UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, ~~2005~~2006

¨	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 001-32430

ECC CAPITAL CORPORATION

(Exact name of registrant as specified in its charter)

Maryland		84-1642470
(State or other jurisdiction incorporation or organization)		(I. R. S. Employer Identification Number)
1833 Alton Parkway, Irvine, California		92606
1733 Alton Parkway, Irvine, California		92606
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (949) ~~856~~955-~~8300~~8700

Securities registered pursuant to Section 12(b) of the Act:		Name of exchange on which registered:
Common Stock, par value $0.001 per share		New York Stock Exchange
None		N/A

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

~~None~~Common Stock, par value $0.001 per share

Indicate by check mark if the Registrant is a well known seasoned issuer as defined in Rule 405 of the Securities Act. Yes ¨ No x

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

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

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

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

Large accelerated filer ¨ Accelerated filer ¨ x Non-accelerated filer ¨ x

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

The aggregate market value of common stock held by non-affiliates, based on the closing price of the common stock of the Registrant on the last business day of the most recently completed second fiscal quarter as reported on the New York Stock Exchange, was $~~451~~78,~~963~~659,~~078~~541. All executive officers and directors of the Registrant and all persons filing a Schedule 13D with the Securities and Exchange Commission in respect to the Registrant’s common stock have been deemed, solely for the purpose of the foregoing calculations, to be “affiliates” of the Registrant.

As of ~~March~~May 2714, ~~2006,~~2007 the Registrant had ~~100~~101,~~242~~026,~~336~~743 shares of common stock outstanding.

Portions of the Registrant’s definitive Proxy Statement to be delivered in connection with the Registrant’s 2006 Annual Meeting of Stockholders are incorporated by reference into Part III of this annual report.

TABLE OF CONTENTS

		Page
	PART I
Item 1.	Business	1
Item 1A.	Risk Factors	208
Item 1B.	Unresolved Staff Comments	4128
Item 2.	Properties	4128
Item 3.	Legal Proceedings	4228
Item 4.	Submission of Matters to a Vote of Security Holders	4228
	PART II
Item 5.	Market for the Registrant’s Common Equity and Related Stockholder Matters	4329
Item 6.	Selected Financial Data	4430
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	4631
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	6648
Item 8.	Financial Statements and Supplementary Data	7252
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	7252
Item 9A.	Controls and Procedures	7252
Item 9B.	Other Information	7359
	PART III
Item 10.	Directors, ~~and~~ Executive Officers ofand ~~the~~Corporate ~~Registrant~~Governance	7460
Item 11.	Executive Compensation	7462
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	7483
Item 13.	Certain Relationships and Related Transactions and Director Independence	7485
Item 14.	Principal Accountant Fees and Services	7485
	PART IV
Item 15.	Exhibits and Financial Statements and Schedules	7587
Index to Financial Statements		F-1

PART I

Item 1.

Business

Formation transactions

ECC Capital Corporation (the “Company”, ECC Capital”, “we”, or “us”) was incorporated on April 1, 2004 in the state of Maryland. ECC Capital was formed by Encore Credit Corp., ~~solely~~now known as Performance Credit Corporation for the purpose of effecting a restructuring ~~of Encore Credit Corp.~~ that ~~would~~facilitated ~~facilitate~~our an initial public offering and conversion to a real estate investment trust, or REIT. AsEncore aCredit ~~REIT,~~was ~~ECC~~formed ~~Capital~~on ~~invests in residential mortgage loans financed by the issuance of non-recourse debt. On February~~October 18, ~~2005,~~2001 ~~ECC~~in ~~Capital completed its initial public offering and conversion to a REIT. Prior to~~ the ~~completion~~State of ~~its~~California ~~initial~~and ~~public~~began ~~offering,~~operations ~~ECC~~in ~~Capital~~March ~~formed a wholly-owned subsidiary, ECC Merger Sub, for the interim purpose of effecting the merger~~2002. Encore Credit ~~Corp.~~changed ~~merged~~its ~~with~~name ECC Merger Sub, with Encore Credit surviving as a wholly-owned subsidiary of ECC Capital. In connection with the merger, the shareholders of Encore Credit received 1.183 shares of common stock of ECC Capital for each share of common stock, Series A preferred stock and Series B preferred stock of Encore Credit. In addition, each outstanding option to ~~purchase~~Performance ~~Encore~~ Credit ~~common~~Corporation ~~stock was assumed by ECC Capital and was adjusted to reflect the exchange ratio~~ in ~~the~~February ~~merger~~2007. ~~Each warrant to purchase Encore Credit common stock was exercised prior to the merger.~~

As part of the initial public offering, ECC Capital: (i) issued 40,406,108 shares of common stock to the shareholders of Encore Credit in exchange for their outstanding common and preferred stock, (ii) sold 52,500,000 shares of common stock to the public at $6.75 per share, and (iii) sold 3,940,110 shares of common stock in a private placement offering to an affiliate of its lead underwriter, Friedman, Billings, Ramsey, Group, Inc. at $6.345 per share. ECC Capital raised a total of $379,375,000 through the sale of its stock (before offering expenses).

Following the initial public offering, Encore Credit became a wholly-owned subsidiary of ECC Capital. In this annual report, unless the context suggests otherwise, for time periods before February 17, 2005, the terms “the company,” “we,” “our” and “us” refer to Encore Credit and its subsidiaries, and for time periods on and after February 17, 2005, all references to “the company,” “we,” “our” and “us” refer to ECC Capital and its subsidiaries, including Encore Credit.

General background regarding the business

We are a REIT that, ~~through~~owns ~~our~~interests ~~subsidiaries,~~in trusts which issued ~~operates~~securities collateralized by mortgages on residential real estate. The mortgages were originated by our wholly-owned subsidiary Performance Credit Corporation. Performance Credit Corporation is a mortgage finance company that ~~originates~~originated ~~and invests in~~ residential mortgage loans offered to borrowers with a particular emphasis on “nonconforming” borrowers who generally do not satisfy the credit, collateral, documentation or other standards required by conventional mortgage lenders and loan buyers. Performance ~~Prior to the formation transactions described above we operated as Encore~~ Credit. ~~Encore Credit began its lending operations in March 2002. Encore Credit~~ originated approximately $9.1 billion of nonconforming residential mortgage loans in 2004, ~~and~~ approximately $14.0 billion in 2005 and approximately $6.2 billion in 2006. Prior to our initial public offering, we sold substantially all of our loan production to third parties or through securitization transactions structured as sales. Our principal sources of income were the gain on the sale of our loans and the net interest income (difference between interest income and interest expense) earned on our loans between the time we originated them and the time they were sold. We financed the origination of our mortgage loans through various warehouse lines of credit.

As a REIT, we ~~continue~~retained ~~to originate mortgage loans through existing and new production channels. However, we retain~~ a portion of this production in a loan portfolio financed through securitization transactions in which we ~~issue~~issued asset-backed securities ~~that~~in ~~have~~transactions ~~been~~that were structured as financings for financial accounting purposes. ~~We are limited, to some extent, in the amount of loans we are able to retain by leverage constraints imposed by the size of our capital base.~~ Loan production that we ~~determine~~determined ~~cannot~~could not be retained in our portfolio orwas ~~production that does not meet our portfolio criteria objectives are~~ sold to third parties or through securitization transactions accounted for as sales.

AsPrior ato ~~REIT~~the formation transactions described above, ~~earnings~~ we ~~distribute~~completed toone ~~our~~securitization ~~stockholders~~transaction ~~are~~in ~~not~~2003 ~~subject~~and totwo ~~income~~securitization transactions ~~tax~~in ~~for~~2004 ~~federal~~which orwere ~~state~~structured ~~purposes~~ as ~~long~~loan sales. We completed four securitization transactions in 2005 which were structured as wefinancings. ~~distribute~~We atcompleted ~~least~~one ~~90%~~securitization oftransaction ~~our~~in ~~taxable~~2006 ~~earnings~~which ~~and~~was ~~satisfy~~structured ~~certain~~as ~~other~~a ~~qualifying~~loan ~~tests~~sale.

During the second quarter of 2006, ECC Capital’s board of directors began to review and evaluate potential strategic alternatives to enhance shareholder value. Friedman, Billings, Ramsey & Co., Inc. and Milestone Advisors, LLC were engaged as financial advisors to assist it in the review and evaluation of any potential strategic transactions that might be presented.

On October 10, 2006, we announced that we had entered into an agreement (the “Asset Purchase Agreement”) to sell certain operating assets used in our wholesale mortgage banking operation to Bear Stearns Residential Mortgage Corporation, for approximately $26 million in cash and the assumption of certain liabilities

~~Our~~ by ~~loan~~Bear ~~production~~Stearns. ~~operations~~Under ~~and~~the ~~secondary~~terms ~~marketing~~of ~~activities~~the ~~(i.e.~~Asset Purchase Agreement, ~~loan~~Bear ~~sales~~Stearns agreed to ~~third~~acquire ~~parties)~~the ~~are conducted~~assets ~~through~~of our ~~taxable~~wholesale ~~REIT~~mortgage ~~subsidiaries~~banking operation, including orproperty ~~TRSs~~and equipment, customer lists, intellectual property and information technology systems used by us (the “Business”). Bear Stearns agreed to assume those liabilities that are ~~subject~~necessary for it to ~~taxes~~continue onto ~~their~~support ~~income~~the originations atgenerated ~~normal~~by ~~statutory~~the ~~rates~~Business, including leases for our operating centers in Irvine, California, Downers Grove, Illinois and Glen Allen, Virginia. ~~Our~~We ~~principal~~also ~~TRS~~entered ~~operates~~into certain agreements with Bear Stearns under which it agreed to fund and acquire our loan production through the ~~name~~date of ~~Encore~~closing ~~Credit~~of the asset sale.

WeOn ~~underwrite~~February 9, ~~each~~2007, ~~mortgage loan that~~ we ~~originate,~~closed ~~and~~the wesale ~~underwrite~~of ~~each~~our mortgage banking ~~loan~~operation weto ~~purchase~~Bear ~~prior~~Stearns toand settled the ~~origination~~ sale of ~~that~~approximately ~~mortgage~~$1.2 ~~loan,~~billion in ~~accordance~~mortgage ~~with~~loans ~~our~~to ~~internal~~Bear ~~underwriting~~Stearns, ~~guidelines.~~subject Weto ~~base~~certain ~~our~~price ~~underwriting~~adjustments ~~decisions~~and ~~primarily~~call onrights. ~~our~~Upon ~~assessment~~completion of the ~~borrower’s~~transaction, ~~willingness~~we ~~and~~effectively ~~ability~~exited tothe ~~pay~~wholesale mortgage origination business, asagreeing ~~reflected~~not to compete in the ~~borrower’s income,~~subprime ~~historical~~wholesale ~~patterns~~mortgage oforigination ~~debt~~business ~~repayment,~~for ~~the~~a ~~amount~~period of ~~equity~~two inyears. ~~the~~We ~~borrower’s~~are ~~property~~reporting ~~and~~the ~~other~~disposition ~~factors~~of ~~that~~our ~~may~~mortgage bebanking ~~used~~operations toas ~~offset~~a ~~certain~~discontinued ~~areas~~operation offor ~~credit~~the ~~weakness.~~year ended WeDecember 31, ~~have~~2006. ~~developed~~As ~~underwriting~~Bear ~~processes~~Stearns ~~and~~also ~~criteria~~acquired ~~that~~use weof ~~believe generate~~the ~~quality~~Encore ~~borrower~~Credit ~~data and appraisals~~name, ~~allowing~~we uschanged tothe ~~make~~name ~~informed~~Encore ~~underwriting~~Credit ~~and~~Corp. ~~risk-based~~to ~~pricing~~Performance ~~decisions~~Credit ~~and~~Corporation, towhich ~~approve~~remains ~~and~~our ~~fund~~wholly-owned ~~loans efficiently~~subsidiary.

We ~~continue~~have toretained ~~use~~the ~~warehouse~~majority ~~and~~of ~~repurchase~~our ~~facilities~~core toassets, ~~provide~~including ~~short-term funding for~~ our ~~mortgage~~retained ~~loan~~interests ~~originations. In order to provide long-term financing for the mortgage loans we hold~~ in our ~~loan~~securitizations ~~portfolio,~~and wethe ~~securitize~~associated ~~all~~servicing ofrights. ~~those~~We ~~loans~~also retained ~~through~~certain ~~transactions~~obligations ~~that~~arising ~~are~~from ~~structured~~our aswholesale ~~financings~~mortgage ~~for~~banking ~~financial~~operation, ~~accounting~~including ~~purposes.~~but Innot alimited ~~securitization~~to, weloan ~~sell~~repurchase aobligations, ~~pool of~~remaining ~~loans~~lease toobligations, apersonnel ~~trust~~related ~~for~~liabilities aand ~~cash~~regulatory ~~purchase price~~ and alicensing ~~certificate~~expenses. ~~evidencing~~The majority ~~our~~of ~~residual~~these orknown ~~ownership~~obligations ~~interest~~were insettled ~~the~~prior ~~trust.~~to ~~The trust raises~~ the ~~cash~~close ~~portion~~ of the ~~purchase~~transaction ~~price~~with byBear ~~selling~~Stearns ~~securities secured by,~~ or ~~representing~~shortly anthereafter. ~~interest in~~However, ~~loans~~ inthere ~~the~~could ~~trust.~~be Weadditional dounknown ~~not~~obligations ~~generate~~that amay ~~gain~~result orin ~~loss~~future onmaterial ~~sale~~liability. ~~from~~On ~~these securitization activities~~February 9, 2007 ~~and,~~we ~~following~~also ~~these~~closed ~~securitizations,~~ the ~~loans~~sale, ~~remain classified on our consolidated balance sheet as loans held~~ for ~~investment~~$20 ~~with~~million, ~~the securitization~~of ~~debt~~our ~~classified~~retained asinterest ain ~~liability. We generate earnings from~~ the ~~loans~~securitization ~~that~~ we ~~securitize~~completed ~~and/or retain~~ in ~~our~~2006. ~~loan portfolio primarily through:~~

At the present time, our principal sources of revenue are net interest income on our portfolio of loans held for investment and interest accretion on our investments in residual interests in our securitizations. As part of managing our portfolio of loans held for investment, we may also originate mortgage loans as a broker to generate additional revenue from borrowers wishing to prepay their mortgage loans or to facilitate the workout of a loan to mitigate losses. We refer to this as portfolio protection. Revenue we generate from our portfolio protection activities is not material to our financial statements.

We are currently evaluating various operating alternatives which include, among other things, managing our existing investments in our securitizations, acquiring loan portfolios for securitization and making investments in other residual interests in securitizations. We intend to maintain our REIT status for the period of time during which we hold residual interests in our securitizations. The REIT’s earnings are not subject to income tax for federal or state purposes as long as we distribute at least 90% of our taxable earnings to our stockholders and satisfy certain other qualifying tests.

Our securitizations

General considerations

In a securitization structured as either a sale or a financing, we transfer a pool of loans to a trust for a cash purchase price and a certificate evidencing our residual or ownership interest in the trust, or retained interest. The trust raises the cash portion of the purchase price by selling securities as long-term debt secured by, or representing an interest in, loans in the trust.

Our securitizations have been structured to pass through principal collected by the trust on the mortgage loans to repay the principal balance of the securities issued by the trust. The different securities issued, or tranches, receive principal in differing amounts depending on their terms. The more senior securities (which are generally rated investment grade by various rating agencies) are repaid with principal more quickly than the subordinate securities. Interest is payable on the securities issued by the trust at a rate equal to the London Interbank Overnight Rate (or LIBOR) plus a margin. The more senior securities pay a lower margin over LIBOR than do the subordinate securities.

There generally will be a difference between the principal balance of the loans transferred to the securitization trust and the principal balance of the long-term debt issued by the securitization trust. This difference is referred to as overcollateralization or OC. This OC is available to absorb losses that will be realized on the mortgage loans. Losses on the mortgage loans are realized when a borrower defaults on a loan and the securitization trust acquires and liquidates the underlying real estate at an amount less than the unpaid principal balance of the loan.

The difference between the interest paid by borrowers on the mortgage loans in the securitization trust and the interest paid on the long-term debt is referred to as excess cash flow. This excess cash flow is another form of OC available, as necessary to absorb losses that will be realized on the mortgage loans.

Each securitization is required to maintain required balances of OC. The amount of required OC generally declines or steps down over time. If required OC balances are maintained by the securitization trust, we will receive the excess cash flow monthly. When the required OC level steps down, we receive the excess OC.

If the pool of loans held by the securitization trust experiences delinquencies or losses in excess of the specified amount, scheduled step downs of OC and distributions of excess cash flow may be deferred or may not occur. Accordingly, if a securitization experiences delinquencies and losses that are greater or less than what we expected at the inception of the securitization, the cash flows we receive from a securitization will be less or greater than expected.

Because the loans we transfer to a securitization trust generally pay a fixed rate of interest for a period of time before converting to an adjustable rate mortgage and the interest we pay on the long-term debt issued by the securitization varies each month, at the time of the securitization we acquire derivative interest rate contracts to mitigate the effect of interest rate changes on net cash flows.

As we have exited the wholesale mortgage origination business, our principal source of cash is now the cash flow we receive from our interests in our securitizations.

Securitizations structured as financings

In a securitization structured as a financing, we do not generate a gain or loss on the transfer of loans to the securitization trust. The transferred loans are classified on our consolidated balance sheet as loans held for investment with the securitization debt classified as a liability. The debt represents non-recourse obligations of trusts, which are special purpose entities consolidated by ECC Capital.

We generate earnings from the securitizations structured as financings as follows:

•

Net interest income, which is the difference between the:

• ~~interest~~Interest income we receive from the mortgage loans; and

• ~~interest~~Interest we pay to the holders of the mortgage-backed securities that we issue in securitizations;

•

Net of:

• ~~losses~~Losses due to defaults and delinquencies on the loans;

• ~~servicing~~Servicing fees and expenses we must pay; ~~and~~

• ~~other~~Other ongoing securitization costs., and;

•

Net cash flow from derivative instruments.

Our net interest income varies based upon, among other things, (i) the spread between the weighted average interest earned on the mortgage loans and the interest payable to the holders of the mortgage-backed securities, (ii) the performance of the underlying mortgages and (iii) the amount and timing of the borrowers’ prepayments of the underlying mortgages.

The performance of our portfolio of nonconforming mortgage loans is subject to the higher delinquency and default rates characteristic of nonconforming mortgage loans as compared to prime mortgage loans. Delinquencies interrupt the flow of projected interest income from the mortgage loans, and defaults can ultimately lead to a loss if the net realizable value of the real property securing the mortgage loan is insufficient to cover the principal and interest due on the loan.

We continue to sell some of the loans we originate through the whole-loan sales market. These whole-loan sales are executed on a servicing-released basis, meaning that the loans are sold, together with the servicing rights, to the buyers of the loans, primarily through Encore Credit, so that we can capture any gain on the sale of these loans and thereby grow our equity capital base. These loans are generally sold within 60 days of funding, and a third-party servicer services these loans during the period between origination and the transfer of servicing to the buyer, which is generally within 90 days after the sale of the loans. We generate income on these loans primarily from:

• the sale of loans at a premium to our weighted average origination costs (including overhead);

• net interest income, which is the difference between the interest income generated by the mortgage loans and our interest expense on the financing of our lending activities through our warehouse and repurchase facilities during the time we hold the mortgages; and

• origination fee income.

Our Loan Products

We offer a variety of both hybrid/adjustable-rate and fixed-rate loan products that are secured by a first or subordinate mortgage on a borrower’s residence. Our principal loan products are hybrid/adjustable-rate nonconforming residential mortgage loans with a fixed principal amount and term to maturity. We primarily originate nonconforming residential mortgage loans through our wholesale broker network solicited by our account executives throughout the United States.

Product Types

We typically offer the following product types in order to make available a diverse set of mortgage options to our borrowers:

Product	Term	Rate(1) (2)
Hybrid/Adjustable-Rate Mortgages
6 month	30 years	Adjustable-rate after first 6 months
1/29	30 years	Adjustable-rate after first 12 months
2/28	30 years	Adjustable-rate after first 24 months
3/27	30 years	Adjustable-rate after first 36 months
5/25	30 years	Adjustable-rate after first 60 months
Dual amortization 2/28 ARM, 40 yr amortization	30 years	Adjustable-rate after first 24 months, 40 year amortization first 10 years, 20 year amortization years 11 - 30
Interest Only-Hybrid/Adjustable-Rate Mortgages
2/28(3)	30 years	Interest only for first 24 months; Adjustable-rate after first 24 months
2/28	40 years	Interest only for first 24 months; Adjustable-rate after first 24 months
3/27(3)	30 years	Interest only for first 36 months; Adjustable-rate after first 36 months
Fixed-Rate Mortgages
10 Year	10 years	Fixed
15 Year(3)	15 years	Fixed
15 Year Balloon	15 years	Fixed with 30 year amortization schedule; Balloon payment after 15 years
20 Year	20 years	Fixed
25 Year	25 years	Fixed
30 Year(3)	30 years	Fixed

(1) For our hybrid/adjustable-rate mortgage loans, the rate is calculated every six months after the initial rate adjustment period.

(2) Certain prepayment penalties apply within the first three years subject to state imposed limitations. We typically offer rate options for our loan products that do not include prepayment penalties.

(3) We also offer mortgage loans with interest-only payments for the first 60 months.

Loan Programs and Risk Categories. We have established loan programs and risk categories, which identify the types of loans that we originate. A majority of our loan originations are underwritten using the

~~“Credit~~The ~~Score~~performance ~~Advantage”~~of ~~program.~~our ~~This~~portfolio ~~program makes loans available to a broad group~~ of ~~borrowers who fit a more traditional~~ nonconforming ~~profile.~~ ~~However,~~mortgage ~~there~~loans ~~are~~is ~~borrowers~~subject ~~who request loan-~~to~~-value,~~ orthe ~~LTV,~~higher ~~ratios~~delinquency orand default ~~loan~~rates ~~amounts~~characteristic ~~that~~of ~~exceed~~nonconforming ~~those~~mortgage ~~stated~~loans ~~for~~as ~~this~~compared ~~program,~~to orprime ~~who~~mortgage ~~require more customized financing options~~loans. ~~Rather~~Delinquencies ~~than~~interrupt ~~attempt~~the toflow ~~incorporate all~~ of ~~these~~projected ~~specialized requests~~interest ~~into~~income ~~one~~from ~~loan~~the ~~program~~mortgage loans, weand ~~have~~defaults ~~established~~can ~~separate~~ultimately ~~loan~~lead ~~programs~~ to ~~accommodate borrowers who would otherwise require individual exceptions to~~ a ~~single,~~loss ~~broader~~if ~~loan~~the ~~program.~~net Werealizable value ~~established~~of ~~these~~the ~~programs~~real toproperty ~~allow~~securing ~~our~~the ~~underwriting personnel~~mortgage ~~to process~~ loan ~~applications~~is ~~from~~insufficient ~~borrowers~~to ~~who~~cover ~~fit~~the aprincipal ~~particular~~and ~~program’s~~interest ~~criteria~~due ~~quickly~~on ~~and~~the ~~efficiently~~loan.

~~The~~As ~~criteria for each~~ of ~~these programs are guidelines only. We may add or delete programs as market conditions dictate. All of our loan programs have~~ ~~tiered~~December 31, ~~exception~~2006 ~~levels whereby a request for approval of an exception is escalated to a higher loan approval authority. Although~~ we ~~generally~~held do not make adjustments to the credit category of any applicant, we may determine on a case-by-case basis that an applicant warrants an LTV ratio exception, a loan amount exception, a debt-to-income exception or another exception$2.42 Webillion ~~may~~in ~~allow~~loans ~~such~~held ~~an exception if the application reflects certain compensating factors, such as a lower than the maximum LTV ratio~~ for ~~the~~investment ~~specific~~which ~~loan~~collateralize ~~program,~~$2.38 abillion ~~maximum~~in ~~of one 30~~long-~~day~~term late payment on all mortgage loans during the last 12 months, job and income stability or a meaningful amount of liquid assets. We may also grant an exception if the applicant provides a down payment of at least 20% of the purchase price of the underlying property or if the new mortgage loan significantly reduces the applicant’s aggregate monthly debt ~~service~~within ~~payments.~~four Wesecuritization ~~expect that a substantial number of the mortgage loans we originate will represent such underwriting exceptions~~trusts. ~~For the years ended December 31, 2005, 2004, and 2003, approximately 36%, 20%, and 25%, respectively, of the loans we originated represented underwriting exceptions.~~

~~Determining~~Securitizations astructured ~~Borrower’s~~as ~~Credit~~sales ~~Categories~~

~~There~~In ~~are~~a ~~various~~securitization ~~credit~~structured ~~categories~~as ~~within~~a ~~each~~sale ~~loan program. The program~~ for ~~which~~financial areporting ~~borrower~~purposes, ~~applies~~we isremove the ~~determined~~loans byfrom our ~~underwriting~~balance ~~guidelines.~~sheet Weand ~~consider~~record a ~~borrower’s~~gain ~~credit~~or ~~score,~~loss ~~mortgage~~on ~~history,~~sale. ~~bankruptcy~~The ~~and~~gain ~~foreclosure~~or ~~history,~~loss ~~debt-to-income~~on ~~ratios~~sale ~~and~~is ~~the~~equal ~~depth~~to of the ~~borrower’s~~difference ~~credit~~between ~~background as~~ the ~~primary~~proceeds ~~factors~~we toreceive ~~determine~~from ifthe atransfer ~~borrower~~of ~~qualifies~~loans ~~for~~to athe ~~credit~~trust, ~~category~~comprising ~~within~~cash ~~that~~and ~~specific~~the ~~program.~~initial ~~Once~~value aof ~~borrower~~our ~~has been assigned a credit category within a loan program~~residual interests, weand ~~use~~ the ~~borrower’s~~cost ~~credit~~basis ~~score~~of ~~and~~the ~~LTV~~loans ~~ratio~~transferred asto the ~~primary~~ ~~factors~~trust, incomprising ~~determining~~unpaid ~~the~~principal ~~borrower’s~~balance ~~rate,~~and ~~the~~capitalized ~~maximum~~fees ~~LTV~~and ~~ratio~~other ~~allowable~~origination ~~for~~costs, ~~that~~net ~~borrower~~of ~~and~~ the ~~maximum~~expenses ~~loan~~of ~~amount~~completing ~~available~~the ~~to that borrower~~securitization.

~~Credit~~The ~~Score~~initial ~~Advantage~~value ~~Program~~of our residual interests is estimated as the net present value of the projected future cash flows we expect to receive over the life of the securitization. Projected future cash flows reflect the excess cash flow and OC released to us from the securitization trust. In projecting cash flows, we make estimates as to the amount and timing of projected loan prepayments, defaults and loss severity. As we receive distribution of cash flows from our residual interests and assumptions as to projected future cash flows change over time, we adjust the carrying value of our residual interests.

~~This~~We ~~program~~generate ~~offers~~earnings loans to individuals with a wide range of credit backgrounds and offers our widest range of underwriting criteria. The Credit Score Advantage program has five credit categories: AA, A+, B, C and C-. Borrowers with a higher credit category typically qualify for higher allowable LTV ratios and higher loan amounts relative to other borrowers within this program. However, since FICO scores within this credit category can range from ~~500 to 850, loans with different characteristics are available to borrowers within a particular credit category based on a borrower’s FICO score. Within a particular credit category,~~ the ~~borrower’s~~ ~~FICO~~securitizations ~~score~~structured isas ~~used~~sales toas ~~determine~~follows: the applicable interest rate, maximum allowable LTV ratio and maximum available loan amount. Generally, a borrower with a higher FICO score can obtain a loan with a lower rate, higher allowable LTV ratio and higher loan amount than a borrower within the same credit category but with a lower FICO score. For the years ended December 31, 2005, 2004, and 2003, approximately 68.1%, 83.1%, and 98.4%, respectively, of our total loan originations were under this program.

• Interest ~~Only~~income ~~Advantage~~accreted ~~Program~~ on the carrying value of our residual interests plus

~~This~~• ~~program~~The ~~offers~~change ~~borrowers~~in the ~~opportunity~~carrying ~~to obtain~~value ~~a loan that allows them to make an interest only payment for the first two, three or five years~~ of ~~the~~our ~~loan.~~residual ~~At the end of the interest only period, the borrower’s loan balance is fully amortized for the remaining term of the loan~~interests. ~~The initial interest only period provides borrowers with lower payments for a period of time, allowing them to use a greater portion of their cash flow to~~

4As of December 31, 2006 the carrying value of our residual interests in securitization was $45.9 million. This represents an interest in approximately $1.04 billion in loans within four securitization trusts. In February 2007, we completed the sale, for $20 million, of our residual interest in $815 million in loans within one of the four securitization trusts.

pay off other debt, to qualify for larger loan amounts or for other uses. Because there is a slightly higher risk associated with the absence of principal reduction for the initial interest only period, the minimum credit score required for this program is higher than for the Credit Score Advantage program and the rate of the loan is slightly higher. This program is only available to our three highest credit categories, AA, A+ and B. This program was initiated in the second quarter of 2004. For the years ended December 31, 2005 and 2004, approximately 25.8% and 11.6%, respectively, of our total loan originations were made under this program.

Second Mortgage Advantage Program

This program offers subordinate mortgage loans that are generally funded concurrently and in conjunction with a first mortgage loan we originate. This program allows borrowers to obtain a lower rate on a first mortgage loan while obtaining additional funds for either a purchase or a refinancing, which can be paid off without affecting the first mortgage loan, subject to any applicable prepayment limitations. Loans funded under this program normally provide higher maximum combined LTV, or CLTV, ratios. Because of the risk associated with loans with higher LTV ratios in subordinate position, these loans generally have higher interest rates, limitations on loan amounts, lower maximum debt-to-income ratios, higher minimum credit scores and restrictions on property types. This program was initiated in the second quarter of 2004. For the years ended December 31, 2005 and 2004, approximately 0.9% and 1.8%, respectively, of our total loan originations were made under this program.

Specialty Advantage Program

For those borrowers seeking our highest allowable LTV ratios, we offer a specialty program that offers loans with a maximum LTV ratio of up to 100% based on either full income documentation or stated income. These programs offer either first or subordinate mortgages to borrowers in either of our two highest credit categories, AA or A+. Because of the additional risk associated with loans with LTV ratios at the high end of our range, there are additional limitations that are not placed on similar grades in other programs. These additional restrictions reduce the risk associated with originating loans to borrowers with these higher LTV ratios. This program was initiated in the fourth quarter of 2003. For the years ended December 31, 2005 and 2004, approximately 1.7% and 3.0%, respectively, of our total loan originations were made under this program.

Loan Production

Our wholesale lending division originates loans through a network of independent mortgage brokers, and to a lesser extent purchases loans through a network of independent mortgage lenders. We have working relationships with approximately 9,000 brokers and mortgage lenders. These relationships are initiated and maintained by our account executives who are generally able to provide ongoing, on-site customer service to ensure that loans are processed and funded as efficiently as possible. We originated loans through approximately 7,000 of these brokers during fiscal year 2005, with 50 of our highest producing brokers generating approximately 24% of our total loan production.

We developed a retail operation, which is consumer-direct lending, and began originating retail mortgage loans through Encore Credit during the third quarter of 2004. During the first quarter of 2005, we transitioned Encore Credit’s retail operation to Encore Credit’s wholly-owned subsidiary Bravo Credit Corporation. During 2005 approximately 5% of our loan production was originated through Bravo Credit.

As of December 31, 2005, we operated through seven regional processing centers located in Irvine, California, Woodland Hills, California, Walnut Creek, California, Downers Grove, Illinois, Glen Allen, Virginia, Tampa, Florida and White Plains, New York. In addition, Bravo Credit operated through eleven offices throughout the United States. As of December 31, 2005, we employed 426 loan officers and loan production account executives.

addition, beginning in the second quarter, our retail operations will be conducted solely out of Irvine.

Loan Production by Geographic Distribution

For the years ended December 31, 2005, 2004, and 2003, we originated approximately 45.9%, 56.7% and 60.1%, respectively, of our loans in California. During that same period, approximately 63.2%, 70.6% and 76.8%, respectively, of our loans were originated in Illinois, Florida and California.

The following table shows our loan originations by state for the periods shown:

	Percentage of Total Loan Originations for the Year Ended December 31, 2005		Year Ended December 31,
State in which Mortgage Loans were Funded			2005		2004		2003
	(in thousands, except percentages)
California	45.9	%	$	6,446,631	$	5,166,153	$	2,755,967
Illinois	9.2			1,295,800		789,488		488,472
Florida	8.1			1,130,347		476,857		276,561
New York	5.5			769,678		442,290		72,954
Virginia	4.6			640,224		194,984		50,716
Maryland	4.3			603,085		193,242		73,976
New Jersey	2.0			285,963		104,107		827
Nevada	1.9			273,125		237,077		71,195
Massachusetts	1.9			259,779		85,905		65,089
Michigan	1.7			239,698		153,329		89,096
Georgia	1.6			229,887		151,081		26,055
Arizona	1.6			221,064		17,440		41,792
Connecticut	1.3			188,697		117,532		40,612
Minnesota	1.1			153,453		84,954		31,552
Other states*	9.3			1,303,201		899,893		499,756
Total	100.0	%	$	14,040,632	$	9,114,332	$	4,584,620

* Each state included in “Other states” individually accounted for less than one percent of our total loan originations for the years ended December 31, 2005, 2004, and 2003.

Loan Production by Borrower’s Risk Classification

The following table sets forth information about our loan production by borrower risk classification during the periods shown:

	2005			% of TotalOriginations		2004			% of TotalOriginations		2003			% of TotalOriginations
Total Originations (in thousands)	$	14,040,632		100	%	$	9,114,332		100	%	$	4,584,620		100	%
AA Credit Category Loans*
Loan originations (in thousands)	$	9,993,650		71.18	%	$	6,148,109		67.46	%	$	3,413,217		74.45	%
Weighted average interest rate:
FRMs, or fixed-rate mortgages		8.00	%				6.86	%				6.92	%
Hybrid/Adjustable-Rate Mortgages, or Hybrid/Adjustable-Rate Mortgages		7.13	%				7.04	%				7.28	%
Margin		5.79	%				5.86	%				5.48	%
Weighted average FICO scores		640					637					623
A+ Credit Category Loans*
Loan originations (in thousands)	$	2,786,337		19.84	%	$	1,855,798		20.36	%	$	567,127		12.37	%
Weighted average interest rate:
FRMs		7.58	%				7.12	%				7.43	%
Hybrid/Adjustable-Rate Mortgages		7.71	%				7.37	%				7.75	%
Margin		6.35	%				6.30	%				6.19	%
Weighted average FICO scores		588					589					572
B+ and B Credit Category Loans
Loan origination (in thousands)	$	693,977		4.94	%	$	587,189		6.44	%	$	370,762		8.09	%
Weighted average interest rate:
FRMs		7.70	%				7.50	%				7.70	%
Hybrid/Adjustable-Rate Mortgages		8.13	%				7.87	%				8.10	%
Margin		6.55	%				6.72	%				6.45	%
Weighted average FICO scores		563					565					565
C Credit Category Loans
Loan originations (in thousands)	$	453,624		3.23	%	$	404,942		4.44	%	$	173,948		3.79	%
Weighted average interest rate:
FRMs		8.34	%				7.95	%				8.12	%
Hybrid/Adjustable-Rate Mortgages		8.57	%				8.24	%				8.61	%
Margin		6.60	%				6.93	%				6.89	%
Weighted average FICO scores		550					554					551
C- Credit Category Loans
Loan originations (in thousands)	$	113,044		0.81	%	$	118,294		1.30	%	$	59,566		1.30	%
Weighted average interest rate:
FRMs		9.83	%				9.32	%				9.58	%
Hybrid/Adjustable-Rate Mortgages		9.81	%				9.98	%				9.82	%
Margin		6.52	%				6.98	%				7.01	%
Weighted average FICO scores		544					538					541

* The characteristics of the borrowers within the grades assigned by us may differ from those of other lenders. Our AA and A+ grades, although referring to relatively higher quality borrowers within our grading methodology, would generally still be considered nonconforming loans, which carry greater default and delinquency risk than prime loans.

Loan Production by Borrowers’ Credit-Score

The following table sets forth information about our loan production based upon borrowers’ FICO scores obtained from one or more of the three principal credit bureaus:

	Year Ended December 31,
	2005				2004				2003
Weighted Average FICO Score		622				618				608
	(in thousands, except percentages)
> 800	$	18,508	*	%	$	7,713	*	%	$	3,375	*	%
781 to 800		79,194	*			41,789	*			19,824	*
751 to 780		314,809	2.2			161,129	1.8			64,295	1.4
721 to 750		548,221	3.9			298,311	3.3			119,699	2.6
701 to 720		618,581	4.4			350,468	3.9			122,541	2.7
681 to 700		888,680	6.3			533,488	5.9			183,872	4.0
651 to 680		1,979,929	14.1			1,283,869	14.1			532,754	11.6
621 to 650		2,697,027	19.2			1,698,788	18.6			814,867	17.8
601 to 620		1,796,356	12.8			1,128,720	12.4			585,701	12.8
581 to 600		1,455,214	10.4			974,331	10.7			517,936	11.3
551 to 580		1,844,764	13.1			1,212,350	13.3			736,281	16.1
521 to 550		1,182,441	8.4			924,302	10.1			610,237	13.3
501 to 520		582,259	4.1			431,519	4.7			260,974	5.7
475 to 500		34,649	*			67,555	*			12,264	*
Total loan originations	$	14,040,632	100	%	$	9,114,332	100	%	$	4,584,620	100	%

* Less than 1.0%

Loan Production by LTV Ratio

LTV ratio is an important factor for many loan originators and loan investors to measure risk within a loan. An LTV ratio is calculated by using the loan principal balance as the numerator and the lower of the home’s sales price, or appraised value, as the denominator. A loan is said to have an 80% LTV ratio if, for example, the home was purchased for $100,000 and the loan amount is $80,000. This assumes the appraised value of the home is at least $100,000.

During the three years ended December 31, 2005, 2004 and 2003, our mortgage loan origination volume, as measured by principal balance, contained loans within the following LTV ranges:

	2005				2004				2003
LTV	Amount		Percentageof LoanOriginationVolume		Amount		Percentageof LoanOriginationVolume		Amount		Percentageof LoanOriginationVolume
50% or less	$	883,939	6.3	%	$	430,753	4.7	%	$	144,172	3.1	%
50.01% to 60%		520,734	3.7			448,104	4.9			216,999	4.7
60.01% to 70%		1,175,195	8.4			1,189,271	13.0			603,773	13.2
70.01% to 75%		928,077	6.6			886,146	9.7			517,856	11.3
75.01% to 80%		1,292,238	9.2			2,185,130	24.0			920,571	20.1
80.01% to 85%		4,065,052	29.0			1,324,493	14.5			767,340	16.8
85.01% to 90%		1,939,303	13.8			1,740,310	19.1			1,107,543	24.2
90.01% to 95%		2,091,416	14.9			678,229	7.5			130,081	2.8
95.01% or more		1,144,678	8.1			231,896	2.6			176,285	3.8
Total mortgage loans	$	14,040,632	100	%	$	9,114,332	100	%	$	4,584,620	100	%

Mortgage Brokers. The broker’s role is to identify the potential borrower, obtain a completed loan application, gather necessary information and documents, submit the application requesting the interest rate and term of the loan, and serve as a liaison with the borrower through the lending process. We review and underwrite the applications submitted by the broker in accordance with our internal underwriting guidelines and then approve or deny the application. If the loan is approved, we approve the requested interest rate and terms or make a counteroffer. We fund the loan upon completion of the underwriting process and acceptance by the borrower.

Because mortgage brokers generally submit loan files to several prospective lenders simultaneously, consistent underwriting, competitive programs, price, quick response times and personal service are critical to producing loans successfully through independent mortgage brokers. To meet these requirements, we strive to provide a quick response to the loan application (generally within 24 hours). In addition, the loans are processed and underwritten in our regional offices where account executives, account managers and operations managers are available to answer questions, assist in the loan evaluation process and facilitate the ultimate funding of the loan.

We also purchase funded loans on an individual or “flow” basis from other mortgage lenders. We do not presently purchase loans from mortgage lenders on a bulk basis. Each mortgage loan purchased is underwritten to the same standards and by the same process as if we were originating the loan itself, prior to that loan being originated by the seller. Prior to purchasing a loan, we review an application for approval from each mortgage lender seeking to sell us a funded loan. We require each mortgage lender to enter into a purchase and sale agreement with customary representations and warranties regarding the loans the mortgage lender intends to sell to us.

Quality Control. Our quality control program is intended to monitor loan production with the overall goal of improving the quality of loan production generated by our retail loan operation and independent mortgage broker channel. Through systematically monitoring loan production, the quality control department can identify and communicate to our management existing or potential underwriting and loan packaging problems or other areas of concern. The quality control file review is designed to ensure compliance with our underwriting guidelines, appraisal review process and federal and state regulations. This is accomplished by focusing on:

• the accuracy of all credit and legal information;

• a collateral analysis and review of the original appraisal;

• employment and/or income verification; and

• legal document review to ensure that the necessary documents are in place.

Underwriting

We underwrite each mortgage loan that we originate or purchase in accordance with our internal underwriting guidelines. We have developed internal underwriting processes and criteria that we believe generate quality loans and give us the ability to approve and fund loans quickly. Our internal underwriting guidelines are designed to help us evaluate a borrower’s credit history, capacity, willingness and ability to repay the loan, and the value and adequacy of the collateral. We review the borrower’s credit history from Experian Information Solutions, Inc., Trans Union Corp. and Equifax, Inc.

Our Underwriting Guidelines. Our internal underwriting guidelines are established by our secondary marketing committee. Our secondary marketing committee meets regularly with our production and operations managers to review proposed changes to underwriting guidelines. If an individual loan application does not meet our formal written underwriting guidelines, but the underwriter believes both that the borrower has the ability and willingness to pay and that the property provides adequate collateral for the borrower’s obligations, our underwriters can make underwriting exceptions up to certain limits within our exception policies and formal approval authorities. All of our loan programs have tiered exception levels whereby approval of certain exceptions, such as LTV ratio exceptions, loan amount exceptions, and debt-to-income exceptions, are escalated to higher loan approval authority levels.

Our Underwriting Personnel. All of our loans are underwritten by our on-site underwriting personnel. We do not delegate underwriting authority to any broker or third party. We adhere to strict internal standards with respect to who has the authority to approve a loan. In the event that an underwriting exception is required for approval, only specifically designated personnel, dictated by the exception required, are authorized to make such exceptions. We regularly train our operations managers, who supervise our underwriters, on emerging trends in production. We believe that these managers and underwriters are highly qualified and experienced and are familiar with our underwriting guidelines.

Credit Categories. Under our internal underwriting guidelines, we have established several different credit categories within each loan program, and we assign a credit category to each applicant based on his/her credit history. These credit categories establish the maximum permitted LTV ratio, the maximum loan amount and the allowed use of loan proceeds given the borrower’s mortgage payment history, consumer credit history, liens/charge-offs/bankruptcy history, debt-to-income ratio, use of proceeds, documentation type and other factors.

Because the industry does not use standard credit categories, our definitions and credit categories of the loans we originate may differ from those used by our competitors. As a result, the credit categories and other data with respect to our loan production we provide in this annual report may not be comparable to similar data of our competitors. Also, we may change our credit category system from year-to-year, based on our on-going evaluation of historical performance and market demand. Thus, data with respect to specific credit categories within our loan production may not be comparable on a historical basis.

Our guidelines are primarily intended to: (1) determine that the borrower has the ability to repay the mortgage loan in accordance with its terms and (2) determine that the related mortgaged property will provide sufficient value to recover our investment if the borrower defaults. Although we generally do not make adjustments to the credit category of any applicant, we may determine on a case-by-case basis that an applicant warrants an LTV ratio exception, a loan amount exception, a debt-to-income exception or another exception. We may allow such an exception if the application reflects certain factors such as a lower than the maximum allowable LTV ratio, a maximum of one 30-day late payment on all mortgage loans during the last 12 months, or a meaningful amount of liquid reserves. We may also grant an exception if the applicant places in escrow a down payment of at least 20% of the purchase price of the mortgaged property or if the new mortgage loan significantly reduces the applicant’s aggregate monthly payments. All of our loan programs have tiered exception levels whereby approval of exceptions is escalated to higher loan approval authority levels. We expect that a substantial number of the mortgage loans we originate will represent such underwriting exceptions.

We obtain credit scores in connection with mortgage loan applications to help assess a borrower’s creditworthiness. Credit scores are obtained from credit reports provided by Experian Information Solutions, Inc., Trans Union Corp. and Equifax, Inc., each of which may employ differing computer models and methodologies. The credit score is designed to assess a borrower’s credit history at a fixed point in time, using objective information currently on file for the borrower at a particular credit reporting organization. Information utilized to create a credit score may include, among other things, payment history, delinquencies on accounts, level of outstanding indebtedness, length of credit history, types of credit, and bankruptcy experience. Credit scores range from approximately 400 to 850, with higher scores generally indicating an individual with a more favorable credit history compared to an individual with a lower score. However, a credit score purports only to be a measurement of the relative degree of risk a borrower represents to a lender; that is, a borrower with a higher score is statistically expected to be less likely to default in payment than a borrower with a lower score. Moreover, credit scores were developed to indicate a level of default probability over the period of the next two years, which does not correspond to the life of a mortgage loan. Furthermore, credit scores were not developed specifically for use in connection with mortgage loans, but for consumer loans in general. Therefore, a credit score does not take into consideration the differences between mortgage loans and consumer loans generally or the specific characteristics of the related mortgage loan including, for example, the LTV or CLTV, the collateral for the mortgage loan, or the debt-to-income ratio. Our current core underwriting guidelines require a minimum credit score of 500, although a higher credit score is often required to qualify for the maximum LTV under each

program. There can be no assurance that the credit scores of the mortgagors will be accurate predictors of the likelihood of repayment of the related mortgage loans.

The underwriting of a mortgage loan we originate or purchase includes a review of the completed loan package, which includes the loan application, a current appraisal, a preliminary title report and a credit report. We approve all loan applications and all closed loans offered to us for purchase in accordance with our underwriting criteria. We regularly review our underwriting guidelines and make changes when appropriate to respond to market conditions, the performance of loans representing a particular loan product and/or changes in laws or regulations.

We require satisfactory title insurance coverage on all residential properties securing mortgage loans we originate or purchase. The loan originator and its assignees are generally named as the insured. Title insurance policies indicate the lien position of the mortgage loan and protect us against loss if the title or lien position is not as indicated. The applicant is also required to maintain hazard and, in certain instances, flood insurance in an amount that complies with applicable laws and is sufficient to cover the new loan and any senior mortgage, subject to the maximum amount available under the National Flood Insurance Program.

Verification of Borrower’s Income. Our mortgage programs include several levels of documentation used to verify the borrower’s income.

Full income documentation. Our highest level of income documentation generally requires a stable, two-year history of income. A wage-earner may document income by any of the following: a verification of employment or a current pay stub reflecting year-to-date income and the borrower’s most recent Wage and Tax Statement, or W-2; the borrower’s two most recent IRS Form 1040s; or the borrower’s personal bank statements for the previous twelve months showing average monthly deposits sufficient to support the qualifying income. A self-employed borrower may document income with either the two most recent federal tax returns or bank statements for the previous two years. Loan originations made using full income documentation represented approximately 49.6%, 52.1% and 52.4% of our total loan originations, respectively, for the years ended December 31, 2005, 2004, and 2003.

Limited income documentation. This documentation level generally requires a twelve-month history of stable income, together with personal bank statements for the previous twelve months to support the borrower’s qualifying income. Loan originations made using limited income documentation represented approximately 2.3%, 4.1% and 5.7% of our total loan originations, respectively, for the years ended December 31, 2005, 2004, and 2003.

Stated income. The borrower’s income used to qualify for the loan is taken from the borrower’s signed application and compared to the borrower’s line of work or profession for reasonableness. Self-employed borrowers typically must provide satisfactory evidence of existence of the business and demonstrate a two-year history of employment in the same profession. For each stated income loan, we attempt to verify the source of the stated income. Loan originations made using stated income documentation represented approximately 48.1%, 43.8% and 41.9% of our total loan originations, respectively, for the years ended December 31, 2005, 2004, and 2003.

Appraisal Review. An assessment of the adequacy of the real property as collateral for the loan is primarily based upon an appraisal of the property and a calculation of the LTV ratio of the loan applied for and the CLTV to the appraised value of the property at the time of origination. Appraisers determine a property’s value by reference to the sales prices of comparable properties recently sold, adjusted to reflect the condition of the property as determined through inspection. As a lender that generally specializes in loans made to credit impaired borrowers, we have implemented an appraisal review process to support the value used to determine the LTV ratio. Appraisal review staff complete a post-funding review of a portion of all appraisals. We use a variety of steps in our appraisal review process in order to attempt to ensure the accuracy of the value provided by the

initial appraiser. This includes obtaining an independent automated property review on a majority of the loans that we originate. Our review process requires a written review on every appraisal report, either by a qualified independent underwriter or by a staff appraiser. We employ several methods to determine which appraisals are higher risk and attempt to direct those reviews to one of our staff appraisers. The criteria for identifying higher risk appraisal reports include those properties receiving lower scores from the automated property review, properties with larger loan amounts and those units and properties that fail a scoring template used by our internal underwriting staff. As part of their review process, our review staff verify the subject property’s sales history, those of comparable properties and review additional comparable data, where available. In some cases the value of the property used to determine the LTV ratio is reduced where it has been determined by our staff appraisers that the original appraised value cannot be supported.

Loan Sales Process and Securitizations

Prior to our initial public offering, we sold the loans we originated on a whole-loan basis. During 2005 we securitized loans with principal balances of $5.1 billion and sold to third parties loans with principal balances of $7.0 billion.

Whole-Loan Sales

Our whole-loan sales process has been structured primarily around the sale of whole-loans to large institutions for cash. In order to hedge a portion of the risk of declining market values of funded loans on our balance sheet, from time to time we may enter into forward-sale commitments with whole-loan purchasers for a portion of our production. These contracts are arrangements that obligate us to sell a pre-specified quantity of loans in accordance with predetermined guidelines for cash and to deliver the loans on a monthly basis. This process helps us to mitigate interest rate risk by originating loans for which there is a liquid market.

Under the terms of our loan sale agreements, we make representations and warranties about our loans and origination practices to the purchaser. We may be required to repurchase loans in the event that these representations are breached and have a material effect on the value of the loan, or if the applicable borrower under any loan fails to make the first (or in some cases second or third) payment following the sale of the loan to the buyer.

For the year ended December 31, 2005, we sold approximately 66% of our loans to four customers, EMC Mortgage Corporation, Countrywide Securities Corporation, DLJ Mortgage Capital, Inc., and Friedman, Billings, Ramsey, Group, Inc., to whom we sold approximately 27%, 13%, 12%, and 14%, respectively. For the year ended December 31, 2004, we sold approximately 72% of our loans to two customers, Countrywide Securities Corporation and Bear Stearns, to whom we sold approximately 39% and 33%, respectively. For the year ended December 31, 2003, we sold approximately 89% of our loans to 11 customers, including CDC Mortgage Capital Inc. and Countrywide Securities Corporation to whom we sold approximately 20% and 14%, respectively.

Securitization

In a securitization, we sell a pool of loans to a trust, established specifically for the securitization, for a cash purchase price and a certificate evidencing our residual interest ownership in the trust. The trust raises the cash portion of the purchase price by either selling securities representing interests in the loans in the trust or securities secured by the loans in the trust. Following the securitization, purchasers of securities receive the principal collected, including prepayments, on the loans in the trust. In addition, purchasers receive a portion of the interest on the loans in the trust equal to the specified “investor pass-through interest rate” on the principal balance or the stated interest on the bond. We receive the net interest income, if any, after payment of interest due to holders of the securities issued, servicing fees, guarantor fees and other trust expenses, net of the losses due to delinquencies and defaults on the mortgage loans, and provided the specified over-collateralization requirements are met.

We have structured the securitization of the loans that we retain in our loan portfolio as financings rather than sales of the underlying loans under accounting principles generally accepted in the United States, Generally Accepted Accounting Principles, or GAAP. Under these securitizations, the loans remain on our consolidated balance sheet as an asset and the securitization debt is a liability. Thus, we record interest income generated by the mortgage loans and recognize interest expense on the mortgage-backed securities over the life of the loan. The cash flow available to us will vary depending upon a number of factors, including the following:

Interest rate spread. A substantial portion of the net interest income generated by our securitized loans is based upon the spread between the weighted average interest earned on the mortgage loans and the interest payable to holders of the mortgage-backed securities collateralized by our loans. The income we receive from the securitizations structured as financings is subject to fluctuation from time to time. This is because, in the case of hybrid/adjustable-rate loans, the interest rate on the underlying mortgage loans is generally fixed for the first two or three years from origination, and fixed for the life of the loan in the case of fixed rate loans, while the holders of the applicable securities are generally paid based on a monthly adjustable LIBOR-based yield. Therefore, an increase in LIBOR reduces the net income we receive from, and the value of, these mortgage loans. In addition, the net interest income we receive from securitizations will be reduced according to the terms of the securitization documents if there are a significant amount of loan defaults or a large amount of loan prepayments, especially defaults on, or prepayments of, loans with interest rates that are high relative to the rest of the asset pool. We will attempt to mitigate at least a portion of this net interest margin variability by acquiring derivative financial instruments, such as interest rate caps, Eurodollar futures and interest rate swap agreements.

Over-collateralization. The rating agencies that rate the securities issued in our securitization transactions require that the securities have a particular level of over-collateralization in order to receive the desired rating level. We structured our first two securitizations following our initial public offering so that, instead of being released to us, all of the interest rate spread generated is applied to create over-collateralization, until the over-collateralization targets established by the applicable rating agencies are reached. We structured our subsequent two securitizations to fully fund the over-collateralization requirements upfront. In order to minimize the cash outlay in the latter two securitizations, we sold Net Interest Margin bonds, or NIM bonds, to cover the upfront cash requirements of creating over-collateralization at inception of the transaction. The NIM bonds are repaid from the interest rate spread prior to it being released to us. The required level of over-collateralization may be increased or may be prevented from decreasing as would otherwise be permitted if losses and/or delinquencies do not exceed defined levels. This could have the effect of reducing or even eliminating the net interest income payments distributed to us.

We record interest income on the mortgage loans and interest expense on the securities issued in the securitization over the life of the securitization, and do not recognize a gain or loss upon completion of the securitization for GAAP purposes.

We completed four securitizations of mortgage loans during 2005 through the sale of $5.1 billion of notes backed by a pool of fixed and adjustable rate, nonconforming mortgage loans secured by first liens on one-to-four family residential properties. The notes, which are characterized as debt for financial reporting purposes by ECC Capital, represent non-recourse obligations of trusts, which are special purpose entities consolidated by ECC Capital.

Loan Servicing

We ~~currently~~own ~~outsource~~ the servicing ofrights ~~all~~on the loans weincluded ~~originate to third party servicers or sub-servicers. We currently utilize Option One Mortgage Corporation as our sub-servicer for loans held~~ in ~~our portfolio pending sale or transfer to a securitization. Loans included in~~ the four securitizations completed in 2005. The loans are ~~also~~ being sub-serviced by Option One,. ~~and~~ Countrywide Home Loan Servicing LP and CitiMortgage, Inc. act as the master servicers. These companies are experienced in servicing nonconforming mortgage loans and are ~~highly~~ rated by the various agencies (Moody’s Investor Services, Inc., Standard & Poor’s Rating Services, Fitch Ratings, Inc.) that rate the capabilities of mortgage loan servicers. We may decide to contract with these same companies or others for future servicing arrangements or securitizations.

that rate the capabilities of mortgage loan servicers. We may decide to contract with these same companies or others for future servicing arrangements or securitizations.

Additional Financial Information About Segments

Additional financial information regarding our business segments is set forth in “Financial Statements and Supplementary Data” and is incorporated herein by reference.

Competition

WeShould ~~face~~we ~~intense~~decide ~~competition~~to inbegin originating loans on a large scale (subsequent to the ~~business~~expiration of ~~originating~~our two year covenant not to compete that began February 9, ~~purchasing~~2007) ~~and~~or ~~selling~~to ~~mortgage~~purchase loans. ~~Our~~or ~~competitors~~residuals ininterests ~~the~~we ~~nonconforming~~will ~~residential~~face intense competition from others in the mortgage industry ~~include~~including consumer finance companies, mortgage banking companies, investment banks, commercial banks, credit unions, thrift institutions, credit card issuers, insurance companies and ~~mortgage~~other mortgage REITs. Many of these competitors are substantially larger and have considerably greater financial, technical and marketing resources than us. Competition among industry participants can take many forms, including convenience in obtaining a loan, customer service, marketing and ~~distribution~~ channels, amount and term of the loan, loan origination fees and interest rates. Additional competition may lower the rates we can charge borrowers and increase the price we pay for purchased loans, thereby potentially lowering gain on future loan sales and securitizations. To the extent any of these competitors significantly expand their activities in our markets, our operations could be materially adversely affected. Fluctuations in interest rates and general economic conditions may also affect competition. During periods of rising rates, competitors that have locked in lower rates to potential borrowers may have a competitive advantage. During periods of declining rates, competitors may solicit customers in our servicing portfolio to refinance their loans.

distribution channels, amount and term of the loan, loan origination fees and interest rates. Additional competition may lower the rates we can charge borrowers and increase the price we pay for purchased loans, thereby potentially lowering gain on future loan sales and securitizations. To the extent any of these competitors significantly expand their activities in our markets, our operations could be materially adversely affected. Fluctuations in interest rates and general economic conditions may also affect competition. During periods of rising rates, competitors that have locked in lower rates to potential borrowers may have a competitive advantage. During periods of declining rates, competitors may solicit customers in our servicing portfolio to refinance their loans.

Regulation

~~The~~Although we have disposed of our mortgage origination business, we have retained many of our mortgage lending licenses. ~~industry~~To issupport ~~highly~~our ~~regulated~~portfolio protection activities or if we otherwise engage in the origination or acquisition of mortgage loans we will be required to maintain certain of our mortgage lending licenses. ~~Our~~The ~~business~~mortgage lending industry is ~~regulated~~highly regulated by federal, state and local government authorities and is subject to federal, state and local laws, rules and regulations, as well as judicial and administrative decisions, that impose requirements and restrictions on our business. At the ~~federal~~ federal level, these laws, rules and regulations include:

•

the Equal Credit Opportunity Act and Regulation B;

•

the Federal Truth in Lending Act and Regulation Z;

•

the Federal Home Ownership and Equity Protection Act, or HOEPA;

•

the Real Estate Settlement Procedures Act, or RESPA, and Regulation X;

•

the Fair Credit Reporting Act;

•

the Fair Debt Collection Practices Act;

•

the Home Mortgage Disclosure Act and Regulation C;

•

the Fair Housing Act;

•

the Telephone Consumer Protection Act;

•

the Gramm-Leach-Bliley Act;

•

the Fair and Accurate Credit Transactions Act;

•

the CAN-SPAM Act; and

•

the USA Patriot Act.

These laws, rules and regulations, among other things:

•

impose licensing obligations and financial requirements on us;

•

limit the interest rates, finance charges, and other fees that we may charge;

•

prohibit discrimination both in the extension of credit and in the terms and conditions on which credit is extended;

•

prohibit the payment of kickbacks for the referral of business incident to a real estate settlement service;

•

impose underwriting requirements;

•

mandate disclosures and notices to consumers;

•

mandate the collection and reporting of statistical data regarding our customers;

•

require us to safeguard non-public information about our customers;

•

regulate our collection practices;

•

require us to combat money-laundering and avoid doing business with suspected terrorists;

•

restrict the marketing practices we may use to find customers; and

•

in some cases, impose assignee liability on the entities that purchase our mortgage loans.

Our failure to comply with these laws can lead to:

•

civil and criminal liability, including potential monetary penalties;

•

loss of lending licenses or approved status required for continued lending and servicing operations;

•

demands for indemnification or loan repurchases from purchasers of our loans;

•

legal defenses causing delay and expense;

•

adverse effects on the servicer’s ability to enforce loans;

•

the borrower having the right to rescind or cancel the loan transaction;

•

adverse publicity;

•

individual and class action lawsuits;

•

administrative enforcement actions;

•

damage to our reputation in the industry;

•

inability to sell or securitize our loans;

•

loss of the ability to obtain ratings on our securitizations by rating agencies; or

•

inability to obtain credit to fund our operations.

Although we have systems and procedures designed to comply with these legal requirements, we cannot assure you that more restrictive laws and regulations will not be adopted in the future, or that governmental bodies will not interpret existing laws or regulations in a more restrictive manner, which could make compliance more difficult or expensive. These applicable laws and regulations are subject to administrative or judicial interpretation, but some of these laws and regulations have been enacted only recently or may be interpreted infrequently. As a result of infrequent or sparse interpretations, ambiguities in these laws and regulations may leave uncertainty with respect to permitted or restricted conduct under them. Any ambiguity under a law to which we are subject may lead to non-compliance with applicable laws and regulations.

We actively analyze and monitor the laws, rules and regulations that apply to our business, as well as the changes to such laws, rules and regulations. We seek to incorporate these laws, rules and regulations into our

technology tools, in order to eliminate, to the extent possible, human error as a source of non-compliance. In addition, we distribute user-friendly summaries of relevant laws, rules and regulations to all appropriate personnel and, as a matter of policy, we encourage responsibility for compliance throughout our organization, including our loan origination teams. Our compliance with laws, rules and regulations is reviewed not only by our own loan review employees and in-house legal staff, but by the warehouse lenders who finance our loans, the institutional loan purchasers that purchase our loans and the governmental agencies that regulate us.

Areas of Regulation

Regulatory and legal requirements are subject to change, making our compliance more difficult or expensive, or otherwise restricting our ability to conduct our business as it is now conducted. In particular, federal, state and local governments have become more active in the consumer protection area in recent years. For example, the federal Gramm-Leach-Bliley financial reform legislation imposes additional privacy obligations on us with respect to our applicants and borrowers. The Fair and Accurate Credit Transactions Act of 2003, enacted in December 2003, requires us to provide additional disclosures when we disapprove a loan application. Additional requirements will apply to our use of consumer reports and our furnishing of information to the consumer reporting agencies. Additionally, Congress and the Department of Housing and Urban Development have discussed an intent to reform RESPA. Several states have adopted privacy legislation. For example, California passed legislation known as the California Financial Information Privacy Act and the California On-Line Privacy Protection Act. Both pieces of legislation became effective July 1, 2004. If other states choose to follow California and adopt a variety of inconsistent state privacy legislation, our compliance costs could substantially increase. Moreover, several federal, state and local laws, rules and regulations have been adopted, or are under consideration, that are intended to protect consumers from predatory lending. The impact of this legislation, should it be adopted in other states, may negatively affect the availability of credit to a broader segment of the borrowing population than the smaller group that the laws are aiming to protect.

Local, state and federal legislatures, state and federal banking regulatory agencies, state attorneys general offices, the United States Federal Trade Commission, or FTC, the Department of Justice, the Department of Housing and Urban Development and state and local governmental authorities have increased their focus on lending practices by some companies, primarily in the nonconforming lending industry, sometimes referred to as “predatory lending” practices. Sanctions have been imposed by various agencies for practices such as charging excessive fees, imposing higher interest rates than the credit risk of some borrowers warrant, failing to disclose adequately the material terms of loans to borrowers and abrasive servicing and collections practices. The Office of the Comptroller of the Currency, the regulator of national banks, issued a final regulation in 2004, which prescribed an explicit anti-predatory lending standard, which prohibits a national bank from making a loan based predominately on the foreclosure value of the borrower’s home, rather than the borrower’s repayment ability, including current and expected income, current obligations, employment status and relevant financial resources.

HOEPA identifies a category of mortgage loans and subjects such loans to restrictions not applicable to other mortgage loans. Loans subject to HOEPA consist of loans on which certain points and fees or the annual percentage rate, known as the APR, exceed specified levels. Liability for violations of applicable law with regard to loans subject to HOEPA would extend not only to us, but to the institutional loan purchasers of our loans as well. It is our policy to seek not to originate or purchase loans that are subject to HOEPA or state and local laws discussed in the following paragraph because the institutional loan purchasers of our loans and/or the warehouse lenders that provide financing for our loan origination operations do not want to purchase or finance such loans. On October 1, 2002, the APR and points and fees thresholds for determining loans subject to HOEPA were lowered, thereby expanding the scope of loans subject to HOEPA. We anticipate that we will continue to avoid originating or purchasing loans subject to HOEPA, and the lowering of the thresholds beyond which loans become subject to HOEPA may prevent us from originating certain loans and may cause us to reduce the APR or the points and fees on loans that we do originate. If we decide to relax our restrictions on loans subject to HOEPA because our institutional loan purchasers and/or our warehouse lenders relax their restrictions, we will be subject to greater risks for actual or perceived non-compliance with HOEPA and other applicable laws,

including demands for indemnification or loan repurchases from our warehouse lenders and institutional loan purchasers, class action lawsuits and administrative enforcement actions.

Laws, rules and regulations have been adopted, or are under consideration, at the state and local levels that are similar to HOEPA in that they impose certain restrictions on loans on which certain points and fees or the APR exceeds specified thresholds, which generally are lower than under federal law. These restrictions include prohibitions on steering borrowers into loans with high interest rates and away from more affordable products, selling unnecessary insurance to borrowers, flipping or repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans. Compliance with some of these restrictions requires lenders to make subjective judgments, such as whether a loan will provide a “net tangible benefit” to the borrower. These restrictions expose a lender to risks of litigation and regulatory sanction no matter how carefully a loan is underwritten. Often, remedies for violations of these laws are not based on actual harm to the consumer and can result in damages that exceed the loan balance. In addition, an increasing number of these laws, rules and regulations seek to impose liability for violations on assignees, which may include our warehouse lenders, whole-loan buyers and securitization trusts, regardless of whether such assignee knew of or participated in the violation.

The continued enactment of these laws, rules and regulations may prevent us from originating certain loans and may cause us to reduce the interest rate or the points and fees on loans that we do originate. We may decide to originate a loan that is covered by one of these laws, rules or regulations only if, in our judgment, the loan is made in accordance with our strict legal compliance standards and without undue risk relative to litigation or to the enforcement of the loan according to its terms. If we decide to relax our self-imposed restrictions on originating loans subject to these laws, rules and regulations, we will be subject to greater risks for actual or perceived non-compliance with the laws, rules and regulations, including demands for indemnification or loan repurchases from the parties to whom we broker or sell loans, class action lawsuits, increased defenses to foreclosure of individual loans in default, individual claims for significant monetary damages, and administrative enforcement actions. In addition, the difficulty of managing the risks presented by these laws, rules and regulations may decrease the availability of warehouse financing and the overall demand for nonconforming loans, making it difficult to fund or sell any of our loans. If nothing else, the growing number of these laws, rules and regulations will increase our cost of doing business as we are required to develop systems and procedures designed to ensure that we do not violate any aspect of these new requirements.

A substantial portion of our mortgage loans are originated through independent mortgage brokers. Mortgage brokers provide valuable services in the loan origination process and are compensated for their services by receiving fees on loans. Brokers may be paid by the borrower, the lender or both. If a borrower cannot or does not want to pay the mortgage broker’s fees directly, the loan can be structured so that the mortgage broker’s fees are paid from the proceeds of the loan, or the loan can provide for a higher interest rate or higher fees to the lender. The increased value of a loan with a higher interest rate enables the lender to pay all or a portion of the broker’s compensation. This form of compensation is often referred to as a “yield spread premium.” Regardless of its label or method of calculation, the payment is intended to compensate the broker for the services actually performed and the goods and facilities actually provided. Competitive forces currently demand that we pay mortgage brokers yield spread premiums and other forms of compensation on many of the loans we originate.

RESPA prohibits the payment of fees for the mere referral of real estate settlement service business. This law does permit the payment of reasonable value for services actually performed and the goods and facilities actually provided unrelated to the referral. In the past, several lawsuits have been filed against mortgage lenders alleging that such lenders have made certain payments to independent mortgage brokers in violation of RESPA. These lawsuits generally have been filed on behalf of a purported nationwide class of borrowers alleging that payments made by a lender to a broker in addition to payments made by the borrower to a broker are prohibited by RESPA and are therefore illegal. On September 18, 2002, the Eleventh Circuit Court of Appeals issued a decision in Heimmermann v. First Union Mortgage Corp., which reversed the court’s earlier decision in Culpepper v. Irwin Mortgage Corp. in which the court found the yield spread premium payments received by a

mortgage broker to be unlawful per se under RESPA. The Department of Housing and Urban Development responded to the Culpepper decision by issuing a policy statement (2001-1) taking the position that lender payments to mortgage brokers, including yield spread premiums, are not per se illegal. The Heimmermann decision eliminated a conflict that had arisen between the Eleventh Circuit and the Eighth and Ninth Circuit Courts of Appeals, with the result that all federal circuit courts that have considered the issue have aligned with the Department of Housing and Urban Development policy statement and found that yield spread premiums are not prohibited per se. If other circuit courts that have not yet reviewed this issue disagree with the Heimmermann decision, there could be a substantial increase in litigation regarding lender payments to brokers and in the potential costs of defending these types of claims and in paying any judgments that might result. Although we believe that our broker compensation programs comply with all applicable laws and are consistent with long-standing industry practice and regulatory interpretations, in the future new regulatory interpretations or judicial decisions may require us to change our broker compensation practices. Such a change may have a material adverse effect on us and the entire mortgage lending industry.

Compliance, Quality Control and Quality Assurance

We maintain a variety of quality control procedures designed to detect compliance errors prior to funding. We have a stated anti-predatory lending policy, which is communicated to all employees at regular training sessions. In addition, we subject a statistical sampling of our loans to post-funding quality assurance reviews and analysis. We track the results of the quality assurance reviews and report them back to the responsible origination units. Our loans and practices are reviewed regularly in connection with the due diligence that our loan buyers and lenders perform. State regulators also review our practices and loan files and report the results back to us.

Privacy

The federal Gramm-Leach-Bliley Act obligates us to safeguard the information we maintain on our borrowers. California has passed legislation known as the California Financial Information Privacy Act and the California On-Line Privacy Protection Act. Both pieces of legislation became effective on July 1, 2004. Regulations have been enacted and/or proposed by several agencies and states that may affect our obligations to safeguard information. If other states or federal agencies adopt additional privacy legislation, our compliance costs could substantially increase.

Fair Credit Reporting Act

The Fair Credit Reporting Act provides federal preemption for lenders to share information with affiliates and certain third parties and to provide pre-approved offers of credit to consumers. Congress also amended the Fair Credit Reporting Act to place further restrictions on the use of information shared between affiliates, to provide new disclosures to consumers when risk based pricing is used in the credit decision, and to help protect consumers from identity theft. All of these new provisions impose additional regulatory and compliance costs on us and reduce the effectiveness of our marketing programs.

Home Mortgage Disclosure Act

In 2002, the Federal Reserve Board adopted changes to Regulation C promulgated under the Home Mortgage Disclosure Act. Among other things, the new regulations require lenders to report pricing data on loans with annual percentage rates that exceed the yield on treasury bills with comparable maturities by three percent for senior liens and five percent for second liens. The expanded reporting requirements took effect in 2004 for reports filed in 2005 and remain in place today. We anticipate that a number of our loans will be subject to the expanded reporting requirements.

The expanded reporting does not provide for additional loan information such as credit risk, debt-to-income ratio, LTV ratio, documentation level or other salient loan features. As a result, lenders like us are concerned that the reported information may lead to increased litigation as the information could be misinterpreted by third parties.

Telephone Consumer Protection Act and Telemarketing Consumer Fraud and Abuse Prevention Act

The FCC and the FTC adopted “do-not-call” registry requirements, which, in part, mandate that companies such as us maintain and regularly update lists of consumers who have chosen not to be called. These requirements also mandate that we do not call consumers who have chosen to be on the list. Several states have also adopted similar laws, with which we believe we also comply.

Licensing Status

AsWe currently hold licenses (or are exempt from licensing requirements) to originate and service mortgages in a total of ~~December 31,~~40 ~~2005,~~states in the name of ECC Capital ~~was licensed~~, orPerformance ~~exempt~~Credit ~~from~~Corporation ~~licensing~~or PerformanceOne Financial, toInc. ~~table~~(formerly ~~fund~~known ~~first~~as Bravo Credit Corporation). As we have exited the wholesale mortgage ~~loans~~origination inbusiness, 48we ~~states~~anticipate ~~and~~that we will reduce the ~~District~~number of ~~Columbia~~active ~~and~~licenses we hold to ~~table~~those ~~fund~~necessary ~~subordinate~~to ~~mortgage~~support ~~loans~~our inportfolio 47protection ~~states~~activities and ~~the~~ownership ~~District~~of loan servicing rights on our portfolio of loans ~~Columbia~~held for investment.

~~Encore~~6 Credit and Bravo Credit were licensed, or exempt from licensing, to originate first mortgage loans in all 50 states and the District of Columbia and were licensed, or exempt from licensing, to originate subordinate mortgage loans in 49 states and the District of Columbia.

EncoreTable Credit is currently not licensed to originate subordinate mortgage loans in Ohio. Encore Credit may broker first and subordinate mortgage loans in 49 states and the District of Columbia. Encore Credit is currently not licensed to broker any mortgage loans in the State of Montana. Contents

Employees

At December 31, ~~2005~~2006, we employed ~~approximately~~715 ~~1,667~~people. ~~persons,~~Immediately ~~including~~prior ~~426~~to ~~loan~~the ~~officers~~close ~~and~~of ~~loan~~the ~~production~~sale ~~account executives.~~of Wethe ~~believe~~mortgage webanking ~~have~~operations ~~satisfactory~~to ~~relations~~Bear ~~with~~Stearns ~~our~~on ~~employees~~February 9, ~~none~~2007 ofwe ~~whom~~employed ~~are~~732 ~~represented by unions~~people. OnFollowing ~~January 6,~~the ~~2006,~~close weof ~~announced~~the asale ~~cost~~658 ~~savings~~people became ~~initiative~~employees ~~that~~of ~~included~~Bear aStearns. ~~reduction~~As inof ~~our work force~~March 30, ~~after~~2007 ~~which~~ we employed approximately ~~1,227~~40 ~~persons,~~people. ~~including~~We ~~318~~believe ~~loan~~we ~~officers~~have ~~and~~satisfactory ~~loan~~relations ~~production~~with ~~account~~our ~~executives. On April 11~~employees, ~~2006,~~none weof ~~announced~~whom anare ~~additional~~represented ~~reduction~~by inunions ~~workforce of approximately 170 employees.~~

Available Information

We make available, free of charge, on the Investor Relations section of our Web site (www.ecccapital.com), our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16 reports and any amendments to those reports as soon as reasonably practicable after such reports or amendments are electronically filed with or furnished to the SEC.

197

Item 1A.

Risk Factors

Statements made by us in this annual report and in other reports and statements released by us that are not historical facts constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21 of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These forward-looking statements are necessarily estimates reflecting the best judgment of senior management and include comments that express our opinions about trends and factors that may impact future operating results. Disclosures that use words such as we “believe,” “anticipate,” “estimate,” “intend,” “could,” “plan,” “expect” and similar expressions are intended to identify forward-looking statements. Such statements rely on a number of assumptions concerning future events, many of which are outside of our control, and involve risks and uncertainties that could cause actual results to differ materially from opinions and expectations. Any such forward-looking statements, whether made in this annual report or elsewhere, should be considered in context of the various disclosures made by us about our businesses including, without limitation, the risk factors discussed below. We do not plan to update any such forward-looking statements and expressly disclaim any duty to update the information contained in this annual report, except as required by law.

We operate in a rapidly changing environment that involves a number of risks. The following discussion highlights some of these risks and others are discussed elsewhere in this annual report. These and other risks could materially and adversely affect our business, financial condition, prospects, operating results and cash flows.

Risks Related to Our Business Activities

~~Our~~We ~~business~~are limited ~~requires~~in aour ~~significant~~future ~~amount~~operations ofsince ~~cash,~~we ~~and~~agreed ifnot itto iscompete ~~not~~in ~~available,~~wholesale ~~our~~subprime ~~business~~lending ~~and~~until ~~financial~~February ~~performance~~2009 ~~will~~in beconnection ~~significantly~~with ~~harmed~~selling our wholesale lending operations to Bear Stearns.

WeSubstantially ~~require~~all ~~substantial amounts~~ of ~~cash to fund~~ our ~~loan~~mortgage ~~originations and to pay loan origination expenses. By holding our~~ loans ~~pending~~that ~~sale or securitization,~~ we ~~may~~securitized ~~also~~were ~~require~~originated ~~cash~~through as our ~~warehouse~~wholesale ~~facilities~~mortgage ~~may~~operations. ~~not~~When ~~fund~~we ~~the~~sold ~~entire principal balance of our loans, or if our loans are financed past~~ the ~~permitted~~wholesale ~~term~~mortgage operations ~~under~~to ~~our~~Bear ~~warehouse~~Stearns ~~lines, or decline~~ in ~~value~~February 2007, we ~~may~~agreed ~~need~~not ~~cash~~ to ~~reduce~~compete ~~our~~in ~~borrowing under~~ the ~~warehouse~~wholesale ~~facilities~~subprime tomortgage ~~the~~brokerage ~~permitted~~or ~~level.~~correspondent Webusiness ~~also~~for ~~need~~two ~~cash~~years. toAs ~~satisfy~~a ~~our working capital~~result, ~~minimum~~we ~~REIT~~are ~~distribution~~significantly ~~requirements,~~limited ~~financial covenants~~ in our ~~warehouse~~ability ~~facilities~~to ~~and~~originate ~~other needs. We finance~~ the ~~majority~~subprime ~~of the~~ mortgage loans we ~~make~~would byuse ~~borrowing~~to ~~from~~further build our ~~warehouse~~loan ~~facilities~~portfolio and ~~pledging the loans made as collateral~~securitize. IfThis ~~the~~limitation ~~value~~could ofnegatively ~~the~~impact ~~loans~~our ~~we pledged as collateral declines, we may need~~ cash ~~to offset any decline in value. In addition~~flows, ifresults ~~our minimum distribution requirements to maintain our REIT status become large relative to our cash flow as a result~~ of ~~our income exceeding our cash flow~~operations, wefinancial ~~may~~condition beand ~~forced to borrow to raise capital on unfavorable terms in order to maintain our REIT qualification~~liquidity.

~~Our~~The ~~primary~~nonconforming ~~sources~~mortgage ofloans ~~cash~~we hold in our securitizations and in inventory generally have higher delinquency and default rates than prime mortgage loans, which could result in losses on loans that we retain ~~consist~~or ~~of:~~are required to repurchase.

•The ~~borrowings~~nonconforming mortgage loans we hold generally have higher delinquency and default rates than prime mortgage loans. Delinquency interrupts the flow of projected interest income from a mortgage loan, ~~including~~and ~~under~~default can ultimately lead to a loss if the net realizable value of the real property securing the mortgage loan is insufficient to cover the principal and interest due on the loan. Also, our ~~warehouse~~cost ~~facilities;~~of financing and servicing a delinquent or defaulted loan is generally higher than for a performing loan. When we securitize we bear exposure to delinquencies and losses through our residual interests and the loans underlying our on-balance sheet securitization transactions. We have established allowances based on our anticipated delinquencies and losses. We also re-acquire the risks of delinquency and default for loans that we are obligated to repurchase. We attempted to manage these risks with risk-based loan pricing and appropriate underwriting policies and loan collection methods. However, if such policies and methods are insufficient to control our delinquency and default risks and do not result in appropriate loss allowances, our business, financial condition, liquidity and results of operations could be harmed.

•8 ~~our net interest income;~~

• the proceeds from the sale of our loans; and

• net proceeds from the sale of our securities.

Pending the sale or securitization of a pool of mortgage loans, we originate mortgage loans that we finance through borrowings from our warehouse facilities. It is possible that our warehouse lenders could experience changes in their ability to advance funds to us, independent of our performance or the performance of our loans. In addition, if the regulatory capital requirements imposed on our lenders change, our lenders may be required to increase significantly the cost of the lines of credit that they provide to us.

AsOur ofprior ~~December 31,~~internal ~~2005,~~underwriting westandards ~~financed~~used ~~substantially all of our loan originations through warehouse facilities. Each of these facilities may be terminated by the lender upon an event of default, subject in some cases~~ to ~~cure~~qualify ~~periods.~~loans Aswhich ~~of December 31, 2005, the aggregate balance outstanding under these facilities was approximately $2.7 billion. The warehouse facilities mature between April 2006 and November 2006. If~~ we ~~are~~hold ~~not able to renew any of these warehouse facilities or arrange~~ for ~~new~~investment ~~financing~~may onnot ~~terms~~provide ~~acceptable to us, or if we default on our covenants or are otherwise~~adequate ~~unable~~protection toagainst ~~access~~the ~~funds~~risks ~~under~~inherent ~~any~~in ofnonconforming ~~these~~residential ~~facilities,~~mortgage ~~we may not be able to originate new~~ loans orand ~~continue~~as toa ~~fund our operations~~result, ~~which would have a material adverse effect on~~ our ~~business,~~cash ~~financial condition~~flows, ~~liquidity and~~ results of operations~~. We~~, ~~determined that we were not in compliance with certain of these~~ financial ~~covenants~~condition ~~(primarily profitability covenants)~~ and weliquidity, ~~received~~including ~~waivers~~any ~~concerning~~net ~~the~~interest ~~non-compliance~~income ~~with these covenants~~ from ~~the applicable lenders. If we fail to comply with financial covenants in any of our warehouse facilities in the future and are not able to cure the non-compliance or obtain the necessary waiver~~securitizations, ~~these~~could ~~facilities may~~ be ~~terminated by the lender~~materially harmed.

WeA ~~generally~~substantial ~~fund~~portion ~~less~~of ~~than~~the ~~100%~~loans ofwe aoriginated ~~loan~~were ~~balance~~underwritten generally in accordance with ~~warehouse~~our ~~debt,~~underwriting guidelines ~~requiring~~that usare intended to ~~invest~~provide ~~cash~~for nonconforming residential mortgages. The mortgage industry often refers to ~~the~~mortgage ~~extent~~loans ~~the~~that ~~originated~~are ~~balance~~eligible isfor sale to government-sponsored entities, such as Fannie Mae and Freddie Mac, under both size and credit characteristics, as conforming or prime loans, while those mortgage loans that do not ~~funded~~satisfy the credit, documentation or other underwriting standards prescribed by ~~the~~those ~~warehouse~~government ~~facility~~sponsored entities are often referred to as nonconforming loans. Accordingly, ~~This~~mortgage ~~funding~~loans ~~shortfall~~underwritten ~~ranges~~under ~~from~~our 0%underwriting standards are likely to 2%experience onrates ~~newly~~of ~~originated~~delinquency, ~~loans.~~foreclosure ~~The~~and ~~longer~~loss that are higher, and may be substantially higher, than mortgage loans ~~remain~~originated ~~funded~~in byaccordance awith ~~warehouse~~Fannie Mae ~~facility~~or ~~the~~Freddie ~~more~~Mac underwriting guidelines. We cannot be certain that our ~~warehouse~~ ~~lenders~~underwriting ~~require~~criteria uswill toafford ~~advance~~adequate protection against the higher risks associated with loans. Inmade ~~addition,~~to ~~our~~such ~~warehouse~~borrowers. ~~lenders~~If ~~may~~we ~~require~~are usunable to ~~have~~mitigate onthese ~~deposit~~risks, aour cash flows, ~~margin~~results ~~against~~of ~~funded~~operations, ~~loans~~financial ~~based~~condition ~~upon~~and ~~the~~liquidity, ~~loan’s~~including ~~estimated~~any ~~market~~net ~~value~~interest income from securitizations, could be materially harmed.

~~The~~Our ~~market~~adjustable ~~for~~rate ~~any~~mortgage ~~senior~~products orexpose ~~subordinate~~us ~~securities we issue through securitizations could become temporarily illiquid or trade at steep discounts, thereby reducing the cash flow we receive over time from our loans subject~~ to ~~the~~greater securities. In addition, our operating cash flow could be reduced if we sell more loans at a discount than at a premium or at lower premiums. Cash flows from principal repayments could be reduced should prepayments slow or should credit ~~quality trends deteriorate (in the latter case since, for certain of our assets, credit tests must be met for us to receive cash flows)~~risk.

InThrough ~~the~~our ~~event~~securitizations, ~~that~~as ~~our~~of ~~liquidity~~December 31, ~~needs~~2006, ~~exceed~~we hold interests in adjustable rate mortgages or ARM loans totaling $1.8 billion, or 76.0% of our ~~access~~total portfolio. Since the payment is subject to ~~liquidity~~adjustment at some future point in time, weif interest rates increase, the borrower’s income may ~~need~~not be able to ~~sell~~support ~~assets~~the atmonthly anpayment ~~inopportune~~on ~~time~~the loan when the formerly fixed payment adjusts upward to reflect the increased interest rate. During 2007, ~~thus~~we ~~reducing~~expect ~~our~~that ~~earnings~~the initial fixed interest rate periods for a majority of the ARM loans we securitized in 2005 will expire. ~~Adverse~~As ~~cash~~they ~~flow~~expire, ~~could~~it ~~threaten~~is ~~our~~likely ~~continued~~that ~~ability~~the tointerest ~~satisfy~~rate on the ~~income~~loans ~~and~~will ~~asset~~increase, ~~tests~~thereby ~~necessary~~increasing tothe ~~maintain~~monthly ~~our status~~payment asamounts. aThis ~~REIT~~increase orin ~~our~~the ~~solvency~~monthly payment amounts may lead to increased default rates and losses.

Our ~~warehouse~~interest-only ~~and~~loans ~~repurchase~~may ~~facilities contain~~have ~~covenants~~a ~~that~~higher ~~restrict~~risk ~~our~~of ~~operations~~default ~~and~~than our ~~ability~~fully-amortizing ~~to make distributions if we are not in compliance with certain financial and other covenants~~loans.

~~Our~~Through ~~warehouse~~our ~~and~~securitizations, ~~repurchase~~as ~~facilities~~of ~~contain~~December 31, ~~restrictions~~2006, ~~and~~we ~~covenants~~hold ~~that,~~interests ~~among~~in ~~other~~interest-only ~~things~~loans totaling $0.5 billion, or 20.0% of our total portfolio. These interest-only loans require usthe borrowers to ~~satisfy specified~~make ~~financial~~monthly payments only of accrued interest for the first 24, ~~asset~~36, ~~quality~~120 or 160 months following origination. After such interest-only period, the borrower’s monthly payment is recalculated to cover both interest and principal so that the mortgage loan ~~performance~~will ~~tests~~amortize fully prior to its final payment date. IfThe weinterest-only ~~fail~~feature may reduce the likelihood of prepayment during the interest-only period due to ~~meet~~the orsmaller monthly ~~satisfy~~payments ~~any~~relative ofto ~~these~~a ~~covenants~~fully-amortizing mortgage loan. If the monthly payment increases, wethe ~~would~~related borrower may not be inable ~~default~~to ~~under~~pay ~~these~~the ~~agreements~~increased amount and ~~our~~may ~~lenders~~default ~~could~~or ~~elect~~may torefinance ~~declare~~the ~~all~~related ~~amounts~~mortgage ~~outstanding~~loan ~~under~~to avoid the ~~agreements~~higher topayment. Because no principal payments may be ~~immediately~~made ~~due~~on ~~and~~such ~~payable~~mortgage loans for an extended period following origination, ~~enforce~~if ~~their~~the ~~interests~~borrower ~~against~~defaults, ~~collateral~~the ~~pledged~~unpaid ~~under~~principal ~~such~~balance ~~agreements~~of ~~and~~the ~~restrict~~related ~~our~~loans ~~ability~~would tobe ~~make~~greater ~~additional~~than ~~borrowings~~otherwise would be the case for a fully-amortizing loan, increasing the risk of loss on these loans.

~~The~~Declining ~~covenants~~real ~~and~~estate ~~restrictions~~values ~~in our warehouse~~ and ~~repurchase~~tightening ~~facilities~~credit ~~may~~standards ~~restrict~~could harm our operations. ~~ability to, among other things:~~

Declining real estate values and tightening credit standards significantly increase the likelihood that we will incur increased payment delinquencies, foreclosures and losses on loans we own or in our securitization portfolio or in inventory in the event of default. During periods of declining real estate values borrowers may be less likely to make payments if they feel their home is losing value. In addition, if credit standards tighten, borrowers who have financial difficulty and need cash quickly may not be able to access equity in their home and, as a result, may forgo making their mortgage payment to obtain cash. Therefore, any sustained period of declining real estate values or tightening credit standards could adversely affect both our net interest income from loans in our

securitized mortgage loan portfolio and loan inventory which would significantly harm the cash flows we receive from our securitizations, results of operations and value of loans in inventory, availability of credit, financial condition, and our ability to make distributions to our stockholders.

Our business requires a significant amount of cash, and if it is not available, our business and financial performance will be significantly harmed.

We need cash to satisfy our working capital and minimum REIT distribution requirements and to maintain solvency. Although we do not currently fund new loans or have any warehouse agreements, it is possible that we may obtain warehouse facilities and fund loans that subject us to financial covenants. We may also require cash to fund any future retail loan originations and to pay loan origination expenses. We may finance any loans we make in the future in our retail business with cash on hand or by borrowing from a warehouse facility and pledging the loans made as collateral. If the value of the loans we pledged as collateral declines, we may need cash to offset any decline in value. In addition, if our minimum distribution requirements to maintain our REIT status become large relative to our cash flow as a result of our income exceeding our cash flow, we may be forced to borrow to raise capital in order to maintain our REIT qualification. Any borrowings may be on unfavorable terms or may not be available at all.

Our primary sources of cash consist of our net interest income and net proceeds from the sale of our securities.

Should we choose to acquire pools of loans in the future pending the sale or securitization of these mortgage loans, they may be financed through borrowings from warehouse facilities. It is possible that these warehouse lenders could experience changes in their ability to advance funds to us, independent of our performance or the performance of our loans. In addition, if the regulatory capital requirements imposed on our future warehouse lenders change, these lenders may be required to increase significantly the cost of the lines of credit that they provide to us.

If we fail to comply with financial covenants in any of our warehouse facilities in the future and are not able to cure the non-compliance or obtain the necessary waiver, these facilities may be terminated by the lender. The covenants and restrictions in any future warehouse facilities may restrict our ability to, among other things:

•

incur or guarantee additional debt;

•

make certain investments and other restricted payments;

•

pay dividends or distributions on, or redeem or repurchase, capital stock;

•

issue or sell capital stock of restricted subsidiaries;

•

grant liens;

•

enter into transactions with affiliates;

•

engage in mergers or consolidations, transfer substantially all of our assets or other events constituting a change in control;

•

finance loans with certain attributes;

•

reduce liquidity below certain levels; and

•

hold loans for longer than established time periods.

These restrictions may interfere with our ability to obtain financing, to engage in other business activities or to make distributions if we are not in compliance with these covenants, which may materially harm our business, financial condition, liquidity and results of operations. ~~See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Warehouse and Repurchase Facilities.”~~

~~We face~~10 ~~intense competition that could adversely affect our market share and our revenues.~~

We face intense competition from finance and mortgage banking companies, other mortgage REITs and other Internet-based lending companies where entry barriers are relatively low. In addition, certain government-sponsored entities, such as the Federal National Mortgage Association or Fannie Mae and the Federal Home Mortgage Corporation or Freddie Mac, are also expanding their participation in the nonconforming residential mortgage industry. These government-sponsored entities have a size and cost-of-funds advantage that allows them to purchase loans with lower rates or fees than we are willing to offer. While the government-sponsored entities presently do not have the legal authority to originate mortgage loans, including nonconforming loans, they do have the authority to buy loans. A material expansion of their involvement in the market to purchase nonconforming loans could change the dynamics of the industry by virtue of their sheer size, pricing power and the inherent advantages of a government charter. In addition, if as a result of their purchasing practices, these government-sponsored entities experience significantly higher-than-expected losses, such experience could adversely affect the overall investor perception of the nonconforming residential mortgage industry.

The intense competition in the nonconforming residential mortgage industry has also led to rapid technological developments, evolving industry standards and frequent releases of new products and enhancements. Our inability to continue enhancing our current Internet capabilities, or to adapt to other technological changes in the industry, could have a material adverse effect on our results of operations, financial condition and business prospects.

Competition in the industry can take many forms, including interest rates and costs of a loan, less stringent underwriting standards, convenience in obtaining a loan, customer service, amount and term of a loan and marketing and distribution channels. The need to maintain mortgage loan volume in this competitive environment creates a risk of price and quality competition in the mortgage industry. In fact, we have recently experienced significant price competition from other industry participants. Price competition could cause us to lower the interest rates that we charge borrowers, which could lower the value of our loans for either sale or our portfolio. If our competitors in the nonconforming residential mortgage market adopt less stringent underwriting standards, we will be pressured to do so as well, which would result in greater loan risk without compensating pricing. If we do not relax underwriting standards in response to our competitors, we may lose market share. Any increase in these pricing and underwriting pressures could reduce the volume of our loan originations and sales and have a material adverse effect on our business, financial condition, liquidity and results of operations.

We may be required to repurchase mortgage loans or indemnify investors if we breach representations and warranties, which could adversely impact our earnings.

When we sell loans, we are required to make customary representations and warranties about such loans to the loan purchaser. Our whole-loan sale agreements require us to repurchase or substitute loans in the event we breach a representation or warranty given to the loan purchaser or make a misrepresentation during the mortgage loan origination process. In the case of securitized loans, we may be required to replace them with substitute loans or cash. In addition, we may be required to repurchase loans as a result of borrower fraud or in the event of early payment default on a mortgage loan. The remedies available to a purchaser of mortgage loans are generally

~~broader~~If ~~than~~we ~~those~~use ~~available~~a towarehouse usfacility ~~against~~we ~~the~~generally ~~originating~~will ~~broker.~~fund ~~Further,~~less ifthan a100% ~~purchaser~~of ~~enforces~~a ~~its~~loan ~~remedies~~balance ~~against~~with uswarehouse debt, werequiring ~~may~~us ~~not~~to beinvest ~~able~~cash to ~~enforce~~ the ~~remedies~~extent wethe ~~have~~originated ~~against~~balance ~~the~~is ~~broker.~~not ~~The~~funded ~~repurchased~~by ~~loans~~the ~~typically~~warehouse ~~can~~facility. ~~only~~This befunding ~~financed~~shortfall atgenerally aranges ~~steep~~from ~~discount~~0% to ~~their~~2% ~~repurchase~~or ~~price,~~greater ifon atnewly ~~all~~originated loans. ~~Even~~The iflonger weloans ~~are~~remain ~~able~~funded toby ~~resell~~a warehouse facility the ~~repurchased~~more ~~loans,~~our ~~repurchased~~warehouse ~~loans~~lenders ~~are~~require ~~typically~~us ~~sold~~to atadvance ~~a significant~~against ~~discount~~the toloans. ~~the~~In ~~unpaid~~addition, ~~principal~~warehouse ~~balance.~~lenders ~~Significant~~may ~~repurchase~~require ~~activity~~us ~~could~~to ~~negatively~~have ~~affect~~on ~~our~~deposit a cash ~~flow~~margin ~~and~~against ~~results~~funded ofloans ~~operations~~based upon the loan’s estimated market value.

IfThe market for any senior or subordinate securities we doissue ~~not~~through ~~maintain~~securitizations ~~the~~could ~~appropriate~~become ~~state~~temporarily ~~licenses~~illiquid or trade at steep discounts, thereby reducing the cash flow we ~~will~~receive ~~not~~over betime ~~allowed~~from our loans subject to ~~originate~~the ~~and~~securities. ~~purchase~~In ~~mortgage~~addition, our operating cash flow could be reduced if we sell more loans at a discount than at a premium. Cash flows from principal repayments could be reduced should prepayments slow or should credit quality trends deteriorate (in ~~some~~the ~~states,~~latter ~~which~~case ~~would~~since, ~~adversely~~for ~~affect~~certain of our ~~operations~~ assets, credit tests must be met for us to receive cash flows).

~~State~~In ~~mortgage finance licensing laws vary considerably. Most states and~~ the ~~District~~event ofthat ~~Columbia~~our ~~require~~liquidity aneeds ~~license~~exceed inour ~~order~~access to ~~originate~~liquidity, ~~first~~we ~~and/or~~may ~~subordinate~~need ~~residential~~to ~~mortgage~~sell ~~loans.~~assets Inat ~~most~~an ofinopportune ~~these states~~time, ~~the~~thus ~~required~~reducing ~~license~~our ~~covers both first mortgage and subordinate mortgage loans~~earnings. Adverse Incash ~~some~~flow ~~states,~~could athreaten ~~separate~~our ~~license~~continued orability ~~additional license is needed~~ to ~~originate~~satisfy ~~subordinate mortgage loans. In some of~~ the ~~states~~income ~~that~~and ~~require~~asset atests ~~license~~necessary to ~~originate~~maintain ~~residential~~our ~~mortgage~~status ~~loans,~~as a ~~license~~REIT isor ~~also required to purchase closed mortgage loans. If we are unable to obtain and maintain the appropriate state licenses,~~ our ~~operations may be adversely affected~~solvency.

~~The~~We ~~residential~~may ~~mortgage~~be ~~origination~~required ~~business~~to isrepurchase amortgage ~~cyclical~~loans ~~industry~~or ~~and~~indemnify ~~has~~investors ~~recently~~if ~~entered~~we abreach ~~period~~representations ofand ~~declining origination volume~~warranties, which could adversely impact our ~~business~~earnings.

~~The~~In ~~residential~~order ~~mortgage~~to ~~origination business~~sell ~~has~~loans ~~historically~~we have been arequired ~~cyclical~~and ~~industry,~~may ~~enjoying~~be ~~periods~~required ofin ~~strong~~the ~~growth~~future to make customary representations and ~~profitability~~warranties ~~followed~~about bysuch ~~periods~~loans ofto ~~shrinking~~the loan ~~volumes~~purchaser. ~~and~~These ~~industry~~whole-~~wide~~loan ~~losses.~~sale ~~During~~agreements ~~periods~~require ofus ~~rising~~to ~~interest~~repurchase ~~rates,~~or ~~refinancing~~substitute ~~originations~~loans ~~decrease,~~in ~~as higher~~the ~~interest~~event ~~rates~~we ~~provide~~breach ~~reduced~~a ~~economic~~representation ~~incentives~~or ~~for~~warranty ~~borrowers~~given to ~~refinance~~the ~~their~~loan ~~existing~~purchaser ~~mortgages.~~or Wemake ~~expect~~a misrepresentation during the ~~currently~~mortgage ~~occurring~~loan ~~rise~~origination inprocess. In ~~interest~~the ~~rates~~case of securitized loans, we may be required to ~~result~~replace inthem awith ~~decreased~~substitute ~~volume~~loans or cash. In addition, we may be required to repurchase loans as a result of ~~originations~~borrower fraud or in the ~~foreseeable~~event ~~future~~of early payment default on a mortgage loan. ~~Our~~The ~~results~~remedies available to a purchaser of ~~operations~~mortgage loans are generally broader than those available to us against the originating broker. Further, if a purchaser enforces its remedies against us, we may not be ~~materially~~able ~~adversely~~to ~~affected~~enforce the remedies we have against the broker. The repurchased loans typically can only be financed at a steep discount to their repurchase price, if ~~interest~~at ~~rates~~all. ~~rise~~Even if we are able to resell the repurchased loans, repurchased loans are typically sold at a significant discount to the unpaid principal balance. Significant repurchase activity could negatively affect our cash flow and results of operations.

~~Declining~~If ~~real~~we ~~estate~~do ~~values~~not ~~could~~maintain ~~harm~~the appropriate state licenses we will not be allowed to originate, purchase and service mortgage loans in some states, which would adversely affect our operations.

WeState ~~believe~~mortgage ~~the~~finance ~~risks~~licensing ~~associated~~laws ~~with~~vary ~~our business will be more acute during periods of declining real estate values~~considerably. ~~While~~Most ~~periods~~states ofand ~~rapidly increasing real estate values can increase~~ the ~~level~~District of ~~new~~Columbia ~~mortgage~~require ~~loan originations~~a aslicense ~~borrowers use increases~~ in ~~the~~order ~~value of their existing homes~~ to ~~support~~originate ~~the~~first ~~refinancing~~and/or ofsubordinate ~~their~~residential ~~existing~~ mortgage loans. orIn ~~the~~most ~~purchase~~ of ~~new~~these ~~homes at higher levels of borrowings~~states, the ~~declining~~required ~~real~~license ~~estate~~covers ~~values~~both ~~can~~first ~~reduce~~mortgage ~~our~~and ~~level of~~subordinate mortgage ~~loan originations~~loans. ~~Furthermore,~~In ~~declining~~some ~~real~~states, ~~estate~~a ~~values~~separate ~~will~~license ~~likely~~or ~~reduce~~additional ~~our~~license ~~volume~~is ofneeded ~~cash-out~~to ~~refinancings~~originate ~~and~~subordinate ~~debt~~mortgage ~~consolidation~~ loans. asIn ~~the~~some ~~level~~ of ~~home~~the ~~equity~~states ~~available~~that torequire ~~secure~~a ~~such~~license ~~loans~~to ~~will be reduced. For the year~~originate ~~ended~~residential ~~December 31,~~mortgage ~~2005~~loans, ~~approximately~~a ~~72%~~license ofis ~~our~~also ~~loan~~required ~~originations~~to ~~were~~purchase ~~cash-out~~closed ~~refinancings~~mortgage ~~and debt consolidation~~ loans. InIf ~~addition, declining real estate values significantly increase the likelihood that~~ we ~~will~~are ~~incur~~unable ~~increased~~to ~~payment delinquencies,~~obtain ~~foreclosures~~ and ~~losses~~maintain ~~on our loans in~~ the ~~event~~appropriate ofstate ~~default. Therefore~~licenses, ~~any~~our ~~sustained~~operations ~~period~~may ofbe ~~declining real estate values could~~ adversely ~~affect~~affected. ~~both~~In ~~our~~some ~~net~~states ~~interest~~a ~~income~~license ~~from~~is ~~loans~~also inrequired ~~our~~to service ~~mortgage~~or ~~loan~~act ~~portfolio,~~ as ~~well~~the ~~as our~~master ~~ability~~servicer toof ~~originate, sell and securitize~~ loans, ~~which~~held ~~would~~in ~~significantly~~a ~~harm our revenues, results of operations, financial condition, business prospects and our ability to make distributions to our stockholders~~securitization.

Adverse changes in the securitization and whole-loan markets could harm our financial performance.

In order for us to continue originating mortgage loans, we must be able to sell or securitize the loans we originate in the securitization and whole-loan markets on an ongoing basis. We use the cash proceeds from these sales to pay down warehouse facilities and originate new mortgage loans. The value of the mortgage loans we originate depends on a number of factors, including general economic conditions, interest rates and governmental regulations. In addition, we rely on institutional purchasers, such as investment banks, financial institutions and other mortgage lenders, to purchase bonds issued in securitization transactions and mortgage loans in the whole-loan market. We cannot be sure that we can sell or securitize our mortgage loans on at least a quarterly basis. Adverse changes in the securitization and whole-loan markets may affect our ability to securitize or sell our mortgage loans for acceptable prices within a reasonable period of time, which would negatively affect our earnings.

The use of securitizations with credit enhancement requirements may have a negative impact on our cash flow and could adversely impact our business.

In connection with our securitizations, we generally ~~provide~~ provided credit enhancement designed to improve the price at which we sell the securities. We may provide this credit enhancement by providing over- collateralization, paying for financial guaranty insurance policies for the loans, or both. If we use over-collateralization, we will either be required to use cash to fund the over-collateralization amount up front or we may fund the over-collateralization amount through the net interest spread, which would result in us not receiving cash flows from the transaction until the over-collateralization balance reaches certain predefined levels. If we use financial guaranty insurance policies and the expense of these insurance policies increases or the policy insurers are unable to pay claims presented by us, the net interest income we receive will be reduced. While we plan to use credit enhancement features in the future, we cannot assure you that these features will be available at costs that would allow us to achieve the desired level of net interest income from the securitizations of our mortgage loans that we anticipate being able to achieve. In addition, if the performance of our loans pledged to collateralize the securities were worse than certain parameters defined in the securitization documents, then the net interest income we otherwise would have received would be held to build up over-collateralization reserves to provide additional credit enhancements for the senior securities still outstanding at that time.

receiving cash flows from the transaction until the over-collateralization balance reaches certain predefined levels. If we use financial guaranty insurance policies and the expense of these insurance policies increases or the policy insurers are unable to pay claims presented by us, the net interest income we receive will be reduced. While we plan to use credit enhancement features in the future, we cannot assure you that these features will be available at costs that would allow us to achieve the desired level of net interest income from the securitizations of mortgage loans that we anticipate being able to achieve. In addition, if the performance of our loans pledged to collateralize the securities were worse than certain parameters defined in the securitization documents, then the net interest income we otherwise would have received would be held to build up over-collateralization reserves to provide additional credit enhancements for the senior securities still outstanding at that time.

Our securitizations may restrict our cash flow if loan delinquencies or losses exceed certain levels. The terms of securitizations generally provide that, if certain delinquencies and/or losses exceed specified levels, the required level of additional collateral provided as a credit enhancement for the benefit of the investors, or over-collateralization, may be increased or may be prevented from being released as would otherwise be permitted if losses and/or delinquencies did not exceed those levels. An increase in the level of over-collateralization required may restrict our ability to receive cash from net interest income from securitization transactions and could adversely impact our business.

Our inability to realize cash proceeds from loan sales in excess of the loan acquisition cost could adversely affect our financial position and business.

We sell our loans through Encore Credit, our TRS. The net cash proceeds received from loan sales consist of the premiums received on sales of loans in excess of the outstanding principal balance, minus the discounts on loans sold for less than the outstanding principal balance. The proceeds received on loan sales depend in part on demand for consumer credit. Economic slowdowns or recessions may be accompanied by decreased real estate values and an increased rate of delinquencies, defaults and foreclosures. Potential purchasers might reduce the premiums they pay for the loans during these periods to compensate for any increased risks. Any sustained decline in demand for loans or increase in delinquencies, defaults or foreclosures is likely to significantly harm the pricing of future loan sales such that it falls below the cost to originate loans. If we are unable to originate loans at a cost lower than the cash proceeds realized from loan sales, our results of operations, financial condition, liquidity and business prospects could be materially adversely affected.

The limited specific loan performance data on the loans we have originated and sold previously makes it difficult to predict the performance of loans we retain and any revenues from future securitizations.

Prior to 2005, we sold substantially all of the loans that we originated on a whole-loan basis, and, until recently, we did not receive loan performance data on these loans from the servicers. As a result, we have limited default, delinquency, loss, and prepayment experience on these loans. Consequently, the historical delinquency, bankruptcy, foreclosure, default or prepayment experience that may be referred to for purposes of estimating future default, delinquency, loss and prepayment experience of our originated loans may not be representative of actual performance. In view of the limited historical loan performance data available to us, it is extremely difficult to validate our loss or prepayment assumptions used to calculate assumed net interest income in existing and future securitizations of our loans, which could cause us to receive less favorable pricing terms on the mortgage-backed securities we issue than more seasoned issuers with a proven performance record receive. However, general industry loan performance data shows an increase in delinquency rates and we anticipate that our delinquency rates will increase accordingly. Differences between our assumptions and actual performance may have a material adverse effect on the pricing, interest rates and over-collateralization levels of our mortgage-backed securities and could have a material adverse effect on the timing and receipt of our future revenues, the value of the residual interests held on our balance sheet and our cash flow.

over-collateralization levels of our mortgage-backed securities and could have a material adverse effect on the timing and receipt of our future revenues, the value of the residual interests held on our balance sheet and our cash flow.

We depend on a limited number of purchasers of our loans, and the inability or unwillingness of these purchasers to purchase our loans could have a material adverse impact on our financial position and business.

Our ability to continue to originate and purchase loans depends, in part, upon our ability to securitize and sell loans in the whole-loan market in order to generate cash proceeds for new originations and purchases. For the year ended December 31, 2005, we sold approximately 66% of our loans to four customers, EMC Mortgage Corporation, Countrywide Securities Corporation, DLJ Mortgage Capital, Inc., and Friedman, Billings, Ramsey & Co., Inc., to whom we sold approximately 27%, 13%, 12%, and 14%, respectively. For the year ended December 31, 2004, we sold approximately 72% of our loans to two customers, Countrywide Securities Corporation and Bear Stearns, to whom we sold approximately 39% and 33%, respectively. If these purchasers become unable or unwilling to purchase our loans and we are not able to find alternative purchasers, this could have a material adverse effect on our ability to fund future originations and purchases, which could have a material adverse effect on our results of operations, financial condition, liquidity and business prospects.

In a period of rising interest rates, our earnings may decrease.

We expect our primary interest rate exposure to relate to our mortgage loans, mortgage-backed securities and variable-rate debt, as well as the exchange of a fixed amount per payment period for a payment that is not fixed, or interest rate swaps, and option contracts which put an upper limit on a floating exchange rate, or caps, that we utilize for risk management purposes. Changes in interest rates may affect our net interest income, which is the difference between the interest income we earn on our interest-earning investments and the interest expense we incur in financing these investments. Changes in the level of interest rates also can affect our ability to originate or acquire mortgage loans or mortgage-backed securities, the value of our assets and our ability to realize gains from the sale of such assets. In a period of rising interest rates, our interest expense could increase while the interest we earn on our assets might not change as rapidly due to our strategy of funding hybrid/adjustable-rate or fixed-rate assets with floating-rate liabilities. In addition, while the interest we earn on the hybrid/adjustable rate loans we hold for investment is often capped at predetermined maximums, the rate payable on liabilities such as the notes issued in our securitization transactions may be uncapped. These changes would adversely affect our profitability.

~~Although~~12 interest rates have been low over the past few years, the federal funds rate has risen 15 times or 375 basis points during the past two years. The corresponding increase in interest rates may discourage potential borrowers from refinancing mortgages, borrowing to purchase homes or seeking subordinate mortgages. This may decrease the number of mortgages available to be originated or acquired by our mortgage operations, which could adversely affect our operating results. In addition, borrowers with adjustable rate loans may experience “payment shock” when their initial fixed payment adjusts upwards to reflect the increased interest rate, which may result in the borrowers’ income being unable to support the monthly payment and potentially leading to increased defaults.

We originate a significant amount of our mortgage loans in California, Illinois, Florida and New York, and our operations could be harmed by economic downturns or natural disasters in these states.

During the year ended December 31, 2005, we originated approximately 46%, 9%, 8% and 6% of our mortgage loans in California, Illinois, Florida and New York, respectively. Declines in the economy generally or residential real estate markets in any of these states may reduce the demand for mortgage loans or increase losses in the event of foreclosure, either of which would hurt our earnings.

~~The~~A ~~occurrence~~significant ofamount ~~a natural disaster may cause a sudden decrease in the value~~ of ~~real estate in any of these states and would likely reduce~~ the ~~value of the properties collateralizing the~~ mortgage loans wein ~~made.~~our ~~Historically,~~securitizations ~~California~~are ~~has~~secured ~~been~~by ~~vulnerable~~property toin ~~earthquakes~~California, ~~erosion-caused mudslides and wildfires~~Florida, Illinois and ~~Florida~~New ~~has been vulnerable to tropical storms~~York, ~~hurricanes~~ and ~~tornadoes.~~our ~~Since~~operations ~~such~~could ~~natural~~be ~~disasters~~harmed ~~are not typically covered~~ by ~~the~~economic ~~standard~~downturns ~~hazard insurance policies maintained by many borrowers, the borrowers have to pay for repairs due to such disasters. If the property is damaged, uninsured borrowers may not repair the property~~ or ~~may~~natural ~~stop paying their mortgage loans. This would cause the number of foreclosures to increase and decrease our ability to recover losses on properties affected by the~~ disasters. ~~In addition,~~in ~~California~~these ~~has been the focal point for class action and “private attorney general” litigation against nonconforming residential mortgage lenders over the past few years~~states. The litigation typically has been brought under the California Unfair Competition Law, a statute creating liability for “unfair” business practices even if those practices are not otherwise unlawful.

As of December 31, 2006, approximately 37%, 12%, 7% and 6% of the mortgage loans in our securitizations are secured by property in California, Florida, Illinois and New York, respectively. Declines in the economy generally or residential real estate markets in any of these states may increase losses in the event of foreclosure, which would hurt our earnings.

The occurrence of a natural disaster may cause a sudden decrease in the value of real estate in any of these states and would likely reduce the value of the properties collateralizing the mortgage loans in our securitizations. Historically, California has been vulnerable to earthquakes, erosion-caused mudslides and wildfires, and Florida has been vulnerable to tropical storms, hurricanes and tornadoes. Since such natural disasters are not typically covered by the standard hazard insurance policies maintained by many borrowers, the borrowers have to pay for repairs due to such disasters. If the property is damaged, uninsured borrowers may not repair the property or may stop paying their mortgage loans. This would cause the number of foreclosures to increase and decrease our ability to recover losses on properties affected by the disasters.

New legislative restrictions impacting telemarketing activities may harm our ability to market our loan products.

Federal and state laws regulate telemarketing practices, and may adversely impact our business. Enacted in 1991 and 1994, the Telephone Consumer Protection Act and Telemarketing Consumer Fraud and Abuse Prevention Act, respectively, are designed to restrict unsolicited advertising using the telephone and facsimile machine. Since they were enacted, however, telemarketing practices have changed significantly due to new technologies that make it easier to target potential customers while at the same time making it more cost effective to do so. The Federal Communications Commission, or FCC, and the United States Federal Trade Commission, or FTC, have responsibility for regulating various aspects of these laws, such as regulating unwanted telephone solicitations and the use of automated telephone dialing systems, prerecorded or artificial voice messages, and telephone facsimile machines. In 2003, both agencies adopted “do-not-call” registry requirements, which, in part, mandate that companies such as us maintain and regularly update lists of consumers who have chosen not to be called. These requirements also mandate that we do not call consumers who have chosen to be on the list. During the same time, many states have also adopted similar laws, with which we believe we also comply at this time. As with other regulatory requirements, these provisions impose additional regulatory and compliance costs on us and reduce the effectiveness of our marketing programs. They would also subject us to fines and penalties for failure to adhere to these requirements.

If many of our borrowers become subject to the Servicemembers Civil Relief Act of 2003, our cash flows and interest income may be adversely affected.

Under the Servicemembers Civil Relief Act, which in 2003 re-enacted the Soldiers’ and Sailors’ Civil Relief Act of 1940, or the Civil Relief Act, members of the military services on active duty receive certain protections and benefits. Under the Civil Relief Act, a borrower who enters active military service after the origination of his or her mortgage loan generally may not be required to pay interest above an annual rate of 6%, and the lender is restricted from exercising certain enforcement remedies, including foreclosure, during the period of the borrower’s active duty status. The Civil Relief Act also applies to a borrower who was on reserve status and is called to active duty after origination of the mortgage loan. Considering the large number of U.S. Armed Forces personnel on active duty and likely to be on active duty in the future, compliance with the Civil Relief Act could reduce our cash flow and the interest payments collected from those borrowers, and in the event of default or delay, prevent us from exercising the remedies for default that otherwise would be available to us.

If13 ~~we do not manage our growth effectively, our financial performance could be harmed.~~

We have grown from 355 employees at December 31, 2002 to 1,667 employees at December 31, 2005, or an increase of more than 370% in staffing in three years. This rapid increase in staffing places constraints on our ability to find and retain qualified employees, train our new employees to use our technology-based process and integrate them into our culture. The failure to manage growth effectively would significantly impair our ability to

~~grow~~Should ~~and~~we ~~could~~expand ~~have~~into aother ~~material~~lending ~~adverse effect on our business, financial condition, liquidity and results of~~ operations. ~~Since~~or wediversify ~~originated~~portfolio ~~our first mortgage loan in March 2002~~investments, we ~~have experienced rapid growth that has placed, and~~ will ~~continue~~need to ~~place,~~manage ~~certain~~our ~~pressures~~growth effectively, onor our ~~management,~~financial ~~administrative,~~performance ~~operational~~will ~~and~~be ~~financial infrastructure~~harmed.

OnWe ~~January 6,~~have ~~2006,~~exited wethe ~~announced~~subprime awholesale ~~cost~~origination ~~savings~~business ~~initiative~~and ~~that~~our ~~included~~operations aand ~~reduction~~portfolio ~~from~~have ~~seven~~been ~~regional~~reduced. ~~processing~~Should ~~centers~~we ~~down~~expand toour ~~three.~~business Inin ~~addition~~the future, ~~440~~our ~~employees~~ability orto ~~approximately~~manage ~~26%~~any type of ~~our~~rapid ~~workforce~~growth ~~was~~may ~~terminated,~~have ~~including~~a ~~108~~material ~~loan~~adverse ~~officers.~~effect ~~Beginning~~on inour ~~the~~future ~~second~~performance. ~~quarter,~~Any ~~our~~significant ~~retail~~growth ~~operations~~ will beplace ~~conducted solely~~certain ~~out~~pressures ofon ~~Irvine. On April 11~~our management, ~~2006~~administrative, weoperational ~~announced~~and anfinancial ~~additional reduction in workforce of approximately 170 employees~~infrastructure.

Loan prepayment rates may increase, adversely affecting yields on our current and planned investments.

The value of the assets we ~~plan~~hold ~~to acquire~~ may be affected by prepayment rates on mortgage loans. Prepayment rates on mortgage loans are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. In periods of declining mortgage loan interest rates, prepayments on mortgage loans generally increase and the proceeds of such prepayments are likely to be reinvested by us in assets with lower yields than the yields on the assets that were prepaid. In addition, the market value of any mortgage assets may, because of the risk of prepayment, benefit less than other fixed-income securities from declining interest rates. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain investments.

The nonconforming mortgage loans we originate generally have higher delinquency and default rates than prime mortgage loans, which could result in losses on loans that we retain or are required to repurchase.

The nonconforming mortgage loans we originate generally have higher delinquency and default rates than prime mortgage loans. Delinquency interrupts the flow of projected interest income from a mortgage loan, and default can ultimately lead to a loss if the net realizable value of the real property securing the mortgage loan is insufficient to cover the principal and interest due on the loan. Also, our cost of financing and servicing a delinquent or defaulted loan is generally higher than for a performing loan. We bear the risk of delinquency and default on loans at the time we originate them. In whole-loan sales, our risk of delinquency typically only extends to the first or second payment due to the purchaser of the loan, but when we securitize we continue to bear some exposure to delinquencies and losses through our residual interests and the loans underlying our on-balance sheet securitization transactions. We will need to establish allowances based on our anticipated delinquencies and losses. We also re-acquire the risks of delinquency and default for loans that we are obligated to repurchase. We attempt to manage these risks with risk-based loan pricing and appropriate underwriting policies and loan collection methods. However, if such policies and methods are insufficient to control our delinquency and default risks and do not result in appropriate loan pricing and appropriate loss allowances, our business, financial condition, liquidity and results of operations could be harmed.

Our adjustable rate mortgage products expose us to greater credit risk.

For the year ended December 31, 2005, originations of adjustable rate mortgages or ARM loans totaled $11.5 billion, or 85% of our total originations. Since the payment is subject to adjustment at some future point in time, if interest rates increase, the borrower’s income may not be able to support the monthly payment on the loan when the formerly fixed payment adjusts upward to reflect the increased interest rate. This may lead to increased default rates. In addition, already one rating agency (Standard & Poor’s) has required greater credit enhancements for securitization pools that are backed by ARMs.

Our interest-only loans may have a higher risk of default than our fully-amortizing loans.

For the year ended December 31, 2005, originations of interest-only loans totaled $3.6 billion, or 26% of total originations. These interest-only loans require the borrowers to make monthly payments only of accrued

interest for the first 24, 36 or 120 months following origination. After such interest-only period, the borrower’s monthly payment is recalculated to cover both interest and principal so that the mortgage loan will amortize fully prior to its final payment date. The interest-only feature may reduce the likelihood of prepayment during the interest-only period due to the smaller monthly payments relative to a fully-amortizing mortgage loan. If the monthly payment increases, the related borrower may not be able to pay the increased amount and may default or may refinance the related mortgage loan to avoid the higher payment. Because no principal payments may be made on such mortgage loans for an extended period following origination, if the borrower defaults, the unpaid principal balance of the related loans would be greater than otherwise would be the case for a fully-amortizing loan, increasing the risk of loss on these loans.

Our internal underwriting standards may not provide adequate protection against the risks inherent in nonconforming residential mortgage loans and as a result, our cash flows, results of operations, financial condition and liquidity, including any net interest income from securitizations, could be materially harmed.

A substantial portion of the loans we originate are underwritten generally in accordance with our underwriting guidelines that are intended to provide for nonconforming residential mortgages. The mortgage industry often refers to mortgage loans that are eligible for sale to government-sponsored entities, such as Fannie Mae and Freddie Mac, under both size and credit characteristics, as conforming or prime loans, while those mortgage loans that do not satisfy the credit, documentation or other underwriting standards prescribed by those government sponsored entities are often referred to as nonconforming loans. Accordingly, mortgage loans underwritten under our underwriting standards are likely to experience rates of delinquency, foreclosure and loss that are higher, and may be substantially higher, than mortgage loans originated in accordance with Fannie Mae or Freddie Mac underwriting guidelines. We cannot be certain that our underwriting criteria will afford adequate protection against the higher risks associated with loans made to such borrowers. If we are unable to mitigate these risks, our cash flows, results of operations, financial condition and liquidity, including any net interest income from securitizations, could be materially harmed.

We may change our investment strategy without your consent, which may result in our investing in riskier investments than our currently planned investments.

We may change our investment strategy at any time without the consent of our stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described under the caption “Business” in Item 1, Part I of this annual report. A change in our investment strategy may increase our exposure to, among other things, credit risk, interest rate risk and real estate market fluctuations.

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

We use various derivative financial instruments to provide a level of protection against interest rate risks, but no hedging strategy can protect us completely. When rates change, we expect to record a gain or loss on derivatives, which would be offset by an inverse change in the value of loans or residual interests. Our hedging activities may include entering into interest rate swaps, caps and floors, options to purchase these items, and futures and forward contracts. Currently, we use primarily ~~Eurodollar futures contracts to manage~~ interest rate ~~risk on loans held-for-sale and interest rate~~ cap agreements and interest rate swap agreements to manage interest rate risk on ~~loans~~loan ~~held-for-investment~~portfolio; however, our actual hedging decisions will be determined in light of the facts and circumstances existing at the time and may differ from our currently anticipated hedging strategy. ~~Any significant decrease in interest rates could result in a~~ significant margin call on our Eurodollar positions, which would require us to provide the counterparty with additional cash collateral. Any such margin call could harm our liquidity, results of operations, financial condition and business prospects.

We cannot assure you that our use of derivatives will offset the risks related to changes in interest rates. The derivative financial instruments we select may not have the effect of reducing our interest rate risk. In addition, the nature and timing of hedging transactions may influence the effectiveness of these strategies. Poorly designed strategies or improperly executed transactions could actually increase our risk and losses. In addition, hedging strategies involve transaction and other costs. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses, and such losses could harm our results of operations, financial condition and business prospects.

28New legislation and regulations directed at curbing predatory lending practices could cause a credit tightening that may eliminate refinance options and restrict our ability to originate, purchase or price nonconforming residential mortgage loans which could adversely impact our earnings.

~~the~~in ~~nature~~that they impose certain restrictions on loans that exceed certain cost parameters. These state and ~~timing~~local oflaws ~~hedging~~generally ~~transactions~~have ~~may~~lower ~~influence~~thresholds ~~the~~and ~~effectiveness~~broader prohibitions ofthan ~~these~~under ~~strategies~~the federal law. ~~Poorly~~The ~~designed~~restrictions ~~strategies~~include orprohibitions ~~improperly~~on ~~executed transactions~~steering ~~could~~borrowers ~~actually~~into ~~increase~~loans ~~our~~with ~~risk~~high interest rates and ~~losses.~~away Infrom ~~addition~~more affordable products, ~~hedging~~selling ~~strategies~~unnecessary ~~involve~~insurance ~~transaction~~to borrowers, flipping or repeatedly refinancing loans and ~~other~~originating ~~costs.~~loans Wewithout ~~cannot~~a ~~assure~~reasonable ~~you~~expectation that ~~our~~the ~~hedging~~borrowers ~~strategy~~will ~~and~~be able to repay the ~~derivatives~~loans ~~that~~without regard to the value of the mortgaged property. At this time we ~~use~~believe we are adhering to all city, county, state and federal restrictions. Compliance with some of these restrictions requires lenders to make subjective judgments, such as whether a loan will ~~adequately~~provide ~~offset~~a “net tangible benefit” to the ~~risk~~borrower. ofThese ~~interest~~restrictions expose a lender to risks of ~~rate~~litigation ~~volatility~~and orregulatory ~~that~~sanction ~~our~~no ~~hedging~~matter ~~transactions~~how ~~will~~carefully a loan is underwritten and impact the way in which a loan is underwritten. The remedies for violations of these laws are not based on actual harm to the consumer and can result in ~~losses~~damages that exceed the loan balance. Liability for violations of HOEPA, as well as violations of many of the state and ~~such~~local ~~losses~~equivalents, ~~could~~would ~~harm~~extend ~~our~~not ~~results~~only ofto ~~operations~~us, ~~financial~~but ~~condition~~to assignees, which may include our warehouse lenders, whole-loan buyers and securitization ~~business~~trusts, ~~prospects~~regardless of whether such assignee knew of or participated in the violation.

~~New~~It ~~legislation~~is our policy not to originate or purchase loans that are subject to HOEPA or are defined by state and ~~regulations~~local ~~directed~~laws atas ~~curbing~~being predatory ~~lending~~or ~~practices~~high-cost, ~~could~~because ~~restrict~~the institutional purchasers of our ~~ability~~loans and/or the warehouse lenders that provide financing for our loan origination operations do not wish to ~~originate~~purchase or finance such loans. Rating agencies often refuse to rate any securitization including loans subject to these laws or may rate such transactions based on higher over-collateralization levels. If we miscalculated the numerical thresholds regulated by these loans, ~~purchase~~we may have mistakenly originated or purchased such loans and bear the related marketplace and legal risks. The thresholds below which we try to originate loans may create artificial barriers to production and may limit the price ~~nonconforming~~at ~~residential~~which we can offer loans to borrowers and our ability to underwrite, originate, sell and finance mortgage loans. Prior to our initial public offering, ~~which~~we ceased doing business for a period of time in Georgia, New Jersey and certain cities within Ohio because we believed compliance with these requirements could ~~adversely~~not ~~impact~~be assured at a reasonable cost with the degree of certainty that we required, and we may cease doing business in additional jurisdictions in the future where we, or our ~~earnings~~counterparties, make similar determinations with respect to anti-predatory lending laws.

HOEPA identifies a category of residential mortgage loans and subjects such loans to restrictions not applicable to other residential mortgage loans. Loans subject to HOEPA consist of loans on which certain points and fees or the annual percentage rate, known as the interest rate, exceed specified levels. Laws, rules and regulations have been adopted, or are under consideration, at the state and local levels that are similar to HOEPA in that they impose certain restrictions on loans that exceed certain cost parameters. These state and local laws generally have lower thresholds and broader prohibitions than under the federal law. The restrictions include prohibitions on steering borrowers into loans with high interest rates and away from more affordable products, selling unnecessary insurance to borrowers, flipping or repeatedly refinancing loans and originating loans without a reasonable expectation that the borrowers will be able to repay the loans without regard to the value of the mortgaged property. At this time we believe we are adhering to all city, county, state and federal restrictions. Compliance with some of these restrictions requires lenders to make subjective judgments, such as whether a loan will provide a “net tangible benefit” to the borrower. These restrictions expose a lender to risks of litigation and regulatory sanction no matter how carefully a loan is underwritten and impact the way in which a loan is underwritten. The remedies for violations of these laws are not based on actual harm to the consumer and can result in damages that exceed the loan balance. Liability for violations of HOEPA, as well as violations of many of the state and local equivalents, would extend not only to us, but to assignees, which may include our warehouse lenders, whole-loan buyers and securitization trusts, regardless of whether such assignee knew of or participated in the violation.

It is our policy not to originate or purchase loans that are subject to HOEPA or are defined by state and local laws as being predatory or high-cost, because the institutional purchasers of our loans and/or the warehouse lenders that provide financing for our loan origination operations do not wish to purchase or finance such loans. Rating agencies often refuse to rate any securitization including loans subject to these laws or may rate such transactions based on higher over-collateralization levels. If we miscalculate the numerical thresholds regulated by these loans, we may mistakenly originate or purchase such loans and bear the related marketplace and legal risks. The thresholds below which we try to originate loans may create artificial barriers to production and may limit the price at which we can offer loans to borrowers and our ability to underwrite, originate, sell and finance mortgage loans. Prior to our initial public offering, we ceased doing business for a period of time in Georgia, New Jersey and certain cities within Ohio because we believed compliance with these requirements could not be assured at a reasonable cost with the degree of certainty that we required, and we may cease doing business in additional jurisdictions in the future where we, or our counterparties, make similar determinations with respect to anti-predatory lending laws.

We may decide to make a loan that is covered by one of these laws, rules or regulations if, in our judgment, the loan is made in accordance with our strict legal compliance standards and without undue risk relative to litigation or to the enforcement of the loan according to its terms. If we decide to relax our self-imposed restrictions on originating loans subject to these laws, rules and regulations, we will be subject to greater risks for actual or perceived non-compliance with the laws, rules and regulations, including demands for indemnification or loan repurchases from the parties to whom we broker or sell loans, class action lawsuits, increased defenses to foreclosure of individual loans in default, individual claims for significant monetary damages, and administrative enforcement actions. Any of the foregoing could materially harm our business, financial condition and results of operations.

29Some of our competitors that are national banks or federally chartered thrifts and their operating subsidiaries may not be subject to these state and local laws and may as a consequence be able to offer loans that we cannot offer. Federal regulators have expressed their position that these preemption provisions benefit mortgage subsidiaries of federally chartered institutions as well. In January 2004, the Comptroller of the Currency finalized preemption rules that confirm and expand the scope of this federal preemption for national banks and their operating subsidiaries. Such federal preemption rules and interpretations generally have been upheld in the courts. At least one national rating agency has announced, that in recognition of the benefits of federal preemption, it will not require additional credit enhancement by federal institutions when they issue securities backed by mortgages from a state that it deems to have anti-predatory lending laws with clear and objective standards. As a non-federal entity, we will continue to be subject to such rating agency requirements arising from state or local lending-related laws or regulations. Accordingly, as a mortgage lender that is generally subject to the laws of each state in which we do business, except as may specifically be provided in federal rules applicable to all lenders, we may be subject to state legal requirements and legal risks under state laws to which these federally regulated competitors are not subject, and this disparity may have the effect of giving those federal

~~Some of our competitors that are national banks or federally chartered thrifts and their operating~~ subsidiaries may not be subject to these state and local laws and may as a consequence be able to capture market share from us and other lenders. Federal regulators have expressed their position that these preemption provisions benefit mortgage subsidiaries of federally chartered institutions as well. In January 2004, the Comptroller of the Currency finalized preemption rules that confirm and expand the scope of this federal preemption for national banks and their operating subsidiaries. Such federal preemption rules and interpretations generally have been upheld in the courts. At least one national rating agency has announced, that in recognition of the benefits of federal preemption, it will not require additional credit enhancement by federal institutions when they issue securities backed by mortgages from a state that it deems to have anti-predatory lending laws with clear and objective standards. As a non-federal entity, we will continue to be subject to such rating agency requirements arising from state or local lending-related laws or regulations. Accordingly, as a mortgage lender that is generally subject to the laws of each state in which we do business, except as may specifically be provided in federal rules applicable to all lenders, we may be subject to state legal requirements and legal risks under state laws to which these federally regulated competitors are not subject, and this disparity may have the effect of giving those federal entities legal and competitive advantages. Passage of additional laws in other jurisdictions could increase compliance costs, lower fee income and lower origination volume, all of which would have a material adverse effect on our results of operations, financial condition and business prospects.

The United States Congress has recently considered legislation, such as the Ney-Kanjorski Responsible Lending Act introduced in 2005, which, among other provisions, would limit fees that a lender is permitted to charge, including prepayment fees, restrict the terms lenders are permitted to include in their loan agreements and increase the amount of disclosure required to be given to potential borrowers. We cannot predict whether or in what form Congress or the various state and local legislatures may enact legislation affecting our business. We are continually evaluating the potential impact of these initiatives, if enacted, on our lending practices and operations. As a consequence of these and other initiatives, we are unable to predict whether federal, state, or local authorities will require changes in our lending practices in the future, including reimbursement of fees charged to borrowers, or the possible imposition of fines. These changes, if required, could adversely affect our profitability, particularly if we make such changes in response to new or amended laws, regulations or ordinances in California, Illinois, Florida, Massachusetts, New Jersey, or New York, or any other state where we originate a significant portion of our mortgage loans.

We are also seeing an evolution in the regulatory use of alternative means to impact the behavior of mortgage lenders as evidenced by the settlement announced in January 2006, between the retail subsidiaries of ACC Capital Holdings Corporation and 49 State Attorney’s General and the District of Columbia. It is plausible that the entire mortgage lending industry may be subject to additional evolving standards of conduct addressing the broad category of ethical behavior by way of state unfair and deceptive trade practices, which may increase our cost of production and subject us to additional regulatory oversight.

Certain state laws restrict or prohibit the imposition of prepayment fees on mortgage loans.

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

Certain state laws restrict or prohibit the imposition of prepayment fees on mortgage loans. These restrictions prohibit us from charging any prepayment fee on first or subordinate mortgages in several states, and restrict the amount or duration of prepayment fees that we may impose in several states, as well. State laws

regulating prepayment fees vary widely from state to state. Generally speaking, these laws fall into the following four categories: (a) prohibiting prepayment fees for all mortgage loans or certain mortgage loans; (b) authorizing prepayment fees subject to certain conditions, such as the creditor being licensed for certain loans, or pursuant to a certain formula for a certain period of time; (c) prohibiting or restricting prepayment fees for mortgage loans covered under the state’s anti-predatory lending law, but not for other mortgage loans; and (d) including prepayment fees in the calculation of points and fees for purposes of determining whether a loan is covered by an anti-predatory lending law.

Prohibited Prepayment Fees

Blanket prohibitions on imposing prepayment fees may arise under one of two types of laws. First, some state licensing laws prohibit licensees from charging prepayment fees on loans that they originate. Alabama’s Consumer Finance Act is one such licensing law. Second, in the limited number of states that have enacted a version of the Uniform Consumer Credit Code, prepayment fees for mortgage loans covered by such laws are often prohibited, but prepayment fees for mortgage loans that are not covered by such laws may not be prohibited. Colorado is one such example.

Authorized Prepayment Fees Subject to Certain Restrictions

California’s Civil Code is an example of a law of general applicability that authorizes fees subject to certain conditions. The Civil Code permits most lenders to contract for a prepayment fee within the first five years of the loan’s repayment as long as the transaction is not subject to the provision of the state’s “covered loan” statute (in which case the “covered loan” must not include a prepayment penalty after the first 36 months). A prepayment fee may be imposed on any amount prepaid in any twelve month period in excess of 20% of the original principal amount of the loan, which charge must not exceed an amount equal to the payment of six months’ advance interest on the amount prepaid in excess of 20% of the original principal amount.

Prepayment Fee Provisions Under State Anti-Predatory Lending Laws (i) Prohibiting or Restricting such Fees or (ii) Including such Fees in the Points and Fees Test

Over the past few years, states have begun to adopt anti-predatory lending laws. These anti-predatory lending laws typically address prepayment fees in one of two ways: (i) in definitions of loans covered by the law; or (ii) in the prohibited terms and practices for such loans. With respect to defining the loans covered by the law, several laws include prepayment fees in the calculation of “points and fees” for purposes of determining whether a loan is covered by the anti-predatory loan provisions. For example, in New Jersey, lenders must include in the calculation: (i) the maximum amount of prepayment fees and penalties that may be charged or collected under the terms of the loan documents; and (ii) all prepayment fees or penalties that are incurred by the borrower if the loan refinances a previous loan made or currently held by the same creditor or an affiliate of the creditor. With respect to regulated practices, some predatory lending laws prohibit or severely restrict a lender’s ability to contract for a prepayment fee on loans covered by the law. For example, in Georgia, for any loan that constitutes a “high cost home loan,” a lender may not include a prepayment fee after two years or that exceeds in the aggregate: (i) in the first 12 months of the loan, more than 2% of the loan amount prepaid; or (ii) in the second 12 months of the loan, more than 1% of the loan amount prepaid.

This may place us at a competitive disadvantage relative to financial institutions such as national banks and federally-chartered thrifts that will continue to enjoy federal preemption of such state restrictions. Such institutions generally may be able to charge prepayment penalties without regard to state restrictions and, as a result, may be able to offer loans with interest rate and fee structures that are more attractive than the interest rate and fee structures that we are able to offer.

Our business could be harmed if courts in other jurisdictions take a course similar to that of the Appellate Court of Illinois by determining that certain federal laws do not preempt certain state statutes, which could expose us to litigation for fees charged in connection with loans we originated in their jurisdiction.

On March 31, 2004, the Appellate Court of Illinois held, contrary to the understanding of many in the industry, that Section 501(a) of the Depository Institutions Deregulation and Monetary Control Act, or DIDMCA, does not preempt the limitations on loan-related charges and fees contained in Section 4.1a of the Illinois Interest Act. If the Illinois Supreme Court had not overturned the Appellate Court’s decision, we might have reduced our operations in Illinois to reduce our exposure to litigation concerning fees we charged in connection with Illinois loans. Any such litigation, if decided against us, could have had a material adverse effect on our business, results of operations and financial condition. If courts in other jurisdictions follow the Appellate Court of Illinois, we could be exposed to similar litigation in those jurisdictions, which may cause us to limit our operations in those locations.

The broad scope of our prior and current operations exposes us to risks of noncompliance with an increasing and inconsistent body of complex laws and regulations at the federal, state and local levels.

Because we ~~may~~originated ~~originate~~ and ~~purchase~~purchased mortgage loans in ~~all~~many 50 states and may continue to do so in the future, we must comply with the laws and regulations, as well as judicial and administrative decisions, of all of these jurisdictions, as well as an extensive body of federal laws and regulations. The volume of new or modified laws and regulations has increased in recent years, and, in addition, individual cities and counties have begun to enact laws that restrict nonconforming loan origination activities in those cities and counties. State and local governmental authorities have focused on the lending practices of companies in the nonconforming mortgage lending industry, sometimes seeking to impose sanctions for practices such as charging excessive fees, imposing interest rates higher than warranted by the credit risk of the borrower, failing to adequately disclose the material terms of loans and abusive servicing and collection practices. ~~The~~For ~~laws~~example ~~and~~California ~~regulations~~has ofbeen ~~each~~the offocal ~~these~~point ~~jurisdictions~~for ~~are~~class ~~different,~~action ~~complex~~ and~~, in some cases, in direct~~ ~~conflict~~“private ~~with~~attorney ~~each~~general” ~~other.~~litigation Asagainst ~~our~~nonconforming ~~operations~~residential ~~continue~~mortgage tolenders ~~grow,~~over itthe ~~may~~past befew ~~more~~years. ~~difficult~~The tolitigation ~~comprehensively~~typically ~~identify~~has ~~and~~been tobrought ~~accurately~~under ~~interpret~~the ~~applicable~~California ~~laws~~Unfair ~~and~~Competition ~~regulations and to employ properly our policies~~Law, ~~procedures~~a ~~and~~statute ~~systems~~creating ~~and~~liability for ~~effectively~~“unfair” ~~train~~business ~~our~~practices ~~personnel~~even ~~with~~if ~~respect~~those topractices ~~all~~are ofnot ~~these~~otherwise ~~laws and regulations, thereby potentially increasing our exposure to the risks of noncompliance with these laws and regulations~~unlawful.

The laws and regulations of each of these jurisdictions are different, complex and, in some cases, in direct conflict with each other. As we continue our operations, it may be more difficult to comprehensively identify and to accurately interpret applicable laws and regulations and to employ properly our policies, procedures and systems and effectively train our personnel with respect to all of these laws and regulations, thereby potentially increasing our exposure to the risks of noncompliance with these laws and regulations.

Our failure to comply with this regulatory regimen can lead to:

•

civil and criminal liability, including potential monetary penalties;

•

loss of lending licenses or approved status required for continued lending and servicing operations;

•

demands for indemnification or loan repurchases from purchasers of our loans;

•

legal defenses causing delay and expense;

•

adverse effects on the servicer’s ability to enforce loans;

•

the borrower having the right to rescind, void, or cancel the loan transaction;

•

adverse publicity;

•

individual and class action lawsuits;

•

administrative enforcement actions;

•

damage to our reputation in the industry;

•

inability to sell or securitize our loans;

•

loss of the ability to obtain ratings on our securitizations by rating agencies; or

•

inability to obtain credit to fund our operations.

32Although we had systems and procedures directed to compliance with these legal requirements for our prior originations and believe that we are in material compliance with all applicable federal, state and local statutes, rules and regulations, we cannot assure you that more restrictive laws and regulations will not be adopted in the future, or that governmental bodies will not interpret existing laws or regulations in a more restrictive manner, which could make compliance more difficult or expensive. Although our current Retail business relies on other lenders to comply with a majority of laws governing the funding of mortgage loans, if we decide to fund some or all of these loans in the future we will be required to comply with these changing requirements. These applicable laws and regulations are subject to administrative or judicial interpretation, but some of these laws and regulations have been enacted only recently or may be interpreted infrequently. As a result of infrequent or sparse interpretations, ambiguities in these laws and regulations may leave uncertainty with respect to permitted or restricted conduct under them. Any ambiguity under a law to which we are subject may lead to regulatory investigations, governmental enforcement actions or private causes of action, such as class action lawsuits, with respect to our compliance with applicable laws and regulations. Furthermore, judicial resolution of regulatory issues related to our industry, even where we are not involved directly, could impose additional regulations or standards upon us that may materially increase our costs of doing business or restrict our ability to conduct our business as we currently operate.

If our servicers fail to adequately service the loans we originated and sold, this could negatively affect our business, financial condition, liquidity and results of operations.

For the loans we own, we enter into servicing agreements with a third party. If a servicer were to terminate the agreement or refuse or be unable to provide the necessary service, our choices for a new servicer may be limited and we may not be able to identify another servicer at the same cost or at all. If we are unable to engage another servicer, in addition to providing the servicing of the loans, we may be obligated to make advances for delinquent payments and other servicing-related costs may be increased, which could have a negative effect on our results of operations and financial condition.

~~Although~~Poor weservicing ~~have systems~~ and ~~procedures~~collections ~~directed~~for towhich ~~compliance with these legal requirements and believe that~~ we are inreliant ~~material~~on ~~compliance~~third-party ~~with~~servicers ~~all applicable federal, state and local statutes, rules and regulations, we cannot assure you that more restrictive laws and regulations will not be adopted in the future,~~ or ~~that~~a ~~governmental~~transfer ~~bodies will not~~of ~~interpret~~servicing ~~existing laws or regulations in a more restrictive manner, which~~ could ~~make~~adversely ~~compliance~~affect ~~more~~the ~~difficult~~amount or ~~expensive.~~value ~~These~~of ~~applicable~~the ~~laws~~cash ~~and~~flow ~~regulations~~received ~~are~~from ~~subject~~our tosecuritized ~~administrative or judicial interpretation~~portfolio, ~~but~~the ~~some~~value of ~~these~~our ~~laws~~residual ~~and regulations have been enacted only recently or may be interpreted infrequently. As a result of infrequent or sparse interpretations~~interests, ~~ambiguities~~which incould ~~these~~have ~~laws and regulations may leave uncertainty with respect to permitted or restricted conduct under them. Any ambiguity under~~ a ~~law~~material toadverse ~~which~~effect weon ~~are~~our ~~subject may lead to regulatory investigations~~business, ~~governmental~~financial ~~enforcement actions or private causes of action~~condition, ~~such~~liquidity ~~as class action lawsuits, with respect to our compliance with applicable laws~~ and ~~regulations.~~results ~~Furthermore, judicial resolution~~ of regulatory issues related to our industry, even where we are not involved directly, could impose additional regulations or standards upon us that may materially increase our costs of doing business or restrict our ability to conduct our business as we currently operateoperations.

If financial institutions face exposure stemming from legal violations committed by the companies to which they provide financing or underwriting services, this could increase our borrowing costs and negatively affect the market for whole-loans and mortgage-backed securities.

In June 2003, a California jury found a warehouse lender and securitization underwriter liable in part for fraud on consumers committed by a lender to whom it provided financing and underwriting services. The jury found that the investment bank was aware of the fraud and substantially assisted the lender in perpetrating the fraud by providing financing and underwriting services that allowed the lender to continue to operate, and held it liable for 10% of the plaintiff’s damages. This is the first case we know of in which an investment bank was held partly responsible for violations committed by a mortgage lender customer. Shortly after the announcement of the jury verdict in the California case, the Florida Attorney General filed suit against the same financial institution, seeking an injunction to prevent it from financing mortgage loans within Florida, as well as damages and civil penalties, based on theories of unfair and deceptive trade practices and fraud. The suit claims that this financial institution aided and abetted the same lender involved in the California case in its commission of fraudulent representations in Florida. As of the date of this annual report, there has been no ruling in this case. If other courts or regulators adopt this “aiding and abetting” theory, investment banks may face increased litigation as they are named as defendants in lawsuits and regulatory actions against the mortgage companies with which they do business. Some investment banks may exit the business, charge more for warehouse lending and reduce the prices they pay for whole-loans in order to build in the costs of this potential litigation. This could, in turn, have a material adverse effect on our results of operations, financial condition and business prospects.

If we are unable to maintain and expand our network of independent brokers, our loan origination business will decrease.

Substantially all of our originations of mortgage loans comes from independent brokers in our wholesale operation. In 2005, 50 brokers originated approximately 24% of our mortgage loans. The brokers with whom we associate are not contractually obligated to do business with us. Further, our competitors also have relationships with the same brokers with whom we associate and actively compete with us in our efforts to obtain loans from these brokers and to expand our broker network. Accordingly, we cannot assure you that we will be successful in maintaining our existing relationships or expanding our broker network, the failure of which could negatively affect the volume and pricing of our loans, which would have a material adverse effect on our business, financial condition, liquidity and results of operations.

If our servicers fail to adequately service the loans we originate and sell, this could negatively affect our business, financial condition, liquidity and results of operations.

We currently outsource the servicing of all the loans we originate. For the loans we originate and hold for sale and loans we securitize, we enter into servicing agreements with a third party. If a servicer were to terminate

the agreement or refuse or be unable to provide the necessary service, our choices for a new servicer may be limited and we may not be able to identify another servicer at the same cost or at all. With respect to the loans we securitize, if we are unable to engage another servicer, in addition to providing the servicing of the loans, we may be obligated to make advances for delinquent payments and other servicing-related costs may be increased, which could have a negative effect on our results of operations and financial condition.

Poor servicing and collections for which we are reliant on third-party servicers or a transfer of servicing could adversely affect the amount or value of the cash flow received from our securitized portfolio, the value of our residual interests, our ability to sell or securitize loans and increase the likelihood that repurchase obligations are triggered, which could have a material adverse effect on our business, financial condition, liquidity and results of operations.

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

~~When~~For the mortgage loans we ~~originate~~originated in the past, and any future retail mortgage loans we may originate, we have and will rely heavily upon information supplied by third parties, including the information contained in the loan application, property appraisal, title information, and employment and income documentation. If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the actual value of the loan may be significantly lower than expected. Whether a misrepresentation is made by the loan applicant, the mortgage broker, another third party or one of our employees, we generally bear the risk of loss associated with the misrepresentation. A loan subject to a material misrepresentation is typically unsaleable or subject to repurchase if it is sold prior to detection of the misrepresentation. Entities making misrepresentations are often difficult to locate, and it is often difficult to collect any monetary losses we have suffered from them. We cannot assure you that we have detected or will detect all misrepresented information in our loan originations. This may also affect the performance of loans that we have in our portfolio and cause increased losses.

We may be subject to fines or other penalties based upon the conduct of our independent brokers.

The mortgage brokers from which we ~~obtain~~obtained loans have parallel and separate legal obligations to which they are subject. While these laws may not explicitly hold the originating lenders responsible for the legal violations of mortgage brokers, increasingly federal and state agencies have sought to impose such assignee liability. For example, the FTC entered into a settlement agreement with a mortgage lender where the FTC characterized a broker that had placed all of its loan production with a single lender as the “agent” of the lender; the FTC imposed a fine on the lender in part because, as “principal,” the lender was legally responsible for the mortgage broker’s unfair and deceptive acts and practices. In the past, the United States Department of Justice has sought to hold a mortgage lender responsible for the pricing practices of its mortgage brokers, alleging that the mortgage lender was directly responsible for the total fees and charges paid by the borrower under the Fair Housing Act even if the lender neither dictated what the mortgage broker could charge nor kept the money for its own account. Accordingly, we may be subject to fines or other penalties based upon the conduct of our independent mortgage broker customers.

Stockholder, director and officer refusal to comply with regulatory requirements may interfere with our ability to do business in certain states.

Some states in which we operate may impose regulatory requirements on our officers and directors and persons holding certain amounts, usually 10% or more (but in some cases 5%), of our common stock. If any such person fails to meet or refuses to comply with a state’s applicable regulatory requirements for mortgage lending, we could lose our ~~authority~~ability to conduct business in that state.

In many states, unless waived, certain officers, directors and/or securityholders of a license applicant are required to provide certain personal background and/or financial disclosures. In some states, unless waived, certain officers, directors or securityholders of a license applicant are required to submit fingerprint cards for processing by law enforcement agencies. Failure to submit the required personal background or financial disclosures or fingerprint cards could lead to the denial of a license application. We have made the required submissions, in connection with applying for the state licenses required for us to originate, purchase, and/or table fund mortgage loans, in all states except for New York. As new officers or directors are appointed, or as additional investors acquire the requisite shares of stock, the background or financial disclosures or fingerprint

3418

processing by law enforcement agencies. Failure to submit the required personal background or financial disclosures or fingerprint cards could lead to the denial of a license application. We have made the required submissions, in connection with applying for the state licenses required for us to originate, purchase, and/or table fund mortgage loans, in all states except for New York. As new officers or directors are appointed, or as additional investors acquire the requisite shares of stock, the background or financial disclosures or fingerprint card submissions may need to be filed in some states, which may be done as part of the license renewal process in some of these states. Failure to submit required background, financial disclosures, or fingerprint cards could lead to a fine or license suspension or revocation.

We are subject to significant legal and reputational risks and expenses under federal and state laws concerning privacy, use and security of customer information.

The federal Gramm-Leach-Bliley financial reform legislation imposes significant privacy obligations on us in connection with the collection, use and security of financial and other nonpublic information provided to us by applicants and borrowers. ToMany ~~date, thirty~~ states have either enacted or are considering enacting even more stringent privacy or customer-information-security breach legislation. Because laws and rules concerning the use and protection of customer information are continuing to develop at the federal and state levels, we expect to incur increased costs in our effort to be and remain in full compliance with these requirements. Nevertheless, despite our efforts we will be subject to legal and reputational risks in connection with our collection and use of customer information, and we cannot assure you that we will not be subject to lawsuits or compliance actions under such state or federal privacy requirements. To the extent that a variety of inconsistent state privacy rules or requirements are enacted, our compliance costs could substantially increase.

The inability to attract and retain qualified employees could significantly harm our business.

We depend on our account executives to attract borrowers by, among other things, developing relationships with other financial institutions, mortgage companies, real estate agents and brokers, and others. These relationships lead to repeat and referral business. The market for skilled account executives and loan officers is highly competitive. Competition for qualified account executives and loan officers may lead to increased hiring and retention costs. If we are unable to attract or retain a sufficient number of skilled account executives and loan officers at manageable costs, it could harm our business, financial condition, and results of operations. We must continue to motivate employees and keep them focused on our strategies and goals, which may be particularly difficult due to morale challenges posed by workforce reductions and general uncertainty.

The success and growth of our business will depend upon our ability to adapt to and implement technological changes to remain competitive and any failure to do so could result in a material adverse effect on our business.

Our mortgage loan origination business is currently dependent upon our ability to interface effectively with our brokers, borrowers and other third parties and to process loan applications and closings efficiently. The origination process is becoming more dependent upon technological advancement, such as our continued ability to process applications over the Internet, accept electronic signatures, provide process status updates instantly and other customer-expected conveniences that are cost-efficient to our process. Maintaining and improving this new technology and becoming proficient with it may also require significant capital expenditures. As these requirements increase in the future, we will have to develop fully these technological capabilities to remain competitive and any failure to do so could have a material adverse effect on our business, results of operations and financial condition.

Our operations are dependent on our ability to protect our automated underwriting system and data centers against damage.

Our operations are dependent on our ability to protect our computer equipment and the information stored in our data centers against damage that may be caused by fire, power loss, telecommunications failures, unauthorized intrusion, computer viruses and disabling devices, natural disasters and other similar events. We

cannot assure you that a fire or other natural disaster would not result in a prolonged disruption of our automated underwriting system or permanently impair some of our operations. A prolonged service disruption or other impairment of operations could damage our reputation with customers, expose us to liability, cause us to lose existing customers or increase our difficulty in attracting new ones. We may also incur significant costs for using alternative off-site equipment.

We are exposed to environmental liabilities with respect to properties to which we take title.

In the course of our business, we may foreclose and take title to residential properties, and, if we do take title, we could be subject to environmental liabilities with respect to these properties. In such a circumstance, we may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.

Future financing facilities may contain covenants that restrict our operations and our ability to make distributions if we are not in compliance with certain financial and other covenants.

We currently have no financing or warehouse facilities with material restrictive covenants. However, any future financing facilities may likely contain restrictions and covenants that, among other things, require us to satisfy specified financial, asset quality and loan performance tests. If we fail to meet or satisfy any of these covenants, we would be in default under these agreements and our lenders could elect to declare all amounts outstanding under the agreements to be immediately due and payable, enforce their interests against collateral pledged under such agreements and restrict our ability to make additional borrowings.

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

•

incur or guarantee additional debt;

•

make certain investments and other restricted payments;

•

pay dividends or distributions on, or redeem or repurchase, capital stock;

•

issue or sell capital stock of restricted subsidiaries;

•

grant liens;

•

enter into transactions with affiliates;

•

engage in mergers or consolidations, transfer substantially all of our assets or other events constituting a change in control;

•

finance loans with certain attributes;

•

reduce liquidity below certain levels; and

•

hold loans for longer than established time periods.

These restrictions may interfere with our ability to obtain financing, to engage in other business activities or to make distributions if we are not in compliance with these covenants, which may materially harm our business, financial condition, liquidity and results of operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Warehouse and Repurchase Facilities.”

If we make any acquisitions, we will incur a variety of costs and may never realize the anticipated benefits.

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

We have identified numerous material weaknesses in our internal control over financial reporting and determined that our disclosure controls and procedures are not effective, which could adversely impact our ability to report our results of operations and financial condition accurately and in a timely manner.

We have seven material weaknesses in our internal control over financial reporting (“ICFR”). As required by Section 404 of the Sarbanes-Oxley Act of 2002, which we refer to as Section 404, management initiated an assessment of ICFR during the year ended December 31, 2006. Although management was unable to complete its review of ICFR, management identified eleven material weaknesses in our internal control over financial reporting. Management is still reviewing and assessing ICFR, but has concluded that ICFR was not effective as of December 31, 2006, given the material weaknesses that have already been identified.

Each of our material weaknesses results in more than a remote likelihood that a material misstatement will not be prevented or detected. As a result, we must perform extensive additional work to obtain reasonable assurance regarding disclosure controls and procedures and ICFR. Due to the fact that many of our controls and procedures that were in place before the sale of our mortgage origination business to Bear Sterns are no longer in place and many are no longer needed, management is unable to assess the effectiveness of either disclosure controls and procedures or ICFR now and may not be able to do so in the near or long term future. Given the extensive material weaknesses identified, there is a risk of additional errors not being prevented or detected which could result in a failure to accurately report our financial results for the year ended December 31, 2006 and beyond. Management has extensive work remaining to identify and remediate the material weaknesses in ICFR. We are in the process of developing a plan for remediating all of the identified material weaknesses related to our existing business, however, reconstruction, evaluation and assessment of internal controls that were related to our mortgage origination business can not be practically achieved. As a result, management will concentrate its efforts on improving ICRF for our existing operations during fiscal year 2007 and beyond. There can be no assurance as to when, if ever, the remediation plan will be fully developed and when it will be implemented. Until our remedial efforts are completed, management will continue to devote significant time and attention to these efforts, and management will continue to incur the expenses associated with the manual procedures and resources required to prepare our consolidated financial statements. There will also continue to be an increased risk that we will be unable to timely file future periodic reports with the SEC, and that our future financial statements could contain errors that will be undetected. For additional detailed information on disclosure controls and procedures and ICFR, see Item 9A “Controls and Procedures” in this annual report on Form 10-K.

Our securitizations may require us to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, borrower fraud, or certain borrower defaults, which could harm our liquidity, results of operations and financial condition.

When we sold our mortgage loans, pursuant to a securitization, we were required to make customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. In addition, we may be required to repurchase mortgage loans as a result of borrower fraud or in the event of early payment default on a mortgage loan. Likewise, we are required to repurchase or substitute mortgage loans if we breach a representation or warranty in connection with our securitizations. The remedies available to us against the originating broker or correspondent may not be as broad as the remedies available to a purchaser of mortgage loans against us, and we face the further risk that the originating broker or correspondent may not have the financial capacity to perform remedies that otherwise may be available to us. Therefore, if a purchaser enforces its remedies against us, we may not be able to recover losses from the originating broker or correspondent. Repurchased loans are typically sold at a significant discount to the unpaid principal balance and, prior to sale, can be financed by us, if at all, only at a steep discount to our cost. As a result, significant repurchase activity could harm our liquidity, cash flow, results of operations, financial condition and business prospects.

Our investments in mortgage securities and loans are subject to changes in credit spreads which could adversely affect our ability to realize gains on the sale of such investments and may subject us to margin calls or similar liquidity requirements.

The value of mortgage securities is dependent on the yield demanded on these securities by the market based on their credit relative LIBOR. Excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher, or “wider,” spread over the benchmark rate (usually the applicable LIBOR security yield) to value such securities. Under such conditions, the value of our mortgage securities portfolio would tend to decline. Conversely, if the spread used to value such securities were to decrease, or “tighten,” the value of our mortgage securities portfolio would tend to increase.

Differences in our actual experience compared to the assumptions that we use to determine the value of our residual mortgage securities could adversely affect our financial position.

Our securitizations of mortgage loans that are structured as sales for financial reporting purposes result in the recording of the residual mortgage securities we retain at fair value. As of December 31, 2006 we had retained residual mortgage securities from our securitizations of mortgage loans with a fair value of $45.9 million on our balance sheet.

Delinquency, loss, prepayment and discount rate assumptions have a material impact on the carrying value of our residual mortgage securities. It is extremely difficult to validate the assumptions we use in determining the value of our residual mortgage securities. If our actual experience differs materially from the assumptions that we use to determine the value of these mortgage securities, our future cash flows, our financial condition and our results of operations could be negatively affected.

The value of residual interests represents the present value of future cash flows expected to be received by us from the excess cash flows created in the securitization transaction. In general, future cash flows are estimated by taking the coupon rate of the loans underlying the transaction less the interest rate paid to the investors, less contractually specified servicing and trustee fees, and after giving effect to estimated prepayments and credit losses. We estimate future cash flows from these securities and value them utilizing assumptions based in part on projected discount rates, delinquency, mortgage loan prepayment speeds and credit losses. It is extremely difficult to validate the assumptions we use in valuing our residual interests. Even if the general accuracy of the valuation model is validated, valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships which drive the results of the model. Such assumptions are complex as we

must make judgments about the effect of matters that are inherently uncertain. As actual experience differs from our assumptions, we have and will continue to reduce the value of these securities. Furthermore, if our actual experience differs materially from these assumptions, our cash flow, financial condition, results of operations and business prospects may be harmed, including an adverse affect on the amount of dividend payments that are made on our common stock.

Risks Relating to Our Common Stock

We are no longer listed on the New York Stock Exchange and the market in our common stock is highly speculative and may not continue.

Our common stock was delisted from the New York Stock Exchange, or the NYSE, on March 19, 2007. Our common stock now trades on the OTC Bulletin Board under the symbol “ECRO.OB”. Our delisting has reduced the market and liquidity of our common stock and consequently may adversely affect the ability of our stockholders and brokers/dealers to purchase and sell our shares in an orderly manner or at all. Trading in our common stock through market makers and quotation on the OTC Bulletin Board entails other risks. Due in part to the decreased trading price of our common stock and the elimination of analyst coverage, the trading price of our common stock may change quickly, and market makers may not be able to execute trades as quickly as they could when our common stock was listed on the NYSE. The value of our common stock is highly speculative and any investment in our common stock would pose an extremely high degree of risk. Potential investors in our common stock should consider the highly speculative nature of our common stock prior to making any investment decision with respect to our common stock. In addition, the decrease in liquidity of an investment in our common stock could make it more difficult for us to raise capital in the future, if at all.

Our common stock is classified as a “penny stock” under SEC rules, which may make it more difficult for our stockholders to resell our common stock.

Because our common stock is not traded on a stock exchange and the market price of the common stock is less than $5.00 per share, the common stock is classified as a “penny stock.” Rule 15g-9 of the Exchange Act imposes additional sales practice requirements on broker-dealers that recommend the purchase or sale of penny stocks to persons other than those who qualify as an “established customer” or an “accredited investor.” These include the requirement that a broker-dealer must make a determination that investments in penny stocks are suitable for the customer and must make special disclosures to the customer concerning the risks of penny stocks. Application of the penny stock rules to our common stock could adversely affect the market liquidity of the shares, which in turn may affect the ability of holders of our common stock to resell the stock.

We may face deregistration proceedings under Section 12(j) of the Exchange Act.

If we are unable to timely file our periodic reports with the SEC for future periods, we believe that the SEC could commence deregistration proceedings under Section 12(j) of the Exchange Act to deregister our common stock under the Exchange Act. If our common stock is deregistered, publicly available information regarding us may be limited and the price of our common stock would likely suffer an immediate and significant decline. Our common stock would no longer be quoted on the OTC Bulletin Board and there can be no assurance that there will be any active trading market for our common stock. Accordingly, investors would likely find it more difficult to acquire or dispose of our common stock or obtain accurate quotations for our common stock following any such deregistration.

Risks Related to Our Organization and Structure

Our charter prohibits certain entities from owning our shares, which might reduce the demand for our shares by limiting the potential purchasers of our shares.

If certain types of entities hold our shares, then a tax will be imposed on us if we hold a residual interest in a real estate mortgage investment conduit, or REMIC, and, although the law on the matter is unclear, a ~~tax~~ ~~might be imposed on us if we hold an interest in a taxable mortgage pool. To prevent us from being required to pay this~~ tax ~~in that event, our charter prohibits our shares from being held by the entities that~~ might ~~cause this tax to be imposed~~ on us. These entities include: the United States; any state or political subdivision thereof; any foreign government; any international organization; any agency or instrumentality of any of the foregoing; any other tax-exempt organization, other than a farmer’s cooperative described in section 521 of the Internal Revenue Code of 1986 (the “Code”), as amended, that is both exempt from income taxation and exempt from taxation under the unrelated business taxable income provisions of the Code; and any rural electrical or telephone cooperative.

be imposed on us if we hold an interest in a taxable mortgage pool. To prevent us from being required to pay this tax in that event, our charter prohibits our shares from being held by the entities that might cause this tax to be imposed on us. These entities include: the United States; any state or political subdivision thereof; any foreign government; any international organization; any agency or instrumentality of any of the foregoing; any other tax-exempt organization, other than a farmer’s cooperative described in section 521 of the Internal Revenue Code of 1986 (the “Code”), as amended, that is both exempt from income taxation and exempt from taxation under the unrelated business taxable income provisions of the Code; and any rural electrical or telephone cooperative.

Provisions of our charter and Maryland law may limit the ability of a third party to acquire control of our company.

Certain provisions of the Maryland General Corporation Law, or the MGCL, may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then-prevailing market price of such shares, including:

• “business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our shares or an affiliate thereof) for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter impose special super majority stockholder voting requirements on these combinations;

or more of the voting power of our shares or an affiliate thereof) for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter impose special super majority stockholder voting requirements on these combinations;

•

“control share” provisions that provide that “control shares” of our company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares; and

•

“unsolicited takeover” provisions of Maryland law that permit our board of directors, without stockholder approval, to implement possible takeover defenses, such as a classified board or two-third vote requirement for removal of a director that we are not yet eligible to have.

We have opted out of the control share provisions of the MGCL pursuant to a provision in our bylaws. However, we may, by amendment to our bylaws, become subject to the control share provisions of the MGCL in the future. We have also, by resolution of our board of directors, excluded any business combination with us from the business combination provisions of the MGCL. There can be no assurance that this provision will not be amended or eliminated at any time in the future. There can also be no assurance that the “unsolicited takeover” provisions that we are not yet eligible to have will not be implemented by our board of directors in the future.

Our charter and bylaws contain provisions that may have an anti-takeover effect and inhibit a change in our board of directors. These provisions include the following:

• There are ownership limits and restrictions on transferability in our charter. Our charter, subject to certain exceptions, authorizes our board of directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and to limit any person to actual or constructive ownership of no more than 5.6% in value or number of shares, whichever is more restrictive, of the outstanding shares of our common stock and no more than 5.6% in value of our outstanding capital stock. Our board of directors, in its sole discretion, may exempt a proposed transferee from these ownership limits. However, our board of directors may not grant an exemption from the ownership limit to any proposed transferee whose actual or constructive ownership, of in excess of 5.6% of the value of the outstanding shares of our capital stock could jeopardize our status as a REIT. Steven G. Holder and Shabi S. Asghar, together with each of their respective affiliates, will each be permitted to own up to 1920.5885% and 1211.9265%, respectively, of our common stock. These restrictions on transferability and ownership will not apply if our board of directors determines that it is no longer in our best interests to attempt to qualify, or to continue to qualify, as a REIT. These ownership limits may delay or impede a transaction or a change of control that might be in the best interest of our stockholders.

•23 Our charter permits our board of directors to issue common stock or preferred stock, without any action by our stockholders, with terms that may discourage a third party from acquiring us. Our charter permits our board of directors to issue up to 200,000,000 shares of common stock and up to 20,000,000 shares of preferred stock. In addition, our board of directors may classify or reclassify unissued shares of common stock or preferred stock and may set the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption of the classified shares. As a result, our board of directors could authorize the issuance of common stock or preferred stock with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders of some or a majority of our shares might receive a premium for their shares over the then-prevailing market price of our shares.

• Our charter and bylaws contain other possible anti-takeover provisions. Our charter and bylaws contain other provisions that may have the effect of delaying, deterring or preventing a change in control of us or the removal of existing directors and, as a result, could prevent our stockholders from being paid a premium for their common stock over the then prevailing market price.

that it is no longer in our best interests to attempt to qualify, or to continue to qualify, as a REIT. Our charter authorized our board to reduce ownership limits below 5.6% if it is determined to be in the best interest of our stockholders. These ownership limits may delay or impede a transaction or a change of control that might be in the best interest of our stockholders.

Our charter permits our board of directors to issue common stock or preferred stock, without any action by our stockholders, with terms that may discourage a third party from acquiring us. Our charter permits our board of directors to issue up to 200,000,000 shares of common stock and up to 20,000,000 shares of preferred stock. In addition, our board of directors may classify or reclassify unissued shares of common stock or preferred stock and may set the preferences, conversion or other rights, voting powers, restrictions, and limitations as to dividends or other distributions, qualifications and terms or conditions of redemption of the classified shares. As a result, our board of directors could authorize the issuance of common stock or preferred stock with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders of some or a majority of our shares might receive a premium for their shares over the then-prevailing market price of our shares.

•

Our charter and bylaws contain other possible anti-takeover provisions. Our charter and bylaws contain other provisions that may have the effect of delaying, deterring or preventing a change in control of us or the removal of existing directors and, as a result, could prevent our stockholders from being paid a premium for their common stock over the then prevailing market price.

•

Removal of Directors. Under our charter, subject to the rights of one or more future classes or series of preferred stock to elect or remove one or more directors, a director may be removed only for cause and then only by the affirmative vote of at least two-thirds of all votes entitled to be cast by our stockholders generally in the election of directors.

•

Stockholder-Requested Special Meetings. Our bylaws provide that our stockholders have the right to call a special meeting only upon the written request of the stockholders entitled to cast not less than a majority of all the votes entitled to be cast by the stockholders at such meeting.

•

Number of Directors, Board Vacancies, Term of Office. Our charter and bylaws provide a majority of the entire board of directors with the right to determine the number of directors; however, the number of directors may not be fewer than one, as required by Maryland law, or more than fifteen. Vacancies on the board may be filled by a majority of the remaining directors, whether or not constituting a quorum. In addition, a vacancy on the board of directors resulting from the removal of a director may also be filled by the stockholders. We have provided in our charter that, once we have a class of equity securities registered under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and have at least three independent directors, the board of directors has the exclusive right, by the affirmative vote of a majority of the remaining directors, to fill all vacancies on the board of directors, including those resulting from the removal of a director or an increase in the number of directors, even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy shall hold office until the next annual meeting of stockholders and until his or her successor is elected and qualifies.

•

Advance Notice Provisions for Stockholder Nominations and Proposals. Our bylaws require advance written notice for stockholders to nominate persons for election as directors at, or to bring other business before, any meeting of stockholders. This bylaw provision limits the ability of stockholders to make nominations of individuals for election as directors or to introduce other proposals unless we are notified in a timely manner prior to the meeting.

Our rights and the rights of our stockholders to take action against our directors and officers are limited.

Maryland law provides that a director or officer has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Our charter, in the case of directors and officers, will require us to indemnify our directors and officers for actions taken by them in those capacities to the full extent permitted by Maryland law.

Maryland law permits us to include in our charter a provision limiting the liability of our directors and officers to us and our stockholders for monetary damages, except for liability resulting from (a) actual receipt of an improper benefit or profit in money, property or services, or (b) active and deliberate dishonesty established by final judgment and which is material to the cause of action. Our charter contains a provision that eliminates directors and officers’ liability to the maximum extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law.

Maintenance of our Investment Company Act exemption imposes limits on our operations.

We conduct our operations so as not to become regulated as an investment company under the Investment Company Act of 1940, as amended, or the Investment Company Act. ~~The~~An ~~Investment~~entity ~~Company~~can ~~Act~~be ~~exempts~~subject ~~entities~~to ~~that~~regulation ~~are~~as ~~primarily~~an ~~engaged~~investment company if it holds itself out as an investment company. In addition, an entity can be regulated as investment companies even if it does not hold itself out as one, if it engages or proposed to engage in the business of ~~purchasing~~investing, reinvesting, owning, holding or ~~otherwise~~trading ~~acquiring~~in ~~mortgages~~securities, and owns or proposes to acquire investment securities having a value of 40 per centum ~~other~~or ~~liens~~less onin total assets (exclusive of cash and ~~interests~~government insecurities) ~~real~~on ~~estate~~an unconsolidated basis. ToWe ~~qualify~~do ~~for~~not ~~this~~hold ~~exemption~~ourselves out as an investment company, and we ~~must~~organize ~~maintain~~our atbusiness ~~least~~such 55that less than 40% of our assets, ~~directly~~on inan ~~mortgages~~unconsolidated basis, are ~~qualifying~~investment ~~pass-through~~securities. ~~certificates~~To ~~and~~ensure ~~certain~~that ~~other~~we ~~qualifying~~do ~~interests~~not inqualify ~~real~~as ~~estate.~~an ~~Our~~investment ~~ownership~~ company, we may be required at times to adopt less efficient methods of financing certain ~~mortgage~~of our assets and we may be ~~limited~~precluded byfrom ~~the~~acquiring ~~provisions~~certain types of higher-yielding ~~the Investment Company Act~~assets. If the Securities and Exchange Commission, or SEC, adopts a contrary interpretation with respect to these ~~securities~~assets or otherwise believes we should be classified as an investment company, we could be required to restructure our activities or sell certain of our assets in order to qualify for an exemption from registration as an investment company. The net effect of these factors would be to lower our net interest income or to realize a lower price on the sale of assets than might be realized if the assets were held to maturity. If we fail to qualify for an exemption and are required to register as an investment company, our ability to use leverage would be substantially reduced, and we would not be able to conduct our business as described.

38Mr. Holder, together with his respective affiliate, own in the aggregate approximately 17.77% of our outstanding common stock and there may be circumstances under which the interests of Mr. Holder and the interests of the holders of the remainder of our common stock will not be aligned.

~~Table~~Mr. Holder, together with his respective affiliate, own in the aggregate approximately 17.77% of ~~Contents~~our outstanding common stock. This may enable him to exercise substantial influence over the management of our company and on the outcome of any matters submitted to a vote of our stockholders. Circumstances may arise in which the interests of Mr. Holder could be in conflict with the interests of our stockholders. The concentration of ownership of our company may have the effect of delaying, deferring or preventing a change of control of our company, may discourage bids for our stock at a premium over the market price and may have a material adverse effect on the market price of our common stock.

otherwise believes we do not satisfy the above exception, we could be required to restructure our activities or sell certain of our assets. To insure that we continue to qualify for the exemption, we may be required at times to adopt less efficient methods of financing certain of our mortgage assets and we may be precluded from acquiring certain types of higher-yielding mortgage assets. The net effect of these factors will be to lower our net interest income. If we fail to qualify for exemption from registration as an investment company, we will need to restructure our business to qualify for exemption from registration or register as an investment company under the Investment Company Act. If we are required to register as an investment company, our ability to use leverage would be substantially reduced, and we would not be able to conduct our business as described.

Messrs. Holder and Asghar, together with their respective affiliates, own in the aggregate approximately 29% of our outstanding common stock and there may be circumstances under which the interests of Messrs. Holder and Asghar and the interests of the holders of the remainder of our common stock will not be aligned.

Messrs. Holder and Asghar, together with their respective affiliates, own in the aggregate approximately 29% of our outstanding common stock. This may enable them to exercise substantial influence over the management of our company and on the outcome of any matters submitted to a vote of our stockholders. Circumstances may arise in which the interests of Messrs. Holder and Asghar could be in conflict with the interests of our stockholders. The concentration of ownership of our company may have the effect of delaying, deferring or preventing a change of control of our company, may discourage bids for our stock at a premium over the market price and may have a material adverse effect on the market price of our common stock.

Risks Related to Our Qualification and Operation as a REIT

Our failure to qualify as a REIT would have significant adverse consequences to us and the value of our common stock.

We currently operate in a manner that is intended to enable us to qualify as a REIT for federal income tax purposes under the Code commencing with our taxable year ending December 31, ~~2005~~2006. We have not requested and do not plan to request a ruling from the Internal Revenue Service, or IRS, that we qualify as a REIT, and the statements in this annual report are not binding on the IRS or any court. If we were to lose our REIT status, we would face serious tax consequences that would substantially reduce the funds available for distribution to our stockholders for each of the years involved because:

•

we would not be required to make, nor would we be entitled to a deduction for, any distributions to stockholders in computing our taxable income and would be required to pay federal income tax at regular corporate rates;

•

we could be required to pay the federal alternative minimum tax and possibly increased state and local taxes; and

•

unless we are entitled to relief under applicable statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year during which we were disqualified.

In addition, if we fail to qualify as a REIT, we will not be required to make distributions to our stockholders. As a result of all these factors, our failure to qualify as a REIT could impair our ability to expand our business and raise capital, and would adversely affect the value of our common stock.

Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The determination of various factual matters and circumstances not entirely within our control may affect our ability to qualify as a REIT. In order to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the ownership of our shares, the composition of our assets and a requirement that at least 95% of our gross income in any year be derived from qualifying sources, such as interest on mortgage loans. Also, we must make distributions to stockholders aggregating annually at least 90% of our net taxable income, excluding capital gains.

39Even if we qualify as a REIT for federal income tax purposes, we may be required to pay some federal, state and local taxes on our income or property and, in certain cases, a 100% penalty tax in the event we sell property, including mortgage loans, as a dealer or if a taxable REIT subsidiary of ours, including Performance Credit Corporation, Encore Credit Corporation of Minnesota or PerformanceOne Financial, Inc., enters into an agreement with us on a basis that is determined to be other than arm’s-length. In addition, any taxable REIT subsidiary we own will be required to pay federal, state and local income taxes on its taxable income, as well as any other applicable taxes.

Even if we qualify as a REIT for federal income tax purposes, we may be required to pay some federal, state and local taxes on our income or property and, in certain cases, a 100% penalty tax in the event we sell property, including mortgage loans, as a dealer or if a taxable REIT subsidiary of ours, including Encore Credit, Encore Credit Corporation of Minnesota or Bravo Credit, enters into an agreement with us on a basis that is determined to be other than arm’s-length. In addition, any taxable REIT subsidiary we own will be required to pay federal, state and local income taxes on its taxable income, as well as any other applicable taxes.

REIT distribution requirements could adversely affect our liquidity.

To qualify as a REIT, we generally must distribute to our stockholders at least 90% of our net taxable income each year, excluding capital gains, and we will be required to pay regular corporate income taxes to the extent that we distribute less than 100% of our net taxable income each year. In addition, we will be required to pay a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. We currently intend to make distributions to our stockholders to comply with the 90% distribution requirement and to avoid ~~currently~~ corporate income tax and the nondeductible excise tax. However, differences in timing between the recognition of REIT taxable income and the actual receipt of cash or the effect of non-deductible capital expenditures could require us to (i) sell assets in adverse market conditions, (ii) borrow funds on unfavorable terms, or (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt in order to comply with the 90% distribution requirement and to avoid corporate income tax and the nondeductible excise tax. Further, amounts distributed will not be available to fund investment activities. We expect to fund our investments, initially, by raising capital and, subsequently, through borrowings from financial institutions, along with securitization financings. Our failure to obtain debt or equity capital in the future could limit our ability to grow, which could have a material adverse effect on the value of our common stock.

Recognition of excess inclusion income by us could have adverse tax consequences to us or our stockholders.

We may recognize excess inclusion income and our stockholders may be required to treat a portion of the distributions they receive as excess inclusion income. Excess inclusion income may not be offset with net operating losses, represents unrelated business taxable income in the hands of an otherwise tax-exempt shareholder, and is subject to withholding tax, without regard to otherwise applicable exemptions or rate reductions, to the extent such income is allocable to a shareholder who is not a U.S. person.

Generally, excess inclusion income is the income allocable to a REMIC residual interest in excess of the income that would have been allocable to such interest if it were a bond having a yield to maturity equal to 120% of the long-term applicable federal rate, which is a rate based on the weighted average yields of treasury securities and is published monthly by the IRS for use in various tax calculations.

If a REIT holds 100% of the sole class of equity interest in a non-REMIC multi-class mortgage-backed securities offering that qualifies as a borrowing for federal income tax purposes, the equity interest retained by the REIT, under regulations that have not yet been issued, will be subject to rules similar to those applicable to a REMIC residual interest. We believe we have structured our securitization transactions to qualify as non-REMIC financing transactions for federal income tax purposes. As a result, from time to time, we may recognize excess inclusion income attributable to the equity interests we retain in those securitization transactions.

If we recognize excess inclusion income, we may, under regulations that have not yet been issued, have to allocate the excess inclusion income to the distributions we make to our stockholders to the extent our REIT taxable income (taking into account the dividends paid deduction) is less than the sum of our excess inclusions for the taxable year. If a portion of the distributions we distribute to you are characterized as excess inclusion income, then you will be taxed with respect to that excess inclusion income in the same manner that you would be taxed if you held a REMIC residual interest directly.

Generally, to maintain our REIT status, we must distribute at least 90% of our taxable income (determined without regard to the dividends paid deduction and by excluding any net capital gains) in each year. To the extent the sum of our excess inclusion income is less than 10% of our total taxable income, we may elect to pay tax on such excess inclusion income rather than treating a portion of our distributions as comprising excess inclusion income.

Complying with REIT requirements may force us to liquidate otherwise attractive investments.

At the close of each quarter of our taxable year, we must satisfy four tests relating to the nature and composition of our assets. First, at least 75% of the value of our total assets must be represented by real estate assets, cash, cash items and government securities. For purposes of this test, real estate assets include stock or debt instruments that are purchased with the proceeds of a stock offering or a public offering of debt with a term of at least five years, but only for the one-year period beginning on the date we receive such proceeds. Second, not more than 25% of our total assets may be represented by securities, other than those securities includable in the 75% asset test. Third, of the investments included in the 25% asset class, and except for investments in REITs, qualified REIT subsidiaries and taxable REIT subsidiaries, the value of any one issuer’s securities may not exceed 5% of the value of our total assets, and we may not own more than 10% of the total vote or value of the outstanding securities of any one issuer except, in the case of the 10% value test, certain “straight debt” and other excluded securities, as described in the Code. Fourth, not more than 20% of the value of our total assets may be represented by the securities of one or more taxable REIT subsidiaries.

If we fail to satisfy an asset test because we acquire securities or other property during a quarter, we may cure this failure by disposing of sufficient non-qualifying assets within 30 days after the close of that quarter. In addition, other cure provisions may be available to us in the event we fail to meet the REIT qualifications tests. Although we plan to take steps to ensure that we satisfy such tests for any quarter with respect to which testing is to occur, there can be no assurance that such steps will always be successful, or will not require a reduction in our overall interest in an issuer. If we fail to timely cure any noncompliance with the asset tests and certain relief provisions do not apply, we could cease to qualify as a REIT.

U.S. federal income tax treatment of REITs and investments in REITs may change, which may cause us to lose the tax benefits of operating as a REIT.

The present U.S. federal income tax treatment of a REIT and an investment in a REIT may be modified by legislative, judicial or administrative action at any time. Revisions to U.S. federal income tax laws and interpretations of these laws could adversely affect us and the tax consequences of an investment in our securities.

Item 1B.

Unresolved Staff Comments

Not applicable.

Item 2.

Properties

~~Our~~As ~~executive and administrative offices are located at 1833 Alton Parkway, Irvine, California 92606, and consist~~ of ~~approximately 127,718 square feet. Effective approximately June 1, 2005, our corporate headquarters increased by~~ ~~approximately 78,127 square feet to a total of approximately 205,845 square feet, pursuant to leases that will terminate through~~ December 31, ~~2010.~~2006 ~~As of December 31, 2005,~~ we ~~also~~ leased ~~additional~~office ~~property~~space ~~for~~associated with our ~~regional~~mortgage ~~offices~~origination ~~and loan~~operations ~~processing centers~~ in ~~the~~three ~~following~~principal ~~states and metropolitan areas ranging in size from approximately 200 to 30,000 square feet with original lease terms varying from month-to-month to five years~~locations: ~~Arizona~~Irvine, ~~California~~CA, ~~Connecticut,~~Downers ~~Florida~~Grove, ~~Illinois,~~ ~~Indiana~~IL, ~~Iowa,~~and ~~Kansas,~~Glen ~~Kentucky~~Allen, ~~Massachusetts,~~VA. ~~Maryland,~~Leases ~~Minnesota,~~in ~~Montana,~~these ~~Nebraska,~~locations ~~New~~were ~~Jersey,~~assumed ~~New~~by ~~York,~~Bear ~~Nevada,~~Stearns ~~North~~in ~~Carolina,~~connection with ~~Ohio,~~the ~~Pennsylvania,~~sale ~~Texas~~of ~~and~~our ~~Virginia.~~mortgage ~~Subsequent~~origination tooperations. ~~December 31, 2005, we announced a reorganization, which resulted in the~~

41As of December 31, 2006, we also leased various other office space that had previously been used in our wholesale mortgage origination business under operating leases that were not assumed by Bear Stearns. Through April 16, 2007, we have entered into various agreements to terminate or sublease all other operating leases of office space and other real estate not assumed by Bear Stearns, with the exception of two leases for office space. We are in active discussions to terminate these obligations although there can be no assurances we will be successful in this regard. Our lease reserves may prove to be inadequate as there is no assurance that our subtenants will meet their obligations under the sublease agreements.

~~Table~~Our executive and administrative offices were relocated to 1733 Alton Parkway, Irvine, California 92606 following the sale of ~~Contents~~our wholesale mortgage origination operations to Bear Stearns.

consolidation of our processing centers into three central locations: Irvine, CA, Downers Grove, IL, and Glen Allen, VA. Our retail operations will be conducted solely out of Irvine. Additionally, all of our California locations have been consolidated into our corporate headquarters in Irvine. Upon terminating lease arrangements at our closed locations, we may lease executive suites for our loan production account executives in those locations.

Item 3.

Legal Proceedings

WeOn April 4, ~~are~~2007, ~~not~~Performance ~~currently~~Credit aCorporation ~~party~~(“Performance”), tofiled ~~any~~suit ~~material~~in ~~legal~~the ~~proceeding.~~Central WeDistrict ~~have~~of ~~been~~California, ~~involved~~Southern Division, ~~from~~against ~~time~~EMC toMortgage ~~time~~Corporation (“EMC”), a subsidiary of Bear Stearns, seeking damages of more than $20 million for alleged breach of contract in aconnection ~~variety~~with EMC’s purchases of Performance’s residential mortgage ~~lending~~loan ~~related~~portfolio ~~claims~~during the period from and ~~other~~after October 10, 2006 and related matters ~~incidental~~(as amended, the “Complaint”). The Complaint alleges that EMC agreed to ~~our~~purchase ~~business~~and securitize Performance’s entire loan production monthly and assume responsibility for any early payment defaults by mortgage loan borrowers. InThe ~~our~~Complaint ~~opinion,~~also alleges that EMC breached the ~~resolution~~agreement ofby, ~~any~~among other things, delaying the purchase of ~~these~~certain ~~pending~~loans ~~incidental~~originated ~~matters~~by isPerformance ~~not~~and ~~expected~~failing to ~~have~~securitize monthly. As a ~~material~~result ~~adverse~~of ~~effect~~these onalleged ~~our~~breaches ~~consolidated~~by ~~financial~~EMC, ~~position~~the ~~and~~Complaint ~~results~~alleges that Performance suffered losses of ~~operations~~more than $20 million when these mortgage loans declined in value from the date EMC agreed to purchase such loans until the date EMC ultimately did purchase them.

Performance has also commenced arbitration proceedings against EMC, seeking damages of more than $5 million for EMC’s breach of a Loan Servicing Agreement (“Servicing Agreement”). Performance alleges in its Demand for Arbitration that EMC breached the Servicing Agreement by failing to act diligently to collect all payments due under each of the mortgage loans required to be serviced and otherwise to perform its obligations under the Servicing Agreement.

Although we believe that these claims are well-founded, as is true of all legal proceedings, it is impossible at an early stage to predict with accuracy the likely outcome or amount of recovery, if any, that may be obtained from these actions. We expect that there will be substantial costs associated with the prosecution of these claims, which may never be recouped and which may have a material effect on our results of operations. In addition, Bear Stearns has significantly more resources than us, which may lead to prolonged litigation and increased expenses related to the prosecution of these claims.

We are not currently a party to any other material legal proceeding. We have been involved, from time to time, in a variety of mortgage lending related claims and other matters incidental to our business. In our opinion, the resolution of any of these pending incidental matters is not expected to have a material adverse effect on our consolidated financial position and results of operations.

Item 4.

Submission of Matters to a Vote of Security Holders

None.

4228

PART II

Item 5.

Market for the Registrant’s Common Equity and Related Stockholder Matters

~~Our~~Since March 19, 2007 our common stock ~~commenced~~has ~~trading~~traded on the ~~New~~OTC ~~York~~Bulletin ~~Stock~~Board ~~Exchange~~ under the symbol ~~“ECR”~~ECRO.OB. onPrior ~~February~~to March 1519, ~~2005~~2007 our stock traded on the New York Stock Exchange. As of ~~March~~May 2714, ~~2006~~2007, the closing sales price of our common stock, as reported onby the ~~NYSE~~OTC Bulletin Board, was $10.1534 and the number of stockholders of record of our common stock was 8668, which amount does not include stockholders whose shares are held in the name of their broker. The following table provides the high and low sales prices of our common stock for the periods indicated, as reported by the NYSE:

Year ended December 31, 2005	High		Low
Year ended December 31, 2006	High		Low
Fourth quarter	$	1.40	$	0.94
Third quarter	$	1.27	$	0.95
Second quarter	$	1.65	$	1.17
First quarter	$	2.74	$	1.00
Year ended December 31, 2005
Fourth quarter	$	3.40	$	2.20
Third quarter	$	6.85	$	3.20
Second quarter	$	6.79	$	4.99
February 15, 2005 to March 31, 2005	$	6.96	$	5.76

Use of Proceeds from Initial Public Offering

We received approximately $353.7 million in net proceeds from our initial public offering, which closed on February 18, 2005. We have used these proceeds for general working capital needs and to build our portfolio of mortgage loans held for investment.

Recent Sales of Unregistered Securities

On February 18, 2005, we completed the private placement of 3,940,110 shares of our common stock to Friedman, Billings, Ramsey Group, Inc. for $6.345 per share, or an aggregate purchase price of approximately $25 million, which is included in the $353.7 million in net proceeds we received from our initial public offering. Also on February 18, 2005, we completed the private placement of 131,250 shares of our common stock to Milestone Advisors LLC. These shares were issued in consideration for financial advisory services provided by Milestone Advisors LLC. These shares were issued pursuant to an exemption from registration under Section 4(2) of the Securities Act.

Dividends

During ~~2005~~2006, we declared a quarterly ~~dividends~~dividend of $0.~~07,~~24 ~~$0.22, $0.18, and $0.18,~~ which ~~were~~was paid on ~~May~~January 229, ~~2005, July 26, 2005, October 24,~~2007. ~~2005,~~On ~~and January~~March 319, ~~2006~~2007, ~~respectively. In order to comply with REIT qualification requirements, we are required to distribute (within a certain period after~~ the ~~end of each year) at least 90% of our REIT taxable income to holders of our common stock. As discussed in “Management~~Company’s ~~Discussion~~board ~~and Analysis~~ of ~~Financial~~directors ~~Condition~~approved ~~and Results of Operations—Liquidity and Capital Resources—Current Cash Requirements”, we recently announced~~ a ~~revision~~$0.07 toper ~~our~~share dividend. ~~policy~~The ~~and that we would not pay a~~ dividend ~~for~~was ~~the~~paid on ~~first~~March 30, ~~quarter~~2007 ofto ~~2006.~~stockholders ~~Any future distributions will be made at the discretion~~ of ~~our~~record ~~board~~as of ~~directors and will depend on our earnings and financial condition~~March 22, ~~maintenance~~ ~~of REIT status and any other factors the board of directors deems relevant~~2007.

~~Employee~~In ~~Compensation~~order ~~Plan~~to ~~Information~~comply with REIT qualification requirements, we are required to distribute (within a certain period after the end of each year) at least 90% of our REIT taxable income to holders of our common stock. Any future distributions will be made at the discretion of our board of directors and will depend on our earnings and financial condition, maintenance of REIT status and any other factors the board of directors deems relevant.

Securities Authorized for Issuance Under Equity Compensation Plans

Information regarding our equity compensation plans is included in Item 12 of Part III of this annual report.

~~Purchase~~29 ~~of Equity Securities~~

During August 2005, we repurchased 144,367 shares of common stock for $5.00 per share or approximately $722,000. These shares were repurchased in connection with restricted stock vesting for one of our executive vice presidents in order to cover the minimum statutory tax withholding obligation resulting from the shares vesting.

Item 6.

Selected Financial Data

You should read the following summary of our historical consolidated financial and operating data in conjunction with our consolidated financial statements and related notes thereto and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The following table presents our summary historical consolidated financial and other data ~~for~~as ~~the~~of ~~years~~and ~~ended~~for ~~December 31,~~each ~~2005,~~of ~~2004,~~the ~~2003~~five ~~and~~years ~~2002,~~in ~~and~~the ~~from inception~~period toended December 31, ~~2001~~2006, which have been derived from our consolidated financial statements audited by Grant Thornton LLP, our independent auditors.

As a result of our new business strategy in which we retain a portfolio of loans held for investment, interest income generated by our loan portfolio, net of the interest we pay on our liabilities, has become the largest component of our revenues, rather than the net gain received by us as a result of our whole-loan sales, which was the largest component of our revenues prior to 2005.


	Year ended December 31,
	2006			2005			2004		2003		2002
	(in thousands, except per share data)
Net interest income	$	45,456		$	84,840		$	—	$	—	$	—
Provision for loan losses		19,520			41,185			—		—		—
Loss on fair value writedown of residuals		(12,035	)		(7,730	)
Gain on derivative instruments		16,751			16,767			—		—		—
Net loss from continuing operations		(25,823	)		(8,577	)		—		—		—
Net income (loss) from discontinued operations		(108,819	)		(55,547	)		28,276		11,247		1,659
Net income (loss)	$	(134,642	)	$	(64,124	)	$	28,276	$	11,247	$	1,659
Mortgage loans held for investment, net	$	2,403,090		$	44,222,063		$	—	$	—	$	—
Total assets	$	3,779,994		$	7,253,618		$	1,007,546	$	616,680	$	368,350
Long-term debt	$	2,384,025		$	4,166,127		$	—	$	—	$	—
Total stockholders’ equity	$	127,971		$	284,871		$	52,949	$	19,145	$	7,851
Loss per share of common stock from continuing operations	$	(0.26	)	$	(0.10	)	$	—	$	—	$	—
Income (loss) per share of common stock	$	(1.35	)	$	(0.72	)	$	0.66	$	0.30	$	0.05
Dividend declared per share of common stock	$	0.24		$	0.65		$	—	$	—	$	—

	Year Ended December 31,									Period from Inception(1) to December 31, 2001
	2005			2004		2003		2002
	(in thousands, except per share data)
Consolidated Statement of Operations Data:
Revenues
Net interest income, after provision for loan losses	$	94,745		$	28,019	$	14,991	$	5,966	$	—
Gain (loss) on sale of loans, net		(38,332	)		113,832		64,319		30,966		—
Gain on trading securities and derivative instruments, net		39,327			21,486		—		—		—
Total revenues		95,740			163,337		79,310		36,932		—
Expenses
Personnel		84,165			48,655		28,566		19,047		73
Production and marketing		23,612			12,301		6,115		4,490		—
Servicing fees		13,882			7,152		2,966		672		—
Occupancy expense		9,714			5,938		2,671		820		30
General and administrative		46,192			40,727		19,308		7,475		206
Total expenses		177,565			114,773		59,626		32,504		309
Other income		5,382			—		—		—		—
Income/(loss) before income taxes		(76,443	)		48,564		19,684		4,428		(309	)
Provision (benefit) for income taxes		(12,319	)		20,288		8,437		2,769		—
Net income/(loss)	$	(64,124	)	$	28,276	$	11,247	$	1,659	$	(309	)
Income/(loss) per share:
Basic	$	(0.72	)	$	1.15	$	0.47	$	0.07	$	(0.01	)
Diluted	$	(0.72	)	$	0.66	$	0.30	$	0.05	$	(0.01	)
Common stock outstanding:
Basic		89,186			24,493		23,691		23,691		23,662
Diluted		89,186			43,054		37,559		36,206		23,662

(1) This period began on October 18, 2001.

	As of December 31,
	2005		2004		2003		2002		2001
	(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	46,904	$	22,023	$	5,483	$	990	$	512
Mortgage loans held for sale, net		2,744,423		911,784		593,203		358,681		—
Mortgage loans held for investment, net		4,222,063		—		—		—		—
Residual interests in securitization		14,753		20,167		1,596		—		—
Derivative instruments		58,948		2,509		—		—		—
Other assets		166,527		51,063		16,398		8,679		414
Total assets	$	7,253,618	$	1,007,546	$	616,680	$	368,350	$	926
Warehouse and repurchase facilities	$	2,708,266	$	894,307	$	576,777	$	351,128		—
Long-term debt		4,166,127		—		—		—		—
Securities sold under agreements to repurchase		13,074		3,970		—		—		—
Accounts payable and accrued expenses		63,236		40,131		16,382		5,468		—
Dividends payable		18,044		—		—		—		—
Income tax payable		—		16,189		3,481		3,263		—
Subordinated debt to shareholder, net		—		—		895		640		—
Total liabilities	$	6,968,747	$	954,597	$	597,535	$	360,499		—
Cash received for stock not issued		—		—		—		—		235
Total stockholders’ equity	$	284,871	$	52,949	$	19,145	$	7,851	$	691

	Year Ended December 31,												Period from Inception(1) to December 31, 2001
	2005			2004			2003			2002
	(dollars in thousands)
Other data:
Total mortgage loan originations	$	14,040,632		$	9,114,332		$	4,584,620		$	1,485,112		$	—
Wholesale originations	$	13,496,947		$	9,096,095		$	4,854,620		$	1,485,112		$	—
Retail originations	$	543,685		$	18,237		$	—		$	—		$	—
Weighted average coupon rate		7.47	%		7.12	%		7.37	%		7.95	%		N/A
Weighted average credit score		622			618			608			597			N/A
Weighted average loan to value		81	%		80	%		79	%		79	%		N/A
Total loans sales and securitizations	$	12,061,440		$	8,780,365		$	4,349,039		$	1,130,656		$	—
Whole loan sales	$	6,998,892		$	7,700,404		$	4,131,437		$	1,130,656		$	—
Mortgage loans securitized(2)	$	5,062,548		$	1,079,961		$	217,602		$	—		$	—
Average premium received on whole loan sales		101.38	%		102.73	%		103.01	%		103.21	%		N/A
Total number of employees		1,667			1,114			621			355			3

(1) This period began on October 18, 2001.

(2) The securitizations of mortgage loans in 2003 and 2004 are accounted for as sales while the securitizations of mortgage loans in 2005 are accounted for as financings.

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Summary Consolidated Financial and Other Data” and our consolidated financial statements and related notes. The following discussion and analysis discusses our financial condition and results of our operations on a consolidated basis, unless otherwise indicated Except for the historical information contained herein, the following discussion contains forward-looking statements that are subject to known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements. We discuss such risks, uncertainties and other factors throughout this annual report and specifically under the caption “Risk Factors” in Part I, Item ~~1 of~~1A of this annual report.

Formation transactions and sale of mortgage banking operations

ECC Capital Corporation (the “Company”, “ECC Capital”, “we”, or “us”) was incorporated on April 1, 2004 in the state of Maryland. ECC Capital was formed by Encore Credit Corp., ~~solely~~now known as Performance Credit Corporation, for the purpose of effecting a restructuring ~~of Encore Credit Corp.~~ that ~~would~~facilitated ~~facilitate~~our an initial public offering and conversion to a real estate investment trust, or REIT. AsEncore ~~a REIT~~Credit was formed on October 18, ~~ECC~~2001 ~~Capital~~in ~~invests~~the State of California and began operations in ~~residential~~March ~~mortgage~~2002. ~~loans~~Encore ~~financed~~Credit bychanged ~~the~~its ~~issuance~~name ofto ~~non-recourse~~Performance ~~debt~~Credit Corporation in February 2007.

OnAs ~~February 18,~~part ~~2005,~~of ~~ECC~~the ~~Capital completed its~~ initial public offering, ~~and conversion to a REIT. Prior to~~ the ~~completion~~Company: of(i) issued ~~its initial public offering~~40, ~~ECC Capital formed a wholly-owned subsidiary~~406,105 ~~ECC~~shares ~~Merger~~of ~~Sub,~~common ~~for~~stock to the ~~interim~~stockholders ~~purpose~~ of ~~effecting~~Performance ~~the~~Credit Corporation ~~merger.~~in ~~Encore~~exchange ~~Credit~~for ~~Corp.~~their ~~merged~~outstanding ~~with~~common ~~ECC~~and ~~Merger~~preferred ~~Sub~~stock, ~~with~~(ii) sold ~~Encore Credit surviving. In connection with the merger~~52,500,000 ~~the shareholders of Encore Credit received 1.183~~ shares of common stock ofto ~~ECC~~the ~~Capital~~public ~~for~~at ~~each~~$6.75 ~~share~~per ~~of common stock~~share, ~~Series A preferred stock~~ and ~~Series~~(iii) sold B3,940,110 ~~preferred~~shares ~~stock~~ of ~~Encore~~common ~~Credit.~~stock Inin ~~addition,~~a ~~each~~private ~~outstanding~~placement ~~option~~offering ~~to purchase Encore Credit common stock~~at ~~was~~$6.345 ~~assumed~~per byshare. ECC Capital ~~and~~raised ~~was~~a ~~adjusted~~total toof ~~reflect~~$379,375,000 ~~the~~through ~~exchange ratio in~~ the ~~merger.~~sale ~~Each~~of ~~warrant~~its tostock ~~purchase~~(before ~~Encore~~offering ~~Credit~~expenses) ~~common~~in ~~stock~~the ~~was~~public ~~exercised~~offering ~~prior~~and to the ~~merger~~private placement.

AsThe ~~part~~issuance of ~~the initial public offering, ECC Capital: (i) issued 40,406,108~~ shares ofby ~~common~~the ~~stock~~Company to the ~~shareholders~~ stockholders of ~~Encore~~Performance Credit inCorporation ~~exchange~~was accounted for ~~their~~as ~~outstanding~~a ~~common~~transaction ~~and~~between ~~preferred~~entities ~~stock,~~under ~~(ii) sold 52,500,000 shares of~~ common ~~stock to the public at $6~~control.75 ~~per~~The ~~share,~~assets and ~~(iii) sold~~liabilities ~~3,940,110 shares~~ of ~~common~~Performance ~~stock in a private placement offering to~~Credit anCorporation ~~affiliate~~were ofrecorded ~~its~~by ~~lead~~the ~~underwriter,~~Company ~~Friedman, Billings, Ramsey, Group, Inc.~~ at ~~$6.345~~the ~~per~~time ~~share. ECC Capital raised a total~~ of ~~$379,375,000 through~~ the ~~sale~~transaction ofat ~~its~~their ~~stock~~carrying ~~(before offering expenses)~~value.

~~Following~~Prior to February 2007, the ~~initial~~Company originated ~~public~~nonconforming ~~offering,~~mortgage ~~Encore~~loans ~~Credit~~through ~~became~~its ataxable ~~wholly-owned~~ REIT subsidiary, ofPerformance ~~ECC~~Credit ~~Capital.~~Corporation, Inprincipally ~~this~~using ~~annual~~its ~~report,~~network ~~unless~~of brokers throughout the ~~context~~United ~~suggests~~States. ~~otherwise,~~The ~~for~~Company ~~time~~either ~~periods~~sold ~~before~~loans ~~February 17~~to third parties, ~~2005~~through Performance Credit, ~~the~~or ~~terms~~it ~~“the~~transferred ~~company,”~~loans ~~“we,”~~to ~~“our”~~a ~~and~~wholly-owned ~~“us”~~bankruptcy ~~refer~~remote tosubsidiary ~~Encore~~which ~~Credit~~financed ~~and its~~such ~~subsidiaries,~~loans ~~and~~through ~~for~~the ~~time~~issuance ~~periods~~of onasset-backed ~~and~~securities ~~after~~in ~~February 17,~~securitization ~~2005,~~transactions ~~all~~accounted ~~references~~for toas ~~“the~~financings ~~company,”~~or ~~“we,”~~sales. ~~“our”~~The ~~and~~Company’s ~~“us”~~loan origination ~~refer~~operations tocomprised ~~ECC~~the ~~Capital~~majority ~~and~~of its ~~subsidiaries,~~business ~~including~~activities ~~Encore~~within ~~Credit~~its mortgage banking segment.

~~General~~During the second quarter of 2006, ECC Capital’s board of directors began to review and evaluate potential strategic alternatives to enhance shareholder value. On October 10, 2006, the Company announced that it had entered into an agreement (the “Asset Purchase Agreement”) to sell certain operating assets used in its wholesale mortgage banking operation to Bear Stearns Residential Mortgage Corporation, for approximately $26 million in cash and the assumption of certain liabilities by Bear Stearns. Under the terms of the Asset Purchase Agreement, Bear Stearns agreed to acquire the assets of the Company’s wholesale mortgage banking operation, including property and equipment, customer lists, intellectual property and information technology systems used by the Company (the “Business”). Bear Stearns agreed to assume those liabilities that are necessary for it to continue to support the originations generated by the Business, including leases for the Company’s operating centers in Irvine, California, Downers Grove, Illinois and Glen Allen, Virginia. The Company also entered into certain agreements with Bear Stearns under which Bear agreed to fund and acquire the Company’s loan production through the date of closing of the Asset Sale.

~~Our~~On ~~total~~February 9, ~~assets~~2007, ~~grew~~the ~~significantly~~Company ~~during~~closed ~~2005~~the assale ~~a result~~ of ~~growth~~its inmortgage ~~loan~~banking ~~production~~operations ~~and~~to ~~retaining~~Bear aStearns ~~significant portion~~and ofsettled ~~that~~the ~~production~~sale ~~on our balance sheet by establishing a portfolio~~ of ~~loans~~approximately ~~held-for-investment~~$1.2 Webillion ~~financed~~in ~~our~~mortgage ~~portfolio of~~ loans ~~held-for-investment~~to byBear ~~issuing long term debt secured by the portfolio in securitization transactions. As a result~~Stearns, ~~our~~ ~~net~~subject ~~interest income grew significantly and we began recording a provision for loan losses. Net interest income after provision for loan losses grew~~ to ~~$94.7~~certain ~~million~~price ~~in 2005 from $28.0 million in 2004.~~

We31 hedge the risk of changes in interest rates through the use of derivatives—Eurodollar futures, interest rate caps and swaps. As a result of increases in interest rates during 2005, we reported a gain on derivatives of $39.3 million.

~~Loans~~ adjustments ~~that~~and wecall dorights. ~~not~~Upon ~~securitize~~completion ~~are~~of ~~generally~~the ~~sold~~transaction, tothe ~~third~~Company ~~parties~~effectively inexited ~~whole-loan~~the ~~sale~~wholesale ~~transactions. Because~~mortgage oforigination ~~declining~~business, ~~prices~~agreeing wenot ~~received~~to compete in ~~whole-loan~~the ~~sale~~wholesale ~~transactions~~mortgage ~~during~~origination ~~2005~~business for a period of two years. Accordingly, inthe ~~particular~~disposition ~~during~~of the ~~fourth~~mortgage ~~quarter,~~banking weoperations ~~recorded~~is being reported as a ~~loss~~discontinued onoperation for the ~~sale~~year ended December 31, 2006. As Bear Stearns also acquired use of ~~loans~~the Encore Credit name, the Company changed the name of ~~$38~~Encore Credit Corp.3 ~~million~~to Performance Credit Corporation, which remains our wholly-owned subsidiary. ~~This~~The ~~includes~~Company anticipates that it will record a ~~valuation~~gain ~~allowance~~on the sale of its ~~$40.7~~mortgage ~~million~~banking ~~recorded~~ operations during ~~2005~~the tothree ~~reduce~~months ~~the~~ended ~~carrying~~March 31, ~~value~~2007. However, excluding the effect of ~~our~~the ~~loans~~gain ~~held~~on ~~for~~the sale, the Company expects to ~~the~~report ~~lower~~a ofloss ~~cost~~on orits ~~market.~~discontinued operations through the first quarter of 2007.

AsFollowing athe ~~result~~transaction, ofwe ~~the~~continue ~~foregoing,~~to ~~our~~own ~~net~~and ~~revenues~~manage ~~declined~~interests ~~during~~in ~~2005~~securitization totrusts ~~$95.7~~which ~~million~~issued ~~from~~securities ~~$163.3~~collateralized ~~million~~by mortgages inon ~~2004~~residential real estate. Our ~~expenses~~principal ~~increased~~sources ~~significantly~~of ~~as a~~revenue ~~result~~are ofnet ~~the~~interest ~~growth~~income inon our ~~loan~~portfolio ~~production~~of ~~and~~loans ~~related~~held ~~overhead,~~for ~~growing~~investment toand ~~$177.6~~interest ~~million~~accretion inon ~~2005~~our ~~from~~investments ~~$114.8~~in ~~million~~residual interests in ~~2004~~our securitizations. As apart ~~result~~ of ~~the~~managing our ~~decline~~portfolio inof ~~revenues~~loans ~~and~~held ~~increase~~for ~~in expenses~~investment, we ~~are~~may ~~reporting~~also aoriginate ~~loss~~mortgage ~~before~~loans as a ~~benefit~~broker ~~for~~to ~~income taxes~~generate ofadditional ~~$76.4~~revenue ~~million~~from inborrowers ~~2005,~~wishing asto ~~compared~~prepay totheir ~~income~~mortgage ~~before~~loans aor ~~provision~~to ~~for~~facilitate ~~income~~the ~~taxes~~workout or modification of ~~$48.6~~a ~~million~~loan into ~~2004~~mitigate losses. ~~After~~We ~~the~~refer ~~provision~~to ~~(benefit)~~this ~~for~~as ~~income~~portfolio ~~taxes~~protection. Revenue we ~~are~~generate ~~reporting~~from aour ~~net~~portfolio ~~loss~~protection ofactivities ~~$64.1~~is ~~million~~not ~~for~~material ~~2005 as compared~~ to ~~$28.3~~our ~~million~~financial ~~in net income for 2004~~statements.

AsWe ofare ~~December 31,~~currently ~~2005,~~evaluating wevarious ~~operated through~~operating ~~seven~~alternatives ~~regional~~which ~~processing~~include, ~~centers~~among ~~located~~other ~~in Irvine~~things, ~~California,~~managing ~~Woodland~~our ~~Hills,~~existing ~~California,~~investments ~~Walnut~~in ~~Creek,~~our ~~California~~securitizations, ~~Downers~~acquiring ~~Grove,~~loan ~~Illinois,~~portfolios ~~Glen~~for ~~Allen,~~securitization ~~Virginia,~~and ~~Tampa,~~making investments ~~Florida~~in ~~and~~other ~~White~~residual ~~Plains,~~interests ~~New~~in ~~York~~securitizations. InWe ~~addition,~~intend ~~Bravo~~to ~~Credit operated~~maintain ~~through~~our ~~eleven~~REIT ~~offices~~status ~~throughout~~for the ~~United~~period ~~States~~of time during which we hold residual interests in our securitizations. As ofa ~~December 31~~REIT, ~~2005,~~earnings we ~~employed~~distribute ~~426~~to ~~loan~~our ~~officers~~stockholders are not subject to income tax for federal or state purposes as long as we distribute at least 90% of our taxable earnings and ~~loan~~satisfy ~~production~~certain ~~account~~other ~~executives~~qualifying tests.

On January 6, 2006, we announced a cost savings initiative that included a reduction from seven regional processing centers down to three regional processing centers in Irvine, Downers Grove, and Glen Allen. In addition, beginning in the second quarter, our retail operations will be conducted solely out of Irvine. On April 11, 2006, we announced an additional reduction in workforce of approximately 170 employees.

Critical Accounting Policies

We have established various accounting policies that apply accounting principles generally accepted in the United States of America in the preparation of our historical financial statements. Certain accounting policies require us to make significant estimates and assumptions that may have a material impact on certain assets and liabilities or our results of operations, and we consider these to be critical accounting policies. The estimates and assumptions used are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates and assumptions, which could have a material impact on the carrying value of our assets and liabilities and our results of operations.

We believe the following are critical accounting policies that require the most significant estimates and assumptions that are subject to significant change in the preparation of our consolidated financial statements:

Mortgage Loans and Origination Costs and Fees

Our mortgage loans are classified as either held for sale or held for investment. Mortgage loans held for sale are carried at the lower of cost or market on an individual loan basis. Market value is determined by reference to prices obtained on recent sales of similar loans, planned loan sale transactions, or through loan pricing models. The provision to reduce held-for-sale loan inventory to the lower of cost or market is ~~charged~~included toin ~~gain~~discontinued ~~on sale of loans~~operations.

Mortgage loans that we securitize or expect to securitize through on balance sheet securitizations are classified as held for investment and carried at amortized cost. Mortgage loans transferred from held for sale to held for investment are transferred at the lower of cost or market at the date of the transfer.

We capitalize the fees received from borrowers at the time of loan origination, and various costs of originating loans, which consist of fees and premiums paid to brokers, as well as certain direct internal costs. Net ~~capitalized~~ origination costs and fees on loans held for sale are charged to expense at the time the related loans are sold and reduce the gain on sale recorded. Net capitalized origination costs and fees on loans held for

4732

capitalized origination costs and fees on loans held for sale are charged to expense at the time the related loans are sold and reduce the gain on sale recorded. Net capitalized origination costs and fees on loans held for investment are amortized as a component of interest income over the life of the portfolio using the effective yield method in a manner that anticipates prepayments. At each reporting period, if a difference arises between the prepayments anticipated and actual prepayments received, we will recalculate the effective yield to reflect actual prepayments to date and anticipated future prepayments. Accordingly, if actual prepayment speeds exceed anticipated prepayment speeds we will be required to record additional interest expense.

Mortgage loans held for sale are classified as assets of discontinued operations as of December 31, 2006. Income and expenses associated with mortgage loans held for sale, including interest income and gain on sale of loans are included in loss on discontinued operations.

Allowance for Losses on Mortgage Loans Held for Investment

Because we began to maintain a portion of our loan production on our balance sheet, we have established an allowance for losses related to the mortgage loans held for investment. We periodically conduct reviews of all loans held in our portfolio in order to determine collectibility. We determine the amount of the loss allowance for these loans based on a review of static pools, gross defaults, recovery rate trends, current economic conditions and trends, and other relevant data. To date, we have had minimal losses, however, the delinquency and loss trend is expected to increase as our portfolio continues to mature. ~~and~~We ~~we experience losses, we~~ plan to compare actual loss performance to original loss assumptions and, if necessary, make adjustments to the allowance for losses. In order to increase allowances, a loan loss provision is charged to the statement of operations, resulting in a reduction to earnings. Loans that are deemed to be uncollectible will be charged off and deducted from the allowance. Recoveries on loans previously charged off will be added to the allowance. As our portfolio of loans held for investment increases and ages, we would expect a corresponding increase in our allowance for losses.

Our estimate of expected losses could increase if our actual loss experience is different than originally estimated, or if economic facts change the value we could reasonably expect to obtain from a sale. In particular, if actual losses increase, the allowance for losses would increase. Any increase in the allowance for losses relating to these factors may adversely affect our results of operations.

We cease accruing interest income on loans when any portion of principal or interest is 90 days past due, or earlier when any concern exists as to the ultimate collectibility of principal or interest. Interest income recognized prior to loans becoming 90 days past due is not reversed; however, it is included in our allowance for loan losses.

Gain or Loss on Sale of Loans

We recognize a gain or loss on sale of our loans we sell through whole-loan sales. Gains or losses resulting from these sales or securitizations of mortgage loans are recognized at the date of settlement and are based on the difference between the selling price for sales or securitizations and the carrying value of the related loans sold. As part of the sale of a mortgage loan, we sell the servicing rights. The purchasing company pays us a service release premium for that right. ~~This premium is included in “gain (loss) on sale of loans” in the accompanying consolidated statements of operations.~~

Loan sales and securitizations are accounted for as sales when control of the loans is surrendered, to the extent that consideration other than beneficial interests in the loans transferred is received in the exchange. Retained interests in securitizations accounted for as sales are measured by allocating the previous carrying value between the loans sold and the interests retained, if any, based on their relative fair values at the date of transfer.

~~Allowance~~Gain ~~for~~or ~~Repurchase~~loss ~~Losses~~in sale of loans is included in loss on discontinued operations.

~~Losses~~33 incurred on mortgage loans that we have sold and subsequently repurchased due to breaches of representations and warranties contained in the purchase and sale agreements are charged to the allowance for repurchase losses. The allowance represents our estimate based upon management’s evaluation of historical experience with respect to each investor of the principal, premium, interest losses and other costs, if any, expected to occur at the time of repurchase. The provision for expected repurchase losses is charged to gain or loss on sales of loans and credited to an allowance.

Allowance for Repurchase Losses

Losses incurred on mortgage loans that we have sold and subsequently repurchased due to breaches of representations and warranties contained in the purchase and sale agreements are charged to the allowance for repurchase losses. The allowance represents our estimate based upon management’s evaluation of historical experience with respect to each investor’s principal, premium, interest losses and other costs, if any, expected to occur at the time of repurchase. The provision for expected repurchase losses is charged to gain or loss on sales of loans and credited to an allowance.

The allowance for repurchase losses is classified as liabilities of discontinued operations as of December 31, 2006.

Fair Value of Residual Interests in Loan Securitizations

In securitizations completed ~~through~~during 2003, 2004 and 2006, we conveyed loans that we originated to a special purpose entity (such as a trust), or to a third party that subsequently sold the loans to a special purpose entity, in exchange for cash proceeds and a residual interest in the trust. The cash proceeds were raised through an offering of the pass-through certificates or bonds evidencing the right to receive principal payments and interest on the certificate balance or on the bonds. Pursuant to ~~Financial Accounting Standards Board, or~~ FASB, Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, or SFAS No. 140, and its predecessor accounting pronouncements, we recorded gain or loss on sales of loans, equal to the difference between the portion sold and any retained interests, herein referred to as residual interests, based on their relative fair values at the date of transfer and our basis in the loans. The residual interests represent, over the estimated life of the loans, the present value of the estimated cash flows. These cash flows are determined by the excess of the projected interest earned on each pool of securitized loans over the sum of the interest paid to investors, the contractual servicing fee, an estimate for credit losses and other ongoing costs of the securitization. Each agreement that we have entered into in connection with these securitizations requires the over-collateralization of the trust that may initially be funded by cash or an excess of loans deposited into the trust. The amount and timing of the cash flows expected to be released from the securitization trusts consider the impact of the applicable delinquency and credit loss limits specified in the securitization agreements.

We ~~determined~~estimated the present value of the cash flows at the time each securitization transaction closed using certain assumptions and estimates made by management at the time the loans were sold. These assumptions and estimates included:

• estimates of future interest rates based upon the forward London Interbank Offered Rate, or LIBOR, curve;

•

future rates of principal prepayment on the loans;

•

timing and magnitude of credit losses; and

•

discount rate used to calculate present value.

The future cash flows represent management’s best estimate. There can be no assurance of the accuracy of management’s estimates. Most of our residual interests are recorded at estimated fair value and are marked to market through a charge (or credit) to earnings. On a quarterly basis, we review the fair value of our residual interests by analyzing prepayment, credit loss, discount rate assumptions and other performance assumptions and estimates in relation to our actual experience and current rates of prepayment and credit loss prevalent in the industry. We may adjust the value of our residual interests or take a charge to earnings related to the residual interests, as appropriate, to reflect a valuation or write-down of the residual interests based upon the actual performance of the residual interests as compared to our key assumptions and estimates used to determine fair value. Although management believes that the assumptions used to estimate the fair value of the residual interests are reasonable, there can be no assurance as to the accuracy of the assumptions or estimates.

Estimated future cash flows in excess of the amortized cost of our investment in residual interests are recognized as income at a constant rate of interest (level-yield) over the estimated period of time that the cash flows will be received, in accordance with Emerging Issues Task Force 99-20 (“EITF 99-20”), Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. On a quarterly basis, if estimated cash flows generated from the securitized asset’s underlying collateral differ from the cash flows previously estimated due to actual prepayment or credit loss experience, we calculate revised yields based on the current amortized cost of the investment and the revised cash flows. The revised yields are then applied prospectively to recognize interest income.

Derivative Financial Investments and Hedging Activities

Hedging is a critical aspect of our business because the value of our assets is sensitive to the fluctuation of interest rates. From time to time, we have and will continue to use various financial instruments to hedge our exposure to changes in interest rates. The following summarizes the hedging instruments that, subject to limitations imposed by the REIT requirements, we have used to reduce interest rate risks on our residual interests, the loans that we hold for investment and the loans that we hold for sale.

exposure to changes in interest rates. The following summarizes the hedging instruments that, subject to limitations imposed by the REIT requirements, we have used to reduce interest rate risks on our residual interests, the loans that we hold for investment and the loans that we hold for sale.

Interest Rate Swap Agreements and Eurodollar Futures. Interest rate swap agreements allow us to exchange floating rate obligations for fixed-rate obligations effectively locking in our borrowing costs for a period of time. When we enter into a swap agreement we agree to pay a fixed-rate of interest and to receive a variable interest rate, generally based on LIBOR. We may also sell Eurodollar futures contracts in order to mitigate the projected impact of interest rate changes on our forecasted one-month LIBOR based liabilities.

Interest Rate Cap Agreements. Interest rate cap agreements allow us to receive cash payments if the interest rate index specified in the cap agreement increases above contractually specified levels. Therefore, the interest rate cap agreements have the effect of capping the interest rate on a portion of our borrowings to the rate specified by the interest rate cap agreement.

We also may use, from time to time, futures contracts and options on futures contracts on the Eurodollar, federal funds, treasury bills and treasury notes and similar financial instruments to mitigate risk from changing interest rates.

We presently do not intend to enter into derivative instruments, except for hedging purposes. Further, it is unlikely that we can obtain hedging instruments that perfectly offset all of the risks of our assets and liabilities. No hedging strategy can completely insulate us from risk, and certain of the federal income tax requirements that we must satisfy to qualify as a REIT may limit our ability to hedge. We intend to monitor and may have to limit our hedging strategies to ensure that we do not realize excessive hedging income or hold hedging assets having excess value in relation to total assets.

In accordance with SFAS No. 133, all derivative instruments are recorded at fair value. To qualify for hedge accounting under SFAS No. 133, we must demonstrate, on an ongoing basis, that our interest rate risk management activity is highly effective. We must also formally assess, both at inception of the hedge and on an ongoing basis, whether the derivative instruments used are highly effective in offsetting changes in cash flows of hedged items. If we are unable to qualify certain of our interest rate risk management activities for hedge accounting, then the change in fair value of the associated derivative financial instruments would be reflected in current period earnings, but the change in fair value of the related asset or liability may not, thus creating a possible earnings mismatch.

While we may change the classification of our derivative financial instruments in the future, we presently account for all our derivative financial instruments as trading instruments and we do not apply hedge accounting treatment, as defined by SFAS No. 133. Accordingly, realized and unrealized changes in fair value are recognized in income during the period in which the changes occur.

Deferred Bond Issuance Costs

Direct costs associated with the issuance of long-term collateralized debt are capitalized and amortized as a component of interest expense in a manner that produces a constant rate of interest over the estimated term of the debt, expecting that the debt will be paid fully from the cash flows from the underlying collateral. Changes in the estimated amount and timing in cash flows of the collateral that pass through to the debt may cause us to amortize deferred bond issuance costs faster or slower than we anticipated upon issuance of the bonds.

Income taxes

We currently intend to elect to be taxed as a REIT for federal income tax purposes commencing with our taxable year ending December 31, 2005. In order to meet some of the requirements for us to qualify as a REIT, we continue to conduct all of our loan originations and sales through Encore Credit. As a result of our joint elections, Encore Credit and Bravo Credit are treated as our taxable REIT subsidiaries, or TRSs. The origination

and purchase of the loans we sell in whole-loan sales are funded by the applicable TRS. The origination and purchase of the loans we retain for our portfolio are funded by Encore Credit and subsequently sold to ECC Capital. To the extent that ECC Capital purchases mortgage loans from Encore Credit in this manner, ECC Capital is required to purchase those loans at fair market value.

Federal income tax law requires that a REIT distribute to its stockholders annually at least 90% of its net taxable income, excluding its net capital gains and excluding the retained earnings of any taxable REIT subsidiary it owns. If we distribute all of our taxable income to our stockholders and otherwise qualify as a REIT, we generally will not be required to pay federal income tax. Any taxable income generated by our taxable REIT subsidiaries, however, will be subject to regular corporate income tax. Our taxable REIT subsidiaries may retain any income generated, net of any tax liability incurred on that income, without affecting the REIT distribution requirements, subject to our compliance with the 20% asset test applicable to our ownership of securities in taxable REIT subsidiaries. If Encore Credit chooses to make distributions to us, the amount of such distribution that is taxable as a dividend will be included in our taxable income that is subject to the distribution requirements. Any distributions we make in the future will be at the discretion of our board of directors and will depend upon, among other things, our actual results of operations.

As certain of our subsidiaries are taxable entities, we have reported a provision for income taxes within our financial statements, similar to that reflected in our previous financial statements. We use the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates for the periods in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

In determining the possible realization of deferred tax assets, we consider future taxable income from the following sources: (i) the reversal of taxable temporary differences, (ii) taxable income from future operations and (iii) tax planning strategies that, if necessary, would be implemented to accelerate taxable income into periods in which net operating losses might otherwise expire. During 2005 our TRSs had pre-tax losses of approximately $93.2 million. We can utilize the net operating loss of our TRSs to offset taxable income from prior years and carryforward the operating loss to offset future taxable income. We have recorded a valuation allowance against our deferred asset of $22.7 million to reduce the carrying value of this asset to $31.2 million, which we believe to be the realizable value of this asset based on our ability to carry back net operating losses to recover taxes paid in prior years.

Loan sales from Encore Credit, our TRS, to the REIT are recorded at estimated fair value as of the date of sale and the gain or loss on sale is included in the taxable income of Encore Credit and loan premium is recorded in our separate accounts. This intercompany gain or loss and loan premium are eliminated upon consolidation for financial reporting purposes. The difference between our tax basis in the acquired loans and the basis in the loans for financial reporting purposes is not considered a temporary difference for which deferred taxes are provided. The amount of tax paid or to be paid by Encore Credit in its separate return related to this gain is recorded as prepaid taxes for financial reporting purposes and amortized as tax expense. To the extent Encore Credit does not expect to pay tax on this gain, the tax effect of intercompany gains will reduce the tax benefit that would otherwise have been recorded.

Results of Operations

~~Year~~Prior ~~ended~~to ~~December 31,~~our initial public offering in February 2005, ~~Compared~~our business activities consisted primarily of wholesale mortgage origination operations which we sold to ~~Year~~Bear ~~ended~~Stearns ~~December 31~~in February 2007. We are reporting our wholesale mortgage origination operations as discontinued operations. Our continuing operations primarily comprise what had been our portfolio investment segment, ~~2004~~which did not exist prior to 2005.

~~Interest~~Continuing ~~Income.~~operations Interest income increased 509.4% to $342.5 million for the year ended December 31, 2005 from $56.2 million for the year ended December 31, 2004 as a result of the growth in interest earning assets, in particular, mortgage loans held-for-investment.

51Net Interest Income. Prior to 2005, the Company operated primarily as a mortgage originator with no portfolio of loans held for investment and related long-term debt. The Company completed four securitizations that it accounted for as financings during 2005. It completed no securitizations that it accounted for as financings during 2006. The unpaid principal balances on the Company’s portfolio of loans held for investment declined from $4.2 billion at December 31, 2005 to $2.4 billion at December 31, 2006 as a result of normal principal payments and loan prepayments. Similarly, the outstanding bond balances secured by these mortgage loans declined from $4.2 billion as of December 31, 2005 to $2.4 billion as of December 31, 2006.

Although balances declined from year to year, the average balances of unpaid principal and bond balances outstanding during 2006 were higher than the average balance of unpaid principal and bond balances outstanding during 2005 as a result of the timing of the Company’s 2005 securitizations. In addition, the interest rate on the Company’s bond balances increased significantly throughout 2005 and 2006 as a result of increases in one-month LIBOR. At December 31, 2006, one-month LIBOR was 5.32%. At December 31, 2005, one-month LIBOR was 4.39%. At December 31, 2004, one-month LIBOR was 2.40%.

These factors underlie the increase in interest income and expense related to the Company’s portfolio of loans held for investment and related long-term debt. Because of the significant increases in one-month LIBOR throughout 2006 and 2005, interest expense increased by more than interest income, causing a decline in the net interest income earned by the Company.

Interest income is earned on the Company’s portfolio of loans held for investment, investments in residual interests in thousands):


	Year ended December 31,
	2006			2005			2004
Loans held for investment
Coupon interest	$	223,894		$	196,949		$	—
Premium amortization		(23,863	)		(18,366	)		—
Prepayment penalties		28,322			13,958			—

Total		228,353			192,541			—
Residual accretion		12,971			3,046			—
Investment interest income		1,641			685			—

Total interest income	$	242,965		$	196,272		$	—

Residual accretion increased during 2006 reflecting higher expected cash flows from off balance sheet securitizations completed in 2004 and 2003. As the loans underlying these securitizations have seasoned,

In projected ~~prior~~cumulative ~~years~~losses wehave ~~sold~~declined ~~most~~as ofcompared ~~our~~to ~~loans~~initial ~~and~~projections ~~earned~~resulting ~~interest~~in ~~income~~an onincrease ~~loan~~in ~~production~~expected ~~held~~future oncash ~~our warehouse~~flows ~~facilities~~and ~~pending~~an ~~the~~increase ~~eventual~~in accretion ~~sale these loans~~income. ~~Subsequent~~Investment tointerest ~~our~~income ~~initial~~increased ~~public~~primarily ~~offering,~~due weto ~~began~~investing ~~retaining~~excess ~~our~~cash ~~loans~~in ~~for~~higher ~~investment~~yielding ~~purposes and earned significant interest income from these loans~~investments.

~~Interest~~Premium amortization ~~Expense.~~and ~~Interest~~prepayment ~~expense~~penalties increased ~~632.3% to $206.5 million for the year ended December 31, 2005 from $28.2 million for the year ended December 31, 2004,~~ due to ~~the~~normal ~~interest~~seasoning ~~costs~~of on the ~~bonds~~portfolio ~~associated with financing our loans held-for-investment~~ and ~~rising~~the ~~interest~~noted ~~rates.~~increase ~~The~~in ~~interest rates~~average ~~on our borrowings are calculated as a margin over LIBOR~~balances. ~~As of December 31, 2005 and 2004, LIBOR was 4.39% and 2.40%, respectively.~~

~~Provision~~Interest ~~for~~expense ~~Loan~~primarily ~~Losses.~~relates ~~The~~to ~~provision~~the ~~for~~Company’s ~~loan~~long-term ~~losses~~debt onwhich ~~loans~~comprises ~~held~~mortgage ~~for~~backed ~~investment~~bonds ~~increased~~issued toin ~~$41.2~~connection ~~million~~with ~~for~~its ~~the~~securitizations. ~~year~~In ~~ended December 31~~addition, ~~2005 from $0 for~~ the ~~year~~Company ~~ended~~incurred ~~December 31,~~interest ~~2004.~~expense Noon ~~reserve~~borrowings ~~was~~during ~~provided~~the inyear secured ~~2004~~by asthe ~~all~~Company’s ~~loans~~retained ~~were~~interests ~~held for sale. The increase~~ in ~~the~~securitizations ~~provision~~and ~~during~~related ~~2005~~commitment ~~relates solely to establishing a portfolio of loans held-for-investment during 2005~~fees. AsComponents of ~~December 31,~~interest ~~2005,~~expense ~~loan~~are ~~delinquency~~summarized ~~information was~~ as follows (amounts in thousands):

Aging	LoanBalance		Percentage of Total
	Year ended December 31,
	(dollars in thousands)
	2006		2005		2004
Current	$	4,032,985	95.7	%
Bond interest	$	177,306	$	94,935	$	—
30 – 59 days past due		79,404	1.9	%
Amortization of bond discount and deferred bond issuance costs		8,126		4,846		—
60 – 89 days past due		36,485	0.9	%
		185,432		99,781		—
90 – 119 days past due		23,508	0.5	%
Warehouse interest expense		—		11,622		—
120 – 149 days past due		15,982	0.4	%
Other interest expense
150 – 179 days past due		9,786	0.2	%
Securities sold under agreements to repurchase		3,527		29		—
180 + days past due		16,474	0.4	%
Commitment fees		8,550		—		—
	$	4197,~~214,624~~509	$	111,432	$	—

During ~~the~~2006, ~~third quarter~~we ofborrowed ~~2005,~~approximately ~~Hurricane~~$60 ~~Katrina~~million ~~hit~~under ~~the~~a ~~Gulf~~repurchase ~~Coast~~arrangement ~~and~~with ~~caused~~a ~~severe~~financial institution ~~damage~~pledging toour ~~property~~residual interests in ~~parts~~securitizations ofand ~~Louisiana~~our ~~and~~ownership ~~surrounding~~interests ~~areas,~~in ~~including~~securitization ~~property~~trusts ~~securing~~consolidated afor ~~number~~financial ofreporting ~~our~~purposes ~~mortgage~~as ~~loans~~collateral. ~~During~~In ~~the third quarter of 2005~~December 2006, we ~~recorded~~repaid ~~a specific~~all ~~provision~~amounts ~~within~~outstanding ~~the~~under ~~allowance~~these borrowing ~~for loan losses of $6~~arrangements.2 ~~million~~Other ~~for~~interest ~~estimated~~expense ~~losses~~associated ~~arising~~with ~~from~~securities ~~Hurricane~~sold ~~Katrina.~~under Weagreements ~~are continuing~~ to ~~analyze~~repurchase ~~our~~and ~~exposure~~the toamortization ~~potential losses as a result~~ of ~~recent~~commitment ~~natural~~fees ~~disasters,~~was ~~however, we believe amounts recorded~~ related to ~~specific~~this ~~disaster~~repurchase ~~losses will be sufficient to absorb any such losses ultimately realized~~agreement.

~~Gain or Loss on Sale of Loans,~~ Net. Asinterest weincome ~~securitized~~(difference abetween ~~significant~~interest ~~portion~~income ~~of our loan production to build our portfolio of mortgage loans held-for-investment, the volume of loans sold to third parties~~ and ~~securitization~~interest ~~trusts~~expense) inis ~~whole~~summarized loan sales transactions declined by approximately 20.5% to $7.0 billion in 2005 from $8.8 billion in 2004. Gain or loss on sale decreased to a loss of $38.3 million for the year ended December 31, 2005 from a gain of $113.8 million for the year ended December 31, 2004. Throughout 2005, we experienced a decline in whole loan sales prices, in particular during the fourth quarter. During the fourth quarter of 2005, credit market conditions required additional credit enhancements that negatively impacted the prices at which we could sell our loans. The decline in sales prices we experienced during the fourth quarter also reflected, in part, normal seasonal trends, as ~~well~~follows as(amounts a need to reduce higher levels of for-sale inventory we had retained while selecting mortgage loans for securitization. Declining sales prices also required us to record a valuation allowance to reduce the carrying value of our loans held-for-sale as of the end of the third and fourth quarter of 2005 to the lower of cost or market. This valuation allowance reduced the amount we reported as gain or loss on sale and resulted in usthousands): ~~reporting a loss on the sale of loans for the year ended December 31, 2005 of $38.3 million.~~


	Year ended December 31,
	2006		2005		2004
Interest income	$	242,965	$	196,272	$	—
Interest expense		197,509		111,432		—

Net interest income	$	45,456	$	84,840	$	—

Provision for Loan Losses. Activity in the allowance for loan losses is summarized as follows (amounts in thousands):


	For the year ended December 31,
	2006			2005			2004
Beginning balance	$	40,862		$	—		$	—
Additions		19,520			41,185			—
Charge-offs, net		(16,957	)		(323	)		—

Ending balance	$	43,425		$	40,862		$	—

The increase in the provision during 2005 relates solely to establishing a portfolio of loans held-for-investment during 2005. As the Company’s portfolio for loans held for investment seasoned during 2006,

~~The~~ realized ~~following~~losses ~~table~~increased ~~summarizes~~requiring ~~loan~~the ~~sales~~Company to record an additional provision for loan losses to maintain the ~~periods~~allowance ~~indicated:~~at a level management believes appropriate to provide for losses in its portfolio of loans held for investment that have been incurred as of December 31, 2006.

	For the year ended December 31,
	2005			2004
	(in thousands)
Whole-loan sales at a:
Premium	$	6,646,010		$	8,625,504
Discount		352,882			154,861
Total whole-loan sales	$	6,998,892		$	8,780,365
Weighted average price for premium sales		101.59	%		103.04	%
Weighted average price for discount sales		97.26	%		95.41	%

In assessing the adequacy of the allowance for loan losses management considers, among other things, current delinquency trends. Loan delinquency information is summarized as follows (amounts in thousands):

Premium whole-loan sales are sales to investors at prices above par. Conversely, discount sales are sales of loans at prices below par. Discounted sales are generally a result of incomplete documentation or the rejection of the whole-loans by a premium whole-loan buyer because of certain characteristics, or loans repurchased from investors and subsequently resold. Our weighted average price for premium sales decreased by 145 basis points to 101.59% for the year ended December 31, 2005 from 103.04% for the year ended December 31, 2004. We believe this decrease was a result of unfavorable pricing on our loans as a result of the factors noted above.


	December 31,
	2006				2005
Aging	Loan balance		Percentage of total		Loan balance		Percentage of total
Current	$	2,133,450	88.2	%	$	4,032,985	95.7	%
30 – 59 days past due		88,274	3.6	%		79,404	1.9	%
60 – 89 days past due		41,562	1.7	%		36,485	0.9	%
90 – 119 days past due		27,840	1.1	%		23,508	0.5	%
120 – 149 days past due		23,884	1.0	%		15,982	0.4	%
150 – 179 days past due		22,222	0.9	%		9,786	0.2	%
180 + days past due		84,985	3.5	%		16,474	0.4	%

	$	2,422,217			$	4,214,624

Bankruptcy/foreclosure	$	159,239	6.6	%	$	48,018	1.1	%

~~The~~We ~~following~~believe ~~table~~delinquency ~~represents~~levels as of December 31, 2006 have increased due to normal seasoning of the ~~components~~loan portfolio and present market conditions. Although unpaid principal balances at December 31, 2006 have declined from the prior year by 43%, the allowance for loan losses has increased as a percentage of ~~gain~~the oroutstanding ~~loss~~portfolio balance onfrom ~~sales~~1.0% ~~recorded~~as ~~each~~of ~~period:~~December 31, 2005 to 1.8% as of December 31, 2006.

	For the year ended December 31,
	2005			2004
	(in thousands)
Premium from whole-loan sales	$	92,431		$	259,799
Provision for repurchases		(12,837	)		(10,230	)
Non-refundable loan fees, net		(5	)		(135	)
Lower of cost or market adjustment for loans held for sale		(40,689	)		(960	)
Deferred origination costs		(77,232	)		(134,642	)
Gain on sale of loans, net	$	(38,332	)	$	113,832

As of December 31, 2006 the allowance for loan losses represents 22% of unpaid principal balances 60 days or more delinquent. Through December 31, 2006, average loss severity on all liquidated loans has been 18.0%. For the year and three months ended December 31, 2006, average loss severity on liquidated loans during these periods was 17.9% and 20.7%, respectively. We believe average loss severity on liquidated loans will be in excess of 30% during the first quarter of 2007 as evidenced by preliminary results.

~~Our~~Gain practice is to record at the date of the sale a provision for estimated repurchase losses attributable to principal, premium, interest and other costs of loans repurchased based upon our historical experience of the amount of sales that ultimately require repurchase. The obligations to repurchase loans and to reimburse the investor for any premiums paid on ~~loans~~Trading ~~attributable~~Securities ~~to early payment are contractual obligations~~ and ~~require~~Derivative ~~management to estimate such amounts at the time of sale~~Instruments. The ~~provisions,~~ ~~therefore,~~net ~~can~~gain ~~vary from year to year depending~~ on ~~the~~trading ~~contractual~~securities ~~obligations~~ and ~~loan~~derivative ~~performance.~~instruments ~~Our~~comprises ~~provision for repurchase losses decreased for~~ the ~~year ended December 31, 2005 as compared to the year ended December 31,~~following ~~2004,~~(amounts ~~primarily~~in asthousands): ~~a result of decreased whole-loan sales volume, which decreased 20.5% to $7.0 billion for the year ended December 31, 2005 from $8.8 billion for the year ended December 31, 2004.~~

Loan origination fees, as well as discount points and certain direct origination costs, are initially capitalized and recorded as an adjustment to our cost of the loan, which is reflected in the gain or loss on sale we record when the loan is sold. Deferred origination costs decreased 42.6% to $77.2 million for the year ended December 31, 2005 from $134.6 million for the year ended December 31, 2004, primarily due to lower whole-loan sales volume and as a result of lower fees and costs paid to brokers to acquire loans.


	For the year ended December 31,
	2006			2005			2004
Residual mark-to-market gain (loss)	$	(12,035	)	$	(7,730	)	$	—
Derivative gains (losses):
Eurodollar futures		—			2,144			—
Interest rate agreements		(17,960	)		20,378			—
Net receipts (payments) under interest rate agreements		34,711			(5,755	)		—

	$	4,716		$	9,037		$	—

~~Other~~The ~~Income.~~residual ~~Other~~mark-to-market ~~income~~loss ~~increased~~in 2005 relates primarily to ~~$5.4~~a ~~million~~reduction ~~for~~in ~~the~~projected cash flows ~~year~~from ~~ended~~our ~~December 31,~~residual ~~2005~~interests ~~from~~in $0securitizations accounted for ~~the~~as ~~year~~trading ~~ended~~instruments ~~December 31,~~as ~~2004,~~compared ~~due~~ to ~~proceeds~~initial weprojections. ~~received~~The ~~from~~decline in projected cash flows reflected higher than expected prepayments as well as a ~~legal~~reduction ~~settlement~~expected excess cash flows resulting from increasing interest rates.

53We completed a securitization of approximately $1.1 billion in assets in May 2006. The fair value assigned to the residual interests at the date of securitization was $50,185,000. In July 2006, we sold a portion of our

~~Gain~~ residual oninterests ~~Trading~~in ~~Securities~~this ~~and~~securitization ~~Derivative~~which ~~Instruments.~~reduced ~~The~~the ~~net~~fair ~~gain~~value onof ~~trading~~our ~~securities and~~residual ~~derivative~~interests ~~instruments~~to ~~increased~~approximately 82$33 million.8% toIn ~~$39.3~~February ~~million~~2007 ~~for~~we completed the ~~year~~sale ~~ended~~of ~~December 31,~~our ~~2005~~remaining ~~from~~interests ~~$21.5~~in ~~million~~this securitization for ~~the~~$20 ~~year~~million. ~~ended~~As of December 31, ~~2004~~2006, ~~which~~we ~~was~~valued ~~mainly~~these ~~due~~residual tointerests ~~rising~~at ~~interest~~$20 ~~rates~~million ~~increasing~~and ~~the~~recorded ~~value~~a ofmark-to-market ~~our~~loss ~~derivative instruments,~~on ~~partially~~this ~~offset~~asset ~~by decreased values~~ of ~~our~~approximately ~~residual~~$13 ~~interests in securitizations~~million.

WeA ~~use~~summary ~~Eurodollar~~of ~~futures~~the ~~contracts,~~fair ~~interest~~values ~~rate~~of ~~caps, and interest rate swaps to hedge~~ our residual interests in securitizations, ~~loan~~is ~~pipeline,~~as ~~loans held~~follows ~~for~~(amounts ~~sale, and loans held for investment. Due to rising interest rates, these derivative instruments increased~~ in ~~value~~thousands): during 2005. In addition, we were required to make net swap payments during the beginning of 2005 due to the fixed contract interest rate being higher than the floating market interest rate. Due to increases in LIBOR, towards the end of 2005 we began receiving net swap payments and the payments we receive on our interest rate cap contracts have increased.

The residual interests in securitizations represent the present value of the excess of estimated future cash flows received from borrowers on mortgage loans sold into securitization trusts over the cash flows passed through to the related asset-backed securities. Because the interest rates on the asset-backed securities reset more frequently than the interest rates on the underlying mortgage loans securing them, during periods of increasing interest rates, estimated future cash flows and the value of the residual interests will decline. Conversely, during periods of decreasing interest rates, estimated cash flows and the value of the residual interests will generally increase. We acquired most of our residual interests in securitization transactions completed in the second and third quarters of 2004.


	Value as of December 31,
	2006		2005
SASCO ECC 2003-1	$	3,525	$	1,464
CWABS ECC 2004-1		9,407		4,837
CWABS ECC 2004-2		12,988		8,452
Bravo Mortgage Asset Trust 2006-1		20,000		—

Total	$	45,920	$	14,753

~~During~~The ~~2005,~~values ~~interest~~of ~~rates~~the ~~increased~~securitizations ~~causing~~we acompleted ~~decline~~ in ~~value~~ in2003 ~~our~~and ~~residual~~2004 ~~interests.~~increased Inprimarily ~~addition,~~as ~~loans~~a ~~within~~result of the ~~securitization~~recording ~~transactions~~of ~~began~~accretion ~~prepaying~~income atdiscussed ~~higher~~previously. ~~than~~We ~~anticipated~~did ~~rates.~~not Asreceive ~~mortgage~~any ~~loans~~material ~~within~~cash ~~the~~flows ~~securitization~~on ~~are~~these ~~prepaid~~residual interests during 2006; however, ~~estimated~~we ~~future~~began receiving cash flows ~~are~~on ~~reduced,~~both ~~further decreasing~~2004 securitizations during the ~~value~~first quarter of ~~our~~2007. ~~residual~~Loan principal ~~interests.~~balances ~~Based~~in ~~upon~~the 2003 securitization have paid down to the ~~prepayment~~point ~~speeds~~that wethe ~~experienced~~servicer ~~during~~may ~~2005~~exercise their clean up call rights, weupon ~~adjusted~~which the ~~prepayment~~balance ~~assumptions~~of inthe ~~valuing~~overcollateralization ~~our~~account ~~residual~~within ~~interests~~the assecuritization ofwill ~~December 31,~~be ~~2005.~~released ~~The~~to ~~revised~~us. ~~prepayment~~We ~~assumptions~~are ~~reduced~~unable ~~further~~to ~~our~~determine ~~estimate~~when, ofor ~~the~~if, ~~value~~such ofa ~~our~~clean ~~residual~~up ~~interests~~call will occur.

~~Personnel.~~In ~~Personnel~~2005, ~~expenses~~we ~~increased~~utilized ~~72.9%~~Eurodollar futures to ~~$84.2~~hedge ~~million~~the ~~for~~risk ~~the~~of ~~year~~changes ~~ended~~in interest ~~December 31,~~rates ~~2005~~on ~~from~~our ~~$48.7~~LIBOR-indexed ~~million~~warehouse ~~for~~liabilities ~~the~~after ~~year~~loans ~~ended~~were ~~December 31,~~designated ~~2004,~~as ~~due~~held tofor ~~the~~investment ~~increased~~and ~~level~~awaiting ofsecuritization. ~~production~~The ~~and~~gain ~~administrative staffing~~on ~~required~~interest torate ~~accommodate~~contracts ~~our~~in ~~higher~~2005 ~~origination~~reflects ~~volume.~~the ~~Total~~effect ~~staffing~~of ~~was~~increasing ~~1,667~~interest ~~employees~~rates aton ~~December 31,~~the ~~2005~~cap ~~compared~~and swap tointerest ~~total~~rate ~~staffing~~agreements ofhedging ~~1,114~~the ~~employees~~risk atof ~~December 31,~~changes ~~2004,~~in aninterest ~~increase~~rates ofon ~~553~~our ~~employees,~~LIBOR-indexed orlong-term 49debt.~~6%.~~ ~~Subsequent to~~As ~~December 31,~~a result of rates increasing in 2005 and into 2006, we ~~reduced~~received payments under our ~~workforce~~cap byand ~~approximately~~swap ~~610~~interest ~~employees~~rate agreements. The decline in ~~connection~~the ~~with~~value ~~January~~of ~~and~~our ~~April~~interest rate agreements in 2006 ~~workforce~~largely ~~reductions~~reflects ~~and~~the ~~expect~~effect ~~our~~of ~~personnel~~these ~~costs~~distributions toand bethe reduced inremaining term of the ~~future~~agreements.

~~Production~~Operating ~~and Marketing. Production and marketing~~ expenses ~~increased 91~~.9% toThe ~~$23.6~~decline ~~million~~in ~~for~~operating ~~the~~expenses ~~year~~is ~~ended~~consistent ~~December 31,~~with ~~2005~~reductions ~~from~~in ~~$12.3~~personnel ~~million~~headcount ~~for~~and ~~the~~other ~~year~~related ~~ended~~administrative ~~December 31,~~costs ~~2004,~~that ~~which~~occurred ~~was~~during ~~mainly~~2006 ~~due~~as towe ~~the~~implemented ~~purchase~~various ofcost ~~internet leads for our retail operations and increased loan production~~savings ~~expenses associated with loans that did not close~~initiatives.

~~Servicing~~Following ~~Fees.~~the ~~Servicing~~initial ~~fees~~public ~~increased~~offering ~~93.1%~~in 2005, ECC Capital shared personnel and services with its subsidiaries, principally Performance Credit Corporation through the date of the sale of the mortgage origination business to ~~$13~~Bear Stearns.9 ~~million~~Operating expenses for the ~~year~~years ended December 31, 2006 and 2005 ~~from~~include ~~$7.2~~the ~~million~~costs ~~for~~associated with these shared personnel and services despite the ~~year~~fact ~~ended~~that ~~December~~many of the personnel providing such services became employees of Bear Stearns after February 319, ~~2004,~~2007. ~~which~~Although the number of employees was ~~due~~significantly toreduced following the ~~growth~~completion inof ~~our~~the ~~portfolio~~sale of ~~loans~~the ~~held-for-investment~~mortgage origination business to Bear Stearns and anwhile ~~increase~~there can be no assurances as to the amount of operating expenses we incur in the future, we anticipate that our ~~loans~~future ~~held-~~operating expenses will be less than is being reported in continuing operations for~~-sale~~ the year ended December 31, 2006.

~~Occupancy~~Servicing ~~Expense~~fees. ~~Occupancy~~Servicing ~~expense~~fees ~~increased~~are ~~64.4%~~paid to ~~$9.7~~third ~~million~~party ~~for~~loan ~~the~~servicers ~~year~~that service ~~ended~~our ~~December 31,~~portfolio ~~2005~~of ~~from~~loans ~~approximately~~held $5for investment.9 ~~million~~Servicing fees were slightly higher for the year ended December 31, ~~2004,~~2006 ~~which~~as iscompared ~~mainly~~to 2005 due to the ~~expansion~~higher ~~of our~~average ~~corporate~~balance ~~office and opening new regional offices. Subsequent to December 31, 2005, we announced a reorganization that resulted in the consolidation~~ of ~~our~~mortgage ~~processing~~loans ~~centers,~~outstanding ~~which~~during is2006 ~~expected~~as ~~to reduce our future occupancy expense. Our~~previously ~~retail operations will be conducted solely out of Irvine~~discussed.

~~General~~39 and Administrative. General and administrative expenses increased 13.5% to $46.2 million for the year ended December 31, 2005 from $40.7 million for the year ended December 31, 2004. The increase is mainly

~~due~~Discontinued toOperations increased operating expenses such as telephone, insurance, legal, consulting, and depreciation expenses associated with our growth. We also incurred a charge of approximately $1.8 million related to the impairment of fixed assets as a result of the consolidation of our processing centers and closure of most of our retail production offices in January 2006. In addition, during 2004 we incurred a $7.5 million charge for terminating a financing arrangement.

~~Benefit~~Summary /operating ~~Provision~~information for ~~Income~~our ~~Taxes.~~wholesale Wemortgage ~~had~~origination anoperations ~~income~~are ~~tax benefit of $12.3 million for the year ended December 31, 2005~~ as ~~compared~~follows to(amounts a provision for income taxes of $20.3 million for the year ended December 31, 2004, which was due to the operating losses at our taxable REIT subsidiaries. As of December 31, 2005 we had $28.6 million in ~~estimated~~thousands): federal net operating loss carryforwards and $5.7 million in deductible temporary differences available to reduce future taxable income at our taxable REIT subsidiaries. The operating losses of the taxable REIT subsidiaries will be carried back to recover approximately $31.2 million in taxes paid in prior years. Remaining net operating loss carryforwards and deductible temporary differences result in a deferred tax asset of approximately $22.7 million, which has been fully reserved for at December 31, 2005.

We are required to record a valuation allowance to reduce our deferred tax assets to the amount that we believe is more likely than not to be realized. In assessing the need for a valuation allowance, we considered all positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial performance. The accounting guidance states that forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. As a result of this guidance and the recent losses of our taxable REIT subsidiaries, management concluded that a full valuation allowance of $22.7 million against the deferred tax assets was appropriate. While we anticipate that our taxable REIT subsidiaries will be profitable in 2006 and beyond, in view of the recent losses, there is no assurance that there will be sufficient future taxable income to realize the benefit of the deferred tax asset. If, after future assessments of the realizability of the deferred tax assets, we determine a lesser allowance is required, we would record a reduction to income tax expense and the valuation allowance in the period of such determination.


	Year ended December 31,
	2006			2005			2004
Interest income	$	126,655		$	146,182		$	56,189
Interest expense		105,257			95,092			28,170

Net interest income		21,398			51,090			28,019
Gain (loss) on sale of loans		(52,355	)		(38,332	)		171,856
Gain (loss) on trading securities and derivative instruments, net		5,194			30,290			(36,538	)

Net revenues		(25,763	)		43,048			163,337
Operating expenses		82,902			116,296			114,773
Other Income		—			(5,382	)		—
Income tax provision (benefit)		154			(12,319	)		20,288

Income (loss) from discontinued operations	$	(108,819	)	$	(55,547	)	$	28,276

Mortgage loan originations	$	6,235,101		$	14,040,632		$	9,114,332
Loans held for sale as of year end	$	1,137,142		$	2,744,423		$	911,784
Warehouse and repurchase facilities	$	1,169,587		$	2,708,266		$	894,307

~~Year~~The ~~ended~~mortgage ~~December 31~~origination operations grew significantly during the period 2002 through 2005, largely as a result of historically low interest rates and home price appreciation. Interest income and expense increased from 2004 ~~Compared~~to 2005 as a result of the higher average outstanding balances of mortgage loans held for sale and related warehouse borrowings. The interest rate on our warehouse borrowings was generally tied to ~~Year~~one-month ~~ended~~LIBOR ~~December~~and as the general level of interest rates began to increase in 2005, the cost of warehouse financing increased. Increases in interest rates on our mortgage loans held for sale lagged the rate at which interest costs on our warehouse borrowings increased, reducing net interest income beginning in 2005 and through 2006. We also entered into certain agreements under which Bear Stearns agreed to fund and acquire our loan production subsequent to October 3110, ~~2003~~2006 and through the date of the close of the transaction. The interest rate on the warehouse borrowings was equivalent to the weighted average coupon on the loans securing the borrowings. As a result, we received no net interest income during the fourth quarter of 2006 which significantly contributed to the decline in net interest income in 2006.

~~Interest~~The ~~Income.~~following ~~Interest~~table ~~income~~represents ~~increased 62.4% to $56.2 million for~~ the ~~year~~components ~~ended~~of ~~December 31,~~gain ~~2004 from~~or ~~$34.6~~loss ~~million~~on ~~for~~sales ~~the~~recorded ~~year~~each ~~ended~~period: ~~December 31, 2003, mainly due to higher loan origination volume occurring during 2004. Our interest income was generated primarily from loans held for sale.~~

We earned interest income on loan production held on our warehouse facilities pending the eventual sale of these loans. We typically held our mortgage loans for a period of 30 to 45 days before they were sold in the whole-loan market. During that time, we earned the coupon rate of interest paid by the borrower and we paid interest to lenders that provided our financing facilities.


	For the year ended December 31,
	2006			2005			2004
	(in thousands)
Premium from whole-loan sales	$	29,775		$	92,431		$	259,799
Provision for repurchases		(29,453	)		(12,837	)		(10,230	)
Non-refundable loan fees, net		(72	)		(5	)		(135	)
Lower of cost or market adjustment for loans held for sale		(16,295	)		(40,689	)		28,052
Deferred origination costs		(36,310	)		(77,232	)		(134,642	)

Gain (loss) on sale of loans, net	$	(52,355	)	$	(38,332	)	$	142,844

~~Interest~~During ~~Expense.~~2004 ~~Interest~~we ~~expense~~sold ~~increased~~approximately 43$8.9%8 tobillion ~~$28.2~~in ~~million~~loans ~~for~~at ~~the~~a ~~year~~weighted ~~ended~~average ~~December 31~~price of 102.9%. During 2005, ~~2004~~we ~~from~~sold $197.60 ~~million~~billion ~~for~~in ~~the~~loans ~~year~~at ~~ended~~a ~~December 31,~~weighted ~~2003,~~average ~~due~~price toof ~~the~~101.4%. ~~greater~~Throughout ~~financing~~2005, ~~requirements~~we ofexperienced ~~our growing~~a ~~origination~~decline ~~volume,~~in ~~offset~~whole ~~partially~~loan bysales aprices, ~~general~~in ~~decline~~particular induring ~~overall~~the ~~financing~~fourth ~~rates~~quarter. ~~For~~During the ~~year~~fourth ~~ended~~quarter ~~December 31,~~of ~~2004~~2005, credit market conditions required additional credit enhancements that negatively impacted the ~~average~~prices ~~rate~~at ~~paid~~which onwe ~~warehouse~~could ~~financing~~sell ~~was~~our 3loans.~~19%~~ asThe ~~compared~~decline toin ~~3.47%~~sales ~~for~~prices we experienced during the ~~same~~fourth ~~period~~quarter also reflected, in ~~2003.~~part,

~~Gain~~40 on Sale of Loans, Net. Sales on a whole-loan basis increased 104.7% to $8.8 billion for the year ended December 31, 2004 from $4.3 billion for the year ended December 31, 2003. Gain on sale increased 77.0% to $113.8 million for the year ended December 31, 2004 from $64.3 million for the year ended December 31, 2003. The gain represents the cash received less the basis in loans sold, a provision for expected losses due to repurchase obligations, lower of cost or market adjustments for loans held for sale, non-refundable loan fees and deferred loan origination costs taken on sale. We believe that the increase in net gain on sale of loans was the result of favorable conditions in the whole-loan sale market. We believe that this market has been strong due to a

~~favorable~~normal ~~interest~~seasonal ~~rate~~trends, ~~environment~~as well as a need to reduce higher levels of for-sale ~~borrowers~~inventory ~~resulting~~we inhad anretained ~~increase~~while selecting mortgage loans for securitization. Declining sales prices also required us to record a valuation allowance to reduce the carrying value of our loans held-for-sale as of the end of the third and fourth quarter of 2005 to the lower of cost or market. This valuation allowance reduced the amount we reported as gain or loss on sale and resulted in us reporting a loss on the ~~number~~sale of ~~nonconforming~~loans ~~residential~~for ~~mortgage~~the ~~originations~~year ended December 31, 2005 of $38.3 million.

~~The~~We continued to experience negative trends in whole loan sale pricing throughout 2006, selling $7.7 billion at a weighted average price of 100.5%. As we did not have warehouse financing available to retain our loan inventory following ~~table~~the ~~summarizes~~close of the sale of our wholesale mortgage origination operations to Bear Stearns, in February 2007, we sold approximately $1.2 billion in mortgage loans to Bear Stearns at a weighted average price of 97.5%. Loan inventory as of December 31, 2006 that was sold to Bear Stearns in January and February 2007 was marked to the lower of cost or market (LOCOM) based upon these loan ~~sales~~sale transactions, resulting in a LOCOM valuation allowance of approximately $51.4 million at that date and a net LOCOM provision of $16.3 million for the ~~periods~~year ~~indicated:~~ ended December 31, 2006.

	For the year ended December 31,
	2004			2003
	(in thousands)
Whole-loan sales at a:
Premium	$	8,625,504		$	4,191,324
Discount		154,861			157,715
Total whole-loan sales	$	8,780,365		$	4,349,039
Weighted average price for premium sales		103.04	%		103.29	%
Weighted average price for discount sales		95.41	%		95.57	%

In addition, during the first half of 2006 we began to experience an increase in repurchase claims related to early payment defaults (EPD) on mortgage loans for which the borrower has missed the first payment due to the purchaser of the loan or investor. This led to the need to increase our reserve for losses that are incurred in connection with the repurchase and disposition of repurchased loans or the costs incurred in directly settling any repurchase obligation with an investor. During the third and fourth quarters of 2006, we entered into settlement agreements with 11 purchasers of our loans paying or accruing a total of $35.4 million to extinguish various EPD and representation and warranty repurchase claims. Loans sold to these 11 purchasers during 2006 represented the majority of our sales volume for the year. Under the terms of most of the settlement agreements, as well as our agreement with Bear Stearns for the sale of loans through the date of closing the sale of the mortgage banking operations, we settled most known existing and future forecasted claims, limiting the ability of purchasers of our loans to put them back to us. However, there could be additional unknown claims that may result in future material liability.

~~Premium~~The ~~whole-loan sales~~gain ~~are~~on ~~sales~~trading tosecurities ~~investors~~and atderivative ~~prices~~instruments ~~above~~principally ~~par.~~reflects ~~Conversely,~~the ~~discount~~gain ~~sales~~or ~~are~~loss ~~sales~~on ofour ~~loans~~investment atin ~~prices~~Eurodollar ~~below par~~futures. We ~~Discounted~~utilized ~~sales~~Eurodollar ~~are~~futures ~~generally~~to ahedge ~~result~~the risk of ~~incomplete~~changes ~~documentation~~in or the ~~rejection~~value of ~~the~~our ~~whole-loans~~loan byinventory aand ~~premium~~anticipated ~~whole-loan buyer~~originations ~~because~~due ofto ~~certain~~changes ~~characteristics,~~in orinterest ~~loans~~rates. ~~repurchased~~Due ~~from~~to ~~investors~~rising ~~and~~interest ~~subsequently~~rates ~~resold.~~these ~~Our~~derivative ~~weighted~~instruments ~~average~~increased ~~price~~in ~~for~~value. ~~premium~~Interest rates ~~sales~~continued ~~decreased~~to byincrease 25during ~~basis~~2006, ~~points~~although tothe ~~103.04%~~impact ~~for~~of ~~the~~rising ~~year~~rates ~~ended~~was ~~December 31,~~not ~~2004~~as ~~from~~significant ~~103.29%~~as ~~for the~~in ~~year~~2005. ~~ended~~In ~~December 31~~addition, ~~2003.~~we Wereduced ~~believe~~the ~~this~~number ~~decrease~~of ~~was~~outstanding Eurodollar contracts due to ana ~~interest~~decline ~~rate~~in ~~environment~~average inloan ~~which~~inventory ~~rates~~and ~~were~~production ~~beginning~~levels. We tosettled ~~increase~~all ~~after~~outstanding aEurodollar ~~period~~contracts in February 2007 in connection with the sale of ~~historical~~our ~~low~~loan ~~rates~~inventory to Bear Stearns.

~~The~~Operating ~~following~~expenses ~~table~~reflect ~~represents~~those expenses that were directly related to the ~~components~~mortgage origination business. Following the initial public offering in 2005, ECC Capital shared personnel and services with its subsidiaries, principally Performance Credit Corporation through the date of ~~gain~~the onsale ~~sales~~of ~~recorded~~the ~~each~~mortgage ~~period:~~origination business to Bear Stearns. Costs associated with these shared personnel and services have been allocated to continuing operations, despite the fact that many of the personnel providing such services became employees of Bear Stearns after February 9, 2007.

	For the year ended December 31,
	2004			2003
	(in thousands)
Premium from whole-loan sales	$	259,799		$	131,634
Provision for repurchases		(10,230	)		(2,848	)
Non-refundable loan fees, net		(135	)		2
Lower of cost or market adjustment for loans held for sale		(960	)		(1,547	)
Deferred origination costs		(134,642	)		(62,922	)
Gain on sale of loans, net	$	113,832		$	64,319

The increase in operating expenses from 2004 to 2005 primarily reflects the continued growth in loan production levels through 2005. In early 2006, we began implementing various cost savings initiatives which, in conjunction with a decline in production during 2006 resulted in a decrease in operating expenses from 2005 to 2006.

~~Our~~Other ~~practice~~income ~~is to record at the date~~ of the sale a provision for estimated repurchase losses attributable to principal, premium, interest and other costs of loans repurchased based upon our historical experience of the amount of sales that ultimately require repurchase$5.4 ~~The~~million ~~obligations to repurchase loans and to reimburse the investor~~ for ~~any premiums paid on loans attributable to early payment are contractual obligations and require management to estimate such amounts at~~ the ~~time of sale. The provisions, therefore, can vary from~~ year ~~to year depending on the contractual obligations and loan performance. Our provision for repurchase losses increased for the year~~ ended December 31, ~~2004~~2005 asrelated ~~compared~~ to ~~the year ended December 31,~~ ~~2003,~~proceeds ~~primarily~~we asreceived ~~a result of increased whole-loan sales volume, which increased 104.7% to $8.8 billion for the year ended December 31, 2004~~ from ~~$4.3~~a ~~billion~~legal ~~for the year ended December 31, 2003~~settlement.

~~Loan~~Through ~~origination fees~~2004, asour ~~well~~wholesale asmortgage ~~discount points and certain direct~~ origination ~~costs,~~operations ~~are~~were ~~initially~~profitable ~~capitalized~~ and, ~~recorded~~ as ana result, ~~adjustment~~required to ~~our~~pay ~~cost~~federal ofand ~~the~~state ~~loan,~~income ~~which~~taxes. isLosses ~~reflected~~incurred induring ~~the~~2005 ~~gain~~were oncarried ~~sale~~back ~~we record when the loan is sold. Deferred origination costs increased 114.0%~~ to ~~$134.6~~2003 ~~million~~and ~~for the year ended December 31,~~ 2004 ~~from~~to ~~$62.9 million for~~ the ~~year~~extent ~~ended December 31, 2003, primarily due to higher whole-loan sales volume as a result of higher loan origination volume.~~

5641

~~Gain~~ possible onto ~~Trading~~recover ~~Securities~~taxes ~~and~~paid ~~Derivative~~in ~~Instruments.~~those ~~Gain on trading securities and derivative instruments was $21~~years.5 ~~million~~During ~~for the year ended December 31~~2006, ~~2004~~we ~~compared~~received toapproximately $~~0 for the year ended December~~ 31, ~~2003.~~million ~~The increase was due to us beginning our hedging activities~~ in ~~2004~~cash ~~and accounting for our residual interests~~ from ~~our~~refunds ~~2004~~received ~~securitizations as trading securities. The residual interest~~ from ~~our~~federal ~~2003 securitization was classified as available for sale~~ and ~~changes~~state ~~in fair value were recorded as a component of other comprehensive income~~tax jurisdictions.

~~The~~Income ~~residual~~taxes interests represent the present value of the excess of estimated future cash flows received from borrowers on mortgage loans sold into securitization trusts over the cash flows passed through to the related asset-backed securities. Because the interest rates on the asset-backed securities reset more frequently than the interest rates on the underlying mortgage loans securing them, during periods of increasing interest rates, estimated future cash flows and the value of the residual interests will decline. Conversely, during periods of decreasing interest rates, estimated cash flows and the value of the residual interests will generally increase. We acquired most of our residual interests in securitization transactions completed in the second and third quarters of 2004. Through the third quarter of 2004, shifts in the yield curve resulted in an increase in the estimated cash flows from our residual interests and a resultant increase in value. We purchased derivative financial instruments to hedge the variability of a portion of the estimated future cash flows to be received from the residual interests at the time of the securitizations. This shift in the yield curve resulted in us reporting losses on these hedges through the third quarter that offset, in part, the increase in value reported on the residual interests.

~~Late~~We incurrently ~~the~~intend ~~third~~to ~~quarter~~continue ~~and~~to ~~throughout~~be ~~the~~taxed ~~fourth~~as ~~quarter~~a ofREIT ~~2004,~~for ~~interest~~federal ~~rates~~income ~~increased~~tax ~~causing~~purposes. aPerformance ~~decline~~Credit inis ~~value~~treated inas our ~~residual~~taxable ~~interests.~~REIT ~~In addition~~subsidiary, ~~late~~or inTRS. ~~the~~Federal ~~fourth~~income ~~quarter,~~tax ~~loans~~law ~~within~~requires ~~the~~that ~~securitization~~a ~~transactions~~REIT ~~began~~distribute ~~prepaying~~to its stockholders annually at least ~~higher~~90% ~~than~~of ~~anticipated~~its ~~rates.~~net Astaxable ~~mortgage~~income, ~~loans~~excluding ~~within~~its ~~the~~net ~~securitization~~capital ~~prepay,~~gains ~~estimated~~and ~~future~~excluding ~~cash~~the ~~flows~~retained ~~are~~earnings ~~reduced,~~of ~~further~~any ~~decreasing~~TRS ~~the~~it ~~value~~owns. If we distribute all of our ~~residual~~taxable ~~interests.~~income ~~Based~~to ~~upon~~our ~~the~~stockholders ~~prepayment~~and ~~speeds~~otherwise wequalify ~~experienced~~as ina ~~the~~REIT, ~~latter~~we ~~half~~generally ofwill not be required ~~the~~to ~~fourth~~pay ~~quarter~~federal ofincome ~~2004~~tax. Any taxable income generated by our taxable REIT subsidiaries, wehowever, ~~adjusted~~will ~~the~~be ~~prepayment~~subject ~~assumptions~~to inregular ~~valuing~~corporate ~~our~~income ~~residual~~tax. ~~interests~~Our asTRSs may retain any income generated, net of ~~December 31~~any tax liability incurred on that income, ~~2004.~~without affecting ~~The~~the ~~revised~~REIT ~~prepayment~~distribution ~~assumptions~~requirements, ~~reduced~~subject ~~further~~to our ~~estimate~~compliance ofwith the ~~value~~20% ofasset ~~our~~test ~~residual~~applicable ~~interests.~~to ~~While~~our ~~the increase~~ownership of securities in ~~interest~~TRSs. ~~rates~~If ~~resulted~~Performance inCredit anchooses ~~increase~~to inmake distributions to us, the ~~value~~amount of ~~our~~such ~~hedges~~distribution asthat ~~compared~~is taxable toas ~~September 30,~~a ~~2004,~~dividend ~~this~~will ~~increase~~be included in ~~value~~our ~~did~~taxable ~~not~~income ~~offset~~that is subject to the ~~decline~~distribution requirements. Any distributions we make in ~~value~~the future will be at the discretion of our ~~residual~~board ~~interests~~of ~~caused~~directors byand ~~higher~~will ~~prepayment~~depend ~~speeds.~~upon, among other things, our actual results of operations.

~~Personnel.~~As ~~Personnel~~certain ~~expenses~~of ~~increased~~our ~~70.3%~~subsidiaries toare taxable entities, we have reported a provision or benefit for income ~~$48~~taxes within our financial statements.7 ~~million~~We use the asset and liability method of accounting for income taxes. Under the ~~year~~asset ~~ended~~and ~~December 31~~liability method, ~~2004~~deferred ~~from~~tax ~~$28.6~~assets ~~million~~and liabilities are recognized for the ~~year~~future ~~ended~~tax ~~December 31,~~consequences ~~2003,~~attributable ~~due~~ to differences between the ~~increased~~consolidated ~~level~~financial ofstatement ~~production~~carrying ~~and~~amounts ~~administrative~~of ~~staffing~~existing ~~required~~assets toand ~~accommodate~~liabilities ~~our~~and ~~higher~~their ~~origination~~respective ~~volume~~tax bases. ~~In addition,~~Deferred ~~during~~tax ~~the~~assets ~~year~~and ~~ended~~liabilities ~~December 31,~~are ~~2004,~~measured weusing ~~recorded~~enacted ~~stock~~tax ~~compensation~~rates ~~expense~~for ofthe ~~$2.5~~periods ~~million~~ in ~~connection~~which ~~with~~the differences aare ~~severance~~expected ~~arrangement~~to reverse. ~~Total~~The ~~staffing~~effect ~~was~~on ~~1,114~~deferred ~~employees~~tax atassets ~~December 31,~~and ~~2004~~liabilities ~~compared~~of toa ~~total~~change ~~staffing~~in oftax ~~621 employees~~rates atis ~~December 31,~~recognized ~~2003,~~in anincome ~~increase~~in ofthe ~~493~~period ~~employees,~~that orincludes 79the enactment date.~~4%.~~

~~Production~~In ~~and~~determining ~~Marketing.~~the ~~Production~~possible ~~and~~realization ~~marketing~~of ~~expenses~~deferred ~~increased~~tax ~~101.6%~~assets, towe ~~$12.3~~consider ~~million~~future ~~for~~taxable income from the ~~year~~following ~~ended~~sources: ~~December~~(i) 31the reversal of taxable temporary differences, ~~2004~~(ii) taxable income from ~~$6.1~~future ~~million~~operations ~~for~~and ~~the~~(iii) tax ~~year~~planning ~~ended~~strategies ~~December 31~~that, ~~2003~~if necessary, would be implemented to accelerate taxable income into periods in which net operating losses might otherwise ~~was~~expire. ~~mainly~~During ~~due~~2005 toand ~~increased~~2006, ~~loan~~our ~~production~~TRSs ~~expenses~~had ~~resulting~~operating losses. We can utilize the net operating loss of our TRSs to offset taxable income from ~~increased~~prior ~~loan~~years ~~origination~~and ~~volume~~carry forward the operating loss to offset future taxable income.

~~Servicing~~The ~~Fees.~~operating ~~Servicing~~losses ~~fees~~of ~~increased~~the ~~140.0%~~TRS during 2005 has been carried back to recover approximately $~~7.2~~31 million ~~for~~in ~~the~~taxes ~~year~~paid ~~ended~~in ~~December 31,~~prior ~~2004~~years. The remaining net operating loss from 2005 and operating losses from the first half of 2006 resulted in a deferred tax asset of approximately $~~3.0~~72 million, ~~for~~which ~~the~~has ~~year ended~~been fully reserved for at December 31, ~~2003,~~2006. ~~which~~We ~~was~~are ~~mainly~~required ~~due~~to record a valuation allowance to reduce ~~increased~~our ~~fees~~deferred ~~associated~~tax ~~with~~assets to the amount that we believe is more likely than not to be realized. In view of operating losses at our ~~increased~~TRS, ~~loan~~we ~~origination~~do ~~volume~~not believe we will realize any benefit from net operating loss carryforwards and deductible temporary differences and have fully reserved the related deferred tax asset.

Occupancy Expense. Occupancy expense increased 118.5% to $5.9 million for the year ended December 31, 2004 from approximately $2.7 million for the year ended December 31, 2003. This increase is due to the relocation of our corporate offices into a larger facility and expansion of our regional offices.

General and Administrative. General and administrative expenses increased 110.9% to $40.7 million for the year ended December 31, 2004 from $19.3 million for the year ended December 31, 2003. The increase was due to an increase in office supplies, depreciation and other operating expenses associated with our growth.

Additionally, in April 2004, the Company and Residential Funding Corporation, or RFC, executed a series of agreements that included a warehousing agreement, revolving subordinated debt agreement, loan sale commitment agreement, a shared execution mortgage loan purchase agreement whereby we agreed to sell to RFC certain residential mortgage loans and a securities purchase agreement. In August 2004 we negotiated a termination agreement to these various agreements, which required us to pay $7.5 million to RFC.

Provision for Income Taxes. The provision for income taxes increased 141.7% to $20.3 million for the year ended December 31, 2004 from $8.4 million for the year ended December 31, 2003, mainly due to higher pre-tax income resulting from our increased profitability.

Off-Balance Sheet Arrangements

We are party to transactions that have off-balance sheet components. In connection with off-balance sheet securitization transactions, there were $~~491~~1.4038 ~~million~~billion in loans remaining in off-balance sheet trusts as of December 31, ~~2005~~2006. The trust has issued securities or bonds secured by these loans. We have no obligation to provide funding support to either the third party investors or the off-balance sheet trust. The third party investors, or the trust, generally have no recourse to our assets or us and have no ability to require us to repurchase their loans other than for breaches of standard representations and warranties.

We have retained certain residual interests in the securitization trust. The performance of the loans in the trust will impact our ability to realize the current estimated fair value of these assets that are included on our balance sheet.

Contractual Obligations and Commercial Commitments

The following table summarizes our material contractual obligations and commercial commitments as of December 31, ~~2005~~2006, as well as the consolidated obligations of the securitization entities that we sponsored and are consolidated on our balance sheets (amounts in thousands):

	Payment due by period
	Total		Less ~~than~~than1 1 year		1 to ~~3 Years~~3years		34 to ~~5 Years~~5years		More ~~than~~than5 ~~5years~~years
	(in thousands)
Operating leases	$	6,862	$	3,492	$	2,027	$	1,343	$	—
Operating leases	$	36,287	$	8,514	$	13,720	$	10,504	$	3,549
Warehouse and repurchase facilities	$	1,169,587	$	1,169,587		—		—		—
Warehouse and repurchase facilities(1)		2,708,266		2,708,266		—		—		—
Repurchase obligations	$	200	$	200		—		—		—
Equipment leases		3,103		1,609		1,313		181		—
Long-term debt(1)	$	2,389,084	$	1,543,672	$	620,231	$	150,668	$	74,513
Long-term debt(2)		4,166,127		1,934,711		1,726,249		345,969		159,198

(1) ~~These~~The ~~warehouse~~long-term ~~and~~debt ~~repurchase facilities~~ had a weighted average interest rate of 5.1676% at December 31, ~~2005~~2006.

~~(2)~~Operating ~~The~~leases ~~long-term debt had a weighted average interest rate of 4.52% at December 31, 2005.~~

Through April 16, 2007, we have entered into various agreements to terminate or sublease all our material operating leases of office space and other real estate, with the exception of two leases for office space. We are in active discussions to terminate one of the leases or to sublease the property. We hold a minority ownership interest in a small retail lending business which is consolidated in our financial statements. That business leases office space under another lease arrangement that has been guaranteed by the Company and is reflected in the contractual obligations and commercial commitments presented above. Our lease reserves may prove to be inadequate as there is no assurance that our subtenants will meet their obligations under the sublease agreements.

We made total payments of $2,085,000 subsequent to December 31, 2006 to terminate remaining lease obligations. Remaining operating lease commitments as of December 31, 2006 as presented above reflect the two leases referred to above through their termination dates and payments made on terminated leases through March 2007, including termination payments.

Warehouse and repurchase facilities

All amounts due under warehouse and repurchase facilities at December 31, 2006 were payable to Bear Stearns and were repaid in February 2007 in conjunction with the closing of the sale of our wholesale mortgage origination business.

Repurchase obligations

During the third and fourth quarters of 2006, we entered into settlement agreements with 11 purchasers of our loans paying or accruing a total of $35.4 million to extinguish various EPD and representation and warranty repurchase claims. Loans sold to these 11 purchasers during 2006 represented the majority of our sales volume for the year. Under the terms of most of the settlement agreements, as well as our agreement with Bear Stearns for the sale of loans through the date of closing the sale of the mortgage banking operations, we settled most known existing and future forecasted claims, limiting the ability of purchasers of our loans to put them back to us. However, there could be additional unknown claims that may result in future material liability.

As of March 2007, we have unresolved claims from investors to repurchase approximately $5.5 million in loans. As of December 31, 2006, we have reserved $2.2 million for potential losses that may be realized on the settlement of these and other incurred but unknown claims. Although management believes the amount reserved is adequate to provide for losses on the settlement of repurchase claims, the timing and amount of any remaining repurchase claims, is highly uncertain and it is reasonably possible that losses ultimately realized may greater than amounts provided for.

Long-term debt

Long-term debt represents amounts payable to bondholders in connection with our securitizations accounted for as financings. As principal payments on the underlying mortgages are paid through to reduce principal on the bonds, the term of the bonds is ultimately a function of the rate at which principal is paid on the mortgages. Based upon anticipated prepayment speeds the Company estimates that the bonds will be fully repaid by 2015. However, the bonds have a “clean-up call” provision which allows the Company to dissolve the trust and repay outstanding bonds when the remaining principal balance of the underlying loans is 10% or less of their original balance. If the Company exercises this call provision, the Company estimates that the bonds could be fully repaid by 2009.

Liquidity and Capital Resources

WeUpon ~~received~~completion ~~approximately~~of ~~$350~~our ~~million~~transactions with Bear Stearns in ~~net~~February ~~proceeds~~2007, ~~from~~we ~~our~~effectively ~~initial~~exited ~~public~~the ~~offering~~wholesale inmortgage ~~February~~origination ~~2005~~business. ~~The~~Following ~~proceeds~~the transaction, our principal source of liquidity is the ~~public~~cash ~~offering~~flow ~~have~~we ~~been used~~receive from our securitizations. We created our securitizations through transfer of loans to ~~finance~~a trust that issued long-term debt or bonds collateralized by the ~~cash~~loans. ~~investment~~The intrust collects ~~securitizations,~~the ~~investment~~principal inand ~~loan~~interest ~~inventory~~on the loans and passes through all principal collected to ~~meet~~bondholders. ~~general~~Interest ~~working~~is ~~capital~~paid ~~needs~~to holders of the debt based upon the stated rate associated with the class of debt. ~~During~~The difference between the ~~first~~interest collected on the loans and ~~second~~interest ~~quarters,~~paid to the bondholders and ongoing expenses of the trust is excess cash ~~balances~~flow. ~~were~~The ~~utilized~~excess cash flow provides additional collateral to ~~reduce~~the ~~balances~~bondholders ~~due~~as ~~under~~it ~~warehouse~~is ~~lines~~available ofto absorb losses realized on defaulted ~~credit~~loans. ~~During~~To the ~~third~~extent ~~quarter~~excess wecash ~~retained~~flow ~~higher~~exceeds ~~cash~~losses ~~balances~~on the loans, it is used to ~~provide~~pay down principal on senior securities issued by the ~~liquidity~~trust ~~necessary~~to create additional collateralization (over-collateralization or OC) until specified OC levels are maintained by the trust. Excess cash flow not required to ~~support~~cover ~~growth~~losses or build OC will be distributed to us, or in ~~our~~the ~~loan~~event ~~portfolio.~~a ~~During~~Net Interest Margin trust, or NIM, was created in connection with the ~~fourth~~securitization, ~~quarter~~to the related NIM holders until the NIM securities are retired, and then to us. In addition to excess cash ~~balances~~flow ~~were~~from ~~utilized~~the securitizations, we also receive servicing fees to ~~cover~~the ~~our~~extent ~~operating~~that ~~losses~~we ~~and~~have ~~reduced~~retained ~~advance~~ownership in the servicing rights on the loans included in the trust. We ~~rates~~receive cash flows from ~~our~~securitizations ~~warehouse~~as ~~lines~~described regardless of ~~credit~~whether the securitization is accounted for as a sale or a financing.

WeThrough ~~invest~~December 31, ~~our~~2006, ~~cash in~~we ~~our~~have ~~loan~~completed ~~portfolio~~eight ~~in two principal ways~~securitizations. ~~First,~~A ~~the~~summary ~~principal balance~~ of anour ~~originated~~securitizations’ ~~loan~~initial ~~funded~~and bycurrent ~~our~~balances ~~warehouse~~and ~~facilities~~over ~~differs~~collateralization ~~from~~requirements ~~facility~~as toof ~~facility.~~December 31, We2006 ~~generally~~is ~~fund~~as ~~something~~follows ~~less~~(amounts ~~than~~ in thousands):


	As of December 31, 2006
	Date of securitization	Scheduled loan principal balances				Bond balances		NIM bond balances		Over collateralization				60+ days delinquencies(1)
Securitization	Date of securitization	Initial		Current		Bond balances		NIM bond balances		Currently required		Current balance		60+ days delinquencies(1)
	(in thousands)
	(unaudited)
*Retained interests*
SASCO ECC 2003-1	Apr-03	$	278,718	$	28,494	$	24,731	$	—	$	3,763	$	3,763	14.5	%
CWABS ECC 2004-1	Jul-04		530,000		96,961		86,217		—		12,190		10,606	11.6	%
CWABS ECC 2004-2	Sep-04		549,464		97,298		87,138		—		5,449		10,160	12.6	%
Bravo Mortgage Asset Trust 2006-1	May-06		1,058,429		814,757		767,833		7,560		46,029		46,924	13.3	%
*Financing transactions*
ECR 2005-1	Mar-05		1,600,004		625,575		604,775		—		20,800		20,800	9.7	%
ECR 2005-2	May-05		1,400,000		659,960		643,160		—		16,800		16,800	10.2	%
ECR 2005-3	Aug-05		1,029,348		542,243		512,907				29,336		29,336	8.7	%
ECR 2005-4	Nov-05		1,000,002		633,556		625,556		2,687		8,000		8,000	9.7	%

Total				$	3,498,844	$	3,352,317	$	10,247	$	142,367	$	146,389

(1)	60+ days delinquencies also include bankruptcies, foreclosures and REO.

~~100%~~A summary of ~~a loan balance with warehouse debt, requiring us to invest~~ cash toflows ~~the~~received ~~extent the originated balance is not funded~~ by ~~the~~us ~~warehouse facility. This funding shortfall ranges~~ from ~~0% to 2%. Newly originated loans are funded by~~ our ~~warehouse~~retained ~~facilities~~interests ~~until~~in weeach ~~sell~~securitization orduring ~~securitize~~ the ~~loans. The longer loans remain funded by a warehouse facility the more our warehouse lenders require us to advance~~year ~~against~~ended ~~the loans. In addition~~December 31, ~~our~~2006 ~~warehouse~~is ~~lenders~~as ~~may~~follows ~~require~~(amounts usin tothousands): ~~have on deposit a cash margin against funded loans based upon the loan’s estimated market value.~~

Second, when we securitize loans, the proceeds from the securitization are utilized to repay the warehouse debt on the securitized loans and to pay the costs of the securitization. Depending on the structure of the securitization, the proceeds from the securitization may not be sufficient to repay all warehouse debt and the costs of the securitization. A securitization’s over-collateralization requirements, transaction costs (e.g., attorneys’ fees, printing costs, underwriters’ fees, etc.) and the type of derivatives instruments invested in will all effect the amount of cash we are required to invest in our securitizations.


Securitization	Year ended December 31, 2006
*Retained interests*
SASCO ECC 2003-1	$	55
CWABS ECC 2004-1		—
CWABS ECC 2004-2		—
Bravo Mortgage Asset Trust 2006-1		3,983

*Financing transactions*
ECR 2005-1		24,576
ECR 2005-2		25,116
ECR 2005-3		1,938
ECR 2005-4		—

Total	$	55,668

WeAs ~~generate~~of March 2007, we are receiving distributions of cash flow from all of our securitizations ~~through~~except ~~three~~SASCO ECC 2003-1. Loan principal ~~operational~~balances ~~sources:~~in the 2003-1 securitization have paid down to the point that the servicer may exercise their clean up call rights, upon which the balance of the overcollateralization account within the securitization will be released to us. We are unable to determine when, or if, such a clean up call will occur.

~~(i)~~We ~~Net~~sold our interest ~~spread~~in Bravo onMortgage ~~our~~Asset ~~loans—We~~Trust ~~receive~~(BMAT) ~~interest~~2006-1 ~~income~~in onFebruary ~~loans~~2007 ~~we hold~~ for ~~sale~~$20 ~~and~~million. ~~pay~~We ~~interest~~are oncontinuing ~~the~~to ~~warehouse~~explore ~~facilities~~opportunities ~~used~~ to ~~finance~~maximize the ~~funding~~value ofand ~~these~~liquidity ~~loans.~~of ~~Net~~our ~~interest~~remaining ~~spread~~retained isinterests, including the ~~difference~~sale ~~between~~or ~~these~~financing ~~two~~of ~~amounts~~all or part of our retained interests in securitizations.

~~(ii)~~Management ~~Cash~~believes that cash flows from ~~our~~its securitizations~~—In~~, aincluding ~~securitization~~cash wemade ~~transfer~~available ~~loans~~from the tosale aor ~~trust~~financing ~~that~~of ~~issues~~all ~~long-term debt~~ or ~~bonds~~part ~~collateralized~~of by the ~~loans.~~Company’s ~~The~~retained ~~trust~~interests ~~collects~~in ~~the~~securitizations, ~~principal~~will ~~and~~be ~~interest~~adequate onto ~~the~~provide ~~loans~~for ~~and~~operating ~~passes~~needs through ~~all principal collected to bondholders~~2007. ~~Interest~~However, isthere ~~paid~~has torecently ~~holders~~been ofsignificant ~~the~~adverse ~~debt~~publicity ~~based~~regarding ~~upon~~market conditions ~~the~~in ~~stated rate associated with~~ the ~~class~~subprime ofmortgage ~~debt~~industry. ~~The~~Several ~~difference~~companies ~~between~~have ~~the~~announced ~~interest~~an ~~collected~~increase onin ~~the~~loan ~~loans~~defaults and ~~interest~~losses ~~paid to the bondholders~~ and ~~ongoing~~concerns ~~expenses~~regarding of the ~~trust~~growing isimpact ~~excess~~that ~~cash~~slowing ~~flow.~~appreciation ~~The~~and, ~~excess~~in ~~cash~~some ~~flow~~cases, ~~provides~~declines ~~additional~~in ~~collateral~~housing toprices ~~the~~may ~~bondholders~~have ~~as it is available to absorb losses realized~~ on loss ~~defaulted~~reserves ~~loans.~~and To the ~~extent~~values ~~excess~~of ~~cash~~their ~~flow~~mortgage ~~exceeds losses on the~~ loans, itand isretained ~~used~~interests toin ~~pay down principal on senior securities issued by the trust to create additional collateralization (over-collateralization or OC) until specified OC levels are maintained by the trust~~securitizations. ~~Excess~~If ~~cash~~loan ~~flow~~delinquencies ~~not~~and ~~required to cover~~ losses orincrease ~~build~~within OCour ~~will be distributed to us~~securitizations, orcash inflows ~~the~~we ~~event~~receive afrom ~~Net~~our ~~Interest~~securitizations ~~Margin~~may ~~trust,~~be ~~or NIM, was created in connection with the securitization, to the related NIM holders until the NIM securities are retired, and then to us~~reduced. InBased ~~addition~~on tocurrent market ~~excess cash flow from the securitizations~~conditions, weour ~~also~~ability ~~receive servicing fees~~ to ~~the~~sell ~~extent~~and ~~that~~or wesatisfactorily ~~have~~finance ~~retained~~certain ~~ownership~~assets inmay ~~the~~be ~~servicing~~adversely ~~rights on the loans included in the trust~~impacted. WeThese ~~receive~~market ~~cash~~conditions ~~flows from securitizations~~ as ~~described~~well ~~regardless of whether the securitization is accounted for~~ as a ~~sale~~possible ordecline ~~a financing. To date, we have completed seven securitizations. We currently receive excess cash flows from a securitization completed~~ in ~~2003.~~expected ~~While we are not currently receiving excess~~ cash flows from ~~the~~its ~~other~~residual ~~six~~interests ~~securitizations, as OC is accumulating~~ in ~~the trusts, we receive servicing fees from the four~~ securitizations wemay ~~completed~~negatively impact ~~in 2005. We expect to receive cash flows from all our securitizations in 2006. It is through~~ the ~~receipt of these~~ cash ~~flows~~flow ~~that~~generated wefrom ~~expect to recover~~ our ~~investments in~~ securitizations.

(iii) Sale of loans—We sell loans to third parties for cash. The proceeds from the sale are used to repay any warehouse financing. Any excess proceeds generate incremental cash flow to us. It is through the receipt of these cash flows that we expect to recover our investment in loans held for sale (to the extent that such loans are not transferred into securitizations).

We completed securitizations of mortgage loans in March 2005 of $1.6 billion, in May 2005 of $1.4 billion, in August 2005 of $1.1 billion and November 2005 of $1.0 billion through the sale of notes backed by a pool of fixed and adjustable rate, nonconforming mortgage loans secured by first liens on one-to-four family residential properties. The notes were issued through a trust, which used the cash proceeds to pay us the purchase price of the mortgage loans. The notes, which we characterize as debt for financial reporting purposes, represent non-recourse obligations of the trust, a Delaware statutory trust and special purpose entity to be consolidated by ECC Capital.

Factors that could affect our future ability to complete securitizations include the experience and ability of our management team, conditions in the securities markets generally, conditions in the mortgage-backed securities market specifically, the performance of our portfolio of securitized loans and our ability to obtain credit enhancement.

Warehouse and Repurchase Facilities

Most of our warehouse and repurchase facilities are committed lines, meaning the lender is obligated to fund up to the committed amount subject to our meeting the various financial and other covenants. Certain of our current warehouse and repurchase facilities contain a sub-limit for “wet” funding, which is the funding of loans for which the collateral custodian has not yet received the related loan documentation. Lenders generally limit our use of a warehouse facility to wet fund to a portion of our borrowing capacity under the warehouse line. If we have reached our sub-limit for wet funding on a warehouse line, we will not be able to wet fund under that line until borrowing capacity becomes available under the wet funding sub-limit. If we reach a sub-limit for a particular loan type, we will be restricted from funding the loans of that type under the applicable warehouse facility until capacity under the sub-limit has been cleared and we will be in default under the warehouse line if we exceed the sub-limit. Our warehouse and repurchase facilities mature between April 2006 and November 2006 and are secured by the loans we originate or purchase with the funds. Although our warehouse and repurchase facilities mature between April 2006 and November 2006, we expect to renew and extend the maturity of most of the facilities in the ordinary course of business. If these warehouse and repurchase facilities are not renewed, we will repay outstanding amounts with the proceeds from loan sales or from other warehouse and repurchase facilities. The weighted average interest rates on the combined facilities, based on one-month LIBOR, were 4.39%, 3.19%, and 3.47% at December 31, 2005, 2004, and 2003, respectively.

Our warehouse and repurchase facilities are subject to margin calls based on the lender’s opinion of the value of our loan collateral. Each facility provides the lender the right to reevaluate the loan collateral that secures our outstanding borrowings at any time. In the event the lender determines that the value of the loan collateral has decreased, it has the right to initiate a margin call. A margin call would require us to provide the lender with additional collateral or to repay a portion of the outstanding borrowings.

Our warehouse and repurchase facilities currently contain customary covenants, including restrictions on our ability to:

• conduct transactions with affiliates;

• engage in mergers, acquisitions and asset sales;

• alter the business we conduct;

• declare dividends or redeem or repurchase capital stock; and

• incur or guaranty additional indebtedness.

Our warehouse and repurchase facilities also contain financial covenants including:

• minimum tangible net worth;

• minimum amount of cash and cash equivalents;

• minimum liquidity ratios;

• maximum leverage ratios (including subordinate debts); and

• minimum net income.

Events of default under the warehouse and repurchase facilities include, but are not limited to:

• failure to pay obligations when due;

• material breach of any representation or warranty contained in the loan documents;

• covenant defaults;

• events of bankruptcy proceedings;

• cross-defaults to other indebtedness;

• the existence of certain environmental and ERISA claims or liabilities; and

• a change of control of our company.

ECC Capital, Bravo Credit and Encore Credit are jointly and severally liable for all of the obligations under the warehouse and repurchase facilities. ECC Capital and Encore Credit both have the right to borrow the unused portion of the maximum facility amounts and the full amounts of any sub-limits. The assets of ECC Capital will secure borrowings of ECC Capital, Bravo Credit and Encore Credit and the assets of Encore Credit and Bravo Credit only secure their own borrowings. A default by either ECC Capital, Bravo Credit or Encore Credit will also be deemed a default of the other.

As of December 31, 2005, we were in violation of certain covenants of our various credit arrangements (primarily profitability covenants). We have received waivers of compliance from the related lenders.

The material terms and features of these secured warehouse and repurchase facilities as of April 14, 2006 are as follows:

Countrywide Warehouse Lending Warehouse Facility. We have a warehouse facility with Countrywide that matures in July 2006 that provides $500.0 million of committed capacity and $250.0 million of uncommitted capacity. The facility provides sub-limits of $150.0 million for wet funded loans, $50.0 million for jumbo loans, $35.0 million for non-compliant loans, and $3.0 million for loans in default. The facility provides for advances at 97.5% of the market value of first mortgage loans, and 95% of subordinate mortgage loans, not to exceed 100.75% of loan amount funded through this facility. We expect to renew this agreement during 2006 with terms that are similar to our current agreement.

UBS Real Estate Securities Warehouse Facility. This facility matured in November 2005 and we did not extend or renew the terms of this facility. As of December 31, 2005, we had $56.0 million in advances on this line, which was fully repaid in 2006.

IXIS Real Estate Capital, Inc. Master Repurchase Agreement Warehouse Facility. We have a $300.0 million uncommitted warehouse and repurchase facility with IXIS that matures in May 2006. The facility provides for sub-limits of $25.0 million for Alt-A subordinate mortgage loans, $50.0 million for nonconforming subordinate mortgage loans, $40.0 million for non-owner occupied, $150.0 million for interest-only loans, and $200.0 million for wet funded loans. The facility provides for advances at 98% of the market value of first mortgage loans, and 95% of the market value of subordinate mortgage loans, not to exceed 100% of loan amount funded through this facility. We expect to renew this agreement during 2006 with terms that are similar to our current agreement.

Wachovia Bank, N.A. Facilities. We have a $1.0 billion committed repurchase facility with Wachovia Bank, N.A. that matures in May 2006. This facility provides for sublimits of $100.0 million for wet funded loans, $100.0 million for subordinate mortgage loans, and $50.0 million for balloon loans. This facility provides for advances at 98% of the market value of the mortgage loans, not to exceed 100% of the loan amount. We expect to renew this agreement during 2006 with terms that are similar to our current agreement except that we expect a portion of the facility to be committed and a portion of the facility to be uncommitted.

Credit Suisse First Boston. We have a $500.0 million committed and $200.0 million uncommitted repurchase facility that matures in July 2006. This facility provides for sublimits of $225.0 million for wet funded loans, $75.0 million for subordinate mortgage loans, $50.0 million for loans aged 30 to 60 days, $20.0 million for loans aged 120 to 181 days, and $3.0 million for repurchased loans. The facility provides for advances

at 98% of the market value of the loans, not to exceed 100% of the loan amount funded through this facility. We expect to renew this agreement during 2006 with terms that are similar to our current agreement.

Merrill Lynch Bank USA. We had a $500.0 million committed and $250.0 million uncommitted repurchase facility that matured in April 2006 and we did not extend or renew this facility. We repaid all amounts outstanding.

DB Structured Products. We have a $250.0 million committed and $150.0 million uncommitted repurchase facility with DB Structured Products that matures in May 2006. This facility provides for sublimits of $175.0 million for wet funded loans, $25.0 million for loans aged 180 to 270 days, $25.0 million for “super jumbo” loans, $50.0 million for subordinate mortgage loans, and $5.0 million for manufactured housing loans. This facility provides for advances at 98% of the market value of the loans, not to exceed 100% of the loan amount funded through this facility. We expect to renew this agreement during 2006 with terms that are similar to our current agreement.

Bear Stearns Mortgage Capital. We have a $500.0 million uncommitted repurchase facility with Bear Stearns Mortgage Capital that matures in November 2006. This facility provides for sublimits of $25.0 million for non-owner occupied loans and $75.0 million for loans with a high loan to value ratio. This facility provides for advances at 98% of the market value of the loans, not to exceed 100% of the loan amount funded through this facility.

We manage the level of committed and uncommitted capacity to ensure we have the capacity to fund loans without having excessive committed capacity, which may result in us paying unnecessary commitment fees. We continue to negotiate terms with various warehouse lenders and may add new warehouse and repurchase facilities as necessary. In March 2006, we entered into a $30 million uncommitted warehouse and repurchase facility with Residential Mortgage Solutions, a specialty finance company that allows us to warehouse our repurchased loans.

The following table summarizes our warehouse and repurchase facilities as of December 31, 2005 and 2004 and our total facility amount as of December 31, 2005:

						Amount Outstanding
Warehouse, Repurchase and Aggregation Lender	Expiration Date	Total Facility Amount as of December 31, 2005		Wet Funding Sub-Limit		December 31,
						2005		2004
	(unaudited)
	(in thousands)
Countrywide Warehouse Lending	July 2006	$	500,000	$	150,000	$	252,918	$	235,939
UBS Real Estate Securities	Nov. 2005		N/A		N/A		56,034		400,563
IXIS Real Estate Capital	May 2006		500,000		200,000		365,511		154,412
Wachovia Bank, N.A.	May 2006		1,000,000		100,000		400,048		103,393
Credit Suisse First Boston	July 2006		950,000		225,000		735,378		—
Merrill Lynch Bank USA	April 2006		750,000		249,750		429,761		—
DB Structured Products	May 2006		500,000		175,000		413,081		—
Bear Stearns Mortgage Capital Corp.	Nov. 2006		500,000		—		55,535		—
Total		$	4,700,000	$	1,099,750	$	2,708,266	$	894,307

Other Borrowings

WeFrom ~~periodically~~time to time we may also enter into ~~equipment~~repurchase ~~lease~~borrowing arrangements, ~~from~~pledging ~~time~~securities towe ~~time~~own ~~that~~as ~~are~~collateral. ~~treated~~During as2006, ~~capital~~we ~~leases~~borrowed approximately $60 million under a repurchase arrangement with a financial institution pledging our residual interests in securitizations and our ownership interests in securitization trusts consolidated for financial ~~statements~~reporting purposes as collateral. AsIn of December 312006, ~~2005~~we ~~and~~repaid ~~2004,~~all ~~the~~amounts ~~amount~~ outstanding under these borrowing arrangements ~~was $2~~.7 ~~million and $3.1 million, respectively.~~

From time to time we may ~~also~~borrow against ~~enter~~the ~~into~~cash ~~repurchase~~surrender ~~borrowing~~value ~~arrangements,~~of ~~pledging~~corporate ~~securities~~owned welife ~~own~~insurance ~~as collateral~~(“COLI”). At December 31, ~~2005~~2006, we ~~entered into~~had ~~one~~$10.1 ~~such~~million ~~repurchase~~in ~~arrangement~~outstanding ~~with~~borrowings aunder ~~financial~~this ~~institution~~arrangement. ~~pledging~~The ~~debt~~total ~~securities~~cash ~~retained~~surrender asvalue ~~part~~ of the ~~securitization~~COLI, ~~completed~~including inamounts securing ~~November~~borrowings, ~~2005~~was ~~as collateral~~$14.2 Atmillion at December 31, ~~2005, $13~~2006.1 ~~million was outstanding under this arrangement.~~ We ~~entered~~maintain ~~into~~COLI as a ~~second~~mechanism ~~repurchase~~for ~~borrowing~~funding ~~arrangement~~liabilities ~~with~~to ~~another~~employees ~~financial~~that ~~institution~~contribute into ~~January~~a ~~2006~~deferred ~~pledging~~compensation ~~owner~~plan. ~~trust~~Our ~~certificates~~liability ~~retained~~to ~~from~~ the ~~securitizations~~plan ~~completed~~at inDecember 31, ~~March~~2006 ~~2005~~was ~~and May 2005 as collateral~~$15. ~~Through~~8 ~~February~~million. ~~2006,~~This aliability ~~total~~was ofreduced to approximately $294.82 million ~~was~~during ~~outstanding~~the ~~under~~first ~~these~~quarter ~~arrangements~~of 2007.

Cash Flow

Cash provided by operating activities was $1.6 billion for the year ended December 31, 2006 as compared to cash used by operating activities of $7.1 billion for the year ended December 31, 2005. This reflects a decline in loan production from $14.0 billion in 2005 to $6.2 billion in 2006 and the sale of approximately $7.7 billion in loans held for sale in 2006.

Cash provided by investing activities increased to $1.7 billion for the year ended December 31, 2006 from $804.6 million for the year ended December 31, 2005. The increase was mainly due to principal payments received on our loans held for investment.

Cash used by financing activities was $3.3 billion for the year ended December 31, 2006 as compared to cash provided by financing activities of $6.3 billion for the year ended December 31, 2005. The increase is mainly due to repayments of long-term debt (as a result of payments received on our loans held for investment) and a reduction in our warehouse liability (as a result of the decline in our loans held for sale).

Cash used in operating activities increased to $7.1 billion for the year ended December 31, 2005 from $314.6 million for the year ended December 31, 2004. This increase is mainly due to an increase in loan production to $14.0 billion for the year ended December 31, 2005 from $9.1 billion for the year ended December 31, 2004 and the retention of $4.2 billion in loans held for investment.

Cash provided by investing activities increased to $804.6 million for the year ended December 31, 2005 from $10.6 million for the year ended December 31, 2004. The increase was mainly due to principal payments received on our loans held for investment.

Cash provided by financing activities increased to $6.3 billion for the year ended December 31, 2005 from $320.5 million for the year ended December 31, 2004. The increase is mainly due to increased borrowing capacity on our warehouse facilities, proceeds from the issuance of long-term debt, and proceeds received from our initial public offering.

Cash used in operating activities increased 44.6% to $314.6 million for the year ended December 31, 2004 from $217.5 million for the year ended December 31, 2003. This increase is mainly due to an increase in loan production to $9.1 billion for the year ended December 31, 2004 from $4.6 billion for the year ended December 31, 2003, offset by an increase in whole-loan sales volume of approximately $8.8 billion for the year ended December 31, 2004 from $4.3 billion for the year ended December 31, 2003.

Cash provided by investing activities was $10.6 million for the year ended December 31, 2004 as compared to $3.4 million used in investing activities for the year ended December 31, 2003. The increase was mainly due to cash receipts received from residual interests in securitizations.

Cash provided by financing activities increased 42.3% to $320.5 million for the year ended December 31, 2004 from $225.3 million for the year ended December 31, 2003. The increase is mainly due to increased borrowing capacity on our warehouse facilities that was used to finance growth in loan production.

Current Cash Requirements

Our portfolio of loans held-for-sale are financed through our warehouse lines and these lenders typically determine the amount they will advance us based on the fair value and age of our loans. During the fourth quarter, a portion of our loans held-for-sale became aged and lenders reduced the advance rate on these loans. In addition, warehouse advance rates were further reduced by declines in the value attributed to our loans held-for-sale. These factors, coupled with continued operating losses, utilized cash balances during the fourth quarter of 2005 and into early 2006. On January 6, 2006, we announced a restructuring that was designed to improve the quality and efficiency of our loan production and reduce operating costs.

This reorganization involved the consolidation of the Company’s seven wholesale loan processing centers into three. These three centers are located regionally in Irvine, California; Downers Grove, Illinois; and Glen Allen, Virginia. Lending operations for the Company’s retail subsidiary, Bravo Credit Corporation, was consolidated into two centers based in Irvine and Glen Allen. In addition, the reorganization resulted in a reduction in force of more than 440 employees. The reorganization was implemented during the first quarter of 2006 and in April 2006 when we announced a further reduction in our workforce. The estimated costs associated with the reorganization are as follows:

	Termination Costs
	JanuaryEvent		AprilEvent
	(in thousands)
Employee costs	$	1,275	$	1,299
Lease termination costs		6,241		434
Fixed asset write offs		1,834		—
Total	$	9,350	$	1,733

Lease termination costs represent the costs associated with terminating leases or the estimated costs associated with lease payments remaining under the term of the lease, net of the estimated fair value of subleasing the property. Fixed asset write offs reflect the estimated loss on the disposition of fixed assets at locations where we will cease operations. The fixed asset write off was charged to expense during 2005 as an impairment charge. Employee costs and lease termination costs were charged to expense when incurred during the first quarter of 2006.

We are continuing to review the level of operating costs and the cash requirements of operating our business. During the first quarter of 2006 we entered into loan sale transactions to reduce our aged inventory. We expect to continue to dispose of aged inventory either through whole loan sales or securitization transactions to improve warehouse advance rates on loans held-for-sale and reduce cash invested in our loan inventory.

We will focus on originating loans that will provide for improved gain on sale execution and manage to the resulting production volume, ensuring we maximize the efficiency of our operating infrastructure. As we undertake actions to ensure our operations generate necessary operational cash flow we will utilize available liquidity as necessary. Sources of liquidity include additional collateralized borrowing capacity utilizing our ownership interests in securitizations and the assets of the executive deferred compensation plan, refund of income taxes paid during 2003 though 2005 through carryback of operating losses and distributions of excess cash flow from our securitizations. We believe these sources of liquidity will be sufficient to sustain our operations for the foreseeable future and until our operations generate sustainable cash flow.

Depending on the extent we are required to utilize these sources of liquidity our ability to pay a dividend may be negatively impacted. On February 27, 2006, we announced a revision to our dividend policy and that we would not pay a dividend for the first quarter of 2006. To retain our REIT status, we must, among other things, distribute at least 90% of our REIT’s taxable income. If we utilize available liquidity for operations we may not have sufficient liquidity to pay the distributions required for us to maintain our REIT status. In this case, we would likely elect to “de-REIT” and adopt C-Corporation status, which would require stockholder approval. We may, regardless of liquidity requirements, decide to de-REIT as a means of better preserving operating liquidity and capital for future growth.

Recent Accounting Pronouncements

In February ~~December 2004~~2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. ~~123(R)~~155 (“SFAS ~~123(R)~~155”), ~~Share-Based~~Accounting ~~Payment~~for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140. SFAS ~~123(R)~~155 ~~supersedes~~permits ~~APB~~fair ~~25,~~value ~~Accounting~~measurement for ~~Stock~~certain ~~Issued~~hybrid toinstruments, ~~Employees~~clarifies which interest-only and ~~revises~~principal-only strips are subject to Statement of Financial Accounting Standards No. 133 (“SFAS ~~123~~133”), Accounting for ~~Stock-Based~~Derivative ~~Compensation.~~Instruments and Hedging Activities, clarifies and establishes requirements related to derivatives embedded in beneficial interests issued in securitizations, and amends SFAS ~~123(R)~~140 ~~requires~~to ~~equity~~eliminate the prohibition on QSPEs holding certain derivative financial instruments. toSFAS be155 ~~accounted~~is effective for atfiscal ~~fair~~years ~~value~~beginning onafter ~~the~~September 15, ~~date~~2006. The Company does not presently believe that adoption of ~~grant~~SFAS ~~and~~155 ~~for~~will ~~costs~~have toa bematerial effect on its financial statements.

64In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 (“SFAS 156”), Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140. SFAS 156 requires companies to record a servicing asset or servicing liability each time they undertake an obligation to service a financial asset from (i) the transfer of financial assets that meet the requirements for sale accounting, (ii) a transfer of financial assets to a QSPE in a guaranteed mortgage securitization in which the transferor retains the securities and accounts for them as available-for-sale or trading, or (iii) an acquisition or assumption of an obligation to service financial assets that does not relate to financial assets of the servicer or its affiliates. In addition, SFAS 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. SFAS 156 is effective for fiscal years beginning after September 15, 2006. The Company does not presently believe that adoption of SFAS 156 will have a material effect on its financial statements.

~~recognized~~In ~~over~~September 2006, the ~~period~~FASB inissued ~~which~~Statement ~~goods~~of orFinancial ~~services~~Accounting ~~are~~Standards ~~received~~No. 157 ~~In addition, SFAS 123~~(R“SFAS 157”), ~~requires~~Fair ~~liabilities~~Value ~~that~~Measurements. ~~are~~SFAS ~~based~~157 ondefines ~~the~~ fair value, ofestablishes ~~our equity~~a ~~instruments~~framework orfor ~~that~~measuring ~~may be settled by the issuance of equity instruments to be measured at~~ fair value onin ~~the~~generally ~~date~~accepted ofaccounting ~~grant~~principles (GAAP), and toexpands bedisclosures ~~remeasured~~about ~~each reporting period with changes in~~ fair value ~~being recognized during that period~~measurements. ~~SFAS~~The ~~123(R) is~~statement is effective for ~~the~~financial ~~first~~statements ~~interim~~issued ~~or annual reporting period~~ for ~~our~~ fiscal ~~year~~years ~~that~~beginning ~~begins~~ after ~~June~~November 15, ~~2005~~2007, and ~~applies~~interim toperiods ~~all~~within ~~awards~~those ~~granted~~fiscal ~~after~~years. ~~the~~The ~~required~~Company ~~effective~~does ~~date~~not ~~and~~presently tobelieve ~~awards modified, repurchased, or cancelled after~~ that ~~date.~~ ~~As of January 1, 2006, we will apply~~ the ~~modified~~adoption ~~prospective application transition method and record compensation costs for the portion~~ of ~~outstanding~~SFAS ~~awards~~157 ~~for~~will ~~which~~have ~~the~~a ~~requisite~~material ~~service~~effect ~~has not yet been rendered, based~~ on ~~the~~its ~~grant-date~~financial ~~fair value of those awards~~statements. ~~We do not expect the amount of compensation expense we will record in 2006 to be significant.~~

In June ~~2005~~2006, the FASB issued ~~Statement~~FASB ofInterpretation ~~Financial Accounting Standards~~ No. ~~154~~48 (“~~SFAS~~FIN ~~154~~48”), Accounting ~~Changes~~for ~~and~~Uncertainty ~~Error Corrections~~in aIncome ~~replacement~~Taxes—an interpretation of ~~APB Opinion No. 20 and~~ FASB Statement No. 3109. ~~SFAS~~FIN ~~154~~48 ~~applies~~clarifies tothe ~~all~~accounting ~~voluntary~~for ~~changes~~uncertainty in ~~accounting~~income ~~principle. Opinion~~taxes 20recognized ~~previously~~in ~~required~~a ~~that~~company’s ~~most~~financial ~~voluntary~~statements ~~changes~~and inprescribes ~~accounting~~a ~~principle~~recognition bethreshold ~~recognized~~and bymeasurement ~~including~~attribute infor ~~net~~the ~~income~~financial ofstatement ~~the~~recognition ~~period~~and measurement of ~~the~~a ~~change~~tax ~~the~~position ~~cumulative~~taken ~~effect~~or ofexpected ~~changing~~ to ~~the~~be ~~new~~taken ~~accounting~~in ~~principle~~a tax return. This evaluation is done through a two-step process, which requires a company (1) ~~SFAS~~to ~~154~~determine ~~replaces~~whether ~~Opinion~~it 20is more likely than not that a tax position will be sustained upon examination by a taxing authority and ~~requires~~(2) to ~~retrospective~~determine ~~application~~the amount of benefit to ~~prior~~recognize ~~periods’~~in the financial statements. The amount recognized should be the largest amount of ~~changes~~benefit inthat ~~accounting~~has ~~principle~~greater than fifty percent likelihood of being realized upon ultimate settlement. In addition, ~~unless~~FIN it48 isprovides ~~impracticable~~guidance toon ~~determine~~derecognition, ~~either~~classification, ~~the~~interest ~~period-specific~~and ~~effects~~penalties, oraccounting ~~the~~in ~~cumulative~~interim ~~effect~~periods, ofdisclosure, ~~the~~and ~~change~~transition. ~~SFAS~~ ~~154~~FIN 48 is effective for ~~the~~ fiscal years beginning after December 15, ~~2005~~2006. The Company believes the adoption of FIN 48 will not have a material impact on its financial statements.

In February ~~2006~~2007, the FASB issued Statement of Financial Accounting Standards No. ~~155~~159 (“SFAS ~~155~~159”), ~~Accounting~~The Fair Value Option for ~~Certain~~Financial Assets ~~Hybrid~~and Financial ~~Instruments~~Liabilities Including an ~~amendment~~Amendment of FASB ~~Statements~~Statement No. ~~133 and 140~~115. ~~SFAS~~This ~~155~~Statement permits ~~fair~~entities ~~value~~to ~~measurement~~choose ~~for~~to ~~certain~~measure ~~hybrid~~many financial instruments, ~~clarifies~~and ~~which~~certain other items at fair value. The objective is to improve ~~interest-only~~financial ~~and~~reporting ~~principal-only~~by ~~strips~~providing ~~are~~entities ~~subject~~with the opportunity to ~~SFAS~~mitigate ~~133,~~volatility ~~clarifies~~in ~~and~~reported ~~establishes~~earnings ~~requirements~~caused by measuring related assets and liabilities differently without having to ~~embedded~~apply ~~derivatives,~~complex ~~and~~hedge ~~amends~~accounting provisions. SFAS No. 159 ~~140~~is toeffective ~~eliminate~~as of the ~~prohibition~~beginning onof ~~qualified~~an ~~special~~entity’s ~~purpose~~first ~~entities,~~fiscal oryear ~~QSPEs,~~that ~~holding certain~~begins ~~derivative~~after ~~financial~~November 15, ~~instruments~~2007. Early ~~SFAS~~adoption ~~155~~ is ~~effective~~permitted ~~for~~as ~~fiscal~~of ~~years~~the beginning ~~after~~of ~~September~~a fiscal year that begins on or before November 15, ~~2006~~2007, provided the entity also elects to apply the provisions of SFAS 157. WeThe ~~have~~Company has not yet ~~determined~~completed an evaluation of the impact ~~SFAS~~of ~~155~~adopting ~~will~~SFAS ~~have~~159 on ~~our~~its financial statements.

In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 (“SFAS 156”), Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140. SFAS 156 requires companies to record a servicing asset or servicing liability each time they undertake an obligation to service a financial asset from (i) the transfer of financial assets that meet the requirements for sale accounting, (ii) a transfer of financial assets to a QSPE in a guaranteed mortgage securitization in which the transferor retains the securities and accounts for them as available-for-sale or trading, or (iii) an acquisition or assumption of an obligation to service financial assets that does not relate to financial assets of the servicer or its affiliates. In addition, SFAS 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. SFAS 156 is effective for fiscal years beginning after September 15, 2006. We have not yet determined the impact SFAS 156 will have on our financial statements.

Effects of Inflation

Inflation generally increases the cost of funds and operating overhead, and, to the extent that mortgage loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of our assets and liabilities are, and will continue to be, monetary in nature. As a result, interest rates generally have a more significant effect on our performance than the effects of general levels of inflation have on industrial companies. Although interest rates do not necessarily move in the same direction, or to the same extent, as the prices of goods and services, low inflation or deflation generally has resulted in decreased interest rates. In 2001, the Federal Reserve reduced the targeted federal funds rate on 11 occasions for a total of 475 basis points. Inflation remained low in 2002 and 2003, which reflects that interest rates remained fairly steady in 2002, only dropping 50 basis points in 2002 and 25 basis points in the first half of 2003. However, since 2004 the federal funds rate has been increased 15 times by a total of 375 basis points through March 2006.

In addition, inflation results in an increase in the cost of goods and services purchased, salaries and benefits, occupancy expense and similar items. Inflation and any related increases in interest rates generally decrease the market value of investments and mortgage loans held and may adversely affect our liquidity and earnings, as well as our shareholders’ equity. Increases in interest rates tend to slow mortgage loan prepayment rates, adversely affect mortgage loan refinancings, and to a lesser extent, slow purchase money mortgage originations, as increased rates tend to slow home sales. Increased interest rates may reduce our earnings from our sale of mortgage loans in the whole-loan market. Except to the extent offset by changes in the rates earned on our mortgage loans, the value of, and net interest earnings on, our retained mortgage loan portfolio may be affected by changes in interest rates, credit spreads and prepayment rates on the mortgage loans.

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

Market risk is the exposure to loss resulting from changes in interest rates, credit spreads, foreign currency exchange rates, commodity prices and equity prices. As we are invested solely in U.S. dollar denominated instruments, primarily residential mortgage instruments, and our borrowings are also domestic and U.S. dollar denominated, we are not subject to foreign currency exchange, or commodity and equity price risk; the primary market risk that we are exposed to is interest rate risk and its related ancillary risks. Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. None of our market risk sensitive assets, liabilities and related derivative positions are held for speculative purposes.

Risk Management

~~Historical~~Our ~~operations~~ risk management focuses on protecting against possible “compression” in the net interest margin with respect to our portfolio of loans held for investment. The “yield curve” creates this risk because of different repricing durations for instruments with different maturities. In substance, the hedging objective is to protect the net interest margin by matching repricing durations for the hybrid/adjustable-rate mortgage loan portfolio and the corresponding funding sources. For accounting purposes, these hedges are called cash flow hedges, and the accounting is different than for fair value hedges.

WeHybrid/adjustable-rate ~~may~~mortgage ~~enter~~loans ~~into~~have ~~forward~~longer ~~loan~~repricing ~~sales~~durations ~~for~~and ~~the~~we ~~purpose~~may ofnot ~~minimizing~~be ~~the~~able ~~market~~to ~~risks~~obtain ~~associated~~matched repricing ~~with~~durations for the ~~value~~corresponding offunding ~~originated~~sources ~~loans,~~since ~~while~~borrowings ~~maximizing~~generally ~~gain on~~have ~~sale~~a ofshorter ~~such~~repricing ~~loans.~~duration Athan ~~primary~~most ~~risk~~hybrid/adjustable-rate ~~associated~~mortgage ~~with~~loans ~~the~~where ~~loan origination business is~~ the ~~risk~~initial ~~of fluctuating interest rates. The interest~~ rate ~~risk~~ is afixed ~~direct~~for ~~result~~one ofto ~~timing~~five ~~delays~~years. ~~between~~We ~~(1) the~~hedge ~~fixing~~these ofloans ~~the mortgage loan~~ with interest rate ~~with~~ ~~borrowers~~swap agreements and ~~the~~cap ~~funding~~agreements ofin ~~the~~order ~~loan~~to ~~and~~match ~~(2)~~ the ~~funding~~repricing durations of the ~~loan~~loans and ~~the~~our ~~setting~~funding ~~of terms for sale of loans to whole-loan market investors~~sources.

We may also hedge the economic value of funded loans that are held for sale but not yet allocated to an investor sale commitment. Once a loan has been funded, our risk management objective for our mortgage loans held for sale is to protect earnings from an unexpected charge due to a decline in value of our mortgage loans.

Forward-looking risk management

Our risk management focuses on protecting against possible “compression” in the net interest margin with respect to the investment portfolio. The “yield curve” creates this risk because of different repricing durations for instruments with different maturities. In substance, the hedging objective is to protect the net interest margin by matching repricing durations for the hybrid/adjustable-rate mortgage loan portfolio and the corresponding funding sources. For accounting purposes, these hedges are called cash flow hedges, and the accounting is different than for fair value hedges.

Hybrid/adjustable-rate mortgage loans have longer repricing durations and we may not be able to obtain matched repricing durations for the corresponding funding sources since borrowings generally have a shorter repricing duration than most hybrid/adjustable-rate mortgage loans where the initial rate is fixed for one to five years. We hedge these loans with interest rate swap agreements, Eurodollar futures contracts and cap agreements in order to match the repricing durations of the loans and our funding sources.

Interest Rate Risk

~~The~~We ~~objective~~are insubject ~~managing~~to interest rate ~~risk~~exposure isrelating to ~~monitor~~our ~~and~~portfolio ~~assess~~of ~~the~~mortgage ~~potential~~loans ~~risk~~held ~~associated~~for ~~with~~investment. ~~changes~~Changes in interest rates impact our future earnings in various ways. While we originate and hold in our loan portfolio primarily hybrid/adjustable-rate mortgage loans, rising short-term interest rates may temporarily negatively affect our earnings, and, ~~their~~conversely, falling short-term interest rates may temporarily increase our earnings. This impact can occur for a number of reasons and may be mitigated by portfolio prepayment activity as discussed below. First, our borrowings may react to changes in interest rates sooner than our hybrid/adjustable-rate mortgage loans because the reset dates on our ~~business~~borrowings generally occur sooner than that of the hybrid/adjustable-rate mortgage loans. IfThe ~~necessary~~interest expense on the mortgage-backed securities is typically adjusted monthly relative to market interest rates, wegenerally ~~can~~the ~~attempt~~one-month LIBOR. The interest on the underlying mortgage loans is based on fixed rates payable on the underlying loans, generally for the first two or three years from origination, while the holders of the applicable securities are generally paid based on an adjustable LIBOR-based yield. Second, interest rates on hybrid/adjustable-rate mortgage loans may be capped for the first adjustment, per adjustment period and for the life of the loan (commonly referred to ~~mitigate~~as ~~such~~the ~~risk~~initial cap, the periodic cap and the lifetime cap, respectively), and our borrowings may not have similar limitations. Third, interest rates on hybrid/adjustable-rate mortgage loans typically change less frequently than the applicable interest rates on our liabilities.

66The rate of prepayment on mortgage loans may increase if interest rates decline or if the difference between long-term and short-term interest rates diminishes. Increased prepayments would cause us to amortize the premiums paid for our mortgage loans faster, resulting in a reduced yield on our mortgage loans. Increased prepayments would also reduce the length of time we received excess cash flow from our securitizations, reducing the value of our retained interests in securitizations.

Conversely, the rate of prepayment on mortgage loans may decrease if interest rates rise or if the difference between long-term and short-term interest rates increases. Decreased prepayments would cause us to amortize

~~through effective interest rate management tools that are considered hedges, such as financial futures, forward-sale commitments and options and interest rate swaps and caps. In~~ the ~~past,~~premiums wepaid ~~attempted~~for ~~to reduce~~ our ~~exposure to interest~~ hybrid/adjustable-rate ~~risk~~mortgage ~~for a portion of our loan production through the use of forward sales commitments. Pursuant to our forward sales commitments, in exchange for a fixed price, we commit to deliver~~ loans ~~with~~over a ~~set~~longer oftime ~~characteristics, including a weighted average interest rate, that are locked for the term of the applicable commitment. Therefore, during this commitment~~ period, ~~any~~resulting ~~market movement~~ in ~~interest~~an ~~rates~~increased ~~has~~yield ~~no effect~~ on ~~the~~our ~~price~~mortgage ~~we receive for~~ loans. ~~delivered~~Decreased prepayments towould ~~the~~also ~~forward~~increase ~~sale transaction, assuming~~ the ~~agreed~~length ~~upon set~~ of ~~characteristics~~time iswe ~~met.~~receive ~~The~~excess ~~contracts~~cash ~~are~~flow ~~often~~from ~~entered~~our ~~into~~securitizations, ~~and~~increasing ~~priced before most of~~ the ~~loans~~value ~~are originated. By committing to a forward sale prior to origination~~ of ~~the~~our ~~loans~~retained ~~and~~interests ~~through the price protection features embedded~~ in ~~the commitment, we effectively hedge our interest rate risk~~securitizations.

InInterest ~~addition to our interest~~ rate ~~risk~~changes ~~described~~may ~~above,~~also ~~we are subject to interest rate exposure relating to the portfolio of mortgage loans we hold. Changes in interest rates~~ impact our ~~future~~equity ~~earnings~~as inour ~~various~~residual ~~ways.~~interests ~~While we originate~~ and ~~hold~~derivative ininstruments ~~our~~are ~~loan~~held ~~portfolio~~at ~~primarily~~fair ~~hybrid/adjustable-rate~~value. ~~mortgage~~In ~~loans~~general, ~~rising~~we ~~short-term~~would ~~interest rates may temporarily~~expect ~~negatively~~that ~~affect~~over ~~our earnings~~time, ~~and,~~decreases ~~conversely,~~in ~~falling~~income ~~short-term~~from ~~interest rates may temporarily increase~~ our ~~earnings.~~loan ~~This impact can occur for a number of reasons and may be mitigated by~~ portfolio ~~prepayment~~attributable ~~activity as discussed below. First, our borrowings may react~~ to ~~changes in~~ interest ~~rates sooner than our hybrid/adjustable-~~rate ~~mortgage~~changes ~~loans~~will ~~because~~be ~~the~~offset reset dates on our borrowings generally occur sooner than that of the hybrid/adjustable-rate mortgage loans. The interest expense on the mortgage-backed securities is typically adjusted monthly relative to ~~market~~some ~~interest~~degree ~~rates,~~by ~~generally~~increases ~~the~~in ~~one-month~~cash ~~LIBOR.~~flow ~~The~~received ~~interest on the underlying mortgage loans is based on fixed rates payable on the underlying loans, generally for the first two or three years~~ from ~~origination,~~our ~~while~~derivative ~~the~~instruments holders of the applicable securities are generally paid based on an adjustable LIBOR-based yield. Second, interest rates on hybrid/adjustable-rate mortgage loans may be capped for the first adjustment, per adjustment period and ~~for~~vice ~~the life of the loan (commonly referred to as the initial cap, the periodic cap and the lifetime cap, respectively), and our borrowings may not have similar limitations~~versa. ~~Third, interest rates on hybrid/adjustable-rate mortgage loans typically change less frequently than the applicable interest rates on our liabilities.~~

~~Interest~~Changes ~~rates~~in ~~can~~market ~~also affect our net return on hybrid/adjustable-rate mortgage loans. During a declining~~ interest ~~rate environment, the prepayment~~ rates of ~~hybrid/adjustable-rate~~affect ~~mortgage~~our ~~loans~~estimates ~~may accelerate, causing the amount~~ of ~~fixed-rate financing to increase relative to~~ the ~~amount~~fair value of ~~hybrid/adjustable-rate~~our mortgage loans, ~~possibly~~held ~~resulting~~for ininvestment aand ~~decline~~related inderivatives. ~~our~~The ~~net~~changes ~~return on~~in ~~hybrid/adjustable-rate~~fair ~~mortgage~~value ~~loans,~~that asare ~~replacement~~stated ~~hybrid/adjustable-rate~~below ~~mortgage~~are ~~loans~~derived ~~may~~based ~~have~~upon ahypothetical ~~lower~~immediate ~~yield~~and ~~than~~equal ~~the~~changes ~~hybrid/adjustable-rate~~to ~~mortgage~~market ~~loans being prepaid. In contrast, during an increasing~~ interest ~~rate~~rates ~~environment, hybrid/adjustable-rate~~of ~~mortgage~~various ~~loans~~maturities. ~~may~~The ~~prepay~~effects ~~slower~~of ~~than~~the ~~expected,~~hypothetical ~~requiring~~adjustment us to ~~finance~~the abase ~~higher~~or ~~amount~~current ofinterest ~~hybrid/adjustable-~~rate ~~mortgage~~curve ~~loans~~are ~~than~~adjusted ~~originally anticipated at a time when interest rates may be higher, resulting in a decline~~by inthe ~~our~~levels ~~net~~shown ~~return~~below: ~~on hybrid/adjustable-rate mortgage loans.~~

The rate of prepayment on mortgage loans may increase if interest rates decline or if the difference between long-term and short-term interest rates diminishes. Increased prepayments would cause us to amortize the premiums paid for our mortgage loans faster, resulting in a reduced yield on our mortgage loans. Additionally, to the extent proceeds of prepayments cannot be reinvested at a rate of interest at least equal to the rate previously earned on such mortgage loans, our earnings could be adversely affected.


Hypothetical Change in Interest Rate (basis points)	100			50			-50			-100
	(in thousands)
As of December 31, 2006
Change in fair value of loans held for investment	$	(28,670	)	$	(14,095	)	$	13,134		$	26,147
Change in fair value of interest rate cap and swap contracts		3,010			1,505			(1,505	)		(3,010	)

Net change	$	(25,660	)	$	(12,590	)	$	11,629		$	23,137


As of December 31, 2005
Change in fair value of loans held for sale	$	(33,014	)	$	(16,507	)	$	16,507		$	32,172
Change in fair value of loans held for investment		(60,802	)		(29,996	)		29,563			59,126
Change in fair value of Eurodollar contracts		18,575			9,288			(9,288	)		(18,575	)
Change in fair value of interest rate cap and swap contracts		60,562			30,224			(29,649	)		(49,405	)

Net change	$	(14,679	)	$	(6,991	)	$	7,133		$	23,318

~~Conversely,~~Residual ~~the~~Interests. ~~rate~~We ~~of prepayment~~had onresidual ~~mortgage~~interests in the loans ~~may~~held ~~decrease~~in ifthe ~~interest~~trust ~~rates~~utilized ~~rise~~in our oroff-balance ifsheet ~~the~~securitization ~~difference~~transactions ~~between~~of ~~long-term~~$45.9 million and ~~short-term~~$14.8 ~~interest~~million ~~rates~~outstanding ~~increases~~at December 31, 2006 and 2005, respectively. ~~Decreased~~Residual ~~prepayments~~interests ~~would~~are ~~cause~~recorded usat toestimated ~~amortize~~fair ~~the~~value. ~~premiums~~We ~~paid~~value ~~for~~these ~~our~~assets ~~hybrid/adjustable-rate~~based on the present ~~mortgage~~value ~~loans~~of ~~over~~estimated afuture ~~longer~~cash ~~time~~flows ~~period,~~using ~~resulting~~various inassumptions anregarding ~~increased~~prepayments, ~~yield~~defaults, onloss ~~our~~severity ~~mortgage~~and ~~loans~~discount rate.

~~Interest~~Most ~~rate~~of our ~~changes~~residual ~~may~~interests ~~also~~are ~~impact~~recorded ~~our~~at ~~equity~~estimated asfair ~~our~~value ~~securities,~~and ~~mortgage~~are ~~loans~~marked ~~and~~to ~~related~~market ~~derivative~~through ~~instruments~~a ~~are~~charge ~~held~~(or atcredit) to earnings. On a quarterly basis, we review the ~~lower~~fair value of ~~cost~~our residual interests by analyzing prepayment, credit loss and discount ~~market.~~rate Weassumptions ~~seek~~in relation to ~~hedge~~actual toexperience ~~some~~and ~~degree~~current ~~changes~~rates inof ~~value~~prepayment ~~attributable~~and tocredit ~~changes~~loss prevalent in ~~interest~~the ~~rates~~industry. byAlthough ~~selling~~we ~~Eurodollar~~believe ~~futures~~that ~~contracts.~~the Inassumptions ~~general,~~used weto ~~would~~estimate ~~expect~~the ~~that~~fair values of our residual interests are reasonable, there can be no assurance as to the accuracy of the assumptions or estimates.

over time, decreases in income from our loan portfolio attributable to interest rate changes will be offset to some degree by increases in the value of our Eurodollar futures contracts, and vice versa. However, the relationship between spreads on securities may vary from time to time, resulting in a net aggregate book value increase or decline. However, unless there is a material impairment in value that would result in a payment not being received on a security or loan, changes in the book value of our loan portfolio will not directly affect our recurring earnings or our ability to make a distribution to our stockholders.

Changes in market interest rates affect our estimates of the fair value on mortgage loans held for sale, the fair value of our mortgage loans held for investment, and related derivatives. The changes in fair value that are stated below are derived based upon hypothetical immediate and equal changes to market interest rates of various maturities. The effects of the hypothetical adjustment to the base or current interest rate curve are adjusted by the levels shown below:

Hypothetical Change in Interest Rate (basis points)	+100			+50			-50			-100
	(in thousands)
As of December 31, 2005
Change in fair value of loans held for sale	$	(33,014	)	$	(16,507	)	$	16,507		$	32,172
Change in fair value of loans held for investment		(60,802	)		(29,996	)		29,563			59,126
Change in fair value of Eurodollar contracts		18,575			9,288			(9,288	)		(18,575	)
Change in fair value of interest rate cap and swap contracts		60,562			30,224			(29,649	)		(49,405	)
Net change	$	(14,679	)	$	(6,991	)	$	7,133		$	23,318
As of December 31, 2004
Change in fair value of loans held for sale	$	(10,360	)	$	(5,180	)	$	4,951		$	9,764
Change in fair value of Eurodollar contracts		10,140			5,070			(5,070	)		(10,140	)
Net change	$	(220	)	$	(110	)	$	(119	)	$	(376	)

Residual Interests. We had residual interests in the loans held in the trust utilized in our off-balance sheet securitization transactions of $14.8 million and $20.2 million outstanding at December 31, 2005 and 2004, respectively. Residual interests are recorded at estimated fair value. We value these assets based on the present value of estimated future cash flows using various assumptions. The discount rates used to calculate the present value of the residual interests were 33.00%, 18.00%, and 18.00% for the securitization transactions completed in April 2003, June 2004, and July 2004, respectively. The weighted average life of the mortgage loans used for valuation was 0.64 years, 0.71 years, and 0.45 years for the securitization transactions completed in April 2003, June 2004, and July 2004, respectively.

Most of our residual interests are recorded at estimated fair value and are marked to market through a charge (or credit) to earnings. On a quarterly basis, we review the fair value of our residual interests by analyzing prepayment, credit loss and discount rate assumptions in relation to actual experience and current rates of prepayment and credit loss prevalent in the industry.

Although we believe that the assumptions used to estimate the fair values of our residual interests are reasonable, there can be no assurance as to the accuracy of the assumptions or estimates.

The residual interests are subject to actual prepayment or credit loss risk in excess of assumptions used in the valuation. Ultimate cash flows realized from these assets would be reduced should actual prepayments or credit losses exceed assumptions used in the valuation. Conversely, cash flows realized would be greater should actual prepayments or credit losses be below expectations.

6849

The table below illustrates the resulting hypothetical fair values of our residual interests at December 31, ~~2005~~2006 and ~~2004~~2005 caused by assumed immediate increases to the key assumptions used to determine fair value:

	December 31,
	2005		2004
	2006		2005
	(in thousands)
Carrying value / fair value of residual interests	$	1445,~~753~~920	$	2014,~~167~~753
Prepayment speed assumption:
Fair value after:
Impact of a 10% increase	$	1146,~~079~~055	$	1911,~~697~~079
Impact of a 20% increase	$	946,~~996~~179	$	189,~~983~~996
Credit loss assumption:
Fair value after:
Impact of a 10% increase	$	1345,~~169~~618	$	1813,~~870~~169
Impact of a 20% increase	$	1145,~~962~~273	$	1711,~~832~~962
Residual interest cash flows discount rate:
Fair value after:
Impact of a 10% increase	$	1445,~~554~~782	$	1914,~~359~~554
Impact of a 20% increase	$	1445,~~358~~648	$	1814,~~594~~358
Interest rate on adjustable mortgage loans and bonds:
Fair value after:
Impact of a 10% increase	$	1345,~~771~~756	$	1613,~~917~~771
Impact of a 20% increase	$	1245,~~814~~807	$	1412,~~037~~814

These sensitivities are hypothetical, are presented for illustrative purposes only, and should be used with caution. The changes in the assumptions regarding prepayments and credit losses were applied to the cash flows of the mortgage loans underlying the retained interests. Changes in assumptions regarding discount rate were applied to the cash flows of the securitization trusts. Generally, changes in fair value based upon a change in assumptions cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. The change in one assumption was calculated without changing any other assumptions. In reality, changes in one assumption may result in changes in others, which may magnify or offset the sensitivities. For example, changes in market interest rates may simultaneously impact the prepayment, credit loss and discount rate assumptions. In addition, it is possible that prepayment speeds, credit losses and changes in interest rates are subject to market conditions and, as such, may increase by more 20% causing a further reduction in the fair value of our residual interests in securitizations.

Counterparty Risk

Our hedging strategy of using derivative instruments also involves certain additional risks such as counterparty credit risk, the enforceability of hedging contracts and the risk that unanticipated and significant changes in interest rates will cause a significant loss of basis in the contract. The counterparties to our derivative arrangements are major financial institutions and securities dealers that are well capitalized with high credit ratings and with which we may also have other financial relationships. While we do not anticipate nonperformance by any counterparty, we will be exposed to potential credit losses in the event the counterparty fails to perform. Our exposure to credit risk in the event of default by a counterparty will be the difference between the value of the contract and the current market price. There can be no assurance that we will be able to adequately protect against the foregoing risks and will ultimately realize an economic benefit that exceeds the related expenses incurred in connection with engaging in such hedging strategies.

Credit Spread Exposure

The mortgage-backed securities we own are also subject to spread risk. The majority of these securities will be adjustable-rate securities valued based on a market credit spread to U.S. Treasury security yields. In other words, their value depends on the yield demanded on such securities by the market based on their credit relative to U.S. Treasury securities. Excessive supply of such securities combined with reduced demand will generally

cause the market to require a higher yield on such securities, resulting in the use of a higher or wider spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value such securities. Under such conditions, the funding costs for new issuances of our mortgage-backed securities would tend to increase, thus reducing our net interest margin. Conversely, if the spread used to value such securities were to decrease or tighten, our funding costs for new issuances of our mortgage-backed securities would tend to decrease. Such changes in future funding costs may affect our net equity, net income or cash flow directly or indirectly through their impact on our ability to borrow and access capital.

Furthermore, shifts in the U.S. Treasury yield curve, which represents the market’s expectations of future interest rates, would also affect the yield required on our securities and therefore our funding costs. This would have similar effects on our financial position and operations as would a change in spreads.

Credit Risk

WeFor ~~are subject to the risk of default or credit risk on the mortgage~~ loans we ~~originate~~carry ~~and~~as ~~securitize.~~held-for-investment, Wewe are ~~obligated~~subject ~~under the terms of master loan purchase agreements~~ to ~~repurchase loans sold to investors in~~ the ~~event~~risk ofthat a ~~first or early payment~~borrower will default, ~~(FPD~~requiring orforeclosure ~~EPD).~~on Anand ~~FPD~~disposition orof ~~EPD~~the ~~exists~~collateral ~~when~~at aan ~~borrower~~amount ~~does~~less ~~not~~than ~~make a payment on a loan, generally during~~ the ~~first~~principal ~~months following origination~~ and ~~sale~~accrued ~~to an investor~~interest. WeOur ~~usually will resell these repurchased loans, but generally at a~~ ~~discount to the initial sales price.~~

~~For~~50 loans we securitize and carry as held-for-investment, we are subject to the risk that a borrower will default, requiring foreclosure on and disposition of the collateral at an amount less than the principal and accrued interest. Our interests in our securitizations are subordinate to other interests and absorb the losses incurred on these loans, reducing the cash flows ultimately distributed to us. However, we are not obligated to fund losses beyond the interests we hold in our securitizations.

interests in our securitizations are subordinate to other interests and absorb the losses incurred on these loans, reducing the cash flows ultimately distributed to us. However, we are not obligated to fund losses beyond the interests we hold in our securitizations.

A key factor affecting credit risk is the credit quality of the loans we make. Credit quality is impacted by, among other things, the credit history of the borrower, the borrower’s FICO score, the income documentation provided by the borrower and value of the collateral in relation to the amount borrowed (loan to value). We make residential mortgage loans to borrowers who generally do not satisfy the credit, collateral, documentation or other standards required by conventional mortgage lenders and loan buyers. As a result the credit risk associated with loans we make is higher than the credit risk associated with loans made by conventional mortgage lenders.

In recent years there have been a number of “non-traditional” mortgage loan products offered to borrowers such as hybrid loans (interest rate fixed for a period and then converts to adjustable), interest only loans, 80/20 loans (an 80% first mortgage “piggybacked” with a 20% second mortgage) and mortgages with terms in excess of the traditional 30 years (e.g., 40 years). These non-traditional mortgage loan products carry a higher credit risk principally due to the risk of “payment shock” (described below) and/or the limited equity a borrower may have in the collateral.

We generally ~~qualify~~qualified our borrowers based upon the initial payment for the mortgage loan. If the payment is subject to adjustment at some future point in time and if interest rates increase, the borrower’s income may not be able to support the monthly payment on the loan when the formerly fixed payment adjusts upward to reflect the increased interest rate (i.e., payment shock).

The equity held by a borrower in the collateral for a mortgage loan provides incentive to the borrower to repay the mortgage loan. If the borrower has limited or no equity in the collateral it is less likely that the borrower will repay the mortgage loan. Loans that provide the borrower essentially 100% financing for the purchase of a home (e.g., 80/20 loan product) leave the borrower limited or no equity in the collateral. In addition, a decline in the value of the collateral will also reduce or eliminate the borrower’s equity. While home values have generally increased over the past several years in the areas where we make our loans, there is no assurance that values will continue to increase or that values will not decline. These factors all contribute to the credit risk we assume in originating and investing in mortgage loans.

70A summary of loan products in our portfolio of loans held for investment at December 31, 2006 follows:


Product	Loan count	Balance		Weighted average coupon		FICO score	Loan to value	Debt to income
	(loan balances in thousands)
2/28 ARM	6,027	$	1,093,855	7.52	%	605	80	41
30 YR Fixed	2,582		495,584	6.92	%	649	76	40
2 YR I/O 2/28 ARM	875		241,919	6.57	%	661	81	41
3/27 ARM	817		154,367	7.46	%	624	81	40
5 YR I/O 2/28 ARM	421		114,413	6.73	%	666	82	41
2/28 Dual	318		84,580	7.20	%	597	79	42
5 YR I/O 3/27 ARM	178		48,926	6.89	%	673	83	40
15 YR Fixed	165		19,493	7.06	%	629	64	37
5 YR I/O 30 YR Fixed	153		43,121	6.63	%	685	76	40
1 YR 1/29 ARM	145		29,251	9.55	%	618	81	40
5 YR 5/25 ARM	140		31,659	6.72	%	650	78	42
3 YR I/O 3/27 ARM	136		35,870	6.68	%	670	81	41
20 YR Fixed	120		18,488	6.77	%	654	71	40
6 Month LIBOR	26		6,809	10.23	%	646	80	42
10 YR Fixed	17		1,502	7.26	%	622	61	39
25 YR Fixed	13		2,380	6.75	%	655	74	37

Total/Average	12,133	$	2,422,217	7.22	%

A summary of loan products originated by the Company during 2005 follows:

Product	Loan Count	Original Balance		Weighted Average Coupon		FICO Score	Loan toValue		Debt to Income
	(loan balances in thousands)
1 YR 1/29 ARM	1,656	$	420,406	7.34	%	616	82	%	44	%
10 YR Fixed	39		3,653	7.61	%	624	61	%	39	%
15 YR Fixed	438		50,379	7.58	%	630	72	%	38	%
2 YR I/O 2/28 ARM	3,424		1,015,283	6.63	%	649	82	%	41	%
2/28 ARM	27,712		5,785,077	7.68	%	598	80	%	42	%
2/28 Dual	4,872		1,439,813	7.49	%	604	79	%	44	%
20 YR Fixed	2,812		170,961	9.71	%	653	93	%	42	%
25 YR Fixed	40		6,698	7.27	%	647	76	%	40	%
3 YR I/O 3/27 ARM	366		102,517	6.70	%	658	82	%	41	%
3/27 ARM	2,802		568,381	7.57	%	623	81	%	41	%
30 YR Fixed	7,259		1,369,195	7.15	%	637	77	%	41	%
30/15 Fixed	5,723		400,893	10.48	%	668	100	%	43	%
5 YR 5/25 ARM	358		86,680	6.85	%	645	78	%	41	%
5 YR I/O 15 YR Fixed	1		60	7.44	%	713	9	%	45	%
5 YR I/O 2/28 ARM	6,274		2,015,224	6.95	%	655	82	%	42	%
5 YR I/O 3/27 ARM	1,182		335,999	6.85	%	662	81	%	41	%
5 YR I/O 30 YR Fixed	518		151,499	6.68	%	669	77	%	41	%
6 Month LIBOR	379		117,023	7.18	%	640	82	%	44	%
HELOC LR 10/10	8		891	9.27	%	662	91	%	48	%
Total	65,863	$	14,040,632	7.47	%	622	81	%	42	%

A summary of loan products in our portfolio of loans held for investment at December 31, 2005 follows:

Product	Loan Count	Balance		Weighted Average Coupon		FICO Score	Loan toValue		Debt to Income
	(loan balances in thousands)
1 YR 1/29 ARM	738	$	131,048	7.21	%	624	81	%	43	%
10 YR Fixed	24		2,081	7.47	%	610	62	%	40	%
15 YR Fixed	216		24,924	7.11	%	627	65	%	37	%
2 YR I/O 2/28 ARM	1,888		433,234	6.65	%	655	81	%	41	%
20 YR Fixed	167		25,222	6.87	%	644	71	%	40	%
25 YR Fixed	15		2,422	6.80	%	649	77	%	38	%
2/28 ARM	13,048		2,071,392	7.58	%	600	79	%	42	%
2/28 Dual	585		154,499	7.31	%	591	78	%	43	%
3 YR I/O 3/27 ARM	240		58,610	6.76	%	664	82	%	41	%
30 YR Fixed	3,698		666,411	6.97	%	644	76	%	41	%
3/27 ARM	1,432		256,089	7.60	%	618	81	%	41	%
5 YR 5/25 ARM	231		47,193	6.76	%	649	78	%	41	%
5 YR I/O 2/28 ARM	702		183,462	6.80	%	661	81	%	41	%
5 YR I/O 30 YR Fixed	215		55,790	6.65	%	682	76	%	40	%
5 YR I/O 3/27 ARM	284		73,823	6.94	%	666	83	%	40	%
6 Month LIBOR	193		28,424	6.96	%	647	81	%	43	%
Total	23,676	$	4,214,624	7.29	%	620	79	%	41	%

A summary of loan products in our portfolio of loans held for sale at December 31, 2005 follows:

Product	Loan Count	Balance		Weighted Average Coupon		FICO Score	Loan toValue		Debt to Income
	(loan balances in thousands)
1 YR 1/29 ARM	218	$	58,740	7.92	%	607	83	%	44	%
10 YR Fixed	2		147	10.26	%	624	86	%	39	%
15 YR Fixed	64		5,862	8.55	%	620	81	%	38	%
2 YR I/O 2/28 ARM	70		20,720	7.31	%	633	87	%	41	%
20 YR Fixed	610		35,049	10.74	%	645	98	%	43	%
25 YR Fixed	14		1,766	8.39	%	641	83	%	42	%
2/28 ARM	4,250		908,289	8.32	%	592	81	%	42	%
2/28 Dual	2,282		691,493	7.75	%	607	81	%	44	%
3 YR I/O 3/27 ARM	5		1,251	7.03	%	641	79	%	38	%
30 YR Fixed	1,352		201,587	7.97	%	624	80	%	42	%
30/15 Fixed	2,169		163,729	10.98	%	662	100	%	43	%
3/27 ARM	199		41,970	7.92	%	606	82	%	40	%
5 YR 5/25 ARM	24		5,669	7.51	%	650	77	%	41	%
5 YR I/O 2/28 ARM	1,590		551,768	7.29	%	654	83	%	43	%
5 YR I/O 30 YR Fixed	65		21,285	6.79	%	652	79	%	40	%
5 YR I/O 3/27 ARM	101		31,363	7.13	%	644	83	%	43	%
6 Month LIBOR	62		21,711	7.76	%	628	81	%	44	%
Total:	13,077	$	2,762,399	8.08	%	618	83	%	43	%

Item 8.

Financial Statements and Supplementary Data

The information required by this item is contained in the consolidated financial statements set forth in Part IV, Item 15(a) of this annual report.

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A.

Controls and Procedures

Disclosure Controls and Procedures.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports 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 that such information is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

WeAs ~~restated~~of ~~our~~December 31, ~~financial~~2006, ~~statements~~management, ~~for~~under the ~~three~~supervision ~~and~~of ~~nine~~our ~~months~~Chief ~~ended~~Executive Officer ~~September 30~~and Chief Financial Officer, ~~2005.~~conducted ~~The~~an ~~restatement~~evaluation ~~was~~of the ~~result~~effectiveness of athe ~~clerical error in~~design ~~recording~~and ~~interest~~operation ~~income~~of onour ~~certain~~disclosure ~~cash~~controls ~~investments.~~and Inprocedures ~~reviewing~~(as ~~the~~defined ~~circumstances~~in ~~underlying~~Exchange ~~the~~Act ~~restatement,~~Rule ~~management~~13a-15(e) ~~determined~~and ~~that~~Rule ~~the~~15d-15(e)). ~~error~~Based ~~resulted~~upon ~~from~~that aevaluation ~~material~~and taking ~~weakness~~into inaccount the ~~registrant’s~~deficiencies in internal ~~controls~~control ~~and procedures~~over ~~relating~~financial toreporting ~~incompatible~~discussed ~~duties~~below, ~~being~~our ~~performed~~Chief byExecutive ~~staff~~Officers and ~~improper~~Chief ~~preparation~~Financial ~~and~~Officer ~~review~~concluded ofthat ~~account~~as ~~reconciliations.~~of ~~Management~~December 31, ~~has~~2006 ~~revised~~and ~~procedures~~the todate ~~segregate~~of ~~certain~~this ~~responsibilities~~filing, ~~among~~our ~~staff~~disclosure controls and toprocedures ~~facilitate~~were ~~the~~not ~~timely review~~effective ~~and~~at ~~preparation~~a ofreasonable ~~account reconciliations~~level.

72Internal Control Over Financial Reporting

Management’s Report on Internal Control Over Financial Reporting

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) of the Exchange Act). The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Because of these inherent limitations, internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation and presentation, and may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a significant deficiency (as defined in PCAOB Auditing Standard No. 2), or combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement in financial statements will not be prevented or detected on a timely basis by employees in the normal course of their work.

Beginning in 2005 and through the first half of 2006, the Company undertook a significant effort to review the effectiveness of its internal control over financial reporting. However, during 2005 and 2006, the Company incurred significant operating losses and during 2006 the Company began to explore various strategic

As alternatives, including a sale of ~~December 31,~~the ~~2005,~~Company. weThe ~~carried~~Company’s ~~out~~efforts annecessarily ~~evaluation,~~became ~~under~~more ~~the~~focused ~~supervision~~on ~~and~~addressing ~~with~~its operations given the severe ~~participation~~market ofconditions, ~~our~~initiating ~~management,~~further ~~including~~cost ~~our~~reductions ~~Co-Chief~~and ~~Executive~~exploring ~~Officers~~various ~~and~~strategic ~~Chief~~alternatives ~~Financial~~rather ~~Officer,~~than ofreviewing the effectiveness of ~~the~~its ~~design~~internal ~~and~~controls ~~operation~~over offinancial ~~our~~reporting. ~~disclosure~~At ~~controls~~that ~~and~~time, ~~procedures~~management ~~(as~~reasonably ~~defined~~believed inthat ~~Exchange~~the Company ~~Act~~would ~~Rule~~not ~~13a-15(e)~~be ~~and~~a ~~Rule 15d-15(e)).~~SEC ~~Based~~registrant ~~upon~~for ~~that~~the ~~evaluation~~year ~~and~~ended ~~taking~~December 31, ~~into~~2006 ~~account~~or that the ~~deficiencies~~Company ~~discussed~~would ~~above,~~have ~~our~~completely ~~Co-Chief~~restructured ~~Executive~~its ~~Officers~~existing ~~and~~operations ~~Chief~~making ~~Financial~~it ~~Officer~~not ~~concluded~~feasible ~~that~~to astimely review the effectiveness of ~~December~~its internal controls. On October 3110, ~~2005~~2006, ~~our~~the ~~disclosure~~Company ~~controls~~entered ~~and~~into ~~procedures~~an ~~are~~agreement ~~not effective~~to atsell aits ~~reasonable~~mortgage ~~level~~banking inoperations ~~timely~~to ~~alerting~~Bear ~~them~~Stearns toResidential ~~material~~Mortgage ~~information~~Corporation, ~~relating~~which we refer to usas the sale transaction. The agreement contemplated that isthe ~~required~~sale totransaction would beclose ~~included~~on inor ~~our~~about ~~periodic~~December 1, ~~filings~~2006. ~~with~~However, completion of the ~~Securities~~sale ~~and~~transaction ~~Exchange~~did ~~Commission~~not occur until February 9, 2007.

~~Changes~~Prior to the sale transaction, the Company had approximately 700 employees. Following the transaction, the Company retained 40 employees. As a result of the sale transaction, those employees involved in ~~Internal~~the ~~Control~~operating ~~Over~~processes ~~Financial~~of ~~Reporting~~the mortgage banking operation no longer worked for the Company, and the Company’s information systems environment, processes and procedures significantly changed.

~~Pursuant~~During to the ~~provisions~~fourth ofquarter ~~Section 404~~ of ~~the~~2006 ~~Sarbanes-Oxley~~management ~~Act, beginning~~understood ~~with~~that ~~our Annual Report on Form 10-K for~~ the ~~fiscal~~Company ~~year~~would ~~ending December 31, 2006, we will~~ be required to ~~furnish~~complete athe ~~report~~documentation byof ~~our~~controls ~~management~~and onidentify ~~our~~and ~~internal~~test compliance with key controls over financial reporting. Weso ~~have~~as ~~commenced~~to permit amanagement ~~significant~~to ~~effort~~report ~~to review~~on the effectiveness of ~~our~~ internal controls over financial reporting and ~~presently~~restarted ~~are~~efforts into ~~the~~do ~~process~~so. ofHowever, ~~documenting~~management ~~and~~was ~~assessing~~unable ~~the~~to ~~effectiveness~~devote of the ~~design~~time, ofeffort ~~our~~and ~~internal~~resources ~~controls~~necessary ~~over~~to ~~financial~~complete ~~reporting.~~this Toprocess ~~date~~as of December 31, we2006. ~~have~~Management ~~identified and~~did ~~are~~not inknow ~~the~~until ~~process~~mid-December of2006 ~~implementing~~that ~~new~~the ~~procedures~~sale ~~and~~transaction ~~changes~~would tonot ~~existing~~be ~~procedures~~completed in an2006. ~~effort~~After ~~to improve~~ the ~~effectiveness~~close of ~~our~~the ~~internal~~sale ~~controls~~transaction ~~over~~on ~~financial~~February 9, ~~reporting.~~2007, Init ~~general,~~was ~~these~~not ~~measures~~possible ~~include~~for ~~enhancing~~management ~~documentation~~to ofcomplete the ~~policies~~documentation and ~~procedures,~~testing ~~segregation~~ of ~~duties,~~controls and ~~controls~~test ~~surrounding~~compliance ~~the~~with ~~processing~~key ofcontrols ~~critical~~over ~~spreadsheet~~financial ~~applications~~reporting ~~and~~due ~~information~~to ~~technology~~the ~~general~~following: ~~controls (e.g. access, program change).~~

~~The~~• ~~process~~Many ofemployees ~~designing~~with ~~and implementing effective internal controls is~~ a ~~continuous~~ ~~effort~~role ~~that requires us to anticipate and react to changes~~ in ~~our business and~~ the ~~economic and regulatory environments and to expend significant resources to maintain a system of~~ internal control ~~over~~structure ~~financial~~no ~~reporting~~longer ~~that~~worked isfor ~~adequate to~~the ~~satisfy~~Company ~~our~~after ~~reporting~~February ~~obligations~~9, 2007 as a ~~public~~result ~~company. In our undertaking~~ of ~~this~~the ~~continuous~~sale ~~effort,~~transaction. ~~we may identify various control deficiencies~~Further, ~~some~~there ofwas ~~which may be~~ significant ~~deficiencies~~employee orattrition ~~material~~during ~~weaknesses as defined by~~ the ~~rules~~latter half of ~~the Public~~2006. ~~Company~~As ~~Accounting~~a ~~Oversight~~result, ~~Board.~~changes Wein ~~will~~processes ~~assess~~and ~~the~~controls ~~significance~~and ofrelated ~~identified~~compliance ~~control~~were ~~deficiencies~~not ~~that~~always ~~come~~documented toin ~~our~~a ~~attention~~manner ~~and~~that ~~determine~~evidenced the ~~extent~~performance toof ~~which~~required ~~such~~procedures ~~deficiencies~~and ~~may be mitigated or require remediation~~controls.

•

Processes employed by the Company during 2006 were changed during and following the transaction. Many changes involved information systems processes that were abandoned or transitioned to the buyer’s information technology platform after February 9, 2007. Management did not consider it to be cost effective to retain or reconstruct such processes after February 9, 2007 solely for the purpose of facilitating internal control testing on extinct processes.

As a result of these circumstances, management was unable to complete its testing of internal controls over financial reporting for the year ended December 31, 2006. Notwithstanding the foregoing, in the course of performing its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, management identified material weaknesses in the Company’s internal control over financial reporting. Material weaknesses noted and planned remedial actions include the following:


Deficiency noted		Planned remedial action
There are inadequate controls to restrict access to key spreadsheet applications and to test and prevent changes to key spreadsheet applications.		Procedures will be implemented to restrict access and to prevent changes to key spreadsheet applications

Management does not effectively document or evaluate controls surrounding processes performed by third party service providers including loan servicers.		Management has created a servicing oversight function to monitor servicer performance.

The review and approval of transactional activity and significant management estimates and judgements is not regularly documented.		Transactional activity and significant estimates and judgments are already documented and reviewed. Going forward the review and approval process will be regularly documented.


Deficiency noted		Planned remedial action
There is inadequate segregation of duties surrounding the authorization and recording of cash disbursements processed by wire transfer.		We have reassigned responsibilities to mitigate segregation of duties issues and will implement transaction limits to reduce exposure to fraud arising from segregation of duties deficiencies.

Adherence to various policies and procedures within the information systems environment was not documented		The information systems environment was completely changed following the sale transaction. We are in the process of documenting policies and procedures and adherence thereto.

The completion of procedures and processes surrounding the monthly and quarterly accounting close is not fully documented.		Required procedures and processes are completed, however, the completion is not always documented in the Company’s closing checklists. The closing checklists will be completed at each accounting period end and reviewed by the Chief Financial Officer.

There is inadequate segregation of duties surrounding access to payroll accounting systems and information.		This deficiency has been significantly mitigated by the significant reduction in employees. Payrolls will be approved by the Chief Financial Officer or his delegate who will be independent of the payroll function.

In making its limited assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Because of the material weakness described above, management believes that, as of December 31, 2006 and the date of this filing, the Company’s internal control over the financial reporting was not effective based on those criteria.

Grant Thornton LLP (GT), our independent registered public accounting firm, has provided us with an unqualified report on our consolidated financial statements for 2006. However, as management has concluded that it is unable to complete its assessment of internal control over financial reporting as of December 31, 2006 as required under Section 404 of the Sarbanes-Oxley Act, Grant Thornton has issued a report, included herein, that disclaims an opinion on management’s assessment and as to the effectiveness of our internal control over financial reporting as of December 31, 2006.

The table below contains GT’s findings and management’s responses to the findings.


Deficiency noted		Planned remedial action
There are material weaknesses related to management’s assessment process of internal controls related to financial reporting, including:

Documentation is not in conformity with COSO’s Integrated Framework.		Management will implement standards that are intended to meet COSO documentation standards

Specific programs or controls designed to prevent, deter and detect fraud were not identified.		Management will implement controls designed to prevent, deter and detect fraud. that are intended to meet COSO documentation standards

Management’s testing of internal controls was incomplete.		Management will complete test of controls during fiscal year 2007.


Deficiency noted		Planned remedial action
The assessment process did not identify controls related to:

Generation of loan file documents;		The sale of the loan origination business make this finding no longer applicable

Access to warehouse line funding;		The sale of the loan origination business make this finding no longer applicable

Recordkeeping of repurchase claims made under whole loan sale agreements;		Due to settlements of repurchase claims and the exiting of the wholesale loan origination business, management does not consider this to be a material weakness in fiscal year 2007.

Review and approval of the amortization calculations for capitalized fees and costs for loans held for investment;		Management intends to implement controls surrounding this area.

Calculation of the lower of cost or market reserve; and		The sale of the wholesale loan origination business make this finding no longer applicable

Calculation of the valuation reserve for real estate owned property.		The sale of the loan origination business make this finding no longer applicable

There is inadequate documentation that management evaluated the competency and skills of employees who performed internal control testing. In addition, key members of the management team did not appear to be actively involved in implementing and reviewing.		Management will review the competency and skills of employees performing internal control testing

There are material weaknesses related to the design of the Company’s internal control structure, including:

The number and experience of individuals were not sufficient to have adequate segregation of duties.		Management will make its best efforts to implement segregation of duties.

There are material weaknesses related to the operating ineffectiveness of the following loan production controls, including:

Broker and correspondent approval controls and on going monitoring controls were not operating as designed.		The sale of the loan origination business make this finding no longer applicable

Loan underwriting controls were not operating as designed.		The sale of the loan origination business make this finding no longer applicable

Controls ensuring the accuracy of loan data entered into the loan operating systems were not operating as designed.		The sale of the loan origination business make this finding no longer applicable

Controls ensuring the accuracy of loan balances reported in the financial statements were not operating as designed.		The sale of the loan origination business make this finding no longer applicable


Deficiency noted		Planned remedial action
There are material weaknesses related to the operating ineffectiveness for the following controls, including:

There are not sufficient controls in place to ensure that the recording of interest income is accurate and complete.		The sale of the loan origination business makes this finding no longer applicable for loans held for sale. However, management intends to verify third part reports related to loans held for investment.

There are not sufficient controls in place to ensure that the recording of interest expense is accurate and complete.		The sale of the loan origination business makes this finding no longer applicable for loans held for sale. However, management intends to verify third part reports related to securitization debt.

Controls for ensuring the accuracy of the swap and cap values reported in the financial statements were not operating as designed.		Management intends to implement controls to insure proper valuations.

Although management is implementing actions to resolve the noted control deficiencies, there is no assurance that neither management nor the Company’s independent auditors will in the future identify further material weaknesses or significant deficiencies in the Company’s internal control over financial reporting.

Changes in Internal Control Over Financial Reporting

Following the close of the sale of the Company’s mortgage banking operations to Bear Stearns, the Company has been operating with significantly fewer employees. Management has been reviewing remaining processes and procedures to ensure that there are sufficient and qualified personnel remaining to manage the financial reporting process. As a result of changes in the business and the significant reduction in the number of employees there have necessarily been numerous changes in the internal control process over financial reporting through the fourth quarter of 2006 and into the first quarter of 2007. Principal changes have included changes in processes within our information technology environment and reassignment of accounting and financial reporting responsibilities to facilitate appropriate segregation of duties. We would expect there to continue to be significant changes to our internal controls over financial reporting as we implement actions to remediate the various control deficiencies noted in remaining processes.

Attestation Report of Independent Public Accounting Firm

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

ECC Capital Corporation

We were engaged to audit management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that ECC Capital Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). ECC Capital Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.

As described in Management’s Report on Internal Control Over Financial Reporting, management was unable to complete their assessment of internal controls over financial reporting. However, in the course of performing procedures during the limited assessment process, management identified material weaknesses in the Company’s internal controls.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment:

•

There are inadequate controls to restrict access to key spreadsheet applications and to test and prevent changes to key spreadsheet applications.

•

Management does not effectively document or evaluate controls surrounding processes performed by third party service providers including loan servicers.

•

The review and approval of transactional activity and significant management estimates and judgments is not regularly documented.

•

There is inadequate segregation of duties surrounding the authorization and recording of cash disbursements processed by wire transfer.

•

Adherence to various policies and procedures within the information systems environment was not documented.

•

The completion of procedures and processes surrounding the monthly and quarterly accounting close is not fully documented.

•

There is inadequate segregation of duties surrounding access to payroll accounting systems and information.

In addition to material weaknesses identified by management, we identified the following material weaknesses that had not been specifically identified as material weaknesses by management:

•

Material weaknesses related to Management’s assessment process of their internal control related to financial reporting, including:

Documentation was not in conformity with COSO’s Integrated Framework.

Specific programs or controls designed to prevent, deter, and detect fraud as required by Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements were not identified.

Management’s testing of internal controls was incomplete.

The assessment process did not identify controls related to the following areas:

Generation of loan file documents,

Access to warehouse line funding,

Recordkeeping of repurchase claims made under whole-loan sale agreements,

Review and approval of the amortization calculations for capitalized fees and costs for loans held for investment

Calculation of the lower of cost or market reserve for loans held for sale

Calculation of the valuation reserve for real estate owned property

There is inadequate documentation that management evaluated the competency and skills of employees who performed the internal control testing. In addition, key members of the management team did not appear to be actively involved in implementing and reviewing internal controls. Implementation and monitoring efforts appeared to be solely directed by the Chief Accounting Officer.

•

Material weakness related to the design of the Company’s internal control structure:

The number and experience of individuals were not sufficient to have adequate segregation of duties.

•

Material weaknesses related to the operating ineffectiveness of the following loan production controls, including:

Broker and correspondent approval controls and ongoing monitoring controls were not operating as designed.

Loan underwriting controls were not operating as designed.

Controls ensuring the accuracy of loan data entered into the loan operating systems were not operating as designed.

Controls ensuring the accuracy of the loan balances reported in the financial statements were not operating as designed.

•

Material weaknesses related to the operating ineffectiveness for the following controls, including:

There are not sufficient controls in place to ensure that the recording of interest income is accurate and complete.

There are not sufficient controls in place to ensure that the recording of interest expense is accurate and complete.

Controls ensuring the accuracy of the swap and cap values reported in the financial statements were not operating as designed.

These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2006 financial statements. Our report dated May 30, 2007 expressed an unqualified opinion on those financial statements.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance

with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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

Since management did not fully complete its assessment of internal controls over financial reporting and due to the changes in personnel, process and information systems that were occurring, or had occurred, at the Company as described in “Management’s Report on Internal Control Over Financial Reporting” we were unable to apply other procedures to satisfy ourselves as to the effectiveness of the Company’s internal control over financial reporting, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion either on management’s assessment or on the effectiveness of ECC Capital Corporation’s internal control over financial reporting.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of ECC Capital Corporation as of December 31, 2005 and 2006, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2006 and our report dated May 30, 2007 expressed an unqualified opinion on those financial statements.

/s/ GRANT THORNTON LLP

Irvine, California

May 30, 2007

Item 9B.

Other Information

None.

7359

PART III

Item 10. Directors, ~~and~~ Executive Officers ofand ~~the~~Corporate ~~Registrant~~Governance

~~Information~~The ~~regarding our board of~~ directors, and executive officers, ~~audit committee, audit committee financial expert and code~~ of ~~ethics is set forth under~~ the ~~caption “Election of Directors”, “Election of Directors—Committee of the Board”, “Executive Officers of the~~ Company” and ~~“Code~~their ofages ~~Ethics”~~and intheir ~~our~~positions ~~definitive Proxy Statement to be filed in connection~~ with ~~our~~the ~~2006~~Company ~~Annual~~as ~~Meeting~~ of ~~Stockholders and such information is incorporated herein by reference. Information regarding Section~~May ~~16(a)~~14, ~~beneficial~~2007, ~~ownership~~are ~~compliance~~as isfollows: set forth under the caption “Section 16(a) Beneficial Ownership Reporting” of our definitive Proxy Statement to be filed in connection with our 2006 Annual Meeting of Stockholders and such information is incorporated herein by reference.


Name	Age	Position(s)
Steven G. Holder	49	Chairman of the Board and Chief Executive Officer
Roque A. Santi	44	President, Chief Financial Officer, Treasurer, Chief Accounting Officer
Larry E. Moretti	49	Executive Vice President and Chief Operating Officer
James R. Brazil	64	Director, Lead Independent Director
William Jacoby	68	Director
James O. Rollans	64	Director

Background of Directors and Executive Officers

Steven G. Holder

Mr. Holder has served as the Company’s Chief Executive Officer and Chairman of the Board since February 2007. Prior to that he was the Company’s Co-Chief Executive Officer and Chairman of the Board since April 2004. Since October 2001, Mr. Holder also served on the board of directors and in various executive officer positions of the Company’s subsidiaries and affiliates. Before joining the Company, Mr. Holder was Chief Executive Officer and Chairman of the Board of Sprint Funding Corporation, formerly known as Park Place Capital Corporation, an asset management and servicing company, a position he assumed in February 2001. From January 1996 to January 2001, Mr. Holder served as President and Co-Chief Executive Officer of New Century Mortgage Corporation. Mr. Holder also served as New Century Financial Corporation’s Vice Chairman of the Board from 1996 to 2000 and Chief Operating Officer from 1995 to 2000. Prior to his tenure at New Century, Mr. Holder served as Executive Vice President of Long Beach Mortgage Company from 1993 to 1995. Mr. Holder has worked in the financial services industry in various positions, including serving as Vice President of Transamerica Financial Services from 1990 to 1993 and Regional Vice President of NOVA Financial Services, a division of First Interstate Bank, from 1985 to 1990. Mr. Holder has 29 years of subprime lending and consumer finance experience.

Roque A. Santi

Mr. Santi serves as the Company’s President, Chief Financial Officer, Chief Accounting Officer and Treasurer. He assumed the position of Chief Accounting Officer in April 2007 and has been President and Treasurer since February 2007. Prior to that he was the Company’s Executive Vice President and Chief Financial Officer since November 2004. Before joining the Company, Mr. Santi was a partner with Ernst & Young LLP, from May 2002 to November 2004, during which time he was in charge of Tax Financial Services for the Mid-Atlantic Area and was the national tax leader for the Mortgage REIT practice. Prior to his tenure at Ernst & Young, Mr. Santi was a partner with Arthur Andersen LLP, from December 1993 to May 2002, during which time he led Arthur Andersen’s Tax Financial Services practice for the Mid-Atlantic area and served a significant number of Arthur Andersen’s public and private mortgage REIT clients. Mr. Santi has over 20 years of experience in the consumer finance industry. Mr. Santi received a bachelor’s degree from Pace University.

Larry E. Moretti

Mr. Moretti has served as the Company’s Executive Vice President and Chief Administrative Officer since March 2005. Prior to joining the Company, Mr. Moretti was Chief Information Officer and Senior Vice President of New Century Mortgage Corporation from May 1999 to February 2005. He also served as New Century Mortgage Corporation’s Chief Administrative Officer from January 2001 to June 2002 and as a director from

June 2001 through February 2005. Mr. Moretti served as Senior Information Systems Account Manager for TRW Space and Electronics Group from December 1997 to March 1999. From 1994 to 1999, Mr. Moretti was owner and President of Telenet Solutions, a consulting firm that provides technology and strategic development services. Mr. Moretti was previously Manager of Information Technology Support Systems for Transamerica Specialty Financial from 1980 to 1996. Mr. Moretti has over 7 years of subprime lending and over 17 years specialty finance experience.

James R. Brazil

Mr. Brazil has served as one of the Company’s directors since April 2004. From November 2003 to January 2006, Mr. Brazil also served on the board of directors of certain of the Company’s subsidiaries. From September 2000 to September 2003, Mr. Brazil was a consultant for Ameriquest Mortgage Company, a retail mortgage lender, and previously served in various capacities at Ameriquest Mortgage Company from 1994 to 2000, including as Chairman of the Board and Chief Executive Officer and head of its retail operations. Prior to joining Ameriquest Mortgage Company, Mr. Brazil served as Senior Vice President-Acquisitions of Transamerica Financial Services from 1990 to 1994 and as Senior Vice President/Director of Operations of NOVA Financial Services from 1984 to 1990. Mr. Brazil has over 36 years of subprime lending and consumer finance experience.

William Jacoby

Mr. Jacoby has served as one of the Company’s directors since January 2005. Mr. Jacoby founded and served as President and Chief Executive Officer of California Commercial Bankshares and as Chairman and Chief Executive Officer of National Bank of Southern California, a subsidiary of California Commercial Bankshares that was merged with Western Bancorp in 1997. During 1982 through 1997, Mr. Jacoby was responsible for all phases of the business, including profitability, liquidity and assurance of quality of the loan portfolio. Prior to the commencement of his tenure with California Commercial Bankshares, Mr. Jacoby was Senior Vice President and Credit Administrator of Westlands Bank from June 1979 to June 1982, where he was responsible for control of the credit quality of the bank’s loan portfolio and was a member of the executive committee. Between June 1960 and June 1979, Mr. Jacoby worked in various positions for United California Bank. Mr. Jacoby received a bachelor’s degree from Occidental College and graduated from The Pacific Coast Banking School at the University of Washington.

James O. Rollans

Mr. Rollans has served as one of the Company’s directors since January 2005. Mr. Rollans retired in 2003 from the board of directors of Fluor Corporation and from his position as Fluor’s Group Executive of Investor Relations and Corporate Communications, in which he was responsible for leading the company’s external affairs, including Investor Relations, Corporate Communications, Community and Government Relations functions. Prior to assuming that role in February 2002, Mr. Rollans served as Group Executive of Business Services from February 2001. Joining Fluor in 1982, Mr. Rollans’ tenure with the company included several positions at the senior executive level, including that of Senior Vice President and Chief Financial Officer from 1998 to 1999 and from 1992 to 1994; Senior Vice President and Chief Administrative Officer from 1994 to 1998; and Vice President of Corporate Communications from 1982 to 1992. He also served as the first President and Chief Executive Officer of Fluor Signature Services, the former business services enterprise of Fluor Corporation from 1999 to 2001. Mr. Rollans is a member of the board of directors of Flowserve Corporation and is also on the board of directors of Advanced Medical Optics, both of which are publicly traded companies. Mr. Rollans received a bachelor’s degree from California State University, Northridge.

Section 16(A) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires our directors, executive officers and persons who own more than 10% of a registered class of our equity securities to file initial reports of ownership and reports of changes in ownership with the SEC. Such persons are required by

SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based solely on a review of copies of such forms received with respect to the year 2006 and the written representations received from certain reporting persons that no other reports were required, we believe that all directors, executive officers and persons who own more than 10% of our common stock have complied with the reporting requirements of Section 16(a).

Code of Ethics

We have adopted a Code of Business Conduct and Ethics that applies to our officers, directors and employees. The code, as applied to our Chief Executive Officer, principal financial officer, principal accounting officer, controller and other senior financial officers, is intended to comply with the requirement of Section 406 of the Sarbanes-Oxley Act of 2002. A copy of the code will be provided without charge upon request to our Secretary, ECC Capital Corporation, 1733 Alton Parkway, Suite 250, Irvine, California 92606. The code is available on our website at www.ecccapital.com. We intend to disclose timely any amendments to or waivers of certain provisions of the code applicable to our Chief Executive Officer, principal financial officer, principal accounting officer, controller and other senior financial officers on our website at www.ecccapital.com.

Stockholder Recommendations for Board Nominees

Our Nominating/Corporate Governance Committee evaluates recommendations for director nominations by stockholders. The board adopted a Nominating/Corporate Governance Committee Charter in January 2005, a copy of which appears on our website at www.ecccapital.com. We did not implement any changes to our process for stockholder recommendations of director nominees during 2006.

Audit Committee

The Audit Committee currently consists of three directors, Messrs. Brazil, Jacoby and Rollans, with Mr. Rollans serving as the Chairman. Mr. Brazil replaced Mr. Ingram as a member of our Audit Committee subsequent to Mr. Ingram’s resignation from our board effective March 1, 2007. Each of these directors has been determined by our board to be independent and to satisfy the requirements of U.S. Securities and Exchange Commission (“SEC”) Rule 10A-3. The board has also determined that Mr. Rollans qualifies as an audit committee financial expert and each member of the Audit Committee is financially sophisticated within the meaning of SEC Regulation S-K, Item 401(h). The board adopted an Audit Committee Charter in January 2005, a copy of which appears on our website at www.ecccapital.com.

Item 11.

Executive Compensation

~~The information required by this item is set forth under the caption “Executive~~ Compensation ~~and Other Information” and “Election of Directors—Board Compensation and Benefits” in our~~ ~~definitive~~Discussion ~~Proxy Statement to be filed in connection with our 2006 Annual Meeting of Stockholders~~ and ~~such~~Analysis ~~information is incorporated herein by reference.~~

~~Item~~Introduction ~~12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.~~

~~The~~This section provides information ~~required~~regarding bythe ~~this~~compensation ~~item~~programs isfor ~~set~~our ~~forth~~chairman ~~under~~of the ~~captions~~board ~~“Voting~~and ~~Securities~~chief ~~and~~executive ~~Principal~~officer, ~~Holders~~former ~~Thereof”~~co-chief executive officer, ~~“Executive Compensation~~president and ~~Other~~chief ~~Information”~~financial officer and ~~“Equity~~one ~~Compensation~~current ~~Plan~~and ~~Information”~~two informer most highly compensated executive officers for 2006, (collectively our ~~definitive~~“named ~~Proxy~~executives”). ~~Statement~~This tosection beincludes, ~~filed~~among inother ~~connection~~things, ~~with~~the overall objectives of our ~~2006~~compensation ~~Annual~~program, ~~Meeting~~each element of ~~Stockholders~~compensation that we provide, and ~~such~~an explanation ~~information~~of isthe ~~incorporated~~reasons ~~herein~~for ~~by reference~~the compensation decisions we have made regarding the named executives.

~~Item~~Compensation Committee. 13The Compensation Committee consists of three independent directors, Messrs. ~~Certain~~Brazil, ~~Relationships~~Jacoby and ~~Related~~Rollans, ~~Transactions~~with Mr. Brazil serving as the Chairman.

~~Sprint~~The ~~Funding~~Board ~~Corporation~~adopted ~~(“Sprint”)~~a ~~has~~Compensation ~~common~~Committee ~~principal~~Charter ~~owners~~in ~~with~~January us, certain of whom serve as our officers, and subleased facilities from us. Sprint paid us approximately $108,000, $102,000 and $112,000 for office space that was co-leased during the years ended December 31, 2005, ~~2004,~~a ~~and~~copy ~~2003,~~of ~~respectively.~~which Weis ~~also~~available ~~received approximately $41,000 and $101,000~~ for ~~accounting~~viewing ~~and information~~on ~~technology services that were provided to Sprint during~~ the ~~years~~Company’s ~~ended~~website ~~December 31,~~at ~~2004 and 2003, respectively~~www.ecccapital.com. InThe ~~addition,~~Compensation weCommittee’s ~~paid approximately $525,000 and $1,180,000 in fees related to the purchase of loans from Sprint during~~responsibilities ~~the years ended December 31~~include, ~~2004~~but ~~and~~are ~~2003, respectively. We did~~ not ~~provide~~limited ~~any services~~ to: ~~Sprint or purchase any loans from them during 2005.~~

~~The~~• ~~Co-Chief~~establishing ~~Executive~~guidelines ~~Officer~~ and ~~Chairman’s~~standards ~~spouse~~for ~~was~~determining ~~employed by us as an account executive from April 2002 to June 2005. She was paid approximately $712,800 in 2003, $475,200 in 2004, and $271,000 in 2005 in total~~ compensation ~~pursuant to our stated compensation structure~~ for ~~account~~the ~~executives.~~Company’s executive officers;

~~The~~62 Co-Chief Executive Officer and President’s spouse has been employed by us as an account executive since May 2002. She was paid approximately $2.8 million in 2003, $2.9 million in 2004, and $2.3 million in 2005 pursuant to our stated compensation structure for account executives.

ItemTable 14.of Principal Accountant Fees and ServicesContents

~~The~~• ~~information~~evaluating ~~required~~performance byof ~~this item is set forth under~~ the ~~caption~~Company’s ~~“Principal~~senior ~~Accountant Fees and Services” in our definitive Proxy Statement to be filed in connection with our 2006 Annual Meeting of Stockholders and such information is herein incorporated by reference.~~ executives;

•

reviewing the Company’s executive compensation policies;

•

recommending to the Board compensation for the Company’s executive officers;

•

administering and implementing the Company’s equity incentive plans;

•

determining the number of shares underlying, and the terms of, restricted common share awards and stock options to be granted to the Company’s directors, executive officers and other employees pursuant to these plans; and

•

preparing a report on executive compensation for inclusion in the Company’s annual proxy statement for its annual stockholders meeting.

Our executive officers are generally allowed to be present and participate in Compensation Committee meetings and our chief executive officer may make recommendations to the meeting, however all determinations regarding executive compensation are made exclusively by the Compensation Committee.

General Compensation Philosophy and Policy. The Compensation Committee’s executive compensation policies are designed to provide competitive levels of compensation, link pay with the Company’s annual objectives and long-term goals, recognize individual initiative and assist the Company in attracting and retaining qualified executives. The compensation of the Company’s executive officers are set at levels that the Compensation Committee believes to be competitive with others in the Company’s industry, based on public information with respect to compensation paid by comparable companies. The Company is engaged in a very competitive industry and the Company’s success depends upon its ability to attract and retain qualified executives through the competitive compensation packages it offers to such individuals.

The Compensation Committee’s policy is to provide the Company’s executive officers with compensation opportunities that are based upon the financial performance of the Company and the individual’s contribution to that performance, and which are competitive enough to attract and retain highly skilled individuals. Each executive officer’s compensation package is comprised of the following elements: (i) base salary that is competitive with the market and reflects individual responsibilities and performance, (ii) annual variable bonuses payable in cash and tied to individual and Company performance, and (iii) stock-based incentive awards designed to strengthen the mutuality of interests between the executive officers and the Company’s stockholders. As an executive officer’s level of responsibility increases, a greater proportion of his or her total compensation will be dependent upon the Company’s financial performance and stock price appreciation.

The principal factors that were taken into account in establishing each executive officer’s compensation package for 2006 are described below. However, the Compensation Committee may in its discretion apply entirely different factors, such as different measures of financial performance, for future years.

Executive Officer Base Salaries. The Compensation Committee’s philosophy is that the base salary of each executive officer should reflect the salary levels for comparable positions in the industry and in a comparative group of companies, the position’s job scope and responsibilities and the individual’s personal performance and importance to the Company. In addition, the Company’s performance and profitability should be a factor in determining the base salaries of executive officers. The base salaries for the executive officers were set in connection with the Company’s initial public offering and were based on market conditions, anticipated additional responsibilities and growth of the Company. The Compensation Committee reviews salaries of executive officers annually, which may be adjusted from time to time to recognize individual performance, promotions and competitive compensation levels and other subjective factors, without assigning a specific weight to individual factors.

Based upon the recommendation of the Company’s Co-Chief Executive Officers and President and considering the Company’s financial performance during 2005, the Compensation Committee determined to set

2006 base salaries for all executive officers at their respective 2005 levels. In April 2006, and subsequent to this determination by the Compensation Committee, the Company announced a reduction in its workforce as part of its initiatives to reduce costs and achieve profitability. In connection with these initiatives, most of our management team agreed to reductions in salary. Mr. Holder and Mr. Asghar, who where then serving as our Co-CEO’s, volunteered not to receive any salary or bonus for the next twelve months, effective April 1, 2006. Messrs. Moretti and Santi agreed to 20% reductions in their base salaries, from $250,000 to $200,000, effective April 15, 2006.

In the future, salaries may be increased based upon an assessment of competitive pay levels and/or the executive officer’s contribution to the Company.

Executive Officer Bonuses. It is our general policy to set annual executive officer bonuses as a percentage of base salary, with the specific target percentage determined by the person’s position, level and scope of responsibility within the Company. The award of bonuses is dependent upon individual and Company performance. On a case-by-case basis, as our Compensation Committee determines necessary, we sometimes provide other bonuses, such as merit bonuses to motivate officers and/or reward performance, or retention bonuses which may be earned by continuing to be employed by the Company by a certain date.

Pursuant to the terms of Mr. Gotschall’s employment agreement, which was negotiated prior to joining the Company, Mr. Gotschall received a one-time mandatory bonus of $1,000,000, payable in four equal installments from July 1, 2005 through June 30, 2006 and was also entitled by his employment agreement to receive a mandatory bonus equal to 200% of his base compensation each year and received such a bonus for 2006. None of our other named executive officers were entitled by their employment agreements to receive mandatory bonuses in 2006.

2006 Executive Bonus Plan. In April 2006, the Compensation Committee approved an executive bonus plan for 2006 which was designed to reward executive officers for their individual performance and/or the Company’s performance. As discussed above, in April 2006, the Company announced a reduction in its workforce and most of our management team agreed to reductions in salary as part of the Company’s initiatives to regain profitability. The 2006 executive bonus plan was intended to reflect the financial status of the Company and motivate our executives. This plan was approved in connection with the Company’s 2005 year-end financial statements which showed the Company operating at a loss and the executive bonus plan was prepared in light of these circumstances. Increasing portions of bonus compensation were put “at risk” depending upon Company performance for executive officers with the greatest influence on corporate results. Our executive officers were categorized into three “peer groups” with different criteria.

The first peer group consisted of our then Co-Chief Executive Officers, Messrs. Asghar and Holder. They agreed, in light of their substantial equity holdings in the Company, not to receive any bonus for 2006. Therefore, the members of the first peer group were not entitled to any bonuses under the plan.

The second peer group consisted of three key named executive officers, Messrs. Gotschall, Moretti and Santi. Each person in this group was entitled to receive total potential bonuses of up to 200% of his base salary. Eligibility was based entirely on the profitability of the Company determined on a per-quarter basis according to pre-determined performance thresholds, with each executive entitled to receive a bonus ranging from 50% of his pro-rata salary for such quarter, in the event the Company made even a minimal profit in the quarter. No members of the second peer group qualified for any bonuses pursuant to the 2006 executive bonus plan because the Company was not profitable in any quarter during 2006.

The third peer group consisted of other executives and key employees, of which only one, Ms. Darling, is a named executive officer for 2006. Each person in this group was entitled to receive total potential bonuses of up to 75% of his or her base salary. Half of the total potential bonus for members of this peer group was dependent on the Company’s meeting of performance benchmarks, determined on a per-quarter basis according to

pre-determined performance thresholds and half was dependent on the member’s personal performance. Each member of this group was entitled to a Company performance bonus of 18.75% of his or her pro-rata salary for each quarter even if the Company was not profitable and became entitled to increasingly higher amounts on the Company meeting profit benchmarks each quarter up to a maximum Company performance bonus of 37.5% in the event the Company achieved profitability benchmarks.

Individual performance in the third peer group was measured against objectives determined by such officer and his or her supervisor that reflected what each executive officer must do in order for the Company to meet its short and long-term business objectives. The amount of the bonus awards generally determined for each executive officer was based on such officer’s business unit, and such executive officer’s contribution to achieving objectives, such as developing and implementing strategic plans and achieving financial objectives. Determinations regarding individual performance are made following the end of the year by the Compensation Committee after discussion with executives and after receiving the recommendations of our chief executive officers.

In April 2006, the Compensation Committee also determined that bonus payments would be made at the end of 2006 rather then quarterly. Subsequently, the 2006 executive bonus plan was discontinued effective as of the fourth quarter of 2006.

Merit Bonuses. In August 2006, the Compensation Committee approved awarding discretionary merit bonuses to Messrs. Santi and Moretti for their performance in the first two quarters of 2006. These merit bonuses were made outside of the 2006 executive bonus plan and intended to supplement the plan. Because Messrs. Santi and Moretti were part of the second peer group of the 2006 executive bonus plan, they were only eligible for bonuses under the plan if the Company achieved profitability. However, the Company’s financial prospects had not improved and it was apparent that Messrs. Santi and Moretti might not earn any such bonuses in 2006. Additionally, Mr. Gotschall, the third member of the second peer group, was entitled to a mandatory bonus equal to 200% of his base salary. Under the circumstances, the Compensation Committee determined that the merit bonuses were necessary to provide motivation for Messrs. Santi and Moretti and to retain their services. In January 2007, the Compensation Committee awarded Messrs. Santi and Moretti discretionary merit bonuses to reward them for their services in the last two quarters of 2006. In addition Ms. Darling was awarded a discretionary merit bonus to reward her for her service in the last quarter of 2006.

Retention and Transaction Bonuses. On October 10, 2006, we announced that we had entered into an agreement to sell certain operating assets used in our wholesale mortgage banking operation to Bear Stearns Residential Mortgage Corporation. Concurrently, we entered into retention bonus agreements with certain employees and executive officers, providing that each such employee or officer would receive a bonus if he or she remained employed by the Company at a date listed in his or her agreement. Additionally, two named executives were also entitled to a transaction bonus in the event the Company consummated a qualifying transaction prior to March 31, 2007. The retention bonuses were considered necessary incentives to encourage the executive officers and key employees to remain employees of the Company in the face of the impending asset sale transaction. The transaction bonuses were intended to compensate employees for their efforts in consummating a qualifying transaction. For more information regarding the retention and transaction bonuses, see “Retention Agreements” below.

Stock-Based Incentives. The Company’s stock-based incentive program consists of two components: stock options and restricted stock. Each stock option grant and restricted stock award (referred to collectively as “equity participation awards”) is designed to align the interests of the executive officer with those of the stockholders and provide each individual with a significant incentive to manage the Company from the perspective of an owner with an equity stake in the business. While stock options provide an excellent incentive to promote stock price appreciation, restricted shares provide a long-term incentive to preserve stockholder value and achieve other long-term, financial performance goals. Equity participation awards are granted by the Compensation Committee to the Company’s executive officers. Equity participation awards are also often granted as an inducement upon initial hiring.

Each stock option grant allows the officer to acquire shares of the Company’s Common Stock at a fixed price per share (the fair market value on the grant date) over a specified period of time (up to ten years). Generally, options become exercisable in installments equal to 20% of the option shares on the first anniversary of grant date and for the balance of the option shares in 20% equal annual installments thereafter. Accordingly, the options will provide a return to the executive officer only if he remains employed by the Company during the vesting periods, and then only if the market price of the shares appreciates over the option term. During the 2006 fiscal year, the Company granted 490,000 stock options as part of a retention program to retain key employees following its April 2006 reduction in workforce, including 15,000 stock options to a named executive officer, Ms. Darling.

A restricted stock award allows the officer to acquire shares of the Company’s Common Stock over time without payment of an exercise price. Most of the restricted stock awards granted during 2005 were to vest in 33-1/3% annual installments, becoming fully vested three years after the date of grant. The restricted stock certificates are held in escrow and released only when the vesting period lapses. Additionally, upon termination of employment or service during an applicable vesting period, the restricted stock that is not yet vested would be forfeited. No restricted stock awards were granted to named executive officers in fiscal 2006.

The size of the equity participation award to executive officers is set by the Compensation Committee at a level that is intended to create a meaningful opportunity for stock ownership based upon the individual’s current position with the Company, the individual’s personal performance in recent periods, and his or her potential for future responsibility and promotion over the term of the award. The Compensation Committee also takes into account the number and value of unvested equity participation awards held by the executive officers and considers the potential impact that a grant can have on an executive’s motivation and future performance with the desire to maintain an appropriate level of equity incentive for that individual. The relevant weight given to each of these factors varies from individual to individual. Due to significant ownership in the Company and having interests that are closely aligned with the Company’s stockholders, Messrs. Asghar and Holder recommended to the Compensation Committee, and the Compensation Committee agreed, to utilize the available number of equity participation awards for other executive officers and employees and to refrain from recommending any equity participation award grants to Messrs. Asghar and Holder.

Chief Executive Officer Base Salaries. Consistent with the Company’s overall executive compensation program, the 2006 compensation of the Co-Chief Executive Officers, Messrs. Asghar and Holder, consisted of base salary and bonuses determined on the basis of each individual’s responsibilities, qualifications and experience, as well as the salary practices of peer group and other companies with which the Company competes for executive talent.

Mr. Asghar and Mr. Holder’s annual base salaries were set at $450,000 in connection with the Company’s initial public offering and were based on market conditions, anticipated additional responsibilities and growth of the Company. However, at the request of Messrs. Asghar and Holder, their annual base salaries were reduced to $225,000 for 2006. Effective April 1, 2006, Messrs. Asghar and Holder volunteered to work without salary or bonus for the next twelve months.

Internal Revenue Code Section 162(m). Section 162(m) of the Code disallows a tax deduction to publicly held companies for compensation paid to certain of their executive officers, to the extent that compensation exceeds $1 million per covered officer in any year. The limitation applies only to compensation that is not considered to be performance-based. It is the Compensation Committee’s policy to maximize, to the extent reasonably possible, the Company’s ability to obtain a corporate tax deduction for compensation paid to the Company’s executive officers to the extent consistent with the Company’s best interests and those of its stockholders.

Employment Agreements

The Board and the Committee generally believe that employment agreements are necessary to attract and retain a management team committed to the Company’s success. All of the named executives for fiscal 2006 had

written employment agreements with the Company that included severance and other provisions that protected the executive in case of his termination by the Company without cause or his resignation for good reason, including after a change in control of the Company, or due to termination resulting from his death or disability. We believe in providing reasonable severance benefits to employees. With respect to our named executives, these severance benefits reflect the fact that it may be difficult for the executive to find comparable employment within a short period of time. We believe that change in control provisions are critical because they allow management to remain focused on our stockholders’ best interests in the event a potential change in control situation.

See “Employment Agreements” after the Grants of Plan-Based Awards table and “Potential Payments upon Termination of Employment or Change in Control” for additional information regarding the employment agreements and benefits upon termination of employment.

Impact of Accounting and Tax Treatments

Section 162(m) of the Internal Revenue Code limits our ability to deduct annual compensation in excess of $1 million paid to any of the named executives. This limitation generally does not apply to compensation based on performance goals if certain requirements are met. It is the Committee’s position that in administering the “performance-based” portion of our executive compensation program, it will attempt to satisfy the requirements for deductibility under Section 162(m). However, the Committee believes that it needs to retain the flexibility to exercise its judgment in assessing an executive’s performance and that the total compensation system for executives should be managed in accordance with the objectives outlined in this discussion and in the overall best interests of our stockholders. Should the requirements for deductibility under Section 162(m) conflict with our executive compensation philosophy and objectives or with what the Committee believes to be in the best interests of the stockholders, the Committee may authorize compensation which is not fully deductible for any given year.

On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123(R) (“SFAS 123(R)”), Share-Based Payment, and began recognizing stock option-based compensation expense in the consolidated statements of operations using the fair value based method applied on a modified prospective basis. Under this transition method, the Company has applied the provisions of SFAS 123(R) to awards granted after January 1, 2006. Additionally, the Company has eliminated its deferred compensation balance against additional paid in capital and will recognize compensation cost over the remaining service period for the portion of awards for which the requisite service period had not been rendered and remains outstanding as of January 1, 2006. The compensation cost for these awards is based on the grant date fair value.

Perquisites

We provide or pay for various perquisites for the named executives. These perquisites can include car allowances and gross up payments equal to the taxes payable on certain perquisites.

Generally, we believe the perquisites we provide to our named executives are minimal and in the best interests of our stockholders.

COMPENSATION COMMITTEE REPORT

The Compensation Committee of the Company has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Company’s Board that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

From the members of the Compensation Committee

James R. Brazil, Chairman, William Jacoby,

James Rollans

Summary Compensation Table

The following table sets forth summary information concerning the compensation awarded, paid to, or earned for all services rendered in all capacities to us for the year ended December 31, 2006 by our chairman of the board and chief executive officer, former co-chief executive officer, president and chief financial officer and one current and two former most highly compensated executive officers for 2006:


Name and Principal Position	Year	Salary(1)		Bonus(2)		Stock Awards(3)		Option Awards(4)		Non- Equity Incentive Plan Compensation	Change in Pension Value and Nonqualified Deferred Compensation Earnings(5)	All Other Compensation(6)		Total
Steven G. Holder Chairman of the Board and Chief Executive Officer	2006	$	56,250		—		—		—	—	—	$	20,656	$	76,906
Shabi S. Asghar Former President, Co-Chief Executive Officer and Director(7)	2006	$	56,250		—		—		—	—	—	$	15,548	$	71,798
Troy A. Gotschall Former Executive Vice President and Chief Production Officer(8)	2006	$	250,000	$	1,000,000	$	624,998		—	—	—	$	41,910	$	1,916,908
Larry E. Moretti Executive Vice President and Chief Administrative Officer	2006	$	214,583	$	293,125	$	221,666		—	—	—	$	38,250	$	767,624
Roque A. Santi President and Chief Financial Officer	2006	$	214,583	$	364,583	$	333,333		—	—	—	$	50,808	$	963,307
Alanna Darling Former General Counsel and Secretary(9)	2006	$	200,000	$	75,000	$	52,038	$	490	—	—	$	4,370	$	331,943

(1)	Messrs. Holder and Asghar agreed to work without salary and bonus for a one year period, effective April 1, 2006, and Messrs. Santi and Moretti agreed to a 20% reduction in base salary, from $250,000 to $200,000, effective April 15, 2006.

(2)

The amounts shown are the amounts of bonuses earned for services during fiscal 2006 as granted during fiscal 2006 or early fiscal 2007. Such bonuses include discretionary bonuses and bonuses paid pursuant to the terms of employment agreements and retention agreements. For more information regarding these bonuses, see the “Compensation Discussion and Analysis” and

“Employment Agreements.” Bonuses awarded in February 2006 that were earned for services during fiscal 2005 are not included in the amounts shown. The table below shows the bonuses provided to each named executive for fiscal 2006:


Named Executive Officer	Discretionary Merit Bonus		Retention Bonus pursuant to Retention Agreement		Mandatory Bonuses pursuant to Employment Agreement		Bonus under 2006 Executive Bonus Plan
Mr. Holder		—		—		—		—
Mr. Asghar		—		—		—		—
Mr. Gotschall		—		—	$	1,000,000		—
Mr. Moretti	$	193,125	$	100,000		—		—
Mr. Santi	$	214,583	$	150,000		—		—
Ms. Darling	$	18,750		—		—	$	56,250

(3)

The amounts shown are the amounts of compensation cost recognized by us in fiscal 2006 related to the grants of restricted stock in fiscal 2006 and prior fiscal years, as described in SFAS 123(R). For a discussion of valuation assumptions, see Note C to our 2006 Consolidated Financial Statements included in this annual report on Form 10-K. The table below shows how much of the overall amount of the compensation cost is attributable to each award.


Named Executive Officer	Grant Date	Number of Shares of Restricted Stock	2006 Fiscal Year Compensation Cost
Mr. Holder	—	—		—
Mr. Asghar	—	—		—
Mr. Gotschall	July 1, 2005	111,940	$	624,998
Mr. Moretti	March 14, 2005	100,000	$	221,666
Mr. Santi	February 18,2005 June 21, 2005	125,000 25,000	$ $	281,250 52,083
Ms. Darling	June 21, 2005	25,000	$	52,083

The restricted shares of our common stock shown in the above table were issued under our 2004 Incentive Award Plan and vest in equal one-third installments over a three year period on each anniversary of the grant date, subject to continued service with us. The holders of our restricted stock are entitled to vote and receive dividends, if issued, on the shares of common stock covered by the restricted stock grant. See discussion of our 2004 Incentive Award Plan in Note I, on page F-23, of our 2006 Consolidated Financial Statements included in this annual report on Form 10-K.

(4)

The amounts shown are the amounts of compensation cost recognized by us in fiscal 2006 related to the stock option grants in fiscal 2006 and prior fiscal years, as described in SFAS 123(R). For a discussion of valuation assumptions, see Note C to our 2006 Consolidated Financial Statements included in this annual report on Form 10-K.

(5)	There was no aggregate change in the actuarial present value of any of our named executive’s accumulated benefit under our non-qualified defined contribution plan during fiscal 2006, nor did any named executive receive above-market or preferential earnings on deferred compensation under the plan.

(6)	The amounts shown include our incremental cost for the provision to the named executive officers of certain specified perquisites, and dividends, as follows:


Named Executive Officer	Automobile Allowance		Automobile Lease Payments		Life Insurance Premiums		Gift Certificate		Dividend Declared in 2007 for 2006 on Restricted Stock
Mr. Holder	$	6,000		—	$	14,656		—		—
Mr. Asghar	$	6,000		—	$	9,548		—		—
Mr. Gotschall	$	24,000		—		—		—	$	17,910
Mr. Moretti	$	22,250		—		—		—	$	16,000
Mr. Santi	$	21,000	$	5,808		—		—	$	24,000
Ms. Darling		—		—		—	$	370	$	4,000

No severance payments were made to any named executive officers in 2006.

(7)	Mr. Asghar resigned as our President, Co-Chief Executive Officer and Director effective as of February 9, 2007, commensurate with the close of the Bear Stearns Residential Mortgage Corporation transaction.

(8)

Mr. Gotschall resigned as our Executive Vice President and Chief Production Officer effective as of January 15, 2007. On January 17, 2007, we entered into a Separation and General Release Agreement with Mr. Gotschall in connection with Mr. Gotschall’s resignation, pursuant to which Mr. Gotschall will be entitled to receive a one-time payment of $810,000, less applicable withholding taxes. In addition, all of Mr. Gotschall’s outstanding vested shares of restricted stock immediately vest effective as of January 15, 2007.

(9)	Ms. Darling resigned as our General Counsel and Secretary effective as of February 9, 2007, commensurate with the close of the Bear Stearns Residential Mortgage Corporation transaction.

Grants of Plan-Based Awards

The following table sets forth summary information regarding all grants of plan-based awards made to our named executive officers for the year ended December 31, 2006:


	Grant Date		Estimated Future Payouts Under Non-Equity Incentive Plan Awards			All Other Stock Awards: Number of Shares of Stock or Units	All Other Option Awards: Number of Securities Under- lying Options	Exercise or Base Price of Option Awards ($/Sh)		Grant Date Fair Value of Stock and Option Awards(3)
Name	Grant Date		Threshold	Target	Maximum		—	—
Steven G. Holder			$	$	$		—		—
Shabi S. Asghar			—	—	—		—		—
Troy A. Gotschall			—	—	—		—		—
Larry E. Moretti			—	—	—		—		—
Roque A. Santi	10/6/2006	(1)	250,000	250,000	250,000		—		—
Alanna Darling	5/9/2006 10/6/2007	(2) (1)	100,000	100,000	100,000		15,000	$	1.50	$	3,738

(1)

Mr. Santi and Ms. Darling entered into Retention Agreements providing for transaction bonuses in the respective amounts of $250,000 and $100,000 to be paid to them in the event the Company consummated a qualifying transaction prior to March 31, 2007. On February 9, 2007, we consummated the sale of our mortgage banking business to Bear Stearns Residential Mortgage Corporation and subsequently paid Mr. Santi and Ms. Darling the transaction bonuses. Please also see “Retention Agreements” below for more details regarding the transaction bonuses.

(2)

Ms. Darling was granted stock options for the purchase of 15,000 of our common stock as part of a retention program to retain key employees following the Company’s April 2006 reduction in workforce. The stock options granted to Ms Darling were issued under our 2004 Incentive Award Plan and were scheduled to vest in five equal installments of 20% per year. On February 9, 2007 and prior to any vesting or exercise of any of the stock options, Ms. Darling discontinued serving as a Company employee, terminating further rights to the stock options as of February 9, 2007.

(3)

The amount shown represents the fair value of the awards on the date of grant, as computed in accordance with SFAS 123(R). For information regarding significant factors, assumptions and methodologies used in our computations pursuant to SFAS 123(R), see Note C to our 2006 Consolidated Financial Statements included in this annual report on Form 10-K.

Retention Agreements

On October 10, 2006, we announced that we had entered into an agreement to sell certain operating assets used in our wholesale mortgage banking operation to Bear Stearns Residential Mortgage Corporation.

Concurrently, we entered into retention bonus agreements with certain employees and executive officers. These retention bonus agreements provided that the employee would receive a bonus if he or she remained employed by the Company, a successor in interest to the Company or the Company’s subsidiaries’ business at a date listed in his or her agreement. The retention bonuses were deemed to be necessary incentives in the face of the impending asset sale transaction. Pursuant to the terms of their Retention Agreements, Ms. Darling, Messrs. Moretti and Santi were entitled to receive retention bonuses of $50,000, $100,000 and $150,000, respectively, if each individual remained employed by the Company, a successor in interest to the Company or the Company’s subsidiaries’ business through the date set forth in his or her respective Retention Agreements. For Mr. Moretti and Mr. Santi, the applicable date was December 29, 2006 and each of these individuals earned and has been paid his retention bonus. For Ms. Darling, the applicable date is June 30, 2007, which retention bonus was assumed and will be paid, if applicable, by Bear Stearns Residential Mortgage Corporation.

Additionally, the Company was exploring alternatives to maximize shareholder value and, as a result, some employees were entitled to a transaction bonus in the event the Company consummated a qualifying transaction prior to March 31, 2007. The transaction bonuses were intended to compensate employees for their efforts in consummating a qualifying transaction. The Retention Agreements we entered into with Mr. Santi and Ms. Darling provided for them to receive transaction bonuses in the respective amounts of $250,000 and $100,000 to be paid to them in the event the Company entered into a qualifying transaction prior to March 31, 2007. On February 9, 2007, we consummated the sale of our mortgage banking business to Bear Stearns Residential Mortgage Corporation and subsequently paid Mr. Santi and Ms. Darling the transaction bonuses.

Employment Agreements

The following is a description of the material terms of the compensation provided to our named executive officers pursuant to employment agreements between us and each executive. See “Potential Payments Upon Termination or Change in Control” for a description of the payments and benefits that would be provided to our named executive officers in connection with a termination of their employment or a change in control of us.

Steven G. Holder. We entered into an employment agreement with Mr. Holder effective February 15, 2005, which provided that Mr. Holder with a minimum annual base salary of $450,000, an annual discretionary bonus and an automobile allowance in an amount not to exceed $2,000 per month during the term of Mr. Holder’s employment with us. At the request of Mr. Holder, his base salary was reduced to $225,000. Effective April 1, 2006, Mr. Holder has volunteered to work without salary or bonus for the next 12 months. Mr. Holder is entitled to participate in all pensions, 401(k) and other employee plans and benefits in accordance with the terms of such plans or policies as may be in effect from time to time. In the event it is determined that any payment under the employment agreement is subject to Excise Tax, then Mr. Holder is entitled to receive a gross-up payment in an amount equal to the Excise Tax imposed upon such payments, but not any Excise Tax resulting from the receipt of any gross-up payment. In the event of a Change in Control (as defined below), all unvested stock options held by Mr. Holder will become fully vested and exercisable and all restricted stock held by Mr. Holder will become fully vested. This employment agreement may be terminated due to Mr. Holder’s death, disability, by us with or without cause, or by Mr. Holder without or for good reason.

Shabi S. Asghar. We entered into an employment agreement with Mr. Asghar effective February 15, 2005, which provided Mr. Asghar with a minimum annual base salary of $450,000, an annual discretionary bonus and an automobile allowance in an amount not to exceed $2,000 per month during the term of Mr. Asghar’s employment with us. At the request of Mr. Asghar, his base salary was reduced to $225,000, and effective April 1, 2006, Mr. Asghar volunteered to work without salary or bonus for the next 12 months. On October 10, 2006, we entered into an amendment to the employment agreement with Mr. Asghar which provided that he will not receive a base salary, a bonus or an automobile allowance from April 1, 2006 through March 31, 2007. However, for purposes of determining the severance payment, the calculation would be based on a base salary of $450,000. Mr. Asghar was entitled to participate in all pensions, 401(k) and other employee plans and benefits in accordance with the terms of such plans or policies as may be in effect from time to time. In the event it was

determined that any payment under the employment agreement was subject to Excise Tax, then Mr. Asghar is entitled to receive a gross-up payment in an amount equal to the Excise Tax imposed upon such payments, but not any Excise Tax resulting from the receipt of any gross-up payment. In the event of a Change in Control (as defined below), all unvested stock options held by Mr. Asghar would become fully vested and exercisable and all restricted stock held by Mr. Asghar would become fully vested. On February 9, 2007, Mr. Asghar resigned his positions with us, effective February 10, 2009.

Troy Gotschall. We entered into an employment agreement with Mr. Gotschall on July 1, 2005, which provided that Mr. Gotschall would be employed by us through July 1, 2008, unless earlier terminated as provided by the employment agreement. The agreement provided Mr. Gotschall with a minimum annual salary of $250,000; a one-time bonus of $1,000,000 payable in four equal installments; an annual bonus equal to 200% of Mr. Gotschall’s annual salary, and an automobile allowance in an amount not to exceed $2,000 per month during the term of Mr. Gotschall’s employment with us. We also agreed to recommend our Board of Directors to grant him an option to purchase 300,000 shares of our common stock at the fair market value on the date of the grant, vesting 33¹/3% annually and restricted stock in an amount equal to a fair market value of no greater than $750,000 on the date of the grant, vesting 33¹/3% annually. Mr. Gotschall was entitled to participate in all pension, incentive compensation, deferred compensation, 401(k) and other employee plans and benefits in accordance with the terms of such plans or policies as may be in effect from time to time and we agreed to pay for Mr. Gotschall’s COBRA cost not exceeding $500 per month until Mr. Gotschall became eligible for our Company plan. In the event it was determined that any payment under the employment agreement was subject to Excise Tax, then Mr. Gotschall was entitled to receive a gross-up payment in an amount equal to the Excise Tax imposed upon such payments, but not any Excise Tax resulting from the receipt of any gross-up payment. In the event of a Change in Control (as defined below), all unvested stock options held by Mr. Gotschall would become fully vested and exercisable and all restricted stock held by Mr. Gotschall would become fully vested. Mr. Gotschall resigned as our Executive Vice President and Chief Production Officer and the President and Chief Executive Officer of Encore Credit Corp. effective January 15, 2007.

Larry Moretti. We entered into an employment agreement with Mr. Moretti on October 10, 2006, which provides Mr. Moretti with a minimum annual base salary of $200,000, an annual discretionary bonus and an automobile allowance in an amount not to exceed $2,000 per month during the term of Mr. Moretti’s employment with us. Mr. Moretti is entitled to participate in all pensions, 401(k) and other employee plans and benefits in accordance with the terms of such plans or policies as may be in effect from time to time. In the event it is determined that any payment under the employment agreement is subject to Excise Tax, then Mr. Moretti is entitled to receive a gross-up payment in an amount equal to the Excise Tax imposed upon such payments, but not any Excise Tax resulting from the receipt of any gross-up payment. In the event of a Change in Control (as defined below), all unvested stock options held by Mr. Moretti will become fully vested and exercisable and all restricted stock held by Mr. Moretti will become fully vested. This employment agreement may be terminated due to Mr. Moretti’s death, disability, by us with or without cause, or by Mr. Moretti without or for good reason. The terms of Mr. Moretti’s employment with us prior to October 10, 2006 were substantially on the same terms as described herein.

On October 10, 2006, we also entered into a retention agreement which provided Mr. Moretti with a retention bonus of $100,000 if he remained employed by the Company, an affiliate of the Company or a successor in interest to the Company’s business through December 31, 2006. Mr. Moretti would not have been entitled to the retention bonus if he terminated his employment for any reason, refused to accept employment offered by the Company’s successor in interest, or was terminated by the Company for “cause” (as defined in the retention agreement) prior to December 31, 2006.

Roque A. Santi. We entered into an employment agreement with Mr. Santi effective February 15, 2005, which provided that Mr. Roque with a minimum annual base salary of $250,000, an annual discretionary bonus and an automobile allowance in an amount not to exceed $2,000 per month during the term of Mr. Santi’s employment with us.

On October 10, 2006, we entered into an amendment to the employment agreement with Mr. Santi which provided Mr. Santi with a minimum $200,000 base salary. We also entered into a retention agreement which provided Mr. Santi with a retention bonus of $150,000 if he remained employed by the Company, an affiliate of the Company or a successor in interest to the Company’s business through December 31, 2006. Under the agreement, Mr. Santi would not have be entitled to the retention bonus if he terminated his employment for any reason, refused to accept employment offered by the Company’s successor in interest, or was terminated by the Company for “cause” (as defined in the retention agreement). Additionally, Mr. Santi was entitled to receive a transaction bonus in the amount of $250,000 in the event that the Company consummated a qualifying transaction on or before March 31, 2007. Following the sale of certain operating assets used in our wholesale mortgage banking operation to Bear Stearns Residential Mortgage Corporation in February 2007, Mr. Santi received the $250,000 transaction bonus.

On February 9, 2007, we entered into an amended and restated employment agreement with Mr. Santi, which provides that Mr. Santi will be employed by us through February 9, 2009, subject to earlier termination as provided in the agreement. The term of this amended and restated employment agreement is automatically extended for an additional two-year period if the Board of Directors does not notify Mr. Santi that it does not wish to extend the term of this agreement on or before August 11, 2008. Under this agreement, Mr. Santi is entitled to receive a base salary of $375,000; an annual bonus of $375,000 payable in four, quarterly installments; subject to the satisfaction of certain objectives determined by our Board of Directors, a target bonus of up to $375,000; a retention bonus of $250,000 payable on August 11, 2008, if Mr. Santi remains employed by us through August 9, 2008; and automobile allowance in an amount not to exceed $2,000 a month. Mr. Santi is entitled to participate in all pensions, 401(k) and other employee plans and benefits in accordance with the terms of such plans or policies as may be in effect from time to time. In the event it is determined that any payment under the employment agreement is subject to Excise Tax, then Mr. Santi is entitled to receive a gross-up payment in an amount equal to the Excise Tax imposed upon such payments, but not any Excise Tax resulting from the receipt of any gross-up payment. In the event of a Change in Control (as defined below), all unvested stock options held by Mr. Santi will become fully vested and exercisable and all restricted stock held by Mr. Santi will become fully vested. This employment agreement may be terminated due to Mr. Santi’s death, disability, by us with or without cause, or by Mr. Santi without or for good reason.

Alanna Darling. We entered into an employment agreement with Ms. Darling on October 10, 2006 which provided Ms. Darling with a minimum annual base salary of $200,000 and an annual discretionary bonus. Ms. Darling was entitled to participate in all pensions, 401(k) and other employee plans and benefits in accordance with the terms of such plans or policies as may be in effect from time to time. In the event it was determined that any payment under the employment agreement was subject to Excise Tax, then Ms. Darling was entitled to receive a gross-up payment in an amount equal to the Excise Tax imposed upon such payments, but not any Excise Tax resulting from the receipt of any gross-up payment. In the event of a Change in Control (as defined below), all unvested stock options held by Ms. Darling would have become fully vested and exercisable and all restricted stock held by Ms. Darling would become fully vested. The terms of Ms. Darling’s employment with us prior to October 10, 2006 were substantially on the same terms as described herein.

On October 10, 2006, we also entered into a retention agreement with Ms. Darling which provided her with a retention bonus of $50,000 if she remained employed by the Company, an affiliate of the Company or a successor in interest to the Company’s business through April 1, 2007. Ms. Darling would not be entitled to the retention bonus if she terminated her employment for any reason, refused to accept employment offered by the Company’s successor in interest, or was terminated by the Company for “cause” (as defined in the retention agreement). Additionally, Ms. Darling was entitled to receive a transaction bonus in the amount of $100,000 in the event that the Company consummated a qualifying transaction on or before March 31, 2007. Following the sale of certain operating assets used in our wholesale mortgage banking operation to Bear Stearns Residential Mortgage Corporation in February 2007, Ms. Darling received the $100,000 transaction bonus.

Ms. Darling resigned her positions as our general counsel and corporate secretary on February 9, 2007.

Outstanding Equity Awards at Fiscal Year End

The following table sets forth summary information regarding the outstanding equity awards held by our named executive officers at December 31, 2006:


	Option Awards						Stock Awards
Name	Date of Option Grants	Number of Securities Underlying Unexercised Options Exercisable(1)	Equity Incentive Plans Awards: Number of Securities Underlying Unexercised Unearned Options(2)	Option Exercise Price		Option Expiration Date	Number of Shares or Units of Stock That Have Not Vested	Market Value of Shares or Units of Stock That Have Not Vested	Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested(3)		Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested(4)
Steven G. Holder	—	—	—		—
Shabi S. Asghar	—	—	—		—
Troy A. Gotschall	7/1/2005	300,000		$	6.70	6/30/2015			74,627	(5)	$	88,806
Larry E. Moretti	3/11/2005	200,000		$	6.35	3/10/2015			66,666	(6)	$	79,333
Roque A. Santi	2/18/2005 6/21/2005	250,000 65,000		$ $	6.75 6.25	2/17/2015 6/20/2015			100,000	(7)	$	119,000
Alanna Darling	5/9/2006		15,000	$	1.50	5/08/2016			16,667	(8)	$	19,834

(1)	On December 30, 2005, the vesting of the unearned stock options held by Messrs. Asghar, Gotschall, Moretti and Santi was accelerated and they all became fully vested.

(2)

The unearned stock options held by Ms Darling were scheduled to vest in five equal installments of 20% per year, with the first such vesting event occurring on May 9, 2007. In February 2007 and prior to any vesting or exercise of such stock options, Ms. Darling discontinued serving as a Company employee, terminating further rights to the stock options as of February 9, 2007.

(3)	Represents awards of restricted stock made under our 2004 Incentive Award Plan.

(4)	Represents the closing price of a share of our common stock on December 29, 2006, $1.19, multiplied by the number of shares or units that have not vested.

(5)	On January 17, 2007, Encore Credit Corp., our wholly owned subsidiary, entered into a Separation and General Release Agreement with Mr. Gotschall which provided that his outstanding unvested shares of restricted stock became immediately fully vested as of January 15, 2007.

(6)	One half of Mr. Moretti’s unvested restricted shares vested on March 7, 2007 with the remaining half scheduled to vest on March 7, 2008 should Mr. Moretti continue to be employed by the Company on such date.

(7)	41,667 of Mr. Santi’s unvested restricted shares vested on February 18, 2007 and the remainder are scheduled to vest as follows provided Mr. Santi remains employed by the Company on such dates: 8,333 shares on June 21, 2007, 41,666 shares on February 18, 2008, and 8,334 shares on June 21, 2008.

(8)	On February 9, 2007, Ms. Darling’s unvested restricted shares became immediately fully vested commensurate with the close of the Bear Stearns Residential Mortgage Corporation transaction.

Option Exercises and Stock Vested

The following table summarizes the option exercises and vesting of stock awards for each of our named executive officers for the year ended December 31, 2006:


	Option Awards			Stock Awards
Name	Number of Securities Acquired on Exercise	Value Realized on Exercise(1)		Number of Shares Acquired on Vesting	Value Realized on Vesting(2)
Steven G. Holder	637,308	$	31,865	0		0
Shabi S. Asghar	0		0	0		0
Troy A. Gotschall	0		0	37,313	$	45,895
Larry E. Moretti	0		0	33,334	$	41,668
Roque A. Santi	0		0	50,000	$	92,750
Alanna Darling	0		0	8,333	$	10,250

(1)	Represents the difference between the market price of a share of common stock on the date of exercise, less the exercise price per share so exercised.

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ItemTable 14.of Principal Accountant Fees and ServicesContents

Filing Compare · ECC Capital CORP