##### Table of Contents

---



UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---



FORM 10-Q/A

(Amendment No. 2)



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



For the quarterly period ended: June 30, 2003



OR



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



For the transition period from
 to



Commission File Number: 001-11914



---



THORNBURG MORTGAGE, INC.

(Exact name of Registrant as specified in its Charter)



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



|150 Washington Avenue Santa Fe, New Mexico |  | 87501     
|------------------------------------------ |  | ----------
|(Address of principal executive offices)   |  | (Zip Code)



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



(Former name, former address and former fiscal year, if changed since last report)



Not applicable



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



(1)  Yes  x    No ̈

(2)  Yes  x    No ̈



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



Yes  x    No ̈



APPLICABLE ONLY TO CORPORATE ISSUERS:



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



|Common Stock ($.01 par value) |  | 66,087,528 as of August 12, 2003
|----------------------------- |  | --------------------------------



---





---

##### Table of Contents

THORNBURG MORTGAGE, INC.

FORM 10-Q/A

Amendment No. 2



Thornburg Mortgage, Inc. is
filing this Amendment No. 2 on Form 10-Q/A to amend Item 1 (Financial Statements) and Item 2 (Managements Discussion and Analysis of Financial Condition and Results of Operations) of Part I (Financial
Information) of its Quarterly Report on Form 10-Q filed on August 14, 2003 and amended by Amendment No. 1 on August 15, 2003 to correct certain numbers and text primarily related to the change in its securities accounting methodology for loans
securitized by the Company after the date of April 1, 2001, as discussed in Note 1 to Item 1 of Part I.



INDEX



|              |  |                                                                                                          |  | Page
|------------- |  | -------------------------------------------------------------------------------------------------------- |  | ----
|              |  |                                                                                                         
|PART I.       |  | FINANCIAL INFORMATION                                                                                    |  |     
|              |  |                                                                                                         
|Item 1.       |  | Financial Statements                                                                                     |  |     
|              |  |                                                                                                         
|              |  | Consolidated Balance Sheets at June 30, 2003 and December 31, 2002                                       |  | 3   
|              |  |                                                                                                         
|              |  | Consolidated Income Statements for the three and six months ended June 30, 2003 and June 30, 2002        |  | 4   
|              |  |                                                                                                         
|              |  | Consolidated Statement of Shareholders Equity for the six months ended June 30, 2003 and June 30, 2002  |  | 5   
|              |  |                                                                                                         
|              |  | Consolidated Statements of Cash Flows for the three and six months ended June 30, 2003 and June 30, 2002 |  | 6   
|              |  |                                                                                                         
|              |  | Notes to Consolidated Financial Statements                                                               |  | 7   
|              |  |                                                                                                         
|Item 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                    |  | 20  
|              |  |                                                                                                         
|Item 3.       |  | Quantitative and Qualitative Disclosures About Market Risk                                               |  | 46  
|              |  |                                                                                                         
|Item 4.       |  | Controls and Procedures                                                                                  |  | 46  
|              |  |                                                                                                         
|PART II.      |  | OTHER INFORMATION                                                                                        |  |     
|              |  |                                                                                                         
|Item 1.       |  | Legal Proceedings                                                                                        |  | 47  
|              |  |                                                                                                         
|Item 2.       |  | Changes in Securities and Use of Proceeds                                                                |  | 47  
|              |  |                                                                                                         
|Item 3.       |  | Defaults Upon Senior Securities                                                                          |  | 47  
|              |  |                                                                                                         
|Item 4.       |  | Submission of Matters to a Vote of Security Holders                                                      |  | 47  
|              |  |                                                                                                         
|Item 5.       |  | Other Information                                                                                        |  | 47  
|              |  |                                                                                                         
|Item 6.       |  | Exhibits and Reports on Form 8-K                                                                         |  | 47  
|              | 
|SIGNATURES    |  | 48                                                                                                      
|              | 
|EXHIBIT INDEX |  | 49                                                                                                      





2



---

##### Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS (Unaudited)

(Amounts in thousands)



|                                                                                                                                                                                    |  | June 30, 2003 |            |   | December 31, 2002 |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | - | ----------------- | -
|ASSETS                                                                                                                                                                              |  |               |            |   |                   |  
|Adjustable-rate mortgage (ARM) assets:                                                                                                                                            |  |               |            |   |                   |  
|ARM securities                                                                                                                                                                      |  | $             | 9,440,883  |   |                   | $
|                                                                                                                                                                                    |  |              
|ARM loans:                                                                                                                                                                          |  |               |            |   |                   |  
|Securitized ARM loans                                                                                                                                                               |  |               | 3,479,650  |   |                   |  
|ARM loans collateralizing long-term debt                                                                                                                                            |  |               | 981,523    |   |                   |  
|ARM loans held for securitization                                                                                                                                                   |  |               | 832,645    |   |                   |  
|                                                                                                                                                                                    |  |               |            |   |                   |  
|ARM loans                                                                                                                                                                           |  |               | 5,293,818  |   |                   |  
|                                                                                                                                                                                    |  |              
|Cash and cash equivalents                                                                                                                                                           |  |               | 311,080    |   |                   |  
|Hedging instruments                                                                                                                                                                 |  |               | 5,852      |   |                   |  
|Accrued interest receivable                                                                                                                                                         |  |               | 60,221     |   |                   |  
|Prepaid expenses and other                                                                                                                                                          |  |               | 7,634      |   |                   |  
|                                                                                                                                                                                    |  |               |            |   |                   |  
|                                                                                                                                                                                    |  | $             | 15,119,488 |   |                   | $
|                                                                                                                                                                                    |  |               |            |   |                   |  
|                                                                                                                                                                                    |  |              
|LIABILITIES                                                                                                                                                                         |  |               |            |   |                   |  
|Reverse repurchase agreements                                                                                                                                                       |  | $             | 12,085,280 |   |                   | $
|Long-term collateralized debt                                                                                                                                                       |  |               | 967,485    |   |                   |  
|Whole loan financing facilities                                                                                                                                                     |  |               | 614,503    |   |                   |  
|Hedging instruments                                                                                                                                                                 |  |               | 184,946    |   |                   |  
|Senior notes                                                                                                                                                                        |  |               | 194,340    |   |                   |  
|Payable for assets purchased                                                                                                                                                        |  |               |           |   |                   |  
|Accrued interest payable                                                                                                                                                            |  |               | 22,821     |   |                   |  
|Dividends payable                                                                                                                                                                   |  |               | 1,670      |   |                   |  
|Accrued expenses and other                                                                                                                                                          |  |               | 35,865     |   |                   |  
|                                                                                                                                                                                    |  |               |            |   |                   |  
|                                                                                                                                                                                    |  |               | 14,106,910 |   |                   |  
|                                                                                                                                                                                    |  |               |            |   |                   |  
|                                                                                                                                                                                    |  |              
|COMMITMENTS                                                                                                                                                                         |  |               |            |   |                   |  
|                                                                                                                                                                                    |  |              
|SHAREHOLDERS EQUITY                                                                                                                                                                |  |               |            |   |                   |  
|Preferred stock: par value $.01 per share;Series A 9.68% Cumulative Convertible shares,aggregate preference in liquidation
$69,000,2,760 shares authorized, issued and outstanding; |  |               | 65,805     |   |                   |  
|Series B Cumulative, 22 shares authorized,none issued and outstanding                                                                                                               |  |               |           |   |                   |  
|Common stock: par value $.01 per share;497,218 shares authorized, 61,453 and 52,763 sharesissued and outstanding,
respectively                                                      |  |               | 615        |   |                   |  
|Additional paid-in-capital                                                                                                                                                          |  |               | 1,057,637  |   |                   |  
|Accumulated other comprehensive loss                                                                                                                                                |  |               | (147,116   | ) |                   |  
|Notes receivable from stock sales                                                                                                                                                   |  |               | (7,017     | ) |                   |  
|Retained earnings                                                                                                                                                                   |  |               | 42,654     |   |                   |  
|                                                                                                                                                                                    |  |               |            |   |                   |  
|                                                                                                                                                                                    |  |               | 1,012,578  |   |                   |  
|                                                                                                                                                                                    |  |               |            |   |                   |  
|                                                                                                                                                                                    |  | $             | 15,119,488 |   |                   | $
|                                                                                                                                                                                    |  |               |            |   |                   |  



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 EndedJune 30, |         |   | Six Months Ended June 30, |  
|---------------------------------------------------- |  | -------------------------- | ------- | - | ------------------------- | -
|                                                     |  | 2003                       |         |   | 2002                      |  
|Interest income from ARM assets and cash equivalents |  | $                          | 136,897 |   |                           | $
|Interest expense on borrowed funds                   |  |                            | (82,166 | ) |                           |  
|                                                     |  |                            |         |   |                           |  
|Net interest income                                  |  |                            | 54,731  |   |                           |  
|                                                     |  |                            |         |   |                           |  
|Gain on ARM assets, net                              |  |                            | 2,574   |   |                           |  
|Fee income                                           |  |                            | 637     |   |                           |  
|Hedging expense                                      |  |                            | (220    | ) |                           |  
|Management fee                                       |  |                            | (2,686  | ) |                           |  
|Performance fee                                      |  |                            | (6,924  | ) |                           |  
|Long-term incentive awards                           |  |                            | (3,075  | ) |                           |  
|Other operating expenses                             |  |                            | (2,845  | ) |                           |  
|                                                     |  |                            |         |   |                           |  
|NET INCOME                                           |  | $                          | 42,192  |   |                           | $
|                                                     |  |                            |         |   |                           |  
|Net income                                           |  | $                          | 42,192  |   |                           | $
|Dividends on preferred stock                         |  |                            | (1,670  | ) |                           |  
|                                                     |  |                            |         |   |                           |  
|Net income available to common shareholders          |  | $                          | 40,522  |   |                           | $
|                                                     |  |                            |         |   |                           |  
|Basic earnings per share:                            |  |                            |         |   |                           |  
|Net income                                           |  | $                          | 0.68    |   |                           | $
|Average number of shares outstanding                 |  |                            | 59,879  |   |                           |  
|                                                     |  |                            |         |   |                           |  
|Diluted earnings per share:                          |  |                            |         |   |                           |  
|Net income                                           |  | $                          | 0.67    |   |                           | $
|Average number of shares outstanding                 |  |                            | 62,639  |   |                           |  
|                                                     |  |                            |         |   |                           |  



See Notes to Consolidated Financial
Statements.





4



---

##### Table of Contents

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY (Unaudited)

Six months ended June 30, 2003 and 2002

(In thousands, except share data)



|                                                                     |  | PreferredStock |        | CommonStock |   | AdditionalPaid-inCapital |  | Accum. OtherCompre-hensiveIncome (Loss) |           |  | NotesReceivableFromStockSales |          |   | RetainedEarnings/(Deficit) |   |        | Compre- hensiveIncome(Loss) |  |   | Total   |  
|-------------------------------------------------------------------- |  | -------------- | ------ | ----------- | - | ------------------------ |  | --------------------------------------- | --------- |  | ----------------------------- | -------- | - | -------------------------- | - | ------ | --------------------------- |  | - | ------- | -
|Balance, December 31, 2001                                           |  | $              | 65,805 |             | $ | 333                      |  | $                                       | 515,516   |  | $                             | (36,566  | ) |                            | $ | (7,904 | )                           |  | $ | (4,526  | )
|Comprehensive income:                                                |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Net income                                                           |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   | 52,231  |  
|Other comprehensive income:                                          |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Available-for-sale assets:                                           |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Fair value adjustment                                                |  |                |        |             |   |                          |  |                                         |           |  |                               | 16,721   |   |                            |   |        |                             |  |   |         |  
|Hybrid Hedging Instruments:                                          |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Fair value adjustment, net of amortization                           |  |                |        |             |   |                          |  |                                         |           |  |                               | (24,518  | ) |                            |   |        |                             |  |   |         |  
|                                                                     |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Comprehensive income                                                 |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|                                                                     |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Issuance of common stock                                             |  |                |        |             |   | 110                      |  |                                         | 207,474   |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Interest and principal payments on notes receivable from stock sales |  |                |        |             |   |                          |  |                                         | 153       |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Dividends declared on preferred stock$1.21 per share                |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   | (3,340  | )
|Dividends declared on common stock$1.10 per share                   |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   | (22,839 | )
|                                                                     |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Balance, June 30, 2002                                               |  | $              | 65,805 |             | $ | 443                      |  | $                                       | 723,143   |  | $                             | (44,363  | ) |                            | $ | (7,904 | )                           |  | $ | 21,526  |  
|                                                                     |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|                                                                     |  |                |        |             |   |                          |  |                                        
|Balance, December 31, 2002                                           |  | $              | 65,805 |             | $ | 528                      |  | $                                       | 878,929   |  | $                             | (105,254 | ) |                            | $ | (7,437 | )                           |  | $ | 471     |  
|Comprehensive income:                                                |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Net income                                                           |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   | 81,266  |  
|Other comprehensive income:                                          |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Available-for-sale assets:                                           |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Fair value adjustment                                                |  |                |        |             |   |                          |  |                                         |           |  |                               | 13,041   |   |                            |   |        |                             |  |   |         |  
|Hybrid Hedging Instruments:                                          |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Fair value adjustment, net of amortization                           |  |                |        |             |   |                          |  |                                         |           |  |                               | (54,903  | ) |                            |   |        |                             |  |   |         |  
|                                                                     |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Comprehensive income                                                 |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|                                                                     |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Issuance of common stock                                             |  |                |        |             |   | 87                       |  |                                         | 178,567   |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Interest and principal payments on notes receivable from stock sales |  |                |        |             |   |                          |  |                                         | 141       |  |                               |          |   |                            |   | 420    |                             |  |   |         |  
|Dividends declared on preferred stock$1.21 per share                |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   | (3,340  | )
|Dividends declared on common stock$0.60 per share                   |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   | (35,743 | )
|                                                                     |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  
|Balance, June 30, 2003                                               |  | $              | 65,805 |             | $ | 615                      |  | $                                       | 1,057,637 |  | $                             | (147,116 | ) |                            | $ | (7,017 | )                           |  | $ | 42,654  |  
|                                                                     |  |                |        |             |   |                          |  |                                         |           |  |                               |          |   |                            |   |        |                             |  |   |         |  



See Notes to Consolidated Financial
Statements.





5



---

##### Table of Contents

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)



|                                                                                  |  | Three Months Ended June 30, |            |   | Six Months Ended June 30, |  
|--------------------------------------------------------------------------------- |  | --------------------------- | ---------- | - | ------------------------- | -
|                                                                                  |  | 2003                        |            |   | 2002                      |  
|Operating Activities:                                                             |  |                             |            |   |                           |  
|Net Income                                                                        |  | $                           | 42,192     |   |                           | $
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                             |            |   |                           |  
|Amortization                                                                      |  |                             | 10,546     |   |                           |  
|Net gain from investing activities                                                |  |                             | (2,574     | ) |                           |  
|Hedging expense                                                                   |  |                             | 220        |   |                           |  
|Change in assets and liabilities:                                                 |  |                             |            |   |                           |  
|Accrued interest receivable                                                       |  |                             | (7,235     | ) |                           |  
|Prepaid expenses and other                                                        |  |                             | (1,834     | ) |                           |  
|Accrued interest payable                                                          |  |                             | 3,925      |   |                           |  
|Accrued expenses and other                                                        |  |                             | 17,447     |   |                           |  
|                                                                                  |  |                             |            |   |                           |  
|Net cash provided by operating activities                                         |  |                             | 62,687     |   |                           |  
|                                                                                  |  |                             |            |   |                           |  
|Investing Activities:                                                             |  |                             |            |   |                           |  
|ARM securities:                                                                   |  |                             |            |   |                           |  
|Purchases                                                                         |  |                             | (3,115,786 | ) |                           |  
|Proceeds on sales                                                                 |  |                             |           |   |                           |  
|Principal payments                                                                |  |                             | 1,073,494  |   |                           |  
|Securitized ARM loans:                                                            |  |                             |            |   |                           |  
|Issuance costs                                                                    |  |                             | (1,076     | ) |                           |  
|Principal payments                                                                |  |                             | 394,344    |   |                           |  
|ARM loans collateralizing long-term debt:                                         |  |                             |            |   |                           |  
|Principal payments                                                                |  |                             | 66,527     |   |                           |  
|ARM loans held for securitization:                                                |  |                             |            |   |                           |  
|Purchases                                                                         |  |                             | (1,146,227 | ) |                           |  
|Proceeds on sales                                                                 |  |                             |           |   |                           |  
|Principal payments                                                                |  |                             | 6,684      |   |                           |  
|Purchase of interest rate cap agreements                                          |  |                             |           |   |                           |  
|                                                                                  |  |                             |            |   |                           |  
|Net cash used in investing activities                                             |  |                             | (2,722,040 | ) |                           |  
|                                                                                  |  |                             |            |   |                           |  
|Financing Activities:                                                             |  |                             |            |   |                           |  
|Net borrowings from reverse repurchase agreements                                 |  |                             | 1,944,138  |   |                           |  
|Net borrowings (repayments) of collateralized notes                               |  |                             | 967,485    |   |                           |  
|Net whole loan financing facilities borrowings                                    |  |                             | (447,734   | ) |                           |  
|Net senior unsecured debt proceeds                                                |  |                             | 194,340    |   |                           |  
|Payments made on Eurodollar contracts                                             |  |                             | (6,975     | ) |                           |  
|Proceeds from common stock issued, net                                            |  |                             | 56,501     |   |                           |  
|Dividends paid                                                                    |  |                             | (37,411    | ) |                           |  
|Payments on notes receivable from stock sales                                     |  |                             | 390        |   |                           |  
|Purchase of interest rate cap agreements                                          |  |                             | (8,940     | ) |                           |  
|                                                                                  |  |                             |            |   |                           |  
|Net cash provided by financing activities                                         |  |                             | 2,661,794  |   |                           |  
|                                                                                  |  |                             |            |   |                           |  
|Net increase (decrease) in cash and cash equivalents                              |  |                             | 2,441      |   |                           |  
|                                                                                  |  |                             |            |  
|Cash and cash equivalents at beginning of period                                  |  |                             | 308,639    |   |                           |  
|                                                                                  |  |                             |            |   |                           |  
|Cash and cash equivalents at end of period                                        |  | $                           | 311,080    |   |                           | $
|                                                                                  |  |                             |            |   |                           |  



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



See Notes to
Consolidated Financial Statements



6



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note
1. Significant Accounting Policies



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



In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been
included. The operating results for the quarter and six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2003.



Basis of presentation and principles of consolidation



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



Cash and cash equivalents



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



Adjustable-rate mortgage (ARM) assets



The Companys ARM assets are comprised of ARM securities and ARM Loans, which includes securitized ARM loans, ARM loans collateralizing long-term debt and ARM loans held for securitization . All of
the Companys ARM assets are either traditional ARM securities and loans, which have interest rates that reprice in a year or less (Traditional ARMs), or hybrid ARM securities and loans that have a fixed interest rate for an initial
period of three to ten years and then convert to Traditional ARMs for their remaining terms to maturity (Hybrid ARMs).



ARM securities are composed mainly of ARM securities purchased from third parties; also included in this balance are ARM securities relating to loans
securitized by the Company prior to March 31, 2001. The Company has designated all of its ARM securities as available-for-sale. Therefore, they are reported at fair value, with unrealized gains and losses reported in Accumulated other
comprehensive income (loss) as a separate component of shareholders equity. Realized gains or losses on sale of ARM securities are recorded in earnings at the time of sale and are determined by the difference between net sale proceeds
and the cost of the security using specific identification, adjusted for any unamortized premium or discount. Any unrealized loss deemed to be other than temporary is recorded as realized loss.



The Company has the intent and ability to hold its ARM Loans for the
foreseeable future, and until maturity or payoff. ARM Loans are carried at their unpaid principal balances, net of unamortized premium or discount and allowance for loan losses.



Securitized ARM loans are composed of loans originated or acquired by the Company and securitized after April 1, 2001 with
the Company retaining 100% of the beneficial ownership interests. The Company has also securitized and issued AAA certificates to third party investors in structured financing arrangements. ARM loans held for securitization are composed of loans the
Company has acquired or originated and are intended to be securitized by the Company. The Company does not sell any of the securities created from its securitizations to generate gain on sale income. The loan securitization process benefits the
Company by either creating highly liquid securitized assets that can be readily financed in the reverse repurchase agreement market or enabling the



7



---

##### Table of Contents

Company to enter into long-term collateralized debt financing transactions which represent permanent
financing that are not subject to margin calls.



In prior
periods, the Companys securitized ARM loans that were created after April 1, 2001 were accounted for under a securities accounting methodology, in which these assets were carried at their fair market value and the unrealized gains and losses
were recorded in accumulated other comprehensive loss , a component of shareholders equity. Additionally, reserves for estimated future credit losses were established at the time of securitization and were recorded as basis adjustments to the
carrying value of the securities. Management has determined that pursuant to SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, these securitized ARM loans should be accounted for as
loans rather than as securities. Effective June 30, 2003, management has changed its accounting for such securities to be in compliance with SFAS 140. The securitized ARM loans are now carried at amortized cost and their fair value change is not
reflected in accumulated other comprehensive loss , but are disclosed in Note 2 to these financial statements. The effect of this change was to reduce ARM assets and to increase accumulated other comprehensive loss by $34 million from the
Companys prior practice. Implementing this change would have resulted in a reduction of ARM assets and an increase in accumulated other comprehensive loss of $13.3 million at December 31, 2002 and $22.5 million at March 31, 2003.



Second, our methodology for establishing loan loss reserves has changed.
Instead of making an initial basis adjustment to the value of our securitized ARM loans, we now record a monthly loss provision. As a result of this change, the yield on the securitized ARM loans will increase slightly because the cost basis is now
lower. The increased yield was generally offset by a provision for loan loss, resulting in no substantive change to net income. The loan loss reserve was $5.9 million as of June 30, 2003 and would have been $3.2 million and $4.2 million at December
31, 2002 and March 31, 2003.



No revision has been made to
Companys financial information for periods prior to June 30, 2003 due to the immateriality of the amounts to reflect such amounts in accordance with SFAS 140.



Interest income on ARM assets is accrued based on the outstanding principal amount and contractual terms of the assets.
Premiums and discounts associated with the purchase of the ARM assets are amortized into interest income over the lives of the assets using the effective yield method, adjusted for the effects of estimated prepayments.



ARM asset transactions are recorded on the date the ARM assets are purchased
or sold except for purchases of new issue ARM securities and all ARM Loans which are recorded when all significant uncertainties regarding the characteristics of the assets are removed and, in the case of loans, underwriting due diligence has been
completed, generally shortly before the settlement date.



Credit risk



The Company limits its
exposure to credit losses on its portfolio of ARM securities by purchasing ARM securities that have an investment grade rating at the time of purchase and have some form of credit enhancement, or are guaranteed by an agency of the federal government
(Ginnie Mae) or a government-sponsored or federally-chartered corporation (Fannie Mae or Freddie Mac) (collectively Agency Securities). An investment grade security generally has a security rating of
BBB or Baa or better by at least one of two nationally recognized rating agencies, Standard & Poors, Inc. or Moodys Investors Service, Inc. (the Rating Agencies). Additionally, the Company purchases and originates ARM
loans or purchases all classes of an ARM loan securitization (including the classes rated less than Investment Grade) and limits its exposure to credit losses by restricting its whole loan purchases and originations to ARM loans generally originated
to A quality underwriting standards. The Company further limits its exposure to credit risk by limiting its investment in investment grade securities that are rated A or equivalent, BBB or equivalent, or ARM loans originated to
A quality underwriting standards (Other Investments), including the subordinate classes of securities retained as part of the Companys securitization of loans or purchases of 100% of the classes from other loan
securitizations, to no more than 30% of the portfolio.



The
Company maintains an allowance for loan losses based on managements assessment of numerous factors affecting the Companys portfolio of ARM Loans including, but not limited to, current economic conditions, delinquency status, credit
losses to date on underlying loans and remaining credit protection. If the credit performance of its ARM Loans is different than expected, the Company adjusts the allowance for loan losses to a level deemed appropriate by management to provide for
estimated losses inherent in its ARM Loan portfolio. Additionally, once a loan is 90 days or more delinquent, or a borrower declares bankruptcy, the Company adjusts



8



---

##### Table of Contents

the value of its accrued interest receivable to what it believes to be collectible and stops accruing
interest on that loan.



Provisions for credit losses do not
reduce taxable income and thus do not affect the dividends paid by the Company to shareholders in the period the provisions are taken. Actual losses realized by the Company do reduce taxable income in the period the actual loss is realized and would
affect the dividends paid to shareholders for that tax year.



Valuation methods



The fair values of
the Companys ARM securities and securitized ARM loans are generally based on market prices provided by certain dealers who make markets in these financial instruments, or by third-party pricing services. If the fair value of an ARM security or
securitized ARM loan is not reasonably available from a dealer or a third-party pricing service, management estimates the fair value based on characteristics of the security that the Company receives from the issuer and on available market
information. The fair values for ARM loans, other than securitized ARM loans, are estimated by the Company by using the same pricing models employed by the Company in the process of determining a price to bid for loans in the open market, taking
into consideration the aggregated characteristics of groups of loans such as, but not limited to, collateral type, index, interest rate, margin, length of fixed-rate period, life cap, periodic cap, underwriting standards, age and credit. The fair
values of the Companys long-term collateralized debt, senior notes, interest rate swap agreements and interest rate cap agreements are based on market values provided by dealers who are familiar with the terms of the debt, senior notes, swap
agreements and cap agreements. The fair value of futures contracts is determined on a daily basis by the closing price on the Chicago Mercantile Exchange. The fair values reported reflect estimates and may not necessarily be indicative of the
amounts the Company could realize if these instruments were sold. Cash and cash equivalents, interest receivable, reverse repurchase agreements, other borrowings and other liabilities are reflected in the financial statements at their amortized
cost, which approximates their fair value because of the short-term nature of these instruments.



Hedging instruments



All of the Companys hedging instruments are derivative financial instruments (interest rate cap agreements, interest rate swap agreements and
Eurodollar futures contracts) (collectively, Hedging Instruments) and are carried on the balance sheet at their fair value as an asset, if their fair value is positive, or as a liability, if their fair value is negative. In general, the
Companys Hedging Instruments are designated as cash flow hedges, and the effective amount of change in the fair value of the derivative instrument is recorded in Other comprehensive income and is transferred from
Other comprehensive income to earnings as the hedged item affects earnings. The ineffective amount of all Hedging Instruments is recognized in earnings each quarter.



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



Hybrid Hedging Instruments



The Company enters into interest rate swap agreements (Swap Agreements), Eurodollar futures contracts
(Eurodollar Transactions) and interest rate cap agreements (Cap Agreements) in order to manage its interest rate exposure when financing its Hybrid ARM assets (collectively, Hybrid Hedging Instruments). The
Company generally borrows money based on short-term interest rates. The Companys Hybrid ARM assets have an initial fixed interest rate period of three to ten years. As a result, the Companys existing and forecasted borrowings reprice to
a new rate on a more frequent basis than do the Companys Hybrid ARM assets. When the Company enters into a Swap Agreement, it agrees to pay a fixed rate of interest and to receive a variable interest rate, generally based on the London
InterBank Offer Rate (LIBOR). The Company also enters into Eurodollar Transactions in order to fix the interest rate on its forecasted three-month LIBOR-based liabilities. These Swap Agreements and Eurodollar Transactions have the effect
of converting the Companys variable-rate debt into fixed-rate debt over the life of the Swap Agreements and Eurodollar Transactions. The Company also purchases interest rate cap agreements (Cap Agreements) by incurring a one-time
fee or premium. Pursuant to the terms of the Cap Agreements, the Company will receive cash payments if the interest rate index specified in any such



9



---

##### Table of Contents

Cap Agreement increases above contractually specified levels. Therefore, such Cap Agreements have the
effect of capping the interest rate on a portion of the Companys borrowings above a level specified by the Cap Agreement. The notional balances of the Hybrid Hedging Instruments generally decline over the life of these instruments
approximating the declining balance of the Hybrid ARM assets being financed. These Hybrid Hedging Instruments are used to fix the interest rate on the Companys borrowings during the expected fixed rate period of the Companys Hybrid ARM
assets such that the Company maintains a duration on the borrowings and Hybrid Hedging Instruments that closely matches the duration of the Companys Hybrid ARM assets.



All Swap Agreements are designated as cash flow hedges against the benchmark interest rate risk associated with the
Companys borrowings. Although the terms and characteristics of the Companys Swap Agreements and hedged borrowings are nearly identical, due to the explicit requirements of Financial Accounting Standards No. 133 (FAS 133), the
Company does not account for these hedges under a method defined in FAS 133 as the shortcut method, but rather the Company calculates the effectiveness of these hedges on an ongoing basis, and to date, has calculated effectiveness of
approximately 100%. Eurodollar Transactions are also designated as cash flow hedges and are accounted for in accordance with FAS 133 Implementation Issue No. G7, Method 1: Change in Variable Cash Correspondent Method, and application of this method
has resulted in no measured ineffectiveness. All changes in the unrealized gains and losses on Swap Agreements and the Eurodollar Transactions have been recorded in Accumulated other comprehensive income and are reclassified to earnings
as interest expense is recognized on the Companys hedged borrowings. If it becomes probable that the forecasted transaction, which in this case refers to interest payments to be made under the Companys short-term borrowing agreements,
will not occur by the end of the originally specified time period, as documented at the inception of the hedging relationship, or within an additional two-month time period thereafter, then the related gain or loss in Accumulated other
comprehensive income would be reclassified to income.



The 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 and the carrying value of the Swap Agreements adjust to zero and the Company realizes a fixed cost of money over the life of the Hedging Instrument.



The Company has terminated and/or replaced Swap Agreements in the course of
managing its liquidity and balance sheet. Since the Companys adoption of FAS 133, realized gains and losses resulting from the termination of Swap Agreements are initially recorded in Accumulated other comprehensive income as a
separate component of equity. The gain or loss from the terminated Swap Agreements remains in Accumulated other comprehensive income until the forecasted interest payments affect earnings. If it becomes probable that the forecasted
interest payments will not occur, then the entire gain or loss would be reclassified to income.



The Company designates its Cap Agreements used to manage interest rate exposure when financing its Hybrid ARM assets as cash flow hedges. The Company
assesses hedging effectiveness in accordance with the provisions of FAS 133 Implementation Issue No. G20 and has calculated effectiveness of approximately 100%. All changes in the unrealized gains and losses on these Cap Agreements are recorded in
Accumulated other comprehensive income and are reclassified to earnings, along with the fee paid to fix the interest rate on the applicable forecasted transaction, as interest expense when each of the forecasted financing transactions
occurs. The carrying value of these Cap Agreements is included in Hedging Instruments on the balance sheet.



Life Cap Hedging Instruments



The Company also purchases Cap Agreements to manage interest rate risk on the financing of a portion of its Traditional ARM assets that have a contractual
maximum interest rate (Life Cap), which is a component of the fair value of an ARM asset (Life Cap Hedging Instruments).



The Company does not currently apply hedge accounting to its Life Cap Hedging Instruments and, as a result, the Company records the change in fair value
of these Cap Agreements as hedging expense in current earnings. The carrying value of the Life Cap Hedging Instruments is included in Hedging instruments on the balance sheet.



10



---

##### Table of Contents

Accumulated other comprehensive income



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



|                                                     |  | June 30,2003 |          |   | December 31,2002 |  
|---------------------------------------------------- |  | ------------ | -------- | - | ---------------- | -
|Net unrealized gain on available-for-sale ARM assets |  | $            | 56,530   |   |                  | $
|Net unrealized loss on Hedging Instruments           |  |              | (203,646 | ) |                  |  
|                                                     |  |              |          |   |                  |  
|Accumulated other comprehensive loss                 |  | $            | (147,116 | ) |                  | $
|                                                     |  |              |          |   |                  |  



The net unrealized
gain on the Companys ARM Loans of $41.1 million and $18.7 million at June 30, 2003 and December 31, 2002 is not included in Accumulated other comprehensive income because, in accordance with generally accepted accounting principles, the ARM
Loans are carried at their amortized cost basis.



Income taxes



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



Net earnings per share



Basic EPS amounts are computed by dividing net income (adjusted for dividends declared on preferred stock) by the weighted average number of common shares outstanding. Diluted EPS amounts assume the conversion, exercise or issuance of all
potential common stock instruments, unless the effect is to reduce a loss or increase the earnings per common share.



Following is information about the computation of the earnings per share data for the three- and six-month periods ended June 30, 2003 and 2002
(amounts in thousands except per share data):



|                                                   |  | Income |        |   | Shares |        | EarningsPer Share
|-------------------------------------------------- |  | ------ | ------ | - | ------ | ------ | -----------------
|Three Months Ended June 30, 2003                   |  |        |        |   |        |        |                  
|Net income                                         |  | $      | 42,192 |   |        |        |                  
|Less preferred stock dividends                     |  |        | (1,670 | ) |        |        |                  
|                                                   |  |        |        |   |        |        |                  
|Basic EPS, income available to common shareholders |  |        | 40,522 |   |        | 59,879 |                  
|                                                   |  |        |        |   |        |        |                  
|Effect of dilutive securities:                     |  |        |        |   |        |        |                  
|Convertible preferred stock                        |  |        | 1,670  |   |        | 2,760  |                  
|                                                   |  |        |        |   |        |        |                  
|Diluted EPS                                        |  | $      | 42,192 |   |        | 62,639 |                  
|                                                   |  |        |        |   |        |        |                  
|                                                   |  |        |       
|Three Months Ended June 30, 2002                   |  |        |        |   |        |        |                  
|Net income                                         |  | $      | 27,938 |   |        |        |                  
|Less preferred stock dividends                     |  |        | (1,670 | ) |        |        |                  
|                                                   |  |        |        |   |        |        |                  
|Basic EPS, income available to common shareholders |  |        | 26,268 |   |        | 41,950 |                  
|                                                   |  |        |        |   |        |        |                  
|Effect of dilutive securities:                     |  |        |        |   |        |        |                  
|Convertible preferred stock                        |  |        |       |   |        |       |                  
|                                                   |  |        |        |   |        |        |                  
|Diluted EPS                                        |  | $      | 26,268 |   |        | 41,950 |                  
|                                                   |  |        |        |   |        |        |                  



11



---

##### Table of Contents

|                                                   |  | Income |        |   | Shares |        | EarningsPer Share
|-------------------------------------------------- |  | ------ | ------ | - | ------ | ------ | -----------------
|Six Months Ended June 30, 2003                     |  |        |        |   |        |        |                  
|                                                   |  |        |       
|Net income                                         |  | $      | 81,266 |   |        |        |                  
|                                                   |  |        |       
|Less preferred stock dividends                     |  |        | (3,340 | ) |        |        |                  
|                                                   |  |        |        |   |        |        |                  
|                                                   |  |        |       
|Basic EPS, income available to common shareholders |  |        | 77,926 |   |        | 57,767 |                  
|                                                   |  |        |        |   |        |        |                  
|Effect of dilutive securities:                     |  |        |        |   |        |        |                  
|                                                   |  |        |       
|Convertible preferred stock                        |  |        | 3,340  |   |        | 2,760  |                  
|                                                   |  |        |        |   |        |        |                  
|Diluted EPS                                        |  | $      | 81,266 |   |        | 60,527 |                  
|                                                   |  |        |        |   |        |        |                  
|                                                   |  |        |       
|Six Months Ended June 30, 2002                     |  |        |        |   |        |        |                  
|                                                   |  |        |       
|Net income                                         |  | $      | 52,231 |   |        |        |                  
|                                                   |  |        |       
|Less preferred stock dividends                     |  |        | (3,340 | ) |        |        |                  
|                                                   |  |        |        |   |        |        |                  
|Basic EPS, income available to common shareholders |  |        | 48,891 |   |        | 39,199 |                  
|                                                   |  |        |        |   |        |        |                  
|                                                   |  |        |       
|Effect of dilutive securities:                     |  |        |        |   |        |        |                  
|                                                   |  |        |       
|Convertible preferred stock                        |  |        |       |   |        |       |                  
|                                                   |  |        |        |   |        |        |                  
|                                                   |  |        |       
|Diluted EPS                                        |  | $      | 48,891 |   |        | 39,199 |                  
|                                                   |  |        |        |   |        |        |                  



Use of estimates



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



Note 2. Adjustable-Rate Mortgage Assets



The following tables present the Companys ARM assets as of June 30, 2003 and December 31, 2002. The ARM securities are carried at their fair value,
while the ARM Loans, which include securitized ARM loans, ARM loans collateralizing long-term debt and ARM loans held for securitization are carried at their amortized cost basis (dollar amounts in thousands):



12



---

##### Table of Contents

June 30, 2003:



|                              |  | ARMsecurities |           |   | SecuritizedARM loans |   |           | ARM loanscollateralizinglong-term debt |  |   | ARM loansheld forsecuritization |   |  | Total |        
|----------------------------- |  | ------------- | --------- | - | -------------------- | - | --------- | -------------------------------------- |  | - | ------------------------------- | - |  | ----- | -------
|Principal balance outstanding |  | $             | 9,210,520 |   |                      | $ | 3,455,450 |                                        |  | $ | 973,147                         |   |  | $     | 828,946
|Net unamortized premium       |  |               | 145,183   |   |                      |   | 24,407    |                                        |  |   | 9,021                           |   |  |       | 3,949  
|Loan loss reserves            |  |               |          |   |                      |   | (4,967    | )                                      |  |   | (645                            | ) |  |       | (250   
|Basis adjustments             |  |               | (2,682    | ) |                      |   |          |                                        |  |   |                                |   |  |       |       
|Principal payment receivable  |  |               | 30,437    |   |                      |   | 4,760     |                                        |  |   |                                |   |  |       |       
|                              |  |               |           |   |                      |   |           |                                        |  |   |                                 |   |  |       |        
|Amortized cost, net           |  |               | 9,383,458 |   |                      |   | 3,479,650 |                                        |  |   | 981,523                         |   |  |       | 832,645
|Gross unrealized gains        |  |               | 87,233    |   |                      |   | 36,986    |                                        |  |   | 5,461                           |   |  |       | 6,244  
|Gross unrealized losses       |  |               | (29,808   | ) |                      |   | (2,967    | )                                      |  |   | (3,641                          | ) |  |       | (983   
|                              |  |               |           |   |                      |   |           |                                        |  |   |                                 |   |  |       |        
|Fair value                    |  | $             | 9,440,883 |   |                      | $ | 3,513,669 |                                        |  | $ | 983,343                         |   |  | $     | 837,906
|                              |  |               |           |   |                      |   |           |                                        |  |   |                                 |   |  |       |        
|Carrying value                |  | $             | 9,440,883 |   |                      | $ | 3,479,650 |                                        |  | $ | 981,523                         |   |  | $     | 832,645
|                              |  |               |           |   |                      |   |           |                                        |  |   |                                 |   |  |       |        



December 31,
2002:



|                              |  | ARMsecurities |           |   | SecuritizedARM loans |   |           | ARM loanscollateralizinglong-term debt |  |   | ARM loansheld forsecuritization |   |  | Total |        
|----------------------------- |  | ------------- | --------- | - | -------------------- | - | --------- | -------------------------------------- |  | - | ------------------------------- | - |  | ----- | -------
|Principal balance outstanding |  | $             | 6,505,868 |   |                      | $ | 2,656,879 |                                        |  | $ | 287,409                         |   |  | $     | 706,965
|Net unamortized premium       |  |               | 85,765    |   |                      |   | 22,800    |                                        |  |   | 5,613                           |   |  |       | 2,922  
|Loan loss reserves            |  |               |          |   |                      |   |          |                                        |  |   |                                |   |  |       | (100   
|Basis adjustments             |  |               | (1,778    | ) |                      |   | (9,607    | )                                      |  |   | (3,239                          | ) |  |       |       
|Principal payment receivable  |  |               | 26,546    |   |                      |   | 4,487     |                                        |  |   |                                |   |  |       |       
|                              |  |               |           |   |                      |   |           |                                        |  |   |                                 |   |  |       |        
|Amortized cost, net           |  |               | 6,616,401 |   |                      |   | 2,674,559 |                                        |  |   | 289,783                         |   |  |       | 709,787
|Gross unrealized gains        |  |               | 55,704    |   |                      |   | 18,101    |                                        |  |   | 2,297                           |   |  |       | 3,505  
|Gross unrealized losses       |  |               | (24,209   | ) |                      |   | (4,913    | )                                      |  |   | (120                            | ) |  |       | (160   
|Fair value                    |  | $             | 6,647,896 |   |                      | $ | 2,687,747 |                                        |  | $ | 291,960                         |   |  | $     | 713,132
|                              |  |               |           |   |                      |   |           |                                        |  |   |                                 |   |  |       |        
|Carrying value                |  | $             | 6,647,896 |   |                      | $ | 2,687,747 |                                        |  | $ | 289,783                         |   |  | $     | 709,787
|                              |  |               |           |   |                      |   |           |                                        |  |   |                                 |   |  |       |        



The Company realized
a gain on ARM assets of $2.6 million during the six months ended June 30, 2003. This gain consists of a $1.7 million net recovery of estimated credit losses and a $910.5 thousand gain upon the maturity of a collateralized bond obligation.



The Company did not sell any ARM assets during the six months
ended June 30, 2003. During the six months ended June 30, 2002, the Company sold $62.7 million of ARM securities for a gain of $95.0 thousand. The ARM securities sold were classified as available-for-sale. In addition, the Company sold
$3.7 million of loans and realized a gross gain of $5.9 thousand and a gross loss of $14.0 thousand.



During the six months ended June 30, 2003, the Company securitized $2.6 billion of its ARM loans into a series of private-label multi-class ARM
securities. The Company retained $1.6 billion of the securities created for its securitized ARM loan portfolio and placed $1.0 billion of the securities with third party investors, thereby providing an long-term collateralized financing for the
Companys assets. The Company did not account for these securitizations as sales and, therefore, did not record any gain or loss in connection with the securitizations.



During the quarter ended June 30, 2003, the Company recorded a loan loss provision of $1.0 million to reserve for possible
future credit losses on loans bringing its total loan loss provision to $5.9 million. At December 31, 2002, the Company had recorded a basis adjustment for possible future credit losses of $12.8 million on its ARM Loans. As a result of the change in
the Companys classification of securitized ARM loans from ARM securities, the Company reversed and replaced it with an allowance for losses of $5.6 million as of June 30, 2003.



13



---

##### Table of Contents

As of June 30, 2003 and December 31, 2002, the Company had reduced the cost basis of ARM securities by
$2.7 million and $1.8 million, respectively, due to estimated credit losses (other than temporary declines in fair value) related to ARM securities purchased at a discount. The Company recorded a reduction in cost basis of $899.1 thousand related to
ARM securities purchased during the six months ended June 30, 2003 on which the Company had first loss credit exposure. These securities were purchased as part of a transaction in which the Company purchased all of the classes of a loan
securitization in the amount of $614.1 million, including the subordinated classes. The Company also recorded realized losses on ARM securities in the amount of $98.1 thousand and realized recoveries in the amount of $103.1 thousand during the first
six months of 2003.



The Company has credit exposure on its
securitized ARM loans, loans held as collateral for long-term debt and loans held for securitization. The following tables summarize ARM Loan delinquency information as of June 30, 2003 and December 31, 2002 (dollar amounts in thousands):



|June 30, 2003      |  |            |  |              |       |                      |      |   |                         |      |  
|------------------ |  | ---------- |  | ------------ | ----- | -------------------- | ---- | - | ----------------------- | ---- | -
|Delinquency Status |  | Loan Count |  | Loan Balance |       | Percent of ARM Loans |      |   | Percent of Total Assets |     
|60 to 89 days      |  | 1          |  | $            | 986   |                      | 0.02 | % |                         | 0.01 | %
|90 days or more    |  | 2          |  |              | 303   |                      | 0.01 | % |                         | 0.00 | %
|In foreclosure     |  | 7          |  |              | 3,351 |                      | 0.06 | % |                         | 0.02 | %
|                   |  |            |  |              |       |                      |      |   |                         |      |  
|                   |  | 10         |  | $            | 4,640 |                      | 0.09 | % |                         | 0.03 | %
|                   |  |            |  |              |       |                      |      |   |                         |      |  
|                   |  |            |  |             
|December 31, 2002  |  |            |  |              |       |                      |      |   |                         |      |  
|Delinquency Status |  | Loan Count |  | Loan Balance |       | Percent ofARM Loans  |      |   | Percent ofTotal Assets  |     
|60 to 89 days      |  | 2          |  | $            | 270   |                      | 0.01 | % |                         | 0.00 | %
|90 days or more    |  | 1          |  |              | 159   |                      | 0.00 | % |                         | 0.00 | %
|In foreclosure     |  | 5          |  |              | 2,970 |                      | 0.08 | % |                         | 0.03 | %
|                   |  |            |  |              |       |                      |      |   |                         |      |  
|                   |  | 8          |  | $            | 3,399 |                      | 0.09 | % |                         | 0.03 | %
|                   |  |            |  |              |       |                      |      |   |                         |      |  



As of June 30, 2003,
the Company had commitments to purchase or originate the following amounts of ARM assets (dollar amounts in thousands):



|ARM securities                               |  | $ | 1,341,605
|-------------------------------------------- |  | - | ---------
|ARM Whole loans  bulk purchase              |  |   | 595,875  
|ARM Whole loans  correspondent originations |  |   | 561,023  
|ARM Whole loans  direct originations        |  |   | 198,001  
|                                             |  |   |          
|                                             |  | $ | 2,696,504
|                                             |  |   |          



The Company has
entered into transactions whereby the Company expects to acquire the remaining balance of certain AAA rated Hybrid ARM securities, at a price of par, between 2004 and 2007, when the fixed-rate period of the Hybrid ARM securities terminates and the
securities convert into Traditional ARM securities with characteristics similar to the Traditional ARM securities held in the current portfolio. The Company views these as an alternative source of Traditional ARM assets. The current balance of the
Hybrid ARM securities is approximately $2.6 billion, but is expected to be less than 25% of that, and could be zero, at the time they convert into Traditional ARM securities. If the Company decides not to acquire the Hybrid ARM securities when they
convert into Traditional ARM securities, then it is committed to pay or receive the difference between par and the fair value of the Traditional ARM securities at that time, as determined by an auction of the Traditional ARM securities. As of June
30, 2003, the Company had delivered $7.4 million of collateral in connection with these transactions.



14



---

##### Table of Contents

Note 3. Hedging Instruments



Hybrid Hedging Instruments



As of June 30, 2003, the Company was counterparty to Swap Agreements and Eurodollar Transactions having an aggregate current notional balance of $7.6
billion. In addition, the Company entered into two delayed Swap Agreements with notional balances of $100 million and $500 million that become effective in July and August 2003, respectively. These Swap Agreements and Eurodollar Transactions fix the
interest rate on the financing of Hybrid ARM assets during their fixed rate term (generally three to ten years). As of June 30, 2003, these Swap Agreements and Eurodollar Transactions had a weighted average maturity of 3.0 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. As of June 30, 2003, ARM assets with a carrying value of $136.7
million, including accrued interest, and cash totaling $75.6 million collateralized the Swap Agreements. The net fair value of Swap Agreements at June 30, 2003 of $183.1 million included Swap Agreements with gross unrealized gains of $1.9 million
and gross unrealized losses of $184.9 million and are included in Hedging Instruments on the balance sheet. As of June 30, 2003, the net unrealized loss on Swap Agreements, deferred gains from terminated Swap Agreements and deferred
gains and losses on Eurodollar Transactions recorded in Accumulated other comprehensive income was a net loss of $198.7 million. The Company estimates that over the next twelve months, $97.0 million of these net unrealized losses will be
reclassified from Accumulated other comprehensive income to interest expense.



In April 2003, the Company purchased Cap Agreements with a notional balance of $557.5 million at a cost of $8.9 million in order to manage its interest rate risk exposure on the financing of the Hybrid ARM loans
collateralizing the Companys long-term collateralized debt. The fair value of these Cap Agreements at June 30, 2003 was $4.0 million and is included in Hedging Instruments on the balance sheet. Pursuant to the terms of these Cap
Agreements, the notional amount of the Cap Agreements declines such that it is guaranteed to equal the balance of the Hybrid loan collateral and there is generally no mismatch between the notional balance and the Hybrid loan collateral. Under these
Cap Agreements, the Company will receive cash payments should the one-month LIBOR increase above the contract rates of these Hedging Instruments, which range from 3.25% to 4.40% and average 3.83%. The Cap Agreements had an average maturity of 5.1
years as of June 30, 2003. The initial aggregate notional amount of the Cap Agreements declines to $11.6 million over the period of the agreements, which expire between 2006 and 2012.



The Company hedges the funding of its Hybrid ARM assets such that the weighted average net duration of borrowed funds,
Hybrid Hedging Instruments and Hybrid ARM assets is less than one year. At June 30, 2003, the financing and hedging of the Companys Hybrid ARM assets resulted in a net duration of approximately 1 month.



Life Cap Hedging Instruments



The fair value of the Life Cap Hedging Instruments at June 30, 2003 and
December 31, 2002 amounted to $6.5 thousand and $84.7 thousand, respectively, and is included in Hedging instruments on the balance sheet. Purchased Cap Agreements had a remaining notional amount of $1.1 billion and $1.8 billion as of
June 30, 2003 and December 31, 2002, respectively. The notional amount of the Life Cap Hedging Instruments declines at a rate that is expected to approximate the amortization of the Traditional ARM assets. The Company will receive cash payments
should the one-month or three-month LIBOR increase above the contract rates of these Hedging Instruments, which range from 6.00% to 12.00% and average 9.91%. The Life Cap Hedging Instruments had an average maturity of 1 year as of June 30, 2003 and
expire between 2003 and 2005. During the three- and six-month periods ended June 30, 2003, the Company recognized expenses of $219.8 thousand and $396.9 thousand, respectively, which is reported as Hedging expense in the Companys
Consolidated Income Statements.



Note 4. Reverse Repurchase Agreements,
Long-Term Collateralized Debt, Whole Loan Financing Facilities, Senior Notes

and Other Borrowings



Reverse Repurchase Agreements



The Company has arrangements to enter into reverse repurchase agreements, a form of collateralized short-term borrowing, with 23 different financial
institutions, and as of June 30, 2003, had borrowed funds from 15 of these firms. Because the Company borrows money under these agreements based on the fair value of its ARM assets, and because changes in interest rates can negatively impact the
valuation of ARM assets, the Companys borrowing ability under



15



---

##### Table of Contents

these agreements could be limited and lenders could initiate margin calls in the event interest rates
change or the value of the Companys ARM assets declines for other reasons.



As of June 30, 2003, the Company had $12.1 billion of reverse repurchase agreements outstanding with a weighted average borrowing rate of 1.32% and a weighted average remaining maturity of 6.7 months. As of December
31, 2002, the Company had $8.4 billion of reverse repurchase agreements outstanding with a weighted average borrowing rate of 1.59% and a weighted average remaining maturity of 4.6 months. As of June 30, 2003, $11.5 billion of the Companys
borrowings were variable-rate term reverse repurchase agreements with original maturities that range from three months to twenty-four months. The interest rates of these term reverse repurchase agreements are indexed to either the one- or
three-month LIBOR rate and reprice accordingly. ARM assets with a carrying value of $13.0 billion, including accrued interest and cash totaling $204.1 million, collateralized the reverse repurchase agreements at June 30, 2003.



At June 30, 2003, the reverse repurchase agreements had the following
remaining maturities (dollar amounts in thousands):



|Within 30 days |  | $ | 1,665,183 
|-------------- |  | - | ----------
|31 to 89 days  |  |   | 2,039,814 
|90 to 365 days |  |   | 6,732,175 
|Over 365 days  |  |   | 1,648,108 
|               |  |   |           
|               |  | $ | 12,085,280
|               |  |   |           



Long-Term
Collateralized Debt



On April 3, 2003, $1.1 billion of
mortgage loans from the Companys ARM loan portfolio were transferred to Thornburg Mortgage Securities Trust 2003-2 and were securitized. Approximately $1.0 billion of the securities created by this securitization were issued to third-party
investors in the form of AAA-rated floating rate pass-through certificates. This transaction was accounted for as a financing of the loans and represents permanent financing that is not subject to margin calls. The Company retained the AA and A
certificates totaling $21.2 million. The structure of this transaction also includes an overcollateralization certificate that provides $2.6 million of credit support based on the estimated exposure to credit losses on the loans collateralizing the
debt. As of June 30, 2003, the debt had a net balance of $967.5 million and an effective interest cost of 1.48%, which changes each month at a spread to one-month LIBOR. As of June 30, 2003, this debt was collateralized by ARM loans with a principal
balance of $973.1 million. The debt matures on January 25, 2033 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.



Whole Loan Financing Facilities



As of June 30, 2003, the Company had entered into three whole loan financing
facilities. The interest rates on these facilities are indexed to one-month LIBOR and reprice accordingly. The first whole loan financing facility has a committed borrowing capacity of $600 million and matures in January 2004. The second financing
facility has a committed borrowing capacity of $300 million and matures in March 2004. The third financing facility has a committed borrowing capacity of $300 million and an uncommitted capacity of $150 million and matures in November 2003. As of
June 30, 2003, the Company had $614.5 million borrowed against these whole loan financing facilities at an effective cost of 1.99%. As of December 31, 2002, the Company had $589.1 million borrowed against whole loan financing facilities at an
effective cost of 2.11%. The amount borrowed on the whole loan financing agreements at June 30, 2003 was collateralized by ARM loans with a carrying value of $629.0 million, including accrued interest.



The whole loan financing facility with a borrowing capacity of $300 million
and maturing in March 2004, discussed above, is a securitization transaction in which the Company transfers groups of whole loans to a wholly owned bankruptcy-remote special purpose subsidiary. The subsidiary, in turn, simultaneously transfers its
interest in the loans to a trust, which issues beneficial interests in the loans in the form of a note and a subordinated certificate. The note is then used to collateralize borrowings. This whole loan financing facility works similarly to a secured
line of credit whereby the Company can deliver loans into the facility and take loans out of the facility at the Companys discretion subject to the terms and conditions of the facility. This securitization transaction is accounted for as a
structured financing.



16



---

##### Table of Contents

Senior Notes



On May 15, 2003, the Company entered into an Indenture and a First Supplemental Indenture with Deutsche Bank Trust Company
Americas as Trustee, relating to the completion by the Company of an unregistered offering of $200.0 million in senior unsecured notes at par (Notes). The Notes bear interest at 8.0%, payable each May 15 and November 15, commencing
November 15, 2003, and mature on May 15, 2013. The Notes are redeemable at a declining premium, in whole or in part, beginning on May 15, 2008, and at par beginning on May 15, 2011. The Notes may also be redeemed under limited circumstances on or
before May 15, 2006. In connection with the issuance of the Notes, the Company incurred costs of $5.8 million which is being amortized over the expected life of the Notes. At June 30, 2003, the balance of the Notes outstanding, net of unamortized
issuance costs was $194.3 million.



In connection with the
sale of the Notes discussed above, the Company entered into a registration rights agreement with the initial purchaser of the Notes in which the Company agreed to initiate and conclude an exchange offer of the outstanding Notes for new registered
notes with substantially identical terms. The exchange offer was initiated on July 14, 2003, and expired on August 13, 2003.



Other



The total cash paid for interest was $77.6 million and $55.0 million during the quarters ended June 30, 2003 and 2002, 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 June 30, 2003 and December 31, 2002 (dollar amounts in thousands):



|                                |  | June 30, 2003  |            | December 31, 2002
|------------------------------- |  | -------------- | ---------- | -----------------
|                                |  | CarryingAmount |            | Fair Value       
|Assets:                         |  |                |            |                  
|ARM assets                      |  | $              | 14,734,701 |                  
|Life Cap Hedging Instruments    |  |                | 7          |                  
|Hybrid Hedging Instruments      |  |                | 5,845      |                  
|                                |  |                |            |                  
|Liabilities:                    |  |                |            |                  
|Reverse repurchase agreements   |  |                | 12,085,280 |                  
|Long-term collateralized debt   |  |                | 967,485    |                  
|Whole loan financing facilities |  |                | 614,503    |                  
|Senior notes                    |  |                | 194,340    |                  
|Hybrid Hedging Instruments      |  |                | 184,946    |                  



The carrying amount
for securities, which are categorized as available-for-sale, is their fair value, whereas the carrying amount for loans, which are categorized as held for the foreseeable future, is their amortized cost.



Note 6. Common and Preferred Stock



During February 2003, the Company completed a public offering of 3,473,500
shares of common stock and received net proceeds of $65.9 million under its shelf registration statement on Form S-3 that was declared effective by the Securities and Exchange Commission (SEC) on August 30, 2002.



On May 28, 2003, the Company entered into a sales agreement to sell up to
6,829,596 shares of its common stock from time to time with Cantor Fitzgerald & Co., as sales agent, in a controlled equity offering program.



During the three- and six-months ended June 30, 2003, the Company issued 878,313 and 2,327,613 shares of common stock in at-market
transactions under controlled equity offering programs under the August 2002 shelf registration statement and received net proceeds of $21.1 million and $50.3 million. As of June 30, 2003, $25.1 million and $222.0 million of the Companys
registered securities remained available for future issuance and sale under its currently effective July 2001 and August 2002 shelf registration statements, respectively.



17



---

##### Table of Contents

During the three- and six-month periods ended June 30, 2003, the Company issued 1,504,238 and 2,889,084
shares of common stock under its Dividend Reinvestment and Stock Purchase Plan (the DRSPP) and received net proceeds of $35.3 million and $62.4 million.



On June 13, 2003, the Company declared a second quarter dividend of $0.605 per share to the shareholders of the Series A
9.68% Cumulative Convertible Preferred Stock, which was paid on July 10, 2003 to preferred shareholders of record as of June 30, 2003.



On July 16, 2003, the Company announced its intention to redeem all 2,760,000 shares of Series A 9.68% Cumulative Convertible Preferred Stock, or Series A
Preferred Stock, by converting those shares into shares of common stock. The conversion date is August 18, 2003, at which time each share of Series A Preferred Stock will be converted into one share of common stock.



On July 22, 2003, the Company declared the second quarter 2003 dividend of
$0.62 per share of common stock, which is payable on August 18, 2003 to common shareholders of record as of August 5, 2003.



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



Note 7. Long-Term Incentive Awards



The Companys Board of Directors authorizes the Companys
Compensation Committee to grant Dividend Equivalent Rights (DERs), Stock Appreciation Rights (SARs) and Phantom Stock Rights (PSRs).



As of June 30, 2003, there were 1,441,272 DERs outstanding, of which 1,413,111 were vested, and 549,575 PSRs outstanding, of
which 371,278 were vested. The Company recorded an expense associated with DERs and PSRs of $3.1 million and $932.0 thousand for the quarters ended June 30, 2003 and 2002, respectively. During the six-month periods ended June 30, 2003 and 2002, the
Company recorded an expense associated with DERs and PSRs in the amount of $4.7 million and $1.5 million, respectively. Of the expense recorded in the second quarter of 2003, $1.2 million was the amount of dividend equivalents paid on DERs and PSRs,
$320.9 thousand was the amortization of unvested PSRs, and $1.6 million was the impact of the increase in the Companys common stock price on the value of the PSRs which was recorded as a fair value adjustment. Of the expense recorded during
the second quarter of 2002, $676.5 thousand was the amount of dividend equivalents paid on DERs and PSRs, $12.6 thousand was the impact of the decrease in the Companys common stock price on the value of the PSRs which was recorded as a fair
value adjustment, and $268.1 thousand was the amortization of the value of restricted shares (all of which were subsequently cancelled in April 2002 by the Companys Board of Directors and replaced with PSRs of equal value), net of the effect
of cancelled restricted shares due to employment termination.



As of June 30, 2003, there was $7.0 million of notes receivable outstanding from stock sales. All of these notes were made prior to the enactment of the Sarbanes-Oxley Act of 2002 (the Act). As a result of the Act, the notes
made to directors and executive officers of the Company may not be modified and these individuals are not eligible to participate in any such program in the future. In April 2002, the Board approved a limited stock repurchase program for the
repurchase of shares of common stock at current market value that were acquired pursuant to the exercise of stock options under the Companys previous stock option plan. The Company will first apply the proceeds from any such repurchases to the
repayment of any outstanding stock option notes receivable due from the holders. As of June 30, 2003, no shares have been repurchased under this program.



Note 8. Transactions with Affiliates



The Company has no employees and is managed externally by Thornburg Mortgage Advisory Corporation (the Manager) under the terms of a
Management Agreement (the Agreement). During the quarters ended June 30, 2003 and 2002, the Company reimbursed the Manager and affiliates of the Manager $1.1 million and $965.5 thousand for expenses, respectively, in accordance with the
terms of the Agreement. During the six-month periods ended June 30, 2003 and 2002, the Company reimbursed the Manager and affiliates of the Manager $2.2 million and $1.5 million for expenses, respectively. As of June 30, 2003 and 2002, $1.4 million
and $275.0 thousand, respectively, was payable by the Company to the Manager for reimbursable expenses.



18



---

##### Table of Contents

For the quarters ended June 30, 2003 and 2002, the Company incurred costs of $2.7 million and $1.9
million, respectively, in base management fees in accordance with the terms of the Agreement. For the six-month periods ended June 30, 2003 and 2002, the Company incurred base management fees of $5.2 million and $3.5 million, respectively. As of
June 30, 2003 and 2002, $918.6 thousand and $646.5 thousand, respectively, was payable by the Company to the Manager for the base management fee.



For the three- and six-month periods ended June 30, 2003, the Manager earned performance-based compensation in the amount of $6.9 million and $13.1
million, respectively, in accordance with the terms of the Agreement. For the three- and six-month periods ended June 30, 2002, the Manager earned performance based compensation in the amount of $3.7 million and $6.9 million, respectively. As of
June 30, 2003 and 2002, $6.9 million and $3.7 million, respectively, was payable by the Company to the Manager for performance-based compensation. During the three- and six-month periods ended June 30, 2003, TMHL paid $12.5 thousand and $25.0
thousand, respectively, to Thornburg Securities Corporation, a registered broker-dealer, pursuant to the terms of a Joint Marketing Agreement.



As of June 30, 2003, the aggregate balance of mortgage loans outstanding to directors and officers of the Company, and to employees of the Manager and
other affiliates, amounted to $27.2 million, had a weighted average interest rate of 4.31%, and maturities ranging between 2016 and 2033.



19



---

##### Table of Contents

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



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



Corporate Governance



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



| |  |  | Our Board of Directors consists of a majority of independent directors. The Audit, Nominating/Corporate Governance and Compensation Committees of the Board of Directors are composed
exclusively of independent directors.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our long-term incentive plan does not provide for the granting of stock options. All long-term incentive awards are fully expensed in our consolidated income statements and are
fully disclosed in our financial reports.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have established a formal internal audit function to further the effective functioning of our internal controls and procedures. Our internal audit plan is intended to provide
management and the Audit Committee with an effective tool to identify and address areas of financial or operational concerns and ensure that appropriate controls and procedures are in place.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have adopted both a Code of Business Conduct and Ethics and Corporate Governance Guidelines that cover a wide range of business practices and procedures, that apply to all of our
employees, officers and directors, and that foster the highest standards of ethics and conduct in all of our business relationships.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



20



---

##### Table of Contents

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



Critical Accounting Policies



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



| |  |  | Fair Value. We record our adjustable and variable rate mortgage (ARM) securities, interest rate cap agreements (Cap Agreements), interest rate swap
agreements (Swap Agreements) and Eurodollar futures contracts (Eurodollar Transactions) at fair value. The fair values of our ARM securities and Hedging Instruments (collectively, Cap Agreements, Swap Agreements
and Eurodollar Transactions) are generally based on market prices provided by certain dealers who make markets in these financial instruments or third-party pricing services. If the fair value of an ARM security, Hedging Instrument or other
financial instrument is not reasonably available from a dealer or a third-party pricing service, management estimates the fair value. This requires management judgment in determining how the market would value a particular ARM security, Hedging
Instrument or other financial instrument, based on characteristics of the security we receive from the issuer and available market information. The fair values reported reflect estimates and may not necessarily be indicative of the amounts we could
realize in a current market exchange.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Loan loss reserves on ARM Loans. In general, we securitize all of our loans and retain them in our ARM Loan portfolio. At the time of securitization, we obtain a credit review of
the loans being securitized by one or more of the Rating Agencies. Based on this review, a determination is made, which requires management judgment regarding the expected losses to be realized and we begin recording a monthly loan loss provision
based on this assessment. In doing so, we establish, over time, a loan loss reserve to absorb the expected credit losses. The actual losses could be more or less than the amount estimated by management at the time of securitization. Therefore, we
monitor the delinquencies and losses on our mortgage loans. If the credit performance of the mortgage loans is different than expected, we adjust the provision for probable credit losses to a level deemed appropriate by management to provide for
estimated losses inherent in our ARM Loan portfolio. Any such provision is based on managements assessment of numerous factors affecting our portfolio of ARM Loans including, but not limited to, current economic conditions, delinquency status,
credit losses to date on underlying mortgages, loan size and loan age.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Basis Adjustments on ARM securities. When we acquire all of the classes of a loan securitization and certain other ARM securities from a third party, management assesses the results
of the Rating Agency credit review. Based on this assessment, a determination is made, which requires management judgment regarding the expected losses to be realized and we adjust the basis of the purchased securities to their expected realizable
value. This is referred to as a basis adjustment. When recording a basis adjustment, we establish an account, similar to a loss reserve, to absorb the expected credit losses. The actual losses could be more or less than the amount
estimated by management at the time of acquisition. Therefore, we monitor the delinquencies and losses on the underlying mortgage loans backing these ARM securities. If the credit performance of the underlying mortgage loans is different than
expected, we adjust the provision for probable credit losses to a level deemed appropriate by management to provide for estimated losses inherent in these ARM securities. Any such provision is based on managements assessment of numerous
factors affecting our portfolio of ARM securities including, but not limited to, current economic conditions, delinquency status, credit losses to date on underlying mortgages and remaining credit protection. When management determines that there is
a decline in fair value, which is other than temporary, a basis adjustment for ARM securities is made by reducing the cost basis of the individual security and the amount of such write-down is recorded as a realized loss, thereby reducing earnings.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Loan Securitization. For financial statement purposes, we do not account for any of our loan securitizations as sales since we retain the beneficial and economic interests of the
loans.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Revenue Recognition. Interest income on ARM assets is a combination of accruing interest based on the outstanding balance and contractual terms of the assets and the amortization of
yield adjustments using generally accepted interest methods, principally the amortization of purchase premiums and discounts. Premiums and discounts associated with the purchase of ARM assets are amortized into interest income over the lives of the
assets using the effective yield method adjusted for the effects of estimated prepayments. Estimating prepayments and estimating the remaining lives of our ARM assets requires management judgment, which involves consideration of possible future
interest rate environments and an
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



21



---

##### Table of Contents

estimate of how borrowers will behave in those environments. The actual lives could be more or less than
the amount estimated by management at the time of purchase of the ARMs.



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



General



We are a single-family residential mortgage lender that originates, acquires and retains investments in ARM assets comprised of traditional ARM securities and loans and hybrid ARM securities and loans, thereby
providing capital to the single-family residential housing market. Traditional ARM securities and loans have interest rates that reprice in a year or less (Traditional ARMs) and hybrid ARM securities and loans have a fixed interest rate
for an initial periodof three to ten years and then convert to Traditional ARMs for their remaining terms to maturity (Hybrid ARMs). ARM securities represent interests in pools of ARM loans, which are publicly rated and include
guarantees or other credit enhancements against losses from loan defaults. ARM Loans consist of securitized ARM loans, ARM loans collateralizing long-term debt and ARM loans held for securitization.



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



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



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



Portfolio Strategies



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



22



---

##### Table of Contents

securities will enable us to consistently find attractive opportunities to acquire or create high quality assets at
attractive yields and spreads for our portfolio.



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



We have a focused portfolio lending investment policy designed to minimize credit risk and interest rate risk. Our mortgage assets portfolio may consist of ARM pass-through securities guaranteed by an agency of the
federal government (Ginnie Mae), a government-sponsored corporation or federally-chartered corporation (Fannie Mae or Freddie Mac) (collectively, Agency Securities), or privately issued (generally
publicly registered) ARM pass-through securities, multi-class pass-through securities, floating rate classes of collateralized mortgage obligations (CMOs), ARM loans, fixed rate mortgage-backed securities (MBS) with an
expected duration of one year or less or short-term investments that either mature within one year or have an interest rate that reprices within one year.



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



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



| | (1) |  | Agency Securities; or
| | --- |  | ---------------------



| | (2) |  | securities which are rated within one of the two highest rating categories by at least one of either Standard & Poors Corporation or Moodys Investors Service, Inc.
(the Rating Agencies); or
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (3) |  | securities that are unrated or whose ratings have not been updated but are determined to be of comparable quality (by the rating standards of at least one of the Rating Agencies) to
a High Quality rated mortgage security, as determined by the Manager and approved by our Board of Directors; or
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



| | (5) |  | as authorized by our Board of Directors, ARM securities rated less than Investment Grade that are created as a result of our loan acquisition and securitization efforts or are
acquired as part of a loan securitization effected by third parties in which we purchase all of the classes of the loan securitization and that equal an amount no greater than 17.5% of shareholders equity, measured on a historical cost basis.
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



23



---

##### Table of Contents

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 level yield method of accounting. To the extent that the prepayment rate on our ARM assets differs from expectations, our net interest
income will be affected. Prepayments generally increase when mortgage interest rates fall below the interest rates on ARM loans. To the extent there is an increase in prepayment rates, resulting in a shortening of the expected lives of our ARM
assets, our net income and, therefore, the amount available for dividends could be adversely affected. Our portfolio of ARM assets is held at a book price, excluding unrealized gains and losses, of 101.20% of par at June 30, 2003. This is a non-GAAP
measurement that provides the average amount of cash we have paid, net of amortization we have expensed, for the assets we hold in our ARM portfolio above par. We amortize all premiums and discounts over the expected life of the ARM assets. However,
our ARM assets can be paid off at any time, which is why we provide this non-GAAP measurement. The book price, including unrealized gains and losses, was 101.60% at June 30, 2003, compared to 101.45% at December 31, 2002.



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



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



We acquire and originate High Quality mortgage loans through TMHL from three sources: (i) correspondent lending, which involves acquiring individual loans from
correspondent lenders who are approved by the Company and who originate the individual loans using our underwriting criteria and guidelines, or criteria and guidelines that we have approved, (ii) direct retail loan originations, which are loans that
we originate, and (iii) bulk acquisitions, which 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 and securitized for our portfolio.



The loans
acquired or originated by TMHL are first lien, single-family residential Traditional ARM and Hybrid ARM loans with original terms to maturity of not more than forty years and are either fully amortizing or are interest-only up to ten years, and
fully amortizing thereafter. Interest-only loans acquired or originated during the first six months of 2003 represented 90.5% of total loan production during that period. We believe interest-only loans do not pose additional credit risk due to
original effective loan-to-value ratios averaging 66.7% and the credit strength of our borrowers.



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



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



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



We offer a loan modification program on all loans we originate and certain loans we acquire.
We believe this program promotes customer retention and reduces loan prepayments. Under the terms of this program, a borrower pays a fee to modify the mortgage loan to any then-available hybrid or adjustable-rate product that we offer at the offered
interest rate plus 1/8%.



24



---

##### Table of Contents

Financing Strategies



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



|                                                 |  | June 30, 2003 |            |   | December 31, 2002 |  
|------------------------------------------------ |  | ------------- | ---------- | - | ----------------- | -
|Assets                                           |  | $             | 15,119,488 |   |                   | $
|Adjustments:                                     |  |               |            |   |                   |  
|Net unrealized gain on ARM securities            |  |               | (57,425    | ) |                   |  
|ARM loans collateralizing long-term debt         |  |               | (981,523   | ) |                   |  
|Cap agreements (1)                               |  |               | (8,940     | ) |                   |  
|                                                 |  |               |            |   |                   |  
|Adjusted assets                                  |  | $             | 14,071,600 |   |                   | $
|                                                 |  |               |            |   |                   |  
|                                                 |  |              
|Shareholders equity                             |  | $             | 1,012,578  |   |                   | $
|Adjustments:                                     |  |               |            |   |                   |  
|Accumulated other comprehensive loss             |  |               | 147,116    |   |                   |  
|Equity supporting long-term collateralized debt: |  |               |            |   |                   |  
|Long-term collateralized debt                    |  |               | 967,485    |   |                   |  
|ARM loans collateralizing long-term debt         |  |               | (981,523   | ) |                   |  
|Cap agreements (1)                               |  |               | (8,940     | ) |                   |  
|                                                 |  |               |            |   |                   |  
|                                                 |  |               | (22,978    | ) |                   |  
|                                                 |  |              
|Senior notes                                     |  |               | 194,340    |   |                   |  
|                                                 |  |               |            |   |                   |  
|Adjusted shareholders equity                    |  | $             | 1,331,056  |   |                   | $
|                                                 |  |               |            |   |                   |  
|                                                 |  |              
|Adjusted Equity-to-Assets Ratio                  |  |               | 9.46       | % |                   |  
|                                                 |  |               |            |   |                   |  
|                                                 |  |              
|GAAP equity to assets ratio                      |  |               | 6.70       | % |                   |  
|                                                 |  |               |            |   |                   |  

---

|(1) |  | These Cap Agreements were purchased in order to manage interest rate risk exposure on the financing of the Hybrid ARM loans collateralizing our long-term collateralized debt.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We borrow primarily at short-term interest rates and in the form
of reverse repurchase agreements using our ARM securities and securitized ARM loans as collateral. Reverse repurchase agreements involve a simultaneous sale of pledged assets to a lender at an agreed-upon price in return for the lenders
agreement to resell the same assets back to us at a future date (the maturity of the borrowing) at a higher price. The price difference is the cost of borrowing under these agreements. We generally enter into two types of reverse repurchase
agreements: variable rate term reverse repurchase agreements and fixed rate reverse repurchase agreements. Variable rate term reverse repurchase agreements are financings with original maturities ranging from three to 24 months. The interest rates
on these variable rate term reverse repurchase agreements are indexed to either the one- or three-month LIBOR rate, and reprice accordingly. The fixed rate reverse repurchase agreements have



25



---

##### Table of Contents

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



We have also financed the purchase of ARM assets by issuing long-term collateralized debt in the capital markets, which is 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. Using such a structure enables us to make more efficient use of our capital because the capital requirement to support these
financings is less than the amount required to support the same amount of financings in the reverse repurchase agreement market and these transactions represent permanent financing of these loans and are not subject to margin calls.



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



Hedging Strategies



We attempt to mitigate our interest rate risk by funding our ARM assets with borrowings whose maturities approximately match the interest
rate adjustment periods on our ARM assets. Accordingly, some of our borrowings have variable interest rates or short term fixed maturities (one year or less) because, as of June 30, 2003, 22.0% of our ARM assets were Traditional ARMs, which had
interest rates that adjust within one year. However, the majority of our portfolio is comprised of Hybrid ARM assets, which have fixed interest rate periods of 3 to 10 years and, as of June 30, 2003, averaged a 4.2-year fixed rate period. We utilize
Hybrid Hedging Instruments to, in effect, fix the interest rate on our borrowings such that the net duration of our Hybrid ARM assets, related borrowings and Hybrid Hedging Instruments is no more than one year. A lower duration indicates a lower
expected volatility of earnings given future changes in interest rates. When we enter into a Swap Agreement, we agree to pay a fixed rate of interest and to receive a variable interest rate, generally based on LIBOR. We also enter into Eurodollar
Transactions in order to fix the interest rate changes on our forecasted three-month LIBOR based liabilities. We purchase Cap Agreements by incurring a one-time fee or premium. Pursuant to the terms of the Cap Agreements, we will receive cash
payments if the interest rate index specified in any such Cap Agreement increases above contractually specified levels. Therefore, such Cap Agreements have the effect of capping the interest rate on a portion of our borrowings, above a level
specified by the Cap Agreement. The notional balances of the Hybrid Hedging Instruments generally decline over the life of these instruments. As of June 30, 2003, our Hybrid Hedging Instruments had a remaining average term to maturity of 3.1 years
and when combined with our Hybrid ARM assets and related borrowings had a net duration of approximately 1 month.



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



In addition, some ARM assets
are subject to periodic caps. Periodic caps generally limit the maximum interest rate coupon change on any interest rate coupon adjustment date to either a maximum of 1.00% per semiannual adjustment or 2.00% per annual adjustment. The borrowings
that we incur do not have similar periodic caps. However, we believe the impact of the periodic caps is somewhat mitigated because we own our ARM assets at a net price above par and, therefore, the yield on our ARM assets can change by an amount
greater than the associated periodic cap due to changes in the amortization of the net price above par. Further, because the contractual future interest rate adjustments on the ARM assets will cause their interest rates to increase over time and
reestablish the ARM assets interest rate to a spread over the then current index rate. As of June 30, 2003, $1.5 billion of our Traditional ARM assets have periodic caps, representing 10.3% of total ARM assets.



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



26



---

##### Table of Contents

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



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



Financial Condition



At June 30, 2003, we held total assets of $15.1 billion, $14.7 billion of which consisted of ARM assets, as compared to $10.5 billion of total assets and $10.3 billion of
ARM assets at December 31, 2002. Since commencing operations, we have primarily purchased either ARM securities or ARM loans. At June 30, 2003, 23.6% of our ARM assets were securitized ARM loans, 64.1% were ARM securities, 6.7% were ARM loans
collateralizing long-term debt and 5.6% were ARM loans held for securitization. At June 30, 2003, 93.3% of our assets, including cash and cash equivalents, were High Quality assets, far exceeding our investment policy minimum requirement of
investing at least 70% of our total assets in High Quality ARM assets and cash and cash equivalents. Of the ARM assets we owned as of June 30, 2003, 99.5% were in the form of adjustable rate pass-through certificates or ARM loans.



27



---

##### Table of Contents

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



ARM Assets by Issuer and Credit Rating

(Dollar amounts in thousands)



|                                 |  | June 30, 2003 |            |     | December 31, 2002 |      
|-------------------------------- |  | ------------- | ---------- | --- | ----------------- | -----
|                                 |  | CarryingValue |            |     | PortfolioMix      |      
|High Quality:                    |  |               |            |     |                   |      
|Agency Securities                |  | $             | 2,370,224  |     |                   | 16.1 
|Privately Issued:                |  |               |            |     |                   |      
|AAA/Aaa Rating                   |  |               | 10,938,873 | (1) |                   | 74.2 
|AA/Aa Rating                     |  |               | 435,333    |     |                   | 2.9  
|                                 |  |               |            |     |                   |      
|Total Privately Issued           |  |               | 11,374,206 |     |                   | 77.1 
|                                 |  |               |            |     |                   |      
|                                 |  |               |            |    
|                                 |  |               |            |     |                   |      
|Total High Quality               |  |               | 13,744,430 |     |                   | 93.2 
|                                 |  |               |            |     |                   |      
|Other Investment:                |  |               |            |     |                   |      
|Privately Issued:                |  |               |            |     |                   |      
|A Rating                         |  |               | 94,697     |     |                   | 0.6  
|BBB/Baa Rating                   |  |               | 40,361     |     |                   | 0.3  
|BB/Ba Rating and below           |  |               | 22,568     |     |                   | 0.2  
|ARM loans pending securitization |  |               | 832,645    |     |                   | 5.7  
|                                 |  |               |            |     |                   |      
|Total Other Investment           |  |               | 990,271    |     |                   | 6.8  
|                                 |  |               |            |     |                   |      
|Total ARM Portfolio              |  | $             | 14,734,701 |     |                   | 100.0
|                                 |  |               |            |     |                   |      

---

|(1) |  | As of June 30, 2003, the AAA Rating category includes $970.5 million of ARM loans collateralizing long-term debt that have been credit enhanced to AAA through overcollateralization
in the amount of $2.6 million and an unrated subordinate interest-only certificate retained in the amount of $10.5 million.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



As of June 30, 2003, we had loan loss reserves of $5.9 million
for possible future credit losses on loans. At December 31, 2002, we had a basis adjustment for possible future credit losses of $12.8 million. The basis adjustment was reversed and replaced with a loan loss reserve as a result of the change in our
classification to securitized ARM loans from ARM securities during the second quarter of 2003.



In addition as of June 30, 2003 and December 31, 2002, we had reduced the cost basis of ARM securities by $2.7 million and $1.8 million, respectively, related to Other Investments that we purchased at a discount that
included an estimate of credit losses.



As of June 30, 2003, 10 of the
12,395 loans in our ARM loan portfolio were considered seriously delinquent (60 days or more delinquent) and had an aggregate balance of $4.6 million. At June 30, 2003, the ARM loan portfolio included two real estate-owned properties that we
acquired as the result of foreclosure procedures. The average original effective loan-to-value ratio on the delinquent loans and the acquired properties was approximately 69%. We believe that our current level of basis adjustments and allowance for
loan losses is more than adequate to cover estimated losses from these loans and properties.



28



---

##### Table of Contents

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



ARM Assets by Index

(Dollar amounts in thousands)



|                                    |  | June 30, 2003 |            |              | December 31, 2002 |  
|----------------------------------- |  | ------------- | ---------- | ------------ | ----------------- | -
|                                    |  | CarryingValue |            | PortfolioMix |                   |  
|Traditional ARM assets:             |  |               |            |              |                   |  
|Index:                              |  |               |            |              |                   |  
|One-month LIBOR                     |  | $             | 585,177    |              | 4.0               | %
|Six-month LIBOR                     |  |               | 1,636,017  |              | 11.1              |  
|One-year Constant Maturity Treasury |  |               | 854,378    |              | 5.8               |  
|Other                               |  |               | 187,050    |              | 1.2               |  
|                                    |  |               |            |              |                   |  
|                                    |  |               | 3,262,622  |              | 22.1              |  
|                                    |  |               |            |              |                   |  
|Hybrid ARM assets:                  |  |               |            |              |                   |  
|Remaining fixed period:             |  |               |            |              |                   |  
|Within 1-5 years                    |  |               | 10,269,883 |              | 69.7              |  
|Over 5 years                        |  |               | 1,202,196  |              | 8.2               |  
|                                    |  |               |            |              |                   |  
|                                    |  |               | 11,472,079 |              | 77.9              |  
|                                    |  |               |            |              |                   |  
|                                    |  | $             | 14,734,701 |              | 100.0             | %
|                                    |  |               |            |              |                   |  



The ARM portfolio had a current
weighted average coupon of 4.61% at June 30, 2003. This consisted of an average coupon of 4.73% on the Hybrid ARM portion of the portfolio and an average coupon of 3.80% on the Traditional ARM portion of the portfolio. If the portfolio had been
fully indexed, the weighted average coupon of the portfolio would have been approximately 4.37%, based upon the current composition of the portfolio and the applicable indices. Additionally, if the Traditional ARM portion of the
portfolio had been fully indexed, the weighted average coupon of that portion of the portfolio would have been approximately 3.00%, also based upon the current composition of the portfolio and the applicable indices. The term fully
indexed refers to an ARM asset that has an interest rate that is currently equal to its applicable index plus a margin to the index that is specified by the terms of the ARM asset.



29



---

##### Table of Contents

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



At June 30, 2003, the current yield of the ARM assets portfolio was 4.18%, compared to 4.63% as of December 31, 2002. The decrease in the yield of 0.45% as of June 30,
2003, compared to December 31, 2002, is due primarily to the decreased weighted average interest rate coupon discussed above, which decreased by 0.38% which is attributable to the reinvestment of principal prepayments as well as the addition of new
assets purchased with the proceeds of equity offerings in a declining interest rate environment. The higher level of net premium amortization had the effect of decreasing the yield by 0.02% and the relative level of non-interest earning principal
payments receivables also decreased the portfolio yield by 0.05%. The decline in the weighted average interest rate coupon is primarily attributable to reinvestment of principal prepayments as well as the addition of new assets purchased with the
proceeds of equity offerings in a declining interest rate environment.



The ARM
assets portfolio had an average term to the next repricing date of 3.4 years as of June 30, 2003, compared to 2.8 years as of December 31, 2002. The Traditional ARM assets portion of the portfolio had an average term to the next repricing date of 79
days and the Hybrid ARM assets portion had an average term to the next repricing date of 4.2 years at June 30, 2003. As of June 30, 2003, Hybrid ARM assets comprised 77.8% of the total ARM assets portfolio, compared to 72.3% as of the end of 2002.



30



---

##### Table of Contents

The following table presents various characteristics of our ARM loan portfolio as of June 30, 2003. This information
pertains to loans held for securitization, loans held as collateral for notes payable and loans securitized for our own portfolio for which we retained credit loss exposure. The combined amount of the loans included in this table is $5.3 billion.



ARM Loan Portfolio Characteristics



|                         |  | Average |         |   | High |   |           | Low | 
|------------------------ |  | ------- | ------- | - | ---- | - | --------- | --- | 
|Original loan balance    |  | $       | 437,897 |   |      | $ | 6,400,000 |     | 
|Unpaid principal balance |  | $       | 429,747 |   |      | $ | 6,400,000 |     | 
|Coupon rate on loans     |  |         | 4.78    | % |      |   | 9.13      | %   | 
|Pass-through rate        |  |         | 4.60    | % |      |   | 8.73      | %   | 
|Pass-through margin      |  |         | 1.91    | % |      |   | 3.48      | %   | 
|Lifetime cap             |  |         | 10.92   | % |      |   | 18.00     | %   | 
|Original term (months)   |  |         | 359     |   |      |   | 480       |     | 
|Remaining term (months)  |  |         | 342     |   |      |   | 479       |     | 



|Geographic distribution (top 5 states):            |  |      |   |  | Property type:                                   |  |      |     
|-------------------------------------------------- |  | ---- | - |  | ------------------------------------------------ |  | ---- | ----
|California                                         |  | 24.8 | % |  | Single-family                                    |  | 86.3 | %   
|Georgia                                            |  | 13.1 |   |  | Condominium                                      |  | 8.5  |     
|Colorado                                           |  | 7.6  |   |  | Other residential                                |  | 5.2  |     
|New York                                           |  | 7.2  |   |  |                                                  |  |      |     
|Florida                                            |  | 5.4  |   |  | ARM Loan type:                                   |  |      |     
|                                                   |  |      |   |  | Traditional ARM loans                            |  | 33.0 | %   
|                                                   |  |      |   |  | Hybrid ARM loans                                 |  | 67.0 |     
|Occupancy status:                                  |  |      |   |  |                                                  |  |      |     
|Owner occupied                                     |  | 85.4 | % |  | ARM Interest Rate Caps:                          |  |      |     
|Second home                                        |  | 11.8 |   |  | Initial Cap on Hybrid loans:                     |  |      |     
|Investor                                           |  | 2.8  |   |  | 3.00% or less                                    |  | 5.1  | %   
|                                                   |  |      |   |  | 3.01%-4.00%                                      |  | 13.7 |     
|Documentation type:                                |  |      |   |  | 4.01%-5.00%                                      |  | 39.1 |     
|Full/Alternative                                   |  | 92.6 | % |  | 5.01%-6.00%                                      |  | 9.1  |     
|Other                                              |  | 7.4  |   |  |                                                  |  |      |     
|                                                   |  |      |   |  | Periodic Cap on Traditional ARM loans:          
|                                                   |  |      |   |  | None                                             |  | 16.8 | %   
|Loan purpose:                                      |  |      |   |  | 1.00% or less                                    |  | 13.7 |     
|Purchase                                           |  | 32.2 | % |  | Over 1.00%                                       |  | 2.5  |     
|Cash out refinance                                 |  | 30.2 |   |  |                                                  |  |      |     
|Rate & term refinance                              |  | 37.6 |   |  | Percent of loan balances that are interest-only: |  | 80.2 | %(1)
|                                                   |  |      |   |  |                                                  |  |      |     
|Original effective loan-to-value:                  |  |      |   |  | FICO scores:                                     |  |      |     
|80.01%-and over (3)                                |  | 2.7  | % |  | 801 and over                                     |  | 2.5  | %   
|70.01%-80.00%                                      |  | 40.2 |   |  | 751 to 800                                       |  | 40.9 |     
|60.01%-70.00%                                      |  | 25.1 |   |  | 701 to 750                                       |  | 34.4 |     
|50.01%-60.00%                                      |  | 13.8 |   |  | 651 to 700                                       |  | 18.9 |     
|50.00% or less                                     |  | 18.2 |   |  | 650 or less                                      |  | 3.3  |     
|                                                   |  |      |   |  |                                                  |  |      |     
|Weighted average effective original loan-to-value: |  | 66.8 | % |  | Weighted average FICO score                      |  | 737  | (2) 

---

|(1) |  | The weighted average original effective loan-to-value on interest-only loans is 66.7%.
|--- |  | --------------------------------------------------------------------------------------

|(2) |  | FICO is a credit score, ranging from 300 to 850, with 850 being the best score, based upon the credit evaluation methodology developed by Fair, Isaac and Company, a consulting firm
specializing in creating credit evaluation models.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | All loans with an effective original loan-to-value ratio over 80% have mortgage insurance.
|--- |  | ------------------------------------------------------------------------------------------



31



---

##### Table of Contents

As of June 30, 2003 and December 31, 2002, we serviced $3.1 billion and $2.0 billion of our loans, respectively, and had
6,990 and 4,778 customer relationships, respectively. We hold all of the loans that we service in our portfolio in the form of securitized ARM loans, loans collateralizing long-term debt or ARM loans held for securitization.



During the quarter ended June 30, 2003, we purchased $3.1 billion of ARM securities, 99.8% of
which were High Quality assets, and $1.1 billion of ARM loans, generally originated to A quality underwriting standards. Of the ARM assets acquired during the three months ended June 30, 2003, 93.5% were Hybrid ARM assets and 6.5% were
Traditional ARM assets indexed to LIBOR. The following table compares our ARM asset acquisition and origination activity for the three- and six-month periods ended June 30, 2003 and 2002 (dollar amounts in thousands):



|                               |  | For the three months ended: |           | For the six months ended:
|------------------------------ |  | --------------------------- | --------- | -------------------------
|                               |  | June 30, 2003               |           | June 30, 2002            
|ARM securities:                |  |                             |           |                          
|Agency Securities              |  | $                           | 155,203   |                          
|High Quality, privately issued |  |                             | 2,955,289 |                          
|Other privately issued         |  |                             | 5,294     |                          
|                               |  |                             |           |                          
|                               |  |                             | 3,115,786 |                          
|                               |  |                             |           |                          
|ARM loans:                     |  |                             |           |                          
|Bulk acquisitions              |  |                             | 332,096   |                          
|Correspondent originations     |  |                             | 704,547   |                          
|Direct retail originations     |  |                             | 110,660   |                          
|                               |  |                             |           |                          
|                               |  |                             | 1,147,303 |                          
|                               |  |                             |           |                          
|Total acquisitions             |  | $                           | 4,263,089 |                          
|                               |  |                             |           |                          



Since 1997, we have emphasized
purchasing Traditional ARM and Hybrid ARM assets, high quality, floating rate collateralized mortgages and short term, fixed rate securities at substantially lower prices relative to par in order to reduce the potential impact of rapid prepayments.
In doing so, the average premium/(discount) that we paid for ARM assets acquired in the first six months of 2003 and for the year 2002 was 1.22% and 0.86% of par, respectively, as compared to 3.29% of par in 1997 when we emphasized the purchase of
seasoned ARM assets. In part, as a result of this strategy, the book price of our ARM assets, excluding unrealized gains and losses, was 101.20% of par as of June 30, 2003, down from 102.77% of par as of the end of 1997. This is a non-GAAP
measurement that provides the average amount of cash we have paid, net of amortization we have expensed, for the assets we hold in our ARM portfolio above par. We amortize all premiums and discounts over the expected life of the ARM assets. However,
our ARM assets can be paid off at any time, which is why we provide this non-GAAP measurement. The book price, including unrealized gains and losses, was 101.60% at June 30, 2003, compared to 101.45% at December 31, 2002.



During the three- and six-month periods ended June 30, 2003, we securitized $1.8 billion and
$2.6 billion, respectively, of our ARM loans into a series of multi-class ARM securities. The securitization process benefits us by either creating highly liquid assets that can be readily financed in the reverse repurchase agreement market or
enabling us to enter into long-term collateralized debt financing transactions that represent permanent financing and are not subject to margin calls. The securitizations of the Companys loans are not accounted for as sales and we retain all
of the economic interest and risk of the loans. Of the loans that we securitized during the first six months of 2003, 99.9% of our resulting investment was rated at least Investment Grade and 0.1% of our investment was rated below Investment Grade
and provided credit support to the Investment Grade securities.



As of June 30,
2003, we had commitments to purchase $1.3 billion of ARM securities, $595.9 million of ARM loans through wholesale channels and $759.0 million of ARM loans through origination channels.



During the quarter ended June 30, 2003, there were no sales of ARM assets. We sold $12.6 million of ARM securities for a gain of $95.0
thousand and one loan for a loss of $10.5 thousand, resulting in a net gain of $84.5 thousand during the quarter ended June 30, 2002.



For the quarter ended June 30, 2003, our mortgage assets paid down at an approximate average annualized Constant Paydown Rate (CPR) of 31%, compared to 26%
for the quarter ended June 30, 2002 and 32% for the quarter ended March 31, 2003. When prepayment experience increases and because we own our ARM assets at a net premium, we have to amortize our



32



---

##### Table of Contents

premiums over a shorter time period, resulting in a reduced yield to maturity on our ARM assets. Conversely, if actual
prepayment experience decreases, we would amortize the premium over a longer time period, resulting in a higher yield to maturity. We monitor our prepayment experience on a monthly basis in order to adjust the amortization of the net premium, as
appropriate.



The amount of the adjustment to the fair value on the ARM assets
classified as available-for-sale improved from a positive adjustment of $44.7 million as of December 31, 2002, to a positive adjustment of $57.4 million as of June 30, 2003. All of our ARM securities are classified as available-for-sale and are
carried at their fair value.



Our Traditional ARM assets generally have a
maximum lifetime interest rate cap or ceiling, meaning that each Traditional ARM asset contains a contractual maximum interest rate. Since our borrowings are not subject to equivalent interest rate caps, we have entered into Cap Agreements that have
the effect of offsetting a portion of our borrowing costs above a level specified by the Cap Agreement so that the net margin on our Traditional ARM assets will be protected in high interest rate environments. As of June 30, 2003, our Traditional
ARM assets had an average lifetime interest rate cap of 11.31%, far exceeding the current level of interest rates. At June 30, 2003, these Cap Agreements had a remaining notional balance of $1.1 billion with an average final maturity of 1 year,
compared to a remaining notional balance of $1.8 billion with an average final maturity of 1.0 year at December 31, 2002. At June 30, 2003, the fair value of these Cap Agreements was $6.5 thousand compared to a fair value of $84.7 thousand as of
December 31, 2002. Pursuant to the terms of the Cap Agreements, we will receive cash payments if the one month or three month LIBOR indices increase above contractually specified levels, which range from 6.00% to 12.00% and average approximately
9.91%. Due to the current low level of interest rates, we have decided not to purchase additional Cap Agreements at this time, but will reevaluate this policy on an ongoing basis. We do not currently apply hedge accounting to our Cap Agreements
which are used to manage the interest rate risk on our assets with contractual Life Caps and, as a result, we record the change in fair value of these Cap Agreements as hedging expense in current earnings.



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



As of June 30, 2003, we were counterparty to Swap Agreements and Eurodollar Transactions having an aggregate current notional balance of $7.6 billion. In addition, we
entered into two delayed Swap Agreements with notional balances of $100 million and $500 million that become effective in July and August 2003, respectively. These Swap Agreements and Eurodollar Transactions fix the interest rate on the financing of
our Hybrid ARM assets during their fixed rate term (generally three to ten years). As of June 30, 2003, these Swap Agreements and Eurodollar Transactions had a weighted average maturity of 3.0 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 and Eurodollar Transactions was
3.17% and 3.74% at June 30, 2003 and December 31, 2002, respectively. As of June 30, 2003, ARM assets with a carrying value of $136.7 million, including accrued interest, and cash totaling $75.6 million collateralized the Swap Agreements. The net
fair value of Swap Agreements at June 30, 2003 of $183.1 million included Swap Agreements with gross unrealized gains of $1.9 million and gross unrealized losses of $184.9 million and are included in Hedging Instruments on the balance
sheet. As of June 30, 2003, the net unrealized loss on Swap Agreements, deferred gains from terminated Swap Agreements and deferred gains and losses on Eurodollar Transactions recorded in Accumulated other comprehensive income was a net
loss of $198.7 million. We estimate that over the next twelve months, $97.0 million of these net unrealized losses will be reclassified from Accumulated other comprehensive income to interest expense.



In April 2003, we purchased Cap Agreements with a notional balance of $557.5 million at a
cost of $8.9 million in order to manage our interest rate risk exposure on the financing of the Hybrid ARM loans collateralizing our long-term collateralized



33



---

##### Table of Contents

debt. The fair value of these Cap Agreements at June 30, 2003 was $4.0 million and is included in Hedging
Instruments on the balance sheet. Pursuant to the terms of these Cap Agreements, the notional amount of the Cap Agreements declines such that it is guaranteed to equal the balance of the Hybrid loan collateral and there is generally no
mismatch between the notional balance and the Hybrid loan collateral. Under these Cap Agreements, we will receive cash payments should the one-month LIBOR increase above the contract rates of these Hedging Instruments, which range from 3.25% to
4.40% and average 3.83%. The Cap Agreements had an average maturity of 5.1 years as of June 30, 2003. The initial aggregate notional amount of the Cap Agreements declines to $11.6 million over the period of the agreements, which expire between 2006
and 2012.



As a result of entering into these Hybrid Hedging Instruments, we
have reduced the interest rate variability of our cost to finance our Hybrid ARM assets. The average remaining fixed rate term of our Hybrid ARM assets as of June 30, 2003 was 4.2 years. We hedge the funding of our Hybrid ARM assets such that the
weighted average net duration of borrowed funds, Hybrid Hedging Instruments and Hybrid ARM assets is less than one year. At June 30, 2003, the financing and hedging of our Hybrid ARM assets resulted in a net duration of approximately 1 month.



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



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



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



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



For the quarter ended June 30, 2003, our net income was $42.2 million, or $0.68 Basic
earnings per share and $0.67 Diluted earnings per share, based on a weighted average of 59,879,000 and 62,639,000 shares outstanding, respectively. That compares to $27.9 million, or $0.63 per share (Basic and Diluted EPS) for the quarter ended June
30, 2002, based on a weighted average of 41,950,000 shares outstanding, a 7.9% increase in our earnings per share.



34



---

##### Table of Contents

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



Components of Return on Average Common Equity (1)



|For theQuarter Ended |  | NetInterestIncome/Equity |   |  | G & AExpense(1)/Equity |   |  | MgmtFee/Equity |   |  | IncentiveFee/Equity |   |  | OtherExpense(2)/Equity |    |  | PreferredDividend/Equity |   |  | NetIncome/Equity(ROE) |   |  | 10-YearUSTreasuryAverageYield |   |  | ROE inExcess of10-YearUS Treas.AverageYield |  
|-------------------- |  | ------------------------ | - |  | ---------------------- | - |  | -------------- | - |  | ------------------- | - |  | ---------------------- | -- |  | ------------------------ | - |  | --------------------- | - |  | ----------------------------- | - |  | ------------------------------------------- | -
|Jun 30, 2001         |  | 18.50                    | % |  | 1.49                   | % |  | 1.32           | % |  | 1.26                | % |  | 0.73                   | %  |  | 1.97                     | % |  | 11.73                 | % |  | 5.28                          | % |  | 6.45                                        | %
|Sep 30, 2001         |  | 21.36                    | % |  | 1.72                   | % |  | 1.35           | % |  | 1.76                | % |  | 0.79                   | %  |  | 1.80                     | % |  | 13.94                 | % |  | 4.99                          | % |  | 8.95                                        | %
|Dec 31, 2001         |  | 25.25                    | % |  | 2.26                   | % |  | 1.25           | % |  | 2.70                | % |  | 0.27                   | %  |  | 1.46                     | % |  | 17.31                 | % |  | 4.76                          | % |  | 12.55                                       | %
|Mar 31, 2002         |  | 23.16                    | % |  | 1.60                   | % |  | 1.20           | % |  | 2.34                | % |  | 0.24                   | %  |  | 1.22                     | % |  | 16.56                 | % |  | 5.08                          | % |  | 11.49                                       | %
|Jun 30, 2002         |  | 22.53                    | % |  | 1.74                   | % |  | 1.16           | % |  | 2.27                | % |  | 0.33                   | %  |  | 1.02                     | % |  | 16.01                 | % |  | 5.11                          | % |  | 10.90                                       | %
|Sep 30, 2002         |  | 23.15                    | % |  | 1.43                   | % |  | 1.13           | % |  | 2.75                | % |  | 0.08                   | %  |  | 0.91                     | % |  | 16.85                 | % |  | 4.27                          | % |  | 12.58                                       | %
|Dec 31, 2002         |  | 23.05                    | % |  | 2.15                   | % |  | 1.09           | % |  | 2.74                | % |  | (0.24                  | )% |  | 0.82                     | % |  | 16.49                 | % |  | 4.00                          | % |  | 12.48                                       | %
|Mar 31, 2003         |  | 22.58                    | % |  | 1.78                   | % |  | 1.08           | % |  | 2.68                | % |  | 0.09                   | %  |  | 0.72                     | % |  | 16.23                 | % |  | 3.92                          | % |  | 12.31                                       | %
|Jun 30, 2003         |  | 21.27                    | % |  | 2.05                   | % |  | 1.04           | % |  | 2.69                | % |  | (0.91                  | )% |  | 0.65                     | % |  | 15.75                 | % |  | 3.62                          | % |  | 12.13                                       | %

---

|(1) |  | General and administrative (G & A) expense excludes performance fees and is net of loan servicing fees.
|--- |  | ---------------------------------------------------------------------------------------------------------

|(2) |  | Other expense includes gain on ARM assets, fee income, hedging expense and provision for losses.
|--- |  | ------------------------------------------------------------------------------------------------



Our return on average common equity was 15.75% for the quarter ended June 30, 2003 compared to 16.01% for the quarter ended June 30, 2002.



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



Comparative Net Interest Income Components

(Dollar amounts in thousands)



|                                                          |  | For the quarters ended June 30, |        
|--------------------------------------------------------- |  | ------------------------------- | -------
|                                                          |  | 2003                            |        
|Coupon interest income on ARM assets                      |  | $                               | 144,332
|Amortization of net premium                               |  |                                 | (8,244 
|Cash and cash equivalents                                 |  |                                 | 809    
|                                                          |  |                                 |        
|Interest income                                           |  |                                 | 136,897
|                                                          |  |                                 |        
|                                                          |  |                                
|Reverse repurchase agreements                             |  |                                 | 37,066 
|Long-term collateralized debt                             |  |                                 | 4,320  
|Whole loan financing facilities                           |  |                                 | 3,385  
|Senior notes                                              |  |                                 | 2,090  
|Interest rate swap agreements and Eurodollar transactions |  |                                 | 35,305 
|                                                          |  |                                 |        
|Interest expense                                          |  |                                 | 82,166 
|                                                          |  |                                 |        
|Net interest income                                       |  | $                               | 54,731 
|                                                          |  |                                 |        



As presented in the table above, our
net interest income increased by $17.8 million in the second quarter of 2003 compared to the second quarter of 2002. The change was attributable to a $40.5 million increase in interest income primarily due to an increased asset base, partially
offset by a $22.7 million increase in interest expense. Included in this increase in interest expense is a $13.3 million increase resulting from the impact of Swap Agreements and Eurodollar Transactions which is



35



---

##### Table of Contents

commensurate with the increase in borrowings financing our Hybrid ARM assets. Hybrid ARM assets totaled $11.5 billion and
$5.2 billion at June 30, 2003 and 2002, respectively.



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



Average Balance, Rate, Interest Income and Interest Expense Table

(Dollar amounts in thousands)



|                                                  |  | For the quarters ended June 30,
|------------------------------------------------- |  | -------------------------------
|                                                  |  | 2003                           
|                                                  |  | AverageBalance                 
|Interest Earning Assets:                          |  |                                
|Adjustable-rate mortgage assets                   |  | $                              
|Cash and cash equivalents                         |  |                                
|                                                  |  |                                
|                                                  |  |                                
|                                                  |  |                                
|Interest Bearing Liabilities:                     |  |                                
|Reverse repurchase agreements and Swap Agreements |  |                                
|Long-term collateralized debt                     |  |                                
|Whole loan financing facilities                   |  |                                
|Senior notes                                      |  |                                
|                                                  |  |                                
|                                                  |  |                                
|                                                  |  |                                
|Net Interest Earning Assets and Spread            |  | $                              
|                                                  |  |                                
|Yield on Net Interest Earning Assets (1)          |  |                                
|                                                  |  |                                

---

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



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



|                                                  |  | Three Months Ended June 30, 2003 versus 2002
|------------------------------------------------- |  | --------------------------------------------
|                                                  |  | Rate                                        
|Interest Income:                                  |  |                                             
|ARM assets                                        |  | $                                           
|Cash and cash equivalents                         |  |                                             
|                                                  |  |                                             
|Interest Expense:                                 |  |                                             
|Reverse repurchase agreements and Swap Agreements |  |                                             
|Long-term collateralized debt                     |  |                                             
|Whole loan financing facilities                   |  |                                             
|Senior notes                                      |  |                                             
|                                                  |  |                                             
|                                                  |  |                                             
|                                                  |  |                                             
|Net interest income                               |  | $                                           
|                                                  |  |                                             



As presented in the table above, net
interest income increased by $17.8 million. This increase in net interest income included a favorable volume variance partially offset by an unfavorable rate variance. As a result of the yield on our interest-earning assets decreasing to 4.17%
during the second quarter of 2003 from 4.91% during the same period of 2002, a decrease of 0.74%, while our cost of funds decreased to 2.73% from 3.35% during the same time period, a decrease of 0.62%, there was a net



36



---

##### Table of Contents

unfavorable rate variance of $3.2 million. This was due to an unfavorable rate variance on our ARM assets portfolio and
other interest-earning assets that decreased net interest income by $14.2 million, partially offset by a favorable rate variance on our borrowings in the amount of $11.0 million. The potential volatility in the rate variance is reduced through our
use of Hedging Instruments and the net improvement in interest income is primarily a result of the benefits resulting from the ARM asset investments we have made with proceeds from the issuance of additional common equity. The increased average size
of our portfolio during the second quarter of 2003 compared to the same period in 2002 increased net interest income in the amount of $21.0million. The average balance of our interest-earning assets was $13.1 billion during the second quarter of
2003, compared to $7.8 billion during the same period of 2002  an increase of 67.9%.



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



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

(Dollar amounts in millions)



|As of the Quarter Ended |  | Average Interest Earning Assets |          | HistoricalWeighted Average Coupon |      |   | Yield Adjust- ment (2) |      |   | Yield on Interest Earning Assets |      |   | Cost of Funds |      |   | Net Interest Spread |      |   | Yield on Net Interest Earning Assets |     
|----------------------- |  | ------------------------------- | -------- | --------------------------------- | ---- | - | ---------------------- | ---- | - | -------------------------------- | ---- | - | ------------- | ---- | - | ------------------- | ---- | - | ------------------------------------ | ----
|Jun 30, 2001            |  | $                               | 4,399.1  |                                   | 6.97 | % |                        | 0.82 | % |                                  | 6.15 | % |               | 5.19 | % |                     | 0.96 | % |                                      | 1.43
|Sep 30, 2001            |  | $                               | 4,641.4  |                                   | 6.56 | % |                        | 0.85 | % |                                  | 5.71 | % |               | 4.42 | % |                     | 1.29 | % |                                      | 1.71
|Dec 31, 2001            |  | $                               | 5,522.5  |                                   | 5.94 | % |                        | 0.77 | % |                                  | 5.17 | % |               | 3.41 | % |                     | 1.76 | % |                                      | 2.10
|Mar 31, 2002            |  | $                               | 6,421.7  |                                   | 5.59 | % |                        | 0.64 | % |                                  | 4.95 | % |               | 3.30 | % |                     | 1.65 | % |                                      | 1.97
|Jun 30, 2002            |  | $                               | 7,846.0  |                                   | 5.30 | % |                        | 0.39 | % |                                  | 4.91 | % |               | 3.35 | % |                     | 1.56 | % |                                      | 1.88
|Sep 30, 2002            |  | $                               | 9,237.3  |                                   | 5.16 | % |                        | 0.41 | % |                                  | 4.75 | % |               | 3.19 | % |                     | 1.56 | % |                                      | 1.84
|Dec 31, 2002            |  | $                               | 10,104.7 |                                   | 5.04 | % |                        | 0.43 | % |                                  | 4.61 | % |               | 3.03 | % |                     | 1.58 | % |                                      | 1.85
|Mar 31, 2003            |  | $                               | 11,093.9 |                                   | 4.96 | % |                        | 0.52 | % |                                  | 4.44 | % |               | 2.82 | % |                     | 1.62 | % |                                      | 1.88
|Jun 30, 2003            |  | $                               | 13,144.3 |                                   | 4.68 | % |                        | 0.51 | % |                                  | 4.17 | % |               | 2.73 | % |                     | 1.44 | % |                                      | 1.67

---

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

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

|
|

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



Components of the Yield Adjustments on ARM Assets



|As of the Quarter Ended |  | Premium/ Discount Amortization |   |  | Impact of Principal Payments Receivable |   |  | Hedging Activity/ Other |   |  | Total Yield Adjustment |  
|----------------------- |  | ------------------------------ | - |  | --------------------------------------- | - |  | ----------------------- | - |  | ---------------------- | -
|Jun 30, 2001            |  | 0.60                           | % |  | 0.18                                    | % |  | 0.04                    | % |  | 0.82                   | %
|Sep 30, 2001            |  | 0.63                           | % |  | 0.17                                    | % |  | 0.05                    | % |  | 0.85                   | %
|Dec 31, 2001            |  | 0.55                           | % |  | 0.16                                    | % |  | 0.06                    | % |  | 0.77                   | %
|Mar 31, 2002            |  | 0.39                           | % |  | 0.20                                    | % |  | 0.05                    | % |  | 0.64                   | %
|Jun 30, 2002            |  | 0.22                           | % |  | 0.13                                    | % |  | 0.04                    | % |  | 0.39                   | %
|Sep 30, 2002            |  | 0.26                           | % |  | 0.13                                    | % |  | 0.02                    | % |  | 0.41                   | %
|Dec 31, 2002            |  | 0.30                           | % |  | 0.09                                    | % |  | 0.04                    | % |  | 0.43                   | %
|Mar 31, 2003            |  | 0.34                           | % |  | 0.15                                    | % |  | 0.03                    | % |  | 0.52                   | %
|Jun 30, 2003            |  | 0.32                           | % |  | 0.13                                    | % |  | 0.06                    | % |  | 0.51                   | %



We recorded hedging expense during the
second quarter of 2003 of $219.8 thousand. First, the fair value of our Life Cap Hedging Instruments decreased by $67.6 thousand to $6.5 thousand. Second, we incurred hedging expenses of $3.0 thousand related to Eurodollar transactions. Third, we
expensed $149.2 thousand of the transition adjustment recorded in Accumulated other comprehensive income on January 1, 2001, in connection with the implementation of FAS 133.



37



---

##### Table of Contents

We recorded hedging expense during the second quarter of 2002 of $622.4 thousand. First, the fair value of our Life Cap
Hedging Instruments decreased $460.2 thousand to $256.8 thousand. Second, we incurred hedging expenses of $13.0 thousand related to Eurodollar transactions. Third, we expensed $149.2 thousand of the transition adjustment recorded in
Accumulated other comprehensive income on January 1, 2001, in connection with the implementation of FAS 133.



Since we began acquiring whole loans in 1997, we have only experienced losses on three loans, for a total amount of $174.0 thousand. We continue to evaluate our estimated
credit losses on loans prior to their securitization and we may readjust our current policy if the circumstances warrant. As of June 30, 2003, our whole loans, including those that we have securitized, but with respect to which we have retained
credit loss exposure, accounted for 36.0% of our portfolio of ARM assets or $5.3 billion.



For the quarter ended June 30, 2003, our ratio of operating expenses to average assets was 0.47%, compared to 0.43% for the same period in 2002, and 0.47% for the quarter ended March 31, 2003. The most significant
single increase to our expenses was the performance-based fee of $6.9 million that the Manager earned during the second quarter of 2003 as a result of our achieving a return on shareholders equity in excess of the threshold as defined in the
Management Agreement with the Manager. Our return on equity prior to the effect of the performance-based fee was 18.44%, whereas the threshold, the average 10-year treasury rate plus 1%, was 4.62%. Our other expenses increased by approximately $3.8
million from the second quarter of 2002 to the second quarter of 2003, primarily due to increased base management fees, operations of TMHL, expenses associated with long-term incentive awards for our issuance of Dividend Equivalent Rights
(DERs) and Phantom Stock Rights (PSRs), and other corporate matters. The base management fee paid to the Manager increased $783.3 thousand, TMHLs operations increased $622.4 thousand, and our issuance of DERs and PSRs
accounted for $2.1 million of the increase.



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



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



Annualized Operating Expense Ratios



|For the Quarter Ended |  | Management Fee/ Average Assets |  | Performance Fee/ Average Assets |  | Other Expenses/ Average Assets |  | Total Operating Expenses/ Average Assets
|--------------------- |  | ------------------------------ |  | ------------------------------- |  | ------------------------------ |  | ----------------------------------------
|Jun 30, 2001          |  | 0.10%                          |  | 0.10%                           |  | 0.11%                          |  | 0.31%                                   
|Sep 30, 2001          |  | 0.11%                          |  | 0.14%                           |  | 0.14%                          |  | 0.39%                                   
|Dec 31, 2001          |  | 0.10%                          |  | 0.22%                           |  | 0.18%                          |  | 0.50%                                   
|Mar 31, 2002          |  | 0.10%                          |  | 0.20%                           |  | 0.14%                          |  | 0.44%                                   
|Jun 30, 2002          |  | 0.10%                          |  | 0.19%                           |  | 0.14%                          |  | 0.43%                                   
|Sep 30, 2002          |  | 0.09%                          |  | 0.22%                           |  | 0.13%                          |  | 0.44%                                   
|Dec 31, 2002          |  | 0.09%                          |  | 0.22%                           |  | 0.18%                          |  | 0.49%                                   
|Mar 31, 2003          |  | 0.09%                          |  | 0.22%                           |  | 0.16%                          |  | 0.47%                                   
|Jun 30, 2003          |  | 0.08%                          |  | 0.21%                           |  | 0.18%                          |  | 0.47%                                   



Results of Operations for the Six
Months Ended June 30, 2003



For the six months ended June 30, 2003, our
net income was $81.3 million, or $1.35 Basic earnings per share, and $1.34 Diluted EPS, based on a weighted average of 57,767,000 and 60,527,000 shares outstanding, respectively. That compares to $52.2 million, or $1.25 per share (Basic and Diluted
EPS) for the same period in 2002, based on a weighted average of 39,199,000 shares outstanding, an 8% increase in our Basic earnings per share.



38



---

##### Table of Contents

Our return on average common equity was 15.97% for the six months ended June 30, 2003 compared to 16.26% for the six
months ended June 30, 2002.



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



Comparative Net Interest Income
Components

(Dollar amounts in thousands)



|                                                          |  | For the six months ended June 30, |        
|--------------------------------------------------------- |  | --------------------------------- | -------
|                                                          |  | 2003                              |        
|Coupon interest income on ARM assets                      |  | $                                 | 274,315
|Amortization of net premium                               |  |                                   | (15,431
|Cash and cash equivalents                                 |  |                                   | 1,209  
|                                                          |  |                                   |        
|Interest income                                           |  |                                   | 260,093
|                                                          |  |                                   |        
|                                                          |  |                                  
|Reverse repurchase agreements                             |  |                                   | 72,495 
|Long-term collateralized debt                             |  |                                   | 4,906  
|Whole loan financing facilities                           |  |                                   | 7,106  
|Senior notes                                              |  |                                   | 2,090  
|Interest rate swap agreements and Eurodollar transactions |  |                                   | 66,731 
|                                                          |  |                                   |        
|Interest expense                                          |  |                                   | 153,328
|                                                          |  |                                   |        
|                                                          |  |                                  
|Net interest income                                       |  | $                                 | 106,765
|                                                          |  |                                   |        



As presented in the table above, our
net interest income increased by $38.2 million in the first half of 2003 compared to the same period of 2002. The change was attributable to an $84.2 million increase in interest income primarily due to an increased asset base, partially offset by a
$46.0 million increase in interest expense. Included in this increase in interest expense is a $27.9 million increase resulting from the impact of Swap Agreements and Eurodollar Transactions which is commensurate with the increase in borrowings
financing our Hybrid ARM assets. Hybrid ARM assets totaled $11.5 billion and $5.2 billion at June 30, 2003 and 2002, respectively.



39



---

##### Table of Contents

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



Average Balance, Rate, Interest Income and Interest Expense Table

(Dollar amounts in thousands)



|                                                  |  | For the six months ended June 30,
|------------------------------------------------- |  | ---------------------------------
|                                                  |  | 2003                             
|                                                  |  | AverageBalance                   
|Interest Earning Assets:                          |  |                                  
|Adjustable-rate mortgage assets                   |  | $                                
|Cash and cash equivalents                         |  |                                  
|                                                  |  |                                  
|                                                  |  |                                  
|                                                  |  |                                  
|Interest Bearing Liabilities:                     |  |                                  
|Reverse repurchase agreements and Swap Agreements |  |                                  
|Long-term collateralized debt                     |  |                                  
|Whole loan financing facilities                   |  |                                  
|Senior notes                                      |  |                                  
|                                                  |  |                                  
|                                                  |  |                                  
|                                                  |  |                                  
|Net Interest Earning Assets and Spread            |  | $                                
|                                                  |  |                                  
|Yield on Net Interest Earning Assets (1)          |  |                                  
|                                                  |  |                                  



---

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



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





|                                                  |  | Six Months Ended June 30, 2003 versus 2002
|------------------------------------------------- |  | ------------------------------------------
|                                                  |  | Rate                                      
|Interest Income:                                  |  |                                           
|ARM assets                                        |  | $                                         
|Cash and cash equivalents                         |  |                                           
|                                                  |  |                                           
|                                                  |  |                                           
|                                                  |  |                                           
|Interest Expense:                                 |  |                                           
|Reverse repurchase agreements and Swap Agreements |  |                                           
|Long-term collateralized debt                     |  |                                           
|Whole loan financing facilities                   |  |                                           
|Senior notes                                      |  |                                           
|                                                  |  |                                           
|                                                  |  |                                           
|                                                  |  |                                           
|Net interest income                               |  | $                                         
|                                                  |  |                                           



As presented in the table above, net
interest income increased by $38.2 million. This increase in net interest income is a favorable volume variance partially offset by an unfavorable rate variance. As a result of the yield on our interest-earning assets decreasing to 4.29% during the
first six months of 2003 from 4.93% during the same period of 2002, a decrease of 0.64%, while our cost of funds decreased to 2.77% from 3.33% during the same time period, a decrease of 0.56%, there was a net unfavorable rate variance of $3.8
million. This was primarily due to an unfavorable rate variance on our ARM assets portfolio and other interest-earning assets that decreased net interest income by $22.4 million, partially offset by a favorable rate variance on our borrowings in the
amount of $18.6 million. The potential volatility in the rate variance is reduced through



40



---

##### Table of Contents

our use of Hedging Instruments and the net improvement in interest income is primarily a result of the benefits resulting
from the issuance of additional common equity and the investment opportunities we have pursued in our ARM assets portfolio as a result of this growth. The increased average size of our portfolio during the first half of 2003 compared to the same
period in 2002 increased net interest income in the amount of $42.0 million. The average balance of our interest-earning assets was $12.1 billion during the first half of 2003, compared to $7.2 billion during the same period of 2002  an
increase of 68.1%.



For the six months ended June 30, 2003, our ratio of
operating expenses to average assets was 0.47%, compared to 0.43% for the same period in 2002. The most significant single increase to our expenses was the performance-based fee of $13.1 million that the Manager earned during the first six months of
2003 as a result of our achieving a return on shareholders equity in excess of the threshold as defined in the Management Agreement with the Manager. Our return on equity prior to the effect of the performance-based fee was 18.66%, whereas the
threshold, the average 10-year treasury rate plus 1%, was 4.77%. Our other expenses increased by approximately $6.9 million from the first six months of 2002 to the same period of 2003, primarily due to increased base management fees, operations of
TMHL, expenses associated with our issuance of Dividend Equivalent Rights (DERs) and Phantom Stock Rights (PSRs), and other corporate matters. The base management fee paid to the Manager increased $1.6 million, TMHLs
operations increased $1.4 million, and our issuance of DERs and PSRs accounted for $3.3 million of the increase.



Liquidity and Capital Resources



Our primary source of funds for the quarter ended June 30, 2003 consisted of reverse repurchase agreements totaling $12.1 billion, long-term collateralized debt totaling
$967.5 million, whole loan financing facilities of $614.5 million and senior notes totaling $194.3 million. Our other significant sources of funds for the quarter ended June 30, 2003 consisted primarily of payments of principal and interest from our
ARM assets of $1.7 billion. In the future, we expect our primary sources of funds to remain the same. Our liquid assets generally consist of unpledged ARM assets and cash and cash equivalents.



Total borrowings outstanding at June 30, 2003 had a weighted average effective cost of 1.38%.
The reverse repurchase agreements had a weighted average remaining term to maturity of 6.7 months, although we utilize Swap Agreements and Eurodollar Transactions to extend the re-pricing characteristic of total borrowings to 1.8 years. The
long-term collateralized debt matures in January 2033, although it is callable by the Company at par once the total balance of the loans collateralizing the debt is reduced to 20% of the original balance of the debt. The whole loan financing
facilities are committed facilities that mature in November 2003, January 2004 and March 2004. As of June 30, 2003, $11.5 billion of our borrowings were variable rate term reverse repurchase agreements. Term reverse repurchase agreements are
committed financings with original maturities that range from three to 24 months. The interest rates on these term reverse repurchase agreements are indexed to either the one- or three-month LIBOR rate, and reprice accordingly. The interest rates on
the long-term collateralized debt and whole loan financing facilities are indexed to the one-month LIBOR index and are subject to either daily or monthly adjustment.



We have arrangements to enter into reverse repurchase agreements with 23 different financial institutions and on June 30, 2003, had borrowed
funds with 15 of these firms. Because we borrow money under these agreements based on the fair value of our ARM assets, and because changes in interest rates can negatively impact the valuation of ARM assets, our borrowing ability under these
agreements may be limited and lenders may initiate margin calls in the event interest rates change or the value of our ARM assets decline for other reasons. External disruptions to credit markets might also impair access to additional liquidity and,
therefore, we might be required to sell certain mortgage assets in order to maintain liquidity. If required, such sales might be at prices lower than the carrying value of the assets, which would result in losses. We had adequate liquidity
throughout the quarter ended June 30, 2003. We believe we will continue to have sufficient liquidity to meet our future cash requirements from our primary sources of funds for the foreseeable future without needing to sell assets.



As of June 30, 2003, we had entered into three whole loan financing facilities. We borrow
money under these facilities based on the fair value of the ARM loans pledged to secure these facilities. Therefore, the amount of money available to us under these facilities is subject to margin call based on changes in fair value, which can be
negatively affected by changes in interest rates and other factors, including the delinquency status of individual loans. The first whole loan financing facility has a committed borrowing capacity of $600 million and matures in January 2004. The
second facility has a borrowing capacity of $300 million and matures in March 2004. The third facility has a committed borrowing capacity of $300 million and an uncommitted capacity of $150 million and matures in November 2003. We expect to renew
these facilities. As of June 30, 2003, we had $614.5 million borrowed against these whole loan financing facilities, at an effective cost of 1.99%.



41



---

##### Table of Contents

During the quarter ended June 30, 2003, we issued 878,313 shares of common stock through at-market
transactions under controlled equity offering programs under the August 2002 shelf registration statement and received net proceeds of $21.1 million. As of June 30, 2003, $25.1 million and $222.0 million of our registered securities remained
available for future issuance and sale under our currently effective July 2001 and August 2002 shelf registration statements, respectively.



We have a Dividend Reinvestment and Stock Purchase Plan (the DRSPP) designed to provide a convenient and economical way for existing shareholders to
automatically reinvest their dividends in additional shares of our common stock, and for new and existing shareholders to purchase shares at a discount to the current market price of the common stock, as defined in the DRSPP. During the quarter
ended June 30, 2003, we issued 1,504,238 shares of common stock under the DRSPP and received net proceeds of $35.3 million.



On April 3, 2003, approximately $1.1 billion of mortgage loans from our ARM loan portfolio were transferred to Thornburg Mortgage Securities Trust 2003-2 and were
securitized. Approximately $1.0 billion of the securities created by this securitization were issued to third-party investors in the form of AAA-rated floating rate pass-through certificates. Using such a structure enables us to make more efficient
use of our capital because the capital required to support these financings is less than the amount required to support the same amount of financings in the reverse repurchase agreement market and these transactions represent permanent financing of
these loans and are not subject to margin calls. At June 30, 2003, we had $967.5 million of collateralized long-term debt outstanding. This transaction was accounted for as a financing of our loans.



On May 15, 2003, we completed a private placement of $200.0 million in senior unsecured notes
at par. The notes bear interest at 8%, payable each May 15 and November 15, commencing November 15, 2003, and mature on May 15, 2013. The notes are redeemable at a declining premium, in whole or in part, beginning May 2008 and at par beginning May
2011. The notes may also be redeemed under limited circumstances on or before May 15, 2006. In connection with that offering, we entered into a registration rights agreement pursuant to which we agreed to complete an exchange offer in which the
issued notes may be exchanged for registered notes of like term and amount. The exchange offer was initiated on July 14, 2003, and expired on August 13, 2003. We view the senior notes as an alternative form of long-term capital and treat them as we
would treat common stock for purposes of measuring our portfolio borrowing limitations.



On June 4, 2003, we completed a securitization of $762.0 million of loans from our ARM loans portfolio and 99.8% of our resulting investment was rated at least Investment Grade. We continue to retain all of these securities in our ARM
portfolio as securitized ARM loans.



Market Risks



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



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



The table below presents our consolidated interest rate risk using the static gap methodology. This method reports the difference between interest rate-sensitive assets and liabilities at specific points in time as of
June 30, 2003, based on the earlier of term to repricing or the term to repayment of the asset or liability. The table does not include assets and liabilities that are not interest rate-sensitive such as payment receivables, prepaid expenses,
payables and accrued expenses. The table provides a projected repricing or maturity based on scheduled rate adjustments, scheduled payments, and estimated prepayments. For many of our assets and certain of our liabilities, the maturity date is not
determinable with certainty. In general, our ARM assets can be prepaid before contractual amortization and/or maturity. Likewise, our collateralized long-term debt is paid down as the related ARM assets collateral pays down. The static gap report
reflects our investment policy that allows for only the



42



---

##### Table of Contents

acquisition of ARM assets that reprice within one year, short-term fixed rate assets with an average life of one year or
less or Hybrid ARM assets that are match funded to within a net duration of one year.



The difference between assets and liabilities repricing or maturing in a given period is one approximate measure of interest rate sensitivity. More assets than liabilities repricing in a period (a positive gap) implies earnings will rise as
interest rates rise and decline as interest rates decline. More liabilities repricing than assets (a negative gap) implies declining income as rates rise and increasing income as rates decline. The static gap analysis does not take into
consideration constraints on the repricing of the interest rate of ARM assets in a given period resulting from periodic and lifetime cap features nor the behavior of various indices applicable to our assets and liabilities. Different interest rate
indices exhibit different degrees of volatility in the same interest rate environment due to other market factors such as, but not limited to, government fiscal policies, market concern regarding potential credit losses, changes in spread
relationships among different indices and global market disruptions.



The use
of interest rate instruments such as Swaps Agreements, Eurodollar Transactions and Cap Agreements are integrated into our interest rate risk management. The notional amounts of these instruments are not reflected in our balance sheet. The Swap
Agreements and Eurodollar Transactions that hedge the financing of our Hybrid ARM assets are included in the static gap report for purposes of analyzing interest rate risk because they have the effect of adjusting the repricing characteristics of
our liabilities. The Cap Agreements are not considered in a static gap report because they do not affect the timing of the repricing of the instruments they hedge, but rather they, in effect, remove the limit on the amount of interest rate change
that can occur relative to the financing of the applicable asset.



43



---

##### Table of Contents

Interest Rate Sensitivity Gap Analysis

(Dollar amounts in thousands)

June 30, 2003



|                                                                                                         |  | 1 Year or less |            |    | Over 1 Year to 3 Years |   |           | Over 3Years to 5 Years |  |   | Over 5 Years |   |  | Total
|-------------------------------------------------------------------------------------------------------- |  | -------------- | ---------- | -- | ---------------------- | - | --------- | ---------------------- |  | - | ------------ | - |  | -----
|Interest-earning assets:                                                                                 |  |                |            |    |                        |   |           |                        |  |   |              |   |  |      
|Traditional ARM assets                                                                                   |  | $              | 2,274,804  |    |                        | $ |          |                        |  | $ |             |   |  | $    
|Hybrid ARM assets                                                                                        |  |                | 3,203,612  |    |                        |   | 5,398,675 |                        |  |   | 3,472,780    |   |  |      
|Cash and cash equivalents                                                                                |  |                | 311,080    |    |                        |   |          |                        |  |   |             |   |  |      
|                                                                                                         |  |                |            |    |                        |   |           |                        |  |   |              |   |  |      
|Total interest-earning assets                                                                            |  |                | 5,789,496  |    |                        |   | 5,398,675 |                        |  |   | 3,472,780    |   |  |      
|                                                                                                         |  |                |            |    |                        |   |           |                        |  |   |              |   |  |      
|Interest-bearing liabilities:                                                                            |  |                |            |    |                        |   |           |                        |  |   |              |   |  |      
|Reverse repurchase agreements                                                                            |  |                | 10,437,172 |    |                        |   | 1,648,108 |                        |  |   |             |   |  |      
|Long-term collateralized debt                                                                            |  |                | 967,485    |    |                        |   |          |                        |  |   |             |   |  |      
|Whole loan financing facilities                                                                          |  |                | 614,503    |    |                        |   |          |                        |  |   |             |   |  |      
|Senior notes                                                                                             |  |                | 194,340    |    |                        |   |          |                        |  |   |             |   |  |      
|Swap Agreements and Eurodollar Transactions                                                              |  |                | (6,218,276 | )  |                        |   | 4,523,870 |                        |  |   | 1,261,811    |   |  |      
|                                                                                                         |  |                |            |    |                        |   |           |                        |  |   |              |   |  |      
|Total interest bearing liabilities                                                                       |  |                | 5,995,224  |    |                        |   | 6,171,978 |                        |  |   | 1,261,811    |   |  |      
|                                                                                                         |  |                |            |    |                        |   |           |                        |  |   |              |   |  |      
|Interest rate sensitivity gap                                                                            |  | $              | (205,728   | )  |                        | $ | (773,303  | )                      |  | $ | 2,210,969    |   |  | $    
|                                                                                                         |  |                |            |    |                        |   |           |                        |  |   |              |   |  |      
|Cumulative interest rate sensitivity gap                                                                 |  | $              | (205,728   | )  |                        | $ | (979,031  | )                      |  | $ | 1,231,938    |   |  | $    
|                                                                                                         |  |                |            |    |                        |   |           |                        |  |   |              |   |  |      
|Cumulative interest rate sensitivity gap as a percentage of total assets before market value adjustments |  |                | (1.50      | )% |                        |   | (7.14     | )%                     |  |   | 8.99         | % |  |      
|                                                                                                         |  |                |            |    |                        |   |           |                        |  |   |              |   |  |      



Although the static gap methodology 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 relationships among different
indices, changes in asset yields, which can change more quickly than the underlying interest coupon on ARM assets, changes in hedging strategy, changes in prepayment speeds and changes in business volumes. Accordingly, we make extensive use of an
earnings simulation model to analyze our level of interest rate risk. This analytical technique used to measure and manage interest rate risk includes the impact of all on-balance-sheet and off-balance-sheet financial instruments.



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



At June 30, 2003, based on the earnings simulation model, our potential
earnings increase (decrease) from a parallel 100 and 200 basis point rise in market interest rates over the next twelve months and a commensurate slow down in prepayment speeds as interest rates rise, was (1.7%) and (4.3%) of projected net income
for the twelve months ended June 30, 2004, respectively, and 0.6% and (2.9%) of projected net income for the twelve months ended June 30, 2005, respectively. The assumptions used in the earnings simulation model are inherently uncertain and as a
result, the analysis cannot precisely predict the impact of higher interest rates on net income. Actual results could differ from simulated results due to timing, magnitude and frequency of interest rate changes, changes in prepayment speed other
than what was assumed in the model, and changes in other market



44



---

##### Table of Contents

conditions and management strategies to offset our potential exposure, among other factors. This measure of risk
represents our exposure to higher interest rates at a particular point in time. Our actual risk is always changing. We continuously monitor our risk profile as it changes and alter our strategies as appropriate in our view of the likely course of
interest rates and other developments in our business.



Effects of Interest
Rate Changes



Changes in interest rates impact our earnings in various
ways. While we invest primarily in ARM assets, rising short-term interest rates may temporarily negatively affect our earnings, and, conversely, falling short-term interest rates may temporarily increase our earnings. This impact can occur for
several reasons and may be mitigated by portfolio prepayment activity and portfolio funding strategies as discussed below. First, our borrowings may react to changes in interest rates sooner than our ARM assets because the weighted average next
repricing dates of the borrowings may be shorter time periods than that of the ARM assets. Second, interest rates on Traditional ARM assets may be limited to an increase of either 1% or 2% per adjustment period (commonly referred to as the periodic
cap), while our borrowings do not have similar limitations. At June 30, 2003, 10.6% of our total ARM assets were Traditional ARM assets subject to periodic caps. Third, our ARM assets typically lag changes in the applicable interest rate indices by
45 days, due to the notice period provided to ARM borrowers when the interest rates on their loans are scheduled to change.



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



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



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



Conversely, the rate of prepayment on our mortgage assets may decrease if interest rates rise
or if the difference between long term and short term interest rates increases. Decreased prepayments would cause us to amortize the premiums paid for our ARM assets over a longer time period, resulting in an increased yield on our mortgage assets.
Therefore, in rising interest rate environments where prepayments are declining, not only would the interest rate on the ARM assets portfolio increase to re-



45



---

##### Table of Contents

establish a spread over the higher interest rates, but the yield also would rise due to slower prepayments. The combined
effect could significantly mitigate other negative effects that rising short-term interest rates might have on earnings.



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



Other Matters



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



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



Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



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



Item 4. CONTROLS AND PROCEDURES



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



46



---

##### Table of Contents

PART II. OTHER INFORMATION



Item 1. Legal Proceedings



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



Item 2. Changes in Securities and Use of Proceeds



Not applicable



Item 3. Defaults Upon Senior Securities



Not applicable



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



| | (a) |  | Our Annual Meeting of Shareholders was held on April 22, 2003.
| | --- |  | --------------------------------------------------------------



| | (b) |  | Election of Class III Directors
| | --- |  | -------------------------------



|                  |  | Votes     
|----------------- |  | ----------
|Nominee           |  | For       
|Garrett Thornburg |  | 53,568,295
|Joseph H. Badal   |  | 53,627,795
|Stuart C. Sherman |  | 51,286,843



The following Class I
and Class II directors continued in office after the Annual Meeting:



David A. Ater

Larry A. Goldstone

Ike Kalangis

Owen M. Lopez

James H. Lorie

Francis I. Mullin, III

Richard P. Story



Item 5. Other Information



None



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



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



See Exhibit Index



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



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



| | (i) |  | Current Report on Form 8-K, filed on April 25, 2003, attaching the Companys Press Release, dated April 22, 2003, announcing the Companys earnings for the quarter ending
March 31, 2003.
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) |  | Current Report on Form 8-K, filed on May 2, 2003, attaching the Companys Press Release of April 28, 2003 announcing the Companys intention to raise capital through an
unregistered offering of 10-year senior unsecured notes.
| | ---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (iii) |  | Current Report on Form 8-K, filed May 28, 2003, regarding entering into a sales agreement with Cantor Fitzgerald & Co. to sell up to 6,829,596 shares of the Companys
common stock from time to time through Cantor Fitzgerald & Co., as sales agent.
| | ----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (iv) |  | Current Report on Form 8-K, filed May 28, 2003, regarding (1) transfer and securitization of $1.1 billion of mortgage loans in April 2003, and (2) final agreement to raise $200
million through an unregistered offering of 10-year senior unsecured notes.
| | ---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



47



---

##### Table of Contents

SIGNATURES



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



|                       |  |  |  | THORNBURG MORTGAGE, INC.
|---------------------- |  |  |  | ------------------------
|                       |  |  | 
|Dated: August 18, 2003 |  |  |  | By:                     
|                       |  |  |  |                         
|                       |  | 
|                       |  |  |  |                         
|                       |  |  | 
|Dated: August 18, 2003 |  |  |  | By:                     
|                       |  |  |  |                         
|                       |  | 
|                       |  |  |  |                         
|                       |  |  | 
|Dated: August 18, 2003 |  |  |  | By:                     
|                       |  |  |  |                         



48



---

##### Table of Contents

Exhibit Index



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



49