##### Table of Contents



---

---

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

|    |  |                                                                                        
|--- |  | ---------------------------------------------------------------------------------------
|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2003

OR


|      |  |                                                                                         
|----- |  | ----------------------------------------------------------------------------------------
|[   ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period fromto

Commission File Number:  001-11914

THORNBURG MORTGAGE, INC.

(Exact name of Registrant as specified in its Charter)


|                                                                                    |  |                                                
|----------------------------------------------------------------------------------- |  | -----------------------------------------------
|Maryland
(State or other jurisdiction of
incorporation or organization)             |  | 85-0404134
(IRS Employer
Identification Number)
|                                                                                    |  |                                                
|150 Washington Avenue
Santa Fe, New Mexico
(Address of principal executive offices) |  | 87501
(Zip Code)                               

Registrants telephone number, including area code: (505) 989-1900

(Former name, former address and former fiscal year, if changed since last report)
Not applicable

Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

(1) Yes
 [X]          
No  [   ]
(2) Yes
 [X]          
No  [   ]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934).

Yes
 [X]          
No  [   ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date.

|                              |  |                                   
|----------------------------- |  | ----------------------------------
|Common Stock ($.01 par value) |  | 72,032,021 as of November 10, 2003



---

---





---

TABLE OF CONTENTS



|                                                   |                                                                                               |                                                 |  |  |  |  |  | 
|-------------------------------------------------- | --------------------------------------------------------------------------------------------- | ----------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION                     
|                                                   | Item 1. Financial Statements                                                                 
|                                                   |                                                                                               | CONSOLIDATED BALANCE SHEETS                    
|                                                   |                                                                                               | CONSOLIDATED INCOME STATEMENTS                 
|                                                   |                                                                                               | CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
|                                                   |                                                                                               | CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY 
|                                                   |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS          
|                                                   |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS     
|                                                   | Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                   | Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            
|                                                   | Item 4. CONTROLS AND PROCEDURES                                                              
|PART II. OTHER INFORMATION                        
|                                                   | Item 1. Legal Proceedings                                                                    
|                                                   | Item 2. Changes in Securities and Use of Proceeds                                            
|                                                   | Item 3. Defaults Upon Senior Securities                                                      
|                                                   | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                                                   | Item 5. Other Information                                                                    
|                                                   | Item 6. Exhibits and Reports on Form 8-K:                                                    
|SIGNATURES                                        
|Exhibit Index                                     
|EX-10.13 Sale and Servicing Agreement             
|EX-31.1 Certification Pursuant to Rule 13a-14(a)  
|EX-31.2 Certification Pursuant to Rule 13a-14(a)  
|EX-31.3 Certification Pursuant to Rule 13a-14(a)  
|EX-32.1 Certification Pursuant to 18 USC Sec. 1350
|EX-32.2 Certification Pursuant to 18 USC Sec. 1350
|EX-32.3 Certification Pursuant to 18 USC Sec. 1350



---



##### Table of Contents



INDEX

|         |  |                       |  |               |  |                                                                                       |    |  |    |  |  |                                                                                                                               |  |      |   | 
|-------- |  | --------------------- |  | ------------- |  | ------------------------------------------------------------------------------------- | -- |  | -- |  |  | ----------------------------------------------------------------------------------------------------------------------------- |  | ---- | - | 
|         |  |                       |  |               |  |                                                                                       |    |  |    |  |  |                                                                                                                               |  | Page
|         |  |                       |  |               |  |                                                                                       |    |  |    |  |  |                                                                                                                               |  |     
|PART I.  |  | FINANCIAL INFORMATION |  |               |  |                                                                                      
|         |  |                       |  | Item 1.       |  | Financial Statements                                                                  |    |  |    | 
|         |  |                       |  |               |  |                                                                                       |    |  |    |  |  | Consolidated Balance Sheets at September 30, 2003 and December 31, 2002                                                       |  |      | 3 | 
|         |  |                       |  |               |  |                                                                                       |    |  |    |  |  | Consolidated Income Statements for the three and nine months ended
September 30, 2003 and September 30, 2002                  |  |      | 4 | 
|         |  |                       |  |               |  |                                                                                       |    |  |    |  |  | Consolidated Statements of Comprehensive Income for the three and nine months
ended September 30, 2003 and September 30, 2002 |  |      | 5 | 
|         |  |                       |  |               |  |                                                                                       |    |  |    |  |  | Consolidated Statement of Shareholders Equity for the nine months
ended September 30, 2003 and September 30, 2002            |  |      | 6 | 
|         |  |                       |  |               |  |                                                                                       |    |  |    |  |  | Consolidated Statements of Cash Flows for the three and nine months ended
September 30, 2003 and September 30, 2002           |  |      | 7 | 
|         |  |                       |  |               |  |                                                                                       |    |  |    |  |  | Notes to Consolidated Financial Statements                                                                                    |  |      | 8 | 
|         |  |                       |  | Item 2.       |  | Managements Discussion and Analysis of
Financial Condition and Results of Operations |    |  | 23 | 
|         |  |                       |  | Item 3.       |  | Quantitative and Qualitative Disclosures About Market Risk                            |    |  | 49 | 
|         |  |                       |  | Item 4.       |  | Controls and Procedures                                                               |    |  | 49 | 
|PART II. |  | OTHER INFORMATION     |  |               |  |                                                                                      
|         |  |                       |  | Item 1.       |  | Legal Proceedings                                                                     |    |  | 50 | 
|         |  |                       |  | Item 2.       |  | Changes in Securities and Use of Proceeds                                             |    |  | 50 | 
|         |  |                       |  | Item 3.       |  | Defaults Upon Senior Securities                                                       |    |  | 50 | 
|         |  |                       |  | Item 4.       |  | Submission of Matters to a Vote of Security Holders                                   |    |  | 50 | 
|         |  |                       |  | Item 5.       |  | Other Information                                                                     |    |  | 50 | 
|         |  |                       |  | Item 6.       |  | Exhibits and Reports on Form 8-K                                                      |    |  | 50 | 
|         |  |                       |  | SIGNATURES    |  |                                                                                       | 51 | 
|         |  |                       |  | EXHIBIT INDEX |  |                                                                                       | 52 | 

2



---



##### Table of Contents












PART I. FINANCIAL INFORMATION
Item 1.   Financial Statements
THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Unaudited)
(Amounts in thousands)

|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |           |            | 
|-------------------- | -------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------- | ---------- | ---------- | ------------------ | ---------- | ----------------- | --------- | --------- | ---------- | 
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            | September 30, 2003 |            | December 31, 2002
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                  
|ASSETS               |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                  
|                     | Adjustable-rate mortgage (ARM) assets:                                                                                         |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |          
|                     |                                                                                                                                  | ARM securities, net                                                                                                                                             |                                                 | $          | 10,177,743 |                    |            | $                 | 6,640,312 |          
|                     |                                                                                                                                  | ARM loans:                                                                                                                                                      |                                                 |            |            |                    |            |                   |           |          
|                     |                                                                                                                                  |                                                                                                                                                                 | Securitized ARM loans, net                      |            |            | 2,913,391          |            |                   |           | 2,695,331 |           
|                     |                                                                                                                                  |                                                                                                                                                                 | ARM loans collateralizing debt obligations, net |            |            | 2,179,779          |            |                   |           | 289,783   |           
|                     |                                                                                                                                  |                                                                                                                                                                 | ARM loans held for securitization, net          |            |            | 1,228,695          |            |                   |           | 709,787   |           
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |          
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 | ARM loans  |            |                    | 6,321,865  |                   |           |           | 3,694,901  | 
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |          
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 | ARM assets |            |                    | 16,499,608 |                   |           |           | 10,335,213 | 
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |           |            | 
|                     | Cash and cash equivalents                                                                                                        |                                                                                                                                                                 |                                                 | 178,944    |            |                    |            | 47,817            |          
|                     | Restricted cash                                                                                                                  |                                                                                                                                                                 |                                                 | 508,460    |            |                    |            | 74,403            |          
|                     | Hedging instruments                                                                                                              |                                                                                                                                                                 |                                                 | 26,244     |            |                    |            |                  |          
|                     | Accrued interest receivable                                                                                                      |                                                                                                                                                                 |                                                 | 64,159     |            |                    |            | 47,435            |          
|                     | Prepaid expenses and other                                                                                                       |                                                                                                                                                                 |                                                 | 10,030     |            |                    |            | 8,064             |          
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |          
|                     |                                                                                                                                  | $                                                                                                                                                               | 17,287,445                                      |            |            | $                  | 10,512,932 |                  
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |          
|LIABILITIES          |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                  
|                     | Reverse repurchase agreements                                                                                                    |                                                                                                                                                                 | $                                               | 12,579,032 |            |                    | $          | 8,425,729         |          
|                     | Collateralized debt obligations (CDOs)                                                                                         |                                                                                                                                                                 |                                                 | 2,152,809  |            |                    |            | 255,415           |          
|                     | Whole loan financing facilities                                                                                                  |                                                                                                                                                                 |                                                 | 1,021,214  |            |                    |            | 589,081           |          
|                     | Hedging instruments                                                                                                              |                                                                                                                                                                 |                                                 | 155,479    |            |                    |            | 142,531           |          
|                     | Senior notes                                                                                                                     |                                                                                                                                                                 |                                                 | 194,520    |            |                    |            |                  |          
|                     | Payable for assets purchased                                                                                                     |                                                                                                                                                                 |                                                 |           |            |                    |            | 202,844           |          
|                     | Accrued interest payable                                                                                                         |                                                                                                                                                                 |                                                 | 27,402     |            |                    |            | 17,234            |          
|                     | Dividends payable                                                                                                                |                                                                                                                                                                 |                                                 |           |            |                    |            | 32,536            |          
|                     | Accrued expenses and other                                                                                                       |                                                                                                                                                                 |                                                 | 36,714     |            |                    |            | 14,520            |          
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |          
|                     |                                                                                                                                  |                                                                                                                                                                 | 16,167,170                                      |            |            |                    | 9,679,890  |                  
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |          
|COMMITMENTS          |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                  
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |           |            | 
|SHAREHOLDERS EQUITY |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                  
|                     | Preferred stock: par value $.01 per share;                                                                                       |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |          
|                     |                                                                                                                                  | Series A 9.68% Cumulative Convertible shares,
aggregate preference in liquidation $69,000,
0 and 2,760 shares authorized, issued and
outstanding, respectively; |                                                 |            |           |                    |            |                   | 65,805    |          
|                     |                                                                                                                                  | Series B Cumulative, 22 shares authorized,
none issued and outstanding                                                                                          |                                                 |            |           |                    |            |                   |          |          
|                     | Common stock: par value $.01 per share;
497,218 shares authorized, 70,397 and 52,763 shares
issued and outstanding, respectively |                                                                                                                                                                 |                                                 | 704        |            |                    |            | 528               |          
|                     | Additional paid-in-capital                                                                                                       |                                                                                                                                                                 |                                                 | 1,282,481  |            |                    |            | 878,929           |          
|                     | Accumulated other comprehensive loss                                                                                             |                                                                                                                                                                 |                                                 | (204,448   | )          |                    |            | (105,254          | )        
|                     | Notes receivable from stock sales                                                                                                |                                                                                                                                                                 |                                                 | (5,910     | )          |                    |            | (7,437            | )        
|                     | Retained earnings                                                                                                                |                                                                                                                                                                 |                                                 | 47,448     |            |                    |            | 471               |          
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |          
|                     |                                                                                                                                  |                                                                                                                                                                 | 1,120,275                                       |            |            |                    | 833,042    |                  
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |          
|                     |                                                                                                                                  | $                                                                                                                                                               | 17,287,445                                      |            |            | $                  | 10,512,932 |                  
|                     |                                                                                                                                  |                                                                                                                                                                 |                                                 |            |            |                    |            |                   |           |          

See Notes to Consolidated Financial Statements.

3



---



##### Table of Contents






THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED INCOME STATEMENTS (Unaudited)
(In thousands, except per share data)

|                                                     |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |         | 
|---------------------------------------------------- | ------------------------------------ | - | ------------------ | ------ | ----------------- | - | ------- | ------ | ---- | - | -------- | ------- |  | - | -------- | ------- | 
|                                                     |                                      |   | Three Months Ended |        | Nine Months Ended
|                                                     |                                      |   | September 30,      |        | September 30,    
|                                                     |                                      |   | 2003               |        | 2002              |   | 2003    |        | 2002
|                                                     |                                      |   |                    |        |                   |   |         |        |     
|Interest income from ARM assets and cash equivalents |                                      | $ | 151,166            |        |                   | $ | 109,662 |        |      | $ | 411,259  |         |  | $ | 285,527  |        
|Interest expense on borrowed funds                   |                                      |   | (91,261            | )      |                   |   | (67,149 | )      |      |   | (244,589 | )       |  |   | (174,433 | )      
|                                                     |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        
|                                                     | Net interest income                  |   |                    | 59,905 |                   |   |         | 42,513 |      |   |          | 166,670 |  |   |          | 111,094 | 
|                                                     |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        
|Gain on ARM assets, net                              |                                      |   | 1,820              |        |                   |   | 18      |        |      |   | 5,400    |         |  |   | 105      |        
|Fee income                                           |                                      |   | 424                |        |                   |   | 335     |        |      |   | 1,365    |         |  |   | 377      |        
|Provision for credit losses                          |                                      |   | (970               | )      |                   |   |        |        |      |   | (1,976   | )       |  |   |         |        
|Hedging expense                                      |                                      |   | (145               | )      |                   |   | (173    | )      |      |   | (542     | )       |  |   | (1,109   | )      
|Management fee                                       |                                      |   | (3,068             | )      |                   |   | (2,076  | )      |      |   | (8,239   | )       |  |   | (5,623   | )      
|Performance fee                                      |                                      |   | (7,136             | )      |                   |   | (5,044  | )      |      |   | (20,247  | )       |  |   | (11,958  | )      
|Long-term incentive awards                           |                                      |   | (2,299             | )      |                   |   | (718    | )      |      |   | (7,043   | )       |  |   | (2,198   | )      
|Other operating expenses                             |                                      |   | (2,763             | )      |                   |   | (2,245  | )      |      |   | (8,354   | )       |  |   | (5,848   | )      
|                                                     |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        
|                                                     | NET INCOME                           |   | $                  | 45,768 |                   |   | $       | 32,610 |      |   | $        | 127,034 |  |   | $        | 84,840  | 
|                                                     |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        
|Net income                                           |                                      | $ | 45,768             |        |                   | $ | 32,610  |        |      | $ | 127,034  |         |  | $ | 84,840   |        
|Dividends on preferred stock                         |                                      |   |                   |        |                   |   | (1,670  | )      |      |   | (3,340   | )       |  |   | (5,009   | )      
|                                                     |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        
|Net income available to common shareholders          |                                      | $ | 45,768             |        |                   | $ | 30,940  |        |      | $ | 123,694  |         |  | $ | 79,831   |        
|                                                     |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        
|Basic earnings per share:                            |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        
|                                                     | Net income                           |   | $                  | 0.69   |                   |   | $       | 0.68   |      |   | $        | 2.04    |  |   | $        | 1.93    | 
|                                                     | Average number of shares outstanding |   |                    | 66,092 |                   |   |         | 45,733 |      |   |          | 60,572  |  |   |          | 41,401  | 
|                                                     |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        
|Diluted earnings per share:                          |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        
|                                                     | Net income                           |   | $                  | 0.68   |                   |   | $       | 0.67   |      |   | $        | 2.02    |  |   | $        | 1.92    | 
|                                                     | Average number of shares outstanding |   |                    | 67,532 |                   |   |         | 48,493 |      |   |          | 62,887  |  |   |          | 44,161  | 
|                                                     |                                      |   |                    |        |                   |   |         |        |      |   |          |         |  |   |          |        

See Notes to Consolidated Financial Statements.

4



---



##### Table of Contents






THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In thousands)

|                            |                                                         |   |                    |         |                   |   |        |         |      |   |         |         |   |   |        |         |  
|--------------------------- | ------------------------------------------------------- | - | ------------------ | ------- | ----------------- | - | ------ | ------- | ---- | - | ------- | ------- | - | - | ------ | ------- | -
|                            |                                                         |   | Three Months Ended |         | Nine Months Ended
|                            |                                                         |   | September 30,      |         | September 30,    
|                            |                                                         |   | 2003               |         | 2002              |   | 2003   |         | 2002
|                            |                                                         |   |                    |         |                   |   |        |         |     
|Net income                  |                                                         | $ | 45,768             |         |                   | $ | 32,610 |         |      | $ | 127,034 |         |   | $ | 84,840 |        
|Other comprehensive income: |                                                         |   |                    |         |                   |   |        |         |      |   |         |         |   |   |        |        
|                            | Unrealized gains (losses) on securities                 |   |                    | (85,938 | )                 |   |        | 54,599  |      |   |         | (72,897 | ) |   |        | 71,320  |  
|                            | Unrealized gains (losses) on Hybrid Hedging
Instruments |   |                    | 28,606  |                   |   |        | (71,154 | )    |   |         | (26,297 | ) |   |        | (95,672 | )
|                            |                                                         |   |                    |         |                   |   |        |         |      |   |         |         |   |   |        |        
|Other comprehensive income  |                                                         | $ | (11,564            | )       |                   | $ | 16,055 |         |      | $ | 27,840  |         |   | $ | 60,488 |        
|                            |                                                         |   |                    |         |                   |   |        |         |      |   |         |         |   |   |        |        

See Notes to Consolidated Financial Statements.

5



---



##### Table of Contents






THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY (Unaudited)
Nine months ended September 30, 2003 and 2002
(In thousands, except share data)

|                                                                     |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |         |  |         |  
|-------------------------------------------------------------------- | --------------------------- | --------------------------- | ------------------------------------------ | - | --------- | - | ------ |  | ---------------- | - | ------------- |  | ---------- | - | --------- | - | ------------ | ------- | ---------- | - | -------- | - | ------- | ------- |  | - | --------- | ------- |  | ------- | -
|                                                                     |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   | Accum. Other |         | Notes      |   |          |   |         |         |  |   |          
|                                                                     |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   | Compre-      |         | Receivable |   | Retained |   |         |         | 
|                                                                     |                             |                             |                                            |   | Preferred |   | Common |  | Additional Paid- |   | hensive       |  | From Stock |   | Earnings/ |   |              |         |           
|                                                                     |                             |                             |                                            |   | Stock     |   | Stock  |  | in Capital       |   | Income (Loss) |  | Sales      |   | (Deficit) |   | Total       
|                                                                     |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |             
|Balance, December 31, 2001                                           |                             | $                           | 65,805                                     |   |           | $ | 333    |  |                  | $ | 515,516       |  |            | $ | (36,566   | ) |              | $       | (7,904     | ) |          | $ | (4,526  | )       |  | $ | 532,658   |        
|Comprehensive income:                                                |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |        
|                                                                     | Net income                  |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         | 84,840  |  |   |           | 84,840  | 
|                                                                     | Other comprehensive income: |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |         | 
|                                                                     |                             | Available-for-sale assets:  |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |         |  |        
|                                                                     |                             |                             | Fair value adjustment                      |   |           |   |        |  |                  |   |               |  |            |   |           |   |              | 71,320  |            |   |          |   |         |         |  |   |           |         |  | 71,320  |  
|                                                                     |                             | Hybrid Hedging Instruments: |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |         |  |        
|                                                                     |                             |                             | Fair value adjustment, net of
amortization |   |           |   |        |  |                  |   |               |  |            |   |           |   |              | (95,672 | )          |   |          |   |         |         |  |   |           |         |  | (95,672 | )
|Issuance of common stock                                             |                             |                             |                                            |   |           |   | 140    |  |                  |   | 264,325       |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   | 264,465   |        
|Interest and principal payments on
notes receivable from stock sales |                             |                             |                                            |   |           |   |        |  |                  |   | 230           |  |            |   |           |   |              |         | 259        |   |          |   |         |         |  |   | 489       |        
|Dividends declared on preferred
stock  $1.815 per share             |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   | (5,009  | )       |  |   | (5,009    | )      
|Dividends declared on common
stock  $1.12 per share                 |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   | (48,772 | )       |  |   | (48,772   | )      
|                                                                     |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |        
|Balance, September 30, 2002                                          |                             | $                           | 65,805                                     |   |           | $ | 473    |  |                  | $ | 780,071       |  |            | $ | (60,918   | ) |              | $       | (7,645     | ) |          | $ | 26,533  |         |  | $ | 804,319   |        
|                                                                     |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |        
|Balance, December 31, 2002                                           |                             | $                           | 65,805                                     |   |           | $ | 528    |  |                  | $ | 878,929       |  |            | $ | (105,254  | ) |              | $       | (7,437     | ) |          | $ | 471     |         |  | $ | 833,042   |        
|Comprehensive income:                                                |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |        
|                                                                     | Net income                  |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         | 127,034 |  |   |           | 127,034 | 
|                                                                     | Other comprehensive income: |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |         | 
|                                                                     |                             | Available-for-sale assets:  |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |         |  |        
|                                                                     |                             |                             | Fair value adjustment                      |   |           |   |        |  |                  |   |               |  |            |   |           |   |              | (72,897 | )          |   |          |   |         |         |  |   |           |         |  | (72,897 | )
|                                                                     |                             | Hybrid Hedging Instruments: |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |         |  |        
|                                                                     |                             |                             | Fair value adjustment, net of
amortization |   |           |   |        |  |                  |   |               |  |            |   |           |   |              | (26,297 | )          |   |          |   |         |         |  |   |           |         |  | (26,297 | )
|Issuance of common stock                                             |                             |                             |                                            |   |           |   | 148    |  |                  |   | 337,570       |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   | 337,718   |        
|Conversion of preferred stock to
common stock                        |                             |                             | (65,805                                    | ) |           |   | 28     |  |                  |   | 65,777        |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |          |        
|Interest and principal payments on
notes receivable from stock sales |                             |                             |                                            |   |           |   |        |  |                  |   | 205           |  |            |   |           |   |              |         | 1,527      |   |          |   |         |         |  |   | 1,732     |        
|Dividends declared on preferred
stock  $1.21 per share              |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   | (3,340  | )       |  |   | (3,340    | )      
|Dividends declared on common
stock  $1.22 per share                 |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   | (76,717 | )       |  |   | (76,717   | )      
|                                                                     |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |        
|Balance, September 30, 2003                                          |                             | $                           |                                           |   |           | $ | 704    |  |                  | $ | 1,282,481     |  |            | $ | (204,448  | ) |              | $       | (5,910     | ) |          | $ | 47,448  |         |  | $ | 1,120,275 |        
|                                                                     |                             |                             |                                            |   |           |   |        |  |                  |   |               |  |            |   |           |   |              |         |            |   |          |   |         |         |  |   |           |        

See Notes to Consolidated Financial Statements.

6



---



##### Table of Contents






THORNBURG MORTGAGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)

|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |            |         |            |  
|---------------------------------------------------- | --------------------------------------------------------------------------------- | --------------------------------- | --------------------------- | ----------------------------------------- | ---------- | ------------------ | ---------- | ----------------- | ---------- | ------ | -------- | --------- | ---------- | ------- | ---------- | --------- | ---------- | ------- | ---------- | -
|                                                     |                                                                                   |                                   |                             |                                           |            | Three Months Ended |            | Nine Months Ended
|                                                     |                                                                                   |                                   |                             |                                           |            | September 30,      |            | September 30,    
|                                                     |                                                                                   |                                   |                             |                                           |            | 2003               |            | 2002              |            | 2003   |          | 2002     
|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |          
|Operating Activities:                                |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |          
|                                                     | Net Income                                                                        |                                   | $                           | 45,768                                    |            |                    | $          | 32,610            |            |        | $        | 127,034   |            |         | $          | 84,840    |           
|                                                     | Adjustments to reconcile net income to net cash provided
by operating activities: |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|                                                     |                                                                                   | Amortization                      |                             |                                           | 12,772     |                    |            |                   | 4,316      |        |          |           | 31,343     |         |            |           | 12,443     |        
|                                                     |                                                                                   | Gain on ARM assets, net           |                             |                                           | (1,820     | )                  |            |                   | (18        | )      |          |           | (5,400     | )       |            |           | (105       | )      
|                                                     |                                                                                   | Provision for credit losses       |                             |                                           | 970        |                    |            |                   |           |        |          |           | 1,976      |         |            |           |           |        
|                                                     |                                                                                   | Hedging expense                   |                             |                                           | 145        |                    |            |                   | 173        |        |          |           | 542        |         |            |           | 1,109      |        
|                                                     |                                                                                   | Change in assets and liabilities: |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |            |        
|                                                     |                                                                                   |                                   | Accrued interest receivable |                                           |            | (3,938             | )          |                   |            | (3,720 | )        |           |            | (16,724 | )          |           |            | (15,242 | )         
|                                                     |                                                                                   |                                   | Prepaid expenses and other  |                                           |            | (2,393             | )          |                   |            | 689    |          |           |            | (2,050  | )          |           |            | 1,547   |           
|                                                     |                                                                                   |                                   | Accrued interest payable    |                                           |            | 4,581              |            |                   |            | 2,733  |          |           |            | 10,168  |            |           |            | 8,088   |           
|                                                     |                                                                                   |                                   | Accrued expenses and other  |                                           |            | 848                |            |                   |            | 4,761  |          |           |            | 22,194  |            |           |            | 9,364   |           
|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|                                                     |                                                                                   |                                   |                             | Net cash provided by operating activities |            |                    | 56,933     |                   |            |        | 41,544   |           |            |         | 169,083    |           |            |         | 102,044    |  
|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|Investing Activities:                                |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |          
|                                                     | ARM securities:                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|                                                     |                                                                                   | Purchases                         |                             |                                           | (2,639,527 | )                  |            |                   | (1,225,443 | )      |          |           | (7,602,663 | )       |            |           | (4,901,068 | )      
|                                                     |                                                                                   | Proceeds on sales                 |                             |                                           |           |                    |            |                   | 10,164     |        |          |           |           |         |            |           | 72,981     |        
|                                                     |                                                                                   | Principal payments                |                             |                                           | 1,808,092  |                    |            |                   | 917,670    |        |          |           | 3,780,319  |         |            |           | 1,985,478  |        
|                                                     | Securitized ARM loans:                                                            |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|                                                     |                                                                                   | Issuance costs                    |                             |                                           |           |                    |            |                   | (989       | )      |          |           | (2,108     | )       |            |           | (3,023     | )      
|                                                     |                                                                                   | Principal payments                |                             |                                           | 392,664    |                    |            |                   | 120,604    |        |          |           | 1,026,483  |         |            |           | 613,955    |        
|                                                     | ARM loans collateralizing long-term debt:                                         |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|                                                     |                                                                                   | Principal payments                |                             |                                           | 165,175    |                    |            |                   | 30,812     |        |          |           | 256,557    |         |            |           | 147,203    |        
|                                                     | ARM loans held for securitization:                                                |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|                                                     |                                                                                   | Purchases                         |                             |                                           | (1,607,494 | )                  |            |                   | (686,387   | )      |          |           | (3,958,210 | )       |            |           | (1,904,258 | )      
|                                                     |                                                                                   | Proceeds on sales                 |                             |                                           |           |                    |            |                   | 350        |        |          |           |           |         |            |           | 4,061      |        
|                                                     |                                                                                   | Principal payments                |                             |                                           | 20,920     |                    |            |                   | 5,632      |        |          |           | 37,006     |         |            |           | 13,960     |        
|                                                     | Purchase of interest rate cap agreements                                          |                                   |                             |                                          |            |                    |            |                  |            |        |          |          |            |         |            | (505      | )         
|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|                                                     |                                                                                   |                                   |                             | Net cash used in investing activities     |            |                    | (1,860,170 | )                 |            |        | (827,587 | )         |            |         | (6,462,616 | )         |            |         | (3,971,216 | )
|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|Financing Activities:                                |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |          
|                                                     | Net borrowings from reverse repurchase agreements                                 |                                   |                             | 493,752                                   |            |                    |            | 691,685           |            |        |          | 4,153,303 |            |         |            | 3,484,733 |           
|                                                     | Net borrowings (repayments) of collateralized notes                               |                                   |                             | 1,185,324                                 |            |                    |            | (30,540           | )          |        |          | 1,897,394 |            |         |            | (146,273  | )         
|                                                     | Net whole loan financing facilities borrowings                                    |                                   |                             | 406,711                                   |            |                    |            | 112,931           |            |        |          | 432,133   |            |         |            | 353,475   |           
|                                                     | Net senior unsecured debt proceeds                                                |                                   |                             |                                          |            |                    |            |                  |            |        |          | 194,340   |            |         |            |          |           
|                                                     | Payments made on Eurodollar contracts                                             |                                   |                             | (3,620                                    | )          |                    |            | (2,473            | )          |        |          | (16,175   | )          |         |            | (4,661    | )         
|                                                     | Proceeds from common stock issued, net                                            |                                   |                             | 159,064                                   |            |                    |            | 56,881            |            |        |          | 337,718   |            |         |            | 264,465   |           
|                                                     | Dividends paid                                                                    |                                   |                             | (42,644                                   | )          |                    |            | (27,603           | )          |        |          | (112,591  | )          |         |            | (72,099   | )         
|                                                     | Payments on notes receivable from stock sales                                     |                                   |                             | 1,171                                     |            |                    |            | 336               |            |        |          | 1,732     |            |         |            | 422       |           
|                                                     | Purchase of interest rate cap agreements                                          |                                   |                             | (20,197                                   | )          |                    |            |                  |            |        |          | (29,137   | )          |         |            |          |           
|                                                     | Net increase in restricted cash                                                   |                                   |                             | (221,626                                  | )          |                    |            | (33,851           | )          |        |          | (434,057  | )          |         |            | (34,314   | )         
|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|                                                     |                                                                                   |                                   |                             | Net cash provided by financing activities |            |                    | 1,957,935  |                   |            |        | 767,366  |           |            |         | 6,424,660  |           |            |         | 3,845,748  |  
|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|Net increase (decrease) in cash and cash equivalents |                                                                                   |                                   | 154,698                     |                                           |            |                    | (18,677    | )                 |            |        | 131,127  |           |            |         | (23,424    | )        
|Cash and cash equivalents at beginning of period     |                                                                                   |                                   | 24,246                      |                                           |            |                    | 21,707     |                   |            |        | 47,817   |           |            |         | 26,454     |          
|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           
|Cash and cash equivalents at end of period           |                                                                                   | $                                 | 178,944                     |                                           |            | $                  | 3,030      |                   |            | $      | 178,944  |           |            | $       | 3,030      |          
|                                                     |                                                                                   |                                   |                             |                                           |            |                    |            |                   |            |        |          |           |            |         |            |           |           

Supplemental disclosure of cash flow information and non-cash activities is
included in Notes 2, 4 and 6.

See Notes to Consolidated Financial Statements

7



---



##### Table of Contents






NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Significant Accounting Policies



| |  | The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information.                                                                                                                                                                                                                                                                                                                         
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | In the opinion of management, all material adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation have been
included. The operating results for the quarter and nine months ended
September 30, 2003 are not necessarily indicative of the results that may be
expected for the calendar year ending December 31, 2003. The interim financial
information should be read in conjunction with Thornburg Mortgage, Inc.s 2002
Annual Report on Form 10-K.
|
| |  | Basis of presentation and principles of consolidation                                                                                                                                                                                                                                                                                                                                                                                                                                                  



| |  |  | The consolidated financial statements include the accounts of Thornburg
Mortgage, Inc. (together with its subsidiaries referred to as the Company)
and its wholly owned bankruptcy-remote special purpose finance subsidiaries,
Thornburg Mortgage Funding Corporation and Thornburg Mortgage Acceptance
Corporation, its wholly owned mortgage banking subsidiary, Thornburg Mortgage
Home Loans, Inc. (TMHL), and TMHLs two wholly owned special purpose
finance subsidiaries, Thornburg Mortgage Funding Corporation II and Thornburg
Mortgage Acceptance Corporation II. All of the Companys subsidiaries are
wholly owned qualified real estate investment trust (REIT) subsidiaries and
are consolidated with the Company for financial statement and tax reporting
purposes. All material intercompany accounts and transactions are eliminated
in consolidation. Certain prior period amounts have been reclassified to
conform to current period classifications.
| |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Recently adopted accounting pronouncements
| |  | ------------------------------------------



| |  |  | In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS
149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, which provides clarification on the definition of derivative
instruments within the scope of SFAS 133. Generally, this Statement is
effective for contracts entered into or modified after June 30, 2003, and for
hedging relationships designated after June 30, 2003. Prior to SFAS 149, the
Companys net unrealized gain on loans expected to be purchased from
correspondent lenders and bulk sellers did not meet the definition of
derivatives under SFAS 133. In accordance with SFAS 149, effective July 1,
2003, the Companys net unrealized gain on loans expected to be purchased
from correspondent lenders and bulk sellers is recorded at fair value on the
Consolidated Balance Sheet with changes in fair value recorded in Gain on ARM
assets on the Consolidated Income Statement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity (SFAS 150).
This statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as
equity. This statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. On November 7, 2003,
the FASB deferred for an indefinite period certain provisions of SFAS 150
relating to the classification and measurement of mandatorily redeemable
non-controlling interests. The Company believes it does not have any such
interests. The implementation of the remaining effective provisions of SFAS
150 did not impact the Companys financial condition, results of operation or
liquidity.                                                                                                                                                                                                                                                                                                                        
|
| |  |  | FASB Interpretation (FIN) No. 46, Consolidation of Variable Interest
Entities was issued in January 2003 and FASB Staff Position (FSP) No. FIN
46-6 Effective Date of FASB Interpretation No. 46, Consolidation of Variable
Interest Entities was issued in October 2003. This interpretation of
Accounting Research Bulletin No. 51, Consolidated Financial Statements
provides guidance on how to identify a variable interest entity and determine
when the assets, liabilities, non-controlling interests and results of
operations of a variable interest entity should be consolidated by the
primary beneficiary. The primary beneficiary is the enterprise that will
absorb a majority of the variable interest entitys expected losses or
receive a majority of the expected residual returns as a result of holding
variable interests. The recognition and measurement provisions of this FIN
apply immediately to variable interest entities created after January 31,
2003, and apply to the first interim or annual period ending after December
15, 2003 for entities acquired before February 1, 2003 (as deferred by FSP
No. FIN 46-6). This FIN requires the consolidation of results of variable
interest entities in which the Company has a majority variable interest. As
of September 30, 2003, the Company did not own an interest in a variable
interest entity that met the consolidation requirements and believes adoption
of FIN No. 46 will not

8



---



##### Table of Contents





| |  |  | have a material effect on the financial condition,
results of operations, or liquidity of the Company. Interests in entities
acquired or created after September 30, 2003 will be evaluated based on FIN
No. 46 criteria and consolidated, if required.
| |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Cash and cash equivalents
| |  | -------------------------



| |  |  | Cash and cash equivalents includes cash on hand and highly liquid investments
with original maturities of three months or less. The carrying amount of
cash equivalents approximates their fair value.
| |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Restricted cash
| |  | ---------------



| |  |  | Restricted cash is primarily cash collateral held by counter-parties in
connection with reverse repurchase agreements and hedging instruments. The
carrying amount of restricted cash approximates its fair value.
| |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Adjustable-rate mortgage (ARM) assets
| |  | ---------------------------------------



| |  |  | The Companys ARM assets are comprised of ARM securities and securitized ARM
loans, ARM loans collateralizing long-term debt and ARM loans held for
securitization, (collectively referred to as ARM Loans). All of the
Companys ARM assets are either traditional ARM securities and loans, which
have interest rates that reprice in a year or less (Traditional ARMs), or
hybrid ARM securities and loans that have a fixed interest rate for an
initial period of three to ten years and then convert to Traditional ARMs for
their remaining terms to maturity (Hybrid ARMs).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | ARM securities are composed mainly of ARM securities purchased from third
parties; also included in this balance are ARM securities relating to loans
securitized by the Company prior to April 1, 2001. The Company has
designated all of its ARM securities as available-for-sale. Therefore, they
are reported at fair value, with unrealized gains and losses reported in
Accumulated other comprehensive loss as a separate component of shareholders
equity. Realized gains or losses on the sale of ARM securities are recorded
in earnings at the time of sale and are determined by the difference between
net sale proceeds and the cost of the security. Any unrealized loss deemed
to be other than temporary is recorded as realized loss.                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  |  | ARM Loans are designated as held-for-investment as the Company has the intent
and ability to hold them for the foreseeable future, and until maturity or
payoff. ARM Loans are carried at their unpaid principal balances, net of
unamortized premium or discount and allowance for loan losses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  |  | Securitized ARM loans are loans originated or acquired by the Company and
securitized after March 31, 2001 with the Company retaining 100% of the
beneficial ownership interests.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  |  | ARM loans collateralizing long-term debt are also loans the Company has
securitized that provide credit support for AAA certificates issued to third
party investors in structured financing arrangements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  |  | ARM loans held for securitization are loans the Company has acquired or
originated and are intended to be securitized and retained by the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  |  | The Company does not sell any of the securities created from its
securitizations to generate gain on sale income. The loan securitization
process benefits the Company by either creating highly liquid securitized
assets that can be readily financed in the reverse repurchase agreement
market or enabling the Company to enter into floating-rate long-term
collateralized debt obligations (CDOs) which represent permanent financing
that is not subject to margin calls.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  |  | Prior to June 30, 2003, the Companys securitized ARM loans created after
April 1, 2001 were accounted for under a securities accounting methodology
in which these assets were carried at their fair market value and the
unrealized gains and losses were recorded in Accumulated other comprehensive
loss, a component of shareholders equity. Management determined that
pursuant to SFAS 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, these securitized ARM loans
should be accounted for as loans rather than as securities. Effective June
30, 2003, management changed its accounting for such securities to be in
compliance with SFAS 140. The securitized ARM loans are now carried at
amortized cost and their fair value change is not reflected in Accumulated
other comprehensive loss, but is disclosed in Note 2 to these financial
statements. The effect of this change was to reduce ARM assets and to
decrease shareholders equity by $34 million from the Companys prior
practice as of June 30, 2003 due to the elimination of a net unrealized gain

related to securitized ARM loans.

9



---



##### Table of Contents





| |  |  | Interest income on ARM assets is accrued based on the outstanding principal
amount and contractual terms of the assets. Premiums and discounts
associated with the purchase of the ARM assets are amortized into interest
income over the lives of the assets using the effective yield method,
adjusted for the effects of estimated prepayments. Loan origination fees,
net of certain direct loan origination costs, are deferred and amortized as
an interest income yield adjustment over the life of the related loans using
the interest method.
| |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Credit risk and allowance for loan losses
| |  | -----------------------------------------



| |  |  | The Company limits its exposure to credit losses on its portfolio of ARM
securities by purchasing ARM securities that have an investment grade rating
at the time of purchase and have some form of credit enhancement, or are
guaranteed by an agency of the federal government (Ginnie Mae) or a
government-sponsored or federally-chartered corporation (Fannie Mae or
Freddie Mac) (collectively Agency Securities). An investment grade
security generally has a security rating of BBB or Baa or better by at least
one of two nationally recognized rating agencies, Standard & Poors, Inc. or
Moodys Investors Service, Inc. (the Rating Agencies). Additionally, the
Company purchases and originates ARM loans or purchases all classes of a
third-party ARM loan securitization (including the classes rated less than
Investment Grade). When the Company acquires classes of securities that are
below Investment Grade, the purchase price generally includes a discount for
probable credit losses; this reduction, or basis adjustment, is recorded
as part of the purchase price of that security. In the event of impairment,
the Company revises its estimate of probable losses and any difference
between the initial estimate and the new estimate of losses is recorded in
earnings. The Company limits its exposure to credit losses by restricting
its whole loan purchases and originations to ARM loans generally originated
to A quality underwriting standards. The Company further limits its
exposure to credit risk by limiting its investment in investment grade
securities that are rated A or equivalent, BBB or equivalent, or ARM loans
originated to A quality underwriting standards (Other Investments),
including the subordinate classes of securities retained as part of the
Companys securitization of loans or purchases of 100% of the classes from
other loan securitizations, to no more than 30% of the portfolio.
| |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The Company maintains an allowance for loan losses based on managements
estimate of credit losses inherent in the Companys portfolio of ARM Loans.
The estimation of the allowance is based on a variety of factors including,
but not limited to, current economic conditions, loan portfolio composition,
delinquency trends, credit losses to date on underlying loans and remaining
credit protection. If the credit performance of its ARM Loans is different
than expected, the Company adjusts the allowance for loan losses to a level
deemed appropriate by management to provide for estimated losses inherent in
its ARM Loan portfolio. Additionally, once a loan is 90 days or more
delinquent, or a borrower declares bankruptcy, the Company adjusts the value
of its accrued interest receivable to what it believes to be collectible and
stops accruing interest on that loan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  |  | Provisions for credit losses do not reduce taxable income and thus do not
affect the dividends paid by the Company to shareholders in the period the
provisions are taken. Actual losses realized by the Company do reduce
taxable income in the period the actual loss is realized and would affect the
dividends paid to shareholders for that tax year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                



| |  | Valuation methods
| |  | -----------------



| |  |  | The fair values of the Companys ARM securities and securitized ARM loans are
generally based on market prices provided by certain dealers who make markets
in these financial instruments, or by third-party pricing services. If the
fair value of an ARM security or securitized ARM loan is not reasonably
available from a dealer or a third-party pricing service, management
estimates the fair value based on characteristics of the security that the
Company receives from the issuer and on available market information.
| |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The fair values for ARM loans, other than securitized ARM loans, are
estimated by the Company by using the same pricing models employed by the
Company in the process of determining a price to bid for loans in the open
market, taking into consideration the aggregated characteristics of groups of
loans such as, but not limited to, collateral type, index, interest rate,
margin, length of fixed-rate period, life cap, periodic cap, underwriting
standards, age and credit.                                              
|
| |  |  | The net unrealized gain on commitments to purchase ARM loans from
correspondent lenders and bulk sellers is calculated using the same
methodologies that are used to value the Companys ARM loans, adjusted for
anticipated fallout for commitments that will likely not
be funded.                                                                                                                                                                                                                                                

10



---



##### Table of Contents





| |  |  | The fair values of the Companys CDOs, senior notes, interest rate swap
agreements and interest rate cap agreements are based on market values
provided by dealers who are familiar with the terms of the debt, senior
notes, swap agreements and cap agreements.                                                                                                                                                                                             
| |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The fair value of futures contracts is determined on a daily basis by the
closing price on the Chicago Mercantile Exchange.                                                                                                                                                                                                                                                                                                                                   
|
| |  |  | The fair values reported reflect estimates and may not necessarily be
indicative of the amounts the Company could realize if these instruments were
sold. Cash and cash equivalents, restricted cash, interest receivable,
reverse repurchase agreements, other borrowings and other liabilities are
reflected in the financial statements at their amortized cost, which
approximates their fair value because of the short-term nature of these
instruments.



| |  | Hedging instruments
| |  | -------------------



| |  |  | All of the Companys hedging instruments are derivative financial instruments
(interest rate cap agreements, interest rate swap agreements and Eurodollar
futures contracts) (collectively, Hedging Instruments) and are carried on
the balance sheet at their fair value as an asset, if their fair value is
positive, or as a liability, if their fair value is negative. In general,
the Companys Hedging Instruments are designated as cash flow hedges, and
the effective amount of change in the fair value of the derivative instrument
is recorded in Other comprehensive income (loss) and transferred to earnings
as the hedged item affects earnings. The ineffective amount of all Hedging
Instruments is recognized in earnings each quarter.
| |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | As the Company enters into hedging transactions, it formally documents the
relationship between the Hedging Instruments and the hedged items. The
Company has also documented its risk-management policies, including
objectives and strategies, as they relate to its hedging activities. The
Company assesses, both at inception of a hedging activity and on an on-going
basis, whether or not the hedging activity is highly effective. If it is
determined that a hedge is not highly effective, the Company discontinues
hedge accounting prospectively.                                                                                                                                                                                                 
|
| |  |  | Hybrid Hedging Instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  |  | The Company enters into interest rate swap agreements (Swap Agreements),
Eurodollar futures contracts (Eurodollar Transactions) and interest rate
cap agreements (Cap Agreements) in order to manage its interest rate
exposure when financing its Hybrid ARM assets (collectively, Hybrid Hedging
Instruments). The Company generally borrows money based on short-term
interest rates. The Companys Hybrid ARM assets have an initial fixed
interest rate period of three to ten years. As a result, the Companys
existing and forecasted borrowings reprice to a new rate on a more frequent
basis than do the Companys Hybrid ARM assets.                                                                                                       
|
| |  |  | When the Company enters into a Swap Agreement, it agrees to pay a fixed rate
of interest and to receive a variable interest rate, generally based on the
London InterBank Offer Rate (LIBOR). The Company also enters into
Eurodollar Transactions in order to fix the interest rate on its forecasted
three-month LIBOR-based liabilities. These Swap Agreements and Eurodollar
Transactions have the effect of converting the Companys variable-rate debt
into fixed-rate debt over the life of the Swap Agreements and Eurodollar
Transactions.                                                                                                                                                                                                          
|
| |  |  | The Company also purchases Cap Agreements by incurring a one-time fee or
premium. Pursuant to the terms of the Cap Agreements, the Company will
receive cash payments if the interest rate index specified in any such Cap
Agreement increases above contractually specified levels. Therefore, such
Cap Agreements have the effect of capping the interest rate on a portion of
the Companys borrowings above a level specified by the Cap Agreement.                                                                                                                                                                                                                                                                                                        
|
| |  |  | The notional balances of the Hybrid Hedging Instruments generally decline
over the life of these instruments approximating the declining balance of the
Hybrid ARM assets being financed. These Hybrid Hedging Instruments are used
to fix the interest rate on the Companys borrowings during the expected
fixed rate period of the Companys Hybrid ARM assets such that the Company
maintains a duration on the borrowings and Hybrid Hedging Instruments that
closely matches the duration of the Companys Hybrid ARM assets.                                                                                                                                                                                                                            
|
| |  |  | All Swap Agreements and Eurodollar Transactions are designated as cash flow
hedges against the benchmark interest rate risk associated with the Companys
borrowings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  |  | All changes in the unrealized gains and losses on Swap Agreements and the
Eurodollar Transactions have been recorded in Accumulated other comprehensive
income (loss) and are reclassified to earnings as interest expense is
recognized on the Companys hedged borrowings. If it becomes probable that
the forecasted transaction, which in this case refers to interest                                                                                                                                                                                                                                                                                                                                                                                     

11



---



##### Table of Contents





| |  |  | payments to
be made under the Companys short-term borrowing agreements, will not occur
by the end of the originally specified time period, as documented at the
inception of the hedging relationship, or within an additional two-month time
period thereafter, then the related gain or loss in Accumulated other
comprehensive income (loss) would be reclassified to income.                                                                                                                                                                                                                                                                                              
| |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The unrealized gain/loss on Swap Agreements is based on the discounted value
of the remaining future net interest payments expected to be made over the
remaining life of the Swap Agreements. Therefore, over time, as the actual
payments are made, the unrealized gain/loss in Accumulated other
comprehensive income (loss) and the carrying value of the Swap Agreements
adjust to zero and the Company realizes a fixed cost of money over the life
of the Hedging Instrument.                                                                                                                                                                                           
|
| |  |  | In the course of managing its liquidity and balance sheet, the Company has
terminated and/or replaced certain Swap Agreements. Since the Companys
adoption of FAS 133, realized gains and losses resulting from the termination
of Swap Agreements are initially recorded in Accumulated other comprehensive
income (loss) as a separate component of equity. The gain or loss from the
terminated Swap Agreements remains in Accumulated other comprehensive income
(loss) until the forecasted interest payments affect earnings. If it becomes
probable that the forecasted interest payments will not occur, then the
entire gain or loss would be reclassified to income.
|
| |  |  | The Company designates its Cap Agreements used to manage interest rate
exposure when financing its Hybrid ARM assets as cash flow hedges. All
changes in the unrealized gains and losses on these Cap Agreements are
recorded in Accumulated other comprehensive income (loss) and are
reclassified to earnings, along with the fee paid to fix the interest rate on
the applicable forecasted transaction, as interest expense when each of the
forecasted financing transactions occurs. The carrying value of these Cap
Agreements is included in Hedging instruments on the balance sheet.                                                                                 
|
| |  |  | Life Cap Hedging Instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  |  | The Company also purchases Cap Agreements to manage interest rate risk on the
financing of a portion of its Traditional ARM assets that have a contractual
maximum interest rate (Life Cap), which is a component of the fair value of
an ARM asset (Life Cap Hedging Instruments).                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  |  | The Company does not currently apply hedge accounting to its Life Cap Hedging
Instruments and, as a result, the Company records the change in fair value of
these Cap Agreements as hedging expense in current earnings. The carrying
value of the Life Cap Hedging Instruments is included in Hedging instruments
on the balance sheet.                                                                                                                                                                                                                                                                                                                                       

Accumulated other comprehensive income (loss)



| |  |  | The Financial Accounting Standard Boards Statement 130, Reporting
Comprehensive Income, divides comprehensive income into net income and other
comprehensive income (loss), which includes unrealized gains and losses on
marketable securities defined as available-for-sale and unrealized gains and
losses on derivative financial instruments that qualify for hedge accounting
under FAS 133. Accumulated other comprehensive loss at September 30, 2003
and December 31, 2002 includes the following (dollar amounts in thousands):
| |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                             |  |               |          |              |  |   |          |  
|-------------------------------------------- |  | ------------- | -------- | ------------ |  | - | -------- | -
|                                             |  | September 30, |          | December 31,
|                                             |  | 2003          |          | 2002        
|                                             |  |               |          |             
|Net unrealized gain (loss) on ARM securities |  | $             | (29,408  | )            |  | $ | 43,489   |  
|Net unrealized loss on Hedging Instruments   |  |               | (175,040 | )            |  |   | (148,743 | )
|                                             |  |               |          |              |  |   |          |  
|Accumulated other comprehensive loss         |  | $             | (204,448 | )            |  | $ | (105,254 | )
|                                             |  |               |          |              |  |   |          |  



| |  |  | The net unrealized gain on the Companys ARM Loans of $3.8 million and $18.9
million at September 30, 2003 and December 31, 2002 is not included in
Accumulated other comprehensive income because, in accordance with generally
accepted accounting principles, the ARM Loans are carried at their amortized
cost basis.
| |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

12



---



##### Table of Contents



Income taxes



| |  |  | The Company elected to be taxed as a REIT and believes it complies with the
provisions of the Internal Revenue Code of 1986, as amended (the Code) with
respect thereto. Accordingly, the Company will not be subject to Federal
income tax on that portion of its income that is distributed to shareholders,
as long as certain asset, income and stock ownership tests are met.
| |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Net earnings per share



| |  |  | Basic EPS amounts are computed by dividing net income (adjusted for dividends
declared on preferred stock) by the weighted average number of common shares
outstanding. Diluted EPS amounts assume the conversion, exercise or issuance
of all potential common stock instruments, unless the effect is to increase
the earnings per common share.
| |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Following is information about the computation of the earnings per share data
for the three- and nine-month periods ended September 30, 2003 and 2002
(amounts in thousands except per share data):                                                                                                                                               

|                                                   |                             |   |        |       |        |  |           |       |  |   |          |  | 
|-------------------------------------------------- | --------------------------- | - | ------ | ----- | ------ |  | --------- | ----- |  | - | -------- |  | 
|                                                   |                             |   |        |       |        |  |           |       |  |   | Earnings
|                                                   |                             |   | Income |       | Shares |  | Per Share
|                                                   |                             |   |        |       |        |  |          
|Three Months Ended September 30, 2003              |                             |   |        |       |        |  |           |       |  |   |          | 
|Net income                                         |                             | $ | 45,768 |       |        |  |           |       |  |   |          | 
|Less preferred stock dividends                     |                             |   |       |       |        |  |           |       |  |   |          | 
|                                                   |                             |   |        |       |        |  |           |       |  |   |          | 
|Basic EPS, income available to common shareholders |                             |   | 45,768 |       |        |  | 66,092    |       |  | $ | 0.69     | 
|                                                   |                             |   |        |       |        |  |           |       |  |   |          | 
|Effect of dilutive securities:                     |                             |   |        |       |        |  |           |       |  |   |          | 
|                                                   | Convertible preferred stock |   |        |      |        |  |           | 1,440 |  |   |          |  | 
|                                                   |                             |   |        |       |        |  |           |       |  |   |          | 
|Diluted EPS                                        |                             | $ | 45,768 |       |        |  | 67,532    |       |  | $ | 0.68     | 
|                                                   |                             |   |        |       |        |  |           |       |  |   |          | 
|Three Months Ended September 30, 2002              |                             |   |        |       |        |  |           |       |  |   |          | 
|Net income                                         |                             | $ | 32,610 |       |        |  |           |       |  |   |          | 
|Less preferred stock dividends                     |                             |   | (1,670 | )     |        |  |           |       |  |   |          | 
|                                                   |                             |   |        |       |        |  |           |       |  |   |          | 
|Basic EPS, income available to common shareholders |                             |   | 30,940 |       |        |  | 45,733    |       |  | $ | 0.68     | 
|                                                   |                             |   |        |       |        |  |           |       |  |   |          | 
|Effect of dilutive securities:                     |                             |   |        |       |        |  |           |       |  |   |          | 
|                                                   | Convertible preferred stock |   |        | 1,670 |        |  |           | 2,760 |  |   |          |  | 
|                                                   |                             |   |        |       |        |  |           |       |  |   |          | 
|Diluted EPS                                        |                             | $ | 32,610 |       |        |  | 48,493    |       |  | $ | 0.67     | 
|                                                   |                             |   |        |       |        |  |           |       |  |   |          | 

13



---



##### Table of Contents



|                                                   |                             |   |         |       |        |  |           |       |  |   |          |  | 
|-------------------------------------------------- | --------------------------- | - | ------- | ----- | ------ |  | --------- | ----- |  | - | -------- |  | 
|                                                   |                             |   |         |       |        |  |           |       |  |   | Earnings
|                                                   |                             |   | Income  |       | Shares |  | Per Share
|                                                   |                             |   |         |       |        |  |          
|Nine Months Ended September 30, 2003               |                             |   |         |       |        |  |           |       |  |   |          | 
|Net income                                         |                             | $ | 127,034 |       |        |  |           |       |  |   |          | 
|Less preferred stock dividends                     |                             |   | (3,340  | )     |        |  |           |       |  |   |          | 
|                                                   |                             |   |         |       |        |  |           |       |  |   |          | 
|Basic EPS, income available to common shareholders |                             |   | 123,694 |       |        |  | 60,572    |       |  | $ | 2.04     | 
|                                                   |                             |   |         |       |        |  |           |       |  |   |          | 
|Effect of dilutive securities:                     |                             |   |         |       |        |  |           |       |  |   |          | 
|                                                   | Convertible preferred stock |   |         | 3,340 |        |  |           | 2,315 |  |   |          |  | 
|                                                   |                             |   |         |       |        |  |           |       |  |   |          | 
|Diluted EPS                                        |                             | $ | 127,034 |       |        |  | 62,887    |       |  | $ | 2.02     | 
|                                                   |                             |   |         |       |        |  |           |       |  |   |          | 
|Nine Months Ended September 30, 2002               |                             |   |         |       |        |  |           |       |  |   |          | 
|Net income                                         |                             | $ | 84,840  |       |        |  |           |       |  |   |          | 
|Less preferred stock dividends                     |                             |   | (5,009  | )     |        |  |           |       |  |   |          | 
|                                                   |                             |   |         |       |        |  |           |       |  |   |          | 
|Basic EPS, income available to common shareholders |                             |   | 79,831  |       |        |  | 41,401    |       |  | $ | 1.93     | 
|                                                   |                             |   |         |       |        |  |           |       |  |   |          | 
|Effect of dilutive securities:                     |                             |   |         |       |        |  |           |       |  |   |          | 
|                                                   | Convertible preferred stock |   |         | 5,009 |        |  |           | 2,760 |  |   |          |  | 
|                                                   |                             |   |         |       |        |  |           |       |  |   |          | 
|Diluted EPS                                        |                             | $ | 84,840  |       |        |  | 44,161    |       |  | $ | 1.92     | 
|                                                   |                             |   |         |       |        |  |           |       |  |   |          | 

Use of estimates



| |  |  | The preparation of financial statements in conformity with generally accepted
accounting principles (GAAP) requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
| |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

14



---



##### Table of Contents



Note 2. Adjustable-Rate Mortgage Assets



| |  | The following tables present the Companys ARM assets as of September 30, 2003
and December 31, 2002. The ARM securities are carried at their fair value,
while the ARM Loans are carried at their amortized cost basis (dollar amounts
in thousands):
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                 |                     |                |            |            |  |      |             |                |                 |       |           |           |           |   |           |           |  |   |            |            | 
|------------------------------------------------ | ------------------- | -------------- | ---------- | ---------- |  | ---- | ----------- | -------------- | --------------- | ----- | --------- | --------- | --------- | - | --------- | --------- |  | - | ---------- | ---------- | 
|                                                 |                     |                |            |            |  |      | ARM Loans   |                |                 |       |          
|                                                 |                     |                |            |            |  |      |             |                |                 |       |          
|                                                 |                     |                |            |            |  |      |             |                |                 |       | ARM loans |           | ARM loans |   |           |           | 
|                                                 |                     |                |            |            |  |      | Securitized |                | collateralizing |       | held for  |           |           |   |          
|September 30, 2003:                              |                     | ARM securities |            | ARM loans  |  | CDOs |             | securitization |                 | Total
|                                                 |                     |                |            |            |  |      |             |                |                 |      
|Principal balance outstanding                    |                     | $              | 9,998,748  |            |  | $    | 2,892,307   |                |                 | $     | 2,165,429 |           |           | $ | 1,221,456 |           |  | $ | 16,277,940 |           
|Net unamortized premium                          |                     |                | 170,486    |            |  |      | 21,529      |                |                 |       | 15,165    |           |           |   | 5,669     |           |  |   | 212,849    |           
|Loan loss reserves                               |                     |                |           |            |  |      | (5,767      | )              |                 |       | (815      | )         |           |   | (250      | )         |  |   | (6,832     | )         
|Basis adjustments                                |                     |                | (3,368     | )          |  |      |            |                |                 |       |          |           |           |   |          |           |  |   | (3,368     | )         
|Net unrealized gain on purchase loan commitments |                     |                |           |            |  |      |            |                |                 |       |          |           |           |   | 1,820     |           |  |   | 1,820      |           
|Principal payment receivable                     |                     |                | 40,539     |            |  |      | 5,322       |                |                 |       |          |           |           |   |          |           |  |   | 45,861     |           
|                                                 |                     |                |            |            |  |      |             |                |                 |       |           |           |           |   |           |           |  |   |            |           
|                                                 | Amortized cost, net |                |            | 10,206,405 |  |      |             | 2,913,391      |                 |       |           | 2,179,779 |           |   |           | 1,228,695 |  |   |            | 16,528,270 | 
|Gross unrealized gains                           |                     |                | 30,132     |            |  |      | 25,892      |                |                 |       | 3,189     |           |           |   | 1,561     |           |  |   | 60,774     |           
|Gross unrealized losses                          |                     |                | (58,794    | )          |  |      | (11,757     | )              |                 |       | (11,567   | )         |           |   | (3,545    | )         |  |   | (85,663    | )         
|                                                 |                     |                |            |            |  |      |             |                |                 |       |           |           |           |   |           |           |  |   |            |           
|                                                 | Fair value          |                | $          | 10,177,743 |  |      | $           | 2,927,526      |                 |       | $         | 2,171,401 |           |   | $         | 1,226,711 |  |   | $          | 16,503,381 | 
|                                                 |                     |                |            |            |  |      |             |                |                 |       |           |           |           |   |           |           |  |   |            |           
|Carrying value                                   |                     | $              | 10,177,743 |            |  | $    | 2,913,391   |                |                 | $     | 2,179,779 |           |           | $ | 1,228,695 |           |  | $ | 16,499,608 |           
|                                                 |                     |                |            |            |  |      |             |                |                 |       |           |           |           |   |           |           |  |   |            |           

|                              |                     |                |           |           |  |      |             |                |                 |       |           |         |           |   |         |         |  |   |            |            | 
|----------------------------- | ------------------- | -------------- | --------- | --------- |  | ---- | ----------- | -------------- | --------------- | ----- | --------- | ------- | --------- | - | ------- | ------- |  | - | ---------- | ---------- | 
|                              |                     |                |           |           |  |      | ARM Loans   |                |                 |       |          
|                              |                     |                |           |           |  |      |             |                |                 |       |          
|                              |                     |                |           |           |  |      |             |                |                 |       | ARM loans |         | ARM loans |   |         |         | 
|                              |                     |                |           |           |  |      | Securitized |                | collateralizing |       | held for  |         |           |   |        
|December 31, 2002:            |                     | ARM securities |           | ARM loans |  | CDOs |             | securitization |                 | Total
|                              |                     |                |           |           |  |      |             |                |                 |      
|Principal balance outstanding |                     | $              | 6,498,437 |           |  | $    | 2,664,310   |                |                 | $     | 287,409   |         |           | $ | 706,965 |         |  | $ | 10,157,121 |           
|Net unamortized premium       |                     |                | 85,774    |           |  |      | 22,791      |                |                 |       | 5,613     |         |           |   | 2,922   |         |  |   | 117,100    |           
|Loan loss reserves            |                     |                |          |           |  |      |            |                |                 |       |          |         |           |   | (100    | )       |  |   | (100       | )         
|Basis adjustments             |                     |                | (1,778    | )         |  |      | (9,606      | )              |                 |       | (3,239    | )       |           |   |        |         |  |   | (14,623    | )         
|Principal payment receivable  |                     |                | 26,546    |           |  |      | 4,487       |                |                 |       |          |         |           |   |        |         |  |   | 31,033     |           
|                              |                     |                |           |           |  |      |             |                |                 |       |           |         |           |   |         |         |  |   |            |           
|                              | Amortized cost, net |                |           | 6,608,979 |  |      |             | 2,681,982      |                 |       |           | 289,783 |           |   |         | 709,787 |  |   |            | 10,290,531 | 
|Gross unrealized gains        |                     |                | 55,542    |           |  |      | 18,262      |                |                 |       | 2,297     |         |           |   | 3,505   |         |  |   | 79,606     |           
|Gross unrealized losses       |                     |                | (24,209   | )         |  |      | (4,913      | )              |                 |       | (120      | )       |           |   | (160    | )       |  |   | (29,402    | )         
|                              |                     |                |           |           |  |      |             |                |                 |       |           |         |           |   |         |         |  |   |            |           
|                              | Fair value          |                | $         | 6,640,312 |  |      | $           | 2,695,331      |                 |       | $         | 291,960 |           |   | $       | 713,132 |  |   | $          | 10,340,735 | 
|                              |                     |                |           |           |  |      |             |                |                 |       |           |         |           |   |         |         |  |   |            |           
|Carrying value                |                     | $              | 6,640,312 |           |  | $    | 2,695,331   |                |                 | $     | 289,783   |         |           | $ | 709,787 |         |  | $ | 10,335,213 |           
|                              |                     |                |           |           |  |      |             |                |                 |       |           |         |           |   |         |         |  |   |            |           



| |  | The Company realized a gain on ARM assets of $5.4 million during the nine
months ended September 30, 2003. This gain consists of a $2.7 million net
release of previously recorded credit losses, a $910.5 thousand gain upon the
maturity of a collateralized bond obligation and a gain of $1.8 million on
interest rate lock commitments on certain loans in the pipeline at September
30, 2003.                                                                                                                 
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The Company did not sell any ARM assets during the nine months ended September
30, 2003. During the nine months ended September 30, 2002, the Company sold
$72.9 million of ARM securities for a gain of $113.5 thousand. In addition,
during 2002, the Company sold $4.1 million of loans and realized a net loss of
$8.1 thousand.                                                                                                                                                                                
|
| |  | During the nine months ended September 30, 2003, the Company securitized $4.0
billion of its ARM loans into a series of private-label multi-class ARM
securities. The Company retained $1.6 billion of the securities created for
its securitized ARM loan portfolio and placed $2.4 billion of the securities
with third party investors, thereby providing a long-term collateralized
financing for the Companys assets. In October 2003, the Company securitized
an additional $1.0 billion of its ARM loans and

15



---



##### Table of Contents





| |  | retained all of the resulting
securities for its securitized ARM loan portfolio. The Company did not account
for these securitizations as sales and, therefore, did not record any gain or
loss in connection with the securitizations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | During the nine months ended September 30, 2003, the Company recorded loan loss
provisions totaling $2.0 million to reserve for estimated credit losses on ARM
loans bringing its total loan loss provision to $6.8 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | As of September 30, 2003 and December 31, 2002, the Company had basis
adjustments of $3.4 million and $1.8 million, respectively, on its ARM
securities due to estimated credit losses (other than temporary declines in
fair value) related to ARM securities purchased at a discount. As part of its
purchase price, the Company recorded basis adjustments of $1.7 million related
to ARM securities purchased during the nine months ended September 30, 2003 on
which the Company had first loss credit exposure. These securities were
purchased as part of $1.3 billion third party loan securitizations in which the
Company purchased all classes of the securitizations, including the
subordinated classes. The Company also recorded realized losses on ARM
securities in the amount of $147.2 thousand and realized recoveries in the
amount of $157.0 thousand during the first nine months of 2003.
|
| |  | The Company has credit exposure on its ARM Loans. The following tables
summarize ARM Loan delinquency information as of September 30, 2003 and
December 31, 2002 (dollar amounts in thousands):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   



September
30, 2003


|                   |  |            |    |              |  |           |              |  |  |            |      |            |  |  |      |  
|------------------ |  | ---------- | -- | ------------ |  | --------- | ------------ |  |  | ---------- | ---- | ---------- |  |  | ---- | -
|                   |  |            |    |              |  |           |              |  |  | Percent of |      | Percent of
|Delinquency Status |  | Loan Count |    | Loan Balance |  | ARM Loans | Total Assets
|                   |  |            |    |              |  |           |             
|60 to 89 days      |  |            | 3  |              |  | $         | 795          |  |  |            | 0.01 | %          |  |  | 0.01 | %
|90 days or more    |  |            | 0  |              |  |           |             |  |  |            | 0.00 | %          |  |  | 0.00 | %
|In foreclosure     |  |            | 9  |              |  |           | 3,579        |  |  |            | 0.06 | %          |  |  | 0.02 | %
|                   |  |            |    |              |  |           |              |  |  |            |      |            |  |  |      |  
|                   |  |            | 12 |              |  | $         | 4,374        |  |  |            | 0.07 | %          |  |  | 0.03 | %
|                   |  |            |    |              |  |           |              |  |  |            |      |            |  |  |      |  



December 31, 2002


|                   |  |            |   |              |  |           |              |  |  |            |      |            |  |  |      |  
|------------------ |  | ---------- | - | ------------ |  | --------- | ------------ |  |  | ---------- | ---- | ---------- |  |  | ---- | -
|                   |  |            |   |              |  |           |              |  |  | Percent of |      | Percent of
|Delinquency Status |  | Loan Count |   | Loan Balance |  | ARM Loans | Total Assets
|                   |  |            |   |              |  |           |             
|60 to 89 days      |  |            | 2 |              |  | $         | 270          |  |  |            | 0.01 | %          |  |  | 0.00 | %
|90 days or more    |  |            | 1 |              |  |           | 159          |  |  |            | 0.00 | %          |  |  | 0.00 | %
|In foreclosure     |  |            | 5 |              |  |           | 2,970        |  |  |            | 0.08 | %          |  |  | 0.03 | %
|                   |  |            |   |              |  |           |              |  |  |            |      |            |  |  |      |  
|                   |  |            | 8 |              |  | $         | 3,399        |  |  |            | 0.09 | %          |  |  | 0.03 | %
|                   |  |            |   |              |  |           |              |  |  |            |      |            |  |  |      |  



| |  | As of September 30, 2003, the Company owned two real estate properties as a
result of foreclosing on delinquent loans that are included in ARM loans on the
Consolidated Balance Sheet in the aggregate amount of $1.1 million (not
included in the table above.) The Company believes that its current level of
reserves is adequate to cover any loss, should one occur, from the sale of
these properties.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | As of September 30, 2003, the Company had commitments to purchase or originate
the following amounts of ARM assets (dollar amounts in thousands):                                                                                                                                                                                                                                                            

|                                       |  |   |           | 
|-------------------------------------- |  | - | --------- | 
|ARM securities  agency                |  | $ | 602,642   | 
|ARM securities  private high quality  |  |   | 834,883   | 
|ARM securities  private other         |  |   | 4,507     | 
|ARM loans  bulk purchase              |  |   | 63,038    | 
|ARM loans  correspondent originations |  |   | 720,994   | 
|ARM loans  direct originations        |  |   | 100,396   | 
|                                       |  |   |           | 
|                                       |  | $ | 2,326,460 | 
|                                       |  |   |           | 



| |  | The Company has entered into transactions whereby the Company expects to
acquire the remaining balance of certain AAA rated Hybrid ARM securities, at a
price of par, between 2004 and 2008, when the fixed-rate period of the Hybrid
ARM securities
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

16



---



##### Table of Contents





| |  | terminates and the securities convert into Traditional ARM
securities with characteristics similar to the Traditional ARM securities held
in the current portfolio. The Company views these transactions as an
alternative source of Traditional ARM assets. The current balance of the
Hybrid ARM securities is approximately $3.0 billion, but is expected to be less
than 25% of that, and could be zero, at the time they convert into Traditional
ARM securities. If the Company decides not to acquire the Hybrid ARM
securities when they convert into Traditional ARM securities, then it is
committed to pay or receive the difference between par and the fair value of
the Traditional ARM securities at that time, as determined by an auction of the
Traditional ARM securities. As of September 30, 2003, the Company had
delivered ARM assets with a carrying value of $7.2 million as collateral in
connection with these transactions.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Note 3. Hedging Instruments



| |  | Hybrid Hedging Instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | As of September 30, 2003, the Company was counterparty to Swap Agreements and
Eurodollar Transactions having an aggregate current notional balance of $9.6
billion. In addition, the Company entered into five delayed Swap Agreements,
three of which have a total notional balance of $915 million and become
effective in October 2003, one with a notional balance of $180 million becoming
effective in November 2003 and the last with a notional balance of $270 million
becoming effective in February 2004. These Swap Agreements and Eurodollar
Transactions fix the interest rate on the financing of Hybrid ARM assets during
their fixed rate term (generally three to ten years). As of September 30,
2003, these Swap Agreements and Eurodollar Transactions had a weighted average
maturity of 3.5 years. In accordance with the Swap Agreements, the Company
will pay a fixed rate of interest during the term of these Swap Agreements and
receive a payment that varies monthly with the one-month LIBOR rate. As of
September 30, 2003, ARM assets with a carrying value of $84.1 million,
including accrued interest, and cash totaling $43.6 million collateralized the
Swap Agreements.                                                                                                                                                      
|
| |  | The net fair value of Swap Agreements at September 30, 2003 of $150.8 million
included Swap Agreements with gross unrealized gains of $4.7 million and gross
unrealized losses of $155.5 million and is included in Hedging instruments on
the balance sheet.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | As of September 30, 2003, the net unrealized loss on Swap Agreements and
deferred gains and losses on Eurodollar Transactions recorded in Accumulated
other comprehensive income (loss) was a net loss of $167.4 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | The Company estimates that over the next twelve months, $78.6 million of these
net unrealized losses will be reclassified from Accumulated other comprehensive
income (loss) to interest expense.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | In April and August 2003, the Company purchased Cap Agreements with notional
balances of $576.7 million and $995.3 million, respectively, at a cost of $8.9
million and $20.2 million, respectively, in order to manage its interest rate
risk exposure on the financing of the Hybrid ARM loans collateralizing the
Companys CDOs. These Cap Agreements had a remaining notional amount of $1.5
billion as of September 30, 2003. The fair value of these Cap Agreements at
September 30, 2003 was $21.5 million and is included in Hedging instruments on
the balance sheet. The unrealized loss on these Cap Agreements of $7.6 million
is included in Accumulated other comprehensive income (loss). Pursuant to the
terms of these Cap Agreements, the notional amount of the Cap Agreements
declines such that it is expected to equal the balance of the Hybrid ARM loans
collateralizing the Companys CDOs. Under these Cap Agreements, the Company
will receive cash payments should the one-month LIBOR increase above the
contract rates of these Hedging Instruments, which range from 3.25% to 4.61%
and average 3.81%. The Cap Agreements had an average maturity of 5.4 years as
of September 30, 2003. The initial aggregate notional amount of the Cap
Agreements declines over the period of the agreements, which expire between
2006 and 2012.
|
| |  | The Company hedges the funding of its Hybrid ARM assets such that the weighted
average net duration of borrowed funds, Hybrid Hedging Instruments and Hybrid
ARM assets is less than one year. At September 30, 2003, the financing and
hedging of the Companys Hybrid ARM assets resulted in a net duration of
approximately 1.3 months.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | Interest expense for the three months ended September 30, 2003 and 2002
includes net payments on Hybrid Hedging Instruments of $40.9 million and $24.0
million, respectively. Interest expense for the nine months ended September
30, 2003 and 2002 includes net payments on Hybrid Hedging Instruments of $107.6
million and $62.8 million, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

17



---



##### Table of Contents





| |  | Life Cap Hedging Instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The fair value of the Life Cap Hedging Instruments at September 30, 2003 and
December 31, 2002 amounted to $10.7 thousand and $84.7 thousand, respectively,
and is included in Hedging instruments on the balance sheet. Purchased Cap
Agreements had a remaining notional amount of $1.0 billion and $1.8 billion as
of September 30, 2003 and December 31, 2002, respectively. The notional amount
of the Life Cap Hedging Instruments declines at a rate that is expected to
approximate the amortization of the Traditional ARM assets. The Company will
receive cash payments should the one-month or three-month LIBOR increase above
the contract rates of these Hedging Instruments, which range from 6.00% to
12.00% and average 9.91%. The Life Cap Hedging Instruments had an average
maturity of 10 months as of September 30, 2003 and expire between 2003 and
2005. During the three- and nine-month periods ended September 30, 2003, the
Company recognized expenses of $145.0 thousand and $541.8 thousand,
respectively, which is reported as Hedging expense in the Companys
Consolidated Income Statements.

Note 4. Borrowings



| |  | Reverse Repurchase Agreements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The Company has arrangements to enter into reverse repurchase agreements, a
form of collateralized short-term borrowing, with 24 different financial
institutions, and as of September 30, 2003, had borrowed funds from 17 of these
firms. Because the Company borrows money under these agreements based on the
fair value of its ARM assets, and because changes in interest rates can
negatively impact the valuation of ARM assets, the Companys borrowing ability
under these agreements could be limited and lenders could initiate margin calls
in the event interest rates change or the value of the Companys ARM assets
declines for other reasons.                                                                                                                                                                                                                                                                                                            
|
| |  | As of September 30, 2003, the Company had $12.6 billion of reverse repurchase
agreements outstanding with a weighted average borrowing rate of 1.22% and a
weighted average remaining maturity of 6.4 months. As of December 31, 2002,
the Company had $8.4 billion of reverse repurchase agreements outstanding with
a weighted average borrowing rate of 1.59% and a weighted average remaining
maturity of 4.6 months. As of September 30, 2003, $11.8 billion of the
Companys borrowings were variable-rate term reverse repurchase agreements with
original maturities that range from two months to twenty-five months. The
interest rates of these term reverse repurchase agreements are indexed to
either the one-month or three-month LIBOR rate and reprice accordingly. ARM
assets with a carrying value of $12.9 billion, including accrued interest and
cash totaling $464.5 million, collateralized the reverse repurchase agreements
at September 30, 2003.
|
| |  | At September 30, 2003, the reverse repurchase agreements had the following
remaining maturities (dollar amounts in thousands):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

|               |  |   |            | 
|-------------- |  | - | ---------- | 
|Within 30 days |  | $ | 1,317,366  | 
|31 to 89 days  |  |   | 1,569,615  | 
|90 to 365 days |  |   | 8,883,633  | 
|Over 365 days  |  |   | 808,418    | 
|               |  |   |            | 
|               |  | $ | 12,579,032 | 
|               |  |   |            | 



| |  | CDOs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | On April 3, 2003, $1.1 billion of mortgage loans from the Companys ARM loan
portfolio were transferred to Thornburg Mortgage Securities Trust 2003-2 and
were securitized. On August 28, 2003, $1.4 billion of mortgage loans from the
Companys ARM loan portfolio were transferred to Thornburg Mortgage Securities
Trust 2003-4 and were securitized. Approximately $2.4 billion of the
securities created by these securitizations were issued to third-party
investors in the form of AAA-rated floating rate pass-through certificates. In
connection with the issuance of the CDOs, the Company incurred costs of $7.3
million, which were deducted from the proceeds of the transactions and are
being amortized over the expected life of the CDOs. These transactions were
accounted for as financings of the loans and represent permanent financing that
is not subject to margin calls. The Company retained the AA and A certificates
totaling $63.1 million. The structure of these transactions also include
overcollateralization certificates that provide $6.1 million of credit support
based on the estimated exposure to credit losses on the loans collateralizing
the debt. As of September 30, 2003, the CDOs had a net balance of $2.2 billion
and an effective interest cost of 1.55%, which changes each month at a spread
to one-month LIBOR. As of September 30, 2003, the CDOs were collateralized by
ARM loans with a principal balance of $2.2 billion. The debt matures between
2033 and 2043 and is callable by the Company at par once the total balance of
the loans collateralizing the debt is reduced to 20% of their original balance.
The balance of this debt is reduced as the underlying loan collateral is paid
down and is expected to have an average life of three to four years.

18



---



##### Table of Contents





| |  | Whole Loan Financing Facilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | As of September 30, 2003, the Company had entered into three whole loan
financing facilities. The interest rates on these facilities are indexed to
one-month LIBOR and reprice accordingly. The first whole loan financing
facility has a committed borrowing capacity of $600 million and an uncommitted
capacity of $100 million and matures in November 2004. The second financing
facility has a committed borrowing capacity of $300 million and matures in
March 2004. The third financing facility has a committed borrowing capacity of
$300 million and an uncommitted capacity of $250 million and matures in
November 2003. The Company expects this facility to be renewed. As of
September 30, 2003, the Company had $1.0 billion borrowed against these whole
loan financing facilities at an effective cost of 1.85%. As of December 31,
2002, the Company had $589.1 million borrowed against whole loan financing
facilities at an effective cost of 2.11%. The amount borrowed on the whole
loan financing agreements at September 30, 2003 was collateralized by ARM loans
with a carrying value of $1.0 billion, including accrued interest. These
facilities have covenants that are standard for industry practice; the Company
is in compliance with all such covenants at September 30, 2003.
|
| |  | The whole loan financing facility with a borrowing capacity of $300 million and
maturing in March 2004, discussed above, is a securitization transaction in
which the Company transfers groups of whole loans to a wholly owned
bankruptcy-remote special purpose subsidiary. The subsidiary, in turn,
simultaneously transfers its interest in the loans to a trust, which issues
beneficial interests in the loans in the form of a note and a subordinated
certificate. The note is then used to collateralize borrowings. This whole
loan financing facility works similarly to a secured line of credit whereby the
Company can deliver loans into the facility and take loans out of the facility
at the Companys discretion subject to the terms and conditions of the
facility. This securitization transaction is accounted for as a structured
financing.                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | Senior Notes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | On May 15, 2003, the Company entered into an Indenture and a First Supplemental
Indenture with Deutsche Bank Trust Company Americas as Trustee, relating to the
completion by the Company of an unregistered offering of $200.0 million in
senior unsecured notes at par (Notes). The Notes bear interest at 8.0%,
payable each May 15 and November 15, commencing November 15, 2003, and mature
on May 15, 2013. The Notes are redeemable at a declining premium, in whole or
in part, beginning on May 15, 2008, and at par beginning on May 15, 2011. The
Notes may also be redeemed under limited circumstances on or before May 15,
2006. In connection with the issuance of the Notes, the Company incurred costs
of $5.8 million, which are being amortized to interest expense over the
expected life of the Notes. At September 30, 2003, the balance of the Notes
outstanding, net of unamortized issuance costs, was $194.5 million.                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | All outstanding notes were exchanged in the third quarter of 2003 for new
registered notes with terms substantially identical to the original notes,
pursuant to an exchange offer concluded by the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | The Companys senior note obligations contain both financial and non-financial
covenants. Significant financial covenants include limitations on the Companys
ability to incur indebtedness beyond specified levels, restrictions on the
Companys ability to incur liens on assets and limitations on the amount and
type of restricted payments, such as repurchases of its own equity securities,
that the Company makes. As of September 30, 2003, the Company is in compliance
with all financial and non-financial covenants on its senior note obligations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | Other                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | The total cash paid for interest was $85.7 million and $63.8 million during the
quarters ended September 30, 2003 and 2002, respectively, and $232.3 million
and $164.5 million for the nine months ended September 30, 2003 and 2002,
respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

19



---



##### Table of Contents



Note 5. Fair Value of Financial Instruments

| |  |                                                                                                                                                                                              
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The following table presents the carrying amounts and estimated fair values of
the Companys financial instruments at September 30, 2003 and December 31, 2002
(dollar amounts in thousands):

|             |                                   |  |                    |            |                   |  |          |            |       |  |   |           |     |  |   |           |    
|------------ | --------------------------------- |  | ------------------ | ---------- | ----------------- |  | -------- | ---------- | ----- |  | - | --------- | --- |  | - | --------- | ---
|             |                                   |  | September 30, 2003 |            | December 31, 2002
|             |                                   |  |                    |            |                  
|             |                                   |  | Carrying           |            | Fair              |  | Carrying |            | Fair 
|             |                                   |  | Amount             |            | Value             |  | Amount   |            | Value
|             |                                   |  |                    |            |                   |  |          |            |      
|Assets:      |                                   |  |                    |            |                   |  |          |            |       |  |   |           |     |  |   |          
|             | ARM securities                    |  | $                  | 10,177,743 |                   |  | $        | 10,177,743 |       |  | $ | 6,640,312 |     |  | $ | 6,640,312 |    
|             | Securitized ARM loans             |  |                    | 2,913,391  |                   |  |          | 2,927,526  |       |  |   | 2,695,331 |     |  |   | 2,695,331 |    
|             | ARM loans collateralizing CDOs    |  |                    | 2,179,779  |                   |  |          | 2,171,401  |       |  |   | 289,783   |     |  |   | 291,960   |    
|             | ARM loans held for securitization |  |                    | 1,228,695  |                   |  |          | 1,226,711  |       |  |   | 709,787   |     |  |   | 713,132   |    
|             | Hedging instruments               |  |                    | 26,244     |                   |  |          | 26,244     |       |  |   | 85        | (1) |  |   | 85        | (1)
|Liabilities: |                                   |  |                    |            |                   |  |          |            |       |  |   |           |     |  |   |          
|             | Reverse repurchase agreements     |  |                    | 12,579,032 |                   |  |          | 12,579,032 |       |  |   | 8,425,729 |     |  |   | 8,425,729 |    
|             | CDOs                              |  |                    | 2,152,809  |                   |  |          | 2,156,549  |       |  |   | 255,415   |     |  |   | 255,863   |    
|             | Whole loan financing facilities   |  |                    | 1,021,214  |                   |  |          | 1,021,214  |       |  |   | 589,081   |     |  |   | 589,081   |    
|             | Senior notes                      |  |                    | 194,520    |                   |  |          | 194,763    |       |  |   |          |     |  |   |          |    
|             | Hedging instruments               |  |                    | 155,479    |                   |  |          | 155,479    |       |  |   | 142,531   |     |  |   | 142,531   |    



|(1) |  | Life Cap Hedging Instruments were included in Other assets on the balance
sheet as of December 31, 2002.
|--- |  | --------------------------------------------------------------------------------------------------------

Note 6. Common and Preferred Stock



| |  | During February 2003, the Company completed a public offering of 3,473,500
shares of common stock and received net proceeds of $65.9 million under its
shelf registration statement on Form S-3 that was declared effective by the
Securities and Exchange Commission (SEC) on August 30, 2002.                                                                                                                                                              
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | On May 28, 2003, the Company entered into a sales agreement to sell up to
6,829,596 shares of its common stock from time to time with Cantor Fitzgerald &
Co., as sales agent, in a controlled equity offering program.                                                                                                                                                                                                                                        
|
| |  | During the three- and nine-months ended September 30, 2003, the Company issued
974,655 and 3,302,268 shares, respectively, of common stock in at-market
transactions under controlled equity offering programs under the August 2002
shelf registration statement and received net proceeds of $24.4 million and
$74.7 million, respectively.                                                                                                                
|
| |  | During the three- and nine-month periods ended September 30, 2003, the Company
issued 1,209,463 and 4,098,547 shares, respectively, of common stock under its
Dividend Reinvestment and Stock Purchase Plan (the DRSPP) and received net
proceeds of $30.2 million and $92.6 million, respectively.                                                                                                                                                          
|
| |  | On August 5, 2003, the Company completed a public offering of 4,000,000 shares
of common stock and received net proceeds of $104.6 million under the August
2002 shelf registration statement on Form S-3. As of September 30, 2003, $25.1
million and $86.6 million of the Companys registered securities remained
available for future issuance and sale under its currently effective July 2001
and August 2002 shelf registration statements, respectively
|
| |  | On August 18, 2003, the Company redeemed all 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock, or Series A Preferred Stock, by
converting each share of Series A Preferred Stock to one share of common stock.                                                                                                                                                                                                                        
|
| |  | On October 20, 2003, the Company declared the third quarter 2003 dividend of
$0.63 per share of common stock, which is payable on November 17, 2003 to
common shareholders of record as of November 5, 2003.                                                                                                                                                                                                                                                   
|
| |  | For federal income tax purposes, all dividends are expected to be ordinary
income to the Companys common and preferred shareholders, subject to year-end
allocations of the common dividend between ordinary income, capital gain income
and non-taxable income as return of capital, depending on the amount and
character of the Companys full year taxable income.                                                                                        

20



---



##### Table of Contents



Note 7. Long-Term Incentive Awards



| |  | The Compensation Committee of the Companys Board of Directors is authorized to
grant Dividend Equivalent Rights (DERs), Stock Appreciation Rights (SARs)
and Phantom Stock Rights (PSRs) pursuant to the Companys 2002 Long-Term
Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | As of September 30, 2003, there were 1,441,272 DERs outstanding, all of which
were vested, and 591,314 PSRs outstanding, of which 423,342 were vested. The
Company recorded an expense associated with DERs and PSRs of $2.3 million and
$718.3 thousand for the quarters ended September 30, 2003 and 2002,
respectively. During the nine-month periods ended September 30, 2003 and 2002,
the Company recorded an expense associated with DERs and PSRs in the amount of
$7.0 million and $2.2 million, respectively. Of the expense recorded in the
third quarter of 2003, $1.2 million was the amount of dividend equivalents paid
on DERs and PSRs, $438.0 thousand was the amortization of unvested PSRs, and
$614.1 thousand was the impact of the increase in the Companys common stock
price on the value of the PSRs which was recorded as a fair value adjustment.
Of the expense recorded during the third quarter of 2002, $798.6 thousand was
the amount of dividend equivalents paid on DERs and PSRs, $435.8 thousand was
the impact of the decrease in the Companys common stock price on the value of
the PSRs which was recorded as a fair value adjustment, and $355.5 thousand was
the amortization of unvested PSRs.
|
| |  | As of September 30, 2003, there was $5.9 million of notes receivable
outstanding from stock sales. All of these notes were made prior to the
enactment of the Sarbanes-Oxley Act of 2002 (the Act). As a result of the
Act, the notes made to directors and executive officers of the Company may not
be modified and these individuals are not eligible to participate in any such
program in the future. In April 2002, the Board approved a limited stock
repurchase program for the repurchase of shares of common stock at current
market value that were acquired pursuant to the exercise of stock options under
the Companys previous stock option plan. Any request for repurchase must be
approved by the Compensation Committee, which is composed of Independent
Directors of the Board of Directors. The Company will first apply the proceeds
from any such repurchases to the repayment of any outstanding stock option
notes receivable due from the holders. As of September 30, 2003, no shares
have been repurchased under this program.                                                                                                                                                                              

Note 8. Transactions with Affiliates



| |  | The Company has no employees and is managed externally by Thornburg Mortgage
Advisory Corporation (the Manager) under the terms of a Management Agreement
(the Agreement). During the quarters ended September 30, 2003 and 2002, the
Company reimbursed the Manager and affiliates of the Manager $1.0 million and
$696.1 thousand for expenses, respectively, in accordance with the terms of the
Agreement. During the nine-month periods ended September 30, 2003 and 2002,
the Company reimbursed the Manager and affiliates of the Manager $3.2 million
and $2.2 million for expenses, respectively. As of September 30, 2003 and
2002, $2.0 million and $675.0 thousand, respectively, was payable by the
Company to the Manager for reimbursable expenses.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | For the quarters ended September 30, 2003 and 2002, the Company incurred costs
of $3.1 million and $2.1 million, respectively, in base management fees in
accordance with the terms of the Agreement. For the nine-month periods ended
September 30, 2003 and 2002, the Company incurred base management fees of $8.2
million and $5.6 million, respectively. As of September 30, 2003 and 2002,
$1.1 million and $665.2 thousand, respectively, was payable by the Company to
the Manager for the base management fee.                                                                                                                                                                                                                                               
|
| |  | For the three- and nine-month periods ended September 30, 2003, the Manager
earned performance-based compensation in the amount of $7.1 million and $20.2
million, respectively, in accordance with the terms of the Agreement. For the
three- and nine-month periods ended September 30, 2002, the Manager earned
performance-based compensation in the amount of $5.0 million and $12.0 million,
respectively. As of September 30, 2003 and 2002, $7.1 million and $5.0
million, respectively, was payable by the Company to the Manager for
performance-based compensation.                                                                                                                                                                                        
|
| |  | During the nine-month period ended September 30, 2003, TMHL paid $25.0 thousand
to Thornburg Securities Corporation, a registered broker-dealer, pursuant to
the terms of a Joint Marketing Agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | As of September 30, 2003, the aggregate balance of mortgage loans outstanding
to directors and officers of the Company, and to employees of the Manager and
other affiliates, amounted to $29.3 million, had a weighted average interest
rate of 2.60%, and maturities ranging between 2016 and 2033.                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

21



---



##### Table of Contents



Note 9. Recent Developments



| |  | On October 28, 2003, the Company completed a securitization of approximately
$1.0 billion of mortgage loans from our ARM loan portfolio and 99.7% of the
resulting securities were rated Investment Grade. We continue to retain all
classes of the securitization in our securitized ARM loan portfolio.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | In October 2003, the Company entered into an additional whole loan financing
facility with a committed borrowing capacity of $150 million. This facility
matures in September 2004.                                                                                                                      

22



---



##### Table of Contents






Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain information contained in this Quarterly Report on Form 10-Q constitutes
forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934
that are based on our current expectations, estimates and projections. Pursuant
to those sections, we may obtain a safe harbor for forward-looking statements
by identifying those statements and by accompanying those statements with
cautionary statements, which identify factors that could cause actual results
to differ from those expressed in the forward-looking statements. Statements
that are not historical facts, including statements about our beliefs and
expectations, are forward-looking statements. The words believe,
anticipate, intend, aim, expect, will, strive, target and
project and similar words identify forward-looking statements. Such
statements are not guarantees of future performance, events or results and
involve potential risks and uncertainties. Accordingly, our actual results may
differ from our current expectations, estimates and projections. Important
factors that may impact our actual results or may cause our actual results to
differ materially from those expressed in any forward-looking statements made
by us or on our behalf include, but are not limited to, changes in interest
rates, changes in yields available for purchase on adjustable and variable rate
mortgage assets, changes in the yield curve, changes in prepayment rates,
changes in the supply of mortgage-backed securities and loans, our ability to
obtain financing and the terms of any financing that we do obtain. For a
discussion of the risks and uncertainties which could cause actual results to
differ from those contained in the forward-looking statements, see the Risk
Factors section on pages 14 through 17 of our 2002 Annual Report on Form 10K.
We do not undertake, and specifically disclaim, any obligation to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.

Corporate Governance

We pride ourselves on maintaining an ethical workplace in which the highest
standards of professional conduct are practiced. Accordingly, we would like to
highlight the following facts relating to corporate governance:



| |  |  | Our Board of Directors consists of a majority of independent
directors. The Audit, Nominating/Corporate Governance and Compensation
Committees of the Board of Directors are composed exclusively of
independent directors.                                                                                                                                                     
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Our long-term incentive plan does not provide for the granting of
stock options. All long-term incentive awards are fully expensed in our
consolidated income statements and are fully disclosed in our financial
reports.                                                                                                                                                      
|
| |  |  | We have established a formal internal audit function to further the
effective functioning of our internal controls and procedures. Our
internal audit plan is intended to provide management and the Audit
Committee with an effective tool to identify and address areas of
financial or operational concerns and ensure that appropriate controls
and procedures are in place.
|
| |  |  | We have adopted both a Code of Business Conduct and Ethics and
Corporate Governance Guidelines that cover a wide range of business
practices and procedures, that apply to all of our employees, officers
and directors, and that foster the highest standards of ethics and
conduct in all of our business relationships.                                                      
|
| |  |  | We have an Insider Trading Policy that prohibits any of the directors
or officers of the Company or any director, officer or employee of the
Manager from buying or selling our stock on the basis of material
nonpublic information, and prohibits communicating material nonpublic
information to others.                                                                     

Our Internet website address is www.thornburgmortgage.com. We make available
free of charge, through our Internet website, our annual report on Form 10-K,
our quarterly reports on Form 10-Q, our current reports on Form 8-K, ownership
reports on Forms 3, 4 and 5 and any amendments to those reports that we file or
furnish pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934 as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the Securities and Exchange Commission (the
SEC).

You may also find on our website our Code of Business Conduct and Ethics,
Corporate Governance Guidelines and the charters of the Audit Committee,
Nominating/Corporate Governance Committee and Compensation Committee of our
Board of Directors. These documents are also available in print to anyone who
requests them by writing to us at the following address: 150 Washington
Avenue, Suite 302, Santa Fe, New Mexico, 87501, or by phoning us at (505)
989-1900.

23



---



##### Table of Contents



Please note that the reference to our website address is an inactive textual
reference made only for purposes of complying with SEC rules.

Critical Accounting Policies

Our financial statements are prepared in conformity with generally accepted
accounting principles, many of which require the use of estimates and
assumptions. In accordance with recent SEC guidance, those material accounting
policies that we believe are the most critical to an investors understanding
of our financial results and condition and require complex management judgment
have been expanded and discussed below.



| |  | Fair Value. We record our adjustable and variable rate mortgage
(ARM) securities, interest rate cap agreements (Cap Agreements),
interest rate swap agreements (Swap Agreements) and Eurodollar
futures contracts (Eurodollar Transactions) at fair value. The fair
values of our ARM securities and Hedging Instruments (collectively,
Cap Agreements, Swap Agreements and Eurodollar Transactions) are
generally based on market prices provided by certain dealers who make
markets in these financial instruments or third-party pricing
services. If the fair value of an ARM security, Hedging Instrument or
other financial instrument is not reasonably available from a dealer
or a third-party pricing service, management estimates the fair value.
This requires management judgment in determining how the market would
value a particular ARM security, Hedging Instrument or other financial
instrument, based on characteristics of the security we receive from
the issuer and available market information. The net unrealized gain
on loans expected to be purchased from correspondent lenders and bulk
sellers is calculated using the same methodologies that are used to
value our ARM loans, adjusted for anticipated fallout for interest
rate lock commitments that will likely not be funded. The fair values
reported reflect estimates and may not necessarily be indicative of
the amounts we could realize in a current market exchange.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Loan Loss Reserves on ARM Loans. The Company maintains an allowance
for loan losses based on managements estimate of credit losses
inherent in the Companys portfolio of ARM Loans. The estimation of
the allowance is based on a variety of factors including, but not
limited to, current economic conditions, loan portfolio composition,
delinquency trends, credit losses to date on underlying loans and
remaining credit protection. If the credit performance of its ARM
Loans is different than expected, the Company adjusts the allowance
for loan losses to a level deemed appropriate by management to provide
for estimated losses inherent in its ARM Loan portfolio.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| 
| |  | Basis Adjustments on ARM securities. Basis adjustments are a
designated component of the purchase discount on our ARM securities.
Certain of our ARM securities are rated less than Investment Grade and
represent subordinated interests in pools of high-quality, first lien
residential mortgage loans. As a result of these characteristics, we
generally purchase the less than Investment Grade classes at a
discount. Based upon managements use of analytical tools and
judgment, a portion of the purchase discount is subsequently accreted
as interest income under the effective yield method while the
remaining portion of the purchase discount is treated as a basis
adjustment. Basis adjustments are increased by recognizing an
impairment loss when management determines that there is a decline in
the fair value of an ARM security which is considered other than
temporary. Any such determination is based on managements assessment
of numerous factors affecting the fair value of ARM securities,
including, but not limited to, current economic conditions,
delinquency trends, credit losses to date on underlying mortgages and
remaining credit protection.                                                                                                                                                                                                                                                                                  
| 
| |  | Revenue Recognition. Interest income on ARM assets is a combination
of accruing interest based on the outstanding balance and contractual
terms of the assets and the amortization of yield adjustments using
generally accepted interest methods, principally the amortization of
purchase premiums and discounts. Premiums and discounts associated
with the purchase of ARM assets are amortized into interest income
over the lives of the assets using the effective yield method adjusted
for the effects of estimated prepayments. Estimating prepayments and
estimating the remaining lives of our ARM assets requires management
judgment, which involves consideration of possible future interest
rate environments and an estimate of how borrowers will behave in
those environments. The actual lives could be more or less than the
amount estimated by management at the time of purchase of the ARMs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

For additional information on our significant accounting policies, see Note 1
to the Consolidated Financial Statements.

General

We are a single-family residential mortgage lender that originates, acquires
and retains investments in ARM assets comprised of traditional ARM securities
and loans and hybrid ARM securities and loans, thereby providing capital to the
single-family residential housing market. Traditional ARM securities and loans
have interest rates that reprice in a year or less (Traditional

24



---



##### Table of Contents



ARMs) and
hybrid ARM securities and loans have a fixed interest rate for an initial
period of three to ten years and then convert to Traditional ARMs for their
remaining terms to maturity (Hybrid ARMs). ARM securities represent
interests in pools of ARM loans, which are publicly rated and include
guarantees or other credit enhancements against losses from loan defaults.
ARM Loans consist of securitized ARM loans, ARM loans collateralizing
long-term debt and ARM loans held for securitization.

While we are not a bank or savings and loan institution, our business purpose,
strategy, method of operation and risk profile are best understood in
comparison to such institutions. We finance the purchases and originations of
our ARM assets with equity capital and borrowings such as reverse repurchase
agreements, whole loan financing facilities, floating-rate long-term
collateralized debt obligations (CDO) and other collateralized or unsecured
financings that we may establish with approved institutional lenders. We have
a policy to operate with an Adjusted Equity-to-Assets Ratio of at least 8%.
For purposes of applying this ratio, our Adjusted Equity-to-Assets ratio
excludes Other comprehensive income (loss) and assets financed with
non-recourse debt and the related equity and includes senior notes as an
addition to equity. (See Financing Strategies below for a calculation of our
Adjusted Equity-to-Assets Ratio.) Since all of the assets we hold are ARM
assets and we pursue a matched funding strategy, we believe our exposure to
changes in interest rates can be prudently managed. Moreover, we focus on
acquiring primarily high quality assets to ensure our access to financing.
Similarly, we maintain strict credit underwriting standards and have
experienced cumulative credit losses of only $174,000 on our loan portfolio
over the last six years. Our low cost operating structure has resulted in
operating costs well below those of other mortgage originators. We believe our
corporate structure differs from most lending institutions in that we are
organized for tax purposes as a real estate investment trust (REIT) and,
therefore, substantially all of our earnings are paid in the form of dividends
to shareholders, without paying federal or state income tax at the corporate
level.

We have five qualified REIT subsidiaries, all of which are consolidated in our
financial statements and federal and state income tax returns. Two of these
subsidiaries, Thornburg Mortgage Funding Corporation and Thornburg Mortgage
Acceptance Corporation, were created to facilitate financing of our mortgage
loan assets. Thornburg Mortgage Home Loans, Inc. (TMHL), our wholly owned
mortgage-banking subsidiary, conducts our mortgage loan acquisition,
origination, processing, underwriting, securitization, and servicing
activities. TMHLs two wholly owned special purpose subsidiaries, Thornburg
Mortgage Funding Corporation II and Thornburg Mortgage Acceptance Corporation
II, facilitate the financing of loans by TMHL.

We are an externally advised REIT and are managed under a management agreement
(the Management Agreement) with Thornburg Mortgage Advisory Corporation (the
Manager), which manages our operations, subject to the supervision of our
Board of Directors.

Portfolio Strategies

Our business strategy is to acquire and originate ARM assets to hold in our
portfolio, fund them using equity capital and borrowed funds, and generate
earnings from the difference, or spread, between the yield on our assets and
our cost of borrowing. We originate ARM loans for our portfolio through our
correspondent lending program, which currently includes approximately 120
approved correspondents, and we originate loans direct to consumers through
TMHL. Currently, TMHL is authorized to lend in 46 states and the District of
Columbia. Our authorization to lend in these jurisdictions depends on our
compliance with the applicable licensing and other regulatory requirements of
each jurisdiction, and it is our intention to operate in compliance with those
requirements. In addition, we are subject to examination by each jurisdiction,
and if it is determined that we are not in compliance with the applicable
requirements, we may be fined and our license to lend may be suspended or
revoked. Additionally, we acquire ARM assets by purchasing ARM securities or
large packages of ARM loans that other mortgage lending institutions have
originated and serviced. We believe that diversifying our sources for ARM
loans and ARM securities will enable us to consistently find attractive
opportunities to acquire or create high quality assets at attractive yields and
spreads for our portfolio.

We also acquire ARM assets from investment banking firms, broker-dealers and
similar financial institutions that regularly make markets in these assets. We
also acquire ARM assets from other mortgage suppliers, including mortgage
bankers, banks, savings and loan institutions, investment banking firms, home
builders and other firms involved in originating, packaging and selling
mortgage loans. We believe we have a competitive advantage in the acquisition
and investment of these mortgage securities and loans due to the low cost of
our operations relative to traditional mortgage investors, such as banks and
savings and loans.

We have a focused portfolio lending investment policy designed to minimize
credit risk and interest rate risk. Our mortgage assets portfolio may consist
of ARM pass-through securities guaranteed by an agency of the federal
government (Ginnie

25



---



##### Table of Contents



Mae), a government-sponsored corporation or federally-chartered corporation
(Fannie Mae or Freddie Mac) (collectively, Agency Securities), or
privately issued (generally publicly registered) ARM pass-through securities,
multi-class pass-through securities, floating rate classes of collateralized
mortgage obligations (CMOs), ARM loans, fixed rate mortgage-backed securities
(MBS) with an expected duration of one year or less or short-term investments
that either mature within one year or have an interest rate that reprices
within one year.

Our ARM assets also include investments in Hybrid ARM assets, which are
typically 30-year loans with a fixed rate of interest for an initial period,
generally 3 to 10 years, and then convert to an adjustable rate for the balance
of their term. In April 2003, our Board of Directors increased the limitation
on our ownership of Hybrid ARM assets with fixed rate periods of greater than
five years from 10% to 20% of our total assets. We also have a policy to
maintain a net duration of 1 year or less on our Hybrid ARM assets (including
commitments to purchase Hybrid ARM assets), related borrowings and Hybrid
Hedging Instruments. We use Swap Agreements, Cap Agreements and Eurodollar
Transactions (collectively, Hybrid Hedging Instruments) as hedges to fix the
maximum interest rates on our short-term borrowing costs and to manage our
interest rate risk exposure on our CDOs.

Our investment policy requires that we invest at least 70% of total assets in
High Quality ARM assets and short-term investments. High Quality means:



| | (1) |  | Agency Securities; or                                                                                                                                                                                                                                                                                
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (2) |  | securities and securitized loans which are rated within one of the
two highest rating categories by at least one of either Standard &
Poors Corporation or Moodys Investors Service, Inc. (the Rating
Agencies); or                                                                              
|
| | (3) |  | securities that are unrated or whose ratings have not been updated
but are determined to be of comparable quality (by the rating standards
of at least one of the Rating Agencies) to a High Quality rated mortgage
security, as determined by the Manager and approved by our Board of
Directors; or
|
| | (4) |  | the portion of ARM loans that have been deposited into a trust and
have received a credit rating of AA or better from at least one Rating
Agency.                                                                                                                                                    

The remainder of our ARM portfolio, comprising not more than 30% of total
assets, may consist of Other Investment assets, which may include:



| | (1) |  | adjustable or variable rate pass-through certificates, multi-class
pass-through certificates or CMOs backed by loans on single-family,
multi-family, commercial or other real estate-related properties so long
as they are rated at least Investment Grade at the time of purchase.
Investment Grade generally means a security rating of BBB or Baa or
better by at least one of the Rating Agencies; or                       
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (2) |  | ARM loans collateralized by first liens on single-family residential
properties, generally underwritten to A quality standards, and
acquired for the purpose of future securitization; or                                                                                                                                                                                                                                        
|
| | (3) |  | fixed rate mortgage loans collateralized by first liens on single
family residential properties originated for sale to third parties; or                                                                                                                                                                                                                                                                                           
|
| | (4) |  | real estate properties acquired as a result of foreclosing on our ARM
loans; or                                                                                                                                                                                                                                                                                                                                                    
|
| | (5) |  | as authorized by our Board of Directors, ARM securities rated less
than Investment Grade that are created as a result of our loan
acquisition and securitization efforts or are acquired as part of a loan
securitization effected by third parties in which we purchase all of the
classes of the loan securitization and that equal an amount no greater
than 17.5% of shareholders equity, measured on a historical cost basis.

To mitigate the adverse effect of an increase in prepayments on our ARM assets,
we emphasize the purchase of ARM assets at prices close to or below par. We
amortize any premiums paid for our assets over their expected lives using the
effective yield method of accounting. To the extent that the prepayment rate
on our ARM assets differs from expectations, our net interest income will be
affected. Prepayments generally increase when mortgage interest rates fall
below the interest rates on ARM loans. To the extent there is an increase in
prepayment rates, resulting in a shortening of the expected lives of our ARM
assets, our net income and, therefore, the amount available for dividends could
be adversely affected. Our portfolio of ARM assets is held at a book price,
excluding unrealized gains and losses, of 101.24% of par at September 30, 2003,
compared to 101.01% at December 31, 2002. This is a non-GAAP measurement that
provides the average amount of cash we have paid, net of amortization we have
expensed, for the assets we hold in our ARM portfolio above par. We amortize
all premiums and discounts over the expected life of the ARM assets. However,
our ARM assets can be paid off at any time, which is why we provide this
non-GAAP measurement. The corresponding GAAP measurement of book price,
including unrealized gains and losses, was 101.07% at September 30, 2003,
compared to 101.45% at December 31, 2002.

26



---



##### Table of Contents



We believe that our status as a mortgage REIT makes an investment in our equity
securities attractive for tax-exempt investors, such as pension plans, profit
sharing plans, 401(k) plans, Keogh plans and Individual Retirement Accounts.
We do not invest in real estate mortgage investment conduit (REMIC) residuals
or other CMO residuals that would result in the creation of excess inclusion
income or unrelated business taxable income.

Acquisition, Securitization and Retention of Traditional ARM and Hybrid ARM
Loans

We acquire and originate High Quality mortgage loans through TMHL from three
sources: (i) correspondent lending, (ii) direct retail loan originations, and
(iii) bulk acquisitions. Correspondent lending involves acquiring individual
loans from correspondent lenders who are approved by the Company and who
originate the individual loans using our underwriting criteria and guidelines,
or criteria and guidelines that we have approved. We also underwrite each
correspondent loan prior to purchase. Direct retail loan originations are
loans that we originate through retail channels. Bulk acquisitions involve
acquiring pools of whole loans, which are originated using the sellers
guidelines and underwriting criteria. Prior to purchasing a bulk pool, we
review the underwriting on a selected sample of the loans in the pool. The
loans we acquire or originate are financed through warehouse borrowing
arrangements and securitized for our portfolio.

The loans acquired or originated by TMHL are first lien, single-family
residential Traditional ARM and Hybrid ARM loans with original terms to
maturity of not more than forty years and are either fully amortizing or are
interest-only up to ten years, and fully amortizing thereafter. Interest-only
loans acquired or originated during the first nine months of 2003 represented
89.1% of total loan production during that period. We believe interest-only
loans do not pose additional credit risk due to original effective
loan-to-value ratios averaging 66.9% and the credit strength of our borrowers.

All ARM loans that we acquire for our portfolio bear an interest rate tied to
an interest rate index. Most loans have periodic and lifetime constraints on
how much the loan interest rate can change on any predetermined interest rate
reset date. The interest rate on each Traditional ARM loan resets monthly,
semi-annually or annually. The Traditional ARM loans generally adjust to a
margin over a U.S. Treasury index or a LIBOR index. The Hybrid ARM loans have
a fixed rate for an initial period, generally 3 to 10 years, and then convert
to Traditional ARM loans for their remaining term to maturity.

We acquire ARM loans for our portfolio with the intention of securitizing them
into pools of High Quality ARM securities and retaining them in our portfolio
as securitized ARM loans. Alternatively, we may also use our loans as
collateral for long-term debt financings. In order to facilitate the
securitization or financing of our loans, we generally create subordinate
certificates, which provide a specified amount of credit enhancement. Upon
securitization, we retain the securitized ARM loans, including the subordinate
certificates, and either finance them in the repurchase agreement market or
through the issuance of collateralized long-term debt in the capital markets.
Our investment policy limits the amount we may retain of these below Investment
Grade subordinate certificates, and subordinate classes that we purchase in
connection with a whole pool securitization effected by third parties, to 17.5%
of shareholders equity, measured on a historical cost basis.

We believe the acquisition and origination of ARM loans for securitization
benefits us by providing: (i) greater control over the quality and types of ARM
assets acquired; (ii) the ability to acquire ARM assets at lower prices, so
that the amount of the premium to be amortized will be reduced in the event of
prepayment; (iii) additional sources of new whole-pool ARM assets; and (iv)
generally higher yielding investments in our portfolio.

We offer a loan modification program on all loans we originate and certain
loans we acquire. We believe this program promotes customer retention and
reduces loan prepayments. Under the terms of this program, a borrower pays a
fee to modify the mortgage loan to any then-available hybrid or adjustable-rate
product that we offer at the offered retail interest rate plus 1/8%. During
the quarter ended September 30, 2003, we modified 635 loans with balances
totaling $343.7 million. At September 30, 2003, the pipeline of loans to be
modified totaled $22.6 million which represents a significant decline from
recent levels of modification activity due to the recent increase in interest
rates.

27



---



##### Table of Contents



Financing Strategies

We finance our ARM assets using equity capital and borrowings, such as reverse
repurchase agreements, lines of credit, and other collateralized or unsecured
financings that we may establish with approved institutional lenders. We have
established lines of credit and collateralized financing agreements with
twenty-four different financial institutions. Our Board policy requires that
we maintain an Adjusted Equity-to-Assets Ratio, a non-GAAP measurement that we
use to limit the amount of assets we carry relative to the amount of equity on
our balance sheet, of a minimum of 8%. This ratio may vary from time to time
depending upon market conditions and other factors that our management deems
relevant, but cannot fall below 8%. Adjusted equity to assets represents the
long-term capital supporting our recourse or marginable debt. The following
table presents the calculation of our Adjusted Equity-to-Assets ratio, a
non-GAAP measurement:

|                     |                                              |                                          |                                 |            |                    |            |                   |          |          |            |  
|-------------------- | -------------------------------------------- | ---------------------------------------- | ------------------------------- | ---------- | ------------------ | ---------- | ----------------- | -------- | -------- | ---------- | -
|                     |                                              |                                          |                                 |            | September 30, 2003 |            | December 31, 2002
|                     |                                              |                                          |                                 |            |                    |            |                  
|Assets               |                                              | $                                        | 17,287,445                      |            |                    | $          | 10,512,932        |         
|Adjustments:         |                                              |                                          |                                 |            |                    |            |                   |         
|                     | Net unrealized (gain) loss on ARM securities |                                          |                                 | 28,662     |                    |            |                   | (44,682  | )       
|                     | Net unrealized loss on hedging instruments   |                                          |                                 | 2,903      |                    |            |                   |         |         
|                     | ARM loans collateralizing long-term debt     |                                          |                                 | (2,179,779 | )                  |            |                   | (289,783 | )       
|                     | Cap agreements (1)                           |                                          |                                 | (29,137    | )                  |            |                   |         |         
|                     |                                              |                                          |                                 |            |                    |            |                   |         
|                     |                                              |                                          | Adjusted assets                 |            | $                  | 15,110,094 |                   |          | $        | 10,178,467 |  
|                     |                                              |                                          |                                 |            |                    |            |                   |         
|Shareholders equity |                                              | $                                        | 1,120,275                       |            |                    | $          | 833,042           |         
|Adjustments:         |                                              |                                          |                                 |            |                    |            |                   |         
|                     | Accumulated other comprehensive loss         |                                          |                                 | 204,448    |                    |            |                   | 105,254  |         
|                     | Equity supporting CDOs:                      |                                          |                                 |            |                    |            |                   |          |         
|                     |                                              | CDOs                                     |                                 |            | 2,152,809          |            |                   |          | 255,415  |           
|                     |                                              | ARM loans collateralizing long-term debt |                                 |            | (2,179,779         | )          |                   |          | (289,783 | )         
|                     |                                              | Cap agreements (1)                       |                                 |            | (29,137            | )          |                   |          |         |           
|                     |                                              |                                          |                                 |            |                    |            |                   |         
|                     |                                              |                                          | (56,107                         | )          |                    |            | (34,368           | )       
|                     | Senior notes                                 |                                          |                                 | 194,520    |                    |            |                   |         |         
|                     |                                              |                                          |                                 |            |                    |            |                   |         
|                     |                                              |                                          | Adjusted shareholders equity   |            | $                  | 1,463,136  |                   |          | $        | 903,928    |  
|                     |                                              |                                          |                                 |            |                    |            |                   |         
|                     |                                              |                                          | Adjusted equity-to-assets ratio |            |                    | 9.68       | %                 |          |          | 8.88       | %
|                     |                                              |                                          |                                 |            |                    |            |                   |         
|                     |                                              |                                          | GAAP equity-to-assets ratio     |            |                    | 6.48       | %                 |          |          | 7.92       | %
|                     |                                              |                                          |                                 |            |                    |            |                   |         

(1)  These Cap Agreements were purchased in order to manage interest rate risk
exposure on the financing of the Hybrid ARM loans collateralizing our CDOs.

We borrow primarily at short-term interest rates and in the form of reverse
repurchase agreements using our ARM securities and securitized ARM loans as
collateral. Reverse repurchase agreements involve a simultaneous sale of
pledged assets to a lender at an agreed-upon price in return for the lenders
agreement to resell the same assets back to us at a future date (the maturity
of the borrowing) at a higher price. The price difference is the cost of
borrowing under these agreements. We generally enter into two types of reverse
repurchase agreements: variable rate term reverse repurchase agreements and
fixed rate reverse repurchase agreements. Variable rate term reverse
repurchase agreements are financings with original maturities ranging from two
to 25 months. The interest rates on these variable rate term reverse
repurchase agreements are indexed to either the one-month or three-month LIBOR
rate, and reprice accordingly. The fixed rate reverse repurchase agreements
have

28



---



##### Table of Contents



original maturities generally ranging from 30 to 180 days. Generally, upon
repayment of each reverse repurchase agreement, we immediately pledge the ARM
assets used to collateralize the financing to secure a new reverse repurchase
agreement.

We have also financed the purchase of ARM assets by issuing floating-rate CDOs
in the capital markets, which are collateralized by ARM loans that are placed
in a trust. The trust pays the principal and interest payments on the debt out
of the cash flows received on the collateral. This structure enables us to
make more efficient use of our capital because the capital requirement to
support these financings is less than the amount required to support the same
amount of financings in the reverse repurchase agreement market and these
transactions represent permanent financing of these loans and are not subject
to margin calls.

We also enter into financing facilities for whole loans. A whole loan is the
actual mortgage loan evidenced by a note and secured by a mortgage or deed of
trust. We use these credit lines to finance our acquisition of whole loans
while we are accumulating loans for securitization.

Hedging Strategies

We attempt to mitigate our interest rate risk by funding our ARM assets with
borrowings whose maturities approximately match the interest rate adjustment
periods on our ARM assets. Accordingly, some of our borrowings have variable
interest rates or short term fixed maturities (one year or less) because, as of
September 30, 2003, 19.7% of our ARM assets were Traditional ARMs, which had
interest rates that adjust within one year. However, the majority of our
portfolio is comprised of Hybrid ARM assets, which have fixed interest rate
periods of 3 to 10 years and, as of September 30, 2003, averaged a 4.5-year
fixed rate period. We utilize Hybrid Hedging Instruments to, in effect, fix
the interest rate on our borrowings such that the net duration of our Hybrid
ARM assets, related borrowings and Hybrid Hedging Instruments is no more than
one year. A lower duration indicates a lower expected volatility of earnings
given future changes in interest rates. When we enter into a Swap Agreement,
we agree to pay a fixed rate of interest and to receive a variable interest
rate, generally based on LIBOR. We also enter into Eurodollar Transactions in
order to fix the interest rate changes on our forecasted three-month LIBOR
based liabilities. We purchase Cap Agreements by incurring a one-time fee or
premium. Pursuant to the terms of the Cap Agreements, we will receive cash
payments if the interest rate index specified in any such Cap Agreement
increases above contractually specified levels. Therefore, such Cap Agreements
have the effect of capping the interest rate on a portion of our borrowings,
above a level specified by the Cap Agreement. The notional balances of the
Hybrid Hedging Instruments generally decline over the life of these
instruments. As of September 30, 2003, our Hybrid Hedging Instruments had a
remaining average term to maturity of 3.8 years and when combined with our
Hybrid ARM assets and related borrowings had a net duration of approximately
1.3 months.

In general, our Traditional ARM assets have a maximum lifetime interest rate
cap, or ceiling, meaning that each ARM asset contains a contractual maximum
interest rate. Since our borrowings are not subject to equivalent interest
rate caps, we have also entered into Cap Agreements, so that the net margin on
our Traditional ARM assets with maximum lifetime interest rate caps will be
protected in high interest rate environments. These Cap Agreements are
referred to as Life Cap Hedging Instruments. Pursuant to the terms of these
Life Cap Hedging Instruments owned as of September 30, 2003, we will receive
cash payments if the applicable index, generally the three-month or six-month
LIBOR index, increases above contractually specified levels. The fair value of
these Cap Agreements generally increases when general market interest rates
increase and decreases when market interest rates decrease, helping to
partially offset changes in the fair value of our ARM assets related to the
effect of the lifetime interest rate cap. We are not currently purchasing Life
Cap Hedging Instruments because the current interest rate environment is
significantly lower than the contractual life caps on our ARM assets.

In addition, some Traditional ARM assets are subject to periodic caps.
Periodic caps generally limit the maximum interest rate coupon change on any
interest rate coupon adjustment date to either a maximum of 1.00% per
semiannual adjustment or 2.00% per annual adjustment. The borrowings that we
incur do not have similar periodic caps. However, we believe the impact of the
periodic caps is somewhat mitigated because we own our ARM assets at a net
price above par and, therefore, the yield on our ARM assets can change by an
amount greater than the associated periodic cap due to changes in the
amortization of the net price above par. Further, the contractual future
interest rate adjustments on the ARM assets will cause their interest rates to
increase over time and reestablish the ARM assets interest rate to a spread
over the then current index rate. As of September 30, 2003, $1.3 billion of
our Traditional ARM assets have periodic caps, representing 8.2% of total ARM
assets.

We may enter into other hedging-type transactions designed to protect our
borrowing costs or portfolio yields from interest rate changes. We may also
purchase interest-only mortgage derivative assets or other mortgage
derivative products for purposes of mitigating risk from interest rate changes,
although we have not, to date, entered into these types of transactions. We
may

29



---



##### Table of Contents



also use, from time to time, futures contracts and options on futures contracts
on the Eurodollar, Federal Funds, Treasury bills and Treasury notes and similar
financial instruments to mitigate risk from changing interest rates.

The hedging transactions that we currently use generally are designed to
protect our net interest income during periods of changing market interest
rates. We do not hedge for speculative purposes. Further, no hedging strategy
can completely insulate us from risk, and certain of the federal income tax
requirements that we must satisfy to qualify as a REIT may limit our ability to
hedge, particularly with respect to hedging against periodic cap risk. We
carefully monitor and may have to limit our hedging strategies to ensure that
we do not realize excessive hedging income or hold hedging assets having excess
value in relation to total assets.

Financial Condition

At September 30, 2003, we held total assets of $17.3 billion, $16.5 billion of
which consisted of ARM assets, as compared to $10.5 billion of total assets and
$10.3 billion of ARM assets at December 31, 2002. Since commencing operations,
we have primarily purchased either ARM securities or ARM loans. At September
30, 2003, 61.7% of our ARM assets were ARM securities, 17.7% were securitized
ARM loans, 13.2% were ARM loans collateralizing long-term debt and 7.4% were
ARM loans held for securitization. At September 30, 2003, 91.6% of our assets,
including cash and cash equivalents, restricted cash and accrued interest
receivable on High Quality assets, were High Quality assets, far exceeding our
investment policy minimum requirement of investing at least 70% of our total
assets in High Quality ARM assets and cash and cash equivalents.

The following table presents a schedule of ARM assets owned at September 30,
2003 and December 31, 2002 classified by High Quality and Other Investment
assets and further classified by type of issuer and by ratings categories. The
securitized ARM loans are stratified in the table below based on the credit
rating determined by the Rating Agency on the related securities:

ARM Assets by Issuer and Credit Rating
(Dollar amounts in thousands)

|                   |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |      |       |  
|------------------ | -------------------------------- | ---------------------- | ---------------------- | --------- | ------------------ | ---------- | ----------------- | ---- | -------- | ----- | --------- | --------- | --------- | ---------- | ---- | ---- | ---- | ----- | -
|                   |                                  |                        |                        |           | September 30, 2003 |            | December 31, 2002
|                   |                                  |                        |                        |           |                    |            |                  
|                   |                                  |                        |                        |           | Carrying           |            | Portfolio         |      | Carrying |       | Portfolio
|                   |                                  |                        |                        |           | Value              |            | Mix               |      | Value    |       | Mix      
|                   |                                  |                        |                        |           |                    |            |                   |      |          |       |          
|High Quality:      |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |     
|                   | Agency Securities                |                        | $                      | 1,958,499 |                    |            |                   | 11.9 | %        |       | $         | 2,682,555 |           |            |      | 26.0 | %   
|                   | Privately Issued:                |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |     
|                   |                                  | AAA/Aaa Rating         |                        |           | 12,719,844         | (1)        |                   |      | 77.1     |       |           |           | 6,409,860 | (2)        |      |      | 62.0 |      
|                   |                                  | AA/Aa Rating           |                        |           | 411,683            |            |                   |      | 2.5      |       |           |           | 394,096   |            |      |      | 3.8  |      
|                   |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |     
|                   |                                  |                        | Total Privately Issued |           |                    | 13,131,527 |                   |      |          | 79.6  |           |           |           | 6,803,956  |      |      |      | 65.8  |  
|                   |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |     
|                   |                                  |                        | Total High Quality     |           |                    | 15,090,026 |                   |      |          | 91.5  |           |           |           | 9,486,511  |      |      |      | 91.8  |  
|                   |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |     
|Other Investment:  |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |     
|                   | Privately Issued:                |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |     
|                   |                                  | A Rating               |                        |           | 104,861            |            |                   |      | 0.6      |       |           |           | 63,198    |            |      |      | 0.6  |      
|                   |                                  | BBB/Baa Rating         |                        |           | 39,525             |            |                   |      | 0.2      |       |           |           | 31,657    |            |      |      | 0.3  |      
|                   |                                  | BB/Ba Rating and below |                        |           | 43,083             | (1)        |                   |      | 0.3      |       |           |           | 44,060    | (2)        |      |      | 0.4  |      
|                   | ARM loans pending securitization |                        |                        | 1,228,945 |                    |            |                   | 7.4  |          |       |           | 709,887   |           |            |      | 6.9  |     
|                   |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |     
|                   |                                  |                        | Total Other Investment |           |                    | 1,416,414  |                   |      |          | 8.5   |           |           |           | 848,802    |      |      |      | 8.2   |  
|                   |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |     
|Loan Loss Reserves |                                  |                        | (6,832                 | )         |                    |            | (0.0              | )    |          |       | (100      | )         |           |            | (0.0 | )   
|                   |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |     
|                   |                                  |                        | Total ARM Portfolio    |           | $                  | 16,499,608 |                   |      |          | 100.0 | %         |           | $         | 10,335,213 |      |      |      | 100.0 | %
|                   |                                  |                        |                        |           |                    |            |                   |      |          |       |           |           |           |            |      |      |     



---

|(1) |  | As of September 30, 2003, the AAA Rating category includes $2.2
billion of ARM loans collateralizing long-term debt that have been
credit enhanced to AAA through overcollateralization in the amount of
$6.1 million and unrated subordinate interest-only certificates retained
in the amount of $15.2 million. The subordinated interest-only
certificates are included in the BB/Ba Rating and below category.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

30



---



##### Table of Contents



|(2) |  | As of December 31, 2002, the AAA Rating category includes $261.3
million of ARM loans collateralizing long-term debt that have been
credit enhanced to AAA by a combination of an insurance policy purchased
from a third party and an unrated subordinated certificate retained in
the amount of $31.7 million as of December 31, 2002. The subordinated
certificate is included in the BB/Ba Rating and below category.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As of September 30, 2003, 12 of the 14,557 loans in our ARM loan portfolio were
considered seriously delinquent (60 days or more delinquent) and had an
aggregate balance of $4.4 million. The average original effective
loan-to-value ratio on the delinquent loans was approximately 71%. We believe
that our current level of allowance for loan losses is more than adequate to
cover estimated losses from these loans.

At September 30, 2003, the ARM loan portfolio included two real estate-owned
properties totaling approximately $1.1 million that we acquired as a result of
foreclosure procedures.

The following table classifies our portfolio of ARM assets by type of interest
rate index:

ARM Assets by Index
(Dollar amounts in thousands)

|                        |                         |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |   |      |      |  
|----------------------- | ----------------------- | ---------------- | ----------------------------------- | - | ------------------ | --------- | ----------------- | - | -------- | --- | ---------- | - | --------- | --------- | ----- | - | ---- | ---- | -
|                        |                         |                  |                                     |   | September 30, 2003 |           | December 31, 2002
|                        |                         |                  |                                     |   |                    |           |                  
|                        |                         |                  |                                     |   | Carrying           |           | Portfolio         |   | Carrying |     | Portfolio 
|                        |                         |                  |                                     |   | Value              |           | Mix               |   | Value    |     | Mix       
|                        |                         |                  |                                     |   |                    |           |                   |   |          |     |           
|Traditional ARM assets: |                         |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |  
|                        | Index:                  |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |   |     
|                        |                         |                  | One-month LIBOR                     |   | $                  | 658,050   |                   |   |          | 4.0 | %          |   | $         | 576,837   |       |   |      | 5.6  | %
|                        |                         |                  | Six-month LIBOR                     |   |                    | 1,491,057 |                   |   |          | 9.0 |            |   |           | 834,709   |       |   |      | 8.1  |  
|                        |                         |                  | One-year Constant Maturity Treasury |   |                    | 867,129   |                   |   |          | 5.3 |            |   |           | 1,095,945 |       |   |      | 10.6 |  
|                        |                         |                  | Other                               |   |                    | 231,844   |                   |   |          | 1.4 |            |   |           | 359,605   |       |   |      | 3.4  |  
|                        |                         |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |  
|                        |                         |                  | 3,248,080                           |   |                    |           | 19.7              |   |          |     | 2,867,096  |   |           |           | 27.7  |  
|                        |                         |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |  
|Hybrid ARM assets:      |                         |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |  
|                        | Remaining fixed period: |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |   |     
|                        |                         | Within 1-5 years |                                     |   | 10,461,826         |           |                   |   | 63.4     |     |            |   | 6,859,456 |           |       |   | 66.4 |     
|                        |                         | Over 5 years     |                                     |   | 2,796,534          |           |                   |   | 16.9     |     |            |   | 608,761   |           |       |   | 5.9  |     
|                        |                         |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |  
|                        |                         |                  | 13,258,360                          |   |                    |           | 80.3              |   |          |     | 7,468,217  |   |           |           | 72.3  |  
|                        |                         |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |  
|Loan Loss Reserves      |                         |                  | (6,832                              | ) |                    |           | (0.0              | ) |          |     | (100       | ) |           |           | (0.0  | )
|                        |                         |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |  
|                        |                         | $                | 16,499,608                          |   |                    |           | 100.0             | % |          | $   | 10,335,213 |   |           |           | 100.0 | %
|                        |                         |                  |                                     |   |                    |           |                   |   |          |     |            |   |           |           |       |  

The ARM portfolio had a current weighted average coupon of 4.43% at September
30, 2003. This consisted of an average coupon of 4.57% on the Hybrid ARM
portion of the portfolio and an average coupon of 3.67% on the Traditional ARM
portion of the portfolio. If the portfolio had been fully indexed, the
weighted average coupon of the portfolio would have been approximately 4.20%,
based upon the current composition of the portfolio and the applicable indices.
Additionally, if the Traditional ARM portion of the portfolio had been fully
indexed, the weighted average coupon of that portion of the portfolio would
have been approximately 3.12%, also based upon the current composition of the
portfolio and the applicable indices. The term fully indexed refers to an
ARM asset that has an interest rate that is currently equal to its applicable
index plus a margin to the index that is specified by the terms of the ARM
asset.

As of December 31, 2002, the ARM portfolio had a current weighted average
coupon of 4.99%. This consisted of an average coupon of 5.23% on the Hybrid
ARM portion of the portfolio and an average coupon of 4.27% on the Traditional
ARM portion of the portfolio. If the Traditional ARM portion of the portfolio
had been fully indexed, the weighted average coupon of the ARM portfolio
would have been approximately 4.82%, based upon the composition of the
portfolio and the applicable indices at that time.

At September 30, 2003, the current yield of the ARM assets portfolio was 3.96%,
compared to 4.63% as of December 31, 2002. The decrease in the yield of 67
basis points is due primarily to the decreased weighted average interest rate
coupon, which

31



---



##### Table of Contents



decreased by 56 basis points, due to the reinvestment of principal prepayments
and new assets purchased with the equity offering proceeds in a declining
interest rate environment. The higher level of net premium amortization had
the effect of decreasing the yield by 2 basis points, increased loan loss
reserves decreased the yield by 1 basis point and the relative level of
non-interest earning principal payments receivables also decreased the
portfolio yield by 8 basis points.

The ARM assets portfolio had an average term to the next repricing date of 3.8
years as of September 30, 2003, compared to 2.8 years as of December 31, 2002.
The Traditional ARM assets portion of the portfolio had an average term to the
next repricing date of 83 days and the Hybrid ARM assets portion had an average
term to the next repricing date of 4.5 years at September 30, 2003. As of
September 30, 2003, Hybrid ARM assets comprised 80.3% of the total ARM assets
portfolio, compared to 72.3% as of the end of 2002.

32



---



##### Table of Contents



The following table presents various characteristics of our ARM loan portfolio
as of September 30, 2003. This information pertains to loans held for
securitization, loans held as collateral for notes payable and loans
securitized for our own portfolio for which we retained credit loss exposure.
The combined amount of the loans included in this table is $6.3 billion.

ARM Loan Portfolio Characteristics

|                         |  |         |         |      |  |     |           |   |  |   |        |  
|------------------------ |  | ------- | ------- | ---- |  | --- | --------- | - |  | - | ------ | -
|                         |  | Average |         | High |  | Low
|                         |  |         |         |      |  |    
|Original loan balance    |  | $       | 443,165 |      |  | $   | 6,400,000 |   |  | $ | 31,000 |  
|Unpaid principal balance |  | $       | 435,146 |      |  | $   | 6,400,000 |   |  | $ | 1,013  |  
|Coupon rate on loans     |  |         | 4.48    | %    |  |     | 9.13      | % |  |   | 1.67   | %
|Pass-through rate        |  |         | 4.29    | %    |  |     | 8.73      | % |  |   | 1.65   | %
|Pass-through margin      |  |         | 1.88    | %    |  |     | 3.48      | % |  |   | 0.23   | %
|Lifetime cap             |  |         | 10.62   | %    |  |     | 18.00     | % |  |   | 7.25   | %
|Original term (months)   |  |         | 359     |      |  |     | 480       |   |  |   | 120    |  
|Remaining term (months)  |  |         | 344     |      |  |     | 478       |   |  |   | 33     |  

|                                                   |  |      |   |                                                  |  |      |    
|-------------------------------------------------- |  | ---- | - | ------------------------------------------------ |  | ---- | ---
|Geographic distribution (top 5 states):            |  |      |   | Property type:                                   |  |      |    
|California                                         |  | 25.2 | % | Single-family                                    |  | 85.7 | %  
|Georgia                                            |  | 12.2 |   | Condominium                                      |  | 9.3  |    
|Colorado                                           |  | 7.5  |   | Other residential                                |  | 5.0  |    
|New York                                           |  | 7.1  |   |                                                  |  |      |    
|Florida                                            |  | 6.1  |   | ARM Loan type:                                   |  |      |    
|                                                   |  |      |   | Traditional ARM loans                            |  | 29.9 | %  
|Occupancy status:                                  |  |      |   | Hybrid ARM loans                                 |  | 70.1 |    
|Owner occupied                                     |  | 84.9 | % |                                                  |  |      |    
|Second home                                        |  | 12.0 |   | ARM Interest Rate Caps:                          |  |      |    
|Investor                                           |  | 3.1  |   | Initial Cap on Hybrid loans:                     |  |      |    
|                                                   |  |      |   | 3.00% or less                                    |  | 3.4  | %  
|Documentation type:                                |  |      |   | 3.01%-4.00%                                      |  | 12.6 |    
|Full/Alternative                                   |  | 91.2 | % | 4.01%-5.00%                                      |  | 43.2 |    
|Other                                              |  | 8.8  |   | 5.01%-6.00%                                      |  | 10.9 |    
|                                                  
|                                                   |  |      |   | Periodic Cap on Traditional ARM loans:           |  |      |    
|Loan purpose:                                      |  |      |   | None                                             |  | 14.4 | %  
|Purchase                                           |  | 32.7 | % | 1.00% or less                                    |  | 13.4 |    
|Cash out refinance                                 |  | 31.0 |   | Over 1.00%                                       |  | 2.1  |    
|Rate & term refinance                              |  | 36.3 |   |                                                  |  |      |    
|                                                  
|Original effective                                 |  |      |   | Percent of loan balances that
are interest-only: |  | 82.7 | %  
|loan-to-value:                                     |  |      |   |                                                  |  |      |    
|80.01%-and over (2)                                |  | 3.1  | % | FICO scores:                                     |  |      |    
|70.01%-80.00%                                      |  | 40.9 |   | 801 and over                                     |  | 2.5  | %  
|60.01%-70.00%                                      |  | 24.6 |   | 751 to 800                                       |  | 41.9 |    
|50.01%-60.00%                                      |  | 13.0 |   | 701 to 750                                       |  | 34.0 |    
|50.00% or less                                     |  | 18.4 |   | 651 to 700                                       |  | 18.3 |    
|                                                   |  |      |   | 650 or less                                      |  | 3.3  |    
|                                                  
|Weighted average effective original
loan-to-value: |  | 67.0 | % | Weighted average FICO score                      |  | 738  | (1)



|(1) |  | FICO is a credit score, ranging from 300 to 850, with 850 being the
best score, based upon the credit evaluation methodology developed by
Fair, Isaac and Company, a consulting firm specializing in creating
credit evaluation models.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | All loans with an effective original loan-to-value ratio over 80%
have mortgage insurance.                                                                                                                                             

33



---



##### Table of Contents



As of September 30, 2003 and December 31, 2002, we serviced $3.8 billion and
$2.0 billion of our loans, respectively, and had 8,358 and 4,778 customer
relationships, respectively. We hold all of the loans that we service in our
portfolio in the form of securitized ARM loans, loans collateralizing long-term
debt or ARM loans held for securitization.

During the quarter ended September 30, 2003, we purchased $2.6 billion of ARM
securities, 99.7% of which were High Quality assets, and $1.6 billion of ARM
loans, generally originated to A quality underwriting standards. Of the ARM
assets acquired during the three months ended September 30, 2003, 94.9% were
Hybrid ARM assets and 5.1% were Traditional ARM assets indexed to LIBOR. The
following table compares our ARM asset acquisition and origination activity for
the three- and nine-month periods ended September 30, 2003 and 2002 (dollar
amounts in thousands):

|                |                                |                            |                    |           |                             |           |                            |           |               |           |               |           |           |            |           |           |           |           | 
|--------------- | ------------------------------ | -------------------------- | ------------------ | --------- | --------------------------- | --------- | -------------------------- | --------- | ------------- | --------- | ------------- | --------- | --------- | ---------- | --------- | --------- | --------- | --------- | 
|                |                                |                            |                    |           | For the three months ended: |           | For the nine months ended:
|                |                                |                            |                    |           |                             |           |                           
|                |                                |                            |                    |           | September 30,               |           | September 30,              |           | September 30, |           | September 30,
|                |                                |                            |                    |           | 2003                        |           | 2002                       |           | 2003          |           | 2002         
|                |                                |                            |                    |           |                             |           |                            |           |               |           |              
|ARM securities: |                                |                            |                    |           |                             |           |                            |           |               |           |               |           |           |            |           |          
|                | Agency Securities              |                            | $                  |          |                             |           | $                          | 183,604   |               |           | $             | 348,211   |           |            | $         | 2,634,578 |          
|                | High Quality, privately issued |                            |                    | 2,631,050 |                             |           |                            | 1,296,422 |               |           |               | 7,026,579 |           |            |           | 2,504,982 |          
|                | Other privately issued         |                            |                    | 8,477     |                             |           |                            |          |               |           |               | 26,063    |           |            |           |          |          
|                |                                |                            |                    |           |                             |           |                            |           |               |           |               |           |           |            |           |           |          
|                |                                |                            | 2,639,527          |           |                             |           | 1,480,026                  |           |               |           | 7,400,853     |           |           |            | 5,139,560 |          
|                |                                |                            |                    |           |                             |           |                            |           |               |           |               |           |           |            |           |           |          
|ARM loans:      |                                |                            |                    |           |                             |           |                            |           |               |           |               |           |           |            |           |          
|                |                                | Bulk acquisitions          |                    |           | 608,150                     |           |                            |           | 79,744        |           |               |           | 1,281,669 |            |           |           | 448,194   |          
|                |                                | Correspondent originations |                    |           | 778,299                     |           |                            |           | 528,818       |           |               |           | 2,246,728 |            |           |           | 1,223,326 |          
|                |                                | Direct retail originations |                    |           | 221,045                     |           |                            |           | 78,814        |           |               |           | 431,921   |            |           |           | 235,761   |          
|                |                                |                            |                    |           |                             |           |                            |           |               |           |               |           |           |            |           |           |          
|                |                                |                            | 1,607,494          |           |                             |           | 687,376                    |           |               |           | 3,960,318     |           |           |            | 1,907,281 |          
|                |                                |                            |                    |           |                             |           |                            |           |               |           |               |           |           |            |           |           |          
|                |                                |                            | Total acquisitions |           | $                           | 4,247,021 |                            |           | $             | 2,167,402 |               |           | $         | 11,361,171 |           |           | $         | 7,046,841 | 
|                |                                |                            |                    |           |                             |           |                            |           |               |           |               |           |           |            |           |           |          

Since 1997, we have emphasized purchasing ARM assets, high quality, floating
rate collateralized mortgages and short term, fixed rate securities at
substantially lower prices relative to par in order to reduce the potential
impact of rapid prepayments. In doing so, the average premium/(discount) that
we paid for ARM assets acquired in the first nine months of 2003 and for the
year 2002 was 1.14% and 0.78% of par, respectively, as compared to 3.29% of par
in 1997 when we emphasized the purchase of seasoned ARM assets. In part, as a
result of this strategy, the book price of our ARM assets, excluding unrealized
gains and losses, was 101.24% of par as of September 30, 2003, down from
102.77% of par as of the end of 1997. This is a non-GAAP measurement that
provides the average amount of cash we have paid, net of amortization we have
expensed, for the assets we hold in our ARM portfolio above par. We amortize
all premiums and discounts over the expected life of the ARM assets. However,
our ARM assets can be paid off at any time, which is why we provide this
non-GAAP measurement. The corresponding GAAP measurement of book price,
including unrealized gains and losses, was 101.07% at September 30, 2003,
compared to 102.49% at December 31, 1997.

During the three- and nine-month periods ended September 30, 2003, we
securitized $1.4 billion and $4.0 billion, respectively, of our ARM loans into
a series of multi-class ARM securities. The securitization process benefits us
by creating highly liquid assets that can be readily financed in the reverse
repurchase agreement market or by enabling us to enter into floating-rate CDOs
that represent permanent financing and are not subject to margin calls. The
securitizations of the Companys loans are not accounted for as sales and we
retain all of the economic interest and risk of the loans. Of the loans that
we securitized during the first nine months of 2003, 99.9% of our resulting
investment was rated at least Investment Grade and 0.1% of our investment was
rated below Investment Grade and provided credit support to the Investment
Grade securities.

As of September 30, 2003, we had commitments to purchase $1.4 billion of ARM
securities, $63.0 million of ARM loans through wholesale channels and $821.4
million of ARM loans through origination channels.

During the quarter ended September 30, 2003, there were no sales of ARM assets.
We sold $10.1 million of ARM securities for a gain of $18.5 thousand during
the quarter ended September 30, 2002.

For the quarter ended September 30, 2003, our mortgage assets paid down at an
approximate average annualized Constant Paydown Rate (CPR) of 39%, compared
to 30% for the quarter ended September 30, 2002 and 31% for the quarter ended
June 30, 2003. When prepayments increase, we have to amortize the premium at
which we own our ARM assets over a shorter time period, which reduces the yield
to maturity on our ARM assets. Conversely, if actual prepayments decrease, we
would

34



---



##### Table of Contents



amortize the premium over a longer time period, resulting in a higher yield to
maturity. We monitor our prepayment experience on a monthly basis in order to
adjust the amortization of the net premium, as appropriate.

The amount of the adjustment to the fair value on the purchased ARM securities
classified as available-for-sale declined from a positive adjustment of $44.7
million as of December 31, 2002, to a negative adjustment of $28.7 million as
of September 30, 2003. All of our ARM securities are classified as
available-for-sale and are carried at their fair value.

Our Traditional ARM assets generally have a maximum lifetime interest rate cap
or ceiling, meaning that each Traditional ARM asset contains a contractual
maximum interest rate. Since our borrowings are not subject to equivalent
interest rate caps, we have entered into Cap Agreements that have the effect of
offsetting a portion of our borrowing costs above a level specified by the Cap
Agreement so that the net margin on our Traditional ARM assets will be
protected in high interest rate environments. As of September 30, 2003, our
Traditional ARM assets had an average lifetime interest rate cap of 11.14%, far
exceeding the current level of interest rates. At September 30, 2003, these
Cap Agreements had a remaining notional balance of $1.0 billion with an average
final maturity of ten months, compared to a remaining notional balance of $1.8
billion with an average final maturity of one year at December 31, 2002. At
September 30, 2003, the fair value of these Cap Agreements was $10.7 thousand
compared to a fair value of $84.7 thousand as of December 31, 2002. Pursuant
to the terms of the Cap Agreements, we will receive cash payments if the one
month or three month LIBOR indices increase above contractually specified
levels, which range from 6.00% to 12.00% and average approximately 9.91%. Due
to the current low level of interest rates, we have decided not to purchase
additional Cap Agreements for Traditional ARM assets at this time, but will
reevaluate this policy on an ongoing basis. We do not currently apply hedge
accounting to our Cap Agreements which are used to manage the interest rate
risk on our assets with contractual Life Caps and, as a result, we record the
change in fair value of these Cap Agreements as hedging expense in current
earnings.

We enter into Hybrid Hedging Instruments in order to manage our interest rate
exposure when financing our Hybrid ARM assets. We generally borrow money based
on short-term interest rates. Our Hybrid ARM assets generally have an initial
fixed interest rate period of three to ten years. As a result, our existing
and forecasted borrowings reprice to a new interest rate on a more frequent
basis than our Hybrid ARM assets. Both Swap Agreements and Eurodollar
Transactions have the effect of converting our variable rate debt into fixed
rate debt over the life of the Swap Agreements and Eurodollar Transactions. We
use Swap Agreements and Eurodollar Transactions as a cost effective way to
lengthen the average repricing period of our variable rate and short-term
borrowings such that the duration of our borrowings more closely matches the
duration of our ARM assets. We use Cap Agreements to protect the net margin on
our Hybrid ARM assets in higher interest rate environments by establishing a
maximum fixed interest rate on a portion of our borrowings funding Hybrid ARM
assets. We generally enter into Swap Agreements, Eurodollar Transactions and
Cap Agreements that have notional balances that decline over time in
approximate relation to the expected paydown of our Hybrid ARM assets. The
relative balances and duration of our Hybrid ARM assets and our Hybrid Hedging
Instruments are monitored on a continual basis in order to manage the net
duration within our policy limits.

As of September 30, 2003, we were counterparty to Swap Agreements and
Eurodollar Transactions having an aggregate current notional balance of $9.6
billion. In addition, we entered into five delayed Swap Agreements, three of
which have a total notional balance of $915 million and become effective in
October 2003, one with a notional balance of $180 million becoming effective in
November 2003 and the last with a notional balance of $270 million becoming
effective in February 2003. These Swap Agreements and Eurodollar Transactions
fix the interest rate on the financing of our Hybrid ARM assets during their
fixed rate term (generally three to ten years). As of September 30, 2003,
these Swap Agreements and Eurodollar Transactions had a weighted average
maturity of 3.5 years. In accordance with the Swap Agreements, we will pay a
fixed rate of interest during the term of these Swap Agreements and receive a
payment that varies monthly with the one-month LIBOR rate. The combined
weighted average fixed rate payable of the Swap Agreements and Eurodollar
Transactions was 3.05% and 3.74% at September 30, 2003 and December 31, 2002,
respectively. As of September 30, 2003, ARM assets with a carrying value of
$84.1 million, including accrued interest, and cash totaling $43.6 million
collateralized the Swap Agreements. The net fair value of Swap Agreements at
September 30, 2003 of $150.8 million included Swap Agreements with gross
unrealized gains of $4.7 million and gross unrealized losses of $155.5 million
and is included in Hedging instruments on the balance sheet. As of September
30, 2003, the net unrealized loss on Swap Agreements, deferred gains from
terminated Swap Agreements and deferred gains and losses on Eurodollar
Transactions recorded in Accumulated other comprehensive income (loss) was a
net loss of $167.4 million. We estimate that over the next twelve months,
$78.6 million of these net unrealized losses will be reclassified from
Accumulated other comprehensive income (loss) to interest expense.

In April and August 2003, we purchased Cap Agreements with notional balances of
$576.7 million and $995.3 million, respectively, at a cost of $8.9 million and
$20.2 million, respectively, in order to manage our interest rate risk exposure
on the financing of the Hybrid ARM loans collateralizing our CDOs. These Cap
Agreements had a remaining notional amount of $1.5

35



---



##### Table of Contents



billion as of September 20, 2003. The fair value of these Cap Agreements at
September 30, 2003 was $21.5 million and is included in Hedging instruments on
the balance sheet. The unrealized loss on these Cap Agreements of $7.6 million
is included in Accumulated other comprehensive income (loss). Pursuant to the
terms of these Cap Agreements, the notional amount of the Cap Agreements
declines such that it is expected to equal the balance of the Hybrid ARM loans
collateralizing our CDOs. Under these Cap Agreements, we will receive cash
payments should the one-month LIBOR increase above the contract rates of these
Hedging Instruments, which range from 3.25% to 4.61% and average 3.81%. The
Cap Agreements had an average maturity of 5.4 years as of September 30, 2003.
The initial aggregate notional amount of the Cap Agreements declines over the
period of the agreements, which expire between 2006 and 2012.

As a result of entering into these Hybrid Hedging Instruments, we have reduced
the interest rate variability of our cost to finance Hybrid ARM assets. The
average remaining fixed rate term of our Hybrid ARM assets as of September 30,
2003 was 4.5 years. We hedge the funding of our Hybrid ARM assets such that
the weighted average net duration of borrowed funds, Hybrid Hedging Instruments
and Hybrid ARM assets is less than one year. At September 30, 2003, the
financing and hedging of our Hybrid ARM assets resulted in a net duration of
approximately 1.3 months.

In accordance with Financial Accounting Standards No. 133 (FAS 133), we
designate all of these Swap Agreements as cash flow hedges. The Swap
Agreements and the short-term borrowings they hedge have nearly identical terms
and characteristics with respect to the applicable index and interest rate
repricing dates, and we have calculated the effectiveness of this cash flow
hedge to be approximately 100%. As a result, we have recorded all changes in
the unrealized gains and losses on Swap Agreements in Accumulated other
comprehensive income (loss) and we have reclassified all such changes to
earnings as interest expense is recognized on our hedged borrowings.

Also, in accordance with FAS 133, we designate all of the Eurodollar
Transactions as cash flow hedges. The Eurodollar Transactions hedge the change
in the three-month LIBOR interest rate index and we have also entered into
short-term borrowings indexed to three-month LIBOR with re-pricing dates that
correspond to the valuation dates of the Eurodollar Transactions. As a result,
there has not been any measurable ineffectiveness from this activity and,
therefore, the gains and losses from this activity have been recorded in
Accumulated other comprehensive income (loss) and will be reclassified to
earnings as interest expense is recognized on our hedged short-term borrowings.

We designate the Cap Agreements used as Hybrid Hedging Instruments as cash flow
hedges. We assess hedging effectiveness in accordance with the provisions of
FAS 133 Implementation Issue No. G20 and have calculated such effectiveness at
approximately 100%. All changes in the unrealized gains and losses on these
Cap Agreements have been recorded in Accumulated other comprehensive income
(loss) and are reclassified to earnings as interest expense when each of the
forecasted financing transactions occurs.

Results of Operations For the Three Months Ended September 30, 2003

For the quarter ended September 30, 2003, our net income was $45.8 million, or
$0.69 basic earnings per share and $0.68 diluted earnings per share, based on
weighted average basic and diluted shares outstanding of 66,092,000 and
67,532,000, respectively. That compares to $32.6 million, or $0.68 and $0.67
per share, basic and diluted EPS, respectively, for the quarter ended September
30, 2002, based on weighted average basic and diluted shares outstanding of
45,733,000 and 48,493,000, respectively, a 1.5% increase in our earnings per
share.

36



---



##### Table of Contents



The table below highlights the historical trend, the components of return on
average common equity (annualized) and the 10-year U.S. Treasury average yield
during each respective quarter that is applicable to the computation of the
performance fee of the Manager:

Components of Return on Average Common Equity (1)

|             |  |          |       |         |  |        |      |           |  |         |      |           |  |         |      |          |  |           |       |     |  |    |      |         |  |  |       |   |  |         |      |           |  |        |       |  
|------------ |  | -------- | ----- | ------- |  | ------ | ---- | --------- |  | ------- | ---- | --------- |  | ------- | ---- | -------- |  | --------- | ----- | --- |  | -- | ---- | ------- |  |  | ----- | - |  | ------- | ---- | --------- |  | ------ | ----- | -
|             |  |          |       |         |  |        |      |           |  |         |      |           |  |         |      |          |  |           |       |     |  |    |      |         |  |  |       |   |  |         |      |           |  | ROE in
|             |  |          |       |         |  |        |      |           |  |         |      |           |  |         |      |          |  |           |       |     |  |    |      |         |  |  |       |   |  | 10-Year |      | Excess of
|             |  | Net      |       | G & A   |  |        |      |           |  |         |      |           |  | Other   |      |          |  |           |       | Net |  | US |      | 10-Year
|For the      |  | Interest |       | Expense |  | Mgmt   |      | Incentive |  | Expense |      | Preferred |  | Income/ |      | Treasury |  | US Treas.
|Quarter      |  | Income/  |       | (2)/    |  | Fee/   |      | Fee/      |  | (3)/    |      | Dividend/ |  | Equity  |      | Average  |  | Average  
|Ended        |  | Equity   |       | Equity  |  | Equity |      | Equity    |  | Equity  |      | Equity    |  | (ROE)   |      | Yield    |  | Yield    
|             |  |          |       |         |  |        |      |           |  |         |      |           |  |         |      |          |  |          
|Sep 30, 2001 |  |          | 21.36 | %       |  |        | 1.72 | %         |  |         | 1.35 | %         |  |         | 1.76 | %        |  |           | 0.79  | %   |  |    | 1.80 | %       |  |  | 13.94 | % |  |         | 4.99 | %         |  |        | 8.95  | %
|Dec 31, 2001 |  |          | 25.25 | %       |  |        | 2.26 | %         |  |         | 1.25 | %         |  |         | 2.70 | %        |  |           | 0.27  | %   |  |    | 1.46 | %       |  |  | 17.31 | % |  |         | 4.76 | %         |  |        | 12.55 | %
|Mar 31, 2002 |  |          | 23.16 | %       |  |        | 1.60 | %         |  |         | 1.20 | %         |  |         | 2.34 | %        |  |           | 0.24  | %   |  |    | 1.22 | %       |  |  | 16.56 | % |  |         | 5.08 | %         |  |        | 11.49 | %
|Jun 30, 2002 |  |          | 22.53 | %       |  |        | 1.74 | %         |  |         | 1.16 | %         |  |         | 2.27 | %        |  |           | 0.33  | %   |  |    | 1.02 | %       |  |  | 16.01 | % |  |         | 5.11 | %         |  |        | 10.90 | %
|Sep 30, 2002 |  |          | 23.15 | %       |  |        | 1.43 | %         |  |         | 1.13 | %         |  |         | 2.75 | %        |  |           | 0.08  | %   |  |    | 0.91 | %       |  |  | 16.85 | % |  |         | 4.27 | %         |  |        | 12.58 | %
|Dec 31, 2002 |  |          | 23.05 | %       |  |        | 2.15 | %         |  |         | 1.09 | %         |  |         | 2.74 | %        |  |           | (0.24 | )%  |  |    | 0.82 | %       |  |  | 16.49 | % |  |         | 4.00 | %         |  |        | 12.48 | %
|Mar 31, 2003 |  |          | 22.58 | %       |  |        | 1.78 | %         |  |         | 1.08 | %         |  |         | 2.68 | %        |  |           | 0.09  | %   |  |    | 0.72 | %       |  |  | 16.23 | % |  |         | 3.92 | %         |  |        | 12.31 | %
|Jun 30, 2003 |  |          | 21.27 | %       |  |        | 2.05 | %         |  |         | 1.04 | %         |  |         | 2.69 | %        |  |           | (0.91 | )%  |  |    | 0.65 | %       |  |  | 15.75 | % |  |         | 3.62 | %         |  |        | 12.13 | %
|Sep 30, 2003 |  |          | 20.10 | %       |  |        | 1.56 | %         |  |         | 1.03 | %         |  |         | 2.39 | %        |  |           | (0.24 | )%  |  |    | 0.00 | %       |  |  | 15.35 | % |  |         | 4.23 | %         |  |        | 11.12 | %



---

(2)  General and administrative (G & A) expense excludes performance fees and
is net of loan servicing fees.

(3)  Other expense includes gain on ARM assets, fee income, hedging expense and
provision for credit losses.

Components of Return on GAAP Average Common Equity (1)

|             |  |          |       |         |  |        |      |           |  |         |      |           |  |         |      |           |  |  |       |     |  |        |      |   |  |  |       |   |  |         |       | 
|------------ |  | -------- | ----- | ------- |  | ------ | ---- | --------- |  | ------- | ---- | --------- |  | ------- | ---- | --------- |  |  | ----- | --- |  | ------ | ---- | - |  |  | ----- | - |  | ------- | ----- | 
|             |  |          |       |         |  |        |      |           |  |         |      |           |  |         |      |           |  |  |       |     |  |        |      |   |  |  |       |   |  | Average
|             |  | Net      |       | G & A   |  |        |      |           |  |         |      |           |  | Other   |      |           |  |  |       | Net |  | Accum.
|For the      |  | Interest |       | Expense |  | Mgmt   |      | Incentive |  | Expense |      | Preferred |  | Income/ |      | OCL (in  
|Quarter      |  | Income/  |       | (2)/    |  | Fee/   |      | Fee/      |  | (3)/    |      | Dividend/ |  | Equity  |      | Millions)
|Ended        |  | Equity   |       | Equity  |  | Equity |      | Equity    |  | Equity  |      | Equity    |  | (ROE)   |      | (4)      
|             |  |          |       |         |  |        |      |           |  |         |      |           |  |         |      |          
|Sep 30, 2001 |  |          | 25.90 | %       |  |        | 2.09 | %         |  |         | 1.63 | %         |  |         | 2.13 | %         |  |  | 0.97  | %   |  |        | 2.18 | % |  |  | 16.90 | % |  | $       | 65.0  | 
|Dec 31, 2001 |  |          | 28.07 | %       |  |        | 2.52 | %         |  |         | 1.39 | %         |  |         | 3.00 | %         |  |  | 0.30  | %   |  |        | 1.62 | % |  |  | 19.25 | % |  |         | 46.1  | 
|Mar 31, 2002 |  |          | 25.17 | %       |  |        | 1.74 | %         |  |         | 1.31 | %         |  |         | 2.54 | %         |  |  | 0.25  | %   |  |        | 1.33 | % |  |  | 18.01 | % |  |         | 43.8  | 
|Jun 30, 2002 |  |          | 23.80 | %       |  |        | 1.84 | %         |  |         | 1.23 | %         |  |         | 2.40 | %         |  |  | 0.35  | %   |  |        | 1.08 | % |  |  | 16.92 | % |  |         | 35.2  | 
|Sep 30, 2002 |  |          | 24.62 | %       |  |        | 1.52 | %         |  |         | 1.20 | %         |  |         | 2.92 | %         |  |  | 0.09  | %   |  |        | 0.97 | % |  |  | 17.92 | % |  |         | 43.8  | 
|Dec 31, 2002 |  |          | 24.90 | %       |  |        | 2.32 | %         |  |         | 1.17 | %         |  |         | 2.96 | %         |  |  | (0.26 | )%  |  |        | 0.89 | % |  |  | 17.82 | % |  |         | 60.5  | 
|Mar 31, 2003 |  |          | 25.56 | %       |  |        | 2.02 | %         |  |         | 1.22 | %         |  |         | 3.04 | %         |  |  | 0.09  | %   |  |        | 0.82 | % |  |  | 18.38 | % |  |         | 107.8 | 
|Jun 30, 2003 |  |          | 23.93 | %       |  |        | 2.31 | %         |  |         | 1.17 | %         |  |         | 3.03 | %         |  |  | (1.03 | )%  |  |        | 0.73 | % |  |  | 17.72 | % |  |         | 114.6 | 
|Sep 30, 2003 |  |          | 21.97 | %       |  |        | 1.70 | %         |  |         | 1.13 | %         |  |         | 2.62 | %         |  |  | (0.26 | )%  |  |        | 0.00 | % |  |  | 16.79 | % |  |         | 101.7 | 



---

|(1) |  | Average common equity on a GAAP basis includes unrealized gain (loss) on
available-for-sale ARM securities.                                                                                                                        
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | General and administrative (G & A) expense excludes performance fees and
is net of loan servicing fees.                                                                                                                          
|   
|(3) |  | Other expense includes gain on ARM assets, fee income, hedging expense and
provision for credit losses.                                                                                                                            
|   
|(4) |  | Average accumulated other comprehensive loss (OCL) is included in GAAP
equity in this table and excluded from the computations in the non-GAAP
table presented above this table and is included here to reconcile the two
tables.

The following table presents the components of our net interest income:

37



---



##### Table of Contents



Comparative Net Interest Income Components
(Dollar amounts in thousands)

|                                                          |                  |   |                                      |         |      |   |         |         | 
|--------------------------------------------------------- | ---------------- | - | ------------------------------------ | ------- | ---- | - | ------- | ------- | 
|                                                          |                  |   | For the quarters ended September 30,
|                                                          |                  |   |                                     
|                                                          |                  |   | 2003                                 |         | 2002
|                                                          |                  |   |                                      |         |     
|Coupon interest income on ARM assets                      |                  | $ | 160,166                              |         |      | $ | 113,803 |        
|Amortization of net premium                               |                  |   | (10,024                              | )       |      |   | (4,727  | )      
|Cash, cash equivalents and restricted cash                |                  |   | 1,024                                |         |      |   | 586     |        
|                                                          |                  |   |                                      |         |      |   |         |        
|                                                          | Interest income  |   |                                      | 151,166 |      |   |         | 109,662 | 
|                                                          |                  |   |                                      |         |      |   |         |        
|Reverse repurchase agreements                             |                  |   | 36,137                               |         |      |   | 38,381  |        
|CDOs                                                      |                  |   | 5,398                                |         |      |   | 1,967   |        
|Whole loan financing facilities                           |                  |   | 4,688                                |         |      |   | 2,848   |        
|Senior notes                                              |                  |   | 4,180                                |         |      |   |        |        
|Interest rate swap agreements and
Eurodollar transactions |                  |   | 40,858                               |         |      |   | 23,953  |        
|                                                          |                  |   |                                      |         |      |   |         |        
|                                                          | Interest expense |   |                                      | 91,261  |      |   |         | 67,149  | 
|                                                          |                  |   |                                      |         |      |   |         |        
|Net interest income                                       |                  | $ | 59,905                               |         |      | $ | 42,513  |        
|                                                          |                  |   |                                      |         |      |   |         |        

As presented in the table above, our net interest income increased by $17.4
million in the third quarter of 2003 compared to the third quarter of 2002.
The change was attributable to a $41.5 million increase in interest income
primarily due to an increased asset base, partially offset by a $24.1 million
increase in interest expense. Included in this increase in interest expense is
a $16.9 million increase resulting from the impact of Swap Agreements and
Eurodollar Transactions which is commensurate with the increase in borrowings
financing our Hybrid ARM assets. Hybrid ARM assets totaled $13.3 billion and
$6.6 billion at September 30, 2003 and 2002, respectively.

38



---



##### Table of Contents



The following table presents the average balances for each category of our
interest earning assets as well as our interest bearing liabilities, with the
corresponding annualized effective rate of interest and the related interest
income or expense:

Average Balance, Rate, Interest Income and Interest Expense Table
(Dollar amounts in thousands)

|                                         |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |            |   |           |           |  |  |      |      |          |   |         |         | 
|---------------------------------------- | ------------------------------------------------- | - | ------------------------------------ | ---------- | --------- |  | ---------- | ---- | ------- | - | --------- | ------- | ---------- | - | --------- | --------- |  |  | ---- | ---- | -------- | - | ------- | ------- | 
|                                         |                                                   |   | For the quarters ended September 30,
|                                         |                                                   |   |                                     
|                                         |                                                   |   | 2003                                 |            | 2002     
|                                         |                                                   |   |                                      |            |          
|                                         |                                                   |   |                                      |            |           |  |            |      |         |   | Interest  |         |            |   |           |           |  |  |      |      | Interest
|                                         |                                                   |   | Average                              |            | Effective |  | Income and |      | Average |   | Effective |         | Income and
|                                         |                                                   |   | Balance                              |            | Rate      |  | Expense    |      | Balance |   | Rate      |         | Expense   
|                                         |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |           
|Interest Earning Assets:                 |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |            |   |           |           |  |  |      |      |          |   |         |        
|                                         | Adjustable-rate mortgage assets                   |   | $                                    | 15,287,022 |           |  |            | 3.93 | %       |   | $         | 150,142 |            |   | $         | 9,143,764 |  |  |      | 4.77 | %        |   | $       | 109,076 | 
|                                         | Cash, cash equivalents and
restricted cash        |   |                                      | 414,113    |           |  |            | 0.99 |         |   |           | 1,024   |            |   |           | 93,486    |  |  |      | 2.51 |          |   |         | 586     | 
|                                         |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |            |   |           |           |  |  |      |      |          |   |         |         | 
|                                         |                                                   |   | 15,701,135                           |            |           |  | 3.85       |      |         |   | 151,166   |         |            |   | 9,237,250 |           |  |  | 4.75 |      |          |   | 109,662 |        
|                                         |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |            |   |           |           |  |  |      |      |          |   |         |         | 
|Interest Bearing Liabilities:            |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |            |   |           |           |  |  |      |      |          |   |         |        
|                                         | Reverse repurchase agreements
and Swap Agreements |   |                                      | 11,868,573 |           |  |            | 2.59 |         |   |           | 76,995  |            |   |           | 7,703,283 |  |  |      | 3.24 |          |   |         | 62,334  | 
|                                         | CDOs                                              |   |                                      | 1,407,620  |           |  |            | 1.53 |         |   |           | 5,398   |            |   |           | 305,911   |  |  |      | 2.57 |          |   |         | 1,967   | 
|                                         | Whole loan financing facilities                   |   |                                      | 976,095    |           |  |            | 1.92 |         |   |           | 4,688   |            |   |           | 398,690   |  |  |      | 2.86 |          |   |         | 2,848   | 
|                                         | Senior notes                                      |   |                                      | 194,402    |           |  |            | 8.60 |         |   |           | 4,180   |            |   |           |          |  |  |      |     |          |   |         |        | 
|                                         |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |            |   |           |           |  |  |      |      |          |   |         |         | 
|                                         |                                                   |   | 14,446,690                           |            |           |  | 2.53       |      |         |   | 91,261    |         |            |   | 8,407,884 |           |  |  | 3.19 |      |          |   | 67,149  |        
|                                         |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |            |   |           |           |  |  |      |      |          |   |         |         | 
|Net Interest Earning Assets and Spread   |                                                   | $ | 1,254,445                            |            |           |  | 1.32       | %    |         | $ | 59,905    |         |            | $ | 829,366   |           |  |  | 1.56 | %    |          | $ | 42,513  |        
|                                         |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |            |   |           |           |  |  |      |      |          |   |         |         | 
|Yield on Net Interest Earning Assets (1) |                                                   |   |                                      |            |           |  | 1.53       | %    |         |   |           |         |            |   |           |           |  |  | 1.84 | %    |          |   |         |        
|                                         |                                                   |   |                                      |            |           |  |            |      |         |   |           |         |            |   |           |           |  |  |      |      |          |   |         |        



---

|(1) |  | Yield on Net Interest Earning Assets is computed by dividing annualized
net interest income by the average daily balance of interest earning
assets.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------

The following table presents the total amount of change in interest
income/expense from the table above and presents the amount of change due to
changes in interest rates versus the amount of change due to changes in volume
(dollar amounts in thousands):

|                    |                                                   |   |                                  |         |        |   |                  |        |  |   |        |        | 
|------------------- | ------------------------------------------------- | - | -------------------------------- | ------- | ------ | - | ---------------- | ------ |  | - | ------ | ------ | 
|                    |                                                   |   | Three Months Ended September 30,
|                    |                                                   |   |                                  |         |        |   | 2003 versus 2002 |        |  |   |       
|                    |                                                   |   |                                 
|                    |                                                   |   | Rate                             |         | Volume |   | Total           
|                    |                                                   |   |                                  |         |        |   |                 
|Interest Income:    |                                                   |   |                                  |         |        |   |                  |        |  |   |        |       
|                    | ARM assets                                        |   | $                                | (19,270 | )      |   | $                | 60,336 |  |   | $      | 41,066 | 
|                    | Cash, cash equivalents and
restricted cash        |   |                                  | (355    | )      |   |                  | 793    |  |   |        | 438    | 
|                    |                                                   |   |                                  |         |        |   |                  |        |  |   |        |       
|                    |                                                   |   | (19,625                          | )       |        |   | 61,129           |        |  |   | 41,504 |       
|                    |                                                   |   |                                  |         |        |   |                  |        |  |   |        |       
|Interest Expense:   |                                                   |   |                                  |         |        |   |                  |        |  |   |        |       
|                    | Reverse repurchase agreements
and Swap Agreements |   |                                  | (12,360 | )      |   |                  | 27,021 |  |   |        | 14,661 | 
|                    | CDOs                                              |   |                                  | (794    | )      |   |                  | 4,225  |  |   |        | 3,431  | 
|                    | Whole loan financing facilities                   |   |                                  | (933    | )      |   |                  | 2,773  |  |   |        | 1,840  | 
|                    | Senior notes                                      |   |                                  |        |        |   |                  | 4,180  |  |   |        | 4,180  | 
|                    |                                                   |   |                                  |         |        |   |                  |        |  |   |        |       
|                    |                                                   |   | (14,087                          | )       |        |   | 38,199           |        |  |   | 24,112 |       
|                    |                                                   |   |                                  |         |        |   |                  |        |  |   |        |       
|Net interest income |                                                   | $ | (5,538                           | )       |        | $ | 22,930           |        |  | $ | 17,392 |       
|                    |                                                   |   |                                  |         |        |   |                  |        |  |   |        |       

As presented in the table above, net interest income increased by $17.4
million. This increase in net interest income included a favorable volume
variance partially offset by an unfavorable rate variance. As a result of the
yield on our interest-earning assets decreasing to 3.85% during the third
quarter of 2003 from 4.75% during the same period of 2002, a decrease of 90
basis points, while our cost of funds decreased to 2.53% from 3.19% during the
same time period, a decrease of 66 basis points, there was a net unfavorable
rate variance of $5.5 million. This was due to an unfavorable rate variance on
our ARM assets portfolio and other interest-earning assets that decreased net
interest income by $19.6 million, partially offset by a favorable rate variance

39



---



##### Table of Contents



on our borrowings in the amount of $14.1 million. The potential volatility in
the rate variance is reduced through our use of Hedging Instruments and the net
improvement in interest income is primarily a result of the benefits resulting
from the ARM asset investments we have made with proceeds from the issuance of
additional common equity. The increased average size of our portfolio during
the third quarter of 2003 compared to the same period in 2002 increased net
interest income in the amount of $22.9 million. The average balance of our
interest-earning assets was $15.7 billion during the third quarter of 2003,
compared to $9.2 billion during the same period of 2002  an increase of
70.0%.

The following table highlights the components of net interest spread and the
annualized yield on net interest-earning assets as of each applicable quarter
end:

Components of Net Interest Spread and Yield on Net Interest Earning Assets (1)
(Dollar amounts in millions)

|             |  |          |        |            |  |          |      |          |  |          |      |          |  |         |      |          |  |  |      |     |  |  |      |   |  |          |      |  
|------------ |  | -------- | ------ | ---------- |  | -------- | ---- | -------- |  | -------- | ---- | -------- |  | ------- | ---- | -------- |  |  | ---- | --- |  |  | ---- | - |  | -------- | ---- | -
|             |  |          |        |            |  |          |      |          |  |          |      |          |  |         |      |          |  |  |      |     |  |  |      |   |  | Yield on
|             |  | Average  |        | Historical |  |          |      |          |  | Yield on |      |          |  |         |      |          |  |  |      | Net
|As of the    |  | Interest |        | Weighted   |  | Yield    |      | Interest |  |          |      |          |  | Net     |      | Interest
|Quarter      |  | Earning  |        | Average    |  | Adjust-  |      | Earning  |  | Cost of  |      | Interest |  | Earning
|Ended        |  | Assets   |        | Coupon     |  | ment (2) |      | Assets   |  | Funds    |      | Spread   |  | Assets 
|             |  |          |        |            |  |          |      |          |  |          |      |          |  |        
|Sep 30, 2001 |  | $        | 4,641  |            |  |          | 6.56 | %        |  |          | 0.85 | %        |  |         | 5.71 | %        |  |  | 4.42 | %   |  |  | 1.29 | % |  |          | 1.71 | %
|Dec 31, 2001 |  | $        | 5,523  |            |  |          | 5.94 | %        |  |          | 0.76 | %        |  |         | 5.17 | %        |  |  | 3.41 | %   |  |  | 1.76 | % |  |          | 2.10 | %
|Mar 31, 2002 |  | $        | 6,422  |            |  |          | 5.59 | %        |  |          | 0.64 | %        |  |         | 4.95 | %        |  |  | 3.30 | %   |  |  | 1.65 | % |  |          | 1.97 | %
|Jun 30, 2002 |  | $        | 7,846  |            |  |          | 5.30 | %        |  |          | 0.39 | %        |  |         | 4.91 | %        |  |  | 3.35 | %   |  |  | 1.56 | % |  |          | 1.88 | %
|Sep 30, 2002 |  | $        | 9,237  |            |  |          | 5.16 | %        |  |          | 0.42 | %        |  |         | 4.75 | %        |  |  | 3.19 | %   |  |  | 1.56 | % |  |          | 1.84 | %
|Dec 31, 2002 |  | $        | 10,105 |            |  |          | 5.04 | %        |  |          | 0.43 | %        |  |         | 4.61 | %        |  |  | 3.03 | %   |  |  | 1.58 | % |  |          | 1.85 | %
|Mar 31, 2003 |  | $        | 11,094 |            |  |          | 4.96 | %        |  |          | 0.52 | %        |  |         | 4.44 | %        |  |  | 2.82 | %   |  |  | 1.62 | % |  |          | 1.88 | %
|Jun 30, 2003 |  | $        | 13,144 |            |  |          | 4.68 | %        |  |          | 0.51 | %        |  |         | 4.17 | %        |  |  | 2.73 | %   |  |  | 1.44 | % |  |          | 1.67 | %
|Sep 30, 2003 |  | $        | 15,701 |            |  |          | 4.41 | %        |  |          | 0.56 | %        |  |         | 3.85 | %        |  |  | 2.53 | %   |  |  | 1.32 | % |  |          | 1.53 | %



---

|(1) |  | Yield on Net Interest Earning Assets is computed by dividing
annualized net interest income for the applicable quarter by the average
daily balance of interest earning assets during the quarter.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Yield adjustments include the impact of amortizing premiums and
discounts, the impact of principal payment receivables and the impact of
interest earning non-ARM assets.                         

The following table presents the components of the yield adjustments for the
dates presented in the table above.

Components of the Yield Adjustments on ARM Assets

|             |  |              |      |            |  |           |      |            |  |       |      |   |  |  |      |  
|------------ |  | ------------ | ---- | ---------- |  | --------- | ---- | ---------- |  | ----- | ---- | - |  |  | ---- | -
|             |  |              |      |            |  | Impact of |      |            |  |       |      |   |  | 
|As of the    |  | Premium/     |      | Principal  |  |           |      |            |  | Total
|Quarter      |  | Discount     |      | Payments   |  |           |      |            |  | Yield
|Ended        |  | Amortization |      | Receivable |  | Other (1) |      | Adjustment
|             |  |              |      |            |  |           |      |           
|Sep 30, 2001 |  |              | 0.63 | %          |  |           | 0.17 | %          |  |       | 0.05 | % |  |  | 0.85 | %
|Dec 31, 2001 |  |              | 0.55 | %          |  |           | 0.16 | %          |  |       | 0.05 | % |  |  | 0.76 | %
|Mar 31, 2002 |  |              | 0.39 | %          |  |           | 0.20 | %          |  |       | 0.05 | % |  |  | 0.64 | %
|Jun 30, 2002 |  |              | 0.22 | %          |  |           | 0.13 | %          |  |       | 0.04 | % |  |  | 0.39 | %
|Sep 30, 2002 |  |              | 0.26 | %          |  |           | 0.13 | %          |  |       | 0.03 | % |  |  | 0.42 | %
|Dec 31, 2002 |  |              | 0.30 | %          |  |           | 0.09 | %          |  |       | 0.04 | % |  |  | 0.43 | %
|Mar 31, 2003 |  |              | 0.34 | %          |  |           | 0.15 | %          |  |       | 0.03 | % |  |  | 0.52 | %
|Jun 30, 2003 |  |              | 0.32 | %          |  |           | 0.13 | %          |  |       | 0.06 | % |  |  | 0.51 | %
|Sep 30, 2003 |  |              | 0.34 | %          |  |           | 0.14 | %          |  |       | 0.08 | % |  |  | 0.56 | %

(1)  Other includes the impact of interest earning cash and cash equivalents
and restricted cash.

We recorded hedging expense during the third quarter of 2003 of $145.0
thousand. During the quarter, the fair value of our Life Cap Hedging
Instruments increased by $4.2 thousand to $10.7 thousand. We also expensed
$149.2 thousand of the transition adjustment recorded in Accumulated other
comprehensive income (loss) on January 1, 2001, in connection with the
implementation of FAS 133 during the quarter ended September 30, 2003.

40



---



##### Table of Contents



We recorded hedging expense during the third quarter of 2002 of $173.4
thousand, composed of a $24.3 thousand decrease in the fair value of our Life
Cap Hedging Instruments and $149.2 thousand for the transition adjustment
recorded in connection with the implementation of FAS 133.

Since we began acquiring whole loans in 1997, we have only experienced losses
on three loans, for a total amount of $174.0 thousand. We continue to evaluate
our estimated credit losses on loans prior to their securitization and we may
readjust our current policy if the circumstances warrant. As of September 30,
2003, our whole loans, including those that we have securitized, but with
respect to which we have retained credit loss exposure, accounted for 38.4% of
our portfolio of ARM assets or $6.3 billion.

We recorded net gains on ARM assets of $1.8 million and $18.5 thousand during
the quarters ended September 30, 2003 and 2002, respectively. In April 2003,
the FASB issued SFAS 149, Amendment of Statement 133 on Derivative Instruments
and Hedging Activities, which provides clarification on the definition of
derivative instruments within the scope of SFAS 133. Prior to SFAS 149, our
net unrealized gain on loans expected to be purchased from correspondent
lenders and bulk sellers did not meet the definition of derivatives under SFAS
133. In accordance with SFAS 149, effective July 1, 2003, the Companys net
unrealized gain on loans expected to be purchased from correspondent lenders
and bulk sellers is recorded at fair value on the Consolidated Balance Sheet
with changes in fair value recorded in gain on ARM assets on the Consolidated
Income Statement. We realized a net gain on ARM assets of $1.8 million during
the quarter ended September 30, 2003 related to these commitments.

During the quarter ended September 30, 2003, we recorded loan loss provisions
totaling $970.3 thousand to reserve for estimated credit losses on loans.

For the quarter ended September 30, 2003, our ratio of operating expenses to
average assets was 0.39%, compared to 0.44% for the same period in 2002, and
0.47% for the quarter ended June 30, 2003.

Total operating expenses for the quarter ended September 30, 2003 were $15.3
million, compared to $10.1 million for the quarter ended September 30, 2002 and
$15.5 million for the quarter ended June 30, 2003. The most significant single
increase to our 2003 expenses compared to 2002 was the $2.1 million increase in
the performance-based fee that the Manager earned during the third quarter of
2003 as a result of our achieving a return on shareholders equity in excess of
the threshold as defined in the Management Agreement with the Manager. Our
return on equity (excluding accumulated other comprehensive loss) prior to the
effect of the performance-based fee was 17.75%, whereas the threshold, the
average 10-year treasury rate plus 1%, was 5.23%. This is a non-GAAP
measurement that we believe to be more meaningful for comparing 2003 and 2002
because it excludes the volatility caused by unrealized gains (losses) on
available-for-sale ARM assets and Hedging Instruments. Our return on equity on
a GAAP basis was 19.40% and is based on the inclusion of average accumulated
other comprehensive loss of $101.7 million in the computation.

The remaining $3.1 million increase in operating expenses from the third
quarter of 2002 to the third quarter of 2003 related primarily to increased
base management fees, expanded operations of TMHL, expenses associated with
long-term incentive awards for our issuance of Dividend Equivalent Rights
(DERs) and Phantom Stock Rights (PSRs), and other corporate matters. The
base management fee paid to the Manager increased $991.7 thousand due to our
increased average shareholders equity, TMHLs operations increased $149.0
thousand, and our issuance of DERs and PSRs together with improvement in our
stock price accounted for $1.6 million of the increase.

We pay the Manager an annual base management fee, generally based on average
shareholders equity as defined in the Management Agreement, payable monthly in
arrears as follows: 1.23% of the first $300 million of average shareholders
equity, plus 0.90% of average shareholders equity above $300 million, subject
to an annual inflation adjustment based on changes in the Consumer Price Index.
Since the management fee is based on shareholders equity and not assets, the
fee increases as we raise additional equity capital and thereby manage a larger
amount of invested capital on behalf of our shareholders. In order for the
Manager to earn a performance fee, the rate of return on the shareholders
investment, as defined in the Management Agreement, must exceed the average
10-year U.S. Treasury rate during the quarter plus 1%. As presented in the
following table, the performance fee is a variable expense that fluctuates with
our return on shareholders equity relative to the average 10-year U.S.
Treasury rate.

41



---



##### Table of Contents



The following table highlights the quarterly trend of operating expenses as a
percent of average assets:

Annualized Operating Expense Ratios

|              |  |                 |      |                  |  |                 |      |                |  |  |      |   |  |                 |      |  
|------------- |  | --------------- | ---- | ---------------- |  | --------------- | ---- | -------------- |  |  | ---- | - |  | --------------- | ---- | -
|              |  |                 |      |                  |  |                 |      |                |  |  |      |   |  | Total Operating
|For the       |  | Management Fee/ |      | Performance Fee/ |  | Other Expenses/ |      | Expenses/     
|Quarter Ended |  | Average Assets  |      | Average Assets   |  | Average Assets  |      | Average Assets
|              |  |                 |      |                  |  |                 |      |               
|Sep 30, 2001  |  |                 | 0.11 | %                |  |                 | 0.14 | %              |  |  | 0.14 | % |  |                 | 0.39 | %
|Dec 31, 2001  |  |                 | 0.10 | %                |  |                 | 0.22 | %              |  |  | 0.18 | % |  |                 | 0.50 | %
|Mar 31, 2002  |  |                 | 0.10 | %                |  |                 | 0.20 | %              |  |  | 0.14 | % |  |                 | 0.44 | %
|Jun 30, 2002  |  |                 | 0.10 | %                |  |                 | 0.19 | %              |  |  | 0.14 | % |  |                 | 0.43 | %
|Sep 30, 2002  |  |                 | 0.09 | %                |  |                 | 0.22 | %              |  |  | 0.13 | % |  |                 | 0.44 | %
|Dec 31, 2002  |  |                 | 0.09 | %                |  |                 | 0.22 | %              |  |  | 0.18 | % |  |                 | 0.49 | %
|Mar 31, 2003  |  |                 | 0.09 | %                |  |                 | 0.22 | %              |  |  | 0.16 | % |  |                 | 0.47 | %
|Jun 30, 2003  |  |                 | 0.08 | %                |  |                 | 0.21 | %              |  |  | 0.18 | % |  |                 | 0.47 | %
|Sep 30, 2003  |  |                 | 0.08 | %                |  |                 | 0.18 | %              |  |  | 0.13 | % |  |                 | 0.39 | %

Results of Operations for the Nine Months Ended September 30, 2003

For the nine months ended September 30, 2003, our net income was $127.0
million, or $2.04 basic earnings per share, and $2.02 diluted EPS, based on
weighted average basic and diluted shares outstanding of 60,572,000 and
62,887,000, respectively. That compares to $84.8 million, or $1.93 and $1.92
per share, basic and diluted EPS, respectively, for the same period in 2002,
based on weighted average basic and diluted shares outstanding of 41,401,000
and 44,161,000, respectively, a 5.2% increase in our diluted earnings per
share.

Our return on average common equity was 17.55% for the nine months ended
September 30, 2003 compared to 17.60% for the nine months ended September 30,
2002.

The following table presents the components of our net interest income:

Comparative Net Interest Income Components
(Dollar amounts in thousands)

|                                                          |                  |   |                                         |         |      |   |         |         | 
|--------------------------------------------------------- | ---------------- | - | --------------------------------------- | ------- | ---- | - | ------- | ------- | 
|                                                          |                  |   | For the nine months ended September 30,
|                                                          |                  |   |                                        
|                                                          |                  |   | 2003                                    |         | 2002
|                                                          |                  |   |                                         |         |     
|Coupon interest income on ARM assets                      |                  | $ | 434,481                                 |         |      | $ | 297,523 |        
|Amortization of net premium                               |                  |   | (25,455                                 | )       |      |   | (13,306 | )      
|Cash, cash equivalents and restricted cash                |                  |   | 2,233                                   |         |      |   | 1,310   |        
|                                                          |                  |   |                                         |         |      |   |         |        
|                                                          | Interest income  |   |                                         | 411,259 |      |   |         | 285,527 | 
|                                                          |                  |   |                                         |         |      |   |         |        
|Reverse repurchase agreements                             |                  |   | 108,632                                 |         |      |   | 97,658  |        
|CDOs                                                      |                  |   | 10,304                                  |         |      |   | 6,823   |        
|Whole loan financing facilities                           |                  |   | 11,794                                  |         |      |   | 7,166   |        
|Senior notes                                              |                  |   | 6,270                                   |         |      |   |        |        
|Interest rate swap agreements and
Eurodollar transactions |                  |   | 107,589                                 |         |      |   | 62,786  |        
|                                                          |                  |   |                                         |         |      |   |         |        
|                                                          | Interest expense |   |                                         | 244,589 |      |   |         | 174,433 | 
|                                                          |                  |   |                                         |         |      |   |         |        
|Net interest income                                       |                  | $ | 166,670                                 |         |      | $ | 111,094 |        
|                                                          |                  |   |                                         |         |      |   |         |        

As presented in the table above, our net interest income increased by $55.6
million in the first nine months of 2003 compared to the same period of 2002.
The change was attributable to a $125.7 million increase in interest income
primarily due to an increased asset base, partially offset by a $70.2 million
increase in interest expense. Included in this increase in interest expense is
a $44.8 million increase resulting from the impact of Swap Agreements and
Eurodollar Transactions which is commensurate with the increase in borrowings
financing our Hybrid ARM assets. Hybrid ARM assets totaled $13.3 billion and
$6.6 billion at September 30, 2003 and 2002, respectively.

42



---



##### Table of Contents



The following table presents the average balances for each category of our
interest earning assets as well as our interest bearing liabilities, with the
corresponding annualized effective rate of interest and the related interest
income or expense:

Average Balance, Rate, Interest Income and Interest Expense Table
(Dollar amounts in thousands)

|                                         |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |            |           |           |  |  |      |      |   |          |         |         |  | 
|---------------------------------------- | ------------------------------------------------- | - | ---------- | --------------------------------------- |  | --------- | ---- | ---------- | - | ------- | ------- | --------- |  | ---------- | --------- | --------- |  |  | ---- | ---- | - | -------- | ------- | ------- |  | 
|                                         |                                                   |   |            | For the nine months ended September 30,
|                                         |                                                   |   |            |                                        
|                                         |                                                   |   |            | 2003                                    |  | 2002     
|                                         |                                                   |   |            |                                         |  |          
|                                         |                                                   |   |            |                                         |  |           |      |            |   |         |         | Interest  |  |            |           |           |  |  |      |      |   | Interest
|                                         |                                                   |   |            | Average                                 |  | Effective |      | Income and |   | Average |         | Effective |  | Income and
|                                         |                                                   |   |            | Balance                                 |  | Rate      |      | Expense    |   | Balance |         | Rate      |  | Expense   
|                                         |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |           
|Interest Earning Assets:                 |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |            |           |           |  |  |      |      |   |          |         |        
|                                         | Adjustable-rate mortgage assets                   |   | $          | 13,049,508                              |  |           |      | 4.18       | % |         | $       | 409,026   |  |            | $         | 7,747,335 |  |  |      | 4.89 | % |          | $       | 284,217 | 
|                                         | Cash, cash equivalents and
restricted cash        |   |            | 263,606                                 |  |           |      | 1.13       |   |         |         | 2,233     |  |            |           | 87,663    |  |  |      | 1.99 |   |          |         | 1,310   | 
|                                         |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |            |           |           |  |  |      |      |   |          |         |         | 
|                                         |                                                   |   | 13,313,114 |                                         |  |           | 4.12 |            |   |         | 411,259 |           |  |            | 7,834,998 |           |  |  | 4.86 |      |   |          | 285,527 |        
|                                         |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |            |           |           |  |  |      |      |   |          |         |         | 
|Interest Bearing Liabilities:            |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |            |           |           |  |  |      |      |   |          |         |        
|                                         | Reverse repurchase agreements
and Swap Agreements |   |            | 10,499,404                              |  |           |      | 2.75       |   |         |         | 216,221   |  |            |           | 6,424,814 |  |  |      | 3.33 |   |          |         | 160,444 | 
|                                         | CDOs                                              |   |            | 804,598                                 |  |           |      | 1.71       |   |         |         | 10,304    |  |            |           | 351,961   |  |  |      | 2.58 |   |          |         | 6,823   | 
|                                         | Whole loan financing facilities                   |   |            | 781,211                                 |  |           |      | 2.01       |   |         |         | 11,794    |  |            |           | 325,041   |  |  |      | 2.94 |   |          |         | 7,166   | 
|                                         | Senior notes                                      |   |            | 98,224                                  |  |           |      | 8.51       |   |         |         | 6,270     |  |            |           |          |  |  |      |     |   |          |         |        | 
|                                         |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |            |           |           |  |  |      |      |   |          |         |         | 
|                                         |                                                   |   | 12,183,437 |                                         |  |           | 2.68 |            |   |         | 244,589 |           |  |            | 7,101,816 |           |  |  | 3.27 |      |   |          | 174,433 |        
|                                         |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |            |           |           |  |  |      |      |   |          |         |         | 
|Net Interest Earning Assets and Spread   |                                                   | $ | 1,129,677  |                                         |  |           | 1.44 | %          |   | $       | 166,670 |           |  | $          | 733,182   |           |  |  | 1.58 | %    |   | $        | 111,094 |        
|                                         |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |            |           |           |  |  |      |      |   |          |         |         | 
|Yield on Net Interest Earning Assets (1) |                                                   |   |            |                                         |  |           | 1.67 | %          |   |         |         |           |  |            |           |           |  |  | 1.89 | %    |   |          |         |        
|                                         |                                                   |   |            |                                         |  |           |      |            |   |         |         |           |  |            |           |           |  |  |      |      |   |          |         |        



---

|(1) |  | Yield on Net Interest Earning Assets is computed by dividing annualized
net interest income by the average daily balance of interest earning
assets.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------

The following table presents the total amount of change in interest
income/expense from the table above and presents the amount of change due to
changes in interest rates versus the amount of change due to changes in volume
(dollar amounts in thousands):

|                    |                                                   |   |                                 |         |        |   |         |         |  |   |         |         | 
|------------------- | ------------------------------------------------- | - | ------------------------------- | ------- | ------ | - | ------- | ------- |  | - | ------- | ------- | 
|                    |                                                   |   | Nine Months Ended September 30,
|                    |                                                   |   | 2003 versus 2002               
|                    |                                                   |   |                                
|                    |                                                   |   | Rate                            |         | Volume |   | Total  
|                    |                                                   |   |                                 |         |        |   |        
|Interest Income:    |                                                   |   |                                 |         |        |   |         |         |  |   |         |        
|                    | ARM assets                                        |   | $                               | (41,383 | )      |   | $       | 166,192 |  |   | $       | 124,809 | 
|                    | Cash, cash equivalents and
restricted cash        |   |                                 | (568    | )      |   |         | 1,491   |  |   |         | 923     | 
|                    |                                                   |   |                                 |         |        |   |         |         |  |   |         |        
|                    |                                                   |   | (41,951                         | )       |        |   | 167,683 |         |  |   | 125,732 |        
|                    |                                                   |   |                                 |         |        |   |         |         |  |   |         |        
|Interest Expense:   |                                                   |   |                                 |         |        |   |         |         |  |   |         |        
|                    | Reverse repurchase agreements
and Swap Agreements |   |                                 | (28,135 | )      |   |         | 83,912  |  |   |         | 55,777  | 
|                    | CDOs                                              |   |                                 | (2,316  | )      |   |         | 5,797   |  |   |         | 3,481   | 
|                    | Whole loan financing facilities                   |   |                                 | (2,259  | )      |   |         | 6,887   |  |   |         | 4,628   | 
|                    | Senior notes                                      |   |                                 |        |        |   |         | 6,270   |  |   |         | 6,270   | 
|                    |                                                   |   |                                 |         |        |   |         |         |  |   |         |        
|                    |                                                   |   | (32,710                         | )       |        |   | 102,866 |         |  |   | 70,156  |        
|                    |                                                   |   |                                 |         |        |   |         |         |  |   |         |        
|Net interest income |                                                   | $ | (9,241                          | )       |        | $ | 64,817  |         |  | $ | 55,576  |        
|                    |                                                   |   |                                 |         |        |   |         |         |  |   |         |        

As presented in the table above, net interest income increased by $55.6
million. This increase in net interest income included a favorable volume
variance partially offset by an unfavorable rate variance. As a result of the
yield on our interest-earning assets decreasing to 4.12% during the first nine
months of 2003 from 4.86% during the same period of 2002, a decrease of 74
basis points, while our cost of funds decreased to 2.68% from 3.27% during the
same time period, a decrease of 59 basis points, there was a net unfavorable
rate variance of $9.2 million. This was due to an unfavorable rate variance on
our ARM assets portfolio and other interest-earning assets that decreased net
interest income by $42.0 million, partially offset by a favorable

43



---



##### Table of Contents



rate variance on our borrowings in the amount of $32.7 million. The potential
volatility in the rate variance is reduced through our use of Hedging
Instruments and the net improvement in interest income is primarily a result of
the benefits resulting from the issuance of additional common equity and the
investment opportunities we have pursued in our ARM assets portfolio as a
result of this growth. The increased average size of our portfolio during the
first nine months of 2003 compared to the same period in 2002 increased net
interest income in the amount of $64.8 million. The average balance of our
interest-earning assets was $13.3 billion during the first nine months of 2003,
compared to $7.8 billion during the same period of 2002  an increase of
69.9%.

During the nine months ended September 30, 2003, we realized a net gain on ARM
assets of $5.4 million. This gain consists of a $2.7 million net release of
previously recorded credit losses, a $910.5 thousand gain upon the maturity of
a collateralized bond obligation and a net unrealized gain of $1.8 million on
loans expected to be purchased from correspondent lenders and bulk sellers at
September 20, 2003.

We did not sell any ARM assets during the nine months ended September 30, 2003.
During the nine months ended September 30, 2002, we sold $72.9 million of ARM
securities for a gain of $113.5 thousand. The ARM securities sold were
classified as available-for-sale. In addition, we sold $4.1 million of loans
and realized a net loss of $8.1 thousand

During the nine months ended September 30, 2003, we recorded loan loss
provisions totaling $2.0 million to reserve for estimated credit losses on
loans.

For the nine months ended September 30, 2003, our ratio of operating expenses
to average assets was 0.44%, compared to 0.44% for the same period in 2002.
Total operating expenses for the nine-month period ended September 30, 2003
were $43.9 million, compared to $25.6 million for the same period in 2002. The
most significant single increase to our operating expenses was the $8.2 million
increase in the performance-based fee that the Manager earned during the first
nine months of 2003 as a result of our achieving a return on shareholders
equity in excess of the threshold as defined in the Management Agreement with
the Manager. Our return on equity prior to the effect of the performance-based
fee was 18.31%, whereas the threshold, the average 10-year treasury rate plus
1%, was 4.92%. This is a non-GAAP measurement that we believe to be more
meaningful for comparing 2003 and 2002 because it excludes the volatility
caused by unrealized gains (losses) on available-for-sale ARM assets and
Hedging Instruments. Our return on equity on a GAAP basis was 20.42% and is
based on the inclusion of average accumulated other comprehensive loss of
$108.0 million in the computation.

The remaining $10.0 million increase in operating expenses from the first nine
months of 2002 to the same period of 2003 related primarily to increased base
management fees, expanded operations of TMHL, expenses associated with our
issuance of Dividend Equivalent Rights (DERs) and Phantom Stock Rights
(PSRs), and other corporate matters. The base management fee paid to the
Manager increased $2.6 million due to our increased average shareholders
equity, TMHLs operations increased $1.6 million, and our issuance of DERs and
PSRs together with our improved stock price accounted for $4.8 million of the
increase.

Liquidity and Capital Resources

We manage liquidity to ensure that we have the continuing ability to maintain
cash flows that are adequate to fund operations and meet commitments on a
timely and cost-effective basis. At September 30, 2003, we had operating
liquidity of $393.3 million, consisting of unpledged ARM assets and cash and
cash equivalents. Our principal sources of liquidity are the reverse
repurchase market, the issuance of collateralized debt obligations, whole loan
financing facilities as well as principal and interest payments from ARM
assets. The reverse repurchase market is a $6 trillion market that has been a
readily available source of financing for mortgage assets, particularly those
rated AA or better. There is also a robust market for AAA-rated long-term debt
of the type that we issue and this type of financing effectively eliminates
liquidity and margin call risk for the related portion of our balance sheet.
To supplement our funding sources, we also issue equity securities and
unsecured long-term debt. We believe that our liquidity level is in excess of
that necessary to satisfy our operating requirements and we expect to continue
to use diverse funding sources to maintain our financial flexibility.

Our primary sources of funds for the quarter ended September 30, 2003 consisted
of reverse repurchase agreements, floating-rate CDOs and whole loan financing
facilities. Our other significant sources of funds for the quarter ended
September 30, 2003 consisted primarily of payments of principal and interest
from our ARM assets. In the future, we expect our primary sources of funds to
remain the same.

Total borrowings outstanding at September 30, 2003 had a weighted average
effective cost of 1.32%. The reverse repurchase agreements had a weighted
average remaining term to maturity of 6.4 months, although we utilize Swap
Agreements and

44



---



##### Table of Contents



Eurodollar Transactions to extend the re-pricing characteristic of total
borrowings to 2.2 years. The CDOs mature between 2033 and 2043, although it is
callable by the Company at par once the total balance of the loans
collateralizing the debt is reduced to 20% of the original balance of the debt.
The whole loan financing facilities are committed facilities that mature in
November 2003, March 2004, September 2004 and November 2004. As of September
30, 2003, $11.8 billion of our borrowings were variable rate term reverse
repurchase agreements. Term reverse repurchase agreements are committed
financings with original maturities that range from two to 25 months. The
interest rates on these term reverse repurchase agreements are indexed to
either the one-month or three-month LIBOR rate, and reprice accordingly. The
interest rates on the CDOs and whole loan financing facilities are indexed to
one-month LIBOR and are subject to either daily or monthly adjustments.

We have arrangements to enter into reverse repurchase agreements with 24
different financial institutions and on September 30, 2003, had uncommitted
financing facilities of approximately $20.4 billion. At September 30, 2003, we
had borrowed funds totaling $12.6 billion from 17 of these firms. Because we
borrow money under these agreements based on the fair value of our ARM assets,
and because changes in interest rates can negatively impact the valuation of
ARM assets, our borrowing ability under these agreements may be limited and
lenders may initiate margin calls in the event interest rates change or the
value of our ARM assets decline for other reasons. External disruptions to
credit markets might also impair access to additional liquidity and, therefore,
we might be required to sell certain mortgage assets in order to maintain
liquidity. If required, such sales might be at prices lower than the carrying
value of the assets, which would result in losses. We had adequate liquidity
throughout the quarter ended September 30, 2003. We believe we will continue
to have sufficient liquidity to meet our future cash requirements from our
primary sources of funds for the foreseeable future without needing to sell
assets.

On August 28, 2003, approximately $1.4 billion of mortgage loans from our ARM
loan portfolio were transferred to Thornburg Mortgage Securities Trust 2003-4
and were securitized. Approximately $1.4 billion of the securities created by
this securitization were issued to third-party investors in the form of
AAA-rated floating rate pass-through certificates. Using such a structure
enables us to make more efficient use of our capital because the capital
required to support these financings is less than the amount required to
support the same amount of financings in the reverse repurchase agreement
market and these transactions represent permanent financing of these loans and
are not subject to margin calls. At September 30, 2003, we had $2.2 billion of
collateralized long-term debt outstanding.

As of September 30, 2003, we had entered into three whole loan financing
facilities. We borrow money under these facilities based on the fair value of
the ARM loans pledged to secure these facilities. Therefore, the amount of
money available to us under these facilities is subject to margin call based on
changes in fair value, which can be negatively affected by changes in interest
rates and other factors, including the delinquency status of individual loans.
The first whole loan financing facility has a committed borrowing capacity of
$600 million and an uncommitted capacity of $100 million and matures in
November 2004. The second financing facility has a committed borrowing
capacity of $300 million and matures in March 2004. The third financing
facility has a committed borrowing capacity of $300 million and an uncommitted
capacity of $250 million and matures in November 2003. We expect to renew this
facility. In October 2003, we entered into a fourth financing facility that
has a committed borrowing capacity of $150 million and matures in September
2004. As of September 30, 2003, we had $1.0 billion borrowed against these
whole loan financing facilities, at an effective cost of 1.85%.

During the quarter ended September 30, 2003, we issued 974,655 shares of common
stock through at-market transactions under controlled equity offering
programs under the August 2002 shelf registration statement and received net
proceeds of $24.4 million. As of September 30, 2003, $25.1 million and $86.6
million of our registered securities remained available for future issuance and
sale under our currently effective July 2001 and August 2002 shelf registration
statements, respectively.

On August 5, 2003, we completed a public offering of 4,000,000 shares of common
stock under the August 2002 shelf registration statement and received net
proceeds of $104.6 million.

We have a Dividend Reinvestment and Stock Purchase Plan (the DRSPP) designed
to provide a convenient and economical way for existing shareholders to
automatically reinvest their dividends in additional shares of our common
stock, and for new and existing shareholders to purchase shares at a discount
to the current market price of the common stock, as defined in the DRSPP.
During the quarter ended September 30, 2003, we issued 1,209,463 shares of
common stock under the DRSPP and received net proceeds of $30.2 million.

The Companys senior note obligations contain both financial and non-financial
covenants. Significant financial covenants include limitations on the Companys
ability to incur indebtedness beyond specified levels, restrictions on the
Companys ability to incur liens on assets and limitations on the amount and
type of restricted payments, such as repurchases of its own equity

45



---



##### Table of Contents



securities, that the Company makes. As of September 30, 2003, the Company is
in compliance with all financial and non-financial covenants on its senior note
obligations.

Market Risks

The market risk management discussion and the amounts estimated from the
analysis that follows are forward-looking statements that assume that certain
market conditions occur. Actual results may differ materially from these
projected results due to changes in our ARM portfolio and borrowings mix and
due to developments in the domestic and global financial and real estate
markets. Developments in the financial markets include the likelihood of
changing interest rates and the relationship of various interest rates and
their impact on our ARM portfolio yield, cost of funds and cash flows. The
analytical methods that we use to assess and mitigate these market risks should
not be considered projections of future events or operating performance.

As a financial institution that has only invested in U.S.-dollar denominated
instruments, primarily residential mortgage instruments, and has only borrowed
money in the domestic market, we are not subject to foreign currency exchange
or commodity price risk, but rather our market risk exposure is limited solely
to interest rate risk. Interest rate risk is defined as the sensitivity of our
current and future earnings to interest rate volatility, variability of spread
relationships, the difference in repricing intervals between our assets and
liabilities and the effect that interest rates may have on our cash flows,
especially ARM portfolio prepayments. Interest rate risk impacts our interest
income, interest expense and the market value on a large portion of our assets
and liabilities. The management of interest rate risk attempts to maximize
earnings and to preserve capital by minimizing the negative impacts of changing
market rates, asset and liability mix, and prepayment activity.

The table below presents the sensitivity of the market value of the Companys
portfolio using a discounted cash flow simulation model. Application of this
method results in an estimation of the percentage change in the market value of
our assets, liabilities and hedging instruments per 100 basis point (bp)
shift in interest rates expressed in yearsa measure commonly referred to as
duration. Positive portfolio duration indicates that the market value of the
total portfolio will decline if interest rates rise and increase if interest
rates decline. The closer duration is to zero, the less interest rate changes
are expected to affect earnings. Included in the table is a Base Case
duration calculation for an interest rate scenario that assumes future rates
are those implied by the yield curve as of September 30, 2003. The other two
scenarios assume interest rates are instantaneously 100 and 200 bps higher that
those implied by market rates as of September 30, 2003.

The use of interest rate hedging instruments such as Swap Agreements,
Eurodollar Transactions, and Cap Agreements are a critical part of our interest
rate risk management strategies, and the effects of these hedging instruments
on the market value of the portfolio are reflected in the models output. This
analysis also takes into consideration the value of options embedded in our
mortgage assets including constraints on the repricing of the interest rate of
ARM assets resulting from periodic and lifetime cap features, as well as
prepayment options. Assets and liabilities that are not interest
rate-sensitive such as cash, payment receivables, prepaid expenses, payables
and accrued expenses are excluded. The duration calculated from this model is
a key measure of the effectiveness of our interest rate risk management
strategies.

Changes in assumptions including, but not limited to, volatility, mortgage and
financing spreads, prepayment behavior, defaults, as well as the timing and
level of interest rate changes will affect the results of the model.
Therefore, actual results are likely to vary from modeled results.

46



---



##### Table of Contents



Net Portfolio Duration
September 30, 2003

|                       |                  |  |           |       |                   |  |                   |       |       |  |       |       |      
|---------------------- | ---------------- |  | --------- | ----- | ----------------- |  | ----------------- | ----- | ----- |  | ----- | ----- | -----
|                       |                  |  | Base Case |       | Parallel +100 bps |  | Parallel +200 bps
|                       |                  |  |           |       |                   |  |                  
|Assets:                |                  |  |           |       |                   |  |                   |       |       |  |       |      
|                       | Traditional ARMs |  |           | 0.94  | Years             |  |                   | 1.08  | Years |  |       | 1.25  | Years
|                       | Hybrid ARMs      |  |           | 2.12  |                   |  |                   | 2.45  |       |  |       | 2.64  |      
|                       |                  |  |           |       |                   |  |                   |       |       |  |       |       |      
|                       | Total ARM assets |  |           | 1.94  |                   |  |                   | 2.24  |       |  |       | 2.43  |      
|                       |                  |  |           |       |                   |  |                   |       |       |  |       |       |      
|Borrowings and hedges  |                  |  | (1.81     | )     |                   |  | (1.81             | )     |       |  | (1.82 | )    
|                       |                  |  |           |       |                   |  |                   |       |       |  |       |       |      
|Net portfolio duration |                  |  | 0.16      | Years |                   |  | 0.32              | Years |       |  | 0.41  | Years
|                       |                  |  |           |       |                   |  |                   |       |       |  |       |       |      

Based on the assumptions used, the model output suggests a very low degree of
portfolio price change given increases in interest rates, which implies that
the cash flow and earning characteristics of the company should be relatively
stable for comparable changes in interest rates. As a comparison, the
approximate base case duration of a 10 year treasury, a conforming 30-year
fixed mortgage and a conforming 5/1 Hybrid ARM are 7.9, 5.3 and 2.6 years
respectively.

Although market value sensitivity analysis is widely accepted in identifying
interest rate risk, it does not take into consideration changes that may occur
such as, but not limited to, changes in investment and financing strategies,
changes in market spreads, and changes in business volumes. Accordingly, we
make extensive use of an earnings simulation model to further analyze our level
of interest rate risk.

There are a number of key assumptions in our earnings simulation model. These
key assumptions include changes in market conditions that affect interest
rates, the pricing of ARM products, the availability of ARM products, and the
availability and the cost of financing for ARM products. Other key assumptions
made in using the simulation model include prepayment speeds and managements
investment, financing and hedging strategies, and the issuance of new equity.
We typically run the simulation model under a variety of hypothetical business
scenarios that may include different interest rate scenarios, different
investment strategies, different prepayment possibilities and other scenarios
that provide us with a range of possible earnings outcomes in order to assess
potential interest rate risk. The assumptions used represent our estimate of
the likely effect of changes in interest rates and do not necessarily reflect
actual results. The earnings simulation model takes into account periodic and
lifetime caps embedded in our ARM assets in determining the earnings at risk.

At September 30, 2003, based on the earnings simulation model, our potential
earnings increase (decrease) from a parallel 100 and 200 basis point rise in
market interest rates over the next twelve months and a commensurate slow down
in prepayment speeds as interest rates rise, was 0.2% and (3.3%) of projected
net income for the twelve months ended September 30, 2004, respectively, and
(0.6%) and (3.5%) of projected net income for the twelve months ended September
30, 2005, respectively. All of these earnings projections result in earnings
that are higher than the current level. The assumptions used in the earnings
simulation model are inherently uncertain and as a result, the analysis cannot
precisely predict the impact of higher interest rates on net income. Actual
results could differ from simulated results due to timing, magnitude and
frequency of interest rate changes, changes in prepayment speed other than what
was assumed in the model, and changes in other market conditions and management
strategies to offset our potential exposure, among other factors. This measure
of risk represents our exposure to higher interest rates at a particular point
in time. Our actual risk is always changing. We continuously monitor our risk
profile and alter our strategies as appropriate based on our view of interest
rates and other developments in our business.

Effects of Interest Rate Changes

Changes in interest rates impact our earnings in various ways. While we invest
primarily in ARM assets, rising short-term interest rates may temporarily
negatively affect our earnings, and, conversely, falling short-term interest
rates may temporarily increase our earnings. This impact can occur for several
reasons and may be mitigated by portfolio prepayment activity and portfolio
funding strategies as discussed below. First, our borrowings may react to
changes in interest rates sooner than our ARM assets because the weighted
average next repricing dates of the borrowings may be shorter time periods than
that of the ARM assets. Second, interest rates on Traditional ARM assets may
be limited to an increase of either 1% or 2% per adjustment period (commonly
referred to as the periodic cap), while our borrowings do not have similar
limitations. At September 30, 2003, 8.2% of our total ARM assets were
Traditional ARM assets subject to periodic caps. Third, our ARM assets
typically lag

47



---



##### Table of Contents



changes in the applicable interest rate indices by 45 days, due to the notice
period provided to ARM borrowers when the interest rates on their loans are
scheduled to change.

Interest rates can also affect our net return on Hybrid ARM assets (net of the
cost of financing Hybrid ARMs). We estimate the duration of our Hybrid ARM
assets and have a policy to hedge the financing of the Hybrid ARM assets such
that the net duration of our borrowed funds, Hedging Instruments and the Hybrid
ARM assets is less than one year. During a declining interest rate
environment, the prepayment of Hybrid ARM assets may accelerate causing the
amount of fixed rate financing to increase relative to the amount of Hybrid ARM
assets, possibly resulting in a decline in our net return on Hybrid ARM assets
as replacement Hybrid ARM assets may have a lower yield than the ones paying
off. In contrast, during an increasing interest rate environment, Hybrid ARM
assets may prepay slower than expected, requiring us to finance a higher amount
of Hybrid ARM assets than originally anticipated at a time when interest rates
may be higher, resulting in a decline in our net return on Hybrid ARM assets.
In order to manage our exposure to changes in the prepayment speed of Hybrid
ARM assets, we regularly monitor the balance of Hybrid ARM assets and make
adjustments to the amounts anticipated to be outstanding in future periods and,
on a regular basis, make adjustments to the amount of our fixed-rate borrowing
obligations in future periods.

Interest rate changes can also affect the availability and pricing of ARM
assets, which affects our investment opportunities. During a rising interest
rate environment, there may be less total loan origination and refinance
activity. At the same time, a rising interest rate environment may result in a
larger percentage of ARM products being originated, mitigating the impact of
lower overall loan origination and refinance activity. Conversely, during a
declining interest rate environment, consumers, in general, may favor fixed
rate mortgage products, but there may be above average loan origination and
refinancing volume in the industry such that even a small percentage of ARM
product volume may result in sufficient investment opportunities.
Additionally, a flat yield curve may be an adverse environment for ARM products
because there may be little incentive for a consumer to choose an ARM product
over a 30 year fixed-rate mortgage loan and, conversely, in a steep yield curve
environment, ARM products may enjoy an above average advantage over 30 year
fixed-rate mortgage loans, increasing our investment opportunities. The
availability and fluctuations in the volume of ARM loans being originated can
also affect their yield to us as an investment opportunity. During periods of
time when there is a shortage of ARM products, their yield as an investment may
decline due to market forces and conversely, when there is an above average
supply of ARM products, their yield to us as an investment may improve due to
the same market forces. To date, we have always been able to find sufficient
investment and loan origination opportunities in all interest rate environments
we have faced, at attractive prices, such that we have been able to generate
positive earnings and grow our portfolio as appropriate.

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

Conversely, the rate of prepayment on our mortgage assets may decrease if
interest rates rise or if the difference between long term and short term
interest rates increases. Decreased prepayments would cause us to amortize the
premiums paid for our ARM assets over a longer time period, resulting in an
increased yield on our mortgage assets. Therefore, in rising interest rate
environments where prepayments are declining, not only would the interest rate
on the ARM assets portfolio increase to re-establish a spread over the higher
interest rates, but the yield also would rise due to slower prepayments. The
combined effect could significantly mitigate other negative effects that rising
short-term interest rates might have on earnings.

Lastly, because we invest primarily in ARM assets, and a portion of such assets
are purchased with shareholders equity, our earnings, over time, will tend to
increase, after an initial short term decline, following periods when short
term interest rates have risen, and decrease after an initial short term
increase, following periods when short term interest rates have declined. This
is because the financed portion of our portfolio of ARM assets will, over time,
reprice to a spread over our cost of funds, while the portion of our portfolio
of ARM assets purchased with shareholders equity will generally have a higher
yield in a higher interest rate environment and a lower yield in a lower
interest rate environment.

Other Matters

The Internal Revenue Code of 1986, as amended (the Code), requires that at
least 75% of our total assets must be Qualified REIT Assets, as defined by the
Code. The Code also requires that we meet a defined 75% source of income test
and a 90% source of income test. As of September 30, 2003, we calculated that
we were in compliance with all of these requirements. We also met all REIT
requirements regarding the ownership of our common stock and the distributions
of our net income. Therefore, as of September 30, 2003, we believe that we
continue to qualify as a REIT under the provisions of the Code.

48



---



##### Table of Contents



We intend to conduct our business so as not to become regulated as an
investment company under the Investment Company Act of 1940, as amended. If we
were to become regulated as an investment company, our use of leverage would be
substantially reduced. The Investment Company Act exempts entities that are
primarily engaged in the business of purchasing or otherwise acquiring
mortgages and other liens on and interests in real estate (Qualifying
Interests). Under current interpretation of the staff of the SEC, in order to
qualify for this exemption, we must maintain at least 55% of our assets
directly in Qualifying Interests as defined in the Code. In addition, unless
certain mortgage securities represent all the certificates issued with respect
to an underlying pool of mortgages, such mortgage securities may be treated as
securities separate from the underlying mortgage loans and, thus, may not be
considered Qualifying Interests for purposes of the 55% requirement. We
calculated that we are in compliance with this requirement.




Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information called for by Item 3 is incorporated by reference from the
information in Part I, Item 2 under the caption Market Risks.




Item 4. CONTROLS AND PROCEDURES

Under the supervision, and with the participation of the Chief Executive
Officer, the President and Chief Operating Officer and the Executive Vice
President and Chief Financial Officer, management has evaluated the
effectiveness of the design and operation of the Companys disclosure controls
and procedures as of the end of the period covered by this quarterly report
pursuant to Exchange Act Rule 13a-15. Based on that evaluation, the Chief
Executive Officer, the President and Chief Operating Officer and the Executive
Vice President and Chief Financial Officer, concluded that the Companys
disclosure controls and procedures were effective. There have been no
significant changes in the Companys internal controls that could significantly
affect internal controls subsequent to their evaluation.

49



---



##### Table of Contents






PART II. OTHER INFORMATION




Item 1. Legal Proceedings



| |                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------
| | At September 30, 2003, there were no pending legal
proceedings to which we were a party or of which any of our
property was subject.




Item 2. Changes in Securities and Use of Proceeds



| |               
| | --------------
| | Not applicable




Item 3. Defaults Upon Senior Securities



| |               
| | --------------
| | Not applicable




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



| |     
| | ----
| | None




Item 5. Other Information



| |     
| | ----
| | None




Item 6. Exhibits and Reports on Form 8-K:



| |             
| | ------------
| | (a) Exhibits



| |                    
| | -------------------
| | See Exhibit Index



| |                        
| | -----------------------
| | (b) Reports on Form 8-K



| |                                                                                                         
| | --------------------------------------------------------------------------------------------------------
| | The Company filed the following Current Reports on Form 8-K during the
quarter ended September 30, 2003:



|     |                                                                                                                                                                                                                                                                                                
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(i)  | Current Report on Form 8-K, filed on July 28, 2003,
attaching the Companys Press Release, dated July 22, 2003,
announcing the Companys earnings for the quarter ending June 30,
2003.                                                                                                        
|    
|(ii) | Current Report on Form 8-K, filed August 1, 2003,
regarding entering into an Underwriting Agreement with UBS
Securities LLC and A.G. Edwards & Sons, Inc., as lead managers and
Thornburg Mortgage Advisory Corporation relating to the sale of
4,000,000 shares of the Companys common stock.

50



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|                          |  |  |                          |                                                                                                       
|------------------------- |  |  | ------------------------ | ------------------------------------------------------------------------------------------------------
|                          |  |  | THORNBURG MORTGAGE, INC.
|                          |  |  |                          |                                                                                                       
|Dated:  November 13, 2003 |  |  | By:                      | /s/ Garrett Thornburg                                                                                 
|                          |  |  |                          |                                                                                                       
|                          |  |  |                          | Garrett Thornburg
Chairman of the Board and Chief Executive Officer
(authorized officer of registrant)
|                          |  |  |                          |                                                                                                       
|Dated:  November 13, 2003 |  |  | By:                      | /s/ Larry A. Goldstone                                                                                
|                          |  |  |                          |                                                                                                       
|                          |  |  |                          | Larry A. Goldstone
President and Chief Operating Officer
(authorized officer of registrant)           
|                          |  |  |                          |                                                                                                       
|Dated:  November 13, 2003 |  |  | By:                      | /s/ Richard P. Story                                                                                  
|                          |  |  |                          |                                                                                                       
|                          |  |  |                          | Richard P. Story
Executive Vice President and Chief Financial Officer
(principal accounting officer)  

51



---



##### Table of Contents






Exhibit Index

|               |  |                                                                                                                                                                                                                                                                                           
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Exhibit Description                                                                                                                                                                                                                                                                       
|               |  |                                                                                                                                                                                                                                                                                           
|10.13          |  | Sale and Servicing Agreement dated. as of August 1, 2003
among Thornburg Mortgage Securities Trust 2003-4, Thornburg
Mortgage Home Loans, Inc., Greenwich Capital Acceptance,
Inc., Deutsche Bank National Trust Company and Wells Fargo
Bank Minnesota National Association (TMST 2003-4)
|               |  |                                                                                                                                                                                                                                                                                           
|31.1           |  | Certification of Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934                                                                                                                                                                                
|               |  |                                                                                                                                                                                                                                                                                           
|31.2           |  | Certification of President and Chief Operating Officer
pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934                                                                                                                                                                  
|               |  |                                                                                                                                                                                                                                                                                           
|31.3           |  | Certification of Executive Vice President and Chief
Financial Officer pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934                                                                                                                                                   
|               |  |                                                                                                                                                                                                                                                                                           
|32.1           |  | Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002                                                                                                                                         
|               |  |                                                                                                                                                                                                                                                                                           
|32.2           |  | Certification of President and Chief Operating Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                           
|               |  |                                                                                                                                                                                                                                                                                           
|32.3           |  | Certification of Executive Vice President and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                                                                                                            

52