##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---

FORM 10-Q



---



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

For the quarterly period ended: September 30, 2006

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 ofincorporation or organization) |  | (IRS EmployerIdentification 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 reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No ̈

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Securities Exchange Act of 1934.

Large accelerated
filer  x    Accelerated filer ̈Non-accelerated filer ̈

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    Yes ̈No  x

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Common Stock ($.01 par value) 113,501,843 as of November 6,
2006



---



---

##### Table of Contents

INDEX

In this quarterly report, we refer to Thornburg Mortgage, Inc. and its subsidiaries as we,
us, or the Company, unless we specifically state otherwise or the context indicates otherwise. Capitalized terms not otherwise defined in this quarterly report and financial statements below shall have the definitive meanings
assigned to them in the Glossary at the end of this report.



|              |  |                                                                                                                        |  |     
|------------- |  | ---------------------------------------------------------------------------------------------------------------------- |  | ----
|              |  |                                                                                                                        |  | Page
|PART I.       |  | FINANCIAL INFORMATION                                                                                                  |  |     
|              |  |                                                                                                                       
|Item 1.       |  | Financial Statements                                                                                                   |  |     
|              |  |                                                                                                                       
|              |  | Consolidated Balance Sheets at September 30, 2006 and December 31, 2005                                                |  | 3   
|              |  |                                                                                                                       
|              |  | Consolidated Income Statements for the three and nine months ended September 30, 2006 and 2005                         |  | 4   
|              |  |                                                                                                                       
|              |  | Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2006 and 2005 |  | 5   
|              |  |                                                                                                                       
|              |  | Consolidated Statements of Shareholders Equity for the nine months ended September 30, 2006 and 2005                  |  | 6   
|              |  |                                                                                                                       
|              |  | Consolidated Statements of Cash Flows for the three and nine months ended September 30, 2006 and 2005                  |  | 7   
|              |  |                                                                                                                       
|              |  | Notes to Consolidated Financial Statements                                                                             |  | 8   
|              |  |                                                                                                                       
|Item 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                  |  | 24  
|              |  |                                                                                                                       
|Item 3.       |  | Quantitative and Qualitative Disclosures About Market Risk                                                             |  | 60  
|              |  |                                                                                                                       
|Item 4.       |  | Controls and Procedures                                                                                                |  | 60  
|              |  |                                                                                                                       
|PART II.      |  | OTHER INFORMATION                                                                                                      |  |     
|              |  |                                                                                                                       
|Item 1.       |  | Legal Proceedings                                                                                                      |  | 60  
|              |  |                                                                                                                       
|Item 1A.      |  | Risk Factors                                                                                                           |  | 60  
|              |  |                                                                                                                       
|Item 2.       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                            |  | 60  
|              |  |                                                                                                                       
|Item 3.       |  | Defaults Upon Senior Securities                                                                                        |  | 60  
|              |  |                                                                                                                       
|Item 4.       |  | Submission of Matters to a Vote of Security Holders                                                                    |  | 60  
|              |  |                                                                                                                       
|Item 5.       |  | Other Information                                                                                                      |  | 60  
|              |  |                                                                                                                       
|Item 6.       |  | Exhibits                                                                                                               |  | 60  
|              | 
|SIGNATURES    |  | 61                                                                                                                    
|              | 
|EXHIBIT INDEX |  | 62                                                                                                                    
|              | 
|GLOSSARY      |  | 63                                                                                                                    



2



---

##### Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(Unaudited)(In thousands, except share and per share data)



|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ---------- | - | ----------------- | - | ---------- | -
|                                                                                                                                                                                                                                                                |  | September 30, 2006 |            |   | December 31, 2005 |  
|ASSETS                                                                                                                                                                                                                                                          |  |                    |            |   |                   |   |            |  
|ARM Assets:                                                                                                                                                                                                                                                     |  |                    |            |   |                   |   |            |  
|Purchased ARM Assets:                                                                                                                                                                                                                                           |  |                    |            |   |                   |   |            |  
|ARM securities, net                                                                                                                                                                                                                                             |  | $                  | 22,192,010 |   |                   | $ | 20,295,504 |  
|Purchased Securitized Loans, net                                                                                                                                                                                                                                |  |                    | 7,064,517  |   |                   |   | 6,839,004  |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|Purchased ARM Assets                                                                                                                                                                                                                                            |  |                    | 29,256,527 |   |                   |   | 27,134,508 |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|ARM Loans:                                                                                                                                                                                                                                                      |  |                    |            |   |                   |   |            |  
|Securitized ARM Loans, net                                                                                                                                                                                                                                      |  |                    | 2,873,966  |   |                   |   | 3,310,717  |  
|ARM Loans Collateralizing CDOs, net                                                                                                                                                                                                                             |  |                    | 18,618,998 |   |                   |   | 10,396,961 |  
|ARM loans held for securitization, net                                                                                                                                                                                                                          |  |                    | 1,007,703  |   |                   |   | 641,843    |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|ARM Loans                                                                                                                                                                                                                                                       |  |                    | 22,500,667 |   |                   |   | 14,349,521 |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|ARM Assets                                                                                                                                                                                                                                                      |  |                    | 51,757,194 |   |                   |   | 41,484,029 |  
|                                                                                                                                                                                                                                                                |  |                   
|Cash and cash equivalents                                                                                                                                                                                                                                       |  |                    | 39,652     |   |                   |   | 147,228    |  
|Restricted cash and cash equivalents                                                                                                                                                                                                                            |  |                    | 122,452    |   |                   |   | 26,982     |  
|Hedging Instruments                                                                                                                                                                                                                                             |  |                    | 435,907    |   |                   |   | 450,944    |  
|Accrued interest receivable                                                                                                                                                                                                                                     |  |                    | 330,635    |   |                   |   | 230,479    |  
|Other assets                                                                                                                                                                                                                                                    |  |                    | 208,073    |   |                   |   | 168,079    |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|                                                                                                                                                                                                                                                                |  | $                  | 52,893,913 |   |                   | $ | 42,507,741 |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|LIABILITIES                                                                                                                                                                                                                                                     |  |                    |            |   |                   |   |            |  
|Reverse Repurchase Agreements                                                                                                                                                                                                                                   |  | $                  | 21,886,974 |   |                   | $ | 23,390,079 |  
|Asset-backed CP                                                                                                                                                                                                                                                 |  |                    | 8,576,300  |   |                   |   | 4,990,000  |  
|CDOs                                                                                                                                                                                                                                                            |  |                    | 18,286,182 |   |                   |   | 10,254,334 |  
|Whole loan financing facilities                                                                                                                                                                                                                                 |  |                    | 694,679    |   |                   |   | 404,827    |  
|Senior Notes                                                                                                                                                                                                                                                    |  |                    | 305,000    |   |                   |   | 305,000    |  
|Subordinated Notes                                                                                                                                                                                                                                              |  |                    | 240,000    |   |                   |   | 190,000    |  
|Hedging Instruments                                                                                                                                                                                                                                             |  |                    | 223,873    |   |                   |   | 32,904     |  
|Payable for securities purchased                                                                                                                                                                                                                                |  |                    |           |   |                   |   | 463,906    |  
|Accrued interest payable                                                                                                                                                                                                                                        |  |                    | 175,838    |   |                   |   | 107,541    |  
|Dividends payable                                                                                                                                                                                                                                               |  |                    | 2,131      |   |                   |   | 73,132     |  
|Accrued expenses and other liabilities                                                                                                                                                                                                                          |  |                    | 107,369    |   |                   |   | 88,932     |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|                                                                                                                                                                                                                                                                |  |                    | 50,498,346 |   |                   |   | 40,300,655 |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|COMMITMENTS AND CONTINGENCIES SHAREHOLDERS EQUITY                                                                                                                                                                                                              |  |                    |            |   |                   |   |            |  
|Preferred Stock: par value $0.01 per
share; 8% Series C Cumulative Redeemable shares, aggregate preference in liquidation $127,868 and $115,745, respectively; 7,230,000
shares authorized, 5,115,000 and 4,630,000 shares issued and outstanding, respectively |  |                    | 123,396    |   |                   |   | 111,535    |  
|Common Stock: par value $0.01 per share; 492,748,000 shares authorized, 113,461,000 and 104,775,000 shares issued and outstanding, respectively                                                                                                                 |  |                    | 1,134      |   |                   |   | 1,048      |  
|Additional paid-in-capital                                                                                                                                                                                                                                      |  |                    | 2,469,404  |   |                   |   | 2,235,435  |  
|Accumulated other comprehensive loss                                                                                                                                                                                                                            |  |                    | (261,971   | ) |                   |   | (147,517   | )
|Retained earnings                                                                                                                                                                                                                                               |  |                    | 63,604     |   |                   |   | 6,585      |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|                                                                                                                                                                                                                                                                |  |                    | 2,395,567  |   |                   |   | 2,207,086  |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  
|                                                                                                                                                                                                                                                                |  | $                  | 52,893,913 |   |                   | $ | 42,507,741 |  
|                                                                                                                                                                                                                                                                |  |                    |            |   |                   |   |            |  

See Notes to Consolidated Financial Statements.



3



---

##### Table of Contents

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED INCOME STATEMENTS (Unaudited)

(In thousands, except per share data)



|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|---------------------------------------------------- |  | ------------------------------- | -------- | - | ------------------------------ | - | -------- | ---- |  | - | ---------- | - |  | - | --------- | -
|                                                     |  | Three Months EndedSeptember 30, |          |   | Nine Months EndedSeptember 30, |  
|                                                     |  | 2006                            |          |   | 2005                           |   |          | 2006 |  |   | 2005       |  
|Interest income from ARM Assets and cash equivalents |  | $                               | 667,172  |   |                                | $ | 400,118  |      |  | $ | 1,770,470  |   |  | $ | 1,038,997 |  
|Interest expense on borrowed funds                   |  |                                 | (580,037 | ) |                                |   | (307,941 | )    |  |   | (1,514,474 | ) |  |   | (782,854  | )
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Net interest income                                  |  |                                 | 87,135   |   |                                |   | 92,177   |      |  |   | 255,996    |   |  |   | 256,143   |  
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Servicing income, net                                |  |                                 | 4,227    |   |                                |   | 2,076    |      |  |   | 11,867     |   |  |   | 7,701     |  
|Mortgage services income, net                        |  |                                 | 286      |   |                                |   |         |      |  |   | 286        |   |  |   |          |  
|Gain (loss) on ARM Assets, net                       |  |                                 | 65       |   |                                |   |         |      |  |   | (214       | ) |  |   | 7,568     |  
|Gain (loss) on Derivatives, net                      |  |                                 | 5,926    |   |                                |   | (147     | )    |  |   | 21,543     |   |  |   | 2,951     |  
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Net non-interest income                              |  |                                 | 10,504   |   |                                |   | 1,929    |      |  |   | 33,482     |   |  |   | 18,220    |  
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Provision for credit losses                          |  |                                 | (754     | ) |                                |   | (374     | )    |  |   | (1,759     | ) |  |   | (963      | )
|Management fee                                       |  |                                 | (6,402   | ) |                                |   | (5,621   | )    |  |   | (18,242    | ) |  |   | (15,372   | )
|Performance fee                                      |  |                                 | (8,654   | ) |                                |   | (10,315  | )    |  |   | (24,882    | ) |  |   | (30,129   | )
|Long-term incentive awards                           |  |                                 | 735      |   |                                |   | 1,764    |      |  |   | (5,788     | ) |  |   | (2,887    | )
|Other operating expenses                             |  |                                 | (7,220   | ) |                                |   | (5,520   | )    |  |   | (21,392    | ) |  |   | (14,986   | )
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|NET INCOME                                           |  | $                               | 75,344   |   |                                | $ | 74,040   |      |  | $ | 217,415    |   |  | $ | 210,026   |  
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Net income                                           |  | $                               | 75,344   |   |                                | $ | 74,040   |      |  | $ | 217,415    |   |  | $ | 210,026   |  
|Dividends on Preferred Stock                         |  |                                 | (2,485   | ) |                                |   | (2,273   | )    |  |   | (7,257     | ) |  |   | (3,787    | )
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Net income available to common shareholders          |  | $                               | 72,859   |   |                                | $ | 71,767   |      |  | $ | 210,158    |   |  | $ | 206,239   |  
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Earnings per common share:                           |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Net income                                           |  | $                               | 0.64     |   |                                | $ | 0.70     |      |  | $ | 1.91       |   |  | $ | 2.11      |  
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Average number of shares outstanding                 |  |                                 | 113,316  |   |                                |   | 102,758  |      |  |   | 110,195    |   |  |   | 97,518    |  
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  
|Dividends declared per common share                  |  | $                               | 0.68     |   |                                | $ | 0.68     |      |  | $ | 2.04       |   |  | $ | 2.04      |  
|                                                     |  |                                 |          |   |                                |   |          |      |  |   |            |   |  |   |           |  

See Notes to Consolidated Financial Statements.



4



---

##### Table of Contents

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

(In thousands)



|                                                                      |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  
|--------------------------------------------------------------------- |  | ------------------------------- | -------- | - | ------------------------------ | - | -------- | ---- |  | - | -------- | - |  | - | -------- | -
|                                                                      |  | Three Months EndedSeptember 30, |          |   | Nine Months EndedSeptember 30, |  
|                                                                      |  | 2006                            |          |   | 2005                           |   |          | 2006 |  |   | 2005     |  
|Net income                                                            |  | $                               | 75,344   |   |                                | $ | 74,040   |      |  | $ | 217,415  |   |  | $ | 210,026  |  
|Other comprehensive income (loss):                                    |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  
|Unrealized gains (losses) on securities:                              |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  
|Net unrealized holdings gains (losses) arising during the period      |  |                                 | 358,093  |   |                                |   | (209,620 | )    |  |   | 81,857   |   |  |   | (253,875 | )
|Reclassification adjustment for net gains included in income          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   | (7,590   | )
|                                                                      |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  
|Net change in unrealized gains (losses) on securities                 |  |                                 | 358,093  |   |                                |   | (209,620 | )    |  |   | 81,857   |   |  |   | (261,465 | )
|                                                                      |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  
|Unrealized (losses) gains on Hedging Instruments:                     |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  
|Net unrealized (losses) gains arising during the period               |  |                                 | (403,129 | ) |                                |   | 203,845  |      |  |   | 27,251   |   |  |   | 224,527  |  
|Reclassification adjustment for net (gains) losses included in income |  |                                 | (93,475  | ) |                                |   | (9,995   | )    |  |   | (223,562 | ) |  |   | 26,933   |  
|                                                                      |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  
|Net change in unrealized (losses) gains on Hedging Instruments        |  |                                 | (496,604 | ) |                                |   | 193,850  |      |  |   | (196,311 | ) |  |   | 251,460  |  
|                                                                      |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  
|Other comprehensive loss                                              |  |                                 | (138,511 | ) |                                |   | (15,770  | )    |  |   | (114,454 | ) |  |   | (10,005  | )
|                                                                      |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  
|Total comprehensive (loss) income                                     |  | $                               | (63,167  | ) |                                | $ | 58,270   |      |  | $ | 102,961  |   |  | $ | 200,021  |  
|                                                                      |  |                                 |          |   |                                |   |          |      |  |   |          |   |  |   |          |  

See Notes to Consolidated Financial Statements.



5



---

##### Table of Contents

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY (Unaudited)

Nine months ended September 30, 2006 and 2005

(In thousands, except per share data)



|                                                        |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|------------------------------------------------------- |  | -------------- | ------- | ----------- | - | ------------------------ |  | --------------------------------------- | --------- |  | ---------------- | -------- | - | ----- | - | -------- | - |  | - | --------- | -
|                                                        |  | PreferredStock |         | CommonStock |   | AdditionalPaid-inCapital |  | Accum. OtherComprehensive Income (Loss) |           |  | RetainedEarnings |          |   | Total |  
|Balance, December 31, 2004                              |  | $              |        |             | $ | 919                      |  | $                                       | 1,872,487 |  | $                | (90,715  | ) |       | $ | 6,493    |   |  | $ | 1,789,184 |  
|Comprehensive income:                                   |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Net income                                              |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   | 210,026  |   |  |   | 210,026   |  
|Other comprehensive income (loss):                      |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Available-for-sale assets:                              |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Fair value adjustment                                   |  |                |         |             |   |                          |  |                                         |           |  |                  | (261,465 | ) |       |   |          |   |  |   | (261,465  | )
|Hedging Instruments:                                    |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Fair value adjustment                                   |  |                |         |             |   |                          |  |                                         |           |  |                  | 251,460  |   |       |   |          |   |  |   | 251,460   |  
|Issuance of Common Stock                                |  |                |         |             |   | 121                      |  |                                         | 343,002   |  |                  |          |   |       |   |          |   |  |   | 343,123   |  
|Issuance of Preferred Stock                             |  |                | 111,567 |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   | 111,567   |  
|Dividends declared on Common Stock - $1.36 per share    |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   | (134,684 | ) |  |   | (134,684  | )
|Dividends declared on Preferred Stock - $1.05 per share |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   | (3,787   | ) |  |   | (3,787    | )
|                                                        |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Balance, September 30, 2005                             |  | $              | 111,567 |             | $ | 1,040                    |  | $                                       | 2,215,489 |  | $                | (100,720 | ) |       | $ | 78,048   |   |  | $ | 2,305,424 |  
|                                                        |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Balance, December 31, 2005                              |  | $              | 111,535 |             | $ | 1,048                    |  | $                                       | 2,235,435 |  | $                | (147,517 | ) |       | $ | 6,585    |   |  | $ | 2,207,086 |  
|Comprehensive income:                                   |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Net income                                              |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   | 217,415  |   |  |   | 217,415   |  
|Other comprehensive income (loss):                      |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Available-for-sale assets:                              |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Fair value adjustment                                   |  |                |         |             |   |                          |  |                                         |           |  |                  | 81,857   |   |       |   |          |   |  |   | 81,857    |  
|Hedging Instruments:                                    |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Fair value adjustment                                   |  |                |         |             |   |                          |  |                                         |           |  |                  | (196,311 | ) |       |   |          |   |  |   | (196,311  | )
|Issuance of Common Stock                                |  |                |         |             |   | 86                       |  |                                         | 233,969   |  |                  |          |   |       |   |          |   |  |   | 234,055   |  
|Issuance of Preferred Stock                             |  |                | 11,861  |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   | 11,861    |  
|Dividends declared on Common Stock - $1.36 per share    |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   | (153,139 | ) |  |   | (153,139  | )
|Dividends declared on Preferred Stock - $1.50 per share |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   | (7,257   | ) |  |   | (7,257    | )
|                                                        |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  
|Balance, September 30, 2006                             |  | $              | 123,396 |             | $ | 1,134                    |  | $                                       | 2,469,404 |  | $                | (261,971 | ) |       | $ | 63,604   |   |  | $ | 2,395,567 |  
|                                                        |  |                |         |             |   |                          |  |                                         |           |  |                  |          |   |       |   |          |   |  |   |           |  

See Notes to Consolidated Financial Statements.



6



---

##### Table of Contents

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)



|                                                                                 |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|-------------------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ------------------------------ | - | ---------- | ---- |  | - | ----------- | - |  | - | ----------- | -
|                                                                                 |  | Three Months EndedSeptember 30, |            |   | Nine Months EndedSeptember 30, |  
|                                                                                 |  | 2006                            |            |   | 2005                           |   |            | 2006 |  |   | 2005        |  
|Operating activities:                                                            |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Net income                                                                       |  | $                               | 75,344     |   |                                | $ | 74,040     |      |  | $ | 217,415     |   |  | $ | 210,026     |  
|Adjustments to reconcile net income to net cashprovided by operating activities: |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Amortization                                                                     |  |                                 | 11,477     |   |                                |   | 27,970     |      |  |   | 70,327      |   |  |   | 71,692      |  
|(Gain) loss on ARM Assets, net                                                   |  |                                 | (65        | ) |                                |   |           |      |  |   | 214         |   |  |   | (7,568      | )
|(Gain) loss on Derivatives, net                                                  |  |                                 | (5,926     | ) |                                |   | 147        |      |  |   | (21,543     | ) |  |   | (2,951      | )
|Provision for credit losses                                                      |  |                                 | 754        |   |                                |   | 374        |      |  |   | 1,759       |   |  |   | 963         |  
|Change in assets and liabilities:                                                |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Accrued interest receivable                                                      |  |                                 | (29,363    | ) |                                |   | (27,814    | )    |  |   | (100,156    | ) |  |   | (74,911     | )
|Other assets                                                                     |  |                                 | (8,861     | ) |                                |   | (27,518    | )    |  |   | (60,284     | ) |  |   | (50,872     | )
|Accrued interest payable                                                         |  |                                 | 28,424     |   |                                |   | 10,326     |      |  |   | 68,297      |   |  |   | 34,132      |  
|Accrued expenses and other liabilities                                           |  |                                 | (5,231     | ) |                                |   | 7,651      |      |  |   | 25,543      |   |  |   | (15,326     | )
|                                                                                 |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Net cash provided by operatingactivities                                         |  |                                 | 66,553     |   |                                |   | 65,176     |      |  |   | 201,572     |   |  |   | 165,185     |  
|                                                                                 |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Investing activities:                                                            |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|ARM securities:                                                                  |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Purchases                                                                        |  |                                 | (474,756   | ) |                                |   | (4,030,330 | )    |  |   | (5,501,165  | ) |  |   | (10,367,626 | )
|Proceeds on sales                                                                |  |                                 |           |   |                                |   | 483,808    |      |  |   |            |   |  |   | 1,498,460   |  
|Principal payments                                                               |  |                                 | 1,073,006  |   |                                |   | 1,541,942  |      |  |   | 3,078,294   |   |  |   | 4,146,678   |  
|Purchased Securitized Loans:                                                     |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Purchases                                                                        |  |                                 |           |   |                                |   | (1,714,472 | )    |  |   | (933,043    | ) |  |   | (3,835,205  | )
|Principal payments                                                               |  |                                 | 265,665    |   |                                |   | 392,126    |      |  |   | 767,953     |   |  |   | 689,442     |  
|Securitized ARM loans:                                                           |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Principal payments                                                               |  |                                 | 135,390    |   |                                |   | 111,237    |      |  |   | 237,583     |   |  |   | 418,910     |  
|ARM Loans Collateralizing CDOs:                                                  |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Principal payments                                                               |  |                                 | 695,151    |   |                                |   | 682,134    |      |  |   | 1,746,786   |   |  |   | 1,468,386   |  
|ARM loans held for securitization:                                               |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Purchases and originations                                                       |  |                                 | (4,612,996 | ) |                                |   | (2,249,135 | )    |  |   | (10,098,501 | ) |  |   | (4,852,896  | )
|Principal payments                                                               |  |                                 | 14,063     |   |                                |   | 10,809     |      |  |   | 40,426      |   |  |   | 30,385      |  
|                                                                                 |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Net cash used in investing activities                                            |  |                                 | (2,904,477 | ) |                                |   | (4,771,881 | )    |  |   | (10,661,667 | ) |  |   | (10,803,466 | )
|                                                                                 |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Financing activities:                                                            |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Net (paydowns) borrowings from ReverseRepurchase Agreements                      |  |                                 | (1,772,445 | ) |                                |   | 2,837,495  |      |  |   | (1,503,105  | ) |  |   | 8,019,097   |  
|Net borrowings from Asset-backed CP                                              |  |                                 | 979,300    |   |                                |   |           |      |  |   | 3,586,300   |   |  |   | 85,000      |  
|CDO borrowings                                                                   |  |                                 | 4,206,695  |   |                                |   | 2,648,881  |      |  |   | 9,672,863   |   |  |   | 4,205,899   |  
|CDO paydowns                                                                     |  |                                 | (644,921   | ) |                                |   | (630,166   | )    |  |   | (1,641,015  | ) |  |   | (1,461,930  | )
|Net whole loan financing facilities borrowings(paydowns)                         |  |                                 | 278,822    |   |                                |   | 12,298     |      |  |   | 289,852     |   |  |   | (243,684    | )
|Net proceeds from issuance of Subordinated Notes                                 |  |                                 |           |   |                                |   | 135,884    |      |  |   | 50,000      |   |  |   | 135,884     |  
|Payments made on Eurodollar contracts                                            |  |                                 | (29,769    | ) |                                |   | (110       | )    |  |   | (20,597     | ) |  |   | (1,969      | )
|Proceeds from Common Stock issued, net                                           |  |                                 | 10,433     |   |                                |   | 66,232     |      |  |   | 234,055     |   |  |   | 343,123     |  
|Proceeds from Preferred Stock issued, net                                        |  |                                 | 5,534      |   |                                |   | 2,589      |      |  |   | 11,965      |   |  |   | 111,567     |  
|Dividends paid                                                                   |  |                                 | (79,463    | ) |                                |   | (72,011    | )    |  |   | (231,503    | ) |  |   | (199,069    | )
|Purchase of Cap Agreements                                                       |  |                                 | (363       | ) |                                |   | (89        | )    |  |   | (826        | ) |  |   | (159        | )
|Net increase in restricted cash                                                  |  |                                 | (108,281   | ) |                                |   | (386,203   | )    |  |   | (95,470     | ) |  |   | (389,260    | )
|                                                                                 |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Net cash provided by financingactivities                                         |  |                                 | 2,845,542  |   |                                |   | 4,614,800  |      |  |   | 10,352,519  |   |  |   | 10,604,499  |  
|                                                                                 |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Net increase (decrease) in cash and cash equivalents                             |  |                                 | 7,618      |   |                                |   | (91,905    | )    |  |   | (107,576    | ) |  |   | (33,782     | )
|                                                                                 |  |                                 |            |  
|Cash and cash equivalents at beginning of period                                 |  |                                 | 32,034     |   |                                |   | 170,745    |      |  |   | 147,228     |   |  |   | 112,622     |  
|                                                                                 |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  
|Cash and cash equivalents at end of period                                       |  | $                               | 39,652     |   |                                | $ | 78,840     |      |  | $ | 39,652      |   |  | $ | 78,840      |  
|                                                                                 |  |                                 |            |   |                                |   |            |      |  |   |             |   |  |   |             |  

See noncash disclosures in Note 2 and Note 4.

See Notes to Consolidated Financial Statements.



7



---

##### Table of Contents

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In these financial statements, Thornburg Mortgage, Inc. and its subsidiaries are referred to as the Company, unless specifically stated
otherwise or the context indicates otherwise. Capitalized terms not otherwise defined in the financial statements below shall have the definitive meanings assigned to them in the Glossary at the end of this report.

Note 1. Significant Accounting Policies

The accompanying unaudited consolidated financial statements have been prepared in accordance with GAAP for interim financial information.

In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair statement have been included. The operating results for the quarter ended September 30, 2006 are not
necessarily indicative of the results that may be expected for the calendar year ending December 31, 2006. The interim financial information should be read in conjunction with Thornburg Mortgage, Inc.s 2005 Annual Report on Form 10-K.

Basis of presentation and principles of consolidation

The consolidated financial statements include the accounts of TMA, TMD, TMCR, TMHS, TMHL and Adfitech. TMD and TMCR are qualified REIT
subsidiaries and are consolidated with the Company for financial statement and tax reporting purposes. TMHL, Adfitech and TMHS are taxable REIT subsidiaries and are consolidated with the Company for financial statement purposes but are not
consolidated with the Company for tax reporting purposes. All material intercompany accounts and transactions are eliminated in consolidation. Certain prior period amounts have been reclassified to conform to current period classifications.

Accounting changes and other accounting developments

On January 1, 2006, the Company adopted SFAS 123(R) entitled Share-Based Payment. It requires all public companies to report share-based compensation expense at the grant date
fair value of the related share-based awards and to record subsequent changes in the fair value of the awards in current period earnings. Since the Company has accounted for its long-term incentive awards on this basis since inception of the Plan,
the adoption had no material impact on the financial statements.

In January 2006, the FASB issued an exposure draft titled,
The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. If approved, the proposed standard would provide an option under which an entity may irrevocably elect to report
certain financial assets and financial liabilities at fair value. Companies would be permitted to make the election on a contract-by-contract basis at the time each contract is initially recognized in the financial statements or upon an event that
gives rise to a new basis of accounting for the item. Under the fair value option, changes in the fair value of each financial asset or financial liability would be reflected in earnings as those changes occur. Until the final standard is approved
and the full scope is established, the Company is not able to assess the impact, if any, that the adoption of the standard may have on its financial position or results of operations.

In February 2006, the FASB issued SFAS 155, Accounting for Certain Hybrid Financial Instruments. Key provisions of SFAS 155
include: (1) a broad fair value measurement option for certain hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation; (2) clarification that only the simplest separations of interest
payments and principal payments qualify for the exception afforded to interest-only strips and principal-only strips from derivative accounting under paragraph 14 of SFAS 133, Accounting for Derivative Instruments and Hedging Activities,
(thereby narrowing such exception); (3) a requirement that beneficial interests in securitized financial assets be analyzed to determine whether they are freestanding derivatives or whether they are hybrid instruments that contain embedded
derivatives requiring bifurcation; (4) clarification that concentrations of credit risk in the form of subordination are not embedded derivatives; and (5) elimination of the prohibition on a QSPE holding passive derivative financial
instruments that pertain to beneficial interests that are or contain a derivative financial instrument. In October 2006, the FASB proposed that securitized interests that only contain an embedded derivative tied to the prepayment risk of the
underlying prepayable financial assets be excluded from the scope of SFAS 155. Until the scope exception is finalized, the Company is not able to assess the impact, if any, that the adoption of SFAS 155 may have on its financial position or results
of operations. SFAS 155 will become effective for the Company beginning January 1, 2007.



8



---

##### Table of Contents

In March 2006, the FASB issued SFAS 156, Accounting for Servicing of Financial
Assets. SFAS 156 amends SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately-recognized servicing assets and liabilities. Under SFAS
156, servicing assets and liabilities are no longer recognized in securitizations that are not accounted for as sales under SFAS 140. It also requires all separately-recognized servicing assets and liabilities to be initially measured at fair value,
and permits companies to elect, on a class-by-class basis, to account for servicing assets and liabilities on either a lower of cost or market value basis or a fair value measurement basis. The Company adopted SFAS 156 on January 1, 2006 and
has not recognized any servicing assets or liabilities in connection with its securitizations subsequent to that date because they are accounted for as secured borrowings under SFAS 140. The Company did not elect to measure its previously existing
servicing assets at fair value and continues to measure them at the lower of cost or market value.

In September 2006, the
FASB issued SFAS 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This statement applies under other
accounting pronouncements that require or permit fair value measurements. The Company is required to adopt the provisions of the standard effective January 1, 2007.

During September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, which discusses the process of quantifying financial statement misstatements. This pronouncement is effective
for fiscal years ending after November 15, 2006. The Company believes adoption of this pronouncement will have no material impact on its financial position, results of operations or cash flows.

Cash and cash equivalents

Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. The carrying amounts of cash equivalents approximate their respective fair values.

Restricted cash

Restricted cash and cash equivalents include cash and highly liquid investments with original maturities of three months or less that are held by counter-parties as collateral for Reverse Repurchase Agreements,
Asset-backed CP and Hedging Instruments. The carrying amounts of restricted cash and cash equivalents approximate their respective fair values.

ARM Assets

The Companys ARM Assets are comprised of Purchased ARM Assets and ARM Loans. All of
the Companys ARM Assets are either Traditional ARMs or Hybrid ARMs.

Purchased ARM Assets are composed mainly of ARM
securities and Purchased Securitized Loans obtained from third parties. The Company has designated all of its Purchased ARM Assets 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. Any unrealized loss deemed to be other-than-temporary is recorded as a realized loss. Realized gains or losses on the sale of Purchased ARM Assets
are recorded in earnings at the time of sale and are determined by the difference between net sale proceeds and the amortized cost of the securities.

Purchased Securitized Loans are third-party loan securitizations in which the Company has purchased all principal classes of the securitizations, including the subordinated classes.

ARM Loans are designated as held-for-investment as the Company has the intent and ability to hold them for the foreseeable future, and
until maturity or payoff. ARM Loans are carried at their unpaid principal balances, including unamortized premium or discount, unamortized loan origination costs, unamortized deferred loan origination fees, net unrealized gain (loss) on purchase
loan commitments and reserve for loan losses.In accordance with SFAS 140, Securitized ARM Loans and ARM Loans Collateralizing CDOs are accounted for as loans and are not considered investments subject to classification under SFAS 115,
Accounting for Certain Investments in Debt and Equity Securities.

Securitized ARM Loans are loans originated or
acquired by the Company and securitized by the Company with the Company retaining 100% of the beneficial ownership interests.



9



---

##### Table of Contents

ARM Loans Collateralizing CDOs are loans originated or acquired by the Company and
financed in their entirety on its balance sheet through securitization by the Company into sequentially rated classes. The Company retains the classes that are not High Quality which provide credit support for the higher rated classes issued to
third-party investors in structured financing arrangements.

In accordance with SFAS 140, loan securitizations resulting in
Securitized ARM Loans and ARM Loans Collateralizing CDOs are accounted for as secured borrowings under paragraphs 9(a)-9(c) of SFAS 140 because (1) the Company has the unilateral ability to cause the return of transferred assets and, therefore,
has maintained effective control over the transferred assets and (2) the transactions are completed through SPEs that do not meet the requirements of SFAS 140 to be considered QSPEs.

ARM loans held for securitization are loans the Company has acquired or originated and are intended to be securitized and retained by the
Company.

Interest income on ARM Assets is accrued based on the outstanding principal amount and contractual terms of the
assets. Premiums and discounts associated with the purchase of the ARM Assets are amortized through interest income over the estimated lives of the assets considering the actual and future estimated prepayments of the assets using the interest
method in determining an effective yield. Estimating future lifetime prepayments and estimating the remaining lives of the Companys ARM Assets requires management judgment, which involves consideration of possible future interest rate
environments and an estimate of how borrowers will behave in those environments. The actual lives of the ARM Assets could be longer or shorter than the lives estimated by management. Loan origination fees, net of certain direct loan origination
costs and the cost of securitizing ARM loans, are deferred and amortized as an interest income yield adjustment over the life of the related loans using the effective yield method.

MSRs

Effective January 1, 2006 with the adoption
of SFAS 156, the Company does not capitalize any MSRs in connection with securitizations accounted for as secured borrowings under SFAS 140. The Company did not elect to measure its previously existing servicing assets at fair value and continues to
measure them at the lower of cost or market value. Prior to January 1, 2006, MSRs were capitalized upon the securitization of ARM loans as required by GAAP by allocating a portion of the cost basis of the securitized loans to the estimated
value of the servicing asset related to the loans retained by the Company as collateral in securitizations. MSRs are included in Other assets on the Consolidated Balance Sheets. The servicing revenue, net of servicing costs, MSR amortization and
impairment charges, is recorded as Servicing income, net on the Consolidated Income Statements.

MSRs are amortized in
proportion to, and over the expected period of, the estimated future net servicing income. MSRs are carried at the lower of cost or fair value at the risk strata level and are periodically evaluated for impairment based on fair value, which is
determined using a discounted future cash flow model that considers portfolio characteristics and assumptions regarding prepayment speeds, delinquency rates and other economic factors. Estimating prepayments and estimating the remaining lives of the
Companys ARM Assets requires management judgment, which involves consideration of possible future interest rate environments and an estimate of how borrowers will behave in those environments. The actual lives could be longer or shorter than
the amount estimated by management. For purposes of evaluating and measuring impairment of MSRs, the Company stratifies its portfolio on the basis of predominant risk characteristics, including loan type (Traditional ARM or Hybrid ARM).

Credit risk and reserve for loan losses

The Companys Purchased Securitized Loans comprise all classes of third-party ARM loan securitizations (including the classes rated less than Investment Grade). Like the Companys own loan originations and
acquisitions, these assets are Qualifying Interests for purposes of maintaining the Companys exemption from the Investment Company Act because the Company retains a 100% ownership interest in the underlying loans. When the Company acquires all
classes of third-party ARM loan securitizations, some of the classes are below Investment Grade and the purchase price of those securities generally includes a discount for probable credit losses. This discount is recorded as part of the purchase
price of that security. Based upon managements analysis and judgment, a portion of the purchase discount is subsequently accreted as interest income under the effective yield method while the remaining portion of the purchase discount is
treated as a non-accretable discount which reflects the estimated unrealized loss on the securities due to credit risk. If management ultimately concludes that the non-accretable discount will not represent realized losses, the balance is accreted
into earnings over the remaining life of the security through the effective yield



10



---

##### Table of Contents

method. In the event that management concludes that losses may exceed the non-accretable
discount, the Company revises its estimate of probable losses and the change in the estimate of losses is recorded as a reduction in earnings.

The Company also maintains a reserve for loan losses based on managements estimate of credit losses inherent in the Companys portfolio of ARM Loans. The estimation of the reserve is based on a variety of
factors including, but not limited to, current economic conditions, the potential for natural disasters, loan portfolio composition, delinquency trends, credit losses to date on underlying loans and remaining credit protection. If the credit
performance of its ARM Loans is different than expected, the Company adjusts the reserve for loan losses to a level deemed appropriate by management to provide for estimated losses inherent in its ARM Loan portfolio. Additionally, once a loan is 90
days or more delinquent, or a borrower declares bankruptcy, the Company adjusts the value of its accrued interest receivable to what it believes to be collectible and stops accruing interest on that loan. The Company provides specific reserves for
loan losses on loans that are considered to be impaired when a significant permanent decline in value is identified.

Valuation
methods

The fair values of the Companys Purchased ARM Assets and Securitized ARM Loans are generally based on
market prices provided by third-party pricing services or by broker/dealers who make markets in these financial instruments. If the fair value of a Purchased ARM Asset, a Securitized ARM Loan or ARM Loans Collateralizing CDOs is not reasonably
available from a dealer or a third-party pricing service, management estimates the fair value based on characteristics of the security that the Company receives from the issuer and on available market information.

The fair values of ARM Loans Collateralizing CDOs and ARM loans held for securitization are estimated by the Company using the same
pricing models employed by the Company to determine prices to purchase loans in the open market, taking into consideration the aggregated characteristics of groups of loans such as, but not limited to, collateral type, index, interest rate, margin,
length of fixed interest rate period, life cap, periodic cap, underwriting standards, age and credit.

Purchase commitments
related to correspondent and bulk loans that will be held for investment purposes generally qualify as derivatives under SFAS 133 and SFAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, and are recorded
at fair value. The fair value of the net unrealized gain or loss on purchase commitments is calculated using the same methodologies that are used to price the Companys originated ARM Loans, adjusted for anticipated fallout for purchase
commitments that will likely not be funded. The Companys net unrealized gain (loss) on purchase commitments is recorded as a component of ARM loans held for securitization on the Consolidated Balance Sheets with the respective changes in fair
value recorded in Gain (loss) on Derivatives, net on the Consolidated Income Statements. Commitments to originate retail and wholesale loans are not considered derivatives under GAAP.

The fair values of the Companys CDOs, Senior Notes, Subordinated Notes, Swap Agreements and Cap Agreements are based on market
values provided by dealers who are familiar with the terms of these instruments.

The fair value of Eurodollar Transactions
is determined on a daily basis by the closing prices on the Chicago Mercantile Exchange.

The fair values reported reflect
estimates and may not necessarily be indicative of the amounts the Company could realize if these instruments were sold. Cash and cash equivalents, restricted cash and cash equivalents and interest receivable are reflected in the consolidated
financial statements at cost. Prepaid expenses and other assets, Reverse Repurchase Agreements, Asset-backed CP, other borrowings and other liabilities are reflected in the consolidated financial statements at their amortized cost, which
approximates their fair value because of the short-term nature of these instruments.

Hedging Instruments

All of the Companys Hedging Instruments are carried on the Consolidated Balance Sheets at their fair value as an asset, if their
fair value is positive, or as a liability, if their fair value is negative. In general, most of the Companys Hedging Instruments are designated as cash flow hedges, and the effective amount of change in the fair value of the Derivative is
recorded in accumulated other comprehensive income (loss) and transferred to earnings as the hedged item affects earnings. The ineffective amount of all Hedging Instruments is recognized in earnings each quarter. Generally, a hedging strategy is
effective under SFAS 133 if it achieves offsetting cash flows attributable to the risk



11



---

##### Table of Contents

being hedged and meets certain statistical thresholds pursuant to SFAS 133. If the
hedging strategy is not successful in achieving offsetting cash flows or meeting the statistical thresholds, it is ineffective and will not qualify for hedge accounting.

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 the inception of a hedging activity and on an on-going basis, whether or not the hedging activity is highly effective. If it is
determined that a hedge has been highly effective, but will not be prospectively, the Company discontinues hedge accounting prospectively.

Hybrid ARM Hedging Instruments

The Company enters into Hybrid ARM Hedging
Instruments in order to manage its interest rate exposure when financing its Hybrid ARM Assets. Although the Company generally borrows money based on short-term interest rates, its Hybrid ARM Assets have an initial fixed interest rate period of
three to ten years. As a result, the Companys existing and forecasted borrowings reprice to a new rate on a more frequent basis than do the Hybrid ARM Assets. Consequently, the Company uses Hybrid ARM Hedging Instruments to fix the interest
rate on its borrowings during the expected fixed interest rate period of the Hybrid ARM Assets such that the combined Effective Duration of its borrowings and Hybrid ARM Hedging Instruments closely matches the Effective Duration of the Hybrid ARM
Assets, the difference being Net Effective Duration. The notional balances of the Hybrid ARM Hedging Instruments generally decline over the life of these instruments approximating the declining balance of the Hybrid ARM Assets being financed.

Swap Agreements have the effect of converting the Companys variable-rate debt into fixed-rate debt over the life of
the Swap Agreements. 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 has two-way collateral agreements protecting its
credit exposure to Swap Agreement counterparties.

The Company enters into Cap Agreements in connection with some of its CDO
securitizations by incurring a one-time fee or premium. Pursuant to the terms of the respective Cap Agreements, the Company will receive cash payments if the interest rate index specified in any such Cap Agreement increases above contractually
specified levels. Therefore, such Cap Agreements have the effect of capping the interest rate on a portion of the Companys borrowings so as not to exceed the level specified by the Cap Agreement. The purchase price of these Cap Agreements is
expensed over the life of the Cap Agreements and the expense increases as the Cap Agreements approach maturity.

The Company
designates its Hybrid ARM Hedging Instruments as cash flow hedges. All changes in the unrealized gains and losses on Hybrid ARM Hedging Instruments have been recorded in accumulated other comprehensive income (loss) and are reclassified to earnings
as interest expense when each of the forecasted financing transactions occurs. 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
or its debt obligations, will not occur by the end of the originally specified time period as documented at the inception of the hedging relationship, or within an additional two-month time period thereafter, then the related gain or loss in
accumulated other comprehensive income (loss) would be reclassified to income. The carrying value of these Hybrid ARM Hedging Instruments is included in Hedging Instruments on the Consolidated Balance Sheets.

The unrealized gain (loss) on Swap Agreements is based on the discounted value of the remaining future net interest payments expected to
be made over the remaining life of the Swap Agreements. Therefore, over time, as the actual payments are made, the unrealized gain (loss) in accumulated other comprehensive income (loss) and the carrying value of the Swap Agreements adjust to zero
and the Company realizes a fixed financing cost over the life of the Hedging Instrument.



12



---

##### Table of Contents

Pipeline Hedging Instruments

The Company enters into Pipeline Hedging Instruments to manage interest rate risk associated with commitments to purchase correspondent
and bulk loans. The Company does not currently apply hedge accounting to its Pipeline Hedging Instruments and, therefore, the change in fair value and the realized gains (losses) on these Pipeline Hedging Instruments are recorded in current
earnings. The net gain (loss) related to Pipeline Hedging Instruments is reflected in Gain on Derivatives, net, on the Consolidated Income Statements as an offset to the net gain (loss) recorded for the change in fair value of the loan commitments.

Long-term incentive awards

The Company has a long-term incentive plan which is more fully described in Note 8. Since inception of the Plan in 2002, the Company has accounted for all awards at fair value on the grant date and recorded subsequent
changes in the fair value of the awards in current period earnings. The PSRs issued under the Plan are variable in nature and are settled in cash. The liability for PSRs is measured each period based on the fair value of the Common Stock. The
effects of changes in the stock price during the vesting period, generally three years, are recognized as expense over the vesting period. Dividend-equivalent payments on DERs and vested and unvested PSRs granted on or before October 20, 2003
are recognized as compensation expense in the period in which they are declared. PSRs granted after October 20, 2003 do not earn a dividend-equivalent until they are vested.

Accumulated other comprehensive income (loss)

SFAS 130,
Reporting Comprehensive Income, divides comprehensive income into net income and other comprehensive income (loss), which includes unrealized gains and losses on marketable securities defined as available-for-sale and unrealized gains
and losses on derivative financial instruments that qualify for cash flow hedge accounting under SFAS 133.

Income taxes

The Company, excluding TMHL, Adfitech and TMHS, elected to be taxed as a REIT and believes it complies with the
provisions of 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.
TMHL, its wholly owned subsidiary Adfitech, and TMHS are taxable REIT subsidiaries and, as such, are subject to both federal and state corporate income tax.

Income taxes are provided under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period the change occurs. Subject to managements judgment, a valuation allowance is established if
realization of deferred tax assets is not more likely than not.

Income taxes for the quarter ended September 30, 2006
were immaterial and no provision is reflected on the Consolidated Income Statements. The significant differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases relate to MSRs
capitalized for financial statement purposes, REMIC transactions accounted for as financings for financial statement purposes and sales for tax purposes, and TMHLs net operating loss carryforward from 2004 and 2005. Management has established
a valuation allowance against the net deferred tax assets at September 30, 2006.



13



---

##### Table of Contents

Earnings per share

EPS amounts are computed by dividing net income (adjusted for dividends declared on Preferred Stock) by the weighted average number of common shares outstanding. The Company had no outstanding
Common Stock equivalents during the periods presented.

Following is information about the computation of the EPS data for
the three- and nine-month periods ended September 30, 2006 and 2005 (in thousands except per share data):



|                                             |  |        |         |               |         |     |   |     
|-------------------------------------------- |  | ------ | ------- | ------------- | ------- | --- | - | ----
|                                             |  | Income |         | AverageShares |         | EPS
|Three Months Ended September 30, 2006        |  |        |         |               |         |     |   |     
|EPS, income available to common shareholders |  | $      | 72,859  |               | 113,316 |     | $ | 0.64
|                                             |  |        |         |               |         |     |   |     
|Three Months Ended September 30, 2005        |  |        |         |               |         |     |   |     
|EPS, income available to common shareholders |  | $      | 71,767  |               | 102,758 |     | $ | 0.70
|                                             |  |        |         |               |         |     |   |     
|Nine Months Ended September 30, 2006         |  |        |         |               |         |     |   |     
|EPS, income available to common shareholders |  | $      | 210,158 |               | 110,195 |     | $ | 1.91
|                                             |  |        |         |               |         |     |   |     
|Nine Months Ended September 30, 2005         |  |        |         |               |         |     |   |     
|EPS, income available to common shareholders |  | $      | 206,239 |               | 97,518  |     | $ | 2.11
|                                             |  |        |         |               |         |     |   |     

Use of estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates.



14



---

##### Table of Contents

Note 2. ARM Assets

The following tables present the Companys ARM Assets as of September 30, 2006 and December 31, 2005 (in thousands):



|                                                 |  |                |            |   |                            |   |           |                      |  |   |                              |   |  |                                 |            |   |       |   |           |   |  |   |            |  
|------------------------------------------------ |  | -------------- | ---------- | - | -------------------------- | - | --------- | -------------------- |  | - | ---------------------------- | - |  | ------------------------------- | ---------- | - | ----- | - | --------- | - |  | - | ---------- | -
|September 30, 2006                               |  | ARM securities |            |   | PurchasedSecuritized Loans |   |           | Securitized ARMLoans |  |   | ARM LoansCollateralizingCDOs |   |  | ARM loansheld forsecuritization |            |   | Total |  
|Principal balance outstanding                    |  | $              | 22,328,445 |   |                            | $ | 7,147,991 |                      |  | $ | 2,866,645                    |   |  | $                               | 18,537,194 |   |       | $ | 987,829   |   |  | $ | 51,868,104 |  
|Net unamortized premium                          |  |                | 182,443    |   |                            |   | 60,380    |                      |  |   | 14,605                       |   |  |                                 | 86,780     |   |       |   | 17,531    |   |  |   | 361,739    |  
|Loan loss reserves                               |  |                |           |   |                            |   |          |                      |  |   | (7,284                       | ) |  |                                 | (4,976     | ) |       |   | (250      | ) |  |   | (12,510    | )
|Non-accretable discounts                         |  |                |           |   |                            |   | (15,243   | )                    |  |   |                             |   |  |                                 |           |   |       |   |          |   |  |   | (15,243    | )
|Net unrealized gain on purchase loan commitments |  |                |           |   |                            |   |          |                      |  |   |                             |   |  |                                 |           |   |       |   | 2,593     |   |  |   | 2,593      |  
|Principal payment receivable                     |  |                | 8,065      |   |                            |   | 99        |                      |  |   |                             |   |  |                                 |           |   |       |   |          |   |  |   | 8,164      |  
|                                                 |  |                |            |   |                            |   |           |                      |  |   |                              |   |  |                                 |            |   |       |   |           |   |  |   |            |  
|Amortized cost, net                              |  |                | 22,518,953 |   |                            |   | 7,193,227 |                      |  |   | 2,873,966                    |   |  |                                 | 18,618,998 |   |       |   | 1,007,703 |   |  |   | 52,212,847 |  
|Gross unrealized gains                           |  |                | 28,082     |   |                            |   | 9,217     |                      |  |   | 14,331                       |   |  |                                 | 14,929     |   |       |   | 1,667     |   |  |   | 68,226     |  
|Gross unrealized losses                          |  |                | (355,025   | ) |                            |   | (137,927  | )                    |  |   | (56,681                      | ) |  |                                 | (142,609   | ) |       |   | (2,057    | ) |  |   | (694,299   | )
|                                                 |  |                |            |   |                            |   |           |                      |  |   |                              |   |  |                                 |            |   |       |   |           |   |  |   |            |  
|Fair value                                       |  | $              | 22,192,010 |   |                            | $ | 7,064,517 |                      |  | $ | 2,831,616                    |   |  | $                               | 18,491,318 |   |       | $ | 1,007,313 |   |  | $ | 51,586,774 |  
|                                                 |  |                |            |   |                            |   |           |                      |  |   |                              |   |  |                                 |            |   |       |   |           |   |  |   |            |  
|Carrying value                                   |  | $              | 22,192,010 |   |                            | $ | 7,064,517 |                      |  | $ | 2,873,966                    |   |  | $                               | 18,618,998 |   |       | $ | 1,007,703 |   |  | $ | 51,757,194 |  
|                                                 |  |                |            |   |                            |   |           |                      |  |   |                              |   |  |                                 |            |   |       |   |           |   |  |   |            |  
|                                                 |  |                |            |   |                            |  
|December 31, 2005                                |  | ARM securities |            |   | PurchasedSecuritized Loans |   |           | Securitized ARMLoans |  |   | ARM LoansCollateralizingCDOs |   |  | ARM loansheld forsecuritization |            |   | Total |  
|Principal balance outstanding                    |  | $              | 20,433,994 |   |                            | $ | 6,942,452 |                      |  | $ | 3,300,677                    |   |  | $                               | 10,370,356 |   |       | $ | 631,543   |   |  | $ | 41,679,022 |  
|Net unamortized premium                          |  |                | 243,967    |   |                            |   | 52,450    |                      |  |   | 17,440                       |   |  |                                 | 29,704     |   |       |   | 4,286     |   |  |   | 347,847    |  
|Loan loss reserves                               |  |                |           |   |                            |   |          |                      |  |   | (7,400                       | ) |  |                                 | (3,099     | ) |       |   | (250      | ) |  |   | (10,749    | )
|Non-accretable discounts                         |  |                | (236       | ) |                            |   | (11,315   | )                    |  |   |                             |   |  |                                 |           |   |       |   |          |   |  |   | (11,551    | )
|Net unrealized loss on purchase loan commitments |  |                |           |   |                            |   |          |                      |  |   |                             |   |  |                                 |           |   |       |   | 6,264     |   |  |   | 6,264      |  
|Principal payment receivable                     |  |                | 10,688     |   |                            |   | 18        |                      |  |   |                             |   |  |                                 |           |   |       |   |          |   |  |   | 10,706     |  
|                                                 |  |                |            |   |                            |   |           |                      |  |   |                              |   |  |                                 |            |   |       |   |           |   |  |   |            |  
|Amortized cost, net                              |  |                | 20,688,413 |   |                            |   | 6,983,605 |                      |  |   | 3,310,717                    |   |  |                                 | 10,396,961 |   |       |   | 641,843   |   |  |   | 42,021,539 |  
|Gross unrealized gains                           |  |                | 4,761      |   |                            |   | 2,242     |                      |  |   | 13,331                       |   |  |                                 | 2,320      |   |       |   | 1,707     |   |  |   | 24,361     |  
|Gross unrealized losses                          |  |                | (397,670   | ) |                            |   | (146,843  | )                    |  |   | (64,462                      | ) |  |                                 | (77,596    | ) |       |   | (515      | ) |  |   | (687,086   | )
|                                                 |  |                |            |   |                            |   |           |                      |  |   |                              |   |  |                                 |            |   |       |   |           |   |  |   |            |  
|Fair value                                       |  | $              | 20,295,504 |   |                            | $ | 6,839,004 |                      |  | $ | 3,259,586                    |   |  | $                               | 10,321,685 |   |       | $ | 643,035   |   |  | $ | 41,358,814 |  
|                                                 |  |                |            |   |                            |   |           |                      |  |   |                              |   |  |                                 |            |   |       |   |           |   |  |   |            |  
|Carrying value                                   |  | $              | 20,295,504 |   |                            | $ | 6,839,004 |                      |  | $ | 3,310,717                    |   |  | $                               | 10,396,961 |   |       | $ | 641,843   |   |  | $ | 41,484,029 |  
|                                                 |  |                |            |   |                            |   |           |                      |  |   |                              |   |  |                                 |            |   |       |   |           |   |  |   |            |  

The Company did not sell assets during the nine months ended September 30, 2006. The Company
realized a gain of $7.6 million on the sale of $1.5 billion of ARM Assets during the nine months ended September 30, 2005.

During the
nine months ended September 30, 2006, the Company securitized $10.0 billion of ARM loans into six CDOs. While TMHL transferred all of the ARM loans to a separate bankruptcy-remote legal entity, on a consolidated basis the Company did not
account for these securitizations as sales and, therefore, did not record any gain or loss in connection with the securitizations. The Company retained $376.4 million of the resulting securities for its ARM Loan portfolio and financed $9.7 billion
with third-party investors, thereby providing long-term collateralized financing for these assets. As of September 30, 2006 and December 31, 2005, the Company held $18.6 billion and $10.4 billion, respectively, of ARM Loans Collateralizing
CDOs. As of September 30, 2006 and December 31, 2005, the Company held $2.9 billion and $3.3 billion, respectively, of Securitized ARM Loans as a result of the Companys securitization efforts. All discussions relating to
securitizations in these financial statements and notes are on a consolidated basis and do not reflect the separate legal ownership of the loans by various bankruptcy-remote legal entities.

During the nine months ended September 30, 2006, the Company acquired $933.0 million of Purchased Securitized Loans. At September 30, 2006 and December 31, 2005, the Companys
Purchased Securitized Loans totaled $7.1 billion and $6.8 billion, respectively. These assets are Qualifying Interests for purposes of maintaining the Companys exemption from the Investment Company Act because the Company retains 100%
ownership interest in the underlying loans. Because the Company purchases all classes of these securitizations, the Company has credit exposure on the underlying loans. The purchase price of the classes that are less than Investment Grade generally
includes a discount for probable credit losses and,



15



---

##### Table of Contents

based on managements judgment, the portion of the purchase discount which reflects the estimated
unrealized loss on the securities due to credit risk is treated as a non-accretable discount. As of September 30, 2006, 45 of the underlying loans of the Companys Purchased Securitized Loans were 60 days or more delinquent and had an
aggregate balance of $35.3 million. Activity in non-accretable discounts for the nine-month periods ended September 30, 2006 and 2005 is as follows (in thousands):



|                                         |  |      |        |   |      |   |        |  
|---------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                         |  | 2006 |        |   | 2005 |  
|Balance at beginning of period           |  | $    | 11,551 |   |      | $ | 6,478  |  
|Increase for securities purchased        |  |      | 3,975  |   |      |   | 4,843  |  
|Increase for expected future losses      |  |      | 214    |   |      |   |       |  
|Realized losses                          |  |      | (397   | ) |      |   |       |  
|Reclassifications to accretable discount |  |      | (100   | ) |      |   | (1,210 | )
|                                         |  |      |        |   |      |   |        |  
|Balance at end of period                 |  | $    | 15,243 |   |      | $ | 10,111 |  
|                                         |  |      |        |   |      |   |        |  

The following table shows the gross unrealized losses and fair value of Purchased ARM Assets,
aggregated by credit rating and length of time that the 747 individual securities have been in a continuous unrealized loss position, at September 30, 2006 (in thousands):

Unrealized Losses on Purchased ARM Assets as of September 30, 2006



|                       |  |                     |           |                |                   |         |            |       |                |            |  |            |          |                |  |   |            |  |   |          |  
|---------------------- |  | ------------------- | --------- | -------------- | ----------------- | ------- | ---------- | ----- | -------------- | ---------- |  | ---------- | -------- | -------------- |  | - | ---------- |  | - | -------- | -
|                       |  | Less Than 12 Months |           |                | 12 Months or More |         |            | Total |               
|                       |  | Fair Value          |           | UnrealizedLoss |                   |         | Fair Value |       | UnrealizedLoss |            |  | Fair Value |          | UnrealizedLoss | 
|Agency Securities      |  | $                   | 29,412    |                | $                 | (189    | )          |       | $              | 1,380,854  |  | $          | (34,662  | )              |  | $ | 1,410,266  |  | $ | (34,851  | )
|AAA/Aaa rating         |  |                     | 2,369,188 |                |                   | (12,330 | )          |       |                | 19,454,335 |  |            | (425,922 | )              |  |   | 21,823,523 |  |   | (438,252 | )
|AA/Aa rating           |  |                     | 37,241    |                |                   | (388    | )          |       |                | 300,530    |  |            | (12,354  | )              |  |   | 337,771    |  |   | (12,742  | )
|A rating               |  |                     | 35,635    |                |                   | (208    | )          |       |                | 165,006    |  |            | (3,483   | )              |  |   | 200,641    |  |   | (3,691   | )
|BBB/Baa rating         |  |                     | 27,694    |                |                   | (227    | )          |       |                | 69,740     |  |            | (1,967   | )              |  |   | 97,434     |  |   | (2,194   | )
|BB/Ba rating and below |  |                     | 3,819     |                |                   | (188    | )          |       |                | 17,562     |  |            | (1,034   | )              |  |   | 21,381     |  |   | (1,222   | )
|                       |  |                     |           |                |                   |         |            |       |                |            |  |            |          |                |  |   |            |  |   |          |  
|Total                  |  | $                   | 2,502,989 |                | $                 | (13,530 | )          |       | $              | 21,388,027 |  | $          | (479,422 | )              |  | $ | 23,891,016 |  | $ | (492,952 | )
|                       |  |                     |           |                |                   |         |            |       |                |            |  |            |          |                |  |   |            |  |   |          |  

The unrealized losses in the above table are temporary impairments due to changes in market
interest rates and, based upon review of credit ratings, delinquency data and other information, are not reflective of credit deterioration. As the Company has the ability and intent to hold its Purchased ARM Assets until recovery, losses are not
considered to be other than temporary impairments. As presented in Note 7, during the nine-month period ended September 30, 2006, the net unrealized loss of $537.5 million on Purchased ARM Assets decreased by $81.9 million to a net unrealized
loss of $455.7 million. During the same nine-month period in 2006, the net unrealized gain on Hedging Instruments of $390.0 million decreased by $196.3 million to a net unrealized gain of $193.7 million, for a combined increase in the net unrealized
loss on Purchased ARM Assets and Hedging Instruments of $114.5 million. While the Companys Purchased ARM Assets are designated as available-for-sale, the Company does not typically sell its Purchased ARM Assets and therefore does not expect to
realize these gross unrealized losses.

The Company has credit exposure on its ARM Loans. The following tables summarize ARM Loan
delinquency information as of September 30, 2006 and December 31, 2005 (dollar amounts in thousands):



|                              |  |           |  |             |        |                    |      |   |                        |      |  
|----------------------------- |  | --------- |  | ----------- | ------ | ------------------ | ---- | - | ---------------------- | ---- | -
|September 30, 2006            |  |           |  |             |        |                    |      |   |                        |      |  
|                              |  |           |  |            
|Delinquency Status            |  | LoanCount |  | LoanBalance |        | Percent ofARMLoans |      |   | Percent ofTotal Assets |     
|60 to 89 days                 |  | 0         |  | $           | 0      |                    | 0.00 | % |                        | 0.00 | %
|90 days or more               |  | 1         |  |             | 233    |                    | 0.00 |   |                        | 0.00 |  
|In bankruptcy and foreclosure |  | 15        |  |             | 11,756 |                    | 0.05 |   |                        | 0.02 |  
|                              |  |           |  |             |        |                    |      |   |                        |      |  
|                              |  | 16        |  | $           | 11,989 |                    | 0.05 | % |                        | 0.02 | %
|                              |  |           |  |             |        |                    |      |   |                        |      |  



16



---

##### Table of Contents

|                              |  |           |  |             |        |                    |      |   |                        |      |  
|----------------------------- |  | --------- |  | ----------- | ------ | ------------------ | ---- | - | ---------------------- | ---- | -
|December 31, 2005             |  |           |  |             |        |                    |      |   |                        |      |  
|                              |  |           |  |            
|Delinquency Status            |  | LoanCount |  | LoanBalance |        | Percent ofARMLoans |      |   | Percent ofTotal Assets |     
|60 to 89 days                 |  | 4         |  | $           | 1,230  |                    | 0.01 | % |                        | 0.00 | %
|90 days or more               |  | 0         |  |             |       |                    |     |   |                        |     |  
|In bankruptcy and foreclosure |  | 12        |  |             | 9,998  |                    | 0.07 |   |                        | 0.02 |  
|                              |  |           |  |             |        |                    |      |   |                        |      |  
|                              |  | 16        |  | $           | 11,228 |                    | 0.08 | % |                        | 0.02 | %
|                              |  |           |  |             |        |                    |      |   |                        |      |  

As of September 30, 2006, the Company owned four real estate properties as a result of
foreclosing on delinquent loans in the amount of $881,000 (not included in the table above.) The Company believes that its current level of loan loss reserves is adequate to cover estimated losses from these loans as well as probable losses inherent
in the ARM Loan portfolio at September 30, 2006.

During the nine months ended September 30, 2006 and 2005, the Company recorded
loan loss provisions totaling $1.8 million and $963,000, respectively, to reserve for estimated credit losses on ARM Loans, bringing its total loan loss reserve to $12.5 million and $10.4 million, respectively.

The Company originates fully amortizing loans with interest only payment terms for a period not to exceed ten years. Interest only loans represented
84.6% and 88.9% of ARM loans at September 30, 2006 and December 31, 2005, respectively. Beginning in the first quarter of 2006, the Company also began acquiring Pay Option ARMs. The Companys investment in Pay Option ARMs comprised
4.2% of ARM Assets at September 30, 2006. Loans with interest only features and Pay Option ARMs have been identified as potentially having a concentration of credit risk as defined in SFAS 107, Disclosures about Fair Value of Financial
Instruments. The Company believes that its pricing, underwriting, appraisal, and other processes are sufficient to manage potential credit risks.

In accordance with SFAS 156, no MSRs were capitalized in connection with the securitization of $10.0 billion of ARM loans during the nine months ended September 30, 2006 because the securitizations were accounted
for as secured borrowings under SFAS 140. MSRs capitalized upon the securitization of $5.6 billion of ARM loans during the nine months ended September 30, 2005 totaled $25.6 million. MSRs of $36.2 million, net of amortization of $6.3 million
during the nine months ended September 30, 2006, are included in other assets on the Consolidated Balance Sheets at September 30, 2006. MSRs of $45.3 million are included in other assets on the Consolidated Balance Sheets at
December 31, 2005. At September 30, 2006, the fair value of the MSRs of $51.8 million exceeded their cost basis in each risk stratum. During the nine months ended September 30, 2006, the Company recorded an impairment charge of
$536,000 against the amortized cost of the MSRs in the Traditional ARM risk stratum.

As of September 30, 2006, the Company had
commitments to purchase or originate the following amounts of ARM assets, net of fallout (in thousands):



|                                       |  |   |          
|-------------------------------------- |  | - | ---------
|ARM securities  AAA/AA                |  | $ | 69,000   
|ARM loans  bulk acquisitions          |  |   | 336,654  
|ARM loans  correspondent originations |  |   | 689,462  
|ARM loans  direct originations        |  |   | 33,242   
|ARM loans  wholesale originations     |  |   | 33,448   
|                                       |  |   |          
|                                       |  | $ | 1,161,806
|                                       |  |   |          



17



---

##### Table of Contents

Note 3. Hedging Instruments

Hybrid ARM Hedging Instruments

As of September 30, 2006
and December 31, 2005, the Company was counterparty to Hybrid ARM Hedging Instruments that consist of Swap Agreements having aggregate notional balances of $37.0 billion and $32.0 billion, respectively. As of September 30, 2006, these Swap
Agreements had a weighted average maturity of 4.0 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. The combined weighted average fixed rate payable of the Swap Agreements was 4.42% and 3.79% at September 30, 2006 and December 31, 2005, respectively. In addition, as of September 30, 2006, the Company had entered into
delayed Swap Agreements with notional balances totaling $13.3 billion that become effective between October 2006 and June 2009 and are also accounted for as cash flow hedges as of September 30, 2006. These delayed Swap Agreements have been
entered into to hedge the financing of the Companys existing ARM Assets and the forecasted financing of the Companys ARM Assets purchase commitments at September 30, 2006, and to replace Swap Agreements as they mature. The combined
weighted average fixed rate payable of the delayed Swap Agreements was 5.26% at September 30, 2006.

The net unrealized
gain on Swap Agreements at September 30, 2006 of $201.2 million included Swap Agreements with gross unrealized gains of $340.6 million and gross unrealized losses of $139.4 million and is included in Hedging Instruments on the Consolidated
Balance Sheets. As of December 31, 2005, the net unrealized gain of $400.2 million included Swap Agreements with gross unrealized gains of $403.2 million and gross unrealized losses of $3.0 million. As of September 30, 2006, the net
unrealized gain on Swap Agreements recorded in accumulated other comprehensive income (loss) totaled a net gain of $201.2 million. In the twelve month period following September 30, 2006 based on the current level of interest rates, $205.0
million of these net unrealized gains are expected to be realized through interest margin.

As of September 30, 2006
and December 31, 2005, the Companys Cap Agreements used to manage the interest rate risk exposure on the financing of Hybrid ARM Loans Collateralizing CDOs had remaining net notional amounts of $984.9 million and $970.3 million,
respectively. The Company has also entered into Cap Agreements that have start dates ranging from 2008 to 2010. The notional balance at the start date will be the lesser of the scheduled amount of $197.5 million or the balance of Hybrid ARM loans
associated with these Cap Agreements. The fair value of all of these Cap Agreements at September 30, 2006 and December 31, 2005 was $15.0 million and $19.5 million, respectively, and is included in Hedging Instruments on the Consolidated
Balance Sheets. As of September 30, 2006 and December 31, 2005, the unrealized losses on these Cap Agreements of $6.8 million and $9.9 million, respectively, are included in accumulated other comprehensive income (loss). In the twelve
month period following September 30, 2006, $178,000 of net unrealized losses are expected to be realized. Pursuant to the terms of these Cap Agreements and subject to future prepayment behavior, the notional amount of the Cap Agreements
declines such that it is expected to equal the balance of the Hybrid ARM loans collateralizing CDOs. Under these Cap Agreements, the Company will receive cash payments should the one-month LIBOR increase above the contract rates of these Hedging
Instruments, which range from 3.05% to 9.67% and average 5.40%. The Cap Agreements had an average maturity of 3.7 years as of September 30, 2006 and will expire between 2007 and 2013.

The Company hedges the funding of its Hybrid ARM Assets such that the Net Effective Duration is less than one year. At September 30,
2006, the financing and hedging of the Companys Hybrid ARM Assets resulted in a Net Effective Duration of approximately negative 0.10 years while the financing and hedging of all of the Companys ARM Assets resulted in a Net Effective
Duration of approximately negative 0.06 years. This duration calculation suggests a low degree of portfolio price change based on small changes in interest rates, implying that the Companys cash flow and earnings characteristics should be
relatively stable as interest rates change.

Interest expense for the three- and nine-month periods ended September 30,
2006 includes net receipts on Hybrid ARM Hedging Instruments of $96.4 million and $231.7 million, respectively. Interest expense for the same periods in 2005 includes net receipts on Hybrid ARM Hedging Instruments of $11.0 million and net payments
of $23.6 million, respectively.



18



---

##### Table of Contents

Pipeline Hedging Instruments

Purchase commitments related to correspondent and bulk loans that will be held for investment purposes generally qualify as Derivatives
under SFAS 133 and SFAS 149 and are recorded at fair value. The Company hedges these purchase commitments with Pipeline Hedging Instruments. The change in fair value of the Pipeline Hedging Instruments is included in Gain on Derivatives, net in the
Consolidated Income Statements. The fair value of the Pipeline Hedging Instruments at September 30, 2006 and December 31, 2005 was a net unrealized loss of $4.4 million and $2.0 million, respectively, and is included in Hedging Instruments
on the Consolidated Balance Sheets. Pipeline Hedging Instruments had remaining notional balances of $347.0 million and $1.9 billion at September 30, 2006 and December 31, 2005, respectively.

The Company recorded a net gain of $21.5 million on Derivatives during the nine months ended September 30, 2006. This gain consisted
of a net gain of $43.6 million on commitments to purchase loans from correspondent lenders and bulk sellers and a net gain of $1.2 million on other Derivative transactions partially offset by a net loss of $23.3 million on Pipeline Hedging
Instruments. The Company recorded a net gain of $3.1 million on Derivatives during the same period in 2005. This gain consisted of a net gain of $5.7 million on Pipeline Hedging Instruments offset partially by a net loss of $2.6 million on
commitments to purchase loans from correspondent lenders and bulk sellers.

Note 4. Borrowings

Reverse Repurchase Agreements

The Company has arrangements to enter into Reverse Repurchase Agreements, a form of collateralized short-term borrowing, with 20 different financial institutions, and as of September 30, 2006, had borrowed funds from 19 of these firms.

As of September 30, 2006, the Company had $21.9 billion of Reverse Repurchase Agreements outstanding with a weighted
average borrowing rate of 5.37% and a weighted average remaining maturity of 4.6 months. As of December 31, 2005, the Company had $23.4 billion of Reverse Repurchase Agreements outstanding with a weighted average borrowing rate of 4.43% and a
weighted average remaining maturity of 3.0 months. As of September 30, 2006, $21.3 billion of the Companys borrowings were variable-rate term Reverse Repurchase Agreements with original maturities that range from four to sixty months. The
interest rates of these term Reverse Repurchase Agreements are generally indexed to the one-month LIBOR rate and reprice accordingly. ARM Assets with a carrying value of $23.0 billion, including accrued interest, and cash totaling $5.6 million,
collateralized the Reverse Repurchase Agreements at September 30, 2006.

At September 30, 2006, the Reverse
Repurchase Agreements had the following remaining maturities (in thousands):



|                      |  |   |           
|--------------------- |  | - | ----------
|Within 30 days        |  | $ | 3,695,585 
|31 to 89 days         |  |   | 7,476,130 
|90 to 365 days        |  |   | 10,045,258
|Greater than 365 days |  |   | 670,001   
|                      |  |   |           
|                      |  | $ | 21,886,974
|                      |  |   |           

Asset-backed CP

The Company issues Asset-backed CP to investors in the form of secured liquidity notes that are recorded as borrowings on the Companys Consolidated Balance Sheets and are rated P-1 by
Moodys Investors Service, F1+ by Fitch Ratings and A-1+ by Standard and Poors. As of September 30, 2006 and December 31, 2005, the Company had $8.6 billion and $5.0 billion, respectively, of Asset-backed CP
outstanding with a weighted average interest rate of 5.34% and 4.38%, respectively, and a weighted average remaining maturity of 31 days and 18 days, respectively.

As of September 30, 2006 and December 31, 2005, these notes were collateralized by AAA-rated MBS from the Companys ARM Asset portfolio with a carrying value of $9.1 billion and
$5.3 billion, respectively, including accrued interest.



19



---

##### Table of Contents

CDOs

All of the Companys CDOs are secured by ARM loans. For financial reporting purposes, the ARM loans held as collateral are recorded as assets of the Company and the CDOs are recorded as the Companys debt.
In some transactions, Hedging Instruments are held by the trusts and recorded as assets or liabilities of the Company. The Hedging Instruments either fix the interest rates of the pass-through certificates or cap the interest rate exposure on these
transactions. As of September 30, 2006, the following CDOs were outstanding (dollar amounts in thousands):



|                                                |  |                   |            |                           |      |  
|----------------------------------------------- |  | ----------------- | ---------- | ------------------------- | ---- | -
|Description                                     |  | Principal Balance |            | EffectiveInterestRate (1) |     
|Floating-rate financing                         |  | $                 | 1,050,979  |                           | 5.68 | %
|Floating-rate financing with Cap Agreements (2) |  |                   | 9,546,266  |                           | 5.68 | %
|Fixed-rate financing (3)                        |  |                   | 7,688,937  |                           | 5.26 | %
|                                                |  |                   |            |                           |      |  
|Total                                           |  | $                 | 18,286,182 |                           | 5.51 | %
|                                                |  |                   |            |                           |      |  

---

|(1) | Effective interest rate includes the impact of issuance costs and Hedging Instruments.
|--- | --------------------------------------------------------------------------------------

|(2) | Includes financing hedged with Cap Agreements with strike prices in excess of one-month LIBOR with a notional balance of $9.5 billion as of September 30,
2006.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Includes floating-rate financing hedged with Swap Agreements with a notional balance of $1.3 billion and Cap Agreements with strike prices less than one-month
LIBOR with a notional balance of $5.4 billion and fixed-rate financing of $1.0 billion as of September 30, 2006.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As of September 30, 2006, the CDOs were collateralized by ARM loans with a principal balance of $18.6 billion. The debt matures between 2033 and 2046 and is callable by the Company at par once the total balance
of the loans collateralizing the debt is reduced to 20% of their original balance. The balance of this debt is reduced as the underlying loan collateral is paid down and is expected to have an average life of approximately three years.

Whole Loan Financing Facilities

As of September 30, 2006, the Company had entered into three committed whole loan financing facilities with a total borrowing capacity of $900 million that expire between November 2006 and February 2007. In
addition to this committed borrowing capacity, the Company has an uncommitted borrowing capacity of $1.4 billion. The interest rates on these facilities are indexed to one-month LIBOR and reprice accordingly. The Company expects to renew these
facilities when they expire or replace them with new facilities with similar terms. As of September 30, 2006, the Company had $694.7 million borrowed against these whole loan financing facilities at an effective rate of 5.92%. As of
December 31, 2005, the Company had $404.8 million borrowed against these whole loan financing facilities at an effective rate of 5.04%. The amount borrowed on the whole loan financing facilities at September 30, 2006 was collateralized by
ARM loans with a carrying value of $711.4 million, including accrued interest. These facilities have covenants that are standard for industry practice and the Company was in compliance with all such covenants at September 30, 2006.

Senior Notes

The
Company had $305.0 million in Senior Notes outstanding at September 30, 2006. The Senior Notes bear interest at 8.0%, payable each May 15 and November 15, and mature on May 15, 2013. The Senior Notes are redeemable at a declining
premium, in whole or in part, beginning on May 15, 2008, and at par beginning on May 15, 2011. In connection with the issuance of the Senior Notes, the Company incurred costs of $5.4 million, which are being amortized to interest expense
over the expected life of the Senior Notes. The Company received premiums totaling $3.6 million in connection with the issuance of Senior Notes, which are being amortized over the remaining expected life of the Senior Notes. At September 30,
2006 and December 31, 2005, the balance of the Senior Notes outstanding, net of unamortized issuance costs and premiums, was $304.4 million and $304.3 million, respectively, and had an effective cost of 8.06%, which reflects the effect of
issuance costs and premiums received at issuance.

The Companys Senior Note obligations contain both financial and
non-financial covenants. Significant financial covenants include limitations on the Companys ability to incur indebtedness beyond specified levels, restrictions on the Companys ability to incur liens on assets and limitations on the
amount and type of restricted payments, such as repurchases of its own equity securities, that the Company makes. As of September 30, 2006, the Company was in compliance with all financial and non-financial covenants on its Senior Note
obligations.



20



---

##### Table of Contents

Subordinated Notes

The Company had $240.0 million in Subordinated Notes outstanding at September 30, 2006. TMA is a guarantor of the Subordinated Notes. The Subordinated Notes bear interest at a weighted
average fixed rate of 7.47% per annum for the first ten years and thereafter at a variable rate equal to three-month LIBOR plus a weighted average rate of 2.53% per annum, payable each January 30, April 30, July 30
and October 30, and mature between October 30, 2035 and April 30, 2036. TMHL has the option to redeem the Subordinated Notes at par, in whole or in part, on or after October 30, 2010. The Subordinated Notes may also be redeemed
at a premium under limited circumstances on or before October 30, 2010. In connection with the issuance of the Subordinated Notes, the Company incurred costs of $7.2 million, which are being amortized over the remaining expected life of the
Subordinated Notes.

At September 30, 2006 and December 31, 2005, the balance of all Subordinated Notes
outstanding, net of unamortized issuance costs, was $233.0 million and $184.2 million, respectively, and had an effective cost of 7.70% and 7.65%, respectively, which reflects the effect of issuance costs. TMHLs Subordinated Note obligations
contain non-financial covenants. As of September 30, 2006, TMHL was in compliance with all non-financial covenants on its Subordinated Note obligations.

Other

The total cash paid for interest was $534.6 million and $292.9 million for the
quarters ended September 30, 2006 and 2005, respectively, and $1.4 billion and $737.2 million for the nine months ended September 30, 2006 and 2005, 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, 2006 and December 31, 2005 (in thousands):



|                                  |  |                    |            |                   |   |                |  |            |            |  |   |           
|--------------------------------- |  | ------------------ | ---------- | ----------------- | - | -------------- |  | ---------- | ---------- |  | - | ----------
|                                  |  | September 30, 2006 |            | December 31, 2005
|                                  |  | CarryingAmount     |            | Fair Value        |   | CarryingAmount |  | Fair Value
|Assets:                           |  |                    |            |                   |   |                |  |            |            |  |   |           
|ARM securities                    |  | $                  | 22,192,010 |                   | $ | 22,192,010     |  | $          | 20,295,504 |  | $ | 20,295,504
|Purchased Securitized Loans       |  |                    | 7,064,517  |                   |   | 7,064,517      |  |            | 6,839,004  |  |   | 6,839,004 
|Securitized ARM Loans             |  |                    | 2,873,966  |                   |   | 2,831,616      |  |            | 3,310,717  |  |   | 3,259,586 
|ARM Loans Collateralizing CDOs    |  |                    | 18,618,998 |                   |   | 18,491,318     |  |            | 10,396,961 |  |   | 10,321,685
|ARM loans held for securitization |  |                    | 1,007,703  |                   |   | 1,007,313      |  |            | 641,843    |  |   | 643,035   
|Hedging Instruments               |  |                    | 435,907    |                   |   | 435,907        |  |            | 450,944    |  |   | 450,944   
|                                  |  |                    |            |                  
|Liabilities:                      |  |                    |            |                   |   |                |  |            |            |  |   |           
|Reverse Repurchase Agreements     |  | $                  | 21,886,974 |                   | $ | 21,886,974     |  | $          | 23,390,079 |  | $ | 23,390,079
|Asset-backed CP                   |  |                    | 8,576,300  |                   |   | 8,576,300      |  |            | 4,990,000  |  |   | 4,990,000 
|CDOs                              |  |                    | 18,286,182 |                   |   | 18,336,093     |  |            | 10,254,334 |  |   | 10,222,064
|Whole loan financing facilities   |  |                    | 694,679    |                   |   | 694,679        |  |            | 404,827    |  |   | 404,827   
|Senior Notes                      |  |                    | 305,000    |                   |   | 305,000        |  |            | 305,000    |  |   | 300,425   
|Subordinated Notes                |  |                    | 240,000    |                   |   | 240,000        |  |            | 190,000    |  |   | 190,000   
|Hedging Instruments               |  |                    | 223,873    |                   |   | 223,873        |  |            | 32,904     |  |   | 32,904    

As of September 30, 2006, the Company had no off-balance sheet credit risk.



21



---

##### Table of Contents

Note 6. Common and Preferred Stock

During the three- and nine-month periods ended September 30, 2006, the Company issued 175,000 and 5,625,500 shares, respectively, of Common Stock through at-market and off-market
transactions and received net proceeds of $4.8 million and $154.4 million, respectively, under a controlled equity offering program. During the same periods in 2006, the Company issued 224,900 and 484,900 shares, respectively, of Preferred Stock and
received net proceeds of $5.4 million and $11.8 million, respectively.

During the three- and nine-month periods ended September 30,
2006, the Company issued 239,060 and 3,061,161 shares, respectively, of Common Stock under the DRSPP and received net proceeds of $5.7 million and $79.7 million, respectively.

As of September 30, 2006, $912.0 million of the Companys registered securities remained available for future issuance and sale under its shelf registration statement, declared
effective on June 16, 2005.

On July 20, 2006, the Company declared the second quarter 2006 dividend of $0.68 per share of Common
Stock, which was paid on August 16, 2006 to shareholders of record as of August 4, 2006.

On September 15, 2006, the Company
declared the third quarter 2006 dividend of $0.50 per share of Preferred Stock, which was paid on October 16, 2006 to shareholders of record as of September 29, 2006.

For federal income tax purposes, all dividends are expected to be ordinary income to the Companys common shareholders, subject to year-end allocations of the 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. Comprehensive Income (Loss)

Comprehensive income (loss) is composed of net income and OCI,
which includes the change in unrealized gains and losses on available-for-sale Purchased ARM Assets and Hedging Instruments designated as cash flow hedges. The following table presents OCI balances (in thousands):



|                            |  |                                         |          |   |                                      |   |          |                                   |  |   |          |  
|--------------------------- |  | --------------------------------------- | -------- | - | ------------------------------------ | - | -------- | --------------------------------- |  | - | -------- | -
|                            |  | Unrealized losseson PurchasedARM Assets |          |   | Unrealizedgains onHedgingInstruments |   |          | Accumulatedothercomprehensiveloss | 
|Balance, December 31, 2004  |  | $                                       | (177,337 | ) |                                      | $ | 86,622   |                                   |  | $ | (90,715  | )
|Net change                  |  |                                         | (261,465 | ) |                                      |   | 251,460  |                                   |  |   | (10,005  | )
|                            |  |                                         |          |   |                                      |   |          |                                   |  |   |          |  
|Balance, September 30, 2005 |  | $                                       | (438,802 | ) |                                      | $ | 338,082  |                                   |  | $ | (100,720 | )
|                            |  |                                         |          |   |                                      |   |          |                                   |  |   |          |  
|Balance, December 31, 2005  |  | $                                       | (537,510 | ) |                                      | $ | 389,993  |                                   |  | $ | (147,517 | )
|Net change                  |  |                                         | 81,857   |   |                                      |   | (196,311 | )                                 |  |   | (114,454 | )
|                            |  |                                         |          |   |                                      |   |          |                                   |  |   |          |  
|Balance, September 30, 2006 |  | $                                       | (455,653 | ) |                                      | $ | 193,682  |                                   |  | $ | (261,971 | )
|                            |  |                                         |          |   |                                      |   |          |                                   |  |   |          |  

Note 8. Long-Term Incentive Awards

The Companys Board of Directors adopted the Plan, effective September 29, 2002. The Plan authorizes TMAs Compensation Committee to grant DERs, SARs and PSRs.

As of September 30, 2006, there were 1,598,067 DERs outstanding, all of which were vested, and 1,349,740 PSRs outstanding, of which 1,210,118 were
vested. The Company recorded income associated with DERs and PSRs of $735,000 for the quarter ended September 30, 2006 and income of $1.8 million for the quarter ended September 30, 2005. The income recorded in the third quarter of 2006
consists of $3.1 million resulting from the impact of the decrease in the Common Stock price on the value of the PSRs which was recorded as a fair value adjustment, partially offset by $1.9 million associated with dividend equivalents paid on DERs
and PSRs and $504,000 related to the amortization of unvested PSRs The income recorded in the third quarter of 2005 consisted of $4.4 million resulting from the impact of the decrease in the Common Stock price on the value of the PSRs which was
recorded as a fair value adjustment, partially offset by $1.7 million associated with dividend equivalents paid on DERs and PSRs and $870,000 related to the amortization of unvested PSRs. During the nine-month periods ended September 30, 2006
and 2005, the Company recorded an expense associated with DERs and PSRs in the amount of $5.8 million and $2.9 million, respectively.



22



---

##### Table of Contents

Note 9. Transactions with Related Parties

The Company is managed externally by the Manager under the terms of the Management Agreement. The Manager receives an annual base management fee of 1.36% on the first $300 million of Average
Historical Equity, plus 1.00% on Average Historical Equity above $300 million but less than $1.5 billion. The additional fee earned on Average Historical Equity is limited to 0.88% on Average Historical Equity greater than $1.5 billion but less than
$2.0 billion, to 0.82% for Average Historical Equity greater than $2.0 billion but less than $2.5 billion, to 0.77% for Average Historical Equity greater than $2.5 billion but less than $3.0 billion, and is capped at 0.72% on any Average Historical
Equity greater than $3.0 billion. These percentages are subject to an inflation adjustment each July based on changes to the Consumer Price Index over the prior twelve month period. The Manager earns a performance-based incentive fee of 20% of the
Companys annualized net income, before performance-based compensation, above an annualized ROE as defined in the Management Agreement equal to the Ten Year U.S. Treasury Rate plus 1%, with the fee limited such that once the Manager has earned
a performance fee of $30 million, the performance fee percentage of 20% is reduced by 1% for each additional $5 million earned in performance fees until reaching a performance fee percentage of 15% for any amount greater than $50 million.

The Management Agreement provides for an annual review of the Managers performance under the Management Agreement by the
Companys independent directors. In addition, the Board of Directors reviews the Companys financial results, policy compliance and strategic direction on a quarterly basis. If the Company terminated the Management Agreement for a reason
other than for cause, a substantial cancellation fee would be payable to the Manager.

During the quarters ended September 30, 2006
and 2005, the Company reimbursed the Manager $3.2 million and $1.9 million, respectively, for expenses in accordance with the terms of the Management Agreement. During the nine months ended September 30, 2006 and 2005, the Company reimbursed
the Manager $8.6 million and $5.3 million, respectively, for expenses. As of September 30, 2006 and 2005, $5.7 million and $4.2 million, respectively, was payable by the Company to the Manager for these reimbursable expenses.

For the quarters ended September 30, 2006 and 2005, the Company incurred base management fees of $6.4 million and $5.6 million, respectively, in
accordance with the terms of the Management Agreement. For the nine-month periods ended September 30, 2006 and 2005, the Company incurred base management fees of $18.2 million and $15.4 million, respectively. As of September 30, 2006 and
2005, $2.1 million and $1.9 million, respectively, was payable by the Company to the Manager for the base management fee.

For the quarters
ended September 30, 2006 and 2005, the Manager earned performance-based compensation in the amount of $8.7 million and $10.3 million, respectively. For the nine-month periods ended September 30, 2006 and 2005, the Manager earned
performance-based compensation in the amount of $24.9 million and $30.1 million, respectively. As of September 30, 2006 and 2005, $8.7 million and $10.3 million, respectively, was payable by the Company to the Manager for performance-based
compensation.

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 and officers of the Company and employees of the Manager 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 or association
with the Company or the related entity 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 are not eligible for the employee
discount. As of September 30, 2006, the aggregate balance of mortgage loans outstanding to directors and officers of the Company, employees of the Manager and other affiliates amounted to $52.1 million, had a weighted average interest rate of
4.98%, and maturities ranging between 2030 and 2036.

Note 10. Subsequent Events

On October 16, 2006, the Company declared the third quarter 2006 dividend of $0.68 per share of Common Stock, which is payable on November 15,
2006 to shareholders of record as of November 3, 2006.

In October 2006, the Company realized a gain of $8.6 million on the sale of
$1.6 billion of Hybrid ARM Assets.



23



---

##### Table of Contents

In this quarterly report, we refer to Thornburg Mortgage, Inc. and its subsidiaries as we,
us, or the Company, unless we specifically state otherwise or the context indicates otherwise. Capitalized terms not otherwise defined in this quarterly report shall have the definitive meanings assigned to them in the
Glossary at the end of this report.

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

Executive Overview

Our goal is to acquire or originate ARM Assets for our
portfolio using both equity capital and borrowed funds and finance them in such a way so as to achieve earnings and dividend stability as our primary objective, and earnings and dividend growth as our secondary objective. In order to achieve these
objectives, we must mitigate key risks inherent in the mortgage portfolio lending business, principally credit risk and interest rate risk, while simultaneously pursuing earnings growth strategies. Our three primary strategies are (i) to
increase our more profitable, higher margin mortgage loan origination business; (ii) to raise Common Stock and access alternative sources of long-term capital such as preferred stock and unsecured debt that provide increased earnings to our
existing Common Stock and (iii) to grow our assets relative to our existing capital base by pursuing non-recourse funding sources, relying less on Reverse Repurchase Agreements and more on CDOs to finance our balance sheet.

Earnings Growth Strategies

Higher
Margin Loan Originations.Our goal remains to increase our loan originations as a percentage of our annual portfolio acquisitions due to the higher margin potential of those assets. Despite continued highly competitive pricing, industry-wide
origination decreases and a more aggressive approach to granting credit by other mortgage lenders, our loan originations totaled $1.4 billion in the third quarter, up 10% from the same period last year. We expect our mortgage origination volumes
will remain strong going forward based on the $756.2 million of loans in the fallout-adjusted pipeline at September 30, 2006, most of which we expect will close in the fourth quarter of 2006. Our correspondent relationships have increased 52%
year-over-year, and we now have approximately 273 correspondent partners across the country.

In the second quarter of 2006, we began
originating loans through mortgage brokers, our wholesale channel. We remain confident that as this channel grows, it will become an attractive source of higher yielding loans for us. We also believe our entry into the wholesale business on a fully
paperless and internet-based basis will offer improved levels of service within the industry. Leveraging the same strategy that has proven successful with correspondent lenders, including superior service, sensible underwriting and products designed
to meet our sophisticated clients needs, we anticipate generating similar success over time. As of September 30, 2006, we had 70 brokers approved to do business with us.

We have also expanded our customer retention and referral program  The Thornburg Mortgage Exchange ProgramSM as the earnings benefit of retaining an existing client is greater than on new origination business. Our core service feature under this program has
been the loan modification option, in which our borrowers can change the rate or other terms of their loans with a brief phone call and a small fee. Since 2002, we have modified 3,910 loans representing $2.1 billion. Another feature of The Thornburg
Mortgage Exchange ProgramSMis that, on a streamlined basis, our borrowers can cash out equity from their homes. Our
growing loan servicing portfolio, or client base, which grew 33% over the year ago period to $11.3 billion, should be a promising source for loan exchanges and new loans in the future. This servicing portfolio now represents 20,109 customers.

As part of our ARM Asset acquisition strategy in the current environment, we also made a decision to acquire and/or originate Pay Option
ARMs. Year-to-date, we have acquired or originated $2.3 billion of these ARM loans. Spreads on these assets are wider than on standard Hybrid ARMs, which should enhance profitability going forward notwithstanding anticipated higher
delinquencies. We believe our underwriting capabilities and extensive experience with jumbo and super jumbo loans will allow us to prudently acquire these assets at better risk-adjusted returns than are currently available through standard
Hybrid ARM acquisitions.

Adfitech Acquisition.On August 21, 2006, we acquired Adfitech, a provider of quality control
post-closing audit and document delivery services to the mortgage industry, from a subsidiary of Centex Corporation. Prior to the acquisition, we partnered with Adfitech for three years on an outsourced basis for quality control services, imaging
and other selected mortgage-related functions that supported our loan origination business across all loan origination channels  correspondent, wholesale and retail.



24



---

##### Table of Contents

In the near term, the acquisition expands our operational platform and gives us increased control over
many of the back-office operations needed to grow our loan origination business. Over the longer term, Adfitech will provide us with an entry point into providing pre- and post-funding quality control services to the mortgage industry giving us the
opportunity to develop a new source of non-interest income. Adfitech will continue to operate as a separate business unit as a wholly-owned subsidiary of TMHL and will continue to serve its mortgage lending clients on a business-as-usual basis from
its headquarters in Edmond, Oklahoma. The results of Adfitechs operations have been included in our consolidated financial statements since it was acquired and are not material.

Long-term Capital Growth.We raised $10.5 million of new common equity capital during the third quarter at an average net price of $25.29 per share and $5.4 million of new preferred equity
capital at an average net price of $24.20 per share. This new long-term capital will contribute modestly to additional balance sheet and earnings growth in the future, principally through the acquisition and origination of high quality ARM Assets.
Going forward, given the tight spread environment on ARM Assets, rate of return opportunities are lower than they have been in previous years, and we may consider utilizing alternative lower cost, long-term capital sources such as preferred stock
and unsecured debt to support future earnings and balance sheet growth.

Capital-Efficient CDO Transactions.Since CDOs represent
long-term financing and have no margin call risk, they reduce our capital requirements when used to finance our portfolio, providing an additional source of balance sheet and earnings growth. Our financing capital requirement for CDOs is lowered to
the capital required to support the financing which, in the aggregate, approximates 2% versus our customary 8% to 10% capital policy requirement for Reverse Repurchase Agreement and Asset-backed CP financing. This more efficient use of capital
allows us to invest in additional high quality ARM Assets financed through recourse borrowings. In the third quarter of 2006, we completed CDO transactions totaling $4.4 billion that freed up an estimated $304.6 million of capital, which will allow
us to acquire an additional $3.4 billion in ARM Assets.

Use of Excess Capital to Grow Interest Earning Assets.Since the second
quarter of 2005 we began utilizing a portion of our excess capital to increase our holdings of interest earning assets. By reducing our Adjusted Equity-to-Assets ratio from an average of 8.96% during the second quarter of 2005 to 8.02% at
September 30, 2006, we were able to boost core earnings without compromising our strong liquidity position, as evidenced by our continued strong unencumbered asset position and growing value of Hedging Instruments, which totaled $1.3 billion at
September 30, 2006.

Consistent Profitability and Dividend Stability

Our business model is designed to protect our profitability during periods of changing interest rates or yield curves in that we fund our Hybrid ARM portfolio with fixed-rate borrowings and
hybrid Hedging Instruments of comparable duration. Because longer-duration funds are usually more expensive, this strategy reduced our net interest income and earnings potential in prior years, but has been a contributor to our relative earnings
stability through this current rising interest rate cycle and flattening yield curve environment. Nevertheless, our earnings during the third quarter of 2006 reflect the continued difficult competitive and operating environment, which has continued
to put downward pressure on our Portfolio Margin resulting in earnings that were below the level required to maintain the current dividend on our Common Stock. We have seen tighter spreads on ARM assets caused by reduced mortgage loan volume in
general and intense competition for the volume that remains. Further, our older Swap Agreements have begun to mature whereas our older Hybrid ARMs are not resetting or prepaying as quickly as we had anticipated because of the current higher interest
rate environment. While the Federal Funds rate did not change during the quarter, the yield curve responded by inverting further with short-term rates holding flat and longer-term rates decreasing, which may also impact future ARM origination
volume.

Our approach to offsetting these competitive market and balance sheet pressures remains the same  to grow our balance sheet
using an array of asset acquisition, financing and capital strategies including employing our strong capital base while still managing interest rate and credit risk. Additionally, approximately $2.6 billion of our Hybrid ARMs have interest rates
that will reset over the next year. We believe these factors will improve our earnings over time, but that improvement may not materialize quickly enough to allow us to maintain the current dividend level during 2007. For now, we remain committed to
long-term dividend consistency and are confident that the combination of our fourth quarter earnings and undistributed taxable earnings will cover the dividend for the fourth quarter. After the payment of the third quarter dividend, we expect to
have in reserve an estimated $0.12 per share of Common Stock of undistributed taxable income.

Prepayment activity remained constant in the
third quarter with a CPR of 15%, down materially from 28% a year ago. In accordance with SFAS 91, we made a 3% downward adjustment in our expected future prepayment rates on our Hybrid ARM assets to more accurately reflect the actual prepayment
experience we have observed over the past nine months and expect to see in the future. This adjustment reduced the premium amortization of our Hybrid ARMs by $14.0 million for the quarter ($0.10 per share on a performance fee adjusted basis) and
explains why our Portfolio Margin remained unchanged for the



25



---

##### Table of Contents

quarter. Had we not made this adjustment for the quarter, our Portfolio Margin of 0.69% would have been
0.61%. Our quarterly premium amortization expense has remained manageable because the unamortized cost basis of our ARM portfolio is very low  100.6% of par at September 30, 2006. This premium marks a historic low for us and will
advantageously limit our exposure to prepayments should refinance activity increase in the future.

We possess a number of strategic
advantages that allow us to generate consistent profitability over time. One of these strategic advantages is our low operating expense structure which is also variable generally based on ROE performance. During the third quarter of 2006, our
operating expenses as a percent of average assets were 0.17%, compared to 0.22% for the same quarter of 2005. We are able to operate at this low level of operating expenses relative to the size of our portfolio because we do not operate like a
traditional mortgage lender or FDIC-insured depository institution. We acquire many of our assets through MBS purchases, originate loans by developing strategic partnerships with correspondent lenders, mortgage brokers, lending partners and other
sources, and fund our balance sheet using capital market-sourced funds, as opposed to FDIC insured deposits and FHLB advances. As a result, we generally avoid the high overhead associated with retail branch networks and commissioned loan officers.
In addition, we have developed other outsourced strategic partnerships that provide loan fulfillment services on a variable cost basis. A significant component of our cost structure is a performance fee paid to the Manager based on ROE which has
declined over the past year, resulting in a comparable decline in operating expense as a percentage of assets. This low, variable-cost model has allowed us to operate profitably with a lower interest rate spread on our portfolio, enabling us to
mitigate certain cyclical risks frequently associated with mortgage banking and portfolio lending activities. Our low operating cost structure and REIT tax status have allowed us to reduce investment risk and invest primarily in High Quality ARM
Assets. We elect to securitize our acquired and originated ARM loans or invest primarily in AAA- or AA-rated securities, Agency Securities or A quality ARM loans. This strategy has resulted in very low credit losses. See additional
discussion in the Exceptional Credit Quality and Securitization section below. Finally, by employing a portfolio lending strategy and retaining all of our ARM loans rather than employing a mortgage-banking strategy and selling our ARM
loan production, we do not depend on gain on sale income, which can fluctuate significantly with loan origination volume and market conditions.

Exceptional Credit Quality and Securitization

One of our strategic focuses is high credit quality assets. We believe this
strategy keeps our credit losses and financing costs low. It also creates significant portfolio liquidity and low portfolio price volatility, which gives us access to financing through the credit cycle and contributes to maintaining consistent
profitability. As of September 30, 2006, 96.8% of our ARM Asset portfolio was High Quality. Many of our High Quality ARM Assets consist of A quality ARM loans that we have purchased or originated and securitized either into ARM
pass-through certificates or into CDO financings for our own portfolio. We retain the risk of potential credit losses on all of these loans and have loan loss reserves totaling $12.5 million, or 6 BP, at September 30, 2006. We did not
experience any credit losses on our ARM Loans during the third quarter of 2006 and since 1997 have only experienced $174,000 in credit losses on loans we have originated or acquired.

Additionally, our High Quality ARM Assets include Purchased Securitized Loans, which are A quality ARM loans originated and securitized by third parties which we have acquired for our
portfolio. These assets are Qualifying Interests for purposes of maintaining our exemption from the Investment Company Act because we retain a 100% ownership interest in the underlying loans. Because we purchase all classes of these securitizations,
we have the credit exposure on the underlying loans. Prior to the purchase of these securities, our due diligence process allows us to remove loans that do not meet our credit standards based on loan-to-value ratios, borrowers credit scores,
income and asset documentation and other criteria that we believe to be important indications of credit risk. The purchase price of the classes that are less than Investment Grade generally includes a discount for probable credit losses, and based
on managements judgment, the portion of the purchase discount which reflects the estimated unrealized loss on the securities due to credit risk is treated as a non-accretable discount and totaled $15.2 million, or 21 BP, at September 30,
2006.

Interest Rate Risk Management

Interest rate changes affect our short-term borrowing costs, which as a spread lender can pose a risk to our profitability if not responsibly managed. To counter this potential risk, when we purchase or originate
Hybrid ARM Assets, we adhere to a matched funding or duration matching strategy which means we use Hybrid ARM Hedging Instruments to fix, or cap, the interest rates on the short-term borrowings and CDOs that finance our Hybrid ARM Assets. We hedge
our financing cost such that we maintain a Net Effective Duration of less than one year. The lower the Effective Duration gap, the less impact interest rate changes should have on the market value of our portfolio and therefore on earnings. As of
September 30, 2006, we had $45.4 billion of Hybrid ARM Assets and had entered into Swap Agreements with notional balances totaling $37.0 billion and delayed Swap Agreements with notional balances totaling $13.3 billion that become effective
between October 2006 and June 2009. These delayed Swap Agreements have been entered into to hedge the financing of existing ARM



26



---

##### Table of Contents

Assets and the forecasted financing of ARM Assets purchase commitments at September 30, 2006, and to
replace Swap Agreements as they mature. Additionally, at September 30, 2006, we had Cap Agreements with aggregate net notional balances of $984.9 million. These Cap Agreements receive payments if one-month LIBOR rises above a range of 3.05% to
9.67%, and on average 5.40%. During the quarter ended September 30, 2006, we received payments of $3.6 million related to these Cap Agreements. As of September 30, 2006, we measured the Net Effective Duration applicable to our Hybrid ARM
portfolio, related borrowings and Hybrid ARM Hedging Instruments at approximately negative 0.10 years, while the financing and hedging of all of our ARM Assets resulted in a Net Effective Duration of approximately negative 0.06 years.

We continue to employ a duration matching funding strategy as we acquire Hybrid ARM Assets in order to stabilize earnings during periods of rising
interest rates. As we acquire ARM Assets, we attempt to lock-in a spread that is expected to provide a rate of return at or above our threshold requirement. In order to stabilize the spread over the expected life of our ARM Assets, we
use Hedging Instruments in conjunction with our borrowings to approximate the repricing characteristics of our ARM Assets. Given the prepayment uncertainties on our ARM Assets, there is no guaranteed way to lock-in a spread between the
yield on our ARM Assets and the related borrowing that would produce an acceptable rate of return. However, through active management, we believe we can continue to mitigate a significant amount of net interest income volatility. See the discussion
of Effects of Interest Rate Changes on page 58.

Funding Diversification

Another long-term objective is to achieve a more balanced funding mix between Asset-backed CP, CDOs and Reverse Repurchase Agreements in order to reduce our reliance on any one funding source.
Historically, we have relied principally on Reverse Repurchase Agreements for our funding needs. Since year end 2002, we have been actively working towards diversifying our financing sources. At that time, 91% of our borrowings were provided through
Reverse Repurchase Agreements. At September 30, 2006, Reverse Repurchase Agreements accounted for only 44% of our borrowings, while CDOs represented 37% and our Asset-backed CP facility accounted for 17%. We anticipate that CDOs and
Asset-backed CP will continue to grow as a percentage of our financing sources in the future.

Forward-Looking Statements

Certain information contained in this Quarterly Report on Form 10-Q constitutes forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are based on our current expectations, estimates and projections. Pursuant to those sections, we may obtain a safe
harbor for forward-looking statements by identifying those statements and by accompanying those statements with cautionary statements, which identify factors that could cause actual results to differ from those expressed in the forward-looking
statements. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. The words believe, anticipate, intend, aim,
expect, will, strive, target, confidence and project and similar words identify forward-looking statements. Such statements are not guarantees of future performance, events or
results and involve potential risks and uncertainties. Accordingly, our actual results may differ from our current expectations, estimates and projections. Important factors that may impact our actual results or may cause our actual results to
differ materially from those expressed in any forward-looking statements made by us or on our behalf include, but are not limited to, changes in interest rates, changes in yields available for purchase on adjustable and variable rate mortgage
assets, changes in the yield curve, changes in prepayment rates, changes in the supply of mortgage-backed securities and loans, our ability to obtain financing and the terms of any financing that we do obtain. Other factors that may impact our
actual results are discussed in our 2005 Annual Report on Form 10-K under the section entitled Risk Factors. We do not undertake any obligation to publicly release the result of any revisions that may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Corporate Governance

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



| |  |  | The Board of Directors is, and always has been, composed of a majority of independent directors. The Audit, Nominating/Corporate Governance and Compensation
Committees of the Board of Directors are, and always have been, composed exclusively of independent directors. The Board of Directors 1) reviews our financial results, policy compliance and strategic direction on a quarterly basis, 2) reviews our
budget and five-year strategic plan annually and 3) performs an annual review of the Managers compensation, performance and implementation of our strategic plan.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



27



---

##### Table of Contents

| |  |  | We have a Code of Conduct and Corporate Governance Guidelines that cover a wide range of business practices and procedures that apply to all of our employees,
officers, directors and the Manager that foster the highest standards of ethics and conduct in all of our business relationships. In addition, we have instituted a Nonretaliation Policy and Procedure for Whistleblowers that sets forth procedures by
which any officer or employee of the Company or the Manager may raise concerns regarding alleged violations of federal fraud or securities laws, which may involve financial matters, such as accounting, auditing or financial reporting, as well as
non-financial matters, with the appropriate supervisors, officers or committees of the Board of Directors.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have an Insider Trading Policy to prohibit any of the directors, officers or employees of the Company or the Manager from buying or selling our stock on the
basis of material nonpublic information or communicating material nonpublic information to others.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We are managed externally by the Manager under the terms of the Management Agreement, subject to the supervision of the Board of Directors. The Managers
compensation is based on formulas tied to our success in increasing equity capitalization and generating net income above defined targets. The Compensation Committee and the independent directors annually evaluate the Managers performance and
determine whether the compensation paid to the Manager is reasonable in relation to the nature and quality of services performed.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have a formal internal audit function to further the effective functioning of our internal controls and procedures. Our internal audit plan is approved
annually by the Audit Committee of the Board of Directors and is based on a formal risk assessment and is intended to provide management and the Audit Committee with an effective tool to identify and address areas of financial or operational
concerns and ensure that appropriate controls and procedures are in place. Section 404 of the Sarbanes-Oxley Act of 2002 requires an annual evaluation of internal control over financial reporting. See Controls and Procedures 
Managements Annual Report on Internal Control over Financial Reporting on page 51 of our 2005 Annual Report on Form 10-K.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

You may also find the Code of Conduct, the
Corporate Governance Guidelines and the charters of the Audit Committee, Nominating/Corporate Governance Committee and Compensation Committee of the Board of Directors at our website under the Investor Information  Corporate
Governance section. These documents are also available in print to anyone who requests them by writing to us at the following address: 150 Washington Avenue, Suite 302, Santa Fe, New Mexico, 87501, or by phoning us at 1-888-898-8698.

Critical Accounting Policies and Estimates

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



| |  | Revenue Recognition. Interest income on ARM Assets is a combination of the interest earned based on the outstanding balance and contractual terms of the assets
and the amortization of yield adjustments, principally the amortization of purchase premiums and discounts. Premiums and discounts associated with the purchase of ARM Assets are amortized into interest income over the estimated lives of the assets
in accordance with FASB 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, using the interest method adjusted for the effects of actual and future estimated
prepayments. The use of these methods requires us to project cash flows over the remaining life of each asset. These projections include assumptions about interest rates, prepayment rates, timing and amount of credit losses, estimates regarding the
likelihood and timing of calls of securities at par, and other factors. Estimating prepayments and estimating the remaining lives of our ARM Assets requires management judgment, which involves consideration of possible future interest rate
environments and an estimate of how borrowers will behave in those environments. We review our cash flow projections on an ongoing basis and monitor these projections based on input and analyses received from external sources, internal models, and
our own judgment and experience. We regularly review our assumptions and make adjustments to the cash flows as deemed necessary. There is
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



28



---

##### Table of Contents

no assurance that the assumptions we use to estimate future cash flows, or the current
periods yield for each asset, will prove to be accurate.

The following table presents a sensitivity analysis to show
the one-time adjustment we would have to make to our net purchase premium of $361.7 million at September 30, 2006 for 5% and 10% increases and decreases to our lifetime prepayment assumptions. The purpose of this analysis is to provide an
indication of the impact that changes to the lifetime prepayment assumptions have on our purchase premium. We believe the current lifetime assumptions used are appropriate and consistent with our long-term portfolio experience.



|                                       |  |                                                          |         |  
|-------------------------------------- |  | -------------------------------------------------------- | ------- | -
|Changed Assumption                     |  | Increase (Decrease) inNet Purchase Premium(in thousands) |        
|Prepayment assumption increased by 5%  |  | $                                                        | (5,427  | )
|Prepayment assumption increased by 10% |  | $                                                        | (10,663 | )
|Prepayment assumption decreased by 5%  |  | $                                                        | 5,531   |  
|Prepayment assumption decreased by 10% |  | $                                                        | 11,275  |  



| |  | Fair Value. We record our Purchased ARM Assets, commitments to purchase ARM loans and Hybrid ARM Hedging Instruments at fair value. The fair values of our
Purchased ARM Assets and Hybrid ARM Hedging Instruments are generally based on market prices provided by third-party pricing services or certain dealers which make markets in these financial instruments. If the fair value of a Purchased ARM Asset,
Hybrid ARM Hedging Instrument or other financial instrument is not reasonably available from a third-party pricing service or dealer, management estimates the fair value. This requires management judgment in determining how the market would value a
particular Purchased ARM Asset, Hybrid ARM Hedging Instrument or other financial instrument, based on characteristics of the security and available market information. The net unrealized gain or loss on loans expected to be purchased from
correspondent lenders and bulk sellers is calculated using the same methodologies that are used to price our ARM Loans, adjusted for anticipated fallout of purchase loan commitments that will likely not be funded. The fair values reported reflect
estimates and may not necessarily be indicative of the amounts we could realize in a current market exchange.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Impairment of Purchased ARM Assets and Non-Accretable Discounts on Purchased ARM Assets. Purchased ARM Assets are evaluated for impairment on a quarterly basis,
or more frequently if events or changes in circumstances indicate that these investments may be impaired. We evaluate whether our Purchased ARM Assets are considered impaired, evaluate whether the impairment is other than temporary, and, if the
impairment is other than temporary, recognize an impairment loss equal to the difference between the Purchased ARM Assets amortized cost basis and its fair value. These evaluations require management to make estimates and judgments based on
changes in market interest rates, changes in credit ratings, delinquency data on the loans underlying the respective securities and other information to determine whether unrealized losses are reflective of credit deterioration and to evaluate
managements ability and intent to hold the investment to maturity or recovery. Because the estimate for other-than-temporary impairment requires management judgment, we consider this to be a critical accounting estimate. We have determined
that the gross unrealized losses on Purchased ARM Assets of $493.0 million at September 30, 2006 are not reflective of credit deterioration and because we have the ability and intent to hold the Purchased ARM Assets until recovery, the losses
are not other-than-temporary impairments.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A portion of our Purchased Securitized Loans are rated less
than Investment Grade and represent subordinated interests in High-Quality, first lien residential mortgage loans where we own all of the securitized classes. We generally purchase the less than Investment Grade classes at a discount. Based upon
managements use of analysis and judgment, a portion of the purchase discount is subsequently accreted as interest income under the effective yield method while the remaining portion of the purchase discount is treated as a non-accretable
discount which reflects the estimated unrealized loss on the securities due to credit losses on the underlying loans. We review Purchased Securitized Loans periodically for impairment and record or adjust non-accretable discounts accordingly.
Non-accretable discounts are increased by recognizing an impairment loss when management determines that there is a decline in the fair value of a Purchased Securitized Loan that is considered other than temporary and decreased when there is
improvement in the risk exposures. Any such determinations are based on managements assessment of numerous factors affecting the fair value of Purchased Securitized Loans, including, but not limited to, current economic conditions, potential
for natural disasters, delinquency trends, credit losses to date on underlying mortgages and remaining credit protection. If management ultimately concludes that the non-accretable discounts will not represent realized losses, the balances are
accreted into earnings over the remaining life of the loan under the interest method.



29



---

##### Table of Contents

| |  | Loan Loss Reserves on ARM Loans. We maintain a reserve for loan losses based on managements estimate of credit losses inherent in our portfolio of ARM
Loans. The estimation of the reserve is based on a variety of factors including, but not limited to, industry statistics, current economic conditions, potential for natural disasters, loan portfolio composition, delinquency trends, credit losses to
date on underlying loans and remaining credit protection. If the credit performance of our ARM Loans is different than expected, we adjust the reserve for loan losses to a level deemed appropriate by management to provide for estimated losses
inherent in our ARM Loan portfolio. Two critical assumptions used in estimating the loan loss reserves are an assumed rate of default, which is the expected rate at which loans go into foreclosure over the life of the loans, and an assumed rate of
loss severity, which represents the expected rate of realized loss upon disposition of the properties that have gone into foreclosure.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The following table presents a sensitivity analysis to show the impact on our loan loss reserves at September 30, 2006 of using 5% increases and decreases in the borrowers propensity to default and the loss
severity if there is a default. The purpose of this analysis is to provide an indication of the impact that defaults and loss severity assumptions have on our estimate of loan loss reserves. It is not intended to imply our expectation of future
default levels or changes in loss severity. We believe the current assumptions used for defaults and loss severity are appropriate.



|                                         |  |                                                        |        |  
|---------------------------------------- |  | ------------------------------------------------------ | ------ | -
|Changed Assumption                       |  | Increase (Decrease)in Loan Loss Reserves(in thousands) |       
|Default assumption increased by 5%       |  | $                                                      | 1,344  |  
|Default assumption decreased by 5%       |  | $                                                      | (1,359 | )
|Loss severity assumption increased by 5% |  | $                                                      | 3,031  |  
|Loss severity assumption decreased by 5% |  | $                                                      | (3,052 | )

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

Accounting Changes and Other Accounting Developments

On January 1, 2006, we adopted SFAS 123(R) entitled Share-Based Payment. It requires all public companies to report share-based compensation expense at the grant date fair value
of the related share-based awards and to record subsequent changes in the fair value of the awards in current period earnings. Since we have accounted for our long-term incentive awards on this basis since inception of the Plan, the adoption had no
impact on our financial statements.

In January 2006, the FASB issued an exposure draft titled, The Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. If approved, the proposed standard would provide an option under which an entity may irrevocably elect to report certain financial assets and financial
liabilities at fair value. Companies would be permitted to make the election on a contract-by-contract basis at the time each contract is initially recognized in the financial statements or upon an event that gives rise to a new basis of accounting
for the item. Under the fair value option, changes in the fair value of each financial asset or financial liability would be reflected in earnings as those changes occur. Until the final standard is approved and the full scope is established, we are
not able to assess the impact, if any, that the adoption of the standard may have on our financial position or results of operations.

In
February 2006, the FASB issued SFAS 155, Accounting for Certain Hybrid Financial Instruments. Key provisions of SFAS 155 include: (1) a broad fair value measurement option for certain hybrid financial instruments that contain an
embedded derivative that would otherwise require bifurcation; (2) clarification that only the simplest separations of interest payments and principal payments qualify for the exception afforded to interest-only strips and principal-only strips
from derivative accounting under paragraph 14 of SFAS 133, Accounting for Derivative Instruments and Hedging Activities, (thereby narrowing such exception); (3) a requirement that beneficial interests in securitized financial assets
be analyzed to determine whether they are freestanding derivatives or whether they are hybrid instruments that contain embedded derivatives requiring bifurcation; (4) clarification that concentrations of credit risk in the form of subordination
are not embedded derivatives; and (5) elimination of the prohibition on a QSPE holding passive derivative financial instruments that pertain to beneficial interests that are or contain a derivative financial instrument. In October 2006, the
FASB proposed that securitized interests that only contain an embedded derivative tied to the prepayment risk of the underlying prepayable financial assets be excluded from the scope of SFAS 155. Until the scope exception is finalized, we are not
able to assess the impact, if any, that the adoption of SFAS 155 may have on our financial position or results of operations. SFAS 155 will become effective for us beginning January 1, 2007.



30



---

##### Table of Contents

In March 2006, the FASB issued SFAS 156, Accounting for Servicing of Financial Assets. SFAS
156 amends SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately-recognized servicing assets and liabilities. Under SFAS 156, servicing
assets and liabilities are no longer recognized in securitizations that are not accounted for as sales under SFAS 140. It also requires all separately-recognized servicing assets and liabilities to be initially measured at fair value, and permits
companies to elect, on a class-by-class basis, to account for servicing assets and liabilities on either a lower of cost or market value basis or a fair value measurement basis. We adopted SFAS 156 on January 1, 2006 and have not recognized any
servicing assets or liabilities in connection with our securitizations subsequent to that date because they are accounted for as secured borrowings under SFAS 140. We did not elect to measure our previously existing servicing assets at fair value
and continue to measure them at the lower of cost or market value.

In September 2006, the FASB issued SFAS 157, Fair Value
Measurements. This statement defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or
permit fair value measurements. We are required to adopt the provisions of the standard effective January 1, 2007.

During September
2006, the SEC staff issued Staff Accounting Bulletin No. 108, which discusses the process of quantifying financial statement misstatements. This pronouncement is effective for fiscal years ending after November 15, 2006. We believe
adoption of this pronouncement will have no material impact on our financial position, results of operations or cash flows.

General

We are a single-family residential mortgage lender that originates, acquires and retains investments in ARM Assets, thereby providing
capital to the single-family residential housing market. Our ARM Assets consist of Purchased ARM Assets and ARM Loans and are comprised of Traditional ARM Assets and Hybrid ARM Assets. Purchased ARM Assets are MBS that represent interests in pools
of ARM loans, which are publicly rated and issued by third parties and may include guarantees or other third-party credit enhancements against losses from loan defaults. ARM Loans are either loans that we have securitized from our own loan
origination or acquisition activities, loans that we use as collateral to support the issuance of CDOs or loans pending securitization. Like traditional banking institutions, our income is generated primarily from the net spread or difference
between the interest income we earn on our ARM Assets and the cost of our borrowings. Our strategy is to maximize the long-term sustainable difference between the yield on our ARM Assets and the cost of financing these assets, and to maintain that
difference through interest rate and credit cycles.

While we are not a bank or savings and loan institution, our business purpose,
strategy, method of operation and risk profile are best understood in comparison to such institutions. We finance the purchases and originations of our ARM Assets with equity capital, unsecured debt, CDOs and short-term borrowings such as Reverse
Repurchase Agreements, Asset-backed CP, whole loan financing facilities, and other collateralized financings that we may establish in the future. When we borrow short-term or floating-rate funds to finance our Hybrid ARM Assets, we also enter into
interest rate hedging transactions, which are intended to fix, or cap, our borrowing costs during the fixed-rate period of the Hybrid ARM assets. We believe we have minimized our exposure to changes in interest rates since the assets we hold are
primarily ARM Assets and we generally match the Effective Duration, which is a calculation expressed in months or years that is a measure of the expected price change of financial instruments based on changes in interest rates, of those assets with
funding of comparable Effective Duration. We have a policy to operate with an Adjusted Equity-to-Assets Ratio, a non-GAAP measurement, of at least 8%. See Capital Utilization and Leverage on page 46 for a calculation of our Adjusted
Equity-to-Assets Ratio. Moreover, we focus on acquiring high quality assets to minimize potential credit losses and to ensure our access to financing. Our operating structure has resulted in operating costs well below those of other mortgage
originators. Our corporate structure differs from most lending institutions in that we are organized for tax purposes as a REIT and, therefore, pay substantially all of our earnings in the form of dividends to shareholders.

We are an externally advised REIT and, as such, we are managed externally by the Manager under the terms of the Management Agreement, subject to the
supervision of the Board of Directors.

Portfolio Strategies

Our business strategy is to acquire and originate primarily ARM Assets to hold in our portfolio, fund them using equity capital and borrowed funds, and generate earnings from the difference, or
spread, between the yield on our assets and our cost of borrowings. Our ARM Assets include investments in Hybrid ARM Assets and Traditional ARM Assets.



31



---

##### Table of Contents

We acquire Purchased ARM Securities and ARM loans from investment banking firms, broker-dealers, mortgage
bankers, banks, savings and loan institutions, credit unions, home builders and other entities involved in originating, securitizing, packaging and selling mortgage loans. We believe we have a competitive advantage in acquiring and investing in
these ARM Assets due to the low cost of our operations relative to traditional mortgage investors and originators.

We acquire and
originate ARM loans for our portfolio primarily through our correspondent lending program, which currently includes approximately 273 approved correspondents. In the second quarter of 2006, we began originating ARM loans through our wholesale
channel and as of September 30, 2006 we had 70 approved mortgage brokers. Our retail lending channel and other lending partners originate ARM loans through direct contact with consumers. We are authorized to lend in all 50 states and the
District of Columbia. We believe that diversifying our sources for ARM loans and Purchased ARM Assets will enable us to consistently find attractive opportunities to acquire or create high quality assets at attractive yields and spreads for our
portfolio.

We have a focused portfolio lending investment policy designed to minimize credit risk and interest rate risk. Our policy
requires us to have a mortgage assets portfolio with an expected Net Effective Duration of one year or less and which may consist of Agency Securities guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac, or privately issued (generally publicly
registered) ARM pass-through securities, multi-class pass-through securities, CMOs, A quality ARM loans that we intend to securitize, Purchased Securitized Loans or other short-term investments that either mature within one year or have
an interest rate that reprices within one year.

Our investment policy requires that we invest at least 70% of our total assets in High
Quality ARM Assets and short-term investments. The remainder of our ARM portfolio, comprising not more than 30% of total assets, may consist of Other Investments.

In 2006, we began acquiring and originating Pay Option ARMs as well as Purchased Securitized Loans collateralized by Pay Option ARMs and as of September 30, 2006, we held $2.2 billion of Pay Option ARMs in our
portfolio. Pay Option ARMs have features that allow borrowers to defer making the full interest payment on their loans. Therefore, the potential loss in the event of default could be higher than on a loan that does not provide for deferral of
interest. The Pay Option ARMs have features that limit the deferred interest to 110% to 125% of the original loan balance. If the loan balance reaches the applicable limit, additional interest may not be deferred and the monthly minimum payment is
increased to an amount that would amortize the loan over its remaining term. As of September 30, 2006, accumulated deferred interest was $23.7 million. We expect the number of delinquencies related to Pay Option ARMs to be greater than those
related to Traditional and Hybrid ARMs; however, we do not expect our credit losses to increase materially. We believe that our pricing, underwriting, appraisal, and other processes are sufficient to manage the potential credit risks that have been
associated with Pay Option ARMs. Specifically, when qualifying a borrower, we evaluate the borrowers ability to make fully amortizing monthly payments, even if the borrower has the option to make lower monthly payments. Our Pay Option ARMs had
an average original effective loan-to-value ratio of 70% and an average original FICO score of 726 at September 30, 2006.

In the
second quarter of 2006, our ownership of Hybrid ARM Assets with fixed-rate periods of greater than five years was limited to no more than 50% of our total assets. In July 2006, the Board of Directors removed this limitation in response to consumer
preference for longer-term Hybrid ARM products in the current interest rate environment. We may also invest up to 5% of total assets in fifteen year fixed-rate assets, although, as of September 30, 2006, we did not hold any fixed-rate assets.
We use Hybrid ARM Hedging Instruments to fix, or cap, the interest rates on the short-term borrowings and floating-rate CDOs financing our Hybrid ARM Assets. We have a policy that requires us to maintain a Net Effective Duration on Hybrid ARM Assets
of less than one year. We use a financial model that simulates interest rate changes and calculates the impact of those changes on the fair value of our portfolio. By maintaining a Net Effective Duration of less than one year on our Hybrid ARM
Assets, we believe that we can maintain relatively stable earnings and dividends given changing interest rates.

To mitigate the adverse
effect of an increase in prepayments on our ARM Assets, we emphasize the purchase of ARM Assets at prices close to or below par. We amortize any premiums paid for our assets over their expected lives using the effective yield method of accounting.
To the extent that the prepayment rate on our ARM Assets differs from expectations, our net interest income will be affected. Prepayments generally increase when current mortgage interest rates fall below the interest rates on existing ARM loans. To
the extent there is an increase in prepayment rates, resulting in a shortening of the expected lives of our ARM Assets, our net income and, therefore, the taxable income available for distribution and dividends paid to shareholders could be
adversely affected.

We believe that our status as a mortgage REIT makes an investment in our equity securities attractive for tax-exempt
investors, such as pension plans, profit sharing plans, 401(k) plans, Keogh plans and IRAs. We do not invest in REMIC



32



---

##### Table of Contents

residuals or other CMO residuals that would result in the creation of excess inclusion income or
unrelated business taxable income.

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

We acquire and originate A quality ARM loans through TMHL, our wholly-owned mortgage loan origination and acquisition subsidiary, from four
sources: (i) correspondent lending, (ii) wholesale loan originations, (iii) direct retail originations and (iv) bulk acquisitions. Correspondent lending involves acquiring individual loans that we re-underwrite from lending
partners which we have approved and which originate and close the individual loans using our product pricing, underwriting criteria and guidelines, or other approved criteria and guidelines. Wholesale loan originations are loans that are sourced
from approved mortgage brokers which we underwrite and close. Direct retail loan originations are loans that we originate directly to consumers via the internet or by telephone. Bulk acquisitions involve acquiring pools of whole loans, which are
originated using the sellers guidelines and underwriting criteria. The loans we acquire or originate are financed through warehouse borrowing arrangements pending securitization for our portfolio.

The loans acquired or originated by TMHL are first lien, single-family residential Traditional ARM and Hybrid ARM loans with original terms to maturity
of not more than forty years and are either fully amortizing, interest-only for up to ten years and fully amortizing thereafter, or to a lesser extent negatively amortizing.

All ARM loans that we acquire or originate for our portfolio bear an interest rate tied to an interest rate index. Most loans have periodic and lifetime constraints on the amount to which the
loan interest rate can change on any predetermined interest rate reset date. The interest rate on each Traditional ARM loan resets monthly, semi-annually or annually. Traditional ARM loans generally adjust to a margin over a U.S. Treasury index, a
LIBOR index or the 12-Month Treasury Average Index. Hybrid ARM loans have a fixed rate for an initial period, generally 3 to 10 years, and then convert to Traditional ARM loans for their remaining term to maturity.

We acquire and originate ARM loans for our portfolio with the intention of using them as collateral for CDOs. Alternatively, we may also securitize them
to create High Quality ARM securities and retain them in our portfolio as Securitized ARM Loans. In order to facilitate the securitization or financing of our loans, we generally create subordinate certificates, which provide a specified amount of
credit enhancement and which we retain in our portfolio. Our investment policy limits the amount we may retain of below Investment Grade subordinate certificates or classes created as a result of our loan acquisition and securitization efforts or
acquired as Purchased Securitized Loans, to 17.5% of shareholders equity, measured on a historical cost basis.

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

We offer The Thornburg Mortgage Exchange ProgramSMfor loans
we originate and/or service. We believe this program promotes customer retention and reduces loan prepayments. Our core feature under this program is the loan modification option where borrowers pay fees to change their current mortgage loan
products to any then-available Hybrid or Traditional ARM product that we offer. During the third quarter of 2006, we modified 213 loans with balances totaling $109.2 million. At September 30, 2006, the pipeline of loans to be modified totaled
$93.6 million. Another feature of The Thornburg Mortgage Exchange ProgramSMis that, on a streamlined basis, our
borrowers can cash out equity from their homes.

Financing Strategies

We finance our ARM Assets using Common and Preferred equity capital, unsecured debt, CDOs and short-term borrowings such as Reverse Repurchase Agreements, Asset-backed CP, whole loan financing
facilities and other collateralized financings that we may establish in the future. See Hedging Strategies below for a discussion of how we convert short-term borrowings into the equivalent of long-term fixed-rate financing for
purposes of managing our interest rate risk. Our long-term objective is to achieve a more diversified funding mix including Asset-backed CP, CDOs and Reverse Repurchase Agreements.



33



---

##### Table of Contents

Reverse Repurchase Agreements involve a simultaneous sale of pledged securities to a lender at an
agreed-upon price in return for our agreement to repurchase the same securities at a future date (the maturity of the borrowing) at a higher price. The price difference is the cost of borrowing under these agreements. We have established lines of
credit and collateralized financing agreements with 20 different financial institutions.

We enter into two types of Reverse Repurchase
Agreements: variable rate term Reverse Repurchase Agreements and fixed-rate Reverse Repurchase Agreements. Our variable rate term Reverse Repurchase Agreements are financings with original maturities ranging from four to sixty months. The interest
rates on these variable rate term Reverse Repurchase Agreements are generally indexed to the one-month LIBOR rate, and reprice accordingly. The fixed-rate Reverse Repurchase Agreements have original maturities within one month. Generally, upon
repayment of each Reverse Repurchase Agreement, we immediately pledge the ARM Assets used to collateralize the financing to secure a new Reverse Repurchase Agreement.

We have an Asset-backed CP facility, which provides us with an alternative way to finance our High Quality ARM Assets portfolio. We issue Asset-backed CP in the form of secured liquidity notes that have been rated P-1
by Moodys Investors Service, F1+ by Fitch Ratings and A-1+ by Standard and Poors to money market investors. The notes can be collateralized by Agency Securities and AAA-rated, adjustable-rate MBS that we have either purchased
or created through our loan securitization process. Importantly, we have diversified our funding sources by replacing a portion of our Reverse Repurchase Agreement borrowings with the issuance of Asset-backed CP under terms that are comparable to
our existing Reverse Repurchase Agreement funding.

Because we borrow money under Reverse Repurchase Agreements and Asset-backed CP based
on the fair value of our ARM Assets, our borrowing ability under these agreements could be limited and lenders could initiate margin calls in the event of interest rate changes or if the value of our ARM Assets declines for other reasons.

We have also financed the origination and purchase of ARM Assets by issuing hedged floating-rate and fixed-rate CDOs in the capital
markets. The CDOs are collateralized by ARM loans that are placed in a trust. The trust pays the principal and interest payments on the debt out of the cash flows received on the collateral. This structure enables us to make more efficient use of
our capital because the capital requirement to support these financings is less than the amount our policy requires to support the same amount of financings in the Reverse Repurchase Agreement or Asset-backed CP markets. These transactions are a
long-term form of financing and are not subject to margin calls or disruptions in the asset-backed financing market.

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

We have issued Senior Notes in the amount of $305.0 million as a form of long-term capital. The
Senior Notes bear interest at 8.0%, payable each May 15 and November 15, and mature on May 15, 2013. The Senior Notes are unsecured and are redeemable at a declining premium, in whole or in part, beginning on May 15, 2008, and at
par beginning on May 15, 2011.

We have issued Subordinated Notes in the amount of $240.0 million as another form of long-term
capital. The Subordinated Notes bear interest at a weighted average fixed rate of 7.47% per annum for the first ten years and thereafter at a variable rate equal to three-month LIBOR plus a weighted average rate of 2.53% per annum, payable
each January 30, April 30, July 30 and October 30, and mature between October 30, 2035 and April 30, 2036. The Subordinated Notes are unsecured and are redeemable at par, in whole or in part, beginning on
October 30, 2010. The Subordinated Notes may also be redeemed at a premium under limited circumstances on or before October 30, 2010.

Capital Utilization

The Board of Directors has approved a policy that limits our capacity to borrow funds to finance
mortgage assets based on long-term capital. We monitor the relationship between our assets, borrowings and long-term capital using a variety of different measures. However, the primary operating policy that limits our borrowings and leverage is a
requirement to maintain our Adjusted Equity-to-Assets Ratio, a non-GAAP measurement, at a minimum of 8%. Broadly speaking, this ratio reflects the relationship between those assets financed with borrowings that are subject to margin calls and our
long-term capital position. See further discussion of capital utilization and leverage beginning on page 45 and the calculation of our Adjusted Equity-to-Assets Ratio on page 46.



34



---

##### Table of Contents

Liquidity Management

Our primary focus is to acquire and originate high quality, highly liquid assets such that sufficient assets could be readily converted to cash, if necessary, in order to meet our financial obligations. We have a
Liquidity Management Policy, which is designed to minimize potential shortfalls in liquidity resulting from adverse changes in interest rates or market conditions. The Liquidity Management Policy requires the frequent measurement of the potential
market value exposure of the portfolio to a 100 BP instantaneous parallel increase in interest rates above expected future interest rates as well as a 100 BP instantaneous parallel decrease in interest rates below expected future interest rates. The
calculated potential mark-to-market exposure resulting from this scenario is probability weighted, increased by a multiple of three, and compared to recent minimum liquidity levels in order to determine whether management needs to take specific
actions to improve liquidity or further reduce interest rate risk.

Hedging Strategies

We attempt to mitigate our interest rate risk by funding our ARM Assets with a combination of short-term borrowings and Hedging Instruments whose combined
Effective Durations approximately match the Effective Durations on our ARM Assets. Some of our borrowings are at interest rates that are either variable or short-term (one year or less) because a portion of our ARM Assets, the Traditional ARM
Assets, have interest rates that adjust within one year. We finance our Hybrid ARM portfolio with borrowings hedged with Hybrid ARM Hedging Instruments that fix the interest rate on our floating-rate borrowings such that the Net Effective Duration
is less than one year. A shorter Net Effective Duration indicates a lower expected volatility of earnings when interest rates change during future periods. When we enter into a Swap Agreement, we agree to pay a fixed rate of interest and to receive
a variable interest rate, generally based on LIBOR. We purchase Cap Agreements by incurring a one-time fee or premium. Pursuant to the terms of the Cap Agreements, we will receive cash payments if the interest rate index specified in any such Cap
Agreement increases above contractually specified levels. Therefore, such Cap Agreements have the effect of capping the interest rate on a portion of our borrowings above a specified level as opposed to fixing our cost of funds as in a swap
transaction. The notional balances of the Hybrid ARM Hedging Instruments generally decline over the life of these instruments. As of September 30, 2006, our Hybrid ARM Hedging Instruments had a remaining average term to maturity of 4.0 years
before considering the effects of prepayments and when combined with our Hybrid ARM Assets and related borrowings had a Net Effective Duration of approximately negative 0.10 years, including the effects of estimated prepayments.

We enter into Pipeline Hedging Instruments to manage interest rate risk associated with commitments to purchase ARM loans. The gain (loss) on the
Pipeline Hedging Instruments is expected to offset the gain (loss) recorded for the change in fair value of the loan commitments.

We may
enter into additional hedging transactions designed to protect our borrowing costs or portfolio yields from interest rate changes. We may purchase interest-only or principal-only mortgage assets or other mortgage derivative
products for purposes of mitigating risk from interest rate changes. We may also use, from time to time, futures contracts and options on futures contracts on the Eurodollar, Federal Funds, Treasury bills and Treasury notes and similar financial
instruments to mitigate risk from changing interest rates.

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



35



---

##### Table of Contents

Financial Condition

Asset Quality

At September 30, 2006, we held total assets of $52.9
billion, $51.8 billion of which consisted of ARM Assets. That compares to $42.5 billion in total assets and $41.5 billion of ARM Assets at December 31, 2005. Since commencing operations, we have purchased either Agency Securities,
privately-issued MBS or ARM loans generally originated to A quality underwriting standards. At September 30, 2006, 95.2% of the assets we held, 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.

The following tables present schedules of ARM Assets owned at September 30, 2006 and December 31, 2005 classified by High Quality and Other Investment assets and further classified by type of issuer and by ratings categories. All
Purchased ARM Assets included in the tables have been rated by the Rating Agencies. ARM Loans include Securitized ARM Loans that have been rated by the Rating Agencies, ARM Loans Collateralizing CDOs that have been stratified by credit rating based
on the ratings received from the Rating Agencies on the respective CDOs and ARM loans held for securitization that have not been rated by the Rating Agencies.

ARM Assets by Issuer and Credit Rating

(dollar amounts in thousands)



|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|-------------------------------- |  | -------------------- | ---------- | --- | ------------ | ----- | - | -------------- | - | ---------- | ------------ |  | ----- | -------------- |  | - | ------------ | - |  | ----- | -
|                                 |  | September 30, 2006   |           
|                                 |  | Purchased ARM Assets |            |     | ARM Loans    |       |   | Total          |  
|                                 |  | Carrying Value       |            |     | PortfolioMix |       |   | Carrying Value |   |            | PortfolioMix |  |       | Carrying Value |  |   | PortfolioMix |  
|High Quality                     |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Agency Securities                |  | $                    | 2,023,509  |     |              | 6.9   | % |                | $ | 329        |              |  | 0.0   | %              |  | $ | 2,023,838    |   |  | 3.9   | %
|Non-Agency ARM Assets:           |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|AAA/Aaa Rating                   |  |                      | 26,060,415 |     |              | 89.1  |   |                |   | 21,316,475 | (1)          |  | 94.7  |                |  |   | 47,376,890   |   |  | 91.5  |  
|AA/Aa Rating                     |  |                      | 704,505    |     |              | 2.4   |   |                |   | 38,629     | (1)          |  | 0.2   |                |  |   | 743,134      |   |  | 1.4   |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Total Non-Agency ARM Assets      |  |                      | 26,764,920 |     |              | 91.5  |   |                |   | 21,355,104 |              |  | 94.9  |                |  |   | 48,120,024   |   |  | 92.9  |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Total High Quality               |  |                      | 28,788,429 |     |              | 98.4  |   |                |   | 21,355,433 |              |  | 94.9  |                |  |   | 50,143,862   |   |  | 96.8  |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Other Investments                |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Non-Agency ARM Assets:           |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|A Rating                         |  |                      | 262,337    |     |              | 0.9   |   |                |   | 27,002     |              |  | 0.1   |                |  |   | 289,339      |   |  | 0.6   |  
|BBB/Baa Rating                   |  |                      | 145,859    |     |              | 0.5   |   |                |   | 16,553     |              |  | 0.1   |                |  |   | 162,412      |   |  | 0.3   |  
|BB/Ba Rating and Below           |  |                      | 59,902     | (2) |              | 0.2   |   |                |   | 106,236    | (1)          |  | 0.5   |                |  |   | 166,138      |   |  | 0.3   |  
|ARM loans pending securitization |  |                      |           |     |              |      |   |                |   | 1,007,953  |              |  | 4.4   |                |  |   | 1,007,953    |   |  | 2.0   |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Total Other Investments          |  |                      | 468,098    |     |              | 1.6   |   |                |   | 1,157,744  |              |  | 5.1   |                |  |   | 1,625,842    |   |  | 3.2   |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Loan Loss Reserves               |  |                      |           |     |              |      |   |                |   | (12,510    | )            |  |      |                |  |   | (12,510      | ) |  |      |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Total ARM Portfolio              |  | $                    | 29,256,527 |     |              | 100.0 | % |                | $ | 22,500,667 |              |  | 100.0 | %              |  | $ | 51,757,194   |   |  | 100.0 | %
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  

---

|(1) | As of September 30, 2006, the Investment Grade classes of ARM Loans Collateralizing CDOs had been credit-enhanced through overcollateralization and
subordination in the amount of $154.3 million.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | As of September 30, 2006, we had total non-accretable discounts of $15.2 million on our Purchased ARM Assets due to estimated credit losses (other than
temporary declines in fair value) related to securities purchased at a discount, which is included in the BB/Ba Rating and Below category.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



36



---

##### Table of Contents

|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|-------------------------------- |  | -------------------- | ---------- | --- | ------------ | ----- | - | -------------- | - | ---------- | ------------ |  | ----- | -------------- |  | - | ------------ | - |  | ----- | -
|                                 |  | December 31, 2005    |           
|                                 |  | Purchased ARM Assets |            |     | ARM Loans    |       |   | Total          |  
|                                 |  | Carrying Value       |            |     | PortfolioMix |       |   | Carrying Value |   |            | PortfolioMix |  |       | Carrying Value |  |   | PortfolioMix |  
|High Quality                     |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Agency Securities                |  | $                    | 1,842,998  |     |              | 6.8   | % |                | $ | 706        |              |  | 0.0   | %              |  | $ | 1,843,704    |   |  | 4.4   | %
|Non-Agency ARM Assets:           |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|AAA/Aaa Rating                   |  |                      | 24,441,684 |     |              | 90.0  |   |                |   | 13,550,974 | (1)          |  | 94.5  |                |  |   | 37,992,658   |   |  | 91.6  |  
|AA/Aa Rating                     |  |                      | 542,681    |     |              | 2.0   |   |                |   | 59,387     | (1)          |  | 0.4   |                |  |   | 602,068      |   |  | 1.4   |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Total Non-Agency ARM Assets      |  |                      | 24,984,365 |     |              | 92.0  |   |                |   | 13,610,361 |              |  | 94.9  |                |  |   | 38,594,726   |   |  | 93.0  |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Total High Quality               |  |                      | 26,827,363 |     |              | 98.8  |   |                |   | 13,611,067 |              |  | 94.9  |                |  |   | 40,438,430   |   |  | 97.4  |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Other Investments                |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Non-Agency ARM Assets:           |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|A Rating                         |  |                      | 182,199    |     |              | 0.7   |   |                |   | 34,125     |              |  | 0.2   |                |  |   | 216,324      |   |  | 0.5   |  
|BBB/Baa Rating                   |  |                      | 76,261     |     |              | 0.3   |   |                |   | 20,821     |              |  | 0.1   |                |  |   | 97,082       |   |  | 0.2   |  
|BB/Ba Rating and Below           |  |                      | 48,685     | (2) |              | 0.2   |   |                |   | 52,164     | (1)          |  | 0.4   |                |  |   | 100,849      |   |  | 0.3   |  
|ARM loans pending securitization |  |                      |           |     |              | 0.0   |   |                |   | 642,093    |              |  | 4.5   |                |  |   | 642,093      |   |  | 1.6   |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Total Other Investments          |  |                      | 307,145    |     |              | 1.2   |   |                |   | 749,203    |              |  | 5.2   |                |  |   | 1,056,348    |   |  | 2.6   |  
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Loan Loss Reserves               |  |                      |           |     |              | 0.0   |   |                |   | (10,749    | )            |  | (0.1  | )              |  |   | (10,749      | ) |  | (0.0  | )
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  
|Total ARM Portfolio              |  | $                    | 27,134,508 |     |              | 100.0 | % |                | $ | 14,349,521 |              |  | 100.0 | %              |  | $ | 41,484,029   |   |  | 100.0 | %
|                                 |  |                      |            |     |              |       |   |                |   |            |              |  |       |                |  |   |              |   |  |       |  

---

|(1) | As of December 31, 2005, the Investment Grade classes of ARM Loans Collateralizing CDOs had been credit-enhanced through overcollateralization and
subordination in the amount of $67.3 million.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | As of December 31, 2005, we had total non-accretable discounts of $11.6 million on our Purchased ARM Assets due to estimated credit losses (other than
temporary declines in fair value) related to securities purchased at a discount, which is included in the BB/Ba Rating and Below category.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As of September 30, 2006, 16 of the 37,683 loans in our $22.5 billion ARM Loan portfolio were considered seriously delinquent (60 days or more delinquent) and had an aggregate balance of $12.0 million. At
September 30, 2006, we had four real estate-owned properties as a result of foreclosing on delinquent loans in the amount of $881,000. We believe that our current level of reserves for loan losses is adequate to cover estimated losses from
these loans as well as losses inherent in the ARM loan portfolio at September 30, 2006.

At September 30, 2006, our Purchased
Securitized Loans totaled $7.1 billion. Like our own loan originations and acquisitions, these assets are Qualifying Interests for purposes of maintaining our exemption from the Investment Company Act because we retain a 100% ownership interest in
the underlying loans. Because we purchase all classes of these securitizations, we have the entire credit exposure on the underlying loans. The purchase price of the classes that are less than Investment Grade generally includes a discount for
probable credit losses and, based on managements judgment, the portion of the purchase discount which reflects the estimated unrealized loss on the securities due to credit risk is treated as a non-accretable discount. As of September 30,
2006, 45 of the underlying loans in these Purchased Securitized Loans were 60 days or more delinquent and had an aggregate balance of $35.3 million. We believe the losses inherent in our Purchased Securitized Loan portfolio at September 30,
2006 are appropriately reflected in the fair value of these assets.



37



---

##### Table of Contents

ARM Loan Portfolio Characteristics

The following table presents various characteristics of our ARM Loan portfolio as of September 30, 2006. This information pertains to ARM loans held
for securitization, ARM loans held as collateral for CDOs and ARM loans securitized for our own portfolio for which we retained credit loss exposure. The combined unpaid principal balance of the loans included in this information is $22.5 billion.

ARM Loan Portfolio Characteristics



|                         |  |         |         |   |      |   |            |     |  |   |        |  
|------------------------ |  | ------- | ------- | - | ---- | - | ---------- | --- |  | - | ------ | -
|                         |  | Average |         |   | High |   |            | Low | 
|Original loan balance    |  | $       | 608,524 |   |      | $ | 14,000,000 |     |  | $ | 13,190 |  
|Unpaid principal balance |  | $       | 593,984 |   |      | $ | 14,000,000 |     |  | $ | 238    |  
|Coupon rate on loans     |  |         | 5.84    | % |      |   | 9.25       | %   |  |   | 1.00   | %
|Pass-through rate        |  |         | 5.57    | % |      |   | 9.00       | %   |  |   | 0.75   | %
|Pass-through margin      |  |         | 1.93    | % |      |   | 4.92       | %   |  |   | 0.35   | %
|Lifetime cap             |  |         | 10.78   | % |      |   | 18.00      | %   |  |   | 7.25   | %
|Original term (months)   |  |         | 361     |   |      |   | 480        |     |  |   | 120    |  
|Remaining term (months)  |  |         | 343     |   |      |   | 480        |     |  |   | 55     |  



|                                                   |  |      |   |  |  |  |                                                  |  |           |  
|-------------------------------------------------- |  | ---- | - |  |  |  | ------------------------------------------------ |  | --------- | -
|Geographic distribution (top 5 states):            |  |      |   |  |  |  | Property type:                                   |  |           |  
|California                                         |  | 35.3 | % |  |  |  | Single-family                                    |  | 82.9      | %
|New York                                           |  | 8.4  |   |  |  |  | Condominium                                      |  | 14.0      |  
|Florida                                            |  | 7.5  |   |  |  |  | Other residential                                |  | 3.1       |  
|Colorado                                           |  | 6.5  |   |  |  |  |                                                  |  |           |  
|Georgia                                            |  | 4.7  |   |  |  |  | ARM Loan type:                                   |  |           |  
|                                                   |  |      |   |  |  |  | Pay Option ARM loans                             |  | 5.9       | %
|Occupancy status:                                  |  |      |   |  |  |  | Traditional ARM loans                            |  | 4.5       |  
|Owner occupied                                     |  | 78.1 | % |  |  |  | Hybrid ARM loans                                 |  | 89.6      |  
|Second home                                        |  | 13.9 |   |  |  |  |                                                  |  |           |  
|Investor                                           |  | 8.0  |   |  |  |  | ARM interest rate caps:                          |  |           |  
|                                                   |  |      |   |  |  |  | Initial cap on Hybrid ARM loans:                 |  |           |  
|Documentation type:                                |  |      |   |  |  |  | 3.00% or less                                    |  | 12.9      | %
|Full/alternative                                   |  | 81.2 | % |  |  |  | 3.01%-4.00%                                      |  | 5.9       |  
|Stated income/no ratio                             |  | 18.8 |   |  |  |  | 4.01%-5.00%                                      |  | 63.3      |  
|                                                   |  |      |   |  |  |  | 5.01%-6.00%                                      |  | 7.4       |  
|Loan purpose:                                      |  |      |   |  |  |  |                                                  |  |           |  
|Purchase                                           |  | 51.5 | % |  |  |  | Periodic cap on Traditional ARM loans:           |  |           |  
|Cash out refinance                                 |  | 28.2 |   |  |  |  | None                                             |  | 7.9       | %
|Rate & term refinance                              |  | 20.3 |   |  |  |  | 1.00% or less                                    |  | 1.4       |  
|                                                   |  |      |   |  |  |  | Over 1.00%                                       |  | 1.2       |  
|Unpaid principal balance:                          |  |      |   |  |  |  |                                                  |  |           |  
|$417,000 or less                                   |  | 17.7 | % |  |  |  | Percent of interest-only loan balances:          |  | 84.6      | %
|$417,001 to $650,000                               |  | 24.4 |   |  |  |  |                                                  |  |           |  
|$650,001 to $1,000,000                             |  | 21.7 |   |  |  |  | Weighted average length of interest-only period: |  | 9.5 years |  
|$1,000,001 to $2,000,000                           |  | 24.0 |   |  |  |  |                                                  |  |           |  
|$2,000,001 to $3,000,000                           |  | 6.2  |   |  |  |  |                                                  |  |           |  
|Over $3,000,001                                    |  | 6.0  |   |  |  |  | FICO scores:                                     |  |           |  
|                                                   |  |      |   |  |  |  | 801 and over                                     |  | 4.5       | %
|Original effective loan-to-value:                  |  |      |   |  |  |  | 751 to 800                                       |  | 44.0      |  
|80.01% and over                                    |  | 1.0  | % |  |  |  | 701 to 750                                       |  | 33.3      |  
|70.01%-80.00%                                      |  | 45.9 |   |  |  |  | 651 to 700                                       |  | 16.5      |  
|60.01%-70.00%                                      |  | 25.3 |   |  |  |  | 650 or less                                      |  | 1.7       |  
|50.01%-60.00%                                      |  | 13.6 |   |  |  |  |                                                  |  |           |  
|50.00% or less                                     |  | 14.2 |   |  |  |  | Weighted average FICO score:                     |  | 747       |  
|                                                   |  |      |   | 
|Weighted average effective original loan-to-value: |  | 66.7 | % |  |  |  |                                                  |  |           |  



38



---

##### Table of Contents

As of September 30, 2006 and December 31, 2005, we serviced $11.3 billion and $9.2 billion of
our loans, respectively, and had 20,109 and 18,070 customer relationships, respectively. We hold all of the loans that we service in our portfolio in the form of Securitized ARM Loans, Arm Loans Collateralizing CDOs or ARM loans that are pending
securitization.

Asset Repricing Characteristics

The following table classifies our ARM portfolio by type of interest rate index and frequency of repricing.

ARM Assets by Index and Repricing Frequency

(dollar amounts in thousands)



|                        |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  
|----------------------- |  | ------------------ | ---------- | - | ----------------- | ----- | - | ------------- | - | ---------- | ------------- |  | ----- | -
|                        |  | September 30, 2006 |            |   | December 31, 2005 |      
|                        |  | CarryingValue      |            |   | PortfolioMix      |       |   | CarryingValue |   |            | Portfolio Mix | 
|Traditional ARM Assets: |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  
|Index:                  |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  
|One-month LIBOR         |  | $                  | 3,172,941  |   |                   | 6.1   | % |               | $ | 2,570,289  |               |  | 6.2   | %
|Six-month LIBOR         |  |                    | 561,318    |   |                   | 1.1   |   |               |   | 306,167    |               |  | 0.7   |  
|MTA                     |  |                    | 2,186,560  |   |                   | 4.2   |   |               |   | 15,542     |               |  | 0.0   |  
|Other                   |  |                    | 467,622    |   |                   | 0.9   |   |               |   | 309,546    |               |  | 0.8   |  
|                        |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  
|                        |  |                    | 6,388,441  |   |                   | 12.3  |   |               |   | 3,201,544  |               |  | 7.7   |  
|                        |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  
|Hybrid ARM Assets:      |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  
|Remaining fixed period: |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  
|3 years or less         |  |                    | 8,155,773  |   |                   | 15.8  |   |               |   | 8,278,786  |               |  | 20.0  |  
|Over 3 years  5 years  |  |                    | 10,557,941 |   |                   | 20.4  |   |               |   | 13,442,861 |               |  | 32.4  |  
|Over 5 years            |  |                    | 26,667,549 |   |                   | 51.5  |   |               |   | 16,571,587 |               |  | 39.9  |  
|                        |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  
|                        |  |                    |            |  
|                        |  |                    | 45,381,263 |   |                   | 87.7  |   |               |   | 38,293,234 |               |  | 92.3  |  
|Loan Loss Reserves      |  |                    | (12,510    | ) |                   | (0.0  | ) |               |   | (10,749    | )             |  | (0.0  | )
|                        |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  
|                        |  | $                  | 51,757,194 |   |                   | 100.0 | % |               | $ | 41,484,029 |               |  | 100.0 | %
|                        |  |                    |            |   |                   |       |   |               |   |            |               |  |       |  

The ARM portfolio had a weighted average coupon of 5.41% as of September 30, 2006. This
consisted of a weighted average coupon of 5.32% on the Hybrid ARM Assets and a weighted average coupon of 6.34% on the Traditional ARM Assets. If the portfolio had been Fully Indexed, the weighted average coupon of the portfolio would have been
5.48%, based upon the composition of the portfolio and the applicable indices at September 30, 2006. Additionally, if the Traditional ARM portion of the portfolio had been Fully Indexed, the weighted average coupon of that portion of the
portfolio would have been 7.14%, also based upon the composition of the portfolio and the applicable indices at that time.

As of
December 31, 2005, the ARM portfolio had a weighted average coupon of 5.02%. This consisted of a weighted average coupon of 5.01% on the Hybrid ARM Assets and a weighted average coupon of 5.37% on the Traditional ARM assets. If the portfolio
had been Fully Indexed, the weighted average coupon of the portfolio would have been 5.05%, based upon the composition of the portfolio and the applicable indices at December 31, 2005. Additionally, if the Traditional ARM portion of the
portfolio had been Fully Indexed, the weighted average coupon of that portion of the portfolio would have been 6.00%, also based upon the composition of the portfolio and the applicable indices at that time.

At September 30, 2006, the current yield of the ARM Assets portfolio was 5.22% up from 4.62% as of December 31, 2005. The increase in the yield
of 60 BPs as of September 30, 2006, compared to December 31, 2005, is primarily due to a 49 BP increase in the weighted average coupon as a result of new asset purchases at higher weighted average coupons and an 11 BP increase due to lower
net premium amortization and payments receivable due to lower prepayments.



39



---

##### Table of Contents

Interest Rate Risk Management

The Hybrid ARM portfolio comprised 87.7% of the total ARM portfolio, or $45.4 billion, at September 30, 2006 compared to 92.3%, or $38.3 billion as
of December 31, 2005. We attempt to mitigate our interest rate risk by funding our ARM portfolio with borrowings and Hedging Instruments with an Effective Duration approximately matching the Effective Duration on our ARM Assets. Some of our
borrowings bear variable or short-term (one year or less) fixed interest rates because our Traditional ARM Assets have interest rates that adjust within one year. However, most of our Hybrid ARM Assets are financed with short-term borrowings that
are hedged with Hybrid ARM Hedging Instruments that fix the interest rate on those borrowings such that the Net Effective Duration is less than one year. By maintaining a Net Effective Duration of less than one year, which is our maximum Effective
Duration policy limit, the combined price change of our Hybrid ARM Assets, associated Hybrid ARM Hedging Instruments and other borrowings is expected to be a maximum of 1% for a 1% parallel shift in interest rates. A lower Effective Duration
indicates a lower expected volatility of earnings given future changes in interest rates. As of September 30, 2006, the Net Effective Duration applicable to our Hybrid ARM Assets was approximately negative 0.10 years while the Net Effective
Duration applicable to the ARM portfolio was approximately negative 0.06 years.

As of September 30, 2006 and December 31, 2005,
we were counterparty to Swap Agreements having an aggregate notional balance of $37.0 billion and $32.0 billion, respectively. As of September 30, 2006, our Swap Agreements had a weighted average maturity of 4.0 years. In accordance with the
Swap Agreements, we will pay a fixed rate of interest during the term of these Swap Agreements and receive a payment that varies monthly with the one-month LIBOR rate. The combined weighted average fixed rate payable of the Swap Agreements was 4.42%
and 3.79% at September 30, 2006 and December 31, 2005, respectively. In addition, as of September 30, 2006, we had entered into delayed Swap Agreements with notional balances totaling $13.3 billion that will become effective between
October 2006 and June 2009. We entered into these delayed Swap Agreements to hedge the financing of existing ARM Assets and the forecasted financing of our ARM Assets purchase commitments at September 30, 2006, and to replace Swap Agreements as
they mature. The combined weighted average fixed rate payable of the delayed Swap Agreements was 5.26% at September 30, 2006. The net unrealized gain on Swap Agreements at September 30, 2006 of $201.2 million included Swap Agreements with
gross unrealized gains of $340.6 million and gross unrealized losses of $139.4 million and is included in Hedging Instruments on the Consolidated Balance Sheets. As of September 30, 2006, the net unrealized gain on Swap Agreements recorded in
accumulated other comprehensive income (loss) was $201.2 million. Over the next twelve months, $205.0 million of these net unrealized gains are expected to be realized as a component of net interest income.

As of September 30, 2006 and December, 31, 2005, our Cap Agreements, used to manage our interest rate risk exposure on the financing of the Hybrid
ARM Assets, had remaining net notional amounts of $984.9 million and $970.3 million, respectively. We have also entered into Cap Agreements that have start dates ranging from 2008 to 2010. The notional balance at the start date will be the lesser of
the scheduled amount of $197.5 million or the balance of Hybrid ARM loans associated with these Cap Agreements. The fair value of all of our Cap Agreements at September 30, 2006 and December, 31, 2005 was $15.0 million and $19.5 million,
respectively, and is included in Hedging Instruments on the Consolidated Balance Sheets. As of September 30, 2006, the unrealized loss on these Cap Agreements of $6.8 million was included in accumulated other comprehensive income (loss). In the
twelve month period following September 30, 2006, a $178,000 loss is expected to be realized. Pursuant to the terms of these Cap Agreements, the notional amount of the Cap Agreements declines such that it is expected to equal the balance of the
Hybrid ARM loans collateralizing our CDOs. Under these Cap Agreements, we will receive cash payments should the one-month LIBOR increase above the contract rates of these Hedging Instruments, which range from 3.05% to 9.67% and average 5.40%. The
Cap Agreements had an average maturity of 3.7 years as of September 30, 2006 and will expire between 2007 and 2013.



40



---

##### Table of Contents

The following table presents the outstanding notional balance of our Hybrid ARM Hedging Instruments as of
September 30, 2006 and the balance of these same Hybrid ARM Hedging Instruments as of September 30 for each of the following five years (assuming that no additional Hybrid ARM Hedging Instruments are added to the portfolio in the future
periods) (in thousands):



|                           |  |                     |            |      |   |            |  |      |            |      |   |            |  |   |           |  |   |          
|-------------------------- |  | ------------------- | ---------- | ---- | - | ---------- |  | ---- | ---------- | ---- | - | ---------- |  | - | --------- |  | - | ---------
|                           |  | As of September 30,
|                           |  | 2006                |            | 2007 |   | 2008       |  | 2009 |            | 2010 |   | 2011      
|Swap Agreements:           |  |                     |            |      |   |            |  |      |            |      |   |            |  |   |           |  |   |          
|Balance-guaranteed (1) (3) |  | $                   | 1,270,404  |      | $ | 862,083    |  | $    | 457,647    |      | $ | 140,994    |  | $ | 80,186    |  | $ | 46,303   
|Other (2)                  |  |                     | 35,733,895 |      |   | 28,591,415 |  |      | 20,907,300 |      |   | 10,515,134 |  |   | 6,918,559 |  |   | 3,669,836
|                           |  |                     |            |      |   |            |  |      |            |      |   |            |  |   |           |  |   |          
|                           |  |                     | 37,004,299 |      |   | 29,453,498 |  |      | 21,364,947 |      |   | 10,656,128 |  |   | 6,998,745 |  |   | 3,716,139
|                           |  |                     |            |      |   |            |  |      |            |      |   |            |  |   |           |  |   |          
|Cap Agreements (1) (3)     |  |                     | 984,930    |      |   | 656,159    |  |      | 451,223    |      |   | 301,294    |  |   | 205,229   |  |   | 201,425  
|                           |  |                     |            |      |   |            |  |      |            |      |   |            |  |   |           |  |   |          
|                           |  | $                   | 37,989,229 |      | $ | 30,109,657 |  | $    | 21,816,170 |      | $ | 10,957,422 |  | $ | 7,203,974 |  | $ | 3,917,564
|                           |  |                     |            |      |   |            |  |      |            |      |   |            |  |   |           |  |   |          

---

|(1) | These Swap Agreements and Cap Agreements have been entered into in connection with our CDO transactions. The notional balances of these agreements are guaranteed
to match the balance of the Hybrid ARM collateral in the respective CDO transactions, subject to a maximum notional balance over the term of those agreements. The notional balances presented in the table above for these balance-guaranteed agreements
represent forward-looking statements which are calculated based on a CPR assumption of 20%. The actual balances will likely be different based on the actual prepayment performance of the applicable Hybrid ARM collateral. The final maturity of these
agreements is 2015.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | These hedging instruments have a pre-determined schedule of notional balances over the term of the respective instruments, based on the expected decline in the
balance of our short-term borrowings used to finance our Hybrid ARM portfolio. The final maturity of these agreements is 2015.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | The following table presents the maximum outstanding notional balance of our balance-guaranteed Hybrid ARM Hedging Instruments as of September 30, 2006 and
as of September 30 for each of the following five years (in thousands):
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                |  |                     |           |      |   |           |  |      |         |      |   |         |  |   |         |  |   |        
|--------------- |  | ------------------- | --------- | ---- | - | --------- |  | ---- | ------- | ---- | - | ------- |  | - | ------- |  | - | -------
|                |  | As of September 30,
|                |  | 2006                |           | 2007 |   | 2008      |  | 2009 |         | 2010 |   | 2011   
|Swap Agreements |  | $                   | 1,270,404 |      | $ | 918,290   |  | $    | 508,950 |      | $ | 159,471 |  | $ | 91,356  |  | $ | 55,639 
|Cap Agreements  |  |                     | 984,930   |      |   | 753,915   |  |      | 474,115 |      |   | 323,054 |  |   | 234,136 |  |   | 234,504
|                |  |                     |           |      |   |           |  |      |         |      |   |         |  |   |         |  |   |        
|                |  | $                   | 2,255,334 |      | $ | 1,672,205 |  | $    | 983,065 |      | $ | 482,525 |  | $ | 325,492 |  | $ | 290,143
|                |  |                     |           |      |   |           |  |      |         |      |   |         |  |   |         |  |   |        

The fair value of the Pipeline Hedging Instruments at September 30, 2006 and
December 31, 2005 was a net unrealized loss of $4.4 million and $2.0 million, respectively, and is included in Hedging Instruments on the Consolidated Balance Sheets. Pipeline Hedging Instruments had remaining notional balances of $347.0
million and $1.9 billion at September 30, 2006 and December 31, 2005, respectively. We recorded a net gain of $21.5 million on Derivatives during the nine months ended September 30, 2006. This gain consisted of a net gain of $43.6
million on commitments to purchase loans from correspondent lenders and bulk sellers and a net gain of $1.2 million on other Derivative transactions partially offset by a net loss of $23.3 million on Pipeline Hedging Instruments. We recorded a net
gain of $3.1 million on Derivatives during the same period in 2005. This gain consisted of a net gain of $5.7 million on Pipeline Hedging Instruments partially offset by a net loss of $2.6 million on commitments to purchase loans from correspondent
lenders and bulk sellers. The net gain of $5.9 million on Derivatives during the three months ended September 30, 2006 consisted of a net gain of $45.3 million on commitments to purchase loans from correspondent lenders and bulk sellers
partially offset by a net loss of $39.3 million on Pipeline Hedging Instruments. The net loss of $147,000 on Derivatives during the three months ended September 30, 2005 consisted of a net gain of $6.0 million on Pipeline Hedging Instruments
partially offset by a net loss of $6.0 million on commitments to purchase loans from correspondent lenders and bulk sellers. The net gain on Derivatives is driven by several factors including: the size of the loan pipeline, the expected and actual
fallout rates, changes in interest rates, changes in the shape of the yield curve, changes in mortgage spreads, and our pipeline hedging long or short bias. These factors work together or in opposition to increase or decrease respectively the net
gain or loss on Derivatives in a particular reporting period.



41



---

##### Table of Contents

Asset Acquisitions

During the quarter ended September 30, 2006, we purchased $440.7 million of Purchased ARM Assets, 100% of which were High Quality assets, and $4.6 billion of ARM loans, generally originated
to A quality underwriting standards. Of the ARM Assets acquired during the third quarter of 2006, 90.3% were Hybrid ARM Assets and 9.7% were Traditional ARM assets generally indexed to LIBOR. The following table compares our ARM asset
acquisition and origination activity for the three-and nine-month periods ended September 30, 2006 and 2005 (dollar amounts in thousands):



|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|------------------------------ |  | -------------------------- | ---------- |  | ------------------ | - |  | - | ---------- |  | ----- | -
|                               |  | For the three months ended |           
|                               |  | September 30, 2006         |            |  | September 30, 2005 |  
|ARM securities:                |  |                            |            |  |                    |   |  |   |            |  |       |  
|Agency Securities              |  | $                          | 349,651    |  | 6.9                | % |  | $ |           |  | 0.0   | %
|High Quality, privately issued |  |                            | 91,078     |  | 1.8                |   |  |   | 5,658,879  |  | 70.8  |  
|Other privately issued         |  |                            |           |  | 0.0                |   |  |   | 82,186     |  | 1.0   |  
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|                               |  |                            | 440,729    |  | 8.7                |   |  |   | 5,741,065  |  | 71.8  |  
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|ARM loans:                     |  |                            |            |  |                    |   |  |   |            |  |       |  
|Bulk acquisitions              |  |                            | 3,188,247  |  | 63.1               |   |  |   | 957,291    |  | 12.0  |  
|Correspondent originations     |  |                            | 1,347,302  |  | 26.7               |   |  |   | 1,215,157  |  | 15.2  |  
|Direct retail originations     |  |                            | 40,390     |  | 0.8                |   |  |   | 76,686     |  | 1.0   |  
|Wholesale originations         |  |                            | 37,058     |  | 0.7                |   |  |   |           |  | 0.0   |  
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|                               |  |                            | 4,612,997  |  | 91.3               |   |  |   | 2,249,134  |  | 28.2  |  
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|Total acquisitions             |  | $                          | 5,053,726  |  | 100.0              | % |  | $ | 7,990,199  |  | 100.0 | %
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|                               | 
|                               |  | For the nine months ended  |           
|                               |  | September 30, 2006         |            |  | September 30, 2005 |  
|ARM securities:                |  |                            |            |  |                    |   |  |   |            |  |       |  
|Agency Securities              |  | $                          | 580,848    |  | 3.5                | % |  | $ |           |  | 0.0   | %
|High Quality, privately issued |  |                            | 5,692,266  |  | 34.4               |   |  |   | 13,199,176 |  | 72.4  |  
|Other privately issued         |  |                            | 161,094    |  | 1.0                |   |  |   | 187,740    |  | 1.0   |  
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|                               |  |                            | 6,434,208  |  | 38.9               |   |  |   | 13,386,916 |  | 73.4  |  
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|ARM loans:                     |  |                            |            |  |                    |   |  |   |            |  |       |  
|Bulk acquisitions              |  |                            | 5,799,828  |  | 35.1               |   |  |   | 1,289,526  |  | 7.1   |  
|Correspondent originations     |  |                            | 4,110,663  |  | 24.9               |   |  |   | 3,358,877  |  | 18.4  |  
|Direct retail originations     |  |                            | 147,183    |  | 0.9                |   |  |   | 204,493    |  | 1.1   |  
|Wholesale originations         |  |                            | 40,828     |  | 0.2                |   |  |   |           |  | 0.0   |  
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|                               |  |                            | 10,098,502 |  | 61.1               |   |  |   | 4,852,896  |  | 26.6  |  
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  
|Total acquisitions             |  | $                          | 16,532,710 |  | 100.0              | % |  | $ | 18,239,812 |  | 100.0 | %
|                               |  |                            |            |  |                    |   |  |   |            |  |       |  

As of September 30, 2006, we had commitments to purchase $69.0 million of ARM securities and
$1.1 billion of ARM loans. At September 30, 2006, we used a 21.0% fallout assumption in the determination of our ARM loan commitments based on our historical experience with the conversion of loan commitments to funded loans.



42



---

##### Table of Contents

Securitization Activity

During the quarter ended September 30, 2006, we securitized $4.4 billion of our ARM loans into two CDOs. While TMHL transferred all of the ARM loans to a separate bankruptcy-remote legal
entity, on a consolidated basis we did not account for these securitizations as sales and, therefore, did not record any gain or loss in connection with the securitizations. We retained $144.2 million of the resulting securities for our ARM Loan
portfolio and financed $4.2 billion with third-party investors, thereby providing long-term collateralized financing for these assets. As of September 30, 2006 and December 31, 2005, we held $18.6 billion and $10.4 billion, respectively,
of ARM Loans Collateralizing CDOs. As of September 30, 2006 and December 31, 2005, we held $2.9 billion and $3.3 billion, respectively, of Securitized ARM Loans as a result of our securitization efforts. All discussions relating to
securitizations in these financial statements and notes are on a consolidated basis and do not reflect the separate legal ownership of the loans by various bankruptcy-remote legal entities.

Prepayment Experience

For the quarter ended September 30, 2006, our mortgage assets paid down at an approximate average annualized CPR of 15%, compared to 22% for the quarter ended December 31, 2005 and 28% for the quarter ended September 30,
2005. When prepayment expectations over the remaining life of the assets increase, we have to amortize our premiums over a shorter time period, resulting in a reduced yield to maturity on our ARM Assets. Conversely, if prepayment expectations
decrease, 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 and adjust the amortization of the net premium, as appropriate.

Liquidity and Capital Resources

We
manage liquidity to ensure that we have the continuing ability to maintain cash flows that are adequate to fund operations and meet commitments on a timely and cost-effective basis. At September 30, 2006 and December 31, 2005, we had
unencumbered assets of $1.3 billion, consisting of unpledged ARM Assets, cash and cash equivalents, and other assets. We believe that our liquidity level is in excess of that necessary to satisfy our operating requirements and we expect to continue
to use diverse funding sources to maintain our financial flexibility.

Sources of Funds

Our primary sources of funds for the quarter ended September 30, 2006 consisted of Reverse Repurchase Agreements, Asset-backed CP, CDOs and whole
loan financing facilities, as well as new equity proceeds and principal and interest payments from ARM Assets. The Reverse Repurchase Agreement market is approximately a $4 trillion market, the Asset-backed CP market is approximately an $830 billion
market and the AAA-rated mortgage- and asset- backed securities market is approximately a $10 trillion market, all of which have been readily available sources of financing for mortgage assets, particularly those rated AA or better. Using CDOs as
financing effectively eliminates refinancing and margin call risk for the related portion of our balance sheet. To supplement our funding sources, we also issue equity securities and unsecured long-term debt.

We have arrangements to enter into Reverse Repurchase Agreements with 20 different financial institutions and as of September 30, 2006, had borrowed
funds from 19 of these firms. At September 30, 2006, we had $21.9 billion of Reverse Repurchase Agreements outstanding with a weighted average effective borrowing rate of 5.37% and a weighted average remaining term to maturity of 4.6 months.

We also have a $10 billion Asset-backed CP facility, which provides an alternative way to finance a portion of our ARM portfolio. We issue
Asset-backed CP to investors in the form of secured liquidity notes that are recorded as borrowings on our Consolidated Balance Sheets and are rated P-1 by Moodys Investors Service, F1+ by Fitch Ratings and A-1+ by Standard and
Poors. As of September 30, 2006, we had $8.6 billion of Asset-backed CP outstanding with a weighted average interest rate of 5.34% and a weighted average remaining maturity of 31 days.

Because we borrow money under reverse repurchase and Asset-backed CP 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 declines for other
reasons. External disruptions to credit markets might also impair access to additional liquidity and, therefore, we might be required to sell certain mortgage assets in order to maintain liquidity. If required, such sales might be at prices lower
than the carrying value of the assets, which would result in losses. Our Hedging Instruments help offset this risk and since inception of our operations, we have never had to sell assets to maintain liquidity.



43



---

##### Table of Contents

All of our CDOs are secured by ARM loans. For financial reporting purposes, the ARM Loans Collateralizing
CDOs are recorded as our assets and the CDOs are recorded as our debt. In some transactions, Hedging Instruments are held by the trusts and are recorded as our assets or liabilities. The Hedging Instruments either fix the interest rates of the
pass-through certificates or cap the interest rate exposure on these transactions. As of September 30, 2006, the following CDOs were outstanding (dollar amounts in thousands):



|                                                |  |                   |            |                           |      |  
|----------------------------------------------- |  | ----------------- | ---------- | ------------------------- | ---- | -
|Description                                     |  | Principal Balance |            | EffectiveInterestRate (1) |     
|Floating-rate financing                         |  | $                 | 1,050,979  |                           | 5.68 | %
|Floating-rate financing with Cap Agreements (2) |  |                   | 9,546,266  |                           | 5.68 | %
|Fixed-rate financing (3)                        |  |                   | 7,688,937  |                           | 5.26 | %
|                                                |  |                   |            |                           |      |  
|Total                                           |  | $                 | 18,286,182 |                           | 5.51 | %
|                                                |  |                   |            |                           |      |  

---

|(1) | Effective interest rate includes the impact of issuance costs and Hedging Instruments.
|--- | --------------------------------------------------------------------------------------

|(2) | Includes financing hedged with Cap Agreements with strike prices in excess of one-month LIBOR with a notional balance of $9.5 billion as of September 30,
2006.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Includes floating-rate financing hedged with Swap Agreements with a notional balance of $1.3 billion and Cap Agreements with strike prices less than one-month
LIBOR with a notional balance of $5.4 billion and fixed-rate financing of $1.0 billion as of September 30, 2006.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As
of September 30, 2006, the CDOs were collateralized by ARM loans with a principal balance of $18.6 billion. The debt matures between 2033 and 2046 and is callable at par once the total balance of the loans collateralizing the debt is reduced to
20% of their original balance. The balance of this debt is reduced as the underlying loan collateral is paid down and is expected to have an average life of approximately three years.

As of September 30, 2006, we had entered into three committed whole loan financing facilities with a total borrowing capacity of $900 million that expire between November 2006 and February
2007. In addition to our committed borrowing capacity, we have an uncommitted borrowing capacity of $1.4 billion. The interest rates on these facilities are indexed to one-month LIBOR and reprice accordingly. We expect to renew these facilities when
they expire or replace them with new facilities with similar terms. As of September 30, 2006, we had $694.7 million borrowed against these whole loan financing facilities at an effective cost of 5.92%.



44



---

##### Table of Contents

Capital Utilization and Leverage

The Board of Directors has approved a policy that limits our capacity to borrow funds to finance ARM Assets based on our long-term capital. We monitor the
relationship between our ARM Assets, borrowings and long-term capital using a variety of different measures. However, the primary operating policy that limits our borrowings and leverage is a requirement to maintain our Adjusted Equity-to-Assets
Ratio, a non-GAAP measurement, at a minimum of 8%. Broadly speaking, this ratio reflects the relationship between those ARM Assets financed with borrowings that are subject to margin calls and our long-term capital position. See the table below for
the calculation of this ratio.

Recourse or marginable debt generally consists of Reverse Repurchase Agreements, Asset-backed CP and whole
loan financing facilities. These borrowings are based on the current market value of our ARM Assets, are short-term in nature, mature on a frequent basis (weighted average maturity of 3.6 months as of September 30, 2006), need to be rolled over
at each maturity date and are subject to margin calls based on collateral value changes or changes in margin requirements. For these reasons, our policy requires that we maintain significant excess capital and liquidity above the initial margin
requirement to meet future margin calls as a result of unexpected changes in margin requirements and collateral value. Our initial margin requirements typically average between 4% and 5% for these borrowings, so our policy requires that we maintain
an Adjusted Equity-to-Assets Ratio of at least 8% against the financing of these ARM Assets. The 8% minimum policy requirement provides a capital cushion that we feel confident will be sufficient to allow us to fund future margin requirements that
might result from changes in the value of our assets or Hedging Instruments or changes in margin requirements. Historically, this capital cushion has proved to be more than adequate to support our borrowing arrangements through a variety of interest
rate and credit cycles.

We use the Adjusted Equity-to-Assets Ratio as a way to ensure that we always have an adequate capital cushion
relative to those recourse borrowings subject to margin call. If we did not maintain a sufficient capital cushion to meet initial and ongoing margin requirements, we could be forced to liquidate ARM Assets, potentially at a loss, at a time when our
ARM Assets had declined in value or when margin requirements had changed. The potential limitation that may result from the use of the non-GAAP measurement is that, in an economic environment where the market value of the investment portfolio is
increasing, the amount of capital that we can invest will be less than the amount then available for investment under a comparable GAAP measurement. Although we acknowledge this limitation, we believe that it is not prudent to factor these market
gains into the calculation of leveragable capital because the gains may be short-term in nature. The potential volatility in market prices could result in subsequent reversal of the gains that would require subsequent disposition of ARM Assets in
unfavorable market conditions.

As we increase our use of CDOs, the risk of margin calls, changes in margin requirements and potential
refinancing risk is reduced because CDOs represent long-term non-recourse financing whose terms are established at the time of the financing and are not subject to change. As a result, the need to maintain a capital cushion comparable to what we
maintain on our recourse borrowings is eliminated. For purposes of maintaining an adequate capital cushion, our policy allows us to eliminate all assets (and the associated long-term equity capital) associated with CDOs from our operating capital
ratio. Because the CDOs only require approximately 2% of equity capital to support the transactions, versus the minimum 8% policy requirement on our recourse borrowings, we are able to use this freed-up capital to acquire additional ARM Assets. We
expect that we will be able to retain and carry an increased amount of assets in the future as a percentage of our equity capital base. Additionally, we eliminate from our Adjusted Equity-to-Assets Ratio any unrealized market value adjustments,
recorded as accumulated other comprehensive income (loss), from our equity accounts and we include our Senior Notes and Subordinated Notes as forms of long-term capital as if the notes were equity capital.



45



---

##### Table of Contents

The following table presents the calculation of our Adjusted Equity-to-Assets Ratio, a non-GAAP
measurement (dollar amounts in thousands):



|                                                         |  |                   |             |   |                  |   |             |  
|-------------------------------------------------------- |  | ----------------- | ----------- | - | ---------------- | - | ----------- | -
|                                                         |  | September 30,2006 |             |   | December 31,2005 |  
|Assets                                                   |  | $                 | 52,893,913  |   |                  | $ | 42,507,741  |  
|Adjustments:                                             |  |                   |             |   |                  |   |             |  
|Net unrealized loss on Purchased ARM Assets              |  |                   | 455,653     |   |                  |   | 537,510     |  
|Net unrealized gain on Hedging Instruments               |  |                   | (317,969    | ) |                  |   | (393,583    | )
|ARM Loans Collateralizing CDOs                           |  |                   | (18,618,998 | ) |                  |   | (10,396,961 | )
|Cap Agreements                                           |  |                   | (117,938    | ) |                  |   | (54,241     | )
|                                                         |  |                   |             |   |                  |   |             |  
|Adjusted assets                                          |  | $                 | 34,294,661  |   |                  | $ | 32,200,466  |  
|                                                         |  |                   |             |   |                  |   |             |  
|Shareholders equity                                     |  | $                 | 2,395,567   |   |                  | $ | 2,207,086   |  
|Adjustments:                                             |  |                   |             |   |                  |   |             |  
|Accumulated other comprehensive loss                     |  |                   | 261,971     |   |                  |   | 147,517     |  
|Equity supporting CDOs:                                  |  |                   |             |   |                  |   |             |  
|CDOs                                                     |  |                   | 18,286,182  |   |                  |   | 10,254,334  |  
|ARM Loans Collateralizing CDOs                           |  |                   | (18,618,998 | ) |                  |   | (10,396,961 | )
|Cap Agreements                                           |  |                   | (117,938    | ) |                  |   | (54,241     | )
|                                                         |  |                   |             |   |                  |   |             |  
|                                                         |  |                   | (450,754    | ) |                  |   | (196,868    | )
|                                                         |  |                  
|Senior Notes                                             |  |                   | 305,000     |   |                  |   | 305,000     |  
|Subordinated Notes                                       |  |                   | 240,000     |   |                  |   | 190,000     |  
|                                                         |  |                   |             |   |                  |   |             |  
|Adjusted shareholders equity                            |  | $                 | 2,751,784   |   |                  | $ | 2,652,735   |  
|                                                         |  |                   |             |   |                  |   |             |  
|Adjusted Equity-to-Assets Ratio                          |  |                   | 8.02        | % |                  |   | 8.24        | %
|                                                         |  |                   |             |   |                  |   |             |  
|GAAP equity-to-assets ratio                              |  |                   | 4.53        | % |                  |   | 5.19        | %
|                                                         |  |                   |             |   |                  |   |             |  
|Ratio of historical equity-to-average quarterly assets   |  |                   | 5.16        | % |                  |   | 5.76        | %
|                                                         |  |                   |             |   |                  |   |             |  
|Ratio of long-term equity to historical assets           |  |                   | 6.04        | % |                  |   | 6.68        | %
|                                                         |  |                   |             |   |                  |   |             |  
|Estimated total risk-based capital /risk-weighted assets |  |                   | 18.08       | % |                  |   | 21.33       | %
|                                                         |  |                   |             |   |                  |   |             |  

The above table also presents four alternative capital utilization measurements to our Adjusted
Equity-to-Assets Ratio. The first alternative capital utilization measurement is the GAAP equity-to-assets ratio, a calculation that simply divides total GAAP equity by total assets. While the simplest of all equity-to-assets calculations, it is not
used by management to manage our balance sheet because it includes factors such as unrealized gains and losses on assets and Hedging Instruments deemed to be less important to the long-term operating nature of our business since our assets are not
held for sale and since the unrealized gains and losses are not permanent impairments of our equity or of these assets and Hedging Instruments. If we did use the GAAP measurement as a basis for our leverage limitation and if our Board of
Directors-approved policy limited our GAAP equity-to-assets to a minimum of 8%, our total assets would have been reduced to $29.9 billion instead of the $52.9 billion of assets owned as of September 30, 2006. In part, we are able to carry those
additional assets by financing a portion of our ARM Assets with CDO financings, which have an initial fixed capital requirement of approximately 2% of the assets financed in this way. The GAAP measurement ignores changes in the level of equity
required to support various forms of financing as the mix of our financing of ARM Assets changes between financing subject to margin requirements and CDO financings which are not subject to margin requirements. This is another reason why we do not
use the GAAP measurement to make leverage or capital utilization decisions.



46



---

##### Table of Contents

The second alternative capital utilization measurement is the ratio of historical equity to average
quarterly assets. This is a non-GAAP measurement that eliminates the market value adjustment of our assets and Hedging Instruments included in accumulated other comprehensive income (loss). This measurement is calculated by dividing the sum of
shareholders equity and OCI by the average daily balance of our assets during the quarter. Our historical equity-to-average quarterly assets ratio is higher than the regulatory well-capitalized threshold of 5% required of banks and
savings and loan institutions for the Tier I Core Capital Ratio.

The third alternative capital utilization measurement is the ratio of
long-term equity to historical assets. This is a non-GAAP measurement that eliminates the market value adjustment of our assets and Hedging Instruments included in accumulated other comprehensive income (loss). This calculation also includes Senior
Notes and Subordinated Notes as a component of our long-term capital base. This measurement is calculated by dividing the sum of the assets, net unrealized gain (loss) on Purchased ARM Assets and net unrealized gain (loss) on Hedging Instruments in
the table above by long-term capital. We monitor these ratios in order to have a complete picture of the relationship between our total assets and long-term capital position.

The fourth alternative capital utilization measurement is a calculation of our estimated total risk-based capital ratio, a regulatory calculation required to be made by banks and savings and loan
institutions that comply with Federal Reserve Board capital requirements. The ratio results from dividing the sum of our historical and supplementary capital by total risk weighted assets as presented in the Thrift Financial Report instructions.
Risk-based capital measures capital requirements for assets based on their credit exposure as defined by the regulation, with lower credit risk assets requiring less capital and higher credit risk assets requiring more capital. Although we are not
subject to these regulatory requirements, we focus our efforts on only high quality assets. Therefore, our risk-based capital ratio tends to be quite high when compared to banking institutions, and well in excess of the regulatory minimum of 10%
required for banks and savings and loan institutions to qualify as well-capitalized.

Equity Transactions

During the three-month period ended September 30, 2006, we issued 175,000 shares of Common Stock and 224,900 shares of Preferred
Stock through at-market and off-market transactions and received net proceeds of $4.8 million and $5.4 million, respectively, under a controlled equity offering program.

During the three-month period ended September 30, 2006, we issued 239,060 shares of Common Stock under the DRSPP and received net proceeds of $5.7 million.

Off-Balance Sheet Commitments

As of September 30, 2006, we had commitments in the ordinary course of business to purchase or originate the following amounts of ARM Assets (in thousands):



|                                       |  |   |          
|-------------------------------------- |  | - | ---------
|ARM securities  AAA/AA                |  | $ | 69,000   
|ARM loans  bulk acquisitions          |  |   | 336,654  
|ARM loans  correspondent originations |  |   | 689,462  
|ARM loans  direct originations        |  |   | 33,242   
|ARM loans  wholesale originations     |  |   | 33,448   
|                                       |  |   |          
|                                       |  | $ | 1,161,806
|                                       |  |   |          



47



---

##### Table of Contents

Contractual Obligations

As of September 30, 2006, we had the following contractual obligations (in thousands):



|                                |  |                        |            |                 |   |             |  |             |        |                  |   |         |  |   |           
|------------------------------- |  | ---------------------- | ---------- | --------------- | - | ----------- |  | ----------- | ------ | ---------------- | - | ------- |  | - | ----------
|                                |  | Payments Due by Period
|                                |  | Total                  |            | Less than 1year |   | 1  3 years |  | 3  5 years |        | More than 5years
|Reverse Repurchase Agreements   |  | $                      | 21,886,974 |                 | $ | 21,216,973  |  | $           |       |                  | $ | 670,001 |  | $ |          
|Asset-backed CP                 |  |                        | 8,576,300  |                 |   | 8,576,300   |  |             |       |                  |   |        |  |   |          
|CDOs (1)                        |  |                        | 18,286,182 |                 |   | 37,865      |  |             | 98,349 |                  |   | 136,017 |  |   | 18,013,951
|Whole loan financing facilities |  |                        | 694,679    |                 |   | 694,679     |  |             |       |                  |   |        |  |   |          
|Senior Notes                    |  |                        | 305,000    |                 |   |            |  |             |       |                  |   |        |  |   | 305,000   
|Subordinated Notes              |  |                        | 240,000    |                 |   |            |  |             |       |                  |   |        |  |   | 240,000   
|                                |  |                        |            |                 |   |             |  |             |        |                  |   |         |  |   |           
|Total (2)                       |  | $                      | 49,989,135 |                 | $ | 30,525,817  |  | $           | 98,348 |                  | $ | 806,018 |  | $ | 18,558,951
|                                |  |                        |            |                 |   |             |  |             |        |                  |   |         |  |   |           

---

|(1) | Maturities of our CDOs are dependent upon cash flows received from the underlying loans receivable. Our estimate of their repayment is based on scheduled
principal payments on the underlying loans receivable. This estimate will differ from actual amounts to the extent we experience prepayments and/or loan losses.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Our Consolidated Balance Sheets include a liability for Hedging Instruments with negative market values, which are not reflected in this table.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------

Results of Operations For the Three Months Ended September 30, 2006

For the quarter ended September 30, 2006, our net income was $75.3 million, or $0.64 EPS, based on weighted average shares of Common Stock
outstanding of 113,316,000. That compares to $74.0 million, or $0.70 EPS for the quarter ended September 30, 2005, based on weighted average shares of Common Stock outstanding of 102,758,000, an 8.6% decrease in our EPS.

The table below highlights the historical trend in the components of return on average common equity (annualized) during each respective quarter:

Components of Return on Average Common Equity



|                      |  |                          |   |  |                             |   |  |                |   |  |                        |   |  |                 |    |  |                          |   |  |                       |  
|--------------------- |  | ------------------------ | - |  | --------------------------- | - |  | -------------- | - |  | ---------------------- | - |  | --------------- | -- |  | ------------------------ | - |  | --------------------- | -
|For the Quarter Ended |  | NetInterestIncome/Equity |   |  | G & AExpense,net (1)/Equity |   |  | MgmtFee/Equity |   |  | PerformanceFee/ Equity |   |  | Other(2)/Equity |    |  | PreferredDividend/Equity |   |  | NetIncome/Equity(ROE) |  
|Sep 30, 2004          |  | 18.76                    | % |  | 1.43                        | % |  | 1.09           | % |  | 2.23                   | % |  | (1.16           | )% |  | 0.00                     | % |  | 15.17                 | %
|Dec 31, 2004          |  | 18.84                    | % |  | 1.10                        | % |  | 1.06           | % |  | 2.23                   | % |  | (0.86           | )% |  | 0.00                     | % |  | 15.31                 | %
|Mar 31, 2005          |  | 17.91                    | % |  | 0.74                        | % |  | 1.01           | % |  | 2.16                   | % |  | (0.54           | )% |  | 0.02                     | % |  | 14.52                 | %
|Jun 30, 2005          |  | 16.53                    | % |  | 1.04                        | % |  | 1.03           | % |  | 2.00                   | % |  | (1.54           | )% |  | 0.29                     | % |  | 13.71                 | %
|Sep 30, 2005          |  | 17.85                    | % |  | 0.33                        | % |  | 1.09           | % |  | 2.00                   | % |  | 0.09            | %  |  | 0.44                     | % |  | 13.90                 | %
|Dec 31, 2005          |  | 17.59                    | % |  | 1.05                        | % |  | 1.13           | % |  | 1.74                   | % |  | (0.83           | )% |  | 0.46                     | % |  | 14.04                 | %
|Mar 31, 2006          |  | 16.29                    | % |  | 1.31                        | % |  | 1.07           | % |  | 1.67                   | % |  | (1.06           | )% |  | 0.43                     | % |  | 12.88                 | %
|Jun 30, 2006          |  | 13.86                    | % |  | 1.03                        | % |  | 1.04           | % |  | 1.24                   | % |  | (1.48           | )% |  | 0.42                     | % |  | 11.61                 | %
|Sep 30, 2006          |  | 15.08                    | % |  | 0.34                        | % |  | 1.11           | % |  | 1.50                   | % |  | (0.91           | )% |  | 0.43                     | % |  | 12.61                 | %

---

|(1) | G & A expense excludes management and performance fees and is net of servicing income.
|--- | --------------------------------------------------------------------------------------

|(2) | Other includes gain on ARM assets and Hedging Instruments, hedging expense and provision for credit losses.
|--- | -----------------------------------------------------------------------------------------------------------

Our ROE declined in the third quarter of 2006 compared to the same period in 2005 primarily due to increased competition for mortgage assets, continued
narrowing of mortgage spreads over our cost of funds, a decline in the percent of Hybrid ARMs hedged with fixed rate borrowings as a result of slowing prepayments, increased hedging activity as interest rates rose and the lag in reset dates on our
Traditional ARM portfolio compared to the associated financing cost. This ROE decline was partially offset by growing our balance sheet and better utilizing our existing capital base.



48



---

##### Table of Contents

The following table presents the components of our net interest income for the quarters ended
September 30, 2006 and 2005:

Comparative Net Interest Income Components

(in thousands)



|                                                  |  |                                     |         |   |      |   |         |  
|------------------------------------------------- |  | ----------------------------------- | ------- | - | ---- | - | ------- | -
|                                                  |  | For the quarters endedSeptember 30, |        
|                                                  |  | 2006                                |         |   | 2005 |  
|Coupon interest income on ARM Assets              |  | $                                   | 673,498 |   |      | $ | 424,456 |  
|Amortization of net premium                       |  |                                     | (8,038  | ) |      |   | (26,318 | )
|Cash and cash equivalents                         |  |                                     | 1,712   |   |      |   | 1,980   |  
|                                                  |  |                                     |         |   |      |   |         |  
|Interest income                                   |  |                                     | 667,172 |   |      |   | 400,118 |  
|                                                  |  |                                     |         |   |      |   |         |  
|Reverse Repurchase Agreements and Asset-backed CP |  |                                     | 421,188 |   |      |   | 233,978 |  
|CDOs                                              |  |                                     | 230,960 |   |      |   | 71,964  |  
|Whole loan financing facilities                   |  |                                     | 13,572  |   |      |   | 6,767   |  
|Senior Notes                                      |  |                                     | 6,133   |   |      |   | 6,134   |  
|Subordinated Notes                                |  |                                     | 4,541   |   |      |   | 58      |  
|Hedging Instruments                               |  |                                     | (96,357 | ) |      |   | (10,960 | )
|                                                  |  |                                     |         |   |      |   |         |  
|Interest expense                                  |  |                                     | 580,037 |   |      |   | 307,941 |  
|                                                  |  |                                     |         |   |      |   |         |  
|Net interest income                               |  | $                                   | 87,135  |   |      | $ | 92,177  |  
|                                                  |  |                                     |         |   |      |   |         |  



49



---

##### Table of Contents

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

Average Balance, Rate and Interest Income/Expense Table

(dollar amounts in thousands)



|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|-------------------------------------------------------- |  | ------------------------------------ | ---------- | ------------- | ----- | - | ------------------------- | - | ------- | -------------- |  | ------------- | ---------- |  | ------------------------- | - |  | - | ------- | -
|                                                         |  | For the quarters ended September 30, |           
|                                                         |  | 2006                                 |            |               | 2005  |  
|                                                         |  | AverageBalance                       |            | EffectiveRate |       |   | InterestIncome andExpense |   |         | AverageBalance |  | EffectiveRate |            |  | InterestIncome andExpense |  
|Interest-earning assets:                                 |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|ARM Assets (1)                                           |  | $                                    | 50,299,776 |               | 5.29  | % |                           | $ | 665,460 |                |  | $             | 35,759,888 |  | 4.45                      | % |  | $ | 398,138 |  
|Cash and cash equivalents                                |  |                                      | 147,834    |               | 4.63  |   |                           |   | 1,712   |                |  |               | 98,611     |  | 8.03                      |   |  |   | 1,980   |  
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|                                                         |  |                                      | 50,447,610 |               | 5.29  |   |                           |   | 667,172 |                |  |               | 35,858,499 |  | 4.46                      |   |  |   | 400,118 |  
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|Interest-bearing liabilities:                            |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|Reverse Repurchase Agreements and Asset-backed CP        |  |                                      | 31,067,274 |               | 5.42  |   |                           |   | 421,188 |                |  |               | 25,836,941 |  | 3.62                      |   |  |   | 233,978 |  
|Plus: (Benefit) of Hedging Instruments (2)               |  |                                      |            |               | (1.16 | ) |                           |   | (89,944 | )              |  |               |            |  | (0.21                     | ) |  |   | (13,813 | )
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|Hedged Reverse Repurchase Agreements and Asset-backed CP |  |                                      |            |               | 4.26  |   |                           |   | 331,244 |                |  |               |            |  | 3.41                      |   |  |   | 220,165 |  
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|CDOs                                                     |  |                                      | 16,266,995 |               | 5.68  |   |                           |   | 230,960 |                |  |               | 7,147,917  |  | 4.03                      |   |  |   | 71,964  |  
|Plus: (Benefit) cost of Hedging Instruments (2)          |  |                                      |            |               | (0.16 | ) |                           |   | (6,413  | )              |  |               |            |  | 0.16                      |   |  |   | 2,853   |  
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|Hedged CDOs                                              |  |                                      |            |               | 5.52  |   |                           |   | 224,547 |                |  |               |            |  | 4.19                      |   |  |   | 74,817  |  
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|Whole loan financing facilities                          |  |                                      | 870,547    |               | 6.24  |   |                           |   | 13,572  |                |  |               | 622,149    |  | 4.35                      |   |  |   | 6,767   |  
|Senior and Subordinated Notes                            |  |                                      | 545,000    |               | 7.83  |   |                           |   | 10,674  |                |  |               | 313,854    |  | 7.89                      |   |  |   | 6,192   |  
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|                                                         |  |                                      | 48,749,816 |               | 4.76  |   |                           |   | 580,037 |                |  |               | 33,920,861 |  | 3.63                      |   |  |   | 307,941 |  
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|Net interest-earning assets and spread                   |  | $                                    | 1,697,794  |               | 0.53  | % |                           | $ | 87,135  |                |  | $             | 1,937,638  |  | 0.83                      | % |  | $ | 92,177  |  
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  
|Yield on net interest-earning assets (3)                 |  |                                      |            |               | 0.69  | % |                           |   |         |                |  |               |            |  | 1.03                      | % |  |   |         |  
|                                                         |  |                                      |            |               |       |   |                           |   |         |                |  |               |            |  |                           |   |  |   |         |  

---

|(1) | Effective rate includes impact of amortizing ARM Assets net premium.
|--- | --------------------------------------------------------------------

|(2) | Includes Swap Agreements with notional balances of $37.0 billion and $26.5 billion as of September 30, 2006 and 2005, respectively, and Cap Agreements with
net notional balances of $984.9 million and $1.0 billion as of September 30, 2006 and 2005, respectively.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Yield on Net Interest-Earning Assets is computed by dividing annualized net interest income by the average daily balance of interest-earning assets.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------



50



---

##### Table of Contents

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 (in thousands):



|                                                  |  |                                                                       |        |   |        |   |         |  |   |         |  
|------------------------------------------------- |  | --------------------------------------------------------------------- | ------ | - | ------ | - | ------- |  | - | ------- | -
|                                                  |  | Rate/Volume Variance Three Months ended September 30,2006 versus 2005 |       
|                                                  |  | Rate                                                                  |        |   | Volume |   | Total   | 
|Interest income:                                  |  |                                                                       |        |   |        |   |         |  |   |         |  
|ARM Assets                                        |  | $                                                                     | 74,961 |   |        | $ | 192,361 |  | $ | 267,322 |  
|Cash and cash equivalents                         |  |                                                                       | (838   | ) |        |   | 570     |  |   | (268    | )
|                                                  |  |                                                                       |        |   |        |   |         |  |   |         |  
|                                                  |  |                                                                       | 74,123 |   |        |   | 192,931 |  |   | 267,054 |  
|                                                  |  |                                                                       |        |   |        |   |         |  |   |         |  
|Interest expense:                                 |  |                                                                       |        |   |        |   |         |  |   |         |  
|Reverse Repurchase Agreements and Asset-backed CP |  |                                                                       | 55,312 |   |        |   | 55,767  |  |   | 111,079 |  
|CDOs                                              |  |                                                                       | 23,852 |   |        |   | 125,878 |  |   | 149,730 |  
|Whole loan financing facilities                   |  |                                                                       | 2,932  |   |        |   | 3,873   |  |   | 6,805   |  
|Senior and Subordinated Notes                     |  |                                                                       | (45    | ) |        |   | 4,527   |  |   | 4,482   |  
|                                                  |  |                                                                       |        |   |        |   |         |  |   |         |  
|                                                  |  |                                                                       | 82,051 |   |        |   | 190,045 |  |   | 272,096 |  
|                                                  |  |                                                                       |        |   |        |   |         |  |   |         |  
|Net interest income                               |  | $                                                                     | (7,928 | ) |        | $ | 2,886   |  | $ | (5,042  | )
|                                                  |  |                                                                       |        |   |        |   |         |  |   |         |  

Net interest income decreased $5.0 million in the third quarter of 2006, compared to the same
quarter of the prior year. This decrease in net interest income is composed of an unfavorable rate variance and a favorable volume variance. The increased average size of our portfolio during the third quarter of 2006 compared to the same period of
2005 increased net interest income in the amount of $2.9 million. The average balance of our interest-earning assets was $50.4 billion during the quarter ended September 30, 2006, compared to $35.9 billion during the same period of 2005 
an increase of 40.8%. As a result of the yield on our interest-earning assets increasing to 5.29% during the third quarter of 2006 from 4.46% during the same quarter of 2005, an increase of 83 BPs, and our cost of funds increasing to 4.76% from
3.63% during the same period, an increase of 113 BPs, there was a net unfavorable rate variance of $7.9 million.

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

Components of Net Interest Spread and Yield on Net Interest-Earning Assets (1)

(dollar amounts in millions)



|                      |  |                               |        |                                 |      |   |                      |      |   |                               |      |   |              |      |   |                   |      |   |                                   |      |  
|--------------------- |  | ----------------------------- | ------ | ------------------------------- | ---- | - | -------------------- | ---- | - | ----------------------------- | ---- | - | ------------ | ---- | - | ----------------- | ---- | - | --------------------------------- | ---- | -
|For the Quarter Ended |  | AverageInterest-EarningAssets |        | HistoricalWeightedAverageCoupon |      |   | YieldAdjust-ment (2) |      |   | Yield onInterestEarningAssets |      |   | Cost ofFunds |      |   | NetInterestSpread |      |   | Yield onNetInterest-EarningAssets |     
|Sep 30, 2004          |  | $                             | 24,450 |                                 | 4.30 | % |                      | 0.38 | % |                               | 3.92 | % |              | 2.93 | % |                   | 0.99 | % |                                   | 1.17 | %
|Dec 31, 2004          |  | $                             | 27,193 |                                 | 4.42 | % |                      | 0.35 | % |                               | 4.07 | % |              | 3.11 | % |                   | 0.96 | % |                                   | 1.15 | %
|Mar 31, 2005          |  | $                             | 29,414 |                                 | 4.55 | % |                      | 0.36 | % |                               | 4.19 | % |              | 3.25 | % |                   | 0.94 | % |                                   | 1.13 | %
|Jun 30, 2005          |  | $                             | 30,854 |                                 | 4.65 | % |                      | 0.36 | % |                               | 4.29 | % |              | 3.44 | % |                   | 0.85 | % |                                   | 1.05 | %
|Sep 30, 2005          |  | $                             | 35,858 |                                 | 4.83 | % |                      | 0.37 | % |                               | 4.46 | % |              | 3.63 | % |                   | 0.83 | % |                                   | 1.03 | %
|Dec 31, 2005          |  | $                             | 40,501 |                                 | 4.98 | % |                      | 0.32 | % |                               | 4.66 | % |              | 3.96 | % |                   | 0.70 | % |                                   | 0.87 | %
|Mar 31, 2006          |  | $                             | 42,841 |                                 | 5.10 | % |                      | 0.21 | % |                               | 4.89 | % |              | 4.22 | % |                   | 0.67 | % |                                   | 0.83 | %
|Jun 30, 2006          |  | $                             | 46,183 |                                 | 5.21 | % |                      | 0.19 | % |                               | 5.02 | % |              | 4.48 | % |                   | 0.54 | % |                                   | 0.69 | %
|Sep 30, 2006          |  | $                             | 50,448 |                                 | 5.36 | % |                      | 0.07 | % |                               | 5.29 | % |              | 4.76 | % |                   | 0.53 | % |                                   | 0.69 | %

---

|(1) | Yield on net interest-earning assets is computed by dividing net interest income by the average daily balance of interest-earning assets during the quarter.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Yield adjustments include the impact of amortizing premiums and discounts, the impact of principal payment receivables and the impact of interest-earning non-ARM
assets.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



51



---

##### Table of Contents

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

Components of the Yield Adjustments on ARM Assets



|                      |  |                              |   |  |                                      |   |  |           |    |  |                       |  
|--------------------- |  | ---------------------------- | - |  | ------------------------------------ | - |  | --------- | -- |  | --------------------- | -
|For the Quarter Ended |  | Premium/DiscountAmortization |   |  | Impact ofPrincipalPaymentsReceivable |   |  | Other (1) |    |  | Total YieldAdjustment |  
|Sep 30, 2004          |  | 0.30                         | % |  | 0.08                                 | % |  | 0.00      | %  |  | 0.38                  | %
|Dec 31, 2004          |  | 0.30                         | % |  | 0.07                                 | % |  | (0.02     | )% |  | 0.35                  | %
|Mar 31, 2005          |  | 0.32                         | % |  | 0.07                                 | % |  | (0.01     | )% |  | 0.36                  | %
|Jun 30, 2005          |  | 0.35                         | % |  | 0.06                                 | % |  | (0.05     | )% |  | 0.36                  | %
|Sep 30, 2005          |  | 0.35                         | % |  | 0.06                                 | % |  | (0.04     | )% |  | 0.37                  | %
|Dec 31, 2005          |  | 0.30                         | % |  | 0.07                                 | % |  | (0.05     | )% |  | 0.32                  | %
|Mar 31, 2006          |  | 0.23                         | % |  | 0.05                                 | % |  | (0.07     | )% |  | 0.21                  | %
|Jun 30, 2006          |  | 0.23                         | % |  | 0.04                                 | % |  | (0.08     | )% |  | 0.19                  | %
|Sep 30, 2006          |  | 0.10                         | % |  | 0.04                                 | % |  | (0.07     | )% |  | 0.07                  | %

---

|(1) | Other includes the impact of interest-earning cash and cash equivalents, restricted cash and cash equivalents and mark-to-market adjustments.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------

During the quarter ended September 30, 2006, we made a 3% downward adjustment in our expected future CPR on our
Hybrid ARM assets to more accurately reflect the actual prepayment experience we have observed over the past nine months and expect to see in the future. This adjustment reduced the premium/discount amortization component of the yield adjustment on
ARM assets.

As of September 30, 2006, our ARM Loans, including those that we have securitized, but with respect to which we have
retained credit loss exposure, accounted for 43.5% of our portfolio of ARM Assets or $22.5 billion. During the third quarters of 2006 and 2005, we recorded loan loss provisions totaling $754,000 and $374,000, respectively, to reserve for estimated
credit losses on ARM Loans.

At September 30, 2006 and December 31, 2005, our Purchased Securitized Loans totaled $7.1 billion
and $6.8 billion, respectively. Like our own loan originations and acquisitions, these assets are Qualifying Interests for purposes of maintaining our exemption from the Investment Company Act because we retain a 100% ownership interest in the
underlying loans. Because we purchase all classes of these securitizations, we have the entire credit exposure on the underlying loans. The purchase price of the classes that are less than Investment Grade generally includes a discount for probable
credit losses and, based on managements judgment, the portion of the purchase discount which reflects the estimated unrealized loss on the securities due to credit risk is treated as a non-accretable discount. As of September 30, 2006, 45
of the underlying loans in these Purchased Securitized Loans were 60 days or more delinquent and had an aggregate balance of $35.3 million. Activity in non-accretable discounts for the three month periods ended September 30, 2006 and 2005 was
as follows (in thousands):



|                                  |  |      |        |   |      |   |       
|--------------------------------- |  | ---- | ------ | - | ---- | - | ------
|                                  |  | 2006 |        |   | 2005
|Balance at beginning of period    |  | $    | 15,251 |   |      | $ | 7,996 
|Increase for securities purchased |  |      |       |   |      |   | 2,115 
|Realized losses                   |  |      | (8     | ) |      |   |      
|                                  |  |      |        |   |      |   |       
|Balance at end of period          |  | $    | 15,243 |   |      | $ | 10,111
|                                  |  |      |        |   |      |   |       

We recorded a net gain of $5.9 million on Derivatives during the third quarter of 2006, which
consisted of a net gain of $45.2 million on commitments to purchase loans from correspondent lenders and bulk sellers partially offset by a net loss of $39.3 million on Pipeline Hedging Instruments. We recorded a net loss of $147,000 on Derivatives
during the same period in 2005, which consisted of a net gain of $6.0 million on Pipeline Hedging Instruments and a net loss of $6.1 million on commitments to purchase loans from correspondent lenders and bulk sellers.

We did not sell any ARM Assets during the quarters ended September 30, 2006 or 2005.



52



---

##### Table of Contents

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

Annualized Operating Expense Ratios



|                      |  |                               |   |  |                                |   |  |                               |   |  |                                          |  
|--------------------- |  | ----------------------------- | - |  | ------------------------------ | - |  | ----------------------------- | - |  | ---------------------------------------- | -
|For the Quarter Ended |  | Management Fee/Average Assets |   |  | Performance Fee/Average Assets |   |  | Other Expenses/Average Assets |   |  | Total Operating Expenses/ Average
Assets |  
|Sep 30, 2004          |  | 0.07                          | % |  | 0.14                           | % |  | 0.12                          | % |  | 0.33                                     | %
|Dec 31, 2004          |  | 0.06                          | % |  | 0.14                           | % |  | 0.10                          | % |  | 0.30                                     | %
|Mar 31, 2005          |  | 0.06                          | % |  | 0.14                           | % |  | 0.08                          | % |  | 0.28                                     | %
|Jun 30, 2005          |  | 0.06                          | % |  | 0.13                           | % |  | 0.10                          | % |  | 0.29                                     | %
|Sep 30, 2005          |  | 0.06                          | % |  | 0.11                           | % |  | 0.05                          | % |  | 0.22                                     | %
|Dec 31, 2005          |  | 0.06                          | % |  | 0.09                           | % |  | 0.08                          | % |  | 0.23                                     | %
|Mar 31, 2006          |  | 0.05                          | % |  | 0.08                           | % |  | 0.11                          | % |  | 0.24                                     | %
|Jun 30, 2006          |  | 0.05                          | % |  | 0.06                           | % |  | 0.08                          | % |  | 0.19                                     | %
|Sep 30, 2006          |  | 0.05                          | % |  | 0.07                           | % |  | 0.05                          | % |  | 0.17                                     | %

The most significant decrease to our operating expenses for the quarter ended September 30,
2006 compared to September 30, 2005 was the $1.7 million decrease in the performance-based fee that the Manager earned as a result of our achieving a Return on Equity in excess of the threshold as defined in the Management Agreement which was
partially offset by a $1.0 million decrease in benefits associated with long-term incentive awards resulting from the decrease in the Common Stock price, a $781,000 increase in the base management fee and the $1.2 million increase in expenses
related to expanded operations of TMHL. Our ROE prior to the effect of the performance-based fee of $8.7 million for the third quarter of 2006 was 14.11%, whereas the threshold, the average Ten Year U.S. Treasury Rate plus 1%, was 5.89%. This ROE is
a non-GAAP measurement used solely to calculate the amount of the performance-based fee earned by the Manager, in accordance with the formula contained in the Management Agreement. Our GAAP ROE for the quarter ended September 30, 2006, which
includes the effect of the performance-based fee of $8.7 million, was 12.61%.

Results of Operations For the Nine Months Ended
September 30, 2006

For the nine months ended September 30, 2006, our net income was $217.4 million, or $1.91 EPS, based on
weighted average common shares outstanding of 110,195,000. That compares to $210.0 million, or $2.11 EPS for the nine months ended September 30, 2005, based on weighted average common shares outstanding of 97,518,000, a 9.5% decrease in our
EPS.

Our ROE was 12.36% for the nine months ended September 30, 2006 compared to 14.03% for the same period in 2005. Our ROE decline
in the first nine months of 2006 compared to the same period in 2005 was primarily due to increased competition for mortgage assets, continued narrowing of mortgage spreads over our cost of funds, a decline in the percent of Hybrid ARMs hedged with
fixed rate borrowings, increased hedging activity as interest rates rose and the lag in reset dates on our Traditional ARM portfolio compared to the associated financing cost. This ROE decline was partially offset by growing our balance sheet and
better utilizing our existing capital base.



53



---

##### Table of Contents

The following table presents the components of our net interest income for the nine months ended
September 30, 2006 and 2005:

Comparative Net Interest Income Components

(in thousands)



|                                                  |  |                                        |           |   |      |   |           |  
|------------------------------------------------- |  | -------------------------------------- | --------- | - | ---- | - | --------- | -
|                                                  |  | For the nine months endedSeptember 30, |          
|                                                  |  | 2006                                   |           |   | 2005 |  
|Coupon interest income on ARM Assets              |  | $                                      | 1,817,969 |   |      | $ | 1,103,529 |  
|Amortization of net premium                       |  |                                        | (50,927   | ) |      |   | (67,632   | )
|Cash and cash equivalents                         |  |                                        | 3,428     |   |      |   | 3,100     |  
|                                                  |  |                                        |           |   |      |   |           |  
|Interest income                                   |  |                                        | 1,770,470 |   |      |   | 1,038,997 |  
|                                                  |  |                                        |           |   |      |   |           |  
|Reverse Repurchase Agreements and Asset-backed CP |  |                                        | 1,136,961 |   |      |   | 543,585   |  
|CDOs                                              |  |                                        | 535,388   |   |      |   | 179,243   |  
|Whole loan financing facilities                   |  |                                        | 42,743    |   |      |   | 17,933    |  
|Senior Notes                                      |  |                                        | 18,399    |   |      |   | 18,402    |  
|Subordinated Notes                                |  |                                        | 12,639    |   |      |   | 58        |  
|Hedging Instruments                               |  |                                        | (231,656  | ) |      |   | 23,633    |  
|                                                  |  |                                        |           |   |      |   |           |  
|Interest expense                                  |  |                                        | 1,514,474 |   |      |   | 782,854   |  
|                                                  |  |                                        |           |   |      |   |           |  
|Net interest income                               |  | $                                      | 255,996   |   |      | $ | 256,143   |  
|                                                  |  |                                        |           |   |      |   |           |  



54



---

##### Table of Contents

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

Average Balance, Rate and Interest Income/Expense Table

(dollar amounts in thousands)



|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|-------------------------------------------------------- |  | --------------------------------------- | ---------- | ------------- | ----- | - | ------------------------- | - | --------- | -------------- |  | ------------- | ---------- |  | ------------------------- | - |  | - | ---------
|                                                         |  | For the nine months ended September 30,
|                                                         |  | 2006                                    |            |               | 2005 
|                                                         |  | AverageBalance                          |            | EffectiveRate |       |   | InterestIncome andExpense |   |           | AverageBalance |  | EffectiveRate |            |  | InterestIncome andExpense
|Interest-earning assets:                                 |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|ARM Assets (1)                                           |  | $                                       | 46,372,856 |               | 5.08  | % |                           | $ | 1,767,042 |                |  | $             | 31,965,534 |  | 4.32                      | % |  | $ | 1,035,897
|Cash and cash equivalents                                |  |                                         | 106,831    |               | 4.28  |   |                           |   | 3,428     |                |  |               | 76,630     |  | 5.39                      |   |  |   | 3,100    
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|                                                         |  |                                         | 46,479,687 |               | 5.08  |   |                           |   | 1,770,470 |                |  |               | 32,042,164 |  | 4.32                      |   |  |   | 1,038,997
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|Interest-bearing liabilities:                            |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|Reverse Repurchase Agreements and Asset-backed CP        |  |                                         | 29,991,747 |               | 5.05  |   |                           |   | 1,136,961 |                |  |               | 22,702,988 |  | 3.19                      |   |  |   | 543,585  
|Plus: (Benefit) cost of Hedging Instruments (2)          |  |                                         |            |               | (0.97 | ) |                           |   | (218,086  | )              |  |               |            |  | 0.05                      |   |  |   | 7,769    
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|Hedged Reverse Repurchase Agreements and Asset-backed CP |  |                                         |            |               | 4.08  |   |                           |   | 918,875   |                |  |               |            |  | 3.24                      |   |  |   | 551,354  
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|CDOs                                                     |  |                                         | 13,342,795 |               | 5.35  |   |                           |   | 535,388   |                |  |               | 6,585,391  |  | 3.63                      |   |  |   | 179,243  
|Plus: (Benefit) cost of Hedging Instruments (2)          |  |                                         |            |               | (0.14 | ) |                           |   | (13,570   | )              |  |               |            |  | 0.32                      |   |  |   | 15,864   
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|Hedged CDOs                                              |  |                                         |            |               | 5.21  |   |                           |   | 521,818   |                |  |               |            |  | 3.95                      |   |  |   | 195,107  
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|Whole loan financing facilities                          |  |                                         | 977,574    |               | 5.83  |   |                           |   | 42,743    |                |  |               | 633,405    |  | 3.77                      |   |  |   | 17,933   
|Senior and Subordinated Notes                            |  |                                         | 528,692    |               | 7.83  |   |                           |   | 31,038    |                |  |               | 307,414    |  | 8.01                      |   |  |   | 18,460   
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|                                                         |  |                                         | 44,840,808 |               | 4.50  |   |                           |   | 1,514,474 |                |  |               | 30,229,198 |  | 3.45                      |   |  |   | 782,854  
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|Net interest-earning assets and spread                   |  | $                                       | 1,638,879  |               | 0.58  | % |                           | $ | 255,996   |                |  | $             | 1,812,966  |  | 0.87                      | % |  | $ | 256,143  
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          
|Yield on net interest-earning assets (3)                 |  |                                         |            |               | 0.73  | % |                           |   |           |                |  |               |            |  | 1.07                      | % |  |   |          
|                                                         |  |                                         |            |               |       |   |                           |   |           |                |  |               |            |  |                           |   |  |   |          

---

|(1) | Effective rate includes impact of amortizing ARM Assets net premium.
|--- | --------------------------------------------------------------------

|(2) | Includes Swap Agreements with notional balances of $37.0 billion and $26.5 billion as of September 30, 2006 and 2005, respectively, and Cap Agreements with
net notional balances of $984.9 million and $1.0 billion as of September 30, 2006 and 2005, respectively.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Yield on net interest-earning assets is computed by dividing annualized net interest income by the average daily balance of interest-earning assets.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------



55



---

##### Table of Contents

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 (amounts in thousands):



|                                                  |  |                                                                       |         |   |        |   |         |  |   |         |  
|------------------------------------------------- |  | --------------------------------------------------------------------- | ------- | - | ------ | - | ------- |  | - | ------- | -
|                                                  |  | Rate/Volume Variance Nine Months ended September 30, 2006 versus 2005 |        
|                                                  |  | Rate                                                                  |         |   | Volume |   | Total   | 
|Interest income:                                  |  |                                                                       |         |   |        |   |         |  |   |         |  
|ARM Assets                                        |  | $                                                                     | 182,153 |   |        | $ | 548,992 |  | $ | 731,145 |  
|Cash and cash equivalents                         |  |                                                                       | (641    | ) |        |   | 969     |  |   | 328     |  
|                                                  |  |                                                                       |         |   |        |   |         |  |   |         |  
|                                                  |  |                                                                       | 181,512 |   |        |   | 549,961 |  |   | 731,473 |  
|                                                  |  |                                                                       |         |   |        |   |         |  |   |         |  
|Interest expense:                                 |  |                                                                       |         |   |        |   |         |  |   |         |  
|Reverse Repurchase Agreements and Asset-backed CP |  |                                                                       | 144,211 |   |        |   | 223,310 |  |   | 367,521 |  
|CDOs                                              |  |                                                                       | 62,440  |   |        |   | 264,271 |  |   | 326,711 |  
|Whole loan financing facilities                   |  |                                                                       | 9,762   |   |        |   | 15,048  |  |   | 24,810  |  
|Senior and Subordinated Notes                     |  |                                                                       | (414    | ) |        |   | 12,992  |  |   | 12,578  |  
|                                                  |  |                                                                       |         |   |        |   |         |  |   |         |  
|                                                  |  |                                                                       | 215,999 |   |        |   | 515,621 |  |   | 731,620 |  
|                                                  |  |                                                                       |         |   |        |   |         |  |   |         |  
|Net interest income                               |  | $                                                                     | (34,487 | ) |        | $ | 34,340  |  | $ | (147    | )
|                                                  |  |                                                                       |         |   |        |   |         |  |   |         |  

Net interest income decreased $147,000 in the nine months ended September 30, 2006, compared
to the same period of the prior year. This decrease in net interest income is composed of an unfavorable rate variance and a favorable volume variance. The increased average size of our portfolio during the first nine months of 2006 compared to the
same period of 2005 increased net interest income in the amount of $34.3 million. The average balance of our interest-earning assets was $46.5 billion during the nine months ended September 30, 2006, compared to $32.0 billion during the same
period of 2005  an increase of 45.1%. As a result of the yield on our interest-earning assets increasing to 5.08% during the first nine months of 2006 from 4.32% during the same period of 2005, an increase of 76 BPs, and our cost of funds
increasing to 4.50% from 3.45% during the same period, an increase of 105 BPs, there was a net unfavorable rate variance of $34.5 million.

For the nine months ended September 30, 2006, our ratio of operating expenses to average assets was 0.20%, compared to 0.26% for the same period in 2005. The most significant increases to our operating expenses for the nine months
ended September 30, 2006 compared to September 30, 2005 were the $4.8 million increase in expenses related to expanded operations of TMHL, the $2.9 million increase in base management fees and the $2.9 million increase in the expenses
associated with our long-term incentive awards partially offset by a $5.2 million decrease in the performance-based fee that the Manager earned as a result of our achieving a Return on Equity in excess of the threshold as defined in the Management
Agreement. Our ROE prior to the effect of the performance-based fee of $24.9 million for the first nine months of 2006 was 13.82%, whereas the threshold, the average Ten Year U.S. Treasury Rate plus 1%, was 5.85%. Our GAAP ROE for the nine months
ended September 30, 2006, which includes the effect of the performance-based fee, was 12.36%.

Market Risks

The market risk management discussion and the amounts estimated from the analysis that follows are forward-looking statements that assume that certain
market conditions will occur. Actual results may differ materially from these projected results due to changes in our ARM portfolio and borrowings mix and due to developments in the domestic and global financial and real estate markets. Developments
in the financial markets include the likelihood of changes in interest rates and in the relationship of various interest rates and their impact on our ARM portfolio yield, cost of funds and cash flows.

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



56



---

##### Table of Contents

The table below presents an approximation of the sensitivity of the market value of our ARM portfolio,
including purchase commitments, using a discounted cash flow simulation model. Application of this method results in an estimation of the percentage change in the market value of our assets, liabilities and Hedging Instruments per 100 and 200 BP
shifts in interest rates expressed in years  a measure commonly referred to as Effective Duration. Positive portfolio Effective Duration indicates that the market value of the total portfolio will decline if interest rates rise and increase if
interest rates decline. Negative portfolio Effective Duration indicates that the market value of the total portfolio will decline if interest rates decline and increase if interest rates rise. The closer Effective Duration is to zero, the less
interest rate changes are expected to affect earnings. Included in the table is a base case Effective Duration calculation for an interest rate scenario that assumes future rates are those implied by the yield curve as of September 30, 2006.
The other three scenarios assume interest rates are instantaneously 100 and 200 BPs lower and 100 and 200 BPs higher than those implied by interest rates as of September 30, 2006.

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

Net Portfolio
Effective Duration

September 30, 2006



|                                 |  |              |  |                   |  |                   |  |                   |  |                  
|-------------------------------- |  | ------------ |  | ----------------- |  | ----------------- |  | ----------------- |  | -----------------
|                                 |  | Base Case    |  | Parallel -100 BPs |  | Parallel +100 BPs |  | Parallel -200 BPs |  | Parallel +200 BPs
|Assets:                          |  |              |  |                   |  |                   |  |                   |  |                  
|Traditional ARMs                 |  | 0.58 Years   |  | 0.37 Years        |  | 1.06 Years        |  | 0.34 Years        |  | 1.49 Years       
|Hybrid ARMs                      |  | 1.84         |  | 1.01              |  | 2.53              |  | 0.76              |  | 2.93             
|                                 |  |              |  |                   |  |                   |  |                   |  |                  
|Total ARM Assets                 |  | 1.68         |  | 0.93              |  | 2.34              |  | 0.71              |  | 2.75             
|                                 |  |              |  |                   |  |                   |  |                   |  |                  
|Borrowings and hedges            |  | (1.89)       |  | (1.93)            |  | (1.86)            |  | (1.95)            |  | (1.84)           
|                                 |  |              |  |                   |  |                   |  |                   |  |                  
|Net Portfolio Effective Duration |  | (0.06) Years |  | (0.46) Years      |  | 0.29 Years        |  | (0.59) Years      |  | 0.51 Years       
|                                 |  |              |  |                   |  |                   |  |                   |  |                  

Based on the assumptions used, the model output suggests a very low degree of portfolio price
change given decreases and increases in interest rates, which implies that our cash flow and earning characteristics should be relatively stable for comparable changes in interest rates. As a comparison, the approximate base case Effective Duration
of a ten year U.S. treasury, a conforming 30-year fixed mortgage and a conforming 5/1 Hybrid ARM are 7.7, 2.6 and 1.8 years respectively.

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

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

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



57



---

##### Table of Contents

At September 30, 2006, our base case implies a normalized upward sloping yield curve rather than the
current inverted yield curve. Based on the earnings simulation model, our potential earnings increase (decrease) from our base case earnings forecast for a parallel 100 and 200 BP decline and 100 and 200 BP rise in market interest rates over the
next twelve months and an adjustment in prepayment speeds as interest rates change, was 14.22%, 24.62%, 4.59% and 2.24%, respectively, of projected net income for the twelve months ended September 30, 2007. The assumptions used in the earnings
simulation model are inherently uncertain and, as a result, the analysis cannot precisely predict the impact of higher or lower interest rates on net income. Actual results could differ from simulated results due to timing, magnitude and frequency
of interest rate changes, changes in prepayment speed other than what was assumed in the model, and changes in other market conditions and management strategies to offset our potential exposure, among other factors. This measure of risk represents
our exposure to higher or lower interest rates at a particular point in time. Our actual risk is always changing. We continuously monitor our risk profile and alter our strategies as appropriate based on our view of interest rates and other
developments in our business.

Effects of Interest Rate Changes

Changes in interest rates impact our earnings in various ways. While we invest primarily in ARM Assets, rising short-term interest rates may temporarily negatively affect our earnings, and,
conversely, falling short-term interest rates may temporarily increase our earnings. This impact can occur for several reasons and may be mitigated by portfolio prepayment activity and portfolio funding and hedging strategies. For example, our
borrowings may react to changes in interest rates sooner than our ARM Assets because the weighted average next repricing date of our borrowings may be sooner than that of our ARM Assets. Additionally, interest rates on Traditional ARM Assets may be
limited to an increase of either 1% or 2% per adjustment period (commonly referred to as the periodic cap), or indices may be based on weighted averages rather than current rates, while our borrowings do not have similar limitations. At
September 30, 2006, 7.88% of our ARM Assets were Traditional ARM Assets subject to periodic caps. Our ARM Assets also 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 ARM Assets (net of
the cost of financing Hybrid ARM Assets). We estimate the Effective Duration of our Hybrid ARM Assets and have a policy to hedge the financing of the Hybrid ARM Assets such that the Net Effective Duration is less than one year. During a declining
interest rate environment, the prepayment of Hybrid ARM Assets may accelerate causing the amount of fixed-rate financing to increase relative to the amount of Hybrid ARM Assets, possibly resulting in a decline in our net return on Hybrid ARM Assets
as replacement Hybrid ARM Assets may have lower yields than the ones paying off. In contrast, during a rising interest rate environment, Hybrid ARM Assets may prepay slower than expected, requiring us to finance more Hybrid ARM Assets with more
costly funds than was originally anticipated, resulting in a decline in our net return on Hybrid ARM Assets. In order to manage our exposure to changes in the prepayment speed of Hybrid ARM Assets, we regularly monitor the balance of Hybrid ARM
Assets and make adjustments to the amounts anticipated to be outstanding in future periods and, on a regular basis, make adjustments to the amount of our fixed-rate borrowing obligations in future periods.

Interest rate changes can also affect the availability and pricing of ARM Assets, which affects our investment opportunities. During a rising interest
rate environment, there may be less total loan origination and refinance activity, but a larger percentage of ARM products being originated, mitigating the impact of lower overall loan origination and refinance activity. Conversely, during a
declining interest rate environment, consumers, in general, may favor fixed-rate mortgage products, but because there will likely be above average loan origination and refinancing volume in the industry, even a small percentage of ARM product volume
may provide sufficient investment opportunities. Additionally, a flat or inverted yield curve may be an adverse environment for ARM products because there may be little incentive for a consumer to choose an ARM product over a 30 year fixed-rate
mortgage loan. Conversely, in a steep yield curve environment, ARM products may enjoy an above average advantage over 30-year fixed-rate mortgage loans, increasing our investment opportunities. The volume of ARM loans being originated industry-wide
can also affect their investment yield. During periods when there is a shortage of ARM products, yields may decline due to market forces and conversely, when there is an above average supply of ARM products, yields may improve due to the same market
forces.

The prepayment rate on our ARM Assets may increase if interest rates decline or if the difference between long-term and short-term
interest rates diminishes. An increase in prepayments would cause us to amortize the premiums paid for our ARM Assets faster, resulting in a lower yield on our ARM Assets. Additionally, if prepayment proceeds cannot be reinvested in ARM Assets
having similar yields to those being replaced, our earnings may be adversely affected. Conversely, the prepayment rate on our ARM 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 ARM Assets. Therefore, in rising interest rate environments where prepayments are
declining, not only would the interest rate on the ARM portfolio reset to reflect higher interest rates, but the



58



---

##### Table of Contents

yield would also rise due to slower prepayments. The combined effect could significantly mitigate other
negative effects that rising short-term interest rates might have on earnings.

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

Taxable income per share

As a REIT, we pay substantially all of our taxable earnings in the form of
dividends to shareholders. Therefore, taxable income per share, a non-GAAP financial measurement, is a meaningful measurement for both management and investors. A reconciliation of our REIT taxable income per common share to GAAP EPS follows:

Reconciliation of REIT Taxable Income Per Share to GAAP EPS



|                                        |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   |       |  
|--------------------------------------- |  | ------------------------------- | ----- | - | ------------------------------ | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                        |  | Three Months EndedSeptember 30, |       |   | Nine Months EndedSeptember 30, |  
|                                        |  | 2006                            |       |   | 2005                           |   |       | 2006 |  |   | 2005  |  
|REIT taxable income per share           |  | $                               | 0.57  |   |                                | $ | 0.69  |      |  | $ | 1.86  |   |  | $ | 2.09  |  
|Dividend on preferred shares            |  |                                 |      |   |                                |   | 0.02  |      |  |   |      |   |  |   | 0.03  |  
|Gain on purchase loan commitments       |  |                                 |      |   |                                |   |      |      |  |   |      |   |  |   | (0.01 | )
|Payments under long-term incentive plan |  |                                 |      |   |                                |   |      |      |  |   | 0.03  |   |  |   | 0.01  |  
|Taxable REIT subsidiary (loss) income   |  |                                 |      |   |                                |   | (0.01 | )    |  |   | 0.02  |   |  |   | 0.03  |  
|Hedging Instruments, net                |  |                                 | 0.13  |   |                                |   | (0.01 | )    |  |   | 0.10  |   |  |   | (0.01 | )
|Provision for credit losses, net        |  |                                 |      |   |                                |   |      |      |  |   | (0.01 | ) |  |   | (0.01 | )
|Long-term incentive plan expense        |  |                                 |      |   |                                |   | 0.01  |      |  |   | (0.03 | ) |  |   | (0.02 | )
|Issuance of CDOs                        |  |                                 | (0.06 | ) |                                |   |      |      |  |   | (0.06 | ) |  |   |       |  
|Other                                   |  |                                 |      |   |                                |   |      |      |  |   |      |   |  |   |      |  
|                                        |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   |       |  
|GAAP EPS                                |  | $                               | 0.64  |   |                                | $ | 0.70  |      |  | $ | 1.91  |   |  | $ | 2.11  |  
|                                        |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   |       |  

We estimate that our undistributed taxable income as of September 30, 2006, after deducting
the estimated third quarter dividend declared on October 16, 2006, was $13.4 million, or $0.12 per share, based on estimated outstanding common shares of 114,860,000 as of the third quarter dividend record date.

Other Matters

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 95% source of income test. As of September 30, 2006, we calculated that we were in compliance with all
of these requirements. We also met all REIT requirements regarding the ownership of capital stock and the distributions of our net income. Therefore, as of September 30, 2006, we believed 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. If we were to become regulated as an investment company, our use of leverage would be substantially reduced. The Investment Company Act exempts from regulation entities that are primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. In order to maintain our exempt status under the Investment Company Act, current SEC staff interpretations require that at least 55% of our
assets must consist of Qualifying Interests, as such term has been defined by the SEC staff. 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.



59



---

##### Table of Contents

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information called for by
Item 3 is incorporated by reference from the information in Part I, Item 2 under the captions General - Hedging Strategies, Interest Rate Risk Management and Market Risks.

Item 4. CONTROLS AND PROCEDURES

Our Chief Executive Officer, Chief Operating Officer and Chief Financial
Officer, after evaluating the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended, have concluded that, as of the end of the period covered by this
report, our disclosure controls and procedures were effective to provide reasonable assurances that information required to be disclosed in the reports filed or submitted under such Act is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms. In addition, during the quarter ended September 30, 2006, there has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

At September 30, 2006, there were no material pending
legal proceedings to which we were a party or of which any of our property was subject.

Item 1A. RISK FACTORS

There have been no material changes from risk factors as previously
disclosed in our 2005 Annual Report on Form 10-K.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable

Item 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable

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

None

Item 5. OTHER INFORMATION

None

Item 6. EXHIBITS

See Exhibit Index



60



---

##### Table of Contents

SIGNATURES

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



|                        |  |                                                            
|----------------------- |  | -----------------------------------------------------------
|                        |  | THORNBURG MORTGAGE, INC.                                   
|                        |  | (Registrant)                                               
|                        | 
|Dated: November 8, 2006 |  | /s/ Garrett Thornburg                                      
|                        |  | Garrett Thornburg                                          
|                        |  | Chairman of the Board and Chief Executive Officer          
|                        |  | (Principal Executive Officer)                              
|                        | 
|Dated: November 8, 2006 |  | /s/ Larry A. Goldstone                                     
|                        |  | Larry A. Goldstone                                         
|                        |  | President and Chief Operating Officer                      
|                        |  | (authorized officer of registrant)                         
|                        | 
|Dated: November 8, 2006 |  | /s/ Clarence G. Simmons, III                               
|                        |  | Clarence G. Simmons, III                                   
|                        |  | Senior Executive Vice President and Chief Financial Officer
|                        |  | (Principal Financial and Accounting Officer)               



61



---

##### Table of Contents

Exhibit Index



|              |  |                                                                                                                                                                                       
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                   
|31.1          |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934*                                                             
|              | 
|31.2          |  | Certification of President and Chief Operating Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934*                                               
|              | 
|31.3          |  | Certification of Senior Executive Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of
1934*                         
|              | 
|32.1          |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*                                    
|              | 
|32.2          |  | Certification of President and Chief Operating Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002*                      
|              | 
|32.3          |  | Certification of Senior Executive Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002*

---

|* | Being filed herewith.
|- | ---------------------



62



---

##### Table of Contents

GLOSSARY

There follows a definition of certain capitalized and other terms and abbreviations used in this
Quarterly Report on Form 10-Q.

Adfitech means ADFITECH, Inc., a wholly-owned mortgage
services subsidiary of TMHL.

Adjusted Equity-to-Assets Ratio means a ratio that reflects the relationship between assets
financed with recourse debt that is subject to margin calls and our long-term capital. The ratio is a non-GAAP measurement that we have adopted and that the Board of Directors has approved as an internal policy. Our policy requires us to maintain
this ratio at a minimum of 8%, which represents approximately twice the initial margin requirement for our recourse debt.

Agency
Securities means Purchased ARM Assets that are guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac.

Agent means American
Stock Transfer & Trust Company, TMAs transfer agent.

ARM means adjustable-rate and variable-rate mortgage,
which signifies that adjustments of the underlying interest rate are made at predetermined times based on an agreed margin to an established index.

ARM Assets means all of the Companys ARM Loans and Purchased ARM Assets comprised of Traditional ARM Assets and Hybrid ARM Assets.

ARM Loans means Securitized ARM Loans, ARM Loans Collateralizing CDOs and ARM loans held for securitization.

ARM Loans Collateralizing CDOs means loans originated or acquired by the Company and financed in their entirety on its balance sheet through securitization by the Company into sequentially rated classes.
The Company retains the classes that are not High Quality which provide credit support for higher rated classes issued to third-party investors in structured financing arrangements.

Asset-backed CP means asset-backed commercial paper, which provides an alternative way to finance our High Quality ARM Assets portfolio. We issue Asset-backed CP to investors in the
form of secured liquidity notes that are recorded as borrowings on our Consolidated Balance Sheets.

Average Historical Equity
means for any period the difference between our total assets and total liabilities calculated on a consolidated basis in accordance with GAAP, excluding (i) OCI, (ii) goodwill and (iii) other intangibles, computed by taking the
average of such values at the end of each month during such period, adjusted for equity sold during the period on a pro rata basis.

Average Net Worth means for any period the average of the sum of the gross proceeds from any offering of our equity securities, before deducting any underwriting discounts and commissions and other expenses and costs relating to
the offering, plus our retained earnings (without taking into account any losses incurred in prior periods) computed by taking the average of such values at the end of each month during such period, and shall be reduced by any amount that we pay for
the repurchases of Common Stock.

Board of Directors means the board of directors of TMA.

BP means basis point, a hundredth of a percent.

Cap Agreements means interest rate cap agreements, pursuant to which we receive cash payments if the interest rate index specified in any such agreement increases above contractually specified levels, thus
effectively capping the interest rate on a specified amount of borrowings at a level specified by the agreement.

CDOs means
collateralized debt obligations, which can be either floating-rate or fixed-rate non-recourse financing, all of which are issued by trusts and secured by ARM loans and may also include Hedging Instruments. CDOs represent long-term financing that is
not subject to margin calls. Approximately 2% of equity capital is required to support CDO financing.



63



---

##### Table of Contents

CMOs means collateralized mortgage obligations which are debt obligations ordinarily issued
in series and backed by a pool of fixed-rate mortgage loans, Hybrid ARM loans, Traditional ARM loans or ARM securities, each of which consists of several serially maturing classes. Generally, principal and interest payments received on the
underlying mortgage-related assets securing a series of CMOs are applied to principal and interest due on one or more classes of the CMOs of such series.

Code means the Internal Revenue Code of 1986, as amended.

Code of Conduct means
the Code of Business Conduct and Ethics adopted by TMA.

Common Stock means shares of TMAs common stock, $.01 par value
per share.

Company means TMA and its subsidiaries, unless specifically stated otherwise or the context indicates otherwise.

Consumer Price Index means an inflationary indicator that measures the change in the cost of a fixed basket of products and
services, including housing, electricity, food, and transportation. The Consumer Price Index is published monthly.

Corporate
Governance Guidelines means the Corporate Governance Guidelines adopted by TMA.

CPR means constant prepayment rate,
which refers to the annualized rate at which the mortgage assets in our portfolio are prepaid. The CPR typically increases as interest rates decrease and, conversely, the CPR typically decreases as interest rates increase.

Derivative means a contract or agreement whose value is derived from changes in interest rates, prices of securities or commodities, or
financial or commodity indices. The Companys Derivatives include commitments to purchase loans from correspondent and bulk sellers, Pipeline Hedging Instruments and Hybrid ARM Hedging Instruments.

DERs means dividend equivalent rights, which may be granted under the Plan. A DER consists of the right to receive either cash or PSRs in an
amount equal to the value of the cash dividends paid on a share of Common Stock.

DRSPP means the Dividend Reinvestment and
Stock Purchase Plan adopted by TMA.

Effective Duration is a calculation expressed in months or years that is a measure of the
expected price change of financial instruments based on changes in interest rates. For example, a duration of 4.4 months implies that a 1% change in interest rates would cause a .37% change in the opposite direction in the value of our portfolio
(i.e., 4.4 months equals 37% of twelve months.)

EITF means Emerging Issues Task Force Abstract which is an authoritative GAAP
pronouncement issued by the FASB.

EPS means earnings per share calculated by dividing net income available to common
shareholders by the average common shares outstanding during the period.

Eurodollar Transactions means Eurodollar futures
contracts, which are three month contracts with a price that represents the forecasted three-month LIBOR rate. The sale of these contracts locks in a future interest rate.

Fannie Mae means the Federal National Mortgage Association, a government-sponsored private corporation that operates under a federal charter.

FASB means the Financial Accounting Standards Board.

FDIC means Federal Depository Insurance Corporation.

Federal Funds means the
overnight intrabank lending rate.

FHLB means the Federal Home Loan Bank.



64



---

##### Table of Contents

FICO means a credit score, ranging from 300 to 850, with 850 being the best score, based upon
the credit evaluation methodology developed by Fair, Isaac and Company, a consulting firm specializing in creating credit evaluation models.

FIN means Financial Accounting Standards Board Interpretation.

Freddie Mac means the Federal Home Loan
Mortgage Corporation, a federally-chartered private corporation.

Fully Indexed means an ARM Asset that has an interest rate
currently equal to its applicable index plus a margin to the index that is specified by the terms of the ARM Asset.

G &
A means general and administrative.

GAAP means generally accepted accounting principles set forth in the statements,
opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and the FASB or in such other statements by such other entity as may be approved by a significant segment of the accounting
profession of the United States.

Ginnie Mae means the Government National Mortgage Association, a government-owned corporation
within the United States Department of Housing and Urban Development.

Hedging Instruments means Cap Agreements and Swap
Agreements which are Derivatives that we use to manage our interest rate exposure when financing the purchase of ARM Assets.

High
Quality means (i) Agency Securities, (ii) Purchased ARM Assets and Securitized ARM Loans which are rated within one of the two highest rating categories by at least one of the Rating Agencies, (iii) Purchased ARM Assets and
Securitized ARM Loans that are unrated or whose ratings have not been updated but are determined to be of comparable quality (by the rating standards of at least one of the Rating Agencies) to a High Quality-rated mortgage security, as determined by
the Manager and approved by the Board of Directors, or (iv) 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. Our investment policy requires that we
invest at least 70% of total assets in High Quality ARM Assets and short-term investments.

Hybrid ARM Hedging Instruments
means Hedging Instruments, including Swap Agreements and Cap Agreements, that we use to manage our interest rate exposure when financing the purchase of Hybrid ARMs.

Hybrid ARMs or Hybrid ARM Assets means ARM Loans and Purchased ARM Assets that have a fixed interest rate for an initial period of three to ten years, after which they convert to Traditional
ARM Assets for their remaining terms to maturity.

Insider Trading Policy means the Insider Trading Policy adopted by TMA.

Investment Company Act means the Investment Company Act of 1940, as amended.

Investment Grade generally means a security rating of BBB or better by Standard & Poors Corporation or Baa or better by
Moodys Investors Service, Inc.

IRA means Individual Retirement Account.

LIBOR means the London InterBank Offer Rate, which is fixed each morning at 11 a.m. London time, by the British Bankers Association.
The rate is an average derived from sixteen quotations provided by banks determined by the British Bankers Association, the four highest and lowest are then eliminated and an average of the remaining eight is calculated to arrive at the fixed
rate.

Liquidity Management Policy means the Liquidity Management Policy adopted by TMA.



65



---

##### Table of Contents

Management Agreement means the management agreement by and between TMA and the Manager
whereby the Manager performs certain services for TMA in exchange for certain fees.

Manager means Thornburg Mortgage Advisory
Corporation, a Delaware corporation.

MBS means mortgage-backed securities, which are pools of mortgages used as collateral for
the issuance of securities in the secondary market. MBS are commonly referred to as pass-through certificates because the principal and interest of the underlying loans is passed through to investors. The interest rate of the
security is lower than the interest rate of the underlying loan to allow for payment of servicing and guaranty fees.

MSRs
means mortgage servicing rights.

MTA means the monthly treasury average. This index is the 12 month average of the monthly
average yields of U.S. Treasury securities adjusted to a constant maturity of one year.

Net Effective Duration means the
Effective Duration of assets minus the Effective Duration of borrowings and Hedging Instruments.

OCI means the Companys
accumulated other comprehensive income or loss calculated on a consolidated basis in accordance with GAAP.

Other Investments
means assets that are (i) adjustable or variable rate pass-through certificates, multi-class pass-through certificates or CMOs backed by loans that are rated at least Investment Grade at the time of purchase, (ii) 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, (iii) fixed-rate mortgage loans collateralized by first liens on
single-family residential properties originated for sale to third parties, (iv) real estate properties acquired as a result of foreclosing on our ARM Loans, or (v) as authorized by the Board of Directors, ARM Assets rated less than
Investment Grade that are created as a result of our loan acquisition and securitization efforts or are acquired as Purchased Securitized Loans, and that equal an amount no greater than 17.5% of shareholders equity, measured on a historical
cost basis. Other Investments may not comprise more than 30% of our total assets.

Pay Option ARM means a Traditional ARM Asset
that typically has an initial payment based on a below market interest rate, has no interest rate change cap, offers an annual maximum payment cap of 7.5% and offers borrowers the ability to select a payment amount with the understanding that if a
payment is selected that is less than a fully indexed rate the shortfall will be added to the principal balance of the loan until the loan balance increases to a maximum of 110% to 125% of the original loan balance, at which time the loan is recast
to fully amortize over the remaining term of the loan.

Pipeline Hedging Instruments means Eurodollar Transactions that we use
to limit interest rate risk associated with commitments to purchase ARM loans.

Plan means TMAs Amended and Restated 2002
Long-Term Incentive Plan, as amended.

Portfolio Margin means yield on net interest earning assets.

Preferred Stock means the 8% Series C Cumulative Redeemable Preferred Stock, $.01 par value per share, issued by TMA.

PSRs means phantom stock rights, which may be granted under the Plan. A PSR consists of (i) the unfunded deferred obligation of TMA to
pay the recipient of a PSR, upon exercise, an amount of cash equal to the fair market value of a share of Common Stock at the time of exercise, and (ii) the recipients right to receive distributions, either in the form of cash or
additional PSRs, in an amount equal to the value of the cash dividends that are paid on a share of Common Stock.

Purchased ARM
Assets means ARM securities and Purchased Securitized Loans.



66



---

##### Table of Contents

Purchased Securitized Loans means loans securitized by third parties and purchased by the
Company. The Company purchases all principal classes of the securitizations, including the subordinated classes. These assets are Qualifying Interests for purposes of maintaining the Companys exemption from the Investment Company Act because,
like the Companys own loan originations and acquisitions, the Company retains a 100% interest in the underlying loans.

QSPE means qualifying SPE.

Qualified REIT Assets means real estate assets as defined by the Code.
Substantially all the assets that we have acquired and will acquire for investment are expected to be Qualified REIT Assets.

Qualifying Interests means mortgages and other liens on and interests in real estate, as such term has been defined by SEC staff. Under current SEC staff interpretations, we must maintain at least 55% of our assets
directly in Qualifying Interests.

Rating Agencies means Standard & Poors Corporation and Moodys Investors
Service, Inc.

REIT means real estate investment trust as defined in the Code.

REMIC means real estate mortgage investment conduit which is an entity that holds a fixed pool of mortgages and issues multiple classes of
interests in itself to investors as defined in the Code.

Return on Equity or ROE means the quotient obtained by
dividing our annualized net income by our Average Net Worth.

Reverse Repurchase Agreement means an agreement between two
parties whereby one party sells the other a security at a specified price with a commitment to buy the security back at a later date for another specified price.

SARs means stock appreciation rights, which may be granted under the Plan. An SAR consists of the right to receive the value of the appreciation of our Common Stock that occurs from the date the right is
granted up to the date of exercise.

Service means the Internal Revenue Service.

SEC means the United States Securities and Exchange Commission.

Securitized ARM Loans means loans originated or acquired by the Company and securitized by the Company with the Company retaining 100% of the beneficial ownership interests.

Senior Notes means the 8% senior unsecured notes due May 15, 2013, issued by TMA.

SFAS means Statement of Financial Accounting Standards which is an authoritative GAAP pronouncement issued by the FASB.

SPE means special purpose entity.

Subordinated Notes means the floating rate junior subordinated notes, issued by TMHL and guaranteed by TMA.

Swap Agreements means interest rate swap agreements, pursuant to which we agree to pay a fixed rate of interest and to receive a variable interest rate, thus effectively fixing the cost of funds.

Ten Year U.S. Treasury Rate means the arithmetic average of the weekly average yield to maturity for actively traded current coupon U.S.
Treasury fixed interest rate securities (adjusted to a constant maturity of ten years) published by the Federal Reserve Board during a quarter, or, if such rate is not published by the Federal Reserve Board, any Federal Reserve Bank or agency or
department of the federal government that we select. If we determine in good faith that the Ten Year U.S. Treasury Rate cannot be calculated as provided above, then the rate shall be the arithmetic average of the per annum average yields to
maturities, based upon closing asked prices on each business day during a quarter, for each actively traded marketable U.S. Treasury fixed interest rate security with a final



67



---

##### Table of Contents

maturity date not less than eight nor more than twelve years from the date of the closing asked prices as
chosen and quoted for each business day in each such quarter in New York City by at least three recognized dealers in U.S. Government securities that we select.

The Thornburg Mortgage Exchange ProgramSM means the program where
borrowers can choose to take equity out of their homes, select another ARM loan product, extend the fixed-rate period of their loan, modify to a current interest rate or change to an interest-only payment option by paying a small flat fee.

TMA means Thornburg Mortgage, Inc., a Maryland corporation.

TMCR means Thornburg Mortgage Capital Resources, LLC, a wholly-owned special purpose finance subsidiary of TMD.

TMD means Thornburg Mortgage Depositor, LLC, a wholly-owned special purpose finance subsidiary of TMA.

TMHL means Thornburg Mortgage Home Loans, Inc., a wholly-owned mortgage loan origination and acquisition subsidiary of TMA.

TMHS means Thornburg Mortgage Hedging Strategies, Inc., a wholly-owned taxable REIT subsidiary of TMA.

Traditional ARMs or Traditional ARM Assets means ARM Loans and Purchased ARM Assets that have interest rates that reprice in a year or less.



68