ANTHRACITE CAPITAL INC - 10-K Annual Report

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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

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

For the transition period from: ________ to ________

Commission File No. 001-13937

ANTHRACITE CAPITAL, INC.
(Exact name of Registrant as specified in its charter)

MARYLAND 13-3978906
------------------------------------- ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

40 East 52nd Street
New York, New York 10022
- ---------------------------------------- -----------------------
(Address of principal executive office) (Zip Code)

(212) 409-3333
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(g) of the Act: Not Applicable
Securities registered pursuant to Section 12(b) of the Act:

COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE
(Title of each class) (Name of each exchange on which registered)

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
of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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. |X|

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |X| No |_|

The aggregate market value of the registrant's Common Stock, $.001 par value,
held by non-affiliates of the registrant, computed by reference to the closing
sale price of $13.25 as reported on the New York Stock Exchange on June 28,
2002, was $602,514,269 (for purposes of this calculation affiliates include
only directors and executive officers of the registrant).

The number of shares of the registrant's Common Stock, $.001 par value,
outstanding as of March 21, 2003 was 47,681,985 shares.

Documents Incorporated by Reference: The registrant's Definitive Proxy
Statement for the 2003 Annual Meeting of Stockholders is incorporated by
reference into Part III.

2

ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS

3

Cautionary Statement Regarding Forward-Looking Statements

Certain statements contained herein are not, and certain statements contained
in future filings by Anthracite Capital, Inc. (the "Company") with the
Securities and Exchange Commission (the "SEC") in the Company's press releases
or in the Company's other public or stockholder communications may not be,
based on historical facts and are "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements which are based on various assumptions (some of
which are beyond the Company's control) may be identified by reference to a
future period or periods, or by the use of forward-looking terminology, such
as "believe," "expect," "anticipate," "intend," "estimate," "position,"
"target," "mission," "assume," "achievable," "potential," "strategy," "goal,"
"objective," "plan," "aspiration," "outlook," "outcome," "continue," "remain,"
"maintain," "strive," "trend," and variations of such words and similar
expressions, or future or conditional verbs such as "will," "would," "should,"
"could," "may," or similar terms or variations on those terms, or the negative
of those terms.

Actual results could differ materially from those set forth in forward-looking
statements and future results could differ materially from historical
performance due to a variety of factors, including, but not limited to: (1)
the introduction, withdrawal, success and timing of business initiatives and
strategies; (2) changes in political, economic or industry conditions, the
interest rate environment or financial and capital markets, which could result
in deterioration in credit performance; (3) the performance and operations of
the Manager; (4) the impact of increased competition; (5) the impact of
capital improvement projects; (6) the impact of future acquisitions; (7) the
unfavorable resolution of legal proceedings; (8) the extent and timing of any
share repurchases; (9) the impact, extent and timing of technological changes
and the adequacy of intellectual property protection; (10) the impact of
legislative and regulatory actions and reforms; (11) terrorist activities,
which may adversely affect the general economy, financial and capital markets,
the real estate industry and the Company; and (12) the ability of the Manager
to attract and retain highly talented professionals. Forward-looking
statements speak only as of the date they are made. The Company does not
undertake, and specifically disclaims any obligation, to publicly release the
result of any revisions which may be made to any forward-looking statements to
reflect the occurrence of anticipated or unanticipated events or circumstances
after the date of such statements.

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PART I

ITEM 1. BUSINESS

All dollar figures expressed herein are expressed in thousands, except share
or per share amounts.

General

Anthracite Capital, Inc. (the "Company"), a Maryland corporation, is a real
estate finance company that generates income based on the spread between the
interest income on its mortgage loans and securities investments and the
interest expense from borrowings to finance its investments. The Company's
primary activity is investing in high yielding commercial real estate debt.
The Company focuses on acquiring pools of performing loans in the form of
Commercial Mortgage Backed Securities ("CMBS"), issuing secured debt backed by
CMBS and providing strategic capital for the commercial real estate industry
in the form of mezzanine loan financing. The Company commenced operations on
March 24, 1998.

The Company's stock is traded on the New York Stock Exchange under the symbol
"AHR". The Company's goal is to provide a consistent quarterly dividend
supported by earnings that are sustainable over the long term. The Company
seeks to achieve this consistent performance through pro-active credit risk
management and the application of value-added capital markets strategies to
traditional commercial real estate finance activities.

The Company establishes its dividend by analyzing the long-term sustainability
of earnings given existing market conditions and the current composition of
its portfolio. This includes an analysis of the Company's credit loss
assumptions, general level of interest rates and projected hedging costs.
During the year ended December 31, 2002, the Company's total distributions to
stockholders were $1.40 per share paid quarterly.

The Company is managed by BlackRock Financial Management, Inc. (the
"Manager"), a subsidiary of BlackRock, Inc., a publicly traded (NYSE: BLK)
asset management company with over $273 billion of global assets under
management as of December 31, 2002. The Manager provides an operating platform
that incorporates significant asset origination, risk management and
operational capabilities.

The Company's investment activities encompass three distinct lines of
business:
1) Commercial Real Estate Securities
2) Commercial Real Estate Loans
3) Residential Mortgage Backed Securities

The Company believes that these three investment activities represent an
integrated strategy where each line of business supports the others and
creates value over and above operating each line in isolation. The commercial
real estate securities portfolio provides diversification and high yields that
are adjusted for anticipated losses over a long period of time (typically, a
ten year weighted average life) and can be financed through the issuance of
secured debt that matches the life of the investment. Commercial real estate
loans provide attractive risk adjusted returns over shorter periods of time
through strategic investments in specific property types or regions. The
residential mortgage backed securities ("RMBS") portfolio is a highly liquid
portfolio that supports the liquidity needs of the Company while earning

5

attractive returns after hedging costs. The Company believes the risks of
these portfolios are not highly correlated and thus can serve to provide
stable earnings over long periods of time.

Commercial Real Estate Securities

The Company's principal activity is to underwrite and acquire high yielding
CMBS that are rated below investment grade. The Company's CMBS are securities
backed by pools of loans secured by first mortgages on commercial real estate
throughout the United States. The commercial real estate securing the first
mortgages consist of income producing properties including office buildings,
shopping centers, apartment buildings, industrial properties, healthcare
properties and hotels, amongst others. The terms of a typical loan include a
fixed rate of interest, thirty year amortization, some form of prepayment
protection, and a large interest rate increase if not paid off after ten
years. The loans are originated by various lenders and pooled together in a
trust that issues securities in the form of various classes of fixed rate debt
secured by the cash flows from the underlying loans. The securities issued by
the trust are rated by one or more nationally recognized credit rating
organization and are rated AAA down to CCC. Additionally, the security which
is affected first by loan losses is not rated. Generally, the Company does not
acquire the investment grade rated securities from newly formed trusts. The
principal amount of the pools of loans securing the CMBS securities varies.

Each trust will also have a designated special servicer. Special servicers are
responsible for carrying out the loan loss mitigation strategies. A special
servicer will also advance funds to a trust to maintain principal and interest
cash flows on the bonds so long as it believes there is a significant
probability of recovering those advances from the underlying borrowers. The
special servicer is paid a fee for advancing funds and for its efforts in
carrying out loss mitigation strategies.

The Company focuses on acquiring the securities rated below investment grade
and therefore that are rated BB+ or lower. The lowest rated securities are the
first to absorb realized losses in the loan pools. If a loss of par is
experienced in the underlying loans, a corresponding reduction in the par of
the lowest rated security occurs, reducing cash flow. The majority owner of
the first loss position has the right to control the workout process and
therefore designate the special servicer. The Company will generally seek to
be in the control position by purchasing the majority of the non-rated
securities and sequentially rated securities as high as BB+. Typically, the
par amount of all securities that are rated below investment grade represents
4.5% - 6.5% of the par of the underlying loans of newly issued CMBS
transactions. This is known as the subordination level because 4.5% - 6.5% of
the loan balance is subordinated to the senior, investment grade rated
securities.

The Company does not typically purchase a BB- rated security without having
the right to control the workout process on the underlying loans. The Company
purchases BB+ and BB rated securities at their original issue or in the
secondary market without necessarily having control of the workout process.
These other below investment grade CMBS do not absorb losses until the BB- and
lower rated securities have experienced losses of their entire principal
amounts. The Company believes the 4.0% - 4.5% subordination levels of these
securities provide additional credit protection and diversification with an
attractive risk return profile.

As of December 31, 2002, the Company owns seven different trusts ("Controlling
Class") where it is in the

6

first loss position and as a result controls the workout process on $9,616,797
of underlying loans. The total par amount owned of these Controlling Class
securities is $690,052. The Company does not own the senior securities that
represent the remaining par amount of the underlying mortgage loans. The
special servicer on five of the seven trusts is Midland Loan Services, Inc.;
the special servicer on the remaining two trusts is GMAC Commercial Mortgage
Management, Inc.

The Company also purchases investment grade commercial real estate related
securities in the form of CMBS and unsecured debt of commercial real estate
companies. The addition of these higher rated securities is intended to add
greater stability to the long-term performance of the Company's portfolios as
a whole and to provide greater diversification to optimize secured financing
alternatives. The Company generally seeks to assemble a portfolio of high
quality issues that will maintain consistent performance over the life of the
security.

The Company also acquires CMBS interest only securities ("IOs"). These
securities represent a portion of the interest coupons paid by the underlying
loans. The Company views this portfolio as an attractive relative value versus
other alternatives. These securities do not have significant prepayment risk
because the underlying loans generally have prepayment restrictions.
Furthermore, the credit risk is also mitigated because the IO represents a
portion of all underlying loans, not solely the first loss.

The following table indicates the amounts of each category of commercial real
estate asset the Company owns as of December 31, 2002.

The Company finances the majority of these portfolios with match funded,
secured term debt through Collateralized Debt Obligation ("CDO") offerings. To
accomplish this, the Company forms a special purpose entity ("SPE") and
contributes a portfolio of mostly below investment grade CMBS, investment
grade CMBS, and unsecured debt of commercial real estate companies. As this
transaction is considered a financing, the SPE is fully consolidated on the
Company's consolidated financial statements. The SPE will then issue fixed and
floating rate debt secured by the cash flows of the securities in the
portfolio. The SPE will enter into an interest rate swap agreement to convert
all floating rate debt issued to a fixed rate, thus matching the cash flow
profile of the underlying portfolio. The structure of the debt also eliminates
the mark to market requirement of other types of financing, thus eliminating
the need to provide additional collateral if the value of the portfolio
declines. The debt issued by the SPE is generally rated AAA down to BB; the
Company will keep the equity of the portfolio and continue to manage the
credit risk as it did prior

7

to the assets being contributed to the CDOs. The CDO provides an optimal
capital structure to maximize returns on these types of portfolios on a
non-recourse basis. Other forms of financing used for these types of assets
include multi-year committed financing facilities and 30-day reverse
repurchase agreements.

Owning commercial real estate loans in this form allows the Company to earn
its loss-adjusted returns over a long period of time while achieving
significant diversification across geographic areas and property types.

The following table indicates the par values of each category of commercial
real estate asset being used to secure the different types of borrowings as of
December 31, 2002:

Prior to acquiring Controlling Class securities, the Company performs a
significant amount of due diligence on the underlying loans to ensure their
risk profiles fit the Company's criteria. Loans that do not fit the Company's
criteria are removed from the pool. The debt service coverage ratios are
evaluated to determine if they are appropriate for each asset class. The
average loan to value ratio ("LTV") of the underlying loans is generally 70%
at origination. Due to its greater levels of credit protection, other below
investment grade CMBS are subject to comprehensive diligence though less
detailed than Controlling Class securities.

As part of the underwriting process, the Company assumes a certain amount of
loans will incur losses over time. In performing its due diligence on the
seven trusts, at the time of acquisition, the Company estimated that $180,638
of principal on the underlying loans would not ultimately be recoverable. This
amount represents approximately 1.9% of the underlying loan pools and 26.2% of
the par amount of the Controlling Class securities owned by the Company. This
loss assumption is used to compute a loss adjusted yield, which is then used
to report income on the Company's consolidated financial statements. The
weighted average loss adjusted yield for all Controlling Class securities is
10.36% and the weighted average yield if no losses occur is 11.72%. For all
Controlling Class securities with a rating of BB- and below the weighted
average loss adjusted yield is 10.84%. If the loss assumptions prove to be
consistent with actual loss experience, the Company will maintain that level
of income for the life of the security. If actual losses differ from the
original loss assumptions, a change in the original assumptions will be made
to restate the yields accordingly. A write down or write up of the adjusted
purchase price of the security may also be required. (See Item 7A
- -"Quantitative and Qualitative Disclosures About Market Risk" for more
information on the sensitivity of the Company's income and adjusted purchase
price to changes in credit experience.)

Once acquired, the Company uses a performance monitoring system to track the
credit experience of the

8

mortgages in the pools securing both the Controlling Class and the other below
investment grade CMBS. The Company receives remittance reports monthly from
the trustees and closely monitors any delinquent loans or other issues that
may affect the performance of the loans. The special servicer of a loan pool
also assists in this process. The Company also reviews its loss assumptions
every quarter using updated payment and debt service coverage information on
each loan in the context of economic trends on both a national and regional
level.

The Company's anticipated yields to maturity on its investments are based upon
a number of assumptions that are subject to certain business and economic
uncertainties and contingencies. Examples of such contingencies include, among
other things, the timing and severity of expected credit losses, the rate and
timing of principal payments (including prepayments, repurchases, defaults,
liquidations, special servicer fees and other related expenses), the
pass-through or coupon rate and interest rate fluctuations. Additional factors
that may affect the Company's anticipated yields to maturity on its
subordinated CMBS include interest payment shortfalls due to delinquencies on
the underlying mortgage loans and the timing and magnitude of credit losses on
the mortgage loans underlying the subordinated CMBS that are a result of the
general condition of the real estate market (including competition for tenants
and their related credit quality) and changes in market rental rates. As these
uncertainties and contingencies are difficult to predict and are subject to
future events, which may alter these assumptions, no assurance can be given
that the Company's anticipated yields to maturity will be achieved.

Commercial Real Estate Loans

The Company's loan activity is focused on providing mezzanine capital to the
commercial real estate industry. The Company targets well capitalized real
estate operators with strong track records and compelling business plans
designed to enhance the value of their real estate. These loans are generally
subordinated to a senior lender or first mortgage and are priced to reflect a
higher return. The Company has significant experience in closing large,
complex loan transactions and can deliver a timely and competitive financing
package to an underserved part of the real estate industry.

The types of investments in this class include subordinated participations in
first mortgages, loans secured by partnership interests, preferred equity
interests in real estate limited partnerships and loans secured by second
mortgages. The weighted average life of these investments is generally two to
three years and average leverage is 1:1 debt to equity generally funded with
committed financing facilities. These investments have fixed or floating rate
coupons and some provide additional earnings through an internal rate of
return ("IRR") look back or gross revenue participation.

The Company performs significant due diligence before making investments to
evaluate risks and opportunities in this sector. The Company generally focuses
on strong sponsorship, attractive real estate fundamentals, and pricing and
structural characteristics that provide significant control over the
underlying asset.

Since 2001, the Company's activity in this sector has generally been conducted
through Carbon Capital, Inc. ("Carbon"), a private Real Estate Investment
Trust. As of December 31, 2002, the Company owns 18.8% of Carbon and the
remainder is owned by various institutional investors. The Manager also
manages Carbon. The Company believes the use of Carbon allows it to invest in
larger institutional quality assets with greater diversification. The
Company's consolidated financial statements include, on a consolidated basis,
its share of assets and income of Carbon.

9

On December 31, 2002, the Company owned commercial real estate loans with a
carrying value $107,474. The average yield of this portfolio at December 31,
2002 was 9.4%. The majority of these loans pay interest based on one month
LIBOR. Commercial real estate loans with a carrying value of $33,545 were held
in Carbon and $73,929 were held directly. The Company and Carbon each have
committed financing facilities used to finance the acquisition of these
assets.

During the year ended December 31, 2002, the Company invested $3,370 in new
loans and received par payoffs of $82,865. Additionally, the Company invested
$6,100 in Carbon.

Investment Grade Residential Mortgage Backed Securities

The Company also invests a portion of its equity in RMBS with the strategic
objective of providing enhanced earnings and liquidity risk management. A key
element in managing the risk of owning a portfolio of below investment grade
CMBS and commercial real estate loans is to maintain sufficient liquid assets
to support these investments during periods of reduced liquidity in the
financial markets. RMBS can generally be sold quickly to raise cash to meet
margin calls required by lenders that provide secured financing for CMBS and
commercial real estate loans. As the Company continues to exploit the
opportunities available to it in the secured debt markets, such as CDO
offerings, the need for excess liquidity will be reduced. The size of this
investment portfolio can be expected to diminish over time as the Company
continues to match fund its commercial real estate portfolios.

The Company's investments in residential mortgage assets are currently and
expected to be concentrated in Pass-Through Certificates. The Pass-Through
Certificates to be acquired by the Company will consist primarily of
pass-through certificates issued by Federal National Mortgage Association
("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") and Government
National Mortgage Association ("GNMA"), as well as privately issued
adjustable-rate and fixed-rate mortgage pass-through certificates.

FNMA is a federally chartered and privately owned corporation. FNMA provides
funds to the mortgage market primarily by purchasing mortgage loans on homes
from local lenders. FNMA guarantees to the registered holder of an FNMA
Certificate that it will distribute amounts representing scheduled principal
and interest (at the rate provided by the FNMA Certificate) on the mortgage
loans in the pool underlying the FNMA 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 FNMA under its guarantees are solely those of
FNMA and are not backed by the full faith and credit of the United States. If
FNMA were unable to satisfy such obligations, distributions to holders of FNMA
Certificates would consist solely of payments and other recoveries on the
underlying Mortgage loans and, accordingly, monthly distributions to holders
of FNMA Certificates would be affected by delinquent payments and defaults on
such Mortgage loans.

FHLMC is a privately owned corporate instrumentality of the United States
created pursuant to an Act of Congress. The principal activity of FHLMC
currently consists of the purchase of conforming Mortgage loans or
participation interests therein and the resale of the loans and participations
so purchased in the form of guaranteed MBS. FHLMC guarantees to each holder of
its certificates the timely payment of interest at the applicable pass-through
rate and ultimate collection of all principal on the holder's pro rata share
of the unpaid principal balance of the related Mortgage loans, but does not
guarantee the timely

10

payment of scheduled principal of the underlying Mortgage loans. The
obligations of FHLMC under its guarantees are solely those of FHLMC and are
not backed by the full faith and credit of the United States. If FHLMC were
unable to satisfy such obligations, distributions to holders of FHLMC
Certificates would consist solely of payments and other recoveries on the
underlying Mortgage loans and, accordingly, monthly distributions to holders
of FHLMC Certificates would be affected by delinquent payments and defaults on
such Mortgage loans.

GNMA is a wholly owned corporate instrumentality of the United States within
the U.S. Housing and Urban Development Department ("HUD"). GNMA guarantees the
timely payment of the principal of and interest on certificates that represent
an interest in a pool of Mortgage loans insured by the Federal Housing
Administration ("FHA") and other loans eligible for inclusion in mortgage
pools underlying GNMA Certificates. GNMA Certificates constitute general
obligations of the United States backed by its full faith and credit.

Privately Issued Pass-Through Certificates are structured similar to the FNMA,
FHLMC and GNMA pass-through certificates discussed above and are issued by
originators of and investors in Mortgage loans, including savings and loan
associations, savings banks, commercial banks, mortgage banks, investment
banks and special purpose subsidiaries of such institutions. Privately Issued
Pass-Through Certificates are usually backed by a pool of conventional
Mortgage loans and are generally structured with credit enhancements such as
pool insurance or subordination. However, Privately Issued Pass-Through
Certificates are typically not guaranteed by an entity having the credit
status of FNMA, FHLMC or GNMA guaranteed obligations.

The Pass-Through Certificates to be acquired by the Company represent
interests in mortgages that are secured by liens on single-family (one-
to-four-units) residential properties, multifamily residential properties and
commercial properties. Pass-Through Certificates backed by adjustable-rate
Mortgage loans are subject to lifetime interest rate caps and to periodic
interest rate caps that limit the amount an interest rate can change during
any given period. The Company's borrowings are generally not subject to
similar restrictions. In a period of increasing interest rates, the Company
could experience a decrease in net income or incur losses because the interest
rates on its borrowings could exceed the interest rates on adjustable-rate
Pass-Through Certificates owned by the Company. The impact on net income of
such interest rate changes will depend on the adjustment features of the
mortgage assets owned by the Company, the maturity schedules of the Company's
borrowings and related hedging.

The majority of these securities are classified for accounting purposes as
held for trading so the change in their value is marked to market through the
income statement at the end of each quarter. Several factors influence the
value of RMBS including interests rates, interest spreads and paydowns.
Paydowns affect the value of the portfolio because a homeowner can payoff a
mortgage at par, and if the value of the portfolio is marked at a premium due
to falling interest rates, the par paydown generates a loss in the amount of
the premium. Alternatively, if the value of the portfolio is marked at a
discount, a paydown will generate a gain. Prepayments generally occur when
interest rates fall. The low interest rates in the third and fourth quarter of
2002 caused unprecedented levels of prepayments. The portfolio is marked to
market on the last day of each quarter and any change from the end of the
prior quarter is reported on the income statement. The portfolio is actively
hedged to mitigate the effects of interest rate movements.

As of December 31, 2002, the Company's classification of RMBS as either held
for trading or available for

11

sale is detailed below.

At year-end, the RMBS portfolio represented approximately 57% of the Company's
total assets. The equity committed to this portfolio provides a ready source
of cash that can be used to support the Company's other investment operations,
if needed. This allows the Company to earn attractive returns on equity while
maintaining significant liquidity. The leverage on this portfolio varies based
upon the short-term cash needs of the Company.

At December 31, 2002, the Company's assets were allocated among the following
categories:

At December 31, 2002, the Company had $42,796 of excess borrowing capacity in
the CMBS and commercial real estate loans portfolio.

12

Hedging Activities

The Company enters into hedging transactions to protect its investment
portfolio and related borrowings from interest rate fluctuations and other
changes in market conditions. These transactions may include interest rate
swaps, the purchase or sale of interest rate collars, caps or floors, options
and other hedging instruments. These instruments may be used to hedge as much
of the interest rate risk as the Manager determines is in the best interest of
the Company's stockholders, given the cost of such hedges. The Manager may
elect to have the Company bear a level of interest rate risk that could
otherwise be hedged when the Manager believes, based on all relevant facts,
that bearing such risk is advisable. The Manager has extensive experience in
hedging mortgages, mortgage-related assets and related borrowings with these
types of instruments.

Hedging instruments often are not traded on regulated exchanges, guaranteed by
an exchange or its clearinghouse, or regulated by any U.S. or foreign
governmental authorities. Consequently, there may be no requirements with
respect to record keeping, financial responsibility or segregation of customer
funds and positions. The Company will enter into these transactions only with
counterparties with long-term debt rated "A" or better by at least one
nationally recognized statistical rating organization. The business failure of
a counterparty with which the Company has entered into a hedging transaction
will most likely result in a default, which may result in the loss of
unrealized profits and force the Company to cover its resale commitments, if
any, at the then current market price. Although the Company generally will
seek to reserve for itself the right to terminate its hedging positions, it
may not always be possible to dispose of or close out a hedging position
without the consent of the counterparty, and the Company may not be able to
enter into an offsetting contract in order to cover its risk. There can be no
assurance that a liquid secondary market will exist for hedging instruments
purchased or sold, and the Company may be required to maintain a position
until exercise or expiration, which could result in losses.

The Company's hedging activities are intended to address both income and
capital preservation. Income preservation refers to maintaining a stable
spread between yields from mortgage assets and the Company's borrowing costs
across a reasonable range of adverse interest rate environments. Capital
preservation refers to maintaining a relatively steady level in the market
value of the Company's capital across a reasonable range of adverse interest
rate scenarios. However, no strategy can insulate the Company completely from
changes in interest rates.

From time to time, the Company may reduce its exposure to market interest
rates by entering into various financial instruments that adjust portfolio
duration. These financial instruments are intended to mitigate the effect of
interest rates on the value of certain assets in the Company's portfolio.

Interest rate swap agreements as of December 31, 2002 and 2001 consisted of
the following:

The counterparties for all of the Company's swaps are Deutsche Bank AG and
Merrill Lynch Capital Services, Inc., with ratings of AA- and A+,
respectively.

Futures contracts as of December 31, 2002 and 2001 consisted of the following:

Financing and Leverage

The Company has financed its assets with the net proceeds of its initial
public offering, follow-on offerings, the issuance of common stock under the
Company's Dividend Reinvestment and Stock Purchase Plan, the issuance of
preferred stock, long-term secured borrowings, short-term borrowings under
repurchase agreements and the lines of credit discussed below. In the future,
operations may be financed by future offerings of equity securities, as well
as unsecured and secured borrowings. The Company expects that, in general, it
will employ leverage consistent with the type of assets acquired and the
desired level of risk in various investment environments. The Company's
governing documents do not explicitly limit the amount of leverage that the
Company may employ. Instead, the Board of Directors has adopted an
indebtedness policy for the Company that limits total leverage to a maximum
6.0 to 1 debt to equity ratio. At December 31, 2002 and 2001, the Company's
debt-to-equity ratio was approximately 5.3 to 1 and 4.8 to 1, respectively.
The Company anticipates that it will maintain debt-to-equity ratios between
2.5 to 1 and 5.5 to 1 in the foreseeable future, although this ratio may be
higher or lower at any time. The Company's indebtedness policy may be changed
by the Board of Directors at any time in the future.

On May 29, 2002, the Company issued ten tranches of secured debt through CDO
I. In this transaction, a

14

wholly-owned subsidiary of the Company issued secured debt in the par amount of
$419,185 secured by the subsidiary's assets. The adjusted issue price of the
CDO I debt, as of December 31, 2002, is $403,983. Five tranches were issued at
a fixed rate coupon and five tranches were issued at a floating rate coupon
with a combined weighted average remaining maturity of 9.29 years. All
floating rate coupons were swapped to fixed resulting in a total fixed rate
cost of funds for CDO I of approximately 7.21%.

On December 10, 2002, the Company issued seven tranches of secured debt
through CDO II. In this transaction, a wholly-owned subsidiary of the Company
issued secured debt in the par amount of $280,783 secured by the subsidiary's
assets. The adjusted issue price of the CDO II debt as of December 31, 2002 is
$280,607. Four tranches were issued at a fixed rate coupon and three tranches
were issued at a floating rate coupon with a combined weighted average
remaining maturity of 9.34 years. All floating rate coupons were swapped to
fixed resulting in a total fixed rate cost of funds for CDO II of
approximately 5.73%.

Included in CDO II was a ramp facility that will be utilized to fund the
purchase of additional $50,000 of par of below investment grade CMBS by
September 30, 2003. Use of the ramp will permit the Company to increase the
net interest spread of the transaction by adding high yielding CMBS to the
asset portfolio.

On July 19, 1999, the Company entered into a $185,000 committed credit
facility with Deutsche Bank AG (the "Deutsche Bank Facility"). The Deutsche
Bank Facility has a two-year term and provides for extensions at the Company's
option. The Deutsche Bank Facility was extended for a one-year term through
July 19, 2002. The facility was extended a second time through July 15, 2005.
The Deutsche Bank Facility can be used to replace existing reverse repurchase
agreement borrowings and to finance the acquisition of mortgage-backed
securities, loan investments and investments in real estate joint ventures. As
of December 31, 2002 and December 31, 2001, the outstanding borrowings under
this facility were $19,189 and $43,409, respectively. Outstanding borrowings
under the Deutsche Bank Facility bear interest at a LIBOR based variable rate.

On January 15, 2002, the Company renewed a credit facility with Merrill Lynch
Mortgage Capital, Inc. for a twelve-month period, which permits the Company to
borrow up to $200,000. As of December 31, 2002, there were no outstanding
borrowings under this facility. As of December 31, 2001, the outstanding
borrowings under this line of credit were $57,113. The agreement requires
assets to be pledged as collateral, which may consist of rated CMBS, rated
RMBS, residential and commercial mortgage loans, and certain other assets.
Outstanding borrowings under this line of credit bear interest at a LIBOR
based variable rate. The facility expired pursuant to its terms in January
2003.

On July 18, 2002, the Company entered into a $75,000 committed credit facility
with Greenwich Capital, Inc. This facility provides the Company with the
ability to borrow only in the first year with repayment of principal not due
for three years. Outstanding borrowings under this line of credit bear
interest at a LIBOR based variable rate. As of December 31, 2002, there were
no borrowings under this facility.

The Company is subject to various covenants in its lines of credit, including
maintaining a minimum net worth of $305,000 as determined under generally
accepted accounting principles in the United States of America ("GAAP"), a
debt-to-equity ratio not to exceed 5.5 to 1, a minimum cash requirement based
upon certain debt-to-equity ratios, a minimum debt service coverage ratio of
1.5 and a minimum liquidity reserve of $10,000. As of December 31, 2002, the
Company was in compliance with all such

15

covenants.

On December 2, 1999, the Company authorized and issued 1,200,000 shares of
Series A Preferred Stock for aggregate proceeds of $30,000. The Series A
Preferred Stock carries a 10.5% coupon and is convertible into shares of
Common Stock at a price of $7.35 per share. The Series A Preferred Stock has a
seven-year maturity at which time, at the option of the holders, the shares of
preferred stock may be converted into shares of common stock or liquidated for
$28.50 per share. On December 21, 2001, the sole Series A Preferred
shareholder converted 1,190,000 shares of the Series A Preferred Stock into
4,096,854 shares of Common Stock at a conversion price of $7.26 per share
pursuant to the terms of such Preferred Stock, which was $0.09 per share lower
than the original conversion price due to the effects of anti-dilution
provisions in the Series A Preferred Stock. The remaining 10,000 shares of
Series A Preferred Stock were converted into 34,427 shares of the Company's
Common Stock in March 2002 at a conversion price of $7.26 per share.

On February 14, 2001, the Company completed a follow-on offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $33,300. The Company had granted the underwriters an
option, exercisable for 30 days, to purchase up to 600,000 additional shares
of Common Stock to cover over-allotments. This option was exercised on March
13, 2001 and resulted in additional net proceeds to the Company of
approximately $5,000.

On May 11, 2001, the Company completed a follow-on offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $37,800. The Company had granted the underwriters an
option, exercisable for 30 days, to purchase up to 600,000 additional shares
of Common Stock to cover over-allotments. This option was exercised on June 6,
2001 and resulted in additional net proceeds to the Company of approximately
$5,675.

On November 7, 2001, the Company completed a follow-on offering of 4,400,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $39,400. On November 13, 2001, the underwriters exercised
an option to purchase an additional 90,000 shares of Common Stock available
through an over-allotment granted to the underwriters and resulted in
additional net proceeds to the Company of approximately $810.

For the year ended December 31, 2002, the Company issued 1,455,725 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company
were approximately $15,920. For the year ended December 31, 2001, the Company
issued 2,228,566 shares of Common Stock under its Dividend Reinvestment Plan
with net proceeds to the Company of approximately $22,945.

The Company has entered into reverse repurchase agreements to finance most of
its securities available for sale which are not financed under its lines of
credit. The reverse repurchase agreements are collateralized by most of the
Company's securities available for sale and bear interest at rates that have
historically moved in close relationship to LIBOR.

16

Certain information with respect to the Company's collateralized borrowings at
December 31, 2002 is summarized as follows:

At December 31, 2002, the Company's collateralized borrowings had the
following remaining maturities:

As of December 31, 2002, $165,811 of the Company's $185,000 Deutsche Bank
Facility was available for future borrowings. Additionally, as of December 31,
2002, all of the Company's $75,000 committed credit facility with Greenwich
Capital, Inc. was available.

Under the lines of credit and the reverse repurchase agreements, the lender
retains the right to mark the underlying collateral to estimated market value.
A reduction in the value of its pledged assets will require

17

the Company to provide additional collateral or fund cash margin calls. From
time to time, the Company expects that it will be required to provide such
additional collateral or fund margin calls. The Company maintains adequate
liquidity to meet such calls.

Operating Policies

The Company has adopted compliance guidelines, including restrictions on
acquiring, holding and selling assets, to ensure that the Company meets the
requirements for qualification as a Real Estate Investment Trust ("REIT")
under the Internal Revenue Code of 1986 (the "Code") and is excluded from
regulation as an investment company. Before acquiring any asset, the Manager
determines whether such asset would constitute a "Real Estate Asset" under the
REIT Provisions of the Code, as amended. The Company regularly monitors
purchases of mortgage assets and the income generated from such assets,
including income from its hedging activities, in an effort to ensure that at
all times the Company's assets and income meet the requirements for
qualification as a REIT and exclusion under the Investment Company Act of 1940
(the "Investment Company Act").

The Company's unaffiliated directors review all transactions of the Company on
a quarterly basis to ensure compliance with the operating policies and to
ratify all transactions with PNC Bank (an affiliate of the Manager) and its
affiliates, except that the purchase of securities from PNC Bank and its
affiliates require prior approval. The unaffiliated directors rely
substantially on information and analysis provided by the Manager to evaluate
the Company's operating policies, compliance therewith and other matters
relating to the Company's investments.

In order to maintain the Company's REIT status, the Company generally intends
to distribute to its stockholders aggregate dividends equaling at least 90% of
its taxable income each year. The Code permits the Company to fulfill this
distribution requirement by the end of the year following the year in which
the taxable income was earned.

Regulation

The Company intends to continue to conduct its business so as not to become
regulated as an investment company under the Investment Company Act. Under the
Investment Company Act, a non-exempt entity that is an investment company is
required to register with the SEC and is subject to extensive, restrictive and
potentially adverse regulation relating to, among other things, operating
methods, management, capital structure, dividends and transactions with
affiliates. 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 by the staff of the SEC, to qualify for this exemption,
the Company, among other things, must maintain at least 55% of its assets in
Qualifying Interests. Pursuant to such SEC staff interpretations, certain of
the Company's interests in agency pass-through and mortgage-backed securities
and agency insured project loans are Qualifying Interests.

A portion of the CMBS acquired by the Company are collateralized by pools of
first mortgage loans where the Company can monitor the performance of the
underlying mortgage loans through loan management and servicing rights and
when the Company has appropriate workout/foreclosure rights with respect to
the underlying mortgage loans. When such arrangements exist, the Company
believes that the related

18

subordinated CMBS constitute Qualifying Interests for purposes of the
Investment Company Act. Therefore, the Company believes that it should not be
required to register as an "investment company" under the Investment Company
Act as long as it continues to invest in a sufficient amount of such
subordinated CMBS and/or in other Qualifying Interests.

If the SEC or its staff were to take a different position with respect to
whether the Company's subordinated CMBS constitute Qualifying Interests, the
Company could be required to modify its business plan so that either (i) it
would not be required to register as an investment company or (ii) it would
comply with the Investment Company Act and be able to register as an
investment company. In such event, modification of (i) the Company's business
plan so that it would not be required to register as an investment company
would likely entail a disposition of a significant portion of the Company's
subordinated CMBS or the acquisition of significant additional assets, such as
agency pass-through and mortgage-backed securities, which are Qualifying
Interests or (ii) the Company's business plan to register as an investment
company would result in significantly increased operating expenses and would
likely entail significantly reducing the Company's indebtedness (including the
possible prepayment of the Company's short-term borrowings), which could also
require it to sell a significant portion of its assets. No assurances can be
given that any such dispositions or acquisitions of assets, or deleveraging,
could be accomplished on favorable terms. Consequently, any such modification
of the Company's business plan could have a material adverse effect on the
Company. Further, if it were established that the Company were an unregistered
investment company, there would be a risk that the Company would be subject to
monetary penalties and injunctive relief in an action brought by the SEC, that
the Company would be unable to enforce contracts with third parties and that
third parties could seek to obtain recession of transactions undertaken during
the period it was established that the Company was an unregistered investment
company. Any such results would be likely to have a material adverse effect on
the Company.

Competition

The Company's net income depends, in large part, on the Company's ability to
acquire mortgage assets at favorable spreads over the Company's borrowing
costs. In acquiring mortgage assets, the Company competes with other mortgage
REITs, specialty finance companies, savings and loan associations, banks,
mortgage bankers, insurance companies, mutual funds, institutional investors,
investment banking firms, other lenders, governmental bodies and other
entities. In addition, there are numerous mortgage REITs with asset
acquisition objectives similar to the Company's, and others may be organized
in the future. The effect of the existence of additional REITs may be to
increase competition for the available supply of mortgage assets suitable for
purchase by the Company. Some of the Company's anticipated competitors are
significantly larger than the Company, have access to greater capital and
other resources and may have other advantages over the Company. In addition to
existing companies, other companies may be organized for purposes similar to
that of the Company, including companies organized as REITs focused on
purchasing mortgage assets. A proliferation of such companies may increase the
competition for equity capital and thereby adversely affect the market price
of the Company's Common Stock.

Employees

The Company does not have any employees. The Company's officers, each of whom
is a full-time employee of the Manager, perform the duties required pursuant
to the Management Agreement (as defined below) with the Manager and the
Company's bylaws.

19

Management Agreement

The Company is managed pursuant to a management agreement, dated March 27,
1998, between the Company and the Manager (the "Management Agreement"),
pursuant to which the Manager is responsible for the day-to-day operations of
the Company and performs such services and activities relating to the assets
and operations of the Company as may be appropriate. The initial two-year term
of the Management Agreement was to expire on March 27, 2000; on March 16,
2000, the Management Agreement was extended for an additional two years, with
the approval of the unaffiliated directors, on terms similar to the original
agreement. On March 25, 2002, the Management Agreement was extended for one
year through March 27, 2003, with the approval of the unaffiliated directors,
on terms similar to the prior agreement with the following changes: (i) the
incentive fee calculation would be based upon GAAP earnings instead of funds
from operations, (ii) the removal of the four-year period to value the
Management Agreement in the event of termination and (iii) subsequent renewal
periods of the Management Agreement would be for one year instead of two
years. The Board was advised by Houlihan Lokey Howard & Zukin Financial
Advisors, Inc., a national investment banking and financial advisory firm, in
the renewal process.

On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement are similar to the
prior agreement except for the incentive fee calculation which would provide
for a rolling four-quarter high watermark rather than a quarterly calculation.
In determining the rolling four-quarter high watermark, the Manager would
calculate the incentive fee based upon the current and prior three quarters'
net income ("Yearly Incentive Fee"). The Manager would be paid an incentive
fee in the current quarter if the Yearly Incentive Fee is greater than what
was paid to the Manager in the prior three quarters cumulatively. The Company
will phase in the rolling four-quarter high watermark commencing with the
second quarter of 2003. Calculation of the incentive fee will be based on GAAP
and adjusted to exclude special one-time events pursuant to changes in GAAP
accounting pronouncements after discussion between the Manager and the
unaffiliated directors. The incentive fee threshold did not change. The high
watermark will be based on the existing incentive fee hurdle, which provides
for the Manager to be paid 25% of the amount of earnings (calculated in
accordance with GAAP) per share that exceeds the product of the adjusted issue
price of the Company's common stock per share ($11.39 as of December 31, 2002)
and the greater of 9.5% or 350 basis points over the ten-year Treasury note.

The Manager primarily engages in four activities on behalf of the Company: (i)
acquiring and originating mortgage loans and other real estate related assets;
(ii) asset/liability and risk management, hedging of floating rate
liabilities, and financing, management and disposition of assets, including
credit and prepayment risk management; (iii) surveillance and restructuring of
real estate loans and (iv) capital management, structuring, analysis, capital
raising and investor relations activities. In conducting these activities, the
Manager formulates operating strategies for the Company, arranges for the
acquisition of assets by the Company, arranges for various types of financing
and hedging strategies for the Company, monitors the performance of the
Company's assets and provides certain administrative and managerial services
in connection with the operation of the Company. At all times, the Manager is
subject to the direction and oversight of the Company's Board of Directors.

The Company may terminate, or decline to renew the term of, the Management
Agreement without cause at any time upon 60 days' written notice by a majority
vote of the unaffiliated directors. Although no

20

termination fee is payable in connection with a termination for cause, in
connection with a termination without cause, the Company must pay the Manager
a termination fee, which could be substantial. The amount of the termination
fee will be determined by independent appraisal of the value of the Management
Agreement. Such appraisal is to be conducted by a nationally-recognized
appraisal firm mutually agreed upon by the Company and the Manager.

On May 15, 2000, the Company completed the acquisition of CORE Cap, Inc. The
merger was a stock for stock acquisition where the Company issued 4,180,552
shares of its common stock and 2,261,000 shares of its series B preferred
stock. At the time of the CORE Cap acquisition, the Manager agreed to pay GMAC
(CORE Cap, Inc's external advisor) $12,500 over a ten-year period
("Installment Payment") to purchase the right to manage the assets under the
existing management contract ("GMAC Contract"). The GMAC Contract had to be
terminated in order to allow for the Company to complete the merger, as the
Company's management agreement with the Manager did not provide for multiple
managers. As a result the Manager offered to buy-out the GMAC contract as the
Manager estimated it would receive incremental fees above and beyond the
Installment Payment, and thus was willing to pay for, and separately
negotiate, the termination of the GMAC Contract. Accordingly, the value of the
Installment Payment was not considered in the Company's allocation of its
purchase price to the net assets acquired in the acquisition of CORE Cap, Inc.
The Company agreed that should the Management Agreement with its Manager be
terminated, not renewed or not extended for any reason other than for cause,
the Company would pay to the Manager an amount equal to the Installment
Payment less the sum of all payments made by the Manager to GMAC. As of
December 31, 2002, the Installment Payment would be $9,500 payable over eight
years. The Company does not accrue for this contingent liability.

In addition, the Company has the right at any time during the term of the
Management Agreement to terminate the Management Agreement without the payment
of any termination fee upon, among other things, a material breach by the
Manager of any provision contained in the Management Agreement that remains
uncured at the end of the applicable cure period.

To coincide with the increased size of the Company, effective July 1, 2001,
the Manager reduced the base management fee payable under the Management
Agreement to 0.20% of average invested assets rated above BB+ from 0.35%.
Additionally, effective July 1, 2001, the Manager revised the hurdle rate
applicable to the incentive fee from 3.5% over the ten-year U.S. Treasury Rate
to the greater of 3.5% over the ten-year U.S. Treasury Rate or 9.5% on the
adjusted issue price of shares of Common Stock. This revision resulted in
savings of $3,278 and $1,689 to the Company during 2002 and 2001,
respectively. For purposes of calculating the incentive fee during 2002, the
cumulative transition adjustment of $6,327 resulting from the Company's
adoption of SFAS 142 was excluded from earnings in its entirety and included
using an amortization period of three years. This revision saved the Company
$1,314 of incentive fee during 2002.

Taxation of the Company

The Company has elected to be taxed as a REIT under the Code, commencing with
its taxable year ended December 31, 1998, and the Company intends to continue
to operate in a manner consistent with the REIT provisions of the Code. The
Company's qualification as a REIT depends on its ability to meet the various
requirements imposed by the Code, through actual operating results, asset
holdings, distribution levels and diversity of stock ownership.

Provided the Company continues to qualify for taxation as a REIT, it generally
will not be subject to Federal corporate income tax on its net income that is
currently distributed to stockholders. This treatment substantially eliminates
the "double taxation" (at the corporate and stockholder levels) that generally
results from an investment in a corporation. If the Company fails to qualify
as a REIT in any taxable year, its

21

taxable income would be subject to Federal income tax at regular corporate
rates (including any applicable alternative minimum tax). Even if the Company
qualifies as a REIT, it will be subject to Federal income and excise taxes on
its undistributed income.

If in any taxable year the Company fails to qualify as a REIT and, as a
result, incurs additional tax liability, the Company may need to borrow funds
or liquidate certain investments in order to pay the applicable tax, and the
Company would not be compelled to make distributions under the Code. Unless
entitled to relief under certain statutory provisions, the Company would also
be disqualified from treatment as a REIT for the four taxable years following
the year during which qualification is lost. Although the Company currently
intends to operate in a manner designated to qualify as a REIT, it is possible
that future economic, market, legal, tax or other considerations may cause the
Company to fail to qualify as a REIT or may cause the Board of Directors to
revoke the Company's REIT election.

The Company and its stockholders may be subject to foreign, state and local
taxation in various foreign, state and local jurisdictions, including those in
which it or they transact business or reside. The state and local tax
treatment of the Company and its stockholders may not conform to the Company's
Federal income tax treatment.

Website

The Company's website address is www.anthracitecapital.com. The Company makes
available free of charge through its website its Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments
to those reports as soon as reasonably practicable after such material is
electronically filed with or furnished to the SEC.

22

ITEM 2. PROPERTIES

The Company does not maintain an office and owns no real property. It utilizes
the offices of the Manager, located at 40 East 52nd Street, New York, New York
10022.

ITEM 3. LEGAL PROCEEDINGS

The Company is not a party to any material legal proceedings.

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

No matters were submitted to a vote of the Company's security holders during
the fourth quarter of 2002 through the solicitation of proxies or otherwise.

23

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

The Company's Common Stock has been listed and is traded on the New York Stock
Exchange under the symbol "AHR" since the initial public offering in March
1998. The following table sets forth, for the periods indicated, the high, low
and last sale prices in dollars on the New York Stock Exchange for the
Company's Common Stock and the dividends declared by the Company with respect
to the periods indicated as were traded during these respective time periods.

On March 21, 2003, the closing sale price for the Company's Common Stock, as
reported on the New York Stock Exchange, was $11.98. As of March 21, 2003,
there were approximately 877 record holders of the Common Stock. This figure
does not reflect beneficial ownership of shares held in nominee name.

24

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data set forth below as of and for the years ended
December 31, 2002, 2001, 2000, and 1999 and the period from March 24, 1998
(Commencement of Operations) through December 31, 1998 has been derived from
the Company's audited financial statements. This information should be read in
conjunction with "Item 1. Business" and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations", as well as the
audited financial statements and notes thereto included in "Item 8. Financial
Statements and Supplementary Data".

25

The Company's ratio of management fee, incentive fee, and general and
administrative expenses to net income before such fees is 21.7%, 21.2%, 23.2%
and 21.9% for the years ended December 31, 2002, 2001, 2000 and 1999,
respectively. This ratio is not meaningful for the Company's initial year of
operations in 1998.

26

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

All dollar figures expressed herein are expressed in thousands, except share
or per share amounts.

General

The Company's primary long-term objective is to distribute consistent
dividends supported by operating earnings. The Company considers its operating
earnings ("Operating Earnings") to be net income available to common
stockholders as determined under GAAP before gains and losses, changes in
accounting pronouncements and Statement of Financial Accounting Standard
(SFAS) 133 hedging adjustments.

Operating Earnings are primarily maintained by consistent credit performance
on the Company's investments and stability of the Company's liability
structure. In 2002, the Company established a strong long-term secured debt
issuance platform through two Collateralized Debt Obligation ("CDO")
offerings. These transactions effectively match funded a significant part of
the Company's long-term credit sensitive CMBS and REIT portfolios at
attractive terms. In 2003 the Company expects to redeploy capital raised from
these transactions combined with additional equity capital raised from the
Company's strategic common stock issuance program. This is expected to lead to
the accretion of both earnings and book value per share as well as to increase
diversification of credit exposure.

The Company establishes its dividend by analyzing the long-term sustainability
of Operating Earnings given existing market conditions and the current
composition of its portfolio. This includes an analysis of the Company's
credit loss assumptions, general level of interest rates, realized gains and
losses and projected hedging costs. These factors are generally beyond the
Company's control so there is no certainty that dividends will remain at
current levels. During calendar year 2002, the Company distributed $1.40 per
share in the form of fully taxable dividends on a quarterly basis.

For the year ended December 31, 2002, the Company recorded $1.18 of GAAP
earnings per share and $1.67 of Operating Earnings per share. For the year
ended December 31, 2001, the Company recorded $1.35 of GAAP earnings per share
and $1.44 of Operating Earnings per share. The table below reconciles GAAP
earnings per share with Operating Earnings per share for the four years ended
December 31, 2002:

27

Commercial Real Estate Securities Portfolio Activity

The Company continues to increase its investments in commercial real estate
securities. Commercial real estate securities include CMBS and investment
grade REIT debt. During the year ended December 31, 2002, the Company
increased total assets in this sector by 97% from $453,953 to $894,345. This
increase was attributable to the execution of the two CDO offerings that
provided an attractive match funding financing platform for these assets.

The table below is a summary of the Company's investments by asset class since
inception:

The Company's first CDO transaction was issued as Anthracite CDO 2002 CIBC-1
and closed on May 15, 2002 ("CDO I"). The Company issued $403,633 of debt
secured by a portfolio of commercial real estate securities with a total par
of $515,880 and an adjusted purchase price of $431,995. On December 10, 2002,
the Company issued another $280,607 of debt through Anthracite CDO 2002-2
("CDO II") secured by a separate portfolio of commercial real estate
securities with a par of $313,444 and an average adjusted purchase price of
$289,197. Included in CDO II was a ramp facility that will be utilized to fund
the purchase of an additional $50,000 of par of below investment grade CMBS by
September 30, 2003. Use of the ramp facility will permit the Company to
increase the net interest spread of the transaction by adding high yielding
CMBS to the asset portfolio. The Company retained 100% of the equity of both
CDOs and is recording the transaction on its books as a financing.

28

* Weighted Average cost of funds is the current cost of funds plus hedging
expenses.

** The total market value of the assets contributed to the two CDOs at
December 31, 2002 was $726,769, an additional $50,000 of par can be
contributed through the ramp facility. Securities contributed at a
discounted market value would generate excess cash in the amount of the
discount.

*** The company did not sell $22,850 of par of CDO II debt rated BBB- and BB

Assets contributed to the CDOs were a combination of below investment grade
CMBS (rated below BBB-), investment grade CMBS (rated BBB- to BB+) and
investment grade unsecured REIT debt. CMBS securities rated B- or lower were
not contributed into either CDO. The Company did not contribute certain other
below investment grade CMBS rated BB+ down to B. Other securities that were
not contributed to either CDO include a portfolio of AAA rated CMBS IO
securities and other CMBS related securities.

The following table details the par, fair market value, adjusted purchase
price and loss adjusted yield of the Company's commercial real estate
securities outside of the CDOs as of December 31, 2002:

Below Investment Grade CMBS and Underlying Loan Performance

The Company divides its below investment grade CMBS investment activity into
two portfolios, Controlling Class CMBS and other below investment grade CMBS.
The distinction between the two is in the controlling class rights.
Controlling class rights allow the Company to control the workout and/or
disposition of defaults that occur in the underlying loans. These securities
absorb the first losses realized in the underlying loan pools. Other below
investment grade CMBS have no right to control the workout and/or disposition
of underlying loan defaults, however they are not the first to absorb losses
in the underlying pools.

During 2002, the Company acquired $199,840 of par of other below investment
grade CMBS and did not acquire any new Controlling Class securities. The
Company continues to take a cautious approach to the real estate credit
markets and favored CMBS with greater credit protection rather than being in a
first loss position. The total par of the Company's other below investment
grade CMBS at December 31, 2002 was $261,157; the total credit protection, or
subordination level, of this portfolio is 6.50%. The total par of the
Company's Controlling Class CMBS at December 31, 2002 was $690,052 and the
total par of the loans underlying these securities was $9,616,797. The
non-rated security is the first to absorb underlying loan losses until its par
is completely written off. The coupon payment on the non-rated security can
also be reduced for special servicer fees charged to the trust. The next
highest rated security in the structure will then generally be downgraded to
non-rated and becomes the first to absorb losses and expenses from that point
on.

29

The Company's investment in its Controlling Class CMBS by credit rating
category at December 31, 2002 is as follows:

The Company's investment in its Controlling Class CMBS by credit rating
category at December 31, 2001 is as follows:

During 2002, the par for one of the Company's Controlling Class CMBS was
written down by the servicer in the amount of $2,388. This reduction in par
does not affect the Company's loss adjusted yield on this asset. During the
year ended 2002 certain delinquent loans in CMAC 98-C2 caused a temporary
shortfall of interest available to pay the non-rated security which shortfall
may not be recoverable. The Company expects the coupon to resume during the
first half of 2003. These types of shortfalls are expected to occur in
non-rated CMBS classes and therefore the Company currently does not believe
this is an impairment that requires a change in loss assumptions. Further
delinquencies and losses may cause the shortfall to continue and cause the
Company to conclude that a change in loss adjusted yield is required along
with a significant write down of the adjusted purchase price through the
income statement according to EITF 99-20. Also during 2002, the loan pools
were paid down by $128,344. Pay down proceeds are distributed to the highest
rated CMBS class first and reduce the percent of total underlying collateral
represented by each rating category.

For all of the Company's Controlling Class securities, the Company assumes
that 1.88% of the remaining current aggregate loan balance will not be
recoverable. This has not changed from the year ended 2001. This estimate was
developed based on an analysis of individual loan characteristics and
prevailing market conditions at the time of origination. This loss estimate
equates to cumulative expected defaults of

30

approximately 5% over the life of the portfolio and an average assumed loss
severity of 37.6% of the defaulted loan balance. All estimated workout
expenses including special servicer fees are included in these assumptions.
Actual results could differ materially from these estimated results. See Item
7A -"Quantitative and Qualitative Disclosures About Market Risk" for a
discussion of how differences between estimated and actual losses could affect
Company earnings.

The Company monitors credit performance on a monthly basis and debt service
coverage ratios on a quarterly basis. Using these and other statistics, the
Company maintains watch lists for loans that are delinquent thirty days or
more and for loans that are not delinquent but have issues that the Company
feels require close monitoring. The Company plans to perform a detailed
re-underwriting of a substantial number of the underlying loans supporting its
Controlling Class CMBS within the next 18 months. Upon completion, the
Company may determine that its GAAP yields and book values need to be
adjusted.

The Company considers delinquency information from the Lehman Brothers Conduit
Guide to be the most relevant measure of credit performance and market
conditions applicable to its Controlling Class CMBS holdings. The year of
issuance, or vintage year, is important, as older loan pools will tend to have
more delinquencies than newly underwritten loans. The Company owns Controlling
Class CMBS issued in 1998, 1999 and 2001. Comparable delinquency statistics
referenced by vintage year as a percentage of par outstanding as of December
31, 2002 are shown in the table below:

Morgan Stanley also tracks CMBS loan delinquencies for the specific CMBS
transactions with more than $200,000 of collateral and that have been seasoned
for at least one year. This seasoning criterion will generally adjust for the
lower delinquencies that occur in newly originated collateral. As of December
31, 2001, the Morgan Stanley index indicated that delinquencies on 174
securitizations was 1.85%, and as of December 31, 2002, this same index
indicated that delinquencies on 204 securitizations was 2.01%. See Item 7A -
"Quantitative and Qualitative Disclosures About Market Risks" for a detailed
discussion of how delinquencies and loan losses affect the Company.

Delinquencies on the Company's CMBS collateral as a percent of principal
increased in line with expectations. The Company's aggregate delinquency
experience is consistent with comparable data provided in the Lehman Brothers
Conduit Guide.

Of the 36 delinquent loans shown on the chart in Note 2 of the consolidated
financial statements, one was delinquent due to technical reasons, six were
Real Estate Owned (REO) and being marketed for sale, three were in
foreclosure, and the remaining 26 loans were in some form of workout
negotiations. Aggregate realized losses of $6,141 were realized in the fourth
quarter of 2002. This brings cumulative net losses

31

realized to $9,149, which is 5.1% of total estimated losses. These losses
include special servicer and other workout expenses. This experience to date
is in line with the Company's loss expectations. Realized losses are expected
to increase on the underlying loans as the portfolio ages. Special servicer
expenses are also expected to increase as portfolios mature and US economic
activity remains weak.

The Company manages its credit risk through disciplined underwriting,
diversification, active monitoring of loan performance and exercise of its
right to control the workout process as early as possible. The Company
maintains diversification of credit exposures through its underwriting process
and can shift its focus in future investments by adjusting the mix of loans in
subsequent acquisitions. The comparative profiles of the loans underlying the
Company's CMBS by property type as of December 31, 2002 and for the two prior
years is as follows:

As of December 31, 2002, the fair market value of the Company's holdings of
CMBS is $60,738 lower than the adjusted cost for these securities. Except for
the writedown of the FMACT bond, this decline in the value of the investment
portfolio represents market valuation changes and is not due to actual credit
experience or credit expectations. The adjusted purchase price of the
Company's Controlling Class CMBS portfolio as of December 31, 2002 represents
approximately 64% of its par amount. The market value of the Company's
Controlling Class CMBS portfolio as of December 31, 2002 represents
approximately 54% of its par amount. As the portfolio matures, the Company
expects to recoup the unrealized loss, provided that the credit losses
experienced are not greater than the credit losses assumed in the purchase
analysis. As of December 31, 2002, the Company believes there has been no
material deterioration in the credit quality of its portfolio below original
expectations.

As the portfolio matures and expected losses occur, subordination levels of
the lower rated classes of a CMBS investment will be reduced. This may cause
the lower rated classes to be downgraded which would negatively affect their
market value and therefore the Company's net asset value. Reduced market value
will negatively affect the Company's ability to finance any such securities
that are not financed through a CDO or similar matched funding vehicle. In
some cases, securities held by the Company may be upgraded to reflect
seasoning of the underlying collateral and thus would increase the market
value of the securities.

The Company's GAAP income for its CMBS securities is computed based upon a
yield which assumes credit losses would occur. The yield to compute the
Company's taxable income does not assume there would be credit losses, as a
loss can only be deducted for tax purposes when it has occurred. As a result,
for the years 1998 through December 31, 2002, the Company's GAAP income
accrued on its CMBS assets

32

was approximately $19,650 lower than the taxable income accrued on the CMBS
assets.

The FMACT 1998-BA class B security continues to perform poorly. Based on the
information provided by the trustee, as of December 16, 2002, of the 71
borrowers in the loan pool underlying this security, there are 8 borrowers
with loans in the amount of $36,741 which are in default, 10 borrowers with
loans in the amount of $23,722 which are delinquent, and 53 borrowers with
loans in the amount of $135,292 which are current. During the fourth quarter
of 2002, the servicer of the underlying loans recouped principal and interest
advances made in prior years. This action resulted, at least temporarily, in
insufficient cash being available to make the payments required on the
Company's class B security.

Based on the delinquencies and defaults in the underlying pools, and the
missed payments during the fourth quarter of 2002 as described above, the
Company revised its estimated future cash flows from this investment.
Accordingly, in accordance with EITF 99-20, the Company determined that its
investment was impaired and wrote down the adjusted purchase price of this
security by $10,273 to its estimated fair value and increased the GAAP yield
from 7.69% to a market yield for a security of this credit quality, estimated
to be 20%. These figures incorporate the assumption that an additional $31,203
of losses will be experienced by the underlying pools and an estimate of
another 1.0% of losses per year over the remaining life of the trust. This
security was part of the CORE Cap acquisition in May of 2000 and was rated AA
at that time. This security is currently rated D by Standard & Poors and CC by
Fitch Ratings.

Commercial Real Estate Loan Activity

The Company's commercial real estate loan portfolio generally emphasizes
larger transactions located in metropolitan markets, as compared to the
typical loan in the CMBS portfolio. There are no delinquencies in the
Company's commercial real estate loan portfolio which is relatively small and
heterogeneous. The Company has determined it is not necessary to establish a
loan loss reserve.

The following table summarizes the Company's commercial real estate loan
portfolio by property type as of December 31, 2002, 2001 and 2000:

Recent Events

Included in CDO II was a ramp facility that will be utilized to fund the
purchase of $50,000 of par of below investment grade CMBS. On March 14, 2003,
the Company purchased $78,027 par of securities in

33

CSFB 2003-CPN1. Of this purchase, $30,000 par will be contributed into the
ramp facility for CDO II, and $48,027 will be held outside of CDO II.

On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement are similar to the
prior agreement except for the incentive fee calculation which would provide
for a rolling four-quarter high watermark rather than a quarterly calculation.
In determining the rolling four-quarter high watermark, the Company would
calculate the incentive fee based upon the current and prior three quarters'
net income. The Manager would be paid an incentive fee in the current quarter
if the Yearly Incentive Fee is greater than what was paid to the Manager in
the prior three quarters cumulatively. The Company will phase in the rolling
four-quarter high watermark commencing with the second quarter of 2003.
Calculation of the incentive fee will be based on GAAP and adjusted to exclude
special one-time events pursuant to changes in GAAP accounting pronouncements
after discussion between the Manager and the unaffiliated directors. The
incentive fee threshold did not change. The high watermark will be based on
the existing incentive fee hurdle, which provides for the Manager to be paid
25% of the amount of earnings (calculated in accordance with GAAP) per share
that exceeds the product of the adjusted issue price of the Company's common
stock per share ($11.39 as of December 31, 2002) and the greater of 9.5% or
350 basis points over the ten-year Treasury note.

On February 6, 2003, the Company funded a capital call notice from Carbon in
the amount of $2,680. This was used by Carbon to acquire a mezzanine loan
secured by ownership interests in an entity that owns a mixed-use development.

In January 2003, the par for two of the Company's Controlling Class CMBS was
written down by the servicer in the aggregate amount of $4,284. This reduction
in par does not affect the Company's loss adjusted yield on this asset.

In January 2003, the Company's $200,000 financing facility with Merrill Lynch
Mortgage Capital, Inc. expired pursuant to its terms. There was no balance
owing at the expiration.

Critical Accounting Policies

Management's discussion and analysis of financial condition and results of
operations is based on the amounts reported in the Company's consolidated
financial statements. These financial statements are prepared in accordance
with GAAP. In preparing the financial statements, management is required to
make various judgments, estimates and assumptions that affect the reported
amounts. Changes in these estimates and assumptions could have a material
effect on the Company's consolidated financial statements. The following is a
summary of the Company's accounting policies that are the most affected by
management judgments, estimates and assumptions:

Securities Available for Sale

The Company has designated its investments in mortgage-backed securities,
mortgage-related securities and certain other securities as available for
sale. Securities available for sale are carried at estimated fair value with
the net unrealized gains or losses reported as a component of accumulated
other

34

comprehensive income (loss) in stockholders' equity. Many of these investments
are relatively illiquid, and their values must be estimated by management. In
making these estimates, management generally utilizes market prices provided
by dealers who make markets in these securities, but may, under certain
circumstances, adjust these valuations based on management's judgment. Changes
in the valuations do not affect the Company's reported income or cash flows,
but impact stockholders' equity and, accordingly, book value per share.

Management must also assess whether unrealized losses on securities reflect a
decline in value which is other than temporary, and, accordingly, write the
impaired security down to its fair value, through earnings. Significant
judgment of management is required in this analysis which includes but is not
limited to making assumptions regarding the collectibility of the principal
and interest, net of related expenses, on the underlying loans.

Income on these securities is recognized based upon a number of assumptions
that are subject to uncertainties and contingencies. Examples of these
include, among other things, the rate and timing of principal payments
(including prepayments, repurchases, defaults and liquidations), the
pass-through or coupon rate and interest rate fluctuations. Additional factors
that may affect the Company's reported interest income on its mortgage
securities include interest payment shortfalls due to delinquencies on the
underlying mortgage loans, and the timing and magnitude of credit losses on
the mortgage loans underlying the securities that are a result of the general
condition of the real estate market (including competition for tenants and
their related credit quality) and changes in market rental rates. These
uncertainties and contingencies are difficult to predict and are subject to
future events which may alter the assumptions.

The Company adopted EITF 99-20, "Recognition of Interest Income and Impairment
on Purchased and Retained Beneficial Interests in Securitized Financial
Assets" on April 1, 2001. The Company recognizes interest income from its
purchased beneficial interests in securitized financial interests ("beneficial
interests") (other than beneficial interests of high credit quality,
sufficiently collateralized to ensure that the possibility of credit loss is
remote, or that cannot contractually be prepaid or otherwise settled in such a
way that the Company would not recover substantially all of its recorded
investment) in accordance with this guidance. Accordingly, on a quarterly
basis, when significant changes in estimated cash flows from the cash flows
previously estimated occur due to actual prepayment and credit loss
experience, the Company calculates a revised yield based on the current
amortized cost of the investment (including any other-than-temporary
impairments recognized to date) and the revised cash flows. The revised yield
is then applied prospectively to recognize interest income.

Prior to April 1, 2001, the Company recognized income from these beneficial
interests using the effective interest method, based on an anticipated yield
over the projected life of the security. Changes in the anticipated yields
were calculated due to revisions in the Company's estimates of future and
actual credit losses and prepayments. Changes in anticipated yields resulting
from credit loss and prepayment revisions were recognized through a cumulative
catch-up adjustment at the date of the change which reflected the change in
income from the security from the date of purchase through the date of change
in the anticipated yield. The new yield was then used prospectively to account
for interest income. Changes in yields from reduced estimates of losses were
recognized prospectively.

For other mortgage-backed and related mortgage securities, the Company
accounts for interest income

35

under SFAS 91, using the effective yield method which includes the
amortization of discount or premium arising at the time of purchase and the
stated or coupon interest payments.

As a result of the pending closing of CDO I, at the end of the first quarter
2002 the Company reclassified all of its subordinated CMBS on the balance
sheet from available-for-sale to held-to-maturity. The effect of this
reclassification changed the accounting basis of these securities,
prospectively, from mark to market to adjusted cost. However, in accordance
with SFAS 133, the interest rate swap agreements entered into by the Company
to hedge the variable rate exposure of the debt of CDO I are required to be
presented on the balance sheet at their fair market value. Accordingly, the
Company has determined that at December 31, 2002, and going forward, it will
classify all of its subordinated CMBS as available-for-sale securities and
record them at fair market value. This is consistent with the mark to market
requirement for the CDO's interest rate swap agreements.

The reclassification of these securities to available-for-sale from
held-to-maturity increased the recorded value of these securities from
$558,522 to $610,713 with the difference being recorded in other comprehensive
income. The circumstance causing the Company to change this classification was
not considered a permitted circumstance as stated in Statement of Financial
Accounting Standard (SFAS) No. 115, "Accounting for Certain Investments in
Debt and Equity Securities", and is therefore inconsistent with the Company's
intent regarding its held-to-maturity classification. Accordingly, the Company
will be prohibited from classifying its subordinated CMBS (current holdings as
well as future purchases) as held-to-maturity for a period of two years.

Securities Held for Trading

The Company has designated certain other securities as held for trading.
Securities held for trading are also carried at estimated fair value, but
changes in fair value are included in income. The valuations of these
securities and the interest income recognized are subject to the same
uncertainties as those discussed above.

Mortgage Loans

The Company purchases and originates commercial mortgage loans to be held as
long-term investments. The Company also has an investment in a private
opportunity fund which invests in commercial mortgage loans and is managed by
the Manager. Management must periodically evaluate each of these loans for
possible impairment. Impairment is indicated when it is deemed probable that
the Company will not be able to collect all amounts due according to the
contractual terms of the loan. If a loan is determined to be impaired, the
Company would establish a reserve for probable losses and a corresponding
charge to earnings. Given the nature of the Company's loan portfolio and the
underlying commercial real estate collateral, significant judgment of
management is required in determining impairment and the resulting loss
allowance which includes but is not limited to making assumptions regarding
the value of the real estate which secures the mortgage loan. To date, the
Company has determined that no loss allowances have been necessary on the
loans in its portfolio or held by the opportunity fund.

Real Estate Joint Ventures

The Company makes investments in real estate entities over which the Company
exercises significant influence, but not control. The real estate held by such
entities must be regularly reviewed for

36

impairment, and would be written down to its estimated fair value, through
earnings, if impairment is determined to exist. This review involves
assumptions about the future operating results of the real estate and market
factors, all of which are subjective and difficult to predict. To date, the
Company has determined that none of the real estate held by its joint ventures
is impaired.

Derivative Instruments

The Company utilizes various hedging instruments (derivatives) to hedge
interest rate and foreign currency exposures or to modify the interest rate or
foreign currency characteristics of related Company investments. All
derivatives are carried at fair value, generally estimated by management based
on valuations provided by the counterparty to the derivative contract. For
accounting purposes, the Company's management must decide whether to designate
these derivatives as hedging borrowings, securities available for sale,
securities held for trading or foreign currency exposure. This designation
decision affects the manner in which the changes in the fair value of the
derivatives are reported.

Deferred Financing

The deferred financing cost which is included in other assets on the Company's
Consolidated Statements of Financial Condition include issuance costs related
to the Company's debt and are amortized using the straight line method which
method is similar to the results of the effective interest method.

Impairment - Securities

In accordance with SFAS 115, when the estimated fair value of the security
classified as available-for-sale has been below amortized cost for a
significant period of time and the Company concludes that it no longer has the
ability or intent to hold the security for the period of time over which the
Company expects the values to recover to amortized cost, the investment is
written down to its fair value. The resulting charge is included in income,
and a new cost basis established. Additionally, under EITF 99-20, when
significant changes in estimated cash flows from the cash flows previously
estimated occur due to actual prepayment and credit loss experience, and the
present value of the revised cash flows using the current expected yield is
less than the present value of the previously estimated remaining cash flows
(adjusted for cash receipts during the intervening period), an
other-than-temporary impairment is deemed to have occurred. Accordingly, the
security is written down to fair value with the resulting change being
included in income, and a new cost basis established. In both instances, the
original discount or premium is written off when the new cost basis is
established.

After taking into account the effect of the impairment charge, income is
recognized under EITF 99-20 or SFAS 91, as applicable, using the market yield
for the security used in establishing the write-down.

Recent Accounting Pronouncements

In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangible Assets". These standards change the
accounting for business combinations by, among other things, prohibiting the
prospective use of pooling-of-interests accounting and requiring companies to
stop amortizing goodwill and certain intangible assets with indefinite useful
lives. Instead, goodwill and intangible assets deemed to have indefinite
useful lives will be subject to an annual review for impairment.

37

The new standards were effective for the Company in the first quarter of 2002.
Upon adoption of SFAS No. 142 in the first quarter of 2002, the Company
recorded a one-time, noncash adjustment of approximately $6,327 to write off
the unamortized balance of its negative goodwill. Such charge is
non-operational in nature and is reflected as a cumulative effect of an
accounting change in the accompanying consolidated statement of operations.
Amortization of negative goodwill was $1,942 and $1,062 for the years ended
December 31, 2001 and 2000, respectively.

In August of 2001, the FASB issued SFAS No, 143, "Accounting for Asset
Retirement Obligations" (effective January 1, 2003) and SFAS No. 144,
"Accounting for the Impairment or Disposal of Long Lived Assets" (effective
January 1, 2002). SFAS No. 143 requires the recording of the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred. SFAS No. 144 supercedes existing accounting literature dealing with
impairment and disposal of long-lived assets, including discontinued
operations. It addresses financial accounting and reporting for the impairment
of long-lived assets and for long-lived assets to be disposed of , and expands
current reporting for discontinued operations to include disposals of a
"component" of an entity that has been disposed of or is classified as held
for sale. The Company has determined that these Interpretations do not have a
significant impact on the Company's consolidated financial statements.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." The Interpretation elaborates on the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees that it has issued. It also clarifies
that a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. This Interpretation does not prescribe a specific approach for
subsequently measuring the guarantor's recognized liability over the term of
the related guarantee. The disclosure provisions of this Interpretation are
effective for the Company's December 31, 2002 consolidated financial
statements. The initial recognition and initial measurement provisions of this
Interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. The Company has determined that this
Interpretation does not currently impact the Company's consolidated financial
statements.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123." SFAS No. 148 amends SAFS No. 123 to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, the statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting
for stock-based compensation and the effect of the method used on reported
results. The Company has determined that this Interpretation does not
currently impact the Company's consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities ("FIN 46")." This Interpretation clarifies the
application of existing accounting pronouncements to certain entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support from other
parties. The provisions of the Interpretation will be immediately effective
for all variable interests in variable interest entities created after January
31, 2003. The Company will need to apply this Interpretation to any existing
variable interests in variable interest entities by no later than July 1,

38

2003. The Company is in the process of evaluating all of its investments and
other interests in entities that may be deemed variable interest entities
under the provisions of FIN 46. These include interests in commercial mortgage
backed securities and their issuers that have issued securities with a total
face value of $9,616,797. The Company's actual loss is limited to the amounts
that are not financed in its non recourse CDOs. The fair value of the
securities financed in the CDOs is $460,210; the amount held outside of the
CDOs is $142,496. The Company's believes that many of these interests and
entities will not be consolidated, and may not ultimately fall under the
provisions of FIN 46. The Company cannot make any definitive conclusion until
it completes its evaluation.

Results of Operations

Net income for the year ended December 31, 2002 was $59,995, or $1.18 per
share ($1.18 diluted). Net income for the year ended December 31, 2001 was
$56,271, or $1.41 per share ($1.35 diluted). Net income for the year ended
December 31, 2000 was $39,326, or $1.37 per share ($1.28 diluted). The
increase in income in both 2002 from 2001 and 2001 from 2000 is primarily due
to the reduction in short-term rates and accretive reinvestment of new
capital.

Interest Income: The following table sets forth information regarding the
total amount of income from certain of the Company's interest-earning assets
and the resulting average yields. Information is based on monthly average
adjusted cost basis during the period.

In addition to the foregoing, the Company earned $1,044, $1,667 and $348 in
earnings from real estate joint ventures during the years ended December 31,
2002, 2001 and 2000, respectively; $1,202 and $80 in earnings from an equity
investment in 2002 and 2001, respectively; and $25 in earnings from U.S.
Treasury securities in the 2000.

Interest Expense: The following table sets forth information regarding the
total amount of interest expense from certain of the Company's collateralized
borrowings. Information is based on daily average balances during the period;
the Collateralized debt obligations for the year ended December 31, 2002
includes the cost of hedging those transactions.

40

The foregoing interest expense amounts for the year ended December 31, 2002
does not include $(236) of hedge ineffectiveness, as well as $13,778 of
interest expense related to swaps outside of the CDOs. The foregoing interest
expense amounts for the year ended December 31, 2001 does not include $428 of
hedge ineffectiveness, as well as $5,643 of interest expense related to swaps.
See Note 13 of the consolidated financial statements, Derivative Instruments,
for further description of the Company's hedge ineffectiveness.

Net Interest Margin and Net Interest Spread from the Portfolio: The Company
considers its portfolio to consist of its securities available for sale,
mortgage loan pools, commercial mortgage loans and cash and cash equivalents
because these assets relate to its core strategy of acquiring and originating
high yield loans and securities backed by commercial real estate, while at the
same time maintaining a portfolio of investment grade securities to enhance
the Company's liquidity.

Net interest margin from the portfolio is annualized net interest income from
the portfolio divided by the average market value of interest-earning assets
in the portfolio. Net interest income from the portfolio is total interest
income from the portfolio less interest expense relating to collateralized
borrowings. Net interest spread from the portfolio equals the yield on average
assets for the period less the average cost of funds for the period. The yield
on average assets is interest income from the portfolio divided by average
amortized cost of interest earning assets in the portfolio. The average cost
of funds is interest expense from the portfolio divided by average outstanding
collateralized borrowings.

The following chart describes the interest income, interest expense, net
interest margin and net interest spread for the Company's portfolio. The
following interest income and interest expense amounts exclude income and
expense related to real estate joint ventures, equity investment and hedge
ineffectiveness.

Other Expenses: Expenses other than interest expense consist primarily of
management fees and general and administrative expenses. Management fees paid
to the Manager of $12,527 for the year ended December 31, 2002 were comprised
of base management fees of $9,332 and incentive fees of $3,195. Management
fees paid to the Manager of $11,018 for the year ended December 31, 2001 were
comprised of base management fees of $7,780 and incentive fees of $3,238.
Management fees paid to the Manager of $7,450 for the year ended December 31,
2000 were comprised of base management fees of $6,483 and incentive fees of
$967. Other expenses/income-net of $2,323 for the year ended December 31,
2002, $1,717 for the year ended December 31, 2001 and $2,277 for the year
ended December 31, 2000 were comprised of accounting agent fees, custodial
agent fees, directors' fees, fees for professional services, insurance
premiums, broken deal expenses and due diligence costs. Other
expenses/income-net for the years ended 2001 and 2000 also includes the
amortization of negative goodwill.

41

Other Gains (Losses): During the year ended December 31, 2002, the Company
sold a portion of its securities available for sale for total proceeds of
$1,017,534, resulting in a realized gain of $11,391. During the year ended
December 31, 2001, the Company sold a portion of its securities available for
sale for total proceeds of $1,452,577, resulting in a realized gain of $7,401.
During the year ended December 31, 2000, the Company sold a portion of its
securities available for sale for total proceeds of $3,176,357, resulting in a
realized gain of $3,212. The (loss) on securities held for trading of
$(29,255), $(2,604) and $(647) for the years ended December 31, 2002, 2001,
and 2000, respectively, consisted primarily of realized and unrealized gains
and losses on U.S. Treasury and Agency Securities, forward commitments to
purchase or sell agency RMBS and financial futures contracts. The foreign
currency loss of $812, $5 and $42 for the years ended December 31, 2002, 2001
and 2000, respectively, relates to the Company's net investment in a
commercial mortgage loan denominated in pounds sterling and associated
hedging.

Dividends Declared: During the year ended December 31, 2002, the Company
declared dividends to stockholders totaling $65,368, or $1.40 per share, of
which $48,779 was paid during the year and $16,589 was paid on January 31,
2003. On March 6, 2003, the Company declared dividends to its stockholders of
$0.35 per share, payable on April 30, 2003 to stockholders of record on March
31, 2003. During the year ended December 31, 2001, the Company declared
dividends to stockholders totaling $47,458 or $1.29 per share. During the year
ended December 31, 2000, the Company declared dividends to stockholders
totaling $27,591 or $1.17 per share. For U.S. Federal income tax purposes, the
dividends are ordinary income to the Company's stockholders.

Tax Basis Net Income and GAAP Net Income: Net income as calculated for tax
purposes (tax basis net income) was estimated at $76,000 or $1.53 ($1.52
diluted) per share, for the year ended December 31, 2002, compared to a net
income as calculated in accordance with GAAP of $59,955, or $1.18 ($1.18
diluted) per share.

Tax basis income was $53,046, or $1.31 ($1.26 diluted) per share, for the year
ended December 31, 2001, compared to a net income as calculated in accordance
with GAAP of $56,271, or $1.41 ($1.35 diluted) per share. Tax basis income was
$37,594, or $1.29 ($1.22 diluted) per share, for the year ended December 31,
2000, compared to a net income as calculated in accordance with GAAP of
$39,326, or $1.37 ($1.28 diluted) per share.

Differences between tax basis net income and GAAP net income arise for various
reasons. For example, in computing income from its subordinated CMBS for GAAP
purposes, the Company takes into account estimated credit losses on the
underlying loans, whereas for tax basis income purposes, only actual credit
losses are taken into account. Certain general and administrative expenses may
differ due to differing treatment of the deductibility of such expenses for
tax basis income. Also, differences could arise in the treatment of premium
and discount amortization on the Company's securities available for sale.

Changes in Financial Condition

Securities Available for Sale: The Company's securities available for sale,
which are carried at estimated fair value, included the following at December
31, 2002 and December 31, 2001:

42

December 31, 2002 December 31, 2001
Estimated Estimated
Fair Fair
Security Description Value Percentage Value Percentage
-------------------------------------------------------------------------------------------------------------------------------

Commercial mortgage-backed securities:
CMBS IOs $43,634 4.5% $ 79,204 5.5%
Investment grade CMBS 55,120 5.7 14,590 1.0
Non-investment grade rated subordinated securities 577,371 59.3 328,532 22.7
Non-rated subordinated securities 25,335 2.7 31,627 2.2
Credit tenant lease 9,063 0.9 - -
Investment grade REIT debt 183,822 18.9 51,386 3.5
---------- ------------------ ------------------- -----------------
Total CMBS $894,345 92.0 $505,339 34.9
---------- ------------------ ------------------- -----------------

Single-family residential mortgage-backed securities:
Agency adjustable rate securities 41,299 4.2 75,035 5.2
Agency fixed rate securities 8,833 0.9 804,759 55.7
Residential CMOs 13,834 1.4 33,522 2.3
Home equity loans - - 27,299 1.9
Hybrid arms 14,751 1.5 - -
---------- ------------------ ------------------- -----------------
Total RMBS $78,717 8.0 $940,615 65.1
---------- ------------------ ------------------- -----------------

---------- ------------------ ------------------- -----------------
Total securities available for sale $973,062 100.0% $ 1,445,954 100.0%
========== ================== =================== =================

The increase in the CMBS and REIT debt is attributable to the attractive
opportunities available to the Company to match fund these assets in its two
CDOs.

Borrowings: As of December 31, 2002, the Company's debt consisted of
line-of-credit borrowings, CDO debt, term loans and reverse repurchase
agreements, collateralized by a pledge of most of the Company's securities
available for sale, securities held for trading and its commercial mortgage
loans. As of December 31, 2001, the Company's debt consisted of line-of-credit
borrowings, term loans and reverse repurchase agreements, collateralized by a
pledge of most of the Company's securities available for sale, securities held
for trading and its commercial mortgage loans. The Company's financial
flexibility is affected by its ability to renew or replace on a continuous
basis its maturing short-term borrowings. As of December 31, 2002 and 2001,
the Company has obtained financing in amounts and at interest rates consistent
with the Company's short-term financing objectives.

Under the lines of credit, term loans and the reverse repurchase agreements,
the lender retains the right to mark the underlying collateral to market
value. A reduction in the value of its pledged assets would require the
Company to provide additional collateral or fund margin calls. From time to
time, the Company expects that it will be required to provide such additional
collateral or fund margin calls. Most of the Company's reverse repurchase
agreements are collateralized by highly liquid RMBS which can be readily
liquidated.

43

The following table sets forth information regarding the Company's
collateralized borrowings:

For the Year Ended
December 31, 2002
-------------------------------------------------------------
December 31, 2002 Maximum Range of
Balance Balance Maturities
--------------------------------------------------------------

CDO debt* $ 684,590 $684,590 8.9 to 10.7 years
Reverse repurchase agreements 1,457,882 1,929,216 3 to 27 days
Line of credit and term loan borrowings 19,189 165,993 211 to 927 days
---------------------------------------------------------------

* Disclosed as adjusted issue price. Total par of CDO debt as of December 31,
2002 is $699,924.

For the Year Ended
December 31, 2001
-----------------------------------------------------------------
December 31, 2001 Maximum Range of
Balance Balance Maturities
-----------------------------------------------------------------

Reverse repurchase agreements $1,717,326 $1,771,596 7 to 35 days
Line of credit and term loan borrowings 118,612 206,278 15 to 830 days
=================================================================

Hedging Instruments: From time to time, the Company may reduce its exposure to
market interest rates by entering into various financial instruments that
adjust portfolio duration. These financial instruments are intended to
mitigate the effect of changes in interest rates on the value of certain
assets in the Company's portfolio. At December 31, 2002, the Company had
outstanding short positions of 3,166 five-year and 1,126 ten-year U.S.
Treasury Note future contracts. At December 31, 2001, the Company had
outstanding short positions of 80 thirty-year U.S. Treasury Bond futures, 500
ten-year U.S. Treasury Note future contracts and a short call swaption with a
notional amount of $400,000.

Interest rate swap agreements as of December 31, 2002 and December 31, 2001
consisted of the following:

December 31, 2002

Weighted
National Estimated Unamortized Average
Value Fair Value Cost Remaining Term

Interest rate swaps 489,000 (11,948) 0 1.79 years
Interest rate swaps - CDO 673,832 (33,654) 0 9.60 years
-------------------------------------------------------------
Total 1,162,832 (45,602) 0 6.31 years
=============================================================

44

December 31, 2001

Weighted
National Estimated Unamortized Average
Value Fair Value Cost Remaining Term

Interest rate swaps ($792,000) ($9,380) $4,764 8.12 years

As of December 31, 2002, the Company had designated $791,287 notional of the
interest rate swap agreements as cash flow hedges. As of December 31, 2001,
the Company had designated $682,000 of the interest rate swap agreements as
cash flow hedges of borrowings under reverse repurchase agreements.

Capital Resources and Liquidity

Liquidity is a measurement of the Company's ability to meet cash requirements,
including ongoing commitments to repay borrowings, fund investments, loan
acquisition and lending activities and for other general business purposes.
The primary sources of funds for liquidity consist of collateralized
borrowings, principal and interest payments on and maturities of securities
available for sale, securities held for trading and commercial mortgage loans,
and proceeds from the maturity or sales thereof.

The Company finances itself with its own equity, follow-on equity offerings,
preferred stock offerings, secured term debt, committed financing facilities
and reverse repurchase agreements. An important part of the Company's risk
analysis includes a thorough assessment of the financing alternatives in the
context of the assets being financed.

Reverse repurchase agreements are secured loans generally with a term of 30
days. The interest rate is based on 30-day LIBOR plus a spread that is
determined based on the asset pledged as security. The terms include a daily
mark to market provision that requires the posting of additional collateral if
the value of the pledged asset declines. After the 30-day period expires,
there is no obligation for the lender to extend credit for an additional
period. This type of financing is generally available only for more liquid
securities. The interest rate charged on reverse repurchase agreements is
usually the lowest relative to the alternatives due to the greater risk
inherent in these transactions.

Committed financing facilities represent multi-year agreements to provide
secured financing for a specific asset class. These facilities include a daily
mark to market provision requiring posting of additional collateral if the
value of the pledged asset declines. A significant difference between
committed financing facilities and reverse repurchase agreements is the term
of the financing. A committed facility provider is generally required to
provide financing for the full term of the agreement, usually two to three
years, rather than thirty days generally used in the reserve repurchase
market. This feature makes the financing of less liquid assets more viable.

Issuance of secured term debt is generally done through a collateralized debt
obligation offering. This entails creating a special purpose entity that holds
assets used to secure the cashflow payments required of the debt issued. As
this transaction is considered a financing, the SPE is fully consolidated on
the Company's consolidated financial statements. Asset cashflows are generally
matched with the debt cashflows over their respective lives and an interest
rate swap is used to match the fixed or floating rate nature of the coupon
payments where necessary. This type of transaction is usually referred to as
"match funding" or "term financing". There is no mark to market requirement in
this structure and the debt cannot

45

be called or terminated by the bondholders. Furthermore, the debt issued is
non-recourse to the issuer so permanent reductions in value do not affect the
liquidity of the Company. However, since the Company expects to earn a positive
spread between the income generated by the assets and the expense of the debt
issued, a permanent impairment of any of the assets would negatively affect the
spread over time.

The Company may issue preferred stock from time to time as a source of long
term or permanent capital. Preferred stock generally has a fixed coupon and
may have a fixed term in the form of a maturity date or other redemption or
conversion feature. The preferred stockholder typically has the right to a
preferential distribution for dividends and any liquidity proceeds.

Another source of permanent capital is the issuance of common stock through a
follow-on offering. This allows investors to purchase a large block of common
stock in one transaction. A common stock issuance can be accretive to the
Company's per share book value if the issue price exceeds the book value of
the Company's assets. It can also be accretive to earnings per share if the
Company deploys the new capital into assets that generate a risk adjusted
return that exceeds the return of the Company's existing assets. Furthermore,
earnings accretion can be achieved at reinvestment rates that are lower than
the return on existing assets if common stock can be issued at a premium to
book value.

The Company continuously evaluates the market for follow-on common stock
offerings as well as the available opportunities to deploy new capital on an
accretive basis. During 2002, the Company did not issue any common stock in
follow-on equity offerings. In 2001, the Company issued 13,690,000 shares of
common stock in two follow-on offerings at an average price of $9.35 per
share.

Contingent Liability

On May 15, 2000, the Company completed the acquisition of CORE Cap, Inc. The
merger was a stock for stock acquisition where the Company issued 4,180,552
shares of its common stock and 2,261,000 shares of its series B preferred
stock. At the time of the CORE Cap acquisition, the Manager agreed to pay GMAC
(CORE Cap, Inc's external advisor) $12,500 over a ten-year period
("Installment Payment") to purchase the right to manage the assets under the
existing management contract ("GMAC Contract"). The GMAC Contract had to be
terminated in order to allow for the Company to complete the merger, as the
Company's management agreement with the Manager did not provide for multiple
managers. As a result the Manager offered to buy-out the GMAC contract as the
Manager estimated it would receive incremental fees above and beyond the
Installment Payment, and thus was willing to pay for, and separately
negotiate, the termination of the GMAC Contract. Accordingly, the value of the
Installment Payment was not considered in the Company's allocation of its
purchase price to the net assets acquired in the acquisition of CORE Cap, Inc.
The Company agreed that should the Management Agreement with its Manager be
terminated, not renewed or not extended for any reason other than for cause,
the Company would pay to the Manager an amount equal to the Installment
Payment less the sum of all payments made by the Manager to GMAC. As of
December 31, 2002, the Installment Payment would be $9,500 payable over eight
years. The Company does not accrue for this contingent liability.

Transactions with Affiliates

The Company has a Management Agreement with the Manager, a majority owned
indirect subsidiary of The PNC Financial Services Group, Inc. ("PNC Bank") and
the employer of certain directors and officers of the Company, under which the
Manager manages the Company's day-to-day operations, subject to the direction
and oversight of the Company's Board of Directors. The initial two-year term
of the Management Agreement was to expire on March 27, 2000; on March 16,
2000, the Management Agreement was extended for an additional two years, with
the approval of the unaffiliated directors, on terms similar to the

46

original agreement. On March 25, 2002, the Management Agreement was extended for
one year through March 27, 2003, with the approval of the unaffiliated
directors, on terms similar to the prior agreement with the following changes:
(i) the incentive fee calculation would be based on GAAP earnings instead of
funds from operations, (ii) the removal of the four-year period to value the
Management Agreement in the event of termination and (iii) subsequent renewal
periods of the Management Agreement would be for one year instead of two years.
The Board was advised by Houlihan Lokey Howard & Zukin Financial Advisors, Inc.,
a national investment banking and financial advisory firm, in the renewal
process.

On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement are similar to the
prior agreement except for the incentive fee calculation which would provide
for a rolling four-quarter high watermark rather than a quarterly calculation.
In determining the rolling four-quarter high watermark, the Company would
calculate the incentive fee based upon the current and prior three quarters'
net income. The Manager would be paid an incentive fee in the current quarter
if the Yearly Incentive Fee is greater than what was paid to the Manager in
the prior three quarters cumulatively. The Company will phase in the rolling
four-quarter high watermark commencing with the second quarter of 2003.
Calculation of the incentive fee will be based on GAAP and adjusted to exclude
special one-time events pursuant to changes in GAAP accounting pronouncements
after discussion between the Manager and the unaffiliated directors. The
incentive fee threshold did not change. The high watermark will be based on
the existing incentive fee hurdle, which provides for the Manager to be paid
25% of the amount of earnings (calculated in accordance with GAAP) per share
that exceeds the product of the adjusted issue price of the Company's common
stock per share ($11.39 as of December 31, 2002) and the greater of 9.5% or
350 basis points over the ten-year Treasury note.

The Company pays the Manager an annual base management fee equal to a
percentage of the average invested assets of the Company as defined in the
Management Agreement. The base management fee is equal to 1% per annum of the
average invested assets rated less than BB- or not rated, 0.75% of average
invested assets rated BB- to BB+, and 0.20% of average invested assets rated
above BB+. In order to coincide with the increased size of the Company,
effective July 1, 2001, the Manager reduced the base management fee from 0.35%
of average invested assets rated above BB+. This revision resulted in $2,360
and $1,059 in savings to the Company during 2002 and 2001, respectively.

The Company incurred $9,332, $7,780 and $6,483 in base management fees in
accordance with the terms of the Management Agreement for the years ended
December 31, 2002, 2001 and 2000, respectively. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements to
the Manager of $14, $216 and $120 for certain expenses incurred on behalf of
the Company during 2002, 2001 and 2000, respectively.

The Company has also paid the Manager on a quarterly basis, as incentive
compensation, an amount equal to 25% of the funds from operations of the
Company (as defined) plus gains (minus losses) from debt restructuring and
sales of property, before incentive compensation in excess of a threshold
rate. The threshold rate for 1999, 2000 and the six months ended June 30, 2001
was based upon an annualized return on equity equal to 3.5% over the ten-year
U.S. Treasury Rate on the adjusted issue price of the Common Stock. Effective
July 1, 2001, the Manager revised the threshold rate to be the greater of 3.5%
over the ten-year U.S. Treasury Rate or 9.5%. This revision resulted in $918
and $630 in savings to the Company during 2002 and 2001, respectively.

47

Pursuant to the March 25, 2002 one-year Management Agreement extension, such
incentive fee was based on 25% of earnings (calculated in accordance with
GAAP) of the Company. For purposes of the incentive compensation calculation,
equity is generally defined as proceeds from issuance of Common Stock before
underwriting discounts and commissions and other costs of issuance. For
purposes of calculating the incentive fee during 2002, the cumulative
transition adjustment of $6,327 resulting from the Company's adoption of SFAS
142 was excluded from earnings in its entirety and included using an
amortization period of three years. This revision saved the Company $1,314 of
incentive fee during 2002. The Company incurred $3,195, $3,238 and $967 in
incentive compensation for the years ended December 31, 2002, 2001 and 2000,
respectively.

On March 17, 1999, the Company's Board of Directors approved an administration
agreement with the Manager and the termination of a previous agreement with an
unaffiliated third party. Under the terms of the administration agreement, the
Manager provides financial reporting, audit coordination and accounting
oversight services to the Company. The Company pays the Manager a monthly
administrative fee at an annual rate of 0.06% of the first $125 million of
average net assets, 0.04% of the next $125 million of average net assets and
0.03% of average net assets in excess of $250 million subject to a minimum
annual fee of $120. For the years ended December 31, 2002, 2001 and 2000, the
Company paid administration fees of $168, $144 and $120, respectively.

During the year ended December 31, 2000, the Company purchased certificates
representing a 1% interest in Midland Commercial Mortgage Owner Trust IV,
Midland Commercial Mortgage Owner Trust V, Midland Commercial Mortgage Owner
Trust VI, Commercial Mortgage Owner Trust VII, PNC Loan Trust VII and PNC Loan
Trust VIII (collectively the "Trusts") for an aggregate investment of $7,021.
These Midland Trusts were purchased from Midland Loan Services, Inc.
("Midland") and the PNC trusts were purchased from PNC Bank. Midland is a
wholly-owned indirect subsidiary of PNC Bank and the depositor to the Trusts.
The assets of these Trusts consist of commercial mortgage loans originated or
acquired by Midland and PNC Bank. In connection with these transactions, the
Company entered into a $4,500 committed line of credit from PNC Funding Corp.,
a wholly-owned indirect subsidiary of PNC Bank, to borrow up to 90% of the
fair market value of the Company's interest in the Trusts. Outstanding
borrowings against this line of credit bear interest at a LIBOR based variable
rate. As of December 31, 2001 and 2000 there were no outstanding borrowings
under this line of credit. The Company earned $163 and $33 from the Trusts and
paid interest of approximately $138 and $20 to PNC Funding Corp. during years
ended December 31, 2000 and 1999, respectively. The Midland Trusts were all
sold prior to December 31, 2000. The gain on sale of these investments was not
significant.

In March 2001, the Company purchased twelve certificates each representing a
1% interest in different classes of Owner Trust NS I Trust ("Owner Trusts")
for an aggregate investment of $37,868. These certificates were purchased from
PNC Bank. The assets of the Owner Trusts consist of commercial mortgage loans
originated or acquired by an affiliate of PNC Bank. The Company entered into a
$50,000 committed line of credit from PNC Funding Corp. to borrow up to 95% of
the fair market value of the Company's interest in the Owner Trusts.
Outstanding borrowings against this line of credit bear interest at a LIBOR
based variable rate. As of December 31, 2001, there was $13,885 borrowed under
this line of credit. The Company earned $1,468 from the Owner Trusts and paid
interest of approximately $849 to PNC Funding Corp. as interest on borrowings
under a related line of

48

credit for year ended December 31, 2001. During 2001, the Company sold four
Owner Trusts. The gain on the sale of those Owner Trusts was $35. The
outstanding borrowings were repaid prior to the expiration of the line of credit
on March 13, 2002, at which time the remaining Owner Trusts were sold at a gain
of $90.

On July 20, 2001, the Company entered into a $50 million commitment to acquire
shares in Carbon. The period during which the Company may be required to
purchase shares under the commitment, expires in July 2004. On November 19,
2001, the Company received a capital call notice to fund $8,784 of its Carbon
investment, which was paid on November 19, 2001. On October 30, 2002, the
Company funded an additional capital call notice in the amount of $6,100. The
proceeds of the capital calls were primarily used by Carbon to acquire
commercial loans secured by real estate or ownership interests in entities
that own real estate. On December 31, 2001, the Company owned 32.5% of the
outstanding shares in Carbon. In March 2002, Carbon obtained additional
commitments from unaffiliated institutional investors while the Company's
commitment remained unchanged. Accordingly, the Company's ownership was
reduced from 32.5% to 18.8%. On December 30, 2002, the Company received
dividends from its investment of $1,089. The Company's remaining commitment at
December 31, 2002 and 2001 was $35,116 and $41,216, respectively. On February
6, 2003, the Company funded an additional capital call notice in the amount of
$2,680, which was used by Carbon to acquire a mezzanine loan secured by
ownership interests in an entity that owns a mixed-use development.

REIT Status: The Company has elected to be taxed as a REIT and therefore must
comply with the provisions of the Code with respect thereto. Accordingly, the
Company generally will not be subject to Federal income tax to the extent of
its distributions to stockholders and as long as certain asset, income and
stock ownership tests are met. The Company may, however, be subject to tax at
corporate rates or at excise tax rates on net income or capital gains not
distributed.

49

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk: Market risk is the exposure to loss resulting from changes in
interest rates, credit curve spreads, foreign currency exchange rates,
commodity prices and equity prices. The primary market risks to which the
Company is exposed are interest rate risk and credit curve risk. Interest rate
risk is highly sensitive to many factors, including governmental, monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the control of the Company. Credit risk is highly
sensitive to dynamics of the markets for commercial mortgage securities and
other loans and securities held by the Company. Excessive supply of these
assets combined with reduced demand will cause the market to require a higher
yield. This demand for higher yield will cause the market to use a higher
spread over the U.S. Treasury securities yield curve, or other benchmark
interest rates, to value these assets. Changes in the general level of the
U.S. Treasury yield curve can have significant effects on the market value of
the Company's portfolio.

The majority of the Company's assets are fixed rate securities valued based on
a market credit spread to U.S. Treasuries. As U.S. Treasury securities are
priced to a higher yield and/or the spread to U.S. Treasuries used to price
the Company's assets is increased, the market value of the Company's portfolio
may decline. Conversely, as U.S. Treasury securities are priced to a lower
yield and/or the spread to U.S. Treasuries used to price the Company's assets
is decreased, the market value of the Company's portfolio may increase.
Changes in the market value of the Company's portfolio may affect the
Company's net income or cash flow directly through their impact on unrealized
gains or losses on securities held for trading or indirectly through their
impact on the Company's ability to borrow. Changes in the level of the U.S.
Treasury yield curve can also affect, among other things, the prepayment
assumptions used to value certain of the Company's securities and the
Company's ability to realize gains from the sale of such assets. In addition,
changes in the general level of the LIBOR money market rates can affect the
Company's net interest income. The majority of the Company's liabilities are
floating rate based on a market spread to U.S. LIBOR. As the level of LIBOR
increases or decreases, the Company's interest expense will move in the same
direction.

The Company may utilize a variety of financial instruments, including interest
rate swaps, caps, floors and other interest rate exchange contracts, in order
to limit the effects of fluctuations in interest rates on its operations. The
use of these types of derivatives to hedge interest-earning assets and/or
interest-bearing liabilities carries certain risks, including the risk that
losses on a hedge position will reduce the funds available for payments to
holders of securities and, that such losses may exceed the amount invested in
such instruments. A hedge may not perform its intended purpose of offsetting
losses or increased costs. Moreover, with respect to certain of the
instruments used as hedges, the Company is exposed to the risk that the
counterparties with which the Company trades may cease making markets and
quoting prices in such instruments, which may render the Company unable to
enter into an offsetting transaction with respect to an open position. If the
Company anticipates that the income from any such hedging transaction will not
be qualifying income for REIT income test purposes, the Company may conduct
part or all of its hedging activities through a to-be-formed corporate
subsidiary that is fully subject to federal corporate income taxation. The
profitability of the Company may be adversely affected during any period as a
result of changing interest rates.

The following tables quantify the potential changes in the Company's net
portfolio value and net interest income under various interest rates and
credit-spread scenarios. The Company views the probability of

50

interest rate changes in terms of standard deviation units. Based on historical
data, there is a 68% and 95% statistical probability that rates remained in a
range of one and two standard deviation units, respectively. This statistical
computation provides an historical context for analyzing changes in interest
rates. Net portfolio value is defined as the value of interest-earning assets
net of the value of interest-bearing liabilities. It is evaluated using an
assumption that interest rates, as defined by the U.S. Treasury yield curve,
increase or decrease and the assumption that the yield curves of the rate shocks
will be parallel to each other. One standard deviation of ten-year treasury
rates for calendar year 2002 was 53 basis points.

Net interest income is defined as interest income earned from interest-earning
assets net of the interest expense incurred by the interest bearing
liabilities. It is evaluated using the assumptions that interest rates, as
defined by the U.S. LIBOR curve, increase or decrease and the assumption that
the yield curves of the LIBOR rate shocks will be parallel to each other.
Market value in this scenario is calculated using the assumption that the U.S.
Treasury yield curve remains constant. One standard deviation of one-month
LIBOR for calendar year 2002 was 16 basis points.

All changes in income and value are measured as percentage changes from the
respective values calculated in the scenario labeled as "Base Case." The base
interest rate scenario assumes interest rates as of December 31, 2002 and
2001. Actual results could differ significantly from these estimates.

Projected Percentage Change In Portfolio Net Market Value
Given U.S. Treasury Yield Curve Movements

2002 Change in 2001
Projected Change in Portfolio Treasury Yield Curve, Projected Change in
Net Market Value +/- Basis Points Portfolio Net Market Value
- ------------------------------- --------------------------------- -----------------------------

0.5% -200 4.0%
2.0% -100 3.9%
1.4% -50 2.4%
Base Case
(2.3)% +50 (3.4)%
(5.5)% +100 (7.8)%
(14.5)% +200 (19.5)%

51

Projected Percentage Change In Portfolio Net Market Value
Given Credit Spread Movements

2002 Change in 2001
Projected Change in Portfolio Credit Spreads, Projected Change in Portfolio
Net Market Value +/- Basis Points Net Market Value
- ------------------------------- ---------------------------------- ------------------------------

17.4% -200 19.1%
10.4% -100 11.5%
5.7% -50 6.2%
Base Case
(6.5)% +50 (7.2)%
(14.0)% +100 (15.4)%
(31.4)% +200 (34.6)%

52

Projected Percentage Change In Portfolio Net Interest Income
Given LIBOR Movements

2001
2002 Projected Change Projected Change in
Projected Change in Portfolio in Net Income per Change in LIBOR, Portfolio Projected Change in
Net Interest Income Share +/- Basis Points Net Interest Income Net Income per Share
- ------------------------------- -------------------- ----------------------- ---------------------------- -----------------------

8.0% $0.15 -100 6.7% $0.16
4.0% $0.08 -50 3.3% $0.08
Base Case
(4.0)% ($0.08) +50 (3.3)% ($0.08)
(8.0)% ($0.15) +100 (6.7)% ($0.16)
(16.1)% ($0.31) +200 (13.4)% ($0.32)

The aggregate sensitivity to short-term rates has not changed year over year.
However, as detailed above a significant portion of the Company's illiquid
credit sensitive CMBS was match funded in 2002 with no short-term rate risk.
As of December 31, 2002 the majority of the Company's short-term rate exposure
was concentrated in the highly liquid RMBS portfolio which can be adjusted
quickly to react to changes in short-term rates.

Credit Risk: The Company's portfolios of commercial real estate assets are
subject to a high degree of credit risk. Credit risk is the exposure to loss
from loan defaults. Default rates are subject to a wide variety of factors,
including, but not limited to, property performance, property management,
supply/demand factors, construction trends, consumer behavior, regional
economics, interest rates, the strength of the American economy and other
factors beyond the control of the Company.

All loans are subject to a certain probability of default. The Company
underwrites its CMBS investments assuming the underlying loans will suffer a
certain dollar amount of defaults and these defaults will lead to some level
of realized losses. Loss adjusted yields are computed based on these
assumptions and applied to each class of security supported by the cash flow
on the underlying loans. The most significant variables affecting loss
adjusted yields include, but are not limited to, the number of defaults, the
severity of loss that occurs subsequent to a default and the timing of the
actual loss. The different rating levels of CMBS will react differently to
changes in these assumptions. The lowest rated securities (B- or lower) are
generally more sensitive to changes in timing of actual losses. The higher
rated securities (B or higher) are more sensitive to the severity of losses.

The Company generally assumes that all of the principal of a non-rated
security and a significant portion, if not all, of CCC and a portion of B-
rated securities will not be recoverable over time. The loss adjusted yields
of these classes reflect that assumption; therefore, the timing of when the
total loss of principal occurs is the key assumption. The interest coupon
generated by a security will cease when there is a total loss of its principal
regardless of whether that principal is paid. Therefore, timing is of
paramount importance because the longer the principal balance remains
outstanding the more interest coupon the holder receives to support a greater
economic return. Alternatively, if principal is lost faster than originally
assumed there is less opportunity to receive interest coupon therefore a lower
or possibly

53

negative return may result. Additional losses occurring due to greater severity
will not have a significant effect as all principal is already assumed to be
non-recoverable.

If actual principal losses on the underlying loans exceed assumptions, the
higher rated securities will be affected more significantly as a loss of
principal may not have been assumed. The Company generally assumes that most
if not all principal will be recovered by classes rated B or higher.

The Company manages credit risk through the underwriting process, establishing
loss assumptions and careful monitoring of loan performance. Before acquiring
a Controlling Class security that represents a proposed pool of loans, the
Company will perform a rigorous analysis of the quality of all of the loans
proposed. As a result of this analysis, loans with unacceptable risk profiles
will be removed from the proposed pool. Information from this review is then
used to establish loss assumptions. The Company will assume that a certain
portion of the loans will default and calculate an expected or loss adjusted
yield based on that assumption. After the securities have been acquired, the
Company monitors the performance of the loans, as well as external factors
that may affect their value.

Factors that indicate a higher loss severity or acceleration of the timing of
an expected loss will cause a reduction in the expected yield and therefore
reduce the earnings of the Company. Furthermore, the Company may be required
to write down a portion of the adjusted purchase price of the affected assets
through its income statement.

For purposes of illustration, a doubling of the losses in the Company's
Controlling Class CMBS, without a significant acceleration of those losses
would reduce GAAP income going forward by approximately $0.21 per share of
common stock per annum and cause a significant write down at the time the loss
assumption is changed The amount of the write down depends on several factors,
including which securities are most affected at the time of the write down,
but is estimated to be in the range of $0.60 to $0.80 per share based on a
doubling of expected losses. A significant acceleration of the timing of these
losses would cause the Company's net income to decrease. The total adjusted
purchase price of Controlling Class CMBS at December 31, 2002 was $9.25 per
share. The amount of adjusted purchase price that is not match funded in a CDO
is $3.95 per share. The Company's exposure to a write down is mitigated by the
fact that most of these assets are financed on a non-recourse basis in the
Company's CDOs, where a significant portion of the risk of loss is transferred
to the CDO bondholders.

Asset and Liability Management: Asset and liability management is concerned
with the timing and magnitude of the repricing and/or maturing of assets and
liabilities. It is the objective of the Company to attempt to control risks
associated with interest rate movements. In general, management's strategy is
to match the term of the Company's liabilities as closely as possible with the
expected holding period of the Company's assets. This is less important for
those assets in the Company's portfolio considered liquid as there is a very
stable market for the financing of these securities.

Other methods for evaluating interest rate risk, such as interest rate
sensitivity "gap" (defined as the difference between interest-earning assets
and interest-bearing liabilities maturing or repricing within a given time
period), are used but are considered of lesser significance in the daily
management of the Company's portfolio. Management considers this relationship
when reviewing the Company's hedging strategies. Because different types of
assets and liabilities with the same or similar maturities react differently
to changes in overall market rates or conditions, changes in interest rates
may affect the

54

Company's net interest income positively or negatively even if the Company were
to be perfectly matched in each maturity category.

55

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

PAGE

Independent Auditors' Report.................................................................51

Financial Statements:

Consolidated Statements of Financial Condition at December 31, 2002 and 2001.................52

Consolidated Statements of Operations
For the Years Ended December 31, 2002, 2001 and 2000.........................................53

Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December, 31, 2002, 2001 and 2000........................................54

Consolidated Statements of Cash Flows
For the Years Ended December 31, 2002, 2001 and 2000.........................................56

Notes to Consolidated Financial Statements...................................................58

All schedules have been omitted because either the required information is not
applicable or the information is shown in the financial statements or notes
thereto.

56

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of
Anthracite Capital, Inc.

We have audited the accompanying consolidated statements of financial
condition of Anthracite Capital, Inc. and subsidiaries (the "Company") at
December 31, 2002 and 2001, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for each of the
years in the three year period ended December 31, 2002. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Anthracite Capital, Inc. and
subsidiaries at December 31, 2002 and 2001 and the results of their operations
and their cash flows for each of the years in the three year period ended
December 31, 2002 in conformity with accounting principles generally accepted
in the United States of America.

As discussed in Note 1 to the consolidated financial statements, on January 1,
2002, the Company adopted the provisions of Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets."

/s/ Deloitte & Touche LLP

New York, New York
March 21, 2003

57

Anthracite Capital, Inc.
Consolidated Statements of Financial Condition
(in thousands, except per share data)

- ----------------------------------------------------------------------------------------------------------------------------------

December 31, 2002 December 31, 2001
----------------- -----------------

ASSETS
Cash and cash equivalents $ 24,698 $ 43,071
Restricted cash equivalents 84,485 37,376
Securities available for sale, at fair value
Subordinated commercial mortgage-backed securities (CMBS) $602,706 $360,159
Investment grade securities 370,356 1,085,795
------------ ------------
Total securities available for sale 973,062 1,445,954
Securities held for trading, at fair value 1,427,733 578,008
Commercial mortgage loans, net 65,664 142,637
Equity investment in Carbon Capital, Inc. 14,997 8,784
Investments in real estate joint ventures 8,265 8,317
Receivable for investments sold - 344,789
Other assets 40,447 18,267
--------------- -----------------
Total Assets $2,639,351 $ 2,627,203
=============== =================

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Borrowings:
Collateralized debt obligations $684,590
Secured by pledge of subordinated CMBS 7,295 $178,631
Secured by pledge of other securities available for sale
and cash equivalents 98,439 1,039,469
Secured by pledge of securities held for trading 1,355,333 559,145
Secured by pledge of investments in real estate joint ventures 1,337 1,337
Secured by pledge of commercial mortgage loans 14,667 57,356
------------ ------------
Total borrowings $2,161,661 $ 1,835,938
Payable for investments purchased 524 346,913
Distributions payable 16,589 17,245
Other liabilities 54,361 43,734
--------------- -----------------
Total Liabilities $2,233,135 $ 2,243,830
--------------- -----------------

10.5% Series A Preferred Stock, redeemable convertible,
liquidation preference $285 in 2001 - 258
--------------- -----------------

Commitments and Contingencies

Stockholders' Equity:
Common Stock, par value $0.001 per share; 400,000 shares
authorized;
47,398 shares issued and outstanding in 2002;
45,286 shares issued and outstanding in 2001 47 45
10% Series B Preferred Stock, liquidation preference $47,817 in 2002
and $55,317 in 2001 36,379 42,086
Additional paid-in capital 515,180 492,531
Distributions in excess of earnings (24,161) (13,588)

58

Accumulated other comprehensive loss (121,229) (137,959)
----------- -----------
Total Stockholders' Equity 406,216 383,115
---------- -----------
Total Liabilities and Stockholders' Equity $2,639,351 $ 2,627,203
=========== ============

The accompanying notes are an integral part of these consolidated financial statements.

Anthracite Capital, Inc.
Consolidated Statements of Operations (in thousands, except per share data)
- ------------------------------------------------------------------------------------------------------------------------------

For the year ended For the year ended For the year ended
December 31, 2002 December 31, 2001 December 31, 2000
Income:

Interest from securities available for sale $99,308 $ 85,137 $ 75,116
Interest from commercial mortgage loans 13,997 15,499 14,359
Interest from mortgage loan pools - 1,575 6,481
Interest from securities held for trading 45,421 24,681 25
Earnings from real estate joint ventures 1,044 1,667 348
Earnings from equity investment 1,202 80 -
Interest from cash and cash equivalents 1,473 2,581 1,313
-------- -------- --------
Total income 162,445 131,220 97,642
-------- -------- --------
Expenses:
Interest 50,987 44,425 51,112
Interest - securities held for trading 14,031 14,976 -
Management and incentive fee 12,527 11,018 7,450
Other expenses / income - net 2,323 1,717 2,277
-------- -------- --------
Total expenses 79,868 72,136 60,839
-------- -------- --------

Other gains (losses):
Gain on sale of securities available for sale 11,391 7,401 3,212
Loss on securities held for trading (29,255) (2,604) (647)
Foreign currency loss (812) (5) (42)
Loss on impairment of asset (10,273) (5,702) -
--------- -------- --------
Total other gain (loss) (28,949) (910) 2,523
-------- -------- --------

Income before cumulative transition adjustments 53,628 58,174 39,326
Cumulative transition adjustment-SFAS 142 6,327 - -
Cumulative transition adjustment-SFAS 133 - (1,903) -
-------- -------- --------

Net Income 59, 955 56,271 39,326
-------- -------- --------

Dividends and accretion on Preferred Stock 5,162 8,964 7,065
-------- -------- --------

Net Income Available to Common Stockholders $54,793 $47,307 $32,261
======== ======= =======
Net income per common share, basic:
Income before cumulative transition adjustment $ 1.04 $1.47 $1.37
Cumulative transition adjustment - SAFS 142 0.14
Cumulative transition adjustment - SFAS 133 - (0.06) -
-------- -------- -------
Net income $1.18 $1.41 $1.37
======== ======= =======
Net income per common share, diluted:

59

Income before cumulative transition adjustment $ 1.04 $1.40 $1.28
Cumulative transition adjustment - SAFS 142 0.14
Cumulative transition adjustment - SFAS 133 - (0.05) -
-------- -------- --------
Net income $1.18 $1.35 $1.28
======== ======= =======
Weighted average number of shares outstanding:
Basic 46,411 33,568 23,587
Diluted 46,452 37,616 27,668

The accompanying notes are an integral part of these consolidated financial statements.

Anthracite Capital, Inc.
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended
December 31, 2002 and 2001 and 2000 (in thousands)

Series Accumulated
Common B Additional Distributions Other Total
Stock, Preferred Paid-In In Excess Comprehensive Comprehensive Stockholders'
Par Value Stock Capital Of Earnings Loss Income Equity
-----------------------------------------------------------------------------------------

Balance at December 31, 1999 $21 $287,486 $(18,107) $(101,139) $168,261
Purchase of common shares (39) (39)
Net income 39,326 $39,326 39,326
Change in net unrealized loss on securities
available for sale, net of reclassification
adjustment (1,732) (1,732) (1,732)
----------------
Other comprehensive loss (1,732)
----------------
Comprehensive income $37,594
================
Dividends declared-common stock (27,591) (27,591)
Dividends and accretion on preferred stock (7,065) (7,065)
Issuance of common stock 4 28,086 28,090
Issuance of Series B preferred stock $43,004 $43,004
---------------------------------------------------------------------------------
Balance at December 31, 2000 25 43,004 315,533 (13,437) (102,871) 242,254
Net income 56,271 $56,271 56,271
Cumulative transition adjustment - SFAS 133 1,903 1,903 1,903
Unrealized loss on cash flow hedges (11,941) (11,941) (11,941)
Reclassification adjustments from cash flow
hedges included in net income 994 994 994
Change in net unrealized loss on securities
available for sale, net of reclassification
adjustment (26,044) (26,044) (26,044)
----------------
Other comprehensive loss (35,088)
----------------
Comprehensive income $21,183
================
Dividends declared-common stock (47,458) (47,458)
Dividends and accretion on preferred stock (8,964) (8,964)
Issuance of common stock 15 145,438 145,453
Conversion of Series B preferred stock to
common stock 1 (918) 917 -
Conversion of Series A preferred stock to
common stock 4 30,492 30,496
Compensation cost - stock options 151 151
-----------------------------------------------------------------------------------
Balance at December 31, 2001 45 42,086 492,531 (13,588) (137,959) 383,115
=================================================================================================================================

60

Net Income 59,955 $59,955 59,955
Unrealized loss on cash flow hedges (56,769) (56,769) (56,769)
Reclassification adjustments from cash flow
hedges included in net income 5,619 5,619 5,619
Change in net unrealized loss on securities
available for sale, net of reclassification
adjustment 67,880 67,880 67,880
------------
Other comprehensive income 16,730
------------
Comprehensive income $76,685
============
Dividends declared-common stock (65,366) (65,366)
Dividends declared-preferred stock (5,162) (5,162)
Issuance of common stock 1 16,685 16,686
Conversion of Series B preferred stock to
common stock 1 (5,707) 5,706
Conversion of Series A preferred stock to
common stock 258 258
---------------------------------------------------------------------------------
Balance at December 31, 2002 $47 $36,379 $515,180 $(24,161) ($121,229) $406,216
=================================================================================

61

Disclosure of reclassification adjustment: Years ended December 31,
-------------------------------------------------------
2002 2001 2000
-------------------------------------------------------

Unrealized holding gain (loss) on securities
available for sale $ 56,489 $(33,445) $ (4,944)
Reclassification for realized gains
previously recorded as unrealized 11,391 7,401 3,212
-------------------------------------------------------
67,880 (26,044) (1,732)
=======================================================

The accompanying notes are an integral part of these consolidatted financial statements.

62

Anthracite Capital, Inc.
Consolidated Statements of Cash Flow (in thousands) Years Ended December 31,
-------------------------------------------
2002 2001 2000
-------------------------------------------

Cash flows from operating activities:

Net income $ 59,955 $ 56,271 $ 39,326

Adjustments to reconcile net income to net cash provided by (used in)

operating activities:

Net (purchase) sale of trading securities (878,980) (454,960) 52,751

Net loss (gain) on sale of securities 17,864 (4,797) (1,732)

Amortization of negative goodwill - (1,942) (1,062)

Cumulative transition adjustment (6,327) 1,903 -

(Discount accretion), premium amortization, net (9,295) 6,376 5,420

Compensation cost - stock options - 151 -

Loss on impairment of asset 10,273 5,702 -

Noncash portion of net foreign currency loss 276 5 42
Distributions (earnings) from joint ventures in excess
of earnings (distributions) 52 116 (84)
(Increase) decrease in other assets (14,215) 12,803 8,316
Increase in other liabilities 16,954 2,657 12,757
-------------------------------------------
Net cash (used in) provided by operating activities (803,443) (375,715) 115,734
-------------------------------------------
Cash flows from investing activities:

Purchase of securities available for sale (686,710) (2,383,483) (991,191)

Principal payments received on securities available for sale 167,570 123,578 102,950

Funding of commercial mortgage loans (3,370) (56,070) (101,100)

Repayments received from commercial mortgage loans 82,865 66,620 17,524

Increase in restricted cash equivalents (47,109) (27,892) (9,484)

Investment in real estate joint ventures, net - 1,921 (10,270)

Investment in Carbon Capital, Inc. (6,100) (8,784) -

Principal payment received on mortgage loan pools - 10,981 20,274

Proceeds from sale of securities available for sale and mortgage loan pools 1,017,534 1,452,577 1,822,107

Net cash acquired in merger - - 33,379

Acquisition costs - - 4,129

Net payments under hedging securities (8,077) (11,973) (4,405)
-------------------------------------------
Net cash (used in) provided by investing activities 516,603 (832,525) 883,913
-------------------------------------------
Cash flows from financing activities:

Net increase (decrease) in borrowings 322,965 1,116,596 (962,396)

Proceeds from issuance of common stock, net of offering costs 16,686 145,803 -

Distributions on common stock (64,633) (40,038) (26,130)

(Distributions) net of issuance of preferred stock (6,551) (8,879) 4,482

Purchase of common shares - - (39)
-------------------------------------------
Net cash provided by (used in) financing activities 268,467 1,213,482 (984,083)
-------------------------------------------
Net (decrease) increase in cash and cash equivalents (18,373) 5,242 15,564

Cash and cash equivalents, beginning of period 43,071 37,829 22,265
-------------------------------------------
Cash and cash equivalents, end of period $ 24,698 $ 43,071 $ 37,829
===========================================
Supplemental disclosure of cash flow information:

Interest paid $ 71,746 $ 54,852 $ 47,504
===========================================
Investments purchased not settled $ 524 $ 346,913 $ -
===========================================
Investments sold not settled $ - $ 344,789 $ -
===========================================

63

Anthracite Capital, Inc.
Consolidated Statements of Cash Flow (in thousands)
Continued

Supplemental schedule of non-cash investing and financing activities:
The Company purchased all of the assets of CORE Cap., Inc. during the
year end December 31, 2000 primarily through issuance of the Company's
common and preferred stock, as follows:

Fair value of assets acquired $ 1,281,070
Cash included in acquired assets 33,379
Liabilities assumed 1,215,534
Common stock issued in connection with acquisition 28,090
Preferred stock issued in connection with the acquisition 43,004

The accompanying notes are an integral part of these consolidated financial statements.

64

Anthracite Capital, Inc.
Notes to Consolidated Financial Statements
(In thousands, except share and per share data)
- -------------------------------------------------------------------------------

Note 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Anthracite Capital, Inc. (the "Company") was incorporated in Maryland in
November 1997 and commenced operations on March 24, 1998. The Company's
principal business activity is to invest in a diversified portfolio of
CMBS, multifamily, commercial and residential mortgage loans, residential
mortgage-backed securities ("RMBS") and other real estate related assets in
the U.S. and non-U.S. markets. The Company is organized and managed as a
single business segment.

In preparing the financial statements in accordance with accounting
principles generally accepted in the United States of America (GAAP),
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the dates of the statements of financial
condition and revenues and expenses for the periods covered. Actual results
could differ from those estimates and assumptions. Significant estimates in
the financial statements include the valuation of the Company's investments
and an estimate of credit performance on CMBS investments.

A summary of the Company's significant accounting policies follows:

Principles of Consolidation

The consolidated financial statements include the financial statements of
the Company and its wholly-owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.

Cash and Cash Equivalents

All highly liquid investments with original maturities of three months or
less are considered to be cash equivalents.

Deferred Financing

The deferred financing cost which is included in other assets on the
Company's consolidated statements of financial condition includes issuance
costs related to the Company's debt and is amortized using the straight
line method which method is similar to the results of the effective
interest method.

Securities Available for Sale

The Company has designated its investments in mortgage-backed securities,
mortgage-related securities and certain other securities as assets
available-for-sale because the Company may dispose of them prior to
maturity and does not hold them principally for the purpose of selling them
in the

65

near term. Securities available for sale are carried at estimated fair
value with the net unrealized gains or losses reported as a component of
accumulated other comprehensive income (loss) in stockholders' equity.
Unrealized losses on securities that reflect a decline in value which is
judged by management to be other than temporary, if any, are charged to
earnings. At disposition, the realized net gain or loss is included in
income on a specific identification basis. The amortization of premiums and
accretion of discounts are computed using the effective yield method after
considering actual and estimated prepayment rates, if applicable, and
credit losses. Actual prepayment and credit loss experience is reviewed
quarterly and effective yields are recalculated when differences arise
between prepayments and credit losses originally anticipated and amounts
actually received plus anticipated future prepayments and credit losses.

As a result of the pending closing of CDO I, at the end of the first quarter
2002 the Company reclassified all of its subordinated CMBS on the balance
sheet from available-for-sale to held-to-maturity. The effect of this
reclassification changed the accounting basis of these securities,
prospectively, from mark to market to adjusted cost. However, in accordance
with SFAS 133, the interest rate swap agreements entered into by the
Company to hedge the variable rate exposure of the debt of CDO I are
required to be presented on the balance sheet at their fair market value
causing fluctuations in the book value of the Company. Accordingly, the
Company has determined that at December 31, 2002, and going forward, it
will classify all of its subordinated CMBS as available-for-sale securities
and record them at fair market value. This is consistent with the mark to
market requirement for the CDO's interest rate swap agreements.

The reclassification of these securities to available-for-sale from
held-to-maturity increased the recorded value of these securities from
$558,522 to $610,713 with the difference being recorded in other
comprehensive income. The circumstance causing the Company to change this
classification was not considered a permitted circumstance as stated in
Statement of Financial Accounting Standard (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities", and is therefore
inconsistent with the Company's intent regarding its held-to-maturity
classification. Accordingly, the Company will be prohibited from
classifying its subordinated CMBS (current holdings as well as future
purchases) as held-to-maturity for a period of two years.

The Company adopted the EITF 99-20, "Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets" on April 1, 2001. The Company recognizes interest income
from its purchased beneficial interests in securitized financial interests
("beneficial interests") (other than beneficial interests of high credit
quality, sufficiently collateralized to ensure that the possibility of
credit loss is remote, or that cannot contractually be prepaid or otherwise
settled in such a way that the Company would not recover substantially all
of its recorded investment) in accordance with this guidance. Accordingly,
on a quarterly basis, when significant changes in estimated cash flows from
the cash flows previously estimated occur due to actual prepayment and
credit loss experience, the Company calculates a revised yield based on the
current amortized cost of the investment (including any
other-than-temporary impairments recognized

66

to date) and the revised cash flows. The revised yield is then applied
prospectively to recognize interest income.

Prior to April 1, 2001, the Company recognized income from these beneficial
interests using the effective interest method, based on an anticipated
yield over the projected life of the security. Changes in the anticipated
yields were calculated due to revisions in the Company's estimates of
future and actual credit losses and prepayments. Changes in anticipated
yields resulting from credit loss and prepayment revisions were recognized
through a cumulative catch-up adjustment at the date of the change which
reflected the change in income from the security from the date of purchase
through the date of change in the anticipated yield. The new yield was then
used prospectively to account for interest income. Changes in yields from
reduced estimates of losses were recognized prospectively.

For other mortgage-backed and related mortgage securities, the Company
accounts for interest income under SFAS 91, using the effective yield
method which includes the amortization of discount or premium arising at
the time of purchase and the stated or coupon interest payments.

In accordance with SFAS 115, when the estimated fair value of the security
classified as available-for-sale has been below amortized cost for a
significant period of time and the Company concludes that it no longer has
the ability or intent to hold the security for the period of time over
which the Company expects the values to recover to amortized cost, the
investment is written down to its fair value. The resulting charge is
included in income, and a new cost basis established. Additionally, under
EITF 99-20, when significant changes in estimated cash flows from the cash
flows previously estimated occur due to actual prepayment and credit loss
experience, and the present value of the revised cash flows using the
current expected yield is less than the present value of the previously
estimated remaining cash flows (adjusted for cash receipts during the
intervening period), an other-than-temporary impairment is deemed to have
occurred. Accordingly, the security is written down to fair value with the
resulting change being included in income, and a new cost basis
established. In both instances, the original discount or premium is written
off when the new cost basis is established.

After taking into account the effect of the impairment charge, income is
recognized under EITF 99-20 or SFAS 91, as applicable, using the market
yield for the security used in establishing the write-down.

Securities Held for Trading

The Company has designated certain securities as assets held for trading
because the Company intends to hold them for short periods of time.
Securities held for trading are carried at estimated fair value with net
unrealized gains or losses included in income.

Mortgage Loans

The Company purchases and originates certain commercial mortgage loans to
be held as long-term investments. Loans held for long-term investment are
recorded at cost at the date of purchase. Premiums and discounts related to
these loans are amortized over their estimated lives using the effective
interest method. Any origination fee income and application fee income net
of direct costs associated with originating or purchasing commercial
mortgage loans are deferred and included in the

67

basis of the loans on the consolidated statement of financial condition.
The net fees are amortized over the life of the loans using the effective
interest method. The Company recognizes impairment on the loans when it is
probable that the Company will not be able to collect all amounts due
according to the contractual terms of the loan agreement. The Company
measures impairment (both interest and principle) based on the present
value of expected future cash flows discounted at the loan's effective
interest rate or the fair value of the collateral if the loan is collateral
dependent.

The Company acquired certain residential mortgage loan pools in the CORE
Cap merger (See Note 14 of the consolidated financial statements).
Residential loan pools are treated as available-for-sale debt securities
and are carried at estimated fair value with net unrealized gains or losses
reported as a component of accumulated other comprehensive income (loss) in
stockholders' equity. Unrealized losses that reflect a decline in value,
which is judged by management to be other than temporary, if any, are
charged to earnings.

Equity Investments and Real Estate Joint Ventures

Investments in real estate entities over which the Company exercises
significant influence, but not control, are accounted for under the equity
method. The Company recognizes its share of each venture's income or loss,
and reduces its investment balance by distributions received. Real estate
held by such entities is regularly reviewed for impairment, and would be
written down to its estimated fair value if impairment is determined to
exist.

Short Sales

As part of its short-term trading strategies (see Note 3 of the
consolidated financial statements), the Company may sell securities that it
does not own ("short sales"). To complete a short sale, the Company may
arrange through a broker to borrow the securities to be delivered to the
buyer. The proceeds received by the Company from the short sale are
retained by the broker until the Company replaces the borrowed securities,
generally within a period of less than one month. In borrowing the
securities to be delivered to the buyer, the Company becomes obligated to
replace the securities borrowed at their market price at the time of the
replacement, whatever that price may be. A gain, limited to the price at
which the Company sold the security short, or a loss, unlimited as to
dollar amount, will be recognized upon the termination of a short sale if
the market price is less than or greater than the proceeds originally
received. The Company's liability under the short sales is recorded at fair
value, with unrealized gains or losses included in net gain or loss on
securities held for trading in the consolidated statement of operations.

The Company is exposed to credit loss in the event of nonperformance by any
broker that holds a deposit as collateral for securities borrowed. However,
the Company does not anticipate nonperformance by any broker.

Forward Commitments - Trading

As part of its short-term trading strategies (see Note 3 of the
consolidated financial statements), the Company may enter into forward
commitments to purchase or

68

sell U.S. Treasury securities or securities issued by FHLMC, FNMA or GNMA
("Agency Securities"), which obligate the Company to purchase or sell such
securities at a specified date at a specified price. When the Company
enters into such a forward commitment, it will, generally within sixty days
or less, enter into a matching forward commitment with the same or a
different counterparty which entitles the Company to sell (in instances
where the original transaction was a commitment to purchase) or purchase
(in instances where the original transaction was a commitment to sell) the
same or similar securities on or about the same specified date as the
original forward commitment. Any difference between the specified price of
the original and matching forward commitments will result in a gain or loss
to the Company. Changes in the fair value of open commitments are
recognized on the consolidated statement of financial condition and
included among assets (if there is an unrealized gain) or among liabilities
(if there is an unrealized loss). A corresponding amount is included as a
component of net gain or loss on securities held for trading in the
consolidated statement of operations.

The Company is exposed to interest rate risk on these commitments, as well
as to credit loss in the event of nonperformance by any other party to the
Company's forward commitments. However, the Company does not anticipate
nonperformance by any counterparty.

Financial Futures Contracts - Trading

As part of its short-term trading strategies (see Note 3 of the
consolidated financial statements), the Company may enter into financial
futures contracts, which are agreements between two parties to buy or sell
a financial instrument for a set price on a future date. Initial margin
deposits are made upon entering into futures contracts and can be either
cash or securities. During the period that the futures contract is open,
changes in the value of the contract are recognized as gains or losses on
securities held for trading by "marking-to-market" on a daily basis to
reflect the market value of the contract at the end of each day's trading.
Variation margin payments are received or made, depending upon whether
gains or losses are incurred.

The Company is exposed to interest rate risk on the contracts, as well as
to credit loss in the event of nonperformance by any other party to the
contract. However, the Company does not anticipate nonperformance by any
counterparty.

Derivative Instruments

As part of its asset/liability management activities, the Company may enter
into interest rate swap agreements, forward currency exchange contracts and
other financial instruments in order to hedge interest rate and foreign
currency exposures or to modify the interest rate or foreign currency
characteristics of related items in its consolidated statement of financial
condition.

Income and expenses from interest rate swap agreements that are, for
accounting purposes, designated as hedging borrowings are recognized as a
net adjustment to the interest expense of the hedged item. During the term
of the interest rate swap agreement, changes in fair value are recognized
on the consolidated statement of financial condition and included among
assets (if there is an unrealized gain) or among liabilities (if there is
an unrealized loss). Changes in fair value are collateralized with cash or
cash equivalents and are recorded on the consolidated statement of
financial condition as restricted cash. A corresponding amount is included
as a component of accumulated other comprehensive income (loss) in
stockholders' equity. The Company accounts for revenues and

69

expenses from the interest rate swap agreements under the accrual basis
over the period to which the payment relates. Amounts paid to acquire these
instruments are capitalized and amortized over the life of the instrument.
Amortization of capitalized fees paid as well as payments received under
these agreements are recorded as an adjustment to interest income. If the
underlying hedged securities are sold, the amount of unrealized gain or
loss in accumulated other comprehensive income (loss) relating to the
corresponding interest rate swap agreement is included in the determination
of gain or loss on the sale of the securities. If interest rate swap
agreements are terminated, the associated gain or loss is deferred over the
shorter of the remaining term of the swap agreement, or the underlying
hedged item, provided that the underlying hedged item has not been sold.

Revenues and expenses from forward currency exchange contracts are
recognized as a net adjustment to foreign currency gain or loss. During the
term of the forward currency exchange contracts, changes in fair value are
recognized on the consolidated statement of financial condition and
included among assets (if there is an unrealized gain) or among liabilities
(if there is an unrealized loss). A corresponding amount is included as a
component of net foreign currency gain or loss in the consolidated
statement of operations.

Financial futures contracts that are, for accounting purposes, designated
as hedging securities held for trading, are carried at fair value, with
changes in fair value included in the consolidated statement of operations.

The Company monitors its hedging instruments throughout their terms to
ensure that they remain effective for their intended purpose. The Company
is exposed to interest rate and/or currency risk on these hedging
instruments, as well as to credit loss in the event of nonperformance by
any other party to the Company's hedging instruments. The Company's policy
is to enter into hedging agreements with counterparties rated A or better.

Stock Options

For option grants prior to December 15, 1998, the Company considered its
officers and directors to be employees for the purposes of stock option
accounting. In accordance with the FASB's Interpretation No. 44, Accounting
for Certain Transactions Involving Stock Compensation, the Company's
officers and directors are not considered to be employees for grants made
subsequent to that date.

Of the options issued under the 1998 Stock Option Plan, options covering
979,426 shares of Common Stock were granted prior to December 15, 1998 to
individuals deemed to be employees. The Company adopted the disclosure-only
provisions of SFAS No. 123, Accounting for Stock-Based Compensation, for
such options. Accordingly, no compensation cost for these options has been
recorded in the consolidated statement of operations. Had compensation cost
for these options been determined based on the fair value of the options at
the grant date consistent with the provisions of SFAS No. 123, the
Company's net income and net income per share would have changed to the pro
forma amounts indicated below:

2002 2001 2000
---------------- ---------------- --------------

Net income - as reported $59,955 $56,271 $39,326
Net income - pro forma 59,955 56,218 39,158

70

Net income per common share, basic - as reported 1.18 1.41 1.37
Net income per common share, basic - pro forma 1.18 1.41 1.36
Net income per common share, diluted - as reported 1.18 1.35 1.28
Net income per common share, diluted - pro forma 1.18 1.35 1.28

For the pro forma, the compensation cost is amortized over the vesting
period of the options.

For the options to purchase 786,915 shares of the Company's Common Stock
granted to non-employees under the 1998 Stock Option Plan, compensation
cost is accrued based on the estimated fair value of the options issued and
amortized over the vesting period. Because vesting of the options is
contingent upon the recipient continuing to provide services to the Company
to the vesting date, the Company estimates the fair value of the
non-employee options at each period end, up to the vesting date, and
adjusts expensed amounts accordingly. The value of these non-employee
options at each period end was negligible and was fully vested by March
2002.

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the periods ending December 31, 2000. There
were no options granted in 2002 and 2001.

December 31, 2000
-----------------

Estimated volatility 25%
Expected life 7 years
Risk-free interest rate 6.0%
Expected dividend yield 11.35%

Negative Goodwill

Negative goodwill reflects the excess of the estimated fair value of the
net assets acquired in the CORE Cap Inc. merger (See Note 14 of the
consolidated financial statements) over the purchase price for such assets.
Negative goodwill was being amortized using the straight-line method from
the date of acquisition over approximately 5.7 years, the weighted average
lives of the assets acquired in the merger that the Company intended to
retain. In March 2001, the Company sold approximately $60,211 of the assets
acquired in the CORE Cap merger. Effective in April 2001, the Company began
amortizing the remaining balance of negative goodwill over 4.5 years, which
represents the weighted average lives of the remaining assets. This
amortization is included in other expenses/income - net. Negative goodwill,
net, was $6,327 at December 31, 2001, and is included in other liabilities.
Pursuant to SFAS 142 (See Recent Accounting Pronouncements), the Company
recognized the unamortized negative goodwill balance in income during the
first quarter of 2002.

Income Taxes

The Company has elected to be taxed as a REIT and to comply with the
provisions of the Code with respect thereto. Accordingly, the Company
generally will not be subject to Federal income tax to the extent of its
distributions to stockholders and as long as certain asset, income and
stock ownership

71

tests are met. As of December 31, 2002, the Company had a Federal capital
loss carryover of approximately $58,000 available to offset future capital
gains.

Recent Accounting Pronouncements

In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets". These standards
change the accounting for business combinations by, among other things,
prohibiting the prospective use of pooling-of-interests accounting and
requiring companies to stop amortizing goodwill and certain intangible
assets with indefinite useful lives. Instead, goodwill and intangible
assets deemed to have indefinite useful lives will be subject to an annual
review for impairment. The new standards were effective for the Company in
the first quarter of 2002. Upon adoption of SFAS No. 142 in the first
quarter of 2002, the Company recorded a one-time, noncash adjustment of
approximately $6,327 to write off the unamortized balance of its negative
goodwill. Such charge is non-operational in nature and is reflected as a
cumulative effect of an accounting change in the accompanying consolidated
statement of operations. Amortization of negative goodwill was $1,942 and
$1,062 for the years ended December 31, 2001 and 2000, respectively.

In August of 2001, the FASB issued SFAS No, 143, "Accounting for Asset
Retirement Obligations" (effective January 1, 2003) and SFAS No. 144,
"Accounting for the Impairment or Disposal of Long Lived Assets" (effective
January 1, 2002). SFAS No. 143 requires the recording of the fair value of
a liability for an asset retirement obligation in the period in which it is
incurred. SFAS No. 144 supercedes existing accounting literature dealing
with impairment and disposal of long-lived assets, including discontinued
operations. It addresses financial accounting and reporting for the
impairment of long-lived assets and for long-lived assets to be disposed
of, and expands current reporting for discontinued operations to include
disposals of a "component" of an entity that has been disposed of or is
classified as held for sale. The Company has determined that these
Interpretations do not have a significant impact on the Company's
consolidated financial statements.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." The Interpretation elaborates on the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees that it has issued. It also clarifies
that a guarantor is required to recognize, at the inception of a guarantee,
a liability for the fair value of the obligation undertaken in issuing the
guarantee. This Interpretation does not prescribe a specific approach for
subsequently measuring the guarantor's recognized liability over the term
of the related guarantee. The disclosure provisions of this Interpretation
are effective for the Company's December 31, 2002 consolidated financial
statements. The initial recognition and initial measurement provisions of
this Interpretation are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002. The Company has determined that
this Interpretation does not currently impact the Company's consolidated
financial statements.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement
No. 123." SFAS No. 148 amends SAFS No. 123 to provide alternative methods
of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, the statement

72

amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based compensation and the effect of the
method used on reported results. The Company has determined that this
Interpretation does not currently impact the Company's consolidated
financial statements.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities ("FIN 46")." This Interpretation clarifies the
application of existing accounting pronouncements to certain entities in
which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated financial support
from other parties. The provisions of the Interpretation will be
immediately effective for all variable interests in variable interest
entities created after January 31, 2003. The Company will need to apply
this Interpretation to any existing variable interests in variable interest
entities by no later than July 1, 2003. The Company is in the process of
evaluating all of its investments and other interests in entities that may
be deemed variable interest entities under the provisions of FIN 46. These
include interests in commercial mortgage backed securities and their
issuers that have issued securities with a total face value of $9,616,797.
The Company's actual loss is limited to the amounts that are not financed
in its non recourse CDOs. The fair value of the securities financed in the
CDOs is $460,210; the amount held outside of the CDOs is $142,496. The
Company's believes that many of these interests and entities will not be
consolidated, and may not ultimately fall under the provisions of FIN 46.
The Company cannot make any definitive conclusion until it completes its
evaluation.

Reclassifications

Certain amounts from 2001 and 2000 have been reclassified to conform to the
2002 presentation.

Note 2 SECURITIES AVAILABLE FOR SALE

The Company's securities available for sale are carried at estimated fair
value. The amortized cost and estimated fair value of securities available
for sale as of December 31, 2002 are summarized as follows:

Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Security Description Cost Gain Loss Value
---------------------------------------------------------------------------------------------------------------------
Commercial mortgage-backed securities ("CMBS"):

CMBS (interest only strips) IO's $42,591 $1,433 $(390) $43,634
Investment grade CMBS 49,843 5,277 - 55,120
Non-investment grade rated subordinated securities 629,273 19,473 (71,375) 577,371
Non-rated subordinated securities 34,170 1,967 (10,802) 25,335
Credit tenant lease 9,063 - - 9,063
Investment grade REIT debt 174,515 9,464 (157) 183,822
----------------------------------------------------------
Total CMBS 939,455 37,614 (82,724) 894,345
----------------------------------------------------------

Single-family residential mortgage-backed
securities ("RMBS"):
Agency adjustable rate securities 40,964 510 (175) 41,299

73

Agency fixed rate securities 8,509 324 - 8,833
Residential CMO's 13,356 478 - 13,834
Hybrid Arms 14,541 210 - 14,751
----------------------------------------------------------
Total RMBS 77,370 1,522 (175) 78,717
----------------------------------------------------------
Total securities available for sale $1,016,825 $39,136 $(82,899) $973,062
==========================================================

As of December 31, 2002, an aggregate of $872,939 in estimated fair value
of the Company's securities available for sale was pledged to secure its
collateralized borrowings.

The amortized cost and estimated fair value of securities available for
sale as of December 31, 2001 are summarized as follows:

Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Security Description Cost Gain Loss Value
-------------------------------------------------------------------------------------------------------------------
Commercial mortgage-backed securities ("CMBS"):

CMBS IO's $ 77,470 $ 2,322 $ (588) $ 79,204
Investment grade CMBS 20,318 - (5,728) 14,590
Non-investment grade rated subordinated securities 416,171 3,461 (91,100) 328,532
Non-rated subordinated securities 40,944 1,173 (10,490) 31,627
------------------------------------------------------------
Total CMBS 554,903 6,956 (107,906) 453,953
------------------------------------------------------------

Single-family residential mortgage-backed
securities ("RMBS"):
Agency adjustable rate securities 74,185 850 - 75,035
Agency fixed rate securities 810,691 3,740 (9,672) 804,759
Residential CMO's 33,319 203 - 33,522
Home Equity Loans 26,302 997 - 27,299
Hybrid Arms 51,322 64 - 51,386
------------------------------------------------------------
Total RMBS 995,819 5,854 (9,672) 992,001
------------------------------------------------------------
Total securities available for sale $ 1,550,722 $ 12,810 $ (117,578) $1,445,954
============================================================

As of December 31, 2001, an aggregate of $1,336,622 in estimated fair value
of the Company's securities available for sale was pledged to secure its
collateralized borrowings.

As of December 31, 2002 and 2001, there were 1,883 and 1,911 loans,
respectively, underlying the Controlling Class CMBS held by the Company,
with a principal balance of $9,616,797 and $9,909,800, respectively.

As of December 31, 2002 and 2001, the aggregate estimated fair values by
underlying credit rating of the Company's securities available for sale are
as follows:

74

December 31, 2002 December 31, 2001
Estimated Estimated
Security Rating Fair Value Percentage Fair Value Percentage
- ---------------------------------------------------------------------------------------------------------------------

Agency and agency insured
securities $50,132 5.1% $875,039 60.5%
AAA 72,923 7.5 160,249 11.1
AA 4,448 0.5 35,917 2.5
A 10,466 1.1 - -
A- 19,116 2.0 - -
BBB+ 93,623 9.6 - -
BBB 101,691 10.4 14,590 1.0
BBB- 17,957 1.8 - -
BB+ 237,839 24.4 74,610 5.2
BB 93,290 9.6 34,246 2.4
BB- 66,844 6.9 56,935 4.0
B+ 21,533 2.2 19,274 1.3
B 99,815 10.2 93,946 6.5
B- 39,035 4.0 37,954 2.6
CCC 19,015 2.0 17,637 1.2
Not rated 25,335 2.7 25,557 1.7
------------------------------------------------------------------
Total securities available for sale $973,062 100.0% $1,445,954 100.0%
==================================================================

As of December 31, 2002 and 2001, the mortgage loans underlying the
Controlling Class CMBS held by the Company were secured by properties of
the types and at the locations identified below:

Percentage (1) Percentage (1)
----------------------------------------------------------------------------------------------
Property Type 2002 2001 Geographic Location 2002 2001
----------------------------------------------------------------------------------------------

Multifamily 34.3% 34.6% California 12.2% 12.8%
Retail 28.1 27.9 Texas 10.6 10.7
Office 18.8 18.8 New York 9.1 9.1
Lodging 8.7 8.6 Florida 6.6 7.0
Other 10.1 10.1 Other (2) 61.5 60.4
----------------------- --------------------------
Total 100.0% 100.0% Total 100.0% 100.0%
======================= ==========================

(1) Based on a percentage of the total unpaid principal balance of the
underlying loans.

(2) No other individual state comprises more than 5% of the total.

The following table sets forth certain information relating to the aggregate
principal balance and payment status of delinquent mortgage loans underlying
the Controlling Class CMBS held by the Company as of December 31, 2002 and
2001:

75

2002 2001
---------------------------------------------------------------------------------
Number of % of Number of % of
Principal Loans Collateral Principal Loans Collateral
---------------------------------------------------------------------------------

Past due 30 days to 60 days $5,476 1 0.05% $15,401 5 0.15%
Past due 60 days to 90 days 49,825 10 0.52 9,865 4 0.10
Past due 90 days or more 102,886 19 1.07 112,017 18 1.13
Resolved loans - - - - - -
Real Estate owned 21,830 6 0.23 8,805 1 0.09
---------------------------------------------------------------------------------
Total Delinquent 180,017 36 1.87% 146,088 28 1.47%
=================================================================================

Total Principal Balance $9,616,797 1,883 $9,909,800 1,911

Of the 36 delinquent loans as of December 31, 2002, one was delinquent due to
technical reasons, six were real estate owned and being marketed for sale,
three were in foreclosure and the remaining 26 loans were in some form of
workout negotiations.

The Controlling Class CMBS owned by the Company has a delinquency experience of
1.87%, which is consistent with industry averages. During 2002, the Company
experienced early payoffs of $128,344 which represents 1.33% of the year-end
pool balance. These loans were paid-off at par with no loss.

To the extent that realized losses, if any, or such resolutions differ
significantly from the Company's original loss estimates, it may be necessary
to reduce or increase the projected GAAP yield on the applicable CMBS
investment to better reflect such investment's expected earnings net of
expected losses, from the date of purchase. While realized losses on
individual assets may be higher or lower than original estimates, the Company
currently believes its aggregate loss estimates and GAAP yields remain
appropriate.

The CMBS held by the Company consist of subordinated securities collateralized
by adjustable and fixed rate commercial and multifamily mortgage loans. The
RMBS held by the Company consist of adjustable rate and fixed rate residential
pass-through or mortgage-backed securities collateralized by adjustable and
fixed rate single-family residential mortgage loans. Agency RMBS were issued
by FHLMC, FNMA or GNMA. Privately issued RMBS were issued by entities other
than FHLMC, FNMA or GNMA. The Company's securities available for sale are
subject to credit, interest rate and/or prepayment risks.

The CMBS owned by the Company provide credit support to the more senior
classes of the related commercial securitization. The Company generally does
not own the senior classes of its below investment grade CMBS. Cash flow from
the mortgages underlying the CMBS generally is allocated first to the senior
classes, with the most senior class having a priority entitlement to cash
flow. Then, any remaining cash flow is allocated generally among the other
CMBS classes in order of their relative seniority. To the extent there are
defaults and unrecoverable losses on the underlying mortgages, resulting in
reduced cash flows, the most subordinated CMBS class will bear this loss
first. To the extent there are losses in excess of the most subordinated
class' stated entitlement to principal and interest, then the remaining CMBS
classes will bear such losses in order of their relative subordination.

76

As of December 31, 2002 and 2001, the anticipated weighted average unleveraged
yield to maturity based upon adjusted cost of the Company's entire
subordinated CMBS portfolio was 9.8% and 10.1% per annum, respectively, and of
the Company's other securities available for sale was 6.8% and 6.04% per
annum, respectively. The Company's anticipated yields to maturity on its
subordinated CMBS and other securities available for sale are based upon a
number of assumptions that are subject to certain business and economic
uncertainties and contingencies. Examples of these include, among other
things, the rate and timing of principal payments (including prepayments,
repurchases, defaults, liquidations and related expenses), the pass-through or
coupon rate and interest rate fluctuations. Additional factors that may affect
the Company's anticipated yields to maturity on its subordinated CMBS include
interest payment shortfalls due to delinquencies on the underlying mortgage
loans, and the timing and magnitude of credit losses on the mortgage loans
underlying the subordinated CMBS that are a result of the general condition of
the real estate market (including competition for tenants and their related
credit quality) and changes in market rental rates. As these uncertainties and
contingencies are difficult to predict and are subject to future events which
may alter these assumptions, no assurance can be given that the anticipated
yields to maturity, discussed above and elsewhere, will be achieved.

The agency adjustable rate RMBS held by the Company are subject to periodic
and lifetime caps that limit the amount the interest rates of such securities
can change during any given period and over the life of the loan. As of
December 31, 2002 and 2001, adjustable rate RMBS with a market value of
$41,299 and $75,035, respectively, is included in securities available for
sale on the consolidated statement of financial condition.

As of December 31, 2002, the unamortized net discount on all securities
available for sale was $1,179,098, which represented 53.69% of the then
remaining face amount of such securities. During 2002, the Company sold
securities available for sale for total proceeds of $1,017,534, resulting in a
realized gain of $11,391. During 2001, the Company sold securities available
for sale for total proceeds of $1,786,400, resulting in a realized gain of
$7,401.

Included in CDO II was a ramp facility that will be utilized to fund the
purchase of $50,000 of par of below investment grade CMBS. On March 14, 2003,
the Company purchased $78,027 par of securities in CSFB 2003-CPN1. Of this
purchase, $30,000 par will be contributed into the ramp facility for CDO II,
and $48,027 will be held outside of CDO II.

Note 3 SECURITIES HELD FOR TRADING

Securities held for trading are generally RMBS that the Company intends to
hold for a short period of time. During the fiscal year 2002, the Company
discontinued its active short-term trading strategies, which the Company
employed from time to time to generate economic and taxable gains. The RMBS
classified as held for trading are actively hedged using treasury futures,
interest rate swap agreements and forward sales and purchases of agency RMBS.

The Company's securities held for trading are carried at estimated fair value.
At December 31, 2002, the Company's securities held for trading consisted of
FNMA and Federal Home Loan Mortgage Corp. mortgage pools with an estimated
fair value of $1,427,733; and short positions of 3,166 five-year and 1,126
ten-year U.S. Treasury Note future contracts, which represented

77

$316,600 and $112,600 in face amount of U.S. Treasury Notes, respectively. The
estimated fair value of the contracts was approximately $476,676 at December
31, 2002. At December 31, 2001, the Company's securities held for trading
consisted of FNMA and Federal Home Loan Mortgage Corp. mortgage pools with an
estimated fair value of $578,008 and short positions of 80 thirty-year U.S.
Treasury Bond future contracts and 500 ten-year U.S. Treasury Note future
contracts expiring in March 2002, which represented $50,000 and $8,000 in face
amount of U.S. Treasury Bonds and Notes, respectively. The estimated fair
value of these contracts was approximately $(61,235) at December 31, 2001.
Also, the Company had outstanding a short position of 140 Eurodollar futures
of which 35 expire in each of June, September and December 2003 and 35 in
March 2004, and an outstanding short call swaption with a notional amount of
$400,000, which expires in December 2004. The estimated fair value of these
Eurodollar futures contracts was approximately $(32,987) and the estimated
fair value of the swaption contract was approximately all Eurodollar future
positions and $(10,500) as of December 31, 2001. During 2002, the Company
closed all eurodollar future positions and the swaption position.

As of December 31, 2002 and 2001, adjustable rate RMBS with a market value of
$21,864 and $38,258, respectively, is included in securities held for trading
on the consolidated statement of financial condition.

The Company's trading strategies are subject to the risk of unanticipated
changes in the relative prices of long and short positions in trading
securities, but are designed to be relatively unaffected by changes in the
overall level of interest rates.

Note 4 COMMERCIAL MORTGAGE LOANS

The following table summarizes the Company's loan investments at December 31,
2002 and 2001:

Scheduled
Date of Initial Maturity/Date of Property Par Interest Rate
Investment Repayment or Sale Location Type 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------

12/17/01 4/9/04 Tyson's Corner, VA(1) Office $22,000 $22,000 8.9 % 8.9%
12/20/00 12/19/02 Los Angeles, CA Office 18,438 22,500 11.4 12.7
11/7/01 11/11/07 San Francisco, CA (2) Office 10,909 10,987 7.2 7.2
11/7/01 11/11/07 San Francisco, CA (2) Office 9,819 9,889 6.7 6.7
5/17/02 12/11/04 Midwest(3) Retail 3,500 - 10.0 -
5/17/02 12/11/04 Southwest(3) Residential 3,013 - 3.6 -
8/26/98 12/17/02 London, England (4) Hotel - 31,199 - 8.1
8/15/00 11/1/02 San Francisco, CA(5) Hotel - 17,892 - 8.4
9/22/00 10/24/02 Chicago, IL Multifamily - 15,000 - 20.0
6/25/01 4/16/02 New York, NY (6) Office - 13,170 - 5.8
------------------------

$67,679 $142,637
========================

(1) The entire principal balance of the Company's investment is pledged
to secure line of credit borrowings.
(2) Two subordinate interests in a $125,000 note secured by one
11-story office building. The entire principal balance of the
Company's investment is pledged to secure collateralized debt
obligations.

78

(3) Secured by the partnership interests in three super regional malls.
The security interest in each of the malls are cross-collateralized
and contain cross-default provisions. The loan was issued at a
discount, which will amortize to its par value at a yield to
maturity of 13.2%. Payments are interest only and reset monthly
based upon a one month LIBOR spread. The loan was paid off in full
on January 10, 2003. In conjunction with this investment, the
Company purchased a 1.46% interest only strip off of a B Note
secured by a portfolio of apartments (5,389 units). Payments
received are the greater of 1.5% or 9.5% less LIBOR+450, based upon
a notional par value.
(4) The exchange rate for the British pound at December 31, 2001 was
(pound)0.687852 to US $1.00. The entire principal balance of the
Company's investment in the London Loan was pledged to secure line
of credit borrowings. The loan and the line of credit matured on
12/17/02.
(5) The entire principal balance of the Company's investment was
pledged to secure line of credit borrowings. The loan and the line
of credit matured on 11/1/02.
(6) The entire principal balance of the Company's investment is pledged
to secure reverse repurchase agreements. The loan and the line of
credit matured on 4/16/02.

Reconciliation of commercial mortgage loans: Par Book Value
----------- --------------

Balance at beginning of period $153,187 $153,187
Proceeds from repayment of mortgage loans (66,620) (66,620)
Investments in commercial mortgage loans 56,070 56,070
----------- --------------

Balance at December 31, 2001 142,637 142,637

Discount accretion - 40
Proceeds from repayment of mortgage loans (81,471) (80,383)
Reduction in notional par value (170) -
Investments in commercial mortgage loans 6,683 3,370
----------- --------------

Balance at December 31, 2002 $67,679 $ 65,664
=========== ==============

Note 5 EQUITY INVESTMENT AND REAL ESTATE JOINT VENTURES

On July 20, 2000, the Company made an investment aggregating $5,121 in two
limited partnerships for the purpose of purchasing a ninety nine thousand
square foot office building and a one hundred twenty thousand square foot
office building, both of which are located in suburban Philadelphia. The
Company's ownership interest is 64.81% in each partnership. The Company
receives a preferred return of 12% compounded on its unreturned capital, which
is payable monthly and a share of the proceeds from a sale or refinancing. The
book value of the partnerships at December 31, 2002 and 2001 was $3,149 and
$3,159, respectively. In January 2003, the Company received a return of
capital distribution from the partnerships in the amount of $400.

On December 14, 2000, the Company made an investment aggregating approximately
$5,149 in a limited liability company and received a 36.4% senior interest.
The joint venture was established for the purpose of acquiring a five hundred
thousand square foot office and retail complex in Tallahassee, Florida. The
Company receives a preferred return of 13.25% and a return of capital of $3,
which is payable monthly. The book value of the investment at December 31,
2002 and 2001 was $5,116 and $5,158, respectively.

On July 20, 2001, the Company entered into a $50 million commitment to acquire
shares in Carbon Capital, Inc. ("Carbon"), a private commercial real estate
income opportunity fund

79

managed by BlackRock Financial Management, Inc., who is also the manager of
the Company (Note 10 of the consolidated financial statements). The period
during which the Company may be required to purchase shares under the
commitment, expires in July 2004. On November 5, 2001, the Company received a
capital call notice to fund $8,784 of its Carbon investment, which was paid on
November 19, 2001. On October 30, 2002, the Company funded an additional
capital call notice in the amount of $6,100. The proceeds of the capital calls
were used by Carbon primarily to acquire commercial loans secured by real
estate or ownership interests in entities that own real estate. On December
31, 2001, the Company owned 32.5% of the outstanding shares in Carbon. In
March 2002, Carbon obtained additional commitments from unaffiliated
institutional investors while the Company's commitment remained unchanged.
Accordingly, the Company's ownership was reduced from 32.5% to 18.8%. On
December 30, 2002, the Company received dividends of $1,089. The Company's
remaining commitment at December 31, 2002 and 2001 was $35,116 and $41,216,
respectively. On February 6, 2003, the Company funded an additional capital
call notice in the amount of $2,680, which was used by Carbon to acquire a
mezzanine loan secured by ownership interests in an entity that owns a
mixed-use development.

Combined summarized financial information of the unconsolidated equity
investment and real estate joint ventures of the Company is as follows:

December 31,
------------------------------------------------
2002 2001
---------------------- ----------------------
Balance Sheets:

Real estate property $44,342 $58,078
Commercial mortgage loans, net 178,429 26,469
Other assets 10,533 8,687
---------------------- ----------------------

Total Assets $233,304 $93,234
====================== ======================

Mortgage debt $30,846 $45,603
Other liabilities 103,954 2,201
Partners', members' and shareholders' equity 98,504 45,430
---------------------- ----------------------

Total liabilities and shareholders' equity $233,304 $93,234
====================== ======================

Anthracite Capital, Inc.'s share of equity $23,262 $17,101
====================== ======================

For the years ended December 31,
------------------------------------------------
2002 2001 2000
-------------- -------------- -----------
Statements of Operations:

Revenues $19,901 $11,119 $1,723
-------------- -------------- -----------

Expenses
Interest expense 4,877 3,796 901
Depreciation and amortization 2,203 1,840 317
Operating expenses 5,611 3,560 559
-------------- -------------- -----------

Total expenses 12,691 9,196 1,777
-------------- -------------- -----------

80

Net Income 7,210 $1,923 $(54)
============== ============== ===========

Anthracite Capital, Inc.'s share of net income $2,246 $1,747 $348
============== ============== ===========

The following tables summarizes the loan investments held by Carbon Capital,
Inc. at December 31, 2002 and 2001:

Date of Initial Scheduled Par
Investment Maturity Location Property Type 2002 2001
----------------- -------------- --------------------------- -------------- ----------------------

11/19/01 9/11/04 New York, NY(1),(4) Office $ 10,000 $10,000
11/20/01 12/11/07 San Francisco, CA(2) Office 12,071 12,138
12/17/01 4/9/04 Tysons Corner, VA(3) Office 10,000 10,000
5/17/02 12/11/04 Midwest(4), (5) Retail 14,500 -
5/17/02 12/11/04 Southwest(4) Residential 12,487 -
10/16/02 11/1/07 Chicago, IL(5) Office 71,952 -
11/1/02 11/9/04 San Francisco, CA(6) Hotel 65,000 -
----------------------
$196,010 $32,138
======================

(1) May be extended at the borrower's option for two additional
twelve-month periods, subject to certain performance hurdles and an
extension fee of $425 for the first extension and $413 for the
second extension.
(2) Anthracite Capital, Inc. owns two subordinate interests, which are
senior to the interest owned by Carbon Capital, Inc.
(3) May be extended at the borrower's options for two additional
twelve-month periods for a .25% extension fee.
(4) Secured by the partnership interests in three super regional malls.
The security interests in each of the malls are cross-collateralized
and contain cross-default provisions. The loan was paid off in full
on January 10, 2003. In conjunction with this investment, Carbon
Capital, Inc. purchased a 1.46% interest only strip off of a B Note
secured by a portfolio of apartments (5,389 units). Anthracite
Capital, Inc. owns subordinate interests in these investments,
which are pari passu to those owned by Carbon Capital, Inc.
(5) The entire principal balance is pledged to secure reverse
repurchase agreements.
(6) Represents a $30,000 subordinate interest in a $160,000 note
secured by a full service hotel and a $35,000 mezzanine loan,
secured by the borrower's interest in the same property. May be
extended at the borrower's option for three additional twelve-month
periods for a .25% extension fee. There is a fee due for the second
and third extension of 0.125% per extension. The entire principal
balance is pledged to secure reverse repurchase agreements.

At December 31, 2002, the weighted average interest spread and the weighted
average yield of loan investments held by Carbon Capital, Inc. was 8.6% and
9.9%, respectively. At December 31, 2001, the weighted average interest
spread and the weighted average yield of the loan investments held by Carbon
Capital, Inc., was 7.4% and 11.7%, respectively.

81

Note 6 FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires
the disclosure of the estimated fair value of financial instruments. The
following table presents the notional amount, carrying value and estimated
fair value of financial instruments as of December 31, 2002 and 2001:

2002 2001
--------------------------------------------------- -------------------------------------------
Notional Carrying Value Estimated Fair Notional Carrying Estimated Fair
Amount Value Amount Value Value
------------- --- --------------- ---------------- ------------ ------------------------------

Securities available for sale $ - $ 973,062 $ 973,062 $ - $ 1,445,954 $ 1,445,954
Securities held for trading - 1,427,733 1,427,733 - 564,081 564,081
Commercial mortgage loans - 65,664 65,664 - 142,637 146,635
Secured borrowings - 2,161,661 2,161,661 - (1,835,938) (1,835,938)
Currency forward contracts - 365 365 12,350 (489) (489)
Interest rate swap agreements 1,162,832 (45,602) (45,602) 792,000 (9,380) (9,380)
Futures 4,292 (476,676) (476,676) 930,000 (94,221) (94,221)

The currency forward contracts as of December 31, 2002 is comprised of two
offsetting currency forward contracts which net to a notional amount of zero.
Notional amounts are a unit of measure specified in a derivative instrument.
The fair values of the Company's securities available for sale, securities
held for trading, mortgage loan pools, currency forward contracts and interest
rate swap agreements are based on market prices provided by certain dealers
who make markets in these financial instruments. The fair values reported
reflect estimates and may not necessarily be indicative of the amounts the
Company could realize in a current market exchange. Commercial mortgage loans
and secured borrowings are floating rate instruments, therefore their carrying
value approximates fair value.

Note 7 IMPAIRMENT - CMBS

The FMACT 1998-BA class B security continues to perform poorly. Based on the
information provided by the trustee, as of December 16, 2002, of the 71
borrowers in the loan pool underlying this security, there are 8 borrowers
with loans in the amount of $36,741 which are in default, 10 borrowers with
loans in the amount of $23,722 which are delinquent, and 53 borrowers with
loans in the amount

82

of $135,292 which are current. During the fourth quarter of 2002, the servicer
of the underlying loans recouped principal and interest advances made in prior
years. This action resulted, at least temporarily, in insufficient cash being
available to make the payments required on the Company's class B security.

Based on the delinquencies and defaults in the underlying pools, and the
missed payments during the fourth quarter of 2002 as described above, the
Company revised its estimated future cash flows from this investment.
Accordingly, in accordance with EITF 99-20, the Company determined that its
investment was impaired and wrote down the adjusted purchase price of this
security by $10,273 to its estimated fair value and increased the GAAP yield
from 7.69% to a market yield for a security of this credit quality, estimated
to be 20%. These figures incorporate the assumption that an additional $31,203
of losses will be experienced by the underlying pools and an estimate of
another 1.0% of losses per year over the remaining life of the trust. This
security was part of the CORE Cap acquisition in May of 2000 and was rated AA
at that time. This security is currently rated D by Standard & Poors and CC by
Fitch Ratings.

Note 8 COMMON STOCK

On July 11, 2001, the Company filed a registration statement to register with
the SEC an additional 10,000,000 shares of Common Stock to be issued under its
Dividend Reinvestment and Stock Purchase Plan (the "Dividend Reinvestment
Plan"). The Dividend Reinvestment Plan allows investors the opportunity to
purchase additional shares of the Company's Common Stock through the
reinvestment of the Company's dividends, optional cash payments and initial
cash investments.

On September 21, 2001, the Company filed a registration statement to register
an additional $300,000 of securities with the SEC. The shelf registration
statement permits the Company to issue a variety of debt and equity securities
in the public markets. There can be no certainty, however, that the Company
will be able to issue, on terms favorable to the Company, or at all, any of
the securities so registered.

On February 14, 2001, the Company completed a follow-on offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
was approximately $33,300. The Company had granted the underwriters an option,
exercisable for 30 days, to purchase up to 600,000 additional shares of Common
Stock to cover over-allotments. This option was exercised on March 13, 2001
and resulted in net proceeds to the Company of approximately $5,000.

On May 11, 2001, the Company completed a follow-on offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
was approximately $37,800. The Company had granted the underwriters an option,
exercisable for 30 days, to purchase up to 600,000 additional shares of Common
Stock to cover over-allotments. This option was exercised on June 6, 2001 and
resulted in additional net proceeds to the Company of approximately $5,675.

On November 7, 2001, the Company completed a follow-on offering of 4,400,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after

83

deducting underwriting fees and expenses) was approximately $39,400. On
November 13, 2001, the underwriters exercised an option to purchase an
additional 90,000 shares of Company Common Stock available through an
over-allotment granted to the underwriters and resulted in additional net
proceeds to the Company of approximately $810.

For the year ended December 31, 2002, the Company issued 1,455,725 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company
was approximately $15,920. For the year ended December 31, 2001, the Company
issued 2,228,566 shares of Common Stock under its Dividend Reinvestment Plan.
Net proceeds to the Company was approximately $22,945.

During the year ended December 31, 2002, the Company declared dividends to
stockholders totaling $65,366 or $1.40 per share, of which $48,777 was paid
during the year and $16,589 was paid on January 31, 2003. During the year
ended December 31, 2001, the Company declared dividends to stockholders
totaling $47,458 or $1.29 per share, of which $31,607 was paid during the year
and $15,850 was paid on January 31, 2002.

On March 6, 2003, the Company declared dividends to its stockholders of $.35
per share, payable on April 30, 2003 to stockholders of record on March 31,
2003. For U.S. Federal income tax purposes, the dividends are ordinary income
to the Company's stockholders.

Note 9 PREFERRED STOCK

On December 2, 1999, the Company authorized and issued 1,200,000 shares of
10.5% Series A Senior Cumulative Redeemable Preferred Stock ("Series A
Preferred Stock"), $0.001 par value per share, for aggregate proceeds of
$30,000. The Series A Preferred Stock carries a 10.5% coupon and is
convertible into the Company's Common Stock at a price of $7.35 per share. The
Series A Preferred Stock has a seven-year maturity at which time, at the
option of the holders, the shares may be converted into shares of Common Stock
or liquidated ("Liquidation Preference") for $28.50 per share. On December 21,
2001, the only Series A Preferred stockholder converted 1,190,000 shares of
the Series A Preferred Stock into 4,096,854 shares of Common Stock at a price
of $7.26 per share pursuant to its terms, which is $0.09 lower than the
original conversion price due to the effects of anti-dilution provisions in
the Series A Preferred Stock. The remaining 10,000 shares of Series A
Preferred Stock were converted into 34,427 shares of Common Stock at a price
of $7.26 per share in March 2002.

The Series A Preferred Stock was privately sold by the Company, and there was
no underwriting discount paid. At the closing of the CORE Cap merger (see Note
14 of the consolidated financial statements), the Liquidation Preference of
the Series A Preferred Stock was increased from $27.75 to $28.50 per share.

As part of the CORE Cap merger, the Company authorized and issued 2,261,000
shares of 10% Series B Cumulative Redeemable Convertible Preferred Stock
("Series B Preferred Stock"), $0.001 par value per share, to CORE Cap
shareholders. The Series B Preferred Stock is perpetual, carries a 10% coupon,
has a preference in liquidation as of December 31, 2002 of $47,817, and is
convertible into the Company's Common Stock at a price of $17.09 per share,
subject to

84

adjustment. If converted, the Series B Preferred Stock would convert into
approximately 2,798,180 shares of the Company's Common Stock. In 2002, 300,000
shares of 10% Series B Preferred Stock with a liquidation preference of $7,500
were converted at the shareholder's option into 438,885 shares of the
Company's Common stock. In 2001, 48,300 shares of 10% Series B Preferred Stock
with a liquidation preference of $1,207 were converted at the shareholder's
option into 70,660 shares of the Company's Common Stock.

As of December 31, 2002, the Company has authorized and unissued 96,539,000
shares of preferred stock.

Note 10 TRANSACTIONS WITH AFFILIATES

The Company has a Management Agreement with the "Manager", a majority owned
indirect subsidiary of PNC Financial Services Group, Inc. ("PNC Bank") and the
employer of certain directors and officers of the Company, under which the
Manager manages the Company's day-to-day operations, subject to the direction
and oversight of the Company's Board of Directors. The initial two-year term
of the Management Agreement was to expire on March 27, 2000; on March 16,
2000, the Management Agreement was extended for an additional two years, with
the approval of the unaffiliated directors, on terms similar to the original
agreement. On March 25, 2002, the Management Agreement was extended for one
year through March 27, 2003, with the approval of the unaffiliated directors,
on terms similar to the prior agreement with the following changes: (i) the
incentive fee calculation would be based on GAAP earnings instead of funds
from operations, (ii) the removal of the four-year period to value the
Management Agreement in the event of termination and (iii) subsequent renewal
periods of the Management Agreement would be for one year instead of two
years. The Board was advised by Houlihan Lokey Howard & Zukin Financial
Advisors, Inc., a national investment banking and financial advisory firm, in
the renewal process.

On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement are similar to the
prior agreement except for the incentive fee calculation which would provide
for a rolling four-quarter high watermark rather than a quarterly calculation.
In determining the rolling four-quarter high watermark, the Company would
calculate the incentive fee based upon the current and prior three quarters'
net income. The Manager would be paid an incentive fee in the current quarter
if the Yearly Incentive Fee is greater than what was paid to the Manager in
the prior three quarters cumulatively. The Company will phase in the rolling
four-quarter high watermark commencing with the second quarter of 2003.
Calculation of the incentive fee will be based on GAAP and adjusted to exclude
special one-time events pursuant to changes in GAAP accounting pronouncements
after discussion between Manager and the unaffiliated directors. The incentive
fee threshold did not change. The high watermark will be based on the existing
incentive fee hurdle, which provides for the Manager to be paid 25% of the
amount of earnings (calculated in accordance with GAAP) per share that exceeds
the product of the adjusted issue price of the Company's common stock per
share ($11.39 as of December 31, 2002) and the greater of 9.5% or 350 basis
points over the ten-year Treasury note.

85

The Company pays the Manager an annual base management fee equal to a
percentage of the average invested assets of the Company as defined in the
Management Agreement. The base management fee is equal to 1% per annum of the
average invested assets rated less than BB- or not rated, 0.75% of average
invested assets rated BB- to BB+, and 0.20% of average invested assets rated
above BB+. In order to coincide with the increased size of the Company,
effective July 1, 2001, the Manager reduced the base management fee from 0.35%
of average invested assets rated above BB+. This revision resulted in $2,360
and $1,059 in savings to the Company during 2002 and 2001, respectively.

The Company incurred $9,332, $7,780 and $6,483 in base management fees in
accordance with the terms of the Management Agreement for the years ended
December 31, 2002, 2001 and 2000, respectively. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements to
the Manager of $14, $216 and $120 for certain expenses incurred on behalf of
the Company during 2002, 2001 and 2000, respectively.

The Company has also paid the Manager on a quarterly basis, as incentive
compensation, an amount equal to 25% of the funds from operations of the
Company (as defined) plus gains (minus losses) from debt restructuring and
sales of property, before incentive compensation in excess of a threshold
rate. The threshold rate for 1999, 2000, and the six months ended June 30,
2001 was based upon an annualized return on equity equal to 3.5% over the ten
year U.S. Treasury Rate on the adjusted issue price of the Common Stock.
Effect July 1, 2001, the Manager revised the threshold rate to be the greater
of 3.5% over the ten-year U.S. Treasury Rate or 9.5%. This revision resulted
in $918 and $630 in savings to the Company during 2002 and 2001, respectively.

Pursuant to the March 25, 2002 one-year Management Agreement extension, such
incentive fee was based on 25% of earnings (calculated in accordance with
GAAP) of the Company. For purposes of the incentive compensation calculation,
equity is generally defined as proceeds from issuance of Common Stock before
underwriting discounts and commissions and other costs of issuance. For
purposes of calculating the incentive fee during 2002, the cumulative
transition adjustment of $6,327 resulting from the Company's adoption of SFAS
142 was excluded from earnings in its entirety and included using an
amortization period of three years. This revision saved the Company $1,314 of
incentive fee during 2002. The Company incurred $3,195, $3,238 and $967 in
incentive compensation for the years ended December 31, 2002, 2001 and 2000,
respectively.

On March 17, 1999, the Company's Board of Directors approved an administration
agreement with the Manager and the termination of a previous agreement with an
unaffiliated third party. Under the terms of the administration agreement, the
Manager provides financial reporting, audit coordination and accounting
oversight services to the Company. The Company pays the Manager a monthly
administrative fee at an annual rate of 0.06% of the first $125 million of
average net assets, 0.04% of the next $125 million of average net assets and
0.03% of average net assets in excess of $250 million subject to a minimum
annual fee of $120. For the years ended December 31, 2002, 2001 and 2000, the
Company paid administration fees of $168, $144 and $120, respectively.

During the year ended December 31, 2000, the Company purchased certificates
representing a 1% interest in Midland Commercial Mortgage Owner Trust IV,
Midland Commercial Mortgage Owner Trust V, Midland Commercial Mortgage Owner
Trust VI, Commercial Mortgage Owner Trust VII,

86

PNC Loan Trust VII and PNC Loan Trust VIII (collectively the "Trusts") for an
aggregate investment of $7,021. These Midland Trusts were purchased from
Midland Loan Services, Inc. ("Midland") and the PNC trusts were purchased from
PNC Bank. Midland is a wholly-owned indirect subsidiary of PNC Bank and the
depositor to the Trusts. The assets of the Trusts consist of commercial
mortgage loans originated or acquired by Midland and PNC Bank. In connection
with these transactions, the Company entered into a $4,500 committed line of
credit from PNC Funding Corp., a wholly-owned indirect subsidiary of PNC Bank,
to borrow up to 90% of the fair market value of the Company's interest in the
Trusts. Outstanding borrowings against this line of credit bear interest at a
LIBOR based variable rate. As of December 31, 2001 and 2000 there were no
outstanding borrowings under this line of credit. The Company earned $163 and
$33 from the Trusts and paid interest of approximately $138 and $20 to PNC
Funding Corp. during years ended December 31, 2000 and 1999, respectively. The
Midland Trusts were all sold prior to December 31, 2000. The gain on sale of
these investments was not significant.

In March 2001, the Company purchased twelve certificates each representing a
1% interest in different classes of Owner Trust NS I Trust ("Owner Trusts")
for an aggregate investment of $37,868. These certificates were purchased from
PNC Bank. The assets of the Owner Trusts consist of commercial mortgage loans
originated or acquired by an affiliate of PNC Bank. The Company entered into a
$50,000 committed line of credit from PNC Funding Corp. to borrow up to 95% of
the fair market value of the Company's interest in the Owner Trusts.
Outstanding borrowings against this line of credit bear interest at a LIBOR
based variable rate. As of December 31, 2001, there was $13,885 borrowed under
this line of credit. The Company earned $1,468 from the Owner Trusts and paid
interest of approximately $849 to PNC Funding Corp. as interest on borrowings
under a related line of credit for year ended December 31, 2001. During 2001,
the Company sold four Owner Trusts. The gain on the sale of those Owner Trusts
was $35. The outstanding borrowings were repaid prior to the expiration on
March 13, 2002, at which time the remaining Owner Trusts were sold at a gain
of $90.

On July 20, 2001, the Company entered into a $50 million commitment to acquire
shares in Carbon Capital, Inc. ("Carbon"), a private commercial real estate
income opportunity fund managed by the Manager (see Note 5 to the consolidated
financial statements). The period during which the Company may be required to
purchase shares under the commitment, expires in July 2004.

On May 15, 2000, the Company completed the acquisition of CORE Cap, Inc. The
merger was a stock for stock acquisition where the Company issued 4,180,552
shares of its common stock and 2,261,000 shares of its series B preferred
stock. At the time of the CORE Cap acquisition, the Manager agreed to pay GMAC
(CORE Cap, Inc's external advisor) $12,500 over a ten-year period
("Installment Payment") to purchase the right to manage the assets under the"
existing management contract ("GMAC Contract"). The GMAC Contract had to be
terminated in order to allow for the Company to complete the merger, as the
Company's management agreement with the Manager did not provide for multiple
managers. As a result the Manager offered to buy-out the GMAC contract as the
Manager estimated it would receive incremental fees above and beyond the
Installment Payment, and thus was willing to pay for, and separately
negotiate, the termination of the GMAC Contract. Accordingly, the value of the
Installment Payment was not considered in the Company's allocation of its
purchase price to the net assets acquired in the acquisition of CORE Cap, Inc.
The Company agreed that should the Management Agreement with its Manager be
terminated, not renewed or not extended for any reason other than for cause,
the Company would pay to the Manager an amount equal to the Installment
Payment less the sum of all payments made by the Manager to GMAC. As of
December 31, 2002, the Installment Payment would be $9,500 payable over eight
years. The Company does not accrue for this contingent liability.

87

Note 11 STOCK OPTIONS

The Company has adopted a stock option plan (the "1998 Stock Option Plan")
that provides for the grant of both qualified incentive stock options that
meet the requirements of Section 422 of the Code and non-qualified stock
options, stock appreciation rights and dividend equivalent rights. Stock
options may be granted to the Manager, directors, officers and any key
employees of the Company, directors, officers and key employees of the Manager
and to any other individual or entity performing services for the Company.

The exercise price for any stock option granted under the 1998 Stock Option
Plan may not be less than 100% of the fair market value of the shares of
Common Stock at the time the option is granted. Each option must terminate no
more than ten years from the date it is granted. Subject to anti-dilution
provisions for stock splits, stock dividends and similar events, the 1998
Stock Option Plan authorizes the grant of options to purchase up to an
aggregate of 2,470,453 shares of Common Stock.

For option grants prior to December 15, 1998, the Company considered its
officers and directors to be employees for the purposes of stock option
accounting. In accordance with the FASB's Interpretation No. 44, Accounting
for Certain Transactions Involving Stock Compensation, the Company's officers
and directors are not considered to be employees for grants made subsequent to
that date.

Of the options issued under the 1998 Stock Option Plan, options covering
979,426 shares of Common Stock were granted prior to December 15, 1998 to
individuals deemed to be employees. The Company adopted the disclosure-only
provisions of SFAS No. 123, Accounting for Stock-Based Compensation, for such
options. Accordingly, no compensation cost for these options has been recorded
in the consolidated statement of operations. Had compensation cost for these
options been determined based on the fair value of the options at the grant
date consistent with the provisions of SFAS No. 123, the Company's net income
and net income per share would have changed to the pro forma amounts indicated
below:

2002 2001 2000
-----------------------------------------------

Net income - as reported $59,955 $56,271 $39,326
Net income - pro forma 59,955 56,218 39,158
Net income per common share, basic - as reported 1.18 1.41 1.37
Net income per common share, basic - pro forma 1.18 1.41 1.36
Net income per common share, diluted - as reported 1.18 1.35 1.28
Net income per common share, diluted - pro forma 1.18 1.35 1.28

For the pro forma, the compensation cost is amortized over the vesting period
of the options.

For the options to purchase 786,915 shares of the Company's Common Stock
granted to non-employees under the 1998 Stock Option Plan, compensation cost
is accrued based on the estimated fair value of the options issued and
amortized over the vesting period. Because vesting of the options is
contingent upon the recipient continuing to provide services to the Company to
the vesting date, the Company estimates the fair value of the non-employee
options at each period end, up to the vesting date, and

88

adjusts expensed amounts accordingly. The value of these non-employee options
at each period end was negligible and was fully vested by March 2002.

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the period ending December 31, 2000. There
were no options granted in 2002 and 2001.

December 31, 2000
-----------------
Estimated volatility 25%
Expected life 7 years
Risk-free interest rate 6.0%
Expected dividend yield 11.35%

On May 15, 2000, pursuant to the acquisition of CORE Cap, the Company granted
stock options to the directors of CORE Cap similar in term and vesting to the
stock options the directors held immediately prior to the date of acquisition.
The strike price was adjusted for the effect of the acquisition. The options
granted are as follows:

Number of Options Exercise %
Granted Price Vested
- ---------------------------------------------------------------
76,998 $15.58 100%
15,400 15.84 100%
15,400 9.11 100%
15,400 7.82 100%

The fair value of the CORE Cap option grants at the grant date was estimated
by the Company using the Black-Scholes option-pricing model. The resulting
valuation was negligible.

The following table summarizes information about options outstanding under the
1998 Stock Option Plan:

2002 2001 2000
----------------------- ------------------------ -----------------------
Weighted- Weighted- Weighted-
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------------------- ------------------------ -----------------------

Outstanding at January 1 1,766,341 $13.87 1,766,341 $13.87 1,718,143 $14.03
Granted 0 0 0 193,198 11.73
Exercised (182,700) 8.33 0 0 0
Cancelled (23,099) 15.63 0 (145,000) 12.91
----------- --------- -----------

Outstanding at December 31 1,560,542 $14.49 1,766,341 $13.87 1,766,341 $13.87
=========== ========= ===========
Options exercisable at December 31 1,560,542 $14.49 1,400,554 $13.70 919,770 $14.02
=========== ========= ===========
Weighted-average fair value of
options granted during the

89

year ended December 31
(per option) - - $ 0.12
=========== ========= =======

The following table summarizes information about options outstanding under the
1998 Stock Option Plan at December 31, 2002:

Exercise Options Outstanding Remaining Options Exercisable
Price at December 31, 2002 Contractual Life at December 31, 2002
-------- -------------------- ---------------- --------------------

7.82 11,550 7.1 Years 11,550
8.44 105,000 6.2 Years 105,000
9.11 11,550 6.2 Years 11,550
15.00 1,363,143 5.2 Years 1,363,143
15.58 57,749 4.7 Years 57,749
15.83 11,550 5.2 Years 11,550
----------- -------------------- --------------------
7.82-$15.83 1,560,542 5.31 Years 1,560,542
=========== ==================== =====================

Shares of Common Stock available for future grant under the 1998 Stock Option
Plan at December 31, 2002 were 727,211.

Note 12 BORROWINGS

The Company's borrowings consist of lines of credit, CDO, and reverse
repurchase borrowings.

On January 15, 2002, the Company renewed a credit facility with Merrill Lynch
Mortgage Capital, Inc. for a twelve-month period, which permits the Company to
borrow up to $200,000. As of December 31, 2002, there were no outstanding
borrowings under this facility. As of December 31, 2001, the outstanding
borrowings under this line of credit were $57,113. The agreement requires
assets to be pledged as collateral, which may consist of rated CMBS, rated
RMBS, residential and commercial mortgage loans, and certain other assets.
Outstanding borrowings under this line of credit bear interest at a LIBOR
based variable rate. The facility expired pursuant to its terms.

On July 19, 1999, the Company entered into a $185,000 committed credit
facility with Deutsche Bank, AG (the "Deutsche Bank Facility"). The Deutsche
Bank Facility has a two-year term and provides for extensions at the Company's
option. The Deutsche Bank Facility was extended for a one-year term through
July 19, 2002. The facility was extended a second time through July 15, 2005.
The Deutsche Bank Facility can be used to replace existing reverse repurchase
agreement borrowings and to finance the acquisition of mortgage-backed
securities, loan investments and investments in real estate joint ventures. As
of December 31, 2002 and December 31, 2001, the outstanding borrowings under
this facility were $19,189 and $43,409, respectively. Outstanding borrowings
under the Deutsche Bank Facility bear interest at a LIBOR based variable rate.

On July 18, 2002, the Company entered into a $75,000 committed credit facility
with Greenwich Capital, Inc. The facility provides the Company with the
ability to borrow only in the first year with repayment of principal not due
for three years. Outstanding borrowings under this line of credit bear
interest at a LIBOR based variable rate. As of December 31, 2002, there were
no borrowings under this facility.

90

The Company is subject to various covenants in its lines of credit, including
maintaining a minimum GAAP net worth of $305,000, a debt-to-equity ratio not
to exceed 5.5 to 1, a minimum cash requirement based upon certain
debt-to-equity ratios, a minimum debt service coverage ratio of 1.5 and a
minimum liquidity reserve of $10,000. As of December 31, 2002 and 2001, the
Company was in compliance with all such covenants.

On May 29, 2002, the Company issued ten tranches of secured debt through CDO
I. In this transaction, a wholly-owned subsidiary of the Company issued
secured debt in the par amount of $419,185 secured by the subsidiary's assets.
The adjusted issue price of the CDO I debt, as of December 31, 2002, is
$403,983. Five tranches were issued at a fixed rate coupon and five tranches
were issued at a floating rate coupon with a combined weighted average
remaining maturity of 9.29 years. All floating rate coupons were swapped to
fixed resulting in a total fixed rate cost of funds for CDO I of approximately
7.21%. The Company incurred $9,857 of issuance costs which will be amortized
over the weighted average life of the CDO. The CDO was structured to match
fund the cash flows from a significant portion of the Company's CMBS and
unsecured real estate investment trust debt portfolio (REIT debt). The par
amount as of December 31, 2002 of the collateral securing CDO I consists of
78% CMBS rated B or higher and 22% REIT debt rated BBB or higher. As of
December 31, 2002, the collateral securing the CDO I has a fair value of
$443,511.

On December 10, 2002, the Company issued seven tranches of secured debt
through CDO II. In this transaction, a wholly-owned subsidiary of the Company
issued secured debt in the par amount of $280,783 secured by the subsidiary's
assets. The adjusted issue price of the CDO II debt as of December 31, 2002 is
$280,607. Four tranches were issued at a fixed rate coupon and three tranches
were issued at a floating rate coupon with a combined weighted average
remaining maturity of 9.34 years. All floating rate coupons were swapped to
fixed resulting in a total fixed rate cost of funds for CDO II of
approximately 5.73%. The Company incurred $6,028 of issuance costs which will
be amortized over the weighted average life of the CDO. The CDO was structured
to match fund the cash flows from a significant portion of the Company's CMBS
and unsecured real estate investment trust debt portfolio (REIT debt). The par
amount as of December 31, 2002 of the collateral securing CDO II consists of
78% CMBS rated B or higher and 22% REIT debt rated BBB or higher. As of
December 31, 2002, the collateral securing CDO II has a fair value of
$283,258.

Proceeds from the CDOs were used to pay off all of the financing of the
Company's CMBS below investment grade portfolio, BBB portfolio and its REIT
debt. Prior to the CDOs, these portfolios were financed with thirty-day
repurchase agreements with various counterparties that marked the assets to
market on a daily basis at interest rates based on 30-day LIBOR. For
accounting purposes, these transactions were treated as a secured financing,
and the debt is non-recourse to the Company.

The Company has entered into reverse repurchase agreements to finance most of
its securities available for sale that are not financed under its lines of
credit or from the issuance of its collateralized debt obligations. The
reverse repurchase agreements are collateralized by most of the Company's
securities available for sale and bear interest at a LIBOR based variable
rate.

Certain information with respect to the Company's collateralized borrowings as
of December 31, 2002 is summarized as follows:

91

Lines of Reverse Total
Credit and Repurchase Collateralized Collateralized
Term Loans Agreements Debt Obligations Borrowings
------------------------------------------------------------------------------------------

Outstanding borrowings $19,189 $1,457,882 $684,590 $2,161,661
Weighted average borrowing
rate 3.40% 1.37% 6.60% 3.04%
Weighted average remaining
maturity 524 days 21 days 3,398 days 1095 days
Estimated fair value of
assets pledged $37,310 $1,527,766 $726,769 $2,291,845

As of December 31, 2002, there were no borrowings outstanding under the lines
of credit that were denominated in pounds sterling.

As of December 31, 2002, the Company's collateralized borrowings had the
following remaining maturities:

Lines of Reverse Total
Credit and Term Repurchase Collateralized Debt Collateralized
Loans Agreements Obligations Borrowings
------------------------------------------------------------------------------------------

Within 30 days $ - $1,457,882 $ - $1,457,882
31 to 59 days - - - -
Over 60 days 19,189 - 684,590 703,779
==========================================================================================
$19,189 $1,457,882 $684,590 $2,161,661
==========================================================================================

Certain information with respect to the Company's collateralized borrowings
as of December 31, 2001 is summarized as follows:

Lines of Reverse Total
Credit and Repurchase Collateralized
Term Loans Agreements Borrowings
-------------------------------------------------------

Outstanding borrowings $ 115,747 $1,720,191 $1,835,938
Weighted average 3.62% 1.94% 2.04%
borrowing rate
Weighted average 186 days 18 days 29 days
remaining maturity
Estimated fair value of $173,139 $1,825,971 $1,999,110
assets pledged

At December 31, 2001, $20,356 of borrowings outstanding under the lines of
credit was denominated in pounds sterling, and interest payable is based on
sterling LIBOR.

As of December 31, 2001, the Company's collateralized borrowings had the
following remaining maturities:

Lines of Reverse Total
Credit and Repurchase Collateralized
Term Loan Agreements Borrowings
-----------------------------------------------------------------

Within 30 days $58,453 $1,700,420 $1,758,873
31 to 59 days - 19,771 19,771

92

Over 60 days 57,294 - 57,294
-----------------------------------------------------------------
$115,747 $1,720,191 $1,835,938
=================================================================

Under the lines of credit and the reverse repurchase agreements, the
respective lender retains the right to mark the underlying collateral to
estimated market value. A reduction in the value of its pledged assets will
require the Company to provide additional collateral or fund margin calls.
From time to time, the Company expects that it will be required to provide
such additional collateral or fund margin calls.

Note 13 DERIVATIVE INSTRUMENTS

Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended, which establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts and for hedging
activities. All derivatives, whether designated in hedging relationships or
not, are required to be recorded on the balance sheet at fair value. If the
derivative is designated as a fair value hedge, the changes in the fair value
of the derivative and of the hedged item attributable to the hedged risk are
recognized in earnings. If the derivative is designated as a cash flow hedge,
the effective portions of change in the fair value of the derivative are
recorded in other comprehensive income ("OCI") and are recognized in the
income statement when the hedged item affects earnings. Ineffective portions
of changes in the fair value of cash flow hedges are recognized in earnings.

The Company uses interest rate swaps to manage exposure to variable cash flows
on portions of its borrowings under reverse repurchase agreements and as
trading derivatives intended to offset changes in fair value related to
securities held as trading assets. On the date in which the derivative
contract is entered, the Company designates the derivative as either a cash
flow hedge or a trading derivative.

The reverse repurchase agreements bear interest at a LIBOR based variable
rate. Increases in the LIBOR rate could negatively impact earnings. The
interest rate swap agreements allow the Company to receive a variable rate
cash flow based on LIBOR and pay a fixed rate cash flow, mitigating the impact
of this exposure.

Interest rate swap agreements contain an element of risk in the event that the
counterparties to the agreements do not perform their obligations under the
agreements. The Company minimizes its risk exposure by entering into
agreements with parties rated at least A or better by Standard & Poor's Rating
Services. Furthermore, the Company has interest rate swap agreements
established with several different counterparties in order to reduce the risk
of credit exposure to any one counterparty. Management currently does not
expect any counterparty to default on their obligations. As of December 31,
2002, the counterparties for all of the Company's swaps are Deutsche Bank AG
and Merrill Lynch Capital Services, Inc., with ratings of AA- and A+,
respectively.

On January 1, 2001, the Company reclassified certain of its adjustable rate
agency debt securities, with an amortized cost of $64,432, from
available-for-sale to held for trading. An interest rate swap agreement with a
$25,000 notional amount that had been designated as hedging these debt
securities was similarly reclassified. The unrealized gain of $895 related to
the adjustable rate agency debt securities and the

93

unrealized loss of $2,798 related to the interest rate swap as of January 1,
2001 were reclassified from OCI and recorded as the cumulative transition
adjustment to earnings upon adoption of SFAS 133. The net cumulative effect of
adopting SFAS 133 was ($1,903) and is reflected as "Cumulative Transition
Adjustment - SFAS 133" on the consolidated statement of operations.

In addition, on January 1, 2001, the Company re-designated interest rate swap
agreements with notional amounts aggregating $98,000 that had been hedging
available-for-sale debt securities as cash flow hedges of its variable rate
borrowings under reverse repurchase agreements. The fair value of these swap
agreements on January 1, 2001, with a cumulative unrealized loss of ($9,853),
remained in OCI at the date of adoption of FAS 133, and therefore, did not
result in a transition adjustment.

Because of the de-designation and re-designation of the $98,000 interest rate
swaps, the Company is required to reclassify the related $9,853 recorded in
OCI. Reclassification is on a straight-line basis over the shorter of the life
of the swap or the previously hedged assets and is recognized as a reduction
of interest income. For the years ended December 31, 2002 and 2001, $994 was
reclassified as a reduction of interest income and $248 will be reclassified
as a reduction of interest income each quarter for the next 12 months.

In addition, on January 1, 2001, the Company re-designated interest rate swap
agreements with notional amounts aggregating $57,744 that had been hedging
available-for-sale debt securities to hedges of trading securities. These
interest rate swap agreements were sold in January 2001 and the loss of $795
is included in loss on securities held for trading. As of December 31, 2000,
the accumulated loss for these interest rate swaps was $3,226. This
accumulated loss is being reclassified from OCI as a reduction of income from
securities available for sale over the weighted average life of the securities
these interest rate swaps were hedging on December 31, 2000. For the years
ended December 31, 2002 and 2001, $257 was reclassified as a reduction of
interest income.

As of December 31, 2002, the Company had interest rate swaps with notional
amounts aggregating $791,287 that were designated as cash flow hedges of
borrowings under reverse repurchase agreements. Their aggregate fair value was
a $42,667 liability included in other liabilities on the consolidated
statement of financial condition. This liability was collateralized with cash
listed as restricted cash on the Company's consolidated statement of financial
condition. For the year ended December 31, 2002, the net change in the fair
value of the interest rate swaps was ($56,553) of which $236 was deemed
ineffective and is included as a reduction of interest expense and the gross
loss of $56,769 was recorded as an increase to other comprehensive loss. As of
December 31, 2002, the $791,287 notional of swaps which were designated as
cash flow hedges had a weighted average remaining term of 6.8 years.

During the year ended December 31, 2002, the Company terminated two of its
interest rate swaps with notional amounts aggregating $290,000 that were
designated as cash flow hedges of borrowings under reverse repurchase
agreements. The Company will reclassify from OCI as an increase to interest
expense the $15,968 loss in value incurred, over 3.4 years, which was the
weighted average remaining term of the swaps at the time they were closed out.
For the year ended December 31, 2002, $425 was reclassified as an increase to
interest expense and $1,275 will be reclassified as an increase to interest
expense each quarter for the next 12 months.

94

As of December 31, 2002, the Company had interest rate swaps with notional
amounts aggregating $371,545 designated as trading derivatives. Their
aggregate fair value at December 31, 2002 of ($2,935) is included in other
liabilities. For the year ended December 31, 2002, the change in fair value
for these trading derivatives was $(1,581) and is included as an addition to
loss on securities held for trading in the consolidated statement of
operations. As of December 31, 2002, the $371,545 notional of swaps which were
designated as trading derivatives had a weighted average remaining term of 5.3
years.

As of December 31, 2001, the Company had interest rate swaps with notional
amounts aggregating $682,000 that were designated as cash flow hedges of
borrowings under reverse repurchase agreements. Their aggregate fair value was
a $9,343 liability included in other liabilities on the consolidated statement
of financial condition. This liability was collateralized with cash listed as
restricted cash on the Company's consolidated statement of financial
condition. For the year ended December 31, 2001, the net change in the fair
value of the interest rate swaps was ($12,369) of which $428 was deemed
ineffective and is included as additional interest expense and $11,941 was
recorded as an increase to other comprehensive loss. As of December 31, 2001,
the $682,000 notional of swaps which were designated as cash flow hedges had a
weighted average remaining term of 4.6 years.

During the year ended December 31, 2001, the Company terminated two of its
interest rate swaps with notional amounts aggregating $105,000 that were
designated as cash flow hedges of borrowings under reverse repurchase
agreements. The Company will reclassify from OCI as an increase to interest
expense the $7,291 loss in value incurred during 2001 though the sale date,
over 8.8 years, which was the weighted average remaining term of the swaps at
the time they were closed out. For the years ended December 31, 2002 and 2001,
$813 and $118 were reclassified as an increase to interest expense in the
accompanying consolidated statement of operations, respectively. $203 will be
reclassified as an increase to interest expense each quarter for the next 12
months.

As of December 31, 2001, the Company had interest rate swaps with notional
amounts aggregating $110,000 designated as trading derivatives. Their
aggregate fair value at December 31, 2001 of ($37) is included in trading
securities. For the year ended December 31, 2001, the change in fair value for
these trading derivatives was $2,320 and is included as a reduction of loss on
securities held for trading in the consolidated statement of operations. As of
December 31, 2001, the $110,000 notional of swaps which were designated as
trading derivatives had a weighted average remaining term of 29.9 years.

The Company formally documents all relationships between hedging instruments
and hedged items, as well as its risk-management objectives and strategies for
undertaking various hedge transactions. The Company assesses, both at the
inception of the hedge and on an on-going basis, whether the derivatives that
are used in hedging transactions are highly effective in offsetting changes in
fair values or cash flows of hedged items. When it is determined that a
derivative is not highly effective as a hedge, the Company discontinues hedge
accounting prospectively.

In July 2000, the Company redesignated two interest rate agreements from
hedging certain of the Company's available-for-sale securities to securities
held for trading. These interest rate agreements were redesignated in
September 2000 back to hedging certain of the Company's available-for-sale
securities. The loss in value of these interest rate agreements during the
period they were designated as trading securities was $612 and is included in
gain on securities held for trading in the consolidated statement of
operations.

95

Occasionally, counterparties will require the Company or the Company will
require counterparties to provide collateral for the interest rate swap
agreements in the form of margin deposits. Net deposits are recorded as a
component of accounts receivable or other liabilities. Should the counterparty
fail to return deposits paid, the Company would be at risk for the fair market
value of that asset. At December 31, 2002 and 2001, the balance of such net
margin deposits owed to counterparties as collateral under these agreements
totaled $14,810 and $1,311, respectively.

The implementation of SFAS 133 did not change the manner in which the Company
accounts for its forward currency exchange contracts. Hedge accounting is not
applied for these contracts and they are carried at fair value, with changes
in fair value included as a component of net foreign currency gain or loss in
the consolidated statement of operations. These contracts are intended to
manage currency risk in connection with the Company's investment in the London
Loan, which is denominated in pounds sterling.

On July 22, 2002, the Company agreed to exchange (pound)8,831 (pounds
sterling) for $13,662 (U.S. dollars) on January 21, 2003. On December 17,
2002, the date the London Loan paid off, the Company entered into a forward
currency exchange contract to deliver (pound)8,831 (pounds sterling) on
January 21, 2003. The Company does not have economic exposure to its forward
currency exchange contract. As of December 31, 2001, the Company agreed to
exchange (pound)8,831 (pounds sterling) for $12,350 (U.S. dollars) on January
22, 2002. These contracts were intended to economically hedge currency risk in
connection with the Company's investment in the London Loan, which was
denominated in pounds sterling. The estimated fair value of the forward
currency exchange contracts was a liability of $365 and $489 at December 31,
2002 and 2001, respectively, which change was recognized as a reduction of
foreign currency losses. In certain circumstances, the Company may be required
to provide collateral to secure its obligations under the forward currency
exchange contracts, or may be entitled to receive collateral from the counter
party to the forward currency exchange contracts. At December 31, 2002 and
2001, no collateral was required under the forward currency exchange
contracts.

The contracts identified in the remaining portion of this footnote have been
entered into to limit the Company's mark to market exposure to long-term
interest rates.

At December 31, 2002, the Company had outstanding short positions of 3,166
five-year and 1,126 ten-year U.S. Treasury Note future contracts, which
represented $316,000 and $112,600 in face amounts of U.S. Treasury Notes,
respectively. The estimated fair value of the contracts was approximately
$(476,676), and the change in fair value related to these contracts is
included as a component of loss on securities held for trading. Additionally,
the Company had a forward LIBOR cap and with a notional amount of $85,000 and
a fair value at December 31, 2002 of $1,207 which is include in other
liabilities.

At December 31, 2001, the Company had outstanding short positions of 80
thirty-year U.S. Treasury Bond future contracts and 500 ten-year U.S. Treasury
Note future contracts expiring in March 2002, which represented $8,000 and
$50,000 in face amount of U.S. Treasury Bonds and Notes, respectively. The
estimated fair value of these contracts was approximately $(61,235) at
December 31, 2001, and the change in fair value related to these contracts in
included as a component of loss on securities held for trading.

96

At December 31, 2001, the Company had outstanding a short position of 140
Eurodollar futures which expire 35 in each of June, September and December
2003 and 35 in March 2004. The estimated fair value of these contracts was
approximately $(32,987) at December 31, 2001, and the change in fair value
related to these contracts in included as a component of loss on securities
held for trading.

In addition, in December 2001, the Company wrote a call option on a 5-year
interest rate swap agreement with a notional amount of $400,000. The option
has an expiration date of December 2004. Proceeds received from the sale were
$13,180. This transaction was entered into to provide additional short-term
rate protection in a rising interest rate environment. The Company wrote the
option to accomplish this and take advantage of the high market value of
option prices at that time. The estimated fair value of this contract was a
liability of $10,500 as of December 31, 2001, and is included in securities
held for trading at a gain of $2,680. The Company closed this position in
February 2002.

Note 14 Acquisition of CORE Cap, Inc.

On May 15, 2000, the Company acquired all of the outstanding capital stock of
CORE Cap, Inc. ("CORE Cap"), a private real estate investment trust investing
in mortgage loans and mortgage-backed securities, in exchange for 4,180,552
shares of the Company's Common Stock and 2,261,000 shares of Series B
Preferred Stock. The shares of Common Stock and Preferred Stock issued by the
Company were valued at approximately $71,094 on May 15, 2000. The acquisition
was accounted for under the purchase method. Application of purchase
accounting resulted in an excess of the value of the acquired net assets over
the value of the Company's shares of Common Stock and Preferred Stock issued
in the acquisition, plus transaction costs. This deferred credit totaled
$9,687 and was being amortized as described in "Negative Goodwill" (see Note 1
of the consolidated financial statements). The operations of CORE Cap are
included in the Company's consolidated financial statements from May 15, 2000.
Pursuant to SFAS 142 (See Recent Accounting Pronouncements), the Company
recognized the December 31, 2001 unamortized negative goodwill balance of
$6,327 in income during the first quarter of 2002.

Note 15 NET INCOME PER SHARE

Net income per share is computed in accordance with SFAS No. 128, Earnings Per
Share. Basic income per share is calculated by dividing net income available
to common stockholders by the weighted average number of shares of Common
Stock outstanding during the period. Diluted income per share is calculated
using the weighted average number of shares of Common Stock outstanding during
the period plus the additional dilutive effect of common stock equivalents.
The dilutive effect of outstanding stock options is calculated using the
treasury stock method, and the dilutive effect of preferred stock is
calculated using the "if converted" method.

For the year ended December 31,
2002 2001 2000
--------------------------------------------
Numerator:
Net income available to common stockholders before

cumulative transition adjustment $ 48,466 $ 49,210 $ 32,261

97

Cumulative transition adjustment - SFAS 142 6,327 - -
Cumulative transition adjustment - SFAS 133 - (1,903) -
--------- --------- ----------
Numerator for basic earnings per share 54,793 47,307 32,261
Effect of 10.5% series A senior cumulative redeemable preferred stock - 3,420 3,232
--------- --------- ----------
Numerator for diluted earnings per share 54,793 $50,727 35,493
========= ========= ==========
Denominator:
Denominator for basic earnings per share--weighted average
common shares outstanding 46,411 33,568 23,587
Effect of 10.5% series A senior cumulative redeemable preferred stock 7 3,993 4,082
Dilutive effect of stock options 34 55 -
--------- --------- ----------
Denominator for diluted earnings per share--weighted average
common shares outstanding and common stock equivalents outstanding 46,452 37,616 27,669
--------- --------- ----------

Basic net income per weighted average common share:
Income before cumulative transition adjustment $1.04 $1.47 $1.37
Cumulative transition adjustment - SFAS 142 0.14 - -
Cumulative transition adjustment - SFAS 133 - (0.06) -
--------- --------- ----------
Net income $1.18 $1.41 $1.37
========= ========= ==========
Diluted net income per weighted average common stock and common stock
equivalents:
Income before cumulative transition adjustment $1.04 $1.40 $1.28
Cumulative transition adjustment - SFAS 142 0.14 - -
Cumulative transition adjustment - SFAS 133 - (0.05) -
--------- --------- ----------
Net income $1.18 $1.35 $1.28
========= ========= ==========

Note 16 SUMMARIZED QUARTERLY RESULTS (UNAUDITED)

The following is a presentation of quarterly results of operations:

Quarters Ending
March 31 June 30 September 30 December 31
2002 2001 2002 2001 2002 2001 2002 2001
---------------------------------------------------------------------------------------------
Interest Income $39,351 $26,340 $38,732 $28,405 $41,754 $36,246 $42,609 $40,229
---------------------------------------------------------------------------------------------
Expenses:

Interest 11,640 12,272 15,474 11,665 18,836 18,341 19,068 17,123
Management fee and
other 5,983 3,135 2,775 2,951 3,083 3,381 3,009 3,268
---------------------------------------------------------------------------------------------
Total Expenses 17,623 15,407 18,249 14,616 21,919 21,722 22,077 20,391
---------------------------------------------------------------------------------------------
Gain (loss) on sale of securities
available for sale (4,079) 1,947 4,154 5,134 9,538 175 1,778 145
Gain (loss) on securities held
for trading 4,014 692 (11,914) (124) (15,948) 1,875 (5,407) (5,047)
Foreign currency (loss) gain (247) 104 18 5 (151) (91) (432) (23)
Loss on impairment of asset (1) - - - (5,702) - - (10,273) -
---------------------------------------------------------------------------------------------

98

Net income before cumulative
transition adjustment $21,416 $13,676 $12,741 $13,102 $13,274 $16,483 6,198 $14,913
---------------------------------------------------------------------------------------------
Cumulative transition adjustment
- - SFAS 133 (1) - (1,903) - - - - - -
Cumulative transition adjustment
- - SFAS 142 (1) 6,327 - - - -
Net Income $27,743 $11,773 $12,741 $13,102 $13,274 $16,483 $6,198 $14,913

Dividends and accretion on redeemable
convertible preferred stock 1,389 2,289 1,382 2,287 1,196 2,290 1,195 2,098
---------------------------------------------------------------------------------------------
Net income available to common
stockholders $26,354 $9,484 $11,359 $10,815 $12,078 $14,193 $5,003 $12,815
=============================================================================================

Net income per share:
Basic $0.58 $0.35 $0.25 $0.33 $0.26 $0.40 $0.11 $0.33
Diluted $0.58 $0.33 $0.25 $0.32 $0.26 $0.38 $0.11 $0.31

(1) The loss on impairment of asset and the cumulative transition adjustments related to the adoption of SFAS 133 and SFAS
142 are considered by the Company to be non-recurring events.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

99

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Incorporated by reference to the Company's Definitive Proxy
Statement for the 2003 Annual Meeting of Stockholders.

ITEM 11. EXECUTIVE COMPENSATION

Incorporated by reference to the Company's Definitive Proxy
Statement for the 2003 Annual Meeting of Stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS

Incorporated by reference to the Company's Definitive Proxy
Statement for the 2003 Annual Meeting of Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Incorporated by reference to the Company's Definitive Proxy
Statement for the 2003 Annual Meeting of Stockholders.

ITEM 14. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. The Company's
Chief Executive Officer and Chief Financial Officer have evaluated
the effectiveness of the Company's disclosure controls and
procedures (as such term is defined in Rules 13a-14(c) and
15d-14(c) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"). Based on
such evaluation, such officers have concluded that, as of the
Evaluation Date, the Company's disclosure controls and procedures
are effective in alerting them on a timely basis to material
information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's reports
filed or submitted under the Exchange Act.

(b) Changes in Internal Controls. Since the Evaluation Date, there
have not been any significant changes in the Company's internal
controls or in other factors that could significantly affect such
controls.

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

100

(a)(3) Exhibit Index
*3.1 Articles of Amendment and Restatement of the Registrant
*3.2 Bylaws of the Registrant
*3.3 Form of Articles Supplementary of the Registrant
establishing 10% Cumulative Convertible Redeemable
Preferred Stock.
*10.1 Investment Advisory Agreement between the Registrant and
BlackRock Financial Management, Inc.
*10.2 Amendment No. 1 to the Investment Advisory Agreement
between the Registrant and BlackRock Financial
Management, Inc.
*10.3 Amendment No. 2 to the Investment Advisory Agreement
between the Registrant and BlackRock Financial Management,
Inc.
*10.4 Amendment No.3 to the Investment Advisory Agreement
between the Registrant and BlackRock Financial Management,
Inc.
*10.5 Form of 1998 Stock Option Incentive Plan
21.1 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP
24.1 Power of Attorney (included on signature page hereto)
99.1 Certification of CEO and CFO Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.

----------------------
* Previously filed.

1. Reports on Form 8-K.

During the last quarter of the year ended December 31, 2002, the
Company filed the following reports on Form 8-K:

On November 7, 2002, the Company filed a current report on Form 8-K
to report under Item 5 the Company's third quarter 2002 results.

On December 3, 2002, the Company filed a current report on Form 8-K
to report under Item 5 the pricing of a $304 million secured debt
offering.

On December 13, 2002, the Company filed a current report on Form
8-K to report under Item 2 the sale of approximately $313 million
(face amount) of the Company's assets which included certain
commercial mortgaged-backed securities and unsecured real estate
investment trust obligations to Anthracite CDO II Ltd., a
wholly-owned subsidiary of the Company.

101

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.

ANTHRACITE CAPITAL, INC.

Date: March 31, 2003 By: /s/ Hugh R. Frater
_______________________________
Hugh R. Frater
President and Chief Executive
Officer and Director
(duly authorized representative)

KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature
appears below constitutes and appoints Richard M. Shea his true and lawful
attorney-in-fact and agents with full power of substitution and
resubstitution, for his name, place and stead, in any and all capacities, to
sign any and all amendments (including post-effective amendments) to this Form
10-K and to file the same with all exhibits thereto, and all documents in
connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof. This power
of attorney may be executed in counterparties.

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.

Date: March 31, 2003 By: /s/ Hugh R. Frater
_______________________________
Hugh R. Frater
President and Chief Executive
Officer and Director

Date: March 31, 2003 By: /s/ Richard M. Shea
_______________________________
Richard M. Shea
Chief Financial Officer and
Chief Operating Officer

Date: March 31, 2003 By: /s/ Laurence D. Fink
_______________________________
Laurence D. Fink
Chairman of the Board of
Directors

102

Date: March 31, 2003 By: /s/ Donald G. Drapkin
_______________________________
Donald G. Drapkin
Director

Date: March 31, 2003 By: /s/ Carl F. Guether
_______________________________
Carl F. Guether
Director

Date: March 31, 2003 By: /s/ Jeffrey C. Keil
_______________________________
Jeffrey C. Keil
Director

Date: March 31, 2003 By: /s/ Kendrick R. Wilson, III
_______________________________
Kendrick R. Wilson, III
Director

Date: March 31, 2003 By: /s/ David M. Applegate
_______________________________
David M. Applegate
Director

Date: March 31, 2003 By: /s/ Leon T. Kendall
_______________________________
Leon T. Kendall
Director

103

CERTIFICATIONS

I, Hugh R. Frater, certify that:

1. I have reviewed this annual report on Form 10-K of Anthracite
Capital, Inc.;

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

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

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

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

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

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

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

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

104

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

105

6. The registrant's other certifying officers and I have indicated
in this annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date: March 31, 2003 /s/ Hugh R. Frater
___________________________
Name: Hugh R. Frater
Title: President and Chief
Executive Officer

106

I, Richard M. Shea, certify that:

1. I have reviewed this annual report on Form 10-K of Anthracite
Capital, Inc.;

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

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

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

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

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

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

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

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

107

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

108

6. The registrant's other certifying officers and I have indicated
in this annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date: March 31, 2003 /s/ Richard M. Shea
__________________________________
Name: Richard M. Shea
Title: Chief Operating Officer and Chief
Financial Officer

109