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, 1998

                                      OR

       TRANSITION  REPORT  PURSUANT  TO SECTION  13 OR 15(D) OF THE  SECURITIES
------ EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM        TO
                                
COMMISSION FILE NUMBER:   001-11914


                     THORNBURG MORTGAGE ASSET CORPORATION
            (Exact name of Registrant as specified in its Charter)

                 MARYLAND                      85-0404134
     (State or other jurisdiction of        (I.R.S. Employer
      incorporation or organization)     Identification Number)

            119 E. MARCY STREET
           SANTA FE, NEW MEXICO                87501
 (Address of principal executive offices)   (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)

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

                    APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Common Stock ($.01 par value)               21,489,663 as of November 13, 1998


<PAGE>


                        THORNBURG MORTGAGE ASSET CORPORATION
                                     FORM 10-Q


                                       INDEX




                                                                          Page
PART I.     FINANCIAL INFORMATION

   Item 1. Financial Statements

               Balance Sheets at September 30, 1998 and
               December 31, 1997 .......................................   3

               Statements of Operations for the three months and nine
               months ended September 30, 1998 and September 30, 1997...   4

               Statement of Stockholders' Equity for the three months
               and nine months ended September 30, 1998.................   5

               Statements of Cash Flows for the three months and nine
               months ended September 30, 1998 and September 30, 1997...   6

               Notes to Financial Statements............................   7

   Item 2.  Management's Discussion and Analysis of
            Financial Condition and Results of Operations...............  17



PART II.    OTHER INFORMATION

   Item 1.  Legal Proceedings...........................................  33

   Item 2.  Changes in Securities ......................................  33

   Item 3.  Defaults Upon Senior Securities ............................  33

   Item 4.  Submission of Matters to a Vote of Security Holders.........  33

   Item 5.  Other Information...........................................  33

   Item 6.  Exhibits and Reports on Form 8-K............................  33

   SIGNATURES  .........................................................  34


<PAGE>


PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

THORNBURG MORTGAGE ASSET CORPORATION

BALANCE SHEETS
(Amounts in thousands)

<TABLE>
<CAPTION>
                                           September 30, 1998  December 31, 1997
                                           ------------------  -----------------
<S>                                          <C>               <C>           
ASSETS

   ARM assets: (Notes 2 and 3)
     ARM securities                          $     4,070,402   $     4,519,707
     ARM loans held for securitization               782,358           118,987
                                               -------------     -------------
                                                   4,852,760         4,638,694

   Cash and cash equivalents                           6,891            13,780
   Accrued interest receivable                        41,972            38,353
   Receivable for assets sold                         30,040              -
   Prepaid expenses and other                          4,661               289
                                               -------------     -------------
                                             $     4,936,324   $     4,691,116
                                               =============     =============


LIABILITIES

   Reverse repurchase agreements (Note 3)    $     4,550,502   $     4,270,170
   Other borrowings (Note 3)                           6,916            10,018
   Accrued interest payable                           28,622            39,749
   Dividends payable (Note 5)                          1,670            11,810
   Accrued expenses and other                          3,976             1,215
                                               -------------     -------------
                                                   4,591,686         4,332,962

SHAREHOLDERS' EQUITY (Note 6)

   Preferred stock:  par value $.01 per
     share;  2,760 shares  authorized;
     9.68% Cumulative Convertible Series A,
     2,760 and 2,760 issued and
     outstanding, respectively; aggregate
     preference in liquidation $69,000                65,805            65,805
   Common stock: par value $.01 per share;
     47,240 shares authorized, 21,990 and
     20,280 shares issued and
     outstanding, respectively                           220               203
   Additional paid-in-capital                        341,689           315,240
   Accumulated other comprehensive income            (55,832)          (19,445)
   Notes receivable from stock sales                  (4,632)           (2,698)
   Retained earnings (deficit)                         2,054              (951)
   Treasury stock: at cost, 500 and 0
     shares, respectively                             (4,666)              -
                                               -------------     -------------
                                                     344,638           358,154
                                               -------------     -------------

                                             $     4,936,324   $     4,691,116
                                               =============     =============
</TABLE>


See Notes to Financial Statements.


<PAGE>


THORNBURG MORTGAGE ASSET CORPORATION

STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)


<TABLE>
<CAPTION>
                                           Three  Months  Ended    Nine Months Ended
                                               September 30,         September 30,
                                             1998      1997        1998       1997
                                          ---------  ---------   --------- -------
<S>                                       <C>        <C>         <C>       <C>      
Interest income from ARM assets and cash  $  72,252  $  68,088   $ 221,587 $ 174,710
Interest expense on borrowed funds          (66,458)   (54,862)   (196,591) (137,977)
                                            --------  ---------   --------- ---------
   Net interest income                        5,794     13,226      24,996    36,733
                                            --------  ---------   ---------  --------

Gain on sale of ARM assets                      755        335       3,780       360
Provision for credit losses                    (561)      (223)     (1,402)     (623)
Management fee (Note 7)                      (1,040)      (974)     (3,115)   (2,661)
Performance fee (Note 7)                       -          (931)       (759)   (2,569)
Other operating expenses                       (270)      (251)       (851)     (689)
                                            --------  ---------   ---------  --------

   NET INCOME                             $   4,678  $  11,182   $  22,649 $  30,551
                                            ========  =========   =========  ========



Net income                                $   4,678  $  11,182   $  22,649 $  30,551
Dividend on preferred stock                  (1,670)    (1,670)     (5,009)   (4,581)
                                            --------  ---------   ---------  --------
Net income available to common
   shareholders                           $   3,008  $   9,512   $  17,640 $  25,970
                                            ========  =========   =========  ========

Basic earnings per share                  $    0.14  $    0.50   $    0.82 $    1.49
                                            =======   ========    ========   =======

Diluted earnings per share                $    0.14  $    0.49   $    0.82 $    1.48
                                            =======   ========    ========   =======
Average number of common shares
   outstanding                               21,858     19,152      21,488    17,437
                                           ========   ========    ========   =======

</TABLE>


See Notes to Financial Statements.



<PAGE>


THORNBURG MORTGAGE ASSET CORPORATION

STATEMENTS OF STOCKHOLDERS' EQUITY

Three Months and Nine Months Ended  September  30, 1998  (Amounts in  thousands,
except share data)

<TABLE>
<CAPTION>
                                                                           Notes
                                                               Accum.     Receiv-
                                                               Other       able
                                                Additional    Compre-      From     Retained               Compre-
                            Preferred   Common    Paid-in     hensive      Stock    Earnings   Treasury    hensive
                              Stock     Stock     Capital     Income       Sales    (Deficit)    Stock     Income      Total
                            ---------  -------  -----------  ----------  ---------  ---------  ---------  ---------  ---------
<S>                         <C>        <C>      <C>          <C>         <C>        <C>        <C>        <C>        <C>     
Balance, December 31, 1997  $ 65,805   $   203  $  315,240   $ (19,445)  $ (2,698)  $   (951)  $   -                 $ 358,154
Comprehensive income:
   Net income                                                                         17,971              $ 17,971      17,971
   Other comprehensive
     income:
Available-for-sale assets:
   Fair value adjustment,
     net of amortization        -          -          -        (10,875)        -         -                 (10,875)    (10,875)
     Deferred gain on sale
     of hedges, net of
     amortization               -          -          -           (909)        -         -                    (909)       (909)
Other comprehensive                                                                                        --------
    income (loss)                                                                                         $  6,187  
                                                                                                           ========
Issuance of common
  stock   (Note 5)              -           17      26,261          -      (1,934)       -                              24,344
Interest from notes
  receivable from
  stock sales                   -          -           121          -          -         -                                 121
Dividends declared on
  preferred stock - 
  $1.21 per share               -          -            -           -          -      (3,340)                           (3,340)
Dividends declared on
  common stock - 
  $0.675 per share              -          -            -           -          -     (14,634)                          (14,634)
                            ---------  -------  -----------  ----------  ---------  ---------  ---------              ---------
Balance, June 30, 1998        65,805       220     341,622     (31,229)    (4,632)      (954)       -                  370,832

Comprehensive income:
   Net income                                                                          4,678               $ 4,678       4,678
   Other comprehensive
     income:
Available-for-sale assets:
   Fair value adjustment,
     net of amortization        -          -          -        (24,264)        -         -                 (24,264)    (24,264)
     Deferred gain on sale
     of hedges, net of
     amortization               -          -          -           (339)        -         -                    (339)       (339)
Other comprehensive                                                                                        --------
    income (loss)                                                                                         $(19,925) 
                                                                                                           ========
Purchase of treasury
  stock (Note 5)                -          -          -             -          -         -       (4,666)                (4,666)
Interest from notes
  receivable from 
  stock sales                   -          -         67             -          -         -                                  67

Dividends declared on
  preferred stock - 
  $0.605 per share              -          -          -             -         -       (1,670)                           (1,670)
                            ---------  -------  -----------  ----------  ---------  ---------  ---------              ---------
Balance, September 30, 1998   65,805   $   220  $  341,689   $ (55,832)  $ (4,632)  $  2,054   $ (4,666)              $344,638
                            =========  =======  ===========  ==========  =========  ========   =========              =========
</TABLE>

See Notes to Financial Statements.


<PAGE>


THORNBURG MORTGAGE ASSET CORPORATION

STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
                                            Three Months Ended     Nine Months Ended
                                               September 30,         September 30,
                                             1998      1997        1998        1997
                                          ---------  ---------   ---------   ---------
<S>                                       <C>        <C>         <C>         <C>      
Operating Activities:
  Net Income                              $   4,678  $  11,182   $  22,649   $  30,551
  Adjustments to reconcile net income
   to net cash provided by operating
   activities:
    Amortization                             13,959      6,962      37,120      16,134
    Net (gain) loss from investing
      activities                               (194)      (112)     (2,378)        263
    Change in assets and liabilities:
      Accrued interest receivable            (1,383)    (2,377)     (3,618)    (13,711)
      Receivable for assets sold              9,951       -        (30,040)       -
      Prepaid expenses and other             (2,213)       (91)     (4,370)       (249)
      Accrued interest payable                 (183)     5,298     (11,128)      5,824
      Accrued expenses and other              2,650      3,140       2,761       7,907
        Net cash provided by (used in)      -------   --------    --------     -------
          operating activities               27,265     24,002      10,996      46,719
                                            -------   --------    --------     -------
Investing Activities:
  Available-for-sale ARM securities:
   Purchases                               (327,140)  (786,268) (1,479,934) (2,256,576)
   Proceeds on sales                        180,032     73,915     513,544     108,217
   Proceeds from calls                       12,227        -       128,006        -
   Principal payments                       420,676    208,511   1,202,405     494,546
  Held-to-maturity ARM securities:
   Principal payments                        -          14,207      16,152      44,732
  ARM Loans:
   Purchases                               (255,491)   (31,325)   (749,463)    (45,075)
   Principal payments                        50,027        337      82,690         337
   Sales                                       -           -         2,043        -
  Purchase of interest rate cap agreements      (99)    (1,234)       (641)     (3,128)
      Net cash provided by (used in)        -------   --------    --------   ---------
        investing activities                 80,232   (521,857)   (285,198) (1,656,947)
                                            -------   --------    --------   ---------
Financing Activities:
  Net borrowings from reverse
     repurchase agreements                  (91,206)   469,338     280,332   1,521,778
  Repayments of other borrowings               (892)      (825)     (3,102)     (2,869)
  Proceeds from preferred stock issued           -          -          -        65,805
  Proceeds from common stock issued              -      48,350      24,344      68,768
  Purchases of treasury stock                (4,666)        -       (4,666)       -
  Dividends paid                             (8,266)   (10,145)    (29,784)    (26,520)
  Interest from notes receivable
    from stock sales                             68         -          189        -
       Net cash provided by (used in)      ---------   --------    --------   ---------
         financing activities              (104,962)   506,718     267,313    1,626,962
                                           ---------   --------    --------   ---------
Net increase (decrease) in cash and
    cash equivalents                          2,535      8,863      (6,889)      16,734
Cash and cash equivalents at
    beginning of period                       4,356     11,564      13,780        3,693
Cash and cash equivalents at               ---------   --------    --------   ---------
    end of period                          $  6,891   $ 20,427    $  6,891    $  20,427
                                           =========   ========    ========   ========= 
</TABLE>

Supplemental disclosure of cash flow information
and non-cash activities are included in Note 3.

See Notes to Financial Statements


<PAGE>


NOTES TO FINANCIAL STATEMENTS

NOTE 1.     SIGNIFICANT ACCOUNTING POLICIES

         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 value.

         ADJUSTABLE-RATE MORTGAGE ASSETS

            The Company's  adjustable-rate mortgage ("ARM") assets are comprised
            of  both  ARM  securities  and  ARM  loans,   primarily  secured  by
            single-family residential housing.

            Effective the second quarter of 1998, the Company  decided to change
            its policy regarding its  classification of ARM securities such that
            each ARM security is classified as  available-for-sale.  The Company
            changed its policy  because the remaining  amount of ARM  securities
            classified  as  held-to-maturity   had  become  a  relatively  small
            percentage  of the  portfolio,  less  than 8% of assets at March 31,
            1998,  and because it is apparent that as more  mortgage  REITs have
            been  formed,  that it is industry  practice  to carry all  mortgage
            securities as available-for-sale. The Company had not classified any
            ARM securities purchased since 1994 as held-to-maturity and does not
            expect to do so in the future. Management has made the determination
            that  all  of  its  ARM   securities   should   be   designated   as
            available-for-sale  in order to be prepared to respond to  potential
            future  opportunities in the market, to sell ARM securities in order
            to optimize the  portfolio's  total return and to retain its ability
            to respond to economic  conditions that might require the Company to
            sell assets in order to maintain an appropriate  level of liquidity.
            Since all ARM securities are designated as available-for-sale,  they
            are  reported  at fair  value,  with  unrealized  gains  and  losses
            excluded   from   earnings   and  reported  in   accumulated   other
            comprehensive  income  as  a  separate  component  of  shareholders'
            equity.

            Management  has the intent and  ability  to hold the  Company's  ARM
            loans for the  foreseeable  future  and until  maturity  or  payoff.
            Therefore,  they are carried at their unpaid principal balances, net
            of unamortized premium or discount and allowance for loan losses.

            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.

            ARM asset  transactions  are recorded on the date the ARM assets are
            purchased  or sold.  Purchases  of new issue ARM assets are recorded
            when all significant  uncertainties regarding the characteristics of
            the assets are removed,  generally  shortly before  settlement date.
            Realized gains and losses on ARM asset  transactions  are determined
            on the specific identification basis.

         CREDIT RISK

            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
            or are  determined to be of equivalent  credit quality as determined
            by the Manager and approved by the Company's Board of Directors.  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 Investor Services, Inc.
            (the  "Rating  Agencies").   Additionally,   the  Company  has  also
            purchased  ARM loans and limits  its  exposure  to credit  losses by
            restricting   its  whole  loan  purchases  to  ARM  loans  generally
            originated to "A" quality underwriting  standards or loans that have
            at least five years of pay history and/or low loan to property value
            ratios.  The Company further limits its exposure to credit losses 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") to no
            more than 30% of the portfolio.

            The Company monitors the  delinquencies and losses on the underlying
            mortgage loans backing its ARM assets. If the credit  performance of
            the underlying mortgage loans is not as expected,  the Company makes
            a provision for possible credit losses at a level deemed appropriate
            by  management  to provide for known losses as well as  unidentified
            potential future losses in its ARM assets  portfolio.  The provision
            is based on management's  assessment of numerous  factors  affecting
            its portfolio of ARM assets  including,  but not limited to, current
            and projected economic conditions, delinquency status, credit losses
            to date on underlying mortgages and remaining credit protection. The
            provision  for ARM  securities is made by reducing the cost basis of
            the individual security for the decline in fair value which is other
            than  temporary,  and the amount of such write-down is recorded as a
            realized loss, thereby reducing  earnings.  The Company also makes a
            monthly provision for possible credit losses on its portfolio of ARM
            loans which is an increase to the reserve for possible  loan losses.
            The provision  for possible  credit losses on loans is based on loss
            statistics  of the real estate  industry for similar  loans,  taking
            into   consideration   factors   including,   but  not  limited  to,
            underwriting  characteristics,  seasoning,  geographic  location and
            current and projected economic conditions.  When a loan or a portion
            of a loan is deemed to be  uncollectible,  the portion  deemed to be
            uncollectible   is  charged   against  the  reserve  and  subsequent
            recoveries, if any, are credited to the reserve.

            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.

         DERIVATIVE FINANCIAL INSTRUMENTS

            INTEREST RATE CAP AGREEMENTS

            The  Company  purchases  interest  rate  cap  agreements  (the  "Cap
            Agreements")  to  limit  the  Company's  risks  associated  with the
            lifetime  or maximum  interest  rate caps of its ARM  assets  should
            interest  rates  rise above  specified  levels.  The Cap  Agreements
            reduce the effect of the  lifetime  cap feature so that the yield on
            the  ARM  assets  will  continue  to  rise  in  high  interest  rate
            environments  as the Company's  cost of borrowings  also continue to
            rise.

            Under  policies in effect prior to the second  quarter of 1998,  Cap
            Agreements  classified  as a hedge against  held-to-maturity  assets
            were  initially  carried  at their fair value as of the time the Cap
            Agreements and the related assets are designated as held-to-maturity
            with an adjustment to equity for any  unrealized  gains or losses at
            the time of the designation.  Any adjustment to equity is thereafter
            amortized  into  interest  income as a yield  adjustment in a manner
            consistent with the amortization of any premium or discount. All Cap
            Agreements are now classified as a hedge against  available-for-sale
            assets and are carried at their fair value with unrealized gains and
            losses reported as a separate  component of equity,  consistent with
            the  reporting  of  such  assets.  The  carrying  value  of the  Cap
            Agreements are included in ARM securities on the balance sheet.  The
            Company  purchases  Cap  Agreements  by  incurring a one-time fee or
            premium. The amortization of the premium paid for the Cap Agreements
            is included in interest income as a contra item (i.e., expense) and,
            as  such,  reduces  interest  income  over  the  lives  of  the  Cap
            Agreements.

            Realized gains and losses  resulting from the termination of the Cap
            Agreements that were hedging assets  classified as  held-to-maturity
            under  previous  policies  were  deferred  as an  adjustment  to the
            carrying  value of the related  assets and are being  amortized into
            interest income over the terms of the related assets. Realized gains
            and losses  resulting from the  termination of such  agreements that
            are hedging assets  classified as  available-for-sale  are initially
            reported in  accumulated  other  comprehensive  income as a separate
            component of equity,  consistent with the reporting of those assets,
            and are thereafter amortized as a yield adjustment.



<PAGE>


            INTEREST RATE SWAP AGREEMENTS

            The Company  enters into interest  rate swap  agreements in order to
            manage its interest rate exposure when financing its ARM assets.  In
            general,  the swap agreements have been utilized by the Company as a
            cost effective way to lengthen the average  repricing  period of its
            variable  rate and short term  borrowings.  As the Company  acquires
            hybrid  assets,  it also  enters  into swap  agreements  in order to
            manage the interest rate repricing  mismatch (the difference between
            the remaining  fixed-rate period of a hybrid and the maturity of the
            fixed-rate  liability  funding a hybrid) to approximately  one year.
            Revenues and expenses  from the interest  rate swap  agreements  are
            accounted for on an accrual basis and recognized as a net adjustment
            to interest expense.

         INCOME TAXES

            The  Company  has  elected to be taxed as a Real  Estate  Investment
            Trust  ("REIT") and  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
            and 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 reduce a loss or  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,
            1998 and 1997 (Amounts in thousands except per share data):

<TABLE>
<CAPTION>
                                                Weighted
                                                Average       Earnings
                                   Income        Shares      Per Share
                                ------------- ------------- -------------
<S>                                    <C>          <C>     <C>           
Three Months Ended
  September 30, 1998
Net income                      $      4,678
Less preferred stock dividends        (1,670)
                                 ------------
Basic EPS, income available to
  common shareholders                  3,008        21,858  $         0.14
                                                               ===========
Effect of dilutive securities:
  Stock options                                          -

                                 ------------ -------------
Diluted EPS                     $      3,008        21,858  $         0.14
                                 ============ =============   ===========

Three Months Ended
   September 30, 1997
Net income                      $     11,182
Less preferred stock dividends        (1,670)
                                 ------------
Basic EPS, income available to
  common stockholders                  9,512        19,152  $         0.50
                                                               ===========
Effect of dilutive securities:
  Stock options                                        190
                                 ------------ -------------
Diluted EPS                     $      9,512        19,342  $         0.49
                                 ============ =============    ===========
</TABLE>


<PAGE>
<TABLE>
<CAPTION>
                                                Weighted
                                                Average       Earnings
                                   Income        Shares      Per Share
                                ------------- ------------- -------------
<S>                                   <C>           <C>     <C>           
Nine Months Ended
  September 30, 1998
Net income                      $     22,649
Less preferred stock dividends        (5,009)
                                 ------------
Basic EPS, income available to
  common shareholders                 17,640        21,488  $         0.82
                                                               ===========
Effect of dilutive securities:
  Stock options                                          -
                                 ------------ -------------
Diluted EPS                     $     17,640        21,488  $         0.82
                                 ============ =============    ===========

Nine Months Ended
  September 30, 1997
Net income                      $     30,551
Less preferred stock dividends        (4,581)
                                 ------------
Basic EPS, income available to
  common stockholders                 25,970        17,437  $         1.49
                                                               ===========
Effect of dilutive securities:
  Stock options                                        162
                                 ------------ -------------
Diluted EPS                     $     25,970        17,599  $         1.48
                                 ============ =============    ===========
</TABLE>

            The Company has granted  options to  directors  and  officers of the
            Company and employees of the Manager to purchase  59,784 and 240,320
            shares of common  stock at  average  prices of $14.82 and $20.89 per
            share  during the nine  months  ended  September  30, 1998 and 1997,
            respectively.  The conversion of preferred stock was not included in
            the  computation  of  diluted  EPS  because  such  conversion  would
            increase the diluted EPS.

         USE OF ESTIMATES

            The preparation of financial statements in conformity with generally
            accepted accounting principles 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.

         RECENT ACCOUNTING PRONOUNCEMENTS

            In June 1997,  the Financial  Accounting  Standards  Board  ("FASB")
            issued SFAS No. 130, Reporting  Comprehensive Income. This statement
            requires companies to classify items of other comprehensive  income,
            such  as   unrealized   gains  and   losses  on   available-for-sale
            securities, by their nature in a financial statement and display the
            accumulated  balance of other  comprehensive  income separately from
            retained  earnings  and  additional  paid-in  capital  in the equity
            section of a statement of financial  position.  The Company  adopted
            this statement in the first quarter of 1998.

            In  June  1998,  the  FASB  issued  SFAS  No.  133,  Accounting  for
            Derivative   Instruments  and  Hedging  Activities.   SFAS  No.  133
            established  a  framework  of  accounting   rules  that  standardize
            accounting  and  reporting  for all  derivative  instruments  and is
            effective for financial statements issued for fiscal years beginning
            after June 15, 1999.  The  Statement  requires  that all  derivative
            financial instruments be carried on the balance sheet at fair value.
            Currently  the  only  derivative  instruments  that  are  not on the
            Company's  balance  sheet  at fair  value  are  interest  rate  swap
            agreements.  The fair  value of  interest  rate swap  agreements  is
            disclosed  in Note 4,  Fair  Value  of  Financial  Instruments.  The
            Company  believes  that its use of  interest  rate  swap  agreements
            qualify as cash-flow hedges as defined in the statement.  Therefore,
            changes in the fair value of these  derivatives  instruments will be
            recorded in other  comprehensive  income when the Company adopts the
            statement in the first quarter of its fiscal 2000 year.

            In October  1998,  the FASB  issued  SFAS No.  134,  Accounting  for
            Mortgage-Backed  Securities  Retained  after the  Securitization  of
            Mortgage Loans Held for Sale by a Mortgage Banking Enterprise.  This
            Statement, which is effective for the first fiscal quarter beginning
            after  December  15,  1998,  provides  guidance to mortgage  banking
            entities who securitize  mortgage  loans such that their  accounting
            for  securitized  loans  will  the  same  as  their  accounting  for
            marketable  securities.  The Company has already been accounting for
            its securitized  loans in a manner consistent with the new statement
            and  therefore  expects  no  changes to its  financial  position  or
            results of operations as a result of adopting SFAS No. 134.

NOTE 2.  ADJUSTABLE-RATE MORTGAGE ASSETS AND INTEREST RATE CAP AGREEMENTS

         The following  tables  present the Company's ARM assets as of September
         30, 1998 and  December  31,  1997.  The ARM  securities  classified  as
         available-for-sale   are  carried  at  their  fair  value,   while  the
         held-to-maturity  ARM  securities  and ARM loans are  carried  at their
         amortized cost basis (dollar amounts in thousands):

          September 30, 1998:   
<TABLE>
<CAPTION>
                                                        ARM Securities             
                                           -------------------------------------- 
                                           Available-     Held-to-
                                            for-Sale      Maturity      Total         ARM Loans
                                           ------------  ----------  ------------   ------------
<S>                                        <C>           <C>          <C>           <C>        
          Principal balance outstanding    $ 3,974,291   $     -      $ 3,974,291   $   770,907
          Net unamortized premium              102,981         -          102,981        11,935
          Deferred gain from hedging              (725)        -             (725)          -
          Allowance for losses                  (1,298)        -           (1,298)         (484)
          Interest rate cap agreements           9,649         -            9,649           -
          Principal payment receivable          43,146         -           43,146           -
                                           -----------  -----------   ------------   -----------
            Amortized cost, net              4,128,044         -        4,128,044       782,358
                                           -----------  -----------   ------------   -----------
          Gross unrealized gains                 3,703         -            3,703           -
          Gross unrealized losses              (61,345)        -          (61,345)       (3,953)
                                           -----------  -----------   ------------   -----------
            Fair value                     $ 4,070,402  $      -      $ 4,070,402   $   778,405
                                           ===========  ===========   ============   ===========
            Carrying value                 $ 4,070,402  $      -      $ 4,070,402   $   782,358
                                           ===========  ===========   ============   ===========
</TABLE>

          December 31, 1997:
<TABLE>
<CAPTION>
                                                        ARM Securities             
                                           -------------------------------------- 
                                           Available-     Held-to-
                                            for-Sale      Maturity      Total         ARM Loans
                                           ------------  ----------  ------------   ------------
<S>                                        <C>           <C>          <C>           <C>        
          Principal balance outstanding    $ 3,984,770   $  386,290   $ 4,371,060   $   115,996
          Net unamortized premium              119,133        5,025       124,158         3,033
          Deferred gain from hedging              -          (1,217)       (1,217)          -
          Allowance for losses                  (1,739)        -           (1,739)         (42)
          Interest rate cap agreements          11,144        2,160        13,304           -
          Principal payment receivable          32,337        3,545        35,882           -
                                           -----------  -----------   ------------   -----------
            Amortized cost, net              4,145,645      395,803     4,541,448       118,987
                                           -----------  -----------   ------------   -----------
          Gross unrealized gains                11,075        5,609        16,684           -
          Gross unrealized losses              (32,816)      (2,859)      (35,675)          -
                                           -----------  -----------   ------------   -----------
            Fair value                     $ 4,123,904  $   398,553   $ 4,522,457   $   118,987
                                           ===========  ===========   ============   ===========
            Carrying value                 $ 4,123,904  $   395,803   $ 4,519,707   $   118,987
                                           ===========  ===========   ============   ===========
</TABLE>


         During the quarter  ended  September  30,  1998,  the Company  realized
         $902,000 in gains and $147,000 in losses on the sale of $179.3  million
         of ARM securities. During the same period of 1997, the Company realized
         $446,000 in gains and  $111,000 in losses on the sale of $73.6  million
         of ARM  securities.  All of the ARM securities  sold were classified as
         available-for-sale.

         During the nine months ended  September 30, 1998, the Company  realized
         $4,388,000  in gains  and  $608,000  in  losses  on the sale of  $511.1
         million of ARM securities.  During the same period of 1997, the Company
         realized  $1,301,000  in gains  and  $941,000  in losses on the sale of
         $107.9 million of ARM  securities.  All of the ARM securities sold were
         classified as available-for-sale.

         As of September 30, 1998, the Company had reduced the cost basis of its
         ARM  securities  due to  potential  future  credit  losses  (other than
         temporary  declines  in fair  value) in the  amount of  $1,298,000.  At
         September  30, 1998,  the Company is  providing  for  potential  future
         credit losses on two securities  that have an aggregate  carrying value
         of $12.1 million, which represent less than 0.3% of the Company's total
         portfolio of ARM assets.  Both of these assets are  performing  and one
         has some remaining credit support that mitigates the Company's exposure
         to potential future credit losses. Additionally,  during the first nine
         months of 1998, the Company,  in accordance  with its credit  policies,
         recorded a $442,000  provision for potential  credit losses on its loan
         portfolio,  although no actual  losses  have been  realized in the loan
         portfolio to date.

         The following table summarizes ARM loan  delinquency  information as of
         September 30, 1998 (dollar amounts in thousands):
<TABLE>
<CAPTION>

                                       Loan       Loan      Percent of   Percent of
                 Delinquency Status    Count     Balance    ARM Loans   Total Assets
                 ------------------   ------   ---------    ----------  ------------
<S>                                      <C>   <C>             <C>           <C>  
                 30 to 59 days           4     $   1,239       0.16%         0.03%
                 60 to 89 days           2           240       0.03          0.00
                 90 days or more         -           -         -             -
                 In foreclosure          5           942       0.12          0.02
                                      -----      -------    ---------    ----------
                                        11     $   2,421       0.31%         0.05%
                                      =====      =======    =========    ==========
</TABLE>

         The  following  table  summarizes  the activity for the  allowance  for
         losses  on ARM loans  for the nine  months  ended  September  30,  1998
         (dollar amounts in thousands):

                            Beginning balance     $      42
                            Provision for losses        442
                            Charge-offs, net              0
                                                 ----------
                            Ending balance        $     484
                                                 ==========

         As of  September  30,  1998,  the Company had  commitments  to purchase
         $474.4 million of ARM assets, $452 million of which were commitments to
         purchase  ARM loans.  Subsequent  to September  30,  1998,  the Company
         assigned  the  commitments  to purchase  ARM loans to a third party and
         entered into one  commitment  to purchase $347 million of the ARM loans
         in the  form of  securities  or  loans by  December  29,  1998 and into
         another  commitment  to purchase  $105  million of the ARM loans in the
         form of securities or loans by January 29, 1999.

         The  average  effective  yield on the ARM assets  owned was 5.88% as of
         September  30,  1998 and 6.38% as of  December  31,  1997.  The average
         effective   yield  is  based  on  historical   cost  and  includes  the
         amortization  of the net  premium  paid for the ARM  assets and the Cap
         Agreements,  the impact of ARM principal  payment  receivables  and the
         amortization of deferred gains from hedging activity.

         As of  September  30,  1998 and  December  31,  1997,  the  Company had
         purchased Cap  Agreements  with a remaining  notional  amount of $4.117
         billion and $4.156  billion,  respectively.  The notional amount of the
         Cap  Agreements  purchased  decline  at a  rate  that  is  expected  to
         approximate  the  amortization  of the  ARM  assets.  Under  these  Cap
         Agreements,   the  Company  will  receive  cash  payments   should  the
         one-month,   three-month  or  six-month  London  InterBank  Offer  Rate
         ("LIBOR") increase above the contract rates of the Cap Agreements which
         range  from  7.50% to 13.00%  and  average  approximately  10.10%.  The
         Company's ARM assets  portfolio had an average  lifetime  interest rate
         cap of 11.61%.  The Cap Agreements had an average maturity of 2.6 years
         as of September 30, 1998. The initial aggregate  notional amount of the
         Cap Agreements declines to approximately $3.485 billion over the period
         of the agreements,  which expire between 1999 and 2004. The Company has
         credit risk to the extent that the counterparties to the cap agreements
         do not perform their  obligations  under the Cap Agreements.  If one of
         the counterparties does not perform,  the Company would not receive the
         cash to which it would  otherwise be entitled  under the  conditions of
         the Cap  Agreement.  In  order to  mitigate  this  risk and to  achieve
         competitive  pricing,  the Company has entered into Cap Agreements with
         six different  counterparties,  five of which are rated AAA, and one is
         rated AA.

NOTE 3.  REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS

         The Company has entered into reverse  repurchase  agreements to finance
         most of its ARM assets. The reverse  repurchase  agreements are secured
         by the market value of the Company's ARM assets and bear interest rates
         that have historically moved in close relationship to LIBOR.

         As of September 30, 1998, the Company had outstanding $4.551 billion of
         reverse repurchase agreements with a weighted average borrowing rate of
         5.75% and a weighted average  remaining  maturity of 2.3 months.  As of
         September 30, 1998, $1.104 billion of the Company's reverse  repurchase
         agreements were variable-rate  term reverse repurchase  agreements with
         original  maturities  that  range from  three  months to one year.  The
         interest rates of these term reverse repurchase  agreements are indexed
         to either the one or three-month LIBOR rate and reprice accordingly. In
         addition,  as of September  30, 1998,  $741.5  million of the Company's
         reverse repurchase  agreements were collateralized by whole loans under
         one year financing  agreements  that are indexed to the one-month LIBOR
         rate and reprice either daily or once a month.  The reverse  repurchase
         agreements at September 30, 1998 were collateralized by ARM assets with
         a carrying value of $4.797 billion, including accrued interest.

         At  September  30,  1998,  the reverse  repurchase  agreements  had the
         following remaining maturities (dollars in thousands):

                             Within 30 days        $  2,533,827
                             30 to 90 days              294,118
                             91 days to one year      1,722,557
                                                   ------------
                                                   $  4,550,502
                                                   ============

         As of September 30, 1998, the Company was a  counterparty  to seventeen
         interest rate swap agreements  having an aggregate  notional balance of
         $1.404 billion.  Fifteen of these agreements with a notional balance of
         $1.144  billion have a weighted  average  remaining term of 20.9 months
         and the remaining two are cancelable  monthly. In accordance with these
         agreements,  the Company  will pay a fixed rate of interest  during the
         term of these agreements and receive a payment that varies monthly with
         the  one-month   LIBOR  rate.  As  a  result  of  entering  into  these
         agreements,  the Company has reduced the interest rate  variability  of
         its cost to finance its ARM securities by increasing the average period
         until the next  repricing of its  borrowings  from 45 days to 208 days.
         The swap  agreements at September 30, 1998 were  collateralized  by ARM
         assets  with a  carrying  value  of  $4.8  million,  including  accrued
         interest.

         As of  September  30,  1998,  the Company had financed a portion of its
         portfolio of interest  rate cap  agreements  with $6.9 million of other
         borrowings  which require  quarterly or semi-annual  payments until the
         year  2000.  These  borrowings  have a weighted  average  fixed rate of
         interest of 7.90% and have a weighted average remaining maturity of 1.3
         years. The other  borrowings  financing cap agreements at September 30,
         1998 were  collateralized  by ARM  securities  with a carrying value of
         $10.6 million,  including accrued interest. The aggregate maturities of
         these other borrowings are as follows (dollars in thousands):

                             1998         $      1,407
                             1999                4,877
                             2000                  632
                                            ----------
                                          $      6,916
                                            ==========

         During the quarter ended  September  30, 1998,  the total cash paid for
         interest was $69.3 million.

NOTE 4.  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, 1998 and
         December  31,  1997.   Financial  Accounting  Standard  Board  ("FASB")
         Statement   No.  107,   Disclosures   About  Fair  Value  of  Financial
         Instruments,  defines the fair value of a financial  instrument  as the
         amount  at  which  the  instrument  could  be  exchanged  in a  current
         transaction  between  willing  parties,  other  than  in  a  forced  or
         liquidation sale (dollar amounts in thousands):
<TABLE>
<CAPTION>

                                       September 30, 1998        December 31, 1997
                                    ------------------------  ------------------------
                                      Carrying      Fair        Carrying       Fair
                                       Amount       Value        Amount        Value
                                    -----------  -----------  -----------  -----------
<S>                                 <C>          <C>          <C>          <C>        
            Assets:
              ARM assets            $ 4,852,338  $ 4,848,385  $ 4,634,612  $ 4,639,513
              Cap agreements                422          422        4,082        1,931

            Liabilities:
              Other borrowings            6,916        7,055       10,018       10,321
              Swap agreements               110       10,444          (50)         184
</TABLE>

         The above carrying amounts for assets are combined in the balance sheet
         under  the  caption  ARM  assets.   The  carrying   amount  for  assets
         categorized  as  available-for-sale  is their  fair value  whereas  the
         carrying  amount for assets  held-to-maturity  at December  31, 1997 is
         their amortized cost.

         The fair  values of the  Company's  ARM  securities,  ARM loans and cap
         agreements are based on market prices  provided by certain  dealers who
         make markets in these  financial  instruments  or  third-party  pricing
         services.  The fair value of the Company's  long-term debt and interest
         rate  swap   agreements,   which  are   off-balance   sheet   financial
         instruments,  are based on market  values  provided  by dealers who are
         familiar with the terms of the long-term debt and swap agreements.  The
         fair values  reported  reflect  estimates  and may not  necessarily  be
         indicative of the amounts the Company could realize in a current market
         exchange.  Cash  and cash  equivalents,  interest  receivable,  reverse
         repurchase  agreements  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.

NOTE 5.  COMMON AND PREFERRED STOCK

         During the quarter ended  September 30, 1998, the Company did not issue
         any shares of common  stock under its dividend  reinvestment  and stock
         purchase  plan ("DRP").  For the nine month period ended  September 30,
         1998, the Company issued 1,581,000 shares of common stock under its DRP
         and  received  net  proceeds  of $24.3  million.  The  Company has also
         purchased  shares in the open market on behalf of the  participants  in
         its DRP when the stock  price is trading  below  book value  instead of
         issuing new shares below book value.  In accordance  with the terms and
         conditions  of the DRP, the Company pays the  brokerage  commission  in
         connection with these purchases.

         On October 16, 1998, the Company  declared a third quarter  dividend of
         $0.23 per common  share  which  will be paid on  November  18,  1998 to
         common shareholders of record as of October 31, 1998. Additionally,  on
         September 18, 1998,  the Company  declared a third quarter  dividend of
         $0.605 per share to the  shareholders of the Series A 9.68%  Cumulative
         Convertible  Preferred  Stock  which was paid on  October  13,  1998 to
         preferred  shareholders of record as of September 30, 1998. For federal
         income tax purposes such  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 return of capital,  depending  on the  composition  and
         amount of the Company's full year taxable income.

         On July 13,  1998,  the  Board of  Directors  approved  a common  stock
         repurchase  program of up to 500,000 shares at prices below book value,
         subject to  availability  of shares  and other  market  conditions.  On
         September  18, 1998,  the Board of Directors  expanded  this program by
         approving  the  repurchase of up to an additional  500,000  shares.  To
         date, the company has repurchased  500,016 at an average price of $9.28
         per share.

NOTE 6.  STOCK OPTION PLAN

         The Company has a Stock Option and  Incentive  Plan (the "Plan")  which
         authorizes  the  granting of options to purchase an  aggregate of up to
         1,800,000 shares, but not more than 5% of the outstanding shares of the
         Company's common stock. The Plan authorizes the Board of Directors,  or
         a committee of the Board of Directors, to grant Incentive Stock Options
         ("ISOs") as defined under  section 422 of the Internal  Revenue Code of
         1986,  as  amended,  options  not  so  qualified  ("NQSOs"),   Dividend
         Equivalent Rights ("DERs"),  Stock  Appreciation  Rights ("SARs"),  and
         Phantom Stock Rights ("PSRs").

         The exercise  price for any options  granted  under the Plan may not be
         less than 100% of the fair  market  value of the  shares of the  common
         stock at the time the option is granted. Options become exercisable six
         months  after the date granted and will expire ten years after the date
         granted,  except  options  granted in  connection  with an  offering of
         convertible   preferred  stock,  in  which  case  such  options  become
         exercisable if and when the  convertible  preferred  stock is converted
         into common stock.

         The Company issued DERs at the same time as ISOs and NQSOs based upon a
         formula  defined in the Plan.  During 1998 the number of DERs issued is
         based on 35% of the ISOs and NQSOs granted  during 1998.  The number of
         PSRs issued are based on the level of the  Company's  dividends  and on
         the price of the Company's stock on the related  dividend  payment date
         and is  equivalent  to the  cash  that  otherwise  would be paid on the
         outstanding DERs and previously issued PSRs.

         During the nine month  period  ended  September  30,  1998,  there were
         59,784  options  granted  to buy common  shares at an average  exercise
         price of $14.82 along with 20,931 DERs. As of September  30, 1998,  the
         Company had 612,402 options outstanding at exercise prices of $9.375 to
         $22.625  per share,  469,461 of which were  exercisable.  The  weighted
         average exercise price of the options outstanding was $17.55 per share.
         As of the September 30, 1998, there were 81,012 DERs granted,  of which
         52,032 were vested,  and 4,237 PSRs granted.  In addition,  the Company
         recorded a reduction of expense  associated  with the DERs and the PSRs
         of $15,000  for the  quarter  ended  September  30, 1998 and expense of
         $6,000 for the nine months ended September 30, 1998.

         Notes receivable from stock sales has resulted from the Company selling
         shares of common stock through the exercise of stock options. The notes
         have maturity terms ranging from 3 years to 9 years and accrue interest
         at rates that range from  5.40% to 6.00% per annum.  In  addition,  the
         notes are full recourse promissory notes and are secured by a pledge of
         the shares of the Common Stock acquired. Interest, which is credited to
         paid-in-capital,  is payable  quarterly,  with the  balance  due at the
         maturity  of the notes.  The  payment of the notes will be  accelerated
         only upon the sale of the shares of Common Stock pledged for the notes.
         The notes may be prepaid at any time at the option of each borrower.

NOTE 7.  TRANSACTIONS WITH AFFILIATES

         The Company has a Management Agreement (the "Agreement") with Thornburg
         Mortgage Advisory Corporation ("the Manager").  Under the terms of this
         Agreement,  the Manager,  subject to the  supervision  of the Company's
         Board of Directors, is responsible for the management of the day-to-day
         operations  of the Company and provides all personnel and office space.
         The  Agreement  provides  for an  annual  review  by  the  unaffiliated
         directors of the Board of Directors of the Manager's  performance under
         the Agreement.

         The Company  pays the Manager an annual  base  management  fee based on
         average  shareholders'  equity,  adjusted for liabilities  that are not
         incurred to finance assets ("Average  Shareholders' Equity" or "Average
         Net Invested  Assets" as defined in the Agreement)  payable  monthly in
         arrears  as  follows:  1.1%  of  the  first  $300  million  of  Average
         Shareholders'  Equity, plus 0.8% of Average  Shareholders' Equity above
         $300 million.

         For the quarters  ended  September 30, 1998 and 1997,  the Company paid
         the Manager $1,040,000 and $974,000,  respectively,  in base management
         fees in accordance with the terms of the Agreement.  For the nine month
         periods ended September 30, 1998 and 1997, the Company paid the Manager
         base management fees of $3,115,000 and $2,661,000, respectively.

         The Manager is also entitled to earn performance based  compensation in
         an amount equal to 20% of the Company's  annualized net income,  before
         performance  based  compensation,  above an annualized Return on Equity
         equal to the ten year U.S.  Treasury  Rate plus 1%. For purposes of the
         performance fee  calculation,  equity is generally  defined as proceeds
         from issuance of common stock before  underwriter's  discount and other
         costs of  issuance,  plus  retained  earnings.  For the  quarter  ended
         September 30, 1998, the Company did not pay the Manager any performance
         based  compensation  because the Company's  net income,  as measured by
         Return on Equity,  did not exceed the ten year U.S.  Treasury Rate plus
         1%. For the quarter  ended  September  30,  1997,  the Company paid the
         Manager $931,000 in performance  based  compensation in accordance with
         the  terms  of the  Agreement  and for the  nine  month  periods  ended
         September 30, 1998 and 1997,  the Company paid the Manager  performance
         based   compensation   in  the  amounts  of  $759,000  and  $2,569,000,
         respectively.



<PAGE>


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 constitute
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933,  as  amended,  and Section 21E of the  Exchange  Act,  which can be
identified  by the use of  forward-looking  terminology  such as "may,"  "will,"
"expect,"  "anticipate,"  "estimate," or "continue" or the negatives  thereof or
other variations thereon or comparable terminology. Investors are cautioned that
all forward-looking  statements involve risks and uncertainties  including,  but
not limited to, risks  related to the future level and  relationship  of various
interest rates,  prepayment rates and the timing of new programs. The statements
in the "Risk Factors" of the Company's Prospectus Supplement dated July 14, 1997
and the  "Effects  of  Interest  Rate  Changes"  in  this  Report  on Form  10-Q
constitute  cautionary  statements  identifying  important  factors,   including
certain risks and uncertainties, with respect to such forward-looking statements
that could cause the actual results,  performance or achievements of the Company
to differ materially from those reflected in such forward-looking statements.

GENERAL

Thornburg  Mortgage Asset Corporation (the "Company") is a mortgage  acquisition
company that primarily  invests in  adjustable-rate  and hybrid mortgage ("ARM")
assets comprised of ARM securities and ARM loans,  thereby indirectly  providing
capital to the single family residential  housing market.  Hybrid assets,  which
are included in the  Company's  ARMs  portfolio,  have an interest  rate that is
fixed for an initial period of time, generally 3 to 5 years, and then convert to
an  adjustable-rate  for the  balance  of the term of the loan.  ARM  securities
represent  interests in pools of ARM loans,  which often  include  guarantees or
other credit enhancements  against losses from loan defaults.  While the Company
is not a bank or savings and loan,  its business  purpose,  strategy,  method of
operation   and  risk  profile  are  best   understood  in  comparison  to  such
institutions.  The Company  leverages its equity capital using  borrowed  funds,
invests in ARM  assets  and seeks to  generate  income  based on the  difference
between the yield on its ARM assets  portfolio  and the cost of its  borrowings.
The corporate structure of the Company differs from most lending institutions in
that the Company is organized for tax purposes as a real estate investment trust
("REIT")  and  therefore  generally  passes  through  substantially  all  of its
earnings  to  shareholders  without  paying  federal or state  income tax at the
corporate level.

The  Company's  ARM assets  portfolio  may consist of either agency or privately
issued  (generally  publicly  registered)  mortgage   pass-through   securities,
multiclass   pass-through   securities,   collateralized   mortgage  obligations
("CMOs"), ARM loans or short-term investments that either mature within one year
or have an interest rate that reprices  within one year.  Beginning in 1998, the
Company  began to  acquire  loans and  securities  backed by hybrid  loans.  The
Company  will not invest  more than 20% of its ARM  assets in  hybrids  and will
limit its interest rate repricing mismatch (the difference between the remaining
fixed-rate  period of a hybrid  and the  maturity  of the  fixed-rate  liability
funding a hybrid) to approximately one year.

The  Company's  investment  policy is to invest at least 70% of total  assets in
High Quality  adjustable-rate,  variable-rate and hybrid mortgage securities and
short-term investments. High Quality means:

   (1)securities  that are unrated but are guaranteed by the U.S.  Government
      or issued or guaranteed by an agency of the U.S. Government;
   (2)securities   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 (as defined below) and approved by
      the Company's Board of Directors.

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

   (1)adjustable-rate,   variable-rate  or  hybrid  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,  or
      equivalent to such a rating as  determined  by management  and approved by
      the  Board of  Directors,  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;
   (2)ARM loans secured by first liens on single-family  residential properties,
      generally  underwritten  to "A" quality  standards,  and  acquired for the
      purpose of future securitization; or
   (3)a limited  amount,  currently  $40 million as  authorized  by the Board of
      Directors,  of less than  investment  grade classes of ARM securities that
      are  created  as  a  result  of  the  Company's   loan   acquisition   and
      securitization efforts.

The Company has acquired ARM loans for the purpose of future securitization into
ARM securities for the Company's investment portfolio. As of September 30, 1998,
16.1% of the  Company's  ARM  portfolio  consisted  of ARM loans held for future
securitization.  The Company  believes that its strategy to securitize ARM loans
will  provide  the  Company  with  either  higher  yielding  investments  or  an
additional source of whole pool assets, and give the Company greater flexibility
over the  characteristics  of the ARM assets acquired and held in its investment
portfolio. The Company plans on securitizing the loans that it acquires in order
to continue its current  strategy of owning high quality,  liquid ARM securities
and financing them in the reverse  repurchase  market or through capital markets
transactions  that will  provide the  Company  with a more  permanent  source of
financing for some of its assets.  In pursuing these strategies the Company will
likely have a higher degree of credit risk than when acquiring  investment grade
rated securities directly from the market.  However,  any additional credit risk
will be consistent with the Company's objectives of maintaining a portfolio with
high credit quality assets that provide an attractive return on equity.

The  Company  does not invest in REMIC  residuals  or other CMO  residuals  and,
therefore does not create excess inclusion income or unrelated  business taxable
income for tax  exempt  investors.  Therefore,  the  Company is a mortgage  REIT
eligible for purchase by tax exempt  investors,  such as pension  plans,  profit
sharing  plans,  401(k) plans,  Keogh plans and Individual  Retirement  Accounts
("IRAs").

OVERVIEW OF RECENT EVENTS IN THE MORTGAGE MARKET

As has been true with most other  mortgage  finance  companies,  the Company has
been  affected  by the  recent  turmoil in the  global  and  domestic  financial
markets.  Due to turbulent  market  conditions  since  September  30, 1998,  the
Company  has   simultaneously   seen  its  asset  values  decline,   its  margin
requirements for financing  certain of its ARM assets increase,  especially with
respect to its non-agency portfolio, the market value of its hedging instruments
decline,  which has  required  the Company to post  additional  collateral,  and
difficulty in financing its less than AA rated assets at acceptable  valuations.
Additionally,  due to the high level of  prepayments  on its agency  securities,
which the Company must fund out of its excess liquidity prior to receipt of such
payments from FNMA and FHLMC,  and the heightened  sense of risk aversion on the
part of the Company's  lenders,  the Company's  available excess cash and liquid
securities has diminished from levels maintained in prior periods.  All of these
factors have combined to reduce the level of liquidity available to the Company.
The Company has  undertaken  several  measures to increase its liquidity  during
these difficult  market  conditions.  First,  the Company has requested that its
lenders not make margin  calls on its loans  backed by agency  securities  until
such payments have been received by the Company.  Several lenders have agreed to
this  request,  and several  lenders have also  considered  executing a separate
financing  facility to assist the Company in  bridging  this timing  difference.
Second, the Company has undertaken the sale of certain assets in order to reduce
its asset  portfolio.  Accordingly,  the Company,  during the fourth  quarter to
date,  has sold $363  million  of  assets  and  recorded  a loss on sale of $3.4
million.  Of this loss  amount,  $3.3  million is related to $146 million of ARM
securities that are indexed to the one-year U.S.  Treasury index and which, as a
group, prepaid at an annualized rate of 49% during October and had a yield below
the  Company's  cost of funds.  The Company  believes  that by  selecting  these
specific ARM securities  for sale, it has not only increased its liquidity,  but
it has improved the future return on its remaining ARM securities portfolio. The
Company believes that, barring further assets sales, its equity-to-assets  ratio
before market value  adjustments at the end of November will approximate  9.40%,
up from 8.15% at  September  30,  1998.  Lastly,  the Company is  attempting  to
finance the  majority  of its $1.1  billion of whole  loans and  commitments  to
purchase  whole loans into a short-term  callable  financing  transaction  which
would be issued in the  fourth  quarter of 1998 and would be  callable  prior to
June of 1999.  The benefit of such a  financing  would be to provide the Company
with a capital  efficient  method to finance its whole loan assets over year end
and enable the  Company to call the  transaction  and  refinance  the loans at a
lower  interest  rate  in the  early  part  of 1999  in the  event  that  market
conditions  improve.  However,  the cost of such a  financing  is  greater  than
current  financing  rates  available  to the  Company  for whole  loans and will
therefore  adversely  affect  earnings in the fourth quarter and possibly during
the first half of 1999.



<PAGE>


FINANCIAL CONDITION

At September 30, 1998, the Company held total assets of $4.936  billion,  $4.853
billion of which  consisted  of ARM assets,  as  compared to $4.691  billion and
$4.639 billion, respectively, at December 31, 1997. Since commencing operations,
the Company has purchased either ARM securities  (backed by agencies of the U.S.
government or privately-issued,  generally publicly registered, mortgage assets,
most of which are rated AA or higher by at least one of the Rating  Agencies) or
ARM loans,  including hybrids,  generally originated to "A" quality underwriting
standards.  At September 30, 1998,  79.9% of the assets held by the Company were
High  Quality  assets,   exceeding  the  Company's   investment  policy  minimum
requirement  of  investing  at least 70% of its total assets in High Quality ARM
assets and cash and cash  equivalents.  Approximately  97% of the  Company's ARM
loans,  which  comprise  16.1%  of  the  ARMs  portfolio,  are  expected  to  be
securitized  into AAA  securities  which would bring the Company's  High Quality
assets up to over 95% of total ARMs.  Of the ARM assets  currently  owned by the
Company, 71.0% are adjustable-rate  mortgage pass-through  certificates that are
backed by ARM loans.  The  remainder  are floating  rate classes of CMOs (9.0%),
investments in floating rate classes of trusts backed by mortgaged-backed assets
(3.9%) or ARM loans (16.1%).

The  following  table  presents a schedule of ARM assets owned at September  30,
1998 and  December  31, 1997  classified  by High  Quality and Other  Investment
assets and further classified by type of issuer and by ratings categories.

                       ARM ASSETS BY ISSUER AND CREDIT RATING
                            (Dollar amounts in thousands)

<TABLE>
<CAPTION>
                               September 30, 1998        December 31, 1997
                            ------------------------- -------------------------
                             Carrying     Portfolio    Carrying     Portfolio
                               Value         Mix         Value         Mix
                            ------------  ----------- ------------  -----------
<S>                         <C>                 <C>   <C>                 <C>  
HIGH QUALITY:
  FHLMC/FNMA                $ 2,691,164         55.5% $ 3,117,937         67.2%
  Privately Issued:
   AAA/Aaa Rating               523,187         10.8      476,615         10.3
   AA/Aa Rating                 661,872         13.6      782,206         16.8
                             -----------  -----------  -----------  -----------
     Total Privately Issued   1,185,059         24.4    1,258,821         27.1
                             -----------  -----------  -----------  -----------

                             -----------  -----------  -----------  -----------
     Total High Quality       3,876,223         79.9    4,376,758         94.3
                             -----------  -----------  -----------  -----------
OTHER INVESTMENT:
  Privately Issued:
   A Rating                      91,944          1.9      115,055          2.5
   BBB/Baa Rating                89,926          1.8       17,625          0.4
   BB/Ba Rating and Other        12,309          0.3       10,269          0.2
  Whole loans                   782,358         16.1      118,987          2.6
                             -----------  -----------  -----------  -----------
     Total Other Investment     976,537         20.1      261,936          5.7
                             -----------  -----------  -----------  -----------
 
     Total ARM Portfolio    $ 4,852,760        100.0% $ 4,638,694        100.0%
                             ===========  ===========  ===========  ===========
</TABLE>

As of  September  30,  1998,  the  Company had reduced the cost basis of its ARM
securities by a total of $1,298,000 due to potential future credit losses (other
than temporary  declines in fair value).  The Company is providing for potential
future credit losses on two securities that have an aggregate  carrying value of
$12.1 million,  which  represent less than 0.3% of the Company's total portfolio
of ARM assets.  Although both of these assets continue to perform, there is only
minimal remaining credit support to mitigate the Company's exposure to potential
future credit losses.

Additionally,  during the three and nine months ended  September  30, 1998,  the
Company  recorded  a  $247,000  and  a  $442,000  provision,  respectively,  for
potential  credit losses on its loan  portfolio,  although no actual losses have
been realized in the loan  portfolio to date.  As of September  30, 1998,  there
were 11 loans  totaling  $2.4  million  that were  delinquent,  of which 7 loans
totaling $1.2 million were seriously  delinquent  (60 days or more  delinquent).
Based on a review of the underlying property values, the Company does not expect
to realize a loss on any of the loans  seriously  delinquent as of September 30,
1998. The Company's  credit  reserve  policy  regarding ARM loans is to record a
monthly  provision  of  0.15%  (annualized  rate) on the  outstanding  principal
balance of loans  (including  loans  securitized  by the  Company  for which the
Company has retained  first loss  exposure),  subject to  adjustment  on certain
loans or pools of loans based upon  factors  such as, but not limited to, age of
the loans,  borrower payment history,  low  loan-to-value  ratios and quality of
underwriting standards applied by the originator.

The following table classifies the Company's  portfolio of ARM assets by type of
interest rate index.

                                 ARM ASSETS BY INDEX
                            (Dollar amounts in thousands)

<TABLE>
<CAPTION>
                                 September 30, 1998          December 31, 1997
                              ------------------------   -------------------------
                                Carrying    Portfolio      Carrying    Portfolio
                                 Value         Mix           Value        Mix
                              ------------- ----------   ------------- -----------
<S>                           <C>                 <C>     <C>                 <C> 
ARM ASSETS:
    INDEX:
      One-month LIBOR         $   542,264         11.2%   $    115,198        2.5%
      Three-month LIBOR           188,389          3.9          31,215        0.7
      Six-month LIBOR           1,064,115         21.9       1,489,802       32.1
      Six-month Certificate
        of Deposit                370,743          7.6         278,386        6.0
      Six-month Constant
        Maturity Treasury          53,345          1.1          66,669        1.4
      One-year Constant
        Maturity Treasury       1,817,548         37.5       2,271,914       49.0
      Cost of Funds               315,699          6.5         385,510        8.3
                               ------------ -----------     ---------- -----------
                                4,352,103         89.7       4,638,694      100.0
                               ------------ -----------     ---------- -----------
HYBRID ARM ASSETS                 500,657         10.3            -           0.0
                               ------------ -----------     ---------- -----------
                              $ 4,852,760        100.0%   $  4,638,694      100.0%
                               ============ ===========     ========== ===========
</TABLE>

The portfolio had a current  weighted  average  coupon of 7.40% at September 30,
1998.  If the portfolio had been "fully  indexed," the weighted  average  coupon
would have been approximately 6.97%, based upon the composition of the portfolio
and the  applicable  indices at September 30, 1998. As of December 31, 1997, the
portfolio had a weighted  average  coupon of 7.56% and if the portfolio had been
"fully  indexed,"  the weighted  average  coupon  would have been  approximately
7.64%, based upon the composition of the portfolio and the applicable indices at
that time.

At September 30, 1998, the current yield of the ARM assets  portfolio was 5.88%,
compared  to 6.38% as of December  31,  1997,  with an average  term to the next
repricing date of 254 days as of September 30, 1998,  compared to 110 days as of
December 31, 1997.  The increase in the number of days until the next  repricing
of the ARMs is primarily due to the hybrid loans  acquired by the Company during
the quarters ended June 30, 1998 and September 30, 1998,  which, in general,  do
not reprice  for three to five years from their  origination  date.  The current
yield  includes  the  impact of the  amortization  of  applicable  premiums  and
discounts,  the cost of hedging,  the  amortization  of the deferred  gains from
hedging activity and the impact of principal payment receivables.

The  reduction in the yield as of September  30, 1998,  compared to December 31,
1997, is primarily because of the higher rate of ARM portfolio prepayments which
have occurred during 1998. The higher level of prepayments  increased the amount
of premium amortization expense and increased the impact of non-interest earning
assets in the form of principal  payment  receivables.  The constant  prepayment
rate ("CPR") of the  Company's ARM portfolio was 32% during the third quarter of
1998  compared  to 34%  during the second  quarter of 1998 and  compared  to 22%
during the third  quarter of 1997.  The lower coupon of 7.40%  decreased the ARM
portfolio  yield by 0.16% as of September  30, 1998 compared to the end of 1997.
Additionally,  higher premium  amortization  and the higher balance of principal
payment receivables  decreased the portfolio yield by 0.35%, which was partially
offset  by a  0.01%  decrease  in the  net  cost  of  hedging.  When  prepayment
experience  exceeds  expectations,  the Company has to amortize its net purchase
premiums over a shorter time period, resulting in a reduced yield to maturity on
the Company's ARM assets.  Conversely,  if actual prepayment  experience is less
than the assumed constant prepayment rate, the premium would be amortized over a
longer  time  period,  resulting  in a higher  yield to  maturity.  The  Company
monitors its  prepayment  experience  on a monthly  basis in order to adjust the
amortization of the net premium, as appropriate.

During the three months ended September 30, 1998, the Company  purchased  $327.1
million of ARM securities,  86.9% of which were High Quality assets,  and $255.5
million of ARM loans, generally originated to "A" quality underwriting standards
or  seasoned  loans  with over five  years of good  payment  history  and/or low
loan-to-value   ratios.   Of  the  ARM  assets   acquired  during  this  period,
approximately  41% were hybrids,  28% were indexed to LIBOR, 21% were indexed to
U.S. Treasury bill rates, 5% were indexed to Certificate of Deposit rates and 5%
were indexed to other indices.

During the nine months ended September 30, 1998, the Company purchased  $1,479.9
million of ARM securities,  93.6% of which were High Quality assets,  and $749.5
million of ARM loans, generally originated to "A" quality underwriting standards
or  seasoned  loans  with over five  years of good  payment  history  and/or low
loan-to-value ratios. Of the ARM assets acquired during the first nine months of
1998,  approximately  36% were  indexed  to LIBOR,  23% were  hybrids,  15% were
indexed to U.S.  Treasury bill rates, 13% were indexed to a Cost of Funds Index,
11% were indexed to  Certificate  of Deposit rates and the remaining 2% to other
indices.

The  Company  sold ARM assets in the  amount of $179.3  million at a net gain of
$755,000 and $511.8  million at a net gain of $3,780,000  during the three month
and nine month  periods  ended  September  30, 1998,  respectively.  These sales
reflect the Company's  desire to manage the  portfolio  with a view to enhancing
the total return of the portfolio.  The Company  monitors the performance of its
individual ARM assets and generally  sells an asset when there is an opportunity
to replace it with an ARM asset that has an expected  higher  long-term yield or
more  attractive  interest  rate  characteristics.  Almost  90% of the ARMs sold
during the three  months  ended  September  30, 1998 were  indexed to either the
one-year  U.S.  Treasury  index or a Cost of Funds index,  which are not indices
that the  Company  prefers  to own  long-term.  The  Company is  presented  with
investment  opportunities  in  the  ARM  assets  market  on a  daily  basis  and
management evaluates such opportunities  against the performance of its existing
portfolio.  At times,  the  Company is able to  identify  opportunities  that it
believes  will improve the total return of its  portfolio by replacing  selected
assets.  In managing  the  portfolio,  the Company may realize  either  gains or
losses in the process of replacing selected assets.

The  fair  value  of  the  Company's  portfolio  of  ARM  assets  classified  as
available-for-sale  declined by 0.88% from a negative adjustment of 0.52% of the
portfolio  as of December  31,  1997,  to a negative  adjustment  of 1.40% as of
September 30, 1998. This price decline was primarily because of a decline in the
levels of  liquidity  in the  mortgage  market,  a  widening  of credit  spreads
relative to  treasury  yields due to  uncertainties  regarding  future  economic
activity  in the U.S.  and global  economies  and  because of  increased  future
prepayment  expectations which have the effect of shortening the average life of
the  Company's  ARM assets and  decreasing  their fair value.  The amount of the
negative   adjustment   to  fair   value  on  the  ARM  assets   classified   as
available-for-sale  increased  from $21.7  million as of December 31,  1997,  to
$57.6 million as of September  30, 1998.  As of September  30, 1998,  all of the
Company's ARM securities are classified as available-for-sale and are carried at
their fair value.

The Company has purchased Cap Agreements in order to limit its exposure to risks
associated  with  the  lifetime  interest  rate  caps of its ARM  assets  should
interest rates rise above specified levels. The Cap Agreements act to reduce the
effect  of the  lifetime  or  maximum  interest  rate  cap  limitation.  The Cap
Agreements  purchased  by the Company  will allow the yield on the ARM assets to
continue to rise in a high interest rate  environment just as the Company's cost
of  borrowings  would  continue to rise,  since the  borrowings  do not have any
interest rate cap limitation. At September 30, 1998, the Cap Agreements owned by
the Company had a remaining  notional  balance of $4.117 billion with an average
final maturity of 2.6 years,  compared to a remaining notional balance of $4.156
billion  with an average  final  maturity  of 3.1 years at  December  31,  1997.
Pursuant to the terms of the Cap  Agreements,  the  Company  will  receive  cash
payments if the one-month,  three-month or six-month LIBOR index increases above
certain  specified  levels,  which  range  from  7.50%  to  13.00%  and  average
approximately  10.10%.  The fair  value of these Cap  Agreements  also  tends to
increase when general  market  interest  rates increase and decrease when market
interest rates decrease,  helping to partially  offset changes in the fair value
of the  Company's ARM assets.  At September 30, 1998,  the fair value of the Cap
Agreements  was $0.4 million,  $9.2 million less than the amortized  cost of the
Cap Agreements.



<PAGE>


The  following  table  presents  information  about the  Company's Cap Agreement
portfolio as of September 30, 1998:

                     CAP AGREEMENTS STRATIFIED BY STRIKE PRICE
                            (Dollar amounts in thousands)
<TABLE>
<CAPTION>
                                            Cap                        Weighted
             Hedged       Weighted       Agreement                      Average
           ARM Assets      Average        Notional       Strike        Remaining
          Balance (1)     Life Cap        Balance         Price           Term
         -------------   -----------   -------------   -----------   --------------
<S>      <C>                  <C>      <C>                  <C>            <C>      
         $   451,110          8.58%    $   449,949          7.50%          1.6 Years
             537,133          9.70         538,033          8.00           3.5
             183,538         10.14         183,668          8.50           1.5
             277,513         10.54         277,398          9.00           1.2
             148,563         10.89         147,930          9.50           2.0
             322,670         11.04         323,553         10.00           3.7
             448,813         11.39         448,549         10.50           2.1
             367,881         12.08         369,791         11.00           3.2
             560,905         12.64         560,899         11.50           3.7
             554,474         13.29         552,825         12.00           2.4
             172,906         14.22         172,865         12.50           1.7
             106,265         16.17          91,788         13.00           1.4
           -----------   -----------     -----------   -----------   --------------
         $ 4,131,771         11.43%    $ 4,117,248         10.10%          2.6 Years
           ===========   ===========     ===========   ===========   ==============
<FN>
         -------------
         (1)Excludes  ARM assets that do not have life caps or are hybrids  that
            are match funded during a fixed rate period,  in accordance with the
            Company's investment policy.
</FN>
</TABLE>

As of September 30, 1998, the Company was a counterparty  to seventeen  interest
rate swap  agreements  having an aggregate  notional  balance of $1.404 billion.
Fifteen of these  agreements  with a notional  balance of $1.144  billion have a
weighted  average  remaining  term of 20.9  months  and  the  remaining  two are
cancelable monthly. In accordance with these agreements,  the Company will pay a
fixed rate of interest during the term of these agreements and receive a payment
that varies monthly with the one-month  LIBOR rate. As a result of entering into
these  agreements,  the Company has reduced the interest rate variability of its
cost to finance its ARM assets by increasing  the average  period until the next
repricing  of its  borrowings  from 45  days to 208  days.  Twelve  of the  swap
agreements  with a notional  balance of $453.6 million were entered into for the
purpose of hedging the interest  rate  repricing  mismatch of its hybrid  assets
(the  difference  between the  remaining  fixed-rate  period of a hybrid and the
maturity of the fixed-rate  liability funding a hybrid) to within  approximately
one year, in furtherance of the Company's investment policy regarding hybrids.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998

For the  quarter  ended  September  30,  1998,  the  Company's  net  income  was
$4,678,000,  or $0.14 per share  (Basic  EPS),  based on a  weighted  average of
21,858,000 shares outstanding.  That compares to $11,182,000, or $0.50 per share
(Basic EPS),  based on a weighted average of 19,152,000  shares  outstanding for
the quarter  ended  September  30,  1997.  Net  interest  income for the quarter
totaled  $5,794,000,  compared to  $13,226,000  for the same period in 1997. Net
interest  income  is  comprised  of  the  interest  income  earned  on  mortgage
investments less interest  expense from borrowings.  During the third quarter of
1998,  the Company  recorded a gain on the sale of ARM securities of $755,000 as
compared  to a gain of $335,000  during the same  period of 1997.  Additionally,
during the third  quarter of 1998,  the  Company  reduced its  earnings  and the
carrying  value of its ARM assets by  reserving  $561,000 for  potential  credit
losses,  compared  to  $223,000  during the third  quarter  of 1997.  During the
quarter ended  September 30, 1998, the Company  incurred  operating  expenses of
$1,310,000,  consisting  of a base  management  fee  of  $1,040,000,  and  other
operating expenses of $270,000. There was no performance based fee earned by the
Manager during the quarter. During the same period of 1997, the Company incurred
operating  expenses  of  $2,156,000,  consisting  of a  base  management  fee of
$974,000,  a  performance-based  fee of $931,000 and other operating expenses of
$251,000.  Total operating  expenses decreased as a percentage of average assets
to 0.10% for the three months ended  September  30, 1998,  compared to 0.21% for
the same period of 1997.

The  Company's  return on average  common  equity was 3.5% for the quarter ended
September 30, 1998  compared to 12.7% for the quarter ended  September 30, 1997.
The  primary  reason  for the  lower  return  on  average  common  equity is the
Company's lower interest rate spread,  discussed further below, partially offset
by the higher level of gains recorded this quarter on the sale of ARM securities
and lower operating expenses.

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

                 COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY (1)

                                     
<TABLE>
<CAPTION>
                                                                                                                     ROE in
                                                                                                                    Excess of
                   Net                  Gain (Loss)                                             Net       10-Year     10-Year    
                Interest   Provision      on ARM        G & A       Performance    Preferred   Income/   US Treas.   US Treas.
    For The      Income/  For Losses/     Sales/     Expense (2)/       Fee/       Dividend/   Equity     Average     Average
  Quarter Ended  Equity     Equity        Equity       Equity          Equity       Equity     (ROE)       Yield       Yield
  ------------- -------   -----------   ----------   ------------   -----------    ---------   -------   ---------   ---------
<S>              <C>           <C>         <C>          <C>             <C>           <C>       <C>         <C>         <C>  
  Mar 31, 1996   13.37%         -          0.03%        1.04%           1.27%          -        11.08%      5.90%       5.18%
  Jun 30, 1996   13.14%         -           -           1.00%           0.92%          -        11.22%      6.72%       4.50%
  Sep 30, 1996   13.42%        0.34%       0.88%        1.03%           1.07%          -        11.86%      6.78%       5.08%
  Dec 31, 1996   14.99%        1.32%       1.38%        1.46%           1.23%          -        12.37%      6.35%       6.02%
  Mar 31, 1997   18.85%        0.32%       0.01%        1.65%           1.43%         2.07%     13.40%      6.55%       6.85%
  Jun 30, 1997   19.48%        0.34%       0.03%        1.81%           1.25%         2.67%     13.45%      6.71%       6.74%
  Sep 30, 1997   17.66%        0.30%       0.45%        1.64%           1.24%         2.23%     12.70%      6.26%       6.44%
  Dec 31, 1997   15.62%        0.33%       1.06%        1.59%           1.01%         2.12%     11.63%      5.92%       5.71%
  Mar 31, 1998   14.13%        0.48%       1.89%        1.62%           0.94%         2.06%     10.91%      5.60%       5.31%
  Jun 30, 1998    9.15%        0.53%       1.76%        1.58%           0.00%         1.96%      6.83%      5.60%       1.23%
  Sep 30, 1998    6.82%        0.66%       0.89%        1.54%           0.00%         1.97%      3.54%      5.24%      -1.70%
<FN>
  (1) Average common equity excludes unrealized gain(loss)on available-for-sale
      ARM securities.
  (2) Excludes performance fees.
</FN>
</TABLE>

The decline in the  Company's  return on common equity from the third quarter of
1997  and  from the  second  quarter  of 1998 to the  third  quarter  of 1998 is
primarily  due to the decline in the net interest  spread  between the Company's
interest-earning  assets and  interest-bearing  liabilities,  an increase in the
Company's provision for losses and the decline in gains on ARM sales.

The Company's net interest  spread  declined from 0.79% as of September 30, 1997
and 0.13% as of June 30, 1998,  to 0.09% as of September  30, 1998.  The primary
reasons for these declines continues to be the relationship between the one-year
U. S.  Treasury  yield  and LIBOR and the  impact of the  increased  rate of ARM
prepayments.  From  September 30, 1997 to September 30, 1998,  the one-year U.S.
Treasury yield declined by  approximately  1.06% while LIBOR rates applicable to
the  Company's  borrowings  decreased by only 0.37%,  creating a negative  index
spread as of September  30, 1998 of -0.93%.  Approximately  38% of the Company's
ARM assets are indexed to the one-year U. S. Treasury bill yield and, therefore,
the yield on such  assets  declined  with the index.  To put this in  historical
perspective, the one-year U.S. Treasury bill yield had a spread of -0.26% to the
average of the one-and  three-month LIBOR rate as of December 31, 1997, compared
to having a spread of -0.02% at December 31, 1996,  0.04% on average during 1996
and -0.07% on average during 1995.  For the five-year  period from 1993 to 1997,
the average  spread was 0.15%.  The average spread during the three month period
ended  September  30, 1998 was -0.53%,  which was  substantially  worse than the
average spread during the previous quarter of -0.27%.  The Company does not know
when or if the  relationship  between the one-year U. S. Treasury bill yield and
LIBOR will return to historical norms, but the Company's spreads are expected to
improve if that occurs.  The Company is also continuing to decrease its exposure
to  the  one-year  U.  S.  Treasury/LIBOR  relationship  as the  portion  of the
portfolio  indexed to the one-year U. S.  Treasury  rate and financed with LIBOR
has been declining.  The Company's ARM portfolio yield also was lower during the
third  quarter  of 1998  compared  to the third  quarter  of 1997  because of an
increase in the prepayment rate of ARM assets. During the third quarter of 1998,
the  average  prepayment  rate was 32%,  compared  to 22% during the  comparable
period  in 1997.  The  impact  of this was to  increase  the  average  amount of
non-interest-earning assets in the form of principal payments receivable as well
as to increase the  amortization  expense  related to writing off the  Company's
premiums  and  discounts.  The Company  generally  amortizes  its  premiums  and
discounts on a monthly basis based on the most recent three-month average of the
prepayment rate of its ARM assets, thereby adjusting its amortization to current
market conditions, which is reflected in the yield of the ARM portfolio.

The Company's  provision for losses has increased with the  acquisition of whole
loans.  The provision for loan losses is based on an annualized rate of 0.15% on
the  outstanding  principal  balance of loans as of each  month-end,  subject to
certain  adjustments as discussed above. As of September 30, 1998, the Company's
whole  loans  accounted  for  16.1% of the  Company's  portfolio  of ARM  assets
compared  to 11.6% as of June 30, 1998 and  compared to 2.6% as of December  31,
1997. To date,  the Company has not  experienced  any actual losses in its whole
loan  portfolio,  but based on industry  standards,  losses are expected and are
being provided for as the portfolio ages.

During the third quarter of 1998, the Company  realized a net gain from the sale
of ARM  securities  in the amount of $755,000  compared  to $335,000  during the
third quarter of 1997.  These sales  reflect the Company's  desire to manage the
portfolio  with a view to enhancing the total return of the  portfolio  over the
long-term  while  generating   current  earnings  during  this  period  of  fast
prepayments and narrow interest spreads. The Company monitors the performance of
its  individual  ARM  assets  and  selectively  sells an asset  when there is an
opportunity  to  replace  it with  an ARM  asset  that  has an  expected  higher
long-term yield or more attractive interest rate characteristics.  Almost 90% of
the ARMs sold during the three months ended  September  30, 1998 were indexed to
either the one-year U.S. Treasury index or a Cost of Funds index,  which are not
indices that the Company  prefers to own  long-term.  While the Company has been
selling selected assets, it has been able to reinvest the proceeds in ARM assets
that are  indexed to indices  currently  preferred  by the Company and at prices
that  reflect  current  market  assumptions  regarding  prepayments  speeds  and
interest rates.  Thus far, the newly purchased ARM assets, as a whole, have been
performing better than the portfolio acquired before 1998.

As a REIT, the Company is required to declare dividends amounting to 85% of each
year's  taxable  income by the end of each  calendar  year and to have  declared
dividends  amounting  to 95% of its taxable  income for each year by the time it
files its  applicable  tax  return  and,  therefore,  generally  passes  through
substantially all of its earnings to shareholders  without paying federal income
tax at the corporate  level.  Since the Company,  as a REIT,  pays its dividends
based on  taxable  earnings,  the  dividends  may at times be more or less  than
reported  earnings.  The following table provides a  reconciliation  between the
Company's  third  quarter  earnings  as  reported  based on  generally  accepted
accounting  principles  and the  Company's  taxable  income  before  its' common
dividend deduction:

            RECONCILIATION OF REPORTED NET INCOME TO TAXABLE NET INCOME
                           (Dollar amounts in thousands)
<TABLE>
<CAPTION>

                                            Three Month Period Ending September 30,
                                            ---------------------------------------
                                                  1998                    1997
                                            --------------           --------------
<S>                                          <C>                      <C>         
Net income                                   $      4,678             $     11,182
  Additions:
    Provision for credit losses                       561                      223
    Net compensation related items                     53                       20
  Deductions:
    Dividend on Series A Preferred Shares          (1,670)                  (1,670)
    Actual credit losses on ARM securities           (424)                     (18)
                                             ------------             -------------
Taxable net income                           $      3,198             $      9,737
                                             ============             =============
</TABLE>

On August 7,  1998,  the  Board of  Directors  approved  a  rescheduling  of the
Company's quarterly board meetings and the declaration, record and payment dates
of its regular cash  dividend on its common stock.  Under the new schedule,  the
Board of Directors will meet after the close of each quarter end,  enabling them
to review actual quarterly financial results as they consider the declaration of
common  dividends.  This action is also expected to provide a modest  benefit to
the  financial  results  of the  Company as the  Company  will be able to retain
earnings over each quarter end, allowing the Company to leverage this additional
capital  for an  extended  period  of time,  generating  additional  income  for
shareholders  when the  additional  assets are invested at a positive  effective
margin.  This action does not effect the dividend  dates in connection  with the
Company's Series A 9.68% Cumulative Convertible Preferred Shares.


The following table  highlights the quarterly  dividend history of the Company's
common shares:

                              COMMON DIVIDEND SUMMARY
                (Dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
                                                  Common       Common      Cumulative
                    Taxable       Taxable        Dividend     Dividend   Undistributed
      For The         Net        Net Income      Declared      Pay-out      Taxable
   Quarter Ended   Income (1)   Per Share (2)  Per Share (2)  Ratio (3)    Net Income
   -------------  ------------  -------------  -------------  ---------  -------------
<S>               <C>           <C>             <C>               <C>     <C>      
   Mar 31, 1996   $    5,118    $    0.41       $    0.40         97%     $     188
   Jun 30, 1996        6,169         0.42            0.40        103%           (18)
   Sep 30, 1996        6,708         0.42            0.40         96%           250
   Dec 31, 1996        8,164         0.50            0.45         89%         1,115
   Mar 31, 1997        8,226         0.50            0.48         95%         1,505
   Jun 30, 1997        8,573         0.51            0.49         99%         1,603
   Sep 30, 1997        9,737         0.51            0.50        100%         1,560
   Dec 31, 1997        9,207         0.46            0.50        110%           629
   Mar 31, 1998        8,645         0.42            0.375        93%         1,233
   Jun 30, 1998        5,919         0.27            0.30        111%           556
   Sep 30, 1998        3,198         0.15            0.23 (4)    155%         3,125 (4)

<FN>
   (1) Taxable net income after preferred dividends.
   (2) Weighted average common shares outstanding.
   (3) Common  dividend  declared  divided into  applicable  quarter's  taxable
       income available to common shareholders.
   (4)The  regular  dividend  for the third  quarter of 1998 was  declared  on
      October 16, 1998,  payable on November 18, 1998 to  shareholders of record
      on October 31, 1998.
</FN>
</TABLE>

As of  September  30, 1998,  the  Company's  yield on its ARM assets  portfolio,
including the impact of the amortization of premiums and discounts,  the cost of
hedging, the amortization of deferred gains from hedging activity and the impact
of principal payment receivables,  was 5.88%,  compared to 6.58% as of September
30,  1997-- a decrease of 0.70%,  and compared to 5.94% as of June 30, 1998 -- a
decrease of 0.06%.  The Company's  cost of funds as of September  30, 1998,  was
5.78%,  compared to 5.79% as of September  30, 1997 -- a decrease of 0.01%,  and
compared  to 5.81% as of June 30,  1998 - a  decrease  of 0.03%.  As a result of
these  changes,  the Company's net interest  spread as of September 30, 1998 was
0.09%,  compared to 0.79% as of  September  30, 1997 and compared to 0.13% as of
June 30, 1998. The decline in the net interest spread is largely attributable to
the decline in the ARM portfolio yield as discussed  above.  The decrease in the
Company's  cost of funds as of quarter  end is  generally  the result of actions
taken by the Federal  Reserve  Bank to  decrease  short-term  interest  rates by
0.25%.  These Federal  Reserve Bank actions were taken close to quarter end and,
therefore,  had little impact on the Company's  cost of funds during the quarter
which,  on average,  were 0.06% higher  during the third quarter than during the
second  quarter of 1998.  The  increase in the  Company's  average cost of funds
during the quarter  was  generally  the impact of  extending  the  average  next
repricing date of the Company's  borrowings and the impact of financing a larger
proportion of loans as compared to securities.  The Company extended the average
number of days  until the next  repricing  of its  borrowings  to 208 days as of
September  30,  1998 from 120 days as of June 30,  1998 in  connection  with the
Company's  acquisition  of  hybrids  which,  in  accordance  with the  Company's
investment  policy,  require a matching of fixed rate financing during a portion
of the fixed rate period of hybrids (to within approximately one year of the end
of the hybrid's  fixed rate period).  During the period of time when the Company
is accumulating  loans for  securitization,  the Company incurs a higher cost of
funds to finance ARM loans as compared to securities.  Current market conditions
aside, once the loans are securitized,  the Company expects to realize a benefit
in its cost of funds and an improvement in its return from securitized  loans as
compared to the return from the loans prior to their securitization.



<PAGE>


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)

<TABLE>
<CAPTION>
                                             ARM Assets
                     Average    ----------------------------------------   Yield on                           Yield on
                     Interest     Wgt. Avg.     Weighted                   Interest                 Net     Net Interest
    As of the        Earning    Fully Indexed    Average      Yield         Earning    Cost of   Interest     Earning
   Quarter Ended      Assets       Coupon        Coupon      Adj. (2)        Assets     Funds     Spread      Assets
   -------------   ----------   -------------   --------     --------      --------    -------   --------   ------------
<S>                <C>              <C>           <C>         <C>             <C>       <C>        <C>         <C>  
   Mar 31, 1996    $  2,025.8       7.56%         7.48%       0.99%           6.49%     5.60%      0.89%       1.32%
   Jun 30, 1996       2,248.2       7.83%         7.28%       0.85%           6.43%     5.59%      0.84%       1.32%
   Sep 30, 1996       2,506.0       7.80%         7.31%       0.80%           6.51%     5.71%      0.80%       1.32%
   Dec 31, 1996       2,624.4       7.61%         7.57%       0.93%           6.64%     5.72%      0.92%       1.34%
   Mar 31, 1997       2,950.6       7.93%         7.53%       0.89%           6.65%     5.67%      0.98%       1.54%
   Jun 30, 1997       3,464.1       7.75%         7.57%       0.90%           6.67%     5.77%      0.90%       1.39%
   Sep 30, 1997       4,143.7       7.63%         7.65%       1.07%           6.58%     5.79%      0.79%       1.22%
   Dec 31, 1997       4,548.9       7.64%         7.56%       1.18%           6.38%     5.91%      0.47%       0.96%
   Mar 31, 1998       4,859.7       7.47%         7.47%       1.23%           6.24%     5.74%      0.50%       0.92%
   Jun 30, 1998       4,918.3       7.51%         7.44%       1.50%           5.94%     5.81%      0.13%       0.56%
   Sep 30, 1998       4,963.7       6.97%         7.40%       1.52%           5.88%     5.78%      0.09%       0.46%

<FN>
   (1)Yield on Net Interest  Earning  Assets is computed by dividing  annualized
      net  interest  income by the average  daily  balance of  interest  earning
      assets.
   (2)Yield   adjustments   include  the  impact  of  amortizing   premiums  and
      discounts,  the cost of hedging  activities,  the amortization of deferred
      gains  from  hedging  activities  and  the  impact  of  principal  payment
      receivables.  The following  table presents these  components of the yield
      adjustments for the dates presented in the table above:
</FN>
</TABLE>

                 COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM ASSETS

<TABLE>
<CAPTION>
                                   Impact of                 Amort. of
                      Premium/     Principal               Deferred Gain      Total
        As of the     Discount     Payments      Hedging    from Hedging      Yield
      Quarter Ended    Amort.     Receivable    Activity      Activity      Adjustment
      -------------   --------    ----------    --------   --------------   ----------
<S>                     <C>          <C>          <C>           <C>            <C>  
      Mar 31, 1996      0.77%        0.11%        0.31%         (0.20)%        0.99%
      Jun 30, 1996      0.67%        0.07%        0.27%         (0.16)%        0.85%
      Sep 30, 1996      0.57%        0.08%        0.25%         (0.10)%        0.80%
      Dec 31, 1996      0.69%        0.09%        0.23%         (0.08)%        0.93%
      Mar 31, 1997      0.63%        0.13%        0.19%         (0.07)%        0.89%
      Jun 30, 1997      0.66%        0.13%        0.16%         (0.05)%        0.90%
      Sep 30, 1997      0.85%        0.12%        0.15%         (0.05)%        1.07%
      Dec 31, 1997      0.94%        0.14%        0.14%         (0.04)%        1.18%
      Mar 31, 1998      0.98%        0.16%        0.13%         (0.04)%        1.23%
      Jun 30, 1998      1.24%        0.17%        0.13%         (0.04)%        1.50%
      Sep 30, 1998      1.25%        0.18%        0.13%         (0.04)%        1.52%
</TABLE>


<PAGE>


The  following  table  reflects the average  balances  for each  category of the
Company's  interest  earning  assets as well as the Company's  interest  bearing
liabilities,  with the corresponding  effective rate of interest  annualized for
the quarters ended September 30, 1998 and 1997:

                      AVERAGE BALANCE AND RATE TABLE
                       (Dollar amounts in thousands)

<TABLE>
<CAPTION>
                                           For the Quarter Ended       For the Quarter Ended
                                             September 30, 1998          September 30, 1997
                                           ----------------------      ----------------------
                                            Average     Effective       Average     Effective
                                            Balance       Rate          Balance       Rate
                                           -----------  ---------      -----------  ---------
<S>                                        <C>             <C>         <C>             <C>  
      Interest Earning Assets:
         Adjustable-rate mortgage assets   $ 4,959,879     5.82%       $ 4,116,223     6.58%
         Cash and cash equivalents               3,815     2.89             27,524     5.66
                                           -----------  --------       -----------   -------
                                             4,963,694     5.82          4,143,747     6.57
                                           -----------  --------       -----------   -------
      Interest Bearing Liabilities:
         Borrowings                          4,570,463     5.82          3,788,879     5.79
                                           -----------  --------       -----------   -------
      Net Interest Earning Assets
         and Spread                       $    393,231     0.00%      $    354,868     0.78%
                                           ===========  ========       ===========   =======

      Yield on Net Interest Earning Assets (1)             0.47%                       1.28%
                                                        ========                     =======
<FN>
(1)   Yield on Net Interest  Earning  Assets is computed by dividing  annualized
      net  interest  income by the average  daily  balance of  interest  earning
      assets.
</FN>
</TABLE>

As a result of the yield on the Company's  interest-earning  assets declining to
5.82% during the third  quarter of 1998 from 6.58%  during the third  quarter of
1997 and the  Company's  cost of funds  increasing  to 5.82%  during  the  third
quarter of 1998 from 5.79%  during the third  quarter of 1997,  its net interest
income  decreased  by  $7,432,000.  This  decrease in net  interest  income is a
combination of rate and volume variances.  There was a combined unfavorable rate
variance of $8,181,000, which was almost entirely the result of a lower yield on
the  Company's  ARM assets  portfolio  and other  interest-earning  assets.  The
increased  average size of the Company's  portfolio  during the third quarter of
1998  compared to the same  period of 1997  contributed  to higher net  interest
income  in the  amount  of  $749,000.  The  average  balance  of  the  Company's
interest-earning  assets was  $4.964  billion  during the third  quarter of 1998
compared to $4.144  billion  during the third  quarter of 1997 -- an increase of
20%.

For the quarter  ended  September  30, 1998,  the  Company's  ratio of operating
expenses to average  assets was 0.10% as compared to 0.21% for the same  quarter
of 1997 and as compared to 0.10% for the previous  quarter  ended June 30, 1998.
The Company's  expense  ratios are among the lowest of any company  investing in
mortgage  assets,  giving  the  Company  what it  believes  to be a  significant
competitive   advantage  over  more  traditional   mortgage   portfolio  lending
institutions  such as banks and savings and loans.  This  competitive  advantage
enables the Company to operate with less risk,  such as credit and interest rate
risk, and still generate an attractive  long-term return on equity when compared
to these more traditional mortgage portfolio lending  institutions.  The Company
pays the  Manager an annual  base  management  fee,  generally  based on average
shareholders'  equity,  not  assets,  as  defined in the  Management  Agreement,
payable monthly in arrears as follows: 1.1% of the first $300 million of Average
Shareholders'  Equity,  plus 0.8% of  Average  Shareholders'  Equity  above $300
million.  Since this  management  fee is based on  shareholders'  equity and not
assets, this fee increases as the Company successfully  accesses capital markets
and raises additional equity capital and is, therefore, managing a larger amount
of invested capital on behalf of its  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  ten-year  U.S.
Treasury rate during the quarter plus 1%. During the third quarter of 1998,  the
Manager did not earn a performance  fee because the  Company's  return on equity
declined to 3.5%. As presented in the following  table, the performance fee is a
variable  expense that  fluctuates  with the Company's  return on  shareholders'
equity relative to the average 10-year U.S. Treasury rate.



<PAGE>


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

                        ANNUALIZED OPERATING EXPENSE RATIOS

<TABLE>
<CAPTION>
                    Management Fee &                          Total
      For The       Other Expenses/     Performance Fee/   G & A Expense/
   Quarter Ended    Average Assets       Average Assets    Average Assets
   -------------    ----------------    ----------------   --------------
<S>                      <C>                  <C>               <C>  
   Mar 31, 1996          0.09%                0.12%             0.21%
   Jun 30, 1996          0.10%                0.09%             0.19%
   Sep 30, 1996          0.10%                0.10%             0.20%
   Dec 31, 1996          0.13%                0.11%             0.24%
   Mar 31, 1997          0.14%                0.11%             0.25%
   Jun 30, 1997          0.13%                0.09%             0.22%
   Sep 30, 1997          0.12%                0.09%             0.21%
   Dec 31, 1997          0.12%                0.05%             0.17%
   Mar 31, 1998          0.10%                0.06%             0.16%
   Jun 30, 1998          0.10%                0.00%             0.10%
   Sep 30, 1998          0.10%                0.00%             0.10%
</TABLE>

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998

For the nine months ended  September  30,  1998,  the  Company's  net income was
$22,649,000,  or $0.82 per share  (Basic  EPS),  based on a weighted  average of
21,488,000 shares outstanding.  That compares to $30,551,000, or $1.49 per share
(Basic EPS),  based on a weighted average of 17,437,000  shares  outstanding for
the nine months  ended  September  30, 1997.  Net  interest  income for the nine
months totaled $24,996,000, compared to $36,733,000 for the same period in 1997.
Net  interest  income is comprised  of the  interest  income  earned on mortgage
investments less interest expense from borrowings.  During the first nine months
of  1998,  the  Company  recorded  a gain  on the  sale  of  ARM  securities  of
$3,780,000,  compared  to a gain of  $360,000  during  the same  period of 1997.
Additionally,  during the first nine  months of 1998,  the  Company  reduced its
earnings and the carrying  value of its ARM assets by reserving  $1,402,000  for
potential  credit losses,  compared to $623,000  during the same period of 1997.
During the nine months ended September 30, 1998, the Company incurred  operating
expenses of $4,725,000,  consisting of a base  management  fee of $3,115,000,  a
performance-based  fee of $759,000  and other  operating  expenses of  $851,000.
During the same  period of 1997,  the  Company  incurred  operating  expenses of
$5,919,000,   consisting   of  a   base   management   fee  of   $2,661,000,   a
performance-based  fee of $2,569,000 and other  operating  expenses of $689,000.
Total  operating  expenses  decreased as a percentage of average assets to 0.12%
for the nine months ended  September  30,  1998,  compared to 0.22% for the same
period of 1997.

The Company's return on average common equity was 7.0% for the nine months ended
September  30, 1998  compared to 13.2% for the nine months ended  September  30,
1997.  The primary  reason for the lower return on average  common equity is the
Company's lower interest rate spread,  as discussed  below,  partially offset by
the higher level of gains recorded this period on the sale of ARM securities and
lower operating expenses.

The primary reasons for the decline in the Company's net interest spread,  which
resulted  in lower net  interest  income  during  the nine  month  period  ended
September  30, 1998 as  compared to the same period of 1997,  continue to be the
relationship  between the one-year U. S. Treasury yield and LIBOR and the impact
of increased ARM  prepayment  speeds.  As discussed  above,  the average  spread
between  the  one-year  U. S.  Treasury  yield  and  the  average  of  one-  and
three-month LIBOR was 0.04% during 1996 and -0.07% during 1995 as compared to an
index spread of -0.93% as of September 30, 1998 and an average  spread of -0.38%
for the nine months ended  September  30,  1998.  As  mentioned  above,  for the
five-year  period from 1993 to 1997, the average  spread was 0.15%.  The Company
does not know when or if the  relationship  between the one-year U. S.  Treasury
bill yield and LIBOR will return to historical  norms, but the Company's spreads
are expected to improve if that occurs.  The Company's ARM portfolio  yield also
was lower during the first nine months of 1998 compared to the first nine months
of 1997 because of an increase in the prepayment rate of ARM assets.  During the
first nine months of 1998, the average  prepayment rate was 32%, compared to 22%
during the  comparable  period in 1997.  The impact of this was to increase  the
average amount of non-interest-earning  assets in the form of principal payments
receivable as well as to increase the  amortization  expense  related to writing
off the Company's premiums and discounts.

The  following  table  reflects the average  balances  for each  category of the
Company's  interest  earning  assets as well as the Company's  interest  bearing
liabilities,  with the corresponding  effective rate of interest  annualized for
the nine month periods ended September 30, 1998 and 1997:

                      AVERAGE BALANCE AND RATE TABLE
                       (Dollar amounts in thousands)

<TABLE>
<CAPTION>
                                             For the Nine Month          For the Nine Month
                                                Period Ended                Period Ended
                                             September 30, 1998          September 30, 1997
                                           ----------------------      ----------------------
                                            Average     Effective       Average     Effective
                                            Balance       Rate          Balance       Rate
                                           -----------  ---------      -----------  ---------
<S>                                        <C>             <C>         <C>             <C>  
      Interest Earning Assets:
         Adjustable-rate mortgage assets   $ 4,906,926     6.02%       $ 3,498,843     6.62%
         Cash and cash equivalents               6,981     3.93             20,643     5.61
                                           -----------  --------       -----------   -------
                                             4,913,907     6.01          3,519,486     6.62
                                           -----------  --------       -----------   -------
      Interest Bearing Liabilities:
         Borrowings                          4,526,102     5.79          3,204,859     5.74
                                           -----------  --------       -----------   -------
      Net Interest Earning Assets
         and Spread                       $    387,805     0.22%      $    314,627     0.88%
                                           ===========  ========       ===========   =======

      Yield on Net Interest Earning Assets (1)             0.68%                       1.39%
                                                        ========                     =======
<FN>
(1)   Yield on Net Interest  Earning  Assets is computed by dividing  annualized
      net  interest  income by the average  daily  balance of  interest  earning
      assets.
</FN>
</TABLE>

As a result of the yield on the Company's  interest-earning  assets declining to
6.02% for the first nine  months of 1998 from 6.62% for the same  period of 1997
and the  Company's  cost of funds  increasing  to 5.79%  from 5.74% for the same
respective time periods, its net interest income decreased by $11,737,000.  This
decrease in net interest  income is a combination of rate and volume  variances.
There was a combined  unfavorable rate variance of $17,475,000,  which consisted
of an unfavorable variance of $16,250,000  resulting from the lower yield on the
Company's  ARM  assets  portfolio  and  other  interest-earning  assets  and  an
unfavorable  variance of $1,225,000  resulting from an increase in the Company's
cost of funds. The increased average size of the Company's portfolio during 1998
compared to the same period of 1997 contributed to higher net interest income in
the amount of $5,738,000.  The average balance of the Company's interest-earning
assets was $4.914  billion  during the first  nine  months of 1998  compared  to
$3.519 billion during the same period of 1997 -- an increase of 40%.

During the first nine months of 1998,  the Company  realized a net gain from the
sale of ARM  securities  in the amount of  $3,780,000  as  compared  to $360,000
during the same period of 1997.  As  discussed  above,  these sales  reflect the
Company's  desire to manage the  portfolio  with a view to  enhancing  the total
return of the portfolio over the long-term  while  generating  current  earnings
during this period of fast prepayments and narrow interest spreads.  The Company
monitors the performance of its individual ARM assets and  selectively  sells an
asset when there is an  opportunity  to replace it with an ARM asset that has an
expected   higher   long-term   yield   or   more   attractive   interest   rate
characteristics.  The Company sold $511.8 million of ARM assets during the first
nine months of 1998,  most which were either  indexed to a Cost of Funds  index,
the one-year U. S. Treasury index or were prepaying faster than expected.  While
the Company has been selling selected  assets,  it has been able to reinvest the
proceeds in ARM assets that are indexed to indices  preferred by the Company and
at prices that reflect current market assumptions  regarding  prepayments speeds
and interest rates and thus far, as a whole,  they have been  performing  better
than the portfolio acquired before 1998.  Additionally,  the Company recorded an
expense  for credit  losses in the amount of  $1,402,000  during the nine months
ended  September 30, 1998,  compared to $623,000 during the same period of 1997.
The Company continued its provision level on the two ARM securities for which it
provided  $900,000  for credit  losses  during  this nine month  period  and, in
accordance  with its credit reserve policy for loans,  also recorded a provision
of $442,000 on its ARM loan  portfolio  and  $60,000 on its  portfolio  of loans
securitized  by the Company on which the Company  retained the first loss credit
exposure.

For the nine months ended  September 30, 1998, the Company's  ratio of operating
expenses to average assets was 0.12% as compared to 0.22% for the same period of
1997. The primary  reason for the decline in operating  expenses is the variable
nature of the performance  based fee paid to the Manager,  which is based on the
performance of the Company  relative to the average  10-year U.S.  Treasury rate
during the applicable period.  During the second and third quarters of 1998, the
Manager did not earn a performance  fee because the  Company's  return on equity
declined to 6.8% and 3.5%,  respectively,  and, as a result,  for the nine month
period of 1998,  the Manager was paid  $759,000,  compared to $2,569,000 for the
same period of 1997.

LIQUIDITY AND CAPITAL RESOURCES

The Company's  primary source of funds for the quarters ended September 30, 1998
and 1997  consisted  of reverse  repurchase  agreements,  which  totaled  $4.551
billion and $3.981 billion at the respective quarter ends.  Another  significant
source of funds for the Company for the quarters  ended  September  30, 1998 and
1997  consisted  of  payments  of  principal  and  interest  from its ARM assets
portfolio in the amounts of $558.3 million and $294.9 million,  respectively. In
addition,  during the quarter  ended  September 30, 1998,  the Company  received
$180.0  million from the sale of ARM assets and $12.2  million in proceeds  from
ARM assets  that were called  during the  quarter.  In the  future,  the Company
expects  its  primary  sources of funds will  consist of  borrowed  funds  under
reverse repurchase agreement transactions with one- to twelve-month  maturities,
monthly payments of principal and interest on its ARM assets portfolio and asset
sales as needed.  The Company's liquid assets generally consist of unpledged ARM
assets, cash and cash equivalents.

The borrowings  incurred at September 30, 1998 had a weighted  average  interest
cost of 5.78%,  which  includes  the cost of  interest  rate  swaps,  a weighted
average original term to maturity of 4.3 months and a weighted average remaining
term to maturity of 2.3 months.  As of September 30, 1998, $1.104 billion of the
Company's  reverse   repurchase   agreements  were  variable-rate  term  reverse
repurchase  agreements with original  maturities that range from three months to
one year.  The interest  rates of these term reverse  repurchase  agreements are
indexed to either the one or three-month LIBOR rate and reprice accordingly.  In
addition,  as of September 30, 1998,  $741.5  million of the  Company's  reverse
repurchase  agreements  were  collateralized  by  whole  loans  under  one  year
financing  agreements  that are indexed to the one-month  LIBOR rate and reprice
either  daily  or once a  month.  These  whole  loan  financing  agreements  are
scheduled to mature on November  30, 1998 and December 23, 1998.  The Company is
in the process of negotiating new whole loan facilities to provide financing for
its whole loans beyond the expiration date of these agreements.

The Company has borrowing  arrangements with 23 different financial institutions
and  on  September  30,  1998,  had  borrowed  funds  under  reverse  repurchase
agreements  with 18 of these firms.  Because the Company  borrows money based on
the fair value of its ARM assets and because  increases in  short-term  interest
rates can negatively impact the valuation of ARM assets, the Company's borrowing
ability  could be limited  and lenders may  initiate  margin  calls in the event
short-term  interest  rates  increase or the value of the  Company's  ARM assets
declines for other  reasons.  Additionally,  certain of the Company's ARM assets
are rated  less than AA by the  Rating  Agencies  and have less  liquidity  than
assets that are rated AA or higher.  Other mortgage assets which are rated AA or
higher by the Rating  Agencies  derive their  credit  rating based on a mortgage
pool insurer's rating.  As a result of either changes in interest rates,  credit
performance  of a mortgage  pool or a downgrade of a mortgage  pool issuer,  the
Company may find it difficult to borrow against such assets and, therefore,  may
be required to sell certain mortgage assets in order to maintain  liquidity.  If
required,  these sales could be at prices lower than the  carrying  value of the
assets,  which would result in losses. For the quarter ended September 30, 1998,
the Company had adequate cash flow, liquid assets and unpledged  collateral with
which  to meet  its  margin  requirements  during  such  periods.  However,  the
Company's  liquid assets and unpledged  collateral were declining as a result of
adverse  market  conditions  at the end of the third quarter and into the fourth
quarter.  In order to maintain  adequate  liquidity,  the Company undertook some
asset sales in the fourth quarter in order to reduce its leverage.

In December 1996, the Company's  Registration Statement on Form S-3, registering
the sale of up to $200 million of  additional  equity  securities,  was declared
effective by the Securities and Exchange Commission. This registration statement
includes the possible  issuances of common stock,  preferred stock,  warrants or
shareholder  rights.  As of September 30, 1998,  the Company had $109 million of
its securities registered for future sale under this Registration Statement.

On July 13,  1998,  the Board of Directors  approved a common  stock  repurchase
program  of up to  500,000  shares  at  prices  below  book  value,  subject  to
availability of shares and other market  conditions.  On September 18, 1998, the
Board of Directors  expanded this program by approving  the  repurchase of up to
1,000,000  shares  at  prices  below  book  value.  To  date,  the  company  has
repurchased  500,016 shares at an average price of $9.28 per share.  The Company
has also purchased  shares in the open market on behalf of the  participants  in
its DRP when the stock price is trading  below book value instead of issuing new
shares below book value. In accordance with the terms and conditions of the DRP,
the Company pays the brokerage commission in connection with these purchases.

Subsequent  to September 30, 1998,  the Company and other  investors in mortgage
assets became subject to significant changes that have affected the financing of
mortgage assets. A number of the Company's competitors with a greater proportion
of lesser quality mortgage assets have experienced significant  deterioration of
their asset values and ability to finance  such assets,  causing some of them to
declare  bankruptcy and others to sell assets at significant  losses in order to
avoid  insolvency.  Although the Company's  business plan  anticipates  periodic
disruptions  in the  mortgage  market,  the  Company is still  impacted by these
conditions,  although to a lesser degree. First, some lower quality assets owned
by the Company cannot be financed at any price, and those that can be, are being
financed at lower values with requirements of higher over collateralization than
previously required.  Secondly, in some cases with certain counterparties,  high
quality  assets also require more over  collateralization  and have  experienced
price  declines.  Also,  because of recent  changes in market  conditions it has
become apparent that the originally anticipated  securitization structure of the
Company's  loans  will  require  more  capital  than is  currently  required  by
financing  them as loans,  although the cost of  financing  would be expected to
decline  upon  securitization.   Since  the  Company  finds  itself  temporarily
constrained  by its available  capital,  the Company is making  arrangements  to
continue  the  financing  of  most  of  its  loans  by  issuing   callable  debt
collateralized  by loans and to complete this  financing by the end of 1998. Any
such  callable  debt  transaction,  if  completed,  would  likely  increase  the
Company's cost of financing  loans until the debt  obligation is called.  In the
event that such financing cannot be completed, the Company may be forced to sell
some or all of these ARM loans at a loss.

One of the primary  reasons the  Company's  liquidity  is impacted by the issues
discussed above has to do with FHLMC and FNMA payment  receivables.  It has been
standard  industry  practice of the mortgage finance market to exclude the value
of the payment  receivable  from the market  value of a FHLMC or FNMA  security,
although the executed agreement  governing the financing of mortgage  securities
allows for the  inclusion of such payment  receivables  in the market value of a
security  up until the  respective  payment  date.  In the past the  Company has
accepted this practice and financed the FHLMC and FNMA  receivables with its own
capital. However, given the current market conditions, the Company is requesting
its counterparties to include the value of the payment  receivables in the value
of its securities and,  thereby  deferring  margin calls for principal  paydowns
until the  applicable  payment  date.  This alone  would  return  the  Company's
liquidity  position to an appropriate  level. At present,  some of the Company's
counterparties  are cooperating in this matter but the Company is not relying on
being able to successfully  prevail in this matter. As a result, the Company has
and will continue to sell some assets in order to accelerate  the speed at which
the Company is de-leveraging,  increasing the Company's  liquidity.  The Company
expects  to be able to sell  sufficient  assets to  alleviate  the impact of the
current market conditions without materially impacting its future operations. As
of November 13, 1998,  thus far during the fourth  quarter of 1998,  the Company
has sold approximately $363 million of ARM assets at a loss of $3.4 million. The
Company  does not expect to  provide  additional  updates of the fourth  quarter
sales until it releases its 1998  earnings in January of 1999,  unless there are
material changes in the Company's  situation.  At this time the Company believes
it has adequate  capital and  liquidity  resources to mitigate the impact of the
current  market  conditions  and intends to continue  to  implement  its current
business plan in the future.

EFFECTS OF INTEREST RATE CHANGES

Changes in interest rates impact the Company's  earnings in various ways.  While
the Company only invests in ARM assets,  rising  short-term  interest  rates may
temporarily  negatively  affect the Company's  earnings and  conversely  falling
short-term interest rates may temporarily increase the Company's earnings.  This
impact  can  occur  for  several  reasons  and  may be  mitigated  by  portfolio
prepayment  activity as discussed below.  First,  the Company's  borrowings will
react to changes in interest  rates sooner than the Company's ARM assets because
the weighted  average next repricing date of the borrowings is usually a shorter
time period.  Second,  interest  rates on ARM loans are generally  limited to an
increase of either 1% or 2% per adjustment  period (commonly  referred to as the
periodic  cap) and the  Company's  borrowings  do not have similar  limitations.
Third,  the  Company's  ARM assets lag  changes in the indices due to the notice
period  provided  to ARM  borrowers  when the  interest  rate on their loans are
scheduled to change.  The periodic cap only affects the Company's  earnings when
interest rates move by more than 1% per six-month period or 2% per year.

The rate of prepayment on the Company's 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 the  Company  to  amortize  the
premiums  paid for its ARM assets over a longer  time  period,  resulting  in an
increased  yield on its 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.

Conversely, the rate of prepayment on the Company's 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 the Company to
amortize  the  premiums  paid for its  mortgage  assets  faster,  resulting in a
reduced yield on its 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,  the Company's  earnings may be
adversely affected.

Lastly,  because the Company only invests in ARM assets and  approximately 8% to
10% of such  mortgage  assets  are  purchased  with  shareholders'  equity,  the
Company's  earnings  over time  will tend to  increase  following  periods  when
short-term  interest  rates  have  risen and  decrease  following  periods  when
short-term interest rates have declined. This is because the financed portion of
the Company's  portfolio of ARM assets will, over time, reprice to a spread over
the Company's cost of funds, while the portion of the Company's portfolio of ARM
assets that are 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.

YEAR 2000 ISSUES

The Year 2000 issues  involve both hardware  design flaws in which many computer
systems,  and machines that use computer chips, will not correctly recognize the
date beginning in the Year 2000 and,  additionally,  software  applications  and
compilers that do not use a four-digit reference to years which might not behave
as intended  once the Year 2000 is reached.  Three general areas of concern are:
1) clocks built into  computers and computer chips that will rollover to 1900 or
1980 instead of 2000,  2) purchased  software  that does not  recognize the Year
2000 as a leap year or that does not use a four-digit reference to years, and 3)
internally  developed  applications  that do not store the year as a  four-digit
year. The Company  invests in assets and enters into  agreements that employ the
use of dates and is,  therefore,  concerned  about the ability of equipment  and
computer programs to interpret dates or recognize dates accurately.

In consideration of the Year 2000 issues, the Company's Manager has reviewed the
ability of its own  computers  and computer  programs to properly  recognize and
handle  dates in the  Year  2000.  Through  the  normal  upgrading  of  computer
equipment,  the Manager has already  replaced all  computers  that were not Year
2000 compliant.  The software used by the Company has been internally  developed
using products that are Year 2000  compliant.  The Manager has also reviewed all
the date fields embedded in its internally developed spreadsheets, databases and
other  programs and has determined  that all such programs are using  four-digit
years in references to dates.  Therefore,  the Company  believes that all of its
equipment and internal systems are ready for the Year 2000. To date, the Company
has not incurred any cost in order to be Year 2000  compliant  since the Manager
is responsible for the expense of all equipment.

The Company  believes that most of its exposure to Year 2000 issues involves the
readiness of third parties such as, but not limited to, loan servicers, security
master servicers, security paying agents and trustees, its stock transfer agent,
its securities custodian, the counterparties on its various financing agreements
and hedging contracts and vendors.  The Manager, at its expense,  will conduct a
survey of all such third parties to try to determine the readiness of such third
parties to handle Year 2000 dates and to try to determine the  potential  impact
of Year 2000 issues. The Company cannot be certain that such a survey will fully
identify all Year 2000 issues or to fully access the potential  problems or loss
associated  with  Year 2000  issues or that any  failure  by these  other  third
parties  to resolve  Year 2000  issues  would not have an adverse  effect on the
Company's  operations  and  financial  condition.  The  Company  and the Manager
believe that they are spending the appropriate and necessary resources to try to
identify  Year 2000 issues and to resolve them or to mitigate the impact of them
to the best of their ability as they are identified.

OTHER MATTERS

As of September 30, 1998, the Company  calculates its Qualified REIT Assets,  as
defined in the Internal  Revenue Code of 1986,  as amended (the  "Code"),  to be
99.9% of its total assets, as compared to the Code requirement that at least 75%
of its total assets must be Qualified REIT Assets.  The Company also  calculates
that 99.9% of its 1998 revenue for the first nine months of 1998  qualifies  for
the 75%  source of income  test and 100% of its  revenue  qualifies  for the 95%
source of  income  test  under the REIT  rules.  The  Company  also met all REIT
requirements  regarding the ownership of its common stock and the  distributions
of its net income.  Therefore,  as of September 30, 1998,  the Company  believes
that it will continue to qualify as a REIT under the provisions of the Code.

The  Company at all times  intends to conduct  its  business so as not to become
regulated as an investment  company under the Investment Company Act of 1940. If
the  Company  were to  become  regulated  as an  investment  company,  then  the
Company's 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,  the Company must  maintain at
least 55% of its assets directly in Qualifying  Interests.  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. The Company
calculates that it is in compliance with this requirement.

PART II.    OTHER INFORMATION

Item 1. Legal Proceedings
         At September 30, 1998, there were no pending legal proceedings to which
         the Company was a party or of which any of its property was subject.

Item 2. Changes in Securities
          Not applicable

Item 3. Defaults Upon Senior Securities
          Not applicable

Item 4. Submission of Matters to a Vote of Security Holders
          Not applicable

Item 5. Other Information
          None

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

         (a)   Exhibits
                 None

         (b)   Reports on Form 8-K
                 None


<PAGE>


                                     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 ASSET CORPORATION



Dated:  November 13, 1998              By: /s/ Larry A. Goldstone
                                           -----------------------
                                           Larry A. Goldstone,
                                           President and Chief Operating Officer
                                           (authorized officer of registrant)




Dated:  November 13, 1998              By: /s/ Richard P. Story
                                           --------------------
                                           Richard P. Story,
                                           Chief Financial Officer and Treasurer
                                           (principal accounting officer)