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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2003

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from ____________ to ______________

Commission File Number: 000-33485

Incorporated pursuant to the Laws of Delaware

_________________

Internal Revenue Service
Employer Identification No. 54-2036376

_________________

4860 Cox Road, Suite 300,
Glen Allen, Virginia, 23060

(804) 967-7400

Indicate by check mark whether the Registrant (1) has filed all documents and 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes X No

As of August 11, 2003 there were 28,602,361 shares of our common stock, par value $0.01 per share, outstanding.

Table of Contents

SAXON CAPITAL, INC.

Table of Contents

Table of Contents

Part I. Financial Information

Item 1. Financial Statements

Saxon Capital, Inc.
Condensed Consolidated Balance Sheets
(Dollars in thousands, except for share data)

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

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Saxon Capital, Inc.
Condensed Consolidated Statements of Operations
(Dollars in thousands, except for share data)
(unaudited)

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

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Saxon Capital, Inc.
Condensed Consolidated Statement of Stockholders’ Equity
(Dollars in thousands, except share data)
(unaudited)

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

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Saxon Capital, Inc.
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(unaudited)

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

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Notes to Condensed Consolidated Financial Statements
June 30, 2003 (unaudited)

(1)    Organization and Summary of Significant Accounting Policies

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

        In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring accruals, necessary for a fair presentation. The results of operations and other data for the three and six months ended June 30, 2003 and 2002 are not necessarily indicative of the results that may be expected for any other interim periods or the entire year ending December 31, 2003. The unaudited condensed consolidated financial statements presented herein should be read in conjunction with the audited consolidated financial statements and related notes thereto included in Saxon Capital, Inc.‘s Annual Report on Form 10-K for the year ended December 31, 2002.

        Saxon Capital, Inc. (the “Company”) (NASDAQ: SAXN) was formed on April 23, 2001. The Company acquired all of the issued and outstanding capital stock of SCI Services, Inc. (“Predecessor”) from Dominion Capital, Inc. (“Dominion Capital”) on July 6, 2001. The Company had no activities between April 23, 2001 and the acquisition of Predecessor.

        The Company, through its wholly-owned subsidiaries Saxon Mortgage, Inc. (“Saxon Mortgage”) and America’s MoneyLine, Inc. (“America’s MoneyLine”), is licensed to originate loans or is exempt from licensing requirements, in 49 states. Its activities consist primarily of originating and purchasing single-family residential mortgage loans and home equity loans through three production channels — wholesale, correspondent, and retail. The Company may also, as servicer of record, purchase loans from prior securitizations pursuant to the clean-up call provisions of the trusts. Loans originated or purchased by the Company are secured by a mortgage on the borrower’s property. The Company then either sells these loans or accumulates such loans until a sufficient volume has been reached to securitize into an asset-backed security. In addition, the Company, through its wholly-owned subsidiary Saxon Mortgage Services, Inc. (“Saxon Mortgage Services”), services and sub-services single-family mortgage loans throughout the country that primarily have been purchased or originated by the Company. The Company, headquartered in Glen Allen, Virginia, has operation centers of its subsidiaries in Fort Worth, Texas and Foothill Ranch, California and 27 branch offices located throughout the country at June 30, 2003. The focus of the Company is on originating and purchasing loans to homebuyers who generally do not meet the underwriting guidelines of one of the government-sponsored entities such as the Federal Home Loan Mortgage Corporation, (“Freddie Mac”), the Federal National Mortgage Association, (“Fannie Mae”), and the Government National Mortgage Association, (“Ginnie Mae”). Use of the term “Company” throughout these Notes to Condensed Consolidated Financial Statements shall be deemed to refer to or include the applicable subsidiaries of the Company.

        The unaudited condensed consolidated financial statements of the Company include the accounts of all wholly owned subsidiaries. All inter-company balances and transactions have been eliminated in consolidation.

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

        The Company has elected to follow Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, the intrinsic value method, in accounting for its stock options issued to employees and non-employee directors. Accordingly, the Company does not recognize compensation expense upon the issuance of its stock options because the option terms are fixed and the exercise price equals the market price of the underlying stock on the grant date. Under Statement of Financial Accounting Standard ("SFAS") No. 123, any options issued to consultants are expensed. As of June 30, 2003, no options have been granted to consultants. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value method to stock-based employee compensation using the Black-Scholes option pricing model.

        Certain amounts for 2002 have been reclassified to conform to presentations adopted in 2003.

        In November 2002, Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which provides interpretation of FASB Statements No. 5, 57, and 107 and rescinds FASB Interpretation No. 34. This Interpretation clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation it has guaranteed to a creditor on behalf of a third party. It also elaborates on disclosures a guarantor is to make in its interim and annual financial statements about any obligations under certain guarantees it has issued. The effective date for the initial recognition and initial measurement provisions of this Interpretation is for guarantees issued or modified after December 31, 2002; however, the disclosure requirements are effective for financial statements ending after December 15, 2002. The Company adopted the provisions of FASB Interpretation No. 45 on January 1, 2003, and it did not have a material impact on the financial position, results of operations, or cash flows of the Company.

        In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, which addresses consolidation by business enterprises of variable interest entities and the reporting and disclosure requirements of such. Variable interests are defined as contractual, ownership or other pecuniary interests in an entity that change with changes in the entity’s net asset value. This interpretation requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. The primary beneficiary is one that absorbs a majority of the expected losses, residual returns, or both as a result of holding variable interests. If an entity has a variable interest in which it is the primary beneficiary, the entity must then include the variable interest entity’s assets, liabilities, and results of operations in its consolidated financial statements. This Interpretation is immediately effective and must be applied to variable interest entities created after January 31, 2003 or in which an enterprise obtains an interest in after that date. In connection with the loans the Company services for others, the Company does not own any interests in the related securitized trusts or loan pools or have any other economic interests other than those associated with acting as servicer for the related mortgage loans. Effective February 1, 2003, management adopted Interpretation No. 46, and it did not have a material impact on the Company’s financial position, results of operations, or cash flows.

        In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies financial accounting and reporting for certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133. In particular, this statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying to conform it to language used in FASB Interpretation (“FIN”) No. 45, and amends certain other existing pronouncements. This statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003, with certain exceptions. Effective July 1, 2003, management will implement SFAS 149, but does not expect this to have a material impact on the financial position, results of operations, or cash flows of the Company.

        Effective June 1, 2003, the Company adopted SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for financial instruments with both debt characteristics and equity characteristics and requires that certain instruments previously eligible for classification as equity be classified as a liability after the effective date of this statement. The requirements of this statement apply to issuers’ classification and measurement of freestanding financial instruments and does not apply to features that are embedded in a financial instrument that is not a derivative in its entirety. This statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption, while restatement is not permitted. The adoption of SFAS No. 150 did not have a material impact on the Company’s consolidated results of operations and financial position.

(2)    Earnings Per Share

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

(3)    Mortgage Loan Portfolio

        The Company’s subsidiaries purchase and originate fixed-rate and adjustable-rate mortgage loans that have a contractual maturity of up to 30 years. These mortgage loans are secured by single-family residential properties (which may include manufactured homes affixed to and classified as real property under applicable law), condominiums and one-to-four unit properties, and are being recorded at amortized cost. Most of these mortgage loans are pledged as collateral for a portion of the warehouse financing and securitization financing.

        Approximately 23% of the property securing the Company’s mortgage loan portfolio was located in the state of California at both June 30, 2003 and December 31, 2002. No other state comprised more than 8% of the Company’s mortgage loan portfolio at June 30, 2003 or December 31, 2002.

        During the six months ended June 30, 2003, the Company completed the final funding of Saxon Asset Securities Trust (“SAST”) 2002-3 ($300.2 million in principal balances and $4.4 million in unamortized basis adjustments) and two additional securitizations of mortgage loans ($1.3 billion in principal balances and $19.2 million in unamortized basis adjustments). During the six months ended June 30, 2002, the Company completed one securitization of mortgage loans ($900.0 million in principal balances and $17.2 million in unamortized basis adjustments).

        Mortgage loans as of June 30, 2003 and December 31, 2002 were as follows:

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

(4)    Allowance for Loan Loss

        The Company is exposed to risk of loss from its mortgage loan portfolio and establishes this allowance for loan loss taking into account a variety of criteria including the contractual delinquency status and historical loss experience. The propriety of this allowance for loan loss is evaluated monthly and adjusted based on this review.

        Activity related to the allowance for loan loss for the mortgage loan portfolio for the three and six months ended June 30, 2003 and 2002 is as follows:

(5)    Mortgage Servicing Rights

        Mortgage servicing rights are initially recorded at fair value and subsequently amortized in proportion to, and over the period of the anticipated net cash flows from servicing the loans to arrive at the carrying value. The amount recorded on the condensed consolidated balance sheets represents the carrying value less any temporary impairments of the Company’s servicing portfolio. As of June 30, 2003, the fair value of the mortgage servicing rights, based on independent appraisals, was measured at $39.4 million, compared to $26.8 million at December 31, 2002. The following table summarizes activity in mortgage servicing rights for the three and six months ended June 30, 2003 and 2002:

        The following table summarizes the activity of our valuation allowance for the three and six months ended June 30, 2003 and 2002:

        As of June 30, 2003, the following table summarizes the remaining estimated projected amortization expense for the carrying value of the mortgage servicing rights for each of the five succeeding years and thereafter:

(6)   Warehouse Financing, Securitization Financing and Note Payable

        A summary of the amounts outstanding and available under these agreements at June 30, 2003 and December 31, 2002, respectively, is as follows:

        The following table summarizes our contractual obligations at June 30, 2003:

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

        Under its borrowing agreements, the Company is subject to certain debt covenants and is required to maintain or satisfy specified financial ratios and tests, as well as other customary covenants, representations and warranties, and events of default. In the event of default, the Company may be prohibited from paying dividends and making distributions under certain of its credit facilities without the prior approval of its lenders. At June 30, 2003, the Company was in compliance with all the covenants under the respective borrowing agreements.

(7)    Derivatives

        The Company accounts for its derivative financial instruments as cash flow hedges, which hedge the Company’s variable rate debt. At June 30, 2003 and December 31, 2002, the fair value of the Company’s derivatives totaled $3.1 million and $0.3 million, respectively. The derivative fair value is held on the condensed consolidated balance sheet as part of other assets. As of June 30, 2003 and December 31, 2002, hedge effectiveness recorded in other comprehensive income (loss) was $(18.3) million with a tax benefit of $(6.9) million and $8.6 million with a tax expense of $3.4 million, respectively. Other comprehensive income relating to cash flow hedging is amortized into earnings through interest expense as the hedged transaction affects earnings. The expected effect of amortization of the other comprehensive income on earnings for the next twelve months is $4.9 million of expense. Hedge ineffectiveness associated with hedges resulted in $0.3 million of expense and $0.2 million of income for the three months ended June 30, 2003 and 2002, respectively and $0.5 million of expense and $0.3 million of income for the six months ended June 30, 2003 and 2002, respectively.

        At June 30, 2003 and December 31, 2002, the Company had $59.3 million and $72.6 million, respectively of basis adjustments on mortgage loans related to fair value hedging activity. The basis adjustment is amortized into earnings through interest income based on the life of the previously hedged loans.

(8)    Commitments and Contingencies

         Mortgage Loans

        At June 30, 2003 and December 31, 2002, the Company’s subsidiaries had commitments to fund mortgage loans of approximately $136.5 million and $339.3 million, respectively. These amounts do not necessarily represent future cash requirements, as some portion of the commitments are likely to expire without being drawn upon or may be subsequently declined for credit or other reasons.

        In connection with the approximately $1.8 billion of mortgage loans securitized by Predecessor in off balance sheet transactions from May 1996 to July 5, 2001, and which are still outstanding as of June 30, 2003, the Company made representations and warranties about certain characteristics of the loans, the borrowers, and the underlying properties. In the event of a breach of these representations and warranties, the Company may be required to remove loans from a securitization and replace them with cash or substitute loans. At June 30, 2003 there were no such breaches for any loans that had been securitized.

        In the normal course of business, the Company is subject to indemnification obligations related to the sale of residential mortgage loans. Under these indemnifications, the Company is required to repurchase certain mortgage loans that fail to meet the standard representations and warranties included in the sales contracts. Based on historical experience, total mortgage loans repurchased pursuant to these indemnification obligations would not have a material impact on the Company’s statements of operations, and therefore have not been accrued for as a liability on the Company’s condensed consolidated balance sheets.

         Legal Matters

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

        America’s MoneyLine is named in a case brought as a class action in Illinois. The plaintiff alleges that America’s MoneyLine charged a courier fee in connection with the closing of her loan that was not properly collected or disclosed, constituting violation of the Illinois Consumer Fraud Act and similar laws, if any, in other states, and unjust enrichment as to the plaintiff and a similarly situated class of borrowers. If the purported plaintiff borrowers achieve nationwide class certification and the case is decided adversely to the Company’s subsidiary, the potential loss could materially and adversely affect the Company’s business. At this time, the Company cannot predict the outcome of this matter and cannot reasonably estimate a range of possible loss given the current status of the litigation; accordingly, no amounts have been accrued in the Company’s accompanying condensed consolidated financial statements.

        In addition, America’s MoneyLine is named in a case brought as a collective action under the federal Fair Labor Standards Act (“FLSA”), alleging that loan officers who routinely worked more than 40 hours per week were denied overtime compensation in violation of the FLSA. The plaintiffs seek unpaid wages at the overtime rate, an equal amount in liquidated damages, costs and attorneys fees. Under the FLSA, persons must take steps to affirmatively opt into the proceeding in order to participate as plaintiffs. At this time, the Company cannot predict the number of loan officers that will opt into the proceedings, nor can the Company predict the outcome of this matter with respect to those who opt in as parties. If the plaintiffs achieve certification as a collective action and the case is decided adversely to America’s MoneyLine, the potential loss could materially and adversely affect the Company’s business. At the present time, however, the Company cannot predict the outcome of the case and cannot reasonably estimate a range of possible loss given the current status of the litigation; accordingly, no amounts have been accrued in the Company’s accompanying condensed consolidated financial statements.

        Finally, one of the Company’s subsidiaries, Saxon Mortgage Services, is named in a matter filed in the United States District Court for the Northern District of Illinois, Eastern Division as a class action. The plaintiffs allege that Saxon Mortgage Services collected prepayment penalties on loans that had been accelerated, constituting violations of the Illinois Interest Act, the Illinois Consumer Fraud Act, similar laws, if any, in other states, and a breach of contract. The claims of one of the named plaintiffs have been settled, and the claims of the remaining named plaintiff against Saxon Mortgage Services have been dismissed without prejudice. If the remaining plaintiffs choose to re-file the case, achieve nationwide class certification and the case is decided adversely to Saxon Mortgage Services, the potential loss could materially and adversely affect the Company’s business. At the present time, however, the Company cannot predict the outcome of the case and cannot reasonably estimate a range of possible loss given the current status of the litigation; accordingly, no amounts have been accrued in the Company’s accompanying condensed consolidated financial statements.

         Insurance Policies

        As of June 30, 2003, the Company carried a primary directors and officers liability insurance policy for $10 million, excess directors and officer’s liability insurance policies totaling $40 million and key man insurance policies in the amount of $9.6 million. In addition, the Company carried a banker’s professional/lenders liability policy, a mortgage protection policy, a fiduciary liability policy and an employment practices liability policy for $10 million each; a financial institutions bond and a commercial umbrella coverage for $15 million each; a commercial general liability policy and a property insurance policy for $2 million per occurrence; and a business auto policy and worker’s compensation policy for $1 million per occurrence.

(9)    Related Party Transactions

        At June 30, 2003 and December 31, 2002, the Company had $10.3 million and $8.1 million, respectively, of unpaid principal balances within its mortgage loan portfolio related to mortgage loans originated for executive officers, officers, and employees of the Company. These mortgage loans were underwritten to the Company’s underwriting guidelines. When making loans to officers and employees, the Company waives loan origination fees that otherwise would be paid to us by the borrower and reduces the interest rate by 25 basis points from the market rate. The Company has never made loans to any of its outside directors. Effective December 1, 2002, the Company no longer renews or makes any new loans to its executive officers or directors.

(10)    Segments

        The operating segments reported below are the segments of the Company for which separate financial information is available and for which revenues and operating income amounts are evaluated regularly by management in deciding how to allocate resources and in assessing performance.

        Segment revenues and net operating income amounts are evaluated and include the estimated gains based on the fair value of mortgage loans originated assuming they were sold, servicing income, other income and expense, and general and administrative expenses. Estimated fair value of mortgage loans originated represents the amount in excess of the segment’s basis in its loan production that would be generated assuming the mortgage loans were sold.

        Certain amounts are not evaluated at the segment level and are included in the segment net operating income reconciliation below. The segment’s estimated gain on sale of mortgage loans originated, based on estimated fair values of those loans, is required to be eliminated since the Company structures its securitizations as financing transactions. Net interest income is not allocated at a segment level since it is recorded once the loan production process is complete, and it is therefore included as a reconciling item below.

        Management does not identify assets to the segments and evaluates assets only at the consolidated level. As such, only operating results for the segments are included herein.

(11)    Subsequent Events

        The Company’s $150.0 million Greenwich Capital one-year facility was amended on July 18, 2003, extending the termination date of the facility to July 17, 2004.

Table of Contents

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

        This discussion should be read in conjunction with the unaudited condensed consolidated financial statements, notes and tables included elsewhere in this report and in the Saxon Capital, Inc. Annual Report on Form 10-K for the year ended December 31, 2002 (the “2002 Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”). This report may contain certain statements that may be forward-looking in nature under Section 27 of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Generally, forward-looking statements can be identified by the use of forward-looking terminology including, but not limited to, “may,” “will,” “expect,” “intend,” “should,” “anticipate,” “estimate,” “is likely to,” “could,” “are confident that,” or “believe” or comparable terminology. All statements addressing our operating performance, events, or developments that we expect or anticipate will occur in the future, including statements relating to net interest income growth, earnings or earnings per share growth, and market share, as well as statements expressing optimism or pessimism about future operating results, are forward-looking statements. The forward-looking statements are based upon management’s views and assumptions, as of the date of this Form 10-Q, regarding future events and operating performance, and are applicable only as of the dates of such statements. By their nature, all forward-looking statements involve risk and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements for a number of reasons. Factors which might cause actual results to differ from our plans and expectations and which could have a material adverse affect on our operations and future prospects include, but are not limited to: changes in overall economic conditions or unanticipated changes in interest rates; our ability to successfully implement our growth strategy; our ability to sustain loan origination growth at levels sufficient to absorb costs of production and operational costs; continued availability of credit facilities and access to the securitization markets or other funding sources; deterioration in the credit quality of our loan portfolio; challenges in successfully expanding our servicing platform and technological capabilities; future litigation developments; and increased competitive conditions or changes in the legal and regulatory environment in our industry. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. We undertake no obligation to update publicly any of these statements in light of future events except as required in subsequent periodic reports we file with the SEC.

Overview

        Highlights of our second quarter 2003 performance results, as reported in our press release dated July 24, 2003, are as follows:

• Second quarter 2003 net income increased to $15.4 million, as compared to $5.1 million for the second quarter 2002.
• Our net mortgage loan portfolio, or “owned portfolio,” increased 65% to $4.3 billion at June 30, 2003 from $2.6 billion at June 30, 2002.
• Mortgage loan production for the second quarter 2003 increased by 40% over the second quarter 2002 production and 4% over the first quarter 2003, excluding called loans purchased from previously securitized pools. We have not purchased any called loans from off-balance sheet securitized pools during 2003.

General

        This report, our 2002 Form 10-K, as well as all of our quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are made available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC, free of charge, through our website. Our website address is www.saxoncapitalinc.com. Our common stock is listed on the Nasdaq National Market under the symbol “SAXN.”

        Our business is conducted through our operating subsidiaries. We conduct wholesale and correspondent mortgage loan originations, purchases, secondary marketing, master servicing, and other administrative functions at Saxon Mortgage, Inc. (“Saxon Mortgage”), and retail loan origination activity at America’s MoneyLine, Inc. (“America’s MoneyLine”). We conduct mortgage loan servicing at Saxon Mortgage Services, Inc. (“Saxon Mortgage Services”). Throughout our discussion of our business operations, words such as “we” and “our” are intended to include these operating subsidiaries.

        We originate or purchase loans through three separate origination channels. Our wholesale channel originates or purchases loans through our network of approximately 4,000 independent brokers throughout the country. Our retail channel originates mortgage loans directly to borrowers through our retail branch network of 27 locations. Our correspondent channel purchases mortgage loans from approximately 400 correspondents following a complete re-underwriting of each mortgage loan. Once a loan is purchased or originated, Saxon Mortgage Services begins the process of performing the day-to-day administrative services for the loan, commonly referred to as “servicing.” Saxon Mortgage Services seeks to ensure that the loan is repaid in accordance with its terms.

        Initially, we finance each of our mortgage loans under one or more of several different secured and committed warehouse financing facilities. We then securitize our mortgage loans and pay off the associated warehouse borrowings; however, as we identify opportunities in the marketplace, from time to time we may choose to sell certain mortgage loans rather than securitize them. Since May 1996, we have securitized approximately $14.5 billion in mortgage loans through our securitization program. Since July 6, 2001, we structure our securitizations as financing transactions. These securitizations do not meet the qualifying special purpose entity criteria under SFAS 140 and related interpretations because after the loans are securitized, the securitization trust may acquire derivatives relating to beneficial interests retained by us; also as servicer, subject to applicable contractual provisions, we have sole discretion to use our best commercial judgment in determining whether to sell or work out any loans, securitized through the securitization trust, that become troubled. Accordingly, following a securitization, the mortgage loans remain on our consolidated balance sheet, and the securitization indebtedness replaces the warehouse debt associated with the securitized mortgage loans. We record interest income on the mortgage loans and interest expense on the securities issued in the securitization over the life of the securitization, instead of recognizing a gain or loss upon completion of the securitization.

Critical Accounting Policies

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

        Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. We believe that our critical accounting policies are limited to those described below. We believe the following represent our critical accounting policies, as discussed below:

• Allowance for Loan Loss;
• Mortgage Servicing Rights Valuation;
• Hedging; and
• Accounting for Income Taxes.

Allowance for Loan Loss

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

        Provisions are made to the allowance for loan loss for currently existing losses in the outstanding mortgage loan portfolio balances. Charge-offs to the provision are recorded at the time of liquidation or at the time the loan is transferred to real estate owned. The allowance for loan losses is regularly evaluated by management for propriety by taking into consideration factors such as changes in the nature and volume of the loan portfolio; trends in actual and forecasted portfolio performance and credit quality, including delinquency, charge-off and bankruptcy rates; and current economic conditions that may affect a borrower’s ability to pay. An internally developed roll rate analysis, static pool analysis and historical losses are the primary tools used in analyzing our allowance for loan loss. These tools take into consideration historical information regarding delinquency and loss severity experience and apply that information to the portfolio. If actual results differ from our estimates, we may be required to adjust our provision accordingly. Likewise, the use of different estimates or assumptions could produce different provisions for loan losses. For example, as of June 30, 2003, if we were to assume a 10% increase in both delinquencies and loss severities, our allowance for loan loss and related provision would have increased by $5.1 million.

Mortgage Servicing Rights Valuation

        The valuation of mortgage servicing rights (“MSRs”) requires that we make estimates of numerous market assumptions. Interest rates, prepayment speeds, servicing costs, discount rates, and the payment performance of the underlying loans significantly affects our ongoing valuations and the rate of amortization of MSRs. In general, during periods of declining interest rates, the value of MSRs decline due to increasing prepayments attributable to increased mortgage refinancing activity.

        The carrying values of the MSRs are amortized in proportion to, and over the period of, the anticipated net cash flows from servicing the loans. MSRs are assessed periodically to determine if there has been any impairment to the carrying value, based on the fair value at the date of the assessment and by stratifying the MSRs based on underlying loan characteristics, including the year of capitalization. We obtained independent third-party appraisals to determine the fair value of our MSRs at June 30, 2003 and will regularly obtain these appraisals. At June 30, 2003, key economic assumptions and the sensitivity of the current fair value for the MSRs to immediate changes in those assumptions were as follows:

        These sensitivities are hypothetical and are for illustrative purposes only. As the table above demonstrates, the methodology for estimating the fair value of MSRs is highly sensitive to changes in assumptions. For example, our determination of fair value uses current prepayment speeds. Actual prepayment experience in the future may differ and any difference may have a material effect on the MSR fair value. Changes in fair value based on a variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumption. In reality, changes in one factor may be associated with changes in another (for example, increases in market interest rates may result in lower prepayments, but credit losses may increase), which may magnify or counteract the sensitivities. Any measurement of an MSR’s fair value is limited by the conditions existing and assumptions made as of a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time.

        Due to subsequent changes in economic and other relevant conditions, the actual rates of prepayments and defaults and the value of collateral generally differed from our initial estimates, and these differences are sometimes material. If actual prepayment and default rates are higher than those assumed, less mortgage servicing income would be expected, which would adversely affect the value of the MSRs. As demonstrated above, significant changes in prepayment speeds, delinquencies, and losses may result in impairment of most MSRs, and would be recorded in our consolidated statements of operations.

Hedging

        The determination of effectiveness is the primary assumption and estimate used in hedging. In instances where we use swaps as a hedge, the swap rate is fixed and compared monthly to the one-month London Inter-Bank Offered Rate (“LIBOR”) index. The payment of interest on our bonds issued in a securitization transaction is based upon the same index, and has the same reset day. Therefore, the swaps are an effective hedge against interest rate risk. Likewise, when we use options as a hedge, such as caps and floors, they also are considered to be effective hedges. In the case where we may use Eurodollar futures, correlation analysis is necessary since a slight amount of basis risk can occur. The correlation calculation for Eurodollars is calculated by capturing historic swap rates and the corresponding Eurodollar prices, and then calculating a financing rate, for the maturity deemed necessary. Market changes for each of the respective yields are recorded over time, and a correlation percentage is calculated through use of regression analysis.

Accounting for Income Taxes

        Significant management judgment is required in developing our provision for income taxes, including the determination of deferred tax assets and liabilities and any valuation allowances that might be required against the deferred tax asset. As of June 30, 2003, we have not recorded a valuation allowance on the deferred tax asset based on management’s belief that operating income will, more likely than not, be sufficient to realize the benefit of these assets over time. The determination of the need for a valuation allowance takes into consideration our recent earnings history, current tax position, and estimates of taxable income in the near term. The tax character (ordinary versus capital) and the carryforward periods of certain tax attributes such as capital losses and tax credits are also considered. Significant judgment is required in considering the relative impact of negative and positive evidence related to the ability to realize deferred tax assets. In the event that actual results differ from these estimates or if our current trend of positive operating income changes, we may be required to record a valuation allowance on our deferred tax assets, which could have a material adverse effect on our consolidated financial condition and results of operations.

Mortgage Loan Portfolio

        Characteristics of the mortgage loans we own such as credit grade, coupon, loan-to-value, and prepayment speeds are provided in the following tables. These characteristics are important as they provide key indicators of the credit and prepayment risks inherent in our mortgage loan portfolio, which have a direct impact on our past and future operating performance.

         Overview