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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2003

OR

For the transition period from ________________________ to _______________________

Commission file number 000-22633

NEW CENTURY FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

18400 VON KARMAN, SUITE 1000, IRVINE, CALIFORNIA     92612

(Address of principal executive offices)                                                          (Zip code)

Registrant’s telephone number, including area code:             (949) 440-7030            

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check ü 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 twelve 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  þ         NO  ¨

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

YES  þ         NO  ¨

As of April 30, 2003, the registrant had 23,905,672 shares of common stock outstanding.

NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

FORM 10-Q

QUARTER ENDED MARCH 31, 2003

INDEX

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Certain information included in this Form 10-Q may include “forward-looking” statements under federal securities laws, and we intend that such forward-looking statements be subject to the safe-harbor created thereby. Such statements include, without limitation, (i) our beliefs regarding our critical accounting policies, (ii) the assumptions underlying our hedging strategy, (iii) our plan to mitigate interest rate risk in our residual assets, (iv) our plan to continue to fund repurchases pursuant to our stock repurchase program with available corporate liquidity, (v) our expectation that the number of shares to be purchased pursuant to our stock repurchase plan and the time of the purchases will be based upon the level of cash balances, general business conditions and other factors, including alternative investment opportunities, (vi) our plan to continue to concentrate on generating positive cash flow from operations, (vii) our plan to continue to maintain low loan acquisition costs, (viii) our plan to manage the number of loans that we must sell at a discount as a result of defects because they are rejected by loan buyers or because the borrower failed to make the first payment, (ix) our plan to reduce the size of the average loss on sale for those loans that are sold at a discount, (x) our plan to improve the gain on sale of loans sold at a premium, (xi) our plan to optimize net interest income by holding loans for a longer period of time prior to their sale or securitization, (xii) our plan to employ on-balance sheet securitizations to generate cash flows from net interest spread income, (xiii) our plan to seek a facility to finance servicing-related advance obligations, (xiv) our expectation that our liquidity, credit facilities and capital resources will be sufficient to fund our operations for the foreseeable future, (xv) our expectation that our servicing operations will continue to grow and to contribute an increasing amount to our revenues and earnings in future periods, and (xvi) our belief that any liability with respect to our legal proceedings arising out of the ordinary course of our business will not have a material adverse effect on our business, results of operation or financial position.

We caution that these statements are qualified by important factors that could cause our actual results to differ materially from expected results in the forward-looking statements. Such factors include, but are not limited to, (i) the condition of the U.S. economy and financial system, (ii) the condition of the markets for whole loans and mortgage-backed securities, (iii) the stability of residential property values, (iv) our ability to continue to maintain low loan acquisition costs, (v) the potential effect of new state or federal laws and regulations, (vi) the effect of increasing competition in our sector, (vii) our ability to maintain adequate credit facilities to finance our business, (viii) the interest rate environment, (ix) our ability to adequately hedge our residual values, (x) the ability of our servicing platform to maintain high performance standards, and (xi) the initiation of a margin call under any of our warehouse or aggregation facilities. Additional information on these and other factors is contained in our Annual Report on Form 10-K for the year ended December 31, 2002 and our other periodic filings with the Securities and Exchange Commission. We assume no obligation to update the forward-looking statements contained in this Form 10-Q.

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New Century Financial Corporation and Subsidiaries

Condensed Consolidated Balance Sheets

(Dollars in thousands, except share data)

(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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New Century Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Operations

(Dollars in thousands, except per share amounts)

(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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New Century Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

Three Months Ended March 31, 2003 and 2002

(In thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

March 31, 2003 and 2002

1.    Basis of Presentation

We have prepared the accompanying unaudited consolidated financial statements in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

Recent Accounting Developments

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45, which clarifies previously issued accounting guidance and disclosure requirements for guarantees, expands the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees, and requires the guarantor to recognize a liability for the fair value of an obligation assumed under a guarantee.

In general, FIN 45 applies to contracts or indemnification agreements that contingently require the guarantor to make payments to the guaranteed party based on specified changes in an underlying variable that is related to an asset, liability, or equity security of the guaranteed party. Guarantee contracts excluded from both the disclosure and recognition requirements of FIN 45 include, among others, guarantees relating to employee compensation, residual value guarantees under capital lease arrangements, commercial letters of credit, commitments to extend credit, subordinated interests in a special purpose entity, and guarantees of a company’s own future performance. Other guarantees subject to the disclosure requirements of FIN 45, but not to the recognition provisions, include, among others, a guarantee accounted for as a derivative instrument under SFAS No. 133, a parent’s guarantee of debt owed to a third party by its subsidiary or vice versa, and a guarantee which is based on performance but not price. We adopted the disclosure provisions of FIN 45 and have included all appropriate and necessary disclosures in our financial statements and footnotes. The adoption of FIN 45 did not have a material impact on our consolidated financial position, results of operations, or liquidity.

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In January 2003, the FASB issued Interpretation 46, “Consolidation of Variable Interest Entities an interpretation of ARB No. 51” (“FIN 46”), which requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. Prior to FIN 46, a company included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 also requires disclosures about variable interest entities that the company is not required to consolidate but in which it has a significant variable interest. The consolidated requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidated requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain disclosure requirements of FIN 46 apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. At present, our variable interest entities are special purpose entities, which are outside the scope of FIN 46.

Residual Interests in Securitizations

Residual interests in securitizations are recorded as a result of the sale of loans through securitizations and the sale of residual interests in securitizations through what are sometimes referred to as net interest margin securities, or NIMS.

We generally structure the loan securitizations as follows: First, we sell a portfolio of mortgage loans to a special purpose entity, or SPE, that we have established for the limited purpose of buying and reselling mortgage loans. The SPE then transfers the same mortgage loans to a Real Estate Mortgage Investment Conduit or Owners Trust (the “REMIC” or “Trust”), and the Trust in turn issues interest-bearing asset-backed securities (the “Certificates”) generally in an amount equal to the aggregate principal balance of the mortgage loans. The Certificates are typically sold at face value and without recourse except that we provide representations and warranties customary to the mortgage banking industry to the Trust. One or more investors purchase these Certificates for cash. The Trust uses the cash proceeds to pay us the cash portion of the purchase price for the mortgage loans. The Trust also issues a certificate to us representing a residual interest in the payments on the securitized loans. In addition, we may provide a credit enhancement for the benefit of the investors in the form of additional collateral

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(“Over-collateralization Account” or “OC Account”) held by the Trust. The servicing agreement requires that the OC Account be maintained at certain levels.

At the closing of each securitization structured as a sale, we remove from our consolidated balance sheet the mortgage loans held for sale and add to our consolidated balance sheet (i) the cash received, (ii) the estimated fair value of the interest in the mortgage loans retained from the securitizations (“Residuals”), which consist of (a) the OC Account and (b) the net interest receivable (“NIR”), and (iii) the estimated fair value of the servicing asset. The NIR represents the discounted estimated cash flows that we will receive in the future. The excess of the cash received and the assets retained over the carrying value of the loans sold, less transaction costs, equals the net gain on sale of mortgage loans recorded by us.

The NIMS are generally structured as follows: First, we sell or contribute the Residuals to a SPE that we have established for the limited purpose of receiving and selling asset-backed residual interests in securitization certificates. Next, the SPE transfers the Residuals to the Trust and the Trust, in turn, issues interest-bearing asset-backed securities (the “Bonds and Certificates”). We sell the Residuals without recourse except that we provide representations and warranties customary to the mortgage banking industry to the Trust. One or more investors purchase the Bonds and Certificates and the proceeds from the sale of the Bonds and Certificates, along with a residual interest certificate that is subordinate to the Bonds and Certificates, represents our consideration for the sale of the Residuals.

At closing of each NIMS transaction, we remove from our consolidated balance sheet the carrying value of the Residuals sold and add to our consolidated balance sheet (i) the cash received, and (ii) the estimated fair value of the portion of the Residuals retained, which consists of a NIR. The excess of the cash received and assets retained over the carrying value of the Residuals sold, less transaction costs, equals the net gain or loss on the sale of Residuals recorded by us.

We allocate our basis in the mortgage loans and Residuals between the portion of the mortgage loans and Residuals sold through the Certificates and the portion retained (the Residuals and servicing assets) based on the relative fair values of those portions on the date of sale. We may recognize gains or losses attributable to the changes in the fair value of the Residuals, which are recorded at estimated fair value and accounted for as “held-for-trading” securities. We are not aware of an active market for the purchase or sale of Residuals and, accordingly, we determine the estimated fair value of the Residuals by discounting the expected cash flows released from the OC Account (the cash out method) using a discount rate commensurate with the risks involved. We utilize a discount rate of 12.0% on the estimated cash flows released from the OC Account to value the Residuals through securitization transactions and 14.0% on the estimated cash flows released from the Trust to value Residuals through NIMS transactions.

We are entitled to the cash flows from the Residuals that represent collections on the mortgage loans in excess of the amounts required to pay the Certificates’ principal and interest, the servicing fees and certain other fees, such as trustee and custodial fees. At the end of each collection period, the aggregate cash collections from the mortgage loans are allocated first to the base servicing fees and certain other fees, such as trustee and custodial fees, for the period, then to the Certificate holders for interest at the pass-through

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rate on the Certificates plus principal as defined in the servicing agreements. If the amount of cash required for the above allocations exceeds the amount collected during the collection period, the shortfall is drawn from the OC Account. If the cash collected during the period exceeds the amount necessary for the above allocation, and there is no shortfall in the related OC Account, the excess is released to us. If the OC Account balance is not at the required credit enhancement level, the excess cash collected is retained in the OC Account until the specified level is achieved. We are restricted from using the cash and collateral in the OC Account. Pursuant to certain servicing agreements, we may use cash held in the OC Account to make accelerated principal paydowns on the Certificates to create additional excess collateral in the OC Account which is held by the Trusts on our behalf as the Residual holder. The specified credit enhancement levels are defined in the servicing agreements as the OC Account balance expressed generally as a percentage of the current collateral principal balance.

For NIMS transactions, we receive cash flows once the holders of the Bonds and Certificates created in the NIMS transaction are fully paid. The Annual Percentage Rate, or APR, on the mortgage loans is relatively high in comparison to the pass-through rate on the Certificates. Accordingly, the Residuals described above are a significant asset of New Century. In determining the value of the Residuals, we must estimate the future rates of prepayments, prepayment penalties that we will receive, delinquencies, defaults and default loss severity as they affect the amount and timing of the estimated cash flows. We estimate average cumulative losses as a percentage of the original principal balance of the mortgage loans of 1.44% to 3.94% for adjustable-rate securities and 2.16% to 4.75% for fixed-rate securities. These estimates are based on historical loss data for our loans, the specific characteristics of the loans, and the existence of mortgage insurance. While the range of estimated cumulative pool losses is fairly broad, the weighted average cumulative pool loss estimate for the entire portfolio of residual assets was 3.88% at March 31, 2003. We estimate prepayments by evaluating historical prepayment performance of our loans and the impact of current trends. We use a prepayment curve to estimate the prepayment characteristics of the mortgage loans. The rate of increase, duration, severity, and decrease of the curve depends on the age and nature of the mortgage loans, primarily whether the mortgage loans are fixed or adjustable and the interest rate adjustment characteristics of the mortgage loans (6-month, 1-year, 2-year, 3-year, or 5-year adjustment periods). Our prepayment curve and default estimates have resulted in weighted average lives of between 2.42 to 3.03 years for our adjustable-rate securities and 2.63 to 3.78 years for our fixed-rate securities.

Historically, we have performed an evaluation of our Residuals quarterly, which takes into consideration trends in actual cash flow performance, industry and economic developments, as well as other relevant factors.

Our Residuals performed as projected during the first quarter of 2003 and provided $32.0 million in cash flow. As of March 31, 2003, we updated the model to the current forward LIBOR curve, resulting in a $3.8 million increase in value. We also modeled certain securitizations to fail step-up triggers, thus delaying cash flows to us, resulting in a $2.2 million decrease in value. The net effect of these changes was a net write-up in value of $1.6 million.

The Bond and Certificate holders and their securitization trusts have no recourse to New Century for failure of mortgage loan borrowers to pay when due. Our Residuals are subordinate to the Bonds and Certificates until the Bond and Certificate holders are fully paid.

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On-Balance Sheet Securitization

We structured the current quarter securitization as a financing transaction, and accordingly hold the mortgage loans for investment on our balance sheet. The mortgage loans remain on our balance sheet and the securitization bond financing effectively finances the securitized mortgage loans. We record interest income on the mortgage loans and interest expense on the bond financing issued over the life of the loans instead of recognizing a one-time gain or loss upon completion of the securitization.

Stock-Based Compensation

We have elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations, in accounting for employee stock options rather than the alternative fair value accounting allowed by FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). APB 25 provides that compensation expense relative to our employee stock options is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. Under SFAS 123, the fair value of stock options at the date of grant is recognized in earnings over the vesting period of the options. In December 2002, FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”), which amends SFAS 123 to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results.

As of March 31, 2003 and 2002, there were stock options outstanding for the purchase of 3,456,661 and 2,618,061 shares, respectively, of our common stock. The fair value of the stock options granted during the quarters ended March 31, 2003 and 2002 was $10.27 and $5.98, respectively. The following table shows the pro forma net income as if the fair value method of SFAS No. 123 had been used to account for stock-based compensation expense (dollars in thousands, except per share amounts):

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2.    Loans Receivable Held for Sale

A summary of loans receivable held for sale, at the lower of cost or market at March 31, 2003 and December 31, 2002 follows (dollars in thousands):

3.    Securitized Mortgage Loans Held for Investment

During the first quarter of 2003, we sold loans through a securitization structured as an on-balance sheet securitization. The components of securitized mortgage loans held for investment at March 31, 2003 are as follows (dollars in thousands):

(a)    Interest Income

The following table presents the components of interest income for the three months ended March 31, 2003 and December 31, 2002 (dollars in thousands):

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4.    Residual Interests in Securitizations

Residual interests in securitizations consist of the following components at March 31, 2003 and December 31, 2002 (dollars in thousands):

The following table summarizes activity in the NIR accounts for the three months ended March 31, 2003 and 2002 (dollars in thousands):

The following table summarizes activity in the OC Accounts for the three months ended March 31, 2003 and 2002 (dollars in thousands):

Mortgage servicing assets represent the carrying value of our mortgage loan servicing rights. The following table summarizes activity in mortgage servicing assets for the three months ended March 31, 2003 and 2002 (dollars in thousands):

We record mortgage servicing assets when we sell loans on a servicing retained basis in connection with our plan to grow our servicing portfolio, and when we sell loans through whole loan sales to an investor in the current period and sell the servicing rights to a third party in a subsequent period.

Additions of $7.8 million and $4.6 million during the first quarters of 2003 and 2002, respectively, represent the value of servicing rights held temporarily for loans sold in those periods, pending the sale of those servicing rights to third parties in subsequent periods. We did not sell loans on a servicing-retained basis in the first quarter of 2003 or 2002, other than the securitization structured as a financing in 2003.

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In accordance with generally accepted accounting principles, we do not record mortgage servicing assets for loans sold through securitizations that are structured as financings.

6.    Goodwill

Goodwill is recorded in connection with the acquisition of new subsidiaries and is included in prepaid expenses and other assets. As of March 31, 2003, we had goodwill of $13.7 million. No impairment existed at March 31, 2003 or March 31, 2002.

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7.    Warehouse and Aggregation Lines of Credit

Warehouse and aggregation lines of credit consist of the following at March 31, 2003 and December 31, 2002 (dollars in thousands):

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The warehouse and aggregation line of credit agreements contain certain restrictive financial and other covenants, which require us to, among other things, restrict dividends, maintain certain net worth and liquidity levels, remain below specified debt-to-net-worth ratios and comply with regulatory and investor requirements. At March 31, 2003, we were in compliance with all material financial and other covenants in our warehouse and aggregation facilities.

8.    Financing on Securitized Mortgage Loans

On January 24, 2003, New Century Home Equity Loan Trust, Series 2003-1 (the “Trust”) issued $483.7 million of Asset-Backed Pass-Through Certificates (the “Certificates”) secured by a pool of one- to four-family residential first lien mortgage loans (the “Mortgage Loans”) in a public offering. The Mortgage Loans were sold by NC Capital Corporation to New Century Mortgage Securities, Inc., a special purpose entity (the “Depositor”), pursuant to a Mortgage Loan Purchase Agreement, dated January 23, 2003, and the Depositor sold the Mortgage Loans to the Trust pursuant to a Pooling and Servicing Agreement, dated as of January 1, 2003, among the Depositor, New Century Mortgage Corporation, as master servicer, and Deutsche Bank National Trust Company, as trustee. The Certificates issued pursuant to the Pooling and Servicing Agreement were issued by the Depositor to Salomon Smith Barney Inc. pursuant to an Underwriting Agreement, dated January 23, 2003, and the cash consideration from the sale of the Certificates was remitted to NC Capital Corporation in exchange for the Mortgage Loans. Each class of Certificates accrues interest at a pass-through rate equal to one-month LIBOR plus an applicable margin.

The Mortgage Loans are legally owned by the Trust and are not available to the creditors of the Depositor or its affiliates. As such, the Bond and Certificate holders and their securitization trust have no recourse to New Century for the failure of mortgage loan borrowers to pay when due. Our remaining interests in the assets in the Trust are subordinate to the Bonds and the Certificates until the Bond and Certificate holders are fully paid.

9.    Earnings per Share

The following table illustrates the computation of basic and diluted earnings per share for the periods indicated (dollars in thousands, except per share amounts):

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For the three months ended March 31, 2003, 27,500 stock options are excluded from the calculation of diluted earnings per share because their effect is anti-dilutive. For the three months ended March 31, 2002, 24,300 stock options were excluded from the calculation of diluted earnings per share because their effect is anti-dilutive.

10.    Segment Reporting

We provide, through our origination divisions, a broad range of mortgage products. Our management measures the revenue streams of each of our lending divisions separately. Further, we have a servicing division with operations distinct from our lending operations. The table below provides revenue and expense data by business segment.

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

General

We are a leading nationwide specialty mortgage banking company that, through our subsidiaries, originates, purchases, sells and services residential mortgage loans secured primarily by first mortgages on single-family residences. Our borrowers generally have considerable equity in the property securing the loan, but have impaired or limited credit profiles or higher debt-to-income ratios than traditional mortgage lenders allow. Our borrowers also include individuals who, due to self-employment or other circumstances, have difficulty verifying their income through conventional methods, and who prefer the prompt and personalized service we provide.

We originate and purchase loans through our wholesale and retail divisions. Wholesale loans are either originated through or purchased from independent mortgage brokers by the Wholesale Division of our subsidiary, New Century Mortgage Corporation. We do not purchase bulk pools of loans from third parties, although we do purchase closed loans on a flow basis from our correspondent lenders. Retail originations are made through New Century Mortgage Corporation’s three regional processing centers, our network of branch offices and central retail telemarketing unit and through the strategic alliances of one of our subsidiaries, The Anyloan Company, with third parties who broker their non-prime production through us. After originating or purchasing loans, we then sell those loans through whole loan sales or securitizations. We structure such securitizations as on-balance sheet transactions or as sales, depending on market conditions and other factors. We were incorporated in Delaware in November 1995 and commenced lending operations in February 1996.

Loan Originations and Purchases

As of March 31, 2003, our Wholesale Division operated through 14 regional operating centers and 19 additional sales offices. Our Wholesale Division originated or purchased $4.1 billion in loans during the three months ended March 31, 2003. As of March 31, 2003, our Retail Division operated through three regional processing centers and 66 sales offices, including our centralized telemarketing unit. The Anyloan Company operated through two centralized regional processing centers. The Retail Division and the Anyloan Company originated or purchased $610.8 million in loans during the three months ended March 31, 2003.

Loan Sales and Securitizations

One of our primary sources of revenue is the recognition of gain on sale of our loans through whole loan sales and securitizations. In a whole loan sale, we recognize and receive a cash gain upon sale. In a traditional securitization transaction, we typically recognize a gain on sale at the time the loans are sold, and receive cash flows over the actual life of the loans. The use of a NIM transaction concurrent with or shortly after a securitization transaction allows us to receive a substantial portion of the gain in cash at the closing of the NIM transaction, rather than over the actual life of the loans. Recently, we have also begun to employ a securitizations structure that does not result in gain-on-sale at the time of the transaction, but rather yields interest income as the payments on the underlying mortgages are received. See “On Balance-Sheet Securitization” below.

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The following table sets forth secondary marketing transactions for the periods indicated (dollars in thousands):

On-Balance Sheet Securitization

In the first quarter of 2003, we completed a $494 million securitization structured as a financing for accounting purposes under SFAS No. 140. This “portfolio-based” accounting treatment is designed to more closely match the recognition of income with the receipt of cash payments. Also, such a securitization structure is consistent with our strategy to generate primarily cash-based earnings rather than non-cash gain on sale revenue. Because we do not record gain on sale revenue in the period in which the securitization occurs, the use of such portfolio-based accounting structures will result in lower income in the period in which the securitization occurs than would a traditional gain on sale securitization. However, the recognition of income as interest payments are received on the underlying mortgage loans will result in higher income recognition in future periods than would a traditional gain on sale securitization.

Residual Interests

In a securitization transaction, we sell a portfolio of mortgage loans to a special purpose entity that we establish for the limited purpose of buying and reselling mortgage loans. The special purpose entity transfers the mortgage loans to a trust that in turn issues interest-bearing asset-backed securities generally in an amount equal to the aggregate principal balance of the mortgage loans. One or more investors purchase these asset-backed securities for cash. The trust uses the cash proceeds to pay us for the mortgage loans. The trust also issues a certificate representing a residual interest in the payments on the securitized loans. In addition, we provide credit enhancement for the benefit of the investors in the form of additional collateral, referred to as the over-collateralization account, or OC Account.

To date, we have elected to fund the required OC Account at the closing of most of our securitization transactions. The over-collateralization requirement ranges from 0.75% to 4.75% of the initial securitization bond debt principal balance, or 1.5% to 9.5% of the remaining principal balance after thirty to thirty-six months of principal amortization. The actual amount of the OC Account is determined by the rating agencies based upon

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their assessment of the loan pool characteristics. When funding all of the OC Account up front, we begin to receive cash flow from our residual securities immediately. When we do not fund the OC Account up front, we do not receive cash flow until the OC Account requirement is satisfied. It typically takes between 12 to 24 months to satisfy the OC Account requirement. Cash flows from our Residuals are subject to certain delinquency or credit loss tests, as defined by the rating agencies or the bond insurance companies. Over time, we receive distributions from the OC Account subject to the performance of the mortgage loans in each securitization.

At the closing of each securitization transaction structured as a sale, we add to our balance sheet the residual interest retained based on our calculation of the present value of estimated future cash flows to be received by us. The residual interest we record consists of the OC Account and the net interest receivable, or NIR. Combined, these are referred to as the residual interests.

We review quarterly the underlying assumptions we use to value each residual interest and adjust the carrying value of the securities based on actual experience and industry trends. To determine the residual asset value, we project cash flow for each security. To project cash flow, we use base assumptions for the constant prepayment rate, or CPR, and losses for each product type based on historical performance. We update each security to reflect actual performance to date and we base assumptions for CPR and loss to project performance of the security from that date forward. If the actual performance of the security differs materially from the base assumptions with respect to CPR or loss, we make adjustments. We then use the London Interbank Offer Rate, or LIBOR, forward curve to project future interest rates and finalize cash flow projections for each security. We then discount the projected cash flows at a rate commensurate with the risk involved. At March 31, 2003, we used discount rates of 12% for residual interests and 14% for residual interests through NIM transactions.

During the first quarter of 2003, we recorded a $1.6 million increase in the carrying value of our residual interests as a result of our evaluation. This increase in value was the result of changes in interest rates and the forward LIBOR curve during the quarter, partially offset by the effect of delays in certain expected cash flows due to delinquency triggers. At the same time, we recorded an unrealized loss of $1.3 million on our hedge transactions used to mitigate interest rate risk in the portfolio of Residuals.

Discounted Loan Sales

The following table illustrates the composition of discounted loan sales for each of the periods indicated (dollars in thousands):

For the quarter ended March 31, 2003, we sold $44.7 million in loans that had been repurchased from or rejected by whole loan investors, compared to $21.6 million in loans for the same period in 2002. While the dollar volume increased, the percentage of discounted sales to whole loan sales decreased to 1.1%, compared to 1.3% in 2002, a slight improvement.

Repurchases for securitized pools decreased to $2.8 million in 2003, compared to $27.5 million in 2002. Such repurchases in 2002 were designed to manage triggers that disrupt cash flows to us as the residual holder. Where delinquency and loss rates jeopardize the release of these cash flows, we generally elect to repurchase loans from the pools. The pooling and servicing agreements require the repurchase of the most delinquent loans first, resulting in more severe discounts. While the losses we

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recognize as a result of these repurchases are no less severe than if the loans had remained in the securitization trust, buying the loans from the pools allows us to preserve cash flow and residual value, as well as control the ultimate disposition of the loans.

Critical Accounting Policies

We have established various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in Footnote 1 to the Condensed Consolidated Financial Statements, beginning on page 7. Certain accounting policies require us to make significant estimates and assumptions that may have a material impact on certain assets and liabilities, and we consider these to be critical accounting policies. The estimates and assumptions we use 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 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:

Results of Operations

The following table sets forth our results of operations as a percentage of total revenues for the periods indicated:

Total expenses as a percent of total revenues increased by 4.3% to 56.9% for the three months ended March 31, 2003, compared to the same period during the prior year. However, had we sold the $494 million in loans through a securitization structured as a sale rather than as a financing, we would have reported an additional $21.1 million in revenues, applying our average premium for the quarter of 4.26%. Expenses as a percent of revenues would have been 50.9%, a slight decrease compared to 2002.

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Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002

Originations and Purchases

We originated and purchased $4.7 billion in loans for the three months ended March 31, 2003, compared to $2.7 billion for the three months ended March 31, 2002. Wholesale loan originations and purchases were $4.1 billion, or 87.0% of total originations and purchases for the three months ended March 31, 2003. Retail loan originations and purchases were $610.8 million, or 13.0%, of total originations and purchases for the three months ended March 31, 2003. For the same period in 2002, wholesale and retail originations and purchases totaled $2.2 billion, or 84.6%, and $410.2 million, or 15.4%, respectively, of total originations and purchases. The increase in 2003 is a result of our geographic expansion efforts, as well as an increase in our market share.

Loan Sales and Securitizations

Whole loan sales increased to $4.2 billion for the three months ended March 31, 2003, from $1.7 billion for the corresponding period in 2002, an increase of 148.6%. This increase is the result of higher production volume, as well as $845.5 million in loans sold through securitization in 2002, compared to a $494 million transaction in 2003 that was not structured as a sale.

Revenues

Total revenues for the three months ended March 31, 2003, increased by 61.2% to $181.0 million, from $112.3 million for the same quarter a year ago. This increase was primarily due to a 60.4% increase in gain on sale of loans and a 77.6% increase in interest income, partially offset by a 16.3% decrease in residual income.

Gain on Sale

Gain on sale of loans increased to $125.8 million, a 60.4% increase for the three months ended March 31, 2003, compared to the same quarter last year. The increase in gain on sale of loans was the result of higher loan sale volume as well as significantly lower losses on discounted sales, partially offset by a securitization in 2003 for which we did not record a gain in the period the securitization closed. The components of the gain on sale of loans are illustrated in the following table:

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