Impairment* .
      Servicing income, net of amortization and impairment increased $10.7 million,
      or
      127%, to $19.1 million for the three months ended September 30, 2005 from $8.4
      million for the three months ended September 30, 2004, and increased $29.7
      million, or 147%, to $49.9 million for the nine months ended September 30,
      2005
      from $20.2 million for the nine months ended September 30, 2004. The increase
      in
      gross servicing income was primarily the result of a higher average total
      servicing portfolio due to the continued growth in our owned portfolio, which
      generates servicing income in the form of ancillary fees, as well as the
      acquisition of additional third party servicing rights. This increase was offset
      by an increase of $9.6 million and $20.1 million of amortization and impairment
      expense of MSRs for the three and nine months ended September 30, 2005, compared
      to the three and nine months ended September 30, 2004, respectively. The
      increase in MSR amortization expense was due to an increase in the third party
      servicing rights balance from $81.6 million at September 30, 2004 to $148.0
      million at September 30, 2005. The increase in MSR impairment was primarily
      a
      result of increased prepayment speeds and decreased valuations of MSR assets
      in
      the marketplace.




Due
      to
      the damage caused by Hurricane Katrina during August of 2005, we have
      recorded an additional MSR impairment of $0.4 million. This amount was
      determined based on an analysis of the specific pool of serviced mortgage loans
      within the federally declared disaster areas segmented into categories based
      on
      an estimation of the extent of flooding in each such area. The pool of serviced
      loans’ unpaid principal balances were accumulated and a percentage of loss was
      then applied to each segment to determine the amount of loan principal at risk.
      The resulting amount of loan principal at risk was then applied to the total
      MSR
      balance to determine the impact of impairment.


45


This
      analysis yielded a range of possible loss estimates from $0.4 million to $0.5
      million, with the lowest end of the range representing what we believe to be
      the
      best estimate within the range, given the uncertain nature of the final outcome.
      This estimate is imprecise, and if different loss severities had been applied
      or
      if estimates of the extent of flooding had been altered, numerous different
      estimates may have been obtained. As additional information is obtained and
      processed over the coming months and quarters, this estimate will be revised
      accordingly.





We
      expect
      our servicing income to increase as we continue to grow our third party
      servicing portfolio. To the extent prepayment speeds decline in the future,
      we
      would also anticipate a decline in our amortization and impairment expense
      assuming a constant level in our mortgage loan servicing portfolio. Information
      relating to our servicing income is shown in the table below:





*Servicing
      Income For the Three and Nine months ended September 30, 2005 Compared to the
      Three and Nine months ended September 30, 2004*


**Three
                  Months Ended September 30,**
              **Nine
                  Months Ended September 30,******
              **2005**
              **2004**
              **Variance**
              **2005**
              **2004**
              **Variance**($
                  in thousands)Average
                  third party servicing portfolio
              $20,283
              $8,449
              140%
              $17,673
              $6,458
              174%Average
                  owned portfolio
              $5,982
              $5,298
              13%
              $5,983
              $4,953
              21%Average
                  total servicing portfolio
              $26,264
              $13,747
              91%
              $23,657
              $11,411
              107%Gross
                  servicing income
              $35,889
              $15,623
              130%
              $88,632
              $38,830
              128%Amortization
                  and impairment
              $16,826
              $7,252
              132%
              $38,779
              $18,635
              108%Servicing
                  fees - third party portfolio (1) (2)
              51
              64
              
              52
              64Amortization
                  and impairment- third party portfolio (1)
              33
              34
              
              30
              39Other
                  servicing income - total servicingportfolio
                  (1)(3)
              15
              6
              
              15
              16Servicing
                  income - total servicing portfolio (1)
              55
              45
              
              50
              45





(1)
            Annualized
                and in basis points.


(2)
            Includes
                master servicing fees.


(3)
            Includes
                primarily late fees, electronic processing fees, and tax service
                fee
                expense. Ancillary fees are collected and recorded within other servicing
                income for both the third party portfolio as well as the owned portfolio.







**Expenses**





*Payroll
      and Related Expenses* .
      Payroll
      and related expenses increased $1.6 million, or 8%, to $21.3 million for the
      three months ended September 30, 2005 from $19.7 million for the three months
      ended September 30, 2004. Specifically:





·
            Salary,
                bonus, and related payroll expenses increased $1.6 million, or 10%,
                to
                $18.4 million for the three months ended September 30, 2005, from
                $16.8
                million for the three months ended September 30, 2004. This increase
                was
                primarily attributable to an increase in our average headcount during
                the
                three months ended September 30,
                2005.


46


·
            Severance
                expense increased $1.1 million, or 1100%, to $1.2 million for the
                three
                months ended September 30, 2005, from $0.1 million for the three
                months
                ended September 30, 2004. The severance expense increase reflects
                the
                departures of our Executive Vice President, Capital Markets and our
                Senior
                Vice President and Corporate Strategies Director in July 2005.





·
            Deferred
                payroll and related expenses, as they related to direct loan origination
                costs, decreased $2.2 million, or 27%, to $5.9 million for the three
                months ended September 30, 2005, from $8.1 million for the three
                months
                ended September 30, 2004, due to lower production volume during the
                third
                quarter of2005
                combined with the closing of fifteen retail branches since the third
                quarter of 2004 and the consequently lower deffered payroll
                costs.





·
            The
                increase in payroll and related expenses for the three months ended
                September 30, 2005 was partially offset by a decrease in 1) commission
                expense of $1.1 million due to lower production volume during the
                third
                quarter of 2005 and 2) stock compensation expense of $2.2 million
                due to
                the vesting of all restricted stock units and options as a result
                of the
                REIT conversion in the third quarter of
                2004.





Payroll
      and related expenses increased $6.4 million, or 12%, to $59.3 million for the
      nine months ended September 30, 2005 from $52.9 million for the nine months
      ended September 30, 2004. Specifically:





·
            Salary,
                bonus, and related payroll expenses increased $4.0 million, or 8%
                to $55.1
                million for the nine months ended September 30, 2005 from $51.1 million
                for the nine months ended September 30, 2004. This increase was primarily
                attributable to an increase in our average headcount during the nine
                months ended September 30, 2005.





·
            Our
                401(k) company match expense increased $0.2 million, or 20%, to $1.2
                million for the nine months ended September 30, 2005, from $1.0 million
                for the nine months ended September 30, 2004, as a result of increased
                employee participation in the 401(k) retirement
                plan.





·
            Deferred
                payroll and related expenses, as they related to direct loan origination
                costs, decreased $5.9 million, or 24%, to $18.7 million for the nine
                months ended September 30, 2005, from $24.6 million for the nine
                months
                ended September 30, 2004, due to lower production volume during the
                nine
                months ended September 30, 2005 combined with the closing of fifteen
                retail branches since the third quarter of 2004 and the consequently
                lower
                deferred payroll costs.





·
            The
                increase in payroll and related expenses for the nine months ended
                September 30, 2005 was partially offset by a decrease in 1) commission
                expense of $1.8 million due to lower production volume during the
                third
                quarter
                of 2005 and 2) stock compensation expense of $1.9 million due to
                the
                vesting of all restricted stock units and options as a result of
                the REIT
                conversion in the third quarter of
                2004.


47


*General
      and Administrative Expenses* .
      General
      and administrative expenses increased $2.6 million, or 18%, to $16.9 million
      for
      the three months ended September 30, 2005, from $14.3 million for the three
      months ended September 30, 2004. The increase was due primarily to an increase
      in accounting and consulting/outside services expense of $1.5 million as well
      as
      an increase of $1.1 million in rent expense.





General
      and administrative expenses increased $7.9 million, or 20%, to $48.3 million
      for
      the nine months ended September 30, 2005, from $40.4 million for the nine months
      ended September 30, 2004. The increase was due primarily to an increase in
      accounting, and consulting/outside services expense of $5.6 million as well
      as
      an increase of $2.4 million in lease and rental expenses.





The
      increase in lease and rental expenses for the three and nine months ended
      September 30, 2005 is primarily attributable to our new mortgage loan
      origination facility and second servicing site in Glen Allen, Virginia.
      Additionally, the term of our lease agreement for our principal
      executive facility has been extended to correspond to the term of our
      lease
      agreement for our new mortgage loan origination facility and second servicing
      site, which terminates in the third quarter of 2017.





*Income
      Tax Expense (Benefit)* .
      We
      recorded a $6.3 million tax benefit for the three months ended September 30,
      2005 compared to a $19.0 million tax benefit for the three months ended
      September 30, 2004. We recorded a $7.9 million tax benefit for the nine months
      ended September 30, 2005 compared to a $0.5 million tax expense for the nine
      months ended September 30, 2004. The significant income tax benefit recorded
      for
      the three months ended September 30, 2004 was the result of the impact of the
      structure and formation transactions related to our REIT conversion.





During
      the third quarter of 2005, we recorded a cumulative adjustment to increase
      income tax benefit and increase deferred tax asset of approximately $3.7 million
      to correct the amortization of the net prepaid liability created by the tax
      on
      intercompany gains and losses related to the sales of mortgage loans and
      servicing advance receivables from the taxable REIT subsidiary to the qualified
      REIT subsidiary. We do not believe that the impact of the correction for the
      adjustment is material to the financial statements as of and for the quarters
      ended September 30, 2004; December 31, 2004; March 31, 2005 and June 30, 2005;
      as of and for the year ended December 31, 2004; nor is the cumulative adjustment
      recorded in the third quarter of 2005 expected to be material, in the aggregate,
      to the financial statements as of and for the year ending December 31, 2005.
      The
      adjustment had no impact on cash flows, taxable income or the amount of
      dividends declared for any of these periods.





**Business
      Segment Results**


48





We
      operate our business through three core business segments: portfolio; servicing;
      and mortgage loan production. All segments except the portfolio segment are
      operated by our taxable REIT subsidiaries. In this section, we discuss
      performance and results of our business segments for the three and nine months
      ended September 30, 2005 and 2004. See Note 11 to our unaudited consolidated
      financial statements for additional information about the results of our
      business segments.





***Portfolio
      Segment***




The
      portfolio segment uses our equity capital and borrowed funds to invest in our
      mortgage loan portfolio, which produces net interest income. The portfolio
      segment also records servicing expense associated with servicing its mortgage
      loan portfolio. We evaluate the performance of our portfolio segment based
      on
      total net revenues. Total net revenues for the portfolio segment decreased
      $18.9
      million, or 49%, to $20.0 million for the three months ended September 30,
      2005
      from $38.9 million for the three months ended September 30, 2004. Total net
      revenues for the portfolio segment decreased $18.3 million, or 16%, to $96.5
      million for the nine months ended September 30, 2005 from $114.8 million for
      the
      nine months ended September 30, 2004. The decrease in total net revenues was
      due
      to a decrease in net interest income after provision for mortgage loan losses
      resulting from the margin compression relating to intense pricing pressures
      and
      the increase in our borrowing costs due to the increase in one-month
      LIBOR.





***Servicing
      Segment***




The
      servicing segment services loans, seeking to ensure that loans are repaid in
      accordance with their terms. We evaluate the performance of our servicing
      segment based on servicing income, net of amortization and impairment; cost
      to
      service a loan; and delinquency levels as measures of the performance of the
      segment. We believe these measures assist investors by allowing them to evaluate
      the performance of our servicing segment. The following discussion highlights
      changes in our servicing segment for the periods indicated.





*Our
      Mortgage Loan Servicing Portfolio*





In
      addition to servicing mortgage loans that we originate or purchase through
      our
      taxable REIT subsidiaries and retain in our portfolio, we also service mortgage
      loans for other lenders and investors.





Our
      loan
      servicing portfolio as of September 30, 2005 is summarized below:





**Number
                of**
              **Loans**
            **Principal**
              **Balance**
            **Percent**
              **of
                Total**
            **Average**
              **Loan
                Balance**($
                in thousands)**Owned
                Portfolio:**Saxon
                Capital, Inc.(1)
            42,912
            $6,185,969
            23%
            $144**Third
                Party Servicing:**Greenwich
                Capital, Inc.
            59,279
            $8,734,018
            
            $147Credit
                Suisse First Boston
            36,288
            5,997,350
            
            165Barclays
                Bank, PLC.
            13,542
            2,654,208
            
            196Bank
                of America
            6,763
            1,190,697
            
            176Dominion
                Capital
            6,537
            433,630
            
            66IXIS
            3,313
            597,968
            
            180Lehman
                Brothers
            2,582
            464,922
            
            180Fannie
                Mae
            534
            61,273
            
            115Dynex
                Capital, Inc.
            311
            27,290
            
            88Other
                investors
            283
            9,445
            
            33**Total
                third party servicing**
            129,432
            $20,170,801
            77%
            $156Total
            172,344
            $26,356,770
            
            $153


_________________


(1)
            Includes
                loans we originated and purchased since July 6, 2001.






49


Our
      mortgage loan servicing portfolio, including loans recorded on our consolidated
      balance sheets, increased $6.2 billion, or 31%, to $26.4 billion as of September
      30, 2005, from $20.2 billion as of December 31, 2004. The increase was due
      primarily to the origination and purchase of $2.4 billion of mortgage loans
      as
      well as the acquisition of servicing rights related to $16.0 billion of mortgage
      loans owned by non-affiliated companies during the first nine months of 2005.
      This increase was partially offset by prepayments and losses totaling $7.4
      billion and principal payments on, and sales of loans from, our mortgage
      portfolio totaling $2.2 billion.





We
      believe we can continue to grow our mortgage loan servicing portfolio because
      the mortgage industry’s growth has continued to outpace the growth in servicing
      capacity available for non-conforming mortgage loans. This has resulted in
      an
      increasing number of asset-backed securities being issued by entities that
      do
      not perform servicing, which presents opportunities for us to increase the
      size
      of our portfolio of loans serviced for third parties.




We
      include all costs to service mortgage loans in our owned portfolio and our
      third
      party servicing portfolio within the servicing segment. We reduced our cost
      to
      service to 17 basis points for the three months ended September 30, 2005, from
      20 basis points for the three months ended September 30, 2004, due to an
      increase in our overall servicing portfolio and credit quality of the owned
      portfolio, as well as a continued focus on operating efficiencies. We expect
      to
      see further reductions in our cost to service as we continue to grow our
      mortgage loan servicing portfolio in 2005.





*Delinquency
      and Loss Experience Of Our Total Servicing Portfolio*




We
      experienced an increase in seriously delinquent accounts for our mortgage loan
      servicing portfolio to 6.26% for the three months ended September 30, 2005
      from
      5.83% for the three months ended September 30, 2004. This was mainly a result
      of
      the increased use of forbearance plans to mitigate losses, which causes us
      to
      carry accounts in a delinquent category for the duration of the repayment plan,
      as well as the seasoning of the portfolio. The
      following tables set forth information about the delinquency and loss experience
      of the mortgage loans we service for the periods indicated using the MBA method.
      (See footnote (4) below the table for disclosure of seriously delinquent data
      using the OTS method.)


50





**September
                30,******
            **2005**
            **2004**Total
                Delinquencies and Loss Experience (1)
            ($
                in thousands)Total
                outstanding principal balance (at period end)
            $26,356,770
            $16,098,212Delinquency
                (at period end):30-59
                days:Principal
                balance
            $1,515,753
            $796,261Delinquency
                percentage
            5.75%
            4.95%60-89
                days:Principal
                balance
            $414,500
            $223,377Delinquency
                percentage
            1.57%
            1.39%90
                days or more:Principal
                balance
            $248,530
            $112,732Delinquency
                percentage
            0.94%
            0.70%Bankruptcies
                (2):Principal
                balance
            $397,545
            $261,979Delinquency
                percentage
            1.51%
            1.63%Foreclosures:Principal
                balance
            $542,642
            $286,823Delinquency
                percentage
            2.06%
            1.78%Real
                estate owned:Principal
                balance
            $157,192
            $99,032Delinquency
                percentage
            0.60%
            0.62%Total
                seriously delinquent including real estate owned (3)(4)
            $1,649,245
            $939,282Total
                seriously delinquent including real estate owned (3)(4)
            6.26%
            5.83%Total
                seriously delinquent excluding real estate owned (4)
            $1,492,053
            $840,249Total
                seriously delinquent excluding real estate owned (4)
            5.66%
            5.22%Net
                losses on liquidated loans - quarter ended
            $23,111
            $22,060Percentage
                of net losses on liquidated loans (5)
            0.35%
            0.55%Loss
                severity on liquidated loans (6)
            36.99%
            46.49%


__________


(1)
            Includes
                all loans we service.


(2)
            Bankruptcies
                include both non-performing and performing loans in which the related
                borrower is in bankruptcy. Amounts included for contractually current
                bankruptcies for the total servicing portfolio for September 30,
                2005 and
                2004 are $87.8 million and $32.1 million, respectively.


(3)
            Seriously
                delinquent is defined as loans that are 60 or more days delinquent,
                foreclosed, REO, or held by a borrower who has declared bankruptcy
                and is
                60 or more days contractually delinquent.


(4)
            Total
                seriously delinquent including REO using the OTS method would be
                $1.2
                billion, or 4.63% as of September 30, 2005 and $711.5 million, or
                4.42% as
                of September 30, 2004. Total seriously delinquent excluding REO using
                the
                OTS method would be $1.1 billion, or 4.04% as of September 30, 2005,
                and
                $614.9 million, or 3.82% as of September 30,
                2004.


(5)
            Annualized.


(6)
            Loss
                severity is defined as the total loss amount divided by the actual
                unpaid
                principal balance at the time of liquidation. Total loss amounts
                include
                all accrued interest and interest advances, fees, principal balances,
                all
                costs of liquidating and all other servicing advances for taxes,
                property
                insurance, and other servicing costs incurred and invoiced to us
                within 90
                days following the liquidation
                date.









51


*Delinquency
      by Year Funded* (1)
      (2)




**Year**
            **Original
                Balance**
            **Balance
                Outstanding**
            **Percentage
                of**
              **Original
                Remaining**
            **Cumulative
                Loss**
              **Percentage
                (3)**
            **Loss
                Severity (4) (5)******
            ($
                in thousands)Pre-divestiture:1996
            $741,645
            $10,467
            1%
            1.94%
            31.30%1997
            $1,769,538
            $41,798
            2%
            3.23%
            38.91%1998
            $2,084,718
            $91,152
            4%
            4.09%
            39.52%1999
            $2,381,387
            $188,299
            8%
            5.05%
            41.72%2000
            $2,078,637
            $207,628
            10%
            5.49%
            43.69%2001
            $499,879
            $60,123
            12%
            3.52%
            68.25%Post-divestiture:2001
            $1,833,357
            $253,859
            14%
            3.58%
            40.21%2002
            $2,484,074
            $478,499
            19%
            1.47%
            35.02%2003
            $2,842,942
            $975,928
            34%
            0.34%
            24.21%2004
            $3,764,628
            $2,217,248
            59%
            0.04%
            20.48%2005
            $2,440,750
            $1,917,430
            79%
            —
            18.55%


_________________


(1)
            Includes
                loans originated or purchased by our predecessor and
                us.


(2)
            As
                of September 30, 2005.


(3)
            Includes
                securitization losses and losses incurred from loan repurchases,
                delinquent loan sales, and unsecuritized
                loans.


(4)
            Loss
                severity is defined as the total loss amount divided by the actual
                unpaid
                principal balance at the time of liquidation. Total loss amounts
                include
                all accrued interest and interest advances, fees, principal balances,
                all
                costs of liquidating and all other servicing advances for taxes,
                property
                insurance, and other servicing costs incurred and invoiced to us
                within 90
                days following the liquidation
                date.


(5)
            Loss
                severity amounts are cumulative for each respective funded
                year.







***Mortgage
      Loan Production Segment***




We
      evaluate the performance of our mortgage loan production segment based on
      production levels. We believe the characteristics and level of mortgage loan
      production assists investors by allowing them to evaluate performance of our
      mortgage loan production segment. Our mortgage loan production segment is
      composed of our wholesale, correspondent and retail business channels. It
      purchases and originates non-conforming residential mortgage loans through
      relationships with various mortgage companies, mortgage brokers, and
      correspondent lenders, and originates non-conforming residential mortgage loans
      directly to borrowers through its retail branch offices. The mortgage loan
      production segment records interest income, interest expense, servicing expense,
      and provision for mortgage loan losses on the mortgage loans it holds prior
      to
      selling its loans to the portfolio segment. It also collects revenues, such
      as
      origination and underwriting fees and certain other non-refundable fees, which
      are deferred and recognized over the life of the loan as an adjustment to
      interest income recorded in the portfolio segment. With our continued investment
      in technology in our mortgage loan production segment, as well as the
      reorganization of our wholesale and retail back-end operations and strategically
      located branch locations, we expect to see continued improvements in our loan
      production efficiency during the remainder of 2005.





Mortgage
      loan production was $847.8 million for the three months ended September 30,
      2005, which represents a 15% decrease from the three months ended September
      30,
      2004 production of $999.6 million, which included $50.4 million in called loans.
      Mortgage loan production was $2.4 billion for the nine months ended September
      30, 2005, which represents an 11% decrease from the nine months ended September
      30, 2004 production of $2.7 billion, which included $0.2 million in called
      loans. We did not exercise any clean-up call options during the first nine
      months of 2005. Our wholesale mortgage loan production was $404.6 million for
      the three months ended September 30, 2005, a decrease of 2% from the three
      months ended September 30, 2004, and was $1.1 billion for the first nine months
      of 2005 as well as the first nine months of 2004.


52


Our
      retail channel loan production was $170.2 million for the three months ended
      September 30, 2005, a decrease of 31% from the three months ended September
      30,
      2004, and was $550.6 million during the first nine months of 2005, a decrease
      of
      22% from the first nine months of 2004. Our correspondent flow mortgage loan
      production was $228.7 million for the three months ended September 30, 2005,
      a
      decrease of 14% from the three months ended September 30, 2004, and was $650.8
      million during the first nine months of 2005, an increase of 11% from the first
      nine months of 2004. Our correspondent bulk mortgage loan production was $44.2
      million for the three months ended September 30, 2005, a decrease of 5% from
      the
      three months ended September 30, 2004, and was $115.4 million during the first
      nine months of 2005, a decrease of 2% from the first nine months of 2004. In
      our
      correspondent channel, we continue to focus on growing the flow business while
      pursuing the bulk business when we consider market conditions to be
      advantageous.





**Financial
      Condition**




*September
      30, 2005 Compared to December 31, 2004*





*Net
      Mortgage Loan Portfolio.* Our
      net
      mortgage loan portfolio increased $0.2 billion, or 3%, to $6.2 billion as of
      September 30, 2005 from $6.0 billion as of December 31, 2004. This increase
      was
      the result of the origination and purchase of $2.4 billion of mortgage loans
      offset by principal payments of $2.0 billion and loan sales of $0.2 million.
      We
      expect that our mortgage loan portfolio will continue to grow as we continue
      to
      originate and purchase mortgage loans. However, we anticipate the growth rate
      will be slower than historical growth rates as our portfolio ages, more seasoned
      mortgage loans are paid off, and as competition in our industry remains intense.





*Allowance
      for Loan Loss.* The
      allowance for loan loss increased $11.9 million, or 32%, to $49.2 million as
      of
      September 30, 2005 from $37.3 million as of December 31, 2004. The increase
      in
      the allowance for loan loss was attributable to a specific reserve recorded
      for
      Hurricane Katrina losses of $6.8 million, additional provisions of $31.8 million
      due to an increase in delinquencies, offset by charge-offs of $26.7 million
      from
      primarily our 2001 and 2002 securitizations, which were provided for in previous
      periods. We expect our allowance for loan loss may increase in the future as
      our
      portfolio continues to grow.





*Mortgage
      servicing rights, net.* Mortgage
      servicing rights (MSRs), net increased $39.9 million, or 40%, to $138.9 million
      as of September 30, 2005 from $99.0 million as of December 31, 2004. This
      increase was primarily due to purchases of $78.7 million of rights to service
      $16.0 billion of mortgage loans during the first nine months of 2005. The
      increase in MSRs was partially offset by amortization of servicing rights of
      $33.9 million during the first nine months of 2005. Also, our valuation
      allowance increased $4.8 million as the result of: 1) decreased valuations
      of
      MSRs in the marketplace; 2) actual prepayment speeds being greater than
      projected during the first nine months of 2005 on certain aged third party
      servicing pools, and 3) probable losses relating to Hurricane Katrina. We have
      sought to strategically position ourselves to take advantage of the increased
      supply of servicing assets in the


53


marketplace
      and have been able to purchase servicing assets at what we believe to be
      favorable prices. We anticipate that the demand for non-conforming servicing
      will continue and that we will continue to purchase servicing rights in the
      future, which would increase our net servicing income. We have committed
      to
      purchase the rights to service an additional $1.1 billion unpaid principal
      balance of third party mortgage loans during the remainder of 2005, of which
      $0.2 billion have been purchased in October 2005 for approximately $1.1 million.





*Servicing
      Related Advances.* Servicing related advances increased $42.7 million, or 38%, to $155.8 million
      as
      of September 30, 2005 from $113.1 million as of December 31, 2004. The increase
      was primarily due to the increase in our third party servicing balances, an
      increase in delinquencies in the third party servicing pools, and increased
      delinquencies related to Hurricane Katrina.





*Trustee
      Receivable.* Trustee
      receivable increased $18.0 million, or 16%, to $130.1 million as of September
      30, 2005 from $112.1 million as of December 31, 2004. The increase was primarily
      due to the completion of three securitizations during the first nine months
      of
      2005, as well as increased collections after the applicable trust cut-off date
      as a result of higher prepayment activity. On each payment date, the trust
      distributes securitization loan payments to the related bondholders. These
      loan
      payments are collected by the trust before the cut-off date, which is typically
      the 17 th of each
      month. Therefore, all principal payments received after the cut-off date are
      recorded as a trustee receivable and reduce our mortgage loan portfolio on
      our
      consolidated balance sheet. The trustee retains these principal payments until
      the following payment date. As we continue to securitize mortgage loans, we
      anticipate that our trustee receivable balance will increase.





*Other
      Assets.* Other
      assets decreased $23.9 million, or 27%, to $65.8 million as of September 30,
      2005 from $89.7 million as of December 31, 2004. The decrease in other assets
      is
      primarily the result of a decrease in our net current tax receivable balance
      of  $24.3 million. Additionally, we had decreases of $1.9 million in
      prepaid expenses and $0.7 million in our required cash margin account on
      derivative instruments. These decreases were partially offset by an increase
      in
      net capital expenditures of $4.4 million.





*Warehouse
      Financing.* Warehouse financing decreased $456.5 million, or 76%, to $144.1 million as
      of
      September 30, 2005 from $600.6 million as of December 31, 2004. We expect our
      warehouse financing to continue to fluctuate from one reporting period to the
      next as a result of the timing of our securitizations and mortgage loan
      production.





*Securitization
      Financing.* Securitization financing increased $0.9 billion, or 17%, to $6.2 billion as
      of
      September 30, 2005 from $5.3 billion as of December 31, 2004. This increase
      resulted primarily from the execution of three asset-backed securitizations,
      which resulted in debt being issued in the amount of $1.0 billion during the
      first quarter of 2005, $1.0 billion during the second quarter of 2005, and
      $0.9
      billion during the third quarter of 2005. This increase was partially offset
      by
      debt and certificate payments of $2.1 billion. In general, we expect increases
      in our securitization financing as we experience increased mortgage loan
      production and continue to securitize our mortgage loans.


54




*Shareholders’
      Equity.* Shareholders’
      equity increased $41.4 million, or 7%, to $660.3 million as of September 30,
      2005, from $618.9 million as of December 31, 2004. The increase in shareholders’
      equity was due primarily to net income of $62.7 million and an increase in
      accumulated other comprehensive income of $26.8 million. These increases were
      partially offset by the declaration of $55.8 million in dividends.





**Liquidity
      and Capital Resources**




Cash
      decreased by $3.4 million during the nine months ended September 30, 2005 and
      increased by $221.6 million during the nine months ended September 30, 2004.
      The
      overall change in cash consisted of the following:


**Nine
                months ended September 30,******
            **2005**
            **2004**($
                in thousands)Cash
                provided by operations
            $110,377
            $
                102,844Cash
                used by investing activities
            (516,832)
            (1,048,448)Cash
                provided by financing activities
            403,096
            1,167,166Increase
                (decrease) in cash
            $(3,359)
            $
                221,562





*Operating
      Activities* .
      Cash
      provided by operations for the nine months ended September 30, 2005 was $110.4
      million, reflecting an increase of $7.6 million, or 7%, compared to the first
      nine months of 2004. Although our net interest margin decreased due to the
      increase in the cost of our borrowings, our adjustments to net income for
      noncash items such as depreciation and amortization as well as provision for
      mortgage loan losses increased by 136% and 34%, respectively. Further details
      are discussed in “-- Consolidated Results.”





*Investing
      Activities* .
      Cash
      used for investing activities was $516.8 million for the nine months ended
      September 30, 2005. Investing activities consist principally of the origination
      and purchase of mortgage loans as well as the acquisition of MSRs. The
      origination and purchase of mortgage loans including basis adjustments totaled
      $2.5 billion for the nine months ended September 30, 2005. In addition, MSRs
      were purchased totaling $78.7 million. These decreases to cash were partially
      offset by cash received from principal payments on our mortgage loan portfolio
      totaling $1.9 billion and proceeds from the sale of mortgage loans and REO
      which
      totaled $251.3 million and $41.8 million, respectively.





Restricted
      cash increased $140.7 million to $142.2 million at September 30, 2005 due to
      the
      timing of the receipt of cash related to prefunded securitizations. Prefunded
      amounts are held in a trust account and made available once all required
      mortgage loans have been included in the securitization. During the third
      quarter of 2005, the SAST 2005-3 securitization was closed, requiring a
      prefunding settlement. Because settlement had not occurred as of September
      30,
      2005, restricted cash increased.


55


Capital
      expenditures during the nine months ended September 30, 2005 were $9.1 million
      and were primarily related to the new mortgage loan origination facility
      and second servicing site as well as various information technology
      enhancements.





*Financing
      Activities* .
      Cash
      provided by financing activities during the nine months ended September 30,
      2005
      was $403.1 million and was the result of proceeds from the issuance of
      securitization financing of $3.0 billion partially offset by principal payments
      on securitization financings of $2.1 billion, net repayment of warehouse
      financing of $456.5 million, payment of dividends of $84.7 million, and debt
      issuance costs of $11.1 million relating to the completion of three
      securitizations during the nine months ended September 30, 2005. Fluctuations
      in
      warehouse and securitization financing period over period can occur due to
      the
      timing of securitizations and the related repayment of the warehouse financing
      facilities.





Derivative
      financial instrument transactions during the nine months ended September 30,
      2005 used primarily as cash flow hedges with the objective of hedging interest
      rate risk related to our financing activities resulted in an increase in cash
      of
      $9.0 million.





*Dividends.* On July
      19, 2005, we declared a dividend of $0.55 per common share payable on August
      11,
      2005 to stockholders of record as of the close of business on July 29, 2005.
      On
      October 18, 2005, we declared a dividend of $0.50 per common share payable
      on
      November 10, 2005 to shareholders of record as of the close of business on
      October 28, 2005. Due to our election to be treated as a REIT, we expect to
      continue making quarterly distributions to shareholders, the amount and timing
      of which will be determined by our Board of Directors.





*Trends.* At
      this
      time, we see no material negative trends that we believe would affect our access
      to long-term borrowings, short-term borrowings or bank credit lines sufficient
      to maintain our current operations or that would likely cause us to be in danger
      of any debt covenant default.





***Working
      Capital***




We
      intend
      to maintain sufficient working capital to fund the cash flow needs of our
      operations in the event we are unable to generate sufficient cash flows from
      operations to cover our operating requirements. Using our definition of working
      capital, we calculated our working capital as of September 30, 2005 to be
      approximately $154.0 million. Under the commonly defined working capital
      definition, we calculated our working capital as of September 30, 2005 to be
      $291.7 million. A reconciliation between our working capital calculation and
      the
      common definition of working capital is provided below. Management focuses
      on
      our internally defined calculations of working capital rather than the commonly
      used definition of working capital because management believes our definition
      provides a better indication of how much liquidity we have available to conduct
      business at the time of the calculation.


56







**Working
                Capital Reconciliation - September 30, 2005**
            **Saxon
                Defined**
              **Working
                Capital (1)**
            **Commonly
                Defined**
              **Working
                Capital (2)**($
                in thousands)Unrestricted
                cash
            $9,493
            $9,493Borrowing
                availability
            73,650
            —Trustee
                receivable
            —
            130,117Accrued
                interest receivable
            —
            56,784Accrued
                interest payable
            —
            (7,044)Unsecuritized
                mortgage loans - payments less than one year
            193,295
            216,311Warehouse
                financing facility - payments less than one year
            (122,473)
            (144,100)Servicing
                advances
            —
            155,812Financed
                advances - payments less than one year
            —
            (25,147)Securitized
                loans - payments less than one year
            —
            2,300,057Securitized
                financing - payments less than one year
            —
            (2,400,559)Total
            $153,965
            $291,724


_________________


(1)
            Generally
                calculated as unrestricted cash and investments as well as unencumbered
                assets that can be pledged against existing committed facilities
                and
                converted to cash in five days or
                less.


(2)
            Current
                assets less current liabilities.







***Financing
      Facilities***





We
      need
      to borrow substantial sums of money each quarter to originate and purchase
      mortgage loans. We rely upon several counterparties to provide us with financing
      facilities to fund our loan originations and purchases, as well as fund a
      portion of our servicing advances and servicing rights. 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.





To
      accumulate loans for securitization, we borrow money on a short-term basis
      through committed secured warehouse lines of credit and committed repurchase
      agreements. In addition to funding loans prior to securitization, some of our
      committed facilities allow us to finance advances that are required by our
      mortgage servicing contracts, mortgage bonds and mortgage servicing
      rights.





*Committed
      Facilities* .
      There
      were several changes to our financing facilities during the third quarter of
      2005:


·
                Our
                    $175.0 million facility with Greenwich Capital Financial Products,
                    Inc.
                    was amended on August 29, 2005 to extend the termination date
                    to September
                    29, 2005 and was subsequently amended on September 29, 2005 to
                    extend the
                    termination date to October 28,
                    2005.
  ·
                Our
                    $150.0 million facility with Greenwich Capital Financial Products,
                    Inc.
                    was amended on August 29, 2005 to extend the termination date
                    to September
                    29, 2005 and was subsequently amended on September 29, 2005 to
                    extend the
                    termination date to October 28,
                    2005.


57





As
      of
      September 30, 2005 we had committed revolving warehouse and repurchase
      facilities in the amount of approximately $1.7 billion. The table below
      summarizes our facilities and their expiration dates as of September 30, 2005.
      We believe this level of committed financing will allow us flexibility to
      execute our asset-backed securitizations in accordance with our business plans.








**Counterparty
                Committed Lines**
            **Facility
                Amount**
            **Expiration
                Date**($
                in thousands)JP
                Morgan Chase Bank
            $
                375,000
            March
                29, 2006Greenwich
                Capital Financial Products, Inc.
            175,000
            October
                28, 2005Greenwich
                Capital Financial Products, Inc.
            150,000
            October
                28, 2005Bank
                of America, N.A.
            300,000
            June
                22, 2006CS
                First Boston Mortgage Capital, LLC
            300,000
            April
                28, 2006Merrill
                Lynch Bank USA
            400,000
            November
                21, 2005Total
                committed facilities
            $1,700,000





The
      amount we have outstanding on our committed facilities at any quarter end
      generally is a function of the pace of mortgage loan purchases and originations
      relative to the timing of our securitizations. Although we expect to issue
      asset-backed securities on a quarterly basis, our intention is to maintain
      committed financing facilities equal to approximately six months of mortgage
      production to provide us with flexibility in timing our securitizations.





We
      had
      $144.1 million of warehouse borrowings collateralized by residential mortgages
      outstanding as of September 30, 2005. As we complete securitization
      transactions, a portion of the proceeds from the long-term debt issued in the
      securitization will be used to pay down our short-term borrowings. Therefore,
      the amount of short-term borrowings will fluctuate from quarter to quarter,
      and
      could be significantly higher or lower than the $144.1 million we held as of
      September 30, 2005, as our mortgage production and securitization programs
      continue.




Our
      financing facilities require us to comply with various customary operating
      and
      financial covenants, including tests relating to our tangible net worth,
      liquidity, and leverage requirements. In addition, some of the facilities may
      subject us to cross default features. We do not believe that these existing
      financial covenants will restrict our operations or growth. To the extent that
      we fail to comply with the covenants contained in our financing agreements
      or
      are otherwise found to be in default under the terms of such agreements, we
      could be restricted from paying dividends or from engaging in other transactions
      that are necessary for us to maintain our REIT status. Our failure to qualify
      as
      a REIT could reduce materially the value of our common stock. We were in
      compliance with all covenants under the agreements as of and for the three
      and
      nine months ended September 30, 2005.





On
      October 27, 2005 we entered into a new $300.0 million repurchase facility with
      Greenwich Capital Financial Products, Inc. due to expire on September 28, 2006.
      The new facility provides us with the ability to finance first and second lien
      loans on a wet
      or
      dry basis and to finance mortgage bonds. In conjunction with entering into
      the
      new facility, the existing $150.0 million and $175.0 million facilities with
      Greenwich Capital Financial Products, Inc. were both
      terminated.


58




***Securitization
      Financing***





*Mortgage
      Loan Securitization Facilities.* We have
      historically 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 with a low cost method of
      financing our mortgage loan portfolio. In addition, it allows us to reduce
      our
      interest rate risk on our fixed rate loans by securitizing them. Our ability
      to
      issue asset backed securities depends on the overall performance of our assets,
      as well as the continued general demand for securities backed by non-conforming
      mortgage loans and home equity loans.





We
      are
      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 must look for repayment from the cash flows generated
      by
      the mortgage loans specifically collateralizing the debt.





*Servicing
      Advance Facility.* As of
      September 30, 2005 we had $165.1 million of borrowings outstanding and an
      additional $64.9 million of available borrowing capacity under a facility that
      allows for the issuance of notes to finance principal, interest and other
      servicing advances that we are required to make for our owned portfolio as
      well
      as those related to certain third party servicing contracts.





During
      the quarter, our servicing advance facility issued a new series of notes, called
      the Series 2005-A Notes. These notes include two classes, which replaced two
      retired classes of the original Series 2004-1 Notes and increased the total
      borrowing capacity of the facility. The Series 2005-A Notes include a class
      of
      term notes with a face value of $85.0 million and a class of variable funding
      notes with a maximum face value of $95.0 million. The Series 2004-1 Notes have
      one remaining class outstanding, term notes with a face value of $55.0
      million.





Our
      servicing advance facility requires us to comply with various customary
      operating covenants and performance tests on the underlying receivables related
      to payment rates and minimum balance. In the event of a breach, the Notes issued
      by the servicing advance facility may begin to amortize earlier than scheduled.
      We do not believe that these existing covenants and performance tests will
      restrict our operations or growth. We were in compliance with all covenants
      and
      performance tests under the servicing advance facility as of and for the three
      and nine months ended September 30, 2005.





As
      of
      September 30, 2005, securitization financing related to mortgage loans and
      servicing advances on our consolidated balance sheet was approximately $6.2
      billion.


59


***REIT
      Taxable Income***





The
      following table is a reconciliation of GAAP net income to estimated REIT taxable
      net income for the three and nine months ended September 30, 2005:





**Three
                months ended**
              **September
                30, 2005**
            **Nine
                months ended**
              **September
                30, 2005**($
                in thousands)Consolidated
                GAAP income before taxes, including cumulative effect of change in
                accounting principle (SFAS 123(R))
            $5,296
            $54,800Estimated
                tax adjustments:Plus:Provision
                for mortgage loan losses
            19,369
            38,551Elimination
                of intercompany income before taxes
            2,095
            15,515Securitized
                loan adjustments for tax
            3,351
            —Miscellaneous
            —
            907Less:Taxable
                REIT subsidiary income before taxes
            544
            12,490Securitized
                loan adjustments for tax
            —
            5,901Miscellaneous
            99
            —Estimated
                REIT taxable income
            $29,468
            $91,382Estimated
                REIT taxable income per common share
            $0.59
            $1.83








The
      estimated REIT taxable income for the three and nine months ended September
      30,
      2005 set forth in the table above is an estimate only and is subject to change
      until we file our 2005 REIT federal tax returns.





**Off
      Balance Sheet Items and Contractual Obligations**





***Off
      Balance Sheet Items***





In
      connection with the approximately $433.6 million of mortgage loans securitized
      in off balance sheet transactions from May 1996 to July 5, 2001, and which
      were
      still outstanding as of September 30, 2005, and in connection with the sales
      of
      mortgage loans to nonaffiliated parties, our subsidiaries made representations
      and warranties about certain characteristics of the loans, the borrowers, and
      the underlying properties. In the event of a breach of these representations
      and
      warranties, our subsidiaries may be required to remove loans from a
      securitization and replace them with cash or substitute loans, and to indemnify
      parties for any losses related to such breach. As of September 30, 2005 our
      subsidiaries neither had nor expected to incur any material obligation to remove
      any such loans, or to provide any such indemnification.





Our
      subsidiaries had commitments to fund mortgage loans with agreed upon rates
      of
      approximately $261.8 million and $240.3 million as of September 30, 2005 and
      December 31, 2004, respectively. Commitments do not necessarily represent future
      cash requirements, as some portion of the commitments are likely to expire
      without being drawn upon or may be subsequently declined for credit or other
      reasons.





***Contractual
      Obligations and Commitments***


60





Our
      subsidiaries are obligated under non-cancelable operating leases for property
      and equipment. Future minimum rental payments for all of our operating leases
      increased to $64.3 million as of September 30, 2005 from $22.7 million as of
      December 31, 2004. In 2005, we began lease payments for our new mortgage loan
      origination facility and second servicing site in Glen Allen,
      Virginia. Additionally, the term of our lease agreement for our principal
      executive facility has been extended to correspond to the term of our
      lease
      agreement for our new mortgage loan origination facility and second servicing
      site, which terminates in the third quarter of 2017.





We
      have
      committed to purchase the rights to service an additional $1.1 billion unpaid
      principal balance of third party mortgage loans during the remainder of 2005,
      of
      which $0.2 billion were purchased during July 2005 for approximately $1.1
      million.




As
      of
      September 30, 2005, we did not have any other material changes in our
      contractual obligations and commitments as presented in our annual report on
      Form 10-K for the year ended December 31, 2004 other than those described
      above.




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




We
      define
      market risk as the sensitivity of income to changes in interest rates. Changes
      in prevailing market interest rates may have two general effects on our
      business. First, any general increase in mortgage loan interest rates may tend
      to reduce customer demand for new mortgage loans, which can negatively impact
      our future production volume and our projected income. Second, increases or
      decreases in interest rates can cause changes in the interest income on the
      mortgage loans that we own or are committed to fund, and as a result, cause
      changes in our net income. We refer to this second type of risk as our “managed
      interest rate risk”. Substantially all of our managed interest rate risk arises
      from debt related to the financing of our mortgage loan portfolio. Interest
      rate
      risk is managed within an overall asset/liability management framework. The
      principal objective of asset/liability management is to manage the sensitivity
      of net income due to changes in liability costs. In our case, changes in
      liability costs are a result of changes in interest rates.




Since
      December 31, 2004, there have been many market changes with respect to interest
      rate outlooks. Our framework for measuring the potential impact on our exposure
      to market risk from changing interest rates has remained constant while
      potential scenarios have been modified in response to economic developments
      and
      their impact on interest rate outlooks. For further information on our interest
      rate risk profile and our types of managed interest rate risks, we refer you
      to
      Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” contained
      in our 2004 Form 10-K.




***Maturity
      and Repricing Information*** **




As
      shown
      in the tables below from December 31, 2004 to September 30, 2005, there was
      an
      increase in our hedging activity due to additional existing and forecasted
      debt
      and our belief that interest rates may rise in the future. The following tables
      summarize
      the notional amounts, expected maturities and weighted average strike rates
      for
      interest rate floors, caps, swaps, options and futures that we held as of
      September 30, 2005 and December 31, 2004.




61






**As
                of September 30, 2005******
            **2005**
            **2006**
            **2007**
            **2008**
            **2009**
            **Thereafter**($
                in thousands)Caps
                bought - notional:
            $830,519
            $1,186,583
            $18,167
            —
            —
            —Weighted
                average rate
            3.97%
            3.86%
            3.25%
            —
            —
            —Caps
                sold - notional:
            $819,519
            $1,186,583
            $18,167
            —
            —
            —Weighted
                average rate
            5.20%
            4.69%
            5.00%
            —
            —
            —Futures
                sold - notional:
            —
            $771,250
            $313,750
            $127,500
            $20,000
            $7,500Weighted
                average rate
            —
            4.27%
            4.38%
            4.51%
            4.87%
            4.78%Swaps
                bought - notional:
            $2,500,000
            $1,650,000
            $600,000
            —
            —
            —Weighted
                average rate
            3.28%
            3.77%
            4.17%
            —
            —
            —Puts
                bought - notional:
            $9,525,000
            $500,000
            —
            —
            —
            —Weighted
                average rate
            4.50%
            4.75%
            —
            —
            —
            —Puts
                sold - notional:
            $2,000,000
            $125,000
            —
            —
            —
            —Weighted
                average rate
            4.25%
            3.75%
            —
            —
            —
            —Calls
                bought - notional:
            —
            $50,000
            —
            —
            —
            —Weighted
                average rate
            —
            3.75%
            —
            —
            —
            —Total
                notional:
            $15,675,038
            $5,469,416
            $950,084
            $127,500
            $20,000
            $7,500









**As
                of December 31, 2004******
            **2005**
            **2006**
            **2007**
            **2008**
            **2009**
            **Thereafter**($
                in thousands)Caps
                bought - notional:
            $898,216
            $686,583
            $18,167
            —
            —
            —Weighted
                average rate
            3.92%
            3.39%
            3.25%
            —
            —
            —Caps
                sold - notional:
            $865,966
            $686,583
            $18,167
            —
            —
            —Weighted
                average rate
            5.13%
            4.46%
            5.00%
            —
            —
            —Futures
                sold - notional:
            225,000
            $695,000
            $570,000
            $12,500
            $6
            —Weighted
                average rate
            3.57%
            3.99%
            4.33%
            5.08%
            5.45%
            —Swaps
                bought - notional:
            500,000
            $700,000
            $200,000
            —
            —
            —Weighted
                average rate
            2.31%
            3.53%
            3.91%
            —
            —
            —Puts
                bought - notional:
            50,000
            —
            —
            —
            —
            —Weighted
                average rate
            2.25%
            —
            —
            —
            —
            —Puts
                sold - notional:
            $112,500
            $250,000
            —
            —
            —
            —Weighted
                average rate
            4.11%
            3.75%
            —
            —
            —
            —Total
                notional:
            $2,651,682
            $3,018,166
            $806,334
            $12,500
            $6
            $—






*Analyzing
      Rate Shifts*




In
      our
      method of analyzing the potential effect of interest rate changes, we study
      the
      published forward yield curves for applicable interest rates and instruments,
      and we then develop various interest rate scenarios for those yield curves
      based
      on assumptions concerning economic growth rates, market conditions, and
      inflation rates, as well as the timing, duration, and amount of corresponding
      Federal Reserve Board, or FRB, responses, in order to determine hypothetical
      impacts on relevant interest rates. We use this method of analysis as a means
      of
      valuation to manage our interest rate risk on our mortgage loan financing over
      long periods of time. The table below represents the change in our interest
      expense as determined by changes in our debt costs and offsetting values of
      derivative instruments under the four different analysis scenarios that we
      used
      as of September 30, 2005 and December 31, 2004.




62









**Effect
                on Interest Expense of Assumed Changes in Interest Rates Over a Three
                Year
                Period******
            **September
                30, 2005**
            **December
                31, 2004******
            **Scenario
                1**
            **Scenario
                2**
            **Scenario
                3**
            **Scenario
                4**
            **Scenario
                1**
            **Scenario
                2**
            **Scenario
                3**
            **Scenario
                4**($
                in thousands)Change
                in interest expense
            $7,985
            $(10,075)
            $(26,429)
            $(42,476)
            $65,786
            $40,758
            $(219)
            $(40,701)Change
                in interest expense from  hedging instruments:Futures
            (1,831)
            1,893
            5,025
            9,792
            (12,302)
            (11,698)
            (1,322)
            5,834Swaps
            (3,212)
            3,672
            10,485
            16,388
            (11,753)
            (7,866)
            (276)
            6,766Puts
            (1,077)
            134
            (272)
            (83)
            1,702
            1,178
            (19)
            (310)Calls
            (2)
            (10)
            (33)
            (49)
            —
            —
            —
            —Caps
            (357)
            512
            1,647
            2,846
            (6,885)
            (3,967)
            168
            661Total
                change in interest expense from hedging instruments
            $(6,479)
            $6,201
            $16,852
            $28,894
            $(29,238)
            $(22,353)
            $(1,449)
            $12,951Net
                change in interest expense
            $1,506
            $(3,874)
            $(9,577)
            $(13,582)
            $36,548
            $18,405
            $(1,668)
            $(27,750)




Each
      scenario is more fully discussed below, and tables of the hypothetical yield
      curves are included below.





Scenario
      1 - Under this scenario we show mortgage loan and derivative valuations based
      upon an assumed aggressive response from the Board of Governors of the FRB,
      with
      the assumption that the economy is growing at a pace inconsistent with the
      FRB
      desire to maintain a stable or declining inflation environment. Under this
      scenario, we assume a hypothetical interest rate increase of approximately
      100
      basis points over a fifteen-month period. Such an increase provides us with
      a
      view of the interest expense changes assuming a comparable rise in financing
      rates. Making these assumptions as of September 30, 2005, we estimated that
      our
      interest expense would increase by $8.0 million over the life of our existing
      liabilities. However, we estimated that this amount would be partially offset
      by
      a decrease in interest expense from our hedging instruments of $6.5 million
      over
      the same period. The net effect of this scenario would be a potential increase
      of $1.5 million in our interest expense. At December 31, 2004, assuming a
      hypothetical interest rate increase of approximately 225 basis points over
      a
      twelve-month period, we estimated at that time that our interest expense would
      increase by approximately $36.5 million.




Scenario
      2 - In this scenario we assume a slightly less severe hypothetical rise in
      interest rates compared to Scenario 1, but a relatively aggressive rise over
      the
      next six months. Under this scenario, we assume that interest rates have the
      potential to rise approximately 50 basis points over a six month period. Making
      these assumptions as of September 30, 2005, we estimated that our interest
      expense would decline by $10.1 million over the life of our liabilities.
      However, we estimated that this amount would be partially offset by an increase
      in interest expense from our hedging instruments of $6.2 million. The net effect
      of this scenario would be a potential decrease of $3.9 million in our interest
      expense. At December 31, 2004, assuming interest rates had the potential to
      rise
      approximately 250 basis points over a two year period, we estimated at that
      time
      that our interest expense would increase by approximately $18.4 million.




63




Scenario
      3 - In this scenario we assume relatively stable hypothetical short-term rates.
      This scenario assumes that the FRB temporarily stops raising interest rates
      to
      assess any lag in the impact of previous rate increases on the domestic and
      global economy. Given these assumptions as of September 30, 2005, we estimated
      that our interest expense from changes in borrowing costs would decrease by
      $26.4 million. However, we estimated that this amount would be partially offset
      by an increase in interest expense from our hedging instruments of $16.8
      million. The net effect of this scenario would be a potential decrease in
      interest expense of $9.6 million. At December 31, 2004, assuming interest rates
      increased another 100 basis points over a 12 month period, we estimated at
      that
      time that our interest expense would decline by approximately $1.7
      million.




Scenario
      4 -This scenario assumes that the FRB increases rates another 25 basis points
      and then becomes concerned about the future prospects of economic growth and
      by
      mid 2006 reduces rates by 75 basis points to stimulate economic growth again.
      Given these assumptions as of September 30, 2005, we estimated that our interest
      expense would decrease by approximately $42.5 million, which would partially
      be
      offset by an estimated increase in interest expense from hedging instruments
      of
      approximately $28.9 million, for a total potential decrease in interest expense
      of approximately $13.6 million. At December 31, 2004, assuming interest rates
      remained steady for one year and then increased 150 basis points over a two
      year
      period, we estimated at that time that our interest expense could decline by
      approximately $27.8 million.






The
      hypothetical yield curve data for each scenario at September 30, 2005 and
      December 31, 2004 are as follows:




**September
                30, 2005****Month**
            **Current
                Market (1)**
            **Scenario
                1**
            **Scenario
                2**
            **Scenario
                3**
            **Scenario
                4**Oct-05
            4.00
            4.02
            3.89
            3.76
            3.89Dec-05
            4.39
            4.40
            4.27
            4.02
            4.14Mar-06
            4.55
            4.41
            4.40
            4.15
            4.15Jun-06
            4.61
            4.55
            4.41
            4.15
            4.03Sep-06
            4.61
            4.81
            4.42
            4.16
            3.66Dec-06
            4.61
            4.95
            4.43
            4.16
            3.41Mar-07
            4.58
            4.96
            4.44
            4.17
            3.42Jun-07
            4.57
            4.97
            4.44
            4.17
            3.42Sept-07
            4.57
            4.98
            4.45
            4.18
            3.43Dec-07
            4.60
            5.00
            4.46
            4.18
            3.43Mar-08
            4.60
            5.01
            4.47
            4.19
            3.56Jun-08
            4.61
            5.02
            4.48
            4.19
            3.69Sep-08
            4.64
            5.03
            4.49
            4.20
            3.70Dec-08
            4.67
            5.04
            4.49
            4.20
            3.70Mar-09
            4.68
            5.06
            4.50
            4.21
            3.71























64





**December
                31, 2004****Month**
            **Current
                Market (1)**
            **Scenario
                1**
            **Scenario
                2**
            **Scenario
                3**
            **Scenario
                4**Jan-05
            2.39
            2.89
            2.61
            2.63
            2.35Mar-05
            2.91
            3.40
            2.89
            2.89
            2.36Jun-05
            3.18
            3.91
            3.40
            2.89
            2.39Sep-05
            3.39
            4.43
            3.65
            3.15
            2.40Dec-05
            3.56
            4.69
            3.91
            3.40
            2.65Mar-06
            3.68
            4.70
            4.41
            3.65
            3.15Jun-06
            3.78
            4.71
            4.67
            3.91
            3.66Sep-06
            3.87
            4.72
            4.92
            4.16
            3.66Dec-06
            3.97
            4.73
            4.93
            4.17
            3.67Mar-07
            4.05
            4.75
            4.93
            4.17
            3.67Jun-07
            4.13
            4.76
            4.94
            4.18
            3.68Sept-07
            4.22
            4.77
            4.94
            4.43
            4.18Dec-07
            4.31
            4.78
            4.95
            4.43
            4.18


________________


(1)
              Current market is depicted using the forward
                  Eurodollar
                  Futures Curve. The Eurodollar Future curve is the series of benchmark
                  rates of Libor with a 3-month maturity.
                The series of 3 month rates depicted represent
                  the
                  current market expectations of Libor spot rates in the future based
                  on
                  expectations of economic activity.


These
      scenarios are provided for illustrative purposes only and are intended to assist
      in the understanding of our sensitivity to changes in interest rates. While
      there may be an immediate impact on our interest expense due to changes in
      interest rates, the impact of the anticipated changes in cash flows for our
      hedges is included in accumulated other comprehensive income, net of tax effect
      in shareholders’ equity on our consolidated balance sheets and is recognized
      into earnings over the expected life of the variable rate debt. This may result
      in short-term mismatches and changes in our borrowing costs and the effect
      of
      our hedges. While these scenarios are developed based on current economic and
      market conditions, we cannot make any assurances as to the predictive nature
      of
      assumptions made in this analysis.





**Item
      4. Controls and Procedures**





We
      carried out an evaluation, as required by Exchange Act Rule 13a-5(b), under
      the
      supervision and with the participation of our management, including our Chief
      Executive Officer and Chief Financial Officer, of the effectiveness of the
      design and operation of our disclosure controls and procedures as of the end
      of
      the period covered by this report. Based upon that evaluation, our Chief
      Executive Officer and Chief Financial Officer concluded that, as of the date
      of
      such evaluation, our disclosure controls and procedures are effective in
      ensuring that information required to be disclosed by us in the reports that
      we
      file or submit under the Exchange Act is recorded, processed, summarized and
      reported within the time periods specified in the Securities and Exchange
      Commission’s rules and forms, and in timely alerting them to material
      information relating to us (including our consolidated subsidiaries) required
      to
      be included in the periodic reports we are required to file and submit to the
      Securities and Exchange Commission under the Exchange Act.




65


There
      have been no significant changes in our internal controls or other factors
      that
      could significantly affect those controls subsequent to the date of such
      evaluation.




Our
      management, including our Chief Executive Officer and Chief Financial Officer,
      has determined that there were no changes in our internal controls over
      financial reporting that have materially affected, or are reasonably likely
      to
      materially affect, our internal control over financial reporting during the
      period covered by this report.




Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. 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.




**PART
      II**




**Item
      1. Legal Proceedings**





Because
      we are subject to many laws and regulations, including but not limited to
      federal and state consumer protection laws, we are regularly involved in
      numerous lawsuits filed against us, some of which seek certification as class
      action lawsuits on behalf of similarly situated individuals. If class actions
      are certified and there is an adverse outcome or we do not otherwise prevail
      in
      the following matters, we could suffer material losses, although we intend
      to
      vigorously defend these lawsuits.





Bauer,
      et al., v. Dean Morris, L.L.P., et al., and Patterson,
      et al., v. Dean Morris, et al., are
      successor matters to Bauer,
      et al., v. Saxon Mortgage Services, Inc., et al. ,
      previously described in Part I, Item 3 of our 2004 Form 10-K. On January 26,
      2005, the plaintiffs in Bauer,
      et al., v. Saxon Mortgage Services, Inc., et al. filed a
      motion to dismiss the case without prejudice, and the court entered an order
      dismissing the case on January 31, 2005. On February 17, 2005, the plaintiffs
      re-filed the case as two separate class action lawsuits, Bauer,
      et al., vs. Dean Morris, et al. ,
      filed
      as Case No. 05-2173 in the Civil District Court for the Parish of Orleans,
      State
      of Louisiana, and Patterson
      et al., v. Dean Morris, et al. ,
      filed
      as Case No. 05-2174 in the Civil District Court for the Parish of Orleans,
      State
      of Louisiana. There were no material developments in this legal proceeding
      during the quarter ended September 30, 2005.





Cechini,
      et al., v. America’s MoneyLine, Inc .
      is a
      matter filed on August 10, 2005 in the United States District Court for the
      Northern District of Illinois, Eastern Division, as Case No. 05C 4570. The
      Plaintiff filed the case as a class action, alleging violation of the Fair
      Credit Reporting Act in connection with the use of pre-approved offers of credit
      by our subsidiary, America’s MoneyLine, Inc. The plaintiff seeks certification
      as a class, statutory damages, injunctive relief, costs, attorneys’ fees, and
      other relief deemed appropriate by the court. As with other pending litigation,
      if a class is certified and there is an adverse outcome or we do not otherwise
      prevail in the matter, we could suffer material losses, although we intend
      to
      vigorously defend this lawsuit. At the present time, we cannot predict the
      outcome of this case.


66


Jumar
      Hooks and Diane Felder, et al., v. Saxon Mortgage, Inc. is a matter filed
      o n
      October
      12, 2005 in the Common Pleas Court for Cuyahoga County, Ohio as Case No. CV
      05
      574577. The plaintiffs filed this case as a class action, alleging, on behalf
      of
      themselves and similarly situated Ohio borrowers, that the Company’s subsidiary
      engaged in unlawful practices in originating and servicing the plaintiffs’
      loans. The plaintiffs seek certification as a class and a judgment in favor
      of
      the plaintiffs for money damages, costs, attorneys’ fees, and other relief
      deemed appropriate by the court. As with other pending litigation, if a class
      is
      certified and there is an adverse outcome or we do not otherwise prevail in
      the
      matter, we could suffer material losses, although we intend to vigorously defend
      this lawsuit. At the present time, we cannot predict the outcome of this
      case.




We
      are
      subject to other legal proceedings arising in the normal course of our business.
      In the opinion of management, the resolution of these other proceedings is
      not
      expected to have a material adverse effect on our financial position or our
      results of operations.




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




None.




**Item
      3. Defaults Upon Senior Securities**




None.




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




None.





**Item
      5. Other Information**




(a)
      None.




(b)  None.





**Item
      6. Exhibits**





3.1
            Amended
                and Restated Certificate of Incorporation of Saxon Capital, Inc.
                (1)




3.2
            Amended
                and Restated Bylaws of Saxon Capital, Inc.
                (2)




4.1
            Form
                of Common Stock Certificate of Saxon Capital, Inc.
                (3)




4.2
            Certain
                instruments defining the rights of the holders of long-term debt
                of the
                Company and certain of its subsidiaries, none of which authorize
                a total
                amount of indebtedness in excess of 10% of the total assets of the
                Company
                and its subsidiaries on a consolidated basis, have not been filed




4.3
            as
                Exhibits. The Company hereby agrees to furnish a copy of any of these
                agreements to the Securities and Exchange Commission upon
                request.




10.1
            Sale
                and Servicing Agreement, dated as of September 1, 2005, among Saxon
                Asset
                Securities Trust 2005-3, as issuer, Saxon Asset Securities Company,
                as
                depositor, Saxon Funding Management, Inc., as master servicer, Saxon
                Mortgage Services, Inc., as servicer and Deutsche Bank Trust Company
                Americas, as indenture trustee. (4)




31.1
            Certification
                of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) under
                the
                Securities Exchange Act of 1934.




31.2
            Certification
                of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) under
                the
                Securities Exchange Act of 1934.




32.1
            Certification
                  of Chief Executive Officer and Chief Financial Officer pursuant
                  to Rule
                  13a-14(b)/15d-14(b) under the Securities Exchange Act of 1934 and
                  18
                  U.S.C. Section 1350 as adopted pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.


___________________


(1)
                Incorporated
                    herein by reference to our Annual Report on Form 10-K for the
                    year ended
                    December 31, 2004, filed with the Securities and Exchange Commission
                    on
                    March 16, 2005.(2)
                Incorporated
                    herein by reference to our Current Report on Form 8-K filed with
                    the
                    Securities and Exchange Commission on March 4, 2005.(3)
                Incorporated
                    herein by reference to Amendment No. 3 to our registration statement
                    on
                    Form S-4 (No. 333-112834) filed with the Securities and Exchange
                    Commission on June 18, 2004.(4)
                Incorporated
                    herein by reference to Saxon Asset Securities Trust 2005-3’s (SEC File No.
                    333-111832-06) Current Report on Form 8-K filed with the Securities
                    and
                    Exchange Commission on October 13,
                    2005.





67


**SIGNATURES**




Pursuant
      to the requirements 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.





SAXON
                CAPITAL, INC.Dated:
                November 9, 2005
            By:/s/
                Michael L.
                SawyerName:
                Michael L. SawyerTitle:
                Chief Executive Officer (authorizedofficer
                of registrant)Dated:
                November 9, 2005
            By:/s/
                Robert B.
                EastepName:
                Robert B. EastepTitle:
                Chief Financial Officer (principalfinancial
                officer)





68