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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(mark one)

x

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

            For the fiscal year ended: December 31, 2002

OR

o

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)

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

Securities registered pursuant to Section 12(b) of the Act:

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

     Yes    X     No          

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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          

At June 28, 2002, the aggregate market value of the voting stock held by non-affiliates was $847,465,461, based on the closing price of the common stock on the New York Stock Exchange.

Number of shares of Common Stock outstanding at March 4, 2003: 57,633,721

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Registrant’s Proxy Statement to be filed within 120 days after the close of the Registrant’s fiscal year in connection with the Annual Meeting of Shareholders of the Registrant to be held on April 22, 2003, are incorporated by reference into Part III.

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THORNBURG MORTGAGE, Inc.
2002 FORM 10-K ANNUAL REPORT
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PART I

Item 1. BUSINESS

General

We are a single-family residential mortgage lender that originates, acquires and retains investments in adjustable and variable rate mortgage (“ARM”) assets comprised of ARM securities and ARM loans, hybrid ARM securities and loans, thereby providing capital to the single-family residential housing market. ARM securities represent interests in pools of ARM loans, which are publicly rated and include guarantees or other credit enhancements against losses from loan defaults. While we are not a bank or savings and loan institution, our business purpose, strategy, method of operation and risk profile are best understood in comparison to such institutions. We use our equity capital and borrowed funds to originate, acquire and invest in ARM assets and seek to generate income for distribution to our shareholders based on the difference between the yield on our ARM assets portfolio and the cost of our borrowings. Our corporate structure differs from most lending institutions in that we are organized for tax purposes as a real estate investment trust (“REIT”) and therefore dividend substantially all of our earnings to shareholders, without paying federal or state income tax at the corporate level. See “Federal Income Tax Considerations — Requirements for Qualification as a REIT.” 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, are involved in financing our mortgage loan assets. Thornburg Mortgage Home Loans, Inc. (“TMHL”), our wholly owned mortgage-banking subsidiary, conducts our mortgage loan acquisition, origination, processing, underwriting and securitization activities. TMHL’s two wholly owned special purpose subsidiaries, Thornburg Mortgage Funding Corporation II and Thornburg Mortgage Acceptance Corporation II, facilitate the financing of loans by TMHL. Effective January 1, 2002, we changed the tax status of TMHL and its subsidiaries from taxable REIT subsidiaries to qualified REIT subsidiaries because we determined that the activities of these subsidiaries are consistent with permitted REIT activities and the change would not jeopardize our ability to maintain our tax status as a REIT.

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. See “Employees – The Management Agreement.”

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, 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 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 at our website. These documents are also available in print to any shareholder 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.

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

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Corporate Governance

In light of recent legislation and new regulations regarding corporate governance, we would like to highlight our compliance with these new requirements:

	•		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 also 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 a Code of Business Conduct and Ethics and Corporate Governance Guidelines that cover a wide range of business practices and procedures, apply to all of our employees, officers and directors, and 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 or communicating material nonpublic information to others.

Operating Policies and Strategies

Portfolio Strategies

Our business strategy is to hold ARM assets in 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 acquire ARM assets by purchasing ARM securities or large packages of ARM loans that other mortgage lending institutions have originated and serviced. Additionally, we originate ARM loans for our portfolio through our correspondent lending program, which currently includes approximately 100 approved correspondents, and we originate loans directly through TMHL. Currently, TMHL is authorized to lend in forty-two states and has licensing applications pending in additional states. We believe that this diversification of sourcing of ARM loans and ARM securities will enable us to consistently find attractive opportunities to acquire or create high quality assets at attractive yields and spreads for our portfolio.

In addition to our direct origination efforts, we 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 loans, investment banking firms, home builders and other firms involved in originating, packaging and selling mortgage loans. We believe that 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 either guaranteed by an agency of the federal government (“Ginnie Mae”), a government-sponsored corporation (“Fannie Mae”) or a federally-chartered corporation (“Freddie Mac”), or privately issued (generally publicly registered) ARM pass-through securities, multi-class pass-through securities, floating rate classes of collateralized mortgage obligations (“CMOs”), collateralized bond obligations (“CBOs”) which are generally backed by high quality mortgage-backed securities (“MBS”), ARM loans, fixed rate MBS that have an expected duration of one year or less, or short-term investments that either mature within one year or have an interest rate that reprices within one year. Agency securities (“Agency Securities”) are MBS for which a U.S. Government agency or a government-sponsored or

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federally chartered corporation, such as Ginnie Mae, Fannie Mae or Freddie Mac, guarantees payments of principal or interest on the certificates. Agency Securities are not rated, but carry an implied AAA rating.

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. We limit our ownership of hybrid ARM assets with fixed rate periods of greater than five years to no more than 10% of our total assets. We also have a policy to fund our hybrid ARM assets with fixed rate borrowings such that the duration difference of hybrid ARM assets and the corresponding borrowings is one year or less. We use interest rate swap agreements (“Swap Agreements”) and Eurodollar futures contracts (“Eurodollar Transactions”) to fix our borrowing cost.

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 or hybrid 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 and that equal an amount no greater than 17.5% of shareholders’ equity, measured on a historical cost basis.

To mitigate the adverse effect of an increase in prepayments on our ARM assets, we emphasize the purchase of ARM assets at prices close to or below par. We amortize any premiums paid for our assets over their expected lives using the 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 currently held at a book price, excluding unrealized gains and losses, of 101.01% of par, down from 102.77% of par as of the end of 1997.

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.

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Acquisition and Securitization of ARM and hybrid ARM Loans

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

The loans acquired or originated by TMHL are first lien, single-family residential, ARM and hybrid ARM loans with original terms to maturity of not more than forty years and are either fully amortizing or are interest only up to ten years, and fully amortizing thereafter. Interest only loans acquired or originated during 2002 represented 84.4% of total loan production during that period. We believe the interest only loans do not pose additional credit risk due to original effective loan-to-value ratios averaging 70.3% and the credit strength of our borrowers.

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

We acquire ARM loans for our portfolio with the intention of securitizing them into pools of High Quality ARM securities. In order to facilitate the securitization of our loans, we generally create subordinate certificates, which provide a specified amount of credit enhancement. Upon securitization, we hold the High Quality ARM securities and the subordinate certificates in our portfolio that we then finance in the repurchase agreement market or through the issuance of debt obligations in the capital markets. We have a policy that limits the amount of subordinate certificates created from these securitization efforts and rated below Investment Grade that we may hold in our portfolio to 17.5% of our shareholders’ equity, as 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 that we originate and certain loans that we acquire. We believe this program promotes customer retention and reduces loan prepayments. Under the terms of this program, a borrower may choose to pay a fee and modify the mortgage loan to any then-available hybrid or adjustable-rate product that we offer at the offered interest rate plus 1/8%, at any time during the life of the loan.

Bulk Acquisitions

Third-party mortgage originators or aggregators sell us pools of single-family residential ARM and hybrid ARM loans at market prices, with or without the servicing rights. The loans are originated using the seller’s loan products, programs and underwriting guidelines. Additionally, the originator performs the credit review of the borrower, the appraisal of the property and the quality control procedures. We generally only consider the purchase of loans when all of the borrowers have had their income and assets verified, their credit checked and appraisals of the properties have been obtained. We or a third party then perform an independent underwriting review of the processing, underwriting and loan closing methodologies that the originators used in qualifying a borrower for a loan. Depending on the size of the loan package, we may not review all of the loans in a bulk package of loans, but rather select loans for underwriting review based upon specific risk-based criteria such as property location, loan size, effective loan-to-value ratios, borrowers’ credit score and other criteria that we believe to be important indicators of credit risk. Additionally, prior to the purchase of loans, we obtain representations and warranties from each seller stating that each loan either meets the seller’s pre-approved underwriting standards and other requirements or is underwritten to our standards. A seller who breaches such representations and warranties may be obligated to repurchase the loan. As added security, we use the services of a third party document custodian to insure the quality and accuracy of all individual mortgage loan closing documents and to hold the documents in safekeeping. As a result, all of the original

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individual loan closing documents that are signed by the borrower, other than the original credit verification documents, are examined, verified and held by the custodian.

Correspondent Lending

In the correspondent lending channel, we acquire mortgage loans from Company-approved correspondent lenders. We pre-qualify all correspondents to determine their financial strength, the soundness of their own established in-house mortgage procedures and their ability to fulfill their representations and warranties to us. Correspondents’ compliance with these qualifications is assessed annually. The majority of loans acquired from correspondents are originated to our approved specifications including our internally developed loan products, credit and property guidelines, and underwriting criteria. In certain cases, correspondents sell their own loan products to us, which are originated according to the correspondents’ product specifications and underwriting guidelines and have been pre-approved by us.

Prior to purchase, we review all of the loans generated by our correspondents to insure product quality and compliance with our guidelines. As an additional due diligence step, we also obtain a mortgage score for each of the loans acquired through correspondents. The mortgage score evaluates not only the borrower’s credit but also the geographic location of the property, the economic viability of the area, the general market conditions and the loan product chosen by the borrower. We believe that obtaining mortgage scores for the loans will help in reducing our securitization costs by insuring that we purchase the highest quality mortgage loans with the lowest risk possible. After closing, we contract with a third party to perform an additional quality control review of certain loans in order to verify that such loans were properly underwritten and to confirm that the loan documents are complete and properly executed.

Direct Retail Loan Origination

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

We originate mortgage loans through TMHL. As of February 26, 2003, TMHL was authorized to originate loans in the following forty-two states:

Our direct retail lending origination model is built upon strategic partnerships with third party providers of traditional “back office” processing and underwriting and other services such as appraisals, title and settlement services. We have entered into agreements with two Company-approved third party, private label fulfillment vendors for the processing, underwriting and closing of our retail loans. In addition, we work with nationally recognized providers of appraisal, credit, title insurance and settlement services. We oversee the activities of these service providers through on-site visits, report monitoring, customer service surveys, post-closing quality control, and periodic direct participation in the customer experience.

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We use one of two channels to originate loans directly with borrowers. We originate loans using a call center, where borrowers can call to inquire about loan products and interest rates, as well as to seek advice and counseling regarding qualifying for a loan and the approval process. In 2001, we expanded this channel to employ third party call center specialists versed in mortgage loan origination so that prospective borrowers are able to apply for a loan over the telephone. A completed mortgage loan application along with a request for additional supporting documentation is sent to the borrower for signature. Our loan processors, or their third party agents, are responsible for working with the borrower to complete the processing of the loan application, obtain a final loan approval and schedule the loan for closing.

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

The mortgage origination process is a labor- and document-intensive business that requires significant “back office” systems and personnel. We have contracted with third party mortgage service providers to provide loan processing, underwriting, documentation and closing functions required to originate and close mortgage loans. Additionally, another third party service provider has staffed a mortgage loan call center for our benefit. These services are provided on a private label basis, meaning that these providers will identify themselves as being our representatives. The benefit to us of this arrangement is that we pay for these services as we use them, without a significant investment in personnel, systems, office space and equipment.

Mortgage Loan Servicing

In the third quarter of 2001, we began purchasing the servicing rights on some of the loans we acquired through the bulk and correspondent loan acquisition programs, with the intent of providing borrowers with integrated, ongoing high quality customer service, as well as loan modification and refinance opportunities. We also retain the servicing rights on loans originated through the retail channel. These efforts are designed to lower prepayment rates on the portfolio through customer retention. We contract with a qualified third party subservicer to service our loans for our customers on a private label basis. This third party subservicer collects mortgage loan payments, manages escrow accounts, provides monthly statements and notices to borrowers, offers on-line mortgage servicing information and provides customer service, loan collection, loss mitigation, foreclosure, bankruptcy and real estate-owned management services. We pay fees for this service based on a fixed fee schedule per mortgage loan.

Underwriting Guidelines

Our underwriting guidelines are intended to determine the collateral value of the mortgaged property and to consider the borrower’s credit standing and repayment ability. Each prospective borrower completes an application that includes information with respect to the applicant’s assets, liabilities, income and employment history, as well as certain other personal information. A credit report is required for each applicant from at least one credit reporting company. The report typically contains information relating to matters such as credit history with local and national merchants and lenders, installment debt payments and any record of default, bankruptcy, repossession, suit or judgment. At December 31, 2002, our borrowers had an average credit score, called a FICO (based upon the credit evaluation methodology developed by Fair, Isaac and Company, a consulting firm specializing in creating credit evaluation models) of 737. On a case-by-case basis, we may determine that, based upon compensating factors, a prospective borrower not strictly qualifying under the applicable underwriting guidelines warrants an underwriting exception. Compensating factors may include, but are not limited to, low loan-to-value ratios, low debt-to-income ratios, good credit history, stable employment, financial reserves, and time in residence at the applicant’s current address.

Our underwriting guidelines for both the correspondent lending and direct retail loan origination channels are applied in accordance with a procedure that generally requires (1) one appraisal report for loan amounts up to $650 thousand, one appraisal report and one field review for loan amounts between $650 thousand and $1 million, and two appraisal reports for loan amounts greater than $1 million, (2) a review of such appraisal by a third party appraisal review firm for loans over $650 thousand if deemed necessary and (3) an internal review by us of all appraisal reports. Our underwriting guidelines permit single-family mortgage loans with loan-to-value ratios at origination of up to 95% (or, with respect to additional collateral

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mortgage loans, up to 100%) for the highest credit grading category, depending on the creditworthiness of the borrower, the type and use of the property, the purpose of the loan application and the loan amount. All loans with loan-to-value ratios greater than 80% must either have mortgage insurance or additional collateral securing the loan.

Financing Strategies

We finance our purchased or securitized ARM assets using (i) equity capital and (ii) borrowings, such as reverse repurchase agreements, lines of credit, and other secured or unsecured financings that we may establish with approved institutional lenders. We have established lines of credit and collateralized financing agreements with twenty-two different financial institutions. We generally expect to maintain an equity-to-assets ratio of between 8% and 10%, as measured on a historical cost basis. This ratio may vary from time to time within the above stated range depending upon market conditions and other factors that our management deems relevant, but cannot fall below 8% without the approval of our Board of Directors.

Our borrowings are primarily at short-term interest rates and in the form of reverse repurchase agreements using our ARM securities 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. 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. In the event of the insolvency or bankruptcy of a lender during the term of a reverse repurchase agreement, the lender, under the Federal Bankruptcy Code, may be allowed to assume or reject the agreement to resell the assets. If a bankrupt lender rejects its obligation to resell pledged assets to us, our claim against the lender for the resulting damages may be treated as one of many unsecured claims against the lender’s assets. These claims would be subject to significant delay and, if and when payments are received, they may be substantially less than the damages that we actually suffer. To mitigate this risk, we enter into collateralized borrowings with only financially sound institutions approved by our Board of Directors, including a majority of unaffiliated directors, and monitor the financial condition of such institutions on an ongoing basis.

We have also financed the purchase of ARM assets by issuing debt obligations in the capital markets, which are collateralized by securitized pools of our ARM assets 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 issue debt that will not be subject to margin calls once the debt obligation has been issued.

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 or until we arrange financing in a capital markets, collateralized debt transaction.

Hedging Strategies

We attempt to mitigate our interest rate risk by funding our ARM assets with borrowings that have maturities that approximately match the interest rate adjustment periods on our ARM assets. Accordingly, some of our borrowings have variable interest rates or short term fixed (one year or less) maturities because, as of December 31, 2002, 27.7% of our ARM assets had interest rates that adjust within one year. However, for that part of our portfolio that is financing our hybrid ARM assets, which generally have fixed interest rate periods of 3 to 10 years and, as of December 31, 2002, averaged a 3.9-year fixed rate period, we extend the maturity of our borrowings such that the difference between the duration of our hybrid ARM assets and the duration of the fixed-rate borrowings funding our hybrid ARM assets is no more than one year. By maintaining a duration mismatch of less than one year, we expect the net market value change of our hybrid ARM portfolio and associated fixed-rate liabilities to be no more than 1.00% for a 1.00% change in interest rates. A lower duration indicates a lower expected volatility of earnings given future changes in interest rates. We generally accomplish this fixed rate maturity extension through the use of Swap Agreements and Eurodollar Transactions. When we enter into a Swap Agreement, we generally agree to pay a fixed rate of interest and to receive a variable interest rate, generally based on LIBOR. We enter into Eurodollar Transactions in order to hedge changes in our forecasted three-month LIBOR based liabilities. These Swap Agreements and Eurodollar Transactions have the effect of converting our short-term borrowings into fixed-rate borrowings over the life of the Swap Agreements and Eurodollar Transactions. As of December 31, 2002, our current Swap Agreements and Eurodollar Transactions that hedged the financing of hybrid ARM assets had a remaining fixed rate term to maturity of 2.8 years and a duration mismatch of approximately 3 months, which is in compliance with our hedging policy.

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We may also enter into Swap Agreements to manage the average interest rate reset period on our borrowings that finance non-hybrid ARM assets. We may also use Swap Agreements from time to time to change from one interest rate index to another interest rate index and thus decrease further the basis risk between our interest-yielding assets and the financing of such assets.

In general, 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 entered into interest rate cap agreements (“Cap Agreements”) which have the effect of offsetting a portion of our borrowing costs, thereby reducing the effect of the lifetime cap feature on our ARM assets and protecting the net margin on our ARM assets in high interest rate environments. A Cap Agreement is a contractual agreement for which we pay a fee, which may at times be financed, typically to either a commercial bank or investment banking firm. Pursuant to the terms of the Cap Agreements owned as of December 31, 2002, we will receive cash payments if the applicable index, generally the three- or six-month LIBOR index, increases above certain specified levels, which range from 6.00% to 12.00% and average 10.00%. 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.

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. We do not hedge against the risk of our borrowing costs rising above the periodic interest rate cap level on the ARM assets because the contractual future interest rate adjustments on the ARM assets will cause their interest rates to increase over time and reestablish the ARM assets’ interest rate to a spread over the then current index rate. As of December 31, 2002, $8.6 billion of our ARM securities and ARM loans did not have periodic caps or were hybrid ARM assets, representing 83.5% 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 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. In connection with our use of these instruments, the Commodity Futures Trading Commission has indicated to us that it will not seek enforcement against our directors for failure to register as “Commodity Pool Operators” or against the Manager for failure to register as a “Commodity Trading Adviser.”

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. See “Federal Income Tax Considerations — Requirements for Qualification as a REIT.”

Operating Restrictions

Our Board of Directors has established our operating and investing policies and strategies, and any revisions in such policies and strategies require the approval of the Board of Directors, including a majority of the unaffiliated directors. In general, the Board of Directors has the power to modify or alter such policies without the consent of our shareholders.

We have elected to qualify as a REIT for tax purposes. We have adopted certain compliance guidelines, which include restrictions on our acquisition, holding and sale of assets, thus limiting the investment strategies that we may employ. Substantially all the assets that we have acquired and will acquire for investment are expected to be real estate assets (“Qualified REIT Assets”) as defined by the Internal Revenue Code of 1986, as amended (the “Code”). Our whole loans and our ARM securities and other MBS fall within the definition of Qualified REIT Assets.

We closely monitor our purchases of ARM assets and the income from such assets, including from our hedging strategies, so that we maintain our qualification as a REIT at all times. We developed certain accounting systems and testing procedures

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with the help of qualified accountants and tax experts to facilitate our ongoing compliance with the REIT provisions of the Code. See “Federal Income Tax Considerations — Requirements for Qualification as a REIT.”

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, we must maintain at least 55% of our assets directly in Qualifying Interests as defined in the Code. We closely monitor our compliance with this requirement and we intend to maintain our exempt status. We have been able to maintain our exemption so far through the purchase of whole pool Agency Securities and privately issued ARM securities and loans that qualify for the exemption. See “Portfolio of Mortgage Assets — Pass-Through Certificates — Privately Issued ARM Pass-Through Certificates.”

PORTFOLIO OF MORTGAGE ASSETS

As of December 31, 2002, ARM assets comprised 99.0% of our total assets. We have invested in the following types of ARM assets in accordance with the operating policies established by our Board of Directors and described in “Business — Operating Policies and Strategies — Operating Restrictions.”

Pass-Through Certificates

Our investments in mortgage assets are concentrated in High Quality ARM pass-through certificates, which account for 90.0% of the ARM assets that we hold. These certificates consist of Fannie Mae, Freddie Mac and privately issued ARM pass-through certificates that meet the High Quality credit criteria. See “Business — Operating Policies and Strategies — Investment Strategies.” The High Quality ARM pass-through certificates that we acquire represent interests in ARM loans that are secured primarily by first liens on single-family (one-to-four units) residential properties, although we may also acquire ARM pass-through certificates secured by liens on other types of real estate-related properties. We also include in this category of assets a portion of the ARM and hybrid ARM loans that have been deposited in a trust and held as collateral for our notes payable in the amount equivalent to the “AAA” portion of the debt issued by the trust.

The following is a discussion of each type of pass-through certificate that we held as of December 31, 2002:

Freddie Mac ARM Programs

Freddie Mac is a shareholder-owned, federally chartered enterprise created pursuant to an Act of Congress on July 24, 1970. The principal activity of Freddie Mac consists of the purchase of first lien, conventional residential mortgages, including both whole loans and participation interests in such mortgages and the resale of the loans and participations in the form of guaranteed mortgage assets. Each Freddie Mac ARM Certificate issued to date has been issued in the form of a pass-through certificate representing an undivided interest in a pool of ARM loans purchased by Freddie Mac. The ARM loans included in each pool are fully amortizing, conventional mortgage loans with original terms to maturity of up to 40 years secured by first liens on one-to-four unit family residential properties or multi-family properties. The interest rates paid on Freddie Mac ARM Certificates adjust periodically on the first day of the month following the month in which the interest rates on the underlying mortgage loans adjust.

Freddie Mac guarantees to each holder of its ARM Certificates the timely payment of interest at the applicable pass-through rate and the ultimate collection of all principal on the holder’s pro rata share of the unpaid principal balance of the related ARM loans, but does not guarantee the timely payment of scheduled principal of the underlying mortgage loans. The obligations of Freddie Mac under its guarantees are solely those of Freddie Mac and are not backed by the full faith and credit of the U.S. Government. If Freddie Mac were unable to satisfy such obligations, distributions to holders of Freddie Mac ARM Certificates would consist solely of payments and other recoveries on the underlying mortgage loans and, accordingly, monthly distributions to holders of Freddie Mac ARM Certificates would be affected by delinquent payments and defaults on such mortgage loans.

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Fannie Mae ARM Programs

Fannie Mae is a government sponsored, privately owned corporation organized and existing under the Federal National Mortgage Association Charter Act. Fannie Mae provides funds to the mortgage market primarily by purchasing home mortgage loans from mortgage loan originators, thereby replenishing their funds for additional lending. Fannie Mae established its first ARM programs in 1982 and currently has several ARM programs under which ARM certificates may be issued, including programs for the issuance of assets through REMICS under the Code. Each Fannie Mae ARM Certificate issued to date has been issued in the form of a pass-through certificate representing a fractional undivided interest in a pool of ARM loans formed by Fannie Mae. The ARM loans included in each pool are fully amortizing conventional mortgage loans secured by a first lien on either one-to-four family residential properties or multi-family properties. The original term to maturity of the mortgage loans generally does not exceed 40 years. Fannie Mae has issued several different series of ARM Certificates. Each series bears an initial interest rate and margin tied to an index based on all loans in the related pool, less a fixed percentage representing servicing compensation and Fannie Mae’s guarantee fee.

Fannie Mae guarantees to the registered holder of a Fannie Mae ARM Certificate that it will distribute amounts representing scheduled principal and interest (at the rate provided by the Fannie Mae ARM Certificate) on the mortgage loans in the pool underlying the Fannie Mae ARM Certificate, whether or not received, and the full principal amount of any such mortgage loan foreclosed or otherwise finally liquidated, whether or not the principal amount is actually received. The obligations of Fannie Mae under its guarantees are solely those of Fannie Mae and are not backed by the full faith and credit of the U.S. Government. If Fannie Mae were unable to satisfy such obligations, distributions to holders of Fannie Mae ARM Certificates would consist solely of payments and other recoveries on the underlying mortgage loans and, accordingly, monthly distributions to holders of Fannie Mae ARM Certificates would be affected by delinquent payments and defaults on such mortgage loans.

Privately Issued ARM Pass-Through Certificates

Privately issued ARM pass-through certificates are structured similar to the agency certificates discussed above but are issued by originators of, and investors in, mortgage loans, including us, savings and loan associations, savings banks, commercial banks, mortgage banks, investment banks and special purpose subsidiaries of such institutions. Privately issued ARM pass-through certificates are usually backed by a pool of conventional ARM loans and are generally structured with one or more types of credit enhancement, including pool insurance, guarantees, or subordination. Accordingly, privately issued ARM pass-through certificates typically are not guaranteed by an entity having the credit status of Freddie Mac or Fannie Mae.

Privately issued ARM pass-through certificates that are credit enhanced by mortgage pool insurance provide us with an alternative source of ARM assets (other than agency ARM assets) that meet the Qualifying Interests test for purposes of maintaining our exemption under the Investment Company Act. However, since many providers of mortgage pool insurance have stopped providing such insurance, privately issued ARM pass-through certificates are not commonly available.

Collateralized Mortgage Obligations (“CMOs”), Multi-class Pass-Through Securities and Collateralized Bond Obligations (“CBOs”)

CMOs are debt obligations, ordinarily issued in series and most commonly backed by a pool of fixed rate mortgage loans or pass-through certificates, each of which consists of several serially maturing classes. Multi-class pass-through securities are equity interests in a trust composed of similar underlying mortgage assets. Generally, principal and interest payments received on the underlying mortgage-related assets securing a series of CMOs or multi-class pass-through securities are applied to principal and interest due on one or more classes of the CMOs of such series or to pay scheduled distributions of principal and interest on multi-class pass-throughs.

The CBOs that we have acquired are debt obligations, but are collateralized by security interests in portfolios of High Quality, low duration, mortgage-backed, asset-backed and other fixed and floating rate securities managed by third parties. We only acquire CBOs that have portfolios that consist primarily of High Quality mortgage-backed securities. In a CBO transaction, principal and interest payments are used to pay current period interest and any excess is reinvested into the portfolio. The amount of proceeds at maturity on the CBO classes that we own is generally dependent upon the total rate of return performance of the underlying collateral and can result in a final redemption value that is less than the face value of the investment. CBOs typically do not amortize monthly; rather, they mature on a specific maturity date.

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Scheduled payments of principal and interest on the mortgage-related assets and other collateral securing a series of CMOs, CBOs or multi-class pass-throughs are intended to be sufficient to make timely payments of principal and interest on such issues or securities and to retire each class of such obligations at their stated maturity.

The multi-class pass-through securities that we create or purchase are typically backed by ARM securities or ARM loans, however we also purchase variable rate classes of CMOs and CBOs that are backed by both fixed- and adjustable-rate mortgages that are issued by a U.S. Government agency, federally chartered or government-sponsored enterprises or other private issuers.

Multi-class pass-through securities are usually structured with credit enhancement whereby certain classes are given priority of payment over other classes. Credit enhancement takes the form of internal credit support via allocation of losses to lower rated classes. Accordingly, the higher the rating level, the more likely it is that cash flows from the underlying mortgage loans will be sufficient to meet the scheduled payments of interest and principal on any given class.

The classes of securities we have purchased were all rated at least Investment Grade by one of the Rating Agencies at the time of purchase, and in most cases are High Quality. We do not purchase classes with below Investment Grade ratings. We do own securities rated below Investment Grade that were created as a result of securitizing our loans.

ARM and hybrid ARM Loans

When originating or acquiring ARM and hybrid ARM loans, we focus our attention on all aspects of a borrower’s profile and the characteristics of a mortgage loan product that we believe are most important in insuring excellent loan performance and minimal credit exposure. Our borrowers generally make large down payments and have adequate liquid asset reserves, verified income, job stability and excellent credit (as measured by a credit report and a credit score). In addition, full real estate appraisals are underwritten to ensure the property collateral is well valued, appropriate to the neighborhood and located in a stable market. The ARM and hybrid ARM loans we have acquired are all first mortgages on single-family residential properties. Some have additional collateral in the form of pledged financial assets. Pledged assets are limited to marketable equity securities, investment grade bonds, cash or other approved securities. We acquire loans that are generally underwritten to “A” quality standards. We consider loans to be “A” quality when they are underwritten so as to assure that the borrower has adequate verified income to make the required loan payment, adequate verified equity in the underlying property, adequate liquid asset reserves, job stability and is willing and able to repay the mortgage as demonstrated by an excellent credit history. As a result, the loans we acquire are generally fully documented loans, generally with 80% or lower effective loan-to-value ratios based on independently appraised property values, or are seasoned loans with good payment history. The average original effective loan-to-value ratio of our loans averaged 66.7% as of December 31, 2002.

If an ARM or hybrid ARM loan acquired has a loan-to-value ratio above 80%, we require the borrower to pay for private mortgage insurance or acquire additional collateral, providing additional protection to us against credit risk. We only acquire loans with original maturities of forty years or less. The ARM and hybrid ARM loans are either fully amortizing or are interest only, generally up to ten years, and fully amortizing thereafter. All ARM loans we acquire bear an interest rate tied to an interest rate index. Some loans have periodic and lifetime constraints on how much the loan interest rate can change on any predetermined interest rate reset date. In general, the interest rate on each ARM loan resets at a frequency that is either monthly, semi-annual or annual. The ARM loans generally adjust based upon the following indices: a U.S. Treasury Bill index, a LIBOR index, a Certificate of Deposit index, a Cost of Funds index or Prime Rate index. The hybrid ARM loans have an initial fixed rate period, generally 3 to 10 years, and then convert to an ARM loan with the features of an ARM loan described above.

RISK FACTORS

FORWARD-LOOKING STATEMENTS

In accordance with the Private Securities Litigation Reform Act of 1995 (the “1995 Act”), we can 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 in the forward-looking statements. Statements that are not historical facts, including statements about our beliefs or expectations, are forward-looking statements. The words “believe,” “anticipate,” “intend,” “aim,” “expect,” “will,” and similar words identify forward-looking statements. Such

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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. Readers should understand that many factors govern whether any forward-looking statement will be or can be achieved. Any one of those factors could cause actual results to differ materially from those projected.

We actively manage the risks associated with our business. Interest rate risks, credit risks, earnings volatility, REIT qualification risks and other risks are monitored, measured and quantified by management in order to assure minimal earnings and dividend fluctuations. However, investors should understand the nature of the risks that we face. Those key risks are discussed below. If we fail to manage these risks, our actual results could differ from our expectations.

ARM yields change as short term interest rates change.

	•		In low short term interest rate environments, the yields on our ARM assets will be low, reducing return on equity.
	•		We own ARM assets tied to various interest rate indices. If the interest rate indices applicable to our ARM assets change independently of other market interest rates, our ARM yields, spreads and earnings may be adversely affected.
	•		We own ARM assets with various repricing, or interest rate adjustment frequencies. The yields on these assets may also respond to changes in their underlying indices on a delayed basis due to borrower notification requirements. As a result, our yields and earnings on these assets could be temporarily below longer term expectations.
	•		Increases in interest rates may result in a decline in the fair value of our ARM assets. A decrease in the fair value of our ARM assets will result in a reduction of our book value due to the accounting rules that we follow.

We borrow money to fund the purchase of additional ARM assets. A significant contributor to our earnings is the interest margin between the yield on our ARM assets and the cost of our borrowings.

	•		All of the risks highlighted above could be magnified because we use borrowed funds to acquire additional ARM assets for our portfolio.
	•		Our ability to borrow and our cost of borrowing could be adversely affected by deterioration in the quality or fair value of our ARM assets or by general availability of credit in the mortgage market.
	•		We borrow funds based on the fair value of our ARM assets less a margin amount. If either the fair value of our ARM assets declines, or our margin requirements increase, we could be subject to margin calls that would require us to either pledge additional ARM assets as collateral or reduce our borrowings. If we did not have sufficient unpledged assets or liquidity to meet these requirements, we may need to sell assets under adverse market conditions to satisfy our lenders.
	•		Our borrowings are tied primarily to the LIBOR interest rates, while our assets are indexed to LIBOR and other various interest rate indices. If these other short-term indices move differently than LIBOR, our earnings could be adversely affected to the extent of the difference.
	•		The interest rate adjustment or repricing characteristics of our ARM assets and borrowings may not be perfectly matched. Rising interest rates could adversely affect our earnings and dividends if the interest payments that we must make on our borrowings rise faster than the interest payments we earn on our ARM assets. Declining interest rates could adversely affect our earnings and dividends if the interest payments we receive on our ARM assets decline more quickly than the interest payments that we must make on our borrowings. In general, our borrowings adjust more frequently than the interest rates on our ARM assets.
	•		Some of our ARM assets have caps that limit the amount that the interest rate can change for a given change in an underlying index. Our borrowings do not have similar limitations. If the interest rate change on our ARM assets is limited while the interest rates on our borrowings increase, our portfolio margins and earnings may be adversely affected.
	•		We employ various hedging and funding strategies to minimize the adverse impact that changing interest rates might have on our earnings, but our strategies may prove to be less effective in practice than we anticipate, or our ability to use such strategies may be limited due to our need to comply with federal income tax requirements that are necessary to preserve our REIT status.

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•

The fair value of the hedging instruments that we use to manage our interest rate risk may decline during periods of declining interest rates, adversely affecting our book value because of the accounting rules that we follow.

Our mortgage assets may be prepaid at any time at the borrower’s option.

	•		Mortgage prepayment rates typically rise during falling interest rate environments. If mortgages prepay, the prepayment proceeds may be invested in lower yielding assets, thus reducing earnings.
	•		Mortgage prepayment rates typically fall during rising interest rate environments. If mortgages do not prepay, we would have less cash flow to use to purchase new mortgage assets in a higher interest rate environment, potentially adversely affecting earnings.
	•		We purchase and originate ARM assets at prices greater than par. We amortize the premiums over the expected life of the ARM asset. To the extent that we have purchased such assets, our yields, spreads and earnings could be adversely affected if mortgage prepayment rates are greater than anticipated at the time of acquisition because we would have to amortize the premiums at a faster rate.

We acquire hybrid ARMs that have fixed interest rate periods.

	•		A decline in interest rates may result in an increase in prepayment of our hybrid ARMs, which could cause the amount of our fixed rate financing to increase relative to the total amount of our hybrid ARM assets. This may result in a decline in our net spread on hybrid ARM assets as replacement hybrid ARM assets may have a lower yield than the assets that are paying off.
	•		An increase in interest rates may result in a decline in prepayment of our hybrid ARMs, requiring us to finance a greater amount of hybrid ARM assets than originally anticipated at a time when interest rates may be higher, which would result in a decline in our net spread on hybrid ARM assets.
	•		We typically do not borrow fixed rate funds to cover the last year of the fixed rate period of our hybrid ARMs because, at that point, the next repricing period is within one year which is consistent with our investment policy of investing in ARM assets that reprice within one year or less. As a result, higher short term interest rate borrowings that we acquire to finance the remaining year of the fixed rate period of our hybrid ARMs could adversely affect our portfolio margins and earnings due to a reduced net interest margin.

We originate and acquire ARM loans and ARM securities and have risk of loss due to mortgage loan defaults.

	•		The ability of our borrowers to make timely principal and interest payments could be adversely affected by a rise in interest rates, a recession, declining real estate property values or other economic events, resulting in losses to us.
	•		If a borrower defaults on a mortgage loan that we own and if the liquidation proceeds from the sale of the property do not cover our loan amount and our legal, broker and selling costs, we would experience a loss.
	•		We bear the risk of loss on loans we have originated or acquired due to hazard losses such as earthquakes, floods, fires or similar hazards, unless the homeowner had insurance for such hazards.
	•		We could experience losses if we fail to detect that a borrower has misrepresented its financial situation, or that an appraisal misrepresented the value of the property collateralizing our loan.
	•		We purchase ARM securities that have various degrees of third-party credit protection and are rated at least Investment Grade at the time of purchase. It is possible that default and loan loss experience on the underlying securitized loans could exceed any credit enhancement, subjecting us to risk of loss.

Our expansion into mortgage loan origination may not be successful.

	•		We rely on third party providers who specialize in the underwriting processing, servicing and closing of mortgage loans. We are dependent upon the availability and quality of the performance of such providers and we cannot guarantee that they will successfully perform the services for which we engage them.
	•		As a mortgage lender we are subject to changes in consumer and real estate related laws and regulations that could subject us to lawsuits or adversely affect our profitability or ability to remain competitive.

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	•		We are competing for mortgage loans against much larger, better-known mortgage originators that could affect our ability to acquire or originate ARM assets at attractive yields and spreads.
	•		ARM assets may not always be readily available for purchase or origination in the marketplace at attractive yields because their availability is somewhat dependent on the relationship between 30 year fixed rate mortgage rates and ARM mortgage rates.

Our REIT tax status creates certain risks.

	•		The requirements to qualify for REIT tax status are complex and technical, and we may not be able to qualify for reasons beyond our control. Even though we currently exceed all of the requirements for qualifying, a failure to qualify could subject our earnings to taxation at regular corporate rates, thereby reducing the amount of money available for distributions to our shareholders.
	•		The REIT tax rules require that we distribute the majority of our earnings as dividends, leaving us limited ability to maintain our future dividend payments if our earnings decline.
	•		Because we must distribute the majority of our earnings to shareholders in the form of dividends, we have a limited amount of capital available to internally fund our growth.
	•		Additionally, because we cannot retain earnings to grow, we must issue additional shares of stock to grow, which could result in the dilution of our outstanding stock and an accompanying decrease in its market price.
	•		Changes in tax laws related to REIT qualifications or taxation of dividends could adversely affect us. On January 7, 2003, the Bush Administration released a tax proposal intended to eliminate one level of the federal “double taxation” that is currently imposed on corporate income for regular C corporations. The Bush Administration’s proposal, if enacted, could decrease the investment attraction of a REIT relative to that of a regular C corporation. It is not possible to predict whether the proposal will be ultimately enacted, the form that it might take, and, if enacted, the effects it may have on the value of our common stock.

The price of our common stock or preferred stock could be adversely affected due to changes in investor perception or preference for income-producing investments, or due to poor performance by other financial services companies, REIT in general, mortgage REIT or other similar companies.

The loss of the Investment Company Act exemption could adversely affect us.

•

We conduct our business so as not to become regulated as an investment company under the Investment Company Act. If we were to become regulated as an investment company, we would not be able to operate as we currently do.

We are dependent on certain key personnel.

•

The loss of the services of certain officers and key employees could have an adverse effect on our operations.

Some of our directors and officers have ownership interests in the Manager, which may create conflicts of interest.

•

The Manager is entitled to receive performance-based compensation based on our annualized net income. Undue emphasis placed on maximization of our short-term income at the expense of other criteria could result in increased risk to our long-term earnings.

We may change our policies without shareholder approval.

•

Our Board of Directors establishes all of our operating policies, including our investment, financing and dividend policies. The Board of Directors has the ability and authority to revise or amend those policies without shareholder approval.

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COMPETITION

In acquiring ARM assets, we compete with other mortgage REITs, investment banking firms, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, lenders, Fannie Mae, Freddie Mac and other entities purchasing ARM assets, many of which have greater financial resources than we do. The existence of such entities may increase the competition for the acquisition of ARM assets resulting in higher prices and lower yields on such mortgage assets.

EMPLOYEES

As of December 31, 2002, we had no employees. Rather, the Manager provides our management and employees, subject to the supervision of our Board of Directors and under the terms of the Management Agreement discussed below.

The Management Agreement

We entered into the Management Agreement with the Manager for a ten-year term, with an annual review required. If we terminate the Management Agreement other than for cause, we must pay the Manager a minimum fee. The Management Agreement also provides that in the event a person or entity obtains more than 20% of our common stock, we are combined with another entity, or we terminate the Management Agreement other than for cause, we are obligated to acquire substantially all of the Manager’s assets through an exchange of shares with a value based on a formula tied to the Manager’s net profits. We have the right to terminate the Management Agreement upon the occurrence of certain specific events, including a material breach by the Manager of any provision contained in the Management Agreement.

The Manager at all times is subject to the supervision of our Board of Directors and has only such functions and authority as we may delegate to it. The Manager is responsible for our operations and performs all such services and activities relating to the management of our assets and operations. In addition, our wholly owned subsidiaries have entered into separate management agreements with the Manager for additional management services.

The Manager receives an annual base management fee based on average shareholders’ equity, adjusted for liabilities that are not incurred to finance assets (“Average Shareholders’ Equity” or “Average Net Invested Assets” as defined in the Management Agreement), payable monthly in arrears. The base management fee formula is subject to an annual increase based on any increase in the Consumer Price Index over the previous twelve-month period. The Manager is also entitled to receive as incentive compensation for each fiscal quarter an amount equal to 20% of our Net Income (as defined in the Management Agreement), before incentive compensation, in excess of the amount that would produce an annualized return on equity equal to 1% over the Ten Year U.S. Treasury Rate. The Management Agreement also requires us to reimburse the Manager for expenses it incurs related to acquiring, securitizing, selling, hedging, and servicing our portfolio of ARM loans. For further information regarding the base management fee, incentive compensation reimbursable expenses and applicable definitions, see our Proxy Statement dated March 20, 2003 under the caption “Certain Relationships and Related Transactions.”

Subject to the limitations set forth below, we pay all our operating expenses except those that the Manager is specifically required to pay under the Management Agreement. The operating expenses that the Manager is required to pay include the compensation of personnel who are performing management services for the Manager and the cost of office space, equipment and other personnel required for the management of our day-to-day operations. The expenses that we are required to pay include costs incident to the acquisition, disposition, securitization and financing of mortgage loans, the compensation and expenses of operating personnel, marketing expenses, regular legal and auditing fees and expenses, the fees and expenses of our directors, the costs of printing and mailing proxies and reports to shareholders, the fees and expenses of our custodian and transfer agent, if any, and the reimbursement of any obligation of the Manager for any New Mexico Gross Receipts Tax liability. The expenses we are required to pay, which are attributable to our operations, are limited to an amount per year equal to the greater of 2% of our Average Net Invested Assets or 25% of our Net Income for that year. The determination of Net Income for purposes of calculating the expense limitation is the same as for calculating the Manager’s incentive compensation except that it includes any incentive compensation payable for such period. The Manager must pay expenses in excess of such amount, unless the unaffiliated directors determine that, based upon unusual or non-recurring factors, a higher level of expenses is justified for such fiscal year. In that event, the Manager may recover such expenses in succeeding years to the extent that expenses in succeeding quarters are below the limitation of expenses. We are also required to pay expenses

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associated with litigation and other extraordinary or non-recurring expenses. Expense reimbursement is made monthly, subject to adjustment at the end of each year.

Expenses excluded from the expense limitation are those incurred in connection with the servicing of mortgage loans, the raising of capital, the acquisition and disposition of assets, interest expenses, taxes and license fees, non-cash costs and the incentive management fee.

FEDERAL INCOME TAX CONSIDERATIONS

General

We have elected to be treated as a REIT for federal income tax purposes. In brief, if we meet certain detailed conditions imposed by the REIT provisions of the Code, such as investing primarily in real estate and mortgage loans, we will not be taxed at the corporate level on the taxable income that we currently distribute to our shareholders. We can therefore avoid most of the “double taxation” (at the corporate level and then again at the shareholder level when the income is distributed) that we would otherwise experience if we were a corporation.

If we do not qualify as a REIT in any given year, we would be subject to federal income tax as a domestic corporation, which would reduce the amount of the after-tax cash available for distribution to our shareholders. We believe that we have satisfied the requirements for qualification as a REIT since the year ended 1993. We intend at all times to continue to comply with the requirements for qualification as a REIT under the Code, as described below.

Requirements for Qualification as a REIT

To qualify for tax treatment as a REIT under the Code, we must meet certain tests, as described briefly below.

Ownership of Common Stock

For all taxable years after the first taxable year for which we elected to be a REIT, a minimum of 100 persons must hold our shares of capital stock for at least 335 days of a 12-month year (or a proportionate part of a short tax year). In addition, at all times during the second half of each taxable year, no more than 50% in value of our capital stock may be owned directly or indirectly by five or fewer individuals. We are required to maintain records regarding the ownership of our shares and to demand statements from persons who own more than a certain number of our shares regarding their ownership of shares. We must keep a list of those shareholders who fail to reply to such a demand.

We are required to use the calendar year as our taxable year for income tax purposes.

Nature of Assets

On the last day of each calendar quarter, at least 75% of the value of our assets must consist of Qualified REIT Assets, government assets, cash and cash items. We expect that substantially all of our assets will continue to be Qualified REIT Assets. On the last day of each calendar quarter, of the assets not included in the foregoing 75% assets test, the value of securities that we hold issued by any one issuer may not exceed 5% in value of our total assets and we may not own more than 10% of any one issuer’s outstanding securities (with an exception for a qualified electing taxable REIT subsidiary or a qualified REIT subsidiary). Under that exception, the aggregate value of business that we may undertake through taxable subsidiaries is limited to 20% or less of our total assets. We monitor the purchase and holding of our assets in order to comply with the above asset tests.

We may from time to time hold, through one or more taxable REIT subsidiaries, assets that, if we held directly, could otherwise generate income that would have an adverse effect on our qualification as a REIT or on certain classes of our shareholders. We do not reasonably expect that the value of such taxable subsidiaries, in the aggregate, will ever exceed 20% of our assets.

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Sources of Income

We must meet the following separate income-based tests each year:

     1.     The 75% Test. At least 75% of our gross income for the taxable year must be derived from Qualified REIT Assets including interest (other than interest based in whole or in part on the income or profits of any person) on obligations secured by mortgages on real property or interests in real property. The investments that we have made and will continue to make will give rise primarily to mortgage interest qualifying under the 75% income test.

     2.     The 95% Test. In addition to deriving 75% of our gross income from the sources listed above, at least an additional 20% of our gross income for the taxable year must be derived from those sources, or from dividends, interest or gains from the sale or disposition of stock or other assets that are not dealer property. We intend to limit substantially all of the assets that we acquire (other than stock in certain affiliate corporations as discussed below) to Qualified REIT Assets. Our policy to maintain REIT status may limit the type of assets, including hedging contracts and other assets, that we otherwise might acquire.

Distributions

We must distribute to our shareholders on a pro rata basis each year an amount equal to at least (i) 90% of our taxable income before deduction of dividends paid and excluding net capital gain, plus (ii) 90% of the excess of the net income from foreclosure property over the tax imposed on such income by the Code, less (iii) any “excess noncash income”. We intend to make distributions to our shareholders in sufficient amounts to meet the distribution requirement.

The Service has ruled that if a REIT’s dividend reinvestment plan allows shareholders of the REIT to elect to have cash distributions reinvested in shares of the REIT at a purchase price equal to at least 95% of fair market value on the distribution date, then such cash distributions qualify under the 95% distribution test. We believe that our DRP complies with this ruling.

Taxation of Shareholders

For any taxable year in which we are treated as a REIT for federal income purposes, the amounts that we distribute to our shareholders out of current or accumulated earnings and profits will be includable by the shareholders as ordinary income for federal income tax purposes unless properly designated by us as capital gain dividends. Our distributions will not be eligible for the dividends received deduction for corporations. Shareholders may not deduct any of our net operating losses or capital losses.

If we make distributions to our shareholders in excess of our current and accumulated earnings and profits, those distributions will be considered first a tax-free return of capital, reducing the tax basis of a shareholder’s shares until the tax basis is zero. Such distributions in excess of the tax basis will be taxable as gain realized from the sale of our shares. We will withhold 30% of dividend distributions to shareholders that we know to be foreign persons unless the shareholder provides us with a properly completed Service form for claiming the reduced withholding rate under an applicable income tax treaty.

The provisions of the Code are highly technical and complex. This summary is not intended to be a detailed discussion of the Code or its rules and regulations, or of related administrative and judicial interpretations. We have not obtained a ruling from the Service with respect to tax considerations relevant to our organization or operation, or to an acquisition of our common stock. This summary is not intended to be a substitute for prudent tax planning and each of our shareholders is urged to consult his or her own tax advisor with respect to these and other federal, state and local tax consequences of the acquisition, ownership and disposition of shares of our stock and any potential changes in applicable law.

Taxation of the Company

We are subject to corporate level taxation on any undistributed income. In addition, we face corporate level taxation due to any failure to make timely distributions, on the built-in gain on assets acquired from a taxable corporation such as a taxable REIT subsidiary, on the income from any property that we take in foreclosure and on which we make a foreclosure property election, and on the gain from any property that is treated as “dealer property” in our hands.

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Item 2. PROPERTIES

Our principal executive offices are located in Santa Fe, New Mexico and are provided by the Manager in accordance with the Management Agreement. Our subsidiaries have their principal offices in Santa Fe, New Mexico and are leased from the Manager.

Item 3. LEGAL PROCEEDINGS

At December 31, 2002, there were no pending legal proceedings to which we were a party or to which any of our property was subject.

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

No matters were submitted to a vote of our shareholders during the fourth quarter of 2002.

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PART II

Item 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

Our common stock is traded on the New York Stock Exchange under the trading symbol “TMA”. As of February 25, 2003, we had 56,936,385 shares of common stock outstanding, held by 2,999 holders of record and approximately 55,904 beneficial owners.

The following table sets forth, for the periods indicated, the high, low and closing sales prices per share of our common stock as reported on the New York Stock Exchange composite tape and the cash dividends declared per share of common stock.

In order to qualify for the tax benefits accorded to a REIT under the Code, we intend to pay quarterly dividends such that all or substantially all of our taxable income each year (subject to certain adjustments) is distributed to our shareholders. All of the distributions that we make will be at the discretion of our Board of Directors and will depend on our earnings and financial condition, maintenance of REIT status and any other factors that the Board of Directors deems relevant.

Dividend Reinvestment Plan

We have a Dividend Reinvestment and Stock Purchase Plan (the “DRP”) that allows both common and preferred shareholders to reinvest their dividends in, and to purchase, additional shares of our common stock. At our discretion, shareholders may purchase common stock under the DRP directly from us at a discount from the then prevailing market price or in the open market. Shareholders and non-shareholders may also make additional monthly purchases of stock, subject to a minimum of $100 ($500 for non-shareholders) and a maximum of $10 thousand for each optional cash purchase. American Stock Transfer & Trust Company, our transfer agent (the “Agent”), is the trustee and administrator of the DRP. Shareholders who own stock that is registered in their own name and want to participate in the DRP must deliver a completed enrollment form to the Agent. Shareholders who own stock that is registered in a name other than their own (e.g., broker or bank nominee) and want to participate in the DRP must either request the broker or nominee to participate on their behalf or request that the broker or nominee re-register the stock in the shareholder’s name and deliver a completed enrollment form to the Agent. Additional information about the DRP (including a prospectus) and forms are available from the Agent or us. It is also available on our website.

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Item 6. SELECTED FINANCIAL DATA

The following selected financial data is derived from our audited financial statements for the years ended December 31, 2002, 2001, 2000, 1999, and 1998. You should read the selected financial data together with the more detailed information contained in the Financial Statements and associated Notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10-K (dollars in thousands, except per share data).

Operations Statement Highlights

Balance Sheet Highlights

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(3)		Shareholders’ equity before unrealized market value adjustments and excluding $65,805 of preferred stock, divided by common shares outstanding.
(4)		Shareholders’ equity after unrealized market value adjustments and excluding preferred stock, divided by common shares outstanding.

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 Securities and Exchange Commission 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 ARM securities, Cap Agreements, Swap Agreements and Eurodollar Transactions at fair value. The fair values of our ARM securities, 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 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 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.
•		Basis Adjustments on ARM Securities. In general, we securitize all of our loans and retain the resulting securities in our ARM 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 in the future and we adjust the basis of the securities to their expected realizable value. This is referred to as a “basis adjustment.” In doing so, 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 securitization. Therefore, we monitor the delinquencies and losses on the underlying mortgage loans backing our ARM securities. If the credit performance of the underlying mortgage loans is not as expected, we make a provision for additional probable credit losses at a level deemed appropriate by management to provide for known losses as well as estimated losses inherent in our ARM securities portfolio. Any such provision is based on management’s assessment of numerous factors affecting our portfolio of ARM assets including, but not limited to, current economic conditions, delinquency status, credit losses to date on underlying mortgages and remaining credit protection. The basis adjustment for ARM securities is made by reducing the cost basis of the individual security for the decline in fair value, which is other than temporary, and the amount of such write-down is recorded as a realized loss, thereby reducing earnings.
•		Loan Securitization. We do not sell any of the securities created when we securitize loans for our ARM securities portfolio, but rather retain the beneficial and economic interests of the loans. The securitizations of our loans are not accounted for as sales and we do not record any servicing assets or liabilities as a result of this process.
•		Revenue Recognition. Interest income on ARM assets is a combination of accruing interest based on the outstanding balance and contractual terms of the assets and the amortization of yield adjustments using generally accepted interest methods, principally the amortization of purchase premiums and discounts. Premiums and discounts associated with the purchase of ARM assets are amortized into interest income over the lives of the assets using the effective yield method adjusted for the effects of estimated prepayments. Estimating prepayments and estimating the remaining lives of our ARM assets requires management judgment, which involves consideration of possible future interest rate environments and an estimate of how borrowers will behave in those environments. The actual lives could be more or less than the amount estimated by management at the time of purchase of the ARMs.

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

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Financial Condition

At December 31, 2002, we held total assets of $10.5 billion, $10.3 billion of which consisted of ARM assets. That compares to $5.8 billion in total assets and $5.7 billion of ARM assets at December 31, 2001. Since commencing operations, we have purchased either ARM securities (backed by Agency Securities or privately-issued, generally publicly registered, mortgage assets, most of which are rated AA or higher by at least one of the Rating Agencies) or ARM loans generally originated to “A” quality underwriting standards. At December 31, 2002, 92.0% of the assets we held, including cash and cash equivalents, were High Quality assets, far exceeding our investment policy minimum requirement of investing at least 70% of our total assets in High Quality ARM assets and cash and cash equivalents. Of the ARM assets that we owned as of December 31, 2002, 97.8% are in the form of adjustable-rate pass-through certificates or ARM loans. The remainder is floating rate classes of CMOs (0.4%) or investments in floating rate classes of CBOs (1.8%) backed primarily by ARM mortgaged-backed securities.

The following table presents a schedule of ARM assets owned at December 31, 2002 and December 31, 2001 classified by High Quality and Other Investment assets and further classified by type of issuer and by ratings categories.

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

As of December 31, 2002 and 2001, we had reduced the carrying value of our securitized ARM loans by $13.8 million and $7.9 million, respectively, due to estimated credit losses (other than temporary declines in fair value). In addition, we had reduced the cost basis of other ARM securities by $858.8 thousand and $1.2 million, as of the same dates, respectively, related to Other Investments that we purchased at a discount that included an estimate of credit losses.

As of December 31, 2002, 8 of the 9,421 loans in our ARM loan portfolio were considered seriously delinquent (60 days or more delinquent) and had an aggregate balance of $3.4 million. At that date, the ARM loan portfolio also included two real

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estate-owned properties that we acquired as the result of foreclosure processes in the amount of $391.4 thousand. The average original effective loan-to-value ratio on the delinquent loans and the acquired properties was 63.6%. We believe that our current level of basis adjustments and allowance for loan losses is adequate to cover estimated losses from these loans and properties.

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

The following table classifies our portfolio of ARM and short-term mortgage assets by type of interest rate index.

ARM and Short-term Mortgage Assets by Index
(Dollar amounts in thousands)

The ARM portfolio had a current weighted average coupon of 4.99% at December 31, 2002. This consisted of an average coupon of 5.23% on the hybrid portion of the portfolio and an average coupon of 4.27% on the rest of the portfolio. If the portfolio had been “fully indexed,” the weighted average coupon of the portfolio would have been 4.82%, based upon the current composition of the portfolio and the applicable indices. Additionally, if the non-hybrid portion of the portfolio had been “fully indexed,” the weighted average coupon of that portion of the portfolio would have been 3.61%, 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 currently equal to its applicable index plus a margin to the index that is specified by the terms of the ARM asset. The average interest rate on the ARM portion of the portfolio is expected to decrease during 2003 until it reaches the “fully indexed” rate.

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As of December 31, 2001, the ARM portfolio had a weighted average coupon of 5.96%. This consisted of an average coupon of 6.26% on the hybrid portion of the portfolio and an average coupon of 5.71% on the rest of the portfolio. If the non-hybrid portion of the portfolio had been “fully indexed,” the weighted average coupon of the ARM portfolio would have been 5.16%, based upon the composition of the portfolio and the applicable indices at that time.

At December 31, 2002, the current yield of the ARM assets portfolio was 4.63%, compared to 5.09% as of December 31, 2001. The decrease in the yield of 0.46% as of December 31, 2002, compared to December 31, 2001, is due to the decreased weighted average interest rate coupon discussed above, which decreased by 0.97%. This decline in the average interest rate coupon was partially offset by a lower level of net premium amortization, which had the effect of increasing the yield by 0.38%. Additionally, the relative level of non-interest earning principal payment receivables also increased the portfolio yield by 0.13%. The current yield includes the impact of the amortization of applicable premiums and discounts and the impact of principal payment receivables.

The ARM portfolio had an average term to the next repricing date of 2.8 years as of December 31, 2002, compared to 1.7 years as of December 31, 2001. The non-hybrid portion of the portfolio had an average term to the next repricing date of 72 days and the hybrid portion had an average term to the next repricing date of 3.9 years at December 31, 2002. As of December 31, 2002, the hybrid ARM portfolio comprised 72.3% of the total ARM portfolio, compared to 41.7% as of the end of 2001. We attempt to mitigate our interest rate risk by funding our ARM assets with borrowings with maturities approximately matching the interest rate adjustment periods on our ARM assets. Therefore, some of our borrowings bear variable or short term (one year or less) fixed interest rates because a portion of our ARM assets have interest rates that adjust within one year. However, we finance our hybrid ARM portfolio with borrowings hedged with Swap Agreements and Eurodollar Transactions that fix the interest rate on the borrowings such that the duration difference of the fixed interest rate period of the hybrid ARM portfolio and the associated fixed-rate liabilities is one year or less. Duration is a calculation that measures the expected price volatility of financial instruments based on changes in interest rates. By maintaining a duration difference of less than one year, the price change of our hybrid ARM portfolio is expected to be a maximum of 1% for a 1% parallel shift in interest rates, net of the fair value change of our Swap Agreements and other borrowings funding our hybrid ARM portfolio. A lower duration indicates a lower expected volatility of earnings given future changes in interest rates. As of December 31, 2002, the duration difference applicable to our hybrid ARM portfolio was approximately 3 months.

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The following table presents various characteristics of our ARM and hybrid ARM loan portfolio as of December 31, 2002. This information pertains to loans held for securitization, loans held as collateral for the notes payable and loans securitized for our own portfolio for which we retained credit loss exposure. The combined amount of the loans included in this information is $3.7 billion.

ARM and Hybrid ARM Loan Portfolio Characteristics

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	(2)		The average effective original loan-to-value on interest only loans is 70.3%.
	(3)		FICO is a credit score based upon the credit evaluation methodology developed by Fair, Isaac and Company, a consulting firm specializing in creating credit evaluation models.
	(4)		All loans with an effective original loan-to-value ratio over 80% have mortgage insurance.

As of December 31, 2002, we serviced $2.0 billion of our loans and had 4,778 customer relationships. We hold all of the loans that we service in our portfolio in the form of ARM securities or loans to be securitized for our portfolio. We have not capitalized any servicing rights.

During the year ended December 31, 2002, we purchased $6.6 billion of ARM securities, 100.0% of which were High Quality assets and $2.8 billion of ARM loans, generally originated to “A” quality underwriting standards. Of the ARM assets acquired during 2002, 79.7% were hybrid ARM assets, 4.9% were fixed-rate, short-term securities and 15.3% were indexed to LIBOR. The following table compares our ARM asset acquisition and origination activity for each of the consecutive quarters of 2002, along with total activity for 2002:

ARM Asset Acquisitions by Quarter
(Dollar amounts in thousands)

Since 1997, we have emphasized purchasing High Quality ARM and hybrid ARM assets, 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) paid for ARM assets acquired in 2002 and 2001 was 0.86% and 0.12%, of par, respectively, as compared to 3.29% of par in 1997 when we emphasized the purchase of seasoned ARM assets. In part, as a result of this strategy, the book price of our ARM assets, excluding unrealized gains and losses, was 101.01% of par as of December 31, 2002, down from 102.77% of par as of the end of 1997.

During 2002, we securitized $2.3 billion of our ARM loans into a series of privately issued multi-class ARM securities, all of which we retained for our ARM portfolio. We securitize the ARM loans that we acquire into ARM securities for our own portfolio in order to reduce the cost of financing the portfolio and in order to enhance the high quality and highly liquid characteristics of our portfolio, thereby improving our access to financing. In doing so, we retain the economic interest and risk of the loans. Of the loans that we securitized during 2002, 99.7% were at least Investment Grade securities and 0.3% were subordinate securities that provide credit support to the Investment Grade securities.

As of December 31, 2002, we had commitments to purchase $22.2 million of ARM securities, $261.6 million of ARM loans through wholesale channels and $728.7 million of ARM loans through origination channels.

For the quarter ended December 31, 2002, our mortgage assets paid down at an approximate average annualized Constant Paydown Rate (“CPR”) of 37%, compared to 29% for the quarter ended December 31, 2001 and 30% for the quarter ended September 30, 2002. The constant prepayment rate averaged approximately 32% during the full year of 2002 compared to 27% during 2001. When prepayment experience increases, we have to amortize our premiums over a shorter time period,

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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 and 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 negative adjustment of $5.3 million as of December 31, 2001, to a positive adjustment of $44.7 million as of December 31, 2002. All of our ARM securities are classified as available-for-sale and are carried at their fair value. This price improvement was primarily due to the effect of declining medium to long-term interest rates on the fair value of our hybrid ARM assets.

Our ARM assets generally have a maximum lifetime interest rate cap or ceiling, meaning that each ARM asset contains a contractual maximum interest rate. Since our borrowings are not subject to equivalent interest rate caps, we have entered into Cap Agreements which have the effect of offsetting a portion of our borrowing costs, thereby reducing the effect of the lifetime cap feature on our ARM assets and protecting the net margin on our ARM assets in high interest rate environments. As of December 31, 2002, our ARM assets had an average lifetime interest rate cap of 11.64%, far exceeding the current level of interest rates. At December 31, 2002, our Cap Agreements had a remaining notional balance of $1.8 billion with an average final maturity of 1.0 year, compared to a remaining notional balance of $2.3 billion with an average final maturity of 1.5 years at December 31, 2001. At December 31, 2002, the fair value of our Cap Agreements was $84.7 thousand compared to a fair value of $430.5 thousand as of December 31, 2001. Pursuant to the terms of the Cap Agreements, we will receive cash payments if the one month or three month LIBOR indices increase above certain specified levels, which range from 6.00% to 12.00% and average 10.00%. Due to the current low level of interest rates, we have decided not to purchase additional Cap Agreements at this time.

The following table presents information about our Cap Agreement portfolio as of December 31, 2002:

Cap Agreement Contracts Stratified by Strike Price
(Dollar amounts in thousands)