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The following is an excerpt from a 10-K SEC Filing, filed by AMERICAN BUSINESS FINANCIAL SERVICES INC /DE/ on 10/13/2004.
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AMERICAN BUSINESS FINANCIAL SERVICES INC /DE/ - 10-K - 20041013 - FORM

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2004 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 000-22474

AMERICAN BUSINESS FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)

         Delaware                                       87-0418807
         --------                                       ----------
(State or other jurisdiction of                      (I.R.S. Employer
incorporation or organization)                       Identification No.)

100 Penn Square East, Philadelphia, PA 19107
(Address of principal executive offices) (Zip Code)

(215) 940-4000
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

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

Common Stock, par value $.001 per share
(Title of class)

Series A Convertible Preferred Stock, par value $.001 per share
(Title of class)

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. [X] YES [ ] 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. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). [ ] YES [X] NO

The aggregate market value of the registrant's common stock, par value $.001 per share, held by non-affiliates of the registrant based on the price at which the common stock was last sold as of the last business day of the registrant's most recently completed second fiscal quarter was $5.8 million.

The number of shares outstanding of the registrant's sole class of common stock as of September 30, 2004, the latest practicable date before the filing of this Form 10-K, was 3,598,342 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the registrant's definitive proxy statement, in connection with its 2004 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after June 30, 2004, are incorporated by reference into Part III of this Annual Report on Form 10-K.

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PART I

ITEM 1. BUSINESS

FORWARD LOOKING STATEMENTS

Some of the information in this Annual Report on Form 10-K may contain forward-looking statements. You can identify these statements by words or phrases such as "will likely result," "may," "are expected to," "will continue to," "is anticipated," "estimate," "believe," "projected," "intends to" or other similar words. These forward-looking statements regarding our business and prospects are based upon numerous assumptions about future conditions, which may ultimately prove to be inaccurate. Actual events and results may materially differ from anticipated results described in those statements. Forward-looking statements involve risks and uncertainties described under "Risk Factors" as well as other portions of this Annual Report on Form 10-K, which could cause our actual results to differ materially from historical earnings and those presently anticipated. When considering forward-looking statements, you should keep these risk factors in mind as well as the other cautionary statements in this Form 10-K. You should not place undue reliance on any forward-looking statement.

GENERAL INFORMATION REGARDING OUR BUSINESS

American Business Financial Services, Inc. is a financial services organization operating mainly in the eastern and central portions of the United States. Recent expansion has positioned us to increase our operations in the western portion of the United States, especially California. Through our principal direct and indirect subsidiaries, we currently originate, sell and service home equity and purchase money mortgage loans, to which we refer as home mortgage loans, secured by first or second mortgages on one-to-four family residences, which may not satisfy the eligibility requirements of Fannie Mae, Freddie Mac or similar buyers and which we refer to in this document as home mortgage loans. During fiscal 2004, 89.9% of loans originated by us were secured by first mortgages and 10.1% of loans originated by us were secured by second mortgages. See "-- Lending Activities -- Home Mortgage Loans" for a description of our home mortgage loan lending activities.

Additionally, we service loans to businesses secured by real estate and other business assets that we had originated and sold in prior periods, which we refer to in this document as business purpose loans. To the extent we obtain a credit facility to fund business purpose loans, we may originate and sell business purpose loans in future periods.

Our customers are primarily credit-impaired borrowers who are generally unable to obtain financing from banks or savings and loan associations and who are attracted to our products and services. This type of borrower is commonly referred to as a subprime borrower. Loans made to subprime borrowers are frequently referred to as subprime loans. Financial institutions utilize a credit rating system referred to as a FICO score to evaluate the creditworthiness of borrowers and as a means to establish their risk associated with lending to a particular borrower. The higher the FICO score, which can range from 300 to 850, the more creditworthy the borrower is. Generally, borrowers with FICO scores of 720 to 850 would receive the most favorable interest rates. During fiscal 2004, the average FICO score of our subprime home mortgage borrowers was 623. According to Standard & Poor's, subprime lenders issued securitized transactions with mixed collateral (fixed and adjustable rate mortgage loans) with a range of average FICO scores between 584 and 642 during the second quarter of calendar 2004.

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We originate loans through a combination of channels including a national processing center located at our centralized operating office in Philadelphia, Pennsylvania, and a network of mortgage brokers. During fiscal 2004, we acquired broker operations in West Hills, California and Austin, Texas, and opened new offices in Edgewater, Maryland and Irvine, California to support our broker operations. We also process and purchase home mortgage loans through our Bank Alliance Services program. Through this program, we purchase home mortgage loans from other financial institutions and hold these loans as available for sale until they are sold in a whole loan sale or in connection with a future securitization. Our loan servicing and collection activities were performed at our Bala Cynwyd, Pennsylvania office, and were relocated to our Philadelphia office on July 12, 2004. See "-- Lending Activities."

We were incorporated in Delaware in 1985 and began operations as a finance company in 1988, initially offering business purpose loans to customers whose borrowing needs we believed were not being adequately serviced by commercial banks. Since our inception, we have significantly expanded our product line and geographic scope and currently have licenses or are otherwise qualified to offer our home mortgage loan products in 46 states.

Our business strategy has generally involved the sale of substantially all of the loans we originate through a combination of loan sales with servicing released, which we refer to as whole loan sales, and securitizations. Our determination as to whether to dispose of loans through securitizations or whole loan sales depends on a variety of factors including market conditions, profitability and cash flow considerations. From 1995 through the fourth quarter of fiscal 2003, we have elected to utilize securitization transactions extensively due to the favorable conditions we experienced in the securitization markets. We generally realized higher gain on sale in our securitization transactions than on whole loan sales for cash. In whole loan sale transactions, the gain on sale is generally significantly lower than the gains realized in securitization transactions, but we receive the gain in cash. Due to our inability to securitize our loans in the fourth quarter of fiscal 2003, we adjusted our business strategy to emphasize more whole loan sales. The use of whole loan sales enables us to more rapidly generate cash flow, protect against volatility in the securitization markets and reduce risks inherent in retaining an interest in the securitized loans. However, unlike securitizations, where we may retain the right to service the loans we sell for a fee, which we refer to as servicing rights, whole loan sales are typically structured as a sale with servicing rights released and do not result in our receipt of interest-only strips. As a result, using whole loan sales more extensively in the future will reduce our income from servicing activities and limit the amount of securitization assets created. Of the $982.7 million of loans originated by us in fiscal 2004, at June 30, 2004, approximately 10% of these loans were securitized, approximately 60% of these loans were sold in whole loan sales with servicing released and the remainder were on our balance sheet at June 30, 2004 as available for sale pending future sale. We do not intend to hold any of these loans on our balance sheet permanently. See "-- Recent Developments," "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Whole Loan Sales" and "-- Whole Loan Sales."

When we securitize loans originated by our subsidiaries, we may retain interests in the securitized loans in the form of interest-only strips and servicing rights, which we refer to as our securitization assets. A securitization is a financing technique often used by originators of financial assets to raise capital. A securitization involves the transfer of a pool of financial assets, in our case, loans, to a trust in exchange for certificates, notes or other securities issued by the trust and representing an undivided interest in the trust assets. The transfer to the trust involves a sale and pledge of the financial assets, as well as providing representations and warranties regarding these transferred assets, depending on the particular transaction. Next, the trust sells a portion of the certificates, notes or other securities to investors for cash. Often the originator of the loans retains the servicing rights and may also retain an interest in the cash flows generated by the securitized loans which is subordinate to the interest represented by the notes or certificates sold to investors in the securitizations. This interest in the cash flows generated by the securitized loans is called an interest-only strip. See "-- Securitizations" and "-- Loan Servicing and Administrative Procedures" for further information.

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Loans and leases in which we have interests, either because the loans and leases are on our balance sheet or sold into securitizations in which we have retained interests, are referred to as our total portfolio. The managed portfolio includes loans held as available for sale on our balance sheet and loans serviced for others.

In addition to other sources, we fund our operations with subordinated debentures that we offer from our principal operating office located in Philadelphia, Pennsylvania. We offer these debentures without the assistance of an underwriter or dealer. At June 30, 2004, we had $522.6 million in subordinated debentures outstanding which included investment notes and uninsured money market notes. These debentures had a weighted-average interest rate of 9.91% and a weighted-average remaining maturity of 13.5 months. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."

Our principal corporate office is located at 103 Springer Building, 3411 Silverside Road, Wilmington, Delaware 19810. The telephone number at that address is (302) 478-6160. Our principal operating office is located at The Wanamaker Building, 100 Penn Square East, Philadelphia, Pennsylvania 19107. The telephone number at the Philadelphia office is (215) 940-4000. We maintain a web site on the World Wide Web at www.abfsonline.com. The information on our web site is not and should not be considered part of this document and is not incorporated into this prospectus by reference. This web site is only intended to be an inactive textual reference.

RECENT DEVELOPMENTS

EXCHANGE OFFERS. On December 1, 2003, we mailed the Offer to Exchange, referred to as the first exchange offer in this document, to holders of our subordinated debentures issued prior to April 1, 2003. On May 14, 2004, we mailed a second exchange offer, referred to as the second exchange offer in this document, to holders of our subordinated debentures issued prior to November 1, 2003. The first exchange offer and the second exchange offer are collectively referred to as the exchange offers in this document. Pursuant to the terms of the exchange offers, eligible holders of subordinated debentures had the ability to exchange their debentures for (i) equal amounts of senior collateralized subordinated notes and shares of 10.0% Series A convertible preferred stock referred to as Series A preferred stock in this document; and/or (ii) dollar-for-dollar for shares of Series A preferred stock. Pursuant to the terms of the first exchange offer, we exchanged $117.2 million of subordinated debentures for 61.8 million shares of Series A preferred stock and $55.4 million of senior collateralized subordinated notes. As a result of the second exchange offer, we exchanged $91.4 million of subordinated debentures for 47.6 million shares of Series A preferred stock and $43.8 million of senior collateralized subordinated notes. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview -- Exchange Offers" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Subordinated Debentures" for a more detailed discussion of the exchange offers.

Depending on market conditions and our financial condition, we may engage in additional exchange offers in the future and we are considering another exchange offer in our second quarter of fiscal 2005. See "Risk Factors -- We may issue additional preferred stock which could be entitled to dividends, liquidation preferences and other special rights and preferences not shared by holders of our common stock or which could have anti-takeover effects."

OUR RECENT FINANCIAL DIFFICULTIES AND LIQUIDITY CONCERNS. Several events and issues, which occurred beginning in the fourth quarter of fiscal 2003, have negatively impacted our short-term liquidity and contributed to our losses for fiscal 2003 and fiscal 2004. These events included our inability to complete publicly underwritten securitizations during the fourth quarter of fiscal 2003 and all of fiscal 2004 (we completed a privately-placed securitization in the second quarter of fiscal 2004), our inability to draw down upon and the expiration of several of our credit facilities, and our temporary discontinuation of sales of new subordinated debentures for approximately a six-week period during the first quarter of fiscal 2004. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview" for information regarding our continued inability to complete publicly underwritten securitizations.

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As a result of these liquidity issues our loan origination volume during fiscal 2004 was substantially reduced. From July 1, 2003 through June 30, 2004, we originated $982.7 million of loans, as compared to originations of $1.67 billion of loans for the same period in fiscal 2003. We anticipate that depending upon the size of our future quarterly securitizations, if any, we will need to increase our loan originations to approximately $400.0 million to $500.0 million per month to return to profitable operations. If we are unable to complete quarterly securitizations, we will need to increase our loan originations to approximately $550.0 million to $650.0 million per month to return to profitability. Our ability to achieve the levels of loan originations necessary to achieve profitable operations could be hampered by our failure to continue to successfully implement our adjusted business strategy, funding limitations under existing credit facilities and our ability to obtain new credit facilities and renew existing facilities. Our plan is to increase loan originations through the continued application of our business strategy adjustments, particularly as related to building our expanded broker channel and offering adjustable rate mortgages, purchase money mortgages and more competitively priced fixed rate mortgages. See "-- Business Strategy" for a discussion of our plans to achieve this level of originations. For a detailed discussion of our losses, capital resources and commitments, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."

On June 30, 2004, we had unrestricted cash of approximately $0.9 million and up to $210.4 million available under our warehouse credit facilities. We can only use advances under these credit facilities to fund loan originations and not for any other purposes. The combination of our current cash position and expected sources of operating cash may not be sufficient to cover our operating cash requirements.

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For the next six to twelve months, we intend to augment our sources of operating cash with proceeds from the issuance of subordinated debentures. In addition to repaying maturing subordinated debentures, proceeds from the issuance of subordinated debentures may be used to fund overcollateralization requirements, as defined below, in connection with our loan originations and to fund our operating losses. Under the terms of our credit facilities, our credit facilities will advance us 75% to 97% of the value of loans we originate. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" for a discussion of the terms of our credit facilities. As a result of this limitation, we must fund the difference between the loan value and the advances, which we refer to as the overcollateralization requirement, from our operating cash. We can provide no assurances that we will be able to continue issuing subordinated debentures.

See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Remedial Steps Taken to Address Liquidity Issues" for a discussion of the specific actions we undertook to address liquidity concerns.

RECENT OPERATING LOSSES AND SALE OF ASSETS. We incurred a net loss attributable to common stock of $115.1 million and $29.9 million for the fiscal years ended June 30, 2004 and 2003, respectively. In addition, depending on our ability to recognize gains on our future securitizations, we anticipate incurring operating losses at least through the first quarter of fiscal 2005.

The loss for fiscal 2004 primarily resulted from liquidity issues we have experienced since the fourth quarter of fiscal 2003, including the absence of credit facilities until the second quarter of fiscal 2004, which substantially reduced our loan origination volume and our ability to generate revenues, our inability to complete a publicly underwritten securitization during fiscal 2004, our shift in business strategy to focus on whole loan sales, and charges to the income statement of $46.4 million for pre-tax valuation adjustments on our securitization assets. Additionally, operating expense levels that would support greater loan origination volume also contributed to the loss for fiscal 2004.

During fiscal 2004, we recorded total pre-tax valuation adjustments on our interest-only strips and servicing rights of $63.8 million, of which $46.4 million was charged as expense to the income statement and $17.4 million was charged to other comprehensive income, a component of stockholders' equity. The fiscal 2004 adjustments primarily reflect the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2004 due to the low interest rate environment experienced during fiscal 2004. Additionally, the fiscal 2004 valuation adjustment also includes a write down of $5.4 million of the carrying value of our interest-only strips and servicing rights related to five of our mortgage securitization trusts to reflect their values under the terms of a September 27, 2004 sale agreement. The sale of these assets was undertaken to raise cash to pay fees on new warehouse credit facilities and as a result, we did not realize their full value as reflected on our books. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Application of Critical Accounting Estimates - Interest-Only Strips" for a discussion of how valuation adjustments are recorded.

AMOUNT OF OUR INDEBTEDNESS. At June 30, 2004, we had total indebtedness of approximately $847.4 million, comprised of amounts outstanding under our credit facilities, senior collateralized subordinated notes issued in the exchange offers, capitalized leases and subordinated debentures. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" for a comparison at June 30, 2004 of our secured and unsecured obligations to assets which were available to repay those obligations.

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BUSINESS STRATEGY ADJUSTMENTS. In response to our inability to securitize and liquidity issues described above, we adjusted our business strategy at the beginning of fiscal 2004 to shift from gain-on-sale accounting and the use of securitization transactions as our primary method of selling loans to a more diversified strategy which utilizes a combination of whole loan sales and securitizations, while protecting revenues, controlling costs and improving liquidity. See "-- Business Strategy."

If we fail to generate sufficient liquidity through the sales of our loans, the sale of our subordinated debentures, the maintenance of credit facilities or a combination of the foregoing, we will have to restrict loan originations and make additional changes to our business strategy, including restricting or restructuring our operations which could result in losses and impair our ability to repay our subordinated debentures and other outstanding debt. While we currently believe that we will be able to restructure our operations, if necessary, we cannot assure you that such restructuring will enable us to attain profitable operations or repay the subordinated debentures when due. If we fail to successfully implement our adjusted business strategy, we will be required to consider other alternatives, including raising additional equity, seeking to convert an additional portion of our subordinated debentures to equity, seeking protection under federal bankruptcy laws, seeking a strategic investor, or exploring a sale of the company or some or all of its assets. See "Risk Factors -- We depend upon the availability of financing to fund our continuing operations. Any failure to obtain adequate funding could hurt our ability to operate profitably, restrict our ability to repay our outstanding debt, and negatively impact the value of our capital stock" and "-- If we are unable to obtain additional financing, we may not be able to restructure our business to permit profitable operations or repay our outstanding debt and the value of our capital stock will be negatively impacted."

In addition to these restrictions and changes to our business strategy in the event we are unable to offer additional subordinated debentures for any reason, we have developed a contingent financial restructuring plan including cash flow projections for the next twelve-month period. Based on our current cash flow projections, we anticipate being able to make all scheduled subordinated debenture maturities and vendor payments.

The contingent financial restructuring plan is based on actions that we would take, in addition to those indicated in our adjusted business strategy, to reduce our operating expenses and conserve cash. These actions would include reducing capital expenditures, selling all loans originated on a whole loan basis, eliminating or downsizing various lending, overhead and support groups, and obtaining working capital funding. No assurance can be given that we will be able to successfully implement the contingent financial restructuring plan, if necessary, and repay the outstanding debt when due. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Remedial Steps Taken to Address Liquidity Issues."

CREDIT FACILITIES, SERVICING AGREEMENTS AND WAIVERS RELATED TO FINANCIAL COVENANTS. At various times since June 30, 2003, we have been out of compliance with one or more financial covenants contained in our $200.0 million credit facility (reduced to $100.0 million on September 30, 2004). We have continued to operate on the basis of waivers granted by the lender under this facility. We currently anticipate that we will be out of compliance with one or more of these financial covenants at October 31, 2004 and will need a waiver from this lender for this noncompliance to continue to operate. The expiration date of this facility was originally September 21, 2004, but the lender agreed to extend the expiration date until November 5, 2004 in consideration for, among other things, a reduction in the amount that could be borrowed under this facility to $100.0 million.

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At various times since June 30, 2003 we have also been out of compliance with the net worth requirement in several of our pooling and servicing agreements and sale and servicing agreements (collectively referred to in this document as the servicing agreements) and have been required to obtain waivers from and amendments to these agreements. As a result of the amendments to our servicing agreements, all of our servicing agreements associated with bond insurers now provide for term-to-term servicing and, in the case of our servicing agreements with two bond insurers, our rights as servicer may be terminated at the expiration of a servicing term in the sole discretion of the bond insurer.

We cannot assure you that we will continue to receive the waivers and servicing agreement extensions that we need to operate or that they will not contain conditions that are unacceptable to us. Because we anticipate incurring losses through at least the first quarter of fiscal 2005, we anticipate that we will need to obtain additional waivers from our lenders and bond insurers as a result of our non-compliance with financial covenants contained in our credit facilities and servicing agreements. To the extent we are not able to obtain waivers under our credit facilities, we may be unable to pay dividends on the Series A preferred stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" for additional information regarding the waivers obtained. See also "Risk Factors -- Restrictive covenants in the agreements governing our indebtedness may reduce our operating flexibility and limit our ability to operate profitability, and our ability to repay our outstanding debt may be impaired and the value of our capital stock could be negatively impacted" and " -- Our servicing rights may be terminated if we fail to satisfactorily perform our servicing obligations, or fail to meet minimum net worth requirements or financial covenants which could hinder our ability to operate profitably, impair our ability to repay our outstanding debt and negatively impact the value of our capital stock."

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SECURITIES CLASS ACTION LAWSUITS AND SHAREHOLDER DERIVATIVE ACTION. In January and February of 2004, four class action lawsuits were filed against us and certain of our officers and directors. A consolidated amended class action complaint that supersedes these four complaints was filed on August 19, 2004 in the United States District Court for the Eastern District of Pennsylvania. The consolidated complaint alleges that, during the applicable class period, our forbearance and deferment practices enabled us to, among other things, lower our delinquency rates to facilitate the securitization of our loans which purportedly allowed us to collect interest income from our securitized loans and inflate our financial results and market price of our common stock. The consolidated amended class action complaint seeks unspecified compensatory damages, costs and expenses related to bringing the action, and other unspecified relief.

On March 15, 2004, a shareholder derivative action was filed against us, as a nominal defendant, and our director and Chief Executive Officer, Anthony Santilli, our Chief Financial Officer, Albert Mandia, our directors, Messrs. Becker, DeLuca and Sussman, and our former director Mr. Kaufman, as defendants, in the United States District Court for the Eastern District of Pennsylvania and alleges that the named directors and officers breached their fiduciary duties to the Company, engaged in the abuse of control, gross mismanagement and other violations of law. The lawsuit seeks unspecified compensatory damages, equitable or injunctive relief and costs and expenses related to bringing the action, and other unspecified relief. The parties have agreed to stay this case pending disposition of any motion to dismiss the consolidated amended complaint filed in the putative consolidated securities class action. See "Legal Proceedings" and "Risk Factors -- We are subject to private litigation, including lawsuits resulting from the alleged "predatory" lending practices, as well as securities class action and derivative lawsuits, the impact of which on our financial position is uncertain. The inherent uncertainty related to litigation of this type and the preliminary stage of these suits makes it difficult to predict the ultimate outcome or potential liability that we may incur as a result of these matters."

WHERE YOU CAN GET ADDITIONAL INFORMATION

We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy our reports or other filings made with the SEC at the SEC's Public Reference Room, located at 450 Fifth Street, N.W., Washington, DC 20549. You can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. You can also access these reports and other filings electronically on the SEC's web site, www.sec.gov.

We also make these reports and other filings available free of charge on our web site, www.abfsonline.com, as soon as reasonably practicable after filing with the SEC. We will provide, at no cost, paper or electronic copies of our reports and other filings made with the SEC. Requests should be directed to:

Stephen M. Giroux, Esquire American Business Financial Services, Inc. 100 Penn Square East Philadelphia, PA 19107 (215) 940-4000

The information on the web sites listed above, is not and should not be considered part of this Annual Report on Form 10-K and is not incorporated by reference in this document. These web sites are and are only intended to be inactive textual references.

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BUSINESS STRATEGY

Our adjusted business strategy focuses on a shift from gain-on-sale accounting and the use of securitization transactions as our primary method of selling loans to a more diversified strategy which utilizes a combination of whole loan sales and securitizations, while protecting revenues, controlling costs and improving liquidity.

Our adjusted business strategy involves significantly increasing the use of loan brokers to increase loan origination volume and retaining and hiring senior officers to manage the broker program. In December 2003, we hired an experienced industry professional who manages our wholesale business and acquired a broker operation with 35 employees (67 employees at June 30, 2004) located in California. In March 2004, we opened a mortgage broker office in Maryland and hired three experienced senior managers and a loan origination staff of 40 (56 employees at June 30, 2004). In June 2004, we acquired a broker operation with 35 employees in Texas. In addition, we hired 25 account executives to develop relationships with mortgage brokers and to expand our broker presence in the eastern, southern and mid-western areas of the United States and retained 67 employees in our Upland Broker Services Philadelphia headquarters to support our growing broker network. In total at June 30, 2004, we had 285 employees in our broker operations, including 136 account executives.

Our business strategy includes the following:

o Selling substantially all of the loans we originate through a combination of whole loan sales and securitizations. Whole loan sales are generally completed on a weekly basis.

o Shifting from a predominantly publicly underwritten securitization strategy and gain-on-sale business model to a strategy focused on a combination of whole loan sales and smaller securitization transactions. When securitization opportunities are available to us, the size of our quarterly loan securitizations will be reduced from previous levels. We expect to execute our securitizations, if any, as private placements to institutional investors or publicly underwritten securitizations, subject to market conditions. Historically, the market for whole loan sales has provided reliable liquidity for numerous originators as an alternative to securitization. Whole loan sales provide immediate cash premiums to us, while securitizations generate cash over time but generally result in higher gains at the time of sale. We intend to rely less on gain-on-sale accounting and loan servicing activities for our revenue and earnings and will rely more on cash premiums earned on whole loan sales. This strategy is expected to result in relatively lower earnings levels at current loan origination volumes, but will increase cash flow, accelerate the timeframe for becoming cash flow positive and improve our liquidity position. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" for more detail on cash flow.

o Broadening our mortgage loan product line and increasing loan originations. Historically we have originated primarily fixed-rate home equity loans. Under our business strategy, we originate adjustable-rate, alt-A and alt-B mortgage loans which have higher credit scores as well as a wide array of fixed-rate and adjustable rate mortgage loans in order to appeal to a broader base of prospective customers and increase loan originations. During the three months ended June 30, 2004, 46.7% of the loans which we originated were adjustable-rate mortgage loans. We have also begun to originate purchase money mortgage loans primarily through our broker channel. In fiscal 2004, we originated $176.9 million of purchase money mortgages, or 18.0% of total home mortgage loans originated.

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o Offering more competitive interest rates charged to borrowers on new products. By offering more competitive interest rates charged on new products, we originate loans to borrowers with higher credit quality. In addition, by offering more competitive interest rates our loans appeal to a wider customer base which we expect will substantially reduce our marketing costs, make more efficient use of marketing leads and increase loan origination volume.

o Reducing origination of the types of loans that are not well received in the whole loan sale and securitization markets. During fiscal 2004, we originated only $587,000 of business purpose loans. In the future, we may originate business purpose loans to meet demand in the whole loan sale and securitization markets to the extent we obtain a credit facility to fund business purpose loans. We can utilize our current credit facilities only to fund home mortgage loans.

o Expanding the use of e-commerce in our retail and broker channels. This is expected to increase loan applications and reduce the cost to originate loans.

o Reducing the cost of loan originations. We have implemented plans to:

o reduce the cost to originate in our Upland Mortgage direct retail channel by broadening the product line and offering more competitive interest rates in order to increase origination volume, and reducing marketing costs;

o reduce the cost to originate in our broker channel by:
a) increasing volume by broadening the mortgage loan product line, b) consolidating some of the broker channel's operating functions to our centralized operating office in Philadelphia, and c) developing and expanding broker relationships; we also introduced Easy Loan Advisor on our Internet-based website for our offices supporting our broker operations. Easy Loan Advisor offers significant efficiencies by automating the origination and underwriting of loans; and

o reduce the cost to originate in the Bank Alliance Services program by broadening our product line and increasing the amount of fees we would charge to any new participating financial institutions.

o Reducing the amount of outstanding subordinated debentures. The increase in cash flow expected under our business strategy is expected to accelerate a reduction in our reliance on issuing subordinated debentures to meet our liquidity needs and allow us to begin to pay down existing subordinated debentures.

o Reducing operating costs. From June 30, 2003 to June 30, 2004, our workforce has experienced a net reduction of 150 employees. With our business strategy's focus on whole loan sales and offering a broader mortgage product line that we expect will appeal to a wider array of customers, we currently require a smaller employee base with fewer sales, servicing and support positions. However, we expect to increase our sales, servicing and support positions as necessary in the future to handle higher levels of loan originations. Since June 30, 2003 we reduced our workforce by approximately 255 employees and experienced a net loss of approximately 90 additional employees who resigned. Partially offsetting this workforce reduction, we have added 195 loan origination employees in our broker channel as part of our business strategy's focus on expanding our broker operations.

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Our business strategy is dependent on our ability to emphasize lending related activities that provide us with the most economic value. The implementation of this strategy will depend in large part on a variety of factors outside of our control, including, but not limited to, our ability to obtain adequate financing on reasonable terms and to profitably securitize or sell our loans on a regular basis. Our failure with respect to any of these factors could impair our ability to successfully implement our strategy, which could adversely affect our results of operations and financial condition. See "Risk Factors -- If we are unable to successfully implement our adjusted business strategy which focuses on whole loan sales, we may be unable to attain profitable operations which could impair our ability to repay our outstanding debt and could negatively impact the value of our capital stock."

SUBSIDIARIES

As a holding company, our activities have been limited to:

o providing management oversight over subsidiary operations;

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o holding the shares of our subsidiaries; and

o raising capital for use in the subsidiaries' lending and loan servicing operations.

We are the parent holding company of American Business Credit, Inc. and its primary subsidiaries, HomeAmerican Credit, Inc. (doing business as Upland Mortgage), American Business Mortgage Services, Inc., and Tiger Relocation Company.

American Business Credit, Inc., a Pennsylvania corporation incorporated in 1988 and acquired by us in 1993, currently services business purpose loans and home mortgage loans. In the past, this subsidiary also originated and sold business purpose loans.

HomeAmerican Credit, Inc., a Pennsylvania corporation incorporated in 1991, originates, purchases, sells and services home mortgage loans. HomeAmerican Credit, Inc. acquired Upland Mortgage Corp. in 1996 and since that time has conducted business as "Upland Mortgage." HomeAmerican Credit, Inc. also administers the Bank Alliance Services program. See "-- Lending Activities -- Home Mortgage Loans."

American Business Mortgage Services, Inc., a New Jersey corporation organized in 1938 and acquired by us in October 1997, originates, purchases, sells and services home mortgage loans.

Tiger Relocation Company, a Pennsylvania corporation, was incorporated in 1992 to hold, maintain and sell real estate properties acquired due to the default of a borrower under the terms of our loan documents.

We also have numerous special purpose subsidiaries that were incorporated solely to facilitate our securitizations and off-balance sheet mortgage conduit facilities. None of these corporations engage in any business activity other than holding the subordinated certificate, if any, and the interest-only strips created in connection with completed securitizations. See "-- Securitizations" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations." We also utilize special purpose entities in connection with our financing activities, including credit facilities. We also have several additional subsidiaries that are inactive or not significant to our operations.

14

The following chart sets forth our basic organizational structure and our primary subsidiaries.(a)


AMERICAN BUSINESS FINANCIAL
SERVICES, INC.

Holding Company Management oversight over subsidiary operations and raising capital for lending and servicing operations
| |

AMERICAN BUSINESS CREDIT, INC.


Services business purpose loans and
                               home mortgage loans
                  ---------------------------------------------
                                       |
            -------------------------------------------------------
            |                          |                          |
            |                          |                          |
    ----------------        ----------------------      ---------------------
       AMERICAN                  HOMEAMERICAN                   TIGER
       BUSINESS               CREDIT, INC. D/B/A             RELOCATION
       MORTGAGE                     UPLAND                     COMPANY
     SERVICES, INC.                MORTGAGE
    ----------------        ----------------------      ---------------------
    ----------------        ----------------------      ---------------------
      Originates,           Originates, purchases,        Holds, maintains
    purchases, sells          sells and services        and sells foreclosed
          and                 home mortgage loans             real estate
     services home           and administers the
       mortgage                 Bank Alliance
        loans                 Services program
   ----------------        ----------------------       ---------------------


____________________________

(a) In addition to the corporations pictured in this chart, we organized at least one special purpose corporation for each securitization and have several other subsidiaries that are inactive or not significant to our operations.

15

LENDING ACTIVITIES

GENERAL. The following table sets forth information concerning our loan origination, purchase and sale activities for the periods indicated.

                                                            YEAR ENDED JUNE 30,
                                                  -------------------------------------
                                                     2004          2003         2002
                                                  ---------       ------      ---------
                                                           (DOLLARS IN THOUSANDS)
Loans Originated/Purchased
    Business purpose loans....................    $     587    $   122,790  $   133,352
    Home mortgage loans.......................    $ 982,093    $ 1,543,730  $ 1,246,505
Number of Loans Originated/Purchased
    Business purpose loans....................            2          1,340        1,372
    Home mortgage loans.......................        8,281         17,003       14,015
Average Loan Size
    Business purpose loans....................    $     293    $        92  $        97
    Home mortgage loans.......................    $     119    $        91  $        89
Weighted-Average Interest Rate on Loans
    Originated/Purchased
      Business purpose loans..................        14.62%         15.76%       15.75%
      Home mortgage loans.....................         7.86%          9.99%       10.91%
      Combined................................         7.86%         10.42%       11.38%
Weighted-Average Term (in months)
    Business purpose loans....................          150            160          161
    Home mortgage loans.......................          294            272          260
Loans Securitized or Sold
    Business purpose loans....................    $  18,931    $   112,025  $   129,074
    Home mortgage loans.......................    $ 930,853    $ 1,339,752  $ 1,279,740
Number of Loans Securitized or Sold
    Business purpose loans....................          198          1,195        1,331
    Home mortgage loans.......................        9,932         14,952       14,379

The following table sets forth information regarding the average loan-to-value ratios for loans we originated and purchased during the periods indicated.

                                                           YEAR ENDED JUNE 30,
                                                      ------------------------------
                    LOAN TYPE                         2004         2003         2002
                    ---------                         ----         ----         ----
Business purpose loans........................        70.1%        62.2%        62.6%
Home mortgage loans...........................        81.3         78.2         77.8

16

The following table shows the geographic distribution of our loan originations and purchases during the periods indicated.

                                                         YEAR ENDED JUNE 30,
                         -------------------------------------------------------------------------------------
                                     2004                          2003                          2002
                         --------------------------    ----------------------------  -------------------------
                           Amount              %           Amount           %             Amount          %
                         ----------        -------     -------------   --------      --------------   --------
                                                   (dollars in thousands)
California                $230,665          23.47%       $      --          --%        $      --          --%
New York                    99,631          10.14          376,425       22.59           341,205       24.73
Pennsylvania                83,594           8.51          118,915        7.14           103,865        7.53
Massachusetts               64,254           6.54          134,342        8.06           101,383        7.35
Florida                     57,092           5.81          135,164        8.11            97,686        7.08
Maryland                    48,777           4.96           36,542        2.19            25,307        1.83
Virginia                    41,294           4.20           46,508        2.79            33,169        2.40
Michigan                    40,975           4.17           92,009        5.52            89,224        6.47
Ohio                        39,949           4.07           70,957        4.26            65,884        4.77
New Jersey                  38,108           3.88          212,035       12.72           159,117       11.53
Illinois                    37,617           3.83           90,111        5.41            73,152        5.30
Georgia                     26,127           2.66           21,022        1.26            49,956        3.62
Indiana                     17,583           1.79           33,671        2.02            27,833        2.02
Texas                       17,155           1.75            9,746        0.58               304        0.02
Connecticut                 16,841           1.71           42,525        2.55            30,461        2.21
Other (a)                  123,018          12.51          246,548       14.80           181,311       13.14
                          --------         ------       ----------      ------        ----------     -------
      Total               $982,680         100.00%      $1,666,520      100.00%       $1,379,857      100.00%
                          ========         ======       ==========      ======        ==========     =======


(a) No individual state included in "Other" constitutes more than 1.5% of total loan originations for the fiscal year ended June 30, 2004.

CUSTOMERS. Our loan customers are primarily credit-impaired borrowers who are generally unable to obtain financing from banks or savings and loan associations and who are attracted to our products and services. These institutions have historically provided loans only to individuals with the most favorable credit characteristics. These borrowers generally have impaired or unsubstantiated credit histories and/or unverifiable income. Our experience has indicated that these borrowers are attracted to our loan products as a result of our marketing efforts, the personalized service provided by our staff of highly trained lending officers and our timely response to loan requests. Historically, our customers have been willing to pay our origination fees and interest rates even though they are generally higher than those charged by traditional lending sources. This type of borrower is commonly referred to as a subprime borrower. Loans made to subprime borrowers are frequently referred to as subprime loans. See "-- Business Strategy."

HOME MORTGAGE LOANS. We originate home mortgage loans, consisting of home equity loans and purchase money mortgage loans, through Upland Mortgage and American Business Mortgage Services, Inc. We also process and purchase loans through the Bank Alliance Services program. We originate home mortgage loans primarily to credit-impaired borrowers through various channels including retail marketing and broker operations. Our retail channel includes direct mail and our subsidiaries' interactive web sites, and have included radio and television advertisements.

In total at June 30, 2004, we had 285 employees in our broker operations including 136 account executives. Our broker operations originate loans using a broker network that after recent expansion is spread geographically throughout the continental United States. During fiscal 2004, we added four offices with 192 employees at June 30, 2004 to support our broker operations and hired 25 account executives to expand our broker presence and increase loan originations. We also introduced Easy Loan Advisor on our Internet-based broker website for our offices supporting our broker operations. Easy Loan Advisor offers significant efficiencies by automating the origination and underwriting of these loans.

17

We entered the home equity loan market in 1991. With the recent expansion of our broker operations, we added purchase money mortgage loans in 2004. Currently, we are licensed or otherwise qualified to originate home mortgage loans in 46 states. We also hired 25 account executives to develop relationships with mortgage brokers and to expand our broker presence in the eastern, southern and mid-western areas of the United States. We generally sell on a whole loan basis with servicing released, or securitize the loans originated and funded by our subsidiaries.

The business strategy that we are emphasizing beginning in fiscal 2004 has impacted our origination of home mortgage loans. Our business strategy is designed to appeal to a broader prospective customer base and increase the amount of loan originations. We have broadened our mortgage loan product line to include adjustable-rate, alt-A and alt-B and purchase money mortgage loans. Our strategy also emphasizes reducing the cost to originate loans by expanding our broker network and reducing retail marketing costs. Our business strategy also focuses on shifting from a predominantly publicly underwritten securitization strategy and gain-on-sale business model to a strategy focused on a combination of whole loan sales and smaller securitization transactions. For a discussion of our business strategy and its potential impact on our home mortgage loan business, see "-- Business Strategy."

Our retail operations receive home mortgage loan applications from potential borrowers over the phone, in writing, in person or through our subsidiaries' interactive web sites, and most recently through third-party lending-related web sites with whom we have working agreements. The loan request is then evaluated for possible loan approval. The loan processing staff generally provides its home mortgage applicants who qualify for loans with a conditional loan approval within 24 hours and closes its home mortgage loans within approximately fifteen to twenty days of obtaining a conditional loan approval.

Our broker operations receive home mortgage loan applications from third-party unrelated brokers both in writing and increasingly through our newly introduced broker Internet web site. The loan request is then evaluated for possible loan approval. The loan processing staff generally provides the brokers with a conditional loan approval within 24 hours and closes its home mortgage loans within approximately fifteen to twenty days of obtaining a conditional loan approval.

18

The following table presents the amounts of loans we originated in 2004 in our retail and broker operations channels (in thousands):

                                                                                Bank
                                             Retail            Broker          Alliance
                                            Channel          Channel          Services           Total
                                         --------------    -------------    --------------    ------------
Purchase Money Mortgage Loans:
   Fixed rate                                 $  2,177       $ 45,617         $    634         $ 48,428
   Adjustable rate                                 836        127,607                -          128,443
                                              --------       --------         --------         --------
   Total                                      $  3,013       $173,224         $    634         $176,871
                                              ========       ========         ========         ========
Home Equity Loans:
   Fixed rate                                 $424,619       $ 94,051         $127,770         $646,440
   Adjustable rate                              40,423        104,503           13,856          158,782
                                              --------       --------         --------         --------
   Total                                      $465,042       $198,554         $141,626         $805,222
                                              ========       ========         ========         ========
Total Home Mortgage Loans:
   Fixed rate                                 $426,796       $139,668         $128,404         $694,868
   Adjustable rate                              41,259        232,110           13,856          287,225
                                              --------       --------         --------         --------
   Total                                      $468,055       $371,778         $142,260         $982,093
                                              ========       ========         ========         ========

Home mortgage loans ranged from $7,700 to $658,500 with an average loan size of approximately $119,000 during 2004 and $91,000 during 2003. We originated $982.1 million of home mortgage loans during fiscal 2004 and $1.5 billion during fiscal 2003. These loans were made both at fixed rates of interest and adjustable rates of interest, which were tied to 6 month LIBOR, and for terms ranging from five to thirty years, generally, with average origination fees of approximately 1.5% of the aggregate loan amount. The weighted-average interest rate received on home mortgage loans during fiscal 2004 was 7.86% and during fiscal 2003 was 9.99%. The average loan-to-value ratios for the loans originated by us during fiscal 2004 and fiscal 2003 were 81.3% and 78.2%, respectively.

We attempt to maintain our interest rates and other charges on home mortgage loans to be competitive with the lending rates of other sub-prime mortgage finance companies. To the extent permitted by law, borrowers are given an option to choose between a loan without a prepayment fee at a higher interest rate or a loan with a prepayment fee at a lower interest rate. We may waive the collection of a prepayment fee, if any, in the event the borrower refinances a home mortgage loan with us.

We have business arrangements with several financial institutions, which provide for our purchase of home mortgage loans that meet our underwriting criteria, but do not meet the guidelines of the selling institution for loans to be held in its portfolio. This program is called the Bank Alliance Services program. The Bank Alliance Services program is designed to provide an additional source of home mortgage loans. This program targets traditional financial institutions, such as banks, which because of their strict underwriting and credit guidelines for loans held in their portfolio have generally provided mortgage financing only to the most credit-worthy borrowers. This program allows these financial institutions to originate loans to credit-impaired borrowers in order to achieve community reinvestment goals and to generate fee income and subsequently sell such loans to one of our subsidiaries.

Pursuant to the program, a financial institution adopts our underwriting criteria for home mortgage loans not intended to be held in its portfolio. If an applicant meets our underwriting criteria, as adopted by the program, we process the application materials and underwrite the loan for final approval by the financial institution. If the financial institution approves the loan, we close the loan for the financial institution in its name with funding provided by the financial institution. We purchase the loan from the financial institution shortly after the closing. Following our purchase of the loans through this program, we hold these loans as available for sale until they are sold in a whole loan sale or securitization.

19

During fiscal 2004, we received referrals from approximately ten financial institutions participating in this program. As of June 30, 2004, seven financial institutions located in the eastern portion of the United States were actively participating in this program. These financial institutions provide us with the opportunity to process and purchase loans generated by the branch networks of such institutions, which consists of approximately 575 branches. These seven financial institutions accounted for approximately 20.5% of the referrals received by us under the Bank Alliance Services program during fiscal 2004. Pursuant to this program, our subsidiaries purchased approximately $142.3 million of loans during the year ended June 30, 2004 and $201.9 million of loans during the fiscal year ended June 30, 2003. During the year ended June 30, 2004, our top three financial institutions under the Bank Alliance Services program accounted for approximately 96.1% of our loan volume from this program. Only one of the seven remaining active participants was in our top three volume providers in fiscal 2004. We intend to expand the Bank Alliance Services program with financial institutions across the United States. See "-- Business Strategy."

During fiscal 1999, we launched a retail Internet loan distribution channel through Upland Mortgage's web site. Through this interactive web site, borrowers can examine available loan options and calculate monthly principal and interest payments. The Upland Mortgage Internet platform provides borrowers with convenient access to the mortgage loan information 7 days a week, 24 hours a day. Throughout the loan processing period, borrowers who submit applications are supported by our staff of highly trained loan officers. Currently, in addition to the ability to utilize an automated rapid pre-approval process, which we believe reduces time and manual effort required for loan approval, the site features our proprietary software, Easy Loan Advisor, which provides personalized services and solutions to retail customers through interactive web dialog. We have applied to the U.S. Patent and Trademark Office to patent this product.

During fiscal 2004, using our Easy Loan Advisor (referred to as ELA in this document) proprietary software, we launched a broker Internet loan distribution channel. We have added functionality to service the brokerage community and sales channels through its automated underwriting engine thereby providing access to the brokerage communities 7 days a week, 24 hours a day as well as loan structuring options to provide the various loan solutions to borrowers. The ELA software is a state of the art loan restructuring system which provides brokers almost instantaneous loan structure options. This technology is key to our forecasted loan growth.

BUSINESS PURPOSE LOANS. Through our subsidiary, American Business Credit, Inc., we service business purpose loans that we originated and sold in prior periods predominantly in the eastern and central portions of the United States through a network of salespeople, loan brokers and through our business loan web site.

During prior periods, we originated business purpose loans to corporations, partnerships, sole proprietors and other business entities for various business purposes including, but not limited to, working capital, business expansion, equipment acquisition, tax payments and debt-consolidation. We did not target any particular industries or trade groups and, in fact, took precautions against a concentration of loans in any one industry group. All business purpose loans originated generally were collateralized by a first or second mortgage lien on a principal residence of the borrower or a guarantor of the borrower or some other parcel of real property, such as office and apartment buildings and mixed use buildings, owned by the borrower, a principal of the borrower, or a guarantor of the borrower. In most cases, these loans were further collateralized by personal guarantees, pledges of securities, assignments of contract rights, life insurance and lease payments and liens on business equipment and other business assets. Prior to the fourth quarter of fiscal 2003, we generally securitized business purpose loans subsequent to their origination. We originated less than $1.0 million of business purpose loans in fiscal 2004. We are currently not originating these loans; however, in the future, we may originate business purpose loans to meet demand in the whole loan sale and securitization markets to the extent we obtain a credit facility to fund business purpose loans. If we originate business purpose loans in the future, we will focus our marketing efforts on small businesses that do not meet all of the credit criteria of commercial banks and small businesses that our research indicates may be predisposed to using our products and services. See "-- Business Strategy."

20

We originated $587,000 in business purpose loans during the year ended June 30, 2004, and originated $122.8 million during fiscal 2003. When we originated larger volumes of business purpose loans, these loans generally ranged from $14,000 to $685,000 and had an average loan size of approximately $92,000 for the loans originated during the fiscal year ended June 30, 2003. Generally, our business purpose loans are made at fixed interest rates and for terms ranging from five to fifteen years. We generally charged origination fees for these loans of 4.75% to 5.75% of the outstanding principal balance. The weighted-average interest rate charged on the business purpose loans originated by us during the year ended June 30, 2004 was 14.62% and during fiscal year 2003 was 15.76%. Business purpose loans we originated during fiscal 2004 and fiscal 2003 had a loan-to-value ratio, based solely upon the real estate collateral securing the loans, of 70.1% and 62.2%, respectively.

Generally, we compute interest due on our outstanding business purpose loans using the simple interest method. We generally impose a prepayment fee. Although prepayment fees imposed vary based upon applicable state law, the prepayment fees on our business purpose loan documents can be a significant portion of the outstanding loan balance. Whether a prepayment fee is imposed and the amount of such fee, if any, is negotiated between the individual borrower and American Business Credit, Inc. prior to closing of the loan. We may waive the collection of a prepayment fee, if any, in the event the borrower refinances a business loan with us.

PREPAYMENT FEES. Approximately 80% to 85% of our home mortgage loans serviced had prepayment fees at the time of their origination. On home mortgage loans where the borrower has elected the prepayment fee option, the prepayment fee is generally a certain percentage of the outstanding principal balance of the loan. Our typical prepayment fee structure provides for a fee of 5% or less of the outstanding principal loan balance and will not extend beyond the first three years after a loan's origination. Prepayment fees on our existing home mortgage loans range from 1% to 5% of the outstanding principal balance and remain in effect for one to five years. At the time of their origination, approximately 90% to 95% of our business purpose loans had prepayment fees. The prepayment fee on business purpose loans is generally 8% to 12% of the outstanding principal balance, provided that no prepayment option is available until after the 24th scheduled payment is made and no prepayment fee is due after the 60th scheduled payment is made. From time to time, a different prepayment fee arrangement may be negotiated or we may waive prepayment fees for borrowers who refinance their loans with us. At June 30, 2004, approximately 50% to 55% of securitized home mortgage loans in our total portfolio had prepayment fees and approximately 50% to 55% of securitized business purpose loans in our total portfolio had prepayment fees.

State law sometimes restricts our ability to charge a prepayment fee for both home mortgage and business purpose loans. Prior to its preclusion, we used the Parity Act to preempt these state laws for home mortgage loans which meet the definition of alternative mortgage transactions under the Parity Act. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Legal and Regulatory Considerations" for a discussion of how the adoption by the Office of Thrift Supervision in July 2003 of a rule which precludes us from using the Parity Act to preempt state prepayment penalty and late fees laws may impact our new loan originations.

In states which have overridden the Parity Act and in the case of some fully amortizing home mortgage loans, state laws may restrict prepayment fees either by the amount of the prepayment fee or the time period during which it can be imposed. Federal law restrictions in connection with certain high interest rate and fee loans may also preclude the imposition of prepayment fees on these loans. Similarly, in the case of business purpose loans, some states prohibit or limit prepayment fees when the loan is below a specific dollar threshold or is secured by residential property.

21

MARKETING STRATEGY

RETAIL LOAN ORIGINATION CHANNEL. Historically, we concentrated our marketing efforts for home mortgage loans primarily on credit-impaired borrowers who are generally unable to obtain financing from banks or savings and loan associations and who are attracted to our products and services. Although we still intend to lend to credit-impaired borrowers under our current business strategy, we have broadened our mortgage loan product line to include adjustable-rate, alt-A and alt-B and purchase money mortgage loans and to offer competitive interest rates in order to appeal to a wider range of customers. See "-- Business Strategy" and "Risk Factors -- Lending to credit-impaired borrowers may result in higher delinquencies in our total portfolio, which could hinder our ability to operate profitably, impair our ability to repay our outstanding debt and negatively impact the value of our capital stock."

We market home mortgage loans through direct mail campaigns and our interactive web sites, and have in the past used telemarketing, radio and television advertising. Recently, we have begun to accept applications forwarded to us by third-party lending-related web sites with whom we have working agreements. We believe that our targeted direct mail strategy delivers more leads at a lower cost than broadcast marketing channels. Our integrated approach to media advertising that utilizes a combination of direct mail and Internet advertising is intended to maximize the effect of our advertising campaigns. We expect the implementation of our business strategy to improve our response and conversion rates, which will reduce our overall marketing costs. We also use the Bank Alliance Services program as additional sources of loans.

Our marketing efforts for home mortgage loans in our retail channel are focused on the eastern and central portions of the United States and continuing to expand to the western portion of the United States. We previously utilized branch offices in various states to market our loans. Effective June 30, 2003, we no longer originate loans through retail branch offices.

BROKER OPERATIONS CHANNEL. We also use a network of loan brokers as a source of home mortgage loans. We continue to expand our network of loan brokers as part of our focus on whole loan sales in order to increase the amount of loans originated and reduce origination costs. During fiscal 2004, we acquired broker operations in West Hills, California and Austin, Texas, and opened new offices in Edgewater, Maryland and Irvine, California to support our broker operations.

We market our broker operations though various sources including direct broker solicitation, trade shows and trade advertising. We also introduced Easy Loan Advisor on our Internet-based website for our offices supporting our broker operations. Additionally, we market our programs and rates through e-mail.

BUSINESS PURPOSE LOANS. In prior fiscal years, our marketing efforts for business purpose loans focused on our niche market of selected small businesses located in our market area, which generally included the eastern and central portions of the United States. We targeted businesses, which might qualify for loans from traditional lending sources, but elected to use our products and services. Our experience had indicated that these borrowers were attracted to us as a result of our marketing efforts, the personalized service provided by our staff of highly trained lending officers and our timely response to loan applications. Historically, such customers had been willing to pay our origination fees and interest rates, which were generally higher than those charged by traditional lending sources.

We had marketed business purpose loans through various forms of advertising, including large direct mail campaigns, our business loan web site and a direct sales force and loan brokers, and had in the past used newspaper and radio advertising. Although we originated only $587,000 of business purpose loans during the year ended June 30, 2004, we may originate and sell business purpose loans in future periods to the extent we obtain a credit facility to fund business purpose loans. Certain business purpose loans originated by us in prior periods are held for sale. See "-- Business Strategy" and "-- Lending Activities -- Business Purpose Loans."

22

UNDERWRITING PROCEDURES AND PRACTICES

Summarized below are some of the policies and practices which are followed in connection with the origination of home mortgage loans and business purpose loans. These policies and practices may be altered, amended and supplemented, from time to time, as conditions warrant. We reserve the right to make changes in our day-to-day practices and policies at any time.

Our loan underwriting standards are applied to evaluate prospective borrowers' credit standing and repayment ability as well as the value and adequacy of the mortgaged property as collateral. Initially, the prospective borrower is required to provide pertinent credit information in order to complete a detailed loan application. As part of the description of the prospective borrower's financial condition, the borrower is required to provide information concerning assets, liabilities, income, credit, employment history and other demographic and personal information. If the application demonstrates the prospective borrower's ability to repay the debt as well as sufficient income and equity, loan processing personnel generally obtain and review an independent credit bureau report on the credit history of the borrower and verify the borrower's income. Once all applicable employment, credit and property information is obtained, a determination is made as to whether sufficient unencumbered equity in the property exists and whether the prospective borrower has sufficient monthly income available to meet the prospective borrower's monthly obligations.

The following table outlines the key parameters of the major credit grades of our current home mortgage loan underwriting guidelines. During fiscal 2004, we adjusted our credit grade and underwriting guidelines. We believe these adjustments provide more consistency with the guidelines used by institutional purchasers in the whole loan sale secondary market. As a result, we have broadened our home mortgage loan products to include loan programs allowing higher overall loan-to-value ratios, which are offset by compensating credit characteristics. These loans are originated with the primary intent of being sold as whole loans on the secondary market. The implementation of the new credit and underwriting guidelines allows us to be more competitive in the whole loan sale secondary market and enhances our ability to execute our adjusted business strategy. We will continue to monitor our credit and underwriting guidelines to maintain consistency with demand by institutional purchasers of whole loans. During the year ended June 30, 2004, home mortgage loans represented 99.9% of the loans we originated.

23

                          "A" CREDIT GRADE            "B" CREDIT GRADE            "C" CREDIT GRADE                   HOPE
--------------------  -------------------------    -------------------------  -------------------------   -------------------------
General Repayment     Has good credit but might    Pays the majority of       Marginal credit history     Designed to provide a
                      have some minor              accounts on time but has   which is offset by other    borrower with poor credit
                      delinquency                  some 30 and/or 60 day      positive attributes.        history an opportunity to
                                                   delinquency                                            correct past credit
                                                                                                          problems through lower
                                                                                                          monthly payment.

Existing Mortgage     Cannot exceed a maximum      Cannot exceed a maximum    Cannot exceed two 60 day    Cannot exceed a maximum
Loans                 of three 30 day              of four 30 day             delinquencies and/or one    of one 120 day
                      delinquencies in the past    delinquencies/ one 60 day  90 day delinquency in the   delinquency in the past
                      12 months.                   delinquency in the past    past 12 months.             12 months.
                                                   12 months.

Non-Mortgage Credit   Major credit and             Major credit and           Major credit and            Major and minor credit
                      installment debt should      installment debt can       installment debt can        delinquency is
                      be current but may           exhibit some minor 30      exhibit some minor 30       acceptable, but must
                      exhibit some minor 30 day    and/or 60 day              and/or 90 day               demonstrate some payment
                      delinquency. Minor credit    delinquency. Minor credit  delinquency. Minor credit   regularity.
                      may exhibit some minor       may exhibit up to 90 day   may exhibit more serious
                      delinquency.                 delinquency.               delinquency.

Bankruptcy Filings    Discharged more than 2       Discharged more than 18    Discharged more than 1      Discharged more than 2
Chapter 7             years with reestablished     months with reestablished  year with reestablished     years with reestablished
                      credit.                      credit.                    credit.                     credit.

Chapter 13            Filed more than 2 years,     Filed more than 18         Filed more than 1 year,     Filed more than 1 year,
                      satisfactory payment plan    months, satisfactory       satisfactory payment plan   satisfactory payment plan
                      performance                  payment plan performance   performance                 performance

Debt Service-to-      Generally not to exceed      Generally not to exceed    Generally not to exceed     Generally not to exceed
Income                50%.                         50%.                       55%.                        55%.

Owner Occupied:       Generally 80% to 100% for    Generally 80% to 85% for   Generally 70% to 80% for    Generally 65% to 70% for
Loan-to-value ratio   a 1-4 family dwelling        a 1-4 family dwelling      a 1-4 family dwelling       a 1-4 family dwelling
                      residence; 90% for a         residence; 85% for a       residence; 70% for a        residence.
                      condominium.                 condominium.               condominium.

Non-Owner Occupied:   Generally 85% for a 1-4      Generally 75% for a 1-4    Generally 70% for a 1-4     N/A
Loan-to-value ratio   family dwelling or           family dwelling or         family dwelling or
                      condominium.                 condominium.               condominium.

24

In addition to the home mortgage loans we originate under the standard home mortgage loan underwriting guidelines outlined in the preceding table, we also originate a limited number of second mortgage home equity loans that have loan-to-value ratios ranging from 90% to 100%. We consider these loans to be high loan-to-value home equity loans and we underwrite these loans with a more restrictive approach to evaluating the borrowers' qualifications and we require a stronger credit history than our standard guidelines. The borrowers' existing mortgage and installment debt payments must generally be paid as agreed, with no more than one 30-day delinquency on a mortgage within the last 12 months. No bankruptcy or foreclosure is permitted in the last 24 months.

Pursuant to our current business strategy, a greater number of loans that we originate will be offered to the secondary market through whole loan sales. These loans will be underwritten, allocated and sold to specific third party purchasers based on agreed upon products and underwriting guidelines. The purchaser products and guidelines currently being utilized generally conform to key parameters outlined in the preceding table. See "-- Business Strategy."

If originated, business purpose loans generally are secured by residential real estate and at times commercial real estate. Loan amounts generally ranged from $14,000 to $685,000. The loan-to-value ratio (based solely on the appraised fair market value of the real estate collateral securing the loan) on the properties collateralizing the loans generally has a maximum range of 50% to 75%. The actual maximum loan-to-value ratio varies depending on a variety of factors including, the credit grade of the borrower, whether the collateral is a one to four family residence, a condominium or a commercial property and whether the property is owner occupied or non-owner occupied. The credit grade of a business purpose loan borrower will vary depending on the payment history of their existing mortgages, major lines of credit and minor lines of credit, allowing for delinquency but generally requiring major credit to be current at closing. The underwriting of the business purpose loan included confirmation of income or cash flow through tax returns, bank statements and other forms of proof of income and business cash flow. Generally, we made loans to businesses whose bankruptcy was discharged at least two years prior to closing, but we had made exceptions to allow for the bankruptcy to be discharged just prior to or at closing. In addition, we generally received additional collateral in the form of, among other things, personal guarantees, pledges of securities, assignments of contract rights, assignments of life insurance and lease payments and liens on business equipment and other business assets, as available. Based solely on the value of the real estate collateral securing our business purpose loans, the average loan-to-value ratio of business purpose loans we originated during fiscal 2004 and 2003 were 70.1% and 62.2%, respectively.

Generally, the maximum acceptable loan-to-value ratio for home mortgage loans to be securitized is 100%. The average loan-to-value ratios of home mortgage loans we originated during the years ended June 30, 2004 and 2003 were 81.3% and 78.2%, respectively. We generally obtain title insurance in connection with our loans.

In determining whether the mortgaged property is adequate as collateral, we have an appraisal performed for each property considered for financing. The appraisal is completed by a licensed qualified appraiser on a Fannie Mae form and generally includes pictures of comparable properties and pictures of the property securing the loan.

Any material decline in real estate values reduces the ability of borrowers to use home equity to support borrowings and increases the loan-to-value ratios of loans previously made by us, thereby weakening collateral coverage and increasing the possibility of a loss in the event of borrower default. Further, delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. As a result, we cannot assure that the market value of the real estate underlying the loans will at any time be equal to or in excess of the outstanding principal amount of those loans. Although we have expanded the geographic area in which we originate loans, a downturn in the economy generally or in a specific region of the country may have an effect on our originations. See "Risk Factors -- A decline in value of the collateral securing our loans could result in an increase in losses on foreclosure, which could hinder our ability to attain profitable operations, limit our ability to repay our outstanding debt and negatively impact the value of our capital stock."

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LOAN SERVICING AND ADMINISTRATIVE PROCEDURES

We service the loans in accordance with our established servicing procedures. The loans we service include loans we hold as available for sale and most of the loans we have securitized. Our servicing procedures include practices regarding processing of mortgage payments, processing of disbursements for tax and insurance payments, maintenance of mortgage loan records, performance of collection efforts, including disposition of delinquent loans, foreclosure activities and disposition of real estate owned and performance of investor accounting and reporting processes, which in general conform to the mortgage servicing practices of prudent mortgage lending institutions. We generally receive contractual servicing fees for our servicing responsibilities for securitized loans, calculated as a percentage of the outstanding principal amount of the loans serviced. In addition, we receive other ancillary fees related to the loans serviced. On July 12, 2004, our servicing and collections activities, which were previously located at our operating office in Bala Cynwyd, Pennsylvania, were relocated to our Philadelphia, Pennsylvania office. At June 30, 2004, the portfolio we serviced consisted of 27,165 loans with an aggregate outstanding balance of $2.1 billion.

In servicing loans, we send an invoice to borrowers on a monthly basis advising them of the required payment and its scheduled due date. We begin the collection process promptly after a borrower fails to make a scheduled monthly payment. When a loan becomes 45 to 60 days delinquent, it is transferred to a senior collector in the collections department. The senior collector tries to resolve the delinquency by reinstating a delinquent loan, seeking a payoff, or entering into a deferment or forbearance arrangement with the borrower to avoid foreclosure. All proposed arrangements are evaluated on a case-by-case basis, based on, among other things, the borrower's past credit history, current financial status, cooperativeness, future prospects and the reasons for the delinquency. If a mortgage loan becomes 45 days delinquent and we do not reach a satisfactory arrangement with the borrower, our legal department will mail a notice of default to the borrower. If the delinquency is not cured within the time period provided for in the loan documents, we generally start a foreclosure action. The collection department maintains normal collection efforts during the cure periods following a notice of default and the initiation of foreclosure action. If a borrower declares bankruptcy, our in-house attorneys and paralegals promptly act to protect our interests. We may initiate legal action earlier than 45 days following a delinquency if we determine that the circumstances warrant such action.

We employ a staff of experienced mortgage collectors and managers working in shifts seven days a week to manage delinquent loans. In addition, a staff of in-house attorneys and paralegals works closely with the collections staff to optimize collection efforts. The primary goal of our labor-intensive collections program is to emphasize delinquency and loss prevention.

From time to time, borrowers are confronted with events, usually involving hardship circumstances or temporary financial setbacks that adversely affect their ability to continue payments on their loan. To assist borrowers, we may agree to enter into a deferment or forbearance arrangement. Prevailing economic conditions, which may affect the borrower's ability to make their regular payments, may also have an impact on the value of the real estate or other collateral securing the loans, resulting in a change to the loan-to-value ratio. We may take these conditions into account when we evaluate a borrower's request for assistance for relief from the borrower's financial hardship.

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Our policies and practices regarding deferment and forbearance arrangements, like all of our collections policies and practices, are designed to manage customer relationships, maximize collections and avoid foreclosure (or repossession of other collateral, as applicable) if reasonably possible. We review and regularly revise these policies and procedures in order to enhance their effectiveness in achieving these goals.

In a deferment arrangement, we make advances on behalf of the borrower in amounts equal to the delinquent loan payments, which include principal and interest. Additionally, we may pay taxes, insurance and other fees on behalf of the borrower. Based on our review of the borrower's current financial circumstances, the borrower must repay the advances and other payments and fees we make on the borrower's behalf either at the termination of the loan or on a payment plan. Borrowers must provide a written explanation of their hardship, which generally requests relief from their delinquent loan payments. We review the borrower's current financial situation and based upon this review, we may create a payment plan for the borrower which allows the borrower to pay past due amounts over a period ranging from approximately 12 to 42 months, depending on the period for which deferment is requested, but not beyond the maturity date of the loan, in addition to making regular monthly loan payments. Each deferment arrangement must be approved by two of our managers. Deferment arrangements which defer two or more past due payments must also be approved by at least two senior vice presidents.

Principal guidelines currently applicable to the deferment process include: (i) the borrower may have up to six payments deferred during the life of the loan; (ii) no more than three payments may be deferred during a twelve-month period; and (iii) the borrower must have made a minimum of six payments on the loan and twelve months must have passed since the last deferment in order to qualify for a new deferment arrangement. Any deferment arrangement, which includes an exception to our guidelines, must be approved by two senior vice presidents. If the deferment arrangement is approved, a collector contacts the borrower regarding the approval and the revised payment terms.

For borrowers who are three or more payments delinquent, we will consider using a forbearance arrangement. In a forbearance arrangement, we make advances on behalf of the borrower in amounts equal to the delinquent loan payments, which include principal and interest. Additionally, we may pay taxes, insurance and other fees on behalf of the borrower. We assess the borrower's current financial situation and based upon this assessment, we will create a payment plan for the borrower which allows the borrower to pay past due amounts over a longer period than a typical deferment arrangement, but not beyond the maturity date of the loan. We typically structure a forbearance arrangement to require the borrower to make payments of principal and interest equivalent to the original loan terms plus additional monthly payments, which in the aggregate represent the amount that we advanced on behalf of the borrower.

Principal guidelines currently applicable to the forbearance process include the following: (i) the borrower must have first and/or second mortgages with us; (ii) the borrower's account was originated at least six months prior to the request for forbearance; (iii) the borrower's account must be at least three payments delinquent to qualify for a forbearance agreement; (iv) the borrower must submit a written request for forbearance containing an explanation for his or her previous delinquency and setting forth the reasons that the borrower now believes he or she is able to meet his or her loan obligations; and (v) the borrower must make a down payment of at least one month's past due payments of principal and interest in order to enter into a forbearance agreement, and the borrower who is six or more payments delinquent must make a down payment of at least two past due payments. No request for forbearance may be denied without review by our senior vice president of collections or his designee.

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We do not enter into a deferment or forbearance arrangement based solely on the fact that a loan meets the criteria for one of the arrangements. Our use of any of these arrangements also depends upon one or more of the following factors: our assessment of the individual borrower's current financial situation, reasons for the delinquency and our view of prevailing economic conditions. Because deferment and forbearance arrangements are account management tools which help us to manage customer relationships, maximize collection opportunities and increase the value of our account relationships, the application of these tools generally is subject to constantly shifting complexities and variations in the marketplace. We attempt to tailor the type and terms of the arrangement we use to the borrower's circumstances, and we prefer to use deferment over forbearance arrangements, if possible.

As a result of these arrangements, we reset the contractual status of a loan in our managed portfolio from delinquent to current based upon the borrower's resumption of making their principal and interest loan payments. A loan remains current after a deferment or forbearance arrangement with the borrower only if the borrower makes the principal and interest payments as required under the terms of the original note (exclusive of delinquent payments advanced or fees paid by us on the borrower's behalf as part of the deferment or forbearance arrangement), and we do not reflect it as a delinquent loan in our delinquency statistics. However, if the borrower fails to make principal and interest payments, we will declare the account in default, reflect it as a delinquent loan in our delinquency statistics and resume collection actions. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Total Portfolio Quality -- Deferment and Forbearance Arrangements" for information regarding the impact of these arrangements on our operations.

Based on information learned by our in-house legal staff while participating in industry forums and conferences and statements made by outside attorneys to us in the course of their legal representation of us, we believe we are among a small number of non-conforming lenders that have an in-house legal staff dedicated to the collection of delinquent loans and the handling of bankruptcy cases. As a result, we believe our delinquent loans are reviewed from a legal perspective earlier in the collection process than is the case with loans made by traditional lenders so that troublesome legal issues can be noted and, if possible, resolved earlier. For example, if in the course of the collection of a loan or fee the servicing department or collections department becomes aware of problems with a loan, such as title issues, department personnel will immediately notify an in-house attorney who will review the file and immediately initiate any necessary corrective action, including referral to outside counsel if appropriate. Also as an example, every notice of default and bankruptcy proof of claim is signed by an in-house attorney. Frequently, when reviewing the file relevant to a particular notice of default or proof of claim, the reviewing attorney will become aware of inconsistencies or issues and immediately initiate any necessary corrective action, including referral to outside counsel if appropriate. This frequent day-to-day contact between our servicing and collections departments, our in-house legal staff and outside counsel, and the early involvement of an in-house attorney in emerging legal issues that this facilitates, enables our in-house attorneys to resolve issues before they become costly disputes and to negotiate alternatives to foreclosure for problem loans.

Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until it is sold. After acquisition, all costs incurred in maintaining the property are accounted for as expenses. When carried on our balance sheet, we record real estate owned at the lower of cost or estimated fair value.

Most foreclosures are handled by outside counsel who are managed by our in-house legal staff to ensure that the time period for handling foreclosures meets or exceeds established industry standards. Frequent contact between in-house and outside counsel ensures that the process moves quickly and efficiently in an attempt to achieve a timely and economical resolution to contested matters.

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Our ability to foreclose on some properties may be affected by state and federal environmental laws. The costs of investigation, remediation or removal of hazardous substances may be substantial and can easily exceed the value of the property. The presence of hazardous substances, or the failure to properly eliminate the substances from the property, can hurt the owner's ability to sell or rent the property and prevent the owner from using the property as collateral for another loan. Even parties who arrange for the disposal or treatment of hazardous or toxic substances may be liable for the costs of removal and remediation, whether or not the facility is owned or operated by the party who arranged for the disposal or treatment. See "Risk Factors -- Environmental laws and regulations and other environmental considerations may restrict our ability to foreclose on loans secured by real estate or increase costs associated with those loans which could hinder our ability to operate profitably, limit the funds available to repay our outstanding debt and negatively impact the value of our capital stock." The technical nature of some laws and regulations, such as the Truth in Lending Act, can also contribute to difficulties in foreclosing on real estate and other assets, as even immaterial errors can trigger foreclosure delays or other difficulties.

As the servicer of securitized loans, we are obligated to advance funds for scheduled interest payments that have not been received from the borrower unless we determine that our advances will not be recoverable from subsequent collections of the related loan payments. See "-- Securitizations" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations." We are also required to compensate investors (without a right to reimbursement) for interest shortfall resulting from loan prepayments up to the amount of our servicing fee. See "Risk Factors -- Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay our outstanding debt and could negatively impact the value of our capital stock."

Beginning in the fourth quarter of fiscal 2002, we offered customer retention incentives to borrowers who were exploring loan refinancing opportunities for the purpose of lowering their monthly loan payments. In an attempt to retain the loans we were servicing for these borrowers, we offered the borrowers the opportunity to receive a monthly cash rebate equal to a percentage of their scheduled monthly loan payments for periods of six to twelve months. When we were successful in retaining these loans, we reduced the level of loan prepayments in our managed portfolio of securitized loans. To initially qualify for this program, a borrower has to be current on their loan principal and interest payments and to continue to qualify and receive each month's cash rebate, a borrower has to remain current. The percentage of rebates on scheduled monthly loan payments offered to participants ranged from 15% to 20%. At June 30, 2004, $344.8 million in principal amount outstanding on loans were participating in this program on which we expect to pay rebates of approximately $1.3 million.

SECURITIZATIONS

We were unable to complete quarterly publicly underwritten securitizations during the fourth quarter of fiscal 2003 and all of fiscal 2004. We completed a privately-placed securitization in the second quarter of fiscal 2004. Our inability to complete a publicly underwritten securitization during the fourth quarter of fiscal 2003 was the result of our investment bankers' decision in late June 2003 not to underwrite the contemplated June 2003 securitization transaction. Management believes that a number of factors contributed to this decision, including a highly-publicized lawsuit finding liability of an underwriter in connection with the securitization of loans for another unaffiliated subprime lender, an inquiry by the Civil Division of the U.S. Attorney's Office in Philadelphia regarding our forbearance practices, an anonymous letter regarding us received by our investment bankers, the SEC's enforcement action against another unaffiliated subprime lender related to its loan restructuring practices and related disclosure, a federal regulatory agency investigation of practices by another subprime servicer and our investment bankers' prior experience with securitization transactions with non-affiliated originators.

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During the year ended June 30, 2004, we completed a securitization of $135.9 million of loans in the second quarter and sold $5.5 million of loans into an off-balance sheet mortgage conduit facility. During fiscal 2003, we securitized $112.0 million of business purpose loans and $1.3 billion of home equity loans. During fiscal 2002, we securitized $129.1 million of business purpose loans and $1.2 billion of home equity loans. The securitization of loans and sale into the mortgage conduit facility generated gains on sale of loans of $15.1 million during the year ended June 30, 2004, $171.0 million during fiscal 2003 and $185.6 million during fiscal 2002. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations" for additional information regarding our securitizations.

Securitization is a financing technique often used by originators of financial assets to raise capital. A securitization involves the sale of a pool of financial assets, in our case loans, to a trust in exchange for cash and a retained interest in the securitized loans which is called an interest-only strip. The trust issues multi-class securities which derive their cash flows from a pool of securitized loans. These securities, which are senior to our retained interest-only strips in the trust, are sold to public or private investors. We may also retain servicing on securitized loans. See "-- Loan Servicing and Administrative Procedures."

As the holder of the interest-only strips received in a securitization, we are entitled to receive excess (or residual) cash flows. These cash flows are the difference between the payments made by the borrowers on securitized loans and the sum of the scheduled and prepaid principal and pass-through interest paid to trust investors, servicing fees, trustee fees and, if applicable, surety fees. Surety fees are paid to an unrelated insurance entity to provide protection for the trust investors. These cash flows also include cash flows from overcollateralization. Overcollateralization is the excess of the aggregate principal balances of loans in a securitized pool over investor interests. Overcollateralization requirements are established to provide credit enhancement for the trust investors.

We may be required either to repurchase or to substitute loans which do not conform to the representations and warranties we made in the agreements entered into when the loans are sold through a securitization. As of June 30, 2004, we have been required to substitute only one such loan from the securitization trusts for this reason.

When borrowers are delinquent in making scheduled payments on loans included in a securitization trust, we are obligated to advance interest payments with respect to such delinquent loans if we deem that these advances will ultimately be recoverable. These advances can first be made out of funds available in the trust's collection account. If the funds available from the collection account are insufficient to make the required interest advances, then we are required to make the advances from our operating cash. The advances made from a trust's collection account, if not recovered from the borrower or proceeds from the liquidation of the loan, require reimbursement from us. These advances may require funding from our capital resources and may create greater demands on our cash flow than either selling loans with servicing released or maintaining a portfolio of loans on our balance sheet. However, any advances we make from our operating cash can be recovered from the subsequent mortgage loan payments to the applicable trust prior to any distributions to the certificate holders. See "Risk Factors -- Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay our outstanding debt and could negatively impact the value of our capital stock."

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At times we elect to repurchase some delinquent loans from the securitization trusts, some of which may be in foreclosure. Repurchasing loans benefits us by allowing us to limit the level of delinquencies and losses in the securitization trusts and as a result, we can avoid exceeding specified limits on delinquencies and losses that trigger a temporary reduction or discontinuation of residual or stepdown overcollateralization cash flows from our interest-only strips until the delinquencies or losses no longer exceed the triggers. We have the right, but are not obligated, to repurchase a limited amount of delinquent loans from securitization trusts. The purchase price of a delinquent loan is at the loan's outstanding contractual balance plus accrued and unpaid interest and unreimbursed servicing advances, however, unpaid interest and unreimbursed servicing advances are returned to us by the trust. A foreclosed loan is one where we, as servicer, have initiated formal foreclosure proceedings against the borrower and a delinquent loan is one that is 31 days or more past due. The foreclosed and delinquent loans we typically elect to repurchase are usually 90 days or more delinquent and the subject of foreclosure proceedings, or where a completed foreclosure is imminent. In addition, we elect to repurchase loans in situations requiring more flexibility for the administration and collection of these loans in order to maximize their economic recovery. See "Risk Factors - Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay our outstanding debt and could negatively impact the value of our capital stock." See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations -- Trigger Management" for a description of the impact of these repurchases on our business.

In the past, certain of our securitizations included a prefunding option where a portion of the cash received from investors is withheld until additional loans are transferred to the trust. The loans to be transferred to the trust to satisfy the prefund option must be substantially similar in terms of collateral, size, term, interest rate, geographic distribution and loan-to-value ratio as the loans initially transferred to the trust. We had no prefund obligations at June 30, 2004.

WHOLE LOAN SALES

Our determination to engage in whole loan sales depends upon a variety of factors, including market conditions in the securitization markets and the secondary loan markets, profitability and cash flow considerations. Due to our inability to complete a quarterly securitization during the fourth quarter of fiscal 2003, we adjusted our business strategy from a predominantly publicly underwritten securitization strategy to a strategy focused on a combination of whole loan sales and securitizations. See "Managements Discussion and Analysis of Financial Condition and Results of Operations -- Whole Loan Sales" for more detail.

COMPETITION

We have significant competition for home mortgage loans. We concentrate our marketing efforts for home mortgage loans on credit-impaired borrowers. Through Upland Mortgage and American Business Mortgage Services, Inc., we compete with banks, thrift institutions, mortgage bankers and other finance companies. Many large financial institutions have gradually expanded their sub-prime lending capabilities. Many of these companies have name recognition and greater access to capital at a cost lower than our cost of capital. Additionally, federally chartered banks and thrifts can preempt some of the state and local lending laws to which we are subject, thereby giving them a competitive advantage.

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 interest rates we can charge borrowers, thereby potentially lowering gain on future whole loan sales and securitizations.

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We attempt to mitigate these factors through a highly trained staff of professionals, rapid response to prospective borrowers' requests and by maintaining a relatively short average loan processing time. See "-- Marketing Strategy" for information regarding the markets in which we compete. See "-- Business Strategy" for discussion of our emphasis on broadening our mortgage loan product line and offering competitive interest rates. See "Risk Factors -- Competition from other lenders could adversely affect our ability to attain profitable operations and our ability to repay our outstanding debt may be impaired and the value of our capital stock could be negatively impacted."

REGULATION

GENERAL. Our business is regulated by federal, state and, in certain cases, local laws. All home mortgage loans must meet the requirements of, among other statutes and regulations, the Truth in Lending Act, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act of 1974, and their associated Regulations Z, X and B, respectively.

TRUTH IN LENDING. The Truth in Lending Act and Regulation Z contain disclosure requirements designed to provide consumers with uniform, understandable information about the terms and conditions of loans and credit transactions so that consumers may compare credit terms. The Truth in Lending Act also guarantees consumers a three-day right to cancel certain transactions described in the act and imposes specific loan feature restrictions on some loans, including some of the same types of loans originated by us. If we were found not to be in compliance with the Truth in Lending Act, some aggrieved borrowers could, depending on the nature of the non-compliance, have the right to recover actual damages, statutory damages, penalties, rescind their loans and/or to demand, among other things, the return of finance charges and fees paid to us and third parties. Other fines and penalties can also be imposed under the Truth in Lending Act and Regulation Z.

EQUAL CREDIT OPPORTUNITY ACT, FAIR CREDIT REPORTING ACT AND OTHER LAWS. We are also required to comply with the Equal Credit Opportunity Act and Regulation B, which prohibit creditors from discriminating against applicants on the basis of race, color, religion, national origin, sex, age or marital status. Regulation B also restricts creditors from obtaining certain types of information from loan applicants. Among other things, it also requires lenders to advise applicants of the reasons for any credit denial. Equal Credit Opportunity Act violations can also result in fines, penalties and other remedies.

In instances where the applicant is denied credit or the rate of interest for a loan increases as a result of information obtained from a consumer credit reporting agency, the Fair Credit Reporting Act of 1970, as amended, requires lenders to supply the applicant with the name and address of the reporting agency whose credit report was used in making such determinations. It also requires that lenders provide other information and disclosures about the loan application rejection. In addition, we are subject to the Fair Housing Act and regulations under the Fair Housing Act, which broadly prohibit discriminatory practices in connection with our home equity and other lending businesses.

Pursuant to the Home Mortgage Disclosure Act and Regulation C, we are also required to report information on loan applicants and certain other borrowers to the Department of Housing and Urban Development, which is among numerous federal and state agencies which monitor compliance with fair lending laws.

We are also subject to the Real Estate Settlement Procedures Act and Regulation X. This law and this regulation, which are administered by the Department of Housing and Urban Development, impose limits on the amount of funds a borrower can be required to deposit with us in any escrow account for the payment of taxes, insurance premiums or other charges; limits the fees which may be paid to third parties; and imposes various disclosure and other requirements.

We are subject to various other federal, state and local laws, rules and regulations governing the licensing of mortgage lenders and servicers. We must comply with procedures mandated for mortgage lenders and servicers, and must provide disclosures to consumer applicants and borrowers. Failure to comply with these laws, as well as with the laws described above, may result in civil and criminal liability.

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Several of our subsidiaries are licensed and regulated by the departments of banking or similar entities in the various states in which they are conducting business. The rules and regulations of the various states impose licensing and other restrictions on lending activities, such as prohibiting discrimination and regulating collection, foreclosure procedures and claims handling, disclosure obligations, payment feature restrictions and, in some cases, these laws fix maximum interest rates and fees. Failure to comply with these requirements can lead to termination or suspension of licenses, rights of rescission for mortgage loans, individual and class action lawsuits and/or administrative enforcement actions. Our in-house compliance staff, which includes attorneys, and our outside counsel review and monitor the lending policies of our subsidiaries for compliance with the various federal and state laws.

The Gramm-Leach-Bliley Act, which was signed into law at the end of 1999, contains comprehensive consumer financial privacy restrictions. Various federal enforcement agencies, including the Federal Trade Commission, have issued final regulations to implement this act. These restrictions fall into two basic categories. First, a financial institution must provide various notices to consumers about such institution's privacy policies and practices. Second, this act imposes restrictions on a financial institution and gives consumers the right to prevent a financial institution from disclosing non-public personal information about the consumer to non-affiliated third parties, with exceptions. We have prepared the appropriate consumer disclosures and internal procedures to address these requirements.

In addition, on December 22, 2003, we entered into a joint agreement with the Civil Division of the U.S. Attorney's Office for the Eastern District of Pennsylvania, which ended the inquiry by the U.S. Attorney focused on our forbearance policy initiated pursuant to the civil subpoena dated May 14, 2003. See "Legal Proceedings."

The previously described laws and regulations are subject to legislative, administrative and judicial interpretation. Some of these laws and regulations have recently been enacted or amended. Some of these laws and regulations are rarely challenged in, or interpreted by, the courts. Infrequent interpretations, an insignificant number of interpretations and/or conflicting interpretations of these enacted or amended laws and regulations can make it difficult for us to always know what is permitted conduct under these laws and regulations. Any ambiguity or vagueness under the laws and regulations to which we are subject may lead to regulatory investigations or enforcement actions and private causes of action, such as class action lawsuits, with respect to our compliance with the applicable laws and regulations. See "Risk Factors -- Our residential lending business is subject to government regulation and licensing requirements, which may hinder our ability to operate profitably, negatively impair our ability to repay our outstanding debt and negatively impact the value of our capital stock."

PREDATORY LENDING REGULATIONS. State and federal banking regulatory agencies, state attorneys general offices, the Federal Trade Commission, the U.S. Department of Justice, the U.S. Department of Housing and Urban Development and state and local governmental authorities have increased their focus on lending practices by some companies in the subprime lending industry, more commonly referred to as "predatory lending" practices. State, local and federal governmental agencies have imposed sanctions for practices including, but not limited to, charging borrowers excessive fees, imposing higher interest rates than the borrower's credit risk warrants and failing to adequately disclose the material terms of loans to the borrowers. For example, the Pennsylvania Attorney General reviewed fees our subsidiary, HomeAmerican Credit, Inc., charged Pennsylvania customers. Although we believe that these fees were fair and in compliance with applicable federal and state laws, in April 2002, we agreed to reimburse borrowers approximately $221,000 with respect to a particular fee paid by borrowers from January 1, 1999 to mid-February 2001 and to reimburse the Commonwealth of Pennsylvania $50,000 for its costs of investigation and for future public protection purposes. We discontinued charging this particular fee in mid-February 2001. As a result of these initiatives, we are unable to predict whether state, local or federal authorities will require changes in our lending practices in the future, including reimbursement of fees charged to borrowers, or will impose fines on us. These changes, if required, could impact our profitability. These laws and regulations may limit our ability to securitize loans originated in certain states or localities due to rating agency, investor or market restrictions. As a result, we have limited the types of loans we offer in some states and may discontinue originating loans in other states or localities. See "Risk Factors -- Our residential lending business is subject to government regulation and licensing requirements, which may hinder our ability to operate profitably, negatively impair our ability to repay our outstanding debt and negatively impact the value of our capital stock."

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Additionally, the United States Congress is currently considering a number of proposed bills or proposed amendments to existing laws, such as the "Ney - Lucas Responsible Lending Act of 2003" introduced on February 13, 2003 into the U.S. House of Representatives, which could affect our lending activities and make our business less profitable. These bills and amendments, if adopted as proposed, could reduce our profitability by limiting the fees we are permitted to charge, including prepayment fees, restricting the terms we are permitted to include in our loan agreements and increasing the amount of disclosure we are required to give to potential borrowers. While we cannot predict whether or in what form Congress may enact legislation, we are currently evaluating the potential impact of these legislative initiatives, if adopted, on our lending practices and results of operations.

State law sometimes restricts our ability to charge a prepayment fee for both home equity and business purpose loans. Prior to its preclusion, we used the Parity Act to preempt these state laws for home equity loans which meet the definition of alternative mortgage transactions under the Parity Act. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Legal and Regulatory Considerations" for a discussion of how the adoption by the Office of Thrift Supervision in July 2003 of a rule which precludes us from using the Parity Act to preempt state prepayment penalty and late fees laws may impact our new loan originations.

SERVICEMEMBERS CIVIL RELIEF ACT. Under the Servicemembers Civil Relief Act (formerly known as the Soldiers' and Sailors' Civil Relief Act of 1940), referred to as the Relief Act in this document, members of all branches of the military on active duty, including draftees and reservists in military service and state national guard called to federal duty:

o are entitled to have interest rates reduced and capped at 6% per annum, on obligations (including mortgage loans) incurred prior to the commencement of military service for the duration of military service;

o may be entitled to a stay of proceeding on any kind of foreclosure or repossession action in the case of defaults on obligations entered into prior to military service for the duration of military service; and

o may have the maturity of obligations stayed and may have obligations adjusted in a manner to preserve the interests of all parties.

If a borrower's obligation to repay amounts otherwise due on a mortgage loan included in a trust is relieved pursuant to the Relief Act, none of the trust, the servicer, the back-up servicer, the seller, the depositor, the originators or the trustee will be required to advance these amounts, and any resulting loss may reduce the amounts available to be paid to the holders of the certificates. Any shortfalls in interest collections on mortgage loans included in the trust resulting from application of the Relief Act will be allocated to the certificates in reduction of the amounts payable to such certificates on the related distribution date.

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As a result of the current military actions in Iraq and Afghanistan, President Bush authorized the placement of tens of thousands of military reservists and members of the National Guard on active duty status. To the extent that any such person is a borrower under a loan, the interest rate limitations and other provisions of the Relief Act would apply to the loan during the period of active duty. The number of reservists and members of the National Guard placed on active duty status in the near future may increase. In addition, other borrowers who enter military service after the origination of their loans (including borrowers who are members of the National Guard at the time of the origination of their loans and are later called to active duty) would be covered by the terms of the Relief Act. See "Risk Factors - If many of our borrowers become subject to the Servicemembers Civil Relief Act, our cash flows and interest income may be adversely affected which would negatively impair our ability to repay our outstanding debt and would negatively impact the value of our capital stock."

We have procedures and controls to monitor compliance with numerous federal, state and local laws and regulations. However, because these laws and regulations are complex and often subject to interpretation, or as a result of inadvertent errors, we may, from time to time, inadvertently violate these laws and regulations.

If more restrictive laws, rules and regulations are enacted or more restrictive judicial and administrative interpretations of those laws are issued, compliance with the laws could become more expensive or difficult.

RISK FACTORS

YOU SHOULD CAREFULLY CONSIDER RISK FACTORS SET FORTH BELOW TOGETHER WITH ALL OF THE OTHER INFORMATION INCLUDED IN THIS FORM 10-K AND INCORPORATED BY REFERENCE INTO THIS FORM 10-K WHICH COULD IMPACT THE VALUE OF OUR CAPITAL STOCK AND OUR ABILITY TO REPAY OUR OUTSTANDING DEBT.

BECAUSE WE HAVE HISTORICALLY EXPERIENCED NEGATIVE CASH FLOWS FROM OPERATIONS, WE WILL BE REQUIRED TO RELY, IN PART, ON SALES OF ADDITIONAL SUBORDINATED DEBENTURES TO FUND OUR CONTINUING OPERATIONS AND TO REPAY OUR OUTSTANDING DEBT. TO THE EXTENT THAT WE ARE UNABLE TO SELL ADDITIONAL SUBORDINATED DEBENTURES OR OTHER SECURITIES, OUR ABILITY TO REPAY OUR OUTSTANDING DEBT COULD BE IMPAIRED AND THE VALUE OF OUR CAPITAL STOCK COULD BE NEGATIVELY IMPACTED.

We have historically experienced negative cash flows from operations since 1996 primarily because our previous business strategy of selling loans primarily through securitization required us to build an inventory of loans over time. During the period we are building this inventory of loans, we incur costs and expenses. We do not recognize a gain on the sale of loans until we complete a securitization or a whole loan sale, which may not occur until a subsequent period. In addition, our gain on a securitization results from a combination of cash proceeds received and our retained interests in the securitized loans, consisting primarily of interest-only strips which do not generate cash flows immediately. Our cash flow from operations for the fiscal year ended June 30, 2003, was a negative of $285.4 million compared to a negative $13.3 million for fiscal 2002. Negative cash flow from operations increased $272.1 million for the fiscal year ended June 30, 2003 mainly due to our inability to complete a securitization or otherwise sell our loans in the fourth quarter of fiscal 2003. If our adjusted business strategy changes to include a sale of loans through securitizations, then, depending on the size and frequency of our future securitizations, we may experience negative cash flow from operations in the future. We anticipate that we will be required to rely, in part, on the offering of additional securities, including subordinated debentures, to fund both our operations and repay our outstanding debt for at least the next two years.

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During the fiscal year ended June 30, 2004, we experienced positive cash flow from operations of $6.8 million primarily due to whole loan sales of loans we originated. However, the combination of our current cash position and expected sources of operating cash may not be sufficient to cover our operating cash requirements. Should we experience negative cash flows from operations in the future, and if we are unable to sell subordinated debentures to fund our operations, our ability to repay our outstanding debt could be impaired and the value of our capital stock could be negatively impacted. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."

BECAUSE WE HAD NEGATIVE RETAINED EARNINGS IN FISCAL 2004, WE HAVE NOT GENERATED SUFFICIENT EARNINGS TO COVER OUR FIXED CHARGES, WHICH MAY NEGATIVELY IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

At June 30, 2004, we had negative retained earnings of $98.3 million on our balance sheet as a result of our losses for fiscal 2004 and fiscal 2003. Our earnings before income taxes and fixed charges were insufficient to cover fixed charges by $183.4 million for the fiscal year ended June 30, 2004. To the extent that we are unable to generate earnings sufficient to cover our fixed charges, we may have insufficient funds to repay our outstanding debt, which would have a negative impact on the value of our capital stock.

SINCE WE DO NOT SET ASIDE FUNDS TO REPAY OUR OUTSTANDING DEBT AND TO THE EXTENT THE COLLATERAL SECURING SENIOR COLLATERALIZED SUBORDINATED NOTES IS NOT SUFFICIENT FOR THE REPAYMENT OF THE NOTES, HOLDERS OF OUR OUTSTANDING DEBT MUST RELY ON OUR CASH FLOW FROM OPERATIONS AND OTHER SOURCES FOR REPAYMENT. IF OUR SOURCES OF REPAYMENT ARE NOT ADEQUATE, WE MAY BE UNABLE TO REPAY OUR OUTSTANDING DEBT, WHICH WOULD HAVE A NEGATIVE IMPACT ON THE VALUE OF OUR CAPITAL STOCK.

We do not contribute funds on a regular basis to a separate account, commonly known as a sinking fund, to repay our outstanding debt upon maturity. Because funds are not set aside periodically for the repayment of the outstanding debt over its term, holders of the subordinated debentures and senior collateralized subordinated notes, to the extent that the cash flow from interest-only strips securing the senior collateralized subordinated notes is not sufficient for the repayment of the senior collateralized subordinated notes over their terms, must rely on our cash flow from operations and other sources for repayment, such as funds from the sale of additional subordinated debentures and proceeds from whole loan sales. We anticipate that during fiscal 2005 we will incur significant contractual obligations that will negatively impact our cash flow from operations, including, but not limited to: (i) the payment of maturing subordinated debentures and the accrued interest on outstanding subordinated debentures of $326.2 million and $20.0 million, respectively; (ii) the payment of maturing senior collateralized subordinated notes and the accrued interest on senior collateralized subordinated notes of $28.1 million and $1.0 million, respectively; (iii) the payment of dividends on Series A preferred stock of $ 10.9 million; and (iv) the repayment of the warehouse lines of credit of $239.6 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Contractual Obligations" for a discussion of our contractual obligations. To the extent revenues from operations and other sources are not sufficient to repay the outstanding debt, holders of outstanding debt may lose all or a part of their investment. Our ability to repay the outstanding debt at maturity and our ability to meet other financial obligations may depend, in part, on our ability to raise new funds through the sale of additional subordinated debentures. At June 30, 2004, $522.6 million of subordinated debentures were outstanding. We estimate that during fiscal 2005 we will not generate sufficient after-tax earnings to pay the principal and interest on maturing subordinated debentures and we will need to sell approximately $260.0 million to $275.0 million of additional subordinated debentures to pay the principal and interest on our outstanding subordinated debentures and to pay our other obligations, including the principal and interest on the senior collateralized subordinated notes and dividends on our Series A preferred stock. In addition, we use the proceeds from sales of additional subordinated debentures to pay maturities on existing subordinated debentures because we have been unable to issue subordinated debentures with maturities long enough to fund our business. In essence, we replace maturing short-term subordinated debentures with new short-term subordinated debentures to achieve the longer term funding effect we need in order to implement our business strategy. Once cash flows from after tax earnings become available, as anticipated under our adjusted business strategy, we anticipate having cash available to begin paying down maturing subordinated debentures and reducing the amount of maturing short-term subordinated debentures we replace with new subordinated debentures. See "-- Because we have historically experienced negative cash flows from operations, we will be required to rely, in part, on sales of additional subordinated debentures to fund our continuing operations and to repay our outstanding debt. To the extent that we are unable to sell additional subordinated debentures or other securities, our ability to repay our outstanding debt could be impaired and the value of our capital stock could be negatively impacted," "-- We depend upon the availability of financing to fund our continuing operations. Any failure to obtain adequate funding could hurt our ability to operate profitably, restrict our ability to repay our outstanding debt and negatively impact the value of our capital stock," and "-- Delinquencies and prepayments in the pools of securitized loans could adversely affect the cash flow we receive from our interest-only strips, impair our ability to sell or securitize loans in the future, impair our ability to repay our outstanding debt and negatively impact the value of our capital stock."

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SINCE WE DO NOT SET ASIDE FUNDS TO REPAY HOLDERS OF OUR MONEY MARKET NOTES UPON DEMAND, HOLDERS OF MONEY MARKET NOTES MUST RELY ON OUR CASH FLOW FROM OPERATIONS AND OTHER SOURCES FOR REPAYMENT OF THEIR UNINSURED MONEY MARKET NOTES. IF OUR SOURCES OF REPAYMENT ARE NOT ADEQUATE, WE MAY BE UNABLE TO SATISFY THE HOLDERS' REDEMPTION REQUESTS ON A TIMELY BASIS.

Holders of our uninsured money market notes may request a full or partial repayment of their notes at any time by delivering a written notice to us specifying the amount of the redemption. Redemption requests by written notice may be for any amount and we may take up to 10 business days after the receipt of the notice to mail the proceeds of the redemption to the holder. In fiscal 2004, we repaid $26.9 million of money market notes pursuant to redemption requests. At June 30, 2004, we had $12.7 million of money market notes outstanding and $0.9 million of cash and cash equivalents available to repay these money market notes. Since we do not set aside funds to repay money market notes upon the holder's demand, holders must rely on our available cash and cash equivalents when a request is made for repayment. If holders of all of our money market notes requested repayment as of June 30, 2004, we did not have sufficient cash or cash equivalents to repay all money market notes outstanding as of such date. If we do not have sufficient cash to repay all holders requesting redemption, we may take up to 10 business days to mail the proceeds to the holders. To the extent that we continue to experience liquidity issues, are unable to sell additional subordinated debentures or other sources for repayment are not available, we may be unable to satisfy the holders' redemption requests when made. In the event we are unable to mail proceeds to redeeming holders within 10 business days, we would be in default under the terms of our indenture governing the money market notes.

Absent a waiver, our failure to repay the money market notes within a 10 business day period provided for pursuant to the terms of the indenture would result in an event of default which could accelerate debt repayment terms under our credit facilities and indentures due to various cross default provisions contained in the agreements evidencing our outstanding debt, which would have a material adverse effect on our liquidity and capital resources.

Subject to the consent of the trustee under the indenture governing the rights of holders of uninsured money market notes, we have the ability to change the redemption procedures without the approval of holders of money market notes, provided that no changes can be made that will adversely affect the rights of holders of outstanding money market notes. If we experience a significant increase in requests for the redemption of money market notes, we may request that the trustee approve an extension of the 10 business day period provided for the redemption of money market notes. In such event, this modification would only be effective with respect to money market notes issued subsequent to the date of the trustee's consent and our notice regarding the extension to prospective investors. See "-- Since we do not set aside funds to repay our outstanding debt and to the extent the collateral securing senior collateralized subordinated notes is not sufficient for the repayment of the notes, holders of our outstanding debt must rely on our cash flow from operations and other sources for repayment. If our sources of repayment are not adequate, we may be unable to repay our outstanding debt, which would have a negative impact on the value of our capital stock."

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WE DEPEND UPON THE AVAILABILITY OF FINANCING TO FUND OUR CONTINUING OPERATIONS. ANY FAILURE TO OBTAIN ADEQUATE FUNDING COULD HURT OUR ABILITY TO OPERATE PROFITABLY, RESTRICT OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

For our ongoing operations, we depend upon frequent financings, including the sale of our unsecured subordinated debentures and warehouse credit facilities or lines of credit. If we are unable to maintain, renew or obtain adequate funding under a warehouse credit facility, or other borrowings, including the sale of additional subordinated debentures, the lack of adequate funds would hinder our ability to operate profitably, restrict our ability to repay our outstanding debt and negatively impact the value of our capital stock.

On September 22, 2003, we entered into definitive agreements with a financial institution for a $200.0 million credit facility. In addition, on October 14, 2003, we entered into definitive agreements with a warehouse lender for a $250.0 million credit facility to fund loan originations. This $200.0 million credit facility was extended to November 5, 2004 and reduced to $100.0 million. We have entered into a commitment letter and anticipate entering into a definitive agreement regarding a $100.0 million credit facility to replace our expiring credit facility. However, there can be no assurances as to whether we will enter into the definitive agreement prior to November 5, 2004 or that this agreement will contain terms and conditions acceptable to us.

If we are unable to comply with the terms of our credit facilities, these lenders have the option to accelerate payment on these facilities and would have no further obligation to make additional advances under these facilities. In addition, absent a waiver, our inability to comply with the financial and other terms of this debt could accelerate debt repayment terms under our other outstanding debt due to the various cross default provisions contained in the agreements evidencing our outstanding debt. Additionally, our ability to obtain alternative financing sources may be limited to the extent we have agreed to pledge our interest-only strips and residual interests, which represent a significant amount of our assets, to secure our obligations in an amount not to exceed 10% of the outstanding principal balance of, and the payment of fees on, the $250.0 million credit facility and a portion of the cash flows from our interest-only strips to secure the senior collateralized subordinated notes outstanding, and by our current financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" for further discussion of these facilities.

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Although we obtained two warehouse credit facilities totaling $450.0 million in fiscal 2004, and after November 5, 2004 we expect to have at least two warehouse credit facilities totaling at a minimum $500.0 million, the proceeds of these credit facilities could only be used to fund loan originations and could not be used for any other purpose. Consequently, we need to generate cash to fund the balance of our business operations from other sources, such as whole loan sales, additional financings and sales of subordinated debentures. Additionally, our warehouse credit facilities have been obtained at high costs, which have a significant impact on our liquidity.

We are currently negotiating additional credit facilities to provide additional borrowing capacity to fund the increased level of loan originations expected under our adjusted business strategy, however, no assurances can be given that we will succeed in obtaining new credit facilities or that these facilities will contain terms and conditions acceptable to us.

While we currently believe we will continue to have credit facilities available to finance new loan obligations, we cannot assure you that we will be successful in maintaining or replacing existing credit facilities or obtaining alternative financing sources necessary to fund our operations, and to the extent that we are not successful, we may have to limit our loan originations or sell loans earlier than intended and restructure our operations. Limiting our originations or earlier sales of loans would hinder our ability to operate profitably or result in losses, restrict our ability to repay our outstanding debt and negatively impact the value of our capital stock. Our ability to repay our outstanding debt at maturity may depend, in part, on our ability to raise new funds through the sale of additional subordinated debentures. As the servicer of securitized loans, we could also incur certain additional cash requirements with respect to the securitization trusts which could increase our dependence on borrowed funds to the extent funds from non-credit sources were unavailable. If this additional cash requirement were to arise at a time when our access to borrowed funds was restricted, our ability to repay some or all of our outstanding debt as it comes due could be impaired. See "-- Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay our outstanding debt and could negatively impact the value of our capital stock" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."

In the event we are unable to offer subordinated debentures for any reason, we have developed a contingent financial restructuring plan including cash flow projections for the next twelve-month period. Based on our current cash flow projections, we anticipate being able to make all scheduled debt maturities and vendor payments.

The contingent financial restructuring plan is based on actions that we would take, in addition to those indicated in our adjusted business strategy, to reduce our operating expenses and conserve cash. These actions would include reducing capital expenditures, selling all loans originated on a whole loan basis, eliminating or downsizing various lending, overhead and support groups, and obtaining working capital funding. No assurance can be given that we will be able to successfully implement the contingent financial restructuring plan, if necessary, and repay our outstanding debt which would negatively impact the value of our capital stock.

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IF WE ARE UNABLE TO OBTAIN ADDITIONAL FINANCING, WE MAY NOT BE ABLE TO RESTRUCTURE OUR BUSINESS TO PERMIT PROFITABLE OPERATIONS OR REPAY OUR OUTSTANDING DEBT AND THE VALUE OF OUR CAPITAL STOCK WILL BE NEGATIVELY IMPACTED.

Our inability to complete publicly underwritten securitizations during the fourth quarter of fiscal 2003 and all of fiscal 2004 (we completed a privately-placed securitization in the second quarter of fiscal 2004), our inability to draw down upon and the expiration of several of our credit facilities, and our temporary discontinuation of sales of new subordinated debentures for approximately a six-week period during the first quarter of fiscal 2004 adversely impacted our short-term liquidity position and resulted in our inability to comply with financial covenants contained in our credit facilities. The expiration of our $300.0 million mortgage conduit facility in July 2003 and the temporary discontinuation of the sale of new subordinated debentures for approximately a six-week period during the first quarter of fiscal 2004 also adversely impacted our short-term liquidity position.

We have entered into a commitment letter and anticipate entering into definitive agreements for a $100.0 million credit facility to replace our expiring $200.0 million (now $100.0 million) credit facility. However, we cannot give any assurances that we will execute definitive agreements for this facility on or before November 5, 2004 or that the definitive agreements offered to us will contain terms acceptable to us, although preliminary discussions indicate the replacement facility will be structured similarly to our $250.0 million credit facility.

Although we obtained two warehouse credit facilities totaling $450.0 million in fiscal 2004, and after November 5, 2004 we expect to have at least two warehouse credit facilities totaling at a minimum $500.0 million, the proceeds of these credit facilities could only be used to fund loan originations and could not be used for any other purpose. Consequently, we need to generate cash to fund the balance of our business operations from other sources, such as whole loan sales, additional financings and sales of subordinated debentures. Additionally, our warehouse credit facilities have been obtained at high costs, which have a significant impact on our liquidity. We are currently negotiating additional credit facilities to provide additional borrowing capacity to fund the increased level of loan originations expected under our adjusted business strategy, however, no assurances can be given that we will succeed in obtaining new credit facilities or that these facilities will contain terms and conditions acceptable to us.

Our ability to obtain alternative sources of financing may be limited to the extent we have pledged our interest-only strips and residual interests, which represent a significant amount of our assets, to secure our obligations in an amount not to exceed 10% of the outstanding principal balance of, and the payment of fees on, the $250.0 million credit facility and a portion of the cash flows from our interest-only strips to secure the senior collateralized subordinated notes, and by our current financial situation. To the extent that we are not successful in maintaining, replacing or obtaining alternative financing sources on acceptable terms, we may have to limit our loan originations, sell loans earlier than intended and further restructure our operations under our adjusted business strategy. Limiting our originations or earlier sales of our loans would prevent us from operating profitably and restrict our ability to repay our outstanding debt and could negatively impact the value of our capital stock. Likewise, there can be no assurance that we can successfully implement our adjusted business strategy, if necessary, or that the assumptions underlying the adjusted business strategy can be achieved. Our failure to successfully implement our adjusted business strategy, if necessary, would impair our ability to operate profitably and repay our outstanding debt and would negatively impact the value of our capital stock. If we fail to successfully implement our adjusted business strategy, we will be required to consider other alternatives, including raising equity, seeking to convert a portion of our subordinated debentures to equity, seeking protection under federal bankruptcy laws, seeking a strategic investor, or exploring a sale of the company or some or all of its assets.

EVEN IF WE ARE ABLE TO OBTAIN ADEQUATE FINANCING, OUR INABILITY TO SECURITIZE OUR LOANS COULD HINDER OUR ABILITY TO OPERATE PROFITABLY IN THE FUTURE AND REPAY OUR OUTSTANDING DEBT WHICH COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

Since 1995, we have relied on the quarterly securitization of our loans to generate cash for the repayment of our credit facilities and the origination of additional loans. Our inability to complete our typical publicly underwritten quarterly securitization during the fourth quarter of 2003 and during fiscal 2004 and the significant net pre-tax valuation adjustments to our securitization assets resulted in a net loss attributable to common stock of $29.9 million for fiscal 2003 and $115.1 million for fiscal 2004, and contributed to our shift in focus to less profitable whole loan sales. The losses resulted in our inability to comply with certain financial covenants contained in our credit facilities. The losses and the expiration of our mortgage conduit facility adversely impacted our short-term liquidity position. The temporary discontinuation of sales of subordinated debentures further impaired our liquidity.

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Depending on our ability to recognize gains on our future securitizations, we anticipate incurring losses at least through the first quarter of fiscal 2005 causing us to fail to comply with the financial covenants in our credit facilities, increase our reliance on less profitable whole loan sales which will require us to originate more loans to reach the same level of profitability as we experienced in securitization transactions, and increase our need for additional financing to fund our loan originations. Our continued inability to securitize our loans could result in us reaching our capacity under our existing credit facilities or require us to sell our loans when market conditions are less favorable and could cause us to incur a loss on the sale transaction. See "-- An interruption or reduction in the whole loan sale or securitization markets would hinder our ability to operate profitably and repay our outstanding debt which would negatively impact the value of our capital stock."

BASED UPON OUR LOSS FOR THE QUARTER ENDED JUNE 30, 2004 AND OUR ANTICIPATED LOSS FOR THE QUARTER ENDED SEPTEMBER 30, 2004, WE WILL BE OUT OF COMPLIANCE WITH FINANCIAL COVENANTS CONTAINED IN ONE OF OUR CREDIT FACILITIES AND WE WILL CONTINUE TO NEED WAIVERS FROM OUR LENDER.

At various times since June 30, 2003, including at June 30, 2004, July 31, 2004, August 31, 2004 and September 30, 2004, we have been out of compliance with one or more financial covenants contained in our $200.0 million credit facility. We have continued to operate on the basis of waivers granted by the lender under this facility. We currently anticipate that we will be out of compliance with one or more of these financial covenants at October 31, 2004 and will need a waiver from this lender for this noncompliance to continue to operate. The expiration date of this facility was originally September 21, 2004, but the lender agreed to extend the expiration date until November 5, 2004 in consideration for, among other things, a reduction in the amount that could be borrowed under this facility to $100.0 million.

A provision in our $250.0 million credit facility required us to maintain another credit facility for $200.0 million with a $40.0 million sublimit of such facility available for funding loans between the time they are closed by a title agency or closing attorney and the time documentation for the loans is received by the collateral agent. As a result of the reduction of our $200.0 million facility to $100.0 million, as described above, we entered into an amendment to the master loan and security agreement governing our $250.0 million facility which reduced the required amount for another facility to $100.0 million. In the event we do not extend the $200.0 million (now $100.0 million) facility beyond its November 5, 2004 expiration date, or in the event we do not otherwise enter into definitive agreements with other lenders by November 5, 2004 which satisfy the above-described requirements in our $250.0 million facility for $100.0 million in additional credit facilities and a $40.0 million sublimit, we will need an additional amendment to the $250.0 million facility or a waiver from the lender to continue to operate.

We cannot assure you that we will continue to receive the waivers that we need to operate or that they will not contain conditions that are unacceptable to us. Because we anticipate incurring losses through at least the first quarter of fiscal 2005, we anticipate that we will need to obtain additional waivers from our lenders and bond insurers as a result of our non-compliance with financial covenants contained in our credit facilities and servicing agreements. See "-- We depend upon the availability of financing to fund our operations. Any failure to obtain adequate funding could hurt our ability to operate profitably, restrict our ability to repay our outstanding debt and negatively impact the value of our capital stock," and "-- Restrictive covenants in the agreements governing our indebtedness may reduce our operating flexibility and limit our ability to operate profitably, and our ability to repay our outstanding debt may be impaired and the value of our capital stock could be negatively impacted."

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IN THE EVENT OUR COMMON STOCK IS DELISTED FROM TRADING ON THE NASDAQ NATIONAL MARKET SYSTEM, THE VALUE OF OUR CAPITAL STOCK AND OUR ABILITY TO CONTINUE TO SELL SUBORDINATED DEBENTURES WOULD BE NEGATIVELY IMPACTED.

Since our common stock is listed on the NASDAQ National Market System, we are required to meet certain requirements established by the NASDAQ Stock Market in order to maintain this listing. These requirements include, among other things, maintenance of stockholders' equity of $10.0 million, a minimum bid price of $1.00 and a market value of publicly held shares of $5.0 million.

On April 1, 2004, we received a notice from the NASDAQ Stock Market that we were not in compliance with the requirement for continued listing of our common stock on the NASDAQ National Market System on the basis that we have not met the requirement that the minimum market value of our publicly held shares equal at least $5.0 million. Under NASDAQ Marketplace Rules, we had 90 days, or until June 28, 2004, to become compliant with this requirement for a period of 10 consecutive trading days. On June 15, 2004, we advised the NASDAQ Stock Market that we had been in compliance with this requirement for 10 consecutive trading days and we withdrew our application to list our common stock on the American Stock Exchange, referred to as AMEX in this document, which application we filed with AMEX upon our receipt of the letter from the NASDAQ Stock Market described above. On June 24, 2004, we received a letter from the staff of the NASDAQ Stock Market confirming that we had regained compliance with the NASDAQ continued listing requirement related to the market value of our publicly held shares and were not subject to delisting.

There can be no assurance that we will be in compliance with the $10.0 million stockholders' equity requirement on September 30, 2004. We are considering a new exchange offer in order to maintain compliance with this listing requirement.

If we are unable to maintain our listing on the NASDAQ National Market System, the value of our capital stock and our ability to continue to sell subordinated debentures would be negatively impacted by making the process of complying with the state securities laws more difficult, costly and time consuming. As a result, we may be unable to continue to sell subordinated debentures in certain states, which would have a material adverse effect on our liquidity and our ability to repay maturing debt when due.

OUR ESTIMATES OF THE VALUE OF INTEREST-ONLY STRIPS AND SERVICING RIGHTS WE RETAIN WHEN WE SECURITIZE LOANS COULD BE INACCURATE AND COULD LIMIT OUR ABILITY TO OPERATE PROFITABLY, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

We generally retain interest-only strips and may retain servicing rights in the securitization transactions we complete. We estimate the fair value of the interest-only strips and servicing rights based upon discount rates, prepayment and credit loss rate assumptions established by the management of our company. The value of our interest-only strips totaled $459.1 million and the value of our servicing rights totaled $73.7 million at June 30, 2004. Together, these two assets represented 51.1% of our total assets at June 30, 2004. Although we believe that these amounts represent the fair value of these assets, the amounts were estimated based on discounting the expected cash flows to be received in connection with our securitizations using discount rate, prepayment rate and credit loss rate assumptions established by us. Changes in market interest rates may impact our discount rate assumptions and our actual prepayment and default experience may vary materially from these estimates. Even a small unfavorable change in these assumptions could have a significant adverse impact on the value of these assets. In the event of an unfavorable change in these assumptions, the fair value of these assets would be overstated, requiring an accounting adjustment, consisting of a corresponding reduction in pre-tax income or stockholders' equity or both in the period of adjustment. Adjustments to income could impair our ability to repay our outstanding debt and negatively impact the value of our capital stock.

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During fiscal 2004, we recorded a write down of $63.8 million on our securitization assets. The write down consisted of a $46.4 million reduction of pre-tax income and a $17.4 million pre-tax reduction of other comprehensive income, a component of stockholders' equity. The write down was mainly due to actual prepayment experience that was higher than anticipated. During fiscal 2003, we recorded a write down of $63.3 million on our securitization assets. The write down consisted of a $45.2 million reduction of pre-tax income and an $18.1 million pre-tax reduction of stockholders' equity. The write down was mainly due to actual prepayment experience that was higher than our assumptions, but was reduced by the favorable valuation impact of reducing the discount rates used to value our securitization assets at June 30, 2003. We cannot predict with certainty what our future prepayment experience will be. Any unfavorable difference between the assumptions used to value our securitization assets and our actual experience may have a significant adverse impact on the value of these assets. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Impact of Changes in Critical Accounting Estimates in Prior Fiscal Years" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations" for information on the sensitivities of interest-only strips and servicing rights to changes in assumptions. In addition, our servicing rights (and the related fees) can be terminated under certain circumstances, such as failure to make required servicer payments, defined changes in control and reaching certain loss and delinquency levels on the underlying pool. See "-- Our servicing rights may be terminated if we fail to satisfactorily perform our servicing obligations, or fail to meet minimum net worth requirements or financial covenants which could hinder our ability to operate profitably, impair our ability to repay our outstanding debt and negatively impact the value of our capital stock."

LENDING TO CREDIT-IMPAIRED BORROWERS MAY RESULT IN HIGHER DELINQUENCIES IN OUR TOTAL PORTFOLIO, WHICH COULD HINDER OUR ABILITY TO OPERATE PROFITABLY, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

We market a significant portion of our loans to borrowers who are either unable or unwilling to obtain financing from traditional sources, such as commercial banks. This type of borrower is commonly referred to as a subprime borrower. Loans made to subprime borrowers, which are commonly referred to as subprime loans, may entail a higher risk of delinquency and loss than loans made to borrowers who use traditional financing sources. Financial institutions utilize a credit rating system referred to as a FICO score to evaluate the creditworthiness of borrowers and as a means to establish the risk associated with lending to a particular borrower. The higher the FICO score, which can range from 300 to 850, the more creditworthy the borrower is. Generally, borrowers with FICO scores of 720 to 850 would receive the most favorable interest rates. During fiscal 2004, the average FICO score of our subprime home mortgage borrowers was 623. According to Standard & Poor's, subprime lenders issued securitized transactions with mixed collateral (fixed and adjustable rate mortgage loans) with a range of average FICO scores between 584 and 642 during the second quarter of calendar 2004. Historically, we have experienced higher rates of delinquency on these subprime loans as compared to delinquency rates experienced by banks on loans to borrowers who are not credit-impaired. While we use underwriting standards and collection procedures designed to mitigate the higher credit risk associated with subprime loans, our standards and procedures may not offer adequate protection against risks of default. When we securitize loans we continue to bear some exposure to delinquencies and losses through our securitization assets, which are accounted for through our credit loss assumptions. Higher than anticipated delinquencies, foreclosures or losses in our total portfolio could reduce the cash flow we receive from our securitization assets which would hinder our ability to operate profitably, restrict our ability to repay our outstanding debt and negatively impact the value of our capital stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Total Portfolio Quality" and "Business -- Lending Activities."

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DELINQUENCIES AND PREPAYMENTS IN THE POOLS OF SECURITIZED LOANS COULD ADVERSELY AFFECT THE CASH FLOW WE RECEIVE FROM OUR INTEREST-ONLY STRIPS, IMPAIR OUR ABILITY TO SELL OR SECURITIZE LOANS IN THE FUTURE, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

We re-acquire the risks of delinquency and default for non-performing loans that we determine to repurchase from the securitization trusts. Levels of delinquencies or losses in a particular securitized pool of loans, which exceed maximum percentage limits, or "triggers," set in the securitization agreement governing that pool, impact some or all of the cash that we would otherwise receive from our interest-only strips. If delinquencies or losses exceed maximum limits, the securitization trust withholds cash from our interest-only strips. The trust then uses the cash to repay outside investors, which reduces the proportionate interest of outside investors in the pool and results in additional overcollateralization. Additionally, for losses, the securitization trust utilizes cash from our interest-only strips to pay off investors. Our receipt of cash payments on the interest-only strip resumes when the additional overcollateralization created for outside investors meets specified targets or delinquency and loss rates for the pool of loans no longer exceed trigger levels. However, to adequately fund our ongoing operations during a period of suspended cash flow, we may need to borrow funds to replace the cash being withheld. The additional interest expense would hinder our ability to operate profitably, could impair our ability to repay our outstanding debt and negatively impact the value of our capital stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations -- Trigger Management."

We have the ability to repurchase a limited number of delinquent loans from securitized pools. This ability to repurchase loans enables us to avoid disruptions in securitization cash flows by repurchasing delinquent loans before trigger limits are reached, or to restore suspended cash flows by repurchasing sufficient delinquent loans to lower delinquency and loss rates below trigger limits. However, the repurchase of loans for this purpose, called "trigger management," would require funding from the same sources we rely on for our other cash needs and could require us to borrow additional funds. If funds were not available to permit us to repurchase these loans, our cash flow from the interest-only strips would be reduced, our ability to repay our outstanding debt could be impaired and the value of our capital stock could be negatively impacted. Lack of liquidity in these circumstances could result in more pools reaching trigger levels, which, in turn, would further tighten liquidity.

At June 30, 2004, four of our twenty-six mortgage securitization trusts were under a triggering event as a result of delinquencies exceeding specified levels. There were no securitization trusts exceeding specified loss levels at June 30, 2004. At June 30, 2003, none of our mortgage securitization trusts were under a triggering event. Approximately $8.0 million of excess overcollateralization is being held by the four trusts as of June 30, 2004. For the fiscal years ended June 30, 2004 and 2003, we repurchased delinquent loans and real estate owned with an aggregate unpaid principal balance of $54.0 million and $55.0 million, respectively, from securitization trusts primarily for trigger management. We cannot predict when the four trusts currently exceeding triggers will be below trigger limits and release the excess overcollateralization. In order for these trusts to release the excess overcollateralization, delinquent loans would need to decline, or we would need to repurchase delinquent loans of up to $10.4 million as of June 30, 2004. We received $40.9 million and $37.6 million of proceeds from the liquidation of repurchased loans and real estate owned in fiscal 2004 and fiscal 2003, respectively.

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While our managed portfolio has significantly decreased and we anticipate that the amount of loans repurchased from securitization trust will decline, if delinquencies increase and we cannot cure the delinquency or liquidate the loans in the mortgage securitization trusts without exceeding loss triggers, the levels of repurchases required to manage triggers may increase. Our ability to continue to manage triggers in our securitization trusts in the future is affected by our availability of cash from operations or through the sale of subordinated debentures to fund these repurchases.

Prepayments by borrowers also make it more difficult for us to maintain delinquencies below trigger limits set in securitization agreements. During fiscal 2004 and fiscal 2003, $1.3 billion and $1.0 billion, respectively, of our loans were prepaid by the borrowers prior to maturity. By reducing current loans in a securitized pool, prepayments mathematically increase the percentage of delinquent loans remaining in the pool. The consequences resulting from either a suspension of cash flow or our repurchase of delinquent loans from the securitized pool could impair our ability to repay our outstanding debt and negatively impact the value of our capital stock. We currently anticipate that the level of prepayments and prepayment speeds will decline based on current economic conditions and published mortgage industry surveys including the Mortgage Bankers Association's Refinance Indexes available at the time of our quarterly revaluation of our interest-only strips and servicing rights, and our own prepayment experience. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations -- Trigger Management," "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Total Portfolio Quality," "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations" and "Business -- Lending Activities."

AN INTERRUPTION OR REDUCTION IN THE WHOLE LOAN SALE OR SECURITIZATION MARKETS WOULD HINDER OUR ABILITY TO OPERATE PROFITABLY AND REPAY OUR OUTSTANDING DEBT WHICH WOULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

A significant portion of our revenue and net income represents gain on the sale of loans. Our strategy is to sell substantially all of the loans we originate at least quarterly. Operating results for a given period can fluctuate significantly as a result of the timing and size of whole loan sales or securitizations. If we do not close whole loan sales or securitizations on a quarterly basis, we could experience a loss for that quarter. In addition, we rely on the quarterly sale of our loans to generate cash proceeds for the repayment of our warehouse credit facilities and origination of additional loans.

Our ability to complete securitizations depends on several factors, including:

o conditions in the securities markets generally, including market interest rates;

o conditions in the asset-backed securities markets specifically;

o general economic conditions, including conditions in the subprime industry;

o our financial condition;

o the performance of our previously securitized loans;

o the credit quality of our total portfolio; and

o changes in federal tax laws.

If we are not able to sell substantially all of the loans that we originate during the quarter in which the loans are made, we would likely not be profitable for the quarter. Any substantial impairment in the size or availability of the market for our loans could result in our inability to continue to originate loans, repay our outstanding debt which would have a material adverse effect on our results of operations, financial condition and business prospects and would negatively impact the value of our capital stock. If it is not possible or economical for us to complete a whole loan sale or securitization within favorable timeframes, we may exceed our capacity under our warehouse financing and lines of credit. We may be required to sell the accumulated loans at a time when market conditions for our loans are less favorable, and potentially to incur a loss on the sale transaction. If we cannot generate sufficient liquidity upon any such loan sale or through the sale of additional subordinated debentures, we will be required to restrict or restructure our operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and "Business -- Securitizations."

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IF WE ARE UNABLE TO SUCCESSFULLY IMPLEMENT OUR ADJUSTED BUSINESS STRATEGY WHICH FOCUSES ON WHOLE LOAN SALES, WE MAY BE UNABLE TO ATTAIN PROFITABLE OPERATIONS WHICH COULD IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

Our adjusted business strategy seeks to increase our loan volume by broadening our loan product line, offering more competitive interest rates and through further development of existing markets while maintaining our origination fees, underwriting criteria and the interest rate spread between loan interest rates and the interest rates we pay for capital. Implementation of this strategy will depend in large part on our ability to:

o broaden our mortgage loan product line and increase originations of loans;

o obtain additional financing to fund our operations;

o manage the mix of loans originated in order to maximize the timing and levels of advances under our credit facilities and to appeal to a broader group of borrowers;

o expand in markets with a sufficient concentration of borrowers who meet our underwriting criteria;

o maintain adequate financing on reasonable terms to fund our loan origination;

o profitably sell our loans through whole loan sales on a regular basis;

o hire, train and retain skilled employees; and

o successfully implement our marketing campaigns.

Our inability to achieve any or all of these factors could impair our ability to successfully implement our adjusted business strategy and successfully leverage our fixed costs which could hinder our ability to operate profitably, result in continued losses and impair our ability to repay our outstanding debt and could negatively impact the value of our capital stock. If we fail to successfully implement our adjusted business strategy, we will be required to consider other alternatives, including raising equity, seeking to convert a portion of our subordinated debentures to equity, seeking protection under federal bankruptcy laws, seeking a strategic investor, or exploring a sale of the company or some or all of its assets.

CHANGES IN INTEREST RATES COULD NEGATIVELY IMPACT OUR ABILITY TO OPERATE PROFITABLY, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

Rising interest rates could reduce our overall profitability in one or more of the following ways:

o reducing the demand for our loan products, which could reduce our profitability;

o causing investors in asset-backed securities to increase the interest rate spread requirements and overcollateralization requirements for our future securitizations, which could reduce the profitability of our securitizations;

o increasing interest rates required by purchasers of our loans in whole loan sales;

o reducing the spread between the interest rates we receive on loans we originate and the interest rates we pay to fund the originations, which among other effects, increases our carrying costs for these loans during the period they are being pooled for securitization;

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o increasing the interest rates we must pay on our subordinated debentures to attract investors at the levels we require to fund our operations;

o increasing our interest expense on all sources of borrowed funds, such as subordinated debentures, credit facilities and lines of credit, and could restrict our access to the capital markets;

o negatively impacting the value and profitability of loans from the date of origination until the date we sell the loans;

o reducing the spread between the average interest rate on the loans in a securitization pool and the pass-through interest rate to investors issued in connection with the securitization (This reduction in the spread occurs because interest rates on loans in a securitization pool are typically set over the three months preceding a securitization while the pass-through rate on securities issued in the securitization is based on market rates at the time a securitization is priced. Therefore, if market interest rates required by investors increase prior to securitization of the loans, the interest rate spread between the average interest rate on the loans and the pass-through interest rate to investors may be reduced or eliminated. This factor would reduce our profit on the sale of the loans. Any reduction in our profitability could impair our ability to repay our outstanding debt and could negatively impact the value of our capital stock); and

o increasing the cost of floating rate certificates issued in certain securitizations without a corresponding increase in the interest income of the underlying fixed rate loan collateral (This situation would reduce the cash flow we receive from the interest-only strips related to those securitizations and reduce the fair value or expected future cash flow of that asset as well. At June 30, 2004, floating interest rate certificates represented 12.6% of total debt issued by loan securitization trusts. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Interest Rate Risk Management" for further discussion of the impact on our interest-only strips of interest rate changes in floating interest rate certificates issued by securitization trusts and outstanding debt issued by the securitization trusts).

Declining interest rates could reduce our profitability in one or more of the following ways:

o subordinated debentures with terms of one year or more which are not redeemable at our option represent an unfavorable source of borrowing in an environment where market rates fall below those paid on the subordinated debentures (At June 30, 2004, $15.3 million in non-redeemable subordinated debentures with maturities of greater than one year was outstanding.); and

o a decline in market interest rates generally induces borrowers to refinance their loans, which are held in the securitization trusts, and could reduce our profitability; prepayment levels in excess of our assumptions reduce the value of our securitization assets. A significant decline in market interest rates would increase the level of loan prepayments, which would decrease the size of the total managed loan portfolio and the related projected cash flows. Higher than anticipated rates of loan prepayments could require a write down of the fair value of the related interest-only strips and servicing rights, adversely impacting earnings during the period of adjustment which would result in a reduction in our profitability, could impair our ability to repay our outstanding debt and could negatively impact the value of our capital stock (See " -- Our estimates of the value of interest-only strips and servicing rights we retain when we securitize loans could be inaccurate and could limit our ability to operate profitably, impair our ability to repay our outstanding debt and negatively impact the value of our capital stock.").

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Although both rising and falling interest rates negatively impact our business and profitability, the speed at which rates fluctuate, the duration of high or low interest rate environments and the nature and magnitude of any favorable interest rate consequences, as well as economic events and business conditions outside of our control, affect the overall manner in which interest rate changes impact our operations and the magnitude of such impact. In addition, because of the volatile and unpredictable manner in which these factors interact, we may experience interest rate risks in the future that we have not previously experienced or identified. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Interest Rate Risk Management."

OUR SECURITIZATION AGREEMENTS IMPOSE OBLIGATIONS ON US TO MAKE CASH OUTLAYS WHICH COULD IMPAIR OUR ABILITY TO OPERATE PROFITABLY AND OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

Our securitization agreements require us to replace or repurchase loans which do not conform to representations and warranties we made in the agreements. Additionally, as servicer, we are required to:

o compensate investors for interest shortfalls on loan prepayments (up to the amount of the related servicing fee); and

o advance interest payments for delinquent loans if we believe in good faith the advances will ultimately be recoverable by the securitization trust. These advances can first be made out of funds available in the trusts' collection accounts. If the funds available from the trusts' collection accounts are insufficient to make the required advances, then we are required to make the advances from our operating cash. The advances made from the trusts' collection accounts, if not recovered from the borrowers or proceeds from the liquidation of the loans, require reimbursement from us. These advances, if ultimately not recoverable by us, require funding from our capital resources and may create greater demands on our cash flow, which could limit our ability to repay our outstanding debt and could negatively impact the value of our capital stock. See "Business -- Securitizations."

In fiscal 2004, our cash expenditures related to our securitization agreements constituted less than $100,000. We do not anticipate that these cash outlays will increase significantly in the foreseeable future.

OUR SERVICING RIGHTS MAY BE TERMINATED IF WE FAIL TO SATISFACTORILY PERFORM OUR SERVICING OBLIGATIONS, OR FAIL TO MEET MINIMUM NET WORTH REQUIREMENTS OR FINANCIAL COVENANTS WHICH COULD HINDER OUR ABILITY TO OPERATE PROFITABLY, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

As part of the securitization of our loans, we may retain the servicing rights, which is the right to service the loans for a fee. At June 30, 2004, 85.5% of the total portfolio we serviced was owned by third parties. The value of servicing rights related to our total portfolio is an asset on our balance sheet called servicing rights. We enter into agreements in connection with the securitizations that allow bond insurers to terminate us as the servicer if we breach our servicing obligations, fail to perform satisfactorily or fail to meet a minimum net worth requirement or other financial covenants. For example, our servicing rights may be terminated if losses on the pool of loans in a particular securitization exceed prescribed levels for specified periods of time. Since October 2003 we have been out of compliance with the net worth covenant in the servicing agreements associated with one bond insurer and we have obtained a waiver from this bond insurer for this noncompliance on a monthly basis in order to continue as servicer under these servicing agreements. We anticipate having to obtain this waiver on a monthly basis for the foreseeable future. There can be no assurances that we will continue to receive the waivers necessary to operate or that such waivers will not contain conditions that are unacceptable to us.

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As a result of recent amendments to our servicing agreements, all of our servicing agreements associated with the bond insurers now provide for term-to-term servicing and, in the case of our servicing agreements with two bond insurers, our rights as a servicer may be terminated at the expiration of a servicing term in the sole discretion of the bond insurer. During fiscal 2004, we did not experience any termination of servicing rights pursuant to existing term-to-term servicing agreements. There can be no assurances that we will continue to receive the servicing agreement extensions we need to operate or that they will not contain conditions that are unacceptable to us. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."

If we lose the right to service some or all of the loans in our total portfolio, the servicing fees will no longer be paid to us and we would be required to write down or write off this asset, which would decrease our earnings and our net worth, impair our ability to repay our outstanding debt and negatively impact the value of our capital stock. In addition, if we do not meet eligibility criteria to act as servicer in future securitizations, we would not receive income from these future servicing rights.

IF WE ARE NOT ABLE TO EXCEED THE LEVELS OF LOAN ORIGINATIONS THAT WE EXPERIENCED IN THE PAST, WE MAY BE UNABLE TO ATTAIN PROFITABLE OPERATIONS AND OUR ABILITY TO REPAY OUR OUTSTANDING DEBT MAY BE IMPAIRED AND THE VALUE OF OUR CAPITAL STOCK WOULD BE NEGATIVELY IMPACTED.

During fiscal 2003 and 2002, we experienced record levels of loan originations. As a result of our liquidity issues, our loan volume for fiscal 2004 decreased substantially. During fiscal 2004, we originated $982.7 million of loans as compared to originations of $1.67 billion of loans in fiscal 2003. We anticipate that depending upon the size of our future quarterly securitizations, if any, we will need to increase our loan originations to approximately $400.0 million to $500.0 million per month to return to profitable operations. If we are unable to complete quarterly securitizations, we will need to increase our loan originations to approximately $500.0 million to $600.0 million per month to return to profitability. Our ability to achieve the level of loan originations necessary to obtain profitable operations depends upon a variety of factors, some of which are outside our control, including:

o interest rates;

o our ability to manage the mix of loans originated in order to maximize the timing and levels of advances under our credit facilities and to appeal to a broader group of borrowers;

o our ability to broaden our mortgage loan product line;

o our ability to originate loans, which have the characteristics that qualify for us to obtain advances under our new credit facilities (including higher loan-to-value ratios than those originated in the past);

o our ability to obtain additional financing on reasonable terms;

o conditions in the asset-backed securities markets;

o our ability to attract and retain qualified personnel;

o economic conditions in our primary market area;

o competition; and

o regulatory restrictions.

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To the extent that we are not successful in maintaining or replacing outstanding debt upon maturity, increasing and maintaining adequate warehouse credit facilities or lines of credit to fund increasing loan originations, or securitizing and selling our loans, we may have to limit future loan originations and further restructure our operations. If we are unable to attain the level of loan originations of approximately $400.0 to $500.0 million per month with a securitization or approximately $500.0 million to $600.0 million per month without a securitization, we may be unable to attain profitable operations, our ability to repay our outstanding debt may be impaired and the value of our capital stock would be negatively impacted. See "-- Changes in interest rates could negatively impact our ability to operate profitably, impair our ability to repay our outstanding debt and could negatively impact the value of our capital stock."

THE LOANS WE RECENTLY ORIGINATED ARE UNSEASONED AND MAY HAVE HIGHER DELINQUENCY AND DEFAULT RATES THAN MORE SEASONED LOAN PORTFOLIOS, WHICH COULD RESULT IN LOSSES ON LOANS THAT ARE REQUIRED TO BE REPURCHASED BY US UNDER RECOURSE PROVISIONS AND WHICH MAY IMPACT OUR ABILITY TO SELL LOANS IN THE SECONDARY MARKET WHICH WOULD NEGATIVELY IMPAIR OUR ABILITY TO REPAY OUTSTANDING DEBT AND IMPACT THE VALUE OF OUR CAPITAL STOCK.

The mortgage loans which we recently originated are unseasoned and may have higher delinquency and default rates than seasoned 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. We start bearing the risk of delinquency and default on loans when we originate them. Some whole loan sale agreements we enter into with purchasers may include limited recourse provisions obligating us to repurchase loans at the sale price in the event of unfavorable delinquency performance of the loans sold or to refund premiums if a sold loan prepays within a specified period. The duration of these obligations typically ranges from 60 days to one year from the date of the loan sale. We reserve for these premium obligations at the time of sale through an expense charge against the gain on sale. In fiscal 2004, we had sold approximately $803.7 million of loans under agreements containing recourse provisions, of which $624.0 million of loans were still subject to recourse provisions at June 30, 2004. The remaining $4.7 million of whole loan sales during fiscal 2004 were without recourse.

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 reserves, our ability to repay our outstanding debt will be negatively impaired and the value of our capital stock will be negatively impacted.

A DECLINE IN REAL ESTATE VALUES COULD RESULT IN A REDUCTION IN OUR LOAN ORIGINATIONS, WHICH COULD HINDER OUR ABILITY TO ATTAIN PROFITABLE OPERATIONS, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

Our business may be adversely affected by declining real estate values. Any significant decline in real estate values reduces the ability of borrowers to use home equity as collateral for borrowings. This reduction in real estate values may reduce the number of loans we are able to make, which will reduce the gain on sale of loans and servicing and origination fees we will collect, which could hinder our ability to attain profitable operations, limit our ability to repay our outstanding debt and negatively impact the value of our capital stock. See "Business -- Lending Activities."

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A DECLINE IN VALUE OF THE COLLATERAL SECURING OUR LOANS COULD RESULT IN AN INCREASE IN LOSSES ON FORECLOSURE, WHICH COULD HINDER OUR ABILITY TO ATTAIN PROFITABLE OPERATIONS, LIMIT OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

Declining real estate values will increase the loan-to-value ratios of loans we previously made, which in turn, increases the probability of a loss in the event the borrower defaults and we have to sell the mortgaged property. In addition, delinquencies, foreclosures on loans and losses from delinquent and foreclosed loans generally increase during economic slowdowns or recessions, and the increase in delinquencies, foreclosures on loans and losses from delinquent and foreclosed loans we experience may be particularly pronounced because we lend to credit-impaired borrowers. As a result, the market value of the real estate or other collateral underlying our loans may not, at any given time, be sufficient to satisfy the outstanding principal amount of the loans which could hinder our ability to attain profitable operations, limit our ability to repay our outstanding debt and negatively impact the value of our capital stock. In addition, 89.9% of our loans originated during fiscal 2004 were secured by first mortgages and 10.1% of our loans originated during fiscal 2004 were secured by second mortgages. Our loans secured by second mortgages are more frequently subject to delinquencies and losses on foreclosure than the loans secured by first mortgages. Any sustained period of increased delinquencies, foreclosures or losses from delinquent and foreclosed loans could adversely affect our ability to sell loans, the prices we receive for our loans or the value of our interest-only strips which could have a material adverse effect on our results of operations, financial condition and business prospects. See "Business -- Lending Activities."

THE AMOUNT OF OUR OUTSTANDING DEBT COULD IMPAIR OUR FINANCIAL CONDITION, OUR ABILITY TO FULFILL OUR DEBT AND DIVIDEND OBLIGATIONS AND COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

As of June 30, 2004, we had total indebtedness of approximately $847.4 million, comprised of amounts outstanding under our warehouse lines, subordinated debentures, senior collateralized subordinated notes issued in the exchange offers through June 30, 2004, convertible promissory notes and capitalized lease obligations. At June 30, 2004, our ratio of total debt and liabilities to equity was approximately 86.5 to 1. At June 30, 2004, we also had availability to incur additional indebtedness of approximately $210.4 million under our revolving warehouse and credit facilities. In fiscal 2005, we will be obligated to pay $615.9 million of interest and principal on maturing debt outstanding at June 30, 2004 and $10.9 million of dividends on Series A preferred stock outstanding at June 30, 2004. If we issue $275.0 million of additional subordinated debentures during fiscal 2005, we would expect to increase the amount of interest payable in the next twelve months by approximately $14.0 million. In addition, during fiscal 2004, we were required to pay fees and expenses of lenders of $23.3 million in order to maintain existing and obtain new credit facilities. During fiscal 2005, these fees and expenses are estimated to be approximately $30.0 million.

The amount of our outstanding indebtedness could:

o require us to dedicate a substantial portion of our cash flow to the payment of interest, principal and fees on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate requirements, including the payment of dividends on our capital stock;

o limit our flexibility in planning for, or reacting to, changes in operations and the subprime industry in which we operate; and

o place us at a competitive disadvantage compared to our competitors that have proportionately less debt.

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In addition, the interest expense resulting from additional outstanding debt and fees and expenses of lenders payable in order to maintain our credit facilities would reduce our profitability and could impair our ability to repay our outstanding debt as it matures. If we are unable to meet our debt service obligations, we could be forced to restructure or refinance our indebtedness, seek additional equity capital or sell assets. Our ability to obtain additional financing could be limited to the extent that our interest-only strips, which represent a significant portion of our assets, are pledged to secure our obligation in an amount not to exceed 10% of the outstanding principal balance of, and the payment of fees on, our $250.0 million credit facility and a portion of the cash flows from our interest-only strips is pledged to secure the senior collateralized subordinated notes issued in the exchange offers. Our inability to obtain financing or sell assets on satisfactory terms could impair our ability to operate profitably and our ability to repay our outstanding debt and could negatively impact the value of our capital stock. See "-- We depend upon the availability of financing to fund our continuing operations. Any failure to obtain adequate funding could hurt our ability to operate profitably, restrict our ability to repay our outstanding debt and negatively impact the value of our capital stock."

WE DO NOT CURRENTLY PAY CASH DIVIDENDS ON OUR COMMON STOCK AND DO NOT ANTICIPATE DOING SO IN THE FORESEEABLE FUTURE.

During the first quarter of fiscal 2004, we suspended paying cash dividends on our common stock and we do not anticipate paying any cash dividends on the common stock in the foreseeable future. As a Delaware corporation, we may not declare and pay dividends on our capital stock if the amount paid exceeds an amount equal to the surplus which represents the excess of our net assets over paid-in-capital or, if there is no surplus, our net profits for the current and/or immediately preceding fiscal year. Under applicable Delaware case law, dividends may not be paid on our common stock if we become insolvent or the payment of dividends will render us insolvent. As a result, to the extent that we continue to experience losses, we may be prohibited from paying dividends on our common stock under applicable Delaware law. In addition, the terms of Series A preferred stock issued by us in the exchange offers may restrict the payment of dividends on our common stock. See "-- We have issued 109.4 million shares of the Series A preferred stock in the exchange offers, which have dividend rights and rights upon liquidation which rank senior to our common stock."

WE HAVE ISSUED 109.4 MILLION SHARES OF THE SERIES A PREFERRED STOCK IN THE EXCHANGE OFFERS, WHICH HAVE DIVIDEND RIGHTS AND RIGHTS UPON LIQUIDATION WHICH RANK SENIOR TO OUR COMMON STOCK.

Our board of directors has designated 200,000,000 shares of preferred stock as Series A preferred stock. As of August 23, 2004, 109.4 million shares of the Series A preferred stock were outstanding as a result of the exchange offers. Upon any voluntary or involuntary liquidation, dissolution or winding up of our affairs, before any payment to holders of common stock, the holders of the Series A preferred stock will be entitled to receive a liquidation preference of $1.00 per share, plus accrued and unpaid dividends, if any, to the date of final distribution to such holders.

We pay monthly cash dividend payments to the Series A preferred stockholders of $0.008334 per share of the Series A preferred stock, subject to compliance with applicable Delaware law. We are required to pay the cumulative amount of any unpaid dividends upon liquidation of the Series A preferred stock, or the appropriate adjustment, which takes into account unpaid dividends, will be made upon the redemption or conversion of the Series A preferred stock. As long as shares of the Series A preferred stock are outstanding, no dividends will be declared or paid on our common stock unless all monthly dividends accrued and unpaid on outstanding shares of the Series A preferred stock have been paid in full.

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ISSUANCE OF SHARES OF OUR COMMON STOCK UPON THE CONVERSION OF THE SERIES A PREFERRED STOCK WILL RESULT IN SIGNIFICANT DILUTION OF EQUITY INTERESTS OF EXISTING HOLDERS OF OUR COMMON STOCK, REDUCE THE PROPORTIONATE VOTING POWER OF EXISTING HOLDERS OF OUR COMMON STOCK AND MAY DECREASE THE MARKET VALUE PER SHARE OF OUR COMMON STOCK.

On or after the second anniversary of the issuance date (or on or after the one year anniversary of the issuance date if no dividends are paid on the Series A preferred stock outstanding on such date), the holder of shares of the Series A preferred stock has an option to convert each share of the Series A preferred stock into a number of shares of common stock determined by dividing:
(A) $1.00 plus an amount equal to accrued but unpaid dividends (if the conversion date is prior to the second anniversary of the issuance date because the Series A preferred stock has become convertible due to failure to pay dividends), $1.20 plus an amount equal to accrued but unpaid dividends (if the conversion date is prior to the third anniversary of the issuance date but on or after the second anniversary of the issuance date) or $1.30 plus an amount equal to accrued but unpaid dividends (if the conversion date is on or after the third anniversary of the issuance date) by (B) the market price of a share of our common stock (which figure shall not be less than $5.00 per share regardless of the actual market price, such $5.00 minimum figure to be subject to adjustments for stock splits, including reverse stock splits) on the conversion date.

To the extent that holders of the Series A preferred stock issued in the exchange offers exercise their conversion rights described above, the maximum number of shares into which 109.4 million shares of the Series A preferred stock issued in the exchange offers may be converted is 28.5 million shares of common stock based upon the conversion price of $1.30 per share, a market price of $5.00 per share and assuming the payment of all dividends on the shares of the Series A preferred stock currently outstanding. The issuance of 28.5 million shares of common stock will result in significant dilution of equity interests of existing holders of our common stock, reduce the proportionate voting power of existing holders of our common stock and may decrease the market value per share of our common stock.

If we are unable to continue paying dividends on the Series A preferred stock outstanding, this could result in the Series A preferred stock outstanding being converted into shares of our common stock prior to the second anniversary of the issuance date of the Series A preferred stock.

WE MAY ISSUE ADDITIONAL PREFERRED STOCK WHICH COULD BE ENTITLED TO DIVIDENDS, LIQUIDATION PREFERENCES AND OTHER SPECIAL RIGHTS AND PREFERENCES NOT SHARED BY HOLDERS OF OUR COMMON STOCK OR WHICH COULD HAVE ANTI-TAKEOVER EFFECTS.

We are authorized to issue up to 3,000,000 shares of blank check preferred stock, in addition to 200,000,000 shares of preferred stock designated as Series A preferred stock. See "-- We have issued 109.4 million shares of the Series A preferred stock in the exchange offers, which have dividend rights and rights upon liquidation which rank senior to our common stock." We may issue shares of preferred stock in one or more series as our board of directors may from time to time determine without stockholder approval. The voting powers, preferences and other special rights and the qualifications, limitations or restrictions of each such series of preferred stock may differ from those of the Series A preferred stock and all other series of preferred stock at any time outstanding. The issuance of any such preferred stock could materially adversely affect the rights of holders of our common stock and could reduce the value of our capital stock.

Depending on market conditions and our financial condition, we may engage in additional exchange offers in the future and we are considering another exchange offer in the fall of 2004, as a result of which we may issue additional shares of preferred stock.

In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell our assets to, a third party. The ability of the board of directors to issue preferred stock could discourage, delay or prevent a takeover of our company, thereby preserving control of our company by the current stockholders. See "-- Beneficial ownership of 49.7% of our common stock (excluding options) by our executive officers and directors may limit or preclude a change in control of our company."

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THE VALUE OF OUR COMMON STOCK COULD BE ADVERSELY IMPACTED BY THE MARKET PERCEPTION OF OUR COMPANY.

The market value of our common stock has decreased and may continue to decrease based on our performance and market perception and conditions. The market value of our common stock may be based primarily upon the market's perception of the future viability of our company, our ability to implement our adjusted business strategy and our ability to reduce our outstanding debt, and may be secondarily based upon the perceived value of our interest-only strips which constitute a substantial portion of our assets.

IF WE ARE UNABLE TO IMPLEMENT AN EFFECTIVE HEDGING STRATEGY, WE MAY BE UNABLE TO ATTAIN PROFITABLE OPERATIONS WHICH WOULD REDUCE THE FUNDS WE HAVE AVAILABLE TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK. IN A DECLINING INTEREST RATE ENVIRONMENT, EVEN AN EFFECTIVE HEDGING STRATEGY COULD RESULT IN LOSSES IN THE CURRENT PERIOD WHICH COULD IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

From time to time we use hedging strategies in an attempt to mitigate the effect of changes in interest rates on our fixed interest rate mortgage loans prior to securitization. These strategies may involve the use of, among other things, derivative financial instruments including futures, interest rate swaps and forward pricing of securitizations. An effective hedging strategy is complex and no strategy can completely insulate us from interest rate risk. In fact, poorly designed strategies or improperly executed transactions may increase rather than mitigate interest rate risk. Hedging involves transaction and other costs, and these costs could increase as the period covered by the hedging protection increases or in periods of rising and fluctuating interest rates. During fiscal 2004, we recorded gains on the fair value of derivative financial instruments of $2.5 million and paid $0.8 million of cash in settlement of derivative financial instruments. We recorded losses on the fair value of derivative financial instruments of $14.2 million during fiscal 2003 and $9.4 million in fiscal 2002. The amount of losses settled in cash was $7.7 million in fiscal 2003 and $9.4 million in fiscal 2002. In addition, an interest rate hedging strategy may not be effective against the risk that the interest rate spread needed to attract potential buyers of asset-backed securities may widen. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Interest Rate Risk Management."

COMPETITION FROM OTHER LENDERS COULD ADVERSELY AFFECT OUR ABILITY TO ATTAIN PROFITABLE OPERATIONS AND OUR ABILITY TO REPAY OUR OUTSTANDING DEBT MAY BE IMPAIRED AND THE VALUE OF OUR CAPITAL STOCK COULD BE NEGATIVELY IMPACTED.

The lending markets in which we compete are evolving. Some competitors have been acquired by companies with substantially greater resources, lower cost of funds, and a more established market presence than we have. Government sponsored entities are expanding their participation in our market. In addition, we have experienced increased competition over the Internet, where barriers to entry are relatively low. If these companies or entities increase their marketing efforts to include our market niche of borrowers, we may be forced to reduce the interest rates and fees we currently charge in order to maintain and expand our market share. Any reduction in our interest rates or fees could have an adverse impact on our profitability and our ability to repay our outstanding debt may be impaired and the value of our capital stock could be negatively impacted. As we expand our business further, we will face a significant number of new competitors, many of whom are well established in the markets we seek to penetrate. The profitability of other similar lenders may attract additional competitors into this market.

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The competition in the subprime lending industry has also led to rapid technological developments, evolving industry standards, and frequent releases of new products and enhancements. As loan products are offered more widely through alternative distribution channels, such as the Internet, we may be required to make significant changes to our current retail structure, broker structure and information systems to compete effectively. Our ability to adapt to other technological changes in the industry could have a material adverse effect on our business.

The need to increase our loan volume to implement our adjusted business strategy in this competitive environment creates a risk of price competition in the subprime lending industry. Competition in the industry can take many forms, including interest rates and costs of a loan, convenience in obtaining a loan, customer service, amount and term of a loan, marketing and distribution channels, and competition in attracting and retaining qualified employees. Price competition would lower the interest rates that we are able to charge borrowers, which would lower our interest income. Price-cutting or discounting reduces profits and will depress earnings if sustained for any length of time. Increased competition may also reduce the volume of our loan originations and result in a decrease in gain on sale from the securitization or sale of such loans which would decrease our income. As a result, any increase in these pricing pressures could have a material adverse effect on our business. See "Business -- Competition."

AN ECONOMIC DOWNTURN OR RECESSION IN A SMALL NUMBER OF STATES COULD HINDER OUR ABILITY TO OPERATE PROFITABLY AND REDUCE THE FUNDS AVAILABLE TO REPAY OUR OUTSTANDING DEBT WHICH COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

In fiscal 2004, we originated 54.5% of our mortgage loans in California, New York, Pennsylvania, Massachusetts and Florida. The concentration of loans in these states subjects us to the risk that a downturn in the economy or recession in these states would more greatly affect us than if our lending business were more geographically diversified. As a result, an economic downturn or recession in these states could result in decreases in loan originations and increases in delinquencies and foreclosures in our total portfolio which could negatively impair our ability to sell or securitize loans, hinder our ability to operate profitably, limit the funds available to repay our outstanding debt and could negatively impact the value of our capital stock. See "Business -- Lending Activities."

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OUR OPERATIONS IN A SMALL NUMBER OF STATES COULD BE IMPACTED BY THE OCCURRENCE OF A NATURAL DISASTER, WHICH COULD HINDER OUR ABILITY TO OBTAIN PROFITABLE OPERATIONS, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

In fiscal 2004, we originated approximately 37.6% of our mortgage loans in California, Florida, New Jersey, Texas, and Georgia. The occurrence of a natural disaster, such as an earthquake or hurricane, in one or more of these states could result in a decline in loan originations, the declining value or destruction of the mortgaged properties in these states and an increase in the risk of delinquency, foreclosure or loss for the loans originated by us, which could have a material adverse effect on our business, financial conditions and results of operations. See "Business -- Lending Activities" and "-- A decline in value of the collateral securing our loans could result in an increase in losses on foreclosure, which could hinder our ability to attain profitable operations, limit our ability to repay our outstanding debt and negatively impact the value of our capital stock."

OUR RESIDENTIAL LENDING BUSINESS IS SUBJECT TO GOVERNMENT REGULATION AND LICENSING REQUIREMENTS, WHICH MAY HINDER OUR ABILITY TO OPERATE PROFITABLY, NEGATIVELY IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

Our residential lending business is subject to extensive regulation, supervision and licensing by various state departments of banking and other state, local and federal agencies. Our lending business is also subject to various laws and judicial and administrative decisions imposing requirements and restrictions on all or part of our home equity lending activities.

We are also subject to examinations by state departments of banking or similar agencies in the 46 states where we are licensed or otherwise qualified with respect to originating, processing, underwriting, selling and servicing home mortgage loans. We are also subject to Federal Reserve Board, Federal Trade Commission, Department of Housing and Urban Development and other federal and state agency regulations related to residential mortgage lending, servicing and reporting. Failure to comply with these requirements can lead to, among other remedies, termination or suspension of licenses, rights of rescission for mortgage loans, class action lawsuits and administrative enforcement actions. In addition, we are subject to review by state attorneys general and the U.S. Department of Justice and recently entered into a joint agreement with the Civil Division of the U.S. Attorney's Office for the Eastern District of Pennsylvania which ended the inquiry by the U.S. Attorney focused on our forbearance policy initiated pursuant to the civil subpoena dated May 14, 2003. See "Legal Proceedings."

State and federal banking regulatory agencies, state attorneys' general offices, the Federal Trade Commission, the U.S. Department of Justice, the U.S. Department of Housing and Urban Development and state and local governmental authorities have increased their focus on lending practices by some companies in the subprime lending industry, more commonly referred to as "predatory lending" practices. State, local and federal governmental agencies have imposed sanctions for practices, including, but not limited to, charging borrowers excessive fees, imposing higher interest rates than the borrower's credit risk warrants, and failing to adequately disclose the material terms of loans to the borrowers. For example, the Pennsylvania Attorney General reviewed fees our subsidiary, HomeAmerican Credit, Inc., charged Pennsylvania customers. Although we believe that these fees were fair and in compliance with applicable federal and state laws, in April 2002, we agreed to reimburse borrowers approximately $221,000 with respect to a particular fee paid by borrowers from January 1, 1999 to mid-February 2001 and to reimburse the Commonwealth of Pennsylvania $50,000 for its costs of investigation and for future public protection purposes. We discontinued charging this particular fee in mid-February 2001. As a result of these initiatives, we are unable to predict whether state, local or federal authorities will require changes in our lending practices in the future, including reimbursement of fees charged to borrowers, or will impose fines on us. These changes, if required, could impact our profitability. These laws and regulations may limit our ability to securitize loans originated in some states or localities due to rating agency, investor or market restrictions. As a result, we have limited the types of loans we offer in some states and may discontinue originating loans in other states or localities.

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Additionally, the United States Congress is currently considering a number of proposed bills or proposed amendments to existing laws, such as the "Ney - Lucas Responsible Lending Act of 2003" introduced on February 13, 2003 into the U.S. House of Representatives, which could affect our lending activities and make our business less profitable. These bills and amendments, if adopted as proposed, could reduce our profitability by limiting the fees we are permitted to charge, including prepayment fees, restricting the terms we are permitted to include in our loan agreements and increasing the amount of disclosure we are required to give to potential borrowers. See "Business -- Lending Activities" and "Business -- Regulation."

In addition to new regulatory initiatives with respect to so-called "predatory lending" practices, current laws or regulations in some states restrict our ability to charge prepayment penalties and late fees. Prior to its preclusion in July 2003, we had used the Federal Alternative Mortgage Transactions Parity Act of 1982, which we refer to as the Parity Act, to preempt these state laws for loans which meet the definition of alternative mortgage transactions under the Parity Act. However, the Office of Thrift Supervision has adopted a rule effective in July 2003, which precludes us and other non-bank, non-thrift creditors from using the Parity Act to preempt state prepayment penalty and late fee laws on new loan originations. Under the provisions of this rule, we are required to modify or eliminate the practice of charging prepayment and other fees on new loans in some of the states where we originate loans. Prior to this rule becoming effective, 80% to 85% of the home mortgage loans we originated contained prepayment fees. The origination of a high percentage of loans with prepayment fees impacts our securitization gains and securitization assets by helping to reduce the likelihood of a borrower prepaying their loan, thereby prolonging the life of a securitization, and increasing the amounts of residual cash flow, servicing fees and prepayment fees we can expect to collect over the life of a securitization. We currently expect that the percentage of loans that we will originate in the future containing prepayment fees will decrease to approximately 65% to 70%. During fiscal 2004, approximately 72% of the loans we originated contained prepayment fees. This decrease in prepayment fee penetration will potentially reduce the amount of gains and securitization assets we will record on any future securitizations. Because there are many other variables including market conditions, which will also impact securitizations, we are unable to quantify the impact of this rule on any future securitization assets and related gains until we complete a publicly-placed securitization of loans which we originated since this rule became effective.

We have procedures and controls to monitor compliance with numerous federal, state and local laws and regulations. However, because these laws and regulations are complex and often subject to interpretation, or as a result of inadvertent errors, we may, from time to time, inadvertently violate these laws and regulations.

More restrictive laws, rules and regulations may be adopted in the future that could make compliance more difficult or expensive or we may be subject to additional governmental reviews of our lending practices which could hinder our ability to operate profitably and repay our debt which could negatively impact the value of our capital stock. See "Business -- Regulation."

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WE ARE SUBJECT TO PRIVATE LITIGATION, INCLUDING LAWSUITS RESULTING FROM THE ALLEGED "PREDATORY" LENDING PRACTICES, AS WELL AS SECURITIES CLASS ACTION AND DERIVATIVE LAWSUITS, THE IMPACT OF WHICH ON OUR FINANCIAL POSITION IS UNCERTAIN. THE INHERENT UNCERTAINTY RELATED TO LITIGATION OF THIS TYPE AND THE PRELIMINARY STAGE OF THESE SUITS MAKES IT DIFFICULT TO PREDICT THE ULTIMATE OUTCOME OR POTENTIAL LIABILITY THAT WE MAY INCUR AS A RESULT OF THESE MATTERS.

We are subject, from time to time, to private litigation resulting from alleged "predatory lending" practices. Our lending subsidiaries, including HomeAmerican Credit, Inc., which does business as Upland Mortgage, are involved in class action lawsuits, other litigation, claims, investigations by governmental authorities, and legal proceedings arising out of their lending and servicing activities. For example, in the purported class action entitled, Calvin Hale v. HomeAmerican Credit, Inc., d/b/a Upland Mortgage, borrowers in several states alleged that the charging of, and failure to properly disclose the nature of, a document preparation fee were improper under applicable state law. The case was ultimately settled without class certification. In addition, on May 20, 2004, the purported consumer class action lawsuit captioned Moore v. American Business Financial Services, Inc. et al, No. 003237 was filed against us, our lending subsidiaries and an unrelated party in the Philadelphia Court of Common Pleas. The lawsuit was brought on behalf of residential mortgage consumers and challenges the validity of our deed in lieu of foreclosure and force-placed insurance practices as well as certain mortgage service fees charged by us. This lawsuit appears to relate, in part, to the same subject matter as the U.S. Attorney's inquiry concluded in December 2003 with no findings of wrongdoing as discussed in "Legal Proceedings." The lawsuit seeks actual and treble damages, statutory damages, punitive damages, costs and expenses of the litigation and injunctive relief. We believe the complaint contains fundamental factual inaccuracies and that we have numerous defenses to these allegations. We expect, that as a result of the publicity surrounding "predatory lending" practices, we may be subject to other class action suits in the future. See "Legal Proceedings."

In January and February of 2004, four class action lawsuits were filed against us and certain of our officers and directors in the United States District Court for the Eastern District of Pennsylvania. The consolidated amended class action complaint that supersedes complaints filed in those four lawsuits brings claims on behalf of a class of all purchasers of our common stock for a proposed class period of January 27, 2000 through June 26, 2003. The consolidated complaint alleges that, among other things, we and the named directors and officers violated Sections 10(b) and 20(a) of the Exchange Act. The consolidated complaint alleges that, during the applicable class period, our forbearance and deferment practices enabled us to, among other things, lower our delinquency rates to facilitate the securitization of our loans which purportedly allowed us to collect interest income from our securitized loans and inflate our financial results and market price of our common stock. The consolidated amended class action complaint seeks unspecified compensatory damages, costs and expenses related to bringing the action, and other unspecified relief.

In addition, a shareholder derivative action was filed against us, as a nominal defendant, and our directors and certain officers in the United States District Court for the Eastern District of Pennsylvania, alleging that the named directors and officers breached their fiduciary duties to us, engaged in the abuse of control, gross mismanagement and other violations of law during the period from January 27, 2000 through June 25, 2003.

Procedurally, these lawsuits are in a very preliminary stage. We believe that we have several defenses to the claims raised by these lawsuits and intend to vigorously defend the lawsuits. Due to the inherent uncertainties in litigation and because the ultimate resolution of these proceedings is influenced by factors outside of our control, we are currently unable to predict the ultimate outcome of this litigation or its impact on our financial position or results of operations. However, to the extent that our management will be required to participate in or otherwise devote substantial amounts of time to the defense of these lawsuits, such activities would result in the diversion of our management resources from our business operations and the implementation of our adjusted business strategy, which may negatively impact our results of operations. See "Legal Proceedings."

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CLAIMS BY BORROWERS OR INVESTORS IN LOANS COULD HINDER OUR ABILITY TO OPERATE PROFITABLY, WHICH WOULD REDUCE THE FUNDS WE HAVE AVAILABLE TO REPAY OUR OUTSTANDING DEBT AND WOULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

In the ordinary course of our business, we are subject to claims made against us by borrowers and investors in loans arising from, among other things:

o losses that are claimed to have been incurred as a result of alleged breaches of fiduciary obligations, misrepresentation, error and omission by our employees, officers and agents (including our appraisers);

o incomplete documentation; and

o failure to comply with various laws and regulations applicable to our business.

If claims asserted, pending legal actions or judgments against us result in legal expenses or liability, these expenses could hinder our ability to operate profitably, which would reduce funds available to repay our outstanding debt and negatively impact the value of our capital stock. See "Legal Proceedings."

IF WE ARE UNABLE TO REALIZE CASH PROCEEDS FROM THE SALE OF LOANS IN EXCESS OF THE COST TO ORIGINATE THE LOANS, OUR FINANCIAL POSITION AND OUR ABILITY TO REPAY OUR OUTSTANDING DEBT COULD BE ADVERSELY AFFECTED AND THE VALUE OF OUR CAPITAL STOCK COULD BE NEGATIVELY IMPACTED.

The net cash proceeds received from loan sales consist of the premiums we receive on sales of loans in excess of the outstanding principal balance, plus the cash proceeds we receive from securitizations, minus the discounts on loans that we have to sell for less than the outstanding principal balance. 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, business prospects and ability to repay our outstanding debt could be adversely affected and the value of our capital stock could be negatively impacted.

RESTRICTIVE COVENANTS IN THE AGREEMENTS GOVERNING OUR INDEBTEDNESS MAY REDUCE OUR OPERATING FLEXIBILITY AND LIMIT OUR ABILITY TO OPERATE PROFITABLY, AND OUR ABILITY TO REPAY OUR OUTSTANDING DEBT MAY BE IMPAIRED AND THE VALUE OF OUR CAPITAL STOCK COULD BE NEGATIVELY IMPACTED.

The agreements governing our credit facilities and warehouse lines of credit contain various covenants that may restrict our ability to:

o incur other senior indebtedness;

o engage in transactions with affiliates;

o incur liens;

o make certain restricted payments;

o enter into certain business combinations and asset sale transactions;

o engage in new lines of business; and

o make certain investments.

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These restrictions may limit our ability to obtain future financings, make needed capital expenditures, withstand a future downturn in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise. Our credit facilities and warehouse lines of credit also require us to maintain specified financial ratio covenants and satisfy other financial conditions. Our ability to meet those ratio covenants and conditions can be affected by events beyond our control, such as interest rates and general economic conditions.

Pursuant to the terms of these credit facilities, the failure to comply with the financial covenants constitutes an event of default and at the option of the lender, entitles the lender to, among other things, terminate commitments to make future advances to us, declare all or a portion of the loan due and payable, foreclose on the collateral securing the loan, require servicing payments be made to the lender or other third party or assume the servicing of the loans securing the credit facility. In the past, we did not meet certain financial covenants contained in our credit facilities and we requested and obtained waivers or amendments to our credit facilities to address our non-compliance with these financial covenants.

The terms of our $200.0 million credit facility, as amended, required, among other things, that we have a minimum net worth of $25.0 million at October 31, 2003 and November 30, 2003, $30.0 million at December 31, 2003, $32.0 million at March 31, 2004 and $34.0 million at June 30, 2004. An identical minimum net worth requirement applied to an $8.0 million letter of credit facility with the same lender through December 22, 2003, the date this facility expired according to its terms. We obtained waivers from these net worth requirements from the lender under these two facilities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Credit Facilities." As a result of our future anticipated losses, we anticipate that we will also need to obtain additional waivers in future periods from our lenders for our non-compliance with any financial covenants but we cannot give you any assurances as to whether or in what form these waivers will be granted.

Our breach of our financial covenants under our revolving credit facilities could result in a default under the terms of those facilities, which could cause that indebtedness and other senior indebtedness, by reason of cross-default provisions in such indebtedness, to become immediately due and payable. Our failure to repay those amounts could result in a bankruptcy proceeding or liquidation proceeding or our lenders could proceed against the collateral granted to them to secure that indebtedness. If the lenders under the credit facilities and warehouse lines of credit accelerate the repayment of borrowings, we may not have sufficient cash to repay our indebtedness and may be forced to sell assets on less than optimal terms and conditions.

WE DEPENDED ON MORTGAGE BROKERS FOR APPROXIMATELY 39% OF OUR LOAN PRODUCTION IN FISCAL 2004 AND, IF WE ARE UNABLE TO MAINTAIN RELATIONSHIPS WITH THESE BROKERS, IT COULD NEGATIVELY IMPACT THE VOLUME AND PRICING OF OUR LOANS, ADVERSELY AFFECT OUR RESULTS OF OPERATIONS AND ABILITY TO REPAY OUR OUTSTANDING DEBT AND COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

We depended on brokers for approximately 39% of our loan originations in fiscal 2004. In addition, our adjusted business strategy to increase loan originations requires creating an expanded broker network, which will increase the percentage of our loan production that will be dependent on broker relationships. Further, our competitors also have relationships with our brokers and other lenders, and actively compete with us in our efforts 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 which could negatively impact the volume and pricing of our loans, which could have a material adverse effect on our results of operations and our ability to repay our outstanding debt and could negatively impact the value of our capital stock.

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SOME OF OUR WAREHOUSE FINANCING AGREEMENTS INCLUDE PROVISION FOR MARGIN CALLS BASED ON THE LENDER'S OPINION OF THE VALUE OF OUR LOAN COLLATERAL. AN UNANTICIPATED LARGE MARGIN CALL COULD ADVERSELY AFFECT OUR LIQUIDITY, OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND THE VALUE OF OUR CAPITAL STOCK.

The amount of financing we receive under our warehouse agreements depends in large part on the lender's valuation of the mortgage loans that secure the financings. Each warehouse line provides the lender the right, under certain circumstances, 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 borrowing. We have not experienced margin calls on these agreements related to the value of loan collateral. However, during the first four months of fiscal 2004, we did have one previous warehouse lender and the sponsor of a previous mortgage conduit facility request that we use up to 100% of the proceeds received from the sale of loans funded by their facilities to pay down their facilities from their scheduled 97% advance rates to advance rates of 83% and 92%, respectively. The requests from these facility providers were made primarily in response to our liquidity issues and in exchange for waivers and amendments to the credit facility. See "Management's Discussion and Analysis of Financial Position and Results of Operations -- Liquidity and Capital Resources." These facilities were fully paid off in October 2003.

We are unable to predict whether we will be subject to margin calls in the foreseeable future. Any such margin call could have a material adverse effect on our results of operations, financial condition and business prospects, our ability to repay our outstanding debt and the value of our capital stock.

PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND DELAWARE LAW MAY HAVE THE EFFECT OF IMPEDING A CHANGE OF CONTROL WHICH COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

We are subject to restrictions that may impede our ability to effect a change in control. Certain provisions contained in our certificate of incorporation and bylaws and certain provisions of Delaware law may have the effect of discouraging a third party from making an acquisition proposal for us and thereby inhibit a change in control, which could negatively impact the value of our capital stock.

BENEFICIAL OWNERSHIP OF 49.7% OF OUR COMMON STOCK (EXCLUDING OPTIONS) BY OUR EXECUTIVE OFFICERS AND DIRECTORS MAY LIMIT OR PRECLUDE A CHANGE IN CONTROL OF OUR COMPANY.

As of September 30, 2004, our executive officers and directors, in the aggregate, beneficially owned approximately 49.7% of our outstanding common stock (excluding options to purchase shares of our common stock). As a result, these stockholders acting together are able to control most matters requiring approval by our stockholders, including the election of directors. Such concentration of ownership may have the effect of delaying or preventing a change in control of our company, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices.

ENVIRONMENTAL LAWS AND REGULATIONS AND OTHER ENVIRONMENTAL CONSIDERATIONS MAY RESTRICT OUR ABILITY TO FORECLOSE ON LOANS SECURED BY REAL ESTATE OR INCREASE COSTS ASSOCIATED WITH THOSE LOANS WHICH COULD HINDER OUR ABILITY TO OPERATE PROFITABLY, LIMIT THE FUNDS AVAILABLE TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

Our ability to foreclose on the real estate collateralizing our loans may be limited by environmental laws which pertain primarily to commercial properties that require a current or previous owner or operator of real property to investigate and clean up hazardous or toxic substances or chemical releases on the property. In addition, the owner or operator may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and cleanup costs relating to the contaminated property. While we would not knowingly make a loan collateralized by real property that was contaminated, we may not discover the environmental contamination until after we had made the loan or after we had foreclosed on a loan. If we foreclosed upon a property and environmental liabilities subsequently arose, we could face significant liability.

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Since the commencement of our operations, there have been approximately ten instances where we have determined not to foreclose on the real estate collateralizing a delinquent loan because of environmental considerations. Two are currently under administration. Any losses we sustained on these loans did not have a material adverse effect on our profitability and we believe any losses we may sustain in the future will not be material. We may face environmental clean up costs with respect to one of the loans under administration which we do not believe will have a material adverse effect on our financial results.

In addition to federal or state laws, owners or former owners of a contaminated site may be subject to common law claims, including tort claims, by third parties based on damages and costs resulting from environmental contamination migrating from the property. Other environmental considerations, such as pervasive mold infestation of real estate securing our loans, may also restrict our ability to foreclose on delinquent loans. See "Business -- Loan Servicing and Administrative Procedures."

TERRORIST ATTACKS IN THE UNITED STATES MAY CAUSE DISRUPTION IN OUR BUSINESS AND OPERATIONS AND OTHER ATTACKS OR ACTS OF WAR MAY ADVERSELY AFFECT THE MARKETS IN WHICH OUR COMMON STOCK TRADES, THE MARKETS IN WHICH WE OPERATE, OUR ABILITY TO OPERATE PROFITABLY AND OUR ABILITY TO REPAY OUR OUTSTANDING DEBT MAY BE IMPAIRED AND THE VALUE OF OUR CAPITAL STOCK COULD BE NEGATIVELY IMPACTED.

Terrorists' attacks in the United States in September 2001 caused major instability in the United States financial markets. These attacks or new events and responses on behalf of the U.S. government may lead to further armed hostilities or to further acts of terrorism in the U.S. which may cause a further decline in the financial market and may contribute to a further decline in economic conditions. These events may cause disruption in our business and operations including reductions in demand for our loan products and our subordinated debentures, increases in delinquencies and credit losses in our managed loan portfolio, changes in historical prepayment patterns and declines in real estate collateral values. To the extent we experience an economic downturn, unusual economic patterns and unprecedented behaviors in financial markets, these developments may affect our ability to originate loans at profitable interest rates, to price future loan securitizations profitably, to effect whole loan sales and to effectively hedge our loan portfolio against market interest rate changes. Should these disruptions and unusual activities occur, our ability to operate profitably and cash flow could be reduced and our ability to make principal and interest payments on our outstanding debt could be impaired and the value of our capital stock could be negatively impacted.

IF MANY OF OUR BORROWERS BECOME SUBJECT TO THE SERVICEMEMBERS CIVIL RELIEF ACT, OUR CASH FLOWS AND INTEREST INCOME MAY BE ADVERSELY AFFECTED WHICH WOULD NEGATIVELY IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND WOULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

Under the Servicemembers Civil Relief Act (formerly known as the Soldiers' and Sailors' Civil Relief Act of 1940), a borrower who enters military service after the origination of his or her loan generally may not be charged interest above an annual rate of six percent. Additionally, this Relief Act may restrict or delay our ability to foreclose on an affected loan during the borrower's active duty status. The Relief Act also applies to a borrower who was on reserve status and is called to active duty after origination of the loan. A significant mobilization by the U.S. Armed Forces could increase the number of our borrowers who are the subject of this Relief Act, thereby reducing our cash flow and the interest payments we collect from those borrowers, and in the event of default, delaying or preventing us from exercising the remedies for default that otherwise would be available to us.

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WE ARE SUBJECT TO LOSSES DUE TO FRAUDULENT AND NEGLIGENT ACTS ON THE PART OF LOAN APPLICANTS, MORTGAGE BROKERS, OTHER VENDORS AND OUR EMPLOYEES WHICH COULD HINDER OUR ABILITY TO OPERATE PROFITABLY AND IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.

When we originate mortgage loans, we 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 value of the loan may be significantly lower than expected. Whether a misrepresentation or fraudulent act is made by the loan applicant, the mortgage broker, another third party or one of our employees, we generally bear the risk of loss. A loan subject to a material misrepresentation or fraudulent act is typically unsaleable or subject to repurchase if it is sold prior to detection, such persons and entities are often difficult to locate and it is often difficult to collect any monetary losses we have suffered from them.

We have controls and processes designed to help us identify misrepresented or fraudulent information in our loan origination operations. We cannot assure you, however, that we have detected or will detect all misrepresented or fraudulent information in our loan originations.

EMPLOYEES

At June 30, 2004, we employed 931 people on a full-time basis and 38 employees on a part-time basis. None of our employees are covered by a collective bargaining agreement. We consider our employee relations to be good.

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EXECUTIVE OFFICERS WHO ARE NOT ALSO DIRECTORS(1)

BARRY EPSTEIN, age 65, is our Managing Director of the National Wholesale Residential Mortgage Division, a position he has held since December 2003. Mr. Epstein is responsible for the sales, marketing and day-to-day management of our broker origination channel. From October 2003 to December 2003, Mr. Epstein was Chief Operating Officer of Rekaren, Incorporated, a mortgage loan broker. Mr. Epstein was Managing Director and a director of Approved FSB, a federally chartered savings bank, from 2000 to 2002. From 1998 through 2000, he was a consultant with Lincolnshire Management, Inc., an equity fund manager. Mr. Epstein was Senior Vice President of Ocwen Financial Services, a subsidiary of Ocwen Federal Bank of West Palm Beach, Florida, from 1996 to 1998.

STEPHEN M. GIROUX, age 56, is our Executive Vice President, General Counsel and Secretary. Mr. Giroux is also an Executive Vice President and the General Counsel and Secretary of all of our subsidiaries. Mr. Giroux was promoted to Executive Vice President and Secretary in November 2003. Mr. Giroux was our Senior Vice President and General Counsel from April 2001 to November 2003. Mr. Giroux joined us in September 1999 as Senior Vice President and Deputy General Counsel. Prior to such time, he was a partner with the law firm of Weir & Partners, LLC, Philadelphia, Pennsylvania from 1998 to 1999. From 1977 to 1998, Mr. Giroux was Senior Vice President and Lead Counsel for CoreStates Financial Corp., Philadelphia, Pennsylvania, and its predecessors.

ALBERT W. MANDIA, age 57, is our Executive Vice President and Chief Financial Officer, positions he has held since June 1998 and October 1998, respectively. Mr. Mandia is responsible for all financial, treasury, information systems, facilities and investor relations functions. Mr. Mandia also is an Executive Vice President and the Chief Financial Officer of all of our subsidiaries. From 1974 to 1998, Mr. Mandia was associated with CoreStates Financial Corp. where he last held the position of Chief Financial Officer from February 1997 to April 1998.

MILTON RISEMAN, age 68, is our Chairman of our Consumer Mortgage Group. Mr. Riseman has held that position from the time he joined us in June 1999. Mr. Riseman resigned and served as our consultant from July 2, 2003 until November 24, 2003. On November 24, 2003, Mr. Riseman rejoined us as Chairman of our Consumer Mortgage Group. As Chairman of the Consumer Mortgage Group, Mr. Riseman is responsible for the sales, marketing and day-to-day management of Upland Mortgage's retail operation and he held supervisory responsibility for the Bank Alliance Services program. From February 1994 until October 1998, Mr. Riseman served as President of Advanta Mortgage. Mr. Riseman joined Advanta in 1992 as Senior Vice President, Administration. From 1965 until 1992, Mr. Riseman served in various capacities at Citicorp, including serving as President of Citicorp Acceptance Corp. from 1986 to 1992.

JEFFREY M. RUBEN, age 41, is our Executive Vice President, a position he has held since September 1998. Mr. Ruben was our general counsel from April 1992 to April 2001. He is also Executive Vice President of some of our subsidiaries, positions he has held since April 1992. Mr. Ruben is responsible for the loan servicing and collections departments, the asset allocation unit and the legal department. Mr. Ruben served as Vice President from April 1992 to 1995 and Senior Vice President from 1995 to 1998. From June 1990 until he joined us in April 1992, Mr. Ruben was an attorney with the law firm of Klehr, Harrison, Harvey, Branzburg & Ellers in Philadelphia, Pennsylvania. From December 1987 until June 1990, Mr. Ruben was employed as a credit analyst with the CIT Group Equipment Financing, Inc. Mr. Ruben is a member of the Pennsylvania and New Jersey Bar Associations. Mr. Ruben holds a New Jersey Mortgage Banker License and a New Jersey Secondary Mortgage Banker License.

BEVERLY SANTILLI, age 45, is the President of American Business Credit, Inc. and an Executive Vice President of HomeAmerican Credit, Inc., a position she was appointed to on June 1, 2004. Mrs. Santilli is also responsible for our human resources and those of our subsidiaries. Mrs. Santilli was our First Executive Vice President, from September 1998 through May 2004. Prior to September 1998 Mrs. Santilli held a variety of positions including Executive Vice President, Vice President and Secretary. Prior to joining American Business Credit, Inc. and from September 1984 to November 1987, Mrs. Santilli was affiliated with PSFS initially as an Account Executive and later as a Commercial Lending Officer with that bank's Private Banking Group. Mrs. Santilli is the wife of Anthony J. Santilli.
(1) Ages are as of October 1, 2004.

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ITEM 2. PROPERTIES

Except for real estate acquired in foreclosure in the normal course of our business, we do not presently hold title to any real estate for operating purposes. The interests which we presently hold in real estate are in the form of mortgages against parcels of real estate owned by our borrowers or their affiliates and real estate acquired through foreclosure.

We presently lease office space for our corporate headquarters in Philadelphia, Pennsylvania. The current lease term for the Philadelphia facility expires in June 2014. The terms of the rental agreement require increased payments annually for the term of the lease with average minimum annual rental payments of $4.2 million. We have entered into contracts, or may engage parties in the future, related to the relocation of our corporate headquarters such as contracts for building improvements to the leased space, office furniture and equipment and moving services. The provisions of the lease and local and state grants provided us with reimbursement of a substantial amount of our costs related to the relocation, subject to certain conditions and limitations. We do not believe our unreimbursed expenses or unreimbursed cash outlay related to the relocation will be material to our operations.

The lease requires us to maintain a letter of credit in favor of the landlord to secure our obligations to the landlord throughout the term of the lease. The amount of the letter of credit is currently $8.0 million. The letter of credit is currently issued by JPMorgan Chase Bank.

We continue to lease some office space in Bala Cynwyd under a five-year lease expiring in November 2004 at an annual rental of approximately $0.7 million. We performed loan servicing and collection activities at this office, but these activities were relocated to our Philadelphia office on July 12, 2004. The expenses and cash outlay related to the relocation were not material to our operations.

We also lease the office space in Roseland, New Jersey and the nine-year lease expires in January 2012. The terms of the rental agreement require increased payments periodically for the term of the lease with average minimum annual rental payments of $0.8 million.

In connection with the acquisition of the California mortgage broker operation in December 2003, we assumed the obligations under a lease for approximately 3,700 square feet of space in West Hills, California. The remaining term of the lease is 2 years, expiring September 30, 2006 at an annual rental of approximately $0.1 million.

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In connection with the opening of the Irvine, California mortgage broker operation, we entered into a sublease on March 4, 2004 for approximately 6,400 square feet of space. The term of the sublease is 1 2/3 years and expires November 30, 2005. The terms of the sublease require average minimum annual rental payments of $0.1 million.

In connection with the opening of the Maryland mortgage broker operation, we entered into a sublease on March 15, 2004 for approximately 10,300 square feet of space in Edgewater, Maryland. The term of the sublease is 3 years and expires March 15, 2007. The terms of the sublease require increased payments annually for the term of the lease with average minimum annual rental payments of $0.2 million.

In connection with the acquisition of the Texas broker operation, we entered into a sublease on June 11, 2004 for approximately 6,000 square feet of space in Austin, Texas. The term of the sublease is 10 1/2 months, expiring April 28, 2005 at an annual rental of approximately $0.1 million.

ITEM 3. LEGAL PROCEEDINGS

On February 26, 2002, a purported class action titled Calvin Hale v. HomeAmerican Credit, Inc., No. 02 C 1606, United States District Court for the Northern District of Illinois, was filed in the Circuit Court of Cook County, Illinois (subsequently removed by Upland Mortgage to the captioned federal court) against our subsidiary, HomeAmerican Credit, Inc., which does business as Upland Mortgage, on behalf of borrowers in Illinois, Indiana, Michigan and Wisconsin who paid a document preparation fee on loans originated since February 4, 1997. The case consisted of three purported class action counts and two individual counts. The plaintiff alleged that the charging of, and the failure to properly disclose the nature of, a document preparation fee were improper under applicable state law. In November 2002 the Illinois Federal District Court dismissed the three class action counts and an agreement in principle was reached in August 2003 to settle the matter. The terms of the settlement were finalized and the action was dismissed on September 23, 2003. The matter did not have a material effect on our consolidated financial position or results of operations.

On May 20, 2004, the purported consumer class action lawsuit captioned Moore v. American Business Financial Services, Inc. et al, No. 003237 was filed against us, our lending subsidiaries and an unrelated party in the Philadelphia Court of Common Pleas. The lawsuit was brought on behalf of residential mortgage consumers and challenges the validity of our deed in lieu of foreclosure and force-placed insurance practices as well as certain mortgage service fees charged by us. This lawsuit relates, in part, to the same subject matter as the U.S. Attorney's inquiry concluded in December 2003 with no findings of wrongdoing as discussed below. The lawsuit seeks actual and treble damages, statutory damages, punitive damages, costs and expenses of the litigation and injunctive relief. Procedurally, this lawsuit is in a very preliminary stage. We believe the complaint contains fundamental factual inaccuracies and that we have numerous defenses to these allegations. We intend to vigorously defend this lawsuit. Due to the inherent uncertainties in litigation and because the ultimate resolution of this proceeding is influenced by factors outside of our control, we are currently unable to predict the ultimate outcome of this litigation or its impact on our financial position or results of operations.

In addition, our lending subsidiaries, including HomeAmerican Credit, Inc., which does business as Upland Mortgage, and American Business Mortgage Services, Inc., are involved, from time to time, in class action lawsuits, other litigation, claims, investigations by governmental authorities, and legal proceedings arising out of their lending and servicing activities. For example, in July 2004, we received a document request in the form of an administrative subpoena from the New Jersey Attorney General's Office, acting as counsel for the Office of Consumer Protection, in connection with American Business Mortgage Services, Inc. It seeks the loan files of two borrowers and includes a broader request for a list of loans solicited or closed by a former loan officer from January 1, 1999 to the present. The loan officer's employment was terminated in 2001. While it would appear that the request does not raise material issues, since this matter is in the preliminary stages, communications from the Attorney General's Office have not been sufficient to confirm the extent of their interest. Due to our current expectation regarding the ultimate resolution of these actions, management believes that the liabilities resulting from these actions will not have a material adverse effect on our consolidated financial position or results of operations. However due to the inherent uncertainty in litigation and because the ultimate resolution of these proceedings is influenced by factors outside of our control, our estimated liability under these proceedings may change or actual results may differ from our estimates.

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Additionally, court decisions in litigation to which we are not a party may also affect our lending activities and could subject us to litigation in the future. For example, in Glukowsky v. Equity One, Inc., (Docket No. A-3202 - 01T3), dated April 24, 2003, to which we are not a party, the Appellate Division of the Superior Court of New Jersey determined that the Parity Act's preemption of state law was invalid and that the state laws precluding some lenders from imposing prepayment fees are applicable to loans made in New Jersey. On May 26, 2004, the New Jersey Supreme Court reversed the decision of the Appellate Division of the Superior Court of New Jersey and held that the Parity Act had preempted the New Jersey Prepayment Law, which prohibited housing lenders from imposing prepayment penalties. However, the plaintiff has petitioned the United States Supreme Court for certiorari in this matter.

We expect that, as a result of the publicity surrounding predatory lending practices, we may be subject to other class action suits in the future. In addition, from time to time, we are involved as plaintiff or defendant in various other legal proceedings arising in the normal course of our business. While we cannot predict the ultimate outcome of these various legal proceedings, management believes that the resolution of these legal actions should not have a material effect on our financial position, results of operations or liquidity.

We received a civil subpoena, dated May 14, 2003, from the Civil Division of the U.S. Attorney for the Eastern District of Pennsylvania. The subpoena requested that we provide certain documents and information with respect to us and our lending subsidiaries for the period from May 1, 2000 to May 1, 2003, including: (i) all loan files in which we entered into a forbearance agreement with a borrower who is in default; (ii) the servicing, processing, foreclosing, and handling of delinquent loans and non-performing loans, the carrying, processing and sale of real estate owned, and forbearance agreements; and (iii) agreements to sell or otherwise transfer mortgage loans (including, but not limited to, any pooling or securitization agreements) or to obtain funds to finance the underwriting, origination or provision of mortgage loans, any transaction in which we sold or transferred mortgage loans, any instance in which we did not service or act as custodian for a mortgage loan, representations and warranties made in connection with mortgage loans, secondary market loan sale schedules, and credit loss, delinquency, default, and foreclosure rates of mortgage loans. On December 22, 2003, we entered into a Joint Agreement with the Civil Division of the U. S. Attorney's Office for the Eastern District of Pennsylvania which ends this inquiry. We do not believe that the Joint Agreement with the U.S. Attorney's Office has had a significant impact on our operations.

In response to the inquiry and as part of the Joint Agreement, we have adopted a revised forbearance policy, which became effective on November 19, 2003. Under this policy, we no longer require a borrower to execute a deed in lieu of foreclosure as a condition to entering into a forbearance agreement with us where the real estate securing the loan is the borrower's primary residence. Under the Joint Agreement, we also agreed to return to existing borrowers any executed but unrecorded deeds in lieu of foreclosure obtained under our former forbearance policy.

We also agreed to contribute a total of $80 thousand, and made this contribution as required, to a U.S. Department of Housing and Urban Development (HUD) approved housing counseling organization providing housing counseling in states in which we originate mortgage loans. Under our revised forbearance policy, eligible borrowers are sent a letter, along with our standard form forbearance agreement encouraging them to: read the forbearance agreement; seek the advice of an attorney or other advisor prior to signing the forbearance agreement; and contact our consumer advocate by calling a toll-free number with questions. The Joint Agreement requires that for 18 months following its execution, we will notify the U.S. Attorney's Office of any material changes we propose to make to our forbearance policy and form of forbearance agreement (or cover letter) and that no changes to these documents shall be effective until at least 30 days after this notification. The U.S. Attorney reserves the right to reinstitute its inquiry if we do not comply with our revised forbearance policy, fail to provide the 30 days notice described above, or disregard the concerns of the U.S. Attorney's Office after providing such notice. The Joint Agreement also requires that we provide the U.S. Attorney with two independently prepared reports confirming our compliance with our revised forbearance policy (including the standard form of forbearance agreement and cover letter) and internal company training for collections department employees described below. These reports are to be submitted to the U.S. Attorney's Office at 9 and 18 months after the execution of the Joint Agreement. KPMG LLP, which we engaged to perform an independent compliance audit required at the end of the 9-month period, determined that we had complied with our policy requirements entered into as a result of the Joint Agreement with the U.S. Attorney's Office.

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We also agreed to implement a formal training session regarding our revised forbearance policy for all of our collections department employees, at which such employees are directed to inform borrowers that they can obtain assistance from housing and credit counseling organizations and how to find such organizations in their area. We agreed to monitor compliance with our forbearance policy and take appropriate disciplinary action against those employees who do not comply with this policy.

In January and February of 2004, four class action lawsuits were filed against us and certain of our officers and directors. Lead plaintiffs and counsel were appointed on June 3, 2004. A consolidated amended class action complaint that supersedes these four complaints was filed on August 19, 2004 in the United States District Court for the Eastern District of Pennsylvania. The consolidated class action case is American Business Financial Services, Inc. Securities Litigation, Civil Action No. 04-0265.

The consolidated amended class action complaint brings claims on behalf of a class of all purchasers of our common stock for a proposed class period of January 27, 2000 through June 26, 2003. The consolidated complaint names us, our director and Chief Executive Officer, Anthony Santilli, our Chief Financial Officer, Albert Mandia, and former director, Richard Kaufman, as defendants and alleges that, among other things, we and the named directors and officers violated Sections 10(b) and 20(a) of the Exchange Act. The consolidated complaint alleges that, during the applicable class period, our forbearance and deferment practices enabled us to, among other things, lower our delinquency rates to facilitate the securitization of our loans which purportedly allowed us to collect interest income from our securitized loans and inflate our financial results and market price of our common stock. The consolidated amended class action complaint seeks unspecified compensatory damages, costs and expenses related to bringing the action, and other unspecified relief.

On March 15, 2004, a shareholder derivative action was filed against us, as a nominal defendant, and our director and Chief Executive Officer, Anthony Santilli, our Chief Financial Officer, Albert Mandia, our directors, Messrs. Becker, DeLuca and Sussman, and our former director Mr. Kaufman, as defendants, in the United States District Court for the Eastern District of Pennsylvania. The complaint is captioned: Osterbauer v. Santilli, Kaufman, Mandia, Becker, DeLuca and Sussman, Civil Action No. 04-1105. The lawsuit was brought nominally on behalf of the Company, as a shareholder derivative action, alleging that the named directors and officers breached their fiduciary duties to the Company, engaged in the abuse of control, gross mismanagement and other violations of law during the period from January 27, 2000 through June 25, 2003. The lawsuit seeks unspecified compensatory damages, equitable or injunctive relief and costs and expenses related to bringing the action, and other unspecified relief. The parties have agreed to stay this case pending disposition of any motion to dismiss the consolidated amended complaint filed in the putative consolidated securities class action.

Procedurally, these lawsuits are in a very preliminary stage. We believe that we have several defenses to the claims raised by these lawsuits and intend to vigorously defend the lawsuits. Due to the inherent uncertainties in litigation and because the ultimate resolution of these proceedings is influenced by factors outside of our control, we are currently unable to predict the ultimate outcome of this litigation or its impact on our financial position or results of operations. See "Risk Factors -- We are subject to private litigation, including lawsuits resulting from the alleged "predatory" lending practices, as well as securities class action and derivative lawsuits, the impact of which on our financial position is uncertain. The inherent uncertainty related to litigation of this type and the preliminary stage of these suits makes it difficult to predict the ultimate outcome or potential liability that we may incur as a result of these matters."

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Special Meeting of Stockholders of the Company was held on June 29, 2004. The following proposal was presented to stockholders and voted on at the Special Meeting:

To approve a proposal to issue shares of the Series A preferred stock in connection with the second exchange offer and shares of common stock issuable upon the conversion of Series A Preferred Stock (the "Proposal").

The results of the voting on the Proposal at the Special Meeting were as follows:

Shares For Shares Against Shares Abstaining Broker Non-votes

2,102,819 27,877 3,372 0

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PART II

ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OF SECURITIES

Our common stock is currently traded on the NASDAQ National Market System under the symbol "ABFI." Our common stock began trading on the NASDAQ National Market System on February 14, 1997. The following table sets forth the high and low sales prices of our common stock for the periods indicated.

                        QUARTER ENDED               HIGH       LOW
-------------------------------------------------------------------
September 30, 2002............................     14.42       5.78
December 31, 2002.............................     11.52       8.81
March 31, 2003................................     13.56       9.14
June 30, 2003.................................     11.55       5.77
September 30, 2003............................      7.25       4.00
December 31, 2003.............................      6.62       2.83
March 31, 2004................................      4.09       2.73
June 30, 2004.................................      5.60       2.97
September 30, 2004............................      5.75       3.54

On September 30, 2004, the closing price of the common stock on the NASDAQ National Market System was $4.00.

On April 1, 2004, we received a notice from the NASDAQ Stock Market that we were not in compliance with the requirement for continued listing of our common stock on the NASDAQ National Market System on the basis that we have not met the requirement that the minimum market value of our publicly held shares equals at least $5.0 million. Under NASDAQ Marketplace Rules, we had 90 days, or until June 28, 2004, to become compliant with this requirement for a period of 10 consecutive trading days. On June 15, 2004, we advised the NASDAQ Stock Market that we had been in compliance with this requirement for 10 consecutive trading days and we withdrew our application to list our common stock on the American Stock Exchange, referred to as AMEX in this document, which application we filed with AMEX upon our receipt of the letter from the NASDAQ Stock Market described above. On June 24, 2004, we received a letter from the staff of the NASDAQ Stock Market confirming that we had regained compliance with the NASDAQ continued listing requirement related to the market value of our publicly held shares and were not subject to delisting. There can be no assurance that we will be in compliance with the $10.0 million stockholders' equity requirement on September 30, 2004. We are considering a new exchange offer in order to maintain compliance with this listing requirement. If we are unable to maintain our listing on the NASDAQ National Market System, the value of our capital stock and our ability to continue to sell subordinated debentures would be negatively impacted by making the process of complying with the state securities laws more difficult, costly and time consuming. As a result, we may be unable to continue to sell subordinated debentures in certain states, which would have a material adverse effect on our liquidity and our ability to repay maturing debt when due.

As of October 5, 2004, there were 1,131 record holders and approximately 1,470 beneficial holders of our common stock.

On May 13, 2004, our board of directors declared a 10% common stock dividend, which was paid on June 8, 2004 to common stockholders of record as of May 25, 2004. Stock price and related information contained in this document have been adjusted to reflect this stock dividend.

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During the first quarter of fiscal 2004, we suspended paying quarterly cash dividends on our common stock. During the fiscal year ended June 30, 2003, we paid dividends of $0.291 per share on our common stock for an aggregate dividend payment of $0.9 million.

On August 21, 2002, the Board of Directors declared a 10% stock dividend on our common stock which was paid on September 13, 2002 to shareholders of record as of September 3, 2002. All cash dividends on our common stock reported above have been adjusted to reflect all stock dividends.

The payment of dividends on our common stock in the future is at the sole discretion of our Board of Directors and will depend upon, among other things, our earnings, capital requirements and financial condition, as well as other relevant factors.

During fiscal 2004, we declared the following dividends on our Series A preferred stock (in thousands, except per share):

                                                  PREFERRED        TOTAL
                                                DIVIDEND PER     PREFERRED
       FOR THE MONTH ENDED                          SHARE        DIVIDENDS
--------------------------------------------    ------------     ---------
January 31, 2004............................    $  0.008334       $  323
February 29, 2004...........................       0.008334          514
March 31, 2004..............................       0.008334          515
April 30, 2004..............................       0.008334          515
May 31, 2004................................       0.008334          515
June 30, 2004...............................       0.008334          515
                                                                 ---------
                                                                  $2,897
                                                                 =========

As a Delaware corporation, we may not declare and pay dividends on capital stock if the amount paid exceeds an amount equal to the surplus which represents the excess of our net assets over paid-in-capital or, if there is no surplus, our net profits for the current and/or immediately preceding fiscal year. Dividends cannot be paid from our net profits unless the paid-in-capital represented by the issued and outstanding stock having a preference upon the distribution of our assets at the market value is intact. Under applicable Delaware case law, dividends may not be paid on our Series A preferred stock or common stock if we become insolvent or the payment of the dividend will render us insolvent. To the extent we pay dividends and we are deemed to be insolvent or inadequately capitalized, a bankruptcy court could direct the return of any dividends. In addition, pursuant to the terms of the Series A preferred stock, no dividends may be paid on shares of Series A preferred stock or set apart for payment by us if the terms of any of our agreements prohibit such declaration, payment or setting apart for payment or provide that such declaration, payment or setting apart for payment would constitute a breach thereof or a default thereunder, or if such declaration or payment shall be restricted by agreement or law, would be unlawful, or would cause us to become insolvent as contemplated by the Delaware law.

See "Part III - Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters" for the information regarding our equity compensation plans.

On February 11, 2003, the Board of Directors issued 2,000 shares (2,200 shares after the effect of subsequent stock dividends) of common stock to each of Warren E. Palitz, a current director, and Jeffrey S. Steinberg, a former director, in consideration for their board service. This issuance was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, referred to as the Securities Act, based upon a determination that the investors were sophisticated, had access to, and were provided with, information that would otherwise be contained in a registration statement and there was no general solicitation.

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As of December 24, 2003, we issued a convertible non-negotiable promissory note; referred to as the note in this document, in the principal amount of $475,000 to Rekaren, Incorporated, a California corporation referred to as Rekaren, as partial consideration for the purchase of certain assets of Rekaren. At any time on or after December 24, 2004 and before January 31, 2005, the outstanding principal balance of, and accrued interest under, the note is convertible, at the holder's option, into the number of shares of our common stock determined by dividing the aggregate principal amount of the note by the conversion price of $5.00 per share (the conversion price is subject to adjustments in case of a stock split, combination, reclassification or other similar event effected by us with respect to the common stock). We issued the note in reliance on the exemption from registration under Section 4(2) of the Securities Act based upon a determination that the investor was sophisticated, had access to, and was provided with, information that would otherwise be contained in a registration statement and there was no general solicitation.

As of December 24, 2003, we issued 200,000 shares (220,000 after the effect of subsequent stock dividends) of common stock to Barry Epstein, the newly hired experienced industry professional to head the National Wholesale Residential Mortgage Division, as an inducement material to his employment with us pursuant to the employment agreement and restricted stock agreement by and between us and Mr. Epstein, dated December 24, 2003. We issued the foregoing shares in reliance on the exemption from registration under Section 4(2) of the Securities Act based upon a determination that the security was issued to a sophisticated investor who had access to, and was provided with, information that would otherwise be contained in a registration statement and there was no general solicitation.

As of February 6, 2004, in connection with the first exchange offer, we issued $55.4 million in the aggregate principal amount of senior collateralized subordinated notes and 61.8 million shares of Series A preferred stock in exchange for $117.2 million in the aggregate principal amount of subordinated debentures issued prior to April 1, 2003. As of June 30, 2004, in connection with the second exchange offer, we issued $28.6 million in the aggregate principal amount of senior collateralized subordinated notes and 32.0 million shares of Series A preferred stock in exchange for $60.6 million in the aggregate principal amount of subordinated debentures. We issued the foregoing senior collateralized subordinated notes and shares of the Series A preferred stock in reliance on the exemption from the registration under Section 3(a)(9) of the Securities Act.

We believe that the exchange offers met all of the requirements of the exemption provided by Section 3(a)(9) of the Securities Act because (i) we were the issuer of both (a) the senior collateralized subordinated notes and the Series A preferred stock issued in the exchange offers and (b) the subordinated debentures exchanged; (ii) the exchange offers involved an exchange exclusively with our existing security holders and did not involve any new consideration being paid by security holders; and (iii) we did not pay, and do not intend to pay, any compensation for soliciting holders of subordinated debentures to participate in the exchange offers.

As of June 11, 2004, we issued a convertible non-negotiable promissory note, referred to as the ESI note in this document, in the principal amount of $650,000 to ESI Mortgage, LP, a Texas limited partnership referred to as ESI, as partial consideration for the purchase of certain assets of ESI. At any principal payment date (based on an installment schedule), the principal balance due under the ESI note is convertible, at the holder's option, into the number of shares of our common stock determined by dividing the aggregate principal amount then due under the ESI note by the closing sales price per share of our common stock on the immediately preceding principal due date, except for the principal amount due on December 31, 2004, which is based on the closing sales price per share of our common stock on June 11, 2004. However, the ESI note may not be converted by the holder as of the December 31, 2004 principal payment date if such conversion would negatively impact the securities law exemptions available with respect to our unregistered securities offerings occurring during the period from June 11, 2004 through the first principal payment date, in which case the principal amount which would have been convertible as of such date will be convertible on March 31, 2005, at the same exchange ratio that would have applied to a December 31, 2004 conversion. We issued the ESI note in reliance on the exemption from registration under Section 4(2) of the Securities Act based upon a determination that the investor was sophisticated, had access to, and was provided with, information that would otherwise be contained in a registration statement and there was no general solicitation.

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ITEM 6. SELECTED FINANCIAL DATA

You should consider our selected consolidated financial information set forth below together with the more detailed consolidated financial statements, including the related notes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this document.

                                                              YEAR ENDED JUNE 30,
                                            -----------------------------------------------------
                                              2004       2003        2002       2001       2000
                                            ---------   --------  ---------  ---------   --------
STATEMENT OF INCOME DATA:                         (In thousands, except per share data)
Revenues:
   Gain on sale of loans and leases:
     Securitizations....................    $  15,107   $170,950   $185,580   $128,978   $ 90,380
     Whole loan sales...................       18,725        655      2,448      2,742      1,717
   Interest and fees....................       17,732     19,395     18,890     19,840     17,683
   Interest accretion on interest-only
      strips.............................      40,176     47,347     35,386     26,069     16,616
   Other................................        5,332      3,059      5,597      5,707      4,250
                                            ---------   --------   --------   --------   --------
Total revenues..........................       97,072    241,406    247,901    183,336    130,646
Total expenses(a).......................      276,794    290,426    234,351    170,151    120,284
                                            ---------   --------   --------   --------   --------
Income (loss) before provision for income
   taxes (benefit)......................     (179,722)   (49,020)    13,550     13,185     10,362
Provision for income taxes (benefit)....      (68,294)   (19,118)     5,691      5,274      3,938
                                            ---------   --------   --------   --------   --------
Income (loss) before cumulative effect of
   a change in accounting principle.....     (111,428)   (29,902)     7,859      7,911      6,424
Cumulative effect of a change in
   accounting principle.................           --         --         --        174         --
                                            ---------   --------   --------   --------   --------
Income (loss) before dividends on
   preferred stock.......................    (111,428)   (29,902)     7,859      8,085      6,424
Dividends on preferred stock............        3,718         --         --         --         --
                                            ---------   --------   --------   --------   --------
Net income (loss) attributable to common
   stock................................    $(115,146)  $(29,902)  $  7,859   $  8,085   $  6,424
                                            =========   ========   ========   ========   ========
Per Common Share Data:
Income (loss) before cumulative effect of
   a change in accounting principle (b):
   Basic earnings (loss) per common share   $  (34.07)  $  (9.32)  $   2.44   $   1.89   $   1.41
   Diluted earnings (loss) per common share    (34.07)     (9.32)      2.26       1.85       1.37
Net income (loss):
   Basic earnings (loss) per common share   $  (34.07)  $  (9.32)  $   2.44   $   1.94   $   1.41
   Diluted earnings (loss) per common share    (34.07)     (9.32)      2.26       1.89       1.37
Cash dividends declared per common share.          --      0.291      0.255      0.236      0.227


(a) Includes securitization assets fair value adjustments of $41.2 million for the fiscal year ended June 30, 2004, $45.2 million for the fiscal year ended June 30, 2003, $22.1 million for the fiscal year ended June 30, 2002 and $12.6 million for the fiscal year ended June 30, 2000.
(b) Amounts for the years ended June 30, 2003 and prior have been retroactively adjusted to reflect the effect of a 10% common stock dividend declared May 13, 2004 as if the additional shares had been outstanding for each period presented. Amounts for the years ended June 30, 2002 and prior have been retroactively adjusted to reflect the effect of a 10% stock dividend declared August 21, 2002. Amounts for the years ended June 30, 2001 and prior have been retroactively adjusted to reflect the effect of a 10% stock dividend declared October 1, 2001.

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                                                                JUNE 30,
                                    --------------------------------------------------------------
                                        2004        2003         2002          2001         2000
                                    ----------   ----------   ----------   ----------   ----------
                                                          (DOLLARS IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents ...       $      910   $   36,590   $   99,599   $   84,667   $   66,507
Restricted cash .............           13,307       10,885        9,000        6,425        3,244
Loan and lease receivables:
   Loans available for sale .          304,275      263,419       45,919       78,060       29,699
   Non-accrual loans ........            1,993        3,999        3,868        2,831        3,474
   Lease receivables ........             --          3,984        7,891       14,030       18,629
Interest and fees receivable            18,089       10,838        9,595       14,582       11,071
Deferment and forbearance
  advances receivable .......            6,249        4,341        2,697        1,967        1,931
Loans subject to repurchase
  rights.....................           38,984       23,761        9,028        2,428           --
Interest-only strips ........          459,086      598,278      512,611      398,519      277,872
Servicing rights ............           73,738      119,291      125,288      102,437       74,919
Receivable for sold loans and
  leases.....................               --       26,734           --           --       46,333
Total assets ................        1,042,870    1,159,351      876,375      766,487      594,282
Subordinated debentures .....          522,609      719,540      655,720      537,950      390,676
Senior collateralized
  subordinated notes.........           83,639           --           --           --           --
Total liabilities ...........        1,030,955    1,117,282      806,997      699,625      532,167
Stockholders' equity ........           11,915       42,069       69,378       66,862       62,115


                                                          YEAR ENDED JUNE 30,
                                     --------------------------------------------------------------
                                        2004         2003        2002         2001         2000
                                     ----------   ----------   ----------   ----------   ----------
                                                          (DOLLARS IN THOUSANDS)
OTHER DATA:
Total loans and leases on
   balance sheet.................    $  303,603   $  267,325   $   59,386   $   91,615   $   48,580
Originations(a):
   Business purpose loans........           587      122,790      133,352      120,537      106,187
   Home mortgage loans...........       982,093    1,543,730    1,246,505    1,096,440      949,014
Average loan size of loans
  originated(a):
   Business purpose loans........           293           92           97           91           89
   Home mortgage loans...........           119           91           89           82           70
Weighted average interest rate
  of loans originated(a):
   Business purpose loans........        14.62%       15.76%       15.75%       15.99%       15.99%
   Home mortgage loans...........          7.86         9.99        10.91        11.46        11.28
   Combined......................          7.86        10.42        11.38        11.91        11.64
Loans and leases sold:
   Securitizations...............    $  141,407   $1,423,764   $1,351,135   $1,102,066   $1,001,702
   Whole loan sales..............       808,378       28,013       57,679       76,333      102,670


(a) Conventional first mortgages and leases originated in fiscal 2000 have been excluded because we no longer originate these types of loans and leases.

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                                                         YEAR ENDED JUNE 30,
                                    -------------------------------------------------------------
FINANCIAL RATIOS:                     2004          2003         2002         2001         2000
                                    --------      --------     --------     --------     --------
Return on average assets.......      (11.60)%       (3.07)%       0.94%        1.22%        1.31%
Return on average equity.......     (566.80)       (44.20)       11.75        12.22        10.29
Total delinquencies as a
   percentage of total on
   balance sheet portfolio at
   end of period(a)............        1.19          1.97        11.72         3.87         6.08
Real estate owned as a
   percentage of total on
   balance sheet portfolio at
   end of period...............        0.63          1.79         6.37         2.53         3.41
Loan and lease losses as a
   percentage of the average
   total on balance sheet
   portfolio during the
   period (b)..................        8.93          5.17         4.23         3.31         1.09
Pre-tax income (loss) as a
   percentage of total
   revenues....................       (1.11)       (20.00)        5.47         7.19         7.93
Ratio of earnings to fixed
   charges(c)..................       (1.42)x        0.31x        1.19x        1.23x        1.26x


(a) Includes loans delinquent 31 days or more and excludes real estate owned and previously delinquent loans subject to deferment and forbearance agreements if the borrower with this arrangement is current on principal and interest payments as required under the terms of the original note (exclusive of delinquent payments advanced or fees paid by us on the borrower's behalf as part of the deferment or forbearance arrangement).

(b) Percentage based on annualized losses and average total portfolio.

(c) Earnings (loss) before income taxes and fixed charges were insufficient to cover fixed charges by $183.4 million and $49.0 million for the years ended June 30, 2004 and 2003, respectively.

The following table presents financial ratios and measures for our total portfolio and total real estate owned, referred to as REO. The total portfolio measure includes loans and leases recorded on our balance sheet and securitized loans and leases both managed by us and serviced by others. Management believes these measures enhance the users' overall understanding of our current financial performance and prospects for the future because the volume and credit characteristics of off-balance sheet securitized loan and lease receivables have a significant effect on our financial performance as a result of our retained interests in the securitized loans. Retained interests include interest-only strips and servicing rights. In addition, because the servicing and collection of our off-balance sheet securitized loan and lease receivables are performed in the same manner and according to the same standards as the servicing and collection of our on-balance sheet loan and lease receivables, certain of our resources, such as personnel and technology, are allocated based on their pro rata relationship to the total portfolio and total REO. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Reconciliation of Non-GAAP Financial Measures" for a reconciliation of total portfolio and managed real estate owned to our balance sheet.

                                                         YEAR ENDED JUNE 30,
                                  ---------------------------------------------------------------
                                     2004          2003         2002         2001         2000
                                  ----------    ----------   ----------   ----------   ----------
                                                       (Dollars in thousands)
Total Portfolio - Loans and
   Leases.....................    $2,231,689    $3,651,074   $3,066,189   $2,589,395   $1,918,540
FINANCIAL RATIOS:
Total delinquencies as a
   percentage of total
   portfolio at end of period..        10.67%         6.27%        5.59%        4.13%        2.91%
Real estate owned as a
   percentage of total
   portfolio at end of period..         1.54          0.77         1.11         1.10         0.68
Loan and lease losses as a
   percentage of the average
   total portfolio during the
   period......................         1.02          0.36         0.28         0.53         0.31

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following financial review and analysis of the financial condition and results of operations for the fiscal years ended June 30, 2004, 2003 and 2002 should be read in conjunction with the consolidated financial statements and the accompanying notes to the consolidated financial statements, and other detailed information appearing in this document.

OVERVIEW

GENERAL. We are a financial services organization operating mainly in the eastern and central portions of the United States. Recent expansion has positioned us to increase our operations in the western portion of the United States, especially California. See "-- Business Strategy Adjustments" for details of our acquisition of a broker operation located in California. Through our principal direct and indirect subsidiaries, we originate, sell and service home mortgage loans. We also process and purchase home mortgage loans through our Bank Alliance Services program. See "Business -- Lending Activities -- Home Mortgage Loans" for a description of this program and the amount of loans we purchased under this program. Additionally, we service business purpose loans, which we had originated and sold in prior periods. To the extent we obtain a credit facility to fund business purpose loans, we may originate and sell business purpose loans in future periods.

In addition, we offer subordinated debentures to the public, the proceeds of which are used for repayment of existing debt, loan originations, our operations (including repurchases of delinquent assets from securitization trusts and funding our loan overcollateralization requirements under our credit facilities), investments in systems and technology and for general corporate purposes.

Historically, our loans primarily consisted of fixed interest rate loans secured by first or second mortgages on one-to-four family residences. Our business strategy adjustments include increasing loan originations by offering adjustable rate loans and purchase money mortgage loans. During the fourth quarter of fiscal 2004, 46.7% of loans we originated were adjustable rate and 53.3% were fixed rate. During fiscal 2004, 18.0% of the loans we originated were purchase money mortgage loans. During fiscal 2004, 89.9% of the loans we originated were secured by first mortgages and 10.1% were secured by second mortgages.

Our customers are primarily credit-impaired borrowers who are generally unable to obtain financing from banks or savings and loan associations and who are attracted to our products and services. This type of borrower is commonly referred to as a subprime borrower. Loans made to subprime borrowers are frequently referred to as subprime loans.

We originate loans through a combination of channels including a national processing center located at our centralized operating office in Philadelphia, Pennsylvania and a network of mortgage brokers. Our loan servicing and collection activities are performed at our Philadelphia office.

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Our loan origination volumes, and accordingly our financial results, are affected by the economic environment, including interest rates, consumer spending and debt levels, real estate values and employment rates. Additionally, our loan originations are affected by competitive conditions and regulatory influences.

Our principal revenues are derived from gains on the sale of loans in either whole loan sales or securitizations, interest accretion on our interest-only strips, interest income earned on loans while they are carried on our balance sheet and income from servicing loans.

Our principal expenses include interest expense incurred on our subordinated debentures and senior collateralized subordinated notes, interest expense incurred to fund loans while they are carried on our balance sheet, the provision for credit losses recognized on loans carried on our balance sheet and loans repurchased from securitization trusts, employee related costs, marketing costs, costs to service and collect loans and other administrative expenses.

Our critical success factors include our ability to originate loans, our ability to sell loans in whole loan sales or into securitizations, our ability to maintain credit and warehouse facilities to fund loan originations, and our ability to raise capital through the sale of subordinated debentures.

OUR RECENT FINANCIAL DIFFICULTIES AND LIQUIDITY CONCERNS. Several events and issues, which occurred beginning in the fourth quarter of fiscal 2003, have negatively impacted our short-term liquidity and contributed to our losses for fiscal 2003 and fiscal 2004. These events included our inability to complete publicly underwritten securitizations during the fourth quarter of fiscal 2003 and all of fiscal 2004 (we completed a privately-placed securitization in the second quarter of fiscal 2004), our inability to draw down upon and the expiration of several of our credit facilities, and our temporary discontinuation of sales of new subordinated debentures for approximately a six-week period during the first quarter of fiscal 2004.

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Our inability to complete a publicly underwritten securitization during the fourth quarter of fiscal 2003 was the result of our investment bankers' decision in late June 2003 not to underwrite the contemplated June 2003 securitization transaction. Management believes that a number of factors contributed to this decision, including a highly publicized lawsuit finding liability of an underwriter in connection with the securitizations of loans for another unaffiliated subprime leader, an inquiry by the Civil Division of the U.S. Attorney's Office in Philadelphia regarding our forbearance practices, an anonymous letter regarding us received by our investment bankers, the SEC's enforcement action against another unaffiliated subprime lender related to its loan restructuring practices and related disclosure, a federal regulatory agency investigation of practices by another subprime servicer and our investment bankers' prior experience with securitizations transactions with non-affiliated originators.

We were unable to complete a publicly underwritten securitization during fiscal 2004 due to our diminished capacity to originate loans, our commitment to whole loan sales under our adjusted business strategy, our financial condition and liquidity issues, and an absence of market demand for our securitizations. We completed a privately-placed securitization during the second quarter of fiscal 2004.

As a result of these liquidity issues our loan origination volume during fiscal 2004 was substantially reduced. From July 1, 2003 through June 30, 2004, we originated $982.7 million of loans, as compared to originations of $1.67 billion of loans for the same period in fiscal 2003. We anticipate that depending upon the size of our future quarterly securitizations, if any, we will need to increase our loan originations to approximately $400.0 million to $500.0 million per month to return to profitable operations. If we are unable to complete quarterly securitizations, we will need to increase our loan originations to approximately $500.0 million to $600.0 million per month to return to profitability. Our ability to achieve the levels of loan originations necessary to achieve profitable operations could be hampered by our failure to continue to successfully implement our adjusted business strategy, funding limitations under existing credit facilities and our ability to obtain new credit facilities and renew existing facilities. Our plan is to increase loan originations through the continued application of our business strategy adjustments, particularly as related to building our expanded broker channel and offering adjustable rate mortgages and more competitively priced fixed rate mortgages. See "Business -- Business Strategy" for a discussion of our plans to achieve this level of originations. For a detailed discussion of our losses, capital resources and commitments, see "-- Liquidity and Capital Resources."

We have entered into a commitment letter and anticipate entering into a definitive agreement regarding a $100.0 million credit facility to replace our $200.0 million facility (reduced to $100.0 million on September 30, 2004) that expires on November 5, 2004. However, we cannot assure you that we will enter into a definitive agreement regarding the $100.0 million credit facility or that this agreement will contain terms and conditions acceptable to us.

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We are currently negotiating additional credit facilities to provide additional borrowing capacity to fund the increased level of loan originations expected under our adjusted business strategy, however, no assurances can be given that we will succeed in obtaining new credit facilities or that these facilities will contain terms and conditions acceptable to us. See "-- Liquidity and Capital Resources" for a discussion of these facilities.

On June 30, 2004, we had unrestricted cash of approximately $0.9 million and up to $210.4 million available under our warehouse credit facilities. We can only use advances under these credit facilities to fund loan originations and not for any other purposes. The combination of our current cash position and expected sources of operating cash may not be sufficient to cover our operating cash requirements.

For the next six to twelve months, we intend to augment our sources of operating cash with proceeds from the issuance of subordinated debentures. In addition to repaying maturing subordinated debentures, proceeds from the issuance of subordinated debentures may be used to fund overcollateralization requirements, as defined below, in connection with our loan originations and to fund our operating losses. Under the terms of our credit facilities, our credit facilities will advance us 75% to 97% of the value of loans we originate. See "-- Liquidity and Capital Resources" for a discussion of advance rates under the terms of our credit facilities." As a result of this limitation, we must fund the difference between the loan value and the advances, which we refer to as the overcollateralization requirement, from our operating cash. We can provide no assurances that we will be able to continue issuing subordinated debentures.

See "-- Liquidity and Capital Resources -- Remedial Steps Taken to Address Liquidity Issues" for a discussion of the specific actions we undertook to address liquidity concerns.

RECENT OPERATING LOSSES AND SALE OF ASSETS. We incurred a net loss attributable to common stock of $115.1 million and $29.9 million for the fiscal years ended June 30, 2004 and 2003, respectively. In addition, depending on our ability to recognize gains on our future securitizations, we anticipate incurring operating losses at least through the first quarter of fiscal 2005.

The loss for fiscal 2004 primarily resulted from liquidity issues we have experienced since the fourth quarter of fiscal 2003, including the absence of credit facilities until the second quarter of fiscal 2004, which substantially reduced our loan origination volume and our ability to generate revenues, our inability to complete a publicly underwritten securitization during fiscal 2004, our shift in business strategy to focus on whole loan sales, and charges to the income statement of $46.4 million for pre-tax valuation adjustments on our securitization assets. Additionally, operating expense levels that would support greater loan origination volume also contributed to the loss for fiscal 2004.

During fiscal 2004, we recorded total pre-tax valuation adjustments on our interest-only strips and servicing rights of $63.8 million, of which $46.4 million was charged as expense to the income statement and $17.4 million was charged to other comprehensive income, a component of stockholders' equity. These adjustments primarily reflect the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2004 due to the low interest rate environment experienced during fiscal 2004. Additionally, the fiscal 2004 valuation adjustment also includes a write down of $5.4 million of the carrying value of our interest-only strips and servicing rights related to five of our mortgage securitization trusts to reflect their values under the terms of a September 27, 2004 sale agreement. The sale of these assets was undertaken as part of our negotiations to obtain the new $100.0 million warehouse credit facility described in "-- Liquidity and Capital Resources" and to raise cash to pay fees on new warehouse credit facilities and as a result, we did not realize their full value as reflected on our books. This compares to total pre-tax valuation adjustments on our securitization assets of $63.3 million during the year ended June 30, 2003, of which $45.2 million was charged as expense to the income statement and $18.1 million was reflected as an adjustment to other comprehensive income. See "- Application of Critical Accounting Estimates - Interest-Only Strips" for a discussion of how valuation adjustments are recorded.

EXCHANGE OFFERS. On December 1, 2003, we mailed an offer to exchange, which we refer to as the first exchange offer, to holders of our subordinated debentures issued prior to April 1, 2003. On May 14, 2004, we mailed a second offer to exchange, which we refer to as the second exchange offer, to holders of our subordinated debentures issued prior to November 1, 2003. See "-- Liquidity and Capital Resources -- Subordinated Debentures" for more detail on the terms of the exchange offers, senior collateralized subordinated notes and Series A preferred stock issued and the results of the exchange offers.

Depending on market conditions and our financial condition, we may engage in additional exchange offers in the future and we are considering another exchange offer in our second quarter of fiscal 2005.

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AMOUNT OF OUR INDEBTEDNESS. At June 30, 2004, we had total indebtedness of approximately $847.4 million, comprised of amounts outstanding under our credit facilities, senior collateralized subordinated notes issued in the exchange offers, capitalized leases and subordinated debentures. See "-- Liquidity and Capital Resources -- Secured and Unsecured Indebtedness " for a comparison at June 30, 2004 of our secured and senior debt obligations and unsecured subordinated debenture obligations to assets which are available to repay those obligations.

BUSINESS STRATEGY ADJUSTMENTS. In response to our inability to securitize our loans and the liquidity concerns described above, we adjusted our business strategy at the beginning of fiscal 2004. Our adjusted business strategy focuses on shifting from gain-on-sale accounting and the use of securitization transactions as our primary method of selling loans to a more diversified strategy which utilizes a combination of whole loan sales and securitizations, while protecting revenues, controlling costs and improving liquidity. See "Business -- Business Strategy" for information regarding our adjusted business strategy.

Our business strategy is dependent on our ability to emphasize lending related activities that provide us with the most economic value. The implementation of this strategy will depend in large part on a variety of factors outside of our control, including, but not limited to, our ability to obtain adequate financing on reasonable terms and to profitably sell or securitize our loans on a regular basis. Our failure with respect to any of these factors could impair our ability to successfully implement our strategy, which could adversely affect our results of operations and financial condition. See "Risk Factors -- If we are unable to successfully implement our adjusted business strategy which focuses on whole loan sales, we may be unable to attain profitable operations which could impair our ability to repay our outstanding debt and could negatively impact the value of our capital stock."

If we fail to generate sufficient liquidity through the sales of our loans, the sale of our subordinated debentures, the maintenance of credit facilities or a combination of the foregoing, we will have to restrict loan originations and make additional changes to our business strategy, including restricting or restructuring our operations which could result in losses and impair our ability to repay our subordinated debentures and other outstanding debt. While we currently believe that we will be able to restructure our operations, if necessary, we cannot assure you that such restructuring will enable us to attain profitable operations or repay the subordinated debentures when due. If we fail to successfully implement our adjusted business strategy, we will be required to consider other alternatives, including raising additional equity, seeking to convert an additional portion of our subordinated debentures to equity, seeking protection under federal bankruptcy laws, seeking a strategic investor, or exploring a sale of the company or some or all of its assets. See "Risk Factors -- We depend upon the availability of financing to fund our continuing operations. Any failure to obtain adequate funding could hurt our ability to operate profitably, restrict our ability to repay our outstanding debt and negatively impact the value of our capital stock" and "-- If we are unable to obtain additional financing, we may be not be able to restructure our business to permit profitable operations or repay our outstanding debt and the value of our capital stock will be negatively impacted."

In addition to the above potential restrictions and changes to our business strategy, in the event we are unable to offer additional subordinated debentures for any reason, we have developed a contingent financial restructuring plan including cash flow projections for the next twelve-month period. Based on our current cash flow projections, we anticipate being able to make all scheduled subordinated debenture maturities and vendor payments.

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The contingent financial restructuring plan is based on actions that we would take, in addition to those indicated in our adjusted business strategy, to reduce our operating expenses and conserve cash. These actions would include reducing capital expenditures, selling all loans originated on a whole loan basis, eliminating or downsizing various lending, overhead and support groups and obtaining working capital funding. No assurance can be given that we will be able to successfully implement the contingent financial restructuring plan, if necessary, and repay the subordinated debentures when due.

CREDIT FACILITIES, SERVICING AGREEMENTS AND WAIVERS RELATED TO FINANCIAL COVENANTS. At various times since June 30, 2003, including at June 30, 2004, July 31, 2004, August 31, 2004 and September 30, 2004, we have been out of compliance with one or more financial covenants contained in our $200.0 million credit facility (reduced to $100.0 million). We have continued to operate on the basis of waivers granted by the lender under this facility. We currently anticipate that we will be out of compliance with one or more of these financial covenants at October 31, 2004 and will need a waiver from this lender for this noncompliance to continue to operate. The expiration date of this facility was originally September 21, 2004, but the lender agreed to extend the expiration date until November 5, 2004 in consideration for, among other things, a reduction in the amount that could be borrowed under this facility to $100.0 million.

A provision in our $250.0 million credit facility required us to maintain another credit facility for $200.0 million with a $40.0 million sublimit of such facility available for funding loans between the time they are closed by a title agency or closing attorney and the time documentation for the loans is received by the collateral agent. As a result of the reduction of our $200.0 million facility to $100.0 million, as described above, we entered into an amendment to the master loan and security agreement governing our $250.0 million facility which reduced the required amount for another facility to $100.0 million. In the event we do not extend the $200.0 million (now $100.0 million) facility beyond its November 5, 2004 expiration date, or in the event we do not otherwise enter into definitive agreements with other lenders by November 5, 2004 which satisfy the above-described requirements in our $250.0 million facility for $100.0 million in additional credit facilities and a $40.0 million sublimit, we will need an additional amendment to the $250.0 million facility or a waiver from the lender to continue to operate.

At various times since June 30, 2003 we have also been out of compliance with the net worth requirement in several of our pooling and servicing agreements and sale and servicing agreements (collectively referred to in this document as the servicing agreements). Two of the financial insurers who provide financial guaranty insurance to certain bond holders and certificate holders under these servicing agreements (collectively referred to in this document as bond insurers) required us to amend the servicing agreements in consideration for granting us waivers from this noncompliance. One bond insurer granted us a permanent waiver from this noncompliance in consideration for a term-to-term servicing arrangement. The other bond insurer granted us a one-time waiver in consideration for a term-to-term servicing arrangement. Since then, we have had to obtain a waiver of net worth requirements from this bond insurer on a monthly basis and we currently anticipate that we will need to do so for the foreseeable future.

Due to our financial results during fiscal 2004, two other bond insurers required us to amend the servicing agreements related to the securitizations these bond insurers insured. As a result of the amendments to our servicing agreements, all of our servicing agreements associated with bond insurers now provide for term-to-term servicing and, in the case of our servicing agreements with two bond insurers, our rights as servicer may be terminated at the expiration of a servicing term in the sole discretion of the bond insurer.

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We cannot assure you that we will continue to receive the waivers and servicing agreement extensions that we need to operate or that they will not contain conditions that are unacceptable to us. Because we anticipate incurring losses through at least the first quarter of fiscal 2005, we anticipate that we will need to obtain additional waivers from our lenders and bond insurers as a result of our non-compliance with financial covenants contained in our credit facilities and servicing agreements. To the extent we are not able to obtain waivers under our credit facilities, we may be unable to pay dividends on the Series A preferred stock. See "-- Liquidity and Capital Resources" for additional information regarding the waivers obtained. See also "Risk Factors -- Restrictive covenants in the agreements governing our indebtedness may reduce our operating flexibility and limit our ability to operate profitability, and our ability to repay our outstanding debt may be impaired and the value of our capital stock could be negatively impacted" and " -- Our servicing rights may be terminated if we fail to satisfactorily perform our servicing obligations, or fail to meet minimum net worth requirements or financial covenants which could hinder our ability to operate profitably, impair our ability to repay our outstanding debt and negatively impact the value of our capital stock."

DELINQUENCIES; FORBEARANCE AND DEFERMENT ARRANGEMENTS. We had total delinquencies in our managed portfolio of $219.4 million at June 30, 2004, $228.9 million at June 30, 2003 and $171.6 million at June 30, 2002. The managed total portfolio includes loans on our balance sheet and loans serviced for others. At June 30, 2004, the total managed portfolio was $2.1 billion, compared to $3.7 billion at June 30, 2003 and $3.1 billion at June 30, 2002. Total delinquencies (loans and leases, excluding real estate owned, with payments past due for more than 30 days) as a percentage of the total managed portfolio were 10.49% at June 30, 2004 compared to 6.27% at June 30, 2003 and 5.59% at June 30, 2002.

As the managed portfolio continues to season and if the economy does not continue to improve, the delinquency rate may continue to increase, which could negatively impact our ability to sell or securitize loans and reduce our profitability and the funds available to repay our subordinated debentures. As the portfolio seasons, or ages, the likelihood that borrowers will incur credit problems increases. Additionally, continuing low market interest rates could continue to encourage borrowers to refinance their loans and increase the levels of loan prepayments we experience which would negatively impact our delinquency rate.

Delinquencies in our total managed portfolio do not include $216.3 million of previously delinquent loans at June 30, 2004, which are subject to deferment and forbearance arrangements. Generally, a loan remains current after we enter into a deferment or forbearance arrangement with the borrower only if the borrower makes the principal and interest payments as required under the terms of the original note (exclusive of the delinquent payments advanced or fees paid by us on borrower's behalf as part of the deferment or forbearance arrangement) and we do not reflect it as a delinquent loan in our delinquency statistics. However, if the borrower fails to make principal and interest payments, we will generally declare the account in default, reflect it as a delinquent loan in our delinquency statistics and resume collection actions.

During the final six months of fiscal 2003 and the first six months of fiscal 2004, we experienced a pronounced increase in the number of borrowers under deferment arrangements and in light of the weakened economic environment during that twelve-month period we made use of deferment arrangements to a greater degree than in prior periods. Since December 2003, we have experienced a reduction in new deferment arrangements and if the improving economic environment continues, we expect to continue to experience a reduction in new deferment arrangements.

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There was approximately $216.3 million of cumulative unpaid principal balance of loans under deferment and forbearance arrangements at June 30, 2004, as compared to approximately $197.7 million and $138.7 million of cumulative unpaid principal balance at June 30, 2003 and 2002, respectively. Total cumulative unpaid principal balances under deferment or forbearance arrangements as a percentage of the total managed portfolio were 10.34% at June 30, 2004, compared to 5.41% and 4.52% at June 30, 2003 and 2002, respectively. Additionally, there are loans under deferment and forbearance arrangements which have returned to delinquent status. At June 30, 2004, there was $29.9 million of cumulative unpaid principal balance under deferment arrangements and $31.8 million of cumulative unpaid principal balance under forbearance arrangements that are now reported as delinquent 31 days or more. See "-- On Balance Sheet Portfolio Quality -- Deferment and Forbearance Arrangements," "-- Total Portfolio Quality -- Deferment and Forbearance Arrangements" and "Risk Factors -- Restrictive covenants in the agreements governing our indebtedness may reduce our operating flexibility and limit our ability to operate profitably, and our ability to repay our outstanding debt may be impaired and the value of our capital stock could be negatively impacted."

LISTING ON THE NASDAQ NATIONAL MARKET SYSTEM. Since our common stock is listed on the NASDAQ National Market System, we are required to meet certain requirements established by the NASDAQ Stock Market in order to maintain this listing. These requirements include, among other things, maintenance of stockholders' equity of $10.0 million, a minimum bid price of $1.00 and a market value of publicly held shares of $5.0 million. If we are unable to maintain our listing on the NASDAQ National Market System, the value of our capital stock and our ability to continue to sell subordinated debentures would be negatively impacted by making the process of complying with the state securities laws more difficult, costly and time consuming. As a result, we may be unable to continue to sell subordinated debentures in certain states, which would have a material adverse effect on our liquidity and our ability to repay maturing debt when due. There can be no assurance that we will be in compliance with the $10.0 million stockholders' equity requirement on September 30, 2004. We are considering a new exchange offer in order to maintain compliance with this listing requirement. See "Risk Factors -- In the event our common stock is delisted from trading on the NASDAQ National Market System, the value of our capital stock and our ability to continue to sell subordinated debentures would be negatively impacted."

LIQUIDITY AND CAPITAL RESOURCES

GENERAL. Liquidity and capital resource management is a process focused on providing the funding to meet our short and long-term cash needs. We have used a substantial portion of our funding sources to build our serviced portfolio and investments in securitization assets with the expectation that they will generate sufficient cash flows in the future to cover our operating requirements, including repayment of maturing subordinated debentures and senior collateralized subordinated notes outstanding. Our cash needs change as the mix of loan sales through securitization shifts to more whole loan sales, as the serviced portfolio changes, as our interest-only strips mature and release cash, as subordinated debentures and senior collateralized subordinated notes outstanding mature, as operating expenses change and as revenues change. Because we have historically experienced negative cash flows from operations under our prior business strategy and, more recently, have been impacted by short-term liquidity issues, our business requires continual access to short and long-term sources of debt to generate the cash required to fund our operations.

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Our cash requirements include funding loan originations, repaying existing subordinated debentures and senior collateralized subordinated notes outstanding, paying interest expense, preferred dividends and operating expenses, funding capital expenditures, and in connection with our securitizations, funding overcollateralization requirements, costs of repurchasing delinquent loans for trigger management and servicer obligations. When loans are sold through a securitization, we may retain the rights to service the loans. Servicing loans obligates us to advance interest payments for delinquent loans under certain circumstances and allows us to repurchase a limited amount of delinquent loans from securitization trusts. See "-- Securitizations" and "-- Securitizations -- Trigger Management" and "-- Securitizations -- Repurchase Rights" for more information on how the servicing of securitized loans affects requirements on our capital resources and cash flow. At times, we have used cash to repurchase our common stock and could in the future use cash for unspecified acquisitions of related businesses or assets (although no acquisitions are currently contemplated).

Under our business strategy, we initially finance our loans under secured credit facilities. These credit facilities are generally revolving lines of credit that enable us to borrow on a short-term basis against our loans. We then sell our loans to unrelated third parties on a whole loan basis or securitize our loans to generate the cash to pay off these revolving credit facilities.

LIQUIDITY CONCERNS. Several events and issues have negatively impacted our short-term liquidity. First, our inability to complete a publicly underwritten securitization during the fourth quarter of fiscal 2003 adversely impacted our short-term liquidity position and contributed to our loss for fiscal 2003. Because there was no securitization, $453.4 million of the $516.1 million in revolving credit and conduit facilities available to us at June 30, 2003 was drawn upon. Our revolving credit facilities and mortgage conduit facility had only $62.7 million of unused capacity available at June 30, 2003, which significantly reduced our ability to fund loan originations in fiscal 2004 until we sold existing loans, extended existing credit facilities, or added new credit facilities.

Second, our ability to borrow under credit facilities to fund new loan originations in the first three months of fiscal 2004 using borrowings under certain of our credit facilities which carried over into fiscal 2004 was limited, terminated or expired by October 31, 2003. Further advances under a non-committed portion of one of these credit facilities were subject to the discretion of the lender and subsequent to June 30, 2003, there were no new advances under the non-committed portion. Additionally, on August 20, 2003, this credit facility was amended to, among other things, eliminate the non-committed portion, reduce the amount available to $50.0 million and accelerate the expiration date from November 2003 to September 30, 2003. We entered into a subsequent amendment to this facility, which extended its maturity date to October 17, 2003. We also had a $300.0 million mortgage conduit facility with a financial institution that enabled us to sell our loans into an off-balance sheet facility, which expired pursuant to its terms on July 5, 2003. In addition, we were unable to borrow under a $25.0 million warehouse facility after September 30, 2003, and this $25.0 million facility expired on October 31, 2003.

Third, even though we were successful in obtaining one new credit facility in September 2003 and a second new credit facility in October 2003, our ability to finance new loan originations in the second and third quarters of fiscal 2004 with borrowings under these new facilities was limited. The limitations resulted from requirements to fund overcollateralization, which is discussed below, in connection with new loan originations.

Fourth, our temporary discontinuation of sales of new subordinated debentures for approximately a six-week period during the first quarter of fiscal 2004 further impaired our liquidity.

As a result of these liquidity issues, our loan origination volume was substantially reduced. In fiscal 2004, we originated $982.7 million of loans, compared to originations of $1.67 billion of loans in fiscal 2003. As a result of the decrease in loan originations and liquidity issues described above, we incurred losses in fiscal 2003 and 2004 and depending on our ability to complete securitizations and recognize gains in the future, we anticipate incurring losses at least through the first quarter of fiscal 2005.

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For the next six to twelve months, we intend to augment our sources of operating cash with proceeds from the issuance of subordinated debentures. In addition to repaying maturing subordinated debentures, proceeds from the issuance of subordinated debentures may be used to fund overcollateralization requirements in connection with our loan originations and fund our operating losses. Under the terms of our credit facilities, our credit facilities will advance us 75% to 97% of the value of loans we originate. As a result of this limitation, we must fund the difference between the loan value and the advances, which we refer to as the overcollateralization requirement, from our operating cash. We can provide no assurances that we will be able to continue issuing subordinated debentures.

There can be no assurance that we will be in compliance with the $10.0 million stockholders' equity requirement on September 30, 2004. We are considering a new exchange offer in order to maintain compliance with this listing requirement. If we are unable to maintain our listing on the NASDAQ National Market System, our ability to continue to sell subordinated debentures would be negatively impacted by making the process of complying with the state securities laws more difficult, costly and time consuming. As a result, we may be unable to continue to sell subordinated debentures in certain states, which would have a material adverse effect on our liquidity and our ability to repay maturing debt when due.

SECURED AND UNSECURED INDEBTEDNESS. At June 30, 2004, we had total indebtedness of approximately $847.4 million, comprised of amounts outstanding under our credit facilities, senior collateralized subordinated notes issued in the exchange offers, capitalized leases and subordinated debentures. The following table compares our secured and senior debt obligations and unsecured subordinated debenture obligations at June 30, 2004 to assets which were available to repay those obligations. We anticipate that any shortfall in assets available to repay obligations will be funded through cash received on the sale of future loan originations:

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                                                   SECURED AND               UNSECURED
                                                   SENIOR DEBT             SUBORDINATED             TOTAL
(in thousands)                                     OBLIGATIONS              DEBENTURES           DEBT/ASSETS
                                                   -----------             ------------          -----------
Outstanding debt obligations (a)(f)........        $   324,839 (b)         $    522,609          $   847,448
                                                   ===========             ============          ===========
Assets available to repay debt:
    Cash and cash equivalents .............        $        --             $        910          $        910
    Loans..................................            252,326 (c)               51,949               304,275
    Interest-only strips (e)...............            179,207 (a)(b)           279,879               459,086 (d)
    Servicing rights.......................                 --                   73,738                73,738 (d)
                                                   -----------             ------------          ------------
    Total assets available.................        $   431,533             $    406,476          $    838,009
                                                   ===========             ============          ============


(a) Includes the impact of the exchange of $177.8 million of subordinated debentures (unsecured subordinated debentures) for $84.0 million of senior collateralized subordinated notes (secured and senior debt obligations) and 93.8 million shares of Series A preferred stock in the first exchange offer and first closing of the second exchange offer. At June 30, 2004, our interest in the cash flows from the interest-only strips held in the trust, which secure the senior collateralized subordinated notes totaled $411.9 million, of which approximately $125.5 million represents 150% of the principal balance of the senior collateralized subordinated notes outstanding at June 30, 2004. For presentation purposes, $125.5 million is included in the column entitled "secured and senior debt obligations" in the table above.

(b) Security interests under the terms of the $250.0 million credit facility are included in this table. This $250.0 million credit facility is secured by loans when funded under this facility. In addition, interest-only strips secure, as a first priority, obligations in an amount not to exceed 10% of the outstanding principal balance under this facility and the obligations due under the fee letter related to this facility. Assuming the entire $250.0 million available under this credit facility were utilized, the maximum amount secured by the interest-only strips would be approximately $53.7 million. This amount is included as an allocation of our interest-only strips to the secured and senior debt obligations column.

(c) Reflects the amount of loans specifically pledged as collateral against our advances under our credit facilities.

(d) Reflects the fair value of our interest-only strips and servicing rights at June 30, 2004.

(e) The grant of a lien on the collateral to secure the senior collateralized subordinated notes issued upon the completion of the first exchange offer and the senior collateralized subordinated notes to be issued in this exchange offer is not a direct lien on any interest-only strips, but is, rather, a lien on the right of certain of our subsidiaries to receive certain cash flows from ABFS Warehouse Trust 2003-1 which is a special purpose entity which holds the majority of, but not all of, the interest-only strips directly or indirectly held by us. The interest-only strips in this trust also secure, as a first priority, obligations in an amount not to exceed 10% of the outstanding principal balance under our $250.0 million credit facility and the obligations due under the fee letter related to this facility. Assuming the entire $250.0 million available under this credit facility were utilized, the maximum amount secured by the interest-only strips would be approximately $53.7 million.

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(f) The second exchange offer was extended through August 23, 2004 with closings on July 31, 2004 and August 23, 2004. The pro forma effects on the above table of the two closings of an additional $30.8 million of subordinated debentures (unsecured subordinated debentures) for $15.2 million of senior collateralized subordinated notes (secured obligations) and 15.6 million shares of Series A Preferred Stock are summarized below. At August 23, 2004, $22.8 million of our interest-only strips were collateralizing these new senior collateralized subordinated notes. Including the senior collateralized subordinated notes issued as of June 30, 2004, $148.2 million of our interest-only strips are collateralizing senior collateralized subordinated notes. The table below summarizes the pro forma impact of the two closings of our second exchange offer subsequent to June 30, 2004 on the historical comparison of our secured and senior debt obligations and unsecured subordinated debenture obligations at June 30, 2004 to assets which are available to repay those obligations (in thousands):

                                                   SECURED AND               UNSECURED
                                                   SENIOR DEBT             SUBORDINATED             TOTAL
(in thousands)                                     OBLIGATIONS              DEBENTURES           DEBT/ASSETS
                                                   -----------             ------------          -----------
   Outstanding debt obligations -
       historical...............................   $   324,839             $    522,609          $   847,448
   Pro forma effect of the second exchange
       offer extension to August 23, 2004.......        15,173                  (30,811)             (15,638)
                                                   -----------             ------------          -----------
   Pro forma outstanding debt
       obligations..............................   $   340,012             $    491,798          $   831,810
                                                   ===========             ============          ===========
   Total assets available to repay debt -
       historical...............................   $   431,533             $    406,476          $   838,009
   Pro forma effect of the second exchange
       offer extension to August 23, 2004.......        22,760                  (22,760)                  --
                                                   -----------             ------------          -----------
   Pro forma assets available...................   $   454,293             $    383,716          $   838,009
                                                   ===========             ============          ===========

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REMEDIAL STEPS TAKEN TO ADDRESS LIQUIDITY ISSUES. Since June 30, 2003,

we undertook specific remedial actions to address liquidity concerns including:

o We adjusted our business strategy beginning in early fiscal 2004. Our adjusted business strategy focuses on shifting from gain-on-sale accounting and the use of securitization transactions as our primary method of selling loans to a more diversified strategy which utilizes a combination of whole loan sales and securitizations, while protecting revenues, controlling costs and improving liquidity. See "-- Overview -- Business Strategy Adjustments" and "Business -- Business Strategy" for more information.

o We solicited bids and commitments from participants in the whole loan sale market and entered into forward sale agreements and individual sale transactions. In total, from June 30, 2003 through June 30, 2004, we sold approximately $1.1 billion (which includes $222.3 million of loans sold by the expired mortgage conduit facility described under "-- Credit Facilities") of loans through whole loan sales. From July 1, 2004 through September 30, 2004, we sold an additional $586.5 million of loans through whole loan sales.

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o We have entered into an informal arrangement with one recurring purchaser of our loans whereby the purchaser maintains members of its loan underwriting staff on our premises to facilitate its purchase of our loans promptly after we originate them. This arrangement accelerates our receipt of cash proceeds from the sale of loans, accelerates the pay down of our advances under our warehouse credit facilities and adds to our liquidity. This quicker turnaround time is expected to enable us to operate with smaller committed warehouse credit facilities than would otherwise be necessary.

o On October 31, 2003, we completed a privately-placed securitization, with servicing released, of $173.5 million of loans.

o We entered into two definitive loan agreements during fiscal 2004 for the purpose of funding our loan originations. These two agreements replaced those credit facilities, which carried over into fiscal 2004 but were limited, terminated or expired by October 31, 2003. We entered into the first agreement on September 22, 2003 with a financial institution for a one-year $200.0 million credit facility. We entered into the second agreement on October 14, 2003 with a warehouse lender for a three-year revolving mortgage loan warehouse credit facility of up to $250.0 million. The $200.0 million facility was extended to November 5, 2004 and reduced to $100.0 million. The three-year $250.0 million warehouse credit facility continues to be available. See "-- Credit Facilities" for information regarding the terms of these facilities.

o We have recently entered into a commitment letter and anticipate entering into a definitive agreement with a warehouse lender for a one-year $100.0 million credit facility to replace the maturing $200.0 million credit facility (reduced to $100.0 million). However, we cannot assure you that we will enter into a definitive agreement regarding the $100.0 million credit facility or that this agreement will contain the terms and conditions acceptable to us. We also sold the interest-only strips and servicing rights related to five of our mortgage securitization trusts to an affiliate of this facility provider under the terms of a September 27, 2004 sale agreement. The sale of these assets was undertaken as part of our negotiations to obtain the new $100.0 million warehouse credit facility and to raise cash to pay fees on new warehouse credit facilities and as a result, we did not realize their full value as reflected on our books. We wrote down the carrying value of these interest-only strips and servicing rights by $5.4 million at June 30, 2004 to reflect their values under the terms of the sale agreement.

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o We are currently negotiating additional credit facilities to provide additional borrowing capacity to fund the increased level of loan originations expected under our adjusted business strategy, however, no assurances can be given that we will succeed in obtaining new credit facilities or that these facilities will contain terms and conditions acceptable to us. See "-- Credit Facilities" for information regarding the terms of these facilities and "Risk Factors -- If we are unable to obtain additional financing, we may not be able to restructure our business to permit profitable operations or repay our outstanding debt and the value of our capital stock will be negatively impacted."

o We mailed exchange offers on December 1, 2003 and May 14, 2004 to holders of our subordinated debentures in order to increase our stockholders' equity and reduce the amount of our outstanding debt. These exchange offers resulted in the exchange of $208.6 million of our subordinated debentures for 109.4 million shares of Series A preferred stock and $99.2 million of senior collateralized subordinated notes. The issuance of 109.4 million shares of Series A preferred stock results in an annual cash preferred dividend obligation of $10.9 million. See "-- Subordinated Debentures" for more detail on the terms of the exchange offers, senior collateralized subordinated notes and preferred stock issued.

o On January 22, 2004, we executed an agreement to sell our interests in the remaining leases in our portfolio. The terms of the agreement included a cash sale price of approximately $4.8 million in exchange for our lease portfolio balance as of December 31, 2003. We received the cash from this sale in January 2004 and recognized a net gain of $0.5 million.

o We suspended the payment of quarterly dividends on our common stock beginning in the first quarter of fiscal 2004.

Although we obtained two warehouse credit facilities totaling $450.0 million in fiscal 2004, and after November 5, 2004 we expect to have at least two warehouse credit facilities totaling at a minimum $500.0 million, the proceeds of these credit facilities could only be used to fund loan originations and could not be used for any other purpose. Consequently, we need to generate cash to fund the balance of our business operations from other sources, such as whole loan sales, additional financings and sales of subordinated debentures. Additionally, our warehouse credit facilities have been obtained at high costs, which have a significant impact on our liquidity. See "-- Credit Facilities" for detail on the amount of fees we are required to pay under these facilities.

We can provide no assurances that we will be able to sell our loans, maintain existing credit facilities or expand or obtain new credit facilities, if necessary. If we are unable to maintain existing financing, we may not be able to restructure our business to permit profitable operations or repay our subordinated debentures and senior collateralized subordinated notes when due. Even if we are able to maintain adequate financing, our inability to originate and sell our loans could hinder our ability to operate profitably in the future and repay our subordinated debentures and senior collateralized subordinated notes when due.

SHORT AND LONG TERM CAPITAL RESOURCES AND CONTRACTUAL OBLIGATIONS. The following table summarizes our short and long-term capital resources and contractual obligations as of June 30, 2004. For capital resources, the table presents projected and scheduled principal cash flows expected to be available to meet our contractual obligations. For those timeframes where a shortfall in capital resources exists, we anticipate that these shortfalls will be funded through a combination of cash from whole loan sales of future loan originations and the issuance of subordinated debentures. We can provide no assurances that we will be able to continue issuing subordinated debentures. In the event that we are unable to offer additional subordinated debentures for any reason, we have developed a contingent financial restructuring plan. See "-- Overview -- Business Strategy Adjustments" for a discussion of this plan. The terms of our credit facilities provide that we may only use the funds available under the credit facilities to originate home mortgage loans.

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                                               ---------------------------------------------------------------
                                               LESS THAN      1 TO 3       3 TO 5       MORE THAN
                                                1 YEAR         YEARS        YEARS        5 YEARS       TOTAL
                                               ---------------------------------------------------------------
                                                                       (IN THOUSANDS)
Capital Resources from:
    Unrestricted cash......................    $      910    $      --    $      --     $      --    $     910
    Cash pledged as collateral against
      contractual obligation...............         1,000        2,000        1,000         4,000        8,000
    Loans available for sale...............       301,040           73           84         3,078      304,275
    Interest-only strips (a)..............        112,168      174,518      113,000       270,626      670,312
    Servicing rights (a)...................        20,897       30,421       22,578        49,474      123,370
    Investments............................           839           --           --            --          839
                                               ----------    ---------    ---------     ---------    ---------
                                                  436,854      207,012      136,662       327,178    1,107,706
                                               ----------    ---------    ---------     ---------    ---------
Contractual Obligations (b)
    Subordinated debentures................       326,152      170,452       14,036        11,969      522,609
    Accrued interest-subordinated
      debentures (c).......................        20,033       11,332        1,312         1,650       34,327
    Senior collateralized subordinated notes       28,094       50,701        2,516         2,328       83,639
    Accrued interest-senior collateralized
       subordinated notes (d)..............         1,002        1,738          126           109        2,975
    Warehouse lines of credit (e)..........       239,587           --           --            --      239,587
    Convertible promissory note (f)........           697          433           --            --        1,130
    Capitalized lease  (g).................           377          142           --            --          519
    Operating leases (h)...................         5,940       11,217       11,561        27,883       56,601
    Services and equipment.................         1,464           --           --            --        1,464
                                               ----------    ---------    ---------     ---------    ---------
                                                  623,346      246,015       29,551        43,939      942,851
                                               ----------    ---------    ---------     ---------    ---------
    Excess (Shortfall).....................    $ (186,492)   $ (39,003)   $ 107,111     $ 283,239    $ 164,855
                                               ==========    =========    =========     =========    =========


(a) Reflects projected cash flows utilizing assumptions including prepayment and credit loss rates. See "-- Application of Critical Accounting Estimates -- Interest-Only Strips" and "Application of Critical Accounting Estimates - Servicing Rights."
(b) See "-- Contractual Obligations."
(c) This table reflects interest payment terms elected by subordinated debenture holders as of June 30, 2004. In accordance with the terms of the subordinated debenture offering, subordinated debenture holders have the right to change the timing of the interest payment on their notes once during the term of their investment.
(d) This table reflects interest payment terms elected by senior collateralized subordinated note holders as of June 30, 2004.
(e) See the table provided under "-- Credit Facilities" for additional information about our credit facilities.
(f) Amount includes principal and accrued interest at June 30, 2004.
(g) Amounts include principal and interest.
(h) Amounts include lease for office space.

Cash flow from operations, the issuance of subordinated debentures and lines of credit fund our operating cash needs. We expect these sources of funds to be sufficient to meet our cash needs. Loan originations are funded through borrowings against warehouse credit facilities. Each funding source is described in more detail below.

CASH FLOW FROM OPERATIONS. One of our corporate goals is to achieve sustainable positive cash flow from operations. However, we cannot be certain that we will achieve our projections regarding positive cash flow from operations. Our achieving this goal is dependent on our ability to successfully implement our business strategy and on the following items:

o manage the mixture of whole loan sales and securitization transactions to maximize cash flow and economic value;
o manage levels of securitizations to maximize cash flows received at closing and subsequently from interest-only strips and servicing rights;
o maintain a portfolio of mortgage loans which will generate income and cash flows through our servicing activities and the residual interests we hold in the securitized loans;

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o build on our established approaches to underwriting loans, servicing and collecting loans and managing credit risks in order to control delinquency and losses;
o continue to identify and invest in technology and other efficiencies to reduce per unit costs in our loan origination and servicing process; and
o control overall expense levels.

Historically, our cash flow from operations had been negative because we incur the cash expenses as we originate loans, but generally do not recover the cash outflow from these origination expenses until we securitize or sell the underlying loans. With respect to loans securitized, we may be required to wait more than one year to begin recovering the cash outflow from loan origination expenses through cash inflows from our residual assets retained in securitization. However, during the year ended June 30, 2004, we experienced positive cash flow from operations, primarily due to whole loan sales of loans we originated in prior periods that were carried on our balance sheet at June 30, 2003.

Additionally, increasing market interest rates could negatively impact our cash flows. If market interest rates increase, the premiums we would be paid on whole loan sales could be reduced and the interest rates that investors will demand on the certificates issued in future securitizations will increase. The increase in interest rates paid to investors reduces the cash we will receive from interest-only strips created in future securitizations. Although we may have the ability in a rising interest rate market to charge higher loan interest rates to our borrowers, competition, laws and regulations and other factors may limit or delay our ability to do so. Increasing market interest rates would also result in higher interest expense incurred on future issuances of subordinated debentures and interest expense incurred to fund loans while they are carried on our balance sheet.

Cash flow from operations for the year ended June 30, 2004 was a positive $6.8 million compared to a negative $285.4 million for the year ended June 30, 2003. The positive cash flow from operations for the year ended June 30, 2004 was due to our sales during fiscal 2004 of loans originated in the prior fiscal year that were carried on our balance sheet at June 30, 2003. During the year ended June 30, 2004, we received cash on whole loan sales of $835.5 million and $26.7 million during the year ended June 30, 2003 from a whole loan sale transaction, which closed on June 30, 2003, but settled in cash on July 1, 2003. Additionally, cash flow from our interest-only strips in fiscal 2004 increased $18.0 million, compared to fiscal 2003. The following table compares the principal amount of loans sold in whole loan sales during the year ended June 30, 2004, to the amount of loans originated during the same period (in thousands).

                                                  Whole Loan         Loans
Quarter Ended                                       Sales          Originated
---------------------------------------------    -----------       ----------
September 30, 2003...........................    $  245,203        $  124,052
December 31, 2003............................         7,975 (a)       103,084
March 31, 2004...............................       228,629           241,449
June 30, 2004................................       326,571           514,095
                                                 ----------        ----------
Total for the year ended June 30, 2004.......    $  808,378        $  982,680
                                                 ==========        ==========

(a) During the quarter ended December 31, 2003, we completed a securitization of $173.5 million of mortgage loans.

The amount of cash we receive as gains on whole loan sales, and the amount of cash we receive and the amount of overcollateralization we are required to fund at the closing of our securitizations are dependent upon a number of factors including market factors over which we have no control. Although we expect cash flow from operations to continue to fluctuate in the foreseeable future, our goal is to improve upon our historical levels of negative cash flow from operations. We believe that if our projections based on our business strategy prove accurate, our cash flow from operations will continue to be positive. However, negative cash flow from operations may occur in any future quarter depending on the size and frequency of our whole loan sales, the size and frequency of our future securitizations and due to the nature of our operations and the time required to implement our business strategy adjustments. We generally expect the level of cash flow from operations to fluctuate.

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Other factors could negatively affect our cash flow and liquidity such as increases in mortgage interest rates, legislation or other economic conditions, which may make our ability to originate loans more difficult. As a result, our costs to originate loans could increase or our volume of loan originations could decrease.

CONTRACTUAL OBLIGATIONS. Following is a summary of future payments required on our contractual obligations as of June 30, 2004 (in thousands):

                                                                    PAYMENTS DUE BY PERIOD
                                             ----------------------------------------------------------------------
                                                             LESS THAN        1 TO 3        3 TO 5       MORE THAN
CONTRACTUAL OBLIGATIONS                         TOTAL         1 YEAR           YEARS         YEARS        5 YEARS
-----------------------------------------    -----------    -----------     -----------    ----------    ----------
Subordinated debentures.................      $ 522,609     $  326,152      $  170,452     $  14,036     $  11,969
Accrued interest - subordinated
  debentures (a)........................         34,327         20,033          11,332         1,312         1,650
Senior collateralized subordinated notes         83,639         28,094          50,701         2,516         2,328
Accrued interest - senior
  collateralized subordinated notes (b)           2,975          1,002           1,738           126           109
Warehouse lines of credit (c)...........        239,587        239,587              --            --            --
Convertible promissory notes (d)........          1,130            697             433            --            --
Capitalized lease (e)...................            519            377             142            --            --
Operating leases (f)....................         56,601          5,940          11,217        11,561        27,883
Services and equipment..................          1,464          1,464              --            --            --
                                              ---------     ----------      ----------     ---------     ---------
Total obligations.......................      $ 942,851     $  623,346      $  246,015     $  29,551     $  43,939
                                              =========     ==========      ==========     =========     =========


(a) This table reflects interest payment terms elected by subordinated debenture holders as of June 30, 2004. In accordance with the terms of the subordinated debenture offering, subordinated debenture holders have the right to change the timing of the interest payment on their notes once during the term of their investment.
(b) This table reflects interest payment terms elected by senior collateralized subordinated note holders as of June 30, 2004.
(c) See the table provided under "-- Credit Facilities" for additional information about our credit facilities.
(d) Amount includes principal and accrued interest at June 30, 2004.
(e) Amounts include principal and interest.
(f) Amounts include lease for office space.

CREDIT FACILITIES. Borrowings against warehouse credit facilities represent cash advanced to us for a limited duration, generally no more than 270 days, and are secured by the loans we pledge to the lender. These credit facilities provide the primary funding source for loan originations. Under the terms of these facilities, approximately 75% to 97% of our loan originations may be funded with borrowings under the credit facilities and the remaining amounts, our overcollateralization requirements, must come from our operating capital. The ultimate sale of the loans through whole loan sale or securitization generates the cash proceeds necessary to repay the borrowings under the warehouse facilities. We periodically review our expected future credit needs and attempt to negotiate credit commitments for those needs as well as excess capacity in order to allow us flexibility in implementing our adjusted business strategy.

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The following is a description of the warehouse and operating lines of credit facilities, which were available to us at June 30, 2004 (in thousands):

                                                                         FACILITY          AMOUNT        AMOUNT
                                                                          AMOUNT          UTILIZED     AVAILABLE
                                                                         --------         --------     ---------
REVOLVING CREDIT FACILITIES:
Warehouse revolving line of credit, expiring September 2004 (a)......   $  200,000       $  53,223     $ 146,777
Warehouse revolving line of credit, expiring October 2006 (b)........      250,000         186,364        63,636
                                                                        ----------       ---------     ---------
Total revolving credit facilities....................................      450,000         239,587       210,413
OTHER FACILITIES:
   Capitalized leases, maturing January 2006 (c).....................          488             488            --
                                                                        ----------       ---------     ---------
Total credit facilities..............................................   $  450,488       $ 240,075     $ 210,413
                                                                        ==========       =========     =========


(a) $200.0 million warehouse revolving line of credit with JP Morgan Chase Bank entered into on September 22, 2003 and expiring September 2004. The maturity date of this facility was extended to November 5, 2004 and the facility was reduced to $100.0 million. Interest rates on the advances under this facility are based upon one-month LIBOR plus a margin. Obligations under the facility are collateralized by pledged loans. Further detail and provisions of this facility are described below.

Additionally, we have a stand alone letter of credit with JP Morgan Chase Bank to secure lease obligations for corporate office space. The amount of the letter of credit was $8.0 million at June 30, 2004. The letter of credit was collateralized by cash.

(b) $250.0 million warehouse revolving line of credit with Chrysalis Warehouse Funding, LLC, entered into on October 14, 2003 and expiring October 2006. Interest rates on the advances under this facility are based upon one-month LIBOR plus a margin. Obligations under the facility are collateralized by pledged loans. Further detail and provisions of this facility are described below.

(c) Capitalized leases, imputed interest rate of 8.0%, collateralized by computer equipment.

Until their expiration, two other facilities were utilized for portions of fiscal 2004 including:

o A warehouse line of credit with Credit Suisse First Boston Mortgage Capital, LLC originally for $200.0 million. $100.0 million of this facility was continuously committed for the term of the facility while the remaining $100.0 million of the facility was available at Credit Suisse's discretion. Subsequent to June 30, 2003, there were no new advances under the non-committed portion. On August 20, 2003, this credit facility was amended to reduce the committed portion to $50.0 million (from $100.0 million), eliminate the non-committed portion and accelerate its expiration date from November 2003 to September 30, 2003. The expiration date was subsequently extended to October 17, 2003, but no new advances were permitted under this facility subsequent to September 30, 2003. This facility was paid down in full on October 16, 2003. The interest rate on the facility was based on one-month LIBOR plus a margin. Advances under this facility were collateralized by pledged loans.

o A $25.0 million warehouse line of credit facility from Residential Funding Corporation. Under this warehouse facility, advances could be obtained, subject to specific conditions described in the agreements. In connection with our receipt of a waiver of our non-compliance with financial covenants at September 30, 2003, we agreed not to make further advances under this line. Interest rates on the advances were based on one-month LIBOR plus a margin. The obligations under this agreement were collateralized by pledged loans. This facility was paid down in full on October 16, 2003 and it expired pursuant to its terms on October 31, 2003.

Until its expiration, we also had available to us a $300.0 million mortgage conduit facility. This facility expired pursuant to its terms on July 5, 2003. The facility provided for the sale of loans into an off-balance sheet facility. See "-- Application of Critical Accounting Estimates" for further discussion of the off-balance sheet features of this facility. On October 16, 2003, we refinanced through another mortgage warehouse conduit facility $40.0 million of loans that were previously held in the above off-balance sheet mortgage conduit facility. We also refinanced an additional $133.5 million of mortgage loans in the new conduit facility, which were previously held in other warehouse facilities, including the $50.0 million warehouse facility, which expired on October 17, 2003. On October 31, 2003, we completed a privately-placed securitization, with servicing released, of the $173.5 million of loans that had been transferred to this conduit facility. This conduit facility terminated upon the disposition of the loans held by it.

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On September 22, 2003, we entered into definitive agreements with JP Morgan Chase Bank for a $200.0 million credit facility for the purpose of funding our loan originations. Pursuant to the terms of this facility, we are required to, among other things: (i) have a net worth of at least $28.0 million by September 30, 2003; with quarterly increases of $2.0 million thereafter; (ii) apply 60% of our net cash flow from operations each quarter to reduce the outstanding amount of subordinated debentures commencing with the quarter ending March 31, 2004; (iii) as of the end of any month, commencing January 31, 2004, the aggregate outstanding balance of subordinated debentures must be less than the aggregate outstanding balance as of the end of the prior month; and (iv) provide a parent company guaranty of 10% of the outstanding principal amount of loans under the facility. This facility had a term of 364 days and by its original terms would have expired September 21, 2004. This facility is secured by the mortgage loans, which are funded by advances under the facility with interest equal to LIBOR plus a margin. This facility is subject to representations and warranties and covenants, which are customary for a facility of this type, as well as amortization events and events of default related to our financial condition. These provisions require, among other things, our maintenance of a delinquency ratio for the managed portfolio (which represents the portfolio of securitized loans and leases we service for others) at the end of each fiscal quarter of less than 12.0%, our subordinated debentures not to exceed $705.0 million at any time, and our ownership of an amount of repurchased loans not to exceed 1.5% of the managed portfolio.

On September 20, 2004, we entered into an amendment to our $200.0 million credit facility which extended the scheduled expiration date of this credit facility from September 21, 2004 to September 30, 2004.

On September 30, 2004, we entered into an amendment to our $200.0 million credit facility which extends the expiration date of this credit facility from September 30, 2004 to November 5, 2004, subject to earlier termination upon the occurrence of any of the specified events or conditions described in the facility documents, and decreases this facility from $200.0 million to $100.0 million. Since entering into this facility on September 22, 2003, the amount outstanding under this facility at any given time has not exceeded $100.0 million. In addition, the amendment includes changes which reduce the advance rate if the amount outstanding under the facility exceeds $75.0 million. The amendment also changes the portfolio composition requirements to accommodate fluctuations in the pledged loans at the beginning and end of each month, providing greater flexibility to us. The purpose of the amendment is to allow us to continue to borrow under this facility, subject to its terms as described above, while we finalize the definitive agreement for a new credit facility. In light of this amendment, on October 1, 2004, we entered into an amendment to the $250.0 million credit facility described below which decreased the amount of the additional credit facilities that we must maintain from $200.0 million to $100.0 million, provided that there continues to be at least $40.0 million available for funding loans between the time they are closed by a title agency or closing attorney and the time documentation for the loans is received by the collateral agent, as originally required by the facility agreements.

On September 17, 2004, we executed a commitment letter dated as of September 16, 2004 for a mortgage warehouse credit facility with a warehouse lender for the purpose of funding our home mortgage loan originations. The commitment letter provides for a facility that will consist of a $100.0 million senior secured revolving warehouse line of credit, which may be increased prior to closing to $150.0 million at the option of the warehouse lender. The commitment letter provides for a facility that will have a term of one year from closing with the right to extend for up to two additional one-year terms upon mutual agreement of the parties, with interest equal to LIBOR plus a margin. The facility will be secured by the mortgage loans which are funded by advances under the facility, as well as all assets, accounts receivable and all related proceeds held by the special purpose entity organized to facilitate this transaction referred to as the borrower. The stock of the borrower will also be pledged to the warehouse lender. We paid a due diligence fee and also agreed to pay fees of $1.3 million upon commitment, $1.0 million at closing and approximately $3.8 million over the next twelve months plus a non-usage fee based on the difference between the average daily outstanding balance for the current month and the maximum credit amount under the facility, as well as the lender's out-of-pocket expenses. The commitment letter and the closing of the facility will be subject to such customary and commercially reasonable terms, covenants, events of default and conditions as the warehouse lender deems appropriate. It is anticipated that this $100.0 million facility will contain representations and warranties, events of default and covenants which are customary for facilities of this type and will be structured similarly to our $250.0 million credit facility.

The warehouse lender may terminate the commitment at any time prior to entering into a definitive agreement if we fail to fulfill our obligations under the commitment letter, the warehouse lender determines that it is likely that the borrower is not capable of entering into a definitive agreement prior to October 20, 2004 or there is a material adverse change in the business, assets, liabilities, operations or condition of the borrower. The commitment letter expires upon the earlier to occur of: the execution of a definitive agreement, October 20, 2004 and our closing of another similar credit facility with a lender other than this warehouse lender. While we anticipate that we will close on the facility with this warehouse lender, there can be no assurance that these negotiations will result in a definitive agreement or that this agreement will contain terms and conditions acceptable to us.

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We also sold the interest-only strips and servicing rights related to five of our mortgage securitization trusts to an affiliate of this facility provider under the terms of a September 27, 2004 sale agreement. The sale of these assets was undertaken as part of our negotiations to obtain the new $100.0 million warehouse credit facility and to raise cash to pay fees on new warehouse credit facilities and as a result, we did not realize their full value as reflected on our books. We wrote down the carrying value of these interest-only strips and servicing rights by $5.4 million at June 30, 2004 to reflect their values under the terms of the sale agreement.

On October 14, 2003, we entered into definitive agreements with Chrysalis Warehouse Funding, LLC for a revolving mortgage loan warehouse credit facility of up to $250.0 million to fund loan originations. The $250.0 million facility has a term of three years with an interest rate on amounts outstanding equal to the one-month LIBOR plus a margin and the yield maintenance fees (as defined in the agreements). We also agreed to pay an affiliate of the lender fees of $8.9 million upon closing and approximately $10.3 million annually plus a non-usage fee based on the difference between the average daily outstanding balance for the current month and the maximum credit amount under the facility, as well as the lender's out-of-pocket expenses. Advances under this facility are collateralized by specified pledged loans. Additional credit support for a portion of the facility was created by granting a security interest in substantially all of our interest-only strips and residual interests which we contributed to a special purpose entity organized to facilitate this transaction. The interest-only strips and residual interests contributed to this special purpose entity also secured our fee obligations under this facility to an affiliate of the lender, as described above. The interest-only strips sold pursuant to the previously described sale agreement of September 27, 2004 were part of the interest-only strips contributed to this special purpose entity for the purpose of securing our fee obligations to this lender affiliate. In consideration for the release by this lender affiliate of its lien on the interest-only strips involved in the September 27, 2004 sale, we prepaid $3.5 million of fees owed or to be owed to the lender affiliate.

This $250.0 million facility contains representations and warranties, events of default and covenants which are customary for facilities of this type, as well as our agreement to: (i) restrict the total amount of indebtedness outstanding under the indenture related to our subordinated debentures to $750.0 million or less; (ii) make quarterly reductions commencing in April 2004 of an amount of subordinated debentures pursuant to the formulas set forth in the loan agreement; (iii) maintain maximum interest rates offered on subordinated debentures not to exceed 10 percentage points above comparable rates for FDIC insured products; and (iv) maintain minimum cash and cash equivalents of not less than $10.0 million. In addition to events of default which are typical for this type of facility, an event of default would occur if: (1) we are unable to sell subordinated debentures for more than three consecutive weeks or on more than two occasions in a 12 month period; and (2) certain members of management are not executive officers and a satisfactory replacement is not found within 60 days.

The definitive agreements for this $250.0 million facility granted the lender an option for a period of 90 days commencing on the first anniversary of entering into the definitive agreements to increase the credit amount to $400.0 million with additional fees and interest payable by us.

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We intend to amend the security agreements related to the senior collateralized subordinated notes to accommodate a request from the lender on our $250.0 million credit facility, and its affiliate, dated September 30, 2004, to clarify an inconsistency between these agreements and the $250.0 million credit facility documents related to liens on certain assets previously pledged by ABFS Warehouse Trust 2003-1 to Clearwing, the affiliate of the lender.

Although after November 5, 2004 we expect to have mortgage loan warehouse credit facilities available totaling at a minimum $500.0 million, the proceeds of these credit facilities may only be used to fund loan originations and may not be used for any other purpose. Consequently, we will have to generate cash to fund the balance of our business operations from other sources, such as whole loan sales, additional financings and sales of subordinated debentures. We are currently negotiating additional credit facilities to provide additional borrowing capacity to fund the increased level of loan originations expected under our adjusted business strategy, however, assurances can be given that we will succeed in obtaining new credit facilities or that these facilities will contain terms and conditions acceptable to us.

WAIVERS AND AMENDMENTS OF FINANCIAL COVENANTS RELATED TO OUR CREDIT AGREEMENTS AND SERVICING AGREEMENTS. Our warehouse credit agreements require that we comply with one or more financial covenants regarding, for example, net worth, leverage, net income, liquidity, total debt and debt to equity and other debt ratios. Each agreement has multiple individualized financial covenant thresholds and ratio limits that we must meet as a condition to drawing on a particular line of credit. Pursuant to the terms of these credit facilities, the failure to comply with the financial covenants constitutes an event of default and at the option of the lender, entitles the lender to, among other things, terminate commitments to make future advances to us, declare all or a portion of the loan due and payable, foreclose on the collateral securing the loan, require servicing payments be made to the lender or other third party or assume the servicing of the loans securing the credit facility. An event of default under these credit facilities would result in defaults pursuant to cross-default provisions of our other agreements, including but not limited to, other loan agreements, lease agreements and other agreements. The failure to comply with the terms of these credit facilities or to obtain the necessary waivers would have a material adverse effect on our liquidity and capital resources.

As a result of the loss experienced during fiscal 2003, we were not in compliance with the terms of certain financial covenants related to net worth, consolidated stockholders' equity and the ratio of total liabilities to consolidated stockholders' equity under two of our principal credit facilities existing at June 30, 2003 (one for $50.0 million and the other for $200.0 million, which was reduced to $50.0 million as described below). We obtained waivers from these covenant provisions from both lenders. Commencing August 21, 2003, the lender under the $50.0 million warehouse credit facility (which had been amended in December 2002 to add a letter of credit facility) granted us a series of waivers for our non-compliance with a financial covenant in that credit facility through November 30, 2003 and on September 22, 2003, in connection with the creation of a $200.0 million credit facility on the same date, reduced this facility to an $8.0 million letter of credit facility, which secured the lease on our principal executive office. This letter of credit facility expired according to its terms on December 22, 2003, but the underlying letter of credit was renewed for a one year term on December 18, 2003. We also entered into an amendment to the $200.0 million credit facility which provided for the waiver of our non-compliance with the financial covenants in that facility, the reduction of the committed portion of this facility from $100.0 million to $50.0 million, the elimination of the $100.0 million non-committed portion of this credit facility and the acceleration of the expiration date of this facility from November 2003 to September 30, 2003. We entered into subsequent amendments to this credit facility, which extended the expiration date until October 17, 2003. This facility was paid down in full on October 16, 2003 and expired on October 17, 2003.

In addition, in light of the losses experienced during fiscal 2004, we requested and obtained waivers or amendments to several credit facilities to address our non-compliance with certain financial covenants.

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The lender under a $25.0 million credit facility agreed to amend such facility in light of our non-compliance at September 30, 2003 with the requirement that our net income not be less than zero for two consecutive quarters. Pursuant to the revised terms of our agreement with this lender, no additional advances were made under this facility after September 30, 2003. This facility was paid down in full on October 16, 2003 and expired pursuant to its terms on October 31, 2003.

On September 22, 2003, the lender under the $200.0 million facility agreed to extend the deadline for our registration statement to be declared effective by the SEC to November 10, 2003. Our registration statement was declared effective on November 7, 2003. The lender on the $200.0 million credit facility agreed to extend the date by which we were required to close an additional credit facility of at least $200.0 million from October 3, 2003 to October 8, 2003. We subsequently obtained an additional waiver from this lender, which extended this required closing date for obtaining the additional credit facility to October 14, 2003 (this condition was satisfied by the closing of the $250.0 million facility described above). Prior to the closing of the second credit facility, our borrowing capacity on the $200.0 million facility was limited to $80.0 million. We entered into two amendments to the sale and servicing agreement with the lender under our $200.0 million facility which clarified the scope of particular financial covenants: one amendment dated as of May 12, 2004 clarified the scope of the financial covenant regarding the maintenance of minimum adjusted tangible net worth; and one amendment dated as of June 30, 2004 clarified the scope of the financial covenant regarding the maintenance of minimum cash and cash equivalents. This lender waived our noncompliance with the minimum net worth requirements at September 30, 2003, October 31, 2003, November 30, 2003, December 31, 2003, March 31, 2004, June 30, 2004, July 31, 2004, August 31, 2004 and September 30, 2004. This lender also waived our noncompliance with: the minimum adjusted tangible net worth requirement for all monthly compliance periods commencing with the month ending April 30, 2004 and continuing through the month ending September 30, 2004; our noncompliance with the minimum cash and cash equivalents requirement on December 31, 2003, April 30, 2004 and May 31, 2004; and our noncompliance on September 30, 2004 with requirements regarding the aggregate cash flow from all securitization trusts and the ratio of debt to adjust tangible net worth.

We have continued to operate on the basis of waivers granted by the lender under this facility to each of these events of noncompliance. The expiration date of this facility was originally September 21, 2004, but the lender agreed to extend the expiration date until November 5, 2004 in consideration for, among other things, a reduction in the amount that could be borrowed under this facility to $100.0 million. Consequently, we currently anticipate that we will be out of compliance with one or more of the financial covenants contained in this facility at October 31, 2004 and will need an additional waiver for this noncompliance from this lender to continue to operate.

A provision in our $250.0 million credit facility required us to maintain another credit facility for $200.0 million with a $40.0 million sublimit of such facility available for funding loans between the time they are closed by a title agency or closing attorney and the time documentation for the loans is received by the collateral agent. As a result of the reduction of our $200.0 million facility to $100.0 million, as described above, we entered into an amendment to the master loan and security agreement governing our $250.0 million facility which reduced the required amount for another facility to $100.0 million. In the event we do not extend the $200.0 million (now $100.0 million) facility beyond its November 5, 2004 expiration date, or in the event we do not otherwise enter into definitive agreements with other lenders by November 5, 2004 which satisfy the above-described requirements in our $250.0 million facility for $100.0 million in additional credit facilities and a $40.0 million sublimit, we will need an additional amendment to the $250.0 million facility or a waiver from the lender to continue to operate.

Additionally, as a result of being out of compliance at various times since June 30, 2003 with the net worth requirement in several of our servicing agreements, we requested and obtained waivers of this non-compliance from the bond insurers associated with each of two separable groups of these servicing agreements. In connection with the waiver of the net worth covenant granted by one of these bond insurers, for the remaining term of the related servicing agreements, we amended the servicing agreements on September 30, 2003 principally to provide for 120-day term-to-term servicing and for our appointment as servicer for an initial 120-day period commencing as of October 1, 2003. The bond insurer re-appointed us as servicer under these amended servicing agreements for additional 120-day terms commencing, respectively, on January 29, 2004, May 27, 2004 and September 23, 2004. The second of these bond insurers waived our non-compliance with net worth requirements on an oral basis from September 30, 2003 through March 9, 2004, at which time it executed a written waiver document which confirmed its prior oral waivers and extended these waivers through March 14, 2004. Additionally, we entered into an agreement with this second bond insurer on February 20, 2004 which amended the related servicing agreements principally to provide for 30-day term-to-term servicing and which re-appointed us as servicer for an initial term through March 15, 2004. Subsequently, this bond insurer, on a monthly basis, has given us a waiver of the net worth covenant and re-appointed us as servicer for an additional one-month term under these amended servicing agreements for all relevant periods since the execution of the amended servicing agreements. Our reappointment as servicer under these amended servicing agreements occurs in the sole discretion of the associated bond insurer.

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Separately, one bond insurer, as a condition to its participation in our October 31, 2003 privately-placed securitization, required that we amend the servicing agreement related to a previous public securitization in which the bond insurer had provided financial guarantee insurance to the Class M certificate. The resulting amendment to this servicing agreement, dated October 31, 2003, provided, among other things, for a specifically designated back-up servicer, for 90-day term-to-term servicing and for our re-appointment as servicer for an initial 90-day term commencing October 31, 2003. This bond insurer subsequently re-appointed us as servicer under the amended servicing agreement for an additional term through April 30, 2004. On April 30, 2004 this amended servicing agreement was amended again principally to provide for 30-day term-to-term servicing and for our reappointment as servicer for a 30-day term expiring May 31, 2004. On May 24, 2004 this amended servicing agreement was further amended principally to provide for minor administrative changes to the agreement and to reappoint us as servicer for an additional term expiring June 30, 2004. This bond insurer has re-appointed us as servicer under this amended servicing agreement for successive additional terms expiring on, respectively, July 31, 2004, August 31, 2004, September 30, 2004 and October 31, 2004. Our re-appointment as servicer under this amended servicing agreement is determined by reference to our compliance with its provisions.

Also separately, on March 5, 2004, we entered into agreements with another bond insurer which amended the servicing agreements related to all securitizations insured by this bond insurer. These amendments principally provided for a specifically designated back-up servicer. The original provisions of these servicing agreements providing for 3-month term-to-term servicing were not altered by these amendments. We were continuously re-appointed as servicer under these servicing agreements prior to the described amendments and we have continuously been re-appointed as servicer for all relevant periods subsequent to the described amendments. Our re-appointment as servicer under these amended servicing agreements is determined by reference to our compliance with their provisions.

As a result of the foregoing amendments to our servicing agreements, all of our servicing agreements associated with bond insurers now provide for term-to-term servicing. See "Risk Factors -- Our servicing rights may be terminated if we fail to satisfactorily perform our servicing obligations, or fail to meet minimum net worth requirements or financial covenants which could hinder our ability to operate profitably, impair our ability to repay our outstanding debt and negatively impact the value of our capital stock" for information regarding the impact of these amendments to servicing agreements.

We intend to amend the security agreements related to the senior collateralized subordinated notes to accommodate a request from the lender on our $250.0 million credit facility, and its affiliate, dated September 30, 2004, to clarify an inconsistency between these agreements and the $250.0 million credit facility documents related to liens on certain assets previously pledged by ABFS Warehouse Trust 2003-1 to Clearwing, the affiliate of the lender. See "-- Liquidity and Capital Resources" for additional information regarding these amendments.

Because we anticipate incurring losses at least through the first quarter of fiscal 2005 and as a result of any non-compliance with other financial covenants, we anticipate that we will need to obtain additional waivers. We cannot assure you as to whether or in what form a waiver or modification of these agreements would be granted to us.

SUBORDINATED DEBENTURES. The issuance of subordinated debentures funds the majority of our remaining operating cash requirements. We rely significantly on our ability to issue subordinated debentures since our cash flow from operations is not sufficient to meet these requirements. In order to expand our businesses we have issued subordinated debentures to partially fund growth and to partially fund maturities of subordinated debentures. In addition, we utilize proceeds from the issuance of subordinated debentures to fund overcollateralization. During the fiscal year ended June 30, 2004, subordinated debentures decreased by $196.7 million compared to an increase of $63.8 million in fiscal 2003. The reduction in subordinated debentures outstanding at June 30, 2004 was primarily due to the exchange offers and the resulting conversion of $177.8 million of subordinated debentures through June 30, 2004 into 93.8 million of shares of Series A preferred stock and $84.0 million of senior collateralized subordinated notes. The decrease also resulted from our temporary discontinuation of sales of new subordinated debentures for a portion of the first quarter of fiscal 2004. In July 2004 and August 2004, we converted an additional $30.8 million of subordinated debentures into 15.6 million shares of Series A preferred stock and $15.2 million of senior collateralized subordinated notes.

On December 1, 2003, we mailed the first exchange offer to holders of our subordinated debentures issued prior to April 1, 2003. Holders of such subordinated debentures had the ability to exchange their debentures for (i) equal amounts of senior collateralized subordinated notes and shares of Series A preferred stock; and/or (ii) dollar-for-dollar for shares of Series A preferred stock. Senior collateralized subordinated notes issued in the exchange have interest rates equal to 10 basis points above the subordinated debentures tendered. Senior collateralized subordinated notes with maturities of 12 months were issued in exchange for subordinated debentures tendered with maturities of less than 12 months, while subordinated debentures with maturities greater than 36 months were exchanged for senior collateralized subordinated notes with the same maturity or a maturity of 36 months. All other senior collateralized

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subordinated notes issued in the exchange have maturities equal to the subordinated debentures tendered. The senior collateralized subordinated notes outstanding are secured by a security interest in certain cash flows originating from interest-only strips of certain of our subsidiaries held by ABFS Warehouse Trust 2003-1 with an aggregate value of at least an amount equal to 150% of the principal balance of the senior collateralized subordinated notes issued in the first exchange offer plus priority lien obligations secured by interest-only strips and/or the cash flows from the interest-only strips; provided that, such collateral coverage may not fall below 100% of the principal balance of the senior collateralized subordinated notes issued in the first exchange offer, as determined by us on any quarterly balance sheet date. In the event of liquidation, to the extent the collateral securing the senior collateralized subordinated notes is not sufficient to repay these notes, the deficiency portion of the senior collateralized subordinated notes will rank junior in right of payment behind our senior indebtedness and all of our other existing and future senior debt and behind the existing and future debt of our subsidiaries and equally in right of payment with the deficiency portion of the senior collateralized subordinated notes, and any future subordinated debentures issued by us and other unsecured debt.

On May 14, 2004, we mailed the second exchange offer to holders of up to $120,000,000 of investment notes issued prior to November 1, 2003, which offered holders of such notes the ability to exchange their investment notes on substantially the same terms described above.

Under the terms of the exchange offers, the following amounts of subordinated dentures were exchanged for shares of Series A preferred stock and senior collateralized subordinated notes (in thousands):

                                                                            Shares of            Senior
                                                        Subordinated        Series A         Collateralized
                                                         Debentures         Preferred         Subordinated
By Closing Dates                                         Exchanged        Stock Issued        Notes Issued
----------------                                        ------------      ------------       ---------------
First exchange offer:
    December 31, 2003................................     $  73,554           39,095            $  34,459
    February 6, 2004.................................        43,673           22,712               20,961
                                                          ---------          -------            ---------
       Results of first exchange offer...............       117,227           61,807               55,420
                                                          ---------          -------            ---------
Second exchange offer:
    June 30, 2004....................................        60,589           31,980               28,609
    July 31, 2004....................................        25,414           12,908               12,506
    August 23, 2004..................................         5,397            2,730                2,667
                                                          ---------          -------            ---------
       Results of second exchange offer..............        91,400           47,618               43,782
                                                          ---------          -------            ---------
 Cumulative results of exchange offers...............     $ 208,627          109,425            $  99,202
                                                          =========          =======            =========
Note: results as of June 30, 2004, which include the
  first exchange offer and the June 30, 2004 closing
  of the second exchange offer.......................     $ 177,816           93,787            $  84,029
                                                          =========          =======            =========

At June 30, 2004, our interest in the cash flows from the interest-only strips held in the trust which secure the senior collateralized subordinated notes totaled $411.9 million of which approximately $125.5 million represented 150% of the outstanding principal balance of senior collateralized subordinated notes. After the August 23, 2004 closing of the exchange offer, the interest-only strips securing the senior collateralized subordinated notes totaled $148.2 million.

Anthony J. Santilli, our Chairman, Chief Executive Officer and President, Beverly Santilli, formerly our First Executive Vice President, and Dr. Jerome Miller, our director, each held subordinated debentures eligible to participate in the first exchange offer. Each named individual tendered all such eligible subordinated debentures in the first exchange offer and as of February 6, 2004, the expiration date of the first exchange offer, pursuant to the terms of the first exchange offer, were holders of the following number of shares of Series A preferred stock (SAPS) and aggregate amount of senior collateralized subordinated notes (SCSN) outstanding: Mr. Santilli: SAPS - 4,691, SCSN - $4,691; Mrs. Santilli: SAPS - 4,691, SCSN - $4,691; Dr. Miller: SAPS - 30,164, SCSN - $30,164.

Under a registration statement declared effective by the SEC on November 7, 2003, we registered $295.0 million of subordinated debentures. Of the $295.0 million, $134.7 million of debt from this registration statement was available for future issuance as of June 30, 2004.

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In the event we are unable to offer additional subordinated debentures for any reason, we have developed a contingent financial restructuring plan including cash flow projections for the next twelve-month period. Based on our current cash flow projections, we anticipate being able to make all scheduled subordinated debenture maturities and vendor payments.

The contingent financial restructuring plan is based on actions that we would take, in addition to those indicated in our adjusted business strategy, to reduce our operating expenses and conserve cash. These actions would include reducing capital expenditures, selling all loans originated on a whole loan basis, eliminating or downsizing various lending, overhead and support groups, and obtaining working capital funding. No assurance can be given that we will be able to successfully implement the contingent financial restructuring plan, if necessary, and repay our outstanding debt when due.

We intend to meet our obligation to repay such debt and interest as it matures with cash flow from operations, cash flows from interest-only strips and cash generated from additional debt financing. To the extent that we fail to maintain our credit facilities or obtain alternative financing on acceptable terms and increase our loan originations, we may have to sell loans earlier than intended and further restructure our operations which could further hinder our ability to repay the subordinated debentures when due.

The weighted-average interest rate of our subordinated debentures issued in the month of June 2004 was 11.09%, compared to a weighted-average interest rate of 7.49% for subordinated debentures issued in the month of June 2003. We had reduced the interest rates offered on subordinated debentures beginning in the fourth quarter of fiscal 2001 and had continued reducing rates through the fourth quarter of fiscal 2003 in response to decreases in market interest rates as well as declining cash needs during that period. However, during fiscal 2004, the weighted-average interest rate on subordinated debentures we issued had steadily increased, reflecting our financial condition. Subordinated debentures issued at our peak rate, which was in February 2001, was at a rate of 11.85%. We expect to reduce the interest rates offered on subordinated debentures over time as our business and cash needs, our financial condition, liquidity, future results of operations, market interest rates and competitive factors permit. The weighted average remaining maturity of our subordinated debentures at June 2004 was 13.5 months compared to 19.5 months at June 2003.

TERMS OF THE SERIES A PREFERRED STOCK. The Series A preferred stock has a par value of $0.001 per share and may be redeemed at our option at a price equal to the liquidation value plus accrued and unpaid dividends after the second anniversary of the issuance date. At June 30, 2004, 93,787,111 shares of the Series A preferred stock were issued and outstanding.

Upon any voluntary or involuntary liquidation, the holders of the Series A preferred stock will be entitled to receive a liquidation preference of $1.00 per share, plus accrued and unpaid dividends to the date of liquidation. Based on the shares of Series A preferred stock outstanding on June 30, 2004, the liquidation value equals $93.8 million. After completion of all closings under the second exchange offer, the liquidation value increased to $109.4 million.

Monthly cash dividend payments are $0.008334 per share of Series A preferred stock (equivalent to $0.10 per share annually or 10% annually of the liquidation value). Payment of cash dividends on the Series A preferred stock is subject to compliance with applicable Delaware state law. Based on the shares of Series A preferred stock outstanding on June 30, 2004, the annual cash dividend requirement equals $9.4 million. After completion of all closings under the second exchange offer, the annual cash dividend requirement increased to $10.9 million.

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On or after the second anniversary of the issuance date (or on or after the one year anniversary of the issuance date if no dividends are paid on the Series A preferred stock), each share of the Series A preferred stock is convertible at the option of the holder into a number of shares of the our common stock determined by dividing: (A) $1.00 plus an amount equal to accrued but unpaid dividends (if the conversion date is prior to the second anniversary of the issuance date because the Series A preferred stock has become convertible due to a failure to pay dividends), $1.20 plus an amount equal to accrued but unpaid dividends (if the conversion date is prior to the third anniversary of the issuance date but on or after the second anniversary of the issuance date) or $1.30 plus an amount equal to accrued but unpaid dividends (if the conversion date is on or after the third anniversary of the issuance date) by (B) the market value of a share of our common stock (which figure shall not be less than $5.00 per share regardless of the actual market value on the conversion date).

Based on the $5.00 per share market value floor and if each share of Series A preferred stock issued in the first exchange offer and the second exchange offer converted on the anniversary dates listed below, the number of shares of the our common stock which would be issued upon conversion follows (shares in thousands):

                                          As of June 30, 2004                 As of August 23, 2004
                                     -----------------------------        -----------------------------
                                                       Convertible                          Convertible
                                     Number of         into Number        Number of         into Number
                                     Preferred          of Common         Preferred          of Common
                                       Shares             Shares            Shares            Shares
                                     ---------         -----------        ---------         -----------
Second anniversary date....           93,787             22,509            109,425            26,262
Third anniversary date.....           93,787             24,384            109,425            28,451

As described above, the conversion ratio of the Series A preferred stock increases during the first three years following its issuance, which provides the holders of the Series A preferred stock with a discount on the shares of common stock that will be issued upon conversion. Under guidance issued by the EITF in issue 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios," this discount, or beneficial conversion feature, must be valued and amortized to the income statement as additional non-cash preferred dividends over the three-year period that the holders of the Series A preferred stock earn the discount.

We computed the value of the beneficial conversion feature using the conversion ratio of $1.30 to $5.00, which is the conversion term that is most beneficial to the investor, and would result in the issuance of 24.5 million shares of common stock based on the shares of Series A preferred stock that were issued through June 30, 2004. The value of the beneficial conversion feature equals the excess of the intrinsic value of those 24.5 million shares of common stock at their closing prices on the dates the preferred stock was issued, over the value of the Series A preferred stock on the same dates. The value of the Series A preferred stock was equal to the carrying value of the subordinated debentures exchanged. For closings under the exchange offers through June 30, 2004, the value of the beneficial conversion feature was $10.7 million. During fiscal 2004, amortization of $0.8 million was added to the $2.9 million of cash dividends declared resulting in a total charge to the income statement of $3.7 million. The offset to the charge to the income statement for the amortization of the beneficial conversion feature is recorded to additional paid in capital. For closings under the exchange offers through August 23, 2004, the value of the beneficial conversion feature was $11.3 million. Amortization of the total value of the beneficial conversion feature will be $3.6 million in fiscal 2005, $3.8 million in fiscal 2006 and $3.0 million for fiscal 2007.

SALES INTO SPECIAL PURPOSE ENTITIES AND OFF-BALANCE SHEET FACILITIES. In the past, we have relied significantly on access to the asset-backed securities market through securitizations to provide permanent funding of our loan production. Our adjusted business strategy will continue to rely on access to this market, although to a lesser extent. We also may retain the right to service the loans. Residual cash from the loans after required principal and interest payments are made to the investors provides us with cash flows from our interest-only strips. It is our expectation that future cash flows from our interest-only strips and servicing rights will generate more of the cash flows required to meet maturities of our subordinated debentures and our operating cash needs. See "-- Off-Balance Sheet Arrangements" for further detail of our securitization activity and effect of securitizations on our liquidity and capital resources.

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OTHER LIQUIDITY CONSIDERATIONS. At our annual meeting of shareholders held on December 31, 2003, our shareholders approved three proposals to enable us to consummate the first exchange offer: a proposal to increase the number of authorized shares of common stock from 9.0 million to 209.0 million, a proposal to increase the number of authorized shares of preferred stock from 3.0 million to 203.0 million, and a proposal to authorize us to issue Series A preferred stock in connection with our first exchange offer and the common stock issuable upon the conversion of the Series A preferred stock.

At a special meeting of stockholders held on June 29, 2004, our shareholders approved a proposal to authorize the issuance of shares of Series A preferred stock in connection with our second exchange offer and the common stock issuable upon the conversion of the Series A preferred stock.

Shareholder approval of these issuances of securities was required pursuant to the NASDAQ Corporate Governance Rules as the issuance of such shares could result in a change in control of our company. In addition to meeting the requirements of the exchange offers, the preferred shares may be used to raise equity capital, redeem outstanding debt or acquire other companies, although no such acquisitions are currently contemplated. The Board of Directors has discretion with respect to designating and establishing the terms of each series of preferred stock prior to issuance.

In fiscal 1999, the Board of Directors initiated a stock repurchase program in view of the price level of our common stock, which at the time traded and has continued to trade at below book value. In addition, our consistent earnings growth at that time did not result in a corresponding increase in the market value of our common stock. The repurchase program was extended in fiscal 2000, 2001 and 2002. The total number of shares repurchased under the stock repurchase program was: 117,000 shares in fiscal 1999; 327,000 shares in fiscal 2000; 627,000 shares in fiscal 2001; and 352,000 shares in fiscal 2002. The cumulative effect of the stock repurchase program was an increase in diluted net earnings per share of $0.41 and $0.32 for the years ended 2002 and 2001, respectively. We currently have no plans to continue to repurchase additional shares or extend the repurchase program.

A further decline in economic conditions, continued instability in financial markets or further acts of terrorism in the United States may cause disruption in our business and operations including reductions in demand for our loan products and our subordinated debentures, increases in delinquencies and credit losses in our total loan portfolio, changes in historical prepayment patterns and declines in real estate collateral values. To the extent the United States experiences an economic downturn, unusual economic patterns and unprecedented behaviors in financial markets, these developments may affect our ability to originate loans at profitable interest rates, to price future loan securitizations profitably and to hedge our loan portfolio effectively against market interest rate changes which could cause reduced profitability. Should these disruptions and unusual activities occur, our profitability and cash flow could be reduced and our ability to make principal and interest payments on our subordinated debentures could be impaired. Additionally, under the Servicemembers Civil Relief Act, members of all branches of the military on active duty, including draftees and reservists in military service and state national guard called to federal duty are entitled to have interest rates reduced and capped at 6% per annum, on obligations (including mortgage loans) incurred prior to the commencement of military service for the duration of military service and may be entitled to other forms of relief from mortgage obligations. To date, compliance with the Act has not had a material effect on our business.

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LEGAL AND REGULATORY CONSIDERATIONS

Local, state and federal legislatures, state and federal banking regulatory agencies, state attorneys general offices, the Federal Trade Commission, the U.S. Department of Justice, the U.S. Department of Housing and Urban Development and state and local governmental authorities have increased their focus on lending practices by companies in the subprime lending industry, more commonly referred to as "predatory lending" practices. State, local and federal governmental agencies have imposed sanctions for practices including, but not limited to, charging borrowers excessive fees, imposing higher interest rates than the borrower's credit risk warrants, failing to adequately disclose the material terms of loans to the borrowers and abusive servicing and collections practices. As a result of initiatives such as these, we are unable to predict whether state, local or federal authorities will require changes in our lending practices in the future, including reimbursement of fees charged to borrowers, or will impose fines on us. These changes, if required, could impact our profitability. These laws and regulations may limit our ability to securitize loans originated in some states or localities due to rating agency, investor or market restrictions. As a result, we have limited the types of loans we offer in some states and may discontinue originating loans in other states or localities.

Additionally, the United States Congress is currently considering a number of proposed bills or proposed amendments to existing laws, such as the "Ney - Lucas Responsible Lending Act of 2003" introduced on February 13, 2003 into the U.S. House of Representatives, which could affect our lending activities and make our business less profitable. These bills and amendments, if adopted as proposed, could reduce our profitability by limiting the fees we are permitted to charge, including prepayment fees, restricting the terms we are permitted to include in our loan agreements and increasing the amount of disclosure we are required to give to potential borrowers. While we cannot predict whether or in what form Congress may enact legislation, we are currently evaluating the potential impact of these legislative initiatives, if adopted, on our lending practices and results of operations.

In addition to new regulatory initiatives with respect to so-called "predatory lending" practices, current laws or regulations in some states restrict our ability to charge prepayment penalties and late fees. Prior to its preclusion in July 2003, we used the Federal Alternative Mortgage Transactions Parity Act of 1982, which we refer to as the Parity Act, to preempt these state laws for loans which meet the definition of alternative mortgage transactions under the Parity Act. However, the Office of Thrift Supervision has adopted a rule effective in July 2003, which precludes us and other non-bank, non-thrift creditors from using the Parity Act to preempt state prepayment penalty and late fee laws on new loan originations. Under the provisions of this rule, we are required to modify or eliminate the practice of charging prepayment and other fees on new loans in some of the states where we originate loans. Prior to this rule becoming effective, 80% to 85% of the home mortgage loans we originated contained prepayment fees. The origination of a high percentage of loans with prepayment fees impacts our securitization gains and securitization assets by helping to reduce the likelihood of a borrower prepaying their loan, thereby prolonging the life of a securitization, and increasing the amounts of residual cash flow, servicing fees and prepayment fees we can expect to collect over the life of a securitization. We currently expect that the percentage of loans that we will originate in the future containing prepayment fees will decrease to approximately 65% to 70%. During fiscal 2004, approximately 72% of the loans we originated contained prepayment fees. This decrease in prepayment fee penetration will potentially reduce the amount of gains and securitization assets we will record on any future securitizations. Because there are many other variables including market conditions, which will also impact securitizations, we are unable to quantify the impact of this rule on any future securitization assets and related gains until we complete a publicly-placed securitization of loans which we originated since this rule became effective. Additionally, in a recent decision, the Appellate Division of the Superior Court of New Jersey determined that the Parity Act's preemption of state law was invalid and that the state laws precluding some lenders from imposing prepayment fees are applicable to loans made in New Jersey, including alternative mortgage transactions. On May 26, 2004, the New Jersey Supreme Court reversed the decision of the Appellate Division of the Superior Court of New Jersey and held that the Parity Act had preempted the New Jersey Prepayment Law, which prohibited housing lenders from imposing prepayment penalties. However, the plaintiff has petitioned the United States Supreme Court for certiorari in this matter.

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Although we are licensed or otherwise qualified to originate loans in 46 states, our loan originations are concentrated mainly in the eastern half of the United States. Recent expansion has positioned us to increase originations in the western portion of the United States, especially California. The concentration of loans in a specific geographic region subjects us to the risk that a downturn in the economy or recession in the eastern half of the country would more greatly affect us than if our lending business were more geographically diversified. As a result, an economic downturn or recession in this region could result in reduced profitability. See "Risk Factors -- An economic downturn or recession in a small number of states could hinder our ability to operate profitably and reduce the funds available to repay our outstanding debt which could negatively impact the value of our capital stock."

We are also subject, from time to time, to private litigation resulting from alleged "predatory lending" practices. We expect that as a result of the publicity surrounding predatory lending practices and the recent New Jersey court decision regarding the Parity Act, we may be subject to other class action suits in the future. See "Risk Factors -- Our residential lending business is subject to government regulation and licensing requirements, which may hinder our ability to operate profitably, negatively impair our ability to repay our outstanding debt and negatively impact the value of our capital stock."

On May 20, 2004, the purported consumer class action lawsuit captioned Moore v. American Business Financial Services, Inc. et al, No. 003237 was filed against us, our lending subsidiaries and an unrelated party in the Philadelphia Court of Common Pleas. The lawsuit was brought on behalf of residential mortgage consumers and challenges the validity of our deed in lieu of foreclosure and force-placed insurance practices as well as certain mortgage service fees charged by us. This lawsuit relates, in part, to the same subject matter as the U.S. Attorney's inquiry concluded in December 2003 with no findings of wrongdoing as discussed below. The lawsuit seeks actual and treble damages, statutory damages, punitive damages, costs and expenses of the litigation and injunctive relief. Procedurally, this lawsuit is in a very preliminary stage. We believe the complaint contains fundamental factual inaccuracies and that we have numerous defenses to these allegations. We intend to vigorously defend this lawsuit. Due to the inherent uncertainties in litigation and because the ultimate resolution of this proceeding is influenced by factors outside of our control, we are currently unable to predict the ultimate outcome of this litigation or its impact on our financial position or results of operations.

SECURITIES CLASS ACTION LAWSUITS AND SHAREHOLDER DERIVATIVE ACTION. In January and February of 2004, four class action lawsuits were filed against us and certain of our officers and directors. Lead plaintiffs and counsel were appointed on June 3, 2004. A consolidated amended class action complaint that supersedes these four complaints was filed on August 19, 2004 in the United States District Court for the Eastern District of Pennsylvania.

The consolidated amended class action complaint brings claims on behalf of a class of all purchasers of our common stock for a proposed class period of January 27, 2000 through June 26, 2003. The consolidated complaint names us, our director and Chief Executive Officer, Anthony Santilli, our Chief Financial Officer, Albert Mandia, and former director, Richard Kaufman, as defendants and alleges that we and the named directors and officers violated Sections 10(b) and 20(a) of the Exchange Act. The consolidated complaint alleges that, during the applicable class period, our forbearance and deferment practices enabled us to, among other things, lower our delinquency rates to facilitate the securitization of our loans which purportedly allowed us to collect interest income from our securitized loans and inflate our financial results and market price of our common stock. The consolidated amended class action complaint seeks unspecified compensatory damages, costs and expenses related to bringing the action, and other unspecified relief.

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On March 15, 2004, a shareholder derivative action was filed against us, as a nominal defendant, and our director and Chief Executive Officer, Anthony Santilli, our Chief Financial Officer, Albert Mandia, our directors, Messrs. Becker, DeLuca and Sussman, and our former director Mr. Kaufman, as defendants, in the United States District Court for the Eastern District of Pennsylvania. The lawsuit was brought nominally on behalf of the Company, as a shareholder derivative action, alleging that the named directors and officers breached their fiduciary duties to the Company, engaged in the abuse of control, gross mismanagement and other violations of law during the period from January 27, 2000 through June 25, 2003. The lawsuit seeks unspecified compensatory damages, equitable or injunctive relief and costs and expenses related to bringing the action, and other unspecified relief. The parties have agreed to stay this case pending disposition of any motion to dismiss the consolidated amended complaint filed in the putative consolidated securities class action.

Procedurally, these lawsuits are in a very preliminary stage. We believe that we have several defenses to the claims raised by these lawsuits and intend to vigorously defend the lawsuits. Due to the inherent uncertainties in litigation and because the ultimate resolution of these proceedings is influenced by factors outside of our control, we are currently unable to predict the ultimate outcome of this litigation or its impact on our financial position, results of operations or cash flows. See "Risk Factors -- We are subject to private litigation, including lawsuits resulting from the alleged "predatory" lending practices, as well as securities class action and derivative lawsuits, the impact of which on our financial position is uncertain. The inherent uncertainty related to litigation of this type and the preliminary stage of these suits makes it difficult to predict the ultimate outcome or potential liability that we may incur as a result of these matters."

JOINT AGREEMENT WITH THE U.S. ATTORNEY'S OFFICE. On December 22, 2003, we entered into a Joint Agreement with the Civil Division of the U.S. Attorney's Office for the Eastern District of Pennsylvania which ended the inquiry by the U.S. Attorney initiated pursuant to the civil subpoena dated May 14, 2003. The U.S. Attorney's inquiry focused on our forbearance policies, primarily on our practice of requesting a borrower who entered into forbearance agreement to execute a deed in lieu of foreclosure. In response to the inquiry and as part of the Joint Agreement, we, among other things, have adopted a revised forbearance policy, which became effective on November 19, 2003 and will make an $80 thousand contribution to a housing counseling organizations approved by the U.S. Department of Housing and Urban Development. We do not believe that the Joint Agreement with the U.S. Attorney has had a significant impact on our operations. See "Legal Proceedings."

APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

Our consolidated financial statements are prepared in accordance with GAAP. The accounting policies discussed below are considered by management to be critical to understanding our financial condition and results of operations. The application of these accounting policies requires significant judgment and assumptions by management, which are based upon historical experience and future expectations. The nature of our business and our accounting methods make our financial condition, changes in financial condition and results of operations highly dependent on management's estimates. The line items on our income statement and balance sheet impacted by management's estimates are described below.

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REVENUE RECOGNITION. Revenue recognition is highly dependent on the application of Statement of Financial Accounting Standards, referred to as SFAS in this document, No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," referred to as SFAS No. 140 in this document, and "gain-on-sale" accounting to our loan securitizations. Gains on sales of loans through securitizations for the fiscal year ended June 30, 2004 were 15.6% of total revenues compared to 70.8% for the fiscal year ended June 30, 2003. The decline in the percentage of total revenues comprised of securitization gains resulted from our inability to complete securitizations in the first, third and fourth quarters of fiscal 2004 and the reduction in loans originated during fiscal 2004. Securitization gains represent the difference between the net proceeds to us, including retained interests in the securitization, and the allocated cost of loans securitized. The allocated cost of loans securitized is determined by allocating their net carrying value between the loans, the interest-only strips and the servicing rights we may retain based upon their relative fair values. Estimates of the fair values of the interest-only strips and the servicing rights we may retain are discussed below. We believe the accounting estimates related to gain on sale are critical accounting estimates because more than 80% of the securitization gains in fiscal 2003 were based on estimates of the fair value of retained interests. The amount recognized as gain on sale for the retained interests we receive as proceeds in a securitization, in accordance with accounting principles generally accepted in the United States of America, is highly dependent on management's estimates.

INTEREST-ONLY STRIPS. Interest-only strips, which represent the right to receive future cash flows from securitized loans, represented 44.0% of our total assets at June 30, 2004 and 51.6% of our total assets at June 30, 2003 and are carried at their fair values. Interest-only strips are initially recorded at their allocated cost basis at the time of recording a securitization gain and in accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities," referred to as SFAS No. 115 in this document, are then written up to their fair value through other comprehensive income, a component of stockholders' equity.

Fair value is based on a discounted cash flow analysis which estimates the present value of the future expected residual cash flows and overcollateralization cash flows utilizing assumptions made by management. These assumptions include the rates used to calculate the present value of expected future residual cash flows and overcollateralization cash flows, referred to as the discount rates, and expected prepayment and credit loss rates on pools of loans sold through securitizations. We believe the accounting estimates used in determining the fair value of interest-only strips are critical accounting estimates because estimates of prepayment and credit loss rates are made based on management's expectation of future experience, which is based in part, on historical experience, current and expected economic conditions and in the case of prepayment rate assumptions, consideration of the impact of changes in market interest rates. The actual loan prepayment rate may be affected by a variety of economic and other factors, including prevailing interest rates, the availability of alternative financing to borrowers and the type of loan.

We re-evaluate expected future cash flows from our interest-only strips on a quarterly basis. We monitor the current assumptions for prepayment and credit loss rates against actual experience and other economic and market conditions and we adjust assumptions if deemed appropriate. Even a small unfavorable change in our assumptions made as a result of unfavorable actual experience or other considerations could have a significant adverse impact on our estimate of residual cash flows and on the value of these assets. In the event of an unfavorable change in these assumptions, the fair value of these assets would be overstated, requiring an accounting adjustment for impairment. In accordance with the provisions of Emerging Issues Task Force guidance on issue 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets," referred to as EITF 99-20 in this document, and SFAS No. 115, decreases in the fair value of interest-only strips that are deemed to be other than temporary adjustments to fair value are recorded through the income statement, which would adversely affect our income in the period of adjustment. Additionally, to the extent any individual interest-only strip has a portion of its initial write up to fair value still remaining in other comprehensive income, other than temporary decreases in its fair value would first be recorded as a reduction to other comprehensive income, which would adversely affect our stockholders' equity in the period of adjustment.

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During fiscal 2004, we recorded total pre-tax other than temporary valuation adjustments on our interest only-strips of $57.0 million, of which, in accordance with EITF 99-20, $39.6 million was charged as expense to the income statement and $17.4 million was charged to other comprehensive income. During fiscal 2003, we recorded total pre-tax other than temporary valuation adjustments on our interest-only strips of $58.0 million, of which $39.9 million was charged as expense to the income statement and $18.1 million was charged to other comprehensive income. The valuation adjustments primarily reflect the impact of higher than anticipated prepayments on securitized loans experienced during fiscal 2004 and fiscal 2003 due to the continuing low interest rate environment. Additionally, on June 30, 2004, we wrote down the carrying value of our interest-only strips related to five of our mortgage securitization trusts by $4.1 million to reflect their values under the terms of a September 27, 2004 sale agreement. The sale of these assets was undertaken as part of our negotiations to obtain the new $100.0 million warehouse credit facility described in "-- Liquidity and Capital Resources" and to raise cash to pay fees on new warehouse credit facilities and as a result, we did not realize their full value as reflected on our books. See "-- Securitizations" for more detail on the estimation of the fair value of interest-only strips and the sensitivities of these balances to changes in assumptions and the impact on our financial statements of changes in assumptions. See "Risk Factors -- Our estimates of the value of interest-only strips and servicing rights we retain when we securitize loans could be inaccurate and could limit our ability to operate profitably, impair our ability to repay our outstanding debt and negatively impact the value of our capital stock."

Interest accretion income represents the yield component of cash flows received on interest-only strips. We use a prospective approach to estimate interest accretion. As previously discussed, we update estimates of residual cash flow from our securitizations on a quarterly basis. Under the prospective approach, when it is probable that there is a favorable or unfavorable change in estimated residual cash flow from the cash flow previously projected, we recognize a larger or smaller percentage of the cash flow as interest accretion. Any change in value of the underlying interest-only strip could impact our current estimate of residual cash flow earned from the securitizations. For example, a significant change in market interest rates could increase or decrease the level of prepayments, thereby changing the size of the total managed loan portfolio and related projected cash flows. The managed portfolio includes loans held as available for sale on our balance sheet and loans serviced for others.

SERVICING RIGHTS. Servicing rights, which represent the rights to receive contractual servicing fees from securitization trusts and ancillary fees from borrowers, net of adequate compensation that would be required by a substitute servicer, represented 7.1% of our total assets at June 30, 2004 and 10.3% of our total assets at June 30, 2003. Servicing rights are carried at the lower of cost or fair value. The fair value of servicing rights is determined by computing the benefits of servicing in excess of adequate compensation, which would be required by a substitute servicer. The benefits of servicing are the present value of projected net cash flows from contractual servicing fees and ancillary servicing fees. We believe the accounting estimates used in determining the fair value of servicing rights are critical accounting estimates because the projected cash flows from servicing fees incorporate assumptions made by management, including prepayment rates and discount rates. These assumptions are similar to those used to value the interest-only strips retained in a securitization. We monitor the current assumptions for prepayment rates against actual experience and other economic and market conditions and we adjust assumptions if deemed appropriate. Even a small unfavorable change in our assumptions, made as a result of unfavorable actual experience or other considerations could have a significant adverse impact on the value of these assets. In the event of an unfavorable change in these assumptions, the fair value of these assets would be overstated, requiring an adjustment, which would adversely affect our income in the period of adjustment.

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A review for impairment is performed on a quarterly basis by stratifying the serviced loans by loan type, home mortgage or business purpose loans, which we consider to be the predominant risk characteristic in the portfolio of loans we service. In establishing loan type as the predominant risk characteristic, we considered the following additional loan characteristics and determined these characteristics as mostly uniform within our two types of serviced loans and not predominant for risk stratification:

o Fixed versus floating rate loans - All loans we service in our securitizations are fixed-rate loans.
o Conforming versus non-conforming loans - All loans we service are sub-prime (non-conforming) loans, with over 80% of the loans serviced having credit grades of A or B.
o Interest rate on serviced loans - The serviced loan portfolio has a high penetration rate of prepayment fees. Sub-prime borrowers, in general, are not as influenced by movement in market interest rates as conforming borrowers. A sub-prime borrower's ability to `rate shop' is generally limited due to personal credit circumstances that are not market driven.
o Loan collateral - All loans we service are secured by real estate, with approximately 85% secured with first liens on residential property.
o Individual loan size - The average loan size in our serviced portfolio is $75 thousand. The serviced portfolio is approximately $2.1 billion at June 30, 2004 with approximately 25 thousand loans. There are no significant defining groupings with respect to loan size. No loans are greater than $1.0 million, only $10.8 million of loans have principal balances greater than $500 thousand, and only $34.5 million of loans have principal balances greater than $350 thousand.
o Geographic location of loans - The largest percentage of loans we service are geographically located in the mid-Atlantic and northeast sections of the United States.
o Original loan term - Home equity loan terms are primarily 180, 240 or 360 months. Business purpose loan terms are primarily 120 or 180 months.

If our quarterly analysis indicates the carrying value of servicing rights is not recoverable through future cash flows from contractual servicing and other ancillary fees, a valuation allowance or write down would be required. Our valuation analyses indicated that valuation adjustments of $5.5 million and $5.3 million were required during fiscal 2004 and 2003, respectively, for impairment of servicing rights due to higher than expected prepayment experience. Additionally, on June 30, 2004, we wrote down the carrying value of our servicing rights related to five of our mortgage securitization trusts by $1.3 million to reflect their values under the terms of a September 27, 2004 sale agreement. The sale of these assets was undertaken as part of our negotiations to obtain the new $100.0 million warehouse credit facility described in "-- Liquidity and Capital Resources" and to raise cash to pay fees on new warehouse credit facilities and as a result, we did not realize their full value as reflected on our books. In accordance with SFAS No. 140, the write downs were recorded as a charge to the income statement. Impairment is measured as the excess of carrying value over fair value. See "-- Securitizations" for more detail on the estimation of the fair value of servicing rights and the sensitivities of these balances to changes in assumptions and the estimated impact on our financial statements of changes in assumptions.

Amortization of the servicing rights asset for securitized loans is calculated individually for each securitized loan pool and is recognized in proportion to, and over the period of, estimated future servicing income on that particular pool of loans.

DEFERRED TAX ASSET. Estimates of deferred tax assets and deferred tax liabilities make up the deferred income tax asset on our balance sheet. These estimates involve significant judgments and estimates by management, which may have a material impact on the carrying value of the deferred income tax asset. We periodically review the deferred income tax asset to determine if it is more likely than not that we will realize this deferred tax asset.

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Our net deferred income tax position changed from a liability of $17.0 million at June 30, 2003 to an asset of $59.1 million at June 30, 2004. For more detail on this net deferred income tax asset, see Note 14 of the June 30, 2004 Consolidated Financial Statements. This change from a liability position is the result of recording $68.3 million of federal and state income tax benefits on our pre-tax loss for the fiscal year ended June 30, 2004. These federal and state income tax benefits will be realized against anticipated future years' state and federal taxable income. Factors we considered in determining that it is more likely than not we will realize this deferred tax asset included: (i) the circumstances producing the losses for the fourth quarter of fiscal 2003 and the fiscal year ended June 30, 2004; (ii) our historical profitability prior to the fourth quarter of fiscal 2003; (iii) the anticipated impact that our adjusted business strategy will have on producing more currently taxable income than our previous business strategy produced due to higher loan originations and shifting from securitizations to whole loan sales; (iv) the achievability of anticipated levels of future taxable income under our adjusted business strategy; and (v) the likely utilization of our net operating loss carryforwards. Additionally, we consider tax-planning strategies we can use to increase the likelihood that the deferred income tax asset will be realized.

Our adjusted business strategy, as described in "Business -- Business Strategy," will more likely than not produce the level of loan originations that we need to achieve taxable income. For the month of May 2003, we originated $169.0 million of loans, an historical monthly high under our previous business strategy. In the month of September 2004 under our adjusted business strategy, we originated $234.0 million of loans and management believes that amount would have been higher if not for the impact of hurricanes in some of the states in which we originate loans. Once our adjusted business strategy is fully implemented, we anticipate increasing our loan originations to approximately $400.0 million to $600.0 million per month, which will return us to profitable operations. We have significantly expanded our geographic reach and established a strong presence on the west coast in fiscal 2004, and are continuing to apply our adjusted business strategy, particularly as it relates to expanding our broker channel and offering adjustable rate mortgages, purchase money mortgages and more competitively priced fixed rate mortgages. Additionally, economic conditions are favorable for loan originations with growing GDP and employment, high real estate values and moderate increases in interest rates.

ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is maintained on non-accrual loans to account for delinquent loans and leases and delinquent loans that have been repurchased from securitization trusts. The allowance is maintained at a level that management determines is adequate to absorb estimated probable losses. The allowance is calculated based upon management's estimate of our ability to collect on outstanding loans based upon a variety of factors, including, periodic analysis of the loans, economic conditions and trends, historical credit loss experience, borrowers' ability to repay, and collateral considerations. Additions to the allowance arise from the provision for credit losses charged to operations or from the recovery of amounts previously charged-off. Loan charge-offs reduce the allowance. Delinquent loans are charged off against the allowance in the period in which a loan is deemed fully uncollectable or when liquidated in a payoff or sale. If the actual collection of outstanding loans is less than we anticipate, further write downs would be required which would reduce our net income in the period the write down was required.

DERIVATIVE FINANCIAL INSTRUMENTS. We utilize derivative financial instruments to manage the effect of changes in interest rates on the fair value of our loans between the date loans are originated at fixed interest rates and the date the terms and pricing for a whole loan sale are fixed or the date the fixed interest rate pass-through certificates to be issued by a securitization trust are priced. See "-- Interest Rate Risk Management -- Strategies for Use of Derivative Financial Instruments" for more detail.

Derivative contracts receive hedge accounting only if they are designated as a hedge and are expected to be, and are, highly effective in substantially reducing interest rate risk arising from the pools of mortgage loans exposing us to risk. Under hedge accounting, the gain or loss derived from these derivative financial instruments, which are designated as fair value hedges, is reported in the Statement of Income (included in the caption "gains and losses on derivative financial instruments") as it occurs with an offsetting adjustment to the hedged loans attributable to the risk being hedged also reported in the Statement of Income. The fair value of derivative financial instruments is determined based on quoted market prices. The fair value of the hedged loans is determined based on current pricing of these assets in a whole loan sale or securitization. Cash flows resulting from fair value hedges are reported in the period they occur.

Assuming a hedge relationship continues to be highly effective, determined as described below, the relationship continues until the mortgage loan pool is sold in a whole loan sale, is committed to a forward sale agreement or is sold in a securitization. When a hedge relationship is terminated, the derivative financial instrument may be re-designated as a hedge of a new mortgage pool.

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The effectiveness of our fair value hedges is periodically assessed. Fair value hedges must meet specific effectiveness tests to be considered highly effective. Over time the change in the fair values of the derivative financial instrument must be within 80 to 120 percent of the change in the fair value of the hedged loans due to the designated risk. If highly effective correlation does not exist, we discontinue hedge accounting prospectively.

DEVELOPMENT OF CRITICAL ACCOUNTING ESTIMATES. On a quarterly basis, senior management reviews the estimates used in our critical accounting policies. As a group, senior management discusses the development and selection of the assumptions used to perform its estimates described above. Management has discussed the development and selection of the estimates used in our critical accounting policies as of June 30, 2004 and June 30, 2003 with the Audit Committee of our Board of Directors. In addition, management has reviewed its disclosure of the estimates discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" with the Audit Committee.

IMPACT OF CHANGES IN CRITICAL ACCOUNTING ESTIMATES. For a description of the impact of changes in critical accounting estimates related to interest-only strips and servicing rights in the fiscal year ended June 30, 2004, see "-- Securitizations."

INITIAL ADOPTION OF ACCOUNTING POLICIES. In conjunction with the relocation of our corporate headquarters to new leased office space, we entered into a lease agreement and certain governmental grant agreements, which provided us with reimbursement for certain expenditures related to our office relocation. The reimbursable expenditures included both capitalizable items for leasehold improvements, furniture and equipment and expense items such as legal costs, moving costs and employee communication programs. Amounts reimbursed to us in accordance with our lease agreement are initially recorded as a liability on our balance sheet and will be amortized in the income statement on a straight-line basis over the term of the lease as a reduction of rent expense. Amounts received from government grants were initially recorded as a liability. Grant funds received to offset expenditures for capitalizable items are classified as a reduction of the related fixed asset and amortized to income over the depreciation period of the related asset as an offset to depreciation expense. Amounts received to offset expense items were recognized in the income statement as an offset to the expense item.

IMPACT OF CHANGES IN CRITICAL ACCOUNTING ESTIMATES IN PRIOR FISCAL YEARS

DISCOUNT RATES. During fiscal 2003, we recorded total pre-tax valuation adjustments on our securitization assets of $63.3 million, of which $45.2 million was charged as expense to the income statement and $18.1 million was charged to other comprehensive income. The breakout of the total adjustments in fiscal 2003 between interest-only strips and servicing rights and the amount of the adjustments related to changes in discount rates were as follows:

o We recorded total pre-tax valuation adjustments on our interest only-strips of $58.0 million, of which $39.9 million was charged to the income statement and $18.1 million was charged to other comprehensive income. The valuation adjustment reflects the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003, which has impacted the entire mortgage industry. The valuation adjustment on interest-only strips for fiscal 2003 was reduced by a $20.9 million favorable valuation impact as a result of reducing the discount rates applied in valuing the interest-only strips at June 30, 2003. The amount of the valuation adjustment charged to the income statement was reduced by a $10.8 million favorable valuation impact as a result of reducing the discount rates and the charge to other comprehensive income was reduced by $10.1 million for the favorable impact of reducing discount rates. The discount rates were reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The reductions in discount rates are discussed in more detail below.

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o We recorded total pre-tax valuation adjustments on our servicing rights of $5.3 million, which was charged to the income statement. The valuation adjustment reflects the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003. The valuation adjustment on servicing rights for fiscal 2003 was reduced by a $7.1 million favorable valuation impact as a result of reducing the discount rate applied in valuing the servicing rights at June 30, 2003. The discount rate was reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on our servicing rights was reduced from 11% to 9% at June 30, 2003.

See "- Application of Critical Accounting Estimates - Interest-Only Strips" for a discussion of how valuation adjustments are recorded.

From June 30, 2000 through March 31, 2003, we had applied a discount rate of 13% to residual cash flows. On June 30, 2003, we reduced that discount rate to 11% based on the following factors:

o We had experienced a period of sustained decreases in market interest rates. Interest rates on three and five-year term US Treasury securities have been on the decline since mid-2000. Three-year rates had declined approximately 475 basis points and five-year rates have declined approximately 375 basis points over that period.

o The interest rates on the bonds issued in our securitizations over that same timeframe also had experienced a sustained period of decline. The trust certificate pass-through interest rate had declined 426 basis points, from 8.04% in the 2000-2 securitization to 3.78% in the 2003-1 securitization.

o The weighted average interest rate on loans securitized had declined from a high of 12.01% in the 2000-3 securitization to 10.23% in the 2003-1 securitization.

o Market factors and the economy favored the continuation of low interest rates for the foreseeable future.

o Economic analysis of interest rates and data released at the time of the June 30, 2003 evaluation supported declining mortgage refinancings even though predicting the continuation of low interest rates for the foreseeable future.

o The interest rates paid on subordinated debentures issued, which is used to fund our interest-only strips, had declined from a high of 11.85% in February 2001 to a rate of 7.49% in June 2003.

However, because the discount rate is applied to projected cash flows, which consider expected prepayments and losses, the discount rate assumption was not evaluated in isolation. These risks involved in our securitization assets were considered in establishing a discount rate. The impact of this reduction in discount rate from 13% to 11% was to increase the valuation of our interest-only strips by $17.6 million at June 30, 2003.

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We apply a second discount rate to projected cash flows from the overcollateralization portion of our interest-only strips. The discount rate applied to projected overcollateralization cash flows in each mortgage securitization is based on the highest trust certificate pass-through interest rate in the mortgage securitization. In fiscal 2001, we instituted the use of a minimum discount rate of 6.5% on overcollateralization cash flows. At June 30, 2003 we reduced the minimum discount rate to 5.0% to reflect the sustained decline in interest rates. This reduction in the minimum discount rate impacted the valuation of three securitizations and increased the June 30, 2003 valuation of our interest-only strips by $3.3 million.

The blended rate used to value our interest-only strips at June 30, 2003 was 9%.

From June 2000 to March 2003, the discount rate applied in determining the fair value of servicing rights was 11%, which was 200 basis points lower than the 13% discount rate applied to value residual cash flows from interest-only strips during that period. On June 30, 2003, we reduced the discount rate on servicing rights cash flows to 9%. The impact of the June 30, 2003 reduction in discount rate from 11% to 9% was to increase the valuation of our servicing rights by $7.1 million at June 30, 2003. This favorable impact was offset by a decrease of $12.4 million mainly due to prepayment experience in fiscal 2003.

PREPAYMENT RATES. From the second quarter of fiscal 2002 through the fourth quarter of fiscal 2004, we revised the prepayment rate assumptions used to value our securitization assets, thereby decreasing the fair value of these assets. See "-- Securitizations" for discussion of the impacts of these revisions in prepayment rate assumptions.

OFF-BALANCE SHEET ARRANGEMENTS

We use off-balance sheet arrangements extensively in our business activities. The types of off-balance sheet arrangements we use include special purpose entities for the securitization of loans, obligations we incur as the servicer of securitized loans and other contractual obligations such as operating leases for corporate office space. See "-- Liquidity and Capital Resources" for additional information regarding our off-balance sheet contractual obligations.

We have used special purpose entities and off-balance sheet facilities in our mortgage loan securitizations. Asset securitizations are one of the most common off-balance sheet arrangements in which a company transfers assets off of its balance sheet by selling them to a special purpose entity. We sell our loans into off-balance sheet facilities to generate the cash to pay off revolving credit facilities and to generate revenue through securitization gains. The special purpose entities described below meet our objectives for mortgage loan securitization structures and comply with accounting principles generally accepted in the United States of America. We expect to use off-balance sheet facilities in any future securitizations.

Our securitizations involve a two-step transfer that qualifies for sale accounting under SFAS No. 140. First, we sell the loans to a special purpose entity, which has been established for the limited purpose of buying and reselling the loans and establishing a true sale under legal standards. Next, the special purpose entity sells the loans to a qualified special purpose entity, which we refer to as the trust. The trust is a distinct legal entity, independent from us. By transferring title of the loans to the trust, we isolate those assets from our assets. Finally, the trust issues certificates to investors to raise the cash purchase price for the loans we have sold. Cash from the sale of certificates to third party investors is returned to us in exchange for our loan receivables and we use this cash, in part, to repay any borrowings under warehouse and credit facilities. The off-balance sheet trusts' activities are restricted to holding title to the loan collateral, issuing certificates to investors and distributing loan payments to the investors and us in accordance with the relevant agreement.

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When we securitize loans, we also may retain the right to service the loans. We do not service the loans in the 2003-2 securitization, our most recent securitization, which closed in October 2003. We have no additional obligations to the off-balance sheet facilities other than those required as servicer of the loans and for breach of covenants or warranty obligations. We are not required to make any additional investments in the trusts. Under current accounting rules, the trusts do not qualify for consolidation in our financial statements. The trusts carry the loan collateral as assets and the certificates issued to investors as liabilities. Residual cash from the loans after required principal and interest payments are made to the investors and after payment of certain fees and expenses provides us with cash flows from our interest-only strips. We expect that future cash flows from our interest-only strips and servicing rights will generate more of the cash flows required to meet maturities of our subordinated debentures and our operating cash needs.

We may retain the rights to service the loans we sell through securitizations. If we retain the servicing rights, as the servicer of securitized loans, we are obligated to advance interest payments for delinquent loans if we deem that the advances will ultimately be recoverable. These advances can first be made out of funds available in a trust's collection account. If the funds available from the collection account are insufficient to make the required interest advances, then we are required to make the advance from our operating cash. The advances made from a trust's collection account, if not recovered from the borrower or proceeds from the liquidation of the loan, require reimbursement from us. These advances may require funding from our capital resources and may create greater demands on our cash flow than either selling loans with servicing released or maintaining a portfolio of loans on our balance sheet. However, any advances we make on a mortgage loan from our operating cash can be recovered from the subsequent mortgage loan payments to the applicable trust prior to any distributions to the certificate holders.

At June 30, 2004 and 2003, the mortgage securitization trusts held loans with an aggregate principal balance due of $1.9 billion and $3.4 billion as assets and owed $1.7 billion and $3.2 billion to third party investors, respectively. Revenues from the sale of loans to securitization trusts were $15.1 million, or 15.6% of total revenues for the fiscal year ended June 30, 2004 and $171.0 million, or 70.8% of total revenues for the fiscal year ended June 30, 2003. The revenues for fiscal 2004 and 2003 are net of $2.9 million and $5.1 million, respectively, of expenses for underwriting fees, legal fees and other expenses associated with securitization transactions during that period. We have interest-only strips and servicing rights with fair values of $459.1 million and $73.7 million, respectively at June 30, 2004, which combined represent 51% of our total assets. Net cash flows received from interest-only strips and servicing rights were $194.7 million for fiscal 2004 and $132.1 million for fiscal 2003. These amounts are included in our operating cash flows.

We also used special purpose entities in our sales of loans to a $300.0 million off-balance sheet mortgage conduit facility that was available to us until July 5, 2003. Sales into the off-balance sheet facility involved a two-step transfer that qualified for sale accounting under SFAS No. 140, similar to the process described above. This facility had a revolving feature and could be directed by the third party sponsor to dispose of the loans. Typically, the loans were disposed of by securitizing the loans in a term securitization. The third party note purchaser also has the right to have the loans sold in whole loan sale transactions. Under this off-balance sheet facility arrangement, the loans have been isolated from us and our subsidiaries and as a result, transfers to the facility were treated as sales for financial reporting purposes. When loans were sold to this facility, we assessed the likelihood that the sponsor would transfer the loans into a term securitization. As the sponsor had typically transferred the loans to a term securitization prior to the fourth quarter of fiscal 2003, the amount of gain on sale we had recognized for loans sold to this facility was estimated based on the terms we would obtain in a term securitization rather than the terms of this facility. For the fourth quarter of fiscal 2003, the likelihood that the facility sponsor would ultimately transfer the underlying loans to a term securitization was significantly reduced and the amount of gain recognized for loans sold to this facility was based on terms expected in a whole loan sale transaction. Our ability to sell loans into this facility expired pursuant to its terms on July 5, 2003. At June 30, 2003, the off-balance sheet mortgage conduit facility held loans with principal balances due of $275.6 million as assets and owed $267.5 million to third parties. Through September 30, 2003, $222.3 million of the loans which were in the facility at June 30, 2003 were sold in whole loan sales as directed by the facility sponsor. At September 30, 2003, the off-balance sheet mortgage conduit facility held loans with principal balances due of $40.5 million as assets and owed $36.0 million to third parties. This conduit facility was refinanced in the October 16, 2003 refinancing described under "-- Liquidity and Capital Resources -- Credit Facilities."

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SECURITIZATIONS

In our mortgage loan securitizations, pools of mortgage loans are sold to a trust. The trust then issues certificates or notes, which we refer to as certificates in this document, to third-party investors, representing the right to receive a pass-through interest rate and principal collected on the mortgage loans each month. These certificates, which are senior in right to our interest-only strips in the trusts, are sold in public or private offerings. The difference between the weighted-average interest rate that is charged to borrowers on the fixed interest rate pools of mortgage loans and the weighted-average pass-through interest rate paid to investors is referred to as the interest rate spread. The interest rate spread after payment of certain fees and expenses and subject to certain conditions is distributed from the trust to us and is the basis of the value of our interest-only strips. In addition, when we securitize our loans we may retain the right to service the loans for a fee, which is the basis for our servicing rights. Servicing includes processing of mortgage payments, processing of disbursements for tax and insurance payments, maintenance of mortgage loan records, performance of collection efforts, including disposition of delinquent loans, foreclosure activities and disposition of real estate owned, referred to as REO, and performance of investor accounting and reporting processes.

In a declining interest rate environment, such as experienced during fiscal 2003, securitization pass-through interest rates generally decline, which can lead to higher interest rate spreads. Increased interest rate spreads result in increases in the residual cash flow we expect to receive on securitized loans, the amount of cash we receive at the closing of a securitization from the sale of notional bonds or premiums on investor certificates and corresponding increases in the gains we recognize on the sale of loans in a securitization. In our fiscal 2003 securitizations, we experienced improved interest rate spreads. However, in a rising interest rate environment and under our business strategy we would expect our ability to originate loans at interest rates that will maintain our most recent level of securitization gain profitability to become more difficult than during a stable or falling interest rate environment. No assurances can be made that market interest rates will remain at current levels or that we can complete securitizations in the future. We would seek to address the challenge presented by a rising interest rate environment by carefully monitoring our product pricing, the actions of our competition, market trends and the use of hedging strategies in order to continue to originate loans in as profitable a manner as possible. See "-- Interest Rate Risk Management -- Strategies for Use of Derivative Financial Instruments" for a discussion of our hedging strategies.

While a declining interest rate environment can lead to higher interest rate spreads, a declining interest rate environment could also unfavorably impact the valuation of our interest-only strips. In a declining interest rate environment the level of mortgage refinancing activity tends to increase, which could result in an increase in loan prepayment experience and may require increases in assumptions for prepayments for future periods. This has been our experience since fiscal 2002.

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Declining interest rates and resulting high prepayment rates over the last eleven quarters have required revisions to our estimates of the value of our securitization assets. Beginning in the second quarter of fiscal 2002 and on a quarterly basis thereafter, our prepayment rates, as well as those throughout the mortgage industry, remained at higher than expected levels due to continuing low interest rates during this period. As a result, over the last eleven quarters we have recorded cumulative pre-tax write downs to our interest-only strips in the aggregate amount of $175.8 million and pre-tax adjustments to the value of servicing rights of $17.9 million, for total adjustments of $193.7 million, mainly due to the higher than expected prepayment experience. During the same period, we reduced the discount rates we apply to value our securitization assets, resulting in net favorable pre-tax valuation impacts of $20.9 million on interest-only strips and $7.1 million on servicing rights. The discount rates were reduced primarily to reflect the impact of the sustained decline in market interest rates. Additionally, on June 30, 2004, we wrote down the carrying value of our interest-only strips and servicing rights related to five of our mortgage securitization trusts by $5.4 million to reflect their values under the terms of a September 27, 2004 sale agreement. The sale of these assets was undertaken as part of our negotiations to obtain the new $100.0 million warehouse credit facility described in "-- Liquidity and Capital Resources" and to raise cash to pay fees on new warehouse credit facilities and as a result, we did not realize their full value as reflected on our books. The following table summarizes the net cumulative write downs recorded on our securitization assets over the last eleven quarters (in thousands):

                                               TOTAL             INCOME               OTHER
                                            WRITE DOWN          STATEMENT         COMPREHENSIVE
                                            (WRITE UP)           IMPACT           INCOME IMPACT
                                            ----------          ---------         -------------
PRE-TAX ADJUSTMENT RESULTING FROM:
Prepayments..............................   $  193,743          $  128,667         $   65,076
Discount rate............................      (28,038)            (18,427)            (9,611)
Loss on sale.............................        5,452               3,446              2,006
                                            ----------          ----------         ----------
Net cumulative write down................   $  171,157          $  113,686         $   57,471
                                            ==========          ==========         ==========

See "- Application of Critical Accounting Estimates - Interest-Only Strips" for a discussion of how valuation adjustments are recorded in the income statement or other comprehensive income.

During fiscal 2004, we recorded total pre-tax valuation adjustments on our interest-only strips and servicing rights of $63.8 million, of which $46.4 million was charged as expense to the income statement and $17.4 million was charged to other comprehensive income. These adjustments primarily reflect the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2004 due to the low interest rate environment experienced during fiscal 2004. The fiscal 2004 valuation adjustment also includes a write down of the carrying value of our interest-only strips and servicing rights related to five of our mortgage securitization trusts of $5.4 million to reflect their values under the terms of a September 27, 2004 sale agreement. This compares to total pre-tax valuation adjustments on our securitization assets of $63.3 million during the fiscal year ended June 30, 2003, of which $45.2 million was charged as expense to the income statement and $18.1 million was reflected as an adjustment to other comprehensive income. The breakout of the total adjustments in fiscal 2004 and 2003 between interest-only strips and servicing rights was as follows (in thousands):

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                                       YEAR ENDED JUNE 30, 2004                    YEAR ENDED JUNE 30, 2003
                               --------------------------------------      ----------------------------------------

                                            INCOME          OTHER                         INCOME          OTHER
                                 TOTAL     STATEMENT    COMPREHENSIVE        TOTAL       STATEMENT    COMPREHENSIVE
                               WRITE DOWN   IMPACT      INCOME IMPACT      WRITE DOWN     IMPACT      INCOME IMPACT
                               ----------  ---------    -------------      ----------    ---------    -------------
Interest-only strips.......... $  57,031   $  39,659      $   17,372       $  57,973     $  39,900      $   18,073
Servicing rights..............     6,791       6,791              --           5,282         5,282              --
                               -------------------------------------       ---------------------------------------
Total securitization assets... $  63,822   $  46,450      $   17,372       $  63,255     $  45,182      $   18,073
                               =====================================       =======================================

The valuation adjustment on interest-only strips for fiscal 2004 included the net impact of a December 31, 2003 reduction in the discount rate applied to value the residual cash flows from interest-only strips from 11% to 10%, and a subsequent increase in that discount rate at June 30, 2004 back to 11%. The discount rate was reduced to 10% on December 31, 2003 from 11% on September 30, 2003 and June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The increase back to 11% at June 30, 2004 was made to reflect an increase in market interest rates that had occurred since the end of the March 2004 quarter. The December 31, 2004 reduction in discount rate had a favorable impact of $8.4 million on that quarter's valuation adjustment. The June 30, 2004 increase in discount rate had an unfavorable impact of $8.4 million on that quarter's valuation adjustment.

The long duration of historically low interest rates, combined with increasing home values and high consumer debt levels has given borrowers an extended opportunity to engage in mortgage refinancing activities, which resulted in elevated prepayment experience. Low interest rates and increasing home values provide incentive to borrowers to convert high cost consumer debt into lower rate tax deductible loans. As home values have increased, lenders have been highly successful in educating borrowers that they have the ability to access the cash value in their homes.

The persistence of historically low interest rate levels, unprecedented in the last 40 years, has made the forecasting of prepayment levels difficult. We assumed for each quarter end valuation that the decline in interest rates had stopped and a rise in interest rates would occur in the near term. This assumption was supported by published data. Consistent with this view that interest rates would rise, we had utilized derivative financial instruments to manage interest rate risk exposure on our loan production and loan pipeline to protect the fair value of these fixed rate items against potential increases in market interest rates. We believe that once we are beyond the low interest rate environment and its impact on prepayments, the long recurring and highly unfavorable prepayment experience over the last eleven quarters will subside. Also, the rate of increase in home values has slowed considerably, which we expect will mean that fewer borrowers will have excess value in their homes to access. The Mortgage Bankers Association of America has forecast as of September 17, 2004 that mortgage refinancings as a percentage share of total mortgage originations will decline from 49% in the second quarter of calendar 2004 to 24% in the second quarter of calendar 2005. The Mortgage Bankers Association of America has also projected in its September 2004 economic forecast that the 10-year treasury rate (which generally affects mortgage rates) will increase steadily each quarter in their forecast. As a result of our analysis of these factors, we believe prepayments will continue to remain at higher t