THORNBURG MORTGAGE ASSET CORP - 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, 1998

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO
------------- -------------

COMMISSION FILE NUMBER: 001-11914

THORNBURG MORTGAGE ASSET CORPORATION
(Exact name of Registrant as specified in its Charter)

MARYLAND 85-0404134
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

119 E. MARCY STREET
SANTA FE, NEW MEXICO 87501
(Address of principal executive offices) (Zip Code)

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

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

Title of Each Class Name of Exchange on Which Registered
- ---------------------------------------- --------------------------------------
Common Stock ($.01 par value) New York Stock Exchange
Series A 9.68% Cumulative Convertible
Preferred Stock ($.01 par value) New York Stock Exchange

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----

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

At March 9, 1999, the aggregate market value of the voting stock held by
non-affiliates was $199,887,825, based on the closing price of the common stock
on the New York Stock Exchange.

Number of shares of Common Stock outstanding at March 9 , 1999: 21,489,663

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Registrant's definitive Proxy Statement dated March 29,
1999, issued in connection with the Annual Meeting of Shareholders of the
Registrant to be held on April 29, 1999, are incorporated by reference into
Parts I and III.

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1

THORNBURG MORTGAGE ASSET CORPORATION
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS

PART I

Page
----

ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . 3

ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . 17

ITEM 3. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . 17

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 17

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED SHAREHOLDER MATTERS. . . . . . . . . . . 18

ITEM 6. SELECTED FINANCIAL DATA. . . . . . . . . . . . . . . 19

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS. . . . 20

ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISKS . . . . . . . . . . . . . . . . . 39

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. . . . . 39

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE. . . . . . . . . 39

PART III

ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT . 39

ITEM 11.EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . 39

ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT . . . . . . . . . . . . . . . . . . . . . 39

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . 39

PART IV

ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K. . . . . . . . . . . . . . . . . 40

FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . . . . . . F-1

SIGNATURES

EXHIBIT INDEX

2

PART I

ITEM 1. BUSINESS

GENERAL

Thornburg Mortgage Asset Corporation and subsidiaries (the "Company") is a
mortgage acquisition company that primarily invests in adjustable-rate mortgage
("ARM") assets comprised of ARM securities and ARM loans, thereby indirectly
providing capital to the single family residential housing market. In 1998, the
Company began investing in hybrid ARM assets ("Hybrid ARMs") which are included
in the Company's references to ARM securities and ARM loans. Hybrid ARMs have a
fixed rate of interest for an initial period, generally 3 to 5 years, and then
convert to an adjustable-rate for the balance of the term of the Hybrid ARM and
are funded with long-term debt obligations such that the debt obligations mature
within one year of the first interest rate reset date of the Hybrid ARMs. ARM
securities represent interests in pools of ARM loans, which often include
guarantees or other credit enhancements against losses from loan defaults.
While the Company is not a bank or savings and loan, its business purpose,
strategy, method of operation and risk profile are best understood in comparison
to such institutions. The Company leverages its equity capital using borrowed
funds, invests in ARM assets and seeks to generate income based on the
difference between the yield on its ARM assets portfolio and the cost of its
borrowings. The corporate structure of the Company differs from most lending
institutions in that the Company is organized for tax purposes as a real estate
investment trust ("REIT") and therefore generally passes through substantially
all of its earnings to shareholders without paying federal or state income tax
at the corporate level. See "Federal Income Tax Considerations -- Requirements
for Qualification as a REIT". During 1998, in connection with the Company's
issuance of $1.1 billion of callable AAA notes, the Company formed two REIT
qualified subsidiaries. These subsidiaries are consolidated in the Company's
financial statements and federal and state tax returns.

OPERATING POLICIES AND STRATEGIES

Investment Strategies

The Company's investment strategy is to purchase ARM securities and ARM loans
originated and serviced by other mortgage lending institutions. Increasingly,
mortgage lending is being conducted by mortgage lenders who specialize in the
origination and servicing of mortgage loans and then sell these loans to other
mortgage investment institutions, such as the Company. The Company believes it
has a competitive advantage in the acquisition and investment of these mortgage
securities and mortgage loans because of the low cost of its operations relative
to traditional mortgage investors like banks and savings and loans. Like
traditional financial institutions, the Company seeks to generate income for
distribution to its shareholders primarily from the difference between the
interest income on its ARM assets and the financing costs associated with
carrying its ARM assets.

The Company purchases ARM assets from broker-dealers and financial institutions
that regularly make markets in these assets. The Company also purchases ARM
assets from other mortgage suppliers, including mortgage bankers, banks, savings
and loans, investment banking firms, home builders and other firms involved in
originating, packaging and selling mortgage loans.

The Company's mortgage assets portfolio may consist of either agency or
privately issued securities (generally publicly registered) mortgage
pass-through securities, multiclass pass-through securities, collateralized
mortgage obligations ("CMOs"), collateralized bond obligations ("CBOs"),
generally backed by high quality mortgage backed securities, ARM loans, Hybrid
ARMs or short-term investments that either mature within one year or have an
interest rate that reprices within one year. The Company will not invest more
than 30% of its ARM assets in Hybrid ARMs and will limit its interest rate
repricing mismatch (the difference between the remaining fixed-rate period of a
Hybrid ARM and the maturity of the fixed-rate liability funding a Hybrid ARM) to
no more than one year.

3

The Company's investment policy is to invest at least 70% of total assets in
High Quality adjustable and variable rate mortgage securities and short-term
investments. High Quality means:

(1) securities that are unrated but are guaranteed by the U.S. Government or
issued or guaranteed by an agency of the U.S. Government;
(2) securities which are rated within one of the two highest rating
categories by at least one of either Standard & Poor's or Moody's Investors
Service, Inc. (the "Rating Agencies"); or
(3) securities that are unrated or whose ratings have not been updated but
are determined to be of comparable quality (by the rating standards of at least
one of the Rating Agencies) to a High Quality rated mortgage security, as
determined by the Manager (as defined below) and approved by the Company's Board
of Directors; or
(4) the portion of ARM or hybrid loans that have been deposited into a trust
and have received a credit rating of AA or better from at least one Rating
Agency.

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

(1) adjustable or variable rate pass-through certificates, multi-class
pass-through certificates or CMOs backed by loans on single-family,
multi-family, commercial or other real estate-related properties so long as they
are rated at least Investment Grade at the time of purchase. "Investment
Grade" generally means a security rating of BBB or Baa or better by at least one
of the Rating Agencies;
(2) ARM loans secured by first liens on single-family residential
properties, generally underwritten to "A" quality standards, and acquired for
the purpose of future securitization (see description of "A" quality in
"Portfolio of Mortgage Assets - ARM and Hybrid ARM Loans"); or
(3) a limited amount, currently $70 million as authorized by the Board of
Directors, of less than investment grade classes of ARM securities that are
created as a result of the Company's loan acquisition and securitization
efforts.

Since inception, the Company has generally invested less than 15%, currently
approximately 4%, of its total assets in Other Investment assets, excluding
loans held for securitization. Despite the generally higher yield, the Company
does not expect to significantly increase its investment in Other Investment
securities. This is primarily due to the difficulty of financing such assets at
reasonable financing terms and values through all economic cycles. Since the
Company has never had a large investment in Other Investment securities and
believes it has always been very selective and cautious regarding these
investments, this adjustment to the Company's investment strategy is not
expected to have a material impact on the Company's operating results.

The Company does not invest in REMIC residuals or other CMO residuals and,
therefore does not create excess inclusion income or unrelated business taxable
income for tax exempt investors. Therefore, the Company is a mortgage REIT
eligible for purchase by tax exempt investors, such as pension plans, profit
sharing plans, 401(k) plans, Keogh plans and Individual Retirement Accounts
("IRAs").

Acquisition of ARM and Hybrid ARM Loans

The Company acquires existing pools of ARM loans and intends to begin acquiring
individual loans directly from loan originators for future securitization.
Acquiring ARM loans for future securitization is expected to benefit the Company
by providing: (i) greater control over the types of ARM loans originated; (ii)
the ability to acquire ARM loans at lower prices so that the amount of the
premium to be amortized will be reduced in the event of prepayment; (iii)
additional sources of new whole-pool ARM assets; and (iv) potentially higher
yielding investments in its portfolio.

The Company acquires residential ARM and Hybrid ARM whole loans utilizing two
processes which the Company calls the Bulk Acquisition Method ("Bulk Method")
and the Flow Acquisition Method ("Flow Method"). The Bulk Method, which the
Company began utilizing in 1997, involves a number of the Company's established
relationships with mortgage originators, or mortgage aggregators, who sell the
Company pools of whole loans at market prices, with the servicing rights,
generally, remaining with the originator or seller. In cases where the Company
buys the servicing rights along with the loans, the Company contracts with a
qualified loan servicer to perform the loan servicing function for a fee. In
this Bulk Method, the loans are originated using the seller's loan products and
programs, and the credit review of the borrower and the appraisal of the
property and the quality control procedures are performed by the originators.

4

The Company only considers the purchase of loans when all of the borrowers have
had their incomes verified, their credit checked, their assets verified and
appraisals of the properties have been obtained. The Company then obtains an
independent underwriter's review, performed by a third party for the benefit of
the Company, which entails a review of the processes and closing method used by
the originators in verifying the borrower credit as well as a review of the
property valuation. In addition, the Company will, at the request of the third
party credit review providers, utilize its own personnel to re-review some of
the individual loans in order to insure the highest possible loan quality. The
Company generally selects loans for underwriting review based upon specific
criteria such as property location, loan size, effective loan-to-value ratios,
borrowers' credit scoring and other criteria the Company believes to be
important indicators of credit risk. Additionally, prior to the purchase of
loans, the Company obtains representations and warranties from each seller
stating that each loan meets the Company's underwriting standards and other
requirements. The breach of such representations and warranties in regards to a
loan can result in the seller having an obligation to repurchase the loan.

In the Flow Method, which the Company will begin utilizing in the first half of
1999, the Company acquires mortgage loans using the Company's specific loan
programs and underwriting criteria. This means that the originator/seller
originates the individual loans using the Company's established credit and
program guidelines. All program participants, (originators/sellers), are
screened by the Company as to their financial strength as well as to their own
established in-house mortgage procedures. The credit of each borrower and the
value of each property is underwritten by the originators and are subject to the
quality control procedures of the originators. This is the same process used by
originators/sellers in the Bulk Method except that all of the credit and
appraisal guidelines have been developed and designed by the Company to meet the
Company's own credit criteria and portfolio requirements. All of the loans are
then subjected to further credit review by mortgage insurance companies that
also use the Company's guidelines to insure product quality and compliance to
the Company's guidelines. The three mortgage insurance companies chosen by the
Company to perform this function use a two-step loan approval process. After
the credit review and quality control review are performed by the
originator/seller, but prior to the purchase of the loans by the Company, all of
the loans are placed through an automated underwriting system created by the
Federal National Mortgage Association ("Fannie Mae") called "Desktop
Underwriter." This is the same system used by Fannie Mae in connection with
all of their own loan purchases. Secondly, all loans that pass the Desktop
Underwriter test are then screened by the mortgage insurance company personnel
as to their compliance to the Company's guidelines. A select number of these
loans are then subjected to an additional quality control procedure performed by
a third party. Additionally, all of the loans acquired through the Flow Method
are assigned a "Risk Evaluation Score" or "Mortgage Score" by each of the
mortgage insurance companies. The risk score evaluates not only the borrower's
credit but also the geographic location of the property, the economic viability
of the area, the general market conditions and the loan product chosen by the
borrower. The Company believes that obtaining risk scores will help in reducing
the Company's securitization costs by insuring that the Company purchases the
highest quality mortgage loans with the lowest risk possible. As in the Bulk
Method, mortgage loans acquired through the Flow Method are acquired, generally,
with the servicing rights remaining with the originator/seller. As with the
Bulk Method, in cases where the Company buys the servicing rights along with the
loans, the Company contracts with a qualified loan servicer to perform the loan
servicing function for a fee. The Company obtains representations and
warranties from each seller or program participant stating that each loan meets
the Company's underwriting standards and other requirements. As in the Bulk
Method, the breach of such representations and warranties in regards to a loan
can result in the seller having an obligation to repurchase the loan.

In both methods the Company uses its in-house staff as well as third party due
diligence providers to verify the credit quality of the borrowers as well as the
soundness of the mortgage collateral securing the individual loans. As added
security, the Company uses the services of a third party document custodian to
insure the quality and accuracy of all individual mortgage loan documents which
are then held in safekeeping with the third-party document custodian. As a
result, all of the original individual loan documents that are signed by the
borrower, other than the original credit verification documents, are examined
and verified by the custodian.

Securitization of ARM and Hybrid ARM Loans

The Company acquires ARM and Hybrid ARM loans for its portfolio with the
intention of securitizing them in such a way as to maximize the amount of high
quality assets that can be created from an accumulation of the ARM and Hybrid
ARM loans. In order to facilitate the securitization of its loans, the Company
intends to create and retain a subordinate interest in the loans, to provide a
limited amount of credit enhancement, and then to purchase an insurance policy
from a third party financial guarantor that will "wrap" the remaining balance of
the loans to a credit rating of AA or better. Upon securitization, the Company
then plans to either own the high quality ARM certificates and the subordinate
certificates in its portfolio and finance the high quality certificates in the
repurchase agreement market, or to utilize such ARM assets to collateralize
capital markets issued debt obligations with a credit rating of AA or better
from a Rating Agency as an alternative financing source to the repurchase
agreement market.

5

Financing Strategies

The Company employs a leveraging strategy to increase its assets by borrowing
against its ARM assets and then using the proceeds to acquire additional ARM
assets. By leveraging its portfolio in this manner, the Company expects to
maintain an equity-to-assets ratio between 8% to 10%, when measured on a
historical cost basis. The Company believes that this level of capital is
sufficient to allow the Company to continue to operate in interest rate
environments in which the Company's borrowing rates might exceed its portfolio
yield. These conditions could occur when the interest rate adjustments on the
ARM assets lag the interest rate increases in the Company's variable rate
borrowings or when the interest rate of the Company's variable rate borrowings
are mismatched with the interest rate indices of the Company's ARM assets. The
Company also believes that this capital level is adequate to protect the Company
from having to sell assets during periods when the value of its ARM assets are
declining. During the fourth quarter of 1998, the Company did sell some assets
in order to increase its equity ratio from approximately 8% to over 9%, which
under the market conditions at the time was a more appropriate level. If the
ratio of the Company's equity-to-total assets, measured on a historical cost
basis, falls below 8%, the Company will take action to increase its
equity-to-assets ratio to 8% of total assets or greater, when measured on a
historical cost basis, through normal portfolio amortization, raising equity
capital, sale of assets or other steps as necessary.

The Company's ARM assets are financed primarily at short-term borrowing rates
and can be financed utilizing reverse repurchase agreements, dollar-roll
agreements, borrowings under lines of credit and other secured or unsecured
financings which the Company may establish with approved institutional lenders.
Prior to 1998, reverse repurchase agreements had been the primary source of
financing utilized by the Company to finance its ARM assets. In 1998, the
Company issued $1.1 billion of callable AAA rated notes in addition to utilizing
reverse repurchase agreements to finance its assets. Generally, upon repayment
of each reverse repurchase agreement, the ARM assets used to collateralize the
financing will immediately be pledged to secure a new reverse repurchase
agreement. The Company has established lines of credit and collateralized
financing agreements with twenty-four different financial institutions.

Reverse repurchase agreements take the form of a simultaneous sale of pledged
assets to a lender at an agreed upon price in return for the lender's agreement
to resell the same assets back to the borrower at a future date (the maturity of
the borrowing) at a higher price. The price difference is the cost of borrowing
under these agreements. In the event of the insolvency or bankruptcy of a
lender during the term of a reverse repurchase agreement, provisions of the
Federal Bankruptcy Code, if applicable, may permit the lender to consider the
agreement to resell the assets to be an executory contract that, at the lender's
option, may be either assumed or rejected by the lender. If a bankrupt lender
rejects its obligation to resell pledged assets to the Company, the Company's
claim against the lender for the damages resulting therefrom may be treated as
one of many unsecured claims against the lender's assets. These claims would be
subject to significant delay and, if and when payments are received, they may be
substantially less than the damages actually suffered by the Company. To
mitigate this risk the Company enters into collateralized borrowings with only
financially sound institutions approved by the Board of Directors, including a
majority of unaffiliated directors, and monitors the financial condition of such
institutions on a regular, periodic basis.

The Company, commencing in 1998, also utilizes capital market transactions by
issuing debt collateralized by specific pools of ARM assets that are placed in a
trust. The financing of ARM assets in this way eliminates the risk of margin
calls on the financing of those ARM assets and limits the Company's exposure to
credit risk on the ARM and Hybrid ARM loans collateralizing such debt. The
Company receives a credit rating on the debt based on the quality of the ARM
assets, amount of any credit enhancement obtained and subordination levels of
the debt proscribed by the rating agency(ies), all of which affects the interest
rate at which the debt can be issued. The principal and interest payments on
the debt are paid by the trust out of the cash flows received on the collateral.
By utilizing such a structure, the Company can issue either floating rate debt
indexed to various indices that more closely matches the characteristics of the
collateralized ARM assets, depending upon market constraints and conditions, or
fixed rate debt that corresponds to the characteristics of collateralized Hybrid
ARM loans.

6

The Company also enters into financing facilities for whole loans. The Company
uses these credit lines to finance its acquisition of whole loans while it is
accumulating loans for securitization or until more permanent financing is
arranged in a capital markets collateralized debt transaction. In 1998, the
Company utilized two whole loan financing facilities that provided the Company
with uncommitted lines of credit based on the market value of its whole loans.
Uncommitted lines of credit are generally less expensive than a committed line
of credit, but during periods of market turmoil, uncommitted lines of credit can
be terminated by the counterparty with little notice to the Company and at a
time when the Company would have difficulty in replacing the line of credit.
Therefore, beginning in 1999, the Company has decided to negotiate and pay a fee
for committed facilities as well as continue to utilize uncommitted facilities.
During January 1999, the Company entered into one committed facility in the
amount of $150,000,000, which the Company can increase to $300,000,000 for an
additional fee, and is negotiating a number of other committed and uncommitted
facilities.

The Company mitigates its interest-rate risk from borrowings by selecting
maturities that approximately match the interest-rate adjustment periods on its
ARM assets. Accordingly, borrowings bear variable or short-term fixed (one year
or less) interest rates. Generally, the borrowing agreements require the
Company to deposit additional collateral in the event the market value of
existing collateral declines, which, in dramatically rising interest rate
markets, could require the Company to sell assets to reduce the borrowings.

The Company's Bylaws limit borrowings, excluding the collateralized borrowings
in the form of reverse repurchase agreements, dollar-roll agreements and other
forms of collateralized borrowings discussed above, to no more than 300% of the
Company's net assets, on a consolidated basis, unless approved by a majority of
the unaffiliated directors. This limitation generally applies only to unsecured
borrowings of the Company. For this purpose, the term "net assets" means the
total assets (less intangibles) of the Company at cost, before deducting
depreciation or other non-cash reserves, less total liabilities, as calculated
at the end of each quarter in accordance with generally accepted accounting
principles. Accordingly, the 300% limitation on unsecured borrowings does not
affect the Company's ability to finance its total assets with collateralized
borrowings.

Hedging Strategies

The Company makes use of hedging transactions to mitigate the impact of certain
adverse changes in interest rates on its net interest income. In general, ARM
assets have a maximum lifetime interest rate cap, or ceiling, meaning that each
ARM asset contains a contractual maximum rate. The borrowings incurred by the
Company to finance its ARM assets portfolio are not subject to equivalent
interest rate caps. Accordingly, the Company purchases interest rate cap
agreements ("Cap Agreements") to prevent the Company's borrowing costs from
exceeding the lifetime maximum interest rate on its ARM assets. These Cap
Agreements have the effect of offsetting a portion of the Company's borrowing
costs if prevailing interest rates exceed the rate specified in the Cap
Agreement. A Cap Agreement is a contractual agreement for which the Company
pays a fee, which may at times be financed, typically to either a commercial
bank or investment banking firm. Pursuant to the terms of the Cap Agreements
owned as of December 31, 1998, the Company will receive cash payments if the
one-month, three-month or six-month LIBOR index increases above certain
specified levels, which range from 7.50% to 13.00% and average approximately
10.10%. The fair value of these Cap Agreements also tends to increase when
general market interest rates increase and decrease when market interest rates
decrease, helping to partially offset changes in the fair value of the Company's
ARM assets.

In addition, ARM assets are generally subject to periodic caps. Periodic caps
generally limit the maximum interest rate coupon change on any interest rate
coupon adjustment date to either a maximum of 1% per semiannual adjustment or 2%
per annual adjustment. The borrowings incurred by the Company do not have
similar periodic caps. The Company generally does not hedge against the risk of
its borrowing costs rising above the periodic interest rate cap level on the ARM
assets because the contractual future interest rate adjustments on the ARM
assets will cause their interest rates to increase over time and reestablish the
ARM assets' interest rate to a spread over the then current index rate. The
Company attempts to mitigate the effect of periodic caps in several ways.
First, the yield on the Company's ARM assets can change by more that the 1% or
2% per periodic interest rate adjustment limitation depending upon how
prepayment activity changes as interest rates change. Secondly, during 1998,
the Company began to acquired variable rate CMOs and CBOs ("Floaters"), Hybrid
ARMs and certain other ARM loans that do not have a periodic cap. As of
December 31, 1998, approximately $622.9 million of the Company's ARM securities
and $909.2 million of the Company's ARM loans did not have periodic caps or were
Hybrid ARMs, representing approximately 36% of total ARM assets.

7

The Hybrid ARMs have an initial fixed rate period, generally 3 to 5 years.
Since the Company's borrowings are generally short-term, the Company enters into
interest rate swap agreements that hedge a portion of the fixed rate period, so
that the unhedged fixed rate period is no more than one year. In accordance
with the terms of these swap agreements, the Company pays a fixed rate of
interest during the term of the agreements, and receives a payment that varies
monthly with the one month LIBOR Index. Due to the longer term nature of these
agreements and because the hedged Hybrid ARMs are amortizing based on homeowner
scheduled payments and unscheduled prepayments, the Company generally enters
into both a swap that amortizes at an agreed upon single prepayment rate and an
additional swap that amortizes at a prepayment rate which the Company has the
option to change monthly within a range of rates.

The Company also enters into interest rate swap agreements to manage the average
interest rate reset period on its borrowings. In accordance with the terms of
the swap agreements, the Company pays a fixed rate of interest during the term
of the agreements and receives a payment that varies monthly with the one month
LIBOR Index. These agreements have the effect of fixing the Company's borrowing
costs on a similar amount of swaps owned by the Company and, as a result, the
Company reduces the interest rate variability of its borrowings. The Company
may also use interest rate swap agreements from time to time to change from one
interest rate index to another interest rate index and thus decrease further the
basis risk between the Company's interest yielding assets and the financing of
such assets.

The ARM assets held by the Company were generally purchased at prices greater
than par. The Company is amortizing the premiums paid for these assets over
their expected lives using the level yield method of accounting. To the extent
that the prepayment rate on the Company's ARM assets differs from expectations,
the Company's net interest income will be affected. Prepayments generally
increase when mortgage interest rates fall below the interest rates on ARM
loans. To the extent there is an increase in prepayment rates, resulting in a
shortening of the expected lives of the Company's ARM assets, the Company's net
income and, therefore, the amount available for dividends could be adversely
affected. To mitigate the adverse effect of an increase in prepayments on the
Company's ARM assets, the Company has purchased ARM assets at prices at or below
par, however the Company's portfolio of ARM assets is currently held at a net
premium. The Company may also purchase limited amounts of "principal only"
mortgage derivative assets backed by either fixed-rate mortgages or ARM assets
as a hedge against the adverse effect of increased prepayments. To date, the
Company has not purchased any "principal only" mortgage derivative assets.

The Company may enter into other hedging-type transactions designed to protect
its borrowings costs or portfolio yields from interest rate changes. Such
transactions may include the purchase or sale of interest rate futures contracts
or options on interest rate futures contracts. The Company may also purchase
"interest only" mortgage derivative assets or other derivative products for
purposes of mitigating risk from interest rate changes. The Company has not, to
date, entered into these types of transactions, but may do so in the future.
The Company will not invest in any futures transactions unless the Company and
Thornburg Mortgage Advisory Corporation (the "Manager") are exempt from the
registration requirements of the Commodities Exchange Act or otherwise comply
with the provisions of that Act.

Hedging transactions currently utilized by the Company generally are designed to
protect the Company's net interest income during periods of rising market
interest rates. The Company does not intend to hedge for speculative purposes.
Further, no hedging strategy can completely insulate the Company from risk, and
certain of the federal income tax requirements that the Company must satisfy to
qualify as a REIT limit the Company's ability to hedge, particularly with
respect to hedging against periodic cap risk. The Company carefully monitors
and may have to limit its hedging strategies to ensure that it does not realize
excessive hedging income, or hold hedging assets having excess value in relation
to total assets. See "Federal Income Tax Considerations - Requirements for
Qualification as a REIT".

Operating Restrictions

The Board of Directors has established the Company's operating policies and any
revisions in the operating policies and strategies require the approval of the
Board of Directors, including a majority of the unaffiliated directors. Except
as otherwise restricted, the Board of Directors has the power to modify or alter
the operating policies without the consent of shareholders. Developments in the
market which affect the operating policies and strategies mentioned herein or
which change the Company's assessment of the market may cause the Board of
Directors (including a majority of the unaffiliated directors) to revise the
Company's operating policies and financing strategies.

In the event the rating of an ARM security held by the Company is reduced by the
Rating Agencies to below Investment Grade after acquisition by the Company, the
asset may be retained in the Company's investment portfolio if the Manager
recommends that it be retained and the recommendation is approved by the Board
of Directors (including a majority of the unaffiliated directors).

8

The Company has elected to qualify as a REIT for tax purposes. The Company has
adopted certain compliance guidelines which include restrictions on the
acquisition, holding and sale of assets. Prior to the acquisition of any asset,
the Company determines whether such asset will constitute a "Qualified REIT
Asset" as defined by the Internal Revenue Code of 1986, as amended (the "Code").
Substantially all the assets that the Company has acquired and will acquire for
investment are expected to be Qualified REIT Assets. This policy limits the
investment strategies that the Company may employ.

The Company closely monitors its purchases of ARM assets and the income from
such assets, including from its hedging strategies, so as to ensure at all times
that it maintains its qualification as a REIT. The Company developed certain
accounting systems and testing procedures with the help of qualified accountants
and tax experts to facilitate its ongoing compliance with the REIT provisions of
the Code. See "Federal Income Tax Considerations - Requirements for
Qualification as a REIT". No changes in the Company's investment policies and
operating policies and strategies, including credit criteria for mortgage asset
investments, may be made without the approval of the Company's Board of
Directors, including a majority of the unaffiliated directors.

The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940.
The Investment Company Act exempts entities that are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate" ("Qualifying Interests"). Under current
interpretation of the staff of the SEC, in order to qualify for this exemption,
the Company must maintain at least 55% of its assets directly in Qualifying
Interests. In addition, unless certain mortgage assets represent all the
certificates issued with respect to an underlying pool of mortgages, such
mortgage assets may be treated as assets separate from the underlying mortgage
loans and, thus, may not be considered Qualifying Interests for purposes of the
55% requirement. The Company closely monitors its compliance with this
requirement and intends to maintain its exempt status. Up to the present, the
Company has been able to maintain its exemption through the purchase of whole
pool government agency and privately issued ARM securities and loans that
qualify for the exemption. See "Portfolio of Mortgage Assets - Pass-Through
Certificates - Privately Issued ARM Pass-Through Certificates".

The Company does not purchase any assets from or enter into any servicing or
administrative agreements (other than the Management Agreement) with any
entities affiliated with the Manager. Any changes in this policy would be
subject to approval by the Board of Directors, including a majority of the
unaffiliated directors.

PORTFOLIO OF MORTGAGE ASSETS

As of December 31, 1998, ARM assets comprised approximately 98% of the Company's
total assets. The Company has invested in the following types of mortgage
assets in accordance with the operating policies established by the Board of
Directors and described in "Business - Operating Policies and Strategies -
Operating Restrictions".

PASS-THROUGH CERTIFICATES

The Company's investments in mortgage assets are concentrated in High Quality
ARM pass-through certificates which account for approximately 90% of ARM assets
held. These High Quality ARM pass-through certificates consist of Agency
Certificates and privately issued ARM pass-through certificates that meet the
High Quality credit criteria. These High Quality ARM pass-through certificates
acquired by the Company represent interests in ARM loans which are secured
primarily by first liens on single-family (one-to-four units) residential
properties, although the Company may also acquire ARM pass-through certificates
secured by liens on other types of real estate-related properties. The Company
also includes in this category of assets a portion of the ARM and Hybrid ARM
loans that have been deposited in a trust and held as collateral for its AAA
notes payable in the amount equivalent to the AAA portion of the debt issued by
the trust. The ARM pass-through certificates, including the ARM and Hybrid ARM
loans collateralizing AAA notes payable, acquired by the Company are generally
subject to periodic interest rate adjustments, as well as periodic and lifetime
interest rate caps which limit the amount an ARM security's interest rate can
change during any given period.

9

The following is a discussion of each type of pass-through certificate held by
the Company as of December 31, 1998:

FHLMC ARM Programs

FHLMC is a shareholder-owned government sponsored enterprise created pursuant to
an Act of Congress on July 24, 1970. The principal activity of FHLMC consists
of the purchase of first lien, conventional residential mortgages, including
both whole loans and participation interests in such mortgages and the resale of
the loans and participations in the form of guaranteed mortgage assets. During
1998, FHLMC issued $7.2 billion of FHLMC ARM certificates and as of December 31,
1998, there was $37.5 billion of all types of FHLMC ARM certificates
outstanding, of which FHLMC held $9.8 billion in its own portfolio.

Each FHLMC ARM Certificate issued to date has been issued in the form of a
pass-through certificate representing an undivided interest in a pool of ARM
loans purchased by FHLMC. The ARM loans included in each pool are fully
amortizing, conventional mortgage loans with original terms to maturity of up to
40 years secured by first liens on one-to-four unit family residential
properties or multi-family properties. The interest rate paid on FHLMC ARM
Certificates adjust periodically on the first day of the month following the
month in which the interest rates on the underlying mortgage loans adjust.

FHLMC guarantees to each holder of its ARM 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 ARM loans, but does not guarantee the timely 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 U.S. Government. If FHLMC were unable to satisfy such
obligations, distributions to holders of FHLMC ARM Certificates would consist
solely of payments and other recoveries on the underlying mortgage loans and,
accordingly, monthly distributions to holders of FHLMC ARM Certificates would be
affected by delinquent payments and defaults on such mortgage loans.

FNMA ARM Programs

FNMA is a federally chartered and privately owned corporation organized and
existing under the Federal National Mortgage Association Charter Act. FNMA
provides funds to the mortgage market primarily by purchasing home mortgage
loans from mortgage loan originators, thereby replenishing their funds for
additional lending. FNMA established its first ARM programs in 1982 and
currently has several ARM programs under which ARM certificates may be issued,
including programs for the issuance of assets through REMICs under the Code.
During 1998, FNMA issued $14.0 billion of FNMA ARM certificates and as of
December 31, 1998, there was $59.0 billion of all types of FNMA ARM certificates
outstanding, of which FNMA held $11.9 billion in its own portfolio.

Each FNMA ARM Certificate issued to date has been issued in the form of a
pass-through certificate representing a fractional undivided interest in a pool
of ARM loans formed by FNMA. The ARM loans included in each pool are fully
amortizing conventional mortgage loans secured by a first lien on either
one-to-four family residential properties or multi-family properties. The
original terms to maturities of the mortgage loans generally do not exceed 40
years. FNMA has issued several different series of ARM Certificates. Each
series bears an initial interest rate and margin tied to an index based on all
loans in the related pool, less a fixed percentage representing servicing
compensation and FNMA's guarantee fee.

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

10

Privately Issued ARM Pass-Through Certificates

Privately issued ARM Pass-Through Certificates are structured similar to the
Agency Certificates discussed above but are issued by originators of, and
investors in, mortgage loans, including savings and loan associations, savings
banks, commercial banks, mortgage banks, investment banks and special purpose
subsidiaries of such institutions. Privately issued ARM pass-through
certificates are usually backed by a pool of non-conforming conventional
adjustable-rate mortgage loans and are generally structured with one or more
types of credit enhancement, including pool insurance, guarantees, or
subordination. Accordingly, the privately issued ARM pass-through certificates
typically are not guaranteed by an entity having the credit status of FHLMC or
FNMA.

Privately issued ARM pass-through certificates credit enhanced by mortgage pool
insurance provide the Company with an alternative source of ARM assets (other
than Agency ARM assets) that meet the Qualifying Interests test for purposes
maintaining the Company's exemption under the Investment Company Act of 1940.
Since the inception of the Company in 1993, most of the providers of mortgage
pool insurance have stopped providing such insurance. Therefore, the Company
has increased its investment in Agency ARM securities and in whole loans as its
primary sources of Qualifying Interests in real estate.

COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"), COLLATERALIZED BOND OBLIGATIONS
("CBOS") AND MULTICLASS PASS-THROUGH ASSETS

CMOs are debt obligations, ordinarily issued in series and most commonly backed
by a pool of fixed rate mortgage loans or pass-through certificates, each of
which consists of several serially maturing classes. The CBOs acquired by the
Company, like CMOs, are debt obligations, but, in the case of CBOs, are secured
by security interests in portfolios of high quality, low duration,
mortgage-backed, asset-backed and other fixed and floating rate securities
managed by third-parties. The Company only acquires CBO's that have portfolios
that consist primarily of either real estate qualifying assets or high quality
mortgage backed securities. Multiclass pass-through securities are equity
interests in a trust composed of similar underlying mortgage assets. Generally,
principal and interest payments received on the underlying mortgage-related
assets securing a series of CMOs or multiclass pass-through securities are
applied to principal and interest due on one or more classes of the CMOs of such
series or to pay scheduled distributions of principal and interest on multiclass
pass-throughs. In a CBO transaction, principal and interest payments are used
to pay current period interest and any excess is reinvested into the portfolio.
CBOs typically don't amortize monthly, rather they mature on a specific maturity
date. Scheduled payments of principal and interest on the mortgage-related
assets and other collateral securing a series of CMOs, CBOs or multiclass
pass-throughs are intended to be sufficient to make timely payments of principal
and interest on such issues or securities and to retire each class of such
obligations at their stated maturity.

Multiclass pass-through securities backed by ARM assets or ARM loans owned by
the Company are typically structured into classes designated as senior classes,
mezzanine classes and subordinated classes. The Company also owns variable rate
classes of CMOs and CBOs that are backed by both fixed- and adjustable-rate
mortgages.

The senior classes in a multiclass pass-through security generally have first
priority over all cash flows and consequently have the least amount of credit
risk since principal losses are generally covered by mortgage pool insurance
policies or are charged against the subordinated classes in order of
subordination. As a result of these features, the senior classes receive the
highest credit rating from Rating Agencies of the series of classes for each
multiclass pass-through security.

The mezzanine classes of a multiclass pass-through security generally have a
slightly greater risk of principal loss than the senior classes since they
provide some credit enhancement to the senior classes. In most, but not all,
instances, mezzanine classes participate on a pro-rata basis with senior classes
in their right to receive cash flow and have expected lives similar to the
senior classes. In other instances, mezzanine classes are subordinate in their
right to receive cash flow and have average lives that are longer than the
senior classes. However, in all cases, a mezzanine class has a similar or
slightly lower credit rating than the senior class from the Rating Agencies.
Generally, the mezzanine classes that the Company has acquired are rated High
Quality.

Subordinated classes are junior in the right to receive payment from the
underlying mortgages to other classes of a multiclass pass-through security.
The subordination provides credit enhancement to the senior and mezzanine
classes. Subordinated classes may be at risk for some payment failures on the
mortgage loans securing or underlying such assets and generally represent a
greater level of credit risk as they are responsible for bearing the risk of
credit loss on all of the outstanding loans underlying a CMO, CBO or multi-class
pass-through. As a result of being subject to more credit risk, subordinated
classes generally have lower credit ratings relative to the senior and mezzanine
classes.

11

The Subordinated classes which the Company has acquired were all rated at least
Investment Grade at the time of purchase by one of the Rating Agencies, and in
certain cases are High Quality, or were created as part of the Company's process
of securitizing whole loans. The Subordinated classes acquired by the Company
in the open market are limited in amount and bear yields which the Company
believes are commensurate with the increased risks involved. In general, the
Company acquires subordinated classes when they are seasoned and when the more
senior classes of the multi-class security have been paid down to levels that
mitigate the risk of non-payment on the subordinate classes.

The market for Subordinated classes is not extensive and at times may be
illiquid. In addition, the Company's ability to sell Subordinated classes is
limited by the REIT Provisions of the Code. The Company has not purchased any
Subordinated classes that are not Qualified REIT Assets. The Subordinated
classes acquired by the Company, which are not High Quality, together with the
Company's other investments in Other Investment assets, may not, in the
aggregate, comprise more than 30% of the Company's total assets, in accordance
with the Company's investment policy.

The variable rate classes of CMOs and CBOs, or Floaters, owned by the Company
generally float at a spread to the one-month LIBOR index and are backed by
mortgages that are either fixed-rate or are adjustable-rate mortgages indexed to
the one-year U. S. Treasury yield or a Cost of Funds index.

ARM AND HYBRID ARM LOANS

The ARM and Hybrid ARM loans the Company has acquired are all first mortgages on
single-family residential properties. Some have additional collateral in the
form of pledged financial assets that provides the Company with additional
credit protection in exchange for a simpler application and approval process.
The Company acquires loans are underwritten to "A" quality standards. The
Company considers loans to be "A" quality when they are underwritten in such a
way as to assure that the mortgages are protected by adequate borrower income to
make the required loan payment, adequate verifiable equity in the underlying
property, and by the borrower's willingness and ability to repay the mortgage as
demonstrated by a good credit history. As a result, the loans are generally
fully documented loans to borrowers with good credit histories, adequate income
to support the monthly mortgage payment, adequate assets to close the loan, with
80% or lower effective loan-to-value ratios based on independently appraised
property values or are seasoned loans with over five years or more of good
payment history.

When acquiring ARM and Hybrid ARM loans, either originated specifically for the
Company or when the Company acquires pools of loans in bulk, the Company focuses
its attention on key aspects of a borrower's profile and the characteristics of
a mortgage loan product that the Company believes are most important in insuring
excellent loan performance and minimal credit exposure. The Company's loan
programs focus on larger down payments, excellent borrower credit history (as
measured by a credit report and a credit score) and a conservative appraisal
process. If an ARM or Hybrid ARM loan acquired has a loan to property value
that is above 80%, then the borrower is required to pay for private mortgage
insurance providing additional protection to the Company against credit risk.
The loans acquired have original maturities of forty years or less. The ARM
and Hybrid ARM loans are either fully amortizing or are interest only for up to
ten years and fully amortizing thereafter. All ARM loans acquired bear an
interest rate that is tied to an interest rate index and some have periodic and
lifetime constraints on how much the loan interest rate can change on any
predetermined interest rate reset date. In general, the interest rate on each
ARM loan resets at a frequency that is either monthly, semi-annually or
annually. The indices the ARM loans are tied to are generally a U.S. Treasury
Bill index, LIBOR, Certificate of Deposit, a Cost of Funds index or Prime. The
Hybrid ARM loans have an initial fixed rate period, generally 3 to 5 years, and
then they convert to an ARM loan with the features of an ARM loan described
above.

12

RISK FACTORS

FORWARD-LOOKING STATEMENTS

In accordance with the Private Securities Litigation Reform Act of 1995
(the "1995 Act"), the Company can obtain a "Safe Harbor" for forward-looking
statements by identifying those statements and by accompanying those statements
with cautionary statements which identify factors that could cause actual
results to differ from those in the forward-looking statements. Accordingly,
the following information contains or may contain forward-looking statements:
(1) information included in this Annual Report on Form 10-K, including, without
limitation, statements made regarding investments in ARM securities and ARM
loans, and Hybrid ARM loans, hedging, leverage, interest rates and statements in
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations, (2) information included in future filings by the Company with
the Securities and Exchange Commission including, without limitation, statements
with respect to growth, projected revenues, earnings, returns and yields on its
portfolio of mortgage assets, the impact of interest rates, costs, and business
strategies and plans, and (3) information contained in the Company's Annual
Report or other written material, releases and oral statements issued by or on
behalf of, the Company, including, without limitation, statements with respect
to growth, projected revenues, net income, returns and yields on its portfolio
of mortgage assets, the impact of interest rates, costs and business strategies
and plans.

The following is a summary of the factors the Company believes important
and that could cause actual results to differ from the Company's expectations.
The Company is publishing these factors pursuant to the 1995 Act. Such factors
should not be construed as exhaustive or as an admission regarding the adequacy
of disclosure made by the Company prior to the effective date of the 1995 Act.
Readers should understand that many factors govern whether any forward-looking
statement will be or can be achieved. Any one of those factors could cause
actual results to differ materially from those projected. No assurance is or
can be given that any important factor set forth below will be realized in a
manner so as to allow the Company to achieve the desired or projected results.
The words "believe," "except," "anticipate," "intend," "aim," "will," and
similar words identify forward-looking statements. The Company cautions readers
that the following important factors, among others, could affect the Company's
actual results and could cause the Company's actual consolidated results to
differ materially from those expressed in any forward-looking statements made by
or on behalf of the Company.

- - A Dramatic Increase in Short-term Interest Rates

- - The Effectiveness of Using Various Interest Rate Derivative Instruments
for Hedging ARM Assets or Borrowing Costs

- - The Ability to Acquire Attractively Priced and Underwritten ARM and Hybrid
ARM Loans and Securities

- - Interest Rate Repricing Mismatch Between Asset Yields and Borrowing Rates

- - A Decline in the Market Value of ARM Securities, Which Would Result in
Margin Calls

- - Unanticipated Levels of Prepayment Rates

- - A Flattening or Inversion of the Yield Curve Between Short and Long-Term
Interest Rates

- - The Use of Substantial Borrowed Funds to Enhance Returns

- - Risk of Credit Loss Associated with Acquiring, Accumulating and
Securitizing ARM Loans

- - Interest Rate Risks Associated with any Future Unhedged Portion of the
Fixed Term of Hybrid ARMs

- - The Loss of Key Personnel

- - Fundamental Changes in Investment Policies and Strategies

- - Fluctuations or Variability of Dividend Distributions

- - Capital Stock Price Volatility

13

COMPETITION

In acquiring ARM assets, the Company competes with other mortgage REITs,
investment banking firms, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, other lenders, FNMA, FHLMC and other
entities purchasing ARM assets, many of which have greater financial resources
than the Company. The existence of these competitive entities, as well as the
possibility of additional entities forming in the future, may increase the
competition for the acquisition of ARM assets resulting in higher prices and
lower yields on such mortgage assets.

EMPLOYEES

As of December 31, 1998, the Company had no employees. Thornburg Mortgage
Advisory Corporation (the "Manager") carries out the day to day operations of
the Company, subject to the supervision of the Board of Directors and under the
terms of a management agreement discussed below.

THE MANAGEMENT AGREEMENT

On June 17, 1994, the Company renewed its management agreement with Thornburg
Mortgage Advisory Corporation (the "Management Agreement"), the Manager, for a
term of five years, with an annual review required each year. On December 15,
1995, the Agreement was amended to provide that in the event a person or entity
obtains more than 20% of the Company's common stock, if the Company is combined
with another entity, or if the Company terminates the Agreement other than for
cause, the Company is obligated to acquire substantially all of the assets of
the Manager through an exchange of shares with a value based on a formula tied
to the Manager's net profits. The Company has the right to terminate the
Management Agreement upon the occurrence of certain specific events, including a
material breach by the Manager of any provision contained in the Management
Agreement.

The Manager at all times is subject to the supervision of the Company's Board of
Directors and has only such functions and authority as the Company may delegate
to it. 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 Manager receives a per annum base management fee on a declining scale based
on average shareholders' equity, adjusted for liabilities that are not incurred
to finance assets ("Average Shareholders' Equity" or "Average Net Invested
Assets" as defined in the Agreement), payable monthly in arrears. The Manager
is also entitled to receive, as incentive compensation for each fiscal quarter,
an amount equal to 20% of the Net Income of the Company, before incentive
compensation, in excess of the amount that would produce an annualized Return on
Equity equal to 1% over the Ten Year U.S. Treasury Rate. For further information
regarding the base management fee, incentive compensation and applicable
definitions, see the Company's Proxy Statement dated March 29, 1999 under the
caption "Certain Relationships and Related Transactions".

Subject to the limitations set forth below, the Company pays all operating
expenses except those specifically required to be paid by the Manager under the
Management Agreement. The operating expenses required to be paid by the Manager
include the compensation of the Company's officers and the cost of office space,
equipment and other personnel required for the Company's day-to-day operations.
The expenses that will be paid by the Company will include issuance and
transaction costs incident to the acquisition, disposition and financing of
investments, regular legal and auditing fees and expenses, the fees and expenses
of the Company's directors, the costs of printing and mailing proxies and
reports to shareholders, the fees and expenses of the Company's custodian and
transfer agent, if any, and reimbursement of any obligation of the Manager for
any New Mexico Gross Receipts Tax liability. The expenses required to be paid
by the Company which are attributable to the operations of the Company shall be
limited to an amount per year equal to the greater of 2% of the Average Net
Invested Assets of the Company or 25% of the Company's Net Income for that year.
The determination of Net Income for purposes of calculating the expense
limitation will be the same as for calculating the Manager's incentive
compensation except that it will include any incentive compensation payable for
such period. Expenses in excess of such amount will be paid by the Manager,
unless the unaffiliated directors determine that, based upon unusual or
non-recurring factors, a higher level of expenses is justified for such fiscal
year. In that event, such expenses may be recovered by the Manager in
succeeding years to the extent that expenses in succeeding quarters are below
the limitation of expenses. The Company, rather than the Manager, will also be
required to pay expenses associated with litigation and other extraordinary or
non-recurring expenses. Expense reimbursement will be made monthly, subject to
adjustment at the end of each year.

14

The transaction costs incident to the acquisition and disposition of
investments, the incentive compensation and the New Mexico Gross Receipts Tax
liability will not be subject to the 2% limitation on operating expenses.
Expenses excluded from the expense limitation are those incurred in connection
with the servicing of mortgage loans, the raising of capital, the acquisition of
assets, interest expenses, taxes and license fees, non-cash costs and the
incentive management fee.

FEDERAL INCOME TAX CONSIDERATIONS

GENERAL

The Company has elected to be treated as a REIT for federal income tax purposes.
In brief, if certain detailed conditions imposed by the REIT provisions of the
Code are met, electing entities that invest primarily in real estate investments
and mortgage loans, and that otherwise would be taxed as corporations are, with
certain limited exceptions, not taxed at the corporate level on their taxable
income that is currently distributed to their shareholders. This treatment
eliminates most of the "double taxation" (at the corporate level and then again
at the shareholder level when the income is distributed) that typically results
from the use of corporate investment vehicles.

In the event that the Company does not qualify as a REIT in any year, it would
be subject to federal income tax as a domestic corporation and the amount of the
Company's after-tax cash available for distribution to its shareholders would be
reduced. The Company believes it has satisfied the requirements for
qualification as a REIT since commencement of its operations in June 1993. The
Company intends at all times to continue to comply with the requirements for
qualification as a REIT under the Code, as described below.

REQUIREMENTS FOR QUALIFICATION AS A REIT

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

Ownership of Common Stock

For all taxable years after the first taxable year for which a REIT election is
made, the Company's shares of capital stock must be held by a minimum of 100
persons for at least 335 days of a 12 month year (or a proportionate part of a
short tax year). In addition, at all times during the second half of each
taxable year, no more than 50% in value of the capital stock of the Company may
be owned directly or indirectly by five or fewer individuals. The Company is
required to maintain records regarding the actual and constructive ownership of
its shares, and other information, and to demand statements from persons owning
above a specified level of the REIT's shares (as long as the Company has over
200 or more shareholders, only persons holding 1% or more of the Company's
outstanding shares of capital stock) regarding their ownership of shares. The
Company must keep a list of those shareholders who fail to reply to such a
demand.

The Company is required to use the calendar year as its taxable year for income
purposes.

Nature of Assets

On the last day of each calendar quarter at least 75% of the value of the
Company's assets must consist of Qualified REIT Assets, government assets, cash
and cash items. The Company expects that substantially all of its assets will
continue to be Qualified REIT Assets. On the last day of each calendar quarter,
of the investments in assets not included in the foregoing 75% assets test, the
value of securities issued by any one issuer may not exceed 5% in value of the
Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding voting securities. Pursuant to its compliance guidelines,
the Company intends to monitor closely the purchase and holding of its assets in
order to comply with the above assets tests.

15

Sources of Income

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

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

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

Distributions

The Company must distribute to its shareholders on a pro rata basis each year an
amount equal to at least (i) 95% of its taxable income before deduction of
dividends paid and excluding net capital gain, plus (ii) 95% of the excess of
the net income from foreclosure property over the tax imposed on such income by
the Code, less (iii) any "excess noncash income". The Company intends to make
distributions to its shareholders in sufficient amounts to meet this 95%
distribution requirement.

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

TAXATION OF THE COMPANY'S SHAREHOLDERS

For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its shareholders out of
current or accumulated earnings and profits will be includable by the
shareholders as ordinary income for federal income tax purposes unless properly
designated by the Company as capital gain dividends. Distributions of the
Company will not be eligible for the dividends received deduction for
corporations. Shareholders may not deduct any net operating losses or capital
losses of the Company.

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

The Clinton Administration has introduced a proposal in the fiscal 2000 federal
budget that would limit the aggregate value of businesses undertaken by a REIT
through taxable subsidiaries to 5% or less of the REIT's total assets. The
Company may from time to time hold, through one or more taxable subsidiaries,
assets that, if held directly by the Company, could otherwise generate income
that would have an adverse effect on the Company's qualification as a REIT or on
certain classes of the Company's shareholders. The Company does not reasonably
expect that the value of any such taxable subsidiaries, in the aggregate, ever
to exceed 5% of the Company's assets and therefore the Company does not
anticipate that the proposal, if enacted, would have a material effect on the
Company's operations.

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

16

ITEM 2. PROPERTIES

The Company's principal executive offices are located in Santa Fe, New
Mexico and are provided by the Manager in accordance with the Management
Agreement. The Company's two subsidiaries have their principal offices in
Irvine, California.

ITEM 3. LEGAL PROCEEDINGS

At December 31, 1998, there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.

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

No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 1998.

17

PART II

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

The Company's common stock is traded on the New York Stock Exchange under the
trading symbol "TMA". As of January 31, 1999, the Company had 21,989,679 shares
of common stock issued and 21,489,663 shares of common stock outstanding which
were held by 1,161 holders of record and approximately 17,355 beneficial owners.

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

Cash
Stock Prices Dividends
---------------------------- Declared
1998 High Low Close Per Share
- ---- --------- --------- ------ --------

Fourth Quarter ended December 31, 1998 9 1/2 5 5/8 7 5/8 $ 0.23
Third Quarter ended September 30, 1998 13 5/8 7 3/16 9 - (1)
Second Quarter ended June 30, 1998 . . 16 1/8 10 1/2 11 7/8 $ 0.30
First Quarter ended March 31, 1998 . . 18 1/2 14 3/4 15 7/8 $ 0.375

1997
- ----

Fourth Quarter ended December 31, 1997 22 1/4 15 7/8 16 1/2 $ 0.50
Third Quarter ended September 30, 1997 24 9/16 20 21 $ 0.50
Second Quarter ended June 30, 1997 . . 22 1/8 17 3/4 21 1/2 $ 0.49
First Quarter ended March 31, 1997 . . 22 7/8 18 3/4 19 $ 0.48

1996
- ----

Fourth Quarter ended December 31, 1996 21 1/2 16 1/8 21 3/8 $ 0.45
Third Quarter ended September 30, 1996 17 5/8 14 7/8 16 1/4 $ 0.40
Second Quarter ended June 30, 1996 . . 17 14 1/8 16 1/4 $ 0.40
First Quarter ended March 31, 1996 . . 16 5/8 14 1/8 14 3/8 $ 0.40

- ----------------
(1) On August 17, 1998, the Company's Board of Directors announced that
dividends on common stock, in the future, would be declared after each
quarter-end rather than during the applicable quarter. The fourth quarter of
1998 dividend was declared in January 1999 and paid in February 1999.

The Company intends to pay quarterly dividends and to make such distributions to
its shareholders in such amounts that all or substantially all of its taxable
income each year (subject to certain adjustments) is distributed, so as to
qualify for the tax benefits accorded to a REIT under the Code. All
distributions will be made by the Company at the discretion of the Board of
Directors and will depend on the earnings and financial condition of the
Company, maintenance of REIT status and such other factors as the Board of
Directors may deem relevant from time to time.

DIVIDEND REINVESTMENT PLAN

The Company has a Dividend Reinvestment and Stock Purchase Plan (the "DRP") that
allows both common and preferred shareholders to have their dividends reinvested
in additional shares of common stock and to purchase additional shares. The
common stock to be acquired for distribution under the DRP may be purchased at
the Company's discretion from the Company at a discount from the then prevailing
market price or in the open market. Shareholders and non-shareholders also can
make additional purchases of stock monthly, subject to a minimum of $100 ($500
for non-shareholders) and a maximum of $5,000 for each optional cash purchase.
Continental Stock Transfer & Trust Company (the "Agent"), the Company's transfer
agent, is the Trustee and administrator of the DRP. Additional information
about the details of the DRP and a prospectus are available from the Agent or
the Company. Shareholders who own stock that is registered in their own name
and want to participate must deliver a completed enrollment form to the Agent.
Forms are available from the Agent or the Company. Shareholders who own stock
that is registered in a name other than their own (e.g., broker or bank nominee)
and want to participate must either request the broker or nominee to participate
on their behalf or request that the broker or nominee re-register the stock in
the shareholder's name and deliver a completed enrollment form to the Agent.

18

ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data are derived from audited financial
statements of the Company for the years ended December 31, 1998, 1997, 1996,
1995 and 1994. The selected financial data should be read in conjunction with
the more detailed information contained in the Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Conditions and
Results of Operations" included elsewhere in this Form 10-K (Amounts in
thousands, except per share data).

OPERATIONS STATEMENT HIGHLIGHTS
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------

Net interest income . . . . . . . . . $31,040 $49,064 $30,345 $13,496 $13,055
Net income. . . . . . . . . . . . . . $22,695 $41,402 $25,737 $10,452 $11,946
Basic earnings per share. . . . . . . $ 0.75 $ 1.95 $ 1.73 $ 0.88 $ 1.02
Diluted earnings per share. . . . . . $ 0.75 $ 1.94 $ 1.73 $ 0.88 $ 1.02
Average common shares . . . . . . . . 21,488 18,048 14,874 11,927 11,759
Distributable income per common share $ 0.84 $ 1.98 $ 1.76 $ 0.92 $ 1.02
Dividends declared per common share . $ 0.905 $ 1.97 $ 1.65 $ 0.93 $ 1.00
Noninterest expense to average assets 0.13% 0.21% 0.21% 0.13% 0.11%

BALANCE SHEET HIGHLIGHTS
As of December 31
---------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------

Adjustable-rate mortgage assets . . . . . . . . . . $4,268,417 $4,638,694 $2,727,875 $1,995,287 $1,727,469
Total assets. . . . . . . . . . . . . . . . . . . . $4,344,633 $4,691,115 $2,755,358 $2,017,985 $1,751,832
Shareholders' equity (1) . . . . . . . . . . . . . $ 395,484 $ 380,658 $ 238,005 $ 182,312 $ 180,035
Historical book value per share (2) . . . . . . . . $ 15.34 $ 15.53 $ 14.67 $ 14.96 $ 15.29
Market value adjusted book value per share (3). . . $ 11.45 $ 14.42 $ 13.70 $ 13.16 $ 10.19
Number of common shares outstanding . . . . . . . . 21,490 20,280 16,219 12,191 11,773
Yield on ARM assets . . . . . . . . . . . . . . . . 5.86% 6.38% 6.64% 6.73% 5.66%
Yield on net int.-earning assets (Portfolio Margin) 0.61% 0.96% 1.34% 1.11% 0.17%
Return on average common equity . . . . . . . . . . 4.80% 12.72% 11.68% 5.81% 6.94%

- ---------------------------------------------------
(1) Shareholders' equity before unrealized market value adjustments.
(2) Shareholders' equity before unrealized market value adjustments, excluding preferred stock, divided by
common shares outstanding.
(3) Shareholders' equity, excluding preferred stock, divided by common shares outstanding.

19

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

OVERVIEW OF FOURTH QUARTER 1998 EVENTS IN THE MORTGAGE MARKET

Like most other mortgage finance companies, the Company was affected by turmoil
in the global and domestic financial markets during the fourth quarter of 1998.
Due to turbulent market conditions, the Company saw its portfolio asset values
decline, its margin requirements for financing certain of its ARM assets
increase, especially with respect to its non-agency portfolio, and the market
value of its hedging instruments decline, which required the Company to post
additional collateral and caused the Company difficulty in financing its less
than AA rated assets at acceptable valuations. Additionally, due to the high
level of prepayments on its agency securities, which the Company must fund out
of its excess liquidity prior to receipt of payments from FNMA and FHLMC, and
the heightened sense of risk aversion on the part of the Company's lenders, the
Company's level of available excess cash and liquid securities diminished from
levels maintained in prior periods. All of these factors combined to reduce the
level of liquidity available to the Company during the fourth quarter of 1998.
The Company undertook several measures to increase its liquidity during these
difficult market conditions. First, the Company requested that its lenders not
make margin calls on its loans backed by agency securities until the applicable
payments had been received by the Company. Several lenders agreed to this
request. Second, the Company undertook the sale of certain assets in order to
reduce its asset portfolio. Accordingly, during the fourth quarter, the Company
sold $421.2 million of ARM assets and recorded a loss on sale of $4.1 million.
Of this loss amount, $3.4 million is related to $155 million of ARM securities
that are indexed to the one-year U.S. Treasury index and which, as a group,
prepaid at an annualized rate of 49% during October and had a yield below the
Company's cost of funds. The Company believes that by selecting these specific
ARM securities for sale, it not only increased its liquidity, but it improved
the future return on its ARM securities portfolio. Lastly, the Company financed
the majority of its whole loans and commitments to purchase whole loans by
issuing $1.1 billion of AAA rated notes, callable monthly, in a securitized
financing transaction in the fourth quarter of 1998. This financing benefited
the Company by providing the Company with a capital efficient method to finance
its whole loan assets over year end and allows the Company to call the
transaction and refinance the loans at a lower interest rate in early 1999 if
market conditions improve. However, the cost of this financing was greater than
current financing rates available to the Company for whole loans and therefore
adversely affected earnings in the fourth quarter of 1998 and possibly will
continue to do so during the first half of 1999. All of these measures were
successful in maintaining the Company's liquidity throughout the fourth quarter
of 1998 and the Company entered 1999 with a much improved liquidity level.

FINANCIAL CONDITION

At December 31, 1998, the Company held total assets of $4.345 billion, $4.268
billion of which consisted of ARM assets. That compares to $4.691 billion in
total assets and $4.639 billion of ARM assets at December 31, 1997. Since
commencing operations, the Company has purchased either ARM securities (backed
by agencies of the U.S. government or privately-issued, generally publicly
registered, mortgage assets, most of which are rated AA or higher by at least
one of the Rating Agencies) or ARM loans generally originated to "A" quality
underwriting standards. At December 31, 1998, 95.9% of the assets held by the
Company, including cash and cash equivalents, were High Quality assets, far
exceeding the Company's investment policy minimum requirement of investing at
least 70% of its total assets in High Quality ARM assets and cash and cash
equivalents. Of the ARM assets currently owned by the Company, 90.0% are in the
form of adjustable-rate pass-through certificates or ARM loans. The remainder
are floating rate classes of CMOs (5.8%) or investments in floating rate classes
of CBOs (4.2%) backed primarily by mortgaged-backed securities.

20

The following table presents a schedule of ARM assets owned at December 31, 1998
and December 31, 1997 classified by High Quality and Other Investment assets and
further classified by type of issuer and by ratings categories.

ARM ASSETS BY ISSUER AND CREDIT RATING
(Dollar amounts in thousands)

December 31, 1998 December 31, 1997
-------------------------- ---------- -----------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
-------------- ---------- ---------- ----------

HIGH QUALITY:
FHLMC/FNMA . . . . . . . . $ 2,072,871 48.6% $3,117,937 67.2%
Privately Issued:
AAA/Aaa Rating . . . . . 1,398,659 (1) 32.8 476,615 10.3
AA/Aa Rating . . . . . . 597,493 14.0 782,206 16.8
-------------- ---------- ---------- ----------
Total Privately Issued 1,996,152 46.8 1,258,821 27.1
-------------- ---------- ---------- ----------

Total High Quality . . 4,069,023 95.4 4,376,758 94.3
-------------- ---------- ---------- ----------

OTHER INVESTMENT:
Privately Issued:
A Rating . . . . . . . . 40,591 1.0 115,055 2.5
BBB/Baa Rating . . . . . 88,273 2.1 17,625 0.4
BB/Ba Rating and Other . 44,120 (1) 0.9 10,269 0.2
Whole loans. . . . . . . . 26,410 0.6 118,987 2.6
-------------- ---------- ---------- ----------
Total Other Investment 199,394 4.6 261,936 5.7
-------------- ---------- ---------- ----------

Total ARM Portfolio. . $ 4,268,417 100.0% $4,638,694 100.0%
============== ========== ========== ==========

- --------------
(1) AAA Rating category includes $1.020 billion of whole loans that have
been credit enhanced by an insurance policy purchased from a third-party and
credit support from an unrated subordinated certificate for $32.4 million
included in BB/Ba Rating and Other category and that are held as collateral for
callable AAA notes.

As of December 31, 1998, the Company had reduced the cost basis of its ARM
securities by a total of $1,242,000 due to potential future credit losses (other
than temporary declines in fair value). The Company is providing for potential
future credit losses on two securities that have an aggregate carrying value of
$11.8 million, which represent less than 0.3% of the Company's total portfolio
of ARM assets. Although both of these assets continue to perform, there is only
minimal remaining credit support to mitigate the Company's exposure to potential
future credit losses.

Additionally, during 1998, the Company recorded a $762,000 provision for
potential credit losses on its loan portfolio, although no actual losses have
been realized in the loan portfolio to date. As of December 31, 1998, the
Company's ARM loan portfolio included eight loans that are considered seriously
delinquent (60 days or more delinquent) with an aggregate balance of $5.0
million. The average original effective loan-to-value ratio on these eight
delinquent loans is approximately 62%. The Company estimates that the
realizable value of each of the single family homes backing these loans to be
more than the value of the individual loans and, therefore, the Company does not
expect to realize a loss on any of these delinquent loans. The Company's credit
reserve policy regarding ARM loans is to record a monthly provision of 0.15%
(annualized rate) on the outstanding principal balance of loans (including loans
securitized by the Company for which the Company has retained first loss
exposure), subject to adjustment on certain loans or pools of loans based upon
factors such as, but not limited to, age of the loans, borrower payment history,
low loan-to-value ratios and quality of underwriting standards applied by the
originator.

21

The following table classifies the Company's portfolio of ARM assets by type of
interest rate index.

ARM ASSETS BY INDEX
(Dollar amounts in thousands)

December 31, 1998 December 31, 1997
---------------------- ----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- ---------- ---------- ----------

ARM ASSETS:
INDEX:
One-month LIBOR. . . . . . . . . . . $ 556,574 13.0% $ 115,198 2.5%
Three-month LIBOR. . . . . . . . . . 181,143 4.2 31,215 0.7
Six-month LIBOR. . . . . . . . . . . 939,824 22.0 1,489,802 32.1
Six-month Certificate of Deposit . . 313,268 7.3 278,386 6.0
Six-month Constant Maturity Treasury 49,023 1.2 66,669 1.4
One-year Constant Maturity Treasury. 1,479,054 34.7 2,271,914 49.0
Cost of Funds. . . . . . . . . . . . 268,486 6.3 385,510 8.3
---------- ---------- ---------- ----------
3,787,372 88.7 4,638,694 100.0
---------- ---------- ---------- ----------

HYBRID ARM ASSETS . . . . . . . . . . . . 481,045 11.3 - -
---------- ---------- ---------- ----------
$4,268,417 100.0% $4,638,694 100.0%
========== ========== ========== ==========

The ARM portfolio had a current weighted average coupon of 7.28% at December 31,
1998. This consisted of an average coupon of 6.96% on the hybrid portion of the
portfolio and an average coupon of 7.32% on the rest of the portfolio. If the
non-hybrid portion of the portfolio had been "fully indexed," the weighted
average coupon would have been approximately 6.79%, based upon the current
composition of the portfolio and the applicable indices. As of December 31,
1997, the ARM portfolio had a weighted average coupon of 7.56%. If the ARM
portfolio had been "fully indexed," the weighted average coupon would have been
approximately 7.64%, based upon the composition of the portfolio and the
applicable indices at that time. The Company did not own any hybrids as of
December 31, 1997. The lower average coupon on the ARM portfolio as of the end
of 1998 compared to 1997 is reflective of the overall lower interest rates in
the U.S. economy during these respective periods.

At December 31, 1998, the current yield of the ARM assets portfolio was 5.86%,
compared to 6.38% as of December 31, 1997, with an average term to the next
repricing date of 253 days as of December 31, 1998, compared to 110 days as of
December 31, 1997. The increase in the number of days until the next repricing
of the ARMs is primarily due to the hybrid loans acquired by the Company during
1998, which, in general, do not reprice for three to five years from their
origination date and have an average remaining fixed rate period of 4.3 years.
The current yield includes the impact of the amortization of applicable premiums
and discounts, the cost of hedging, the amortization of the deferred gains from
hedging activity and the impact of principal payment receivables.

The reduction in the yield as of December 31, 1998, compared to December 31,
1997, is primarily because of a combination of a lower average interest coupon
on the ARM portfolio by 0.28%, as stated above, and the higher rate of ARM
portfolio prepayments as of the end of 1998 compared to the end of 1997. During
the fourth quarter of 1998 the rate of prepayments had slowed to 29%, but this
was higher than the 24% experienced during the fourth quarter of 1997. The
higher level of prepayments increased the amount of premium amortization expense
and increased the impact of non-interest earning assets in the form of principal
payment receivables. Higher premium amortization and a higher balance of
principal payment receivables decreased the ARM portfolio yield by 0.24% as of
the end of 1998 compared to the end of 1997.

22

The following table presents various characteristics of the Company's ARM and
Hybrid ARM loan portfolio as of December 31, 1998. This information pertains to
both the loans held for securitization and the loans held as collateral for the
callable AAA notes payable.

ARM AND HYBRID ARM LOAN PORTFOLIO CHARACTERISTICS

Average High Low
--------- ----------- ------

Unpaid principal balance. $277,276 $3,450,000 $ 278
Coupon rate on loans. . . 7.50% 9.63% 5.00%
Pass-through rate . . . . 7.15% 9.23% 4.73%
Pass-through margin . . . 2.20% 5.18% 0.48%
Lifetime cap. . . . . . . 13.04% 16.75% 9.75%
Original Term (months). . 333 480 120
Remaining Term (months) . 319 358 93

Geographic Distribution (Top 5 States): Property type:
California . . . . . . . 21.87% Single-family 65.23%
Florida. . . . . . . . . 12.96 DeMinimus PUD 20.00
Georgia. . . . . . . . . 7.06 Condominium 9.59
New York . . . . . . . . 6.96 Other 5.18
Colorado . . . . . . . . 4.42

Occupancy status:. . . . . Loan purpose:
Owner occupied . . . . . 84.14% Purchase 57.60%
Second home. . . . . . . 11.38 Cash out refinance 23.78
Investor . . . . . . . . 4.48 Rate & term refinance 18.62

Documentation type:. . . . Periodic Cap:
Full/Alternative . . . . 95.73% None 49.04%
Other. . . . . . . . . . 4.27 2.00% 49.33
0.50% 1.63
Average effective original
loan-to-value: . . . . . . 67.55%

During the year ended December 31, 1998, the Company purchased $1.502 billion of
ARM securities, 93.7% of which were High Quality assets, and $1.092 billion of
ARM loans generally originated to "A" quality underwriting standards or seasoned
loans with over five years of good payment history and/or low loan-to-value
ratios. Of the ARM assets acquired during 1998, approximately 33% were Hybrid
ARMs, 32% were indexed to LIBOR, 13% were indexed to U.S. Treasury bill rates,
12% were indexed to a Cost of Funds Index, 9% were indexed to a Certificate of
Deposit Index and the remaining 1% to other indices. During 1998, the Company
began the acquisition of Hybrid ARM assets that have an interest rate that is
fixed for an initial period of time, generally 3 to 5 years, and then convert to
an adjustable-rate for the balance of the term of the loan. The Company
emphasized purchasing assets during 1998 at substantially lower prices relative
to par in order to reduce the potential impact of future prepayments. As a
result, the Company emphasized the acquisition of ARM and Hybrid ARM loans and
high quality floating rate collateralized mortgage and bond obligations. In
doing so, the average premium paid for ARM assets acquired in 1998 was 1.09% of
par as compared to 3.29% of par in 1997 when the Company emphasized the purchase
of seasoned ARM assets.

The Company sold ARM assets in the amount of $932.3 million at a net loss of
$278,000 during 1998. As discussed earlier, a large portion of these sales
occurred in the fourth quarter during a period of time when liquidity was a
problem for the mortgage finance industry. During this period, the Company sold
$421.2 million of ARM securities at a net loss of $4.1 million. During the
prior nine months, the Company had sold $511.1 million of ARM assets at a net
gain of $3.8 million. These sales during the first nine months of 1998 reflect
the Company's desire to manage the portfolio with a view to enhancing the total
return of the portfolio. The Company monitors the performance of its individual
ARM assets and generally sells an asset when there is an opportunity to replace
it with an ARM asset that has an expected higher long-term yield or more
attractive interest rate characteristics. The Company is presented with
investment opportunities in the ARM assets market on a daily basis and
management evaluates such opportunities against the performance of its existing
portfolio. At times, the Company is able to identify opportunities that it
believes will improve the total return of its portfolio by replacing selected
assets. In managing the portfolio, the Company may realize either gains or
losses in the process of replacing selected assets.

23

For the quarter ended December 31, 1998, the Company's mortgage assets paid down
at an approximate average annualized constant prepayment rate of 29% compared to
24% during the same period of 1997. The annualized constant prepayment rate
averaged approximately 31% during the full year of 1998 compared to 22% during
1997. When prepayment experience exceeds expectations due to sustained
increased prepayment activity, the Company has to amortize its premiums over a
shorter time period, resulting in a reduced yield to maturity on the Company's
ARM assets. Conversely, if actual prepayment experience is less than the
assumed constant prepayment rate, the premium would be amortized over a longer
time period, resulting in a higher yield to maturity. The Company monitors its
prepayment experience on a monthly basis in order to adjust the amortization of
the net premium, as appropriate.

The fair value of the Company's portfolio of ARM assets classified as
available-for-sale declined by 2.10% from a negative adjustment of 0.52% of the
portfolio as of December 31, 1997, to a negative adjustment of 2.62% as of
December 31, 1998. This price decline was primarily because of a decline in the
levels of liquidity in the mortgage market, the impact of market difficulties in
financing mortgage assets, a widening of credit spreads relative to treasury
yields due to uncertainties regarding future economic activity in the U.S. and
global economies and because of increased future prepayment expectations which
have the effect of shortening the average life of the Company's ARM assets and
decreasing their fair value. The amount of the negative adjustment to fair
value on the ARM assets classified as available-for-sale increased from $21.7
million as of December 31, 1997, to $83.2 million as of December 31, 1998. As
of December 31, 1998, all of the Company's ARM securities are classified as
available-for-sale and are carried at their fair value.

The Company has purchased Cap Agreements in order to limit its exposure to risks
associated with the lifetime interest rate caps of its ARM assets should
interest rates rise above specified levels. The Cap Agreements act to reduce
the effect of the lifetime or maximum interest rate cap limitation. The Cap
Agreements purchased by the Company will allow the yield on the ARM assets to
continue to rise in a high interest rate environment just as the Company's cost
of borrowings would continue to rise, since the borrowings do not have any
interest rate cap limitation. At December 31, 1998, the Cap Agreements owned by
the Company had a remaining notional balance of $4.026 billion with an average
final maturity of 2.3 years, compared to a remaining notional balance of $4.156
billion with an average final maturity of 3.1 years at December 31, 1997.
Pursuant to the terms of the Cap Agreements, the Company will receive cash
payments if the one-month, three-month or six-month LIBOR index increases above
certain specified levels, which range from 7.50% to 13.00% and average
approximately 10.10%. The fair value of these Cap Agreements also tends to
increase when general market interest rates increase and decrease when market
interest rates decrease, helping to partially offset changes in the fair value
of the Company's ARM assets. At December 31, 1998, the fair value of the Cap
Agreements was $1.5 million, $6.8 million less than the amortized cost of the
Cap Agreements.

24

The following table presents information about the Company's Cap Agreement
portfolio as of December 31, 1998:

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

Hedged Weighted Cap Agreement Weighted
ARM Assets Average Notional Average
Balance (1) Life Cap Balance (2) Strike Price Remaining Term
- ------------ --------- --------------- ------------- --------------

$ 439,159 9.12% $ 433,261 7.50% 1.3 Years
533,267 10.13 534,804 8.00 3.3
175,811 10.70 181,896 8.50 1.2
276,916 11.22 274,910 9.00 1.0
144,468 11.38 144,819 9.50 1.8
318,654 11.78 315,879 10.00 3.4
428,068 12.09 432,183 10.50 1.9
363,355 12.48 361,297 11.00 2.9
553,091 13.06 554,112 11.50 3.5
344,475 14.20 538,616 12.00 2.1
49,410 16.41 164,969 12.50 1.4
- - 89,283 13.00 1.1
- ------------ --------- --------------- ------------- --------------
$ 3,626,674 11.70% $ 4,026,029 10.10% 2.3 Years
============ ========= =============== ============= ==============

- ------------
(1) Excludes ARM assets that do not have life caps or are hybrids that are
match funded during a fixed rate period, in accordance with the Company's
investment policy.
(2) As of December 31, 1998, the Company was $399.4 million over hedged,
primarily because of the ARM asset sales that occurred during the fourth quarter
of 1998. The Company has retained these Cap Agreements to hedge its future
acquisitions which it expects to make during 1999. The retained Cap Agreements
have a carrying value of $0.

As of December 31, 1998, the Company was a counterparty to nineteen interest
rate swap agreements ("Swaps") having an aggregate notional balance of $1.473
billion. As of year-end, these Swaps had a weighted average remaining term of
16.5 months. In accordance with these Swaps, the Company will pay a fixed rate
of interest during the term of these Swaps and receive a payment that varies
monthly with the one-month LIBOR rate. As a result of entering into these
Swaps, the Company has reduced the interest rate variability of its cost to
finance its ARM assets by increasing the average period until the next repricing
of its borrowings from 26 days to 204 days. Fourteen of these Swaps were
entered into in connection with the Company's acquisition of Hybrid ARM loans
and commitments to purchase Hybrid ARM loans. These fourteen Swaps that hedge
the fixed rate portion of the Company's Hybrid ARM loans (to within one year of
the first interest rate reset) had a notional balance of $523 million at
year-end and an average maturity of 44.0 months. The other five swaps with a
notional balance of $950 million were entered into for the purpose of
lengthening the average next re-pricing date of the Company's borrowings to more
closely match the re-pricing characteristics of the Company's ARM assets. These
five swaps mature during the first quarter of 1999.

RESULTS OF OPERATIONS - 1998 COMPARED TO 1997

For the year ended December 31, 1998, the Company's net income was $22,695,000,
or $0.75 per share (Basic EPS), based on a weighted average of 21,488,000 shares
outstanding. That compares to $41,402,000, or $1.95 per share (Basic EPS),
based on a weighted average of 18,048,000 shares outstanding for the year ended
December 31, 1997. Net interest income for the year totaled $31,040,000,
compared to $49,064,000 for the same period in 1997. Net interest income is
comprised of the interest income earned on portfolio assets less interest
expense from borrowings. During 1998, the Company recorded a net loss on the
sale of ARM securities of $278,000 as compared to a gain of $1,189,000 during
1997. Additionally, during 1998, the Company reduced its earnings and the
carrying value of its ARM assets by reserving $2,032,000 for potential credit
losses, compared to $886,000 during 1997. During 1998, the Company incurred
operating expenses of $6,035,000, consisting of a base management fee of
$4,142,000, a performance-based fee of $759,000 and other operating expenses of
$1,134,000. During 1997, the Company incurred operating expenses of $7,965,000,
consisting of a base management fee of $3,664,000, a performance-based fee of
$3,363,000 and other operating expenses of $938,000. Total operating expenses
decreased as a percentage of average assets to 0.13% for 1998, compared to 0.21%
for 1997, primarily due to the elimination of the performance-based fee during
the last three quarters of 1998.

25

The Company's return on average common equity was 4.80% for the year ended
December 31, 1998 compared to 12.72% for the year ended December 31, 1997. The
primary reasons for the lower return on average common equity are the Company's
lower interest rate spread, discussed further below and the net loss recorded in
1998 on the sale of ARM securities, which were partially offset by lower
operating expenses.

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

COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY (1)

ROE in
Excess of
Net Gain (Loss) Net 10-Year 10-Year
Interest Provision on ARM G & A Performance Preferred Income/ US Treas. US Treas.
For The Income/ For Losses/ Sales/ Expense (2)/ Fee/ Dividend/ Equity Average Average
Quarter Ended Equity Equity Equity Equity Equity Equity (ROE) Yield Yield
- ------------- --------- ------------ ------- ------------- ------------ ---------- ---------- ---------- ----------

Mar 31, 1996. 13.37% - 0.03% 1.04% 1.27% - 11.08% 5.90% 5.18%
Jun 30, 1996. 13.14% - - 1.00% 0.92% - 11.22% 6.72% 4.50%
Sep 30, 1996. 13.42% 0.34% 0.88% 1.03% 1.07% - 11.86% 6.78% 5.08%
Dec 31, 1996. 14.99% 1.32% 1.38% 1.46% 1.23% - 12.37% 6.35% 6.02%
Mar 31, 1997. 18.85% 0.32% 0.01% 1.65% 1.43% 2.07% 13.40% 6.55% 6.85%
Jun 30, 1997. 19.48% 0.34% 0.03% 1.81% 1.25% 2.67% 13.45% 6.71% 6.74%
Sep 30, 1997. 17.66% 0.30% 0.45% 1.64% 1.24% 2.23% 12.70% 6.26% 6.44%
Dec 31, 1997. 15.62% 0.33% 1.06% 1.59% 1.01% 2.12% 11.63% 5.92% 5.71%
Mar 31, 1998. 14.13% 0.48% 1.89% 1.62% 0.94% 2.06% 10.91% 5.60% 5.31%
Jun 30, 1998. 9.15% 0.53% 1.76% 1.58% 0.00% 1.96% 6.83% 5.60% 1.23%
Sep 30, 1998. 6.82% 0.66% 0.89% 1.54% 0.00% 1.97% 3.54% 5.24% -1.70%
Dec 31, 1998. 7.27% 0.76% -4.88% 1.57% 0.00% 2.01% -1.95% 4.66% -6.61%

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

The decline in the Company's return on common equity from the fourth quarter of
1997 to the fourth quarter of 1998 is primarily due to the decline in the net
interest spread between the Company's interest-earning assets and
interest-bearing liabilities, an increase in the Company's provision for losses
and the impact of a net loss on ARM sales as compared to a net gain on ARM
sales. This decline in net return on common equity was partially offset by the
elimination of the performance-based fee. The decline in the Company's return
on common equity from the third quarter of 1998 to the fourth quarter of 1998 is
primarily due to the impact of a net loss on ARM sales as compared to a net gain
on ARM sales and an increase in the Company's provision for losses. This
decline was partially offset by an increase in the net interest spread between
the Company's interest-earning assets and interest-bearing liabilities.

26

The following table presents the components of the Company's net interest income
for the years ended December 31, 1998 and 1997:

COMPARATIVE NET INTEREST INCOME COMPONENTS
(Dollar amounts in thousands)

1998 1997
--------- ---------

Coupon interest income on ARM assets $335,983 $271,170
Amortization of net premium. . . . . (46,101) (21,343)
Amortization of Cap Agreements . . . (5,444) (5,313)
Amort. of deferred gain from hedging 1,889 1,992
Cash and cash equivalents. . . . . . 705 1,215
--------- ---------
Interest income. . . . . . . . . . 287,032 247,721
--------- ---------

Reverse repurchase agreements. . . . 251,462 197,006
Callable AAA notes payable . . . . . 2,811 -
Other borrowings . . . . . . . . . . 632 969
Interest rate swaps. . . . . . . . . 1,087 682
--------- ---------
Interest expense . . . . . . . . . 255,992 198,657
--------- ---------

Net interest income. . . . . . . . . $ 31,040 $ 49,064
========= =========

As presented in the table above, the Company's net interest income decreased by
$18.0 million in 1998 compared to 1997, primarily because the amortization of
net premium increased by $24.8 million. In 1998 the amortization of net premium
was 13.7% of coupon interest income on ARM assets as compared to 7.9% in 1997,
reflecting, in part, the increased rate of ARM prepayments in 1998 as compared
to 1997.

The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the years ended December 31, 1998 and 1997:

AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)

For the Year Ended For the Year Ended
December 31, 1998 December 31, 1997
----------------------- ----------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------- ---------- ---------- ----------

Interest Earning Assets:
Adjustable-rate mortgage assets. . . . $4,800,772 5.96% $3,755,064 6.56%
Cash and cash equivalents. . . . . . . 16,214 4.35 21,774 5.57
----------- ---------- ---------- ----------
4,816,986 5.96 3,776,838 6.56
----------- ---------- ---------- ----------
Interest Bearing Liabilities:
Borrowings . . . . . . . . . . . . . . 4,430,167 5.78 3,446,913 5.76
----------- ---------- ---------- ----------
Net Interest Earning Assets and Spread . $ 386,819 0.18% $ 329,925 0.80%
=========== ========== ========== ==========

Yield on Net Interest Earning Assets (1) 0.64% 1.30%
========== ==========

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

As a result of the yield on the Company's interest-earning assets declining to
5.96% during 1998 from 6.56% during 1997 and the Company's cost of funds
increasing to 5.78% during 1998 from 5.76% during 1997, net interest income
decreased by $18,024,000. This decrease in net interest income is a combination
of rate and volume variances. There was a combined unfavorable rate variance of
$23,332,000, which was almost entirely the result of a lower yield on the
Company's ARM assets portfolio and other interest-earning assets. The increased
average size of the Company's portfolio during 1998 compared to 1997 contributed
to higher net interest income in the amount of $5,310,000. The average balance
of the Company's interest-earning assets was $4.817 billion during 1998 compared
to $3.777 billion during 1997 -- an increase of 28%.

27

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

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

Average ARM Assets Yield on Yield on
----------------------------------
Interest Wgt. Avg. Weighted Interest Net Net Interest
As of the Earning Fully Indexed Average Yield Earning Cost of Interest Earning
Quarter Ended Assets Coupon Coupon Adj. (2) Assets Funds Spread Assets
- ------------- ---------- -------- -------------- -------- ------- -------- -------- ---------

Mar 31, 1996. $ 2,025.8 7.56% 7.48% 0.99% 6.49% 5.60% 0.89% 1.32%
Jun 30, 1996. 2,248.2 7.83% 7.28% 0.85% 6.43% 5.59% 0.84% 1.32%
Sep 30, 1996. 2,506.0 7.80% 7.31% 0.80% 6.51% 5.71% 0.80% 1.32%
Dec 31, 1996. 2,624.4 7.61% 7.57% 0.93% 6.64% 5.72% 0.92% 1.34%
Mar 31, 1997. 2,950.6 7.93% 7.53% 0.89% 6.65% 5.67% 0.98% 1.54%
Jun 30, 1997. 3,464.1 7.75% 7.57% 0.90% 6.67% 5.77% 0.90% 1.39%
Sep 30, 1997. 4,143.7 7.63% 7.65% 1.07% 6.58% 5.79% 0.79% 1.22%
Dec 31, 1997. 4,548.9 7.64% 7.56% 1.18% 6.38% 5.91% 0.47% 0.96%
Mar 31, 1998. 4,859.7 7.47% 7.47% 1.23% 6.24% 5.74% 0.50% 0.92%
Jun 30, 1998. 4,918.3 7.51% 7.44% 1.50% 5.94% 5.81% 0.13% 0.56%
Sep 30, 1998. 4,963.7 6.97% 7.40% 1.52% 5.88% 5.78% 0.09% 0.46%
Dec 31, 1998. 4,526.2 6.79% 7.28% 1.42% 5.86% 5.94% -0.08% 0.61%

- ------------
(1) Yield on Net Interest Earning Assets is computed by dividing annualized net interest income by the
average daily balance of interest earning assets.
(2) Yield adjustments include the impact of amortizing premiums and discounts, the cost of hedging
activities, the amortization of deferred gains from hedging activities and the impact of principal payment
receivables. The following table presents these components of the yield adjustments for the dates presented
in the table above:

COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM ASSETS

Impact of Amort. of
Premium/ Principal Deferred Gain Total
As of the Discount Payments Hedging from Hedging Yield
Quarter Ended Amort. Receivable Activity Activity Adjustment
- ------------- --------- ----------- --------- -------------- -----------

Mar 31, 1996. 0.77% 0.11% 0.31% (0.20)% 0.99%
Jun 30, 1996. 0.67% 0.07% 0.27% (0.16)% 0.85%
Sep 30, 1996. 0.57% 0.08% 0.25% (0.10)% 0.80%
Dec 31, 1996. 0.69% 0.09% 0.23% (0.08)% 0.93%
Mar 31, 1997. 0.63% 0.13% 0.19% (0.07)% 0.89%
Jun 30, 1997. 0.66% 0.13% 0.16% (0.05)% 0.90%
Sep 30, 1997. 0.85% 0.12% 0.15% (0.05)% 1.07%
Dec 31, 1997. 0.94% 0.14% 0.14% (0.04)% 1.18%
Mar 31, 1998. 0.98% 0.16% 0.13% (0.04)% 1.23%
Jun 30, 1998. 1.24% 0.17% 0.13% (0.04)% 1.50%
Sep 30, 1998. 1.25% 0.18% 0.13% (0.04)% 1.52%
Dec 31, 1998. 1.18% 0.14% 0.14% (0.04)% 1.42%

As of December 31, 1998, the Company's yield on its ARM assets portfolio,
including the impact of the amortization of premiums and discounts, the cost of
hedging, the amortization of deferred gains from hedging activity and the impact
of principal payment receivables, was 5.86%, compared to 6.38% as of December
31, 1997-- a decrease of 0.52%. The Company's cost of funds as of December 31,
1998, was 5.94%, compared to 5.91% as of December 31, 1997 -- an increase of
0.03%. As a result of these changes, the Company's net interest spread as of
December 31, 1998 was -0.08%, compared to 0.47% as of December 31, 1997. The
decline in the net interest spread is largely attributable to the decline in the
ARM portfolio yield which is primarily the result of the lower average interest
coupon and the higher level of premium amortization. The increase in the
Company's cost of funds as of year end is generally the impact of the rate on
the newly issued callable AAA notes payable. The notes were issued on December
18, 1998 at a time when finance rates are generally seasonably high, reflecting
the mortgage finance market's reluctance to finance assets over year-end, and
the notes were issued at a time when mortgage finance spreads were unusually
wide due to the liquidity crises discussed earlier. Subsequent to year-end,
the rate on the callable AAA notes, which floats with one-month LIBOR, decreased
by 0.68%.

28

The Company's net interest spread declined from 0.47% as of December 31, 1997
to -0.08% as of December 31, 1998. The primary reasons for these declines
continues to be the relationship between the one-year U. S. Treasury yield and
LIBOR and the impact of the increased rate of ARM prepayments as well as the
impact of issuing the callable AAA notes close to year-end. From December 31,
1997 to December 31, 1998, the one-year U.S. Treasury yield declined by
approximately 0.98%, from 5.51% to 4.53%, while LIBOR rates applicable to the
Company's borrowings decreased by only 0.70%, from 5.77% to 5.07%, creating a
negative index spread as of December 31, 1998 of -0.54% compared to a negative
index spread as of December 31, 1997 of -0.26%. As of December 31, 1998,
approximately 35% of the Company's ARM assets were indexed to the one-year U. S.
Treasury bill yield, down from approximately 49% as of December 31, 1997, and,
therefore, the yield on such assets declined with the index. To put this in
historical perspective, the one-year U.S. Treasury bill yield had a spread of
- -0.26% to the average of the one- and three-month LIBOR rate as of December 31,
1997, compared to having a spread of -0.02% at December 31, 1996, -.06% on
average during 1997, 0.04% on average during 1996 and -0.07% on average during
1995. For the five-year period from 1993 to 1997, the average spread was 0.15%.
The average spread during the three month period ended December 31, 1998 was
- -0.93%, which was substantially worse than the average spread during the
previous quarter of -0.53% or in the second quarter of 1998 when the average
spread was -0.27%. The Company does not know when or if the relationship
between the one-year U. S. Treasury bill yield and LIBOR will return to
historical norms, but the Company's spreads are expected to improve if that
occurs. As of the middle of March 1999, the one-year U.S. Treasury bill yield
and LIBOR spread had improved back to approximately -.25%. The Company is also
continuing to decrease its exposure to the one-year U. S. Treasury/LIBOR
relationship by reducing the portion of the portfolio indexed to the one-year U.
S. Treasury rate and financed with LIBOR. The Company's ARM portfolio yield
also was lower as of December 31, 1998 compared to December 31, 1997 because of
an increase in the amortization of the net premium on ARM assets which reflects
an increase in the average rate of prepayments on the ARM portfolio. During the
fourth quarter of 1998, the average prepayment rate was 29%, compared to 24%
during the comparable period in 1997. The impact of this was to increase the
average amount of non-interest-earning assets in the form of principal payments
receivable as well as to increase the amortization expense related to writing
off the Company's premiums and discounts. The Company generally amortizes its
premiums and discounts on a monthly basis based on the most recent three-month
average of the prepayment rate of its ARM assets, thereby adjusting its
amortization to current market conditions, which is reflected in the yield of
the ARM portfolio. As of December 31, 1998, the yield adjustment related to
premium amortization amounted to 1.18% compared to 0.94% as of December 31,
1997. As discussed above, the Company's net spread of -.08% also reflects the
cost of the callable AAA notes which were issued on December 18, 1998 and had an
interest rate of 6.32% as of year-end, which has subsequently declined to a rate
of 5.64% in January and which will continue to float with one-month LIBOR.

The Company's provision for losses has increased with the acquisition of whole
loans. The provision for loan losses is based on an annualized rate of 0.15% on
the outstanding principal balance of loans as of each month-end, subject to
certain adjustments as discussed above. As of December 31, 1998, the Company's
whole loans, including those held as collateral for the AAA notes payable,
accounted for 24.5% of the Company's portfolio of ARM assets compared to 2.6% as
of December 31, 1997. To date, the Company has not experienced any actual
losses in its whole loan portfolio, but based on industry standards, losses are
expected and are being provided for as the portfolio ages.

During 1998, the Company realized a net loss from the sale of ARM securities in
the amount of $278,000 compared to a gain of $1,189,000 during 1997. The 1998
sales generally fall into two categories. During the first nine months of 1998,
the Company realized a net gain on the sale of ARM assets in the amount
$3,780,000 as part of the Company's ongoing portfolio management. These sales
reflect the Company's desire to manage the portfolio with a view to enhancing
the total return of the portfolio over the long-term while generating current
earnings during this period of fast prepayments and narrow interest spreads.
The Company monitors the performance of its individual ARM assets and
selectively sells an asset when there is an opportunity to replace it with an
ARM asset that has an expected higher long-term yield or more attractive
interest rate characteristics. The Company sold $511.8 million of ARM assets
during the first nine months of 1998, most which were either indexed to a Cost
of Funds index, the one-year U. S. Treasury index or were prepaying faster than
expected. During the first nine months of 1998 when the Company sold selected
assets, it was able to reinvest the proceeds in ARM assets that were indexed to
indices preferred by the Company and at prices that reflected current market
assumptions regarding prepayments speeds and interest rates and thus far, as a
whole, they have been performing better than the portfolio acquired before 1998.
During the fourth quarter of 1998, the Company sold assets for the primary
purpose of maintaining adequate levels of liquidity at a time when the mortgage
finance market experienced a sudden liquidity crises and, thus, was able to
avoid the forced liquidation of any of its assets by mortgage finance
counterparties. However, the Company realized a net loss of $4,059,000 on these
sales. Although the Company is never pleased when it has to sell assets at a
loss, the Company was very pleased with the response of its mortgage finance
counterparties to the high credit quality and highly liquid characteristics of
the Company's ARM portfolio in that all of the Company's counterparties, upon
review of the company's ARM portfolio and investment policies, continued to
provide financing at reasonable collateral values and reasonable requirements
for over collateralization.

29

As a REIT, the Company is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of its taxable income for each year by the time it
files its applicable tax return and, therefore, generally passes through
substantially all of its earnings to shareholders without paying federal income
tax at the corporate level. As of December 31, 1998, the Company had
distributed all of its cumulative taxable income to its shareholders. Since the
Company, as a REIT, pays its dividends based on taxable earnings, the dividends
may at times be more or less than reported earnings. The following table
provides a reconciliation between the Company's earnings as reported based on
generally accepted accounting principles and the Company's taxable income before
its' common dividend deduction:

RECONCILIATION OF REPORTED NET INCOME TO TAXABLE NET INCOME
(Dollar amounts in thousands)

Years Ending December 31,
-------------------------
1998 1997
-------- --------

Net income. . . . . . . . . . . . . . . . . . $22,695 $41,402
Additions:
Provision for credit losses. . . . . . . . . 2,032 886
Net compensation related items . . . . . . . 165 (195)
Non-deductible capital losses. . . . . . . . 278 -
Deductions:
Dividend on Series A Preferred Shares (5,009) (6,251)
Actual credit losses on ARM securities (1,766) (96)
-------- --------
Taxable net income. . . . . . . . . . . . . . $18,395 $35,746
======== ========

On August 17, 1998, the Company announced that its Board of Directors had
approved a rescheduling of the Company's quarterly board meetings and the
declaration, record and payment dates of its regular cash dividend on its common
stock. Under the new schedule, the Board of Directors will meet after the close
of each quarter end, so the Board can review actual quarterly financial results
as they consider the declaration of common dividends. This action is also
expected to provide a modest benefit to the financial results of the Company as
the Company will be able to retain earnings over each quarter end and to
leverage this additional capital for an extended period of time, generating
additional income for shareholders when the additional assets are invested at a
positive effective margin. This action does not effect the dividend dates in
connection with the Company's Series A 9.68% Cumulative Convertible Preferred
Shares.

For the year ended December 31, 1998, the Company's ratio of operating expenses
to average assets was 0.13% compared to 0.21% for 1997. The Company's expense
ratios are among the lowest of any company investing in mortgage assets, giving
the Company what it believes to be a significant competitive advantage over more
traditional mortgage portfolio lending institutions such as banks and savings
and loans. This competitive advantage enables the Company to operate with less
risk, such as credit and interest rate risk, and still generate an attractive
long-term return on equity when compared to these more traditional mortgage
portfolio lending institutions. The Company pays the Manager an annual base
management fee, generally based on average shareholders' equity, not assets, as
defined in the Management Agreement, payable monthly in arrears as follows:
1.1% of the first $300 million of Average Shareholders' Equity, plus 0.8% of
Average Shareholders' Equity above $300 million. Since this management fee is
based on shareholders' equity and not assets, this fee increases as the Company
successfully accesses capital markets and raises additional equity capital and
is, therefore, managing a larger amount of invested capital on behalf of its
shareholders. In order for the Manager to earn a performance fee, the rate of
return on the shareholders' investment, as defined in the Management Agreement,
must exceed the average ten-year U.S. Treasury rate during the quarter plus 1%.
During 1998, as the Company's return on shareholders' equity declined, compared
to 1997, the performance fee also declined, to an annualized 0.02% of average
assets compared to 0.09% during 1997. As presented in the following table, the
performance fee is a variable expense that fluctuates with the Company's return
on shareholders' equity relative to the average 10-year U.S. Treasury rate.

30

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

ANNUALIZED OPERATING EXPENSE RATIOS

Management Fee & Total
For The Other Expenses/ Performance Fee/ G & A Expense/
Quarter Ended Average Assets Average Assets Average Assets
- ------------- ----------------- ----------------- ---------------

Mar 31, 1996. 0.09% 0.12% 0.21%
Jun 30, 1996. 0.10% 0.09% 0.19%
Sep 30, 1996. 0.10% 0.10% 0.20%
Dec 31, 1996. 0.13% 0.11% 0.24%
Mar 31, 1997. 0.14% 0.11% 0.25%
Jun 30, 1997. 0.13% 0.09% 0.22%
Sep 30, 1997. 0.12% 0.09% 0.21%
Dec 31, 1997. 0.12% 0.05% 0.17%
Mar 31, 1998. 0.10% 0.06% 0.16%
Jun 30, 1998. 0.10% 0.00% 0.10%
Sep 30, 1998. 0.10% 0.00% 0.10%
Dec 31, 1998. 0.11% 0.00% 0.11%

RESULTS OF OPERATIONS - 1997 COMPARED TO 1996

For the year ended December 31, 1997, the Company's net income was $41,402,000,
or $1.95 per share (Basic EPS), based on a weighted average of 18,047,955 shares
outstanding. That compares to $25,737,000, or $1.73 per share (Basic EPS),
based on a weighted average of 14,873,700 shares outstanding for the year ended
December 31, 1996. This 61% increase in earnings -- a 13% increase on a
per-share basis -- was achieved despite a 21% increase in the average number of
shares outstanding during the two periods. Net interest income for the year
totaled $49,064,000, compared to $30,345,000 for the same period in 1996, an
increase of 62%. Net interest income is comprised of the interest income earned
on mortgage investments less interest expense from borrowings. During 1997, the
Company recorded a gain on the sale of ARM securities of $1,189,000 as compared
to a gain of $1,362,000 during 1996. Additionally, during 1997, the Company
reduced its earnings and the carrying value of its ARM assets by reserving
$886,000 for potential credit losses, compared to $990,000 during 1996. During
1997, the Company incurred operating expenses of $7,965,000, consisting of a
base management fee of $3,664,000, a performance-based fee of $3,363,000 and
other operating expenses of $938,000. During 1996, the Company incurred
operating expenses of $4,980,000, consisting of a base management fee of
$1,872,000, a performance-based fee of $2,462,000 and other operating expenses
of $646,000. Total operating expenses decreased as a percentage of net interest
income to 16.2% for 1997, compared to 16.4% for 1996, thereby contributing to
the Company's improved net earnings.

The Company's return on average common equity for the year ended December 31,
1997 was 12.72%, compared to 11.68% for the same period in 1996.

31

The following table presents the components of the Company's net interest income
for the years ended December 31, 1997 and 1996:

COMPARATIVE NET INTEREST INCOME COMPONENTS
(Dollar amounts in thousands)

1997 1996
--------- ---------

Coupon interest income on ARM assets $271,170 $165,105
Amortization of net premium. . . . . (21,343) (12,466)
Amortization of Cap Agreements . . . (5,313) (5,313)
Amort. of deferred gain from hedging 1,992 3,433
Cash and cash equivalents. . . . . . 1,215 752
--------- ---------
Interest income. . . . . . . . . . 247,721 151,511
--------- ---------

Reverse repurchase agreements. . . . 197,006 118,752
Other borrowings . . . . . . . . . . 969 1,332
Interest rate swaps. . . . . . . . . 682 1,082
--------- ---------
Interest expense . . . . . . . . . 198,657 121,166
--------- ---------
Net interest income. . . . . . . . . $ 49,064 $ 30,345
========= =========

Despite the fact that the Company's cost of funds increased from 5.67% in 1996
to 5.76% in 1997, its net interest income increased during this same time
period, primarily due to the increased size of the Company's portfolio. Net
interest income increased by $18,719,000, which is a combination of rate and
volume variances. There was a combined favorable rate variance of $623,000,
which consisted of a favorable variance of $2,691,000 resulting from the higher
yield on the Company's ARM assets portfolio and other interest-earning assets
and an unfavorable variance of $2,068,000 resulting from an increase in the
Company's cost of funds. The increased average size of the Company's portfolio
during 1997 compared to 1996 contributed to higher net interest income in the
amount of $18,096,000. The average balance of the Company's interest-earning
assets was $3.777 billion during 1997 compared to $2.351 billion during 1996 --
an increase of 61%.

The Company's ARM assets portfolio generated a yield of 6.56% during 1997,
compared to 6.45% during 1996. The Company's cost of funds during 1997 was
5.76%, compared to 5.67% during 1996, primarily as a result of higher short-term
interest rates available to the Company for financing purposes. Despite the
fact that the Company's cost of funds increased, the Company's net spread
increased to 0.80% for 1997 from a spread of 0.78% for 1996 -- an increase of
0.02%. The Company's yield on net interest-earning assets, which includes the
impact of shareholders' equity, rose to 1.30% for 1997 from 1.29% for 1996.

32

The following table reflects the average balances for each category of the
Company's interest-earning assets as well as the Company's interest-bearing
liabilities with the corresponding effective rate of interest annualized for the
years ended December 31, 1997, and December 31, 1996:

AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)

For the Year Ended For the Year Ended
December 31, 1997 December 31, 1996
----------------------- ----------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------- ---------- ---------- ----------

Interest-Earning Assets:
Adjustable-rate mortgage assets . . . . $3,755,064 6.56% $2,336,900 6.45%
Cash and cash equivalents . . . . . . . 21,774 5.57 14,200 5.29
----------- ---------- ---------- ----------
3,776,838 6.56 2,351,100 6.45
----------- ---------- ---------- ----------
Interest-Bearing Liabilities:
Borrowings. . . . . . . . . . . . . . . 3,446,913 5.76 2,138,236 5.67

----------- ---------- ---------- ----------
Net Interest-Earning Assets and Spread . $ 329,925 0.80% $ 212,864 0.78%
=========== ========== ========== ==========

Yield on Net Interest-Earning Assets (1) 1.30% 1.29%
========== ==========

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

As of the end of 1997, the Company's yield on its ARM assets portfolio,
including the impact of the amortization of premiums and discounts, the cost of
hedging, the amortization of deferred gains from hedging activity and the impact
of principal payment receivables, was 6.38%, compared to 6.64% as of the end of
1996 -- a decrease of 0.26%. The Company's cost of funds as of December 31,
1997, was 5.91%, compared to 5.72% as of December 31, 1996 -- an increase of
0.19%. This increase was primarily the result of financing a portion of the ARM
portfolio over 1997 year-end at a time when LIBOR interest rates increased
suddenly late in November due to year-end pressures. Fortunately the Company,
expecting this to occur, already had financed most of its portfolio over
year-end before the LIBOR increase and, thus, was able to avoid the full
potential impact. Subsequent to year-end, LIBOR interest rates have generally
returned to their previous level, which will be reflected in first quarter 1998
interest rate spreads. As a result of these changes, the Company's net interest
spread as of the end of 1997 was 0.47%, compared to 0.92% as of the end of 1996
- -- a decrease of 0.45%.

During 1997, the Company realized a net gain from the sale of ARM securities in
the amount of $1,189,000, compared to a gain of $1,362,000 during 1996.
Additionally, the Company recorded a provision for credit losses in the amount
of $886,000 during the year ended December 31, 1997, although the Company only
incurred actual credit losses of $96,000 during the year, compared to a
provision for credit losses in the amount of $990,000 during 1996 with no actual
credit losses. The Company provided for additional credit losses because its
review of underlying ARM collateral indicates potential for some loss on two ARM
securities, which, at December 31, 1997 were being carried at a market value of
$13.1 million, or 0.3% of the Company's ARM portfolio. The Company also has a
policy to regularly record a provision for possible credit losses on its
portfolio of ARM loans.

For both years ended December 31, 1997 and 1996, the Company's ratio of
operating expenses to average assets was 0.21%. The Company's operating expense
ratio is well below the average of other more traditional mortgage portfolio
lending institutions such as banks and savings and loans. The Company pays the
Manager an annual base management fee, generally based on average shareholders'
equity, not assets, as defined in the Management Agreement, payable monthly in
arrears as follows: 1.1% of the first $300 million of Average Shareholders'
Equity, plus 0.8% of Average Shareholders' Equity above $300 million. Since
this management fee is based on shareholders' equity and not assets, this fee
increases as the Company successfully accesses capital markets and raises
additional equity capital and is, therefore, managing a larger amount of
invested capital on behalf of its shareholders. In order for the Manager to
earn a performance fee, the rate of return on the shareholders' investment, as
defined in the Management Agreement, must exceed the average ten-year U.S.
Treasury rate during the quarter plus 1%. During 1997, the Manager earned a
performance fee of $3,363,000. During 1997, after paying this performance fee,
the Company's return on common equity was 12.72%. See Note 7 to the Financial
Statements for a discussion of the management fee formulas.

33

MARKET RISKS

The market risk management discussion and the amounts estimated from the
analysis that follows are forward-looking statements regarding market risk that
assume that certain adverse market conditions occur. Actual results may differ
materially from these projected results due to changes in the Company's ARM
portfolio and borrowings mix and due to developments in the domestic and global
financial and real estate markets. The analytical methods utilized by the
Company to assess and mitigate these market risks should not be considered
projections of future events or operating performance.

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

The table below presents the Company's consolidated interest rate risk using the
static gap methodology. This method reports the difference between interest
rate sensitive assets and liabilities at specific points in time as of December
31, 1998, based on the earlier of term to repricing or the term to repayment of
the of the asset or liability. The table does not include assets and
liabilities that are not interest rate sensitive such as payment receivables,
prepaid expenses, payables and accrued expenses. The table provides a projected
repricing or maturity based on scheduled rate adjustments, scheduled payments,
and estimated prepayments. For many of the Company's assets and certain of the
Company's liabilities, the maturity date is not determinable with certainty. In
general, the Company's ARM assets can be prepaid before contractual amortization
and/or maturity. Likewise, the Company's callable AAA rated notes are paid down
as the related ARM asset collateral pays down. The static gap report reflects
the Company's investment policy that allows for only the acquisition of ARM
assets that reprice within one year or Hybrids ARMs that are match funded to
within one-year of their initial repricing.

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

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

34

INTEREST RATE SENSITIVITY GAP ANALYSIS
(Dollar amounts in millions)

December 31, 1998
Over 3 Over 6
3 Months Months to Months to Over
or less 6 Months 1 Year 1 Year Total
------------ ----------- --------- --------- ----------

Interest-earning assets:
ARM securities . . . . . . . . . . $ 1,722,897 $ 907,114 $620,671 $ - $3,250,682
ARM loans. . . . . . . . . . . . . 413,743 137,813 45,923 - 597,479
Hybrid ARM loans . . . . . . . . . 20,422 22,552 44,834 393,038 480,846
Cash and cash equivalents. . . . . 36,431 - - - 36,431
------------ ----------- --------- --------- ----------
Total interest-earning assets. . 2,193,493 1,067,479 711,428 393,038 4,365,438
------------ ----------- --------- --------- ----------

Interest-bearing liabilities:
Reverse repurchase agreements. . . 2,867,207 - - - 2,867,207
Callable AAA notes . . . . . . . . 1,131,007 - - - 1,131,007
Other borrowings . . . . . . . . . 83 602 712 632 2,029
Swaps. . . . . . . . . . . . . . . (1,249,843) 774,983 58,062 416,798 -
------------ ----------- --------- --------- ----------
Total interest-bearing
liabilities. . . . . . . . . . 2,748,454 775,585 58,774 417,430 4,000,243
------------ ----------- --------- --------- ----------

Interest rate sensitivity gap. . . . $ (554,961) $ 291,894 $652,654 $(24,392) $ 365,195
============ =========== ========= ========= ==========

Cumulative interest rate
sensitivity gap. . . . . . . . . . . $ (554,961) $ (263,067) $389,587 $365,195
============ =========== ========= =========

Cumulative interest rate sensitivity
gap as a percentage of total assets
before market value adjustments. . . (12.53)% (5.94)% 8.79% 8.25%
============ =========== ========= =========

Although the static gap methodology is widely accepted in identifying interest
rate risk, it does not take into consideration changes that may occur such as,
but not limited to, changes in investment and financing strategies, changes in
market spreads and relationships among different indexes, changes in hedging
strategy, changes in prepayment speeds and changes in business volumes.
Accordingly, the Company makes extensive usage of an earnings simulation model
to analyze its level of interest rate risk. This analytical technique used to
measure and manage interest rate risk includes the impact of all
on-balance-sheet and off-balance-sheet financial instruments.

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

At December 31, 1998, based on the earnings simulation model, the Company's
potential earnings at risk to a gradual, parallel 100 basis point rise in market
interest rates over the next twelve months was approximately 6.3% of projected
1998 net income. The assumptions used in the earnings simulation model are
inherently uncertain and as a result, the analysis cannot precisely predict the
impact of higher interest rates on net income. Actual results would differ from
simulated results due to timing, magnitude and frequency of interest rate
changes, changes in prepayment speed other than what was assumed in the model,
changes in other market conditions and management strategies to offset its
potential exposure, among other factors. This measure of risk represents the
Company's exposure to higher interest rates at a particular point in time. The
Company's actual risk is always changing. The Company continuously monitors the
Company's risk profile as it changes and alters its strategies as appropriate in
its view of the likely course of interest rates and other developments in the
Company's business.

35

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary source of funds for the year ended December 31, 1998
consisted of reverse repurchase agreements, which totaled $2.867 billion, and
callable AAA notes, which had a balance of $1.127 billion. The Company's other
significant sources of funds for the year ended December 31, 1998 consisted
primarily of payments of principal and interest from its ARM assets in the
amount of $2.1 billion and proceeds from the sale of ARM assets in the amounts
of $932.0 million. In the future, the Company expects its primary sources of
funds will consist of borrowed funds under reverse repurchase agreement
transactions with one- to twelve-month maturities, capital market financing
transactions collateralized by ARM and hybrid loans, proceeds from monthly
payments of principal and interest on its ARM assets portfolio and occasional
asset sales. The Company's liquid assets generally consist of unpledged ARM
assets, cash and cash equivalents.

Total borrowings incurred at December 31, 1998, had a weighted average interest
rate of 5.84%. The reverse repurchase agreements had a weighted average
remaining term to maturity of 2.0 months and the callable AAA notes payable had
a final maturity of January 25, 2029, but will be paid down as the ARM assets
collateralizing the notes are paid down. As of December 31, 1998, $1.147
billion of the Company's borrowings were variable-rate term reverse repurchase
agreements. Term reverse repurchase agreements are committed financings with
original maturities that range from three months to two years. The interest
rates on these term reverse repurchase agreements are indexed to either the
one-, three- or six-month LIBOR rate and reprice accordingly. The interest rate
on the callable AAA notes adjusts monthly based on changes in one-month LIBOR.

The Company has arrangements to enter into reverse repurchase agreements with 24
different financial institutions and on December 31, 1998, had borrowed funds
with 16 of these firms. Because the Company borrows money under these agreements
based on the fair value of its ARM assets and because changes in interest rates
can negatively impact the valuation of ARM assets, the Company's borrowing
ability under these agreements could be limited and lenders may initiate margin
calls in the event interest rates change or the value of the Company's ARM
assets decline for other reasons. Additionally, certain of the Company's ARM
assets are rated less than AA by the Rating Agencies (approximately 4.0%) and
have less liquidity than assets that are rated AA or higher. Other mortgage
assets which are rated AA or higher by the Rating Agencies derive their credit
rating based on a mortgage pool insurer's rating. As a result of either changes
in interest rates, credit performance of a mortgage pool or a downgrade of a
mortgage pool issuer, the Company may find it difficult to borrow against such
assets and, therefore, may be required to sell certain mortgage assets in order
to maintain liquidity. If required, these sales could be at prices lower than
the carrying value of the assets, which would result in losses. During the
fourth quarter of 1998, as discussed earlier, the Company maintained an adequate
level of liquidity by selling certain ARM securities. The Company believes it
will continue to have sufficient liquidity to meet its future cash requirements
from its primary sources of funds for the foreseeable future without needing to
sell assets.

The Company, by issuing the callable AAA notes, has financed $1.1 billion of its
ARM assets in a structure that is not subject to margin calls. In this
structure, the financing of these assets is not based on their market value or
subject to subsequent changes in mortgage credit markets as is the case of the
reverse repurchase agreement arrangements. The Company has retained a call on
both the notes and the collateral in the event the Company should choose to
refinance these ARM assets in a different manner.

As of December 31, 1998, the Company had one whole loan financing facility with
an uncommitted borrowing capacity of $250,000,000. The Company had no balance
borrowed against this facility as of year-end. This facility matured on January
8, 1999 and has been subsequently re-negotiated for an additional one year
period. Under the new agreement in effect as of January 8, 1999, the whole loan
financing facility is a committed facility in an amount of up to $150,000,000,
with an option to increase the amount to $300,000,000. The Company is also
negotiating to enter into one other committed whole loan financing facility and
three uncommitted whole loan financing facilities in order to facilitate its
acquisitions of whole loans in a prudent manner.

36

In December 1996, the Company's Registration Statement on Form S-3, registering
the sale of up to $200 million of additional equity securities, was declared
effective by the Securities and Exchange Commission. This registration
statement includes the possible issuances of common stock, preferred stock,
warrants or shareholder rights. As of December 31, 1998, the Company had $109
million of its securities registered for future sale under this Registration
Statement.

On July 13, 1998, the Board of Directors approved a common stock repurchase
program of up to 500,000 shares at prices below book value, subject to
availability of shares and other market conditions. On September 18, 1998, the
Board of Directors expanded this program by approving the repurchase of up to
1,000,000 shares at prices below book value. To date, the Company has
repurchased 500,016 shares at an average price of $9.28 per share.

The Company has a Dividend Reinvestment and Stock Purchase Plan (the "DRP")
designed to provide a convenient and economical way for existing shareholders to
automatically reinvest their dividends in additional shares of common stock and
for new and existing shareholders to purchase shares at a discount to the
current market price of the common stock, as defined in the DRP. As a result of
participation in the DRP during the first half of 1998, the Company issued
1,581,550 new shares of common stock and received $24.4 million of new equity
capital. During the second half of 1998, the Company purchased shares in the
open market on behalf of the participants in its DRP instead of issuing new
shares below book value. In accordance with the terms and conditions of the
DRP, the Company pays the brokerage commission in connection with these
purchases.

EFFECTS OF INTEREST RATE CHANGES

Changes in interest rates impact the Company's earnings in various ways. While
the Company only invests in ARM assets, rising short-term interest rates may
temporarily negatively affect the Company's earnings and conversely falling
short-term interest rates may temporarily increase the Company's earnings. This
impact can occur for several reasons and may be mitigated by portfolio
prepayment activity as discussed below. First, the Company's borrowings will
react to changes in interest rates sooner than the Company's ARM assets because
the weighted average next repricing date of the borrowings is usually a shorter
time period. Second, interest rates on ARM loans are generally limited to an
increase of either 1% or 2% per adjustment period (commonly referred to as the
periodic cap) and the Company's borrowings do not have similar limitations.
Third, the Company's ARM assets lag changes in the indices due to the notice
period provided to ARM borrowers when the interest rates on their loans are
scheduled to change. The periodic cap only affects the Company's earnings when
interest rates move by more than 1% per six-month period or 2% per year.

Interest rate changes may also impact the Company's ARM assets and borrowings
differently because the Company's ARM assets are indexed to various indices
whereas the interest rate on the Company's borrowings generally move with
changes in LIBOR. Although the Company has always favored acquiring LIBOR based
ARM assets in order to reduce this risk, LIBOR based ARMs are not generally well
accepted by home owners in the U.S. As a result, the Company has acquired ARM
assets indexed to a mix of indices in order to diversify its exposure to changes
in LIBOR in contrast to changes in other indices. During times of global
economic instability, U.S. Treasury rates generally decline because foreign and
domestic investors generally consider U.S. Treasury instruments to be a safe
haven for investments. The Company's ARM assets indexed to U.S. Treasury rates
then decline in yield as U.S. Treasury rates decline, whereas the Company's
borrowings and other ARM assets may not be affected by the same pressures or to
the same degree. As a result, the Company's income can improve or decrease
depending on the relationship between the various indices that the Company's ARM
assets are indexed to compared to changes in the Company's cost of funds.

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

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

37

Lastly, because the Company only invests in ARM assets and approximately 8% to
10% of such mortgage assets are purchased with shareholders' equity, the
Company's earnings over time will tend to increase following periods when
short-term interest rates have risen and decrease following periods when
short-term interest rates have declined. This is because the financed portion
of the Company's portfolio of ARM assets will, over time, reprice to a spread
over the Company's cost of funds, while the portion of the Company's portfolio
of ARM assets that are purchased with shareholders' equity will generally have a
higher yield in a higher interest rate environment and a lower yield in a lower
interest rate environment.

YEAR 2000 ISSUES

The Year 2000 issues involve both hardware design flaws in which many computer
systems, and machines that use computer chips, will not correctly recognize the
date beginning in the Year 2000 and, additionally, software applications and
compilers that do not use a four-digit reference to years which might not behave
as intended once the Year 2000 is reached. Three general areas of concern are:
1) clocks built into computers and computer chips that will rollover to 1900 or
1980 instead of 2000, 2) purchased software that does not recognize the Year
2000 as a leap year or that does not use a four-digit reference to years, and 3)
internally developed applications that do not store the year as a four-digit
year. The Company invests in assets and enters into agreements that employ the
use of dates and is, therefore, concerned about the ability of equipment and
computer programs to interpret dates or recognize dates accurately.

In consideration of the Year 2000 issues, the Manager has reviewed the ability
of its own computers and computer programs to properly recognize and handle
dates in the Year 2000. Through the normal upgrading of computer equipment, the
Manager has already replaced all computers that were not Year 2000 compliant.
The software used by the Company has been internally developed using products
that are Year 2000 compliant. The Manager has also reviewed all the date fields
embedded in its internally developed spreadsheets, databases and other programs
and has determined that all such programs are using four-digit years in
references to dates. Therefore, the Company believes that all of its equipment
and internal systems are ready for the Year 2000. To date, the Manager has
incurred all costs in order for the Company to be Year 2000 compliant.

The Company believes that most of its exposure to Year 2000 issues involves the
readiness of third parties such as, but not limited to, loan servicers, security
master servicers, security paying agents and trustees, its stock transfer agent,
its securities custodian, the counterparties on its various financing agreements
and hedging contracts and vendors. The Manager, at its expense, is conducting a
survey, which is expected to be completed during the first half of 1999, of all
such third parties to try to determine the readiness of such third parties to
handle Year 2000 dates and to try to determine the potential impact of Year 2000
issues. The Company cannot be certain that such a survey will fully identify
all Year 2000 issues or to fully access the potential problems or loss
associated with Year 2000 issues or that any failure by these other third
parties to resolve Year 2000 issues would not have an adverse effect on the
Company's operations and financial condition. The Company and the Manager
believe that they are spending the appropriate and necessary resources to try to
identify Year 2000 issues and to resolve them or to mitigate the impact of them
to the best of their ability as they are identified. The Company has not
developed likely worst case scenarios nor contingency plans for such scenarios.

OTHER MATTERS

The Company calculates its Qualified REIT Assets, as defined in the Internal
Revenue Code of 1986, as amended (the "Code"), to be 99.1% of its total assets,
compared to the Code requirement that at least 75% of its total assets must be
Qualified REIT Assets. The Company also calculates that 99.8% of its 1998
revenue qualifies for the 75% source of income test and 100% of its 1998 revenue
qualifies for the 95% source of income test under the REIT rules. The Company
also met all REIT requirements regarding the ownership of its common stock and
the distributions of its net income. Therefore, as of December 31, 1998, the
Company believes that it will continue to qualify as a REIT under the provisions
of the Code.

The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, the Company's use
of leverage would be substantially reduced. The Investment Company Act exempts
entities that are "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interests in real estate"
("Qualifying Interests"). Under current interpretation of the staff of the SEC,
in order to qualify for this exemption, the Company must maintain at least 55%
of its assets directly in Qualifying Interests. In addition, unless certain
mortgage assets represent all the certificates issued with respect to an
underlying pool of mortgages, such mortgage assets may be treated as assets
separate from the underlying mortgage loans and, thus, may not be considered
Qualifying Interests for purposes of the 55% requirement. As of December 31,
1998, the Company calculates that it is in compliance with this requirement.

38

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information called for by Item 7A is incorporated by reference from the
information in Item 7 under the caption "Market Risk" set forth on pages 34
through 36 in this Form 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements of the Company, the related notes and schedules to
the financial statements, together with the Independent Auditor's Report thereon
are set forth on pages F-3 through F-23 in this Form 10-K.

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

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Item 10 is incorporated herein by reference to
the definitive Proxy Statement dated March 29, 1999 pursuant to General
Instruction G(3).

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated herein by reference to
the definitive Proxy Statement dated March 29, 1999 pursuant to General
Instruction G(3).

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by Item 12 is incorporated herein by reference to
the definitive Proxy Statement dated March 29, 1999 pursuant to General
Instruction G(3).

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is incorporated herein by reference to
the definitive Proxy Statement dated March 29, 1999 pursuant to General
Instruction G(3).

39

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Documents filed as part of this report:

1. The following Financial Statements of the Company are included
in Part II, Item 8 of this Annual Report on Form-K:

Independent Auditors' Report;
Consolidated Balance Sheets as of December 31, 1998 and 1997;
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996;
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1998, 1997 and 1996;
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 and
Notes to Consolidated Financial Statements.

2. Schedules to Consolidated Financial Statements:

All consolidated financial statement schedules are included in
Part II, Item 8 of this Annual Report on Form-K.

3. Exhibits:

See "Exhibit Index".

(b) Reports on Form 8-K:

None

40

THORNBURG MORTGAGE ASSET CORPORATION
AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AND

INDEPENDENT AUDITOR'S REPORT

For Inclusion in Form 10-K

Filed with

Securities and Exchange Commission

December 31, 1998

THORNBURG MORTGAGE ASSET CORPORATION
AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

PAGE
----

FINANCIAL STATEMENTS:

Independent Auditor's Report . . . . . . . . . F-3

Consolidated Balance Sheets. . . . . . . . . . F-4

Consolidated Statements of Operations. . . . . F-5

Consolidated Statement of Shareholders' Equity F-6

Consolidated Statements of Cash Flows. . . . . F-7

Notes to Consolidated Financial Statements . . F-8

FINANCIAL STATEMENT SCHEDULE:

Schedule IV - Mortgage Loans on Real Estate. . F-22

F-2

INDEPENDENT AUDITOR'S REPORT

To the Board of Directors
Thornburg Mortgage Asset Corporation
Santa Fe, New Mexico

We have audited the accompanying consolidated balance sheets of Thornburg
Mortgage Asset Corporation and subsidiaries as of December 31, 1998 and 1997 and
the related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. 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 generally accepted auditing
standards. 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, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Thornburg
Mortgage Asset Corporation and subsidiaries as of December 31, 1998 and 1997,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.

Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The supplemental Schedule IV is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not a part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in our audits of
the basic financial statements and, in our opinion, is fairly stated in all
material respects in relation to the basic financial statements taken as a
whole.

/s/ McGLADREY & PULLEN, LLP

McGLADREY & PULLEN, LLP

New York, New York
January 20 , 1999

F-3

THORNBURG MORTGAGE ASSET CORPORATION
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
December 31
------------------------
1998 1997
----------- -----------

ASSETS
Adjustable-rate mortgage ("ARM") assets (Notes 2 and 3)
ARM securities . . . . . . . . . . . . . . . . . . . . . $3,094,657 $4,519,707
Collateral for callable collateralized notes . . . . . . 1,147,350 -
ARM loans held for securitization. . . . . . . . . . . . 26,410 118,987
----------- -----------
4,268,417 4,638,694

Cash and cash equivalents (Note 3) . . . . . . . . . . . . 36,431 13,780
Accrued interest receivable. . . . . . . . . . . . . . . . 37,939 38,353
Prepaid expenses and other . . . . . . . . . . . . . . . . 1,846 289
----------- -----------
$4,344,633 $4,691,116
=========== ===========

LIABILITIES

Reverse repurchase agreements (Note 3) . . . . . . . . . . $2,867,207 $4,270,170
Callable collateralized notes (Note 3) . . . . . . . . . . 1,127,181 -
Other borrowings (Note 3). . . . . . . . . . . . . . . . . 2,029 10,018
Accrued interest payable . . . . . . . . . . . . . . . . . 31,514 39,749
Dividends payable (Note 5) . . . . . . . . . . . . . . . . 1,670 11,810
Accrued expenses and other . . . . . . . . . . . . . . . . 3,209 1,215
----------- -----------
4,032,810 4,332,962
----------- -----------

COMMITMENTS (Note 2)

SHAREHOLDERS' EQUITY (Note 5)

Preferred stock: par value $.01 per share;
2,760 shares authorized; 9.68% Cumulative
Convertible Series A, 2,760 and 2,760 issued
and outstanding, respectively; aggregate preference in
liquidation $69,000 . . . . . . . . . . . . . . . . . . 65,805 65,805
Common stock: par value $.01 per share;
47,240 shares authorized, 21,990 and 20,280 shares
issued and 21,490 and 20,280 outstanding, respectively. 220 203
Additional paid-in-capital . . . . . . . . . . . . . . . . 341,756 315,240
Accumulated other comprehensive income (loss). . . . . . . (82,148) (19,445)
Notes receivable from stock sales. . . . . . . . . . . . . (4,632) (2,698)
Retained earnings (deficit). . . . . . . . . . . . . . . . (4,512) (951)
Treasury stock: at cost, 500 and 0 shares respectively . . (4,666) -
----------- -----------
311,823 358,154
----------- -----------

$4,344,633 $4,691,116
=========== ===========

See Notes to Consolidated Financial Statements.

F-4

THORNBURG MORTGAGE ASSET CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)

Year ended December 31
----------------------------------
1998 1997 1996
---------- ---------- ----------

Interest income from ARM assets and cash . . $ 287,032 $ 247,721 $ 151,511
Interest expense on borrowed funds . . . . . (255,992) (198,657) (121,166)
---------- ---------- ----------
Net interest income . . . . . . . . . . . . 31,040 49,064 30,345
---------- ---------- ----------

Gain (loss) on sale of ARM assets. . . . . . (278) 1,189 1,362
Provision for credit losses. . . . . . . . . (2,032) (886) (990)
Management fee (Note 7). . . . . . . . . . . (4,142) (3,664) (1,872)
Performance fee (Note 7) . . . . . . . . . . (759) (3,363) (2,462)
Other operating expenses . . . . . . . . . . (1,134) (938) (646)
---------- ---------- ----------

NET INCOME. . . . . . . . . . . . . . . . . $ 22,695 $ 41,402 $ 25,737
========== ========== ==========

Net income . . . . . . . . . . . . . . . . . $ 22,695 $ 41,402 $ 25,737
Dividend on preferred stock. . . . . . . . . (6,679) (6,251) -
---------- ---------- ----------

Net income available to common shareholders. $ 16,016 $ 35,151 $ 25,737
========== ========== ==========

Basic earnings per share . . . . . . . . . . $ 0.75 $ 1.95 $ 1.73
========== ========== ==========

Diluted earnings per share . . . . . . . . . $ 0.75 $ 1.94 $ 1.73
========== ========== ==========

Average number of common shares outstanding. 21,488 18,048 14,874
========== ========== ==========

See Notes to Consolidated Financial Statements.

F-5

THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Three Years Ended December 31, 1998
(Dollar amounts in thousands, except per share data)

Notes
Accum. Receiv-
Addit- Other able
Pref- ional Compre- From Retained Compre-
erred Common Paid-in hensive Stock Earnings/ Treasury hensive
Stock Stock Capital Income Sales (Deficit) Stock Income Total
------- -------- -------- --------- -------- ---------- ---------- --------- ---------

Balance, December 31, 1995 . . . . . $ - $ 122 $175,708 $(14,826) $ - $ (527) $ - $160,477
Comprehensive income:
Net income. . . . . . . . . . . . 25,737 $ 25,737 25,737
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net
of amortization . . . . . . . . - - - 6,028 - - - 6,028 6,028
Deferred gain on sale of
hedges, net of amortization . . - - - (2,468) - - - (2,468) (2,468)
---------
Other comprehensive income. . . . $ 29,297
=========
Issuance of common
Issuance of common stk. (Note 5) . - 40 57,469 - - - - 57,509
Dividends declared on common
stock - $1.65 per share . . . . . . - - - - - (25,085) - (25,085)
------- -------- -------- --------- -------- ---------- ---------- ---------
Balance, December 31, 1996 . . . . . - 162 233,177 (11,266) - 125 - 222,198
Comprehensive income:
Net income. . . . . . . . . . . . 41,402 $ 41,402
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net
of amortization . . . . . . . . - - - (6,697) - - - (6,697) (6,697)
Deferred gain on sale of
hedges, net of amortization . . - - - (1,482) - - - (1,482) (1,482)
---------
Other comprehensive loss. . . . . $(33,223)
=========
Series A preferred stock issued,
Net of issuance cost (Note 5) . . 65,805 - - - - - - 65,805
Issuance of common
Issuance of common stk. (Note 5) . - 41 82,063 - (2,698) - - 79,406
Dividends declared on preferred
stock - $2.265 per share. . . . . . - - - - - (6,251) - (6,251)
Dividends declared on common
stock - $1.97per share. . . . . . . - - - - - (36,227) - (36,227)
------- -------- -------- --------- -------- ---------- ---------- ---------
Balance, December 31, 1997 . . . . . 65,805 203 315,240 (19,445) (2,698) (951) - 358,154
Comprehensive income:
Net income. . . . . . . . . . . . 22,695 $ 22,695 22,695
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net
of amortization . . . . . . . . - - - (61,157) - - - (61,157) (61,157)
Deferred gain on sale of
hedges, net of amortization . . - - - (1,546) - - - (1,546) (1,546)
Other comprehensive loss. . . . . $(40,008)
=========
Issuance of common stk. (Note 5) . - 17 26,259 - (1,934) - - 24,342
Purchase of treasury stock (Note 5). - - - - - - (4,666) (4,666)
Interest from notes receivable from
stock sales . . . . . . . . . . 257 257
Dividends declared on preferred
stock - $2.42 per share . . . . . . - - - - - (6,679) - (6,679)
Dividends declared on common
stock - $0.905 per share. . . . . . - - - - - (19,577) - (19,577)
------- -------- -------- --------- -------- ---------- ---------- ---------
Balance, December 31, 1998 . . . . . $65,805 $ 220 $341,756 $(82,148) $(4,632) $ (4,512) $ (4,666) $311,823
======= ======== ======== ========= ======== ========== ========== =========

See Notes to Consolidated Financial Statements.

F-6

THORNBURG MORTGAGE ASSET CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)

Year ended December 31
----------------------------------------
1998 1997 1996
------------ ------------ ------------

Operating Activities:
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 22,695 $ 41,402 $ 25,737
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization. . . . . . . . . . . . . . . . . . . . . . . . . . 49,657 24,665 14,346
Net realized (gain) loss from investing activities. . . . . . . 2,310 (303) (372)
Decrease (increase) in accrued interest receivable. . . . . . . 414 (14,789) (4,785)
Decrease (increase) in prepaid expenses and other . . . . . . . (1,557) (62) 33
Increase (decrease) in accrued interest payable . . . . . . . . (8,235) 21,002 8,840
Increase (decrease) in accrued expenses and other . . . . . . . 1,994 101 433
------------ ------------
Net cash provided by operating activities . . . . . . . . . . 67,278 72,016 44,232
------------ ------------ ------------

Investing Activities:
Available-for-sale securities:
Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,501,961) (2,929,746) (1,583,678)
Proceeds on sales . . . . . . . . . . . . . . . . . . . . . . . 929,999 190,196 277,594
Proceeds from calls . . . . . . . . . . . . . . . . . . . . . . 138,926 67,202
Principal payments. . . . . . . . . . . . . . . . . . . . . . . 1,635,298 756,379 441,722
Held-to-maturity securities:
Principal payments. . . . . . . . . . . . . . . . . . . . . . . 16,152 63,120 111,684
Collateral for callable collateralized bonds:
Principal payments. . . . . . . . . . . . . . . . . . . . . . . 13,416 - -
ARM Loans:
Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,092,238) (123,211) -
Principal payments. . . . . . . . . . . . . . . . . . . . . . . 115,081 4,092 -
Proceeds on sales . . . . . . . . . . . . . . . . . . . . . . . 2,043 - -
Purchase of interest rate cap and floor agreements. . . . . . . . (1,081) (4,074) (631)
------------ ------------ ------------
Net cash provided by (used in) investing activities . . . . . 255,635 (1,976,042) (753,309)
------------ ------------ ------------

Financing Activities:

Net borrowings from (repayments of) reverse repurchase agreements. (1,402,963) 1,811,038 678,278
Net borrowings from callable collateralized notes . . . . . . . . 1,127,181 - -
Repayments of other borrowings. . . . . . . . . . . . . . . . . . (7,989) (4,169) (4,259)
Proceeds from preferred stock issued. . . . . . . . . . . . . . . - 65,805 -
Proceeds from common stock issued . . . . . . . . . . . . . . . . 24,342 79,406 57,509
Purchase of treasury stock. . . . . . . . . . . . . . . . . . . . (4,666) - -
Dividends paid. . . . . . . . . . . . . . . . . . . . . . . . . . (36,396) (37,967) (22,418)
Interest from notes receivable from stock sales . . . . . . . . . 229 - -
------------ ------------ ------------
Net cash provided by (used in) financing activities . . . . . . (300,262) 1,914,113 709,110
------------ ------------ ------------

Net increase (decrease) in cash and cash equivalents . . . . . . . 22,651 10,087 33

Cash and cash equivalents at beginning of period . . . . . . . . . 13,780 3,693 3,660
------------ ------------ ------------
Cash and cash equivalents at end of period . . . . . . . . . . . . $ 36,431 $ 13,780 $ 3,693
============ ============ ============

Supplemental disclosure of cash flow information and non-cash investing and financing activities are
included in Notes 2 and 3.

See Notes to Consolidated Financial Statements.

F-7

THORNBURG MORTGAGE ASSET CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Thornburg Mortgage Asset Corporation (the "Company") was incorporated in
Maryland on July 28, 1992. The Company commenced its operations of purchasing
and managing for investment a portfolio of adjustable-rate mortgage assets on
June 25, 1993, upon receipt of the net proceeds from the initial public offering
of the Company's common stock.

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

CASH AND CASH EQUIVALENTS

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

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of the Company and
its wholly owned special purpose finance subsidiaries, Thornburg Mortgage
Funding Corporation and Thornburg Mortgage Acceptance Corporation. The Company
formed these entities in connection with the issuance of the callable
collateralized notes discussed in Note 3. All material intercompany accounts
and transactions are eliminated in consolidation.

ADJUSTABLE-RATE MORTGAGE ASSETS

The Company's adjustable-rate mortgage ("ARM") assets are comprised of ARM
securities, ARM loans and collateral for callable AAA notes payable, which also
consists of ARM securities and ARM loans.

In the second quarter of 1998, the Company decided to change its policy
regarding its classification of ARM securities such that each ARM security is
classified as available-for-sale. The Company changed its policy because the
remaining amount of ARM securities classified as held-to-maturity had become a
relatively small percentage of the portfolio, less than 8% of assets at March
31, 1998, and because it is apparent that as more mortgage REITs have been
formed, that it is industry practice to carry all mortgage securities as
available-for-sale. The Company had not classified any ARM securities purchased
since 1994 as held-to-maturity and does not expect to do so in the future.
Management has made the determination that all of its ARM securities should be
designated as available-for-sale in order to be prepared to respond to potential
future opportunities in the market, to sell ARM securities in order to optimize
the portfolio's total return and to retain its ability to respond to economic
conditions that might require the Company to sell assets in order to maintain an
appropriate level of liquidity. Since all ARM securities are designated as
available-for-sale, they are reported at fair value, with unrealized gains and
losses excluded from earnings and reported in accumulated other comprehensive
income as a separate component of shareholders' equity.

Management has the intent and ability to hold the Company's ARM loans for the
foreseeable future and until maturity or payoff. Therefore, they are carried at
their unpaid principal balances, net of unamortized premium or discount and
allowance for loan losses.

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

Premiums and discounts associated with the purchase of the ARM assets are
amortized into interest income over the lives of the assets using the effective
yield method adjusted for the effects of estimated prepayments.

F-8

ARM asset transactions are recorded on the date the ARM assets are purchased or
sold. Purchases of new issue ARM assets are recorded when all significant
uncertainties regarding the characteristics of the assets are removed, generally
shortly before settlement date. Realized gains and losses on ARM asset
transactions are determined on the specific identification basis.

CREDIT RISK

The Company limits its exposure to credit losses on its portfolio of ARM
securities by only purchasing ARM securities that have an investment grade
rating at the time of purchase and have some form of credit enhancement or are
guaranteed by an agency of the federal government. An investment grade security
generally has a security rating of BBB or Baa or better by at least one of two
nationally recognized rating agencies, Moody's Investor Services, Inc. or
Standard & Poor's, Inc. (the "Rating Agencies"). Additionally, the Company has
also purchased ARM loans and limits its exposure to credit losses by restricting
its whole loan purchases to ARM loans generally originated to "A" quality
underwriting standards or loans that have at least five years of pay history
and/or low loan to property value ratios. The Company further limits its
exposure to credit losses by limiting its investment in investment grade
securities that are rated A, or equivalent, BBB, or equivalent, or ARM loans
originated to "A" quality underwriting standards ("Other Investments") to no
more than 30% of the portfolio.

The Company monitors the delinquencies and losses on the underlying mortgage
loans backing its ARM assets. If the credit performance of the underlying
mortgage loans is not as expected, the Company makes a provision for possible
credit losses at a level deemed appropriate by management to provide for known
losses as well as unidentified losses in its ARM assets portfolio. The
provision is based on management's assessment of numerous factors affecting its
portfolio of ARM assets including, but not limited to, current economic
conditions, delinquency status, credit losses to date on underlying mortgages
and remaining credit protection. The provision for ARM securities is made by
reducing the cost basis of the individual security for the decline in fair value
which is other than temporary, and the amount of such write-down is recorded as
a realized loss, thereby reducing earnings. The Company also makes a monthly
provision for possible credit losses on its portfolio of ARM loans which is an
increase to the reserve for possible loan losses. The provision for possible
credit losses on loans is based on loss statistics of the real estate industry
for similar loans, taking into consideration factors including, but not limited
to, underwriting characteristics, seasoning, geographic location and current
economic conditions. When a loan or a portion of a loan is deemed to be
uncollectible, the portion deemed to be uncollectible is charged against the
reserve and subsequent recoveries, if any, are credited to the reserve.

Credit losses on pools of loans that are held as collateral for AAA notes
payable are also covered by third party insurance policies that protect the
Company from credit losses above a specified level, limiting the Company's
exposure to credit losses on such loans. The Company makes a monthly provision
for possible credit losses on these loans the same as it does for loans that are
not held as collateral for AAA notes payable, except, taking into consideration
its maximum exposure.

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

DERIVATIVE FINANCIAL INSTRUMENTS

INTEREST RATE CAP AGREEMENTS

The Company purchases interest rate cap agreements (the "Cap Agreements") to
limit the Company's risks associated with the lifetime or maximum interest rate
caps of its ARM assets should interest rates rise above specified levels. The
Cap Agreements reduce the effect of the lifetime cap feature so that the yield
on the ARM assets will continue to rise in high interest rate environments as
the Company's cost of borrowings also continue to rise.

F-9

Under policies in effect prior to the second quarter of 1998, Cap Agreements
classified as a hedge against held-to-maturity assets were initially carried at
their fair value as of the time the Cap Agreements and the related assets are
designated as held-to-maturity with an adjustment to equity for any unrealized
gains or losses at the time of the designation. Any adjustment to equity was
thereafter amortized into interest income as a yield adjustment in a manner
consistent with the amortization of any premium or discount. All Cap Agreements
are now classified as a hedge against available-for-sale assets and are carried
at their fair value with unrealized gains and losses reported as a separate
component of equity, consistent with the reporting of such assets. The carrying
value of the Cap Agreements are included in ARM securities on the balance sheet.
The Company purchases Cap Agreements by incurring a one-time fee or premium.
The amortization of the premium paid for the Cap Agreements is included in
interest income as a contra item (i.e., expense) and, as such, reduces interest
income over the lives of the Cap Agreements.

Realized gains and losses resulting from the termination of the Cap Agreements
that were hedging assets classified as held-to-maturity were deferred as an
adjustment to the carrying value of the related assets and are being amortized
into interest income over the terms of the related assets. Realized gains and
losses resulting from the termination of such agreements that are hedging assets
classified as available-for-sale are initially reported in a separate component
of equity, consistent with the reporting of those assets, and are thereafter
amortized as a yield adjustment.

INTEREST RATE SWAP AGREEMENTS

The Company enters into interest rate swap agreements in order to manage its
interest rate exposure when financing its ARM assets. In general, swap
agreements have been utilized by the Company in two ways. One way has been to
use swap agreements as a cost effective way to lengthen the average repricing
period of its variable rate and short term borrowings. Additionally, as the
Company acquires hybrid assets, it also enters into swap agreements in order to
manage the interest rate repricing mismatch (the difference between the
remaining fixed-rate period of a hybrid and the maturity of the fixed-rate
liability funding a hybrid) to approximately one year. Revenues and expenses
from the interest rate swap agreements are accounted for on an accrual basis and
recognized as a net adjustment to interest expense.

INCOME TAXES

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

NET EARNINGS PER SHARE

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

F-10

Following is information about the computation of the earnings per share data
for the years ended December 31, 1998, 1997 and 1996 (Amounts in thousands
except per share data):

Earnings
Income Shares Per Share
---------- ------ ----------

1998
Net income . . . . . . . . . . $ 22,695

Less preferred stock dividends (6,679)
----------

Basic EPS, income available to
common shareholders . . . . . 16,016 21,488 $ 0.75
==========

Effect of dilutive securities:

Stock options . . . . . . . . - -
---------- ------
Diluted EPS. . . . . . . . . . $ 16,016 21,488 $ 0.75
========== ====== ==========

1997
Net income . . . . . . . . . . $ 41,402

Less preferred stock dividends (6,251)
----------

Basic EPS, income available to
common shareholders . . . . . 35,151 18,048 $ 1.95
==========

Effect of dilutive securities:

Stock options . . . . . . . . - 110
---------- ------
Diluted EPS. . . . . . . . . . $ 35,151 18,158 $ 1.94
========== ====== ==========

1996
Net income . . . . . . . . . . $ 25,737

Less preferred stock dividends -
----------

Basic EPS, income available to
common stockholders . . . . . 25,737 14,874 $ 1.73
==========

Effect of dilutive securities:

Stock options . . . . . . . . - 37
---------- ------
Diluted EPS. . . . . . . . . . $ 25,737 14,911 $ 1.73
========== ====== ==========

The Company has granted options to directors and officers of the Company and
employees of the Manager to purchase 59,784 in 1998, 240,320 in 1997 and 169,099
shares of common stock in 1996 at average prices of $14.82, $20.89 and $15.44
per share during the years ended December 31, 1998, 1997 and 1996, respectively.
The conversion of preferred stock was not included in the computation of diluted
EPS for any year because such conversion would increase the diluted EPS.

USE OF ESTIMATES

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

F-11

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
130, Reporting Comprehensive Income. This statement requires companies to
classify items of other comprehensive income, such as unrealized gains and
losses on available-for-sale securities, by their nature in a financial
statement and display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital in the equity
section of a statement of financial position. The Company adopted this
statement in the first quarter of 1998.

In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 established a framework of
accounting rules that standardize accounting and reporting for all derivative
instruments and is effective for financial statements issued for fiscal years
beginning after June 15, 1999. The Statement requires that all derivative
financial instruments be carried on the balance sheet at fair value. Currently
the only derivative instruments that are not on the Company's balance sheet at
fair value are interest rate swap agreements. The fair value of interest rate
swap agreements is disclosed in Note 4, Fair Value of Financial Instruments.
The Company believes that its use of interest rate swap agreements qualify as
cash-flow hedges as defined in the statement. Therefore, the effective portion
of the hedge's change in the fair value of these derivatives instruments will be
recorded in other comprehensive income and the ineffective portion will be
included in earnings when the Company adopts the statement in the first quarter
of its fiscal 2000 year.

In October 1998, the FASB issued SFAS No. 134, Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise. This Statement, which is effective for the first
fiscal quarter beginning after December 15, 1998, provides guidance to mortgage
banking entities who securitize mortgage loans such that their accounting for
securitized loans will be the same as their accounting for marketable
securities. The Company has already been accounting for its securitized loans
in a manner consistent with the new statement and therefore expects no changes
to its financial position or results of operations as a result of adopting SFAS
No. 134.

F-12

NOTE 2. ADJUSTABLE-RATE MORTGAGE ASSETS AND INTEREST RATE CAP AND FLOOR
AGREEMENTS

The following tables present the Company's ARM assets as of December 31, 1998
and December 31, 1997. The ARM securities classified as available-for-sale are
carried at their fair value, while the ARM securities classified as
held-to-maturity in 1997 and ARM loans are carried at their amortized cost basis
(dollar amounts in thousands):

December 31, 1998:

ARM Securities
-----------------------------------
Available- Held-to- Collateral for
for-Sale Maturity Total Notes Payable ARM Loans
----------- --------- ----------- --------------- ---------

Principal balance outstanding $3,070,107 $ - $3,070,107 $ 1,131,007 $26,161
Net unamortized premium . . . 86,956 - 86,956 17,112 324
Deferred gain from hedging. . (613) - (613) - -
Allowance for losses. . . . . (1,242) - (1,242) (729) (75)
Cap Agreements. . . . . . . . 8,302 - 8,302 440 -
Principal payment receivable. 14,330 - 14,330 -
----------- --------- ----------- --------------- --------
Amortized cost, net . . . . 3,177,840 - 3,177,840 1,147,830 26,410
----------- --------- ----------- --------------- --------
Gross unrealized gains. . . . 1,070 - 1,070 38 53
Gross unrealized losses . . . (84,253) - (84,253) (7,606) (87)
----------- --------- ----------- --------------- --------
Fair value. . . . . . . . . $3,094,657 $ - $3,094,657 $ 1,140,262 $26,376
=========== ========= =========== =============== ========

Carrying value. . . . . . . $3,094,657 $ - $3,094,657 $ 1,147,350 $26,410
=========== ========= =========== =============== ========

December 31, 1997:

ARM Securities
------------------------------------
Available- Held-to- Collateral for
for-Sale Maturity Total Notes Payable ARM Loans
----------- ---------- ----------- -------------- ---------

Principal balance outstanding $3,984,770 $ 386,290 $4,371,060 $ - $115,996
Net unamortized premium . . . 119,133 5,025 124,158 - 3,033
Deferred gain from hedging. . - (1,217) (1,217) - -
Allowance for losses. . . . . (1,739) - (1,739) - (42)
Cap Agreements. . . . . . . . 11,144 2,160 13,304 - -
Principal payment receivable. 32,337 3,545 35,882 - -
----------- ---------- ----------- -------------- ---------
Amortized cost, net . . . . 4,145,645 395,803 4,541,448 - 118,987
----------- ---------- ----------- -------------- ---------
Gross unrealized gains. . . . 11,075 5,609 16,684 - -
Gross unrealized losses . . . (32,816) (2,859) (35,675) - -
----------- ---------- ----------- -------------- ---------
Fair value. . . . . . . . . $4,123,904 $ 398,553 $4,522,457 $ - $118,987
=========== ========== =========== ============== =========

Carrying value. . . . . . . $4,123,904 $ 395,803 $4,519,707 $ - $118,987
=========== ========== =========== ============== =========

During 1998, the Company realized $4,634,000 in gains and $4,912,000 in losses
on the sale of $932.3 million of ARM securities and ARM loans. During 1997, the
Company realized $2,179,000 in gains and $990,000 in losses on the sale of
$189.0 million of ARM securities, and during 1996, the Company realized
$1,427,000 in gains and $65,000 in losses on the sale of $276.4 million of ARM
securities. All of the ARM securities sold were classified as
available-for-sale. During 1998, approximately $379 million securities
previously classified as held-to-maturity were reclassified as
available-for-sale.

As of December 31, 1998, the Company had reduced the cost basis of its ARM
securities due to potential future credit losses (other than temporary declines
in fair value) in the amount of $1,242,000. At December 31, 1998, the Company
is providing for potential future credit losses on two assets that have an
aggregate carrying value of $11.8 million, which represent less than 0.3% of the
Company's total portfolio of ARM assets. Both of these assets are performing
and one has some remaining credit support that mitigates the Company's exposure
to potential future credit losses. Additionally, during 1998, the Company, in
accordance with its credit policies, recorded a $762,000 provision for potential
credit losses on its loan portfolio, although no actual losses have been
realized in the loan portfolio to date.

F-13

The following tables summarize ARM loan delinquency information as of December
31, 1998 and 1997 (dollar amounts in thousands):

1998
----

Loan Loan Percent of Percent of
Delinquency Status Count Balance ARM Loans Total Assets
- ------------------ ----- -------- ----------- -------------

30 to 59 days. . 4 $ 1,138 0.11% 0.03%
60 to 89 days. . 2 423 0.04 0.01
90 days or more. 1 3,450 0.32 0.08
In foreclosure . 5 1,097 0.10 0.02
----- -------- ----------- -------------
12 $ 6,108 0.57% 0.14%
===== ======== =========== =============

1997
----

Loan Loan Percent of Percent of
Delinquency Status Count Balance ARM Loans Total Assets
- ------------------ ----- -------- ----------- -------------

30 to 59 days. . - $ - - -
60 to 89 days. . 1 215 0.19% 0.00%
90 days or more. 1 167 0.14 0.00
In foreclosure . - - - -
----- -------- ----------- -------------
2 $ 382 0.33% 0.01%
===== ======== =========== =============

The following table summarizes the activity for the allowance for losses on ARM
loans for the year ended
December 31, 1998 and 1997 (dollar amounts in thousands):

1998 1997
----- -----

Beginning balance. . $ 42 $ 0
Provision for losses 762 42
Charge-offs, net . . 0 0
----- -----
Ending balance . . . $ 804 $ 42
===== =====

As of December 31, 1998, the Company had commitments to purchase $102.1 million
of ARM loans.

The average effective yield on the ARM assets owned was 5.86% as of December 31,
1998 and 6.38% as of December 31, 1997. The average effective yield is based on
historical cost and includes the amortization of the net premium paid for the
ARM assets and the Cap Agreements, the impact of ARM principal payment
receivables and the amortization of deferred gains from hedging activity.

As of December 31, 1998 and December 31, 1997, the Company had purchased Cap
Agreements with a remaining notional amount of $4.026 billion and $4.156
billion, respectively. The notional amount of the Cap Agreements purchased
decline at a rate that is expected to approximate the amortization of the ARM
assets. Under these Cap Agreements, the Company will receive cash payments
should the one-month, three-month or six-month London InterBank Offer Rate
("LIBOR") increase above the contract rates of the Cap Agreements which range
from 7.50% to 13.00% and average approximately 10.10%. The Company's ARM assets
portfolio had an average lifetime interest rate cap of 11.70%. The Cap
Agreements had an average maturity of 2.3 years as of December 31, 1998. The
initial aggregate notional amount of the Cap Agreements declines to
approximately $3.485 billion over the period of the agreements, which expire
between 1999 and 2004. The Company purchased these Cap Agreements by incurring
a one-time fee, or premium. The premium is amortized, or expensed, over the
lives of the Cap Agreements and decreases interest income on the Company's ARM
assets during the period of amortization. The Company has credit risk to the
extent that the counterparties to the cap agreements do not perform their
obligations under the Cap Agreements. If one of the counterparties does not
perform, the Company would not receive the cash to which it would otherwise be
entitled under the conditions of the Cap Agreement. In order to mitigate this
risk and to achieve competitive pricing, the Company has entered into Cap
Agreements with six different counterparties, five of which are rated AAA, and
one is rated AA.

F-14

NOTE 3. REVERSE REPURCHASE AGREEMENTS, CALLABLE COLLATERALIZED NOTES PAYABLE
AND OTHER BORROWINGS

The Company has entered into reverse repurchase agreements to finance most of
its ARM assets. The reverse repurchase agreements are short-term borrowings
that are secured by the market value of the Company's ARM assets and bear
interest rates that have historically moved in close relationship to LIBOR.

As of December 31, 1998, the Company had outstanding $2.867 billion of reverse
repurchase agreements with a weighted average borrowing rate of 5.62% and a
weighted average remaining maturity of 2.0 months. As of December 31, 1998,
$1.147 billion of the Company's borrowings were variable-rate term reverse
repurchase agreements with original maturities that range from three months to
two years. The interest rates of these term reverse repurchase agreements are
indexed to either the one-, three- or six-month LIBOR rate and reprice
accordingly. The reverse repurchase agreements at December 31, 1997 were
collateralized by ARM assets with a carrying value of $3.005 billion, including
accrued interest and cash in the amount of $22.4 million.

At December 31, 1998, the reverse repurchase agreements had the following
remaining maturities (dollar amounts in thousands):

Within 30 days . . $1,440,407
31 to 89 days. . . 748,095
90 days or greater 678,705
----------
$2,867,207
==========

As of December 31, 1998, the Company had one whole loan financing facility with
an uncommitted borrowing capacity of $250,000,000. The Company had no balance
borrowed against this facility as of year-end. This facility matured on January
8, 1999 and has been subsequently re-negotiated for an additional one year
period. Under the new agreement in effect as of January 8, 1999, the whole loan
financing facility is a committed facility in an amount of up to $150,000,000,
with an option to increase this amount to $300,000,000.

On December 18, 1998, the Company, through a special purpose finance subsidiary,
issued $1.144 billion of callable AAA notes payable ("Notes") collateralized by
ARM loans with a principal balance of $1.049 billion and ARM securities with a
balance of $128.3 million. As part of this transaction, the Company retained
ownership of a subordinated certificate in the amount of $32.4 million, which
represents the Company's maximum exposure to credit losses on the loans
collateralizing the Notes. As of December 31, 1998, the Notes had a balance of
$1.127 billion and an interest rate of 6.32%. The interest rate adjusts monthly
at one-month LIBOR plus 0.70% through November 1999 and at one-month LIBOR plus
1.40% thereafter. The Notes mature on January 25, 2029 and are callable by the
Company or Bear Stearns, one of the underwriters, monthly, although Bear Stearns
has indicated it does not intend to exercise its ability to call the collateral
prior to May 1999. The Company may call either the collateral or the Notes, at
its option. In connection with the issuance of the Notes, the Company incurred
costs of $3.9 million which is being amortized over the expected life of the
Notes. Since the Notes are paid down as the collateral pays down, the
amortization of the issuance cost will be adjusted periodically based on actual
payment experience. If the collateral pays down faster than currently
estimated, then the amortization of the issuance cost will increase and the
effective cost of the Notes will increase and, conversely, if the collateral
pays down slower than currently estimated, then the amortization of issuance
cost will be decreased and the effective cost of the Notes will also decrease.

As of December 31, 1998, the Company was a counterparty to nineteen interest
rate swap agreements ("Swaps") having an aggregate notional balance of $1.473
billion. As of year-end, these Swaps had a weighted average remaining term of
16.5 months. In accordance with these Swaps, the Company will pay a fixed rate
of interest during the term of these Swaps and receive a payment that varies
monthly with the one-month LIBOR rate. As a result of entering into these
Swaps, the Company has reduced the interest rate variability of its cost to
finance its ARM securities by increasing the average period until the next
repricing of its borrowings from 26 days to 204 days. Fourteen of these Swaps
were entered into in connection with the Company's acquisition of hybrid loans
and commitments to acquire hybrid loans. These fourteen Swaps that hedge the
fixed rate portion of the Company's hybrid loans (to within one year of the
first interest rate reset) had a notional balance of $523 million at year-end
and an average maturity of 44.0 months. The Swaps at December 31, 1998 were
collateralized by ARM assets with a carrying value of $0.9 million, including
accrued interest.

F-15

As of December 31, 1998, the Company had financed a portion of its portfolio of
interest rate cap agreements with $2.0 million of other borrowings which require
quarterly or semi-annual payments until the year 2000. These borrowings have a
weighted average fixed rate of interest of 7.87% and have a weighted average
remaining maturity of 1.4 years. The other borrowings financing cap agreements
at December 31, 1998 were collateralized by ARM securities with a carrying value
of $3.1 million, including accrued interest. The aggregate maturities of these
other borrowings are as follows (dollars in thousands):

1999 $ 1,397
2000 632
-------
$ 2,029
=======

The total cash paid for interest was $267.9 million, $177.9 million and $112.2
million for 1998, 1997 and 1996 respectively.

NOTE 4. FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents the carrying amounts and estimated fair values of
the Company's financial instruments at December 31, 1998 and December 31, 1997.
FASB Statement No. 107, Disclosures About Fair Value of Financial Instruments,
defines the fair value of a financial instrument as the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale (dollar amounts in thousands):

December 31, 1998 December 31, 1997
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ---------- ----------- ----------

Assets:
ARM assets. . . . . . . . . . $4,266,497 $4,259,374 $4,634,612 $4,639,513
Cap Agreements. . . . . . . . 1,920 1,920 4,082 1,931

Liabilities:
Callable collateralized notes 1,127,181 1,127,181 - -
Other borrowings. . . . . . . 2,029 2,077 10,018 10,321
Swap agreements . . . . . . . (87) 7,326 (50) 184

The above carrying amounts for assets are combined in the balance sheet under
the caption adjustable-rate mortgage assets. The carrying amount for assets
categorized as available-for-sale is their fair value whereas the carrying
amount for assets held-to-maturity or held for the foreseeable future is their
amortized cost.

The fair values of the Company's ARM securities and cap agreements are based on
market prices provided by certain dealers who make markets in these financial
instruments or third-party pricing services. The fair values for ARM loans is
determined by the Company by using the same pricing models employed by the
Company in the process of determining a price to bid for loans in the open
market, taking into consideration the aggregated characteristics of groups of
loans such as, but not limited to, collateral type, index, margin, life cap,
periodic cap, underwriting standards, age and delinquency experience. The fair
value of the Company's long-term debt and interest rate swap agreements, which
are off-balance sheet financial instruments, are based on market values provided
by dealers who are familiar with the terms of the long-term debt and swap
agreements. The fair values reported reflect estimates and may not necessarily
be indicative of the amounts the Company could realize in a current market
exchange. Cash and cash equivalents, interest receivable, reverse repurchase
agreements, callable collateralized notes and other liabilities are reflected in
the financial statements at their amortized cost, which approximates their fair
value because of the short-term nature of these instruments.

F-16

NOTE 5. COMMON AND PREFERRED STOCK

In January 1997, the Company issued 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock at a price of $25 per share pursuant to
its Registration Statement on Form S-3 declared effective in December 1996. Net
proceeds from this issuance totaled $65.8 million. The dividends are cumulative
commencing on the issue date and are payable quarterly, in arrears. The
dividends per share are equal to the greater of (i) $0.605 per quarter, or (ii)
the quarterly dividend declared on the Company's common stock. Each share is
convertible at the option of the holder at any time into one share of common
stock. The preferred shares are redeemable by the Company on and after December
31, 1999, in whole or in part, as follows: (i) for one share of common stock
plus accumulated, accrued but unpaid dividends, provided that for 20 trading
days within any period of 30 consecutive trading days the closing price of the
common stock equals or exceeds the conversion price of $25, or (ii) for cash at
the issue price of $25, plus any accumulated, accrued but unpaid dividends
through the redemption date. In the event of liquidation, the holders of the
preferred shares will be entitled to receive out of the assets of the Company,
prior to any distribution to the common shareholders, the issue price of $25 per
share in cash, plus any accumulated, accrued and unpaid dividends.

During 1998, the Company issued 1,581,550 shares of common stock under its
Dividend Reinvestment and Stock Purchase Plan and received net proceeds of $24.4
million. During 1997, the Company issued 912,590 shares of common stock under
this plan and received net proceeds of $18.0 million, and during 1996, the
Company issued 347,434 shares of common stock under this plan and received net
proceeds of $5.4 million.

During 1998, stock options for 128,377 shares of common stock were exercised at
an average price of $15.23 and $2.0 million of notes receivable were executed in
connection with the exercise of these options. During 1997, stock options for
186,071 shares of common stock were exercised at an average price of $15.71.
The Company received net proceeds of $0.2 million, and $2.7 million of notes
receivable were executed in connection with the exercise of certain options.
During 1996, stock options for 23,595 shares of common stock were exercised at
an average price of $15.41 that generated net proceeds of $0.4 million.

On July 13, 1998, the Board of Directors approved a common stock repurchase
program of up to 500,000 shares at prices below book value, subject to
availability of shares and other market conditions. On September 18, 1998, the
Board of Directors expanded this program by approving the repurchase of up to an
additional 500,000 shares. To date, the company has repurchased 500,016 at an
average price of $9.28 per share.

During the Company's 1998 fiscal year, the Company declared dividends to
shareholders totaling $0.905 per common share, all of which was paid during
1998, and $2.42 per preferred share, of which $1.815 was paid during 1998 and
$0.605 was paid on January 11, 1999. During the Company's 1997 fiscal year, the
Company declared dividends to shareholders totaling $1.97 per common share, of
which $1.47 was paid during 1997 and $0.50 was paid on January 12, 1998, and
$2.265 per preferred share, of which $1.66 was paid during 1997 and $0.605 was
paid on January 12, 1998. During the Company's 1996 fiscal year, the Company
declared dividends to shareholders totaling $1.65 per common share, of which
$1.20 was paid during 1996 and $0.45 was paid on January 12, 1997. For federal
income tax purposes, $0.0638 of the 1998 common stock dividends was return of
capital and not taxable, $0.01 of the 1997 common stock dividend was capital
gains subject to a maximum tax rate of 28%, and $0.05 of the 1997 common stock
dividend was capital gains subject to a maximum tax rate of 20%, and $0.03 of
the 1996 common stock dividend was long-term capital gains. In addition, the
preferred dividend paid on January 11, 1999 will be taken as a dividend
deduction on the Company's 1999 income tax return and is therefore not taxable
income for preferred shareholders until 1999. The remainder of the dividends
paid for fiscal years 1998, 1997 and 1996 was ordinary income to the Company's
common and preferred shareholders.

NOTE 6. STOCK OPTION PLAN

The Company has a Stock Option and Incentive Plan (the "Plan") which authorizes
the granting of options to purchase an aggregate of up to 1,800,000 shares, but
not more than 5% of the outstanding shares of the Company's common stock. The
Plan authorizes the Board of Directors, or a committee of the Board of
Directors, to grant Incentive Stock Options ("ISOs") as defined under section
422 of the Internal Revenue Code of 1986, as amended, options not so qualified
("NQSOs"), Dividend Equivalent Rights ("DERs"), Stock Appreciation Rights
("SARs"), and Phantom Stock Rights ("PSRs").

F-17

The exercise price for any options granted under the Plan may not be less than
100% of the fair market value of the shares of the common stock at the time the
option is granted. Options become exercisable six months after the date granted
and will expire ten years after the date granted, except options granted in
connection with an offering of convertible preferred stock, in which case such
options become exercisable if and when the convertible preferred stock is
converted into common stock.

The Company issued DERs at the same time as ISOs and NQSOs based upon a formula
defined in the Plan. During 1998 the number of DERs issued was based on 35% of
the ISOs and NQSOs granted during 1998. The number of PSRs issued are based on
the level of the Company's dividends and on the price of the Company's stock on
the related dividend payment date and is equivalent to the cash that otherwise
would be paid on the outstanding DERs and previously issued PSRs. The Company
recorded an expense associated with the DERs and the PSRs of $11,000 and $32,000
for the years ended December 31, 1998 and 1997, respectively.

Notes receivable from stock sales has resulted from the Company selling shares
of common stock through the exercise of stock options. The notes have maturity
terms ranging from 3 years to 9 years and accrue interest at rates that range
from 5.40% to 6.00% per annum. In addition, the notes are full recourse
promissory notes and are secured by a pledge of the shares of the Common Stock
acquired. Interest, which is credited to paid-in-capital, is payable quarterly,
with the balance due at the maturity of the notes. The payment of the notes
will be accelerated only upon the sale of the shares of Common Stock pledged for
the notes. The notes may be prepaid at any time at the option of each borrower.
As of December 31, 1998, there were $4.6 million of notes receivable from stock
sales outstanding.

The Company adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation."
Accordingly, no compensation cost has been recognized for the Company's stock
option plan. Had compensation cost for the Company's stock option plan been
determined based on the fair value at the grant date for awards in 1998, 1997
and 1996 consistent with the provisions of SFAS No. 123, the Company's net
earnings and earnings per share would have been reduced to the pro forma amounts
indicated in the table below. The fair value of each option grant is estimated
on the date of grant using the Black-Scholes option-pricing model (dollar
amounts in thousands, except per share data).

1998 1997 1996
--------- --------- ---------

Net income - as reported. . $ 22,695 $ 41,402 $ 25,737
Net income - pro forma. . . 22,629 41,093 25,551

Basic EPS - as reported . . 0.75 1.95 1.73
Basic EPS - pro forma . . . 0.74 1.93 1.72

Diluted EPS - as reported . 0.75 1.94 1.73
Diluted EPS - pro forma . . 0.74 1.92 1.71

Assumptions:
Dividend yield. . . . . 10.00% 10.00% 10.00%
Expected volatility . . 25.60% 21.50% 23.30%
Risk-free interest rate 5.68% 6.40% 6.52%
Expected lives. . . . . 7 years 7 years 7 years

F-18

Information regarding options is as follows:

1998 1997 1996
--------------------- ------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- --------- ---------- -------- --------- --------

Outstanding, beginning of year. 680,995 $ 17.353 626,746 $ 15.510 482,078 $ 15.529
Granted . . . . . . . . . . . . 59,784 14.817 240,320 20.888 169,099 15.439
Exercised . . . . . . . . . . . (128,377) 15.234 (186,071) 15.711 (23,595) 15.407
Expired . . . . . . . . . . . . - - - - (836) 14.375
---------- --------- ---------- -------- --------- --------
Outstanding, end of year. . . . 612,402 $ 17.549 680,995 $ 17.353 626,746 $ 15.511
========== ========= ========== ======== ========= ========

Weighted average fair value of
options granted during the year $ 1.22 $ 1.29 $ 1.10

Options exercisable at year end 479,482 476,875 613,413

The following table summarizes information about stock options outstanding at
December 31, 1998:

Options Outstanding Options Exercisable
----------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Options Contractual Exercise Exercisable Exercise
Range of Exercise Prices Outstanding Life (Yrs) Price At 12/31/98 Price
- ------------------------- ----------- ------------ --------- ----------- ---------

9.375 - $12.4375 . . . . 20,049 9.6 $ 11.953 3,049 $ 12.388
14.375 - $16.125 . . . . 321,061 5.7 15.342 321,061 15.342
17.500 - $20.000 . . . . 183,092 8.2 19.588 67,172 18.876
$22.625. . . . . . . 88,200 8.5 22.625 88,200 22.625
- ------------------------- ----------- ------------ --------- ----------- ---------
$9.375 - $22.625 . . . . 612,402 6.9 17.549 479,482 17.158
========================= =========== ============ ========= =========== =========

NOTE 7. TRANSACTIONS WITH AFFILIATES

The Company has a Management Agreement (the "Agreement") with Thornburg Mortgage
Advisory Corporation ("the Manager"). Under the terms of this Agreement, the
Manager, subject to the supervision of the Company's Board of Directors, is
responsible for the management of the day-to-day operations of the Company and
provides all personnel and office space. The Agreement provides for an annual
review by the unaffiliated directors of the Board of Directors of the Manager's
performance under the Agreement.

The Company pays the Manager an annual base management fee based on average
shareholders' equity, adjusted for liabilities that are not incurred to finance
assets ("Average Shareholders' Equity" or "Average Net Invested Assets" as
defined in the Agreement) payable monthly in arrears as follows: 1.1% of the
first $300 million of Average Shareholders' Equity, plus 0.8% of Average
Shareholders' Equity above $300 million.

For the years ended December 31, 1998, 1997 and 1996, the Company paid the
Manager $4,142,000, $3,664,000 and $1,872,000, respectively, in base management
fees in accordance with the terms of the Agreement.

The Manager is also entitled to earn performance based compensation in an amount
equal to 20% of the Company's annualized net income, before performance based
compensation, above an annualized Return on Equity equal to the ten year U.S.
Treasury Rate plus 1%. For purposes of the performance fee calculation, equity
is generally defined as proceeds from issuance of common stock before
underwriter's discount and other costs of issuance, plus retained earnings. For
the years ended December 31, 1998, 1997 and 1996, the Company paid the Manager
$759,000, $3,363,000 and $2,462,000, respectively, in performance based
compensation in accordance with the terms of the Agreement.

F-19

NOTE 8. NET INTEREST INCOME ANALYSIS

The following table summarizes the amount of interest income and interest
expense and the average effective interest rate for the periods ended December
31, 1998, 1997 and 1996 (dollar amounts in thousands):

1998 1997 1996
------------------- ------------------ ---------------
Average Average Average
Amount Rate Amount Rate Amount Rate
--------- -------- --------- ------- -------- -------

Interest Earning Assets:
ARM assets. . . . . . . . . . . . . . . $286,327 5.96% $246,507 6.56% $150,759 6.45%
Cash and cash equivalents . . . . . . . 705 4.35 1,214 5.57 752 5.29
287,032 5.96 247,721 6.56 151,511 6.44
--------- -------- --------- ------- -------- -------
Interest Bearing Liabilities:
Borrowings. . . . . . . . . . . . . . . 255,992 5.78 198,657 5.76 121,166 5.67
--------- -------- --------- ------- -------- -------

Net Interest Earning Assets and Spread . $ 31,040 0.18% $ 49,064 0.80% $ 30,345 0.77%
========= ======== ========= ======= ======== =======

Yield on Net Interest Earning Assets (1) 0.64% 1.30% 1.29%
======== ======= =======

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

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

1998 versus 1997 1997 versus 1996
------------------------------ ------------------------
Rate Volume Total Rate Volume Total
--------- -------- --------- ------ ------- -------

Interest Income:
ARM assets. . . . . . . . $(22,549) $62,368 $ 39,819 $2,651 $93,097 $95,748
Cash and cash equivalents (266) (242) (508) 40 422 462
--------- -------- --------- ------ ------- -------
(22,815) 62,126 39,311 2,691 93,519 96,210
--------- -------- --------- ------ ------- -------
Interest Expense:
Borrowings. . . . . . . . 518 56,817 57,335 2,068 75,423 77,491
--------- -------- --------- ------ ------- -------

Net interest income. . . . $(23,333) $ 5,309 $(18,024) $ 623 $18,096 $18,719
========= ======== ========= ====== ======= =======

F-20

NOTE 9. SUMMARIZED QUARTERLY RESULTS (UNAUDITED)

The following is a presentation of the quarterly results of operations (amounts
in thousands, except per share amounts):

Year Ended December 31, 1998
------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------

Interest income from ARM assets and cash . . $ 65,446 $ 72,252 $ 73,019 $ 76,315
Interest expense on borrowed funds . . . . . (59,402) (66,458) (65,243) (64,889)
--------- --------- --------- ---------
Net interest income . . . . . . . . . . . . 6,044 5,794 7,776 11,426
--------- --------- --------- ---------

Gain (loss) on ARM assets. . . . . . . . . . (4,689) 194 1,044 1,141

General and administrative expenses. . . . . (1,309) (1,310) (1,345) (2,071)

Dividend on preferred stock. . . . . . . . . (1,669) (1,670) (1,670) (1,670)
--------- --------- --------- ---------
Net income available to common shareholders $ (1,623) $ 3,008 $ 5,805 $ 8,826
========= ========= ========= =========

Basic EPS. . . . . . . . . . . . . . . . . . $ (0.08) $ 0.14 $ 0.27 $ 0.42
========= ========= ========= =========

Diluted EPS. . . . . . . . . . . . . . . . . $ (0.08) $ 0.14 $ 0.27 $ 0.42
========= ========= ========= =========

Average number of common shares outstanding. 21,490 21,858 21,796 20,797
========= ========= ========= =========

Year Ended December 31, 1997
------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------

Interest income from ARM assets and cash . . $ 73,011 $ 68,088 $ 57,623 $ 48,999
Interest expense on borrowed funds . . . . . (60,680) (54,862) (45,448) (37,667)
--------- --------- --------- ---------
Net interest income . . . . . . . . . . . . 12,331 13,226 12,175 11,332
--------- --------- --------- ---------

Gain (loss) on ARM assets. . . . . . . . . . 566 112 (189) (186)

General and administrative expenses. . . . . (2,047) (2,156) (1,911) (1,851)

Dividend on preferred stock. . . . . . . . . (1,670) (1,670) (1,670) (1,241)
--------- --------- --------- ---------
Net income available to common shareholders $ 9,180 $ 9,512 $ 8,405 $ 8,054
========= ========= ========= =========

Basic EPS. . . . . . . . . . . . . . . . . . $ 0.46 $ 0.50 $ 0.50 $ 0.49
========= ========= ========= =========

Diluted EPS. . . . . . . . . . . . . . . . . $ 0.46 $ 0.49 $ 0.50 $ 0.49
========= ========= ========= =========

Average number of common shares outstanding. 19,860 19,152 16,817 16,311
========= ========= ========= =========

F-21

SCHEDULE IV - Mortgage Loans on Real Estate

Column A, Description: The Company's whole loan portfolio at December 31, 1998,
which consists of only first mortgages on single-family residential housing, is
stratified as follows (dollar amounts in thousands):

Column A (continued) Column B Column C Column G Column H
- ----------------------------------- --------- --------- ------------- ---------------------
Description (4)

Principal Amount of
Range of Number Final Carrying Loans Subject to
Carrying Amounts of Interest Maturity Amount of Delinquent
of Mortgages Loans Rate Date Mortgages (3) Principal or Interest
- ------------------------ --------- --------- --------- ------------- ---------------------

ARM Loans:
$ 0 - 250 931 5.73 - 8.98 Various $ 123,067 $ 827
251 - 500 498 5.23 - 8.48 Various 174,335 932
501 - 750 157 5.98 - 8.73 Various 96,788 644
751 - 1,000 78 5.86 - 8.11 Various 71,221
over 1,000 86 5.73 - 8.36 Various 129,613 3,450
---------- ------------ ---------------------
1,750 595,024 5,853
---------- ------------ ---------------------
Hybrid Loans:
0 - 250 1,418 4.73 - 9.23 Various 184,056 255
251 - 500 465 5.61 - 7.98 Various 164,727
501 - 750 95 5.61 - 7.73 Various 57,186
751 - 1,000 41 6.11 - 7.98 Various 37,219
over 1,000 15 5.98 - 7.48 Various 23,481
---------- ------------ ---------------------
2,034 466,669 255
---------- ------------ ---------------------
Premium 17,436
Allowance for losses (2) (804)
---------- ------------ ---------------------
3,784 $ 1,078,325 $ 6,108
========== ============ =====================

Notes:
(1) Reconciliation of carrying amounts of mortgage loans:

Balance at December 31, 1997. . $ 118,987
Additions during 1998:
Loan purchases. . . . . . . . 1,092,238

Deductions during 1998:
Collections of principal. . 128,079
Cost of mortgage loans sold 2,043
Provision for losses. . . . 762
Amortization of premium . . 2,016
----------
132,900
----------
Balance at December 31, 1998. . $1,078,325
==========

(2) The provision for losses is based on management's assessment of various
factors.
(3) Cost for Federal income taxes is the same.
(4) The geographic distribution of the Company's whole loan portfolio at
December 31, 1998 is as follows:

F-22

Number of
State or Territory Loans Carrying Amount
- ----------------------- ---------- ----------------

Arizona . . . . . . . . 92 $ 25,087
California. . . . . . . 559 232,178
Colorado. . . . . . . . 112 46,930
Connecticut . . . . . . 67 29,295
Florida . . . . . . . . 554 137,587
Georgia . . . . . . . . 241 74,916
Illinois. . . . . . . . 189 36,189
Massachusetts . . . . . 84 28,868
Michigan. . . . . . . . 186 31,894
Missouri. . . . . . . . 225 46,515
New Jersey. . . . . . . 154 44,361
New York. . . . . . . . 287 73,875
Pennsylvania. . . . . . 67 17,376
Texas . . . . . . . . . 129 33,138
Washington. . . . . . . 69 21,460
Other states, less than
60 loans each . . . 769 182,024
Premium . . . . . . . . 17,436
Allowance for losses. . (804)
---------- ----------------
TOTAL . . . . . . . . . 3,784 $ 1,078,325
========== ================

F-23

SIGNATURES

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

THORNBURG MORTGAGE ASSET CORPORATION
(Registrant)

Dated: March 26, 1999 /s/ Garrett Thornburg
---------------------------------------
Garrett Thornburg
Chairman of the Board of Directors and
Chief Executive Officer
(Principal Executive Officer)

Dated: March 26, 1999 /s/ Richard P. Story
---------------------------------------
Richard P. Story
Chief Financial Officer and Treasurer
(Principal Accounting Officer)

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

Signature Capacity Date
- ---------------------- ----------------------- --------------

/s/ Garrett Thornburg Chairman of the Board, March 26, 1999
- ----------------------
Garrett Thornburg Director and Chief
Executive Officer

/s/ Larry A. Goldstone President, Director and March 26, 1999
- ----------------------
Larry A. Goldstone Chief Operating Officer

/s/ David A. Ater Director March 26, 1999
- ----------------------
David A. Ater

/s/ Joseph H. Badal Director March 26, 1999
- ----------------------
Joseph H. Badal

/s/ Owen M. Lopez Director March 26, 1999
- ----------------------
Owen M. Lopez

/s/ James H. Lorie Director March 26, 1999
- ----------------------
James H. Lorie

/s/ Stuart C. Sherman Director March 26, 1999
- ----------------------
Stuart C. Sherman

Exhibit Index

Sequentially
Numbered
Exhibit Number Exhibit Description Page
- -------------- -------------------------------------------------------------------------- ------------

1.1 Sales Agency Agreement (a)

3.1 Articles of Incorporation of the Registrant (b)

3.1.1 Articles of Amendment to Articles of Incorporation dated June 29, 1995 (c)

3.1.2 Articles Supplementary dated January 21, 1997 (d)

3.2 Amended and Restated Bylaws of the Registrant (e)

4.1 Specimen Common Stock Certificates (b)

4.2 Specimen Preferred Stock Certificates (d)

10.1 Management Agreement between the Registrant and Thornburg Mortgage
Advisory Corporation dated June 17, 1994 (e)

10.1.1 Amendment to Management Agreement dated June 16, 1995 (a)

10.1.2 Amendment to Management Agreement dated December 15, 1995 (f)

10.1.3 Amendment to Management Agreement dated September 18, 1996 (g)

10.1.4 Amendment to Management Agreement dated October 1, 1998 * 69

10.2 Form of Servicing Agreement (b)

10.3 Form of 1992 Stock Option and Incentive Plan as amended and
restated March 14, 1997 (h)

10.3.1 Amendment dated December 16, 1997 to the amended and restated
1992 Stock Option and Incentive Plan (i)

10.4 Form of Dividend Reinvestment and Stock Purchase Plan (j)

10.5 Trust Agreement dated as of December 1, 1998 * 71

10.6 Indenture Agreement dated as of December 1, 1998 * 105

10.7 Sales and Service Agreement dated as of December 1, 1998 * 145

22. Notice and Proxy Statement for the Annual Meeting of Shareholders to be
held on April 30, 1998 (k)

27 Financial Data Schedule * 187

- ---------------
* Being filed herewith.
(a) Previously filed with Registrant's Form 8-K dated October 10, 1995 and incorporated herein by
reference pursuant to Rule 12b-32.
(b) Previously filed as part of Form S-11 which went effective on June 18, 1993 and incorporated
herein by reference pursuant to Rule 12b-32.
(c) Previously filed with Registrant's Form 10-Q dated June 30, 1995 and incorporated herein by
reference pursuant to Rule 12b-32.
(d) Previously filed as part of Form 8-A dated January 17, 1997 and incorporated herein by reference
pursuant to Rule 12b-32.
(e) Previously filed as part of Form S-8 dated July 1, 1994 and incorporated herein by reference
pursuant to Rule 12b-32.
(f) Previously filed with Registrant's Form 10-K dated December 31, 1995 and incorporated herein by
reference pursuant to Rule 12b-32.

(g) Previously filed with Registrant's Form 10-Q dated September 30, 1996 and incorporated herein by
reference pursuant to Rule 12b-32.
(h) Previously filed with Registrant's Form 10-K dated December 31, 1996 and incorporated herein by
reference pursuant to Rule 12b-32.
(i) Previously filed with Registrant's Form 10-K dated December 31, 1997 and incorporated herein by
reference pursuant to Rule 12b-32.
(j) Previously filed as Exhibit 4 to Registrant's registration statement on Form S-3D dated
September 24, 1997 and incorporated herein by reference pursuant to Rule 12b-32.
(k) Previously filed on March 30, 1998 and incorporated by reference pursuant to Rule 12-b32.