<PAGE>

================================================================================

                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, 2002

                                       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, INC.
             (Exact name of Registrant as specified in its Charter)

                  MARYLAND                                 85-0404134
      (State or other jurisdiction of                     (IRS Employer
       incorporation or organization)                Identification Number)

            150 WASHINGTON AVENUE
            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)
                                 Not applicable

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

                   (1) Yes     X             No
                           ---------            ---------
                   (2) Yes     X             No
                           ---------            ---------

                      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)                49,754,356 as of November 11, 2002


<PAGE>


                            THORNBURG MORTGAGE, INC.
                                    FORM 10-Q


                                      INDEX


<Table>
<Caption>
                                                                                                          Page
                                                                                                          ----
<S>               <C>                                                                                    <C>
PART I.           FINANCIAL INFORMATION

     Item 1.      Financial Statements

                      Consolidated Balance Sheets at September 30, 2002 and December 31, 2001.............    3

                      Consolidated Statements of Operations for the three and nine months ended
                       September 30, 2002 and September 30, 2001..........................................    4

                      Consolidated Statement of Shareholders' Equity for the nine months
                       ended September 30, 2002 and September 30, 2001....................................    5

                      Consolidated Statements of Cash Flows for the three and nine months ended
                       September 30, 2002 and September 30, 2001..........................................    6

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

     Item 2.      Management's Discussion and Analysis of
                  Financial Condition and Results of Operations...........................................   22

     Item 4.      Controls and Procedures.................................................................   42


PART II.          OTHER INFORMATION

     Item 1.      Legal Proceedings.......................................................................   42

     Item 2.      Changes in Securities ..................................................................   42

     Item 3.      Defaults Upon Senior Securities ........................................................   42

     Item 4.      Submission of Matters to a Vote of Security Holders.....................................   42

     Item 5.      Other Information.......................................................................   42

     Item 6.      Exhibits and Reports on Form 8-K........................................................   42


     SIGNATURES...........................................................................................   43

     CERTIFICATIONS.......................................................................................   44

     EXHIBIT INDEX........................................................................................   47
</Table>

<PAGE>


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)

<Table>
<Caption>
                                                          September 30, 2002
ASSETS                                                       (unaudited)       December 31, 2001
                                                          ------------------   -----------------
<S>                                                       <C>                  <C>
   Adjustable-rate mortgage ("ARM") assets:
      ARM securities                                       $     9,098,636      $     5,162,627
      Collateral for collateralized notes                          321,264              470,752
      ARM loans held for securitization                            576,145               98,766
                                                           ---------------      ---------------
                                                                 9,996,045            5,732,145
                                                           ---------------      ---------------

   Cash and cash equivalents                                        44,774               33,884
   Accrued interest receivable                                      48,725               33,483
   Prepaid expenses and other                                        2,391                4,136
                                                           ---------------      ---------------
                                                           $    10,091,935      $     5,803,648
                                                           ===============      ===============


LIABILITIES

   Reverse repurchase agreements                           $     8,313,722      $     4,738,827
   Collateralized notes                                            286,308              432,581
   Whole loan financing facilities                                 393,758               40,283
   Payable for assets purchased                                    253,594               18,200
   Accrued interest payable                                         20,248               12,160
   Dividends payable                                                 1,670               19,987
   Accrued expenses and other                                       18,316                8,952
                                                           ---------------      ---------------
                                                                 9,287,616            5,270,990
                                                           ---------------      ---------------

SHAREHOLDERS' EQUITY

   Preferred stock: par value $.01 per share;
      Series A 9.68% Cumulative Convertible shares,
      aggregate preference in liquidation $69,000,
      2,760 shares authorized, issued and outstanding;              65,805               65,805
      Series B Cumulative, 22 shares authorized,
      none issued and outstanding                                       --                   --
   Common stock: par value $.01 per share; 497,218 and
      47,218 shares authorized, 47,281 and 33,305 shares
      issued and outstanding, respectively                             473                  333
   Additional paid-in-capital                                      780,071              515,516
   Accumulated other comprehensive income (loss)                   (60,918)             (36,566)
   Notes receivable from stock sales                                (7,645)              (7,904)
   Retained earnings (deficit)                                      26,533               (4,526)
                                                           ---------------      ---------------
                                                                   804,319              532,658
                                                           ---------------      ---------------
                                                           $    10,091,935      $     5,803,648
                                                           ===============      ===============
</Table>


See Notes to Consolidated Financial Statements.


                                       3
<PAGE>


THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)

<Table>
<Caption>
                                                            Three Months Ended              Nine Months Ended
                                                               September 30,                   September 30,
                                                            2002            2001            2002            2001
                                                       ------------    ------------    ------------    ------------
<S>                                                    <C>             <C>             <C>             <C>
Interest income from ARM assets and cash equivalents   $    109,662    $     66,249    $    285,527    $    207,155
Interest expense on borrowed funds                          (67,149)        (46,456)       (174,433)       (157,323)
                                                       ------------    ------------    ------------    ------------
Net interest income                                          42,513          19,793         111,094          49,832
                                                       ------------    ------------    ------------    ------------
Gain on sale of ARM assets                                       18              --             105               1
Hedging expense                                                (173)           (507)         (1,109)         (1,124)
Provision for credit losses                                      --            (231)             --            (562)
Management fee                                               (2,076)         (1,249)         (5,623)         (3,463)
Performance fee                                              (5,044)         (1,627)        (11,958)         (3,624)
Other operating expenses                                     (2,628)         (1,594)         (7,669)         (3,907)
                                                       ------------    ------------    ------------    ------------
Net income before cumulative effect of change in
     accounting principle                                    32,610          14,585          84,840          37,153
Cumulative effect of change in accounting principle              --              --              --            (202)
                                                       ------------    ------------    ------------    ------------
     NET INCOME                                        $     32,610    $     14,585    $     84,840    $     36,951
                                                       ============    ============    ============    ============

Net income                                                   32,610          14,585          84,840          36,951
Dividends on preferred stock                                 (1,670)         (1,670)         (5,009)         (5,009)
                                                       ------------    ------------    ------------    ------------
Net income available to common shareholders            $     30,940    $     12,915    $     79,831    $     31,942
                                                       ============    ============    ============    ============
Basic earnings per share (a):
  Net income                                           $       0.68    $       0.52    $       1.93    $       1.40
  Average number of shares outstanding                       45,733          25,004          41,401          22,841
                                                       ============    ============    ============    ============
Diluted earnings per share (a):
  Net income                                           $       0.67    $       0.52    $       1.92    $       1.40
  Average number of shares outstanding                       48,493          25,029          44,161          22,894
                                                       ============    ============    ============    ============
</Table>

(a)  Basic and diluted earnings per share were reduced by $0.01 in the first
     nine months of 2001 due to the impact of the adoption of FAS 133 relating
     to the accounting for derivative instruments and hedging activities.


See Notes to Consolidated Financial Statements.


                                       4
<PAGE>

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
Nine months ended September 30, 2002 and 2001
(In thousands, except share data)

<Table>
<Caption>
                                                                       Accum.
                                                                       Other
                                                                      Compre-    Notes                       Compre-
                                                          Additional  hensive  Receivable Retained           hensive
                                         Preferred Common  Paid-in     Income  From Stock Earnings/ Treasury  Income
                                           Stock   Stock   Capital     (Loss)    Sales    (Deficit) Stock     (Loss)   Total
                                         --------- ------ ---------- --------- ---------- --------- -------- -------- --------
<S>                                      <C>       <C>    <C>        <C>       <C>        <C>       <C>      <C>      <C>
Balance, December 31, 2000               $  65,805 $  221 $  343,036 $(78,427) $  (5,318) $ (3,113) $(4,666)          $317,538
Comprehensive income:
   Net income                                                                               36,951           $ 36,951   36,951
   Other comprehensive income:
      Available-for-sale assets:
         Fair value adjustment                                         54,556                                  54,556   54,556
      Swap Agreements:
         Cumulative adjustment for
          change in accounting
          principle                                                      (629)                                   (629)    (629)
         Fair value adjustment,
          net of amortization                                         (24,898)                                (24,898) (24,898)
                                                                                                             --------
Comprehensive income                                                                                         $ 65,980
                                                                                                             ========
Issuance of common stock                               57     86,336              (2,123)             4,666             88,936
Interest and principal payments on
    notes receivable from stock sales                            260                  36                                   296
Dividends declared on preferred
     stock - $1.815 per share                                                               (5,009)                     (5,009)
Dividends declared on common
     stock - $0.95 per share                                                               (20,722)                    (20,722)
                                         --------- ------ ---------- --------  ---------  --------  --------          --------
Balance, September 30, 2001              $  65,805 $  278 $  429,632 $(49,398) $  (7,405) $  8,107  $     --          $447,019
                                         ========= ====== ========== ========  =========  ========  ========          ========
Balance, December 31, 2001               $  65,805 $  333 $  515,516 $(36,566) $  (7,904) $ (4,526) $     --          $532,658
Comprehensive income:
   Net income                                                                               84,840           $ 84,840   84,840
   Other comprehensive income:
      Available-for-sale assets:
         Fair value adjustment                                         71,320                                  71,320   71,320
      Swap Agreements and Eurodollar
         Transactions
         Fair value adjustment,
          net of amortization                                         (95,672)                                (95,672) (95,672)
                                                                                                             --------
Comprehensive income                                                                                         $ 60,488
                                                                                                             ========

Issuance of common stock                              140    264,325                                                   264,465
Interest and principal payments on
   notes receivable from stock sales                             230                 259                                   489
Dividends declared on preferred
   stock - $1.815 per share                                                                 (5,009)                     (5,009)
Dividends declared on common
   stock - $1.12 per share                                                                 (48,772)                    (48,772)
                                         --------- ------ ---------- --------  ---------  --------  --------          --------
Balance, September 30, 2002              $  65,805 $  473 $  780,071 $(60,918) $  (7,645) $ 26,533  $     --          $804,319
                                         ========= ====== ========== ========  =========  ========  ========          ========
</Table>


See Notes to Consolidated Financial Statements.


                                       5
<PAGE>


THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)

<Table>
<Caption>
                                                                       Three Months Ended              Nine Months Ended
                                                                          September 30,                  September 30,
                                                                     2002            2001            2002            2001
                                                                 ------------    ------------    ------------    ------------
<S>                                                              <C>             <C>             <C>             <C>
Operating Activities:
   Net Income                                                    $     32,610    $     14,585    $     84,840    $     36,951
   Adjustments to reconcile net income to net cash provided
    by operating activities:
      Amortization                                                      4,316           5,542          12,443          14,205
      Net (gain) loss from investing activities                           (18)            476            (105)            560
      Hedging expense                                                     173             507           1,109           1,326
      Change in assets and liabilities:
         Accrued interest receivable                                   (3,720)           (736)        (15,242)           (303)
         Prepaid expenses and other                                       689          (3,445)          1,547            (379)
         Accrued interest payable                                       2,733          (3,375)          8,088          (8,858)
         Accrued expenses and other                                     4,761          (5,925)          9,364           3,612
                                                                 ------------    ------------    ------------    ------------
            Net cash provided by operating activities                  41,544           7,629         102,044          47,114
                                                                 ------------    ------------    ------------    ------------
Investing Activities:
   Available-for-sale ARM securities:
      Purchases                                                    (1,226,432)     (1,083,221)     (4,904,091)     (1,998,677)
      Proceeds on sales                                                10,164           6,462          72,981         108,056
      Principal payments                                            1,038,274         522,182       2,599,433       1,208,152
   Collateral for collateralized notes payable:
      Principal payments                                               30,812          41,859         147,203         130,288
   ARM loans:
      Purchases                                                      (686,387)       (414,553)     (1,904,258)       (665,505)
      Proceeds on sales                                                   350              --           4,061             339
      Principal payments                                                5,632           6,380          13,960          22,983
   Purchase of interest rate cap agreements                                --              --            (505)             --
                                                                 ------------    ------------    ------------    ------------
            Net cash used in investing activities                    (827,587)       (920,891)     (3,971,216)     (1,194,364)
                                                                 ------------    ------------    ------------    ------------
Financing Activities:
   Net borrowings from reverse repurchase agreements                  691,685         530,434       3,484,733         967,321
   Repayments of collateralized notes                                 (30,540)        (41,446)       (146,273)       (129,287)
   Net other borrowings                                               112,931         314,868         353,475         257,921
   Payments made on Eurodollar contracts                               (2,473)             --          (4,661)             --
   Proceeds from common stock issued, net                              56,881          87,593         264,465          88,936
   Dividends paid                                                     (27,603)        (10,445)        (72,099)        (25,731)
   Payments on notes receivable from stock sales                          336              89             422             292
                                                                 ------------    ------------    ------------    ------------
            Net cash provided by financing activities                 801,217         881,093       3,880,062       1,159,452
                                                                 ------------    ------------    ------------    ------------
Net increase (decrease) in cash and cash equivalents                   15,174         (32,169)         10,890          12,202
Cash and cash equivalents at beginning of period                       29,600          57,476          33,884          13,105
                                                                 ------------    ------------    ------------    ------------
Cash and cash equivalents at end of period                       $     44,774    $     25,307    $     44,774    $     25,307
                                                                 ============    ============    ============    ============
</Table>

Supplemental disclosure of cash flow information and non-cash activities are
included in Note 4.

See Notes to Consolidated Financial Statements

                                       6
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SIGNIFICANT ACCOUNTING POLICIES

     The accompanying unaudited consolidated financial statements have been
     prepared in accordance with generally accepted accounting principles for
     interim financial information and with the instructions to Form 10-Q and
     Rule 10-01 of Regulation S-X. Therefore, they do not include all of the
     information and footnotes required by generally accepted accounting
     principles for complete financial statements.

     In the opinion of management, all material adjustments, consisting of
     normal recurring adjustments, considered necessary for a fair presentation
     have been included. The operating results for the quarter and nine months
     ended September 30, 2002 are not necessarily indicative of the results that
     may be expected for the calendar year ending December 31, 2002.

          BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION

               The consolidated financial statements include the accounts of
               Thornburg Mortgage, Inc. (together with its subsidiaries referred
               to hereafter as the "Company") and its two wholly-owned
               bankruptcy-remote special purpose finance subsidiaries, Thornburg
               Mortgage Funding Corporation ("TMFC") and Thornburg Mortgage
               Acceptance Corporation ("TMAC"), its wholly-owned mortgage
               banking subsidiary, Thornburg Mortgage Home Loans, Inc. ("TMHL"),
               and TMHL's two wholly-owned special purpose finance subsidiaries,
               Thornburg Mortgage Funding Corporation II and Thornburg Mortgage
               Acceptance Corporation II. As of January 1, 2002, all of the
               Company's subsidiaries are wholly owned qualified REIT
               subsidiaries and are consolidated with the Company for financial
               statement and tax reporting purposes. All material intercompany
               accounts and transactions are eliminated in consolidation.
               Certain reclassifications have been made to prior years' amounts
               to conform with current year classifications.

          CASH AND CASH EQUIVALENTS

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

          ADJUSTABLE-RATE MORTGAGE ASSETS

               The Company's adjustable-rate mortgage ("ARM") assets are
               comprised of ARM securities, ARM loans and collateral for AAA
               notes payable, which also consists of ARM securities and ARM
               loans. Included in the Company's ARM assets are hybrid ARM
               securities and loans ("Hybrid ARMs") that have a fixed interest
               rate for an initial period, generally three to ten years, and
               then convert to an adjustable rate for their remaining term to
               maturity.

               Management has designated all of the Company's ARM securities as
               available-for-sale. Therefore, they are reported at fair value,
               with unrealized gains and losses reported in "Accumulated other
               comprehensive income (loss)" as a separate component of
               shareholders' equity.

               The Company securitizes loans for its ARM securities portfolio.
               The Company does not sell any of the securities created from this
               securitization process, but rather retains all of the beneficial
               and economic interests of the loans. The securitizations of the
               Company's loans are not accounted for as sales and the Company
               does not capitalize any servicing rights or obligations as a
               result of this process. The fair value reflected in the Company's
               financial statements for these securities is based on market
               prices provided by certain dealers who make markets in these
               financial instruments.


                                       7
<PAGE>


               In general, ARM assets have a maximum lifetime interest rate cap,
               or ceiling, meaning that individual ARM assets contain a
               contractual maximum interest rate ("Life Cap"). ARM securities
               typically have a Life Cap that not only places a constraint on
               the ability of an ARM security to adjust to higher interest
               rates, but also affects the changes in fair value of an ARM
               security. In addition, interest rates on non-hybrid ARM assets
               are generally limited to an increase of either 1% or 2% per
               adjustment period ("Periodic Cap"). Hybrid ARMs generally have a
               higher initial Periodic Cap, up to 6%, that is applicable at the
               end of their fixed interest rate period and they are generally
               subject to a typical non-hybrid Periodic Cap thereafter.

               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.

               The collateral for the AAA notes includes ARM securities and ARM
               loans, which are accounted for in the same manner as the ARM
               securities and ARM loans that are not held as collateral.

               Interest income on ARM assets is accrued based on the outstanding
               principal amount and their contractual terms. 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 securities and
               all ARM loans are recorded when all significant uncertainties
               regarding the characteristics of the assets are removed and, in
               the case of loans, underwriting due diligence has been completed,
               generally shortly before the 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 only purchasing ARM securities that have an
               investment grade rating at the time of purchase and have some
               form of credit enhancement or are guaranteed by an agency of the
               federal government, ("Ginnie Mae") or a federally chartered
               corporation ("Fannie Mae" or "Freddie Mac".) 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 also purchases and
               originates ARM loans and limits its exposure to credit losses by
               restricting its whole loan purchases and originations to ARM
               loans generally originated to "A" quality underwriting standards
               or, in the case of purchased whole loans, to 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 risk by
               limiting its investment in investment grade securities that are
               rated A, or equivalent, BBB, or equivalent, or ARM loans
               originated to "A" quality underwriting standards ("Other
               Investments") to no more than 30% of the portfolio, including the
               subordinate classes of securities retained as part of the
               Company's securitization of loans.

               The Company, in general, securitizes all of its loans and retains
               the resulting securities in its ARM portfolio. At the time of
               securitization, the Company obtains a credit review by one or
               more Rating Agencies of the loans being securitized. Based on
               this review, the Company makes a determination regarding the
               expected losses to be realized in the future and adjusts the
               basis of the securities to their expected realizable value. In
               doing so, the Company establishes a basis adjustment amount to
               absorb the expected credit losses. The Company then monitors the
               delinquencies and losses on the underlying mortgage loans backing
               its ARM securities. If the credit performance of the underlying
               mortgage loans is not as good as expected, the Company makes a
               provision for additional probable credit losses at a level deemed
               appropriate by management to provide for known losses as well as
               estimated losses inherent in its ARM securities portfolio. The
               provision is based on management's assessment of numerous factors


                                       8
<PAGE>


               affecting the Company's portfolio of ARM assets including, but
               not limited to, current 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. Additionally, once a loan within one of these
               securities is 90 days or more delinquent or a borrower declares
               bankruptcy, the Company adjusts the value of its accrued interest
               receivable to what it believes to be collectible and stops
               accruing interest on that portion of the security collateralized
               by the loan.

               In addition, credit losses on pools of loans held as collateral
               for AAA notes payable are also covered by third-party insurance
               policies that protect the Company from credit losses above a
               specified level, limiting the Company's exposure to credit losses
               on such loans. The Company reduces the cost basis of the
               subordinated security retained at the time the collateralized
               notes payable are issued to take into consideration estimated
               credit losses on the underlying loans.

               Loans that are not yet securitized are also reviewed for probable
               losses. The Company's loans are held for securitization, which
               generally occurs within a few months of acquisition or
               origination. As a result, although the Company reviews its
               unsecuritized loans for probable losses, it is unlikely a loan
               would incur a loss prior to securitization. If a loss were
               estimated on an unsecuritized loan, the Company would record a
               provision, which would reduce earnings, and establish a loan loss
               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.

          VALUATION METHODS

               The fair values of the Company's ARM securities are generally
               based on market prices provided by certain dealers who make
               markets in these financial instruments or third-party pricing
               services. If the fair value of an ARM security is not reasonably
               available from a dealer or a third-party pricing service,
               management estimates the fair value based on characteristics of
               the security that the Company receives from the issuer and
               available market information. The fair values for ARM loans are
               estimated by the Company by using the same pricing models
               employed by the Company in the process of determining a price to
               bid for loans in the open market, taking into consideration the
               aggregated characteristics of groups of loans such as, but not
               limited to, collateral type, index, margin, life cap, periodic
               cap, underwriting standards, age and credit. The fair value of
               the Company's collateralized notes payable, interest rate swap
               agreements and interest rate cap agreements is based on market
               values provided by dealers who are familiar with the terms of the
               notes, swap agreements and cap 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, other borrowings and other liabilities are
               reflected in the financial statements at their amortized cost,
               which approximates their fair value because of the short-term
               nature of these instruments.

          DERIVATIVE FINANCIAL INSTRUMENTS

               All of the Company's derivative financial instruments (interest
               rate cap agreements, interest rate swap agreements and Eurodollar
               futures contracts) are carried on the balance sheet at their fair
               value. If a derivative is designated as a "fair value hedge", the
               changes in the fair value of the derivative instrument and the
               changes in the fair value of the hedged item are both recognized
               in earnings. If a derivative is designated as a "cash flow hedge"
               the effective amount of change in the fair value of the
               derivative instrument is recorded in "Other comprehensive income"
               and is transferred from "Other comprehensive income" to earnings
               as the hedged item affects earnings. The ineffective amount of
               all hedges is recognized in earnings each quarter.


                                       9
<PAGE>


               As the Company enters into hedging transactions, it formally
               documents the relationship between the hedging instruments and
               the hedged items. The Company has also documented its
               risk-management policies, including objectives and strategies, as
               they relate to its hedging activities. The Company assesses, both
               at inception of a hedging activity and on an on-going basis,
               whether or not the hedging activity is highly effective. When it
               is determined that a hedge is not highly effective, the Company
               discontinues hedge accounting prospectively.

               INTEREST RATE CAP AGREEMENTS

               The Company purchases interest rate cap agreements ("Cap
               Agreements") to manage interest rate risk on a portion of its
               assets. In general, ARM assets have a Life Cap, which is a
               component of the fair value of an ARM asset. Pursuant to the
               terms of the Cap Agreements, the Company will receive cash
               payments if the interest rate index specified in any such Cap
               Agreement increases above certain specified levels. Therefore,
               such Cap Agreements have the effect of offsetting a portion of
               the Company's borrowing costs, thereby reducing the effect of the
               lifetime cap feature on the Company's ARM assets so that the net
               margin on the Company's ARM assets will be protected in high
               interest rate environments. The Cap Agreements the Company has
               purchased also have the effect of offsetting a portion of the
               fair value change in the Company's ARM assets related to the Life
               Cap.

               The Company does not currently apply hedge accounting to its Cap
               Agreements and, as a result, the Company records the change in
               fair value of the Cap Agreements as hedging expense in current
               earnings. The Company purchases Cap Agreements by incurring a
               one-time fee or premium and carries them at fair value. The
               carrying value of the Cap Agreements is included in "Prepaid
               expenses and other" on the balance sheet.

               INTEREST RATE SWAP AGREEMENTS AND EURODOLLAR FUTURES CONTRACTS

               The Company enters into interest rate swap agreements ("Swap
               Agreements") and Eurodollar futures contracts ("Eurodollar
               Transactions") in order to manage its interest rate exposure when
               financing its ARM assets. The Company generally borrows money
               based on short-term interest rates, either by entering into
               borrowings with maturity terms of less than one year, and
               frequently one to three months, or by entering into borrowings
               with longer maturities of one to two years that have an interest
               rate that is reset based on a frequency that is commonly one to
               three months. The Company's ARM assets generally have an interest
               rate that reprices based on frequency terms of one to twelve
               months. The Company's Hybrid ARMs have an initial fixed interest
               rate period of three to ten years. As a result, the Company's
               existing and forecasted borrowings reprice to a new rate on a
               more frequent basis than do the Company's ARM assets. When the
               Company enters into a Swap Agreement, it generally agrees to pay
               a fixed rate of interest and to receive a variable interest rate,
               generally based on LIBOR. The Company also enters into Eurodollar
               Transactions in order to hedge changes in its forecasted
               three-month LIBOR based liabilities. The notional balances of the
               Swap Agreements and the total contract size of the Eurodollar
               Transactions generally decline over the life of these
               instruments. These Swap Agreements and Eurodollar Transactions
               have the effect of converting the Company's variable-rate debt
               into fixed-rate debt over the life of the Swap Agreements and
               Eurodollar Transactions. These instruments are used as a cost
               effective way to lengthen the average repricing period of the
               Company's variable rate and short-term borrowings such that the
               average repricing of the borrowings more closely matches the
               average repricing of the Company's ARM assets.

               All Swap Agreements are designated as cash flow hedges against
               the interest rate risk associated with the Company's borrowings.
               Although the terms and characteristics of the Company's Swap
               Agreements and hedged borrowings are nearly identical, due to the
               explicit requirements of FAS 133, the Company does not account
               for these hedges under a method defined in FAS 133 as the
               "shortcut" method, but rather the Company calculates the
               effectiveness of these hedges on an ongoing basis, and to date,
               has calculated effectiveness of approximately 100%. Eurodollar
               Transactions are also designated as cash flow hedges and are
               accounted for in accordance with


                                       10
<PAGE>


               FAS 133 implementation issue No. G7, Method 1: Change in Variable
               Cash Flow Method, and application of this method has resulted in
               no measured ineffectiveness. All changes in the unrealized gains
               and losses on Swap Agreements and the Eurodollar Transactions
               have been recorded in "Other comprehensive income" and are
               reclassified to earnings as interest expense is recognized on the
               Company's hedged borrowings. If it becomes probable that the
               forecasted transaction, which in this case refers to interest
               payments to be made under the Company's short-term borrowing
               agreements, will not occur by the end of the originally specified
               time period, as documented at the inception of the hedging
               relationship, or within an additional two-month time period
               thereafter, then the related gain or loss in "Other comprehensive
               income" would be reclassified to income. As of September 30,
               2002, the net unrealized loss on Swap Agreements, deferred gains
               from terminated Swap Agreements and deferred gains and losses on
               Eurodollar Transactions recorded in "Other comprehensive income"
               was a net loss of $125.5 million. The Company estimates that over
               the next twelve months, approximately $60.9 million of these net
               unrealized losses will be reclassified from "Other comprehensive
               income" to earnings.

               The loss on Swap Agreements is the discounted value of the
               remaining future net interest payments expected to be made over
               the remaining life of the Swap Agreements. Therefore, over time,
               as the actual payments are made, the unrealized loss in "Other
               comprehensive income" and the carrying value of the Swap
               Agreements adjusts to zero and the Company realizes a fixed cost
               of money over the life of the hedging instrument. The carrying
               value of the Swap Agreements, in the amount of $124.1 million as
               of September 30, 2002, is included in "Reverse repurchase
               agreements" in the accompanying balance sheets.

               The Company has terminated and replaced Swap Agreements as an
               additional source of liquidity when it was able to do so while
               maintaining compliance with its hedging policies. Since the
               Company's adoption of FAS 133, realized gains and losses
               resulting from the termination of Swap Agreements are initially
               recorded in "Other comprehensive income" as a separate component
               of equity. The gain or loss from the terminated Swap Agreements
               remains in "Other comprehensive income" until the forecasted
               interest payments affect earnings. If it becomes probable that
               the forecasted interest payments will not occur, then the entire
               gain or loss would be reclassified to earnings.

          INCOME TAXES

               The Company elected to be taxed as a Real Estate Investment Trust
               ("REIT") and believes it complies with the provisions of the
               Internal Revenue Code of 1986, as amended (the "Code") with
               respect thereto. Accordingly, the Company will not be subject to
               Federal income tax on that portion of its income that is
               distributed to shareholders, as long as certain asset, income and
               stock ownership tests are met. During 2001, TMHL and each of its
               subsidiaries were taxable REIT subsidiaries and, as such, were
               subject to both federal and state corporate income tax. As of
               January 1, 2002, the Company revoked its election to operate TMHL
               and its subsidiaries as taxable REIT subsidiaries and as a result
               they are now qualified REIT subsidiaries.


                                       11
<PAGE>


          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, 2002
               and 2001 (amounts in thousands except per share data):

               <Table>
               <Caption>
                                                                                                 Earnings
                                                                   Income          Shares       Per Share
                                                                ------------    ------------   ------------
               <S>                                              <C>             <C>            <C>
               Three Months Ended September 30, 2002
               Net income                                       $     32,610
               Less preferred stock dividends                         (1,670)
                                                                ------------
               Basic EPS, income available to common
                 shareholders                                         30,940          45,733   $       0.68
                                                                                               ============
               Effect of dilutive securities:
                 Stock options                                            --              --
                 Convertible preferred stock                           1,670           2,760
                                                                ------------    ------------
               Diluted EPS                                      $     32,610          48,493   $       0.67
                                                                ============    ============   ============
               Three Months Ended September 30, 2001
               Net income                                       $     14,585
               Less preferred stock dividends                         (1,670)
                                                                ------------
               Basic EPS, income available to common
                 shareholders                                        12,915          25,004   $       0.52
                                                                                               ============
               Effect of dilutive securities:
                 Stock options                                            --              25
                 Convertible preferred stock                              --              --
                                                                ------------    ------------
               Diluted EPS                                      $     12,915          25,029   $       0.52
                                                                ============    ============   ============
               </Table>



                                       12
<PAGE>


              <Table>
              <Caption>
                                                                                              Earnings
                                                                Income          Shares        Per Share
                                                             ------------    ------------   ------------
              <S>                                            <C>             <C>            <C>
              Nine Months Ended September 30, 2002
              Net income                                     $     84,840
              Less preferred stock dividends                       (5,009)
                                                             ------------
              Basic EPS, income available to common
                shareholders                                       79,831          41,401   $       1.93
                                                                                            ============
              Effect of dilutive securities:
                Stock options                                          --
                Convertible preferred stock                         5,009           2,760
                                                             ------------    ------------
              Diluted EPS                                    $     84,840          44,161   $       1.92
                                                             ============    ============   ============
              Nine Months Ended September 30, 20
              Net income                                     $     36,951
              Less preferred stock dividends                       (5,009)
                                                             ------------
              Basic EPS, income available to common
                shareholders                                       31,942          22,841   $       1.40
                                                                                            ============
             Effect of dilutive securities:
               Stock options                                           --              53
                Convertible preferred stock                            --              --
                                                             ------------    ------------
              Diluted EPS                                    $     31,942          22,894   $       1.40
                                                             ============    ============   ============
              </Table>

                  The Company did not grant any options to purchase shares of
                  common stock during the nine-month period ended September 30,
                  2002. The Company did grant 35,666 options to purchase common
                  stock to directors and officers of the Company at an average
                  price of $10.56 per share during the nine months ended
                  September 30, 2001. As of September 30, 2002, all of the
                  previously granted options to purchase shares of common stock
                  had either been exercised, cancelled or had expired.

              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.


                                       13
<PAGE>


NOTE 2. ADJUSTABLE-RATE MORTGAGE ASSETS


               The following tables present the Company's ARM assets as of
               September 30, 2002 and December 31, 2001. The ARM securities
               classified as available-for-sale are carried at their fair value,
               while the ARM loans are carried at their amortized cost basis
               (dollar amounts in thousands):


September 30, 2002:

<Table>
<Caption>
                                                                  Collateral for
                                            Available-for-Sale    Collateralized
                                              ARM Securities          Notes           ARM Loans        Total
                                            ------------------    --------------    ------------    ------------
<S>                                         <C>                   <C>               <C>             <C>

Principal balance outstanding               $        8,915,014    $      318,529    $    573,543    $  9,807,086
Net unamortized premium                                 88,575             5,974           2,702          97,251
Basis adjustments/Allowance for losses                  (9,304)           (3,239)           (100)        (12,643)
Principal payment receivable                            38,723                --              --          38,723
                                            ------------------    --------------    ------------    ------------
  Amortized cost, net                                9,033,008           321,264         576,145       9,930,417
Gross unrealized gains                                  89,404             2,462           7,512          99,378
Gross unrealized losses                                (23,776)             (174)           (811)        (24,761)
                                            ------------------    --------------    ------------    ------------
  Fair value                                $        9,098,636    $      323,552    $    582,846    $ 10,005,034
                                            ==================    ==============    ============    ============
Carrying value                              $        9,098,636    $      321,264    $    576,145    $  9,996,045
                                            ==================    ==============    ============    ============
</Table>

December 31, 2001:

<Table>
<Caption>
                                                                  Collateral for
                                            Available-for-Sale    Collateralized
                                              ARM Securities          Notes           ARM Loans        Total
                                            ------------------    --------------    ------------    ------------
<S>                                         <C>                   <C>               <C>             <C>
Principal balance outstanding               $        5,092,713    $      465,733    $     98,711    $  5,657,157
Net unamortized premium                                 45,025             8,204             155          53,384
Basis adjustments/Allowance for losses                  (5,891)           (3,185)           (100)         (9,176)
Principal payment receivable                            36,080                --              --          36,080
                                            ------------------    --------------    ------------    ------------
  Amortized cost, net                                5,167,927           470,752          98,766       5,737,445
Gross unrealized gains                                  35,439             4,346             216          40,001
Gross unrealized losses                                (40,739)           (2,768)           (258)        (43,765)
                                            ------------------    --------------    ------------    ------------
  Fair value                                $        5,162,627    $      472,330    $     98,724    $  5,733,681
                                            ==================    ==============    ============    ============
Carrying value                              $        5,162,627    $      470,752    $     98,766    $  5,732,145
                                            ==================    ==============    ============    ============
</Table>


               During the nine-month period ended September 30, 2002, the
               Company sold $72.9 million of ARM securities for a gain of
               $113,000. The ARM securities sold were classified as
               available-for-sale. In addition, the Company sold $4.1 million of
               loans during the first nine months of 2002 and realized a gross
               gain of $6,000 and a gross loss of $14,000. During the nine-month
               period ended September 30, 2001, the Company sold $108.1 million
               of ARM securities and realized $244,000 in gains and $245,000 in
               losses. In addition, the Company sold $0.3 million of fixed-rate
               loans that it originated during the first nine months of 2001 for
               a gain of $2,000.

               During the nine-month period ended September 30, 2002, the
               Company securitized $1.477 billion of its ARM loans into a series
               of privately-issued multi-class ARM securities. The Company
               retained, for its ARM portfolio, all of the classes of the
               securities created. The Company did not account for any of these
               securitizations as sales and, therefore, did not record any gain
               or loss in connection with the securitizations. As of September
               30, 2002, the Company had $2.706 billion of ARM assets that have
               resulted from the Company's securitization efforts.


                                       14
<PAGE>


               As of September 30, 2002 and December 31, 2001, the Company had
               reduced the cost basis of its securitized ARM loans by
               $11,687,000 and $7,925,000, respectively, due to estimated credit
               losses (other than temporary declines in fair value). The
               reduction in the cost basis recorded during the nine months of
               2002, in the amount of $3,762,000, was recorded in connection
               with the Company's securitization of the $1.477 billion of loans.

               As of September 30, 2002 and December 31, 2001, the Company had
               reduced the cost basis of other ARM securities by $856,000 and
               $1,151,000, respectively, due to estimated credit losses (other
               than temporary declines in fair value). The estimated credit
               losses for these ARM securities relate to Other Investments that
               the Company purchased at a discount that included an estimate of
               credit losses. During the nine-month period ended September 30,
               2002, the Company recorded realized losses on these ARM
               securities in the amount of $460,000 and realized recoveries in
               the amount of $165,000 and, in accordance with its credit
               policies, the Company did not provide for any additional
               estimated credit losses.

               The following tables summarize ARM loan delinquency information
               as of September 30, 2002 and December 31, 2001 (dollar amounts in
               thousands):

               September 30, 2002

               <Table>
               <Caption>
                                                                         Percent of
                                                         Loan           ARM Loans
               Delinquency Status       Loan Count      Balance            (1)
               ------------------      ------------   ------------    ------------
               <S>                     <C>            <C>             <C>

               60 to 89 days                      3   $        480            0.01%
               90 days or more                    1            204            0.01%
               In foreclosure                     6          1,851            0.06%
                                       ------------   ------------    ------------
                                                 10   $      2,535            0.08%
                                       ============   ============    ============
               </Table>


               December 31, 2001

               <Table>
               <Caption>
                                                                      Percent of
                                                          Loan         ARM Loans
               Delinquency Status       Loan Count      Balance            (1)
               ------------------      ------------   ------------    ------------
               <S>                     <C>            <C>             <C>


               60 to 89 days                      3   $        695            0.04%
               90 days or more                    2            385            0.02%
               In foreclosure                     4            552            0.03%
                                       ------------   ------------    ------------
                                                  9   $      1,632            0.09%
                                       ============   ============    ============
               </Table>

                    (1)  ARM loans includes loans held for securitization and
                         loans that the Company has securitized and retained
                         first loss credit exposure for total amounts of $3.227
                         billion and $1.924 billion at September 30, 2002 and
                         December 31, 2001, respectively.

              As of September 30, 2002, the Company also owned two real estate
              properties as a result of foreclosing on delinquent loans in the
              aggregate amount of $506,000 (not included in the table above.)
              The Company has a $100,000 reserve for estimated losses on these
              properties. The Company believes that its current level of
              reserves is adequate to cover any estimated loss, should one
              occur, from the sale of these properties.



                                       15
<PAGE>


              As of September 30, 2002, the Company had commitments to purchase
              or originate the following amounts of ARM assets (dollar amounts
              in thousands):

                        Freddie Mac/Fannie Mae ARM securities      $     211,956
                        Private high quality ARM securities              512,602
                        Whole loans - bulk purchase                      103,947
                        Whole loans - correspondent                      455,289
                        Whole loans - direct originations                221,546
                                                                     -----------
                                                                   $   1,505,340
                                                                     ===========

              During the nine months ended September 30, 2002, the Company
              entered into two transactions whereby the Company expects to
              acquire the remaining balance of certain AAA rated, Hybrid ARM
              securities, at a price of par, in 2006 and 2007, when the
              fixed-rate period of the Hybrid ARM securities terminates and they
              convert into ARM securities that have characteristics similar to
              the ARM securities held in the current portfolio and, therefore,
              the Company views these as an alternative source of ARM assets.
              The current balance of the Hybrid ARM securities is approximately
              $2.56 billion, but is expected to be less than 25% of that, and
              could be zero, at the time they convert into ARM securities. If
              the Company decides not to acquire the Hybrid ARM securities when
              they convert into ARM securities, then it is committed to pay or
              receive the difference between par and the fair value of the ARM
              securities at that time, as determined by an auction of the ARM
              securities. As of September 30, 2002, the Company has delivered
              $4.1 million of collateral in connection with these transactions.

NOTE 3.  INTEREST RATE CAP AGREEMENTS

              Included in "Prepaid expenses and other" are purchased Cap
              Agreements with a remaining notional amount of $2.091 billion and
              $2.254 billion as of September 30, 2002 and December 31, 2001,
              respectively. The notional amount of the Cap Agreements purchased
              declines at a rate that is expected to approximate the
              amortization of the ARM securities. Under these Cap Agreements,
              the Company will receive cash payments should the one-month or
              three-month London InterBank Offer Rate ("LIBOR") increase above
              the contract rates of these hedging instruments that range from
              6.00% to 12.00% and average approximately 9.95%. The Cap
              Agreements had an average maturity of 1.1 years as of September
              30, 2002. The initial aggregate notional amount of the Cap
              Agreements declines to approximately $2.041 billion over the
              period of the agreements, which expire between 2002 and 2005.
              During the three and nine-month periods ended September 30, 2002,
              the Company recognized expenses of $173,000 and $1,109,000,
              respectively, which is reported as "Hedging expense" in the
              Company's Consolidated Statements of Operations.

              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 which is rated A (the Company
              has a two-way collateral agreement protecting its credit exposure
              with this counterparty.) The fair value of the Cap Agreements at
              September 30, 2002 amounted to $233,000 and is included in
              "Prepaid expenses and other" on the balance sheet.

NOTE 4. REVERSE REPURCHASE AGREEMENTS, COLLATERALIZED NOTES PAYABLE AND OTHER
        BORROWINGS

              The Company has arrangements to enter into reverse repurchase
              agreements, a form of short-term borrowing, with 25 different
              financial institutions and on September 30, 2002 had borrowed
              funds from 14 of these firms. Because the Company borrows money
              under these agreements based on the fair value of its ARM assets,
              and because changes in interest rates can negatively impact the
              valuation of ARM assets, the Company's borrowing ability under
              these agreements could be limited and lenders could initiate
              margin calls in the event interest rates change or the value of
              the Company's ARM assets declines for other reasons.


                                       16
<PAGE>


              As of September 30, 2002, the Company had $8.190 billion of
              reverse repurchase agreements outstanding with a weighted average
              borrowing rate of 1.97% and a weighted average remaining maturity
              of 4.4 months. After including the $124.1 million carrying value
              of Swap Agreements, the combined reverse repurchase agreements and
              Swap Agreements outstanding of $8.314 billion as of September 30,
              2002 had a weighted average borrowing rate of 3.17% and a weighted
              average remaining maturity of 1.6 years. As of December 31, 2001,
              the Company had $4.739 billion of reverse repurchase agreements
              outstanding with a weighted average borrowing rate of 2.24% and a
              weighted average remaining maturity of 2.8 months. As of September
              30, 2002, $4.422 billion of the Company's borrowings were
              variable-rate term reverse repurchase agreements with original
              maturities that range from six months to eighteen months. The
              interest rates of these term reverse repurchase agreements are
              indexed to either the one- or three-month LIBOR rate and reprice
              accordingly. ARM assets with a carrying value of $8.883 billion,
              including accrued interest and cash totaling $25.7 million
              collateralized the reverse repurchase agreements at September 30,
              2002.

              At September 30, 2002, the reverse repurchase agreements, which
              includes the carrying value of Swap Agreements, had the following
              remaining maturities (dollar amounts in thousands):

              <Table>
              <S>                                 <C>
              Within 30 days                       $     3,063,458
              31 to 89 days                              1,468,418
              90 to 365 days                             3,552,277
              Over 365 days                                105,475
                                                   ---------------
                                                         8,189,628
              Swap Agreements (carrying value)             124,094
                                                   ---------------
                                                   $     8,313,722
                                                   ===============
               </Table>

               As of September 30, 2002, the Company had entered into three
               whole loan financing facilities. Each of the whole loan financing
               facilities has a committed borrowing capacity of $300 million.
               One facility matures in March 2003 and the other two mature in
               November 2002; the Company expects to renew the facilities
               maturing in November. As of September 30, 2002, the Company had
               $393.8 million borrowed against these whole loan financing
               facilities at an effective cost of 2.43%. As of December 31,
               2001, the Company had $37.7 million borrowed against whole loan
               financing facilities at an effective cost of 2.53%. The amount
               borrowed on the whole loan financing agreements at September 30,
               2002 was collateralized by ARM loans with a carrying value of
               $407.1 million, including accrued interest.

               The whole loan financing facility with a borrowing capacity of
               $300 million and maturing in March 2003, discussed above, is a
               securitization transaction in which the Company transfers groups
               of whole loans to a wholly-owned bankruptcy remote special
               purpose subsidiary. The subsidiary, in turn, simultaneously
               transfers its interest in the loans to a trust, which issues
               beneficial interests in the loans in the form of a note and a
               subordinated certificate. The note is then used to collateralize
               borrowings. This whole loan financing facility works similarly to
               a secured line of credit whereby the Company can deliver loans
               into the facility and take loans out of the facility at the
               Company's discretion. This securitization transaction is
               accounted for as a secured borrowing.

               On December 18, 1998, the Company, through a wholly-owned
               bankruptcy remote special purpose finance subsidiary, issued
               $1.144 billion of notes payable ("Notes") collateralized by ARM
               loans and ARM securities. As part of this transaction, the
               Company retained ownership of a subordinated certificate in the
               amount of $32.4 million, which represents the Company's maximum
               exposure to credit losses on the loans collateralizing the Notes.
               As of September 30, 2002, the Notes had a net balance of $286.3
               million and an effective interest cost of 2.53%, which changes
               each month at a spread to one-month LIBOR. As of September 30,
               2002, these Notes were collateralized by ARM loans with a
               principal balance of $318.5 million. The Notes mature on January
               25, 2029 and are callable by the Company at par once the total
               balance of the loans collateralizing the Notes is reduced to 25%
               of their original balance.


                                       17
<PAGE>


               As of September 30, 2002, the Company was counterparty to
               forty-six Swap Agreements and Eurodollar Transactions having an
               aggregate current notional balance of $4.733 billion. In
               addition, the Company also entered into a delayed Swap Agreement
               with an aggregate notional balance of $500 million that becomes
               effective in August 2003. These Swap Agreements and Eurodollar
               Transactions hedge the cost of financing Hybrid ARMs during their
               fixed rate term (generally three to ten years). The Company
               limits the interest rate mismatch on the funding of its Hybrid
               ARMs (the difference between the duration of the fixed-rate
               period of Hybrid ARMs and the duration of the fixed-rate
               liabilities) to a duration difference of no more than one year.
               As of September 30, 2002, these Swap Agreements and Eurodollar
               Transactions had a weighted average maturity of 2.8 years. In
               accordance with the Swap Agreements, the Company will pay a fixed
               rate of interest during the term of these Swap Agreements and
               receive a payment that varies monthly with the one-month LIBOR
               rate. As a result of entering into these Swap Agreements and
               Eurodollar Transactions, the Company has reduced the interest
               rate variability of its cost to finance its Hybrid ARM assets by
               increasing the average period until the next repricing of its
               borrowings that finance its Hybrid ARM assets from 40 days to 849
               days. As of September 30, 2002, ARM assets with a carrying value
               of $92.1 million (including accrued interest) and cash totaling
               $12.1 million collateralized the Swap Agreements.

               The total cash paid for interest was $63.8 million and $49.3
               million during the quarters ended September 30, 2002 and 2001,
               respectively.

NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET CREDIT RISK

               The following table presents the carrying amounts and estimated
               fair values of the Company's financial instruments at September
               30, 2002 and December 31, 2001 (dollar amounts in thousands):

<Table>
<Caption>
                                                 September 30, 2002            December 31, 2001
                                            ---------------------------   ---------------------------
                                              Carrying         Fair         Carrying         Fair
                                               Amount          Value         Amount         Value
                                            ------------   ------------   ------------   ------------
<S>                                         <C>            <C>            <C>            <C>
Assets:
   ARM assets                               $  9,996,045   $ 10,005,034   $  5,732,145   $  5,733,681
   Cap Agreements                                    233            233            431            431

Liabilities:
   Reverse repurchase agreements               8,189,628      8,189,628      4,704,895      4,704,895
   Collateralized notes payable                  286,308        286,801        432,581        434,469
   Other borrowings                              393,758        393,758         40,283         40,283
   Swap Agreements                               124,094        124,094         33,932         33,932
</Table>

               The above Cap Agreements are included in the balance sheet under
               the caption "Prepaid expenses and other." The carrying amount for
               securities, which are categorized as available-for-sale, is their
               fair value, whereas the carrying amount for loans, which are
               categorized as held for the foreseeable future, is their
               amortized cost.

NOTE 6. COMMON AND PREFERRED STOCK

               During February 2002, the Company completed a public offering of
               6,210,000 shares of common stock and received net proceeds of
               $113.5 million under its shelf registration statement on Form S-3
               that was declared effective by the Securities and Exchange
               Commission ("SEC") on July 6, 2001. On August 30, 2002, a new
               shelf registration statement on Form S-3 registering an
               additional $400 million of equity securities was declared
               effective by the SEC. During the three-month and nine-month
               periods ended September 30, 2002, the Company issued 1,469,200
               and 4,000,000 shares of common stock respectively, and received
               net proceeds of $28.2 million and $76.5 million, respectively
               under a continuous equity offering program under the July 2001
               shelf registration statement. During the three months ended
               September 30, 2002, the Company issued an additional 302,600
               shares of common stock and received net proceeds of $5.7 million
               under a new continuous equity offering program under the August
               2002 shelf registration statement. As of September 3, 2002, $47.4
               million and $394.2 million


                                       18
<PAGE>


               of the Company's registered securities remained available for
               future issuance and sale under its currently effective July 2001
               and August 2002 shelf registration statements, respectively.

               On June 26, 2002, the Company filed a Form S-3D to register an
               additional 8,000,000 shares for issuance under the Dividend
               Reinvestment and Stock Purchase Plan (the "DRP"). During the
               three and nine-month periods ended September 30, 2002, the
               Company issued 1,206,607 and 3,519,419 shares, respectively, of
               common stock under the DRP and received net proceeds of $23.0
               million and $68.9 million, respectively.

               On June 14, 2002, the Company declared a second quarter dividend
               of $0.605 per share to the shareholders of the Series A 9.68%
               Cumulative Convertible Preferred Stock, which was paid on July
               10, 2002 to preferred shareholders of record as of June 28, 2002.

               On July 23, 2002, the Company declared a second quarter dividend
               of $0.57 per common share, which was paid on August 16, 2002 to
               common shareholders of record as of August 5, 2002.

               On September 16, 2002, 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 10, 2002 to preferred shareholders of record as of
               September 30, 2002.

               On October 21, 2002, the Company declared a third quarter
               dividend of $0.58 per common share, which will be paid on
               November 18, 2002 to common shareholders of record as of November
               5, 2002.

               For federal income tax purposes, all dividends are expected to be
               ordinary income to the Company's common and preferred
               shareholders, subject to year-end allocations of the common
               dividend between ordinary income, capital gain income and
               non-taxable income as return of capital, depending on the amount
               and character of the Company's full year taxable income.

NOTE 7. STOCK OPTION PLAN

               The Company's Board of Directors adopted the "2002 Long Term
               Incentive Plan" (the "Plan"), effective September 29, 2002, which
               has replaced the Company's previous Stock Option and Incentive
               Plan that expired on September 28, 2002. The Plan is intended to
               be a long-term incentive program. The Plan authorizes the
               Compensation Committee to grant Incentive 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 present policy of the Compensation Committee and the Board is
               to grant only PSR and DER awards under the Plan. The PSRs are
               granted in lieu of stock options, based on equivalent values as
               calculated by a Black Scholes option model. No stock options have
               been granted under the Plan and there are no options outstanding
               under either the Plan or the previous plan.

               The PSRs, when received as a grant, generally vest over a
               three-year period. DERs may be paid either in cash or in
               additional PSRs, at the option of the recipient. The Company
               usually issues DERs under a formula at the same time that other
               awards under the Plan are granted. The DER and PSR participants
               are allowed to elect to reinvest their PSR and DER cash dividends
               into additional PSRs at the price of the Company's common stock
               on the related dividend payment date. The PSRs are expensed over
               the applicable vesting period. The DERs are fully expensed on the
               Company's income statement.

               Restricted shares of common stock had been granted under the
               Company's previous Stock Option and Incentive Plan pursuant to
               the direction of the Stock Option Committee (now renamed as the
               Compensation Committee) and approval of the Board of Directors.
               Restricted shares of common stock had generally been granted in
               lieu of ISOs and NQSOs, based on equivalent values as calculated
               by a Black Scholes option model. The Board of Directors
               determined a vesting period for the restricted


                                       19
<PAGE>


               shares granted (generally three years). In general, a portion of
               the restricted shares vested at the end of each year of the
               vesting period and the shares participated in the common
               dividends declared during the vesting period. The Company
               expenses the value of the restricted shares over the vesting
               period, based on their value as of the date of grant. In April
               2002, the Company's Board of Directors cancelled all previously
               granted restricted shares of common stock and replaced them with
               PSRs of equal value. The replacement PSRs vest over the original
               vesting period of the cancelled restricted shares.

               As of September 30, 2002, there were 1,094,566 DERs outstanding,
               of which 1,066,405 were vested, and 372,808 PSRs outstanding, of
               which 191,053 were vested. The Company recorded an expense
               associated with DERs and PSRs of $718,000 and $296,000 for the
               three-month periods ended September 30, 2002 and 2001,
               respectively. During the nine-month periods ended September 30,
               2002 and 2001, the Company recorded an expense associated with
               DERs and PSRs in the amount of $2,198,000 and $818,000,
               respectively. Of the expense recorded during the third quarter of
               2002, $799,000 was the amount of dividend equivalents paid on
               DERs and PSRs, $436,000 was the impact of the decrease in the
               Company's common stock price on the value of the PSRs which was
               recorded as a fair value adjustment, and $355,000 was the
               amortization of unvested PSRs. As of September 30, 2002, all of
               the previously issued ISOs and NQSOs had been exercised,
               terminated or cancelled.

               The Plan 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. Notes
               receivable arise from the Company financing a portion of the
               purchase of shares of common stock by directors and employees
               through the exercise of stock options. The notes mature during
               2010 and accrue interest at a rate of 3.91% 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. As of
               September 30, 2002, there was $7.6 million of notes receivable
               outstanding from stock sales. All of these loans were made prior
               to the enactment of the Sarbanes-Oxley Act of 2002. In April,
               2002, the Board approved a limited stock repurchase program for
               the repurchase at current market value of shares of common stock
               that were acquired pursuant to the exercise of stock options
               under the previous plan. The Company will first apply the
               proceeds from any such repurchases to the repayment of any
               outstanding stock option loans due from the holders. As of
               September 30, 2002, no shares have been repurchased under this
               program.

NOTE 8. TRANSACTIONS WITH AFFILIATES

               The Company has a Management Agreement (the "Agreement") with
               Thornburg Mortgage Advisory Corporation ("the Manager"). Under
               the terms of the 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 certain personnel and office space. According to the
               terms of the Agreement, certain defined expenses of the Manager
               and affiliates of the Manager are reimbursed by the Company,
               principally expenses of TMHL, the Company's mortgage banking
               subsidiary, related to mortgage loan acquisition, selling,
               servicing and securitization activities, including the personnel
               and office space attributed to these activities. During the
               quarters ended September 30, 2002 and 2001, the Company
               reimbursed the Manager and affiliates of the Manager $696,000 and
               $550,000 for expenses, respectively, in accordance with the terms
               of the Agreement. During the nine-month periods ended September
               30, 2002 and 2001, the Company reimbursed the Manager and
               affiliates of the Manager $2,200,000 and $1,053,000 for expenses,
               respectively. As of September 30, 2002 and 2001, $675,000 and
               $158,000, respectively, was payable by the Company to the Manager
               for these reimbursable expenses. The Agreement has a ten-year
               term expiring July 15, 2009, and provides for an annual review of
               the Manager's performance under the Agreement by the independent
               directors of the Board of Directors. If the Company terminated
               the Agreement for a reason other than for cause, a substantial
               cancellation fee would be activated.


                                       20
<PAGE>


               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: 1.20% of the
               first $300 million of Average Shareholders' Equity, plus 0.88% of
               Average Shareholders' Equity above $300 million. The Agreement
               also has a cost of living clause that adjusts the base management
               fee formula by the change in the Consumer Price Index over the
               previous twelve-month period, effective as of each annual review
               of the Agreement. In addition, the three wholly-owned
               subsidiaries of the Company and the two wholly-owned subsidiaries
               of TMHL have entered into separate Management Agreements with the
               Manager for additional management services for a combined amount
               of $1,200 per month, paid in arrears.

               For the quarters ended September 30, 2002 and 2001, the Company
               incurred costs of $2,076,000 and $1,249,000, respectively, in
               base management fees in accordance with the terms of the
               Management Agreements. For the nine-month periods ended September
               30, 2002 and 2001, the Company incurred base management fees of
               $5,623,000 and $3,463,000, respectively. As of September 30, 2002
               and 2001, $665,000 and $446,000, respectively, was payable by the
               Company to the Manager for the base management fee.

               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 three- and
               nine-month periods ended September 30, 2002, the Manager earned
               performance-based compensation in the amount of $5,044,000 and
               $11,958,000, respectively. For the three- and nine-month periods
               ended September 30, 2001, the Manager earned performance-based
               compensation in the amount of $1,627,000 and $3,624,000,
               respectively. As of September 30, 2002 and 2001, $5,044,000 and
               $1,627,000, respectively, was payable by the Company to the
               Manager for the incentive management fee.

               Pursuant to an employee residential mortgage loan program
               approved by the Board of Directors as part of the Company's
               residential loan mortgage origination activities, certain of the
               directors, officers and employees of the Company and of other
               affiliates of the Company have obtained residential first lien
               mortgage loans from the Company. In general, the terms of the
               loans and the underwriting requirements are identical to the loan
               programs that the Company offers to unaffiliated third parties,
               except that participants in the program qualify for an employee
               discount on the interest rate. At the time each participant
               enters into a loan agreement, such participant executes an
               addendum that provides for the discount on the interest rate that
               is subject to cancellation at the time such participant's
               employment is terminated for any reason. Effective with the
               enactment of the Sarbanes-Oxley Act of 2002, on July 30, 2002,
               any new loans made to directors or executive officers will not be
               eligible for the employee discount. As of September 30, 2002, the
               aggregate balance of mortgage loans outstanding to directors and
               officers of the Company, employees of the Manager and other
               affiliates amounted to $19.8 million, had a weighted average
               interest rate of 5.101%, and maturities ranging between 2016 and
               2032.

               Effective January 1, 2002, TMHL entered into a Joint Marketing
               Agreement with Thornburg Securities Corporation ("TSC"), a
               registered broker-dealer. The initial term of the agreement
               expires December 31, 2002, but shall continue thereafter for
               successive three-month terms unless terminated by either party.
               Under the terms of the agreement, TMHL shall pay TSC an annual
               fee of $25,000, in quarterly installments, as compensation for
               certain marketing, promotional and advertising services and to
               provide marketing materials to brokers and financial advisers.
               During the three and nine months ended September 30, 2002, TMHL
               paid $18,750 to TSC pursuant to this agreement.


                                       21
<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 constitutes
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. You can identify such forward-looking statements by the presence of
forward-looking terminology such as "may," "will," "expect," "anticipate,"
"estimate," "plan," or "continue" or the negatives thereof or similar
terminology. You should be aware 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,
availability and cost of acquiring new assets, the timing of new programs and
the performance of third party, private-label relationships involved in the
origination and servicing of loans. The cautionary statements that you will find
in the "Risk Factors" section on pages 14 through 20 of our 2001 Annual Report
on Form 10-K identify important factors, including certain risks and
uncertainties, with respect to such forward-looking statements that could cause
our actual results, performance or achievements to differ materially from those
reflected in such forward-looking statements.

MANAGEMENT'S DISCUSSION OF CORPORATE GOVERNANCE

In light of recent legislation and new regulations regarding Corporate
Governance, we would like to highlight our compliance with these new
requirements.

First of all, our Board of Directors consists of a majority of independent
directors. The Audit, Nominating and Compensation Committees of the Board of
Directors are also composed exclusively of independent directors.

Second, all of our long-term incentive compensation programs (which include the
granting of Phantom Stock Rights and Dividend Equivalent Rights) are fully
expensed in our statements of operations, and are fully disclosed in our
financial reports. Third, we have established a formal internal audit function
to further the effective functioning of our internal controls and procedures.
Our internal audit plan will provide management and the Audit Committee with an
effective tool to identify and address areas of financial or operational
concerns and ensure that appropriate controls and procedures are in place.

Finally, we have an Insider Trading Policy designed to prohibit any director,
officer or employee of the Manager from buying or selling our stock on the basis
of material nonpublic information or communicating material nonpublic
information to others.

GENERAL

We are a mortgage origination and acquisition company that originates, acquires
and invests in adjustable and variable rate mortgage ("ARM") assets comprised of
ARM securities and ARM loans, thereby providing capital to the single-family
residential housing market. ARM securities represent interests in pools of ARM
loans, which are publicly rated and include guarantees or other credit
enhancements against losses from loan defaults. While we are not a bank or
savings and loan institution, our business purpose, strategy, method of
operation and risk profile are best understood in comparison to such
institutions. We use our equity capital and borrowed funds to originate, acquire
and invest in ARM assets and seek to generate income for distribution to our
shareholders based on the difference between the yield on our ARM assets
portfolio and the cost of our borrowings. Our corporate structure differs from
most lending institutions in that we are organized for tax purposes as a real
estate investment trust ("REIT") and therefore generally pass substantially all
of our earnings through to shareholders, without paying federal or state income
tax at the corporate level. We have five qualified REIT subsidiaries, all of
which are consolidated in our financial statements and federal and state tax
returns. Two of these subsidiaries, Thornburg Mortgage Funding Corporation and
Thornburg Mortgage Acceptance Corporation, are involved in financing our
mortgage loan assets. Thornburg Mortgage Home Loans, Inc. ("TMHL"), our wholly
owned mortgage banking subsidiary, conducts our mortgage loan acquisition,
origination, processing, underwriting and securitization activities. TMHL's two
wholly owned special purpose subsidiaries, Thornburg Mortgage Funding
Corporation II and Thornburg Mortgage Acceptance Corporation II, facilitate the
financing of loans by TMHL.


                                       22
<PAGE>


Our mortgage assets portfolio may consist of mortgage pass-through securities
either guaranteed by an agency of the federal government, ("Ginnie Mae") or a
federally chartered corporation ("Fannie Mae" or "Freddie Mac") or privately
issued (generally publicly registered) mortgage pass-through securities,
multi-class pass-through securities, collateralized mortgage obligations
("CMOs"), collateralized bond obligations ("CBOs") which are generally backed by
high quality mortgage-backed securities ("MBS"), ARM loans, fixed rate MBS that
have an expected duration of one year or less, or short term investments that
either mature within one year or have an interest rate that reprices within one
year. Agency securities are MBS for which a U.S. Government agency or federally
chartered corporation, such as Freddie Mac, Fannie Mae or Ginnie Mae, guarantees
payments of principal or interest on the certificates. Agency securities are not
rated, but carry an implied AAA rating.

We also invest in hybrid ARM assets ("Hybrid ARMs"), which are typically 30-year
loans having a fixed rate of interest for an initial period, generally 3 to 10
years, and then convert to an adjustable-rate for the balance of their term. We
limit our ownership of Hybrid ARMs with fixed rate periods of greater than five
years to no more than 10% of our total assets. We also have a policy to fund our
+Hybrid ARM assets with fixed rate borrowings such that the duration difference
of Hybrid ARMS and the corresponding borrowings is one year or less. We use Swap
Agreements and Eurodollar Transactions to fix our borrowing cost.

ARM assets are generally subject to periodic caps. Periodic caps generally limit
the maximum interest rate coupon change on any interest rate coupon adjustment
date to either a maximum of 1% per semiannual adjustment or 2% per annual
adjustment. The borrowings that we incur do not have similar periodic caps. We
generally do not hedge against the risk of our borrowing costs rising above the
periodic interest rate cap level on the ARM assets because the contractual
future interest rate adjustments on the ARM assets will cause their interest
rates to increase over time and reestablish the ARM assets' interest rate to a
spread over the then current index rate. We attempt to mitigate the effect of
periodic caps by acquiring variable rate CMOs and CBOs, Hybrid ARMs and certain
other ARM loans that do not have a periodic cap. As of September 30, 2002,
approximately $8.3 billion of our ARM securities and ARM loans did not have
periodic caps or were Hybrid ARMs, representing approximately 83% of total ARM
assets.

Our investment policy is to invest at least 70% of total assets in High Quality
ARM assets 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 Ginnie Mae, Fannie Mae or Freddie Mac; or

     (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 our Board of Directors; or

     (4)  the portion of ARM loans that have been deposited into a trust and
          have received a credit rating of AA or better from at least one Rating
          Agency.

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

     (1)  adjustable or variable rate pass-through certificates, multi-class
          pass-through certificates or CMOs backed by loans on single-family,
          multi-family, commercial or other real estate-related properties so
          long as they are rated at least Investment Grade at the time of
          purchase. "Investment Grade" generally means a security rating of BBB,
          Baa or better by at least one of the Rating Agencies;

     (2)  ARM loans collateralized by first liens on single family residential
          properties, generally underwritten to "A" quality standards and
          acquired for the purpose of future securitization; or

     (3)  fixed rate mortgage loans collateralized by first liens on single
          family residential properties originated for sale to third parties; or

     (4)  real estate properties acquired as a result of foreclosing on our ARM
          loans; or

     (5)  as authorized by our Board of Directors, ARM securities rated less
          than Investment Grade that are created as a result of loan acquisition
          and securitization efforts and that equal an amount no greater than
          17.5% of shareholders' equity, measured on a historical cost basis.


                                       23
<PAGE>


We acquire and originate high quality mortgage loans through TMHL from three
sources: (i) bulk acquisitions, which involve acquiring pools of whole loans
which are originated using the seller's guidelines and underwriting criteria,
(ii) correspondent lending, which involves acquiring individual loans from
correspondent lenders or other loan originators who originate the individual
loans using our underwriting criteria and guidelines or criteria and guidelines
that we have approved, and (iii) direct retail loan originations, which are
loans that we originate. The loans that we acquire or originate are financed
through warehouse borrowing arrangements and securitized for our portfolio, or,
in the case of fixed rate loans, sold to third parties.

The loans acquired or originated by TMHL are first lien, residential ARM and
Hybrid ARM loans with original terms to maturity of not more than forty years
and are either fully amortizing or are interest only up to ten years, and fully
amortizing thereafter. We believe the interest only loans do not pose additional
credit risk because the effective loan-to-values average 68.7% and these loans
generally pay off prior to the expiration of the interest only term of the
loans. Interest only loans acquired or originated during the first nine months
of 2002 represented 81.7% of total loan production during that period.

All ARM loans that we acquire bear an interest rate that is tied to an interest
rate index. Some loans have periodic and lifetime constraints on how much the
loan interest rate can change on any predetermined interest rate reset date. In
general, the interest rate on each ARM loan resets at a frequency that is either
monthly, semi-annually or annually. The ARM loans generally adjust to a margin
over a U.S. Treasury Bill index or a LIBOR index. The Hybrid ARM loans have an
initial fixed rate period, generally 3 to 10 years, and then convert to an ARM
loan with the features of an ARM loan described above.

We offer a loan modification program on all loans that we originate and certain
loans that we acquire. Under the terms of this program, a borrower may pay a fee
and choose to modify the interest rate of a mortgage loan to any then-available
hybrid or adjustable-rate product offered by us, at any time during the life of
the loan.

Our underwriting guidelines are intended to determine the collateral value of
the mortgaged property and to consider the borrower's credit standing and
repayment ability. Each prospective borrower completes an application that
includes information with respect to the applicant's liabilities, income and
employment history, as well as certain other personal information. A credit
report is required for each applicant from at least one credit reporting
company. The report typically contains information relating to matters such as
credit history with local and national merchants and lenders, installment debt
payments and any record of default, bankruptcy, repossession, suit or judgment.
Generally, the borrowers have credit scores, called a FICO (based upon the
credit evaluation methodology developed by Fair, Isaac and Company, a consulting
firm specializing in creating credit evaluation models) of 650 or above. On a
case-by-case basis, we may determine that, based upon compensating factors, a
prospective borrower not strictly qualifying under the applicable underwriting
guidelines warrants an underwriting exception. Compensating factors may include,
but are not limited to, low loan-to-value ratios, low debt-to-income ratios,
good credit history, stable employment, financial reserves, and time in
residence at the applicant's current address.

Our underwriting guidelines for both the correspondent and retail channels are
applied in accordance with a procedure that generally requires (1) one appraisal
report for loan amounts up to $650,000, one appraisal report and one field
review for loan amounts between $650,000 and $1,000,000, and two appraisal
reports for loan amounts greater than $1,000,000, (2) a review of such appraisal
by a third party appraisal review firm for loans over $650,000 and (3) an
internal review by us of all appraisal reports. Our underwriting guidelines
generally permit single-family mortgage loans with loan-to-value ratios at
origination of up to 95% (or, with respect to additional collateral mortgage
loans, up to 100%) for the highest credit grading category, depending on the
creditworthiness of the borrower, the type and use of the property and the
purpose of the loan application. All loans with loan-to-value ratios greater
than 80% must either have mortgage insurance or additional collateral securing
the loan.

We perform our own underwriting reviews (or contract with third parties to
perform underwriting reviews based on our guidelines) of loans that we purchase
from bulk sellers or acquire from approved correspondents. We use private label,
fee-based, third party service providers to underwrite, process and close the
loans that we originate. We also service mortgage loans that we acquire or
originate using a contract, private label subservicer. We believe the
efficiencies and expertise that our third party service providers have developed
through specialization afford us


                                       24
<PAGE>


an opportunity to expand our mortgage origination and loan servicing business in
a cost effective manner with minimum initial investment.

Our loan acquisition and origination strategies are designed to take advantage
of our portfolio lending capability, cost-efficient operation, competitive
advantages and available technology, enabling us to provide attractive and
innovative mortgage products, competitive mortgage rates and a high level of
customer service. By eliminating intermediaries, whenever possible, between the
borrower and the lender, we expect to acquire and originate loans for retention
in our portfolio at attractive yields, while offering our customers innovative
mortgage products at competitive rates and fees. Our expansion into residential
mortgage loan origination is intended to continue our strategy of acquiring only
high quality mortgage loans.

We offer mortgages on-line utilizing a third party, private label, web-based
origination system. Prospective borrowers are able to look up mortgage loan
product and interest rate information through our website, obtain access to a
variety of mortgage calculators and consumer help features, submit an
application on-line and begin the process of obtaining pre-approval of their
loan. Once a mortgage loan application has been submitted, one of our
representatives will assist the borrower in completing the loan process.

Since we do not invest in real estate mortgage investment conduit ("REMIC")
residuals or other CMO residuals, we do not create excess inclusion income or
unrelated business taxable income for tax-exempt investors. Therefore, our
securities are eligible for purchase by tax-exempt investors, such as pension
plans, profit sharing plans, 401(k) plans, Keogh plans and Individual Retirement
Accounts.

FINANCIAL CONDITION

At September 30, 2002, we held total assets of $10.092 billion, $9.996 billion
of which consisted of ARM assets, as compared to $5.804 billion and $5.732
billion, respectively, at December 31, 2001. Since commencing operations, we
have primarily purchased either ARM securities (backed by agencies of the U.S.
government or federally chartered corporations 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 generally originated to "A"
quality underwriting standards. At September 30, 2002, 93.1% of our assets,
including cash and cash equivalents, were High Quality assets, far exceeding our
investment policy minimum requirement of investing at least 70% of our total
assets in High Quality ARM assets and cash and cash equivalents. Of the ARM
assets that we owned as of September 30, 2002, 91.4% were in the form of
adjustable rate pass-through certificates or ARM loans. The remainder were
floating rate classes of CMOs (5.7%), short term, fixed rate classes of CMOs
(0.9%) or investments in floating rate classes of CBOs (2.0%) backed primarily
by ARM MBS.


                                       25
<PAGE>


The following table presents a schedule of ARM assets owned at September 30,
2002 and December 31, 2001 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, 2002                  December 31, 2001
                                      ------------------------------    ------------------------------
                                        Carrying          Portfolio       Carrying          Portfolio
                                          Value              Mix            Value              Mix
                                      ------------      ------------    ------------      ------------
<S>                                   <C>               <C>             <C>               <C>
HIGH QUALITY:
   Freddie Mac/Fannie Mae             $  3,477,938              34.8%   $  2,401,831              41.9%
   Privately Issued:
     AAA/Aaa Rating                      5,417,265(1)           54.2       2,699,868(1)           47.1
     AA/Aa Rating                          384,572               3.8         372,413               6.5
                                      ------------      ------------    ------------      ------------
       Total Privately Issued            5,801,837              58.0       3,072,281              53.6
                                      ------------      ------------    ------------      ------------

                                      ------------      ------------    ------------      ------------
       Total High Quality                9,279,775              92.8       5,474,112              95.5
                                      ------------      ------------    ------------      ------------

OTHER INVESTMENT:
   Privately Issued:
       A Rating                             59,046               0.6          49,627               0.9
     BBB/Baa Rating                         39,092               0.4          69,698               1.2
     BB/Ba Rating and Other                 41,987(1)            0.4          39,942(1)            0.7
   ARM loans pending securitization        576,145               5.8          98,766               1.7
                                      ------------      ------------    ------------      ------------
       Total Other Investment              716,270               7.2         258,033               4.5
                                      ------------      ------------    ------------      ------------

       Total ARM Portfolio            $  9,996,045             100.0%   $  5,732,145             100.0%
                                      ============      ============    ============      ============
</Table>

----------

     (1)  The AAA Rating category includes $292.8 million and $442.2 million of
          whole loans as of September 30, 2002 and December 31, 2001,
          respectively, that have been credit enhanced to AAA by a combination
          of an insurance policy purchased from a third party and an unrated
          subordinated certificate retained in the amount of $31.7 million and
          $31.8 million as of September 30, 2002 and December 31, 2001,
          respectively. The subordinated certificate is included in the BB/Ba
          Rating and Other category.

As of September 30, 2002 and December 31, 2001, we had reduced the carrying
value of our securitized ARM loans by $11,687,000 and $7,925,000, respectively,
due to estimated credit losses (other than temporary declines in fair value). In
addition, we had reduced the cost basis of other ARM securities by $856,000 and
$1,151,000, as of the same dates, respectively, related to Other Investments
that we purchased at a discount that included an estimate of credit losses.

As of September 30, 2002, 10 of the 8,301 loans in our ARM loan portfolio were
considered seriously delinquent (60 days or more delinquent) and had an
aggregate balance of $2.5 million. The ARM loan portfolio also includes two
properties that we acquired as the result of foreclosure procedures in the
amount of $506,000. The average original effective loan-to-value ratio on the
delinquent loans and the acquired properties was approximately 60%. We believe
that our current level of basis adjustments and allowance for loan losses is
more than adequate to cover estimated losses from these loans and properties.


                                       26
<PAGE>


The following table presents a summary of the basis adjustments on our
securitized ARM loans, the basis adjustments on our purchased ARM securities and
the allowance for losses on our ARM loans (dollar amounts in thousands):

<Table>
<Caption>
                                                                    Allowance for
                                           Basis Adjustments           Losses
                                      ---------------------------   -------------
                                       Securitized  Purchased ARM
                                        ARM Loans     Securities      ARM Loans        Total
                                      ------------  -------------   -------------   ------------
<S>                                   <C>           <C>             <C>             <C>
Balance, December 31, 2001            $      7,925   $      1,151    $        100   $      9,176
Basis adjustment recorded at
   time of loan securitization               3,762             --              --          3,762
Charge-offs                                     --           (460)             --           (460)
Recoveries                                      --            165              --            165
                                      ------------   ------------    ------------   ------------
Balance, September 30, 2002           $     11,687   $        856    $        100   $     12,643
                                      ============   ============    ============   ============
</Table>

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

                               ARM ASSETS BY INDEX
                          (Dollar amounts in thousands)

<Table>
<Caption>
                                                       September 30, 2002               December 31, 2001
                                                  ----------------------------    ----------------------------
                                                    Carrying       Portfolio        Carrying        Portfolio
                                                     Value            Mix             Value            Mix
                                                  ------------    ------------    ------------    ------------
<S>                                               <C>             <C>             <C>             <C>
ARM ASSETS:
    INDEX:
       One-month LIBOR                            $  1,160,682            11.6%   $    633,758            11.1%
       Three-month LIBOR                               201,983             2.0         171,262             3.0
       Six-month LIBOR                                 515,613             5.2         261,245             4.6
       Six-month Certificate of Deposit                101,887             1.0         140,887             2.5
       Six-month Constant Maturity Treasury             11,528             0.1          16,809             0.3
       One-year Constant Maturity Treasury           1,198,227            12.0       1,651,453            28.8
       Cost of Funds                                    88,215             0.9         182,437             3.2
                                                  ------------    ------------    ------------    ------------
                                                     3,278,135            32.8       3,057,851            53.5
                                                  ------------    ------------    ------------    ------------

HYBRID ARM ASSETS                                    6,602,706            66.1       2,397,629            41.7
ONE-YEAR EXPECTED LIFE - FIXED RATE                    115,204             1.1         276,665             4.8
                                                  ------------    ------------    ------------    ------------
                                                  $  9,996,045           100.0%   $  5,732,145           100.0%
                                                  ============    ============    ============    ============
</Table>

The ARM portfolio had a current weighted average interest rate coupon of 5.10%
at September 30, 2002. This consisted of an average coupon of 5.42% on the
hybrid portion of the portfolio and an average coupon of 4.38% on the rest of
the portfolio. If the portfolio had been "fully indexed," the weighted average
coupon of the portfolio would have been approximately 4.92%, based upon the
current composition of the portfolio and the applicable indices. Additionally,
if the non-hybrid portion of the portfolio had been "fully indexed," the
weighted average coupon of that portion of the portfolio would have been
approximately 3.80%, also based upon the current composition of the portfolio
and the applicable indices. The term "fully indexed" refers to an ARM asset that
has an interest rate that is currently equal to its applicable index plus a
margin to the index that is specified by the terms of the ARM asset.

The ARM portfolio had a current weighted average interest rate coupon of 5.96%
at December 31, 2001. This consisted of an average coupon of 6.26% on the hybrid
portion of the portfolio and an average coupon of 5.71% on the rest of the
portfolio. If the non-hybrid portion of the portfolio had been "fully indexed,"
the weighted average coupon of the ARM portfolio would have been approximately
5.16%, based upon the composition of the portfolio and the applicable indices at
that time. The average interest rate on the ARM portion of the portfolio is
expected to continue to decrease during 2002 until it reaches the "fully
indexed" rate.


                                       27
<PAGE>


At September 30, 2002, the current yield of the ARM assets portfolio was 4.71%,
compared to 5.09% as of December 31, 2001. The decrease in the yield of 0.38% as
of September 30, 2002, compared to December 31, 2001, is due to the decreased
weighted average interest rate coupon discussed above, which decreased by 0.86%.
This decline in the average interest rate coupon was partially offset by a lower
level of net premium amortization, which had the effect of increasing the yield
by 0.44%. Additionally, the relative level of non-interest earning principal
payments receivables also increased the portfolio yield by 0.04%. The current
yield includes the impact of the amortization of applicable premiums and
discounts and the impact of principal payment receivables.

The ARM portfolio had an average term to the next repricing date of 901 days as
of September 30, 2002, compared to 617 days as of December 31, 2001. The
non-hybrid portion of the portfolio had an average term to the next repricing
date of 71 days and the hybrid portion had an average term to the next repricing
date of 3.7 years at September 30, 2002. As of September 30, 2002, Hybrid ARMs
comprised 66.1% of the total ARM portfolio, compared to 41.7% as of the end of
2001. We attempt to mitigate our interest rate risk by funding our ARM assets
with borrowings that have maturities that approximately match the interest rate
adjustment periods on our ARM assets. Therefore, some of our borrowings bear
variable or short term (one year or less) fixed interest rates because a portion
of our ARM assets have interest rates that adjust within one year. However, we
finance our Hybrid ARM portfolio with longer term, fixed rate borrowings such
that the duration difference of the fixed interest rate period of the Hybrid
ARMs and the corresponding borrowings is one year or less. Duration is a
calculation that measures the expected price volatility of financial instruments
based on changes in interest rates. By maintaining a duration difference of less
than one year, the price change of our Hybrid ARM portfolio is expected to be a
maximum of 1% for a 1% parallel shift in interest rates, net of the fair value
change of our Swap Agreements and other borrowings funding our Hybrid ARMS. As
of September 30, 2002, the duration difference applicable to our Hybrid ARM
portfolio was approximately two months.



                                       28
<PAGE>


The following table presents various characteristics of our ARM and Hybrid ARM
loan portfolio as of September 30, 2002. This information pertains to loans held
for securitization, loans held as collateral for notes payable and loans
securitized for our own portfolio for which we retained credit loss exposure.
The combined amount of the loans included in this information is $3.227 billion.

                ARM AND HYBRID ARM LOAN PORTFOLIO CHARACTERISTICS

<Table>
<Caption>
                                  Average             High              Low
                               --------------    --------------    --------------
<S>                            <C>               <C>               <C>
Original loan balance          $      392,246    $    6,000,000    $       31,000
Unpaid loan balance                   383,356         6,000,000               735
Coupon rate on loans                     5.61%             9.12%             2.28%
Pass-through rate                        5.28%             8.12%             2.26%
Pass-through margin                      1.80%             3.48%             0.23%
Lifetime cap                            11.74%            18.00%             8.12%
Original term (months)                    357               480               120
Remaining term (months)                   341               480                49
</Table>

<Table>
<S>                                  <C>        <C>                        <C>
     Geographic distribution (top 5 states):    Property type:
         California                   27.51%        Single-family            86.87%*
         Georgia                      13.99         Condominium               7.85
         Colorado                      6.61         Other                     5.28
         New York                      6.06
         Florida                       5.30

     Occupancy status:                          Initial Cap on Hybrid loans:
         Owner occupied               86.87%        3.00% or less            13.38%
         Second home                  10.61         3.01%-4.00%              20.51
         Investor                      2.52         4.01%-5.00%              35.79
                                                    5.01%-6.00%              30.32

     Documentation type:                        Periodic Cap on non-Hybrid loans:
         Full/Alternative             93.41%        None                    71.48%
         Other                         6.59         1.00% or less           19.36
                                                    Over 1.00%               9.16
     Loan purpose:
         Purchase                     37.42%    Percent of loan balances that
         Cash out refinance           28.07         are interest only:      78.07%**
         Rate & term refinance        34.51

     Average effective original
         loan-to-value:               66.63%
</Table>

*  Single-family properties include DeMinimus PUD properties (a premise within a
   planned unit development property in which the common property has less than
   a 2% influence upon the value of the premise) representing 24.93% of the loan
   portfolio.

** The average effective loan-to-value on interest only loans is 68.69%.

As of September 30, 2002, we serviced $1.479 billion of our loans and had 3,481
customer relationships. We hold all of the loans that we service in our
portfolio in the form of securitized loans or loans to be securitized for our
portfolio. We have not retained or capitalized any servicing rights on loans
sold.


                                       29
<PAGE>


During the quarter ended September 30, 2002, we purchased $1.480 billion of ARM
securities, 100% of which were High Quality assets, and $686.4 million of ARM
loans, generally originated to "A" quality underwriting standards. Of the ARM
assets that we acquired during the three months ended September 30, 2002,
approximately 85% were Hybrid ARMs, 15% were indexed to LIBOR and less than 1%
were indexed to U.S. Treasury bill rates. The following table compares our ARM
asset acquisition and origination activity for the consecutive quarters ended
September 30, 2002 and June 30, 2002 (dollar amounts in thousands):

<Table>
<Caption>
                                            For the quarters ended:
                                          ---------------------------
                                          September 30,    June 30,
                                              2002           2002
                                          ------------   ------------
<S>                                       <C>            <C>

ARM SECURITIES:
   Freddie Mac/Fannie Mae                 $    183,604   $    730,152
   High Quality, privately issued            1,296,422      1,142,260
                                          ------------   ------------
                                             1,480,026      1,872,412
                                          ------------   ------------

LOANS:
     Bulk acquisitions                          79,744        167,638
     Correspondent purchases                   527,829        380,872
     Direct retail originations                 78,814         70,004
                                          ------------   ------------
                                               686,387        618,514
                                          ------------   ------------

       Total production                   $  2,166,413   $  2,490,926
                                          ============   ============
</Table>

Since 1997, we have emphasized purchasing ARM and Hybrid ARM assets, high
quality, floating rate collateralized mortgages and short term, fixed rate
securities at substantially lower prices relative to par in order to reduce the
potential impact of rapid prepayments. In doing so, the average
premium/(discount) that we paid for ARM assets acquired in the first nine months
of 2002 and for the year 2001 was 0.78% and 0.12% of par, respectively, as
compared to 3.29% of par in 1997 when we emphasized the purchase of seasoned ARM
assets. In part, as a result of this strategy, our unamortized net premium as a
percent of par was 0.99% as of September 30, 2002, down from 2.83% as of the end
of 1997.

During the three month and nine month periods ended September 30, 2002, we
securitized $519.5 million and $1.477 million of our ARM loans into a series of
privately issued multi-class ARM securities, all of which we retained for our
ARM portfolio. We securitize the ARM loans that we acquire into ARM securities
for our own portfolio in order to reduce the cost of financing the portfolio and
in order to enhance the high quality and highly liquid characteristics of our
portfolio, thereby improving our access to mortgage finance markets. In doing
so, we retain all of the economic interest and risk of the loans, except those
swapped for Fannie Mae guaranteed certificates. Of the loans that we securitized
during the first nine months of 2002, 99.8% were at least Investment Grade
securities and 0.2% were subordinate securities that provide credit support to
the Investment Grade securities.

As of September 30, 2002, we had commitments to purchase $724.6 million of ARM
securities, $103.9 of ARM loans through wholesale channels and $676.8 million of
ARM loans through retail channels.

During the three month period ended September 30, 2002, we sold $10.1 million of
ARM securities for a gain of $18,000. We did not sell any assets during the
third quarter of 2001.

For the quarter ended September 30, 2002, our mortgage assets paid down at an
approximate average annualized Constant Paydown Rate ("CPR") of 30%, compared to
30% for the quarter ended September 30, 2001 and 26% for the quarter ended June
30, 2002. When prepayment experience increases, we have to amortize our premiums
over a shorter time period, resulting in a reduced yield to maturity on our ARM
assets. Conversely, if actual prepayment experience decreases, we would amortize
the premium over a longer time period, resulting in a higher yield to maturity.
We monitor our prepayment experience on a monthly basis in order to adjust the
amortization of the net premium, as appropriate.


                                       30
<PAGE>


The fair value of our portfolio of ARM assets classified as available-for-sale
increased by 0.83% from a negative adjustment of 0.10% of the portfolio as of
December 31, 2001, to a positive adjustment of 0.73% as of September 30, 2002.
This price improvement was primarily due to the effect of declining medium to
long-term interest rates on the fair value of our Hybrid ARM assets. The amount
of the adjustment to the fair value on the ARM assets classified as
available-for-sale improved from a negative adjustment of $5.3 million as of
December 31, 2001, to a positive adjustment of $65.6 million as of September 30,
2002. All of our ARM securities are classified as available-for-sale and are
carried at their fair value.

Our ARM assets generally have a maximum lifetime interest rate cap or ceiling,
meaning that each ARM asset contains a contractual maximum interest rate. Since
our borrowings are not subject to equivalent interest rate caps, we have entered
into Cap Agreements which have the effect of offsetting a portion of our
borrowing costs, thereby reducing the effect of the lifetime cap feature on our
ARM assets and protecting the net margin on our ARM assets in high interest rate
environments. As of September 30, 2002, our ARM assets had an average lifetime
interest rate cap of 10.97%, far exceeding the current level of interest rates.
At September 30, 2002, our Cap Agreements had a remaining notional balance of
$2.091 billion with an average final maturity of 1.1 years, compared to a
remaining notional balance of $2.254 billion with an average final maturity of
1.5 years at December 31, 2001. At September 30, 2002, the fair value of our Cap
Agreements was $0.2 million compared to a fair value of $0.4 million as of
December 31, 2001. Pursuant to the terms of the Cap Agreements, we will receive
cash payments if the one month or three month LIBOR indices increase above
certain specified levels, which range from 6.00% to 12.00% and average
approximately 9.95%. Due to the current low level of interest rates, we have
decided not to purchase additional Cap Agreements at this time, but will
reevaluate this policy on an ongoing basis.

The following table presents information about our Cap Agreement portfolio as of
September 30, 2002:

               CAP AGREEMENTS CONTRACTS STRATIFIED BY STRIKE PRICE
                          (Dollar amounts in thousands)

<Table>
<Caption>
   Hedged      Weighted                                            Weighted
ARM Assets     Average       Cap Agreement                          Average
Balance(1)     Life Cap    Notional Balance    Strike Price     Remaining Term
----------     --------    ----------------    ------------     --------------
<S>            <C>         <C>                 <C>              <C>
$   70,400         8.40%   $         70,531            6.41%       1.2 Years
   200,135         8.40             200,000            7.50        1.2
   479,760         8.84             480,000            8.05        1.2
    25,193         9.90              25,000            9.00        0.2
    25,363        10.07              25,000            9.50        0.2
   135,614        10.67             136,000           10.02        0.5
    53,857        10.92              54,000           10.50        0.4
   470,217        11.40             470,000           11.00        1.0
   280,085        12.30             280,000           11.50        1.9
   569,551        13.21             350,000           12.00        1.0
----------     --------    ----------------    ------------      -----------
$2,310,175        10.97%   $      2,090,531            9.95%       1.1 Years
==========     ========    ================    ============      ===========
</Table>

----------
 (1)  Excludes ARM assets that do not have lifetime interest rate caps or are
      hybrids that are match funded during their fixed rate period, in
      accordance with our investment policy.

We enter into interest rate Swap Agreements and Eurodollar Transactions in order
to manage our interest rate exposure when financing our ARM assets. We generally
borrow money based on short term interest rates, either by entering into
borrowings with maturity terms ranging from one month to nine months or by
entering into borrowings with longer maturity terms of one to two years that
reprice based on a frequency ranging from one month to nine months. Our ARM
assets generally have interest rates that reprice based on frequency terms of
one to twelve months. Our Hybrid ARMs generally have an initial fixed interest
rate period of three to ten years. As a result, our existing and forecasted
borrowings reprice to a new interest rate on a more frequent basis than do our
ARM assets. When we enter into a Swap Agreement, we agree to pay a fixed rate of
interest and to receive a variable interest rate based on LIBOR. Both Swap
Agreements and Eurodollar Transactions have the effect of converting our
variable rate debt into fixed rate debt over the life of the Swap Agreements and
Eurodollar Transactions. We use Swap


                                       31
<PAGE>


Agreements and Eurodollar Transactions as a cost effective way to lengthen the
average repricing period of our variable rate and short-term borrowings such
that the average repricing period of our borrowings more closely matches the
average repricing period of our ARM assets.

As of September 30, 2002, we were counterparty to forty-six Swap Agreements and
had entered into Eurodollar Transactions that together had an aggregate current
notional balance of $4.733 billion. In addition, we have also entered into a
delayed Swap Agreement with a notional balance of $500 million that becomes
effective in August 2003. These Swap Agreements and Eurodollar Transactions
hedged our short-term financing during the fixed interest rate period of the
Hybrid ARM assets we held in our portfolio and had a weighted average maturity
of 2.8 years. Entering into these Swap Agreements and Eurodollar Transactions
has enabled us to reduce the interest rate variability of the cost to finance
our Hybrid ARM assets by increasing the average period until the next repricing
of the associated borrowings from 40 days to 849 days. The average remaining
fixed rate term of our Hybrid ARM assets as of September 30, 2002 was 3.7 years.
Further, the difference between the duration of Hybrid ARMs and the duration of
the borrowings funding Hybrid ARMs, as of September 30, 2002, was approximately
two months.

In accordance with Financial Accounting Standards No. 133 ("FAS 133"), we
designate all of these Swap Agreements as cash flow hedges and, as of September
30, 2002, carry them on the balance sheet at their negative fair value of $128.5
million. As of September 30, 2002, the fair value adjustment for Swap Agreements
was a decrease to "Accumulated other comprehensive income" in the amount of
$124.1 million. The Swap Agreements and the short-term borrowings they hedge
have nearly identical terms and characteristics with respect to the applicable
index and interest rate repricing dates, and we have calculated the
effectiveness of this cash flow hedge to be approximately 100%. As a result, we
have recorded all changes in the unrealized gains and losses on Swap Agreements
in "Accumulated other comprehensive income" and we have reclassified all such
changes to earnings as interest expense is recognized on our hedged borrowings.

Also, in accordance with FAS 133, we designate all of the Eurodollar
Transactions as cash flow hedges and, as of September 30, 2002, carry them on
the balance sheet at their negative fair value of $3.8 million. The Eurodollar
Transactions hedge the change in the three-month LIBOR interest rate index and
we have also entered into short-term borrowings indexed to three-month LIBOR
with re-pricing dates that correspond to the expiration dates of the Eurodollar
Transactions. As a result, there has not been any measurable ineffectiveness
from this activity and, therefore, the gains and losses from this activity have
been recorded in "Accumulated other comprehensive income" and will be
reclassified to earnings as interest expense is recognized on our hedged
short-term borrowings.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002

For the quarter ended September 30, 2002, our net income was $32,610,000, or
$0.68 and $0.67 per share, Basic and Diluted EPS, respectively, based on a
weighted average of 45,733,000 and 48,493,000 shares outstanding, respectively.
That compares to $14,585,000, or $0.52 per share (Basic and Diluted EPS) for the
quarter ended September 30, 2001, based on a weighted average of 25,004,000
shares outstanding, a 31% increase in our earnings per share.


                                       32
<PAGE>


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

                COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY(1)

<Table>
<Caption>
                                                                                                                     ROE in
                                                                                                         10-Year    Excess of
                  Net                Provision     Gain     Operating                          Net         US       10-Year
   For the     Interest    Hedging      For       on ARM     Expense    Perform.  Preferred   Income/   Treasury   US Treas.
   Quarter      Income/   Expense/    Losses/     Sales/       (2)/       Fee/    Dividend/   Equity     Average    Average
    Ended       Equity     Equity      Equity     Equity     Equity     Equity     Equity     (ROE)      Yield       Yield
   -------     --------   --------   ---------    ------    ---------   -------   ---------   -------   --------   ----------
<S>            <C>        <C>        <C>          <C>        <C>        <C>       <C>         <C>       <C>        <C>

Sep 30, 2000     11.01%       -         0.33%       -         2.07%        -        2.05%      6.56%      5.89%      0.67%
Dec 31, 2000     11.77%       -         0.21%       0.29%     2.37%      0.06%      2.05%      7.37%      5.57%      1.80%
Mar 31, 2001     17.40%     0.18%       0.22%       -         2.59%      1.12%      2.03%     11.24%      5.04%      6.21%
Jun 30, 2001     18.50%     0.55%       0.18%       -         2.81%      1.26%      1.97%     11.73%      5.28%      6.45%
Sep 30, 2001     21.36%     0.55%       0.25%       -         3.07%      1.76%      1.80%     13.94%      4.99%      8.95%
Dec 31, 2001     25.25%     0.19%       0.08%       -         3.51%      2.70%      1.46%     17.31%      4.76%     12.55%
Mar 31, 2002     22.71%     0.23%        -          -         2.75%      2.29%      1.20%     16.24%      5.79%     11.16%
Jun 30, 2002     22.53%     0.38%        -          0.05%     2.90%      2.27%      1.02%     16.01%      5.11%     10.90%
Sep 30, 2002     23.15%     0.09%        -          0.01%     2.56%      2.75%      0.91%     16.85%      4.27%     12.58%
</Table>

----------

(1)  Average common equity excludes unrealized gain (loss) on available-for-sale
     ARM securities.

(3)  Excludes performance fees and net of loan servicing fees.

Our return on average common equity was 16.85% for the quarter ended September
30, 2002 compared to 13.94% for the quarter ended September 30, 2001. Our return
on equity improved in this past quarter compared to the same quarter of the
prior year primarily because our net interest income improved. This improvement
was due, in part, to the lower cost of funds of our borrowings and because the
yield on our net interest earning assets is benefiting from acquisitions of
loans and other ARM and Hybrid ARM assets acquired at average prices close to
par, replacing lower yielding assets that paid off.

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

                   COMPARATIVE NET INTEREST INCOME COMPONENTS
                          (Dollar amounts in thousands)

<Table>
<Caption>
                                        For the quarters ended September 30,
                                        ------------------------------------
                                                2002            2001
                                        ----------------    ----------------
<S>                                       <C>                 <C>
Coupon interest income on ARM assets      $    113,803        $     72,164
Amortization of net premium                     (4,727)             (6,218)
Cash and cash equivalents                          586                 303
                                          ------------        ------------
    Interest income                            109,662              66,249
                                          ------------        ------------

Reverse repurchase agreements                   38,381              33,788
AAA notes payable                                1,967               5,544
Other borrowings                                 2,848               2,245
Interest rate swaps                             23,953               4,879
                                          ------------        ------------
    Interest expense                            67,149              46,456
                                          ------------        ------------

Net interest income                       $     42,513        $     19,793
                                          ============        ============
</Table>

As presented in the table above, our net interest income increased by $22.7
million in the third quarter of 2002 compared to the third quarter of 2001. The
change was attributable to a $43.4 million increase in interest income primarily
due to an increased asset base, partially offset by a $20.7 million increase in
interest expense.



                                       33
<PAGE>


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

        AVERAGE BALANCE, RATE, INTEREST INCOME AND INTEREST EXPENSE TABLE
                          (Dollar amounts in thousands)

<Table>
<Caption>
                                                                     For the quarters ended September 30,
                                           ---------------------------------------------------------------------------------------
                                                              2002                                         2001
                                           -------------------------------------------   -----------------------------------------
                                                                           Interest                                     Interest
                                              Average       Effective     Income and       Average        Effective    Income and
                                              Balance         Rate          Expense        Balance           Rate        Expense
                                           -----------    ------------    ------------   ------------   ------------  ------------
<S>                                        <C>            <C>             <C>            <C>            <C>           <C>
Interest Earning Assets:
  Adjustable-rate mortgage assets          $ 9,143,764           4.77%   $    109,076   $  4,593,688          5.74%   $     65,946
  Cash and cash equivalents                     93,486           2.51             586         47,745          2.54             303
                                           -----------    -----------    ------------   ------------   -----------    ------------
                                             9,237,250           4.75         109,662      4,641,433          5.71          66,249
                                           -----------    -----------    ------------   ------------   -----------    ------------
Interest Bearing Liabilities:
  Reverse repurchase agreements              7,703,283           3.24          62,334      3,492,997          4.43          38,667
  Collateralized notes payable                 305,911           2.57           1,967        498,110          4.45           5,544
  Other borrowings                             398,690           2.86           2,848        211,450          4.25           2,245
                                           -----------    -----------    ------------   ------------   -----------    ------------
                                             8,407,884           3.19          67,149      4,202,557          4.42          46,456
                                           -----------    -----------    ------------   ------------   -----------    ------------

                                           -----------    -----------    ------------   ------------   -----------    ------------
Net Interest Earning Assets and Spread     $   829,366           1.56%   $     42,513   $    438,876          1.29%   $     19,793
                                           ===========    ===========    ============   ============   ===========    ============
Yield on Net Interest Earning Assets(1)                          1.84%                                        1.71%
                                                          ===========                                  ============
</Table>

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

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

<Table>
<Caption>
                                             Three Months Ended September 30,
                                                    2002 versus 2001
                                      --------------------------------------------
                                          Rate           Volume          Total
                                      ------------    ------------    ------------
<S>                                   <C>             <C>             <C>
Interest Income:
   ARM assets                         $    (11,148)   $     54,278    $     43,130
   Cash and cash equivalents                    (4)            287             283
                                      ------------    ------------    ------------
                                           (11,152)         54,565          43,413
                                      ------------    ------------    ------------
Interest Expense:
   Reverse repurchase agreements           (10,402)         34,069          23,667
   Collateralized notes payable             (2,341)         (1,236)         (3,577)
   Other borrowings                           (735)          1,338             603
                                      ------------    ------------    ------------
                                           (13,478)         34,171          20,693
                                      ------------    ------------    ------------

Net interest income                   $      2,326    $     20,394    $     22,720
                                      ============    ============    ============
</Table>

As presented in the table above, net interest income increased by $22,720,000.
This increase in net interest income is both a favorable rate variance and a
favorable volume variance. As a result of the yield on our interest-earning
assets decreasing to 4.75% during the third quarter of 2002 from 5.71% during
the same period of 2001, a decrease of 0.96%, and our cost of funds decreasing
even more to 3.19% from 4.42% during the same time period, a decrease of 1.23%,
there was a net favorable rate variance of $2,326,000. This was primarily due to
a favorable rate variance on borrowings that increased net interest income by
$13,478,000, partially offset by an unfavorable rate variance on our ARM assets
portfolio and other interest-earning assets in the amount of $11,152,000. The
increased average


                                       34
<PAGE>


size of our portfolio during the third quarter of 2002 compared to the same
period in 2001 increased net interest income in the amount of $20,394,000. The
average balance of our interest-earning assets was $9.237 billion during the
third quarter of 2002, compared to $4.641 billion during the same period of 2001
-- an increase of 99.0%.

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

  COMPONENTS OF NET INTEREST SPREAD AND YIELD ON NET INTEREST EARNING ASSETS(1)
                          (Dollar amounts in millions)

<Table>
<Caption>
                               Weighted                                                                 Yield on
                   Average      Average                             Yield on                               Net
  As of the        Interest      Fully     Weighted       Yield     Interest                   Net      Interest
   Quarter         Earning      Indexed     Average      Adjust-    Earning      Cost of    Interest    Earning
    Ended           Assets      Coupon      Coupon       ment(2)     Assets       Funds      Spread      Assets
------------     ----------    --------    --------      -------    --------     -------    --------    --------
<S>              <C>           <C>         <C>           <C>        <C>         <C>         <C>          <C>

Sep 30, 2000     $  4,066.1       7.84%       7.68%       0.68 %     7.00 %      6.72 %      0.28 %       0.88%
Dec 31, 2000     $  4,131.4       7.46%       7.75%       0.69 %     7.06 %      6.75 %      0.31 %       0.93%
Mar 31, 2001     $  4,260.2       6.64%       7.47%       0.79 %     6.68 %      5.48 %      1.20 %       1.34%
Jun 30, 2001     $  4,394.4       6.06%       6.84%       0.97 %     5.87 %      4.75 %      1.12 %       1.43%
Sep 30, 2001     $  4,641.4       5.63%       6.49%       0.85 %     5.64 %      3.74 %      1.90 %       1.71%
Dec 31, 2001     $  5,522.5       5.16%       5.96%       0.89 %     5.07 %      3.01 %      2.06 %       2.10%
Mar 31, 2002     $  6,421.4       5.05%       5.42%       0.53 %     4.89 %      3.28 %      1.61 %       1.97%
Jun 30, 2002     $  7,846.1       5.06%       5.27%       0.30 %     4.97 %      3.17 %      1.80 %       1.88%
Sep 30, 2002     $  9,237.3       4.92%       5.10%       0.41 %     4.69 %      3.12 %      1.57 %       1.84%
</Table>

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

(2)  Yield adjustments include the impact of amortizing premiums and discounts,
     the cost of hedging activities, the amortization of deferred gains from
     hedging activities and the impact of principal payment receivables.

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

                COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM ASSETS

<Table>
<Caption>
                                                                         Amortization
                                       Impact of                         of Deferred
    As of the        Premium/          Principal         Hedging          Gain From           Total
     Quarter         Discount          Payments         Activity/          Hedging            Yield
      Ended        Amortization       Receivable          Other            Activity        Adjustment
    ---------      ------------       ----------        ---------        ------------      ----------
<S>                <C>                <C>              <C>             <C>           <C>

Sep 30, 2000           0.56%             0.10%            0.05%            (0.03)%             0.68%
Dec 31, 2000           0.54%             0.13%            0.05%            (0.03)%             0.69%
Mar 31, 2001           0.61%             0.14%            0.04%               --%              0.79%
Jun 30, 2001           0.74%             0.20%            0.03%               --%              0.97%
Sep 30, 2001           0.69%             0.14%            0.02%               --%              0.85%
Dec 31, 2001           0.68%             0.20%            0.01%               --%              0.89%
Mar 31, 2002           0.33%             0.16%            0.04%               --%              0.53%
Jun 30, 2002           0.19%             0.11%            0.00%               --%              0.30%
Sep 30, 2002           0.23%             0.16%            0.02%               --%              0.41%
</Table>

We recorded hedging expense during the third quarter of 2002 of $173,000. At
September 30, 2002, the fair value of our Cap Agreements was $233,000 compared
to a fair value of $257,000 as of June 30, 2002, a decrease in fair value of
$24,000. Since we are not currently applying hedge accounting to our Cap
Agreements, we recorded this change in fair value of the Cap Agreements as
hedging expense during the quarter ended September 30, 2002. Additionally,
during the third quarter of 2002, we reclassified to earnings $149,000 of the
transition adjustment recorded in "Accumulated other comprehensive income" on
January 1, 2001, in connection with the implementation of FAS 133.


                                       35
<PAGE>


During the third quarter of 2001, we recorded hedging expense of $507,000. At
September 30, 2001, the fair value of our Cap Agreements and Option Contracts
was $209,000. We determined that the hedge utilizing Cap Agreements was not
effective during the third quarter of 2001 and, as a result, the change in fair
value of the Cap Agreements was recorded as hedging expense.

Since we began acquiring whole loans in 1997, we have only experienced losses on
three loans, for a total amount of $174,000. We continue to evaluate our
estimated credit losses on loans that are not expected to be securitized and on
loans prior to their securitization and we may readjust our current policy if
the circumstances warrant. As of September 30, 2002, our whole loans, including
those held as collateral for notes payable and those that we have securitized,
but with respect to which we have retained credit loss exposure, accounted for
32.9% of our portfolio of ARM assets or $3.227 billion.

For the quarter ended September 30, 2002, our ratio of operating expenses to
average assets was 0.44%, compared to 0.39% for the same period in 2001 and
0.43% for the prior quarter ended June 30, 2002. The most significant single
increase to our expenses was the performance-based fee of $5,044,000 that the
Manager earned during the third quarter of 2002 as a result of our achieving a
return on shareholders' equity in excess of the threshold as defined in the
agreement with the Manager (the "Management Agreement"). Our return on equity
prior to the effect of the performance-based fee was 19.60%, whereas the
threshold, the average 10-year treasury rate plus 1%, was 5.27%. Our other
expenses increased by approximately $1,034,000 from the third quarter of 2001 to
the third quarter of 2002, primarily due to the operations of TMHL, expenses
associated with our issuance of Dividend Equivalent Rights ("DERs") and Phantom
Stock Rights ("PSRs"), and other corporate matters. TMHL's operations accounted
for $863,000 of this increase and our issuance of DERs and PSRs accounted for
$422,000 of the increase. Our expense ratios are among the lowest of any company
originating and investing in mortgage assets, giving us what we believe to be a
significant competitive advantage over more traditional mortgage portfolio
lending institutions, such as banks and savings and loan institutions. This
competitive advantage enables us to operate with less credit and interest rate
risk, and still generate an attractive long-term return on equity when compared
to more traditional mortgage portfolio lending institutions.

We pay the Manager an annual base management fee, generally based on average
shareholders' equity as defined in the Management Agreement, payable monthly in
arrears as follows: 1.20% of the first $300 million of average shareholders'
equity, plus 0.88% of average shareholders' equity above $300 million, subject
to an annual inflation adjustment based on changes in the Consumer Price Index.
Since the management fee is based on shareholders' equity and not assets, the
fee increases as we raise additional equity capital and thereby manage a larger
amount of invested capital on behalf of our shareholders. In order for the
Manager to earn a performance fee, the rate of return on the shareholders'
investment, as defined in the Management Agreement, must exceed the average
10-year U.S. Treasury rate during the quarter plus 1%. As presented in the
following table, the performance fee is a variable expense that fluctuates with
our return on shareholders' equity relative to the average 10-year U.S. Treasury
rate.

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 Operating
   For the        Other Expenses/    Performance Fee/      Expenses/
Quarter Ended     Average Assets      Average Assets    Average Assets
-------------     ----------------   ----------------   ----------------
<S>               <C>                <C>                <C>

Sep 30, 2000             0.16%                -                0.16%
Dec 31, 2000             0.18%                -                0.18%
Mar 31, 2001             0.20%              0.09%              0.29%
Jun 30, 2001             0.21%              0.10%              0.31%
Sep 30, 2001             0.25%              0.14%              0.39%
Dec 31, 2001             0.28%              0.22%              0.50%
Mar 31, 2002             0.24%              0.20%              0.44%
Jun 30, 2002             0.24%              0.19%              0.43%
Sep 30, 2002             0.22%              0.22%              0.44%
</Table>


                                       36
<PAGE>

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002

For the nine months ended September 30, 2002, our net income was $84,840,000, or
$1.93 and $1.92 per share, Basic and Diluted EPS, respectively, based on a
weighted average of 41,401,000 and 44,161,000 shares outstanding, respectively.
That compares to $36,951,000, or $1.40 per share (Basic and Diluted EPS), for
the nine months ended September 30, 2001, based on a weighted average of
22,841,000 shares outstanding, a 38% increase in our earnings per share.

Our return on average common equity was 16.5% for the nine months ended
September 30, 2002 compared to 12.3% for the nine months ended September 30,
2001. Our return on equity improved in this latest nine-month period compared to
the same period of the prior year primarily because our net interest income
improved. This improvement was due, in part, to the lower cost of funds of our
borrowings and because our yield on net interest earning assets is benefiting
from acquisitions of loans and other ARM and Hybrid ARM assets acquired at
average prices close to par, replacing lower yielding assets that paid off.

The following table presents the components of our net interest income for the
nine-month periods ended September 30, 2002 and 2001:

                   COMPARATIVE NET INTEREST INCOME COMPONENTS
                          (Dollar amounts in thousands)

<Table>
<Caption>
                                                   2002            2001
                                               ------------    ------------
<S>                                            <C>             <C>

Coupon interest income on ARM assets           $    297,523    $    222,416
Amortization of net premium                         (13,306)        (16,237)
Cash and cash equivalents                             1,310             976
                                               ------------    ------------
     Interest income                                285,527         207,155
                                               ------------    ------------

Reverse repurchase agreements                        97,658         118,586
AAA notes payable                                     6,823          22,396
Other borrowings                                      7,166           7,148
Interest rate swaps                                  62,786           9,193
                                               ------------    ------------
     Interest expense                               174,433         157,323
                                               ------------    ------------

Net interest income                            $    111,094    $     49,832
                                               ============    ============
</Table>

As presented in the table above, our net interest income increased by $61.3
million in the first nine months of 2002 compared to the same nine months of
2001. The change was attributable to a $78.4 million increase in interest income
due to an increased asset base, partially offset by a $17.1 million increase in
interest expense.


                                       37
<PAGE>


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

        AVERAGE BALANCE, RATE, INTEREST INCOME AND INTEREST EXPENSE TABLE
                          (Dollar amounts in thousands)

<Table>
<Caption>
                                                                  For the nine-month periods ended September 30,
                                             -------------------------------------------------------------------------------------
                                                                2002                                      2001
                                             ---------------------------------------   -------------------------------------------
                                                                           Interest                                     Interest
                                                Average      Effective    Income and      Average       Effective      Income and
                                                Balance         Rate        Expense       Balance         Rate          Expense
                                             ------------    ---------    ----------   ------------   ------------    ------------
<S>                                          <C>             <C>          <C>           <C>            <C>             <C>
Interest Earning Assets:
  Adjustable-rate mortgage assets            $  7,747,237         4.89%   $  284,217   $  4,398,423           6.25%   $    206,179
  Cash and cash equivalents                        87,662         1.99         1,310         35,175           3.70             976
                                             ------------    ---------    ----------   ------------   ------------    ------------
                                                7,834,899         4.86       285,527      4,433,598           6.23         207,155
                                             ------------    ---------    ----------   ------------   ------------    ------------
Interest Bearing Liabilities:
  Reverse repurchase agreements                 6,424,814         3.33       160,444      3,304,397           5.16         127,779
  Collateralized notes payable                    351,961         2.58         6,823        545,776           5.47          22,396
  Other borrowings                                323,709         2.95         7,166        180,457           5.28           7,148
                                             ------------    ---------    ----------   ------------   ------------    ------------
                                                7,100,484         3.28       174,433      4,030,630           5.20         157,323
                                             ------------    ---------    ----------   ------------   ------------    ------------

                                             ------------    ---------    ----------   ------------   ------------    ------------
Net Interest Earning Assets and Spread       $    734,415         1.58%   $  111,094   $    402,968           1.03%   $     49,832
                                             ============    =========    ==========   ============   ============    ============

Yield on Net Interest Earning Assets(1)                           1.89%                                       1.50%
                                                             =========                                ============
</Table>

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

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

<Table>
<Caption>
                                        Nine Months Ended September 30,
                                                2002 versus 2001
                                   --------------------------------------------
                                       Rate           Volume          Total
                                   ------------    ------------    ------------
<S>                                <C>             <C>             <C>
Interest Income:
   ARM assets                      $    (44,817)   $    122,855    $     78,038
   Cash and cash equivalents               (451)            785             334
                                   ------------    ------------    ------------
                                        (45,268)        123,640          78,372
                                   ------------    ------------    ------------
Interest Expense:
   Reverse repurchase agreements        (45,260)         77,925          32,665
   Collateralized notes payable         (11,816)         (3,757)        (15,573)
   Other borrowings                      (3,153)          3,171              18
                                   ------------    ------------    ------------
                                        (60,229)         77,339          17,110
                                   ------------    ------------    ------------

Net interest income                $     14,961    $     46,301    $     61,262
                                   ============    ============    ============
</Table>

As presented in the table above, net interest income increased by $61,262,000.
This increase in net interest income is both a favorable rate variance and a
favorable volume variance. As a result of the yield on our interest-earning
assets decreasing to 4.86% during the first nine months of 2002 from 6.23%
during the same period of 2001 (a decrease of 1.37%), and our cost of funds
decreasing to 3.28% from 5.20% during the same time period (a decrease of
1.92%), there was a net favorable rate variance of $14,961,000. This was
primarily due to a favorable rate variance on borrowings that increased net
interest income by $60,229,000, partially offset by an unfavorable rate variance
on our ARM assets portfolio and other interest-earning assets in the amount of
$45,268,000. The increased average size of our portfolio during the first nine
months of 2002, compared to the same period in 2001, increased


                                       38
<PAGE>


net interest income in the amount of $46,301,000. The average balance of our
interest-earning assets was $7.835 billion during the first nine months of 2002,
compared to $4.434 billion during the same period of 2001 -- an increase of
76.7%.

During the first nine months of 2002, we realized a net gain from the sale of
ARM securities and fixed-rate loans in the amount of $105,000, as compared to
$1,000 during the first nine months of 2001. The sale of ARM securities during
the first nine months of 2002 resulted in a net gain of $113,000, and the sale
of fixed rate loans by TMHL resulted in a net loss of $8,000.

For the nine months ended September 30, 2002, our ratio of operating expenses to
average assets was 0.44%, compared to 0.33% for the same period of 2001. During
the first nine months of 2002, the Manager earned a performance-based fee of
$11,958,000, or 0.20% of average assets. The Manager earned a performance-based
fee of $3,624,000, or 0.11% of average assets during the same nine months of
2001. Other expenses increased by approximately $3,762,000 for the nine months
ended September 30, 2002, compared to the same nine-month period in 2001,
primarily due to the operations of TMHL, expenses associated with our issuance
of DERs and PSRs, and due to other corporate matters. TMHL's operations
accounted for $2,461,000 of this increase and our issuance of DERs, PSRs and
restricted stock accounted for $1,380,000 of the increase.

LIQUIDITY AND CAPITAL RESOURCES

Our primary source of funds for the quarter ended September 30, 2002 consisted
of reverse repurchase agreements totaling $8.314 billion, collateralized notes
payable of $286.3 million, and whole loan financing facilities of $393.8
million. Our other significant sources of funds for the quarter ended September
30, 2002 consisted primarily of payments of principal and interest from our ARM
assets of $1.185 billion. In the future, we expect our primary sources of funds
to continue to consist of borrowed funds under reverse repurchase agreement
transactions with one to twelve month maturities, funds borrowed from whole loan
financing facilities, capital market financing transactions collateralized by
ARM and hybrid loans, proceeds from monthly payments of principal and interest
on our ARM assets portfolio, proceeds from sales of new equity and occasional
asset sales. Our liquid assets generally consist of unpledged ARM assets, cash
and cash equivalents.

Total borrowings outstanding at September 30, 2002 had a weighted average
effective cost of 2.01%. The reverse repurchase agreements had a weighted
average remaining term to maturity of 4.4 months, although we utilize Swap
Agreements and Eurodollar Transactions to extend the re-pricing characteristic
of total borrowings to 1.6 years. The collateralized AAA notes payable had a
final maturity of January 25, 2029, but will be paid down as the ARM assets
collateralizing the notes are paid down. The whole loan financing facilities are
committed facilities that mature in March 2003 and November 2002. As of
September 30, 2002, $4.422 billion of our borrowings were variable rate term
reverse repurchase agreements. Term reverse repurchase agreements are committed
financings with original maturities that range from six to eighteen months. The
interest rates on these term reverse repurchase agreements are indexed to either
the one- or three-month LIBOR rate, and reprice accordingly. The interest rate
on the collateralized AAA notes adjusts monthly based on changes in the
one-month LIBOR rate. The interest rates on the whole loan financing facilities
are indexed to the one-month LIBOR index and are subject to either daily or
monthly adjustment.

We have arrangements to enter into reverse repurchase agreements with
twenty-five different financial institutions, and, at September 30, 2002, we had
borrowed funds from fourteen of these firms. Because we borrow money under these
agreements based on the fair value of our ARM assets, and because changes in
interest rates can negatively impact the valuation of ARM assets, our borrowing
ability under these agreements may be limited and lenders may initiate margin
calls in the event interest rates change or the value of our ARM assets decline
for other reasons. Additionally, approximately 1.4% of our ARM assets are rated
less than AA by the Rating Agencies and have less liquidity than assets that are
rated AA or higher. Mortgage assets rated AA or higher by the Rating Agencies
derive their credit rating based on subordination, guarantees or other credit
enhancements. In the event of dramatic changes in interest rates, performance of
credit support, or a downgrade of a mortgage pool issuer, we might find it
difficult to borrow against such assets. External disruptions to credit markets
might also impair access to additional liquidity and, therefore, we might be
required to sell certain mortgage assets in order to maintain liquidity. If
required, such sales might be at prices lower than the carrying value of the
assets, which would result in losses. We had adequate liquidity throughout the
quarter ended September 30, 2002. We believe we will continue to have


                                       39
<PAGE>


sufficient liquidity to meet our future cash requirements from our primary
sources of funds for the foreseeable future without needing to sell assets.

As of September 30, 2002, we had $286.3 million of AAA collateralized notes
payable outstanding, which are not subject to margin calls. Due to the structure
of the collateralized notes payable, their financing is not based on market
value or subject to subsequent changes in mortgage credit markets, as is the
case of the reverse repurchase agreement arrangements.

As of September 30, 2002, we had entered into three whole loan financing
facilities. We borrow money under these facilities based on the fair value of
the ARM loans. Therefore, the amount of money available to us under these
facilities is subject to margin call based on changes in fair value, which can
be negatively affected by changes in interest rates and other factors, including
the delinquency status of individual loans. One of the whole loan financing
facilities has a committed borrowing capacity of $300 million and matures in
March 2003. Our other two committed whole loan financing facilities also have a
borrowing capacity of $300 million each. They both mature in November 2002 and
we expect to renew these facilities in the normal course of its business. As of
September 30, 2002, we had $393.8 million borrowed against these whole loan
financing facilities, at an effective cost of 2.43%.

During February 2002, the Company completed a public offering of 6,210,000
shares of common stock and received net proceeds of $113.5 million under its
shelf registration statement on Form S-3 that was declared effective by the
Securities and Exchange Commission ("SEC") on July 6, 2001. On August 30, 2002,
a new shelf registration statement on Form S-3 registering an additional $400
million of equity securities was declared effective by the SEC. During the
three-month and nine-month periods ended September 30, 2002, the Company issued
1,469,200 and 4,000,000 shares of common stock respectively, and received net
proceeds of $28.2 million and $76.5 million, respectively under a continuous
equity offering program under the July 2001 shelf registration statement. During
the three months ended September 30, 2002, the Company issued an additional
302,600 shares of common stock and received net proceeds of $5.7 million under a
new continuous equity offering program under the August 2002 shelf registration
statement. As of September 3, 2002, $47.4 million and $394.2 million of the
Company's registered securities remained available for future issuance and sale
under its currently effective July 2001 and August 2002 shelf registration
statements, respectively.

We have a Dividend Reinvestment and Stock Purchase Plan (the "DRP") designed to
provide a convenient and economical way for existing shareholders to
automatically reinvest their dividends in additional shares of our common stock,
and for new and existing shareholders to purchase shares at a discount to the
current market price of the common stock, as defined in the DRP. During the
three- and nine-month periods ended September 30, 2002, we issued 1,206,607 and
3,519,419 shares of common stock, respectively, under the DRP and received net
proceeds of $23.0 and $68.8 million, respectively.

EFFECTS OF INTEREST RATE CHANGES

Changes in interest rates impact our earnings in various ways. While we invest
primarily in ARM assets, rising short-term interest rates may temporarily
negatively affect our earnings, and, conversely, falling short-term interest
rates may temporarily increase our earnings. This impact can occur for several
reasons and may be mitigated by portfolio prepayment activity as discussed
below. First, our borrowings will react to changes in interest rates sooner than
our ARM assets because the weighted average next repricing dates of the
borrowings are usually shorter time periods than that of the ARM assets. Second,
interest rates on non-hybrid ARM assets may be limited to an increase of either
1% or 2% per adjustment period (commonly referred to as the periodic cap), and
our borrowings do not have similar limitations. At September 30, 2002, 16.8% of
our total ARM assets were non-hybrid ARM assets subject to periodic caps. Third,
our ARM assets typically lag changes in the applicable interest rate indices by
45 days, due to the notice period provided to ARM borrowers when the interest
rates on their loans are scheduled to change.

Interest rates can also affect our net return on Hybrid ARMs (net of the cost of
financing Hybrid ARMs). We estimate the duration of the fixed rate period of our
Hybrid ARMs and have a policy to hedge the financing of the Hybrid ARMs such
that the duration difference between our borrowed funds and the Hybrid ARM
assets is less than one year. The cost of financing the unhedged, fixed rate,
remaining period of one year or less is subject to prevailing interest rates on
the remaining balance of the Hybrid ARMs at the expiration of the hedged period.
As a


                                       40
<PAGE>


result, if our cost of short-term funds is higher at the expiration of the
hedged period, our net interest spread on the remaining balance of a Hybrid ARM
asset will be affected unfavorably, and, conversely, if our cost of short-term
funds is lower, the net interest spread will be affected favorably. In addition,
during a declining interest rate environment, the prepayment of Hybrid ARMs may
accelerate causing the amount of fixed rate financing to increase relative to
the amount of Hybrid ARMs, possibly resulting in a decline in our net return on
Hybrid ARMs as replacement Hybrid ARMs may have a lower yield than the ones
paying off. In contrast, during an increasing interest rate environment, Hybrid
ARMs may prepay slower than expected, requiring us to finance a higher amount of
Hybrid ARMs than originally anticipated at a time when interest rates may be
higher, resulting in a decline in our net return on Hybrid ARMs. In order to
manage our exposure to changes in the prepayment speed of Hybrid ARMs, we
regularly monitor the balance of Hybrid ARMs and make adjustments to the amounts
anticipated to be outstanding in future periods and, on a regular basis, make
adjustments to the amount of our fixed-rate borrowing obligations in future
periods.

Interest rate changes may also impact our ARM assets and borrowings differently
because our ARM assets are indexed to various indices, whereas the interest rate
on our borrowings generally move with changes in LIBOR. During times of global
economic instability, U.S. Treasury rates generally decline as foreign and
domestic investors increase their investment in U.S. Treasury instruments,
because they are considered to be a safe haven for investments. Our non-hybrid
ARM assets indexed to U.S. Treasury rates then decline in yield as U.S. Treasury
rates decline, whereas our borrowings and other non-hybrid ARM assets may not be
affected by the same pressures or to the same degree. As a result, our income
can increase or decrease, depending on the relationship between the various
indices to which our non-hybrid ARM assets are indexed, compared to changes in
our cost of funds. At September 30, 2002, 12.1% of our ARM assets were
non-hybrid ARM assets indexed to U.S. Treasury rates.

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

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

Lastly, because we invest primarily in ARM assets, and approximately 8% to 10%
of such assets are purchased with shareholders' equity, our earnings, over time,
will tend to increase, after an initial short term decline, following periods
when short term interest rates have risen, and decrease after an initial short
term increase, following periods when short term interest rates have declined.
This is because the financed portion of our portfolio of ARM assets will, over
time, reprice to a spread over our cost of funds, while the portion of our
portfolio of ARM assets purchased with shareholders' equity will generally have
a higher yield in a higher interest rate environment and a lower yield in a
lower interest rate environment.

OTHER MATTERS

The Internal Revenue Code of 1986, as amended (the "Code"), requires that at
least 75% of our total assets must be Qualified REIT Assets. The Code also
requires that we meet a defined 75% source of income test and a 90% source of
income test. As of September 30, 2002, we calculated that we were in compliance
with all of these requirements. We also met all REIT requirements regarding the
ownership of our common stock and the distributions of our net income.
Therefore, as of September 30, 2002, we believe that we continue to qualify as a
REIT under the provisions of the Code.

We intend to conduct our business so as not to become regulated as an investment
company under the Investment Company Act of 1940, as amended. If we were to
become regulated as an investment company, our use of leverage


                                       41
<PAGE>


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

ITEM 4. CONTROLS AND PROCEDURES

Under the supervision, and with the participation of the Chief Executive
Officer, the President and Chief Operating Officer and the Executive Vice
President, Chief Financial Officer and Treasurer, management has evaluated the
effectiveness of the design and operation of the Company's disclosure controls
and procedures within 90 days prior to the filing date of this quarterly report
pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief
Executive Officer, the President and Chief Operating Officer and the Executive
Vice President, Chief Financial Officer and Treasurer, concluded that the
Company's disclosure controls and procedures were effective. There have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to their evaluation.


PART II. OTHER INFORMATION

Item 1. Legal Proceedings
              At September 30, 2002, there were no pending legal proceedings to
              which we were a party or of which any of our property was subject.

Item 2. Changes in Securities
              Not applicable

Item 3. Defaults Upon Senior Securities
              Not applicable

Item 4. Submission of Matters to a Vote of Security Holders
              None

Item 5. Other Information
              None

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

        (a)  Exhibits
                  See "Exhibit Index"

        (b)  Reports on Form 8-K

             The Company filed a Current Report on Form 8-K, dated September 6,
             2002, regarding entering into a sales agreement with Cantor
             Fitzgerald & Co. to sell up to 6,501,559 shares of its common
             stock from time to time through Cantor Fitzgerald & Co., as sales
             agent.



                                       42
<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, INC.



Dated:  November 13, 2002      By: /s/ Garrett Thornburg
                                   ---------------------------------------------
                                   Garrett Thornburg
                                   Chairman of the Board and Chief Executive
                                   Officer (authorized officer of registrant)



Dated:  November 13, 2002      By: /s/ Larry A. Goldstone
                                   ---------------------------------------------
                                   Larry A. Goldstone
                                   President and Chief Operating Officer
                                   (authorized officer of registrant)




Dated:  November 13, 2002      By: /s/ Richard P. Story
                                   ---------------------------------------------
                                   Richard P. Story,
                                   Executive Vice President, Chief Financial
                                   Officer and Treasurer
                                   (principal accounting officer)



                                       43
<PAGE>


                                 CERTIFICATIONS

I, Garrett Thornburg, certify that:


1. I have reviewed this quarterly report on Form 10-Q of Thornburg Mortgage,
Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.


Date: November 13, 2002          By: /s/ Garrett Thornburg
                                     ------------------------------------------
                                     Garrett Thornburg
                                     Chief Executive Officer
                                     (authorized officer of registrant)



                                       44
<PAGE>

                                 CERTIFICATIONS

I, Larry A. Goldstone, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Thornburg Mortgage,
Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.



Date: November 13, 2002            By: /s/ Larry A. Goldstone
                                       ----------------------------------------
                                       Larry A. Goldstone
                                       President and Chief Operating Officer
                                       (authorized officer of registrant)




                                       45
<PAGE>


I, Richard P. Story, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Thornburg Mortgage,
Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.


Date: November 13, 2002                  By: /s/ Richard P. Story
                                             -----------------------------------
                                             Richard P. Story
                                             Executive Vice President and Chief
                                             Financial Officer and Treasurer
                                             (authorized officer of registrant)


                                       46
<PAGE>


                                  EXHIBIT INDEX


<Table>
<Caption>
EXHIBIT
NUMBER            EXHIBIT DESCRIPTION
-------           -------------------
<S>               <C>

 99.1             Certification of Chief Executive Officer pursuant to 18 U.S.C.
                  Section 1350, as adopted pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002

 99.2             Certification of President and Chief Operating Officer
                  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                  Section 906 of the Sarbanes-Oxley Act of 2002

 99.3             Certification of Executive Vice President, Chief Financial
                  Officer and Treasurer pursuant to 18 U.S.C. Section 1350, as
                  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
                  2002
</Table>



                                       47