THORNBURG MORTGAGE INC - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended: March 31, 2005

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

For the transition period from to

Commission File Number: 001-11914

THORNBURG MORTGAGE, INC.

(Exact name of Registrant as specified in its Charter)

Maryland

85-0404134

(State or other jurisdiction of

incorporation or organization)

(IRS Employer

Identification Number)

150 Washington Avenue

Santa Fe, New Mexico

87501

(Address of principal executive offices)

(Zip Code)

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

Not applicable

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

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

Yes x No ¨

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

Yes x No ¨

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Common Stock ($.01 par value) 95,492,444 as of May 4, 2005

INDEX

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


		Page
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets at March 31, 2005 and December 31, 2004	3

	Consolidated Income Statements for the three months ended March 31, 2005 and March 31, 2004	4

	Consolidated Statements of Comprehensive Income for the three months ended March 31, 2005 and March 31, 2004	5

	Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2005 and March 31, 2004	6

	Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and March 31, 2004	7

	Notes to Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	55

Item 4.	Controls and Procedures	55

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	55

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	55

Item 3.	Defaults Upon Senior Securities	55

Item 4.	Submission of Matters to a Vote of Security Holders	55

Item 5.	Other Information	55

Item 6.	Exhibits	55

SIGNATURES		56

EXHIBIT INDEX		57

GLOSSARY		58

PART I. FINANCIAL INFORMATION

Item 1.

FINANCIAL STATEMENTS

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

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


	March 31, 2005			December 31, 2004
ASSETS

ARM assets:
ARM securities, net	$	19,490,760		$	18,656,045
ARM loans:
Securitized ARM loans, net		4,004,485			2,899,985
ARM loans collateralizing CDOs, net		6,355,580			6,720,810
ARM loans held for securitization, net		449,179			466,221

ARM loans		10,809,244			10,087,016

ARM assets		30,300,004			28,743,061
Cash and cash equivalents		27,204			112,622
Restricted cash and cash equivalents		33,746			30,737
Hedging Instruments		331,651			144,230
Accrued interest receivable		143,345			118,273
Prepaid expenses and other		44,648			40,695

	$	30,880,598		$	29,189,618

LIABILITIES

Reverse repurchase agreements	$	17,076,520		$	14,248,939
Asset-backed CP		4,990,000			4,905,000
CDOs		6,254,720			6,623,641
Whole loan financing facilities		107,185			285,555
Hedging Instruments		4,712			26,027
Senior Notes		304,198			304,173
Payable for securities purchased		—			815,915
Accrued interest payable		65,097			44,109
Dividends payable		100			62,495
Accrued expenses and other		44,785			84,580

		28,847,317			27,400,434

COMMITMENTS AND CONTINGENCIES

SHAREHOLDERS’ EQUITY
Preferred stock: par value $0.01 per share; 8% Series C Cumulative Redeemable shares, aggregate preference in liquidation $50,000; 2,300,000 and 0 shares authorized, 2,000,000 and 0 shares issued and outstanding, respectively		48,344			—
Common stock: par value $0.01 per share; 497,678,000 shares authorized, 94,638,000 and 91,904,000 shares issued and outstanding, respectively		946			919
Additional paid-in-capital		1,947,919			1,872,487
Accumulated other comprehensive loss		(37,777	)		(90,715	)
Retained earnings		73,849			6,493

		2,033,281			1,789,184

	$	30,880,598		$	29,189,618

See Notes to Consolidated Financial Statements.

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED INCOME STATEMENTS (Unaudited)

(In thousands, except per share data)


	Three Months Ended March 31,
	2005			2004
Interest income from ARM assets and cash equivalents	$	308,059		$	195,813
Interest expense on borrowed funds		(224,892	)		(126,093	)

Net interest income		83,167			69,720

Servicing income, net		2,515			822
Gain on ARM assets and Hedging Instruments, net		2,967			3,544
Hedging expense		—			(158	)
Provision for credit losses		(409	)		(432	)
Management fee		(4,706	)		(3,627	)
Performance fee		(10,035	)		(8,334	)
Long-term incentive awards		(1,428	)		(4,495	)
Other operating expenses		(4,615	)		(3,677	)

NET INCOME	$	67,456		$	53,363

Net income	$	67,456		$	53,363
Dividend on preferred stock		(100	)		—

Net income available to common shareholders	$	67,356		$	53,363

Earnings per share:
Net income	$	0.72		$	0.70

Average number of shares outstanding		93,173			76,631

See Notes to Consolidated Financial Statements.

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(In thousands)


	Three Months Ended March 31,
	2005			2004
Net income	$	67,456		$	53,363
Other comprehensive income:
Unrealized gains (losses) on securities:
Net unrealized holdings gains (losses) arising during the period		(145,964	)		87,054
Reclassification adjustment for net gains included in income		(1,645	)		(3,012	)

Net change in unrealized gains (losses) on securities		(147,609	)		84,042

Unrealized gains (losses) on hybrid hedging instruments:
Net unrealized gains (losses) arising during the period		173,724			(177,452	)
Reclassification adjustment for net losses included in income		26,823			61,479

Net change in unrealized gains (losses) on hybrid hedging instruments		200,547			(115,973	)

Other comprehensive income		52,938			(31,931	)

Comprehensive income	$	120,394		$	21,432

See Notes to Consolidated Financial Statements.

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited)

Three months ended March 31, 2005 and 2004

(In thousands, except per share data)


	Preferred Stock		Common Stock		Additional Paid-in Capital		Accum. Other Comprehensive Income (Loss)			Retained Earnings			Total
Balance, December 31, 2003	$	—	$	740	$	1,376,879	$	(142,778	)	$	4,263		$	1,239,104
Comprehensive income:
Net income											53,363			53,363
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment								84,042						84,042
Hedging Instruments:
Fair value adjustment, net of amortization								(115,973	)					(115,973	)
Issuance of Common Stock				60		168,271								168,331

Balance, March 31, 2004	$	—	$	800	$	1,545,150	$	(174,709	)	$	57,626		$	1,428,867


Balance, December 31, 2004	$	—	$	919	$	1,872,487	$	(90,715	)	$	6,493		$	1,789,184
Comprehensive income:
Net income											67,456			67,456
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment								(147,609	)					(147,609	)
Hedging Instruments:
Fair value adjustment, net of amortization								200,547						200,547
Issuance of Common Stock				27		75,432								75,459
Issuance of preferred stock		48,344												48,344
Dividends declared on preferred stock - $0.05 per share											(100	)		(100	)

Balance, March 31, 2005	$	48,344	$	946	$	1,947,919	$	(37,777	)	$	73,849		$	2,033,281

See Notes to Consolidated Financial Statements.

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)


	Three Months Ended March 31,
	2005			2004
Operating Activities:
Net income	$	67,456		$	53,363
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of ARM assets net premium		19,904			12,721
Gain on ARM assets and Hedging Instruments, net		(2,967	)		(3,544	)
Provision for credit losses		409			432
Hedging expense		—			158
Change in assets and liabilities:
Accrued interest receivable		(25,072	)		(8,391	)
Prepaid expenses and other		(3,953	)		(4,573	)
Accrued interest payable		20,988			4,603
Accrued expenses and other		(39,795	)		3,535

Net cash provided by operating activities		36,970			58,304

Investing Activities:
ARM securities:
Purchases		(3,487,063	)		(3,563,852	)
Proceeds on sales		279,496			348,709
Principal payments		1,382,906			1,021,834
Securitized ARM loans:
Principal payments		138,374			129,469
ARM loans collateralizing CDOs:
Principal payments		312,839			116,796
ARM loans held for securitization:
Purchases and originations		(1,175,438	)		(997,871	)
Principal payments		4,983			11,846

Net cash used in investing activities		(2,543,903	)		(2,933,069	)

Financing Activities:
Net borrowings from reverse repurchase agreements		2,827,581			2,319,650
Net borrowings from Asset-backed CP		85,000			—
CDO borrowings		—			1,106,707
CDO paydowns		(368,921	)		(117,355	)
Net whole loan financing facilities paydowns		(178,370	)		(263,438	)
Payments made on Eurodollar contracts		(2,074	)		(2,254	)
Proceeds from Common Stock issued, net		75,459			168,331
Proceeds from preferred stock issued, net		48,344			—
Dividends paid		(62,495	)		(47,350	)
Net increase in restricted cash		(3,009	)		(71,446	)

Net cash provided by financing activities		2,421,515			3,092,845

Net (decrease) increase in cash and cash equivalents		(85,418	)		218,080
Cash and cash equivalents at beginning of period		112,622			85,366

Cash and cash equivalents at end of period	$	27,204		$	303,446

See noncash disclosures in Note 2 and Note 4.

See Notes to Consolidated Financial Statements

THORNBURG MORTGAGE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 1. Significant Accounting Policies

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

In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair statement have been included. The operating results for the quarter ended March 31, 2005 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2005. The interim financial information should be read in conjunction with Thornburg Mortgage, Inc.’s 2004 Annual Report on Form 10-K.

Basis of presentation and principles of consolidation

The consolidated financial statements include the accounts of Thornburg Mortgage, Inc. (“TMA”), Thornburg Mortgage Depositor, LLC (“TMD”), Thornburg Mortgage Home Loans, Inc. (“TMHL”), Thornburg Mortgage Capital Resources, LLC (“TMCR”) and TMHL’s two wholly-owned special purpose finance subsidiaries, Thornburg Mortgage Funding Corporation II and Thornburg Mortgage Acceptance Corporation II. TMCR and TMD are wholly-owned qualified REIT subsidiaries and are consolidated with the Company for financial statement and tax reporting purposes. As of the close of business on May 31, 2004, TMHL and its subsidiaries made the election to be taxable REIT subsidiaries and are consolidated with the Company for financial statement purposes but are not consolidated with the Company for tax reporting purposes from that date forward. All material intercompany accounts and transactions are eliminated in consolidation.

New accounting pronouncements

In June 2004, the FASB issued EITF 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-01 requires an investor to determine when an investment is considered impaired, evaluate whether that impairment is other than temporary, and, if the impairment is other than temporary, recognize an impairment loss equal to the difference between the investment’s cost and its fair value. The guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The impairment loss recognition and measurement guidance was to be applicable to other-than-temporary impairment evaluations in reporting periods beginning after June 15, 2004. In September 2004, the FASB proposed additional guidance related to debt securities that are impaired because of interest rate and/or sector spread increases, and delayed the effective date of EITF 03-01. The Company does not expect the adoption of EITF 03-01 to have a material effect on the financial condition, results of operations, or liquidity of the Company. The Company has already adopted the EITF 03-01 disclosure requirements for investments in an unrealized loss position for which other-than-temporary impairments have not been recognized.

In December 2004, the FASB published SFAS 123(R) entitled “Share-Based Payment.” It requires all public companies to report share-based compensation expense at the grant date fair value of the related share-based awards. The Company is required to adopt the provisions of the standard effective for annual periods beginning after June 15, 2005. Management believes that the Company’s current method of accounting for share-based payments is consistent with SFAS 123(R).

Cash and cash equivalents

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

Restricted cash and cash equivalents

Restricted cash and cash equivalents include cash and highly liquid investments with original maturities of three months or less that are held by counter-parties as collateral for reverse repurchase agreements, Asset-backed CP and Hedging Instruments. The carrying amount of restricted cash and cash equivalents approximates their fair value.

ARM assets

The Company’s ARM assets are comprised of ARM securities and ARM Loans. All of the Company’s ARM assets are either Traditional ARMs or Hybrid ARMs.

ARM securities are composed mainly of ARM securities purchased from third parties. The Company has designated all of its ARM securities as available-for-sale. Therefore, they are reported at fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss) as a separate component of shareholders’ equity. Any unrealized loss deemed to be other than temporary is recorded as a realized loss. Realized gains or losses on the sale of ARM securities are recorded in earnings at the time of sale and are determined by the difference between net sale proceeds and the amortized cost of the securities.

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

ARM loans collateralizing CDOs are loans the Company has securitized into sequentially rated classes with the lower rated classes providing credit support for certificates issued to third-party investors in structured financing arrangements.

In accordance with SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, loan securitizations resulting in securitized ARM loans and ARM loans collateralizing CDOs are accounted for as secured borrowings under paragraphs 9(a)-9(c) of SFAS 140 because (1) the Company has the unilateral ability to cause the return of transferred assets and, therefore, has maintained effective control over the transferred assets and (2) the transactions are completed through SPEs that do not meet the requirements of SFAS 140 to be considered QSPEs.

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

ARM Loans are designated as held-for-investment as the Company has the intent and ability to hold them for the foreseeable future, and until maturity or payoff. ARM Loans are carried at their unpaid principal balances, including unamortized premium or discount, unamortized loan origination costs, unamortized deferred loan origination fees and reserve for loan losses. In accordance with SFAS 140, securitized ARM loans and ARM loans collateralizing CDOs are accounted for as loans and are not considered investments subject to classification under SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities.”

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

MSRs

The Company does not purchase or capitalize any MSRs in connection with any loan sale transaction. MSRs are capitalized upon the securitization of ARM loans as required by GAAP by allocating a portion of the cost basis of

the securitized loans to the estimated value of the servicing asset related to the loans retained by the Company as collateral in securitizations. MSRs are included in prepaid expenses and other on the Consolidated Balance Sheets. The servicing revenue, net of servicing costs and MSR amortization, is recorded as Servicing income, net on the Consolidated Income Statements, rather than being accounted for as interest income.

MSRs are carried at the lower of cost or fair value at the risk strata level and are periodically evaluated for impairment based on fair value, which is determined using a discounted future cash flow model that considers portfolio characteristics and assumptions regarding prepayment speeds, delinquency rates and other economic factors. For purposes of evaluating and measuring impairment of MSRs, the Company stratifies its portfolio on the basis of predominant risk characteristics, including loan type (Traditional ARM or Hybrid ARM).

MSRs are amortized in proportion to, and over the expected period of, the estimated future net servicing income. Projected net servicing income is determined by the estimated future balance of the underlying mortgage loan portfolio, which declines over time from prepayments and scheduled loan amortization. The Company estimates future prepayment rates based on current interest rate levels, other economic conditions and market forecasts, as well as relevant characteristics of the servicing portfolio, such as loan types and recent prepayment experience. Estimating prepayments and estimating the remaining lives of the Company’s ARM assets requires management judgment, which involves consideration of possible future interest rate environments and an estimate of how borrowers will behave in those environments. The actual lives could be longer or shorter than the amount estimated by management.

Credit risk and reserve for loan losses

The Company limits its exposure to credit losses on its portfolio of ARM securities by purchasing ARM securities that generally have at least an Investment Grade rating at the time of purchase and have some form of credit enhancement, or are Agency Securities. The Company also purchases and originates “A quality” ARM loans.

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

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

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

Valuation methods

The fair values of the Company’s ARM securities, securitized ARM loans and ARM loans collateralizing CDOs are generally based on market prices provided by third-party pricing services or by broker/dealers who make markets in these financial instruments. If the fair value of an ARM security or securitized ARM loan is not reasonably available from a dealer or a third-party pricing service, management estimates the fair value based on characteristics of the security that the Company receives from the issuer and on available market information.

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

The net unrealized gain or loss on commitments to purchase ARM loans from correspondent lenders and bulk sellers is calculated using the same methodologies that are used to price the Company’s originated ARM Loans, adjusted for anticipated fallout for purchase loan commitments that will likely not be funded. The Company’s net unrealized gain (loss) on purchase loan commitments is recorded as a component of ARM loans, net on the Consolidated Balance Sheets with the respective changes in fair value recorded in gain (loss) on ARM assets and Hedging Instruments, net on the Consolidated Income Statements.

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

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

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

Hedging Instruments

All of the Company’s Hedging Instruments are carried on the Consolidated Balance Sheets at their fair value as an asset, if their fair value is positive, or as a liability, if their fair value is negative. In general, most of the Company’s Hedging Instruments are designated as cash flow hedges, and the effective amount of change in the fair value of the derivative instrument is recorded in accumulated other comprehensive income (loss) and transferred to earnings as the hedged item affects earnings. The ineffective amount of all Hedging Instruments is recognized in earnings each quarter. Generally, a hedging strategy is effective under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) if it achieves offsetting cash flows attributable to the risk being hedged and meets certain statistical measures pursuant to SFAS 133. If the hedging strategy is not successful in achieving offsetting cash flows or meeting the statistical measures, it is ineffective.

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

Hybrid ARM Hedging Instruments

The Company enters into Hybrid ARM Hedging Instruments in order to manage its interest rate exposure when financing its Hybrid ARM assets. Though the Company generally borrows money based on short-term interest rates, its Hybrid ARM assets have an initial fixed interest rate period of three to ten years. As a result, the Company’s

existing and forecasted borrowings reprice to a new rate on a more frequent basis than do the Hybrid ARM assets. Consequently, the Company uses Hybrid ARM Hedging Instruments to fix the interest rate on its borrowings during the expected fixed interest rate period of the Hybrid ARM assets such that the combined Effective Duration of its borrowings and Hybrid ARM Hedging Instruments closely matches the Effective Duration of the Hybrid ARM assets, the difference being Net Effective Duration. The notional balances of the Hybrid ARM Hedging Instruments generally decline over the life of these instruments approximating the declining balance of the Hybrid ARM assets being financed.

Swap Agreements and Eurodollar Transactions have the effect of converting the Company’s variable-rate debt into fixed-rate debt over the life of the Swap Agreements and Eurodollar Transactions. When the Company enters into a Swap Agreement, it agrees to pay a fixed rate of interest and to receive a variable interest rate, generally based on LIBOR. The Company also enters into Eurodollar Transactions in order to fix the interest rate on its forecasted three-month LIBOR-based liabilities. When the Company enters into a Eurodollar Transaction, it incurs a gain if the applicable interest rate index subsequently rises or a loss if the applicable interest rate index subsequently declines. The amortization of the gain or loss over the hedged period when combined with the variable cost of the short-term debt is expected to result in a fixed interest cost over the life of the Eurodollar Transaction.

The Company enters into Cap Agreements by incurring a one-time fee or premium. Pursuant to the terms of the respective Cap Agreements, the Company will receive cash payments if the interest rate index specified in any such Cap Agreement increases above contractually specified levels. Therefore, such Cap Agreements have the effect of capping the interest rate on a portion of the Company’s borrowings so as not to exceed the level specified by the Cap Agreement. The purchase price of these Cap Agreements is expensed over the life of the Cap Agreements and the expense increases as the Cap Agreements approach maturity. Therefore, the expense in future periods is expected to be greater than that experienced initially.

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

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

Pipeline Hedging Instruments

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

Long-term incentive awards

The Company has a long-term incentive plan which is more fully described in Note 8. Since inception of the plan in 2002, the Company has accounted for all awards issued and future awards under the fair value recognition provisions of SFAS 123, “Accounting for Stock-Based Compensation.” The PSRs issued under the plan are variable in nature and are settled in cash. The liability for PSRs is measured each period based on the fair value of the Common Stock.

The effects of changes in the stock price during the vesting period, generally three years, are recognized as expense over the vesting period in accordance with FIN 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.” Dividend-equivalent payments on vested and unvested PSRs and DERs are recognized as compensation expense in the period in which they are declared.

Accumulated other comprehensive income (loss)

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

The net unrealized gain on the Company’s ARM Loans of $22.4 million and $64.6 million at March 31, 2005 and December 31, 2004, respectively, is not included in accumulated other comprehensive income (loss) because, in accordance with GAAP, the ARM Loans are carried at their amortized cost basis.

Income taxes

The Company, excluding TMHL and its subsidiaries, elected to be taxed as a REIT and believes it complies with the provisions of the Code with respect thereto. Accordingly, the Company will not be subject to federal income tax on that portion of its income that is distributed to shareholders as long as certain asset, income and stock ownership tests are met. TMHL and each of its subsidiaries made the election to be taxable REIT subsidiaries as of the close of business on May 31, 2004 and, as such, are subject to both federal and state corporate income tax after that date.

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

Income taxes for the quarter ended March 31, 2005 were immaterial and no provision is reflected on the Consolidated Income Statements. The only significant difference between the financial statement carrying amount of existing assets and liabilities and their respective tax bases relates to MSRs capitalized for financial statement purposes. The related deferred liability is immaterial at March 31, 2005 and is included in Accrued expenses and other on the Consolidated Balance Sheets.

Net earnings per share

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

Following is information about the computation of the EPS data for the three-month periods ended March 31, 2005 and 2004 (in thousands except per share data):


	Income		Shares	EPS
Three Months Ended March 31, 2005
EPS, income available to common shareholders	$	67,356	93,173	$	0.72

Three Months Ended March 31, 2004
EPS, income available to common shareholders	$	53,363	76,631	$	0.70

Use of estimates

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

Note 2. ARM Assets

The following tables present the Company’s ARM assets as of March 31, 2005 and December 31, 2004 (in thousands):


March 31, 2005	ARM securities			Securitized ARM loans			ARM loans collateralizing CDOs			ARM loans held for securitization			Total
Principal balance outstanding	$	19,538,576		$	3,983,903		$	6,325,134		$	450,963		$	30,298,576
Net unamortized premium		271,445			25,579			32,488			183			329,695
Loan loss reserves		—			(7,552	)		(2,042	)		(250	)		(9,844	)
Non-accretable discounts		(7,991	)		—			—			—			(7,991	)
Net unrealized gain on purchase loan commitments		—			—			—			(1,717	)		(1,717	)
Principal payment receivable		13,676			2,555			—			—			16,231

Amortized cost, net		19,815,706			4,004,485			6,355,580			449,179			30,624,950
Gross unrealized gains		7,623			13,575			65,608			1,826			88,632
Gross unrealized losses		(332,569	)		(57,540	)		—			(1,103	)		(391,212	)

Fair value	$	19,490,760		$	3,960,520		$	6,421,188		$	449,902		$	30,322,370

Carrying value	$	19,490,760		$	4,004,485		$	6,355,580		$	449,179		$	30,300,004


December 31, 2004	ARM securities			Securitized ARM loans			ARM loans collateralizing CDOs			ARM loans held for securitization			Total
Principal balance outstanding	$	18,553,951		$	2,894,025		$	6,683,216		$	464,569		$	28,595,761
Net unamortized premium		275,592			10,844			39,351			2,095			327,882
Loan loss reserves		—			(7,427	)		(1,757	)		(250	)		(9,434	)
Non-accretable discounts		(6,478	)		—			—			—			(6,478	)
Net unrealized gain on purchase loan commitments		—			—			—			(193	)		(193	)
Principal payment receivable		10,317			2,543			—			—			12,860

Amortized cost, net		18,833,382			2,899,985			6,720,810			466,221			28,920,398
Gross unrealized gains		19,832			8,367			90,018			1,062			119,279
Gross unrealized losses		(197,169	)		(32,928	)		(120	)		(1,847	)		(232,064	)

Fair value	$	18,656,045		$	2,875,424		$	6,810,708		$	465,436		$	28,807,613

Carrying value	$	18,656,045		$	2,899,985		$	6,720,810		$	466,221		$	28,743,061

The Company recorded a net gain on ARM assets and Hedging Instruments of $3.0 million during the three months ended March 31, 2005. This gain consists of a $1.6 million gain on the sale of $277.9 million of ARM assets, a net gain of $7.1 million on Pipeline Hedging Instruments and a net loss of $5.7 million on commitments to purchase loans from correspondent lenders and bulk sellers. The Company realized a gain on ARM assets of $3.5 million during the three months ended March 31, 2004. This gain consists of a $3.2 million gain on the sale of $345.5 million of ARM assets and a gain of $3.8 million on commitments to purchase loans from correspondent lenders and bulk sellers, partially offset by a net loss of $3.5 million on Pipeline Hedging Instruments.

During the three months ended March 31, 2005, the Company securitized $1.3 billion of its ARM loans into a series of private-label multi-class ARM securities. While TMHL transferred substantially all of the ARM loans to a separate bankruptcy-remote legal entity, on a consolidated basis: (i) the Company did not account for this securitization as a sale and, therefore, did not record any gain or loss in connection with the securitization and (ii) the Company retained all of the resulting securities for its securitized ARM loan portfolio. Of the securities retained, 99.3% were rated Investment Grade and 0.7%

were rated less than Investment Grade. As of March 31, 2005, the Company had $10.4 billion of ARM assets as a result of the Company’s securitization efforts. As of December 31, 2004, the Company had $9.6 billion of ARM assets as a result of the Company’s securitization efforts. All discussions relating to securitizations in this Form 10-Q are on a consolidated basis and do not reflect the separate legal ownership of the loans by various bankruptcy-remote legal entities that are the Company’s wholly-owned subsidiaries.

During the quarter ended March 31, 2005, the Company purchased $1.4 billion of third party loan securitizations in transactions in which the Company purchased all classes of the securitizations, including the subordinated classes. At March 31, 2005 and December 31, 2004, the Company’s ARM securities included $4.8 billion and $3.6 billion, respectively, resulting from the Company’s aggregate purchase of third party loan securitizations. Because the Company purchases all classes of these securitizations, the Company has credit exposure on the underlying loans. The purchase price of the classes that are less than Investment Grade generally includes a discount for probable credit losses and, based on management’s judgment, the portion of the purchase discount which reflects the estimated unrealized loss on the securities due to credit risk is treated as a non-accretable discount. The Company recorded non-accretable discounts of $1.9 million related to securities purchased during the first quarter of 2005. As of March 31, 2005 and December 31, 2004, the Company had total non-accretable discounts of $8.0 million and $6.5 million, respectively, on its ARM securities due to estimated credit losses (other than temporary declines in fair value) related to ARM securities purchased at a discount. As of March 31, 2005, 31 of the underlying loans were considered seriously delinquent (60 days or more delinquent) and had an aggregate balance of $7.4 million.

During the three months ended March 31, 2005 and 2004, the Company recorded loan loss provisions totaling $409,000 and $432,000, respectively, to reserve for estimated credit losses on ARM Loans bringing its total loan loss reserve to $9.8 million and $9.4 million, respectively.

The following table shows the gross unrealized losses and fair value of ARM securities, aggregated by credit rating and length of time that the 611 individual securities have been in a continuous unrealized loss position, at March 31, 2005 (dollar amounts in thousands):

Unrealized Losses on ARM Securities as of March 31, 2005


	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Agency Securities	$	1,562,847	$	(20,723	)	$	627,463	$	(15,658	)	$	2,190,310	$	(36,381	)
AAA/Aaa rating		11,359,980		(134,576	)		4,971,262		(148,347	)		16,331,242		(282,923	)
AA/Aa rating		127,780		(1,258	)		68,308		(9,328	)		196,088		(10,586	)
A rating		65,350		(917	)		3,724		(135	)		69,074		(1,052	)
BBB/Baa rating		25,804		(554	)		8,732		(803	)		34,536		(1,357	)
BB/Ba rating and below		11,587		(270	)		—		—			11,587		(270	)

Total	$	13,153,348	$	(158,298	)	$	5,679,489	$	(174,271	)	$	18,832,837	$	(332,569	)

The unrealized losses in the above table are temporary impairments due to changes in market interest rates and, based upon review of credit ratings, delinquency data and other information, are not reflective of credit deterioration. As the Company has the ability and intent to hold its ARM securities until recovery, losses are not considered to be other than temporary impairments. As presented in Note 7, during the three-month period ended March 31, 2005, the net unrealized loss of $177.3 million on ARM securities increased by $147.6 million to a net unrealized loss of $324.9 million. During the same three-month period in 2005, the net unrealized gain on Hedging Instruments of $86.6 million increased by $200.5 million to a net unrealized gain of $287.1 million, for a combined increase in the net unrealized loss on ARM securities and Hedging Instruments of $52.9 million. While the Company’s ARM securities are designated as available-for-sale, the Company does not typically sell its ARM securities and therefore does not expect to realize these gross unrealized losses.

The Company has credit exposure on its ARM Loans. The following tables summarize ARM Loan delinquency information as of March 31, 2005 and December 31, 2004 (dollar amounts in thousands):


March 31, 2005
Delinquency Status	Loan Count	Loan Balance		Percent of ARM Loans		Percent of Total Assets
60 to 89 days	1	$	272	0.00	%	0.00	%
90 days or more	1		5,000	0.05		0.02
In bankruptcy and foreclosure	6		2,811	0.03		0.01

	8	$	8,083	0.08	%	0.03	%


December 31, 2004
Delinquency Status	Loan Count	Loan Balance		Percent of ARM Loans		Percent of Total Assets
60 to 89 days	1	$	5,000	0.05	%	0.02	%
90 days or more	2		517	0.01		0.00
In bankruptcy and foreclosure	5		2,165	0.02		0.01

	8	$	7,682	0.08	%	0.03	%

As of March 31, 2005, the Company owned one real estate property as a result of foreclosing on a delinquent loan in the amount of $368,000 (not included in the table above.) The Company believes that its current level of loan loss reserves is adequate to cover estimated losses from this loan as well as losses inherent in the ARM loan portfolio at March 31, 2005.

MSRs capitalized upon the securitization of $1.3 billion and $1.1 billion of ARM loans during the three months ended March 31, 2005 and 2004, respectively, totaled $7.8 million and $3.7 million, respectively. MSRs of $27.4 million, net of amortization of $980,000 during the three months ended March 31, 2005, are included in prepaid expenses and other on the Consolidated Balance Sheets at March 31, 2005. MSRs of $20.6 million are included in prepaid expenses and other on the Consolidated Balance Sheets at December 31, 2004. At March 31, 2005, the fair value of the MSRs in each risk stratum exceeded their cost basis.

As of March 31, 2005, the Company had commitments to purchase or originate the following amounts of ARM assets (dollar amounts in thousands):


ARM securities – private high quality	$	246,504
ARM loans – correspondent originations		542,974
ARM loans – direct originations		78,996

	$	868,474

The Company has entered into transactions whereby the Company expects to acquire the remaining balance of certain AAA-rated Hybrid ARM securities, at a price of par, between 2006 and 2008, when the fixed-rate period of the Hybrid ARM securities terminates and the securities convert into Traditional ARM securities with characteristics similar to the Traditional ARM securities held in the current portfolio. The Company views these transactions as an alternative source of Traditional ARM assets. At March 31, 2005, the balance of the Hybrid ARM securities was approximately $1.3 billion, but is expected to be less than 60% of that, and could be zero, at the time they convert into Traditional ARM securities. If the Company decides not to acquire the Hybrid ARM securities when they convert into Traditional ARM securities, then it is committed to pay or receive the difference between par and the fair value of the Traditional ARM securities at that time, as determined by an auction of the Traditional ARM securities. As of March 31, 2005, the Company had delivered ARM assets with a carrying value of $2.9 million and $3.2 million in cash as collateral in connection with these transactions.

Note 3. Hedging Instruments

Hybrid ARM Hedging Instruments

As of March 31, 2005 and December 31, 2004, the Company was counterparty to Hybrid ARM Hedging Instruments that consist of Swap Agreements and Eurodollar Transactions having aggregate current notional balances of $22.8 billion and $19.6 billion, respectively. In addition, as of March 31, 2005, the Company had entered into delayed Swap Agreements with notional balances totaling $2.8 billion that become effective between April 2005 and October 2006 and are also accounted for as cash flow hedges as of March 31, 2005. These delayed Swap Agreements have been entered into to hedge the forecasted financing of the Company’s ARM asset purchase commitments at March 31, 2005. As of March 31, 2005, these Swap Agreements and Eurodollar Transactions had a weighted average maturity of 2.6 years. In accordance with the Swap Agreements, the Company will pay a fixed rate of interest during the term of these Swap Agreements and receive a payment that varies monthly with the one-month LIBOR rate. The combined weighted average fixed rate payable of the Swap Agreements and Eurodollar Transactions was 3.14% and 3.04% at March 31, 2005 and December 31, 2004, respectively. As of March 31, 2005, ARM assets with a carrying value of $3.0 million, including accrued interest, collateralized the Swap Agreements. The Company held net cash collateral from Swap Agreement counterparties totaling $49.1 million at March 31, 2005.

The net unrealized gain on Swap Agreements at March 31, 2005 of $301.8 million included Swap Agreements with gross unrealized gains of $306.5 million and gross unrealized losses of $4.7 million and is included in Hedging Instruments on the Consolidated Balance Sheets. As of December 31, 2004, the net unrealized gain of $108.1 million included Swap Agreements with gross unrealized gains of $129.4 million and gross unrealized losses of $21.3 million. As of March 31, 2005, the net unrealized gain on Swap Agreements and deferred gains and losses on Eurodollar Transactions recorded in accumulated other comprehensive income (loss) totaled a net gain of $302.1 million. Over the next twelve months, $39.2 million of these net unrealized gains are expected to be realized.

As of March 31, 2005 and December 31, 2004, the Company’s Cap Agreements used to manage the interest rate risk exposure on the financing of Hybrid ARM loans collateralizing CDOs had remaining notional amounts of $1.2 billion and $1.3 billion, respectively. The Company has also entered into Cap Agreements that have start dates ranging from 2006 to 2010. The notional balance at the start date will be the lesser of the scheduled amount of $371.1 million or the balance of Hybrid ARM loans associated with these Cap Agreements. The fair value of all of these Cap Agreements at March 31, 2005 and December 31, 2004 was $20.3 million and $14.8 million, respectively, and is included in Hedging Instruments on the Consolidated Balance Sheets. As of March 31, 2005 and December 31, 2004, the unrealized losses on these Cap Agreements of $14.9 million and $21.1 million, respectively, are included in accumulated other comprehensive income (loss). In the twelve month period following March 31, 2005, $4.4 million of this unrealized loss is expected to be realized. Pursuant to the terms of these Cap Agreements and subject to future prepayment behavior, the notional amount of the Cap Agreements declines such that it is expected to equal the balance of the Hybrid ARM loans collateralizing CDOs. Under these Cap Agreements, the Company will receive cash payments should the one-month LIBOR increase above the contract rates of these Hedging Instruments, which range from 3.25% to 11.50% and average 5.29%. The Cap Agreements had an average maturity of 3.7 years as of March 31, 2005 and will expire between 2006 and 2013.

The Company hedges the funding of its Hybrid ARM assets such that the Net Effective Duration is less than one year. At March 31, 2005, the financing and hedging of the Company’s Hybrid ARM assets resulted in a Net Effective Duration of approximately 4.8 months while the financing and hedging of all of the Company’s ARM assets resulted in a Net Effective Duration of approximately 4.4 months. This suggests a low degree of portfolio price change given small changes in interest rates, and implies that the Company’s cash flow and earning characteristics should be relatively stable as interest rates change.

Interest expense for the quarter ended March 31, 2005 includes net payments on Hybrid ARM Hedging Instruments of $25.8 million. Interest expense for the same period in 2004 includes net payments on Hybrid ARM Hedging Instruments of $61.5 million.

Pipeline Hedging Instruments

The fair value of the Pipeline Hedging Instruments at March 31, 2005 and December 31, 2004 was a net unrealized gain of $6.2 million and a net unrealized loss of $2.0 million, respectively, and is included in Hedging Instruments on the Consolidated Balance Sheets. Pipeline Hedging Instruments had remaining notional balances of $651.0 million and $688.0 million at March 31, 2005 and December 31, 2004, respectively. During the three-month periods ended March 31, 2005 and 2004, the Company recognized a $7.1 million gain and a $3.5 million loss, respectively, on Pipeline Hedging Instruments, which is included in gain on ARM assets and Hedging Instruments, net, in the Company’s Consolidated Income Statements along with a $5.7 million loss and a $3.8 million gain recorded on loan commitments for the three-month periods ended March 31, 2005 and 2004, respectively.

Note 4. Borrowings

Reverse Repurchase Agreements

The Company has arrangements to enter into reverse repurchase agreements, a form of collateralized short-term borrowing, with 23 different financial institutions, and as of March 31, 2005, had borrowed funds from 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 could initiate margin calls in the event interest rates change or the value of the Company’s ARM assets declines for other reasons.

As of March 31, 2005, the Company had $17.1 billion of reverse repurchase agreements outstanding with a weighted average borrowing rate of 2.95% and a weighted average remaining maturity of 3.0 months. As of December 31, 2004, the Company had $14.2 billion of reverse repurchase agreements outstanding with a weighted average borrowing rate of 2.49% and a weighted average remaining maturity of 3.6 months. As of March 31, 2005, $16.6 billion of the Company’s borrowings were variable-rate term reverse repurchase agreements with original maturities that range from three to eighteen months. The interest rates of these term reverse repurchase agreements are indexed to either the one- or three-month LIBOR rate and reprice accordingly. ARM assets with a carrying value of $17.8 billion, including accrued interest, and cash totaling $9.4 million, collateralized the reverse repurchase agreements at March 31, 2005.

At March 31, 2005, the reverse repurchase agreements had the following remaining maturities (in thousands):


Within 30 days	$	3,404,406
31 to 89 days		5,892,644
90 to 365 days		7,779,470

	$	17,076,520

Asset-backed CP

On June 30, 2004, the Company established a $5 billion Asset-backed CP facility, which provides an alternative way to finance the Company’s high quality ARM securities portfolio. The Company issues Asset-backed CP to investors in the form of secured liquidity notes that are recorded as borrowings on the Company’s Consolidated Balance Sheets and are rated P-1 by Moody’s Investors Services and F1+ by Fitch Ratings. As of March 31, 2005, the Company had $5.0 billion of Asset-backed CP outstanding with a weighted average interest rate of 2.99% and a weighted average remaining maturity of 16 days.

As of March 31, 2005, these notes were collateralized by AAA-rated MBS from the Company’s ARM securities portfolio with a carrying value of $5.3 billion, including accrued interest.

CDOs

All of the Company’s CDOs are secured by ARM loans. For financial reporting purposes, the ARM loans held as collateral are recorded as assets of the Company and the CDOs are recorded as the Company’s debt. In some transactions, Hedging Instruments are held by the trusts and recorded as assets or liabilities of the Company. The

Hedging Instruments either fix the interest rates of the pass-through certificates or cap the interest rate exposure on these transactions. As of March 31, 2005, the following CDOs were outstanding (dollar amounts in thousands):


Description	Principal Balance		Effective Interest Rate (1)
Floating-rate financing (2)	$	3,093,485	3.44	%
Fixed-rate financing (3)		3,161,235	4.17	%

Total	$	6,254,720	3.81	%

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

(2)	Includes financing hedged with Cap Agreements with a notional balance of $1.2 billion and a weighted average strike price of 5.29% as of March 31, 2005.

(3)	Includes floating-rate financing hedged with Swap Agreements with a notional balance of $1.8 billion.

As of March 31, 2005, the CDOs were collateralized by ARM loans with a principal balance of $6.4 billion. The debt matures between 2033 and 2044 and is callable by the Company at par once the total balance of the loans collateralizing the debt is reduced to 20% of their original balance. The balance of this debt is reduced as the underlying loan collateral is paid down and is expected to have an average life of approximately four years.

Whole Loan Financing Facilities

As of March 31, 2005, the Company had entered into four whole loan financing facilities. The interest rates on these facilities are indexed to one-month LIBOR and reprice accordingly. These facilities had a total committed borrowing capacity of $900 million and an uncommitted capacity of $650 million and expire between May 2005 and February 2006. The Company expects to renew these facilities when they expire or replace them with new facilities with similar terms. As of March 31, 2005, the Company had $107.2 million borrowed against these whole loan financing facilities at an effective rate of 3.38%. As of December 31, 2004, the Company had $285.6 million borrowed against whole loan financing facilities at an effective cost of 3.36%. The amount borrowed on the whole loan financing facilities at March 31, 2005 was collateralized by ARM loans with a carrying value of $109.9 million, including accrued interest. These facilities have covenants that are standard for industry practice and the Company was in compliance with all such covenants at March 31, 2005.

One of the whole loan financing facilities discussed above (with a committed borrowing capacity of $300 million and maturing in May 2005), is a securitization transaction in which the Company transfers groups of whole loans to a wholly owned bankruptcy-remote special purpose subsidiary. The subsidiary, in turn, simultaneously transfers its interest in the loans to a trust, which issues beneficial interests in the loans in the form of a note and a subordinated certificate. The note is then used to collateralize borrowings. This whole loan financing facility is similar to a secured line of credit whereby the Company can deliver loans into the facility and take loans out of the facility at the Company’s discretion, subject to the terms and conditions of the facility. This securitization transaction is accounted for as a secured borrowing.

Senior Notes

The Company had $305.0 million in Senior Notes outstanding at March 31, 2005. The Senior Notes bear interest at 8.0%, payable each May 15 and November 15, and mature on May 15, 2013. The Senior Notes are redeemable at a declining premium, in whole or in part, beginning on May 15, 2008, and at par beginning on May 15, 2011. The Senior Notes may also be redeemed under limited circumstances on or before May 15, 2006. In connection with the issuance of the Senior Notes, the Company incurred costs of $5.4 million, which are being amortized to interest expense over the expected life of the Senior Notes. The Company received a premium of $3.6 million related to the notes offering, which is being amortized over the remaining expected life of the Senior Notes. At March 31, 2005 and December 31, 2004, the balance of the Senior Notes outstanding, net of unamortized issuance costs and premium, was $304.2 million and $304.2 million, respectively, and had an effective cost of 8.07% and 8.06%, respectively, which reduced the effect of issuance cost and premium received at issuance.

The Company’s Senior Note obligations contain both financial and non-financial covenants. Significant financial covenants include limitations on the Company’s ability to incur indebtedness beyond specified levels, restrictions on the Company’s ability to incur liens on assets and limitations on the amount and type of restricted payments, such as repurchases of its own equity securities, that the Company makes. As of March 31, 2005, the Company was in compliance with all financial and non-financial covenants on its Senior Note obligations.

Other

The total cash paid for interest was $202.1 million and $120.3 million for the quarters ended March 31, 2005 and 2004, respectively.

Contractual Obligations

As of March 31, 2005, the Company had the following contractual obligations (in thousands):


	Payments Due by Period
	Total		Less than 1 year		1 – 3 years		3 – 5 years		More than 5 years
Reverse repurchase agreements	$	17,076,520	$	17,076,520	$	—	$	—	$	—
Asset-backed CP		4,990,000		4,990,000
CDOs (1)		6,254,720		10,780		28,137		58,120		6,157,683
Whole loan financing facilities		107,185		107,185		—		—		—
Senior Notes		304,198		—		—		—		304,198
ARM asset purchase commitments		868,474		868,474		—		—		—

Total (2)	$	29,601,097	$	23,052,959	$	28,137	$	58,120	$	6,461,881

(1)

Maturities of the Company’s CDOs are dependent upon cash flows received from the underlying loans receivable. The estimate of their repayment is based on scheduled principal payments on the underlying loans receivable. This estimate will differ from actual amounts to the extent prepayments and/or loan losses are experienced.

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

Note 5. Fair Value of Financial Instruments and Off-Balance Sheet Credit Risk

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments at March 31, 2005 and December 31, 2004 (in thousands):


	March 31, 2005				December 31, 2004
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets:
ARM securities	$	19,490,760	$	19,490,760	$	18,656,045	$	18,656,045
Securitized ARM loans		4,004,485		3,960,520		2,899,985		2,875,424
ARM loans collateralizing CDOs		6,355,580		6,421,188		6,720,810		6,810,708
ARM loans held for securitization		449,179		449,902		466,221		465,436
Hedging Instruments		331,651		331,651		144,230		144,230
Liabilities:
Reverse repurchase agreements		17,076,520		17,076,520		14,248,939		14,248,939
Asset-backed CP		4,990,000		4,990,000		4,905,000		4,905,000
CDOs		6,254,720		6,256,938		6,623,641		6,640,932
Whole loan financing facilities		107,185		107,185		285,555		285,555
Senior Notes		304,198		311,100		304,173		324,825
Hedging Instruments		4,712		4,712		26,027		26,027

As of March 31, 2005, the Company has no off-balance sheet credit risk.

Note 6. Common and Preferred Stock

In March 2005, the Company completed a public offering of 2,000,000 shares of 8% Series C Cumulative Redeemable Preferred Stock and received net proceeds of $48.3 million. The Preferred Stock is redeemable, in whole or in part, beginning on March 22, 2010 at a price of $25.00 per share, plus accumulated unpaid dividends, if any. The Preferred Stock may also be redeemed under limited circumstances to preserve the Company’s REIT status prior to March 22, 2010. The Company is not required to redeem the shares. The Preferred Stock has no stated maturity date and is not convertible into Common Stock.

During the three-month period ended March 31, 2005, the Company issued 1,063,600 shares of Common Stock through at-market transactions and received net proceeds of $29.8 million under a controlled equity offering program.

During the three-month period ended March 31, 2005, the Company issued 1,670,461 shares of Common Stock under the DRSPP and received net proceeds of $45.7 million.

As of March 31, 2005, $317.6 million of the Company’s registered securities remained available for future issuance and sale under its shelf registration statement, declared effective on January 21, 2004.

On December 16, 2004, the Company declared the fourth quarter 2004 dividend of $0.68 per share of Common Stock, which was paid in January 2005 to shareholders of record as of December 31, 2004.

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

Note 7. Comprehensive Income (Loss)

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


	Unrealized gains (losses) on ARM securities			Unrealized (losses) gains on Hedging Instruments			Accumulated other comprehensive (loss) gain
Balance, December 31, 2003	$	(43,314	)	$	(99,464	)	$	(142,778	)
Net change		84,042			(115,973	)		(31,931	)

Balance, March 31, 2004	$	40,728		$	(215,437	)	$	(174,709	)

Balance, December 31, 2004	$	(177,337	)	$	86,622		$	(90,715	)
Net change		(147,609	)		200,547			52,938

Balance, March 31, 2005	$	(324,946	)	$	287,169		$	(37,777	)

Note 8. Long-Term Incentive Awards

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

As of March 31, 2005, there were 1,548,147 DERs outstanding, all of which were vested, and 1,004,682 PSRs outstanding, of which 842,435 were vested. The Company recorded expenses associated with DERs and PSRs of $1.4 million and $4.5 million for the quarters ended March 31, 2005 and 2004, respectively. The expense recorded in the first quarter of 2005 consists of $1.6 million associated with dividend equivalents paid on DERs and PSRs and $577,000 related to the amortization of unvested PSRs, partially offset by $759,000 resulting from the impact of the decrease in the Common Stock price on the value of the PSRs which was recorded as a fair value adjustment. Of the expense recorded in the first quarter of 2004, $2.5 million was the impact of the increase in the Common Stock price on the value of the PSRs, $1.4 million was the amount of dividend equivalents paid on DERs and PSRs and $585,000 was the amortization of unvested PSRs.

Note 9. Transactions with Related Parties

The Company is managed externally by the Manager under the terms of the Management Agreement. The Manager receives an annual base management fee of 1.23% on the first $300 million of Average Historical Equity, plus 0.93% on Average Historical Equity above $300 million with the fee earned on Average Historical Equity over $1.5 billion limited to 0.82% decreasing an additional 0.05% for each additional $0.5 billion in Average Historical Equity thereafter until reaching a fee of 0.67% on any Average Historical Equity greater than $3.0 billion. These percentages are subject to an inflation adjustment each July based on changes to the Consumer Price Index over the prior twelve month period. The Manager earns a performance-based incentive fee of 20% of the Company’s annualized net income, before performance-based compensation, above an annualized Return on Equity equal to the Ten Year U.S. Treasury Rate plus 1% with the fee limited such that once the Manager has earned a performance fee of $30 million, the performance fee percentage of 20% is reduced by 1% for each additional $5 million earned in performance fees until reaching a performance fee percentage of 15% for any amount greater than $50 million.

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

During the quarters ended March 31, 2005 and 2004, the Company reimbursed the Manager $1.6 million and $1.3 million, respectively, for expenses in accordance with the terms of the Management Agreement. As of March 31, 2005 and 2004, $1.7 million and $1.2 million, respectively, was payable by the Company to the Manager for these reimbursable expenses.

For the quarters ended March 31, 2005 and 2004, the Company incurred base management fees of $4.7 million and $3.6 million, respectively, in accordance with the terms of the Management Agreement. As of March 31, 2005 and 2004, $1.6 million and $1.3 million, respectively, was payable by the Company to the Manager for the base management fee.

For the quarters ended March 31, 2005 and 2004, the Manager earned performance-based compensation in the amount of $10.0 million and $8.3 million, respectively. As of March 31, 2005 and 2004, $10.0 million and $8.3 million, respectively, was payable by the Company to the Manager for performance-based compensation.

Pursuant to an employee residential mortgage loan program approved by the Board of Directors as part of the Company’s residential loan mortgage origination activities, certain of the directors and officers of the Company and employees of the Manager and of other affiliates of the Company have obtained residential first lien mortgage loans from the Company. In general, the terms of the loans and the underwriting requirements are identical to the loan programs that the Company offers to unaffiliated third parties, except that participants in the program qualify for an employee discount on the interest rate. At the time each participant enters into a loan agreement, such participant executes an addendum that provides for the discount on the interest rate that is subject to cancellation at the time such participant’s employment is terminated for any reason. Effective with the enactment of the Sarbanes-Oxley Act of 2002 on July 30, 2002, any new loans made to directors or executive officers are not eligible for the employee discount. As of March 31, 2005, the aggregate balance of mortgage loans outstanding to directors and officers of the Company, employees of the Manager and other affiliates amounted to $38.1 million, had a weighted average interest rate of 4.07%, and maturities ranging between 2030 and 2035.

Note 10. Subsequent Events

On April 19, 2005, the Company declared the first quarter 2005 dividend of $0.68 per share of Common Stock, which is payable on May 13, 2005 to shareholders of record as of May 3, 2005.

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

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Executive Overview

Our goal is to acquire or originate ARM assets for our portfolio and manage them to achieve earnings and dividend stability as our primary objective and earnings and dividend growth as our secondary objective. In order to achieve these objectives, we must mitigate key risks inherent in the mortgage portfolio lending business, principally credit risk and interest rate risk, while simultaneously pursuing earnings growth strategies. Our three primary growth strategies are (i) to increase our more profitable, higher margin mortgage loan origination business; (ii) to raise new equity capital at a premium to book value in order to grow our assets and book value over time; and (iii) to better use our existing capital base by pursuing non-recourse funding sources, relying less on reverse repurchase agreements and more on CDOs to finance our balance sheet.

Growth Strategies

Higher Margin Loan Originations. Our goal remains to increase our loan originations as a percentage of our annual portfolio acquisitions due to the higher margin potential of those assets. Although the MBA is currently projecting a 6% decline in total mortgage originations in 2005, our goal is to originate $4.2 billion in mortgage loans in 2005, just 2% below our 2004 originations. Despite continued aggressive competition among mortgage lenders, our loan originations of $1.2 billion in the first quarter increased 29% over the year-ago period, and accounted for 31% of total acquisitions in the first quarter versus 20% a year ago. Our mortgage origination volumes remain stable with $622.0 million of loans in the pipeline at March 31, 2005, most of which we expect will close in the next quarter. We continue to see excellent growth in our correspondent channel and now have 182 correspondent partners across the country that are approved to originate loans to our pricing and documentation specifications. We intend to intensify our correspondent sales efforts during the second quarter by significantly expanding coverage in the Midwest and South Central U.S., regions that have, until now, remained largely untapped. In addition, we plan to implement a program to test our mortgage origination capability within the mortgage broker community, which historically has generated 65% of all residential mortgage production. This new origination channel has considerable potential, and based on our preliminary research, we believe we can partner effectively with select high quality mortgage brokers to enhance our direct retail origination efforts without compromising the credit quality and performance characteristics of our loan origination portfolio. Our ability to provide competitive rates, common sense underwriting, financially sensible ARM products — including our loan modification feature — and ongoing exceptional customer service should allow us to further grow our loan origination business across multiple channels and through our loyal customer base.

Accretive Capital Raises. Our ability to raise new equity capital at a premium to book value resulted in improvement in book value, asset acquisition activity and earnings growth during the quarter. We raised $75.5 million of new common equity capital during the first quarter by issuing 2.7 million common shares at an average net price of $27.67 per share. In March 2005, we also issued 2.0 million shares of Series C Cumulative Redeemable Preferred Stock for net proceeds of $48.3 million. Primarily as a result of raising this new equity and a reduction in our accumulated other comprehensive loss as a percentage of equity, our book value per common share rose 17% from $17.85 per share at March 31, 2004 to $20.97 per share at March 31, 2005. Our assets grew 38% from $22.4 billion at March 31, 2004 to $30.9 billion at March 31, 2005, and our net earnings increased 3% from $0.70 per share for the first quarter of 2004 to $0.72 per share for the first quarter of 2005.

Capital Efficient CDO Transactions. Since CDOs represent permanent financing and have no margin call risk, they reduce our financing capital requirements and provide an additional source of balance sheet and earnings growth. Our financing capital requirement is lowered to approximately 2% versus our customary 8% to 10% capital policy requirement for reverse repurchase agreement and Asset-backed CP financing. This more efficient use of capital allows us to invest in additional assets. As of March 31, 2005, the seven CDOs we completed over the past two years had freed up approximately $439 million of capital, enabling us to hold approximately $3.1 billion in additional ARM assets.

Consistent Profitability

We possess a number of strategic advantages that allow us to generate consistent profitability. One of these strategic advantages is our low operating expense structure. During the first quarter of 2005, our operating expenses as a percent of average assets were 0.28%, compared to 0.40% for the same quarter of 2004. We are able to operate at this low level of operating expenses relative to the size of our portfolio because we do not operate like a traditional mortgage lender. We acquire many of our assets through MBS purchases and originate loans by developing strategic partnerships with correspondent lenders, financial planners and other sources. As a result, we generally avoid the high overhead associated with retail branch networks and commissioned loan officers. In addition, we have developed other outsourced strategic partnerships that provide loan fulfillment services on a variable cost basis to our customers. We believe that this low, variable-cost model has allowed us to operate profitably with a lower interest rate spread on our portfolio, enabling us to mitigate certain cyclical risks frequently associated with mortgage banking and portfolio lending activities. One of the strategic decisions we have been able to make as a result of our low-cost operating model is to elect either to securitize our acquired and originated ARM loans or invest primarily in AAA- or AA-rated securities, Agency Securities or “A quality” ARM loans. This strategy has resulted in very low credit losses. It has also created a very liquid and readily financeable portfolio that has had low price volatility as compared to a portfolio of 30-year, fixed-rate mortgage assets. Additionally, we have been able to mitigate interest rate risk by entering into hedging transactions and still achieve acceptable returns for our shareholders. Finally, by employing a portfolio lending strategy and retaining all of our ARM loans, we do not depend on gain on sale income, which can fluctuate significantly with loan origination volume and market conditions.

Exceptional Credit Quality and Securitization

Whether we are acquiring ARM assets or originating and securitizing loans, our strategic focus is high credit quality assets. This strategy keeps our credit losses and financing costs low. It also creates significant portfolio liquidity and low portfolio price volatility, which ensures we have access to financing through the credit cycle and contributes to maintaining consistent profitability. As of March 31, 2005, 97.6% of our ARM asset portfolio was High Quality, compared to 97.5% at December 31, 2004. Many of our High Quality ARM assets consist of “A quality” ARM loans that we have either securitized for our own portfolio or that collateralize our CDO financings. We retain the risk of potential credit losses on these loans. We did not experience any credit losses on ARM Loans during the first quarter of 2005 and have only experienced $174,000 in credit losses since we began acquiring ARM loans in 1997. Although we believe our credit performance is reflective of the high credit quality of our borrowers, our prudent underwriting, property appraisal methods and policies and prudent management of our delinquent loan portfolio, we also recognize that our ARM Loan portfolio was, on average, only approximately 18 months old at March 31, 2005. Due to this lack of seasoning and, therefore, lack of relevant historical data, we have recorded a loan loss reserve of $9.8 million as of March 31, 2005, based on management’s expectations given industry loss experience on similar loans.

Interest Rate Risk Management

Interest rate changes affect our short-term borrowing costs, which as a spread lender can pose a risk to our profitability if not responsibly managed. To counter this potential risk, we purchase or originate only ARM assets and we adhere to a matched funding or duration matching strategy which means we use Hybrid ARM Hedging Instruments to fix, or cap, the interest rates on the short-term borrowings and CDOs that finance our Hybrid ARM assets. We hedge our financing cost such that we maintain a Net Effective Duration of less than one year. The lower the Effective Duration gap, the less impact interest rate changes should have on earnings. As of March 31, 2005, we had $26.4 billion of Hybrid ARM assets and had entered into Swap Agreements and Eurodollar Transactions with notional balances totaling $22.8 billion and delayed Swap Agreements with notional balances totaling $2.8 billion that become effective between April 2005 and October 2006. These delayed Swap Agreements have been entered into to hedge the forecasted financing of our ARM asset purchase commitments at March 31, 2005. Additionally, at March 31, 2005, we had Cap Agreements with a notional balance of $1.2 billion. These Cap Agreements do not receive any payments unless one-month LIBOR rises above a range of 3.25% to 11.50%, and on average 5.29%. As of March 31, 2005, we measured the Net Effective Duration applicable to our Hybrid ARM portfolio, related borrowings and Hybrid ARM Hedging Instruments at approximately 4.8 months while the financing and hedging of all of our ARM assets resulted in a Net Effective Duration of approximately 4.4 months.

We continue to employ a duration matching funding strategy as we acquire Hybrid ARM assets in order to stabilize earnings during periods of rising interest rates. As we acquire ARM assets, we attempt to “lock-in” a spread that is expected to provide a rate of return at or above our threshold requirement. In order to stabilize the spread over the expected life of our

ARM assets, we use Hedging Instruments in conjunction with our borrowings to approximate the repricing characteristics of our ARM assets. Given the prepayment uncertainties on our ARM assets, there is no guaranteed way to “lock-in” a spread between the yield on our ARM assets and the related borrowing that would produce an acceptable rate of return. However, through active management, we believe we can continue to mitigate a significant amount of net interest income volatility. See the discussion of Effects of Interest Rate Changes on page 53.

Funding Diversification

Another long-term objective is to achieve a balanced funding mix between Asset-backed CP, CDOs and reverse repurchase agreements in order to reduce our reliance on any one funding source. Historically, we have relied principally on reverse repurchase agreements for our funding needs. Since year end 2002, we have been actively working towards diversifying our financing sources. At that time, 91% of our financing was provided through reverse repurchase agreements. At March 31, 2005, reverse repurchase agreements only accounted for 59% of our borrowings, while CDOs represented 22% and our Asset-backed CP facility accounted for 17%. Given the success of the Asset-backed CP facility established in June 2004, we are now working towards increasing the size of the facility from $5 billion to $10 billion. We anticipate that CDOs and Asset-backed CP will continue to grow as a percentage of our financing sources in the quarters to come.

Forward-Looking Statements

Certain information contained in this Quarterly Report on Form 10-Q constitutes “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are based on our current expectations, estimates and projections. Pursuant to those sections, we may obtain a “safe harbor” for forward-looking statements by identifying those statements and by accompanying those statements with cautionary statements, which identify factors that could cause actual results to differ from those expressed in the forward-looking statements. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. The words “believe,” “anticipate,” “intend,” “aim,” “expect,” “will,” “strive,” “target” and “project” and similar words identify forward-looking statements. Such statements are not guarantees of future performance, events or results and involve potential risks and uncertainties. Accordingly, our actual results may differ from our current expectations, estimates and projections. Important factors that may impact our actual results or may cause our actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf include, but are not limited to, changes in interest rates, changes in yields available for purchase on adjustable and variable rate mortgage assets, changes in the yield curve, changes in prepayment rates, changes in the supply of mortgage-backed securities and loans, our ability to obtain financing and the terms of any financing that we do obtain. Other factors that may impact our actual results are discussed in our 2004 Annual Report on Form 10-K under the section entitled “Risk Factors”. We do not undertake, and specifically disclaim, any obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Corporate Governance

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

•

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

•

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

•

We have an Insider Trading Policy that prohibits any of the directors, officers or employees of the Company or the Manager from buying or selling Common Stock on the basis of material nonpublic information, and prohibits communicating material nonpublic information to others.

•

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

•

We have a formal internal audit function to further the effective functioning of our internal controls and procedures. Our internal audit plan is approved annually by the Audit Committee of the Board of Directors and is based on a formal risk assessment and is intended to provide management and the Audit Committee with an effective tool to identify and address areas of financial or operational concerns and ensure that appropriate controls and procedures are in place. We have implemented Section 404 of the Sarbanes-Oxley Act of 2002, which requires an evaluation of internal control over financial reporting in association with our financial statements for the year ending December 31, 2004. See “Controls and Procedures – Management’s Annual Report on Internal Control over Financial Reporting” on page 49 of our 2004 Annual Report on Form 10-K.

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

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

Critical Accounting Policies and Estimates

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

•

Revenue Recognition. Interest income on ARM assets is a combination of the interest earned based on the outstanding balance and contractual terms of the assets and the amortization of yield adjustments using generally accepted interest methods, principally the amortization of purchase premiums and discounts. Premiums and discounts associated with the purchase of ARM assets are amortized into interest income over the lives of the assets using the effective yield method adjusted for the effects of estimated prepayments. Estimating prepayments and estimating the remaining lives of our ARM assets requires management judgment, which involves consideration of possible future interest rate environments and an estimate of how borrowers will behave in those environments. Prepayment estimates are also periodically reviewed and updated in light of actual prepayment experience. The actual lives could be more or less than the amount estimated by management at the time of purchase of the ARM assets or at each reporting period.

The following table presents a sensitivity analysis to show the impact on our net purchase premium at March 31, 2005 of using different prepayment assumptions (in thousands):


Changed Assumption	Increase (Decrease) in Net Purchase Premium
Prepayment assumption increased by 5%	$	(4,224	)
Prepayment assumption increased by 10%	$	(8,266	)
Prepayment assumption decreased by 5%	$	3,730
Prepayment assumption decreased by 10%	$	7,353

The purpose of this analysis is to provide an indication of the impact that prepayment assumptions have on our purchase premium. It is not intended to imply our expectation of future prepayment levels or estimated remaining lives. We believe the current assumptions used are appropriate.

•

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

•

Impairment of ARM Securities and Non-Accretable Discounts on ARM Securities. ARM securities are evaluated for impairment on a quarterly basis, or more frequently if events or changes in circumstances indicate that these investments may be impaired. We evaluate whether our ARM securities are considered impaired, evaluate whether the impairment is other than temporary, and, if the impairment is other than temporary, recognize an impairment loss equal to the difference between the ARM security’s amortized cost basis and its fair value. These evaluations require management to make estimates and judgments based on changes in market interest rates, changes in credit ratings, delinquency data and other information to determine whether unrealized losses are reflective of credit deterioration and to evaluate management’s ability and intent to hold the investment to maturity or recovery. Because the estimate for other-than-temporary impairment requires management judgment, we consider this to be a critical accounting estimate. We have determined that the unrealized losses on ARM securities of $332.6 million at March 31, 2005 are not reflective of credit deterioration and because we have the ability and intent to hold the ARM securities until recovery, the losses are not other-than-temporary impairments.

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

•

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

The following table presents a sensitivity analysis to show the impact on our loan loss reserves at March 31, 2005 of using different assumptions (in thousands):


Changed Assumption	Increase (Decrease) in Loan Loss Reserves
Default assumption increased by 10%	$	1,591
Default assumption decreased by 10%	$	(1,593	)
Loss severity assumption increased by 5%	$	1,918
Loss severity assumption decreased by 5%	$	(1,918	)

The purpose of this analysis is to provide an indication of the impact that defaults and loss severity assumptions have on our estimate of loan loss reserves. It is not intended to imply our expectation of future default levels or changes in loss severity. We believe the current assumptions used for defaults and loss severity are appropriate.

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

New Accounting Pronouncements

In June 2004, the FASB issued EITF 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-01 requires an investor to determine when an investment is considered impaired, evaluate whether that impairment is other than temporary, and, if the impairment is other than temporary, recognize an impairment loss equal to the difference between the investment’s cost and its fair value. The guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The impairment loss recognition and measurement guidance was to be applicable to other-than-temporary impairment evaluations in reporting periods beginning after June 15, 2004. In September 2004, the FASB proposed additional guidance related to debt securities that are impaired because of interest rate and/or sector spread increases, and delayed the effective date of EITF 03-01. We do not expect the adoption of EITF 03-01 to have a material effect on our financial condition, results of operations, or liquidity. We have already adopted the EITF 03-01 disclosure requirements for investments in an unrealized loss position for which other-than-temporary impairments have not been recognized.

In December 2004, the FASB published SFAS 123(R) entitled “Share-Based Payment.” It requires all public companies to report share-based compensation expense at the grant date fair value of the related share-based awards. We are required to adopt the provisions of the standard effective for annual periods beginning after June 15, 2005. Management believes that our current method of accounting for share-based payments is consistent with SFAS 123(R).

General

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

While we are not a bank or savings and loan institution, our business purpose, strategy, method of operation and risk profile are best understood in comparison to such institutions. We finance the purchases and originations of our ARM assets with equity capital, unsecured debt, CDOs and short-term borrowings such as reverse repurchase agreements, Asset-backed CP, whole loan financing facilities, and other collateralized financings that we may establish in the future. When we borrow short-term or floating-rate funds to finance our Hybrid ARM assets, we also enter into interest rate hedging transactions, which are intended to fix, or cap, our borrowing costs during the fixed-rate period of the Hybrid ARM asset. We believe our exposure to changes in interest rates is minimal since the assets we hold are primarily ARM assets and we generally match the

Effective Duration, which is a calculation expressed in months or years that is a measure of the expected price change of financial instruments based on changes in interest rates, of those assets with funding of comparable Effective Duration. We have a policy to operate with an Adjusted Equity-to-Assets Ratio, a non-GAAP measurement, of at least 8% and we typically operate with a 9% to 10% Adjusted Equity-to-Assets Ratio. See “Capital Utilization and Leverage” on page 42 for a calculation of our Adjusted Equity-to-Assets Ratio. Moreover, we focus on acquiring high quality assets to minimize potential credit losses and to ensure our access to financing. Similarly, we maintain strict credit underwriting standards and have experienced cumulative credit losses of only $174,000 on our loan portfolio since we began acquiring loans in 1997. We believe our operating structure has resulted in operating costs well below those of other mortgage originators. We believe our corporate structure differs from most lending institutions in that we are organized for tax purposes as a REIT and, therefore, pay substantially all of our earnings in the form of dividends to shareholders.

We are an externally advised REIT and are managed under the Management Agreement with Thornburg Mortgage Advisory Corporation, which manages our operations, subject to the supervision of the Board of Directors.

Portfolio Strategies

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

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

We originate ARM loans for our portfolio through our correspondent lending program, which currently includes approximately 182 approved correspondents, and we originate ARM loans directly to consumers. We are authorized to lend in all 50 states and the District of Columbia. We believe that diversifying our sources for ARM loans and ARM securities will enable us to consistently find attractive opportunities to acquire or create high quality assets at attractive yields and spreads for our portfolio.

We have a focused portfolio lending investment policy designed to minimize credit risk and interest rate risk. Our mortgage assets portfolio may consist of Ginnie Mae, Fannie Mae or Freddie Mac securities, or privately issued (generally publicly registered) ARM pass-through securities, multi-class pass-through securities, CMOs, “A quality” ARM loans that we intend to securitize, securities issued by others that are backed by “A quality” loans where we have purchased all of the resulting classes, fixed-rate MBS with an expected Effective Duration of one year or less or other short-term investments that either mature within one year or have an interest rate that reprices within one year.

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

Our ARM assets include investments in Hybrid ARM assets. We limit our ownership of Hybrid ARM assets with fixed-rate periods of greater than five years to no more than 30% of our total assets. We use Hybrid ARM Hedging Instruments to fix, or cap, the interest rates on the short-term borrowings and floating-rate CDOs financing our Hybrid ARM assets. We have a policy that requires us to maintain a Hybrid ARM portfolio Net Effective Duration of less than one year. We use a financial model that simulates interest rate changes and calculates the impact of those changes on the fair value of our Hybrid ARM portfolio. By

maintaining a Net Effective Duration of less than one year, we believe that we can maintain relatively stable earnings and dividends given changing interest rates.

To mitigate the adverse effect of an increase in prepayments on our ARM assets, we emphasize the purchase of ARM assets at prices close to or below par. We amortize any premiums paid for our assets over their expected lives using the effective yield method of accounting. To the extent that the prepayment rate on our ARM assets differs from expectations, our net interest income will be affected. Prepayments generally increase when current mortgage interest rates fall below the interest rates on

existing ARM loans. To the extent there is an increase in prepayment rates, resulting in a shortening of the expected lives of our ARM assets, our net income and, therefore, the amount available for dividends could be adversely affected.

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

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

We acquire and originate “A quality” mortgage loans through our wholly-owned mortgage loan origination subsidiary, TMHL from three sources: (i) correspondent lending, (ii) direct retail loan originations, and (iii) bulk acquisitions. Correspondent lending involves acquiring individual loans from lending partners which we have approved and which originate the individual loans using our product pricing, underwriting criteria and guidelines, or other approved criteria and guidelines. Direct retail loan originations are loans that we originate through financial intermediaries or directly to consumers via the internet or by telephone. Bulk acquisitions involve acquiring pools of whole loans, which are originated using the seller’s guidelines and underwriting criteria. The loans we acquire or originate are financed through warehouse borrowing arrangements pending securitization for our portfolio.

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

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

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

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

We offer a loan modification program on all loans we originate or service. We believe this program promotes customer retention and reduces loan prepayments. Under the terms of this program, a borrower pays a fee to modify the mortgage loan to any then-available Hybrid or Traditional ARM product that we offer at the offered retail interest rate plus 1/8%. During the first quarter of 2005, we modified 190 loans with balances totaling $108.6 million. At March 31, 2005, the pipeline of loans to be modified totaled $75.7 million.

Financing Strategies

We finance our ARM assets using Preferred and Common Stock equity capital, unsecured debt, CDOs and short-term borrowings such as reverse repurchase agreements, Asset-backed CP, whole loan financing facilities and other collateralized financings that we may establish in the future. See “Hedging Strategies” below for a discussion of how we convert short-term borrowings into the equivalent of long-term fixed-rate financing for purposes of managing our interest rate risk. Our

long-term objective is to achieve a balanced funding mix including Asset-backed CP, CDOs and reverse repurchase agreements.

Reverse repurchase agreements involve a simultaneous sale of pledged assets to a lender at an agreed-upon price in return for the lender’s agreement to resell the same assets back to us at a future date (the maturity of the borrowing) at a higher price. The price difference is the cost of borrowing under these agreements. Because we borrow money under these agreements based on the fair value of our ARM assets, our borrowing ability under these agreements could be limited and lenders could initiate margin calls in the event of interest rate changes or if the value of our ARM assets declines for other reasons. We have established lines of credit and collateralized financing agreements with 23 different financial institutions.

We enter into two types of reverse repurchase agreements: variable rate term reverse repurchase agreements and fixed-rate reverse repurchase agreements. Our variable rate term reverse repurchase agreements are financings with original maturities ranging from three to eighteen months. The interest rates on these variable rate term reverse repurchase agreements are generally indexed to either the one-month or three-month LIBOR rate, and reprice accordingly. The fixed-rate reverse repurchase agreements have original maturities generally ranging from 30 to 180 days. Generally, upon repayment of each reverse repurchase agreement, we immediately pledge the ARM assets used to collateralize the financing to secure a new reverse repurchase agreement.

We also have a $5 billion Asset-backed CP facility, which provides us with an alternative way to finance our high quality ARM securities portfolio. We issue Asset-backed CP in the form of secured liquidity notes that have been rated P-1 by Moody’s Investors Service and F1+ by Fitch Ratings to money market investors. The notes can be collateralized by Agency Securities and AAA-rated, adjustable-rate MBS that we have either purchased or created through our loan securitization process. Importantly, we have diversified our funding sources by replacing a portion of our reverse repurchase agreement borrowings with the issuance of Asset-backed CP under terms that are comparable to our existing reverse repurchase agreement funding. As of March 31, 2005, we had $5.0 billion of Asset-backed CP outstanding.

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

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

We have issued Senior Notes in the amount of $305 million as an alternative form of long-term capital. The Senior Notes bear interest at 8.0%, payable each May 15 and November 15, and mature on May 15, 2013. The Senior Notes are unsecured and are redeemable at a declining premium, in whole or in part, beginning on May 15, 2008, and at par beginning on May 15, 2011. The Senior Notes may also be redeemed under limited circumstances on or before May 15, 2006.

Capital Utilization

The Board of Directors has approved a policy that limits our capacity to borrow funds to finance mortgage assets based on our equity capital and unsecured debt (collectively, long-term capital). We monitor the relationship between our assets, borrowings and long-term capital using a variety of different measures. However, the primary operating policy that limits our borrowings and leverage is a requirement to maintain our Adjusted Equity-to-Assets Ratio, a non-GAAP measurement, at a minimum of 8%. Broadly speaking, this ratio reflects the relationship between those assets financed with borrowings that are subject to margin calls and our long term capital position. See further discussion of capital utilization and leverage beginning on page 41 and the calculation of our Adjusted Equity-to-Assets Ratio on page 42.

Liquidity Management

Our primary focus is to acquire and originate high quality, highly liquid assets such that sufficient assets could be readily converted to cash, if necessary, in order to meet our financial obligations. We have a Liquidity Management Policy, which is

designed to minimize potential shortfalls in liquidity resulting from adverse changes in interest rates or market conditions. The Liquidity Management Policy requires the frequent measurement of the potential market value exposure of the portfolio to a 100 BP instantaneous parallel increase in interest rates over expected future interest rates. The calculated potential mark-to-market exposure resulting from this scenario is probability weighted and compared to recent minimum liquidity levels in order to determine whether management needs to take specific actions to improve liquidity or further reduce interest rate risk.

Hedging Strategies

We attempt to mitigate our interest rate risk by funding our ARM assets with a combination of short-term borrowings and Hedging Instruments whose combined Effective Durations approximately match the Effective Durations on our ARM assets. Therefore, some of our borrowings bear variable or short-term (one year or less) fixed interest rates because a portion of our ARM assets, the Traditional ARM assets, have interest rates that adjust within one year. However, we finance our Hybrid ARM portfolio with borrowings hedged with Hybrid ARM Hedging Instruments that fix the interest rate on the borrowings such that the Net Effective Duration is less than one year. A shorter Effective Duration indicates a lower expected volatility of earnings when interest rates change during future periods. When we enter into a Swap Agreement, we agree to pay a fixed rate of interest and to receive a variable interest rate, generally based on LIBOR. We also enter into Eurodollar Transactions in order to fix the interest rate changes on our forecasted three-month LIBOR-based liabilities. Each Eurodollar futures contract is a three-month contract with a price that represents the forecasted three-month LIBOR rate. Selling Eurodollar futures contracts locks in a future interest rate. The difference between these two values results in a gain or loss that offsets the change in the three-month LIBOR rate and “locks-in” the forecasted three-month LIBOR rate for financing purposes. We purchase Cap Agreements by incurring a one-time fee or premium. Pursuant to the terms of the Cap Agreements, we will receive cash payments if the interest rate index specified in any such Cap Agreement increases above contractually specified levels. Therefore, such Cap Agreements have the effect of capping the interest rate on a portion of our borrowings above a specified level as opposed to fixing our cost of funds as in a swap transaction. The notional balances of the Hybrid ARM Hedging Instruments generally decline over the life of these instruments. As of March 31, 2005, our Hybrid ARM Hedging Instruments had a remaining average term to maturity of 2.6 years before considering the effects of prepayments and when combined with our Hybrid ARM assets and related borrowings had a Net Effective Duration of approximately 4.8 months, including the effects of prepayments.

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

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

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

Financial Condition

Asset Quality

At March 31, 2005, we held total assets of $30.9 billion, $30.3 billion of which consisted of ARM assets. That compares to $29.2 billion in total assets and $28.7 billion of ARM assets at December 31, 2004. Since commencing operations, we have purchased either ARM securities (Agency Securities or privately-issued MBS) or ARM loans generally originated to “A quality” underwriting standards. At March 31, 2005, 97.2% of the assets we held, including cash and cash equivalents, were High Quality assets, far exceeding our investment policy minimum requirement of investing at least 70% of our total assets in High Quality ARM assets and cash and cash equivalents.

The following tables present schedules of ARM assets owned at March 31, 2005 and December 31, 2004 classified by High Quality and Other Investment assets and further classified by type of issuer and by ratings categories. All ARM securities included in the tables have been rated by the Rating Agencies. ARM Loans include securitized ARM loans that have been rated by the Rating Agencies, ARM loans collateralizing CDOs that have been stratified by credit rating based on the ratings received from the Rating Agencies on the respective CDOs and ARM loans held for securitization that have not been rated by the Rating Agencies.

ARM Assets by Issuer and Credit Rating

(dollar amounts in thousands)


	March 31, 2005
	ARM Securities				ARM Loans							Total
	Carrying Value		Portfolio Mix		Carrying Value					Portfolio Mix		Carrying Value					Portfolio Mix
High Quality
Agency Securities	$	2,516,528	12.9	%	$	1,520				0.0	%	$	2,518,048				8.3	%
Non-Agency ARM Assets:
AAA/Aaa Rating		16,586,135	85.1			10,177,714		(1	)	94.2			26,763,849		(1	)	88.3
AA/Aa Rating		233,810	1.2			69,120				0.6			302,930				1.0

Total Non-Agency ARM Assets		16,819,945	86.3			10,246,834				94.8			27,066,779				89.3

Total High Quality		19,336,473	99.2			10,248,354				94.8			29,584,827				97.6

Other Investments
Non-Agency ARM Assets:
A Rating		79,996	0.4			41,051				0.4			121,047				0.4
BBB/Baa Rating		41,659	0.2			23,928				0.2			65,587				0.2
BB/Ba Rating and Below		32,632	0.2			56,326		(1	)	0.5			88,958		(1	)	0.3
ARM loans pending securitization		—	0.0			449,429				4.2			449,429				1.5

Total Other Investments		154,287	0.8			570,734				5.3			725,021				2.4

Loan Loss Reserves		—	0.0			(9,844	)			(0.1	)		(9,844	)			(0.0	)

Total ARM Portfolio	$	19,490,760	100.0	%	$	10,809,244				100.0	%	$	30,300,004				100.0	%

(1)	As of March 31, 2005, the Investment Grade classes of ARM loans collateralizing CDOs have been credit-enhanced through over collateralization in the amount of $56.1 million, which is included in the BB/Ba Rating and below category.


	December 31, 2004
	ARM Securities				ARM Loans							Total
	Carrying Value		Portfolio Mix		Carrying Value					Portfolio Mix		Carrying Value					Portfolio Mix
High Quality
Agency Securities	$	2,720,307	14.6	%	$	1,523				0.0	%	$	2,721,830				9.5	%
Non-Agency ARM Assets:
AAA/Aaa Rating		15,659,634	83.9			9,319,573				92.4			24,979,207				86.9
AA/Aa Rating		172,234	1.0			144,795				1.4			317,029				1.1

Total Non-Agency ARM Assets		15,831,868	84.9			9,464,368				93.8			25,296,236				88.0

Total High Quality		18,552,175	99.5			9,465,891				93.8			28,018,066				97.5

Other Investments
Non-Agency ARM Assets:
A Rating		48,854	0.3			81,172				0.8			130,026				0.4
BBB/Baa Rating		26,920	0.1			20,450				0.2			47,370				0.2
BB/Ba Rating and Below		28,096	0.1			62,466		(2	)	0.5			90,562		(2	)	0.3
ARM loans pending securitization		—	0.0			466,471				4.7			466,471				1.6

Total Other Investments		103,870	0.5			630,559				6.2			734,429				2.5

Loan Loss Reserves		—	0.0			(9,434	)			(0.0	)		(9,434	)			(0.0	)

Total ARM Portfolio	$	18,656,045	100.0	%	$	10,087,016				100.0	%	$	28,743,061				100.0	%

(2)	As of December 31, 2004, the Investment Grade classes of ARM loans collateralizing CDOs have been credit-enhanced through over collateralization in the amount of $51.0 million, which is included in the BB/Ba Rating and below category.

As of March 31, 2005, eight of the 22,864 loans in our ARM loan portfolio were considered seriously delinquent (60 days or more delinquent) and had an aggregate balance of $8.1 million. At March 31, 2005, we had one real estate-owned property as a result of foreclosing on a delinquent loan in the amount of $368,000. We believe that our current level of reserves for loan losses is adequate to cover estimated losses from this loan as well as losses inherent in the ARM loan portfolio at March 31, 2005.

ARM Loan Portfolio Characteristics

The following table presents various characteristics of our ARM Loan portfolio as of March 31, 2005. This information pertains to ARM loans held for securitization, ARM loans held as collateral for CDOs and ARM loans securitized for our own portfolio for which we retained credit loss exposure. The combined unpaid principal balance of the loans included in this information is $10.8 billion.

ARM Loan Portfolio Characteristics


	Average			High			Low
Original loan balance	$	483,503		$	12,500,000		$	17,650
Unpaid principal balance	$	471,107		$	12,500,000		$	105
Coupon rate on loans		4.66	%		9.13	%		2.38	%
Pass-through rate		4.56	%		8.60	%		2.24	%
Pass-through margin		1.94	%		4.73	%		0.23	%
Lifetime cap		10.40	%		19.90	%		7.13	%
Original term (months)		360			480			120
Remaining term (months)		341			478			15


Geographic distribution (top 5 states):			Property type:
California	26.5	%	Single-family	83.1	%
Georgia	9.5		Condominium	14.1
Florida	8.3		Other residential	2.8
New York	7.8
Colorado	7.5		ARM Loan type:
			Traditional ARM loans	30.1	%
Occupancy status:			Hybrid ARM loans	69.9
Owner occupied	77.5	%
Second home	14.8		ARM interest rate caps:
Investor	7.7		Initial cap on Hybrid ARM loans:
			3.00% or less	0.9	%
Documentation type:			3.01%-4.00%	14.0
Full/alternative	92.9	%	4.01%-5.00%	42.5
Stated income/no ratio	7.1		5.01%-6.00%	12.5

Loan purpose:			Periodic cap on Traditional ARM loans:
Purchase	45.3	%	None	11.6	%
Cash out refinance	28.5		1.00% or less	10.5
Rate & term refinance	26.2		Over 1.00%	8.0
			Percent of interest-only loan balances	90.0	%

Original effective loan-to-value:			Weighted average length of interest-only period	8.1 years
80.01% and over (1)	2.0	%
70.01%-80.00%	45.1		FICO scores:
60.01%-70.00%	24.9		801 and over	3.0	%
50.01%-60.00%	12.7		751 to 800	43.2
50.00% or less	15.3		701 to 750	33.3
			651 to 700	17.8
Weighted average effective original loan-to-value:	66.4	%	650 or less	2.7

			Weighted average FICO score:	737

(1)	All loans with an effective original loan-to-value ratio over 80% have mortgage insurance. This ratio includes the effect of pledged assets, but not the impact of mortgage insurance.

As of March 31, 2005 and December 31, 2004, we serviced $7.8 billion and $7.2 billion of our loans, respectively, and had 16,613 and 15,998 customer relationships, respectively. We hold all of the loans that we service in our portfolio in the form of ARM securities or loans that are pending securitization.

Asset Repricing Characteristics

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

ARM Assets by Index and Repricing Frequency

(Dollar amounts in thousands)


	March 31, 2005					December 31, 2004
	Carrying Value			Portfolio Mix		Carrying Value			Portfolio Mix
Traditional ARM assets:
Index:
One-month LIBOR	$	914,074		3.0	%	$	1,020,954		3.6	%
Six-month LIBOR		1,483,967		4.9			1,752,298		6.1
One-year LIBOR		840,413		2.8			704,844		2.4
One-year Constant Maturity Treasury		530,233		1.8			548,269		1.9
Other		159,328		0.5			157,361		0.5

		3,928,015		13.0			4,183,726		14.5

Hybrid ARM assets:
Remaining fixed period:
3 years or less		5,691,881		18.8			4,947,963		17.2
Over 3 years – 5 years		13,506,403		44.5			14,824,132		51.6
Over 5 years		7,183,549		23.7			4,796,674		16.7

		26,381,833		87.0			24,568,769		85.5
Loan Loss Reserves		(9,844	)	(0.0	)		(9,434	)	(0.0	)

	$	30,300,004		100.0	%	$	28,743,061		100.0	%

The ARM portfolio had a weighted average coupon of 4.59% at March 31, 2005. This consisted of a weighted average coupon of 4.63% on the Hybrid ARM assets and a weighted average coupon of 3.98% on the Traditional ARM assets. If the portfolio had been Fully Indexed, the weighted average coupon of the portfolio would have been 4.67%, based upon the composition of the portfolio and the applicable indices at March 31, 2005. Additionally, if the Traditional ARM portion of the portfolio had been Fully Indexed, the weighted average coupon of that portion of the portfolio would have been 5.14%, also based upon the composition of the portfolio and the applicable indices at that time.

As of December 31, 2004, the ARM portfolio had a weighted average coupon of 4.47%. This consisted of a weighted average coupon of 4.52% on the Hybrid ARM assets and a weighted average coupon of 3.74% on the Traditional ARM assets. If the portfolio had been Fully Indexed, the weighted average coupon of the portfolio would have been 4.52%, based upon the composition of the portfolio and the applicable indices at December 31, 2004. Additionally, if the Traditional ARM portion of the portfolio had been Fully Indexed, the weighted average coupon of that portion of the portfolio would have been 4.45%, also based upon the composition of the portfolio and the applicable indices at that time.

At March 31, 2005, the current yield of the ARM assets portfolio was 4.23%, up from 4.13% as of December 31, 2004. The increase in the yield of 10 basis points as of March 31, 2005, compared to December 31, 2004, is primarily due to a 12 basis point increase in the weighted average coupon, partially offset by higher net premium amortization.

Interest Rate Risk Management

The Hybrid ARM portfolio comprised 87.0% of the total ARM portfolio, or $26.4 billion, compared to 85.5%, or $24.6 billion as of December 31, 2004. We attempt to mitigate our interest rate risk by funding our ARM portfolio with borrowings and Hedging Instruments with an Effective Duration approximately matching the Effective Duration on our ARM assets. Some of our borrowings bear variable or short-term (one year or less) fixed interest rates because our Traditional ARM assets have interest rates that adjust within one year. However, most of our Hybrid ARM assets are financed with short-term borrowings that are hedged with Hybrid ARM Hedging Instruments that fix the interest rate on those borrowings such that the Net Effective Duration is less than one year. By maintaining a Net Effective Duration of less than one year, which is our maximum Effective Duration policy limit, the combined price change of our Hybrid ARM assets, associated Hybrid ARM Hedging Instruments and other borrowings is expected to be a maximum of 1% for a 1% parallel shift in interest rates. A lower Effective Duration indicates a lower expected volatility of earnings given future changes in interest rates. As of March 31, 2005, the Net Effective Duration applicable to our Hybrid ARM assets was approximately 4.8 months while the Net Effective Duration applicable to the ARM portfolio was approximately 4.4 months.

As of March 31, 2005 and December 31, 2004, we were counterparty to Swap Agreements and Eurodollar Transactions having an aggregate notional balance of $22.8 billion and $19.6 billion, respectively. In addition, as of March 31, 2005, we had entered into delayed Swap Agreements with notional balances totaling $2.8 billion that will become effective between April 2005 and October 2006. We entered into these delayed Swap Agreements to hedge the forecasted financing of our ARM asset purchase commitments at March 31, 2005. As of March 31, 2005, our Swap Agreements and Eurodollar Transactions had a weighted average maturity of 2.6 years. In accordance with the Swap Agreements, we will pay a fixed rate of interest during the term of these Swap Agreements and receive a payment that varies monthly with the one-month LIBOR rate. The combined weighted average fixed rate payable of the Swap Agreements and Eurodollar Transactions was 3.14% and 3.04% at March 31, 2005 and December 31, 2004, respectively. As of March 31, 2005, ARM assets with a carrying value of $3.0 million, including accrued interest, collateralized the Swap Agreements. We held net cash collateral from Swap Agreement counterparties totaling $49.1 million at March 31, 2005. The net unrealized gain on Swap Agreements at March 31, 2005 of $301.8 million included Swap Agreements with gross unrealized gains of $306.5 million and gross unrealized losses of $4.7 million and is included in Hedging Instruments on the Consolidated Balance Sheets. As of December 31, 2004, the net unrealized loss of $108.1 million included Swap Agreements with gross unrealized gains of $129.4 million and gross unrealized losses of $21.3 million. As of March 31, 2005, the net unrealized gain on Swap Agreements and deferred gains and losses on Eurodollar Transactions recorded in accumulated other comprehensive income (loss) was a net gain of $302.1 million. Over the next twelve months, $39.2 million of these net unrealized gains are expected to be realized as a component of net interest income.

As of March 31, 2005 and December, 31, 2004, our Cap Agreements, used to manage our interest rate risk exposure on the financing of the Hybrid ARM loans collateralizing our CDOs, had remaining notional amounts of $1.2 billion and $1.3 billion, respectively. We have also entered into Cap Agreements that have start dates ranging from 2006 to 2010. The notional balance at the start date will be the lesser of the scheduled amount of $371.1 million or the balance of Hybrid ARM loans associated with these Cap Agreements. The fair value of all of our Cap Agreements at March 31, 2005 and December, 31, 2004 was $20.3 million and $14.8 million, respectively, and is included in Hedging Instruments on the Consolidated Balance Sheets. As of March 31, 2005 and December, 31, 2004, the unrealized loss on these Cap Agreements of $14.9 million and $21.1 million, respectively, is included in accumulated other comprehensive income (loss). In the twelve month period following March 31, 2005, $4.4 million of this unrealized loss is expected to be realized. Pursuant to the terms of these Cap Agreements, the notional amount of the Cap Agreements declines such that it is expected to equal the balance of the Hybrid ARM loans collateralizing our CDOs. Under these Cap Agreements, we will receive cash payments should the one-month LIBOR increase above the contract rates of these Hedging Instruments, which range from 3.25% to 11.50% and average 5.29%. The Cap Agreements had an average maturity of 3.7 years as of March 31, 2005 and will expire between 2006 and 2013.

The following table presents the outstanding notional balance of our Hybrid ARM Hedging Instruments as of March 31, 2005 and the balance of these same Hybrid ARM Hedging Instruments as of March 31 for each of the following five years, without any assumption that additional Hybrid ARM Hedging Instruments are added to the portfolio in the future periods (amounts in thousands):


	As of March 31,
	2005		2006		2007		2008		2009		2010
Swap Agreements:
Balance-guaranteed (1) (3)	$	1,915,418	$	1,606,318	$	1,202,984	$	858,407	$	342,136	$	155,425
Other (2)		20,540,521		12,100,664		5,353,446		1,270,319		917,157		588,342

		22,455,939		13,706,982		6,556,430		2,128,726		1,259,293		743,767

Eurodollar Transactions (2)		375,000		112,000		—		—		—		—
Cap Agreements (1) (3)		1,157,513		926,011		721,396		378,970		303,176		26,958

	$	23,988,452	$	14,744,993	$	7,277,826	$	2,507,696	$	1,562,469	$	770,725

(1)

These Swap Agreements and Cap Agreements have been entered into in connection with our CDO transactions. The notional balances of these agreements are guaranteed to match the balance of the Hybrid ARM collateral in the respective CDO transactions, subject to a maximum notional balance over the term of those agreements. The notional balances presented in the table above for these balance-guaranteed agreements represent forward-looking statements which are calculated based on a CPR assumption of 20%. The actual balances will likely be different based on the actual prepayment performance of the applicable Hybrid ARM collateral. The final maturity of these agreements is 2014.

(2)	These hedging instruments have a pre-determined schedule of notional balances over the term of the respective instruments, based on the expected decline in the balance of our short-term borrowings used to finance our Hybrid ARM portfolio. The final maturity of these agreements is 2013.

(3)	The following table presents the maximum outstanding notional balance of our balance-guaranteed Hybrid ARM Hedging Instruments as of March 31, 2005 and as of March 31 for each of the following five years (in thousands):


	As of March 31,
	2005		2006		2007		2008		2009		2010
Swap Agreements	$	1,915,418	$	1,532,334	$	1,104,372	$	758,568	$	308,555	$	131,392
Cap Agreements		1,157,513		1,076,407		998,413		526,085		574,687		255,092

	$	3,072,931	$	2,608,741	$	2,102,785	$	1,284,653	$	883,242	$	386,484

The fair value of the Pipeline Hedging Instruments at March 31, 2005 and December 31, 2004 was a net unrealized gain of $6.2 million and a net unrealized loss of $2.0 million, respectively, and is included in Hedging Instruments on the Consolidated Balance Sheets. Pipeline Hedging Instruments had remaining notional balances of $651.0 million and $688.0 million at March 31, 2005 and December 31, 2004, respectively. The net gain of $7.1 million on Pipeline Hedging Instruments for the three months ended March 31, 2005 is reflected in gain (loss) on ARM assets and Hedging Instruments, net on the Consolidated Income Statements as is the $5.7 million loss on purchase loan commitments for the three months ended March 31, 2005.

Asset Acquisitions

During the quarter ended March 31, 2005, we purchased $2.7 billion of ARM securities, 98.0% of which were High Quality assets and $1.2 billion of ARM loans, generally originated to “A quality” underwriting standards. Of the ARM assets acquired during the first quarter of 2005, 97.3% were Hybrid ARM assets and 2.7% were Traditional ARM assets generally indexed to LIBOR. The following table compares our ARM asset acquisition and origination activity for the three-month periods ended March 31, 2005 and 2004 (dollar amounts in thousands):


	For the three months ended
	March 31, 2005				March 31, 2004
ARM securities:
Agency Securities	$	—	0.0	%	$	783,546	17.2	%
High Quality, privately issued		2,618,620	68.1			2,769,753	60.7
Other privately issued		52,528	1.4			10,553	0.2

		2,671,148	69.4			3,563,852	78.1

ARM loans:
Bulk acquisitions		—	0.0			88,959	2.0
Correspondent originations		1,114,563	29.0			813,030	17.8
Direct retail originations		60,875	1.6			95,882	2.1

		1,175,438	30.6			997,871	21.9

Total acquisitions	$	3,846,586	100.0	%	$	4,561,723	100.0	%

As of March 31, 2005, we had commitments to purchase $246.5 million of ARM securities and $622.0 million of ARM loans through origination channels. At March 31, 2005, we used a 22.0% fallout assumption in the determination of our ARM loan commitments based on our historical experience with the conversion of loan commitments to funded loans.

Securitization Activity

On March 29, 2005, we securitized $1.3 billion of ARM loans into a series of private-label multi-class ARM securities. While TMHL transferred substantially all of the ARM loans to a separate bankruptcy-remote legal entity, on a consolidated basis: (i) we did not account for this securitization as a sale and, therefore, did not record any gain or loss in connection with the securitization and (ii) we retained all of the resulting securities for our securitized ARM loan portfolio. Of the securities retained, 99.3% were rated Investment Grade and 0.7% were rated less than Investment Grade. As of March 31, 2005, we had $10.4 billion of ARM assets as a result of our securitization efforts. As of December 31, 2004, we had $9.6 billion of ARM assets as a result of our securitization efforts. All discussions relating to securitizations in this Form 10-Q are on a consolidated basis and do not reflect the separate legal ownership of the loans by various bankruptcy-remote legal entities that are our wholly-owned subsidiaries.

Prepayment Experience

For the quarter ended March 31, 2005, our mortgage assets paid down at an approximate average annualized CPR of 21%, compared to 22% for the quarter ended December 31, 2004 and 19% for the quarter ended March 31, 2004. When prepayment expectations over the remaining life of the assets increase, we have to amortize our premiums over a shorter time period, resulting in a reduced yield to maturity on our ARM assets. Conversely, if prepayment expectations decrease, we would amortize the premium over a longer time period, resulting in a higher yield to maturity. We monitor our prepayment experience on a monthly basis and adjust the amortization of the net premium, as appropriate.

Liquidity and Capital Resources

We manage liquidity to ensure that we have the continuing ability to maintain cash flows that are adequate to fund operations and meet commitments on a timely and cost-effective basis. At March 31, 2005, we had unencumbered assets of $1.3 billion,

consisting of unpledged ARM assets, cash and cash equivalents, and other assets. We had unencumbered assets of $712.4 million at December 31, 2004. We believe that our liquidity level is in excess of that necessary to satisfy our operating requirements and we expect to continue to use diverse funding sources to maintain our financial flexibility.

In January 2005, the Board of Directors adopted a Liquidity Management Policy, which is designed to minimize potential shortfalls in liquidity resulting from adverse changes in interest rates or market conditions. The Liquidity Management Policy requires the frequent measurement of the potential market value exposure of the portfolio to a 100 BP instantaneous parallel increase in interest rates over expected future interest rates. The calculated potential mark-to-market exposure resulting from this scenario is probability weighted and compared to recent minimum liquidity levels in order to determine whether management needs to take specific actions to improve liquidity or further reduce interest rate risk.

We had adequate liquidity throughout the quarter ended March 31, 2005. We believe we will continue to have sufficient liquidity to meet our future cash requirements from our primary sources of funds for the foreseeable future, without needing to sell assets.

Sources of Funds

Our primary sources of funds for the quarter ended March 31, 2005 consisted of reverse repurchase agreements, Asset-backed CP, CDOs and whole loan financing facilities, as well as new equity proceeds and principal and interest payments from ARM assets. The reverse repurchase agreement market is a $4 trillion market, the Asset-backed CP market is an $830 billion market and the AAA-rated mortgage- and asset- backed securities market is a $10 trillion market, all of which have been readily available sources of financing for mortgage assets, particularly those rated AA or better. Using CDOs as financing effectively eliminates rollover and margin call risk for the related portion of our balance sheet. To supplement our funding sources, we also issue equity securities and unsecured long-term debt.

We have arrangements to enter into reverse repurchase agreements with 23 different financial institutions and on March 31, 2005, had borrowed funds from 16 of these firms. Reverse repurchase agreement borrowings outstanding at March 31, 2005 had a weighted average effective cost of 2.49% and a weighted average remaining term to maturity of 3.6 months.

We also have a $5 billion Asset-backed CP facility, which provides an alternative way to finance a portion of our ARM portfolio. We issue Asset-backed CP to investors in the form of secured liquidity notes that are recorded as borrowings on our Consolidated Balance Sheets and are rated P-1 by Moody’s Investors Service and F1+ by Fitch Ratings. As of March 31, 2005, we had $5.0 billion of Asset-backed CP outstanding with a weighted average interest rate of 2.99% and a weighted average remaining maturity of 16 days.

Because we borrow money under reverse repurchase and Asset-backed CP agreements based on the fair value of our ARM assets, and because changes in interest rates can negatively impact the valuation of ARM assets, our borrowing ability under these agreements may be limited and lenders may initiate margin calls in the event interest rates change or the value of our ARM assets declines for other reasons. External disruptions to credit markets might also impair access to additional liquidity and, therefore, we might be required to sell certain mortgage assets in order to maintain liquidity. If required, such sales might be at prices lower than the carrying value of the assets, which would result in losses. However, since inception of our operations, we have never had to sell assets to maintain liquidity.

All of our CDOs are secured by ARM loans. For financial reporting purposes, the ARM loans held as collateral are recorded as our assets and the CDOs are recorded as our debt. In some transactions, Hedging Instruments are also recorded as our assets or liabilities. The Hedging Instruments either fix the interest rates of the pass-through certificates or cap the interest rate exposure on these transactions. As of March 31, 2005, the following CDOs were outstanding (dollar amounts in thousands):


Description	Principal Balance		Effective Interest Rate (1)
Floating-rate financing (2)	$	3,093,485	3.44	%
Fixed-rate financing (3)		3,161,235	4.17	%

Total	$	6,254,720	3.81	%

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

(2)	Includes financing hedged with Cap Agreements with a notional balance of $1.2 billion and a weighted average strike price of 5.29% as of March 31, 2005.

(3)	Includes floating-rate financing hedged with Swap Agreements with a notional balance of $1.8 billion.

As of March 31, 2005, the CDOs were collateralized by ARM loans with a principal balance of $6.4 billion. The debt matures between 2033 and 2044 and is callable at par once the total balance of the loans collateralizing the debt is reduced to 20% of their original balance. The balance of this debt is reduced as the underlying loan collateral is paid down and is expected to have an average life of approximately four years.

As of March 31, 2005, we had entered into four whole loan financing facilities. The interest rates on these facilities are indexed to one-month LIBOR and reprice accordingly. These facilities had a total committed borrowing capacity of $900 million and an uncommitted capacity of $650 million and expire between April 2005 and February 2006. We expect to renew these facilities when they expire or replace them with new facilities with similar terms. As of March 31, 2005, we had $107.2 million borrowed against these whole loan financing facilities at an effective cost of 3.38%.

Capital Utilization and Leverage

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

Recourse or marginable debt generally consists of reverse repurchase agreements, Asset-backed CP and whole loan financing facilities. These borrowings are based on the current market value of our ARM assets, are short-term in nature, mature on a frequent basis (weighted average maturity of 2.5 months as of March 31, 2005), need to be rolled over at each maturity and are subject to margin calls based on collateral value changes or changes in margin requirements. For these reasons, our policy requires that we maintain significant excess capital and liquidity above the initial margin requirement to meet future margin calls as a result of unexpected changes in margin requirements and collateral value. Our initial margin requirements typically average between 4% and 5% for these borrowings, so our policy requires that we maintain an Adjusted Equity-to-Assets Ratio of at least 8%, though we typically maintain a ratio of 9% to 10%, against the financing of these ARM assets. The 8% minimum policy requirement provides a capital cushion that we feel confident will be sufficient to fund future margin requirements that might result from changes in the value of our assets or changes in margin requirements. Historically, this capital cushion has proved to be more than adequate to support our borrowing arrangements through a variety of interest rate and credit cycles.

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

As we increase our use of CDOs, the risk of margin calls, changes in margin requirements and potential rollover risk is reduced because CDOs represent permanent non-recourse financing whose terms are established at the time of the financing and are not subject to change. As a result, the need to maintain a capital cushion comparable to what we maintain on our recourse borrowings is eliminated. For purposes of maintaining an adequate capital cushion, our policy allows us to eliminate all assets (and the associated long-term equity capital) associated with CDOs from our operating capital ratio. Because the

CDOs only require approximately 2% of equity capital to support the transactions, versus the minimum 8% policy requirement on our recourse borrowings, we are able to use this freed-up capital to acquire additional ARM assets. We expect that we will be able to retain and carry an increased amount of assets in the future as a percentage of our equity capital base. Additionally, we eliminate from our Adjusted Equity-to-Assets Ratio any unrealized market value adjustments, recorded as accumulated other comprehensive income (loss), from our equity accounts and we include our Senior Notes as an additional form of long-term capital as if the notes were equity capital.

The following table presents the calculation of our Adjusted Equity-to-Assets ratio, a non-GAAP measurement:


(dollar amounts in thousands)	March 31, 2005			December 31, 2004
Assets	$	30,880,598		$	29,189,618
Adjustments:
Net unrealized loss on ARM securities		324,946			177,337
Net unrealized gain on Hedging Instruments		(287,169	)		(108,278	)
ARM loans collateralizing CDOs		(6,355,580	)		(6,720,810	)
Cap Agreements		(35,169	)		(35,952	)

Adjusted assets	$	24,527,626		$	22,501,915

Shareholders’ equity	$	2,033,281		$	1,789,184
Adjustments:
Accumulated other comprehensive loss		37,777			90,715
Equity supporting CDOs:
CDOs		6,254,720			6,623,641
ARM loans collateralizing CDOs		(6,355,580	)		(6,720,810	)
Cap Agreements		(35,169	)		(35,952	)

		(136,029	)		(133,121	)
Senior Notes		304,198			304,173

Adjusted shareholders’ equity	$	2,239,227		$	2,050,951

Adjusted equity-to-assets ratio		9.13	%		9.11	%

GAAP equity-to-assets ratio		6.58	%		6.13	%

Ratio of historical equity-to-historical assets		6.70	%		6.43	%

Ratio of historical equity plus Senior Notes to historical assets		7.68	%		7.46	%

Estimated total risk-based capital /risk-weighted assets		22.65	%		21.69

The above table also presents four alternative capital utilization measurements to our Adjusted Equity-to-Assets ratio. The first capital utilization measurement is the GAAP equity-to-assets ratio, a calculation that simply divides total GAAP equity by total assets. While the simplest of all equity-to-assets calculations, it is not used by management to manage our balance

sheet because it includes factors such as unrealized gains and losses on assets and Hedging Instruments deemed to be less important to the long-term operating nature of our business, since our assets are not held for sale and since the unrealized gains and losses are not permanent impairments of our equity or of these assets and Hedging Instruments. If we did use the GAAP measurement as a basis for our leverage limitation and if our Board of Directors-approved policy limited our GAAP equity-to-assets to a minimum of 8%, our total assets would have been reduced to $25.4 billion instead of the $30.9 billion of assets owned as of March 31, 2005. In part, we are able to carry those additional assets by financing a portion of our ARM assets with CDO financings, which have an initial fixed capital requirement of approximately 2% of the assets financed in this way. The GAAP measurement ignores changes in the level of equity required to support various forms of financing as the mix of our financing of ARM assets changes between financing subject to margin requirements and CDO financings which are not subject to margin requirements. This is another reason why we do not use the GAAP measurement to make leverage or capital utilization decisions.

The second alternative capital utilization measurement is the ratio of historical equity to historical assets. This is a non-GAAP measurement that eliminates the market value adjustment of our assets and Hedging Instruments included in accumulated other comprehensive income (loss). This measurement is calculated by dividing the sum of the assets, net unrealized gain (loss) on ARM securities and net unrealized gain (loss) on Hedging Instruments in the table above by shareholders’ equity.

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

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

Equity Transactions

In March 2005, we completed a public offering of 2,000,000 shares of 8% Series C Cumulative Redeemable Preferred Stock and received net proceeds of $48.3 million. On April 19, 2005, we issued an additional 25,000 shares of 8% Series C Cumulative Redeemable Preferred Stock and received net proceeds of $607,000.

During the quarter ended March 31, 2005, we issued 1,670,461 shares of Common Stock under the DRSPP and received net proceeds of $45.7 million, and we issued 1,063,600 shares of Common Stock through a controlled equity offering program and received net proceeds of $29.8 million.

Off-Balance Sheet Commitments

As of March 31, 2005, we had commitments in the ordinary course of business to purchase or originate the following amounts of ARM assets (in thousands):


ARM securities – private high quality	$	246,504
ARM loans – correspondent originations		542,974
ARM loans – direct originations		78,996

	$	868,474

We also have entered into transactions whereby we expect to acquire the remaining balance of certain AAA-rated Hybrid ARM securities, at a price of par, between 2006 and 2008, when the fixed-rate period of the Hybrid ARM securities

terminates and the securities convert into Traditional ARM securities with characteristics similar to the Traditional ARM securities held in the current portfolio. We view these transactions as an alternative source of Traditional ARM assets. At March 31, 2005, the balance of the Hybrid ARM securities was approximately $1.3 billion, but is expected to be less than 60% of that, and could be zero, at the time they convert into Traditional ARM securities. If we decide not to acquire the Hybrid ARM securities when they convert into Traditional ARM securities, then we are committed to pay or receive the difference between par and the fair value of the Traditional ARM securities at that time, as determined by an auction of the Traditional ARM securities. As of March 31, 2005, we had delivered ARM assets with a carrying value of $2.9 million and $3.2 million in cash as collateral in connection with these transactions.

Contractual Obligations

As of March 31, 2005, we had the following contractual obligations (in thousands):


	Payments Due by Period
	Total		Less than 1 year		1 – 3 years		3 –5 years		More than 5 years
Reverse repurchase agreements	$	17,076,520	$	17,076,520	$	—	$	—	$	—
Asset-backed CP		4,990,000		4,990,000
CDOs (1)		6,254,720		10,780		28,137		58,120		6,157,683
Whole loan financing facilities		107,185		107,185		—		—		—
Senior Notes		304,198		—		—		—		304,198
ARM asset purchase commitments		868,474		868,474		—		—		—

Total (2)	$	29,601,097	$	23,052,959	$	28,137	$	58,120	$	6,461,881

(1)

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

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

Results of Operations For the Three Months Ended March 31, 2005

For the quarter ended March 31, 2005, our net income was $67.5 million, or $0.72 EPS, based on weighted average shares outstanding of 93,173,000. That compares to $53.4 million, or $0.70 EPS for the quarter ended March 31, 2004, based on weighted average shares outstanding of 76,631,000, a 2.9% increase in our EPS.

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

Components of Return on Average Common Equity


For the Quarter Ended	Net Interest Income/ Equity		G & A Expense, net (1)/ Equity		Mgmt Fee/ Equity		Performance Fee/ Equity		Other (2)/ Equity		Preferred Dividend/ Equity		Net Income/ Equity (ROE)
Mar 31, 2003	25.56	%	2.02	%	1.22	%	3.04	%	0.08	%	0.82	%	18.38	%
Jun 30, 2003	23.93	%	2.31	%	1.17	%	3.03	%	(1.03	)%	0.73	%	17.72	%
Sep 30, 2003	21.97	%	1.70	%	1.13	%	2.62	%	(0.27	)%	0.00	%	16.79	%
Dec 31, 2003	22.79	%	2.10	%	1.11	%	2.59	%	0.23	%	0.00	%	16.76	%
Mar 31, 2004	21.35	%	2.25	%	1.11	%	2.55	%	(0.90	)%	0.00	%	16.34	%
Jun 30, 2004	19.98	%	0.62	%	1.06	%	2.29	%	0.39	%	0.00	%	15.62	%
Sep 30, 2004	18.81	%	1.48	%	1.09	%	2.23	%	(1.16	)%	0.00	%	15.17	%
Dec 31, 2004	18.86	%	1.23	%	1.06	%	2.23	%	(0.86	)%	0.00	%	15.19	%
Mar 31, 2005	17.93	%	0.76	%	1.01	%	2.16	%	(0.54	)%	0.02	%	14.52	%

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

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

Our ROE declined in the first quarter of 2005 compared to the same period in 2004 primarily due to a decline in our Portfolio Margin resulting from spread compression related to our Traditional ARM assets, the hedging of a portion of our Hybrid ARM assets with Cap Agreements which are not currently providing cash flow benefits, narrower reinvestment spreads and an increase in our hedging position to reduce our exposure to rising interest rates on our Hybrid ARM assets. This decline was partially offset by a lower level of G & A expenses and more effective use of capital.

The following table presents the components of our net interest income for the quarters ended March 31, 2005 and 2004:

Comparative Net Interest Income Components

(in thousands)


	For the quarters ended March 31,
	2005			2004
Coupon interest income on ARM assets	$	326,264		$	205,748
Amortization of net premium		(18,913	)		(10,316	)
Cash and cash equivalents		708			381

Interest income		308,059			195,813

Reverse repurchase agreements and Asset-backed CP		135,764			44,113
CDOs		51,619			11,905
Whole loan financing facilities		5,548			3,378
Senior Notes		6,134			5,235
Hedging Instruments		25,827			61,462

Interest expense		224,892			126,093

Net interest income	$	83,167		$	69,720

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

Average Balance, Rate and Interest Income/Expense Table

(Dollar amounts in thousands)


	For the quarters ended March 31,
	2005						2004
	Average Balance		Effective Rate		Interest Income and Expense		Average Balance		Effective Rate		Interest Income and Expense
Interest-Earning Assets:
ARM assets (1)	$	29,328,087	4.19	%	$	307,351	$	19,699,895	3.97	%	$	195,432
Cash and cash equivalents		85,557	3.31			708		210,833	0.71			381

		29,413,644	4.19			308,059		19,910,728	3.93			195,813

Interest-Bearing Liabilities:
Reverse repurchase agreements and Asset-backed CP		20,218,608	2.69			135,764		14,385,052	1.23			44,113
Plus: Cost of Hedging Instruments (2)			0.35			17,662			1.57			56,304

Hedged reverse repurchase agreements and Asset-backed CP			3.04			153,426			2.79			100,417

CDOs		6,498,392	3.18			51,619		3,087,059	1.54			11,905
Plus: Cost of Hedging Instruments (2)			0.50			8,165			0.67			5,158

Hedged CDOs			3.68			59,784			2.21			17,063

Whole loan financing facilities		683,144	3.25			5,548		750,840	1.80			3,378
Senior Notes		304,179	8.07			6,134		251,097	8.34			5,235

		27,704,323	3.25			224,892		18,474,048	2.73			126,093

Net Interest-Earning Assets and Spread	$	1,709,321	0.94	%	$	83,167	$	1,436,680	1.20	%	$	69,720

Yield on Net Interest-Earning Assets (3)			1.13	%					1.40	%

(1)	Effective rate includes impact of amortizing ARM assets net premium.

(2)	Includes Swap Agreements and Eurodollar Transactions with notional balances of $22.8 billion and $14.4 billion as of March 31, 2005 and 2004, respectively, and Cap Agreements with notional balances of $1.2 billion and $1.4 billion as of March 31, 2005 and 2004, respectively.

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

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):


	Rate/Volume Variance
	Three Months ended March 31, 2005 versus 2004
	Rate			Volume			Total
Interest Income:
ARM assets	$	11,018		$	100,901		$	111,919
Cash and cash equivalents		1,364			(1,037	)		327

		12,382			99,864			112,246

Interest Expense:
Reverse repurchase agreements and Asset-backed CP		8,741			44,268			53,009
CDOs		11,338			31,383			42,721
Whole loan financing facilities		2,720			(550	)		2,170
Senior Notes		(171	)		1,070			899

		22,628			76,171			98,799

Net interest income	$	(10,246	)	$	23,693		$	13,447

Net interest income increased $13.4 million in the first quarter of 2005, compared to the same quarter of the prior year. This increase in net interest income is composed of an unfavorable rate variance and a favorable volume variance. The increased average size of our portfolio during the first quarter of 2005 compared to the same period of 2004 increased net interest income in the amount of $23.7 million. The average balance of our interest-earning assets was $29.4 billion during the quarter ended March 31, 2005, compared to $19.9 billion during the same period of 2004 — an increase of 47.7%. As a result of the yield on our interest-earning assets increasing to 4.19% during the first quarter of 2005 from 3.93% during the same quarter of 2004, an increase of 26 BPs, and our cost of funds increasing to 3.25% from 2.73% during the same period, an increase of 52 BPs, there was a net unfavorable rate variance of $10.2 million.

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

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

(Dollar amounts in millions)


For the Quarter Ended	Average Interest- Earning Assets		Historical Weighted Average Coupon		Yield Adjustment (2)		Yield on Interest Earning Assets		Cost of Funds		Net Interest Spread		Yield on Net Interest Earning Assets
Mar 31, 2003	$	11,094	4.96	%	0.52	%	4.44	%	2.82	%	1.62	%	1.88	%
Jun 30, 2003	$	13,144	4.68	%	0.51	%	4.17	%	2.73	%	1.44	%	1.67	%
Sep 30, 2003	$	15,701	4.41	%	0.56	%	3.85	%	2.53	%	1.32	%	1.53	%
Dec 31, 2003	$	18,327	4.35	%	0.46	%	3.89	%	2.62	%	1.27	%	1.47	%
Mar 31, 2004	$	19,911	4.29	%	0.36	%	3.93	%	2.73	%	1.20	%	1.40	%
Jun 30, 2004	$	22,628	4.25	%	0.41	%	3.84	%	2.72	%	1.12	%	1.31	%
Sep 30, 2004	$	24,450	4.30	%	0.37	%	3.93	%	2.93	%	1.00	%	1.18	%
Dec 31, 2004	$	27,193	4.42	%	0.35	%	4.07	%	3.11	%	0.96	%	1.16	%
Mar 31, 2005	$	29,414	4.55	%	0.36	%	4.19	%	3.25	%	0.94	%	1.13	%

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

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

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

Components of the Yield Adjustments on ARM Assets


For the Quarter Ended	Premium/ Discount Amortization		Impact of Principal Payments Receivable		Other (1)		Total Yield Adjustment
Mar 31, 2003	0.34	%	0.15	%	0.03	%	0.52	%
Jun 30, 2003	0.32	%	0.13	%	0.06	%	0.51	%
Sep 30, 2003	0.34	%	0.14	%	0.08	%	0.56	%
Dec 31, 2003	0.28	%	0.11	%	0.07	%	0.46	%
Mar 31, 2004	0.27	%	0.06	%	0.03	%	0.36	%
Jun 30, 2004	0.29	%	0.10	%	0.02	%	0.41	%
Sep 30, 2004	0.3029	%	0.0510	%	0.02	%	0.37	%
Dec 31, 2004	0.30	%	0.04	%	0.01	%	0.35	%
Mar 31, 2005	0.3229	%	0.0410	%	0.00	%	0.36	%

(1)	Other includes the impact of interest-earning cash and cash equivalents and restricted cash and cash equivalents.

Since we began acquiring whole loans in 1997, we have only experienced losses on three loans, for a total amount of $174,000. We continue to evaluate our estimated credit losses on loans prior to their securitization and we may readjust our current policy if the circumstances warrant. As of March 31, 2005, our ARM loans, including those that we have securitized, but with respect to which we have retained credit loss exposure, accounted for 35.7% of our portfolio of ARM assets or $10.8 billion. During the quarters ended March 31, 2005 and 2004, we recorded loan loss provisions totaling $409,000 and $432,000, respectively, to reserve for estimated credit losses on loans.

During the quarter ended March 31, 2005, we purchased $1.4 billion of third party loan securitizations in transactions in which we purchased all classes of the securitizations, including the subordinated classes. At March 31, 2005 and December 31, 2004, our ARM securities included $4.8 billion and $3.6 billion, respectively, resulting from our aggregate purchase of third party loan securitizations. Like the Company’s own loan originations and acquisitions, these assets are Qualifying Interests for purposes of maintaining the Company’s exemption from the Investment Company Act because we retain a 100% ownership interest in the underlying loans. Because we purchase all classes of these securitizations, we have credit exposure on the underlying loans. The purchase price of the classes that are less than Investment Grade generally includes a discount for probable credit losses and, based on management’s judgment, the portion of the purchase discount which reflects the estimated unrealized loss on the securities due to credit risk is treated as a non-accretable discount. We recorded non-accretable discounts of $1.9 million related to securities purchased during the first quarter of 2005. As of March 31, 2005 and December 31, 2004, we had total non-accretable discounts of $8.0 million and $6.5 million, respectively, on our ARM securities due to estimated credit losses (other than temporary declines in fair value) related to ARM securities purchased at a discount. As of March 31, 2005, 31 of the underlying loans were considered seriously delinquent (60 days or more delinquent) and had an aggregate balance of $7.4 million.

We recorded a net gain on ARM assets and Hedging Instruments of $3.0 million during the first quarter of 2005. This gain consisted of a $1.6 million gain on the sale of $277.9 million of ARM assets, a net gain of $7.1 million on Pipeline Hedging Instruments and a net loss of $5.7 million on commitments to purchase loans from correspondent lenders and bulk sellers. We realized a gain on ARM assets of $3.5 million during the three months ended March 31, 2004. This gain consisted of a $3.2 million gain on the sale of $345.5 million of ARM assets and a gain of $3.8 million on commitments to purchase loans from correspondent lenders and bulk sellers, partially offset by a net loss of $3.5 million on Pipeline Hedging Instruments.

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

Annualized Operating Expense Ratios


For the Quarter Ended	Management Fee/ Average Assets		Performance Fee/ Average Assets		Other Expenses/ Average Assets		Total Operating Expenses/ Average Assets
Mar 31, 2003	0.09	%	0.22	%	0.16	%	0.47	%
Jun 30, 2003	0.08	%	0.21	%	0.18	%	0.47	%
Sep 30, 2003	0.08	%	0.18	%	0.13	%	0.39	%
Dec 31, 2003	0.07	%	0.17	%	0.14	%	0.38	%
Mar 31, 2004	0.07	%	0.17	%	0.16	%	0.40	%
Jun 30, 2004	0.07	%	0.15	%	0.06	%	0.28	%
Sep 30, 2004	0.07	%	0.14	%	0.12	%	0.33	%
Dec 31, 2004	0.06	%	0.14	%	0.10	%	0.30	%
Mar 31, 2005	0.06	%	0.14	%	0.08	%	0.28	%

The most significant increases to our operating expenses for the quarter ended March 31, 2005 compared to March 31, 2004 were the $1.7 million increase in the performance-based fee that the Manager earned as a result of our achieving a Return on Equity in excess of the threshold as defined in the Management Agreement, the $1.1 million increase in base management fees and the $1.1 million increase in expenses related to expanded operations of TMHL, partially offset by the $3.1 million decrease in the expenses associated with our long-term incentive awards. Our ROE prior to the effect of the performance-based fee of $10.0 million for the first quarter of 2005 was 16.69%, whereas the threshold, the average 10-year treasury rate plus 1%, was 5.30%.

We believe our expense ratios are among the lowest of any company originating and investing in mortgage assets, giving us a significant competitive advantage over more traditional mortgage portfolio lending institutions such as banks and savings and loan institutions. This competitive advantage enables us to operate with less risk, such as credit and interest rate risk, and still generate an attractive long-term ROE when compared to more traditional mortgage portfolio lending institutions.

The Manager receives an annual base management fee of 1.23% on the first $300 million of Average Historical Equity, plus 0.93% on Average Historical Equity above $300 million with the fee earned on Average Historical Equity over $1.5 billion limited to 0.82% with the fee decreasing an additional 0.05% for each additional $0.5 billion in Average Historical Equity thereafter until reaching a fee of 0.67% on any Average Historical Equity greater than $3.0 billion. These percentages are subject to an inflation adjustment each July based on changes to the Consumer Price Index over the prior twelve month period. The Manager earns a performance-based incentive fee of 20% of our annualized net income, before performance-based compensation, above an annualized ROE equal to the Ten Year U.S. Treasury Rate plus 1% with the fee limited such that once the Manager has earned a performance fee of $30 million, the performance fee percentage of 20% is reduced by 1% for each additional $5 million earned in performance fees until reaching a performance fee percentage of 15% for any amount greater than $50 million.

Market Risks

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

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

The table below presents an approximation of the sensitivity of the market value of our ARM portfolio, including purchase commitments, using a discounted cash flow simulation model. Application of this method results in an estimation of the percentage change in the market value of our assets, liabilities and Hedging Instruments per 100 BP shift in interest rates expressed in years–a measure commonly referred to as Effective Duration. Positive portfolio Effective Duration indicates that the market value of the total portfolio will decline if interest rates rise and increase if interest rates decline. The closer Effective Duration is to zero, the less interest rate changes are expected to affect earnings. Included in the table is a base case Effective Duration calculation for an interest rate scenario that assumes future rates are those implied by the yield curve as of March 31, 2005. The other three scenarios assume interest rates are instantaneously 100, 200 and 300 BPs higher than those implied by interest rates as of March 31, 2005.

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

Net Portfolio Effective Duration

March 31, 2005


	Base Case			Parallel +100 BPs			Parallel +200 BPs			Parallel +300 BPs
Assets:
Traditional ARMs	0.48		Years	0.54		Years	0.83		Years	1.06		Years
Hybrid ARMs	2.46			2.68			3.14			3.37

Total ARM assets	2.21			2.41			2.85			3.08

Borrowings and hedges	(1.60	)		(1.60	)		(1.61	)		(1.60	)

Net Portfolio Effective Duration	0.37		Years	0.47		Years	0.69		Years	0.81		Years

Based on the assumptions used, the model output suggests a very low degree of portfolio price change given increases in interest rates, which implies that our cash flow and earning characteristics should be relatively stable for comparable changes in interest rates. As a comparison, the approximate base case Effective Duration of an unhedged 10 year treasury, a conforming 30-year fixed mortgage and a conforming 5/1 Hybrid ARM are 8.0, 5.0 and 2.3 years respectively.

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

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

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

At March 31, 2005, based on the earnings simulation model, our potential earnings increase (decrease) from our base case earnings forecast for a parallel 100, 200 and 300 BP rise in market interest rates over the next twelve months and a commensurate slowdown in prepayment speeds as interest rates rise, was (1.5)%, (2.4)% and (4.1)%, respectively, of projected net income for the twelve months ended March 31, 2006. All of these earnings projections result in earnings that provide sufficient coverage of dividends at their current level. The assumptions used in the earnings simulation model are inherently uncertain and, as a result, the analysis cannot precisely predict the impact of higher interest rates on net income. Actual results could differ from simulated results due to timing, magnitude and frequency of interest rate changes, changes in prepayment speed other than what was assumed in the model, and changes in other market conditions and management strategies to offset our potential exposure, among other factors. This measure of risk represents our exposure to higher interest rates at a particular point in time. Our actual risk is always changing. We continuously monitor our risk profile and alter our strategies as appropriate based on our view of interest rates and other developments in our business.

Effects of Interest Rate Changes

Changes in interest rates impact our earnings in various ways. While we invest primarily in ARM assets, rising short-term interest rates may temporarily negatively affect our earnings, and, conversely, falling short-term interest rates may temporarily increase our earnings. This impact can occur for several reasons and may be mitigated by portfolio prepayment activity and portfolio funding and hedging strategies. For example, our borrowings may react to changes in interest rates sooner than our ARM assets because the weighted average next repricing date of our borrowings may be sooner than that of our ARM assets. Additionally, interest rates on Traditional ARM assets may be limited to an increase of either 1% or 2% per adjustment period (commonly referred to as the periodic cap), while our borrowings do not have similar limitations. At March 31, 2005, 8.8% of our ARM assets were Traditional ARM assets subject to periodic caps. Our ARM assets also typically lag changes in the applicable interest rate indices by 45 days, due to the notice period provided to ARM borrowers when the interest rates on their loans are scheduled to change.

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

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

The prepayment rate on our ARM assets may increase if interest rates decline or if the difference between long-term and short-term interest rates diminishes. An increase in prepayments would cause us to amortize the premiums paid for our ARM assets faster, resulting in a lower yield on our ARM assets. Additionally, if prepayments proceeds cannot be reinvested in ARM assets having similar yields to those being replaced, our earnings may be adversely affected. Conversely, the prepayment rate on our ARM assets may decrease if interest rates rise or if the difference between long-term and short-term interest rates increases. Decreased prepayments would cause us to amortize the premiums paid for our ARM assets over a longer time period, resulting in an increased yield on our ARM assets. Therefore, in rising interest rate environments where prepayments are declining, not only would the interest rate on the ARM portfolio reset to reflect higher interest rates, but the yield would also rise due to slower prepayments. The combined effect could significantly mitigate other negative effects that rising short-term interest rates might have on earnings.

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

portion of our ARM portfolio purchased with shareholders’ equity will generally have a higher yield in a higher interest rate environment and a lower yield in a lower interest rate environment.

Taxable income per share

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

Reconciliation of REIT Taxable Income Per Share to GAAP EPS


	Three Months Ended March 31
	2005			2004
REIT Taxable income per share	$	0.74		$	0.76
Additions:
Gain on purchase loan commitments		—			0.05
Payments under long-term incentive plan		—			0.04
Taxable REIT subsidiary income		0.03			—
Deductions:
Hedging Instruments, net		(0.01	)		(0.03	)
Provision for credit losses, net		(0.01	)		(0.06	)
Long-term incentive plan expense		—			(0.06	)
Issuance of CDOs		(0.03	)		(0.02	)
Other		—			0.02

GAAP EPS	$	0.72		$	0.70

We estimate that our undistributed taxable income as of March 31, 2005, after deducting the first quarter dividend declared on April 19, 2005, was $35.8 million, or $0.38 per share, based on outstanding common shares at March 31, 2005 of 94,637,944.

Other Matters

The Code requires that at least 75% of our total assets must be qualified REIT assets, as defined by the Code. The Code also requires that we meet a defined 75% source of income test and a 95% source of income test. As of March 31, 2005, we calculated that we were in compliance with all of these requirements. We also met all REIT requirements regarding the ownership of our Common Stock and the distributions of our net income. Therefore, as of March 31, 2005, we believe that we continued to qualify as a REIT under the provisions of the Code.

We intend to conduct our business so as not to become regulated as an investment company under the Investment Company Act. If we were to become regulated as an investment company, our use of leverage would be substantially reduced. The Investment Company Act exempts entities that are “primarily engaged in the business of purchasing or otherwise acquiring Qualifying Interests. Under current interpretation of the staff of the SEC, in order to qualify for this exemption, we must maintain at least 55% of our assets directly in Qualifying Interests as defined in the Code. In addition, unless certain mortgage securities represent all the certificates issued with respect to an underlying pool of mortgages, such mortgage securities may be treated as securities separate from the underlying mortgage loans and, thus, may not be considered Qualifying Interests for purposes of the 55% requirement. As of March 31, 2005, we calculated that we were in compliance with this requirement.

Effective May 6, 2005, Richard P. Story is retiring after twelve years of service as our Chief Financial Officer and four years of service as a member of the Board of Directors. Clarence G. Simmons, III has been named Senior Executive Vice President and, effective May 6, 2005, Chief Financial Officer. Mr. Simmons joins us from Countrywide Financial Corporation (CFC), currently the nation’s largest mortgage originator, where he was a Managing Director. He was a founder of CFC’s bank subsidiary, Treasury Bank, N.A., and has served as chief operating officer, chief risk oversight officer and chief accounting officer of the unit.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Item 4.

CONTROLS AND PROCEDURES

Our Chief Executive Officer, Chief Operating Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended, have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurances that information required to be disclosed in the reports filed or submitted under such Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. In addition, during the quarter ended March 31, 2005, there has been no significant change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

Item 1.

LEGAL PROCEEDINGS

At March 31, 2005, there were no material pending legal proceedings to which we were a party or of which any of our property was subject.

Item 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable

Item 3.

DEFAULTS UPON SENIOR SECURITIES

Not applicable

Item 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

Item 5.

OTHER INFORMATION

None

Item 6.

EXHIBITS

See “Exhibit Index”

SIGNATURES

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


				THORNBURG MORTGAGE, INC.
				(Registrant)

Dated: May 6, 2005				/s/ GARRETT THORNBURG
				Garrett Thornburg
				Chairman of the Board and Chief Executive Officer
				(Principal Executive Officer)

Dated: May 6, 2005				/s/ LARRY A. GOLDSTONE
				Larry A. Goldstone
				President and Chief Operating Officer
				(authorized officer of registrant)

Dated: May 6, 2005				/s/ RICHARD P. STORY
				Richard P. Story
				Senior Executive Vice President and Chief Financial Officer
				(Principal Financial and Accounting Officer)

Exhibit Index


Exhibit Number		Exhibit Description

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934*

31.2		Certification of President and Chief Operating Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934*

31.3		Certification of Senior Executive Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934*

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

32.2		Certification of President and Chief Operating Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

32.3		Certification of Senior Executive Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

*	Being filed herewith.

GLOSSARY

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

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

“Agency Securities” means ARM securities that are guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac.

“Agent” means American Stock Transfer & Trust Company, TMA’s transfer agent.

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

“ARM Loans” means securitized ARM loans, ARM loans collateralizing CDOs and ARM loans held for securitization.

“Asset-backed CP” means asset-backed commercial paper, which provides an alternative way to finance our high quality ARM securities portfolio. We issue Asset-backed CP to investors in the form of secured liquidity notes that are recorded as borrowings on our Consolidated Balance Sheets and are rated P-1 by Moody’s Investors Service and F1+ by Fitch Ratings.

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

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

“Board of Directors” means the board of directors of TMA.

“BP” means basis point, a hundredth of a percent.

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

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

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

“Code” means the Internal Revenue Code of 1986, as amended.

“Code of Conduct” means the Code of Business Conduct and Ethics adopted by TMA.

“Common Stock” means shares of TMA’s common stock, $.01 par value per share.

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

“Corporate Governance Guidelines” means the Corporate Governance Guidelines adopted by TMA.

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

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

“DRSPP” means the Dividend Reinvestment and Stock Purchase Plan adopted by TMA.

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

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

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

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

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

“FASB” means the Financial Accounting Standards Board.

“Federal Funds” means the overnight intrabank lending rate.

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

“FIN” means Financial Accounting Standards Board Interpretation.

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

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

“G & A” means general and administrative.

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

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

“Hedging Instruments” means Cap Agreements, Swap Agreements and Eurodollar Transactions which are derivative financial instruments that we use to manage our interest rate exposure when financing the purchase of ARM assets.

“High Quality” means (i) Agency Securities, (ii) ARM securities and securitized ARM loans which are rated within one of the two highest rating categories by at least one of the Rating Agencies, (iii) securities and securitized loans that are unrated or whose ratings have not been updated but are determined to be of comparable quality (by the rating standards of at least one of the Rating Agencies) to a High Quality-rated mortgage security, as determined by the Manager and approved by the Board of Directors, or (iv) the portion of ARM loans that have been deposited into a trust and have received a credit rating of AA or better from at least one Rating Agency. Our investment policy requires that we invest at least 70% of total assets in High Quality ARM assets and short-term investments.

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

“Hybrid ARMs” means ARM securities and loans that have a fixed interest rate for an initial period of three to ten years, after which they convert to Traditional ARMs for their remaining terms to maturity.

“Insider Trading Policy” means the Insider Trading Policy adopted by TMA.

“Investment Company Act” means the Investment Company Act of 1940, as amended.

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

“IRA” means Individual Retirement Account.

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

“Liquidity Management Policy” means the Liquidity Management Policy adopted by TMA.

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

“Manager” means Thornburg Mortgage Advisory Corporation, a Delaware corporation.

“MBA” means the Mortgage Bankers Association.

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

“MSRs” means mortgage servicing rights.

“Net Effective Duration” means the Effective Duration of ARM assets minus the Effective Duration of borrowings and Hedging Instruments.

“OCI” means the Company’s accumulated other comprehensive income or loss calculated on a consolidated basis in accordance with GAAP.

“Other Investments” means assets that are (i) adjustable or variable rate pass-through certificates, multi-class pass-through certificates or CMOs backed by loans that are rated at least Investment Grade at the time of purchase, (ii) ARM loans

collateralized by first liens on single-family residential properties, generally underwritten to “A quality” standards and acquired for the purpose of future securitization, (iii) fixed-rate mortgage loans collateralized by first liens on single-family residential properties originated for sale to third parties, (iv) real estate properties acquired as a result of foreclosing on our ARM Loans, or (v) as authorized by the Board of Directors, ARM securities rated less than Investment Grade that are created as a result of our loan acquisition and securitization efforts or are acquired as part of a loan securitization effected by third parties in which we purchase all of the classes of the loan securitization, and that equal an amount no greater than 17.5% of shareholders’ equity, measured on a historical cost basis. Other Investments may not comprise more than 30% of our total assets.

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

“Plan” means TMA’s Amended and Restated 2002 Long-Term Incentive Plan, as amended.

“Preferred Stock” means the 8% Series C Cumulative Redeemable Preferred Stock issued by TMA.

“Portfolio Margin” means yield on net interest earning assets.

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

“QSPE” means qualifying special purpose entity.

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

“Qualifying Interests” means “mortgages and other liens on and interests in real estate,” as defined in Section 3(c)(5)(C) under the Investment Company Act. Under current SEC staff interpretations, we must maintain at least 55% of our assets directly in Qualifying Interests as defined in the Code.

“Rating Agencies” means Standard & Poor’s Corporation and Moody’s Investors Service, Inc.

“REIT” means real estate investment trust as defined in the Code.

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

“Return on Equity” or “ROE” means for any quarter the quotient obtained by dividing our annualized net income for the quarter by our Average Net Worth for the quarter.

“SEC” means the United States Securities and Exchange Commission.

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

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

“SPE” means special purpose entity.

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

“Ten Year U.S. Treasury Rate” means the arithmetic average of the weekly average yield to maturity for actively traded current coupon U.S. Treasury fixed interest rate securities (adjusted to a constant maturity of ten years) published by the Federal Reserve Board during a quarter, or, if such rate is not published by the Federal Reserve Board, any Federal Reserve Bank or agency or department of the federal government that we select. If we determine in good faith that the Ten Year U.S. Treasury Rate cannot be calculated as provided above, then the rate shall be the arithmetic average of the per annum average yields to maturities, based upon closing asked prices on each business day during a quarter, for each actively traded marketable U.S. Treasury fixed interest rate security with a final maturity date not less than eight nor more than twelve years from the date of the closing asked prices as chosen and quoted for each business day in each such quarter in New York City by at least three recognized dealers in U.S. Government securities that we select.

“TMA” means Thornburg Mortgage, Inc., a Maryland corporation.

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

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

“TMHL” means Thornburg Mortgage Home Loans, Inc., a wholly-owned mortgage loan origination subsidiary of TMA.

“Traditional ARMs” means ARM securities and loans that have interest rates that reprice in a year or less.