**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, 2006


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 a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.





Large
                accelerated filerx
            Accelerated
                filero
            Non-accelerated
                filero





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
      October 31, 2006 there were 50,096,970 shares of our common stock, par value
      $0.01 per share, outstanding.









TABLE
                OF CONTENTSPage**Part
                I**
            **Financial
                Information**Item
                1.
            Financial
                StatementsUnaudited
                Consolidated Balance Sheets at September 30, 2006
                and December 31, 2005
            1Unaudited
                Consolidated Statements of Operations for the three
                and nine months ended September 30, 2006 and September 30,
                2005
            2Unaudited
                Consolidated Statement of Shareholders’ Equity
                for the nine months ended September 30, 2006 and September 30,
                2005
            3Unaudited
                Consolidated Statements of Cash Flows for the
                nine months ended September 30, 2006 and September 30,
                2005
            4Notes
                to Unaudited Consolidated Financial
                Statements
            5Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations
            33Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            77Item
                4.
            Controls
                and Procedures
            81**Part
                II**
            **Other
                Information**Item
                1.
            Legal
                Proceedings
            82Item
                1A.
            Risk
                Factors
            84Item
                2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            84Item
                3.
            Defaults
                Upon Senior Securities
            84Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            85Item
                5.
            Other
                Information
            85Item
                6.
            Exhibits
            85











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


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


**Saxon
        Capital, Inc.**
 **Consolidated
        Balance Sheets**
 **(in
        thousands, except share data)**
 **(unaudited)**





**September
                30, 2006**
            **December
                31, 2005****Assets:**Cash
            $13,027
            $6,053Trustee
                receivable
            139,528
            135,957Restricted
                cash
            6,092
            147,473Accrued
                interest receivable, net of allowance for past due interest of $15,942
                and
                $16,086 respectively
            47,025
            38,182Mortgage
                loan portfolio
            6,830,880
            6,444,872Allowance
                for loan losses
            (37,853)
            (36,639)Net
                mortgage loan portfolio
            6,793,027
            6,408,233Servicing
                related advances
            234,895
            185,297Mortgage
                servicing rights, net
            149,158
            129,742Real
                estate owned
            43,108
            38,933Derivative
                assets
            17,084
            19,954Deferred
                tax asset
            68,640
            53,724Other
                assets, net
            73,113
            68,530Total
                assets
            $7,584,697
            $7,232,078**Liabilities
                and shareholders’ equity:****Liabilities:**Accrued
                interest payable
            $16,939
            $8,357Dividends
                payable
            —
            32,539Warehouse
                financing
            1,090,613
            378,144Securitization
                financing
            5,716,375
            6,182,389Derivative
                liabilities
            15,793
            8,589Senior
                notes
            150,000
            —Other
                liabilities
            40,572
            28,925Total
                liabilities
            7,030,292
            6,638,943Commitments
                and contingencies - Note 10**Shareholders’
                equity:**Common
                stock, $0.01 par value per share, 100,000,000 shares authorized;
                shares
                issued and outstanding: 50,096,970 and 50,001,909 as of September
                30, 2006
                and December 31, 2005, respectively
            501
            500Additional
                paid-in capital
            637,401
            634,023Accumulated
                other comprehensive loss, net of income tax of $(11) and $(16),
                respectively
            (253)
            (355)Accumulated
                deficit
            (83,244)
            (41,033)Total
                shareholders’ equity
            554,405
            593,135Total
                liabilities and shareholders’ equity
            $7,584,697
            $7,232,078


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,****2006**
            **2005**
            **2006**
            **2005****Revenues
                and Gains:**Interest
                income
            $126,903
            $116,101
            $372,297
            $339,600Interest
                expense
            (108,932)
            (68,807)
            (292,267)
            (185,285)Net
                interest income
            17,971
            47,294
            80,030
            154,315Provision
                for mortgage loan losses
            (15,065)
            (19,092)
            (29,052)
            (30,828)Net
                interest income after provision for mortgage loan losses
            2,906
            28,202
            50,978
            123,487Servicing
                income, net of amortization and impairment
            17,891
            19,063
            57,961
            49,853Derivative
                (losses) gains
            (19,913)
            19,890
            5,458
            26,040(Loss)
                gain on sale of mortgage assets
            (832)
            44
            (2,600)
            2,451Total
                net revenues and gains
            52
            67,199
            111,797
            201,831**Expenses:**Payroll
                and related expenses
            18,281
            21,324
            53,608
            59,330General
                and administrative expenses
            16,613
            16,918
            44,605
            48,277Depreciation
            1,724
            1,558
            5,252
            4,401Other
                expense, net
            2,927
            1,286
            5,483
            3,127Total
                operating expenses
            39,545
            41,086
            108,948
            115,135(Loss)
                income before taxes
            (39,493)
            26,113
            2,849
            86,696Income
                tax benefit
            (13,086)
            (5,796)
            (5,789)
            (6,179)**(Loss)
                income before cumulative effect of change in accounting
                principle**
            (26,407)
            31,909
            8,638
            92,875Cumulative
                effect of change in accounting principle
            —
            —
            —
            31**Net
                (loss) income**
            $(26,407)
            $31,909
            $8,638
            $92,906**(Loss)
                earnings per common share:**Weighted
                average common shares - basic
            50,080
            49,942
            50,050
            49,892Weighted
                average common shares - diluted
            50,080
            50,945
            51,047
            50,753Basic
                (loss) earnings per common share before cumulative effect of change
                in
                accounting principle
            $(0.53)
            $0.64
            $0.17
            $1.86Cumulative
                effect of change in accounting principle
            —
            —
            —
            —Basic
                (loss) earnings per common share
            $(0.53)
            $0.64
            $0.17
            $1.86Diluted
                (loss) earnings per common shares before cumulative effect of change
                in
                accounting principle
            $(0.53)
            $0.63
            $0.17
            $1.83Cumulative
                effect of change in accounting principle
            —
            —
            —
            —Diluted
                (loss) earnings per common share
            $(0.53)
            $0.63
            $0.17
            $1.83Dividends
                declared per common share
            —
            $0.55
            $1.00
            $1.10







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






2


**Saxon
      Capital, Inc.**


**Consolidated
      Statements of Shareholders’
Equity**


**Nine
      Months Ended September 30, 2006 and 2005**


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


**(unaudited)**





**Common
                Shares Outstanding**
            **Common**
              **Stock**
            **Additional**
              **Paid-in
                Capital**
            **Accumulated**
              **Other**
              **Comprehensive**
              **Loss**
            **Accumulated**
              **Deficit**
            **Total****Balance
                as of January 1, 2006**
            50,001,909
            $500
            $634,023
            $(355)
            $(41,033)
            $593,135Issuance
                of common stock
            95,061
            1
            742
            —
            —
            743Refund
                of costs associated with issuance of common stock
            —
            —
            60
            —
            —
            60Shared-based
                compensation expense
            —
            —
            2,529
            —
            —
            2,529Share-based
                compensation tax benefit
            —
            —
            47
            —
            —
            47Dividends
                declared ($1.00 per common share)
            —
            —
            —
            —
            (50,849)
            (50,849)**Comprehensive
                income:**Net
                income
            —
            —
            —
            —
            8,638Mortgage
                bonds:Change
                in unrealized loss
            —
            —
            —
            98
            —Reclassification
                adjustment
            —
            —
            —
            8
            —Tax
                effect
            —
            —
            —
            (4)
            —**Total
                comprehensive income**
            —
            —
            —
            102
            8,638
            8,740**Balance
                as of September 30, 2006**
            50,096,970
            $501
            $637,401
            $(253)
            $(83,244)
            $554,405







**Common
                Shares Outstanding**
            **Common**
              **Stock**
            **Additional**
              **Paid-in
                Capital**
            **Accumulated**
              **Other**
              **Comprehensive**
              **Loss**
            **Accumulated**
              **Deficit**
            **Total****Balance
                as of January 1, 2005**
            49,849,386
            $498
            $625,123
            $(474)
            $(38,074)
            $587,073Issuance
                of common stock
            130,749
            2
            2,013
            —
            —
            2,015Shared-based
                compensation expense
            —
            1
            2,061
            —
            —
            2,062Share-based
                compensation tax benefit
            —
            —
            3,536
            —
            —
            3,536Cumulative
                effect of change in accounting principle
            —
            —
            (31)
            —
            —
            (31)Dividends
                declared ($1.10 per share)
            —
            —
            —
            —
            (55,754)
            (55,754)**Comprehensive
                income:**
              Net
                income
            —
            —
            —
            —
            92,906Mortgage
                bonds:Change
                in unrealized loss
            —
            —
            —
            (161)
            —Reclassification
                adjustment
            —
            —
            —
            346
            —Tax
                effect
            —
            —
            —
            (8)
            —**Total
                comprehensive income**
            —
            —
            —
            177
            92,906
            93,083**Balance
                as of September 30, 2005**
            49,980,135
            $501
            $632,702
            $(297)
            $(922)
            $631,984




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,****2006**
            **2005****Operating
                Activities:**Net
                income
            $8,638
            $92,906Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            80,240
            55,259Deferred
                income tax benefit
            (14,916)
            (26,912)Impairment
                of assets
            9,026
            7,560Non
                cash change in fair value of derivative instruments
            4,867
            (6,975)Loss
                (gain) on sale of assets
            2,600
            (2,451)Provision
                for mortgage loan losses
            29,052
            30,828Provision
                for past due interest
            11,721
            9,719Compensation
                expense for share-based compensation plans
            2,529
            2,061Cumulative
                effect of change in accounting principle
            —
            (31)Increase
                in servicing related advances
            (49,598)
            (42,451)Increase
                in accrued interest receivable
            (10,896)
            (652)Increase
                (decrease) in accrued interest payable
            8,582
            (1,001)Increase
                in trustee receivable
            (3,571)
            (18,055)Decrease
                in income tax receivable
            1,533
            24,348Proceeds
                from (purchases of) derivative instruments
            5,206
            (4,332)Net
                change in miscellaneous assets and liabilities
            (15,810)
            (1,939)Net
                cash provided by operating activities
            69,203
            117,882**Investing
                Activities:**Purchase
                and origination of mortgage loans
            (2,532,373)
            (2,470,538)Principal
                payments received on mortgage loan portfolio
            1,958,607
            1,890,283Proceeds
                from the sale of mortgage loans
            100,050
            251,264Proceeds
                from the sale of real estate owned
            43,277
            41,792Decrease
                (increase) in restricted cash
            141,381
            (140,738)Acquisition
                of mortgage servicing rights
            (71,012)
            (78,727)Capital
                expenditures
            (3,955)
            (9,100)Net
                cash used in investing activities
            (364,025)
            (515,764)**Financing
                Activities:**Proceeds
                from issuance of securitization financing-bonds
            1,477,975
            2,867,371Proceeds
                from issuance of securitization financing-certificates
            49,420
            150,249Proceeds
                received from issuance of senior notes
            150,000
            —Debt
                issuance costs
            (11,082)
            (10,667)Principal
                payments on securitization financing-bonds
            (1,990,071)
            (1,970,147)Principal
                payments on securitization financing-certificates
            (4,270)
            (103,089)Borrowings
                under (repayment of) warehouse financing, net
            712,469
            (456,546)Proceeds
                received from issuance of stock
            743
            2,015Payment
                of dividends
            (83,388)
            (84,663)Net
                cash provided by financing activities
            301,796
            394,523Net
                increase (decrease) in cash
            6,974
            (3,359)Cash
                at beginning of period
            6,053
            12,852Cash
                at end of period
            $13,027
            $9,493**Supplemental
                Cash Flow Information:**Cash
                paid for interest
            $(309,148)
            $(185,644)Cash
                (paid) received for income taxes, net
            $(7,275)
            $7,143**Non-Cash
                Investing Activities:**Transfer
                of mortgage loans to real estate owned
            $76,360
            $63,143


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


4


**Notes
      to 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, 2006 are not necessarily
      indicative of the results that may be expected for any other interim periods
      or
      the entire year ending December 31, 2006. 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
      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, 2005,
      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”), 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.





On
      August
      9, 2006, the Company announced that it had entered into a definitive agreement
      with Morgan Stanley Mortgage Capital Inc. (“MSMC”) pursuant to which MSMC will
      acquire the Company for $14.10 per common share in cash, or approximately $706
      million, through a merger between the Company and a wholly-owned subsidiary
      of
      MSMC. The transaction is expected to close in December 2006, subject to
      regulatory approval and the satisfaction of other customary closing
      conditions.




5


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




The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America, or 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 the allowances
      for
      loan losses and past due interest, valuation of mortgage servicing rights,
      deferral of certain direct loan origination costs, amortization of yield
      adjustments to net interest income, and income taxes.


****


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




The
      Company adopted Statement of Financial Accounting Standard, or SFAS, No. 123(R), *Share
      Based Payment,* on April
      1, 2005 to account for its two share-based compensation plans, namely its 2001
      Stock Incentive Plan and its 2004 Employee Stock Purchase Plan. The Company
      opted to utilize the modified prospective method of transition in adopting
      SFAS
      No. 123(R). Therefore, prior periods were not restated. Prior to adopting SFAS
      No. 123(R), the Company accounted for its share based payments in accordance
      with Accounting Principles Board, or APB, Opinion No. 25, *Accounting
      for Stock Issued to Employees* .




The
      following table illustrates that there would have been no effect on net income
      and earnings per share if the Company had applied the fair value method using
      the Black-Scholes option pricing model to options and restricted stock units
      granted to employees during the nine months ended September 30, 2005. This
      is
      because all outstanding options were vested upon the Company’s conversion to
      REIT status in 2004, and restricted stock unit awards are accounted for
      similarly under either method.




**Nine
                Months Ended**
              **September
                30,****2005**(in
                thousands, except per share data)Net
                income
            $92,906Add:
                share-based compensation expense included in net income, net of related
                tax effects
            694Deduct:
                total share-based compensation expense determined under fair value
                based
                method for all awards, net of related tax effects
            (694)Pro
                forma net income
            $92,906Earnings
                per share:Basic
                - as restated
            $1.86Basic
                - pro forma
            $1.86Diluted
                - as restated
            $1.83Diluted
                - pro forma
            $1.83





6


**(d)**
            **Impaired
                Loans Acquired in a
                Transfer**





The
      Company periodically acquires mortgage loans that show evidence of deterioration
      of credit quality since the mortgage loans’ origination, and if it is probable
      that the Company will not be able to collect all amounts contractually due,
      the
      Company determines the excess of contractual amounts due on these mortgage
      loans
      over their fair value at the time of acquisition. The fair value of these credit
      impaired loans is based on historical prices received on our delinquent loan
      sales to third parties. This excess amount is recorded as a nonaccretable
      difference that reduces the carrying value of the mortgage loans on the
      Company’s balance sheet. Statement of Position (SOP) 03-3, *Accounting
      for Certain Loans or Debt Securities Acquired in a Transfer,* states
      that the nonaccretable difference should be calculated as the excess of
      contractual amounts due over the cash flows expected to be collected at the
      time
      of acquisition. The use of fair value provides a result similar to the use
      of
      cash flows expected to be collected at the time of acquisition. The excess
      of
      the fair value over the amount paid for these mortgage loans at the time of
      acquisition is recorded as an accretable difference, and accreted into interest
      income over the remaining life of the mortgage loans. On a quarterly basis,
      these mortgage loans are reevaluated to determine if there have been any
      subsequent increases in fair value, and if so, the Company adjusts the amount
      of
      accretable difference recognized on a prospective basis over the mortgage loan’s
      remaining life. Subsequent decreases in fair value due to further credit
      impairment are reserved for within the provision for mortgage loan losses.





**(e)**  **Recently
      Issued Accounting Pronouncements**





In
      February 2006, the FASB issued SFAS No. 155, *Accounting
      for Certain Hybrid Instruments* ,
      which
      allows financial instruments that have embedded derivatives to be accounted
      for
      as a whole (eliminating the need to bifurcate the derivative from its host)
      if
      the holder elects to account for the whole instrument on a fair value basis.
      SFAS No. 155 is effective for all financial instruments acquired or issued
      after
      the beginning of an entity’s first fiscal year that begins after September 15,
      2006. The adoption of this statement is not anticipated to have a significant
      impact on the Company’s financial condition or results of
      operations.





In
      March
      2006, the FASB issued SFAS No. 156, *Accounting
      for Servicing of Financial Assets - An Amendment of FASB Statement No. 140.* This
      standard amends the guidance in FASB Statement No. 140, *Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities.* Among
      other requirements, SFAS No. 156 requires an entity to recognize a servicing
      asset or servicing liability each time it undertakes an obligation to service
      a
      financial asset by entering into a servicing contract in any of the following
      situations: a transfer of the servicer’s financial assets that meets the
      requirements for sale accounting; a transfer of the servicer’s financial assets
      to a qualifying special-purpose entity in a guaranteed mortgage securitization
      in which the transferor retains all of the resulting securities and classifies
      them as either available-for-sale securities or trading securities; or an
      acquisition or assumption of an obligation to service a financial asset that
      does not relate to financial assets of the servicer or its consolidated
      affiliates. SFAS No. 156 is effective the beginning of the first fiscal year
      beginning after September 15, 2006. At this time, management has not yet
      completed its assessment of the impact of the implementation of this
      statement.





7


In
      July
      2006, the FASB issued FASB Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes* ,
      or FIN
      48 *.* This
      interpretation clarifies the accounting for uncertainty in income taxes
      recognized in an enterprise’s financial statements in accordance with FASB
      Statement No. 109, *Accounting
      for Income Taxes* .
      FIN 48
      prescribes a recognition threshold and measurement attribute for the financial
      statement recognition and measurement of a tax position taken or expected to
      be
      taken in a tax return. FIN 48 also provides guidance on derecognition,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition. FIN 48 is effective for fiscal years beginning after
      December 15, 2006. At this time, management has not yet completed its assessment
      of the impact of this interpretation.





In
      September 2006, the FASB issued SFAS No.157, *Fair
      Value Measurements* .
      This
      standard provides guidance for using fair value to measure assets and
      liabilities. Prior to the issuance of this standard, the methods for measuring
      fair value were diverse and inconsistent. SFAS No.157 clarifies that for items
      that are not actively traded, fair value should reflect the price in a
      transaction with a market participant, including an adjustment for risk. SFAS
      No. 157 also requires expanded disclosure of the effect on earnings for items
      measured using unobservable data. SFAS No.157 is effective the beginning of
      the
      first fiscal year beginning after November 15, 2007. At this time, management
      has not yet completed its assessment of the impact of this
      statement.





In
      September 2006, the SEC issued Staff Accounting Bulletin, or SAB, No. 108, *Considering
      the Effects of Prior Year Misstatements When Quantifying Misstatements in
      Current Year Financial Statements.* SAB No.
      108 states that registrants should use both a balance sheet approach and an
      income statement approach when quantifying and evaluating the materiality of
      a
      misstatement. SAB No. 108 also provides transition guidance on correcting errors
      under this dual approach. If prior year errors that had been previously
      considered immaterial now are considered to be material based on using the
      approach specified in SAB No. 108, the registrant need not restate prior period
      financials. SAB No. 108 is effective for annual financial statements covering
      the first fiscal year ending after November 15, 2006. At this time, management
      has not yet completed its assessment of the impact of SAB No. 108.





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




On
        October 23, 2006, the scheduled pre-amortization period termination date
        of the
        Company’s Class A-1 variable funding notes, Series 2005-A was extended to
        January 31, 2007, and the maximum variable funding note balance with respect
        to
        the Class A-1 variable funding notes was increased to $200.0 million.




At
      a
      special meeting of the Company’s shareholders held on October 31, 2006, the
      Company’s shareholders approved the merger of the Company with and into a
      wholly-owned subsidiary of MSMC. The merger was approved by approximately 72%
      of
      the Company’s outstanding shares of common stock.





8


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




Basic
      (loss) earnings per share is based on the weighted average number of common
      shares outstanding, excluding any dilutive effects of options, warrants, or
      restricted stock units. Diluted (loss) earnings per share is based on the
      weighted average number of common shares, dilutive stock options, dilutive
      stock
      warrants, and dilutive restricted stock units outstanding during the year.
      For
      the three months ended September 30, 2006, there are 3,000 stock options and
      845,000 restricted stock units excluded from the calculation of diluted loss
      per
      share because their effect is anti-dilutive due to the net loss for the three
      months ended September 30, 2006. Thus, basic and diluted loss per share and
      weighted average shares are the same for the three months ended September 30,
      2006. Computations of (loss) earnings per share were as follows:




**Three
                Months**
              **Ended
                September 30,**
            **Nine
                Months**
              **Ended
                September 30,****2006**
            **2005**
            **2006**
            **2005**(in
                thousands, except per share data)**Basic:**Net
                (loss) income
            $(26,407)
            $31,909
            $8,638
            $92,906Weighted
                average common shares outstanding
            50,080
            49,942
            50,050
            49,892(Loss)
                earnings per share
            $(0.53)
            $0.64
            $0.17
            $1.86**Diluted:**Net
                (loss) income
            $(24,601)
            $31,909
            $8,638
            $92,906Weighted
                average common shares outstanding
            50,080
            49,942
            50,050
            49,892Dilutive
                effect of stock options, warrants and restricted stock
                units
            —
            1,003
            997
            861Weighted
                average common shares outstanding - diluted
            50,080
            50,945
            51,047
            50,753(Loss)
                earnings per share
            $(0.53)
            $0.63
            $0.17
            $1.83




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





Mortgage
      loans reflected on the Company’s consolidated balance sheets as of September 30,
      2006 and December 31, 2005 were comprised of the following:




**September
                30, 2006**
            **December
                31, 2005**($
                in thousands)Securitized
                mortgage loans - principal balance
            $5,547,396
            $5,894,780Unsecuritized
                mortgage loans - principal balance
            1,175,304
            439,632Premiums,
                net of discounts
            97,796
            95,634Deferred
                origination costs, net
            9,782
            12,100Purchase
                accounting fair value adjustments
            2,093
            2,726Non-accretable
                differences
            (1,489)
            —Total
            6,830,880
            6,444,872Less
                allowance for loan losses
            (37,853)
            (36,639)Net
                mortgage loan portfolio
            $6,793,027
            $6,408,233




9


Non-accretable
      differences relate to mortgage loans the Company acquired during the three
      and
      nine months ended September 30, 2006 that showed evidence of deterioration
      of
      credit quality since origination of the mortgage loans. This amount represents
      the excess of contractual amounts due at the time of acquisition over the fair
      value of the impaired mortgage loans at the time of acquisition, and is
      therefore not being accreted into interest income. The fair value and the
      estimated remaining contractual payments due on these mortgage loans at the
      time
      of acquisition were $0.7 million and $3.4 million, respectively. The outstanding
      principal balance and related carrying amount for these mortgage loans as of
      September 30, 2006 were $2.3 million and $0.8 million, respectively. During
      the
      three and nine months ended September 30, 2006, $0.3 million and $0.6 million,
      respectively, of non-accretable differences was reclassified to accretable
      yield. This reclassification represents the amount of subsequent increases
      in
      fair value for some of these impaired mortgage loans and is accreted into
      interest income on a prospective basis over the mortgage loan’s remaining life.
      The following table summarizes activity relating to accretable yield on these
      impaired mortgage loans, which is included as a component of premiums, net
      of
      discounts for the three and nine months ended September 30, 2006:




**Three
                Months Ended**
              **September
                30, 2006**
            **Nine
                Months Ended**
              **September
                30, 2006**($
                in thousands)Balance,
                beginning of period
            $(265)
            $—Additions
            —
            —Reclassification
            (269)
            (575)Accretion
            60
            60Disposals
            158
            199Balance,
                end of period
            $(316)
            $(316)





During
      the three and nine months ended September 30, 2006, $0.3 million and $0.6
      million, respectively, of expense was recorded as a component of provision
      for
      mortgage loan losses related to some of these impaired mortgage loans, and
      represents the amount of subsequent decreases in fair value.





During
      the nine months ended September 30, 2006, the Company completed the prefunding
      settlement of the Saxon Asset Securities Trust, or SAST, 2005-4 securitization
      of mortgage loans, totaling $140.4 million in principal balances and $1.6
      million in unamortized basis adjustments, and completed the issuances of SAST
      2006-1 and SAST 2006-2, totaling $500.0 million and $999.9 million in principal
      balances and $4.8 million and $7.3 million in unamortized basis adjustments,
      respectively.





The
      Company originates both fixed-rate and adjustable-rate fully-amortizing loans
      for periods up to 40 years. The Company originates balloon products - 50/30
      and
      40/30 fixed and adjustable rate first mortgage balloon loans and 30/20 fixed
      rate balloon loans on second liens. The underwriting guidelines for the
      Company’s fixed-rate and adjustable-rate fully-amortizing products allow
      loan-to-value ratios, or LTVs, and combined LTVs, or CLTVs, of up to 100%,
      and
      debt ratios of either 50% or 55% in circumstances where disposable income meets
      a specified threshold. No loans originated or purchased allow for negative
      amortization, nor does the Company offer a minimum payment option product that
      would result in a borrower’s monthly payment being less than the accrued
      interest amount or minimum principal and interest amount. Fixed-rate and
      adjustable-rate interest-only mortgage loans are also available to customers
      with credit scores in excess of 560. The interest-only period is for five years
      and debt ratios for interest-only products are restricted to a maximum of 50%.





10


The
      Company’s credit committee monitors the performance of each product originated
      and looks at characteristics of any loans that pose a concern from a performance
      standpoint. Adverse trends that share any common guideline characteristic are
      analyzed to determine if action needs to be taken from a guideline restriction
      or additional risk based pricing aspect. The Company also uses mortgage
      insurance to reduce its loss exposure in the event of borrower credit defaults.





The
      following table sets forth information about the Company’s mortgage loan
      portfolio composition based on product type as of September 30, 2006 and
      December 31, 2005.





**September
                30, 2006 (1)**
            **December
                31, 2005 (1)**Floating
                adjustable rate mortgage loans
            0.21%
            0.27%Interest-only
                adjustable rate mortgage loans
            22.55%
            26.21%Two
                - five year hybrids (2)
            34.10%
            39.62%Two
                - three year hybrids with 40 year terms
            0.03%
            —40/30
                and 50/30 adjustable rate mortgage loans (3)
            9.96%
            2.32%Total
                adjustable rate mortgage loans
            66.85%
            68.42%15
                and 30 year fixed rate mortgage loans
            25.39%
            24.49%40
                year fixed rate mortgage loans
            0.08%
            —Interest-only
                fixed rate mortgage loans
            1.57%
            1.75%Balloons
                and other (4)
            4.20%
            4.84%40/30
                and 50/30 fixed rate mortgage loans (3)
            1.91%
            0.50%Total
                fixed rate mortgage loans
            33.15%
            31.58%


_______________


(1)
            Excludes
                loans funded but not transmitted to the servicing system as of September
                30, 2006 and December 31, 2005 of $159.1 million and $110.7 million,
                respectively.


(2)
            Hybrid
                loans are loans that have a fixed interest rate for the initial two
                to
                five years and after that specified time period, become adjustable
                rate
                loans.


(3)
            40/30
                and 50/30 mortgage loans are loans with payments calculated according
                to a
                40-year or 50-year amortization schedule, but which require the entire
                unpaid principal and accrued interest to be paid in full on a specified
                date that is 30 years after
                origination.


(4)
            Balloon
                loans are loans with payments calculated according to a 30-year
                amortization schedule, but which require the entire unpaid principal
                and
                accrued interest to be paid in full on a specified date that is less
                than
                30 years after origination.





***Loan
      Sales***





From
      time
      to time, the Company’s subsidiaries may choose to sell certain mortgage loans
      rather than securitize them. The Company retains the servicing rights with
      respect to sales of conforming first lien mortgage loans, and releases the
      servicing on all other loan sales.





11


The
      following table summarizes the Company’s activity with respect to conforming
      mortgage loans sold during the periods presented.


**Conforming
                  mortgage loans (1) sold**
              **Three
                  Months**
                **Ended
                  September 30,**
              **Nine
                  Months**
                **Ended
                  September 30,****2006**
              **2005**
              **2006**
              **2005**($
                  in thousands)Performing
                  first lien mortgage loans
              $13,962
              $12,758
              $59,759
              $52,845Less:
                  servicing rights retained
              (57)
              —
              (482)
              —Less:
                  basis adjustments, net
              (61)
              (120)
              (660)
              (343)Less:
                  cash received
              14,103
              12,811
              60,097
              53,096Gain
                  on sale of conforming mortgage loans
              $259
              $173
              $1,480
              $594


___________


(1)
            Conforming
                mortgage loans are loans that generally meet the underwriting guidelines
                of one of the government-sponsored entities such as Freddie Mac or
                Fannie
                Mae.





The
      following table summarizes the Company’s activity with respect to non-conforming
      mortgage loans sold during the periods presented.




**Non-conforming
                  mortgage loans sold**
              **Three
                  Months**
                **Ended
                  September 30,**
              **Nine
                  Months**
                **Ended
                  September 30,****2006**
              **2005**
              **2006**
              **2005**($
                  in thousands)Performing
                  second lien mortgage loans
              $8,630
              $21,636
              $40,625
              $193,469Plus:
                  basis adjustments, net
              955
              546
              3,408
              2,864Less:
                  cash received
              8,494
              22,056
              39,953
              198,167(Loss)
                  gain on sale of non-conforming mortgage loans
              $(1,091)
              $(126)
              $(4,080)
              $1,834




***Concentrations
      of Risk***




Properties
      securing the mortgage loans in the Company’s mortgage loan portfolio are
      geographically dispersed throughout the Unites States. At September 30, 2006,
      30%, 17%, and 18% of the unpaid principal balance of mortgage loans in the
      Company’s mortgage loan portfolio were secured by properties located in the
      Southern region, California region, and Mid-Atlantic region, respectively.
      At
      December 31, 2005, 30%, 19%, and 16% of the unpaid principal balances were
      secured by properties located in these same regions, respectively. The remaining
      properties securing mortgage loans did not exceed 15% in any other region at
      either period end.





In
      recent
      years, mortgage loan production was also geographically concentrated in the
      Southern, Mid-Atlantic, and California regions. During the first nine months
      of
      2006, these regions accounted for 30%, 26%, and 15%, respectively, of the
      Company’s collateral for mortgage loan production. During the first nine months
      of 2005, these regions accounted for 27%, 21%, and 23%, respectively, of the
      Company’s collateral for mortgage loan production.





12


** **(5)**  **Allowance
      for Loan Losses and Past Due Interest**




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





Activity
      related to the allowance for loan losses and past due interest for the mortgage
      loan portfolio is as follows:





**September
                30, 2006**
            **December
                31, 2005**($
                in thousands)Allowance
                for loan losses (1)
            $37,853
            $36,639Allowance
                for past due interest (2)
            15,942
            16,086Total
                allowance for loan losses and past due interest
            $53,795
            $52,725








**Three
                Months**
              **Ended
                September 30,**
            **Nine
                Months**
              **Ended
                September 30,****2006**
            **2005**
            **2006**
            **2005**($
                in thousands)Beginning
                balance
            $50,083
            $36,278
            $52,725
            $37,310Provision
                for loan losses (1)
            15,065
            19,092
            29,052
            30,828Provision
                for past due interest (3)
            4,072
            2,423
            9,255
            7,009Charge-offs
            (15,425)
            (8,618)
            (37,237)
            (25,972)Ending
                balance
            $53,795
            $49,175
            $53,795
            $49,175


_________


(1)
            During
                the three and nine months ended September 30, 2006, $0.3 million
                and $1.8
                million, respectively, of the Company’s allowance for loan losses was
                reversed relating to Hurricane Katrina due to the Company receiving
                additional inspection reports and due to liquidation of certain mortgage
                loans, which left a remaining allowance for probable losses related
                to
                Hurricane Katrina of $2.7 million.




(2)
            Provided
              for within accrued interest receivable on the consolidated balance
              sheets.





(3)
            Recorded
                as a component within interest income on the consolidated statements
                of
                operations and represents the reversal of interest income on loans
                delinquent for 90 days or more.





An
      internally developed roll rate analysis, static pool analysis and historical
      losses are the primary tools used in analyzing the Company’s allowance for loan
      losses and past due interest. The Company’s roll rate analysis is defined as the
      historical progression of loans through the various delinquency categories.
      The
      Company’s 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, as a percentage, 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 the Company within 90 days
      following the liquidation date. As of September 30, 2006, the Company is
      experiencing an 18-month average loss severity of 40.6% on its owned portfolio,
      and this is the assumption currently used in the loan loss allowance model.
      The
      40.6% loss severity includes the following loss components: 12.7% for principal,
      13.7% for past due interest, and 14.2% for advances and other costs. This
      average loss severity has increased over time because loss severities typically
      increase as a portfolio gets older. In addition, the decline in the housing
      market has caused an increase in the severity of losses on liquidated
      properties, as home prices are decreasing and properties are remaining on the
      market longer.





13


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





As
      of
      September 30, 2006, the fair value of the mortgage servicing rights, or MSRs,
      in
      total was $163.2 million compared to $156.1 million as of December 31, 2005.
      The
      fair value is estimated by discounting estimated future cash flows from the
      servicing assets using discount rates that approximate current market rates.
      The
      fair value as of September 30, 2006 was determined using prepayment assumptions
      ranging from 23% to 49% and discount rates ranging from 11% to 18%. The fair
      value as of December 31, 2005 was determined using prepayment assumptions
      ranging from 20% to 45% and discount rates ranging from 11% to 18%. The
      following table summarizes activity in mortgage servicing rights for the three
      and nine months ended September 30, 2006 and 2005:





**Three
                Months**
              **Ended
                September 30,**
            **Nine
                Months**
              **Ended
                September 30,****2006**
            **2005**
            **2006**
            **2005**($
                in thousands)Beginning
                balance of MSRs, gross
            $154,823
            $135,122
            $138,370
            $106,619Purchases
            23,463
            26,729
            71,012
            78,727Amortization
            (16,868)
            (13,410)
            (47,964)
            (33,931)Permanent
                impairment
            —
            (419)
            —
            (3,393)Ending
                balance of MSRs, gross
            $161,418
            148,022
            $161,418
            148,022Beginning
                balance of valuation allowance
            (9,496)
            (6,083)
            (8,628)
            (7,624)Impairment
            (2,764)
            (3,415)
            (3,632)
            (4,848)Permanent
                impairment
            —
            419
            —
            3,393Ending
                balance of valuation allowance
            (12,260)
            (9,079)
            (12,260)
            (9,079)MSRs,
                net
            $149,158
            $138,943
            $149,158
            $138,943





As
      of
      September 30, 2006, the following table summarizes the remaining estimated
      projected amortization expense for the carrying value of the MSRs for each
      of
      the five succeeding years and thereafter:




**Years
                Ending December 31,**($
                in thousands)October
                2006 through December 2006
            $35,5362007
            57,1042008
            32,1062009
            16,2782010
            8,973Thereafter
            11,421Total
            $161,418










14




**(7)**  **Warehouse
      Financing, Securitization Financing and Senior Notes**




A
      summary
      of the amounts outstanding under these agreements as of September 30, 2006
      and
      December 31, 2005 is as follows:





**September
                30, 2006**
            **December
                31, 2005**($
                in thousands)**Debt
                Outstanding**Warehouse
                financing - loans
            $343,841
            $154,339Repurchase
                agreements - loans
            746,772
            215,158Repurchase
                agreements - retained bond (1)
            —
            8,383Repurchase
                agreements - mortgage bonds
            —
            264Total
                warehouse financing
            $1,090,613
            $378,144Securitization
                financing - servicing advances
            $241,079
            $195,929Securitization
                financing - loans and real estate owned
            5,475,296
            5,986,460Total
                securitization financing
            $5,716,375
            $6,182,389Senior
                notes
            $150,000
            $—Total
            $6,956,988
            $6,560,533


___________________




(1)
            Class
                B-4 of the 2005-3 securitization was retained by the Company rather
                than
                being sold to third-party investors. The purchase price of the retained
                bond was financed using borrowing availability from the Company’s
                Greenwich repurchase agreement which was terminated on September
                28, 2006.







15


The
      following table provides an estimate of the contractual due dates for the
      principal amounts of the Company’s outstanding debt obligations as of September
      30, 2006:





**As
                of September 30, 2006**
            **Total**
            **2006**
            **2007**
            **2008**
            **2009**
            **2010**
            **Thereafter**($
                in thousands)Warehouse
                financing - loans
            $343,841
            $343,841
            $—
            $—
            $—
            $—
            $—Repurchase
                agreements - loans (1)
            746,772
            746,772
            —
            —
            —
            —
            —Securitization
                financing - servicing advances
            241,079
            156,079
            85,000
            —
            —
            —
            —Securitization
                financing - loans and real estate owned (2)
            5,475,296
            2,373,009
            1,595,008
            655,448
            685,301
            154,672
            11,858Senior
                notes
            150,000
            —
            —
            —
            —
            —
            150,000Total
                outstanding debt obligations
            $6,956,988
            $3,619,701
            $1,680,008
            $655,448
            $685,301
            $154,672
            $161,858


________________


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




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




Interest
      on the warehouse financing and repurchase facilities is based on a margin over
      the London Interbank Offered Rate, or LIBOR, with the margin above LIBOR varying
      by facility and depending on the type of asset that is being financed.  As
      of September 30, 2006, these margins ranged from 0.55% to 1.10%. The weighted
      average interest rate on these borrowings outstanding at September 30, 2006
      and
      December 31, 2005 was 6.03% and 5.10%, respectively. Interest on the
      securitization financing is either based on a fixed rate or is based on a margin
      above LIBOR varying by securitization deal and the type of asset that is being
      financed. As of September 30, 2006, these fixed rates ranged from 3.5% to 6.7%
      and these margins above LIBOR ranged from 0.03% to 4.0%. As of December 31,
      2005, these fixed rates ranged from 3.5% to 6.7% and these margins above LIBOR
      ranged from 0.09% to 4.0%.




A
      summary
      of interest expense and the weighted average cost of funds for the three and
      nine months ended September 30, 2006, and 2005 is as follows:





**Three
                Months Ended September 30,**
            **Nine
                Months Ended September 30,****2006**
            **2005**
            **2006**
            **2005**($
                in thousands)**Interest
                Expense**Warehouse
                financing - loans
            $1,415
            $126
            $2,926
            $2,307Warehouse
                financing - servicing rights
            —
            —
            113
            —Repurchase
                agreements
            6,587
            3,258
            20,124
            7,357Securitization
                financing
            94,305
            64,325
            256,721
            172,419Senior
                notes
            4,613
            —
            7,533
            —Other
                (1)
            2,012
            1,098
            4,850
            3,202Total
            $108,932
            $68,807
            $292,267
            $185,285**Weighted
                Average Cost of Funds**Warehouse
                financing - loans
            2.55%
            0.28%
            2.00%
            1.70%Warehouse
                financing - servicing rights
            —
            —
            2.49%
            —Repurchase
                agreements
            5.91%
            4.22%
            5.60%
            3.80%Securitization
                financing
            6.12%
            4.48%
            5.68%
            4.01%Senior
                notes
            12.30%
            —
            12.30%
            —Other
            —
            —
            —
            —Total
            6.26%
            4.42%
            5.75%
            4.01%


________________


(1)
            Represents
                primarily facility, commitment, and non-use fees as well as lender
                paid
                private mortgage insurance.





16


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. The Company determined that it was not in compliance
      with certain financial covenants for the quarter ended September 30, 2006 and
      received waivers from its lenders concerning the non-compliance with the
      covenants.




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





The
      Company uses a variety of financial instruments to manage the exposure to
      changes in interest rates. The Company may enter into interest rate swap
      agreements, interest rate cap agreements, interest rate floor agreements,
      financial forwards, financial futures, and options on financial instruments
      (collectively referred to as “Interest Rate Agreements”) to manage the
      sensitivity to changes in market interest rates. The Interest Rate Agreements
      used have an active secondary market, and none are obtained for speculation.
      The
      Company accounts for all of its derivative financial instruments as undesignated
      derivative instruments. The maximum term over which the Company is currently
      managing its exposure for forecasted transactions is 46 months. The Company
      has
      classified cash activity associated with derivatives as an operating activity
      in
      the consolidated statements of cash flows. Derivative (losses) gains totaled
      $(19.9) million and $19.9 million for the three months ended September 30,
      2006
      and September 30, 2005, respectively, and derivative gains totaled $5.5 million
      and $26.0 million for the nine months ended September 30, 2006 and September
      30,
      2005, respectively. The components of these derivative (losses) gains consist
      of
      the following:




**Three
                Months Ended September 30,**
            **Nine
                Months Ended September 30,****2006**
            **2005**
            **2006**
            **2005**($
                in thousands)Non
                cash fair value gain (loss)
            $(17,710)
            $11,191
            $(4,867)
            $6,975Cash
                received (paid) for change in fair value of futures
            (4,636)
            5,475
            3,763
            10,207Cash
                settlements of swaps and caps
            2,534
            3,287
            6,993
            9,173Broker
                commissions
            (72)
            (81)
            (362)
            (372)Interest
                on margin, net
            (29)
            18
            (69)
            57Total
            $(19,913)
            $19,890
            $5,458
            $26,040








17


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





Compensation
      cost charged against income for the Company’s share-based compensation plans was
      $0.8 million and $1.5 million for the three months ended September 30, 2006
      and
      September 30, 2005, respectively, and $2.6 million and $3.1 million for the
      nine
      months ended September 30, 2006 and September 30, 2005,
      respectively.




*Stock
      Options -* The
      following table summarizes the transactions relating to the Company’s stock
      options for the nine months ended September 30, 2006:




**Number
                of Options**
            **Weighted
                Average Exercise**
              **Price
                Per Share**Options
                outstanding, January 1, 2006 (includes 6,000 exercisable options
                with a
                remaining contractual life of 5.8 years outstanding under the Stock
                Incentive Plan)
            6,000
            $10.10Options
                granted
            —
            —Options
                exercised
            (3,000)
            $10.10Options
                cancelled / forfeited
            —
            —Options
                outstanding, September 30, 2006 (represents 3,000 exercisable options
                with
                a remaining contractual life of 5.1 years outstanding under the Stock
                Incentive Plan)
            3,000
            $10.10





No
      options were exercised during the three months ended September 30, 2006 or
      September 30, 2005. Cash received from options exercised under all share-based
      payment arrangements for the nine months ended September 30, 2006 and September
      30, 2005 was $30.3 thousand and $50.5 thousand, respectively. The actual tax
      benefit realized for the tax deductions from option exercises under share-based
      payment arrangements was immaterial for the nine months ended September 30,
      2006
      and September 30, 2005. The total intrinsic value of options exercised during
      the nine months ended September 30, 2006 and September 30, 2005 was $0.4
      thousand and $34.7 thousand, respectively. The total intrinsic value of options
      outstanding and exercisable as of September 30, 2006 was $7.8
      thousand.




If
      the
      merger between the Company and the wholly-owned subsidiary of MSMC becomes
      effective, each of the unexercised options to purchase shares of the Company’s
      common stock that is outstanding immediately prior to the effective time of
      the
      merger will be cancelled and converted into the right to receive a cash payment
      of $4.00 per unexercised option, which represents the excess of the merger
      consideration of $14.10 per share over the exercise price of $10.10 per share
      of
      common stock.





18


*Restricted
      Stock Units -* 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.
      If
      the pending merger between the Company and the wholly-owned subsidiary of MSMC
      becomes effective, each restricted stock unit outstanding immediately prior
      to
      the effective time of the merger, whether vested or unvested, will be converted
      into, and will be exchangeable for, the merger consideration of $14.10 per
      share
      in cash. As of September 30, 2006, there was $10.4 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 at the effective
      time of the merger. If the merger agreement terminates, that cost is expected
      to
      be recognized over a weighted-average period of 3.4 years.





A
      summary
      of the status of the Company’s nonvested restricted stock units as of September
      30, 2006, and changes during the nine months ended September 30, 2006, is
      presented below:




**Number
                of Restricted Stock Units**
            **Weighted
                Average Grant-Date Fair Value**Nonvested
                at January 1, 2006
            840,000
            $20.19Granted
            55,000
            $10.81Vested
            (20,000)
            $20.29Forfeited
            (30,000)
            $21.50Nonvested
                at September 30, 2006
            845,000
            $19.53




*Warrants*  **-** ****** In
      connection with the Company’s private offering in 2001, the Company granted
      warrants to Friedman, Billings, Ramsey & Co., Inc. (“FBR”) to purchase an
      aggregate of 1,200,000 shares of common stock, of which 1,192,000 had been
      exercised as of December 31, 2005. The 8,000 remaining warrants had an exercise
      price of $10.00 per share and expired on July 6, 2006.





*Employee
      Stock Purchase Plan* - The
      Company 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. As a result, the Company incurred $35.3
      thousand and $49.1 thousand of expense during the three months ended September
      30, 2006 and September 30, 2005, respectively, and incurred $125.8 thousand
      and
      $96.4 thousand of expense during the nine months ended September 30, 2006 and
      September 30, 2005, respectively. The Company issued 16.8 thousand shares of
      common stock at $11.93 per share for a total of $200.0 thousand in proceeds
      during the third quarter of 2006. Due to the pending merger with MSMC, the
      employee stock purchase plan has been suspended since October 1, 2006. No
      further shares will be issued under this plan unless the merger agreement is
      terminated.




19


**(10)**  **Commitments
      and Contingencies**




***Mortgage
      Loans***




As
      of
      September 30, 2006 and December 31, 2005, the Company’s subsidiaries had
      commitments with agreed-upon rates to fund mortgage loans of $212.6 million
      and
      $262.6 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.





From
      May
      1996 to July 5, 2001, the Company securitized its mortgage loans in off balance
      sheet transactions, of which $301.6 million are still outstanding as of
      September 30, 2006. In connection with these mortgage loans as well as 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
      or
      expenses related to such breach. As of September 30, 2006 those subsidiaries
      did
      not have any material obligation to remove any such loans, or to provide any
      such indemnification.





In
      the
      normal course of business, the Company is subject to indemnification obligations
      related to the sale of residential mortgage loans. Under these obligations,
      the
      Company is required to repurchase certain mortgage loans that fail to meet
      the
      standard representations and warranties included in the sales contracts. The
      Company accrues an estimate of the losses associated with the obligation to
      repurchase such loans. The Company’s subsidiaries are also subject to premium
      recapture expenses and early payment default in connection with the sale of
      residential mortgage loans. Premium recapture expenses represent repayment
      of a
      portion of certain loan sale premiums to investors on previously sold loans
      that
      are repaid within six months of the loan sale. The Company accrues an estimate
      of the potential refunds of premium received on loan sales based upon historical
      experience. As of September 30, 2006 and December 31, 2005, the liability
      recorded for premium recapture expense and for obligations to repurchase
      mortgage loans was $0.5 million and $0.4 million, respectively, and the
      associated expense was recorded within (loss) gain on sale of assets in the
      consolidated statements of operations.





***Mortgage
      Servicing Rights***




The
      Company is committed to purchasing third party servicing rights for an
      additional $3.5 billion unpaid principal balance of third party mortgage loans
      during the fourth quarter of 2006, $0.5 billion of which have been purchased
      as
      of October 31, 2006.





***Legal
      Matters***




Because
      the Company is subject to many laws and regulations, including but not limited
      to federal and state consumer protection laws, it is regularly involved in
      numerous lawsuits filed against it, some of which seek certification as class
      action lawsuits on behalf of similarly situated individuals. With respect to
      each matter in which class action status has been asserted, in the event class
      action status is certified, if there is an adverse outcome or we do not
      otherwise prevail in each of the following matters, we could suffer material
      losses, although we intend to vigorously defend each of these lawsuits. The
      following is a summary of litigation matters that could be significant. Unless
      otherwise noted, the Company cannot predict the outcome of these matters.
      Accordingly, no amounts have been accrued in the accompanying consolidated
      financial statements, except as noted below.





20


Bauer,
      et al., v. Saxon Mortgage Services, Inc., et al. is a
      matter filed on December 1, 2004 in the Civil District Court for the Parish
      of
      Orleans, State of Louisiana, Case No. 2004-17015. On January 26, 2005, the
      plaintiffs 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., v. 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. In the Bauer case, the Company is not a named defendant but may
      owe
      defense and indemnification to Deutsche Bank Trust Company Americas, N.A.,
      as
      custodian of a mortgage loan for which one named plaintiff is mortgagor. A
      subsidiary, Saxon Mortgage Services, Inc., is a named defendant in the Patterson
      case. In both cases, the named plaintiffs allege misrepresentation, fraud,
      conversion and unjust enrichment on the part of the lender defendants and law
      firm hired by a number of defendants, including Saxon Mortgage Services, Inc.,
      to enforce mortgage loan obligations against borrowers who had become delinquent
      pursuant to the terms of their mortgage loan documents. Specifically, the
      plaintiffs alleged that the law firm quoted inflated court costs and sheriff’s
      fees on reinstatement proposals to the plaintiffs. In both cases, the Plaintiffs
      seek certification as a class action, compensatory damages, pre-judgment
      interest, attorneys’ fees, litigation costs, and other unspecified general,
      special and equitable relief. On January 24, 2006, the United States District
      Court for the Eastern District of Louisiana granted the Company’s motion to
      compel arbitration and stayed the court proceedings as to named plaintiffs
      Keenan and Karen Duckworth in Bauer,
      et al., v. Dean Morris, et al., filed as
      Case No. 05-2173 in the Civil District Court for the Parish of Orleans, State
      of
      Louisiana. On January 25, 2006, the United States District Court for the Eastern
      District of Louisiana granted the Company’s motion to compel arbitration and
      stayed the court proceedings as to named plaintiff Debra Herron in 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. The court subsequently remanded the underlying court proceedings
      in
      both the Bauer and Patterson cases to
      the Civil District Court for the Parish of Orleans, State of Louisiana. There
      were no significant developments in this matter during the quarter ended
      September 30, 2006.





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 America’s MoneyLine, Inc., a former subsidiary of the Company, which was
      merged with Saxon Mortgage, Inc., a subsidiary of the Company, effective January
      1, 2006. Saxon
      Mortgage, Inc. is successor in interest to the defendant. **** On
      June
      19, 2006, the parties reached an agreement to settle this case, pending the
      court’s approval. The
      settlement requires the defendant to create a settlement fund for approximately
      $0.5 million. The claims of settlement class members and plaintiff’s attorney’s
      fees will be paid out of the fund. On August 30, 2006, the court preliminarily
      approved the settlement and a final fairness hearing is scheduled for February
      13, 2007. The estimate of possible loss for this matter in the amount of $0.5
      million was accrued by the Company in June 2006.




21


Jumar
      Hooks and Diane Felder, et al., v. Saxon Mortgage, Inc. is a
      matter filed on 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,
      on behalf of themselves and similarly situated Ohio borrowers, alleging that
      the
      Company’s subsidiary engaged in unlawful practices in originating and servicing
      the plaintiffs’ loans. The plaintiffs sought 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. During the second quarter
      of
      2006, the court granted the Company’s motion to compel individual arbitration as
      to each of the two named plaintiffs and
      stayed the court proceedings with no class having been certified. There
      were no significant developments in this matter during the quarter ended
      September 30, 2006.





Brian
      Harris, et al., v. Capital Mortgage Company, et al .,
      is a
      matter filed in the Circuit Court of Cook County, County Department-Chancery
      Division, Illinois as Case No. 05CH 22369. The Company’s subsidiary, Saxon
      Mortgage Services, was served with a summons and complaint on March 1, 2006.
      The
      plaintiffs included a class action claim, alleging, on behalf of themselves
      and
      those similarly situated, that Saxon Mortgage Services and other named
      defendants engaged in unfair and deceptive acts and violated the Illinois
      Consumer Fraud Act in connection with 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. There
      were no significant developments in this matter during the quarter ended
      September 30, 2006.





**(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
      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 the cost of
      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 eight branch
      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 nonrefundable fees that are deferred and recognized over the life
      of
      the loan as an adjustment to interest income recorded in the portfolio segments.
      The production segment is also the legal entity named as master servicer for
      some third party loans, and as such, records fees received for these services
      as
      servicing income. The servicing segment services loans the production segment
      originates or purchases as well as third party loans, seeking to ensure that
      loans are repaid in accordance with their terms. The data presented below for
      “Gain (loss) on sale of mortgage assets” includes third party sales as well as
      intercompany gains (losses) on sales of mortgage assets such as loans and
      servicing advances. The intercompany gains (losses) are eliminated at the
      consolidated level.





**Three
                Months Ended September 30, 2006****Portfolio**
            **Mortgage
                Loan**
              **Production**
            **Servicing**
            **Eliminations**
            **Total**($
                in thousands)Interest
                income
            $112,742
            $17,879
            $3
            $(3,721)
            $126,903Interest
                expense
            (100,488)
            (11,611)
            (1,312)
            4,479
            (108,932)Net
                interest income
            12,254
            6,268
            (1,309)
            758
            17,971Provision
                for mortgage loan losses
            (14,046)
            (1,019)
            —
            —
            (15,065)Net
                interest income after provision for mortgage loan losses
            (1,792)
            5,249
            (1,309)
            758
            2,906Servicing
                income, net of amortization and impairment
            —
            976
            25,513
            (8,598)
            17,891Derivative
                losses
            (19,913)
            —
            —
            —
            (19,913)Gain
                (loss) on sale of mortgage assets
            —
            12,855
            (7,841)
            (5,846)
            (832)Total
                net revenues and gains
            (21,705)
            19,080
            16,363
            (13,686)
            52Payroll,
                general and administrative,
              and
                other expenses
            13,771
            13,060
            13,218
            (2,228)
            37,821DepreciationOperating
                expenses
            87
            1,225
            412
            —
            1,724Total
                operating expenses
            13,858
            14,285
            13,630
            (2,228)
            39,545(Loss)
                income before taxes
            (35,563)
            4,795
            2,733
            (11,458)
            (39,493)Income
                tax (benefit) expense
            (1,502)
            2,688
            (4,054)
            (10,218)
            (13,086)**Net
                (loss) income**
            $(34,061)
            $2,107
            $6,787
            $(1,240)
            $(26,407)








22







**Three
                Months Ended September 30, 2005****Portfolio**
            **Mortgage
                Loan**
              **Production**
            **Servicing**
            **Eliminations**
            **Total**($
                in thousands)Interest
                income
            $102,919
            $12,901
            $511
            $(230)
            $116,101Interest
                expense
            (65,109)
            (8,107)
            (839)
            5,248
            (68,807)Net
                interest income
            37,810
            4,794
            (328)
            5,018
            47,294Provision
                for mortgage loan losses
            (18,764)
            (328)
            —
            —
            (19,092)Net
                interest income afterprovision
              for
                mortgage loan losses
            19,046
            4,466
            (328)
            5,018
            28,202Servicing
                income, net of amortizationand
                impairment
            —
            741
            25,564
            (7,242)
            19,063Derivative
                gains
            19,890
            —
            —
            —
            19,890Gain
                (loss) on sale of mortgage assets
            —
            13,012
            (5,277)
            (7,691)
            44Total
                net revenues and gains
            38,936
            18,219
            19,959
            (9,915)
            67,199Payroll,
                general and administrative,and
                other expenses
            13,075
            20,256
            12,053
            (5,856)
            39,528Depreciation
            64
            869
            625
            —
            1,558Total
                operating expenses
            13,139
            21,125
            12,678
            (5,856)
            41,086Income
                (loss) before taxes
            25,797
            (2,906)
            7,281
            (4,059)
            26,113Income
                tax expense (benefit)
            1,356
            (1,101)
            2,694
            (8,745)
            (5,796)**Net
                income (loss)**
            $24,441
            $(1,805)
            $4,587
            $4,686
            $31,909







**Nine
                Months Ended September 30, 2006****Portfolio**
            **Mortgage
                Loan**
              **Production**
            **Servicing**
            **Eliminations**
            **Total**($
                in thousands)Interest
                income
            $334,708
            $54,468
            $973
            $(17,852)
            $372,297Interest
                expense
            (269,702)
            (36,106)
            (2,382)
            15,923
            (292,267)Net
                interest income
            65,006
            18,362
            (1,409)
            (1,929)
            80,030Provision
                for mortgage loan losses
            (27,283)
            (1,769)
            —
            —
            (29,052)Net
                interest income after provision for mortgage loan losses
            37,723
            16,593
            (1,409)
            (1,929)
            50,978Servicing
                income, net of amortization and impairment
            —
            2,902
            79,511
            (24,452)
            57,961Derivative
                gains
            5,458
            —
            —
            —
            5,458Gain
                (loss) on sale of mortgage assets
            —
            16,546
            (22,527)
            3,381
            (2,600)Total
                net revenues and gains
            43,181
            36,041
            55,575
            (23,000)
            111,797Payroll,
                general and administrative,and
                other expenses
            37,750
            44,708
            35,566
            (14,328)
            103,696Depreciation
            243
            3,522
            1,487
            —
            5,252Total
                operating expenses
            37,993
            48,230
            37,053
            (14,328)
            108,948Income
                (loss) before taxes
            5,188
            (12,189)
            18,522
            (8,672)
            2,849Income
                tax expense (benefit)
            213
            (4,208)
            5,728
            (7,522)
            (5,789)**Net
                income (loss)**
            $4,975
            $(7,981)
            $12,794
            $(1,150)
            $8,638








23





**Nine
                Months Ended September 30, 2005****Portfolio**
            **Mortgage
                Loan**
              **Production**
            **Servicing**
            **Eliminations**
            **Total**($
                in thousands)Interest
                income
            $297,237
            $39,265
            $1,441
            $1,657
            $339,600Interest
                expense
            (175,270)
            (22,497)
            (1,872)
            14,354
            (185,285)Net
                interest income
            121,967
            16,768
            (431)
            16,011
            154,315Provision
                for mortgage loan losses
            (30,053)
            (775)
            —
            —
            (30,828)Net
                interest income afterprovision
                for
              mortgage
                loan losses
            91,914
            15,993
            (431)
            16,011
            123,487Servicing
                income, net of amortization and
                impairment
            —
            2,255
            68,329
            (20,731)
            49,853Derivative
                gains
            26,040
            —
            —
            —
            26,040Gain
                (loss) on sale of mortgage assets
            —
            48,892
            (12,719)
            (33,722)
            2,451Total
                net revenues and gains
            117,954
            67,140
            55,179
            (38,442)
            201,831Payroll,
                general and administrative,and
                other expenses
            35,585
            60,106
            34,305
            (19,262)
            110,734Depreciation
            64
            2,805
            1,532
            —
            4,401Total
                operating expenses
            35,649
            62,911
            35,837
            (19,262)
            115,135Income
                before taxes
            82,305
            4,229
            19,342
            (19,180)
            86,696Income
                tax expense
            3,424
            1,722
            7,467
            (18,792)
            (6,179)**Income
                before cumulative effect of change in accounting
                principle**
            78,881
            2,507
            11,875
            (388)
            92,875Cumulative
                effect of change in
              accounting
                principle
            31
            —
            —
            —
            31**Net
                income**
            $78,912
            $2,507
            $11,875
            $(388)
            $92,906





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





**September
                30, 2006**
            **December
                31, 2005****Segment
                Assets:**Portfolio
            $7,028,780
            $6,768,778Servicing
            384,053
            315,039Total
                segment assets
            $7,412,833
            7,083,817Corporate
                assets
            171,864
            148,261Total
                assets
            $7,584,697
            $7,232,078





**(12)**  **Non-guarantor
      / Guarantor** **Financial Data**





The
      Company issued
      $150.0 million in aggregate principal amount of its 12% senior notes due 2014
      in
      an offering that closed May 4, 2006. The notes are fully and unconditionally
      guaranteed on a joint and several basis by Saxon Funding Management, Inc.,
      Saxon
      Capital Holdings, Inc., SCI Services, Inc., Saxon Mortgage Services, Inc.,
      Saxon
      Mortgage, Inc. and Saxon Holding, Inc., each of which is a direct or indirect
      wholly-owned subsidiary of the Company, or sub-guarantors. All of the
      sub-guarantors are taxable REIT subsidiaries except for Saxon Funding
      Management, Inc., which is a qualified REIT subsidiary. One non-guarantor is
      a
      taxable REIT subsidiary and the other non-guarantors are qualified REIT
      subsidiaries. The financing facilities to which the Company and certain of
      its
      subsidiaries are party prohibit distributions to the Company in the event of
      default thereunder. In addition, the ability of the Company and the
      sub-guarantors to obtain funds from their subsidiaries by dividend or loan
      may
      be limited by legal restrictions and regulatory and rating agency considerations
      applicable to such subsidiaries.





24


The
      following tables present the financial condition, results of operations, and
      cash flows for the Company, its sub-guarantors, and its non-guarantors as of
      September 30, 2006 and December 31, 2005 and for the three and nine months
      ended
      September 30, 2006 and 2005.





**Consolidating
                Balance Sheet**
              **As
                of September 30, 2006****Saxon
                Capital, Inc. (Parent)**
            **Sub-guarantors**
            **Non-guarantors**
            **Eliminations**
            **Total**($
                in thousands)**Assets:**Cash
            $305
            $6,157
            $6,565
            $—
            $13,027Trustee
                receivable
            —
            25,655
            113,873
            —
            139,528Restricted
                cash
            —
            3,681
            2,411
            —
            6,092Accrued
                interest receivable, net
            —
            15,301
            36,413
            (4,689)
            47,025Mortgage
                loan portfolio
            —
            2,643,565
            4,315,549
            (128,234)
            6,830,880Allowance
                for loan losses
            —
            (6,703)
            (31,150)
            —
            (37,853)Net
                mortgage loan portfolio
            —
            2,636,862
            4,284,399
            (128,234)
            6,793,027Servicing
                related advances
            —
            11,456
            206,578
            16,861
            234,895Mortgage
                servicing rights, net
            —
            149,158
            —
            —
            149,158Real
                estate owned
            —
            7,088
            36,020
            —
            43,108Derivative
                assets
            —
            12,164
            4,920
            —
            17,084Deferred
                tax asset
            —
            34,129
            3,381
            31,130
            68,640Investment
                in subsidiaries
            414,700
            155,008
            (7,884)
            (561,824)
            —Other
                assets, net
            7,711
            52,040
            13,745
            (383)
            73,113Total
                assets
            $422,716
            $3,108,699
            $4,700,421
            $(647,139)
            $7,584,697**Liabilities
                and shareholders’ equity:****Liabilities:**Accrued
                interest payable
            $7,350
            $8,282
            $5,996
            $(4,689)
            $16,939Dividends
                payable
            —
            —
            —
            —
            —Warehouse
                financing
            —
            1,090,613
            —
            —
            1,090,613Securitization
                financing
            —
            1,452,299
            4,264,076
            —
            5,716,375Derivative
                liabilities
            —
            15,793
            —
            —
            15,793Senior
                notes
            150,000
            —
            —
            —
            150,000Due
                to (from) affiliates
            477
            (435)
            (42)
            —
            —Other
                liabilities
            —
            40,485
            87
            —
            40,572Total
                liabilities
            157,827
            2,607,037
            4,270,117
            (4,689)
            7,030,292**Shareholders’
                equity:**Common
                stock
            501
            353
            2
            (355)
            501Preferred
                stock
            —
            10
            —
            (10)
            —Additional
                paid-in capital
            633,970
            829,453
            348,966
            (1,174,988)
            637,401Accumulated
                other comprehensive loss, net of tax of $(11)
            —
            —
            (253)
            —
            (253)Net
                accumulated (deficit) earnings
            (369,582)
            (328,154)
            81,589
            532,903
            (83,244)Total
                shareholders’ equity
            264,889
            501,662
            430,304
            (642,450)
            554,405Total
                liabilities and shareholders’ equity
            $422,716
            $3,108,699
            $4,700,421
            $(647,139)
            $7,584,697








25




**Consolidating
                Balance Sheet**
              **As
                of December 31, 2005****Saxon
                Capital, Inc. (Parent)**
            **Sub-guarantors**
            **Non-guarantors**
            **Eliminations**
            **Total**($
                in thousands)**Assets:**Cash
            $222
            $4,054
            $5,255
            $(3,478)
            $6,053Trustee
                receivable
            —
            1,219
            6,204
            128,534
            135,957Restricted
                cash
            —
            145,513
            1,960
            —
            147,473Accrued
                interest receivable, net
            —
            4,636
            15,134
            18,412
            38,182Mortgage
                loan portfolio
            —
            952,263
            5,722,105
            (229,496)
            6,444,872Allowance
                for loan losses
            —
            (211)
            (36,428)
            —
            (36,639)Net
                mortgage loan portfolio
            —
            952,052
            5,685,677
            (229,496)
            6,408,233Servicing
                related advances
            —
            10,591
            199,667
            (24,961)
            185,297Mortgage
                servicing rights, net
            —
            129,742
            —
            —
            129,742Real
                estate owned
            —
            6,149
            32,784
            —
            38,933Derivative
                assets
            —
            5,471
            14,483
            —
            19,954Deferred
                tax asset
            —
            25,789
            2,341
            25,594
            53,724Investment
                in subsidiaries
            339,704
            127,090
            (4,742)
            (462,052)
            —Other
                assets, net
            10,688
            38,069
            19,773
            —
            68,530Total
                assets
            $350,614
            $1,450,375
            $5,978,536
            $(547,447)
            $7,232,078**Liabilities
                and shareholders’ equity:****Liabilities:**Accrued
                interest payable
            $—
            $1,978
            $6,379
            $—
            $8,357Dividends
                payable
            32,539
            —
            —
            —
            32,539Warehouse
                financing
            —
            369,496
            8,648
            —
            378,144Securitization
                financing
            —
            645,262
            5,537,127
            —
            6,182,389Derivative
                liabilities
            —
            8,589
            —
            —
            8,589Due
                (from) to affiliates
            (1,563)
            (27,504)
            29,067
            —
            —Other
                liabilities
            —
            29,777
            2,627
            (3,479)
            28,925Total
                liabilities$
            30,976
            1,027,598
            5,583,848
            (3,479)
            6,638,943**Shareholders’
                equity:**Common
                stock
            500
            353
            2
            (355)
            500Preferred
                stock
            —
            10
            —
            (10)
            —Additional
                paid-in capital
            630,592
            740,707
            296,941
            (1,034,217)
            634,023Accumulated
                other comprehensive income (loss), net of tax of $(16)
            —
            24
            (379)
            —
            (355)Net
                accumulated (deficit) earnings
            (311,454)
            (318,317)
            98,124
            490,614
            (41,033)Total
                shareholders’ equity
            319,638
            422,777
            394,688
            (543,968)
            593,135Total
                liabilities and shareholders’ equity
            $350,614
            $1,450,375
            $5,978,536
            $(547,447)
            $7,232,078










26


**Consolidating
                Statement of Operations**
              **For
                the three months ended September 30, 2006****Saxon
                Capital, Inc. (Parent)**
            **Sub-guarantors**
            **Non-guarantors**
            **Eliminations**
            **Total**($
                in thousands)**Revenues
                and Gains:**Interest
                income
            $—
            $46,979
            $81,562
            $(1,638)
            $126,903Interest
                expense
            (4,618)
            (34,037)
            (72,957)
            2,680
            (108,932)Intercompany
                interest
            (50)
            14,579
            (5,140)
            (9,389)
            —Net
                interest income
            (4,668)
            27,521
            3,465
            (8,347)
            17,971Provision
                for mortgage loan losses
            —
            (5,920)
            (9,145)
            —
            (15,065)Net
                interest income after provision for mortgage loan losses
            (4,668)
            21,601
            (5,680)
            (8,347)
            2,906Servicing
                income, net of amortization and impairment
            —
            18,476
            (585)
            —
            17,891Derivative
                losses
            —
            (9,952)
            (9,961)
            —
            (19,913)Loss
                on sale of mortgage assets
            —
            (832)
            —
            —
            (832)Total
                net revenues and gains
            (4,668)
            29,293
            (16,226)
            (8,347)
            52**Expenses:**Payroll
                and related expenses
            —
            18,281
            —
            —
            18,281General
                and administrative expenses
            (22)
            16,626
            9
            —
            16,613Depreciation
            —
            1,724
            —
            —
            1,724Other
                expenses, net
            —
            1
            2,926
            —
            2,927Total
                operating expenses
            (22)
            36,632
            2,935
            —
            39,545Loss
                before taxes
            (4,646)
            (7,339)
            (19,161)
            (8,347)
            (39,493)Income
                tax benefit
            (168)
            (4,349)
            (3,836)
            (4,733)
            (13,086)**Net
                loss**
            $(4,478)
            $(2,990)
            $(15,325)
            $(3,614)
            $(26,407)








27


**Consolidating
                Statement of Operations**
              **For
                the three months ended September 30, 2005****Saxon
                Capital, Inc. (Parent)**
            **Sub-guarantors**
            **Non-guarantors**
            **Eliminations**
            **Total**($
                in thousands)**Revenues
                and Gains:**Interest
                income
            $—
            $9,714
            $102,242
            $4,145
            $116,101Interest
                expense
            —
            (4,101)
            (64,706)
            —
            (68,807)Intercompany
                interest
            20
            11,154
            (2,620)
            (8,554)
            —Net
                interest income
            20
            16,767
            34,916
            (4,409)
            47,294Provision
                for mortgage loan losses
            —
            (328)
            (18,764)
            —
            (19,092)Net
                interest income after provision for mortgage loan losses
            20
            16,439
            16,152
            (4,409)
            28,202Servicing
                income, net of amortization and impairment
            —
            19,875
            (812)
            —
            19,063Derivative
                (losses) gains
            —
            (2,033)
            21,923
            —
            19,890Gain
                (loss) on sale of mortgage assets
            —
            47
            (3)
            —
            44Total
                net revenues and gains
            20
            34,328
            37,260
            (4,409)
            67,199**Expenses:**Payroll
                and related expenses
            —
            17,253
            6,057
            (1,986)
            21,324General
                and administrative expenses
            8
            10,792
            6,233
            (115)
            16,918Depreciation
            —
            1,382
            176
            —
            1,558Other
                expense (income), net
            —
            2,391
            (2,801)
            1,696
            1,286Total
                operating expenses
            8
            31,818
            9,665
            (405)
            41,086Income
                before taxes
            12
            2,510
            27,595
            (4,004)
            26,113Income
                tax expense (benefit)
            1
            2,840
            (538)
            (8,099)
            (5,796)**Net
                income (loss**)
            $11
            $(330)
            $28,133
            $4,095
            $31,909







28


**Consolidating
                Statement of Operations**
              **For
                the nine months ended September 30, 2006****Saxon
                Capital, Inc. (Parent)**
            **Sub-guarantors**
            **Non-guarantors**
            **Eliminations**
            **Total**($
                in thousands)**Revenues
                and Gains:**Interest
                income
            $—
            $108,245
            $272,388
            $(8,336)
            $372,297Interest
                expense
            (7,538)
            (72,465)
            (216,953)
            4,689
            (292,267)Intercompany
                interest
            (29)
            16,035
            (15,845)
            (161)
            —Net
                interest income
            (7,567)
            51,815
            39,590
            (3,808)
            80,030Provision
                for mortgage loan losses
            —
            (9,583)
            (19,469)
            —
            (29,052)Net
                interest income after provision for mortgage loan losses
            (7,567)
            42,232
            20,121
            (3,808)
            50,978Servicing
                income, net of amortization and impairment
            —
            59,855
            (1,894)
            —
            57,961Derivative
                (losses) gains
            —
            (3,954)
            9,412
            —
            5,458Loss
                on sale of mortgage assets
            —
            (2,600)
            —
            —
            (2,600)Total
                net revenues and gains
            (7,567)
            95,533
            27,639
            (3,808)
            111,797**Expenses:**Payroll
                and related expenses
            —
            53,339
            —
            269
            53,608General
                and administrative expenses
            —
            44,586
            19
            —
            44,605Depreciation
            —
            5,252
            —
            —
            5,252Other
                expense, net
            —
            406
            5,291
            (214)
            5,483Total
                operating expenses
            —
            103,583
            5,310
            55
            108,948(Loss)
                income before taxes
            (7,567)
            (8,050)
            22,329
            (3,863)
            2,849Income
                tax (benefit) expense
            (287)
            1,785
            (2,134)
            (5,153)
            (5,789)**Net
                (loss) income**
            $(7,280)
            $(9,835)
            $24,463
            $1,290
            $8,638







29


**Consolidating
                Statement of Operations**
              **For
                the nine months ended September 30, 2005****Saxon
                Capital, Inc. (Parent)**
            **Sub-guarantors**
            **Non-guarantors**
            **Eliminations**
            **Total**($
                in thousands)**Revenues
                and Gains:**Interest
                income
            $—
            $30,605
            $294,872
            $14,123
            $339,600Interest
                expense
            —
            (11,902)
            (173,383)
            —
            (185,285)Intercompany
                interest
            44
            35,539
            825
            (36,408)
            —Net
                interest income
            44
            54,242
            122,314
            (22,285)
            154,315Provision
                for mortgage loan losses
            —
            (775)
            (30,053)
            —
            (30,828)Net
                interest income after provision for mortgage loan losses
            44
            53,467
            92,261
            (22,285)
            123,487Servicing
                income, net of amortization and impairment
            —
            59,378
            (9,525)
            —
            49,853Derivative
                (losses) gains
            —
            (1,890)
            27,930
            —
            26,040Gain
                on sale of mortgage assets
            —
            2,428
            23
            —
            2,451Total
                net revenues and gains
            44
            113,383
            110,689
            (22,285)
            201,831**Expenses:**Payroll
                and related expenses
            —
            42,779
            19,326
            (2,775)
            59,330General
                and administrative expenses
            23
            27,713
            20,733
            (192)
            48,277Depreciation
            —
            3,938
            463
            —
            4,401Other
                expense (income), net
            —
            10,250
            (9,676)
            2,553
            3,127Total
                operating expenses
            23
            84,680
            30,846
            (414)
            115,135Income
                before taxes
            21
            28,703
            79,843
            (21,871)
            86,696Income
                tax expense (benefit)
            1
            14,671
            (3,242)
            (17,609)
            (6,179)**Income
                before cumulative effect of change in accounting
                principle**
            20
            14,032
            83,085
            (4,262)
            92,875Cumulative
                effect of change in accounting principle
            —
            31
            —
            —
            31**Net
                income**
            $20
            $14,063
            $83,085
            $(4,262)
            $92,906







30


**Consolidating
                Statement of Cash Flows**
              **For
                the nine months ended September 30, 2006****Saxon
                Capital, Inc. (Parent)**
            **Sub-guarantors**
            **Non-guarantors**
            **Eliminations**
            **Total**($
                in thousands)**Operating
                Activities:**Net
                (loss) income
            $(7,280)
            $(9,835)
            $24,463
            $1,290
            $8,638Adjustments
                to reconcile net (loss) income to net cash provided by (used in)
                operating
                activities:Depreciation
                and amortization
            183
            56,486
            23,573
            (2)
            80,240Intercompany
                amortization
            —
            (2,277)
            (1,372)
            3,649
            —Deferred
                income tax benefit
            —
            (8,340)
            (1,040)
            (5,536)
            (14,916)Impairment
                of assets
            —
            3,735
            5,291
            —
            9,026Non
                cash derivative gains
            —
            4,350
            517
            —
            4,867Loss
                from sale of mortgage assets
            —
            2,600
            —
            —
            2,600Intercompany
                gain from sale of loans and advances
            —
            (161)
            —
            161
            —Provision
                for mortgage loan losses
            —
            9,583
            19,469
            —
            29,052Provision
                for advanced interest
            —
            1,433
            10,288
            —
            11,721Compensation
                expense for share-based compensation plans
            —
            2,529
            —
            —
            2,529(Increase)
                decrease in servicing related advances
            —
            (632,211)
            601,907
            (19,294)
            (49,598)Increase
                in accrued interest receivable
            —
            (13,644)
            (20,352)
            23,100
            (10,896)Increase
                (decrease) in accrued interest payable
            7,350
            6,304
            (383)
            (4,689)
            8,582Increase
                in trustee receivable
            —
            (24,436)
            (107,669)
            128,534
            (3,571)Decrease
                (increase) in income tax receivable
            8,741
            (10,262)
            2,672
            382
            1,533(Purchases
                of) proceeds from derivative instruments
            —
            (5)
            5,211
            —
            5,206Net
                change in miscellaneous assets and liabilities
            2,637
            (7,139)
            6,586
            (17,894)
            (15,810)Net
                cash provided by (used in) operating activities
            11,631
            (621,290)
            569,161
            109,701
            69,203**Investing
                Activities:**Purchase
                and origination of mortgage loans
            —
            (2,529,510)
            (6,863)
            4,000
            (2,532,373)Principal
                payments received on mortgage loan portfolio
            —
            261,854
            1,806,976
            (110,223)
            1,958,607Proceeds
                from the sale of mortgage loans
            —
            100,050
            —
            —
            100,050Proceeds
                received from (paid for) the intercompany sale of loans
            —
            1,108,820
            (1,108,820)
            —
            —Proceeds
                from the sale of real estate owned
            —
            2,989
            40,288
            —
            43,277Decrease
                (increase) in restricted cash
            —
            141,832
            (451)
            —
            141,381Acquisition
                of mortgage servicing rights
            —
            (71,012)
            —
            —
            (71,012)Capital
                expenditures
            —
            (3,955)
            —
            —
            (3,955)Capital
                contributions (to) from affiliates
            (74,996)
            60,827
            14,169
            —
            —Net
                cash (used in) provided by investing activities
            (74,996)
            (928,105)
            745,299
            (106,223)
            (364,025)**Financing
                Activities:**Proceeds
                from issuance of securitization financing-bonds
            —
            1,013,441
            464,534
            —
            1,477,975Proceeds
                from issuance of securitization financing-certificates
            —
            —
            49,420
            —
            49,420Proceeds
                received from issuance of senior notes
            150,000
            —
            —
            —
            150,000Debt
                issuance costs
            (5,947)
            (3,304)
            (1,831)
            —
            (11,082)Principal
                payments on securitization financing-bonds
            —
            (206,825)
            (1,783,246)
            —
            (1,990,071)Principal
                payments on securitization financing-certificates
            —
            —
            (4,270)
            —
            (4,270)Borrowings
                    under (repayment of) warehouse financing, net
            —
            721,117
            (8,648)
            —
            712,469Proceeds
                received from issuance of stock
            743
            —
            —
            —
            743Payment
                of dividends
            (83,388)
            —
            —
            —
            (83,388)Due
                from (to) affiliates
            2,040
            27,069
            (29,109)
            —
            —Net
                cash provided by (used in) financing
              Activities
            63,448
            1,551,498
            (1,313,150)
            —
            301,796Net
                increase in cash
            83
            2,103
            1,310
            3,478
            6,974Cash
                at beginning of year
            222
            4,054
            5,255
            (3,478)
            6,053Cash
                at end of period
            $305
            $6,157
            $6,565
            $—
            $13,027







31


**Consolidating
                Statement of Cash Flows**
              **For
                the nine months ended September 30, 2005****Saxon
                Capital, Inc. (Parent)**
            **Sub-guarantors**
            **Non-guarantors**
            **Eliminations**
            **Total**($
                in thousands)**Operating
                Activities:**Net
                income
            $20
            $14,063
            $83,085
            $(4,262)
            $92,906Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:Depreciation
                and amortization
            —
            37,129
            18,855
            (725)
            55,259Intercompany
                amortization
            —
            (718)
            (12,681)
            13,399
            —Deferred
                income tax (benefit) provision
            —
            (2,765)
            67
            (24,214)
            (26,912)Impairment
                of assets
            —
            5,007
            2,553
            —
            7,560Non
                cash derivative (gains) losses
            —
            (8,551)
            1,576
            —
            (6,975)Gain
                from sale of mortgage assets
            —
            (2,428)
            (23)
            —
            (2,451)Intercompany
                gain from sale of loans and advances
            —
            (27,470)
            (8,939)
            36,409
            —Provision
                for mortgage loan losses
            —
            775
            30,053
            —
            30,828Provision
                for advanced interest
            —
            —
            9,719
            —
            9,719Compensation
                expense for share-based compensation plans
            —
            2,061
            —
            —
            2,061Cumulative
                effect of change in accounting principle
            —
            (31)
            —
            —
            (31)(Increase)
                decrease in servicing related advances
            —
            (440,829)
            386,031
            12,347
            (42,451)Decrease
                (increase) in accrued interest receivable
            —
            3,834
            (3,934)
            (552)
            (652)Decrease
                in accrued interest payable
            —
            (133)
            (868)
            —
            (1,001)Increase
                in trustee receivable
            —
            (1,782)
            (1,072)
            (15,201)
            (18,055)(Increase)
                decrease in income tax receivable
            11,092
            16,530
            (3,274)
            —
            24,348Purchases
                of derivative instruments
            —
            —
            (4,332)
            —
            (4,332)Net
                change in miscellaneous assets and liabilities
            5,590
            40,698
            24,922
            (73,149)
            (1,939)Net
                cash provided by (used in) operating activities
            16,702
            (364,610)
            521,738
            (55,948)
            117,882**Investing
                Activities:**Purchase
                and origination of mortgage loans
            —
            (1,867,562)
            (639,469)
            36,493
            (2,470,538)Principal
                payments received on mortgage loan portfolio
            —
            18,928
            1,856,965
            14,390
            1,890,283Proceeds
                from the sale of mortgage loans
            —
            251,264
            —
            —
            251,264Proceeds
                received from (paid for) the intercompany sale of loans
            —
            2,631,365
            (2,631,365)
            —
            —Proceeds
                from the sale of real estate owned
            —
            2,099
            39,693
            —
            41,792Increase
                in restricted cash
            —
            —
            (140,738)
            —
            (140,738)Acquisition
                of mortgage servicing rights
            —
            (78,727)
            —
            —
            (78,727)Capital
                expenditures
            —
            (9,100)
            —
            —
            (9,100)Capital
                contributions from (to) affiliates
            71,644
            (32,465)
            (44,244)
            5,065
            —Net
                cash provided by (used in) investing activities
            71,644
            915,802
            (1,559,158)
            55,948
            (515,764)**Financing
                Activities:**Proceeds
                from issuance of securitization financing-bonds
            —
            —
            2,867,371
            —
            2,867,371Proceeds
                from issuance of securitization financing-certificates
            —
            —
            150,249
            —
            150,249Debt
                issuance costs
            —
            —
            (10,667)
            —
            (10,667)Principal
                payments on securitization financing-bonds
            —
            —
            (1,970,147)
            —
            (1,970,147)Principal
                payments on securitization financing-certificates
            —
            —
            (103,089)
            —
            (103,089)(Repayment
                of) borrowings under warehouse financing, net
            —
            (464,841)
            8,295
            —
            (456,546)Proceeds
                received from issuance of stock
            2,015
            —
            —
            —
            2,015Payment
                of dividends
            (84,663)
            —
            —
            —
            (84,663)Due
                (to) from affiliates
            (6,408)
            (92,662)
            99,070
            —
            —Net
                cash (used in) provided by financing activities
            (89,056)
            (557,503)
            1,041,082
            
            394,523Net
                (decrease) increase in cash
            (710)
            (6,311)
            3,662
            —
            (3,359)Cash
                at beginning of year
            743
            8,998
            3,111
            —
            12,852Cash
                at end of period
            $33
            $2,687
            $6,773
            $—
            $9,493





32





**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, 2005, or the 2005 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,” “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, including, but not
      limited to, those addressed in “Part II - Item 1A. Risk Factors” in this report
      and our quarterly report on Form 10-Q for the periods ended March 31, 2006
      and
      June 30, 2006 as well as those included in the 2005 Form 10-K, and the following
      summary of risks and uncertainties:





·
            decreases
                in residential real estate values, which could reduce both the credit
                quality of our mortgage loan portfolio and the ability of borrowers
                to use
                their home equity to obtain cash through mortgage loan refinancings,
                which
                would adversely impact our ability to produce new mortgage
                loans;





·
            changes
                in overall regional or local economic conditions or changes in interest
                rates, particularly those conditions that affect demand for new housing,
                housing resales or the value of
                houses;





·
            our
                ability to successfully implement our growth strategy throughout
                the
                various cycles experienced by our
                industry;





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





·
            our
                ability to sustain loan production growth at historical
                levels;





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







33


·
            our
                ability to securitize 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 if our existing
                sources of funding become
                unavailable;





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





·
            our
                ability to maintain our current servicer
                ratings;





·
            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 continue to qualify as
                qualified
                REIT subsidiaries for federal income tax
                purposes;





·
            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;





·
            changes
                in mortgage loan prepayment speeds;





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





·
            future
                litigation developments or regulatory or enforcement
                actions;





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





·
            the
                effects, timing and completion of the pending merger transaction
                with
                Morgan Stanley Mortgage Capital Inc., or
                MSMC.





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.





34


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
            35Description
                of Other Data
            38Third
                Quarter 2006 Events and Outlook
            39Critical
                Accounting Policies
            40Consolidated
                Results
            45Business
                Segment Results
            60Financial
                Condition
            65Liquidity
                and Capital Resources
            67Off
                Balance Sheet Items and Contractual Obligations
            74Other
                Matters
            75




**Executive
      Summary**




***Company
      Overview***




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





·  Mortgage
      loan production;





·  Portfolio;
      and





·  Mortgage
      loan servicing.





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,
      correspondent, retail and conduit channels, which we refer to collectively
      as
      our “mortgage loan production segment”. We earn most of our revenues from the
      net interest income generated by those mortgage loans through our portfolio
      segment and from servicing loans for other companies through our mortgage loan
      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,
      servicing rights 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 and purchases through short-term
      warehouse lines of credit and through repurchase facilities, as well as with
      the
      amounts borrowed under our senior notes, which are replaced by permanent
      financing when we securitize the loans. We structure our securitization
      transactions as financing transactions, with the mortgage loans and related
      debt
      to finance those loans remaining on our balance sheet.




35


We
      access
      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 lines of credit and repurchase agreement
      facilities. These loans are subsequently financed using asset-backed securities
      issued through securitization trusts. From May 1996 to September 30, 2006,
      we
      securitized $24.0 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 produce remain on our consolidated balance sheet; (2) the
      securitization indebtedness replaces the warehouse and repurchase 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.




***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 Board of Governors of the Federal Reserve System, or FRB, the residential
      mortgage loan market is the largest consumer finance market in the United
      States. According to the Mortgage Bankers Association of America, or MBAA,
      website as of October 24, 2006, lenders in the United States originated more
      than $3.0 trillion in one-to-four family mortgage loans in 2005. A substantial
      portion of the loan originations in 2005 was attributable to mortgage loan
      refinancings, and we believe this was a result of customers taking advantage
      of
      strong housing appreciation and increased mortgage product offerings in the
      marketplace. Additionally, customers benefited from the increased competition
      within the mortgage loan industry which kept interest rates low in spite of
      a
      slightly rising interest rate environment. According to the MBAA website as
      of
      October 24, 2006, lenders are expected to originate $2.5 trillion in
      single-family mortgage loans in 2006, reflecting an anticipated decrease in
      refinancing activity. Generally, we believe sub-prime borrowers are not solely
      motivated by fluctuations in interest rates.




Generally,
      the mortgage loan industry is segmented by the size of the mortgage loans and
      the credit characteristics of the borrowers. Mortgage loans that conform to
      the
      guidelines of GSEs, such as Fannie Mae or Freddie Mac, which have guidelines
      for
      both size and credit characteristics, are called conforming mortgage loans.
      Most
      of our mortgage loans are considered non-conforming mortgage loans because
      of
      the size of the loans (generally referred to as jumbo mortgage loans), or the
      credit profiles of the borrowers (generally referred to as sub-prime mortgage
      loans), or both. We believe the mortgage loan originators in the non-conforming
      segment of the mortgage industry provide credit to a broad range of consumers
      who are underserved by the conforming mortgage loan market. In addition, we
      believe that many sub-prime mortgage loan products that have very low initial
      interest rates for a period of one or two years continue to present borrowers
      with economic incentives to refinance their existing mortgage loans when the
      low
      interest rate period expires, regardless of interest rate movements; therefore,
      we do not expect the same level of decline in loan demand in the non-conforming
      mortgage loan market as would be expected in the overall mortgage loan market
      as
      interest rates rise.




36


We
      have
      seen a trend of consolidation among companies in the non-conforming, residential
      mortgage industry in the marketplace. Today, the industry is dominated by a
      small number of large companies and is rapidly consolidating further. This
      market share domination by a small number of large companies has led to intense
      competition within the industry and has negatively impacted our profitability.
      Specifically, lenders in the industry, including us, have not raised interest
      rates in line with increases in market interest rates. As a result, we have
      experienced reductions in our net interest margin and our liquidity has been
      negatively impacted.




We
      have
      also seen an increase in delinquencies and loan repurchases across our industry
      during the third quarter of 2006, primarily due to early payment defaults.
      The
      increase in delinquencies appears to be closely tied to less stringent lending
      standards and a cooling housing market; while the increase in loan repurchases
      appears to also be the result of loan buyers’ higher than expected repurchase
      requests, in response to a changing secondary market view of the industry.
      The
      increase in delinquencies and loan repurchases has resulted in increased
      provisions for losses being recorded across the industry during the third
      quarter of 2006.




Over
      the
      last several years, the housing price index has increased faster than the
      consumer price index and growth in personal income. We are beginning to see
      home
      price appreciation slow in the marketplace, and we expect that this trend will
      continue for some time. A report released in September 2006 by the Office of
      Federal Housing Enterprise Oversight indicated that while U.S. home prices
      continued to rise in the second quarter of 2006, the rate of increase fell
      sharply, and this was seen in almost every region of the country. The report
      also indicated that some states actually had negative house price appreciation
      during the second quarter of 2006. 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 mortgage loans tend to increase as borrowers look to realize the
      additional equity in their homes. If housing prices fall dramatically, our
      future results of operations would be adversely affected by lower production
      and
      higher credit losses.




37


**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, and our calculations of
      these
      data may be different than other registrants. These measures have
      limitations as analytical tools, and you should not consider them in isolation
      or as a substitute for analysis of our results as reported under GAAP. These
      measures should be used only supplementally. See our consolidated financial
      statements and related notes included elsewhere in this report and see
“Consolidated Results” for the reconciliations of these financial measures to
      GAAP. 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 securitization net losses on liquidated loans to
      charge-offs.* Securitization net losses on liquidated loans is a non-GAAP financial measure
      within the meaning of Regulation G promulgated by the Securities and Exchange
      Commission. We present a reconciliation of securitization net losses on
      liquidated loans to charge-offs, which are recognized in our financial
      statements in accordance with GAAP, because management believes that it is
      useful to show both measures of losses to evaluate securitization 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 securitization 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 securitization
      net
      losses on liquidated loans. In addition, securitization 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 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 REIT taxable 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:





38


·
            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





·
            there
                are differences between GAAP and tax related to the timing of recognition
                of income (loss) from derivative instruments;
                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 estimated REIT taxable income provides useful
      information to investors regarding our estimated annual distributions to our
      investors. The presentation of estimated 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 2005 Form 10-K.





**Third
      Quarter****2006
      Events and Outlook**




On
      August
      9, 2006, we announced that we had entered into a definitive agreement with
      MSMC
      pursuant to which MSMC will acquire our company for $14.10 per common share
      in
      cash, or approximately $706 million, through a merger between us and a
      wholly-owned subsidiary of MSMC. At a special meeting of our shareholders held
      on October 31, 2006, the merger was approved, with approximately 72% of the
      outstanding shares of common stock voting in favor of the merger. The
      transaction is expected to close in December 2006, subject to receipt of all
      necessary regulatory approvals and the satisfaction of remaining customary
      closing conditions.





Overall
      for the majority of 2006, increases in the interest rates we charge on our
      mortgage loans have not kept pace with the markets’ changes in one-month LIBOR
      due to competitive pressures during a rising rate environment. As a result,
      we
      expect to continue to experience margin compression in 2006. In the third
      quarter of 2006, the forward LIBOR curve decreased causing our competitors
      and
      us to reduce interest rates charged to borrowers.  Given such margin
      compression, 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.





39


For
      a
      majority of the first nine months of 2006, we experienced an increase in
      short-term borrowing interest rates and a continued increase in competitiveness
      of pricing within our industry. We also experienced a reduction in our
      prepayment penalty income as a result of fewer loans in our portfolio containing
      prepayment features and a decrease in prepayment penalty fees collected per
      loan
      during the first nine months of 2006 as compared to the first nine months of
      2005. This resulted in a substantial reduction in the net interest margin
      including prepayment penalty income on our mortgage loan portfolio. During
      the
      third quarter of 2006, we experienced a decrease in the 2/3 year part of the
      forward LIBOR curve, which negatively impacted the fair value of our
      derivatives, resulting in our derivative loss for the three months ended
      September 30, 2006.





During
      the third quarter of 2006, we made loan repurchases of $1.0 million in mortgage
      loans for first payment defaults and recorded $0.7 million of losses relating
      to
      these repurchases, of which $0.3 million had been accrued for in prior periods
      as part of our accrual for loan repurchase liability. We also experienced a
      12%
      rise in our delinquencies, bankruptcies and foreclosures in the third quarter
      of
      2006 compared to December 31, 2005.





During
      the first nine months of 2006, we purchased the rights to service $8.6 billion
      of mortgage loans at a cost of $71.0 million. We have generally seen prices
      of
      mortgage servicing rights increase in the marketplace due to an anticipated
      decrease in prepayment speeds.





Throughout
      the first nine months of 2006, we increased our mortgage loan production over
      levels achieved during the comparable period in 2005. This increase in mortgage
      loan production is the result of having adjusted to our new, more efficient
      centralized loan production structure, the investments we have made in
      technology, and our focus on controlling our general and administrative
      expenses. We expect short-term market interest rates to remain stable and
      competitive pressures to continue to be intense during the remainder of 2006.





**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
      ongoing basis, management evaluates its estimates and judgments. Management
      bases its estimates and judgments on historical experience and on various other
      factors that it believes 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.





40


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;




·
            allowance
                for loan losses and past due
                interest;




·
            mortgage
                servicing rights;




·
            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 required by 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. The projections used in our interest method
      calculations are based on six-month LIBOR.




Mortgage
      loan prepayments generally increase on our adjustable rate mortgage loans 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. The majority of our penalties expire two to three years
      from origination. As of September 30, 2006, 71% of our mortgage loan portfolio
      had active prepayment penalty features. We
      anticipate that prepayment rates on a significant portion of our adjustable
      rate
      mortgage loan portfolio will increase as these adjustable rate mortgage loans
      reach their initial adjustments during 2006 and 2007, due to the high
      concentration of two to three year hybrid loans we originated or purchased
      during 2003 and 2004. The constant prepayment rate, or CPR, currently used
      to
      project cash flows is 38% over twelve months.




41


Interest
      expense on our warehouse, repurchase and securitization financings, as well
      as
      our senior notes is a combination of accruing interest based on the contractual
      terms of the financing arrangements and the amortization/accretion of premiums,
      discounts, and debt issuance costs. These yield adjustments are amortized
      against interest expense over the life of the debt in a manner similar to that
      described above for interest income, using the interest method adjusted for
      the
      effects of the estimated payments on the debt.




*Allowance
      for Loan Losses and Past Due Interest*





The
      allowance for loan losses is established through the provision for mortgage
      loan
      losses, which is charged to earnings on a monthly basis. The allowance for
      past
      due interest is charged to earnings through interest income. The accounting
      estimate of the allowance for loan losses and past due interest 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 losses and past due interest and our results
      of operations. The assumptions used by management regarding these key estimates
      involve a great deal of judgment.





Provisions
      are made to the allowance for loan losses and past due interest 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 REO status. The allowance
      for loan losses and past due interest 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 as well as 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 losses and past due interest.
      Our
      roll rate analysis is defined as the historical progression of our loans through
      the various delinquency categories. 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, as a percentage, 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.




42


The
      allowance for loan losses and past due interest was impacted in the first nine
      months of 2006 primarily by the reversal of $1.8 million in Hurricane Katrina
      reserves, offset by an increase in overall delinquencies since December 31,
      2005. We are currently experiencing an 18-month average loss severity of 40.6%
      on our owned portfolio, and this is the assumption currently used in our loan
      loss allowance model. We did not make any significant changes in our reserve
      methodologies or assumptions during the third quarter of 2006.





*Mortgage
      Servicing Rights*





The
      valuation of 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. With respect to prepayment
      speeds, our MSRs decline in value when prepayment activity increases, as is
      common during periods of increased mortgage refinancing activity.





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 may differ from our
      initial estimates, and these differences may be 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 our MSRs. We perform an impairment analysis using independent
      valuations that we obtain each quarter. We consider estimates of numerous market
      assumptions, changes in interest rates, prepayment speeds, servicing costs,
      discount rates, and the payment performance of the underlying mortgage 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, such as prepayments, 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. In the
      event the impairment is subsequently reversed, the related allowance amount
      is
      recognized in our income; however, reversals of impairment may not be reversed
      passed the amount of the original fair value recorded. When the Company
      determines that a portion of the mortgage servicing rights are not recoverable,
      the related mortgage servicing rights and the previously established valuation
      allowance are correspondingly reduced to reflect the permanent impairment.





43


As
      a
      result of increased actual prepayment speeds and future prepayment speed
      assumptions applied to certain aged third party servicing portfolios, we
      recorded a temporary impairment of $3.6 million on our MSRs for the first nine
      months of 2006. It is possible that we may experience, in whole or in part,
      a
      reversal of the temporary impairment if actual future prepayments are lower
      than
      our future prepayment speed assumptions. Every quarter we value the third-party
      portion of our loan servicing portfolio using a prepayment speed assumption
      which management believes is appropriate given the product mix of the
      third-party servicing portfolio. The prepayment speed assumption used to value
      the servicing rights is an average of the CPR over the remaining life of the
      servicing rights and is therefore re-evaluated every quarter.





*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 policy 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 months
      ended September 30, 2006 based on existing facts and circumstances. Management
      evaluates its time and cost estimates quarterly to determine if updates and
      refinements to the deferral amounts are necessary. Updates will be necessary
      if
      it is determined that the time spent and/or costs incurred related to performing
      the above activities have significantly changed from the previous period. This
      estimate is made for all loans originated in 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
      expensed as incurred. In the third quarter of 2006, we deferred $4.9 million
      in
      costs associated with originating loans and $5.4 million in nonrefundable fees
      related to mortgage loan originations. We also recorded net amortization of
      these deferred loan origination costs and fees of $1.1 million.




44


*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, 2006, we recorded $6.0 thousand as a valuation allowance on
      our
      deferred tax assets for capital losses incurred by a qualified REIT subsidiary
      during the first nine months of 2006 based on management’s belief that it is
      more likely than not that capital gains will not be generated within the next
      five years by the qualified REIT subsidiary to realize the benefit of this
      asset. 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 additional valuation allowances 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 the remainder of our
      deferred tax assets.





We
      believe we have complied with the REIT provisions of the Internal Revenue Code
      for the three months ended September 30, 2006 and currently intend to continue
      to comply with such provisions in the future. Accordingly, we do not expect
      to
      be subject to federal or state income tax on net income that is distributed
      to
      shareholders as long as we continue to comply with the requirements necessary
      to
      maintain our qualification as a REIT. In the event that we do not qualify as
      a
      REIT in any year, we will be subject to federal and state 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 are 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 2005
      Form 10-K.







**Consolidated
      Results**





*Three
      and Nine Months Ended September 30, 2006 Compared to the Three and Nine Months
      Ended September 30, 2005*





45


*Overview.* The
      two
      most influential factors currently affecting our net income in 2006 are the
      rising short-term interest rate environment, which causes our interest expense
      to increase significantly, and intense competitive pricing within our industry,
      which causes the interest rates we charge on our new loan production to be
      substantially lower in relation to our cost of funds than has historically
      been
      the case. These two factors compressed interest margins compared to the more
      favorable interest margins that we experienced in prior years. Additionally,
      decreases in the 2/3 year part of the forward LIBOR curve during the most recent
      quarter have negatively impacted the fair value of our derivative instruments.
      We expect that accounting for our derivative instruments as undesignated
      derivatives will continue to result in increased volatility in our results
      of
      operations, as fluctuations in the market price of the derivative instruments
      will result in changes in the fair value of the derivatives being recorded
      in
      our consolidated statements of operations, while the liability that our
      derivatives are hedging is not recorded at fair market value on our consolidated
      balance sheet.





Net
      income decreased $58.3 million, or 183%, to a net loss of $26.4 million for
      the
      three months ended September 30, 2006 from net income of $31.9 million for
      the
      three months ended September 30, 2005. This decrease was primarily the result
      of: (1) a decrease of $39.8 million in derivative (losses) gains due to declines
      in the 2/3 year part of the forward LIBOR curve; (2) a decrease of $29.3 million
      on our net interest income due primarily to an increase in the cost of our
      borrowings; and (3) a decrease of $1.2 million in our servicing income, net
      of
      amortization and impairment, due primarily to an increase in delinquencies.
      Offsetting these decreases, our provision for mortgage loan losses and our
      total
      operating expenses decreased $4.0 million and $1.5 million, respectively. Net
      income decreased $84.3 million, or 91%, to $8.6 million for the nine months
      ended September 30, 2006 from $92.9 million for the nine months ended September
      30, 2005. This decrease was primarily the result of: (1) a decrease in our
      net
      interest income of $74.3 million due primarily to an increase in the cost of
      our
      borrowings; (2) a decrease of $20.6 million in derivative (losses) gains due
      to
      declines in the 2/3 year part of the forward LIBOR curve; and (3) an increase
      of
      $5.1 million in our loss on sale of mortgage assets due primarily to the
      repurchase of mortgage loans previously sold that had early payment defaults.
      Offsetting these factors, we had decreases in our provision for mortgage loan
      losses and total operating expenses of $1.7 million and $6.2 million,
      respectively.




46


**Revenues**





*Total
      Net Revenues and Gains.* Total
      net
      revenues and gains decreased $67.1 million, or almost 100%, to $0.1 million
      for
      the three months ended September 30, 2006 from $67.2 million for the three
      months ended September 30, 2005. Total net revenues and gains decreased $90.0
      million, or 45%, to $111.8 million for the nine months ended September 30,
      2006
      from $201.8 million for the nine months ended September 30, 2005. The decrease
      in total net revenues and gains was primarily attributable to an increase in
      the
      cost of our borrowings as well as to decreases in our derivative gains and
      increases in our losses on sale of mortgage assets, offset by increases in
      our
      servicing income.





*Interest
      Income.* Interest
      income increased $10.8 million, or 9%, to $126.9 million for the three months
      ended September 30, 2006 from $116.1 million for the three months ended
      September 30, 2005. Interest income increased $32.7 million, or 10%, to $372.3
      million for the nine months ended September 30, 2006 from $339.6 million for
      the
      nine months ended September 30, 2005. The increase in interest income was due
      primarily to the growth in our securitized mortgage loan portfolio and an
      increase of 61 basis points and 32 basis points in the weighted average coupons
      on our mortgage loan portfolio for the three and nine months ended September
      30,
      2006 as compared to the three and nine months ended September 30, 2005,
      respectively.





As
      shown
      in the table below, for the three and nine months ended September 30, 2006
      compared to the three and nine months ended September 30, 2005, our interest
      income increased $9.3 million and $26.1 million, respectively, due to an
      increase in the size of our mortgage loan portfolio, and increased $4.7 million
      and $13.1 million, respectively, as a result of higher interest rates earned
      on
      our mortgage loan portfolio.





*Rate/Volume
      Table For the Three and Nine Months Ended September 30, 2006 Compared to the
      Three and Nine Months Ended September 30, 2005*




**Three
                months ended September 30, 2006 Compared to**
              **Three
                months ended September 30, 2005**
            **Nine
                months ended September 30, 2006 Compared to**
              **Nine
                months ended September 30, 2005******
            **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
            $2,172
            $5,903
            $8,075
            $9,122
            $14,553
            $23,675Loans
                funded by warehouse and repurchase financing
            2,504
            3,366
            5,870
            3,845
            11,554
            15,399Mortgage
                bonds
            60
            (1)
            59
            149
            (9)
            140Other
            —
            (4)
            (4)
            —
            (12)
            (12)Total
            $4,736
            $9,264
            14,000
            $13,116
            $26,086
            39,202Prepayment
                penalty income
            
            
            (3,198)
            
            
            (6,505)$10,802
            
            
            $32,697







47


*Interest
      Income Yield Analysis For the Three and Nine Months Ended September 30, 2006
      and
      2005*




The
      following table presents the average yield on our interest-earning assets for
      the three and nine months ended September 30, 2006 and 2005.




**Three
                months ended September 30, 2006**
            **Three
                months ended September 30, 2005******
            **Average**
              **Balance**
            **Interest**
              **Income**
            **Average**
              **Yield**
            **Average**
              **Balance**
            **Interest**
              **Income**
            **Average**
              **Yield**($
                in thousands)Gross
            $6,639,306
            $129,673
            7.81%
            $6,132,934
            $110,450
            7.20%Less
                amortization of yield adjustments (1)
            —
            (8,643)
            (0.52)%
            —
            (3,420)
            (0.22)%$6,639,306
            $121,030
            7.29%
            $6,132,934
            $107,030
            6.98%Add
                prepayment penalty income
            —
            5,873
            0.35%
            —
            9,071
            0.59%**Total
                interest-earning assets**
            $6,639,306
            $126,903
            7.64%
            $6,132,934
            $116,101
            7.57%





**Nine
                months ended September 30, 2006**
            **Nine
                months ended September 30, 2005******
            **Average**
              **Balance**
            **Interest**
              **Income**
            **Average**
              **Yield**
            **Average**
              **Balance**
            **Interest**
              **Income**
            **Average**
              **Yield**($
                in thousands)Gross
            $6,538,864
            $372,675
            7.60%
            $6,070,007
            $331,473
            7.28%Less
                amortization of yield adjustments (1)
            —
            (18,284)
            (0.37)%
            —
            (16,284)
            (0.36)%$6,538,864
            $354,391
            7.23%
            $6,070,007
            $315,189
            6.92%Add
                prepayment penalty income
            —
            17,906
            0.36%
            —
            24,411
            0.54%**Total
                interest-earning assets**
            $6,538,864
            $372,297
            7.59%
            $6,070,007
            $339,600
            7.46%


_______________


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





The
      increase in interest income correlated with the growth of our mortgage loan
      portfolio; however, it did not increase at the same rate as the increases in
      LIBOR as competitive pricing pressures constrained us from charging higher
      interest rates on our mortgage loan production. Our net mortgage loan portfolio
      increased $0.6 billion, or 10%, to $6.8 billion as of September 30, 2006 from
      $6.2 billion as of September 30, 2005. We anticipate that our interest income
      in
      dollars will continue to grow as our mortgage loan portfolio grows if interest
      rates rise. We also expect that our interest income may increase in 2006 if
      market-weighted average coupons increase.





Amortization
      of yield adjustments increased $5.2 million, or 153%, to $8.6 million for the
      three months ended September 30, 2006 from $3.4 million for the three months
      ended September 30, 2005. Amortization of yield adjustments increased $2.0
      million, or 12%, to $18.3 million for the nine months ended September 30, 2006
      from $16.3 million for the nine months ended September 30, 2005. This increase
      was predominantly caused by a decrease in the projected six-month LIBOR curve,
      which decreases cash flows in the future as adjustable rate mortgage loans,
      or
      ARMs, enter their reset period. A decrease in cash flows negatively affects
      the
      retrospective adjustment component of our level yield amortization by decreasing
      the internal rate of return used to calculate our net investment in the
      underlying mortgage loans.





Prepayment
      penalty income decreased $3.2 million, or 35%, to $5.9 million for the three
      months ended September 30, 2006 from $9.1 million for the three months ended
      September 30, 2005. This decrease was primarily related to a 32% decline in
      the
      number of loans paying off in our portfolio which contained prepayment penalty
      features as well as a 1% decline in the average amount of the prepayment penalty
      fees we collected. Prepayment penalty income decreased $6.5 million, or 27%,
      to
      $17.9 million for the nine months ended September 30, 2006 from $24.4 million
      for the nine months ended September 30, 2005. This decrease was primarily
      related to a 23% decline in the number of loans paying off in our portfolio
      which contained prepayment penalty features as well as a 2% decline in the
      average amount of the prepayment penalty fees we collected. The declines in
      the
      average size and number of loans with prepayment penalties is a direct result
      of
      amendments to government regulations related to the Alternative Mortgage
      Transactions Parity Act, which became effective July 1, 2003. These amendments
      eliminated federal preemption of state restrictions on prepayment penalties
      on
      certain types of mortgage loans. Management expects that these amendments will
      continue to reduce our prepayment penalty income in future periods.





48


*Securitized
      Mortgage Loan Coupon and Prepayment Penalty Coverage*





Our
      securitized loan principal balance was composed of 66% adjustable rate mortgage
      loans and 34% fixed rate loans at September 30, 2006. The aggregate unpaid
      principal balances of our adjustable rate loans in their reset period was $548.1
      million, or 14.8% of our portfolio, at September 30, 2006. As shown in the
      following tables, the weighted average coupon, or WAC, on the ARM portion of
      our
      securitizations increased as of September 30, 2006 compared to December 31,
      2005, while the WAC on the fixed rate mortgage, or FRM, portion of our
      securitizations decreased slightly or remained constant as of September 30,
      2006
      compared to December 31, 2005. The following tables set forth information about
      our securitized mortgage loan portfolio, by Saxon Asset Securities Trust, or
      SAST, transaction, including those loans associated with our securitized REO
      properties as of September 30, 2006 and December 31, 2005.




**Issue
                date**
            **Original
                aggregate loan principal balance**
            **Current
                aggregate loan principal balance**
            **Fixed
                current aggregate loan principal balance**
            **ARM
                current aggregate loan principal balance**
            **Percentage
                of portfolio**
            **Percentage
                of original remaining**
            **Current
                WAC fixed**
            **Current
                WAC ARM**($
                in thousands)**September
                30, 2006**SAST
                2001-2
            8/2/2001
            $650,410
            $74,861
            $54,488
            $20,373
            1%
            12%
            9.09%
            11.05%SAST
                2001-3
            10/11/2001
            699,999
            60,009
            29,399
            30,610
            1%
            9%
            9.88%
            10.78%SAST
                2002-1
            3/14/2002
            899,995
            105,934
            65,323
            40,611
            2%
            12%
            8.83%
            10.55%SAST
                2002-2
            7/10/2002
            605,000
            71,591
            35,671
            35,920
            1%
            12%
            8.96%
            10.74%SAST
                2002-3
            11/8/2002
            999,999
            132,706
            70,134
            62,572
            2%
            13%
            8.35%
            10.55%SAST
                2003-1
            3/6/2003
            749,996
            133,507
            96,555
            36,952
            2%
            18%
            7.35%
            10.10%SAST
                2003-2
            5/29/2003
            599,989
            106,563
            70,302
            36,261
            2%
            18%
            7.20%
            9.26%SAST
                2003-3
            9/16/2003
            1,000,000
            235,184
            156,294
            78,890
            4%
            24%
            7.11%
            9.23%SAST
                2004-1
            2/19/2004
            1,099,999
            272,836
            124,720
            148,116
            5%
            25%
            7.79%
            9.18%SAST
                2004-2
            7/27/2004
            1,199,994
            466,318
            319,548
            146,770
            8%
            39%
            6.91%
            8.20%SAST
                2004-3
            10/27/2004
            899,956
            382,186
            83,128
            299,058
            7%
            42%
            7.79%
            7.87%SAST
                2005-1
            1/25/2005
            999,972
            519,205
            86,044
            433,161
            9%
            52%
            7.40%
            6.78%SAST
                2005-2
            6//07/2005
            979,990
            566,111
            110,254
            455,857
            10%
            58%
            7.51%
            7.12%SAST
                2005-3
            9/29/2005
            899,999
            632,914
            152,528
            480,386
            11%
            70%
            7.28%
            7.18%SAST
                2005-4
            12/21/2005
            639,994
            504,460
            118,507
            385,953
            9%
            79%
            7.69%
            7.69%SAST
                2006-1
            5/2/2006
            499,973
            415,564
            92,829
            322,735
            7%
            83%
            8.22%
            8.24%SAST
                2006-2
            6/7/2006
            999,949
            925,645
            239,653
            685,992
            17%
            93%
            8.18%
            8.41%Total
            
            $14,425,214
            $5,605,594
            $1,905,377
            $3,700,217Less:
                unpaid principal balance of securitized
              REO
                properties
            (58,198)Total
                securitized loans
            $5,547,396**December
                31, 2005**SAST
                2001-2
            8/2/2001
            $650,410
            $96,608
            $68,777
            27,831
            2%
            15%
            9.18%
            10.34%SAST
                2001-3
            10/11/2001
            699,999
            84,561
            37,340
            47,221
            1%
            12%
            9.93%
            9.98%SAST
                2002-1
            3/14/2002
            899,995
            142,946
            79,862
            63,084
            2%
            16%
            8.87%
            9.61%SAST
                2002-2
            7/10/2002
            605,000
            102,646
            45,899
            56,747
            2%
            17%
            8.97%
            9.76%SAST
                2002-3
            11/8/2002
            999,999
            189,019
            88,057
            100,961
            3%
            19%
            8.37%
            9.28%SAST
                2003-1
            3/6/2003
            749,996
            194,274
            122,268
            72,006
            3%
            26%
            7.38%
            8.79%SAST
                2003-2
            5/29/2003
            599,989
            160,949
            89,336
            71,613
            3%
            27%
            7.21%
            8.27%SAST
                2003-3
            9/16/2003
            1,000,000
            344,009
            192,094
            151,915
            6%
            34%
            7.17%
            8.14%SAST
                2004-1
            2/19/2004
            1,099,999
            477,122
            156,521
            320,601
            8%
            43%
            7.82%
            7.73%SAST
                2004-2
            7/27/2004
            1,199,994
            710,671
            384,640
            326,031
            12%
            59%
            6.95%
            6.68%SAST
                2004-3
            10/27/2004
            899,956
            563,859
            103,023
            460,836
            9%
            63%
            7.80%
            7.07%SAST
                2005-1
            1/25/2005
            999,972
            711,372
            106,440
            604,932
            12%
            71%
            7.40%
            6.77%SAST
                2005-2
            6//07/2005
            979,990
            808,742
            132,692
            676,050
            14%
            83%
            7.49%
            7.16%SAST
                2005-3
            9/29/2005
            899,999
            857,855
            175,798
            682,057
            14%
            95%
            7.29%
            7.22%SAST
                2005-4
            12/21/2005
            499,625
            496,839
            111,207
            385,633
            8%
            99%
            7.70%
            7.68%Total
            $12,784,923
            $5,941,472
            $1,893,954
            $4,047,518Less:
                unpaid principal balance of securitized
              REO
                properties
            (46,692)Total
                securitized loans
            $5,894,780




49


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
      of
      interest on 80% of the remaining principal when prepaying their loans. If the
      mortgage loan is prepaid 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 as part of interest income on our
      consolidated statements of operations. In addition, if a loan prepays we fully
      expense any related deferred costs for that loan upon prepayment. We also
      reflect the amortization of these deferred costs as part of interest income
      on
      our consolidated statement of operations.





As
      discussed above, we experienced a decrease in prepayments of our mortgage loans
      and a decrease in our prepayment penalty income during the third quarter of
      2006
      compared to the third quarter of 2005. This was due to a decline in the amount
      of the average prepayment penalty as well as a decline in the percentage of
      mortgage loans in our portfolio having prepayment penalty features. We expect
      our prepayment speeds to continue to decrease in future periods if interest
      rates continue to rise and housing prices continue to decline.




**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, 2006**SAST
                2001-2
            8/2/2001
            3.58%
            24.75%
            32.63%
            29.44%
            40.57%SAST
                2001-3
            10/11/2001
            30.45%
            25.56%
            43.19%
            33.15%
            43.42%SAST
                2002-1
            3/14/2002
            41.33%
            22.44%
            43.88%
            30.00%
            43.88%SAST
                2002-2
            7/10/2002
            17.61%
            30.23%
            43.35%
            32.97%
            43.45%SAST
                2002-3
            11/8/2002
            1.28%
            28.91%
            51.24%
            30.44%
            45.77%SAST
                2003-1
            3/6/2003
            3.15%
            27.24%
            57.09%
            27.78%
            49.67%SAST
                2003-2
            5/29/2003
            2.26%
            25.24%
            56.41%
            27.73%
            50.55%SAST
                2003-3
            9/16/2003
            27.43%
            24.84%
            59.46%
            24.03%
            47.69%SAST
                2004-1
            2/19/2004
            35.72%
            26.17%
            61.01%
            25.77%
            48.57%SAST
                2004-2
            7/27/2004
            50.55%
            23.37%
            58.63%
            22.84%
            48.67%SAST
                2004-3
            10/27/2004
            54.62%
            24.32%
            40.88%
            21.34%
            37.78%SAST
                2005-1
            1/25/2005
            63.08%
            23.00%
            37.35%
            20.21%
            34.62%SAST
                2005-2
            6/07/2005
            60.35%
            19.86%
            40.19%
            17.66%
            37.30%SAST
                2005-3
            9/29/2005
            58.87%
            —
            —
            14.78%
            33.84%SAST
                2005-4
            12/21/2005
            62.53%
            —
            —
            19.68%
            29.75%SAST
                2006-1
            5/2/2006
            52.75%
            —
            —
            23.17%
            42.47%SAST
                2006-2
            6/7/2006
            58.18%
            —
            —
            11.69%
            25.32%**December
                31, 2005**SAST
                2001-2
            8/2/2001
            51.36%
            28.82%
            36.73%
            30.34%
            41.58%SAST
                2001-3
            10/11/2001
            30.33%
            29.52%
            45.52%
            34.30%
            43.45%SAST
                2002-1
            3/14/2002
            37.03%
            32.32%
            51.35%
            31.59%
            44.02%SAST
                2002-2
            7/10/2002
            14.15%
            36.81%
            51.72%
            34.13%
            43.72%SAST
                2002-3
            11/8/2002
            14.81%
            33.0%
            52.65%
            31.39%
            45.12%SAST
                2003-1
            3/6/2003
            59.40%
            30.08%
            56.22%
            28.05%
            46.60%SAST
                2003-2
            5/29/2003
            57.73%
            32.01%
            59.97%
            28.44%
            47.53%SAST
                2003-3
            9/16/2003
            51.60%
            30.59%
            54.33%
            24.49%
            44.19%SAST
                2004-1
            2/19/2004
            57.64%
            29.80%
            45.96%
            25.35%
            39.91%SAST
                2004-2
            7/27/2004
            63.00%
            25.99%
            41.89%
            22.81%
            37.58%SAST
                2004-3
            10/27/2004
            58.56%
            21.63%
            37.56%
            19.21%
            35.58%SAST
                2005-1
            1/25/2005
            61.53%
            —
            —
            16.78%
            33.40%SAST
                2005-2
            6/07/2005
            58.70%
            —
            —
            13.44%
            31.24%SAST
                2005-3
            9/29/2005
            56.23%
            —
            —
            8.87%
            22.95%SAST
                2005-4
            12/21/2005
            58.65%
            —
            —
            —
            —





50


*Interest
      Expense.* Interest
      expense increased $40.1 million, or 58%, to $108.9 million for the three months
      ended September 30, 2006 from $68.8 million for the three months ended September
      30, 2005. Interest expense increased $107.0 million, or 58%, to $292.3 million
      for the nine months ended September 30, 2006 from $185.3 million for the nine
      months ended September 30, 2005. The table below presents the total change
      in
      interest expense for the three and nine months ended September 30, 2006 compared
      to the three and nine months ended September 30, 2005, and the amount of the
      total change that was attributable to increasing interest rates and an increase
      in our outstanding debt. Our interest expense increased $27.8 million and $79.9
      million for the three and nine months ended September 30, 2006 compared to
      the
      three and nine months ended September 30, 2005 as a result of higher interest
      rates on our interest-bearing liabilities and increased $12.2 million and $27.0
      million for the three and nine months ended September 30, 2006 compared to
      the
      three and nine months ended September 30, 2005 due to an increase in our
      borrowings.





*Rate/Volume
      Table For the Three and Nine Months Ended September 30, 2006 Compared to the
      Three and Nine Months Ended September 30, 2005*




**Three
                months ended September 30, 2006 Compared to**
              **Three
                months ended September 30, 2005**
            **Nine
                months ended September 30, 2006 Compared to**
              **Nine
                months ended September 30, 2005******
            **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
            $25,048
            $4,931
            $29,979
            $74,961
            $9,341
            $84,302Warehouse
                and repurchase financing:Lines
                of credit
            1,254
            36
            1,290
            470
            262
            732Repurchase
                agreements
            1,587
            1,742
            3,329
            4,546
            8,221
            12,767Senior
                notes
            —
            4,613
            4,613
            —
            7,533
            7,533Other
            —
            914
            914
            —
            1,648
            1,648Total
            $27,889
            $12,236
            $40,125
            $79,977
            $27,005
            $106,982





As
      seen
      in the table below, our average balance of borrowings increased $0.8 billion,
      or
      13%, to $7.0 billion for the three months ended September 30, 2006 from $6.2
      billion for the three months ended September 30, 2005 and increased $0.6
      billion, or 10%, to $6.8 billion for the nine months ended September 30, 2006
      from $6.2 billion for the nine months ended September 30, 2005 as a result
      of
      the growth in our mortgage loan portfolio. Compensating balance credits
      increased $0.8 million, or 62%, to $2.1 million for the three months ended
      September 30, 2006 from $1.3 million for the three months ended September 30,
      2005 and increased $3.4 million, or 126%, to $6.1 million for the nine months
      ended September 30, 2006 from $2.7 million for the nine months ended September
      30, 2005 as a result of increases in the underlying escrow balances and an
      increase in the LIBOR index rate. Additionally, our yield adjustments increased
      $0.8 million, or 32%, to $3.3 million net amortization for the three months
      ended September 30, 2006 from $2.5 million net amortization for the three months
      ended September 30, 2005 and increased $7.7 million, to $8.3 million net
      amortization for the nine months ended September 30, 2006 from $0.6 million
      net
      amortization for the nine months ended September 30, 2005. This increase was
      due
      primarily to a decrease of $8.4 million in the accretion of bond premium on
      the
      interest only classes of some of our bonds, partially offset by a $0.7 million
      decrease in our amortization of bond issuance costs and a $0.2 million decrease
      in our amortization of bond discount on other classes of our bonds.








51


*Interest
      Expense Yield Analysis For the Three and Nine Months Ended September 30, 2006
      and For the Three and Nine Months Ended September 30, 2005*





**Three
                months ended September 30, 2006**
            **Three
                months ended September 30, 2005******
            **Average**
              **Balance**
            **Interest**
              **Expense**
            **Average**
              **Yield**
            **Average**
              **Balance**
            **Interest**
              **Expense**
            **Average**
              **Yield**($
                in thousands)**Warehouse
                financing - loans**
            $217,210
            $3,524
            6.35%
            $175,874
            $1,465
            3.26%Less
                compensating balance credits (1)
            —
            (2,109)
            (3.80)%
            —
            (1,339)
            (2.98)%**Net
                warehouse financing - loans**
            217,210
            1,415
            2.55%
            175,874
            126
            0.28%**Repurchase
                agreements**
            436,010
            6,587
            5.91%
            302,438
            3,258
            4.22%**Securitization
                financing:**Gross
            6,160,865
            91,152
            5.92%
            5,745,518
            61,855
            4.31%Add
                net amortization of yield adjustments (2)
            —
            3,153
            0.20%
            —
            2,470
            0.17%**Net
                securitization financing:**
            6,160,865
            94,305
            6.12%
            5,745,518
            64,325
            4.48%**Senior
                notes:**Gross
            150,000
            4,500
            12.00%
            —
            —
            —Add
                amortization of yield adjustments (2)
            —
            113
            0.30%
            —
            —
            —**Net
                senior notes:**
            150,000
            4,613
            12.30%
            —
            —
            —**Other
                expenses**
            —
            2,012
            —
            —
            1,098
            —**Total
                interest-bearing liabilities**
            $6,964,085
            $108,932
            6.26%
            $6,223,830
            $68,807
            4.42%





**Nine
                months ended September 30, 2006**
            **Nine
                months ended September 30, 2005******
            **Average**
              **Balance**
            **Interest**
              **Expense**
            **Average**
              **Yield**
            **Average**
              **Balance**
            **Interest**
              **Expense**
            **Average**
              **Yield**($
                in thousands)**Warehouse
                financing - loans**
            $192,439
            $8,862
            6.07%
            $179,333
            $4,961
            3.65%Less
                compensating balance credits (1)
            —
            (5,936)
            (4.07)%
            —
            (2,654)
            (1.95)%**Net
                warehouse financing - loans**
            192,439
            2,926
            2.00%
            $179,333
            $2,307
            1.70%**Warehouse
                financing - servicing rights**
            5,965
            302
            6.68%
            —
            —
            —Less
                compensating balance credits (1)
            —
            (189)
            (4.19)%
            —
            —
            —**Net
                warehouse financing - servicing rights**
            5,965
            113
            2.49%
            —
            —
            —**Repurchase
                agreements**
            473,535
            20,124
            5.60%
            $255,098
            $7,357
            3.80%**Securitization
                financing:**Gross
            6,022,204
            248,563
            5.50%
            5,725,673
            171,777
            4.00%Add
                net amortization of yield adjustments (2)
            —
            8,158
            0.18%
            —
            642
            0.01%**Net
                securitization financing:**
            6,022,204
            256,721
            5.68%
            $5,725,673
            $172,419
            4.01%**Senior
                notes:**Gross
            81,667
            7,350
            12.00%
            —
            —
            —Add
                amortization of yield adjustments (2)
            —
            183
            0.30%
            —
            —
            —**Net
                senior notes:**
            81,667
            7,533
            12.30%
            —
            —
            —**Other
                expenses**
            —
            4,850
            —
            —
            3,202
            —**Total
                interest-bearing liabilities**
            $6,775,810
            $292,267
            5.75%
            $6,160,104
            $185,285
            4.01%


_____________


(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 bonds and senior notes.




52


*Net
      Interest Margin.* Our
      net
      interest margin decreased to 1.1% for the three months ended September 30,
      2006
      from 3.1% for the three months ended September 30, 2005. Our net interest margin
      decreased to 1.6% for the nine months ended September 30, 2006 from 3.4% for
      the
      nine months ended September 30, 2005. The decline in our net interest margin
      was
      primarily attributable to an increase in the cost of our borrowings due to
      an
      increase of 150 basis points in one-month LIBOR from the third quarter of 2005
      to the third quarter of 2006. At the same time, competitive pricing pressures
      were constraining us from charging higher interest rates on our mortgage loan
      production.





*Provision
      for Mortgage Loan Losses.* Provision
      for mortgage loan losses decreased $4.0 million, or 21%, to $15.1 million for
      the three months ended September 30, 2006 from $19.1 million for the three
      months ended September 30, 2005. Provision for mortgage loan losses decreased
      $1.7 million, or 6%, to $29.1 million for the nine months ended September 30,
      2006 from $30.8 million for the nine months ended September 30, 2005. In the
      third quarter of 2005, we reserved $6.8 million for estimated losses due to
      damage from Hurricane Katrina, which caused our provision for mortgage loan
      losses for both the three and nine months ended September 30, 2005 to be higher
      than normal. During the three and nine months ended September 30, 2006, we
      also
      reversed $0.3 million and $1.8 million, respectively, of the Katrina reserve
      due
      to the receipt of additional inspection reports and due to the liquidation
      of
      certain mortgage loans. The effect of the Hurricane Katrina provisions and
      reversals in 2005 and 2006 offset the actual increase in the provision for
      mortgage loan losses for the three and nine months ended September 30, 2006
      as
      compared to the three and nine months ended September 30, 2005.





Total
      delinquencies, bankruptcies, and foreclosures for the third quarter of 2006
      were
      24% higher at $911.1 million than total delinquencies, bankruptcies, and
      foreclosures for the third quarter of 2005 at $737.5 million. Total
      delinquencies, bankruptcies, and foreclosures as a percentage of our owned
      portfolio were 14% as of September 30, 2006 while total delinquencies,
      bankruptcies, and foreclosures as a percentage of our owned portfolio were
      12%
      as of September 30, 2005. This rise in delinquency levels in our owned servicing
      portfolio was due primarily to the seasoning of our assets and general macro
      economic conditions, such as declining home price appreciation and increasing
      interest rates. We also saw an increase in loss severities in the third quarter
      2006 from the third quarter of 2005 primarily as a result of the flattening
      in
      the housing market causing an increase in the severity of losses on liquidated
      properties, as home prices are decreasing and properties are remaining on the
      market longer.





Two
      widely accepted methodologies of reporting delinquency data are the Mortgage
      Bankers Association, or MBA, and the Office of Thrift Supervision, or 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 sub-prime 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 of securitization net losses on liquidated loans to charge-offs.
      (See footnote (4) below the table for disclosure of seriously delinquent data
      using the OTS method.)





53


*Delinquency
      and Loss Experience Of Our Owned Portfolio*




**September
                30,******
            **2006**
            **2005****Total
                Delinquencies and Loss Experience**
            ($
                in thousands)Total
                outstanding principal balance (at period end)
            $6,794,992
            $6,185,969Delinquency
                (at period end):30-59
                days:Principal
                balance
            $416,159
            $357,960Delinquency
                percentage
            6.12%
            5.79%60-89
                days:Principal
                balance
            $136,128
            $85,159Delinquency
                percentage
            2.00%
            1.38%90
                days or more:Principal
                balance
            $93,124
            $40,316Delinquency
                percentage
            1.37%
            0.65%Bankruptcies
                (1):Principal
                balance
            $123,684
            $125,780Delinquency
                percentage
            1.82%
            2.03%Foreclosures:Principal
                balance
            $141,962
            $128,253Delinquency
                percentage
            2.09%
            2.07%Real
                estate owned (2):Principal
                balance
            $59,508
            $46,310Delinquency
                percentage
            0.88%
            0.75%Total
                seriously delinquent including real estate owned (3) (4)
            $521,798
            $393,843Total
                seriously delinquent including real estate owned (3) (4)
            7.68%
            6.37%Total
                seriously delinquent excluding real estate owned (4)
            $462,291
            $347,533Total
                seriously delinquent excluding real estate owned (4)
            6.80%
            5.62%Securitization
                net losses on liquidated loans - quarter ended
            $13,891
            $9,496Percentage
                of securitization net losses on liquidated loans (5)
            0.82%
            0.61%Loss
                severity on liquidated loans for the quarter (6)
            43.93%
            37.32%Charge-offs
                - quarter ended(7)
            $15,425
            $8,618Percentage
                of charge-offs (5)
            0.91%
            0.56%


________________




(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 as of September 30, 2006 and
                2005 are
                $22.6 million and $24.5 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 losses and past due
                interest.




(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
                $379.0
                million, or 5.58% as of September 30, 2006, and $303.3 million, or
                4.90%,
                as of September 30, 2005. Total seriously delinquent excluding REO
                using
                the OTS method would be $319.5 million, or 4.70% as of September
                30, 2006
                and $257.0 million, or 4.16% as of September 30,
                2005.




(5)
            Annualized.




54


(6)
            Loss
                severity, as a percentage, 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.




(7)
            Charge-offs
                represent the losses recognized in our financial statements in accordance
                with GAAP. See reconciliation of securitization net losses on liquidated
                loans to charge-offs below.




*Reconciliation
      of Securitization Net Losses on Liquidated Loans to
      Charge-offs*





**Three
                Months Ended September 30,******
            **2006**
            **2005**(in
                thousands)Securitization
                net losses on liquidated loans
            $13,891
            $9,496Loan
                transfers to real estate owned
            12,695
            7,530Realized
                losses on real estate owned
            (11,649)
            (7,789)Timing
                differences between liquidation and claims processing
            —
            (258)Interest
                not advanced on warehouse loans
            (48)
            (157)Other
            536
            (204)Charge-offs
                (1)
            $15,425
            $8,618


________________


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







*Servicing
      Income, Net of Amortization and Impairment.* Servicing
      income, net of amortization and impairment, decreased $1.2 million, or 6%,
      to
      $17.9 million for the three months ended September 30, 2006 from $19.1 million
      for the three months ended September 30, 2005. Servicing income, net of
      amortization and impairment, increased $8.1 million, or 16%, to $58.0 million
      for the nine months ended September 30, 2006 from $49.9 million for the nine
      months ended September 30, 2005. The increase in gross servicing income for
      the
      nine months ended September 30, 2006 compared to the nine months ended September
      30, 2005 was primarily the result of the acquisition of additional third-party
      servicing rights as well as 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 our total servicing portfolio grew and LIBOR
      increased during the third quarter of 2006 as compared to the third quarter
      of
      2005, interest earned on the associated escrow balances increased $3.9 million,
      or 62%, to $10.2 million for the three months ended September 30, 2006 from
      $6.3
      million for the three months ended September 30, 2005 and increased $12.4
      million, or 97%, to $25.2 million for the nine months ended September 30, 2006
      from $12.8 million for the nine months ended September 30, 2005. These increases
      were offset by an increase of $2.8 million and $12.8 million of amortization
      and
      impairment expense of MSRs for the three and nine months ended September 30,
      2006 compared to the three and nine months ended September 30, 2005,
      respectively. The increase in amortization and impairment expenses was due
      to
      increased prepayment speeds on certain aged third-party servicing portfolios
      during the three months ended September 30, 2006 compared to the three months
      ended September 30, 2005 as well as growth in our servicing portfolio.





We
      expect
      our servicing income, net of amortization and impairment, to increase as we
      grow
      our third-party servicing portfolio. To the extent prepayment speeds on mortgage
      loans in our servicing portfolio decline in the future, as anticipated; 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:





55


*Servicing
      Income For the Three and Nine Months Ended September 30, 2006 Compared to the
      Three and Nine Months Ended September 30, 2005*




**Three
                Months Ended September 30,**
            **Nine
                Months Ended September 30,******
            **2006**
            **2005**
            **Variance**
            **2006**
            **2005**
            **Variance**($
                in thousands)
            ($
                in thousands)Average
                third-party servicing portfolio
            $19,223,402
            $20,282,597
            (5)%
            $19,559,134
            $17,673,359
            11%Average
                owned portfolio
            $6,594,384
            $5,981,671
            10%
            $6,456,321
            $5,983,204
            8%Average
                total servicing portfolio
            $25,817,786
            $26,264,268
            (2)%
            $26,015,455
            $23,656,563
            10%Gross
                servicing income
            $37,522
            $35,889
            5%
            $109,557
            $88,632
            24%Amortization
                and impairment
            $19,631
            $16,826
            17%
            $51,596
            $38,779
            33%Servicing
                fees - third-party portfolio (1)(2)
            49
            51
            
            50
            52Amortization
                and impairment- third-party portfolio(1)
            41
            33
            
            35
            30Other
                servicing income - total servicing portfolio(1)(3)
            22
            15
            
            25
            15Servicing
                income - total servicing portfolio(1)
            58
            55
            
            56
            50


___________




(1)
            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.







*Derivative
      gains (losses).* We
      use
      derivative instruments to manage our exposure to changes in interest rates.
      Changes in one-month LIBOR may have an immediate impact on our borrowing costs
      and our net interest margin, while the immediate impact of such changes on
      derivative instruments is reflected in derivative gains (losses), which is
      not a
      component of net interest margin. Over the term of the debt, we believe the
      derivatives should effectively protect our net revenues.





Derivative
      losses increased $39.8 million, or 200%, to a loss of $19.9 million for the
      three months ended September 30, 2006 from a gain of $19.9 million for the
      three
      months ended September 30, 2005. This increase in derivative losses was
      primarily due to a $28.9 million decrease in the non cash fair value of our
      derivative instruments as well as a $10.1 million decrease in cash received
      for
      the change in the fair value of futures and a $0.8 million decrease in cash
      received for the settlement of caps and swaps. Derivative gains decreased $20.5
      million, or 79%, to a gain of $5.5 million for the nine months ended September
      30, 2006 from a gain of $26.0 million for the nine months ended September 30,
      2005. This decrease was primarily due to a decrease of $11.8 million in the
      non
      cash fair value of our derivative instruments as well as a $6.4 million decrease
      in cash received for the change in the fair value of futures and a $2.2 million
      decrease in cash received for the settlement of caps and swaps.





56


The
      change in derivative (losses) gains during the three and nine months ended
      September 30, 2006 as compared to the three and nine months ended September
      30,
      2005 was primarily the result of the inversion of the forward LIBOR curve during
      the third quarter of 2006, both of which negatively impacted the fair value
      of
      our derivatives. We expect that accounting for the derivative instruments as
      undesignated derivatives will continue to result in increased volatility in
      our
      results of operations, as fluctuations in the market price of the derivative
      instruments will result in changes in the fair value of the derivatives being
      recorded in our consolidated statements of operations **.**





*(Loss)
      gain on sale of assets.* Loss
      on
      sale of assets was $(0.8) million for the three months ended September 30,
      2006
      compared to a gain of $44.0 thousand for the three months ended September 30,
      2005. Loss on sale of assets increased $5.1 million, or 204%, to a loss of
      $(2.6) million for the nine months ended September 30, 2006 from a gain of
      $2.5
      million for the nine months ended September 30, 2005. This increase in loss
      was
      primarily due to repurchases of $1.0 million of loans previously sold due to
      early payment default as well as increased losses recorded on the sale of $40.6
      million in principal balances of second lien mortgage loans.





**Operating
      expenses**





During
      the first nine months of 2006, we made significant progress in reducing our
      operating expenses and increasing our efficiencies due to management’s continued
      focus in this area. Despite having incurred $2.6 million in expenses during
      the
      third quarter of 2006 related to the pending merger with MSMC, total operating
      expenses decreased by $1.4 million, or 3%, to $39.5 million for the three months
      ended September 30, 2006 from $41.1 million for the three months ended September
      30, 2005 and decreased $6.0 million, or 5%, to $109.1 million for the nine
      months ended September 30, 2006 from $115.1 million for the nine months ended
      September 30, 2005.





*Payroll
      and Related Expenses.* Payroll
      and related expenses decreased $3.0 million, or 14%, to $18.3 million for the
      three months ended September 30, 2006 from $21.3 million for the three months
      ended September 30, 2005. Payroll and related expenses decreased $5.7 million,
      or 10%, to $53.6 million for the nine months ended September 30, 2006 from
      $59.3
      million for the nine months ended September 30, 2005. Specifically:





·
            Salary
                and overtime expense and associated payroll taxes and benefits decreased
                $0.3 million, or 1.8%, to $16.3 million for the three months ended
                September 30, 2006 from $16.6 million for the three months ended
                September
                30, 2005, and decreased $2.6 million, or 5%, to $47.8 million for
                the nine
                months ended September 30, 2006 from $50.5 million for the nine months
                ended September 30, 2005. These decreases were primarily due to a
                9%
                decline in average headcount from 1,229 employees for the period
                ended
                September 30, 2005 to 1,121 employees for the period ended September
                30,
                2006, primarily due to headcount reductions made in the fourth quarter
                of
                2005.


·
            Bonus
                expense decreased $0.5 million, or 23%, to $1.7 million for the three
                months ended September 30, 2006 from $2.2 million for the three months
                ended September 30, 2005, and decreased $0.9 million, or 15%, to
                $5.1
                million for the nine months ended September 30, 2006 from $6.0 million
                for
                the nine months ended September 30, 2005. The decrease was primarily
                due
                to our decline in headcount and our revised bonus
                structure.






57


·
            Commission
                expense decreased $1.6 million, or 29%, to $4.0 million for the three
                months ended September 30, 2006 from $5.6 million for the three months
                ended September 30, 2005, and decreased $3.4 million, or 21%, to
                $12.8
                million for the nine months ended September 30, 2006 from $16.2 million
                for the nine months ended September 30, 2005. The significant decrease
                was
                primarily due to revisions to our commission plan structure, offset
                by
                increased mortgage loan production during the nine months ended September
                30, 2006.


·
            Severance
                expense decreased $1.1 million, or 92%, to $0.1 million for the three
                months ended September 30, 2006 from $1.2 million for the three months
                ended September 30, 2005, and decreased $1.5 million, or 88%, to
                $0.2
                million for the nine months ended September 30, 2006 from $1.7 million
                for
                the nine months ended September 30,
                2005.


·
            Deferred
                payroll and related expenses, as they related to direct loan origination
                costs, decreased $1.2 million, or 20%, to $4.7 million for the three
                months ended September 30, 2006 from $5.9 million for the three months
                ended September 30, 2005, and decreased $3.6 million, or 19%, to
                $15.1
                million for the nine months ended September 30, 2006 from $18.7 million
                for the nine months ended September 30, 2005. These decreases were
                primarily due to significant decreases in our operating expenses
                that can
                be deferred as it now costs us less to produce mortgage loans, and
                as a
                result, there are fewer expenses to defer.





*General
      and Administrative Expenses.* General
      and administrative expenses decreased $0.3 million, or 2%, to $16.6 million
      for
      the three months ended September 30, 2006, from $16.9 million for the three
      months ended September 30, 2005, and decreased $3.7 million, or 8%, to $44.6
      million for the nine months ended September 30, 2006 from $48.3 for the nine
      months ended September 30, 2005. These decreases were primarily due to our
      continued efforts to reduce our operating expenses.





The
      decrease in general and administrative expenses for the three months ended
      September 30, 2006 compared to the three months ended September 30, 2005
      consisted of:





·
            a
                $0.8 million decrease in advertising
                expense;


·
            a
                $0.7 million decrease in rent
                expense;


·
            a
                $0.6 million decrease in employee related
                expenses;


·
            a
                $0.2 million decrease in credit report and appraisal fee expenses
                primarily due to our policy change to begin collecting these amounts
                from
                the borrowers;


·
            a
                $0.3 million decrease in office
                expenses.





These
      decreases were partially offset by $2.6 million in one-time expenses relating
      to
      the pending merger with MSMC.





58


The
      decrease in general and administrative expenses for the nine months ended
      September 30, 2006 compared to the nine months ended September 30, 2005
      consisted of:





·
            a
                $2.5 million decrease in advertising
                expense;


·
            a
                $0.4 million decrease in rent
                expense;


·
            a
                $2.0 million decrease in employee related
                expenses;


·
            a
                $0.9 million decrease in consulting
                services;


·
            a
                $1.0 million decrease in credit report and appraisal fee expenses
                primarily due to our policy change to begin collecting these amounts
                from
                the borrowers;


·
            a
                $0.9 million decrease in office
                expenses;


·
            a
                $0.4 million decrease in conference
                expenses;


·
            a
                $0.3 million decrease in investor relations
                expense.





These
      decreases were partially offset by $2.6 million in one-time expenses relating
      to
      the pending merger with MSMC, a $0.6 million increase in litigation expenses,
      a
      $0.5 million increase in accounting fees primarily relating to the restatement
      of our financial statements, a $0.9 million decrease in our deferred loan
      origination costs, and a $0.8 million increase in lease expense.





*Income
      Tax Benefit.* We
      recorded a $13.1 million tax benefit during the three months ended September
      30,
      2006, and a $5.8 million tax benefit during the nine months ended September
      30,
      2006.  The primary drivers of this benefit include: 1) the impact of
      intercompany activity between our taxable REIT subsidiaries and our qualified
      REIT subsidiaries, 2) the provision for taxes on the income earned in our
      taxable REIT subsidiaries, 3) state tax adjustments related to the enactment
      of
      new tax legislation in the state of Texas, and 4) the impact of the throwback
      distribution to the 2005 REIT taxable year.





*Reconciliation
      of GAAP Net (Loss) Income to Estimated REIT Taxable Net (Loss)
      Income*





The
      following table is a reconciliation of GAAP net (loss) income to estimated
      REIT
      taxable net (loss) income for the three and nine months ended September 30,
      2006:








59




**Three
                months ended**
              **September
                30, 2006**
            **Nine
                months ended**
              **September
                30, 2006**($
                in thousands)Consolidated
                GAAP (loss) income before taxes
            $(39,493)
            $2,849Estimated
                tax adjustments:Plus:Provision
                for losses - REIT portfolio
            6,101
            20,088Provision
                for past due interest - REIT portfolio
            2,657
            7,840Elimination
                of intercompany pre tax net loss
            8,346
            4,013Hedging
                income (1)
            13,049
            4,996Taxable
                REIT subsidiary pre-tax net loss
            2,690
            —Securitized
                loan adjustments for tax
            1,686
            —Miscellaneous
            1,492
            2,962Less:Taxable
                REIT subsidiary pre-tax net income
            —
            8,006Securitized
                loan adjustments for tax
            —
            5,120Estimated
                Qualified REIT taxable (loss) income
            $(3,472)
            $29,622Estimated
                Qualified REIT taxable (loss) income per basic common
                share
            $(0.07)
            $0.59


________________


(1)
            Although
                we have eliminated the use of hedge accounting under SFAS No. 133
                for
                financial purposes, we continue to account for certain of our derivative
                instruments as hedges for tax
                purposes.





The
      estimated REIT taxable (loss) income for the three and nine months ended
      September 30, 2006 set forth in the table above is an estimate only and is
      subject to change until we file our 2006 REIT federal tax returns.





**Business
      Segment
      Results**





We
      operate our business through three core business segments: mortgage loan
      production, portfolio and mortgage loan servicing. 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, 2006 and for the three and nine months
      ended September 30, 2005. See Note 11 to our unaudited consolidated financial
      statements for additional information about the results of our business
      segments.





***Portfolio
      Segment***




In
      our
      portfolio segment, we use our equity capital and borrowed funds to invest in
      our
      mortgage loan portfolio to produce net interest income. We conduct certain
      mortgage loan table funding activities through our qualified REIT subsidiary
      in
      our portfolio segment. We also record servicing expense associated with
      servicing our mortgage loan portfolio in our portfolio segment. We evaluate
      the
      performance of our portfolio segment based on total net revenues and gains.
      Total net revenues and gains for the portfolio segment decreased $17.2 million,
      or 44%, to $21.7 million for the three months ended September 30, 2006 from
      $38.9 million for the three months ended September 30, 2005. Total net revenues
      and gains for the portfolio segment decreased $74.8 million, or 63%, to $43.2
      million for the nine months ended September 30, 2006 from $118.0 million for
      the
      nine months ended September 30, 2005. The fluctuation in total net revenues
      and
      gains was primarily due to the increase in our borrowing costs as well as
      volatility in derivative gains (losses) during those periods.





60


***Mortgage
      Loan Servicing Segment***




We
      service mortgage loans in our mortgage loan servicing segment, 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.
      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 mortgage loan servicing portfolio,
      including loans recorded on our consolidated balance sheets, increased $1.8
      billion, or 7%, to $26.6 billion as of September 30, 2006 from $24.8 billion
      as
      of December 31, 2005. As of September 30, 2006, we serviced 123,077 loans with
      a
      principal balance of $19.8 billion for third-parties and 44,599 loans with
      a
      principal balance of $6.8 billion related to our owned portfolio. As of December
      31, 2005, we serviced 119,311 loans with a principal balance of $18.4 billion
      for third-parties and 43,636 loans with a principal balance of $6.4 billion
      related to our owned portfolio. The increase during the first nine months of
      2006 was due primarily to the acquisition of servicing rights related to $8.6
      billion of mortgage loans owned by non-affiliated companies a well as the
      origination and purchase of $2.5 billion of mortgage loans. This increase was
      partially offset by reductions due to payments totaling $9.0 billion during
      the
      nine months ended September 30, 2006.




*Our
      Delinquency and Loss Experience - Total Servicing Portfolio*




We
      experienced an increase in seriously delinquent accounts for our total servicing
      portfolio to 9.48% as of September 30, 2006 from 6.26% as of September 30,
      2005.
      In the first nine months of 2006, we saw a rise in delinquency levels in our
      total servicing portfolio due primarily to the aging of the portfolio and
      general macro- economic conditions. Higher delinquencies on our third-party
      servicing portfolio will negatively impact our servicing income and the fair
      value of our MSRs and will cause us to pay more in servicing advances. The
      following tables set forth information about the delinquency and loss experience
      of the total mortgage loan portfolio 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.)








61




**September
                30,******
            **2006**
            **2005****Total
                Delinquencies and Loss Experience (1)**
            **Total
                Servicing Portfolio**($
                in thousands)Total
                outstanding principal balance (at period end)
            $26,605,552
            $26,356,770Delinquency
                (at period end):30-59
                days:Principal
                balance
            $1,740,898
            $1,515,753Delinquency
                percentage
            6.54%
            5.75%60-89
                days:Principal
                balance
            $598,466
            $414,500Delinquency
                percentage
            2.25%
            1.57%90
                days or more:Principal
                balance
            $471,033
            $248,530Delinquency
                percentage
            1.77%
            0.94%Bankruptcies
                (2):Principal
                balance
            $415,796
            $397,545Delinquency
                percentage
            1.56%
            1.51%Foreclosures:Principal
                balance
            $747,668
            $542,642Delinquency
                percentage
            2.81%
            2.06%Real
                estate owned:Principal
                balance
            $384,793
            $157,192Delinquency
                percentage
            1.45%
            0.60%Total
                seriously delinquent including real estate owned (3)(4)
            $2,523,351
            $1,649,245Total
                seriously delinquent including real estate owned (3)(4)
            9.48%
            6.26%Total
                seriously delinquent excluding real estate owned(3)(4)
            $2,138,558
            $1,492,053Total
                seriously delinquent excluding real estate owned(3)(4)
            8.04%
            5.66%Securitization
                net losses on liquidated loans - quarter ended
            $62,607
            $23,111Percentage
                of securitization net losses on liquidated loans (5)
            0.94%
            0.35%Loss
                severity on liquidated loans for the quarter (6)
            41.31%
            36.99%


________________


(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 as of September 30,
                2006
                and September 30, 2005 are $69.8 million and $87.8 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
                $1.9
                billion, or 7.19%, as of September 30, 2006 and $1.2 billion, or
                4.63%, as
                of September 30, 2005. Total seriously delinquent excluding REO using
                the
                OTS method would be $1.5 billion, or 5.74%, as of September 30, 2006
                and
                $1.1 billion, or 4.04%, as of September 30, 2005.




(5)
            Annualized.




(6)
            Loss
                severity, as a percentage, 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.







62


*Losses
      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
            $7,749
            1%
            1.94%
            31.35%1997
            $1,769,538
            $29,311
            2%
            3.27%
            39.11%1998
            $2,084,718
            $65,738
            3%
            4.14%
            39.63%1999
            $2,381,387
            $133,140
            6%
            5.34%
            42.50%2000
            $2,078,637
            $141,042
            7%
            5.96%
            44.65%2001
            $499,879
            $42,837
            9%
            4.09%
            46.15%Post-divestiture:2001
            $1,833,357
            $172,624
            9%
            4.20%
            42.54%2002
            $2,484,074
            $286,043
            12%
            1.98%
            37.72%2003
            $2,842,942
            $537,628
            19%
            0.75%
            30.18%2004
            $3,764,628
            $1,306,294
            35%
            0.36%
            31.78%2005
            $3,349,035
            $2,071,133
            62%
            0.07%
            22.35%2006
            $2,512,672
            $2,144,029
            85%
            —
            13.92%


_________________


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




(2)
      As of
      September 30, 2006.




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




(4)
      Loss
      severity, as a percentage, 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. Excludes loss
      severity amounts on called loans.




***Mortgage
      Loan Production Segment***




We
      evaluate the performance of our mortgage loan production segment based on the
      production levels of our three business channels. We believe that information
      about 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. We characterize our
      wholesale and correspondent channels as indirect lending sources and our retail
      channel as a direct lending source. Through our mortgage loan production
      segment, we originate and purchase non-conforming residential mortgage loans
      through relationships with various approved mortgage companies, mortgage
      brokers, and lenders; and we originate non-conforming residential mortgage
      loans
      directly to borrowers through our retail sales centers. We record interest
      income, interest expense, servicing expense and provision for mortgage loan
      losses on the mortgage loans held in our mortgage loan production segment prior
      to the sale of those loans to the portfolio segment. We also collect revenues
      in
      our mortgage loan production segment, 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 into three centralized lending facilities and
      strategically-located retail sales center locations, we expect to see continued
      improvements in our loan production efficiency in 2006, although we cannot
      be
      certain that we will.





63


Mortgage
      loan production was $846.3 million for the three months ended September 30,
      2006, which represents a 0.2% decrease from our production of $847.8 million
      for
      the three months ended September 30, 2005. Mortgage loan production was $2.5
      billion for the nine months ended September 30, 2006, which represents a 4%
      increase from our production of $2.4 billion for the nine months ended September
      30, 2005.





Our
      wholesale mortgage loan production was $394.4 million for the three months
      ended
      September 30, 2006, a decrease of 3% from the three months ended September
      30,
      2005. Our wholesale mortgage loan production was $1.2 billion for the nine
      months ended September 30, 2006, an increase of 9% from the nine months ended
      September 30, 2005.





Our
      retail mortgage loan production was $159.6 million for the three months ended
      September 30, 2006, a decrease of 6% from the three months ended September
      30,
      2005. Our retail mortgage loan production was $469.9 million for the nine months
      ended September 30, 2006, a decrease of 15% from the nine months ended September
      30, 2005.





Our
      correspondent flow mortgage loan production was $155.7 million for the three
      months ended September 30, 2006, a decrease of 32% from the three months ended
      September 30, 2005. Our correspondent flow mortgage loan production was $573.7
      million for the nine months ended September 30, 2006, a decrease of 12% from
      the
      nine months ended September 30, 2005.





We
      had no
      correspondent bulk mortgage loan production for the three months ended September
      30, 2006, as compared to $44.2 million of correspondent bulk mortgage loan
      production for the three months ended September 30, 2005. Our correspondent
      bulk
      mortgage loan production was $18.1 million for the nine months ended September
      30, 2006, a decrease of 84% from the nine months ended September 30, 2005.





Our
      conduit bulk mortgage loan purchases were $136.6 million and $256.0 million
      for
      the three and nine months ended September 30, 2006, respectively. We apply
      our
      conduit bulk purchase process to selected pools of loans from sellers that
      we
      consider qualified based on factors that include our assessment of the
      correspondent seller's financial strength, management, industry experience,
      and
      quality of loan underwriting guidelines and procedures. The primary differences
      between our traditional bulk purchase process and our conduit bulk purchase
      process are that: (a) pools of loans purchased through the conduit bulk purchase
      process may be underwritten in accordance with the underwriting guidelines
      of
      the seller, not our underwriting guidelines; and (b) pools of loans purchased
      through the conduit bulk purchase process are reviewed by third parties hired
      by
      us to perform either underwriting on a full or sample basis to determine that
      the loans were underwritten in accordance with the applicable underwriting
      guidelines, whereas under our traditional bulk purchase process, we
      re-underwrite each loan in a pool under our underwriting guidelines. We
      distinguish loans purchased through our traditional bulk purchase process from
      loans purchased through our conduit bulk purchase process on our systems, for
      management reporting purposes as well to ensure that we clearly identify loans
      purchased through the conduit bulk purchase process in connection with each
      pool
      of loans that we pledge, sell, or securitize. Generally, we expect to securitize
      the loans we purchase through our conduit bulk purchase process separately
      from
      the other loans we produce, but we may choose to combine all or a portion of
      conduit loans with other loans if it is deemed economically desirable. We intend
      to continue to engage in conduit bulk purchase transactions only where we
      believe the net interest income generated by the loans we purchase will offset
      the potential for higher credit losses and funding costs resulting from our
      not
      re-underwriting each loan and where we believe it will provide us with
      attractive risk-adjusted returns.





64


**Financial
      Condition**




*September
      30, 2006 Compared to December 31, 2005*





*Net
      Mortgage Loan Portfolio.* Our
      net
      mortgage loan portfolio increased $0.4 billion, or 6%, to $6.8 billion as of
      September 30, 2006 from $6.4 billion as of December 31, 2005. This increase
      was
      the result of the origination and purchase of $2.5 billion of mortgage loans
      offset by principal payments of $2.0 billion and loan sales of $102.7
      million.





*Allowance
      for Loan Losses.* Allowance
      for loan losses increased $1.3 million, or 4%, to $37.9 million as of September
      30, 2006 from $36.6 million as of December 31, 2005. This increase was due
      to a
      12% increase in total delinquencies, bankruptcies, and foreclosures since
      December 31, 2005 offset by the reversal of $1.8 million relating to previous
      Hurricane Katrina estimates.





*Accrued
      Interest Receivable, Net of Allowance for Past Due Interest.* Our
      net
      accrued interest receivable increased $8.8 million, or 23%, to $47.0 million
      as
      of September 30, 2006 from $38.2 million as of December 31, 2005. This increase
      was primarily the result of the growth in our mortgage loan portfolio and upward
      interest rate resets occurring on our adjustable-rate mortgage loans. During
      the
      three months ended September 30, 2006, we also implemented an automated
      interface between our loan servicing system and our general ledger, which
      changed the way in which accrued interest receivable is recorded and resulted
      in
      an increase in our accrued interest receivable of $2.5 million since December
      31, 2005. Of this amount, $0.9 million increased interest income, while the
      remaining $1.6 million related to reclassifications to other asset line items
      on
      the consolidated balance sheet. The allowance for past due interest decreased
      $0.2 million, or 1%, to $15.9 million as of September 30, 2006 from $16.1
      million as of December 31, 2005. This decrease was attributable to a 4% decrease
      in the loss severity component for the provision for past due interest since
      December 31, 2005.





*Mortgage
      Servicing Rights, Net.* Mortgage
      servicing rights (MSRs), net increased $19.5 million, or 15%, to $149.2 million
      as of September 30, 2006 from $129.7 million as of December 31, 2005. This
      increase was primarily due to purchases of $71.0 million of rights to service
      $8.6 billion of mortgage loans during the nine months ended September 30, 2006.
      This increase in MSRs was offset by amortization and temporary impairment of
      servicing rights of $48.0 million and $3.6 million, respectively. The impairment
      of MSRs was primarily the result of increased prepayment speeds on mortgage
      loans in certain aged third-party servicing portfolios.





65


*Servicing
      Related Advances.* Servicing related advances increased $49.6 million, or 27%, to $234.9 million
      as
      of September 30, 2006 from $185.3 million as of December 31, 2005. The increase
      was due to the increase in delinquencies in our third-party servicing and owned
      portfolio balances.





*Trustee
      Receivable.* Trustee
      receivable increased $3.5 million, or 3%, to $139.5 million as of September
      30,
      2006 from $136.0 million as of December 31, 2005. 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 our trustee receivable balance will increase.





*Other
      Assets, Net.* Other
      assets, net increased $4.6 million, or 7%, to $73.1 million as of September
      30,
      2006 from $68.5 million as of December 31, 2005. The increase in other assets
      was attributable to an increase in deferred issuance costs of $3.7 million,
      net
      of amortization, primarily relating to the issuance of our senior notes. Our
      margin receivables on our derivative instruments also increased $0.5 million
      since December 31, 2005.





*Warehouse
      Financing.* Warehouse financing, which includes borrowings under our warehouse lines of
      credit and repurchase agreement facilities, increased $0.7 billion, or 175%,
      to
      $1.1 billion as of September 30, 2006 from $0.4 billion as of December 31,
      2005.
      This increase is due to the mortgage loan production during the third quarter
      of
      2006, which had not been securitized at September 30, 2006. 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, as a result of the
      deployment of our senior notes offering proceeds, and in relation to our
      mortgage loan production volumes.





*Securitization
      Financing.* Securitization financing decreased $0.5 billion, or 8%, to $5.7 billion as
      of
      September 30, 2006 from $6.2 billion as of December 31, 2005. During the first
      nine months of 2006, we received bond principal payments of $2.0 billion and
      we
      also issued two new asset-backed securitizations totaling $1.5 billion. In
      general, we expect increases in our securitization financing as we continue
      to
      securitize our mortgage loans.





*Senior
      Notes.* Senior
      notes increased to $150.0 million as of September 30, 2006 as a result of our
      private offering that closed on May 4, 2006.





*Shareholders’
      Equity.* Shareholders’
      equity decreased $38.7 million, or 7%, to $554.4 million as of September 30,
      2006 from $593.1 million as of December 31, 2005. The decrease in shareholders’
equity was due primarily to the declaration of $50.8 million in dividends
      partially offset by net income of $8.6 million, additional issuances of common
      stock of $0.7 million, and compensation expense related to restricted stock
      units of $2.5 million.





66


**Liquidity
      and Capital
      Resources**




Cash
      increased by $7.0 million during the nine months ended September 30, 2006.
      Cash
      had decreased $3.4 million during the nine months ended September 30, 2005.
      The
      overall change in cash consisted of the following:





**For
                the Nine Months Ended September 30,******
            **2006**
            **2005**(in
                thousands)Cash
                provided by operating activities
            $69,203
            $117,882Cash
                used in investing activities
            (364,025)
            (515,764)Cash
                provided by financing activities
            301,796
            394,523Increase
                (decrease) in cash
            $6,974
            $(3,359)





*Operating
      Activities* .
      Cash
      provided by operating activities decreased $48.7 million, or 41%, to $69.2
      million for the nine months ended September 30, 2006 from $117.9 million for
      the
      nine months ended September 30, 2005. This change was the result of decreased
      net income from operations adjusted for non-cash items such as depreciation
      and
      amortization, deferred income taxes, non-cash changes in the fair value of
      derivative instruments, and provision for mortgage loan losses. Our earnings
      are
      primarily from net interest income, servicing income, and derivative gains,
      offset by general and administrative expenses, derivative losses and income
      tax
      expense. Further details are discussed in “-- Consolidated
      Results.”





*Investing
      Activities* .
      Cash
      used in investing activities decreased $151.8 million, or 29%, to $364.0 million
      for the nine months ended September 30, 2006 from $515.8 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 premiums totaled $2.5
      billion for the nine months ended September 30, 2006. In addition, cash payments
      of $71.0 million had been made for MSRs purchased during the first nine months
      of 2006. These decreases to cash were partially offset by principal payments
      received on our mortgage loan portfolio of $2.0 billion and mortgage loan and
      REO sales to third parties of $100.1 million and $43.3 million, respectively.
      Capital expenditures during the nine months ended September 30, 2006 were $4.0
      million and related primarily to computer equipment and leasehold improvements
      as well as various information technology enhancements.





Restricted
      cash decreased $141.4 million to $6.1 million at September 30, 2006 from $147.5
      million at December 31, 2005 due to the timing of the receipt of cash related
      to
      prefunded securitizations. Prefunded amounts are held in a SAST trust account
      and made available once all required mortgage loans have been included in the
      securitization. The balance at December 31, 2005 was higher due to the
      prefunding balance of the SAST 2005-4 securitization which did not close until
      the first quarter of 2006.




67


*Financing
      Activities* .
      Cash
      provided by financing activities decreased $92.7 million, or 23%, to $301.8
      million for the nine months ended September 30, 2006 from $394.5 million for
      the
      nine months ended September 30, 2005. Cash provided by financing activities
      primarily consisted of $1.5 billion from the securitization of mortgage loans
      and servicing advances, $712.5 million in borrowings under warehouse and
      repurchase financing facilities, and $150.0 million in proceeds from the
      issuance of senior notes during the second quarter of 2006, offset by $2.0
      billion related to principal payments on securitization financing. Fluctuations
      in warehouse, repurchase and securitization financing from period to period
      can
      occur due to the timing of securitizations and the related repayment of the
      warehouse and repurchase financings.




*Dividends* .
      The
      merger agreement with MSMC provides that we may pay up to 95% of our estimated
      REIT taxable income for the period from July 1, 2006 through the earlier of
      the
      merger effective date or December 31, 2006 (the
      “Final Period”). In light of the pending merger, no dividends were declared
      during the third quarter of 2006. Instead, we determined that we would declare
      a
      dividend for the entire Final Period at some time during the fourth quarter
      of
      2006. We estimated that we incurred a loss for REIT taxable income
      purposes for the period of July 1, 2006 through September 30, 2006 of $3.5
      million, or $0.07 per share. Whether we pay any dividend for the Final Period,
      and the amount of any such dividend, will depend on whether our estimated REIT
      taxable income for the Final Period improves from a loss amount to an income
      amount. If we do not have positive estimated REIT taxable income for the Final
      Period, we will not declare any dividend for the period. When we are able to
      make a determination as to the timing and amount, if any, of the dividend,
      we
      expect to announce such information.





The
      regular and special dividends declared in the fourth quarter of 2005, in the
      aggregate amount of $32.5 million, were paid on January 11, 2006. The regular
      dividend declared in the first quarter of 2006, in the aggregate amount of
      $25.4
      million, was paid on April 28, 2006. The regular dividend declared in the second
      quarter of 2006, in the aggregate amount of $25.5 million, was paid on July
      13,
      2006.





*Trends* .
      At this
      time, we believe the continued margin pressure and increasing delinquencies
      that
      we are experiencing have the potential to negatively impact our access to
      long-term borrowings, short-term borrowings or bank credit lines necessary
      for
      us to maintain our current operations. If we cannot maintain or access
      sufficient funds our ability to operate our business and to meet capital
      commitments for the next 12 months and beyond could be inhibited.





***Working
      Capital***




We
      would
      use working capital to fund the cash flow needs of our operations in the event
      we were unable to generate sufficient cash flows from operations to cover our
      operating requirements. Under the commonly defined working capital definition,
      which is current assets less current liabilities, we calculated our working
      capital as of September 30, 2006 to be $442.4 million. Using our definition
      of
      working capital, we calculated our working capital as of September 30, 2006
      to
      be $165.5 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.




68




**Working
                Capital Reconciliation - September 30, 2006**
            **Saxon
                Defined**
              **Working
                Capital**
            **Commonly
                Defined**
              **Working
                Capital**($
                in thousands)Unrestricted
                cash
            $13,027
            $13,027Trustee
                receivable
            —
            139,528Accrued
                interest receivable
            —
            47,025Current
                tax receivable
            —
            11,539Accrued
                interest payable
            —
            (16,939)Other
                current liabilities
            —
            (39,115)Unsecuritized
                mortgage loans, MSRs, & mortgage bonds - payments less than one year
            496,347
            1,254,961Warehouse
                financing - payments less than one year
            (343,841)
            (343,841)Repurchase
                financing - payments less than one year
            —
            (746,772)Servicing
                advances
            —
            234,895Financed
                advances - payments less than one year
            —
            (156,079)Securitized
                loans - payments less than one year
            —
            2,417,160Securitized
                financing - payments less than one year
            —
            (2,373,009)Total
            $165,533
            $442,380





***Financing
      Facilities***





We
      need
      to borrow substantial sums of money each quarter to originate and purchase
      mortgage loans, as well as to acquire servicing rights and fund a portion of
      our
      servicing advances. We rely upon several counterparties to provide us with
      financing facilities for these purposes. Our ability to fund current operations
      and accumulate loans for securitization depends upon our ability to secure
      these
      types of short-term financing on acceptable terms.





69


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





Under
      certain of our warehouse lines of credit and repurchase facilities, we obtain
      advances of less than 100% of the principal balance of the mortgage loans,
      requiring us to use working capital to fund the remaining portion of the
      principal balance of the mortgage loans. Some of our warehouse lines of credit
      and repurchase facilities contain sub-limits that provide us with the ability
      to
      finance assets such as non-performing loans, mortgage bonds, mortgage servicing
      rights, advances that are required by our mortgage servicing contracts and
“wet”
loans. “Wet” loans are mortgage loans for which the collateral custodian has not
      yet received the related loan documentation.





Under
      our
      warehouse lines of credit and repurchase facilities, interest is payable monthly
      in arrears and outstanding principal is payable upon receipt of loan sale
      proceeds or transfer of a loan into a securitization trust. Outstanding
      principal is also repayable upon the occurrence of certain events, such as
      a
      mortgage loan which is in default for a period of time, a repaid mortgage loan,
      a mortgage loan obtained with fraudulent information or the failure to cure
      a
      defect in a mortgage loan’s documentation. In addition, our facilities contain
      terms requiring principal repayment if a loan remains funded by the facilities
      longer than a contractual period of time from the date of funding or on the
      maturity date of the facility.





Interest
      on our warehouse lines of credit and repurchase facilities is based on a margin
      over the London Interbank Offered Rate, or LIBOR, with the margin above LIBOR
      varying by facility and depending on the type of asset that is being financed.
      Dry funded loans carry the lowest rate and mortgage servicing rights carry
      the
      highest rate.





Loans,
      mortgage bonds and mortgage servicing rights financed under our warehouse lines
      of credit and repurchase facilities are subject to changes in market valuation
      and margin calls. The market value of our loans, mortgage bonds and mortgage
      servicing rights depends on a variety of economic conditions, including interest
      rates and demand for our asset-backed securities. To the extent the value of
      the
      loans, mortgage bonds or mortgage servicing rights declines significantly,
      we
      would be required to repay portions of the amounts we have
      borrowed.





There
      were several changes to our revolving warehouse and repurchase facilities during
      the third quarter of 2006.





·
            Effective
                July 19, 2006, we entered into a new $300.0 million committed repurchase
                facility with DB Structured Products, Inc.. The facility allows for
                the
                financing of mortgage loan purchases or originations as well as mortgage
                bonds and servicing advances required by our mortgage servicing contracts.
                The facility terminates on July 18,
                2007.






70


·
            Our
                $375 .0 million syndicated warehouse facility with JPMorgan Chase
                Bank was
                amended effective August 23, 2006, extending the termination date
                of the
                facility to October 20, 2006. Subsequently, this facility was amended
                again in October 2006, extending the termination date of the facility
                to
                December 31, 2006 and amending certain financial covenants contained
                in
                the facility.


·
            Effective
                August 28, 2006, we entered into a new $600.0 million committed repurchase
                facility with MSMC. The facility allows for the financing of mortgage
                loan
                purchases or originations and terminates on August 27,
                2007.


·
            Our
                $300.0 million repurchase facility with Greenwich Capital Financial
                Products, Inc. was terminated effective September 28,
                2006.


·
            Our
                $400.0 million repurchase facility with Merrill Lynch Bank USA was
                terminated effective September 28,
                2006.





As
      of
      September 30, 2006, we had committed revolving warehouse and repurchase
      facilities in the amount of $1.6 billion. The table below summarizes our
      facilities and their expiration dates as of September 30, 2006. We believe
      this
      level of financing will allow us flexibility to execute our asset-backed
      securitizations in accordance with our business plans.




**Lender**
              **Committed**
                **Facility
                  Amount**
              **Expiration
                  Date**($
                  in thousands)JPMorgan
                  Chase Bank, N.A.
              $375,000
              October
                  20, 2006DB
                  Structured Products, Inc..
              300,000
              July
                  18, 2007CS
                  First Boston Mortgage Capital, LLC
              300,000
              April
                  25, 2007MSMC.
              600,000
              August
                  27, 2007Total
              $1,575,000






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
      $1.1 billion of warehouse and repurchase borrowings collateralized by
      residential mortgage loans and mortgage bonds outstanding as of September 30,
      2006. 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 $1.1 billion we had outstanding as of September 30, 2006, as our
      mortgage production and securitization programs continue.





71


Our
      financing facilities require us to comply with various customary operating
      and
      financial covenants, including, without limitation, tests relating to our
      tangible net worth and liquidity, leverage requirements and restrictions on
      guarantees and the granting of liens. In addition, some of the facilities may
      subject us to cross default features. In the event of default, we may be
      prohibited from paying dividends and making distributions under certain of
      our
      financing facilities without the prior approval of our lenders. 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 determined
      we
      were not in compliance with certain financial covenants for the quarter ended
      September 30, 2006 and received waivers from our lenders concerning the
      non-compliance with the covenants.





***Senior
      Notes***





On
      May 4,
      2006, we closed a private offering of $150 million of 12% senior notes due
      2014.
      The notes bear interest at a fixed rate of 12% per annum, commencing on May
      4,
      2006, and will mature on May 1, 2014. Interest on the notes will be payable
      on
      May 1 and November 1 of each year, beginning November 1, 2006. The notes are
      guaranteed by certain of our subsidiaries (the “Guarantees”). We began using the
      net proceeds from the sale of the notes for general corporate purposes,
      principally the acquisition of additional third-party mortgage servicing rights
      and whole loans in bulk. Initially, we used the net proceeds to temporarily
      reduce outstanding debt under one or more of our warehouse and repurchase
      facilities. The notes are general, unsecured, senior obligations and rank senior
      to all of our future debt that is expressly subordinated in right of payment
      to
      the notes.





We
      may
      redeem some or all of the notes at any time at a price equal to 100% of the
      aggregate principal amount thereof plus accrued and unpaid interest and a
      make-whole premium. We may also redeem at any time up to May 1, 2009 (which
      may
      be more than once) up to 35% of the aggregate principal amount of the notes
      using the proceeds of certain equity offerings at a redemption price of 112%
      of
      the principal amount outstanding plus accrued and unpaid interest. We must
      offer
      to purchase the notes at a purchase price of 101% of the principal amount plus
      accrued and unpaid interest to the date of purchase if we experience certain
      specific kinds of changes of control. We must offer to purchase the notes at
      a
      purchase price of 100% of the principal amount plus accrued and unpaid interest
      to the date of purchase if we sell assets under certain circumstances. We also
      must offer to repurchase up to $10 million in aggregate principal amount of
      notes at a purchase price of 100% of the principal amount plus accrued and
      unpaid interest to the date of purchase if we have Excess Cash Flow (as defined
      in the indenture governing the notes) for the six months ended March 31, 2007,
      and each six-month period thereafter.





The
      indenture governing the notes contains certain covenants that restrict the
      ability of our company and certain subsidiaries to, among other things: incur
      additional indebtedness; make certain distributions, investments, and certain
      other payments; sell certain assets; agree to restrictions on the ability of
      certain subsidiaries from making payments to us; create certain liens; merge,
      consolidate, or sell substantially all of our assets; and enter into certain
      transactions with affiliates. In addition, the indenture includes a covenant
      relating to the maintenance of unencumbered assets. The indenture also contains
      certain exceptions from and qualifications to such covenants; it does not
      restrict the ability to incur Funding Indebtedness (as defined in the
      indenture); and it does not restrict us from paying dividends on our common
      stock to the extent necessary to maintain our status as a REIT absent a default
      with respect to the notes. The indenture also contains customary default
      provisions.





72


***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.





Generally,
      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 can look for repayment only from the cash flows relating
      to the assets specifically collateralizing the debt.





*Servicing
      Advance Facility.* As of
      September 30, 2006 we had $241.1 million of borrowings outstanding and an
      additional $43.9 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.





Our
      servicing advance facility contains two series of notes, the Series 2004-1
      Notes
      and the Series 2005-A Notes. The Series 2004-1 Notes have one remaining class
      of
      term notes outstanding with a face value of $55.0 million. 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 $145.0 million.
      The
      total borrowing capacity of our servicing advance facility is $285.0 million.
      In
      October 2006, the Series 2004-1 term note began its scheduled amortization
      period. We expect to replace the capacity afforded by these notes through an
      increase in the maximum face value of the Series 2005-A variable funding notes.





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 nine
      months ended September 30, 2006.





As
      of
      September 30, 2006, securitization financing related to mortgage loans and
      servicing advances on our consolidated balance sheet was $5.7 billion.





73


**Off-Balance
      Sheet Items and Contractual
      Obligations**





***Off-Balance
      Sheet Items***





Prior
      to
      July 6, 2001, our predecessor sold mortgage loans, while retaining certain
      residual interests, through securitizations structured as sales, with a
      corresponding one-time recognition of gain or loss, under GAAP. All such
      residual interests were retained by Dominion Capital in connection with our
      July
      6, 2001 acquisition of the issued and outstanding shares of capital stock of
      our
      predecessor from Dominion Capital. Mortgage loans that were securitized in
      off-balance sheet transactions by our predecessor from May 1996 to July 5,
      2001
      were still outstanding with an aggregate unpaid principal balance of $301.6
      million as of September 30, 2006. In connection with those loans and in
      connection with the sales of mortgage loans to nonaffiliated parties, our
      subsidiaries have 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 or expenses related
      to such breach. As of September 30, 2006 our subsidiaries neither had nor
      expected to incur any material obligation to remove any loans from any
      securitizations, or to provide any such indemnification to any
      party.





In
      the
      normal course of business, we are subject to indemnification obligations related
      to the sale of residential mortgage loans. Under these obligations, we are
      required to repurchase certain mortgage loans that fail to meet the standard
      representations and warranties included in the sales contracts. We accrue an
      estimate for the fair value of those obligations, which includes premium
      recapture expenses and early payment defaults. Our subsidiaries are also subject
      to these obligations in connection with the sale of residential mortgage loans.
      Premium recapture expenses represent repayment of a portion of certain loan
      sale
      premiums to investors on previously sold loans that are repaid within six months
      of the loan sale. We accrue an estimate of the potential refunds of premium
      received on loan sales based upon historical experience. As of September 30,
      2006 and December 31, 2005, the liability recorded for premium recapture
      expenses and for obligations to repurchase mortgage loans was $0.5 million
      and
      $0.4 million, respectively and the associated expense was recorded within (loss)
      gain on sale of assets in the consolidated statements of operations.





Our
      subsidiaries had commitments to fund mortgage loans with agreed upon rates
      of
      $212.6 million and $262.6 million as of September 30, 2006 and December 31,
      2005, respectively. These 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.





74


***Contractual
      Obligations and Commitments***





Our
      subsidiaries are obligated under non-cancelable operating leases for property
      and equipment. Future minimum rental payments for all of our operating leases
      as
      of September 30, 2006 and December 31, 2005 totaled $59.3 million and $67.5
      million, respectively. We have one capital lease for equipment with total future
      minimum rental payments of $1.7 million as of September 30, 2006.





We
      are
      committed to purchasing third-party servicing rights of an additional $3.5
      billion unpaid principal balance of third-party mortgage loans during the fourth
      quarter of 2006, $0.5 billion of which have been purchased as of October 31,
      2006.





**Other
      Matters**





***Related
      Party Transactions***





We
      have
      entered into an agreement to be acquired by MSMC. Pursuant to the terms of
      the
      merger agreement, we entered into a $600.0 million committed repurchase facility
      with MSMC. In addition, of the $3.5 billion unpaid principal balance of
      third-party mortgage loans we are committed to purchasing during the fourth
      quarter of 2006, $0.5 billion were purchased from MSMC during October 2006
      for
      approximately $4.6 million and an additional $1.5 billion are expected to be
      purchased from MSMC during the remainder of the fourth quarter of 2006.





On
      August
      22, 2006, the Class A-1 variable funding notes, Series 2005-A was sold to MSMC,
      and the scheduled pre-amortization period termination date of the Class A-1
      variable funding notes, Series 2005-A was extended to October 24, 2006. On
      October 23, 2006, the scheduled pre-amortization period termination date of
      the
      Class A-1 variable funding notes, Series 2005-A was extended to January 31,
      2007, and the maximum variable funding note balance with respect to the Class
      A-1 variable funding notes was increased to $200.0 million.





On
      October 10, 2006, Morgan Stanley Capital Services, Inc., an affiliate of MSMC,
      sold a derivative instrument to Saxon Asset Securities Trust,
      2006-3.





***Impact
      of New Accounting Pronouncements*** ****





In
      February 2006, t he
      FASB
      issued SFAS No. 15 5, *Accounting
      for Certain Hybrid Instruments* ,
      which
      allows financial instruments that have embedded derivatives to be accounted
      for
      as a whole (eliminating the need to bifurcate the derivative from its host)
      if
      the holder elects to account for the whole instrument on a fair value basis.
      SFAS No. 155 is effective for all financial instruments acquired or issued
      after
      the beginning of an entity’s first fiscal year that begins after September 15,
      2006. The adoption of this statement is not anticipated to have a significant
      impact on our financial condition or results of operations.




75


In
      March
      2006, the FASB issued SFAS No. 156, *Accounting
      for Servicing of Financial Assets - An Amendment of FASB Statement No. 140.* This
      standard amends the guidance in SFAS No. 140, *Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities.* Among
      other requirements, SFAS No. 156 requires an entity to recognize a servicing
      asset or servicing liability each time it undertakes an obligation to service
      a
      financial asset by entering into a servicing contract in any of the following
      situations: a transfer of the servicer’s financial assets that meets the
      requirements for sale accounting; a transfer of the servicer’s financial assets
      to a qualifying special-purpose entity in a guaranteed mortgage securitization
      in which the transferor retains all of the resulting securities and classifies
      them as either available-for-sale securities or trading securities; or an
      acquisition or assumption of an obligation to service a financial asset that
      does not relate to financial assets of the servicer or its consolidated
      affiliates. SFAS No. 156 is effective the beginning of the first fiscal year
      beginning after September 15, 2006. At this time, management has not yet
      completed its’ assessment of the impact of the implementation of this
      statement.




In
      July
      2006, the FASB issued FASB Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes* ,
      or FIN
      48 *.* This
      interpretation clarifies the accounting for uncertainty in income taxes
      recognized in an enterprise’s financial statements in accordance with FASB
      Statement No. 109, *Accounting
      for Income Taxes* .
      FIN 48
      prescribes a recognition threshold and measurement attribute for the financial
      statement recognition and measurement of a tax position taken or expected to
      be
      taken in a tax return. FIN 48 also provides guidance on derecognition,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition. FIN 48 is effective for fiscal years beginning after
      December 15, 2006. At this time, management has not yet completed its assessment
      of the impact of this interpretation.




In
      September 2006, the FASB issued SFAS No.157, *Fair
      Value Measurements* .
      This
      standard provides guidance for using fair value to measure assets and
      liabilities. Prior to the issuance of this standard, the methods for measuring
      fair value were diverse and inconsistent. SFAS No.157 clarifies that for items
      that are not actively traded, fair value should reflect the price in a
      transaction with a market participant, including an adjustment for risk, not
      just the company’s mark-to-model value. SFAS No. 157 also requires expanded
      disclosure of the effect on earnings for items measured using unobservable
      data.
      SFAS No.157 is effective the beginning of the first fiscal year beginning after
      November 15, 2007. At this time, management has not yet completed its assessment
      of the impact of this statement.




In
      September 2006, the SEC issued Staff Accounting Bulletin, or SAB, No. 108, *Considering
      the Effects of Prior Year Misstatements When Quantifying Misstatements in
      Current Year Financial Statements.* SAB No.
      108 states that registrants should use both a balance sheet approach and an
      income statement approach when quantifying and evaluating the materiality of
      a
      misstatement. SAB No. 108 also provides transition guidance on correcting errors
      under this dual approach. If prior year errors that had been previously
      considered immaterial now are considered to be material based on using the
      approach specified in SAB No. 108, the registrant need not restate prior period
      financials. SAB No. 108 is effective for annual financial statements covering
      the first fiscal year ending after November 15, 2006. At this time, management
      has not yet completed its assessment of the impact of SAB No. 108.





76


**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. Firstly, 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. Secondly, increases
      or
      decreases in interest rates can cause changes in net interest income on the
      mortgage loans that we own or are committed to fund, and as a result, cause
      changes in our future earnings. 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 to changing interest rates.




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




As
      shown
      in the tables below, there was a slight increase in our derivative activity
      at
      September 30, 2006 compared to December 31, 2005 due to additional, existing
      and
      forecasted debt. 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, 2006 and December
      31, 2005.




**As
                of September 30, 2006******
            **2006**
            **2007**
            **2008**
            **2009**
            **2010**
            **Thereafter**($
                in thousands)Caps
                bought - notional:
            $1,119,000
            $18,167
            —
            —
            —
            —Weighted
                average rate
            3.91%
            3.25%
            —
            —
            —
            —Caps
                sold - notional:
            $1,119,000
            $18,167
            —
            —
            —
            —Weighted
                average rate
            4.70%
            5.00%
            —
            —
            —
            —Futures
                sold - notional:
            $100,000
            $277,500
            $533,750
            $83,750
            —
            —Weighted
                average rate
            5.28%
            4.92%
            4.84%
            5.04%
            —
            —Swaps
                bought - notional:
            $2,269,566
            $2,489,378
            $970,873
            $335,962
            $74,853
            —Weighted
                average rate
            5.23%
            4.97%
            5.22%
            5.23%
            5.23%
            —Puts
                bought - notional:
            $2,000,000
            $875,000
            —
            —
            —
            —Weighted
                average rate
            5.75%
            5.75%
            —
            —
            —
            —Puts
                sold - notional:
            —
            $500,000
            $875,000
            —
            —
            —Weighted
                average rate
            —
            6.25%
            6.50%
            —
            —
            —Total
                notional activity:
            $6,607,566
            $4,178,212
            $2,379,623
            $419,712
            $74,853
            $—







77




**As
                of December 31, 2005******
            **2006**
            **2007**
            **2008**
            **2009**
            **2010**
            **Thereafter**($
                in thousands)Caps
                bought - notional:
            $1,186,583
            $18,167
            —
            —
            —
            —Weighted
                average rate
            3.86%
            3.25%
            —
            —
            —
            —Caps
                sold - notional:
            1,186,583
            18,167
            —
            —
            —
            —Weighted
                average rate
            4.69%
            5.00%
            —
            —
            —
            —Futures
                bought - notional:
            30,250
            —
            —
            —
            —
            —Weighted
                average rate
            3.75%
            —
            —
            —
            —
            —Futures
                sold - notional:
            118,750
            293,750
            103,750
            —
            —
            —Weighted
                average rate
            4.49%
            4.38%
            4.49%
            —
            —
            —Swaps
                bought - notional:
            —
            600,000
            —
            —
            —
            —Weighted
                average rate
            —
            4.17%
            —
            —
            —
            —Puts
                bought - notional:
            4,487,500
            —
            —
            —
            —
            —Weighted
                average rate
            5.22%
            —
            —
            —
            —
            —Puts
                sold - notional:
            58,250
            —
            —
            —
            —
            —Weighted
                average rate
            3.75%
            —
            —
            —
            —
            —Total
                notional activity:
            $7,067,916
            $930,084
            $103,750
            $—
            $—
            $—




*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
      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 the term of the
      liabilities. 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, 2006 and the four scenarios that we used as of December 31, 2005.
      The change in values represented under each of the scenarios depicts value
      improvements, or declines, relative to the rate scenario depicted by the forward
      curve. If the forward curve at the end of the period depicts two potential
      rate
      increases by the FRB and the scenario only depicts one increase, the cost in
      forward liabilities may actually decline while interest rates are going
      up.  The
      change from September 30, 2006 to December 31, 2005 represents our change in
      forecasted transactions, changes in forward rates during the period, and
      assumptions for each scenario as described below.




78


**Effect
                on Interest Expense of Assumed Changes in Interest Rates Over a Three
                Year
                Period******
            **September
                30, 2006**
            **December
                31, 2005******
            **Scenario
                1**
            **Scenario
                2**
            **Scenario
                3**
            **Scenario
                4**
            **Scenario
                1**
            **Scenario
                2**
            **Scenario
                3**
            **Scenario
                4**(in
                thousands)Change
                in interest expense
            $78,675
            $21,165
            $(8,053)
            $(48,085)
            $22,620
            $(1,170)
            $(25,519)
            $12,665Impact
                from derivative instruments:Futures
            (11,936)
            (4,022)
            392
            6,921
            (2,292)
            (990)
            1,655
            (165)Swaps
            (45,894)
            (12,894)
            6,548
            29,614
            (2,740)
            (1,084)
            2,064
            (203)Puts
            4,336
            768
            (32)
            (200)
            (661)
            265
            428
            (1,699)Caps
            (9)
            3
            (1)
            (1)
            (1,117)
            949
            1,036
            (990)Total
                impact from derivative instruments
            $(53,503)
            $(16,145)
            $6,907
            $36,334
            $(6,810)
            $(860)
            $5,183
            $(3,057)Net
                change
            $25,172
            $5,020
            $(1,146)
            $(11,751)
            $15,810
            $(2,030)
            $(20,336)
            $9,608




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




Scenario
      1 - Under this scenario we show liability costs 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’s
      desire to maintain a stable or declining inflation environment. Under this
      scenario, we assumed a hypothetical interest rate increase of 100 basis points
      over a six-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, 2006, we estimated that our interest
      expense would increase by $78.7 million. However, we estimated that this amount
      would be partially offset by the impact of our derivative instruments of $53.5
      million. The net effect of this scenario would be a potential decrease of $25.2
      million in our net revenues. At December 31, 2005, assuming a hypothetical
      interest rate increase of 75 basis points over a five-month period, we estimated
      at that time that our net revenues would decrease by $15.8 million.




Scenario
      2 - In this scenario we assumed a slightly less severe hypothetical rise in
      interest rates compared to Scenario 1. Under this scenario, we assumed that
      spot
      interest rates will be unchanged while forward curve rates could increase 25
      basis points. Making these assumptions as of September 30, 2006, we estimated
      that our interest expense would increase by $21.2 million offset by the impact
      of our derivative instruments of $16.1 million, for a net decrease of $5.0
      million in our net revenues. At December 31, 2005, assuming interest rates
      had
      the potential to rise 50 basis points over a three-month period, we estimated
      at
      that time that our net revenues would decrease by $2.0 million.




Scenario
      3 - In this scenario we assumed relatively stable hypothetical short-term rates.
      This scenario assumed that the FRB pauses its increasing rate scenario and
      reverses course by mid-2007. This scenario assumed that the FRB lowers rates
      by
      75 basis points in 2007 to compensate for the prior rate increases. Given these
      assumptions as of September 30, 2006, we estimated that our interest expense
      would decrease by $8.1 million. However, we estimated that this amount would
      be
      partially offset by the impact of our derivative instruments of $6.9 million.
      The net effect of this scenario would be a potential increase of $1.1 million
      in
      our net revenues. As of December 31, 2005, assuming interest rates remained
      relatively stable, we estimated at that time that our net revenues would decline
      by $20.3 million.






79


Scenario
      4 -This scenario assumed that the FRB begins to lower rates by the middle of
      2007 and spot rates decline 150 basis points to avert recessionary pressures.
      Given these assumptions, at September 30, 2006, we estimated that our interest
      expense would decrease by $48.1 million, which would be partially offset by
      the
      impact of derivative instruments of $36.3 million, for a total potential
      increase in net revenues of $11.8 million. At December 31, 2005, assuming
      interest rates increased 125 basis points over an eight-month period, and then
      decreased 100 basis points over the following six months, we estimated at that
      time that our net revenues would increase by $9.6 million.




The
      hypothetical yield curve data for each scenario at September 30, 2006 and
      December 31, 2005 are as follows:




**September
                30, 2006****Month**
            **Current
                Market (1)**
            **Scenario
                1**
            **Scenario
                2**
            **Scenario
                3**
            **Scenario
                4**Oct-06
            5.40
            5.64
            5.33
            5.39
            5.39Dec-06
            5.33
            5.65
            5.33
            5.27
            5.14Mar-07
            5.18
            5.78
            5.34
            4.82
            4.57Jun-07
            5.02
            6.16
            5.34
            4.57
            4.07Sep-07
            4.88
            6.42
            5.35
            4.60
            3.83Dec-07
            4.79
            6.43
            5.35
            4.60
            3.85Mar-08
            4.77
            6.44
            5.36
            4.61
            3.86Jun-08
            4.78
            6.44
            5.36
            4.61
            3.86Sept-08
            4.81
            6.45
            5.37
            4.80
            3.87Dec-08
            4.85
            6.46
            5.37
            5.18
            3.90Mar-09
            4.88
            6.47
            5.38
            5.44
            3.91Jun-09
            4.92
            6.48
            5.38
            5.44
            3.91Sep-09
            4.95
            6.49
            5.39
            5.45
            4.04


________________


(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.







**December
                31, 2005****Month**
            **Current
                Market (1)**
            **Scenario
                1**
            **Scenario
                2**
            **Scenario
                3**
            **Scenario
                4**Jan-06
            4.49
            4.52
            4.39
            4.39
            4.51Mar-06
            4.78
            4.90
            4.52
            4.39
            4.89Jun-06
            4.85
            5.16
            4.65
            4.40
            5.40Sep-06
            4.84
            5.18
            4.79
            4.40
            5.53Dec-06
            4.80
            5.19
            4.92
            4.41
            5.13Mar-07
            4.75
            5.20
            4.93
            4.41
            4.76Jun-07
            4.74
            5.21
            4.94
            4.42
            4.64Sep-07
            4.74
            5.22
            4.94
            4.42
            4.64Dec-07
            4.75
            5.23
            4.95
            4.43
            4.65Mar-08
            4.75
            5.25
            4.96
            4.43
            4.65Jun-08
            4.77
            5.26
            4.97
            4.44
            4.66Sept-08
            4.79
            5.27
            4.98
            4.44
            4.66Dec-08
            4.83
            5.28
            4.99
            4.45
            4.67




80


________________


(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
      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**




***Conclusion
      Regarding the Effectiveness of Disclosure Controls and
      Procedures***




We
      carried out an evaluation, as required by Exchange Act Rule 13a-15(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 end
      of
      the period covered by this report, our disclosure controls and procedures were
      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 accumulated and communicated to our
      management to allow timely decisions regarding disclosure 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.




Our
      management, including our Chief Executive Officer and Chief Financial Officer,
      has determined that there have been no changes in our internal control over
      financial reporting during the quarter ended September 30, 2006 that have
      materially affected, or are likely to materially affect, our internal control
      over financial reporting, except for the successful implementation
      of an automated interface between our loan servicing system and our general
      ledger .
      This
      interface changed the way in which we recognize interest income and record
      accrued interest receivable. Changes to internal controls over financial
      reporting related to the implementation of this automated interface were limited
      to the revision of certain policies and procedures inherent in that
      process.






**PART
      II**




81





**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. With respect to
      each matter in which class action status has been asserted, in the event class
      action status is certified, if there is an adverse outcome or we do not
      otherwise prevail in each of the following matters, we could suffer material
      losses, although we intend to vigorously defend each of these lawsuits. The
      following is a summary of litigation matters that could be significant. Unless
      otherwise noted, we cannot predict the outcome of these matters. Accordingly,
      no
      amounts have been accrued in our accompanying consolidated financial statements,
      except as noted below.





Bauer,
      et al., v. Saxon Mortgage Services, Inc., et al. is a
      matter filed on December 1, 2004 in the Civil District Court for the Parish
      of
      Orleans, State of Louisiana, Case No. 2004-17015. On January 26, 2005, the
      plaintiffs 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., v. 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. In the Bauer case, we are not a named defendant but may owe defense
      and indemnification to Deutsche Bank Trust Company Americas, N.A., as custodian
      of a mortgage loan for which one named plaintiff is mortgagor. Our subsidiary,
      Saxon Mortgage Services, is a named defendant in the Patterson case. In both
      cases, the named plaintiffs allege misrepresentation, fraud, conversion and
      unjust enrichment on the part of the lender defendants and a law firm hired
      by a
      number of defendants, including our subsidiary, Saxon Mortgage Services, to
      enforce mortgage loan obligations against borrowers who had become delinquent
      pursuant to the terms of their mortgage loan documents. Specifically, the
      plaintiffs alleged that the law firm quoted inflated court costs and sheriff’s
      fees on reinstatement proposals to the plaintiffs. In both cases, the plaintiffs
      seek certification as a class action, compensatory damages, pre-judgment
      interest, attorneys’ fees, litigation costs, and other unspecified general,
      special and equitable relief. On January 24, 2006, the United States District
      Court for the Eastern District of Louisiana granted our motion to compel
      arbitration and stayed the court proceedings as to named plaintiffs Keenan
      and
      Karen Duckworth in Bauer,
      et al., v. Dean Morris, et al., filed as
      Case No. 05-2173 in the Civil District Court for the Parish of Orleans, State
      of
      Louisiana. On January 25, 2006, the United States District Court for the Eastern
      District of Louisiana granted our motion to compel arbitration and stayed the
      court proceedings as to named plaintiff Debra Herron in 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. The court subsequently remanded the underlying court proceedings
      in
      both the Bauer and Patterson cases to
      the Civil District Court for the Parish of Orleans, State of Louisiana. There
      were no significant developments in this matter during the quarter ended
      September 30, 2006.





82


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 America’s MoneyLine, Inc., our former subsidiary, which was merged with Saxon
      Mortgage, Inc., our subsidiary, effective January 1, 2006. Saxon
      Mortgage, Inc. is successor in interest to the defendant. **** On
      June
      19, 2006, the parties reached an agreement to settle this case, pending the
      court’s approval. The
      settlement requires the defendant to create a settlement fund for approximately
      $0.5 million. The claims of settlement class members and plaintiff’s attorney’s
      fees will be paid out of the fund. On August 30, 2006, the court preliminarily
      approved the settlement and a final fairness hearing is scheduled for February
      13, 2007. The estimate of possible loss for this matter in the amount of $0.5
      million was accrued for in June 2006.




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 on behalf of themselves
      and similarly situated Ohio borrowers, alleging that our 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. During the second quarter of 2006, the court granted
      our motion to compel individual arbitration as to each of the two named
      plaintiffs and stayed the court proceedings with no class having been certified. There
      were no significant developments in this matter during the quarter ended
      September 30, 2006.





Brian
      Harris, et al., v. Capital Mortgage Company, et al .,
      is a
      matter filed in the Circuit Court of Cook County, County Department-Chancery
      Division, Illinois as Case No. 05CH 22369. Our subsidiary, Saxon Mortgage
      Services, was served with a summons and complaint on March 1, 2006. The
      plaintiffs included a class action claim, alleging, on behalf of themselves
      and
      those similarly situated, that our subsidiary Saxon Mortgage Services, Inc.
      and
      other named defendants engaged in unfair and deceptive acts and violated the
      Illinois Consumer Fraud Act in connection with 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. There were no significant developments
      in this matter during the quarter ended September 30, 2006.





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.





83


**Item
      1A. Risk Factors**





The
      significant risk factors and uncertainties known to us that, if they were to
      occur, could materially adversely affect our business, financial condition,
      operating results or cash flows are set forth under “Part I - Item 1A. “Risk
      Factors” in our 2005 Form 10-K and under “Part II - Item 1A. “Risk Factors” in
      our quarterly report on Form 10-Q for the periods ended March 31, 2006 and
      June
      30, 2006. Risk factors contained herein consist of new risks or risks that
      have
      materially changed since June 30, 2006. You should carefully consider the risks
      described below. If any of the following risks actually occurs, our business,
      financial condition, liquidity and results of operations could suffer. You
      should also refer to the other information contained in this report, including
      the information provided under “Part 1, Item 1 - Financial Statements” and “Part
      1, Item 2 - Management’s Discussion and Analysis of Financial Condition and
      Results of Operations”.





***The
      completion of our proposed merger with Angle Merger Subsidiary Corporation,
      a
      subsidiary of MSMC, is subject to various closing
      conditions.***





Although
      we expect our proposed merger with Angle Merger Subsidiary Corporation, a
      wholly-owned subsidiary of MSMC, to be completed in the fourth quarter of 2006,
      it is possible that we may not complete the merger in the fourth quarter of
      2006, or at all. Either MSMC or we may terminate the merger agreement if the
      merger is not effective by March 31, 2007 and if the terminating party has
      not
      caused that failure by its breach of the merger agreement. The completion of
      the
      merger is subject to customary closing conditions, including, among others,
      the
      absence of a material adverse change in the Company and the receipt of required
      regulatory approvals.  We can provide no assurance that these closing
      conditions, some of which are beyond our control, will be satisfied or waived
      in
      the fourth quarter of 2006 or at all. Therefore, we can provide no
      assurance that the merger will be consummated in the fourth quarter or at all.
      If the merger is not consummated, we will continue to be a publicly traded
      company.





***If
      the proposed merger does not close, we will continue to be subject to the risks
      we face as a public company.***





If
      the
      merger does not close, we will continue as a stand-alone publicly-traded
      company. In such event, margin compression, increases in delinquencies and
      other
      factors will continue to affect our ability to access long-term borrowings,
      short-term borrowings or bank credit lines necessary to maintain our liquidity,
      which could inhibit our ability to fund our operations.





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




None.




**Item
      3. Defaults Upon Senior Securities**




None.




84


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




None.





**Item
      5. Other Information**




(a)
            None.




(b)
            None.




**Item
      6. Exhibits**





2.1
            Agreement
                and Plan of Merger, dated as of August 8, 2006, among Saxon Capital,
                Inc.,
                Morgan Stanley Mortgage Capital Inc. and Angle Merger Subsidiary
                Corporation.




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




3.2
            Amended and Restated Bylaws of Saxon Capital,
              Inc.




4.1
            Form
                of Common Stock Certificate of Saxon Capital,
                Inc.




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




4.3
            Indenture,
                dated as of May 4, 2006, among Saxon Capital, Inc., as issuer, Saxon
                Capital Holdings, Inc., SCI Services, Inc., Saxon Mortgage, Inc.,
                Saxon
                Mortgage Services, Inc., Saxon Holding, Inc., and Saxon Funding
                Management, Inc., as guarantors, and Deutsche Bank Trust Company
                Americas,
                as trustee.




4.4
            Registration
                Rights Agreement, dated as of May 4, 2006, among Saxon Capital, Inc.,
                Saxon Capital Holdings, Inc., SCI Services, Inc., Saxon Mortgage,
                Inc.,
                Saxon Mortgage Services, Inc., Saxon Holding, Inc., and Saxon Funding
                Management, Inc., and J.P. Morgan Securities,
                Inc.





12.1
            Statement regarding computation of ratios of earnings
              to
              fixed charges.




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.




85


**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 3, 2006
            By:/s/
                Michael L.
                SawyerName:
                Michael L. SawyerTitle:
                Chief Executive Officer (authorizedofficer
                of registrant)Dated:
                November 3, 2006
            By:/s/
                Robert B.
                EastepName:
                Robert B. EastepTitle:
                Chief Financial Officer (principalfinancial
                officer)











86




**EXHIBIT
      INDEX**





Exhibit
      No.  Description





2.1
            Agreement
                and Plan of Merger, dated as of August 8, 2006, among Saxon Capital,
                Inc.,
                Morgan Stanley Mortgage Capital Inc. and Angle Merger Subsidiary
                Corporation. (Incorporated herein by reference to our Exhibit 2.1
                to
                Current Report on Form 8-K filed with the Securities and Exchange
                Commission on August 9, 2006.)





3.1
            Amended
                and Restated Certificate of Incorporation of Saxon Capital, Inc.
                (Incorporated herein by reference to our Annual Report on Form 10-K
                for
                the year ended December 31, 2005, filed with the Securities and Exchange
                Commission on March 31, 2006. Our Commission file number is
                001-32447.)




3.2
            Amended
                and Restated Bylaws of Saxon Capital, Inc. (Incorporated herein by
                reference to our Current Report on Form 8-K filed with the Securities
                and
                Exchange Commission on March 4, 2005.)




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




4.2
            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
                as
                Exhibits. The Company hereby agrees to furnish a copy of any of these
                agreements to the Securities and Exchange Commission upon
                request.




4.3
            Indenture,
                dated as of May 4, 2006, among Saxon Capital, Inc., as issuer, Saxon
                Capital Holdings, Inc., SCI Services, Inc., Saxon Mortgage, Inc.,
                Saxon
                Mortgage Services, Inc., Saxon Holding, Inc., and Saxon Funding
                Management, Inc., as guarantors, and Deutsche Bank Trust Company
                Americas,
                as trustee. (Incorporated herein by reference to our Current Report
                on
                Form 8-K filed with the Securities and Exchange Commission on May
                5,
                2006.)




4.4
            Registration
                Rights Agreement, dated as of May 4, 2006, among Saxon Capital, Inc.,
                Saxon Capital Holdings, Inc., SCI Services, Inc., Saxon Mortgage,
                Inc.,
                Saxon Mortgage Services, Inc., Saxon Holding, Inc., and Saxon Funding
                Management, Inc., and J.P. Morgan Securities, Inc. (Incorporated
                herein by
                reference to our Current Report on Form 8-K filed with the Securities
                and
                Exchange Commission on May 5,
                2006.)




12.1
            Statement regarding computation of ratios of earnings
              to
              fixed charges.




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.











87