10-K: Annual report pursuant to Section 13 and 15(d)

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

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FORM 10-K

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

For the year ended December 31, 2002

OR

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

For the transition period from ______________ to ______________

Commission File Number: 1-13991

MFA MORTGAGE INVESTMENTS, INC.
(Exact name of registrant as specified in its charter)

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Maryland 13-3974868
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

350 Park Avenue, 21st Floor, New York, New York 10022
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (212) 207-6400

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

Title of Each Class Name of Each Exchange on Which Registered
Common Stock, $0.01 par value New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (229.405 of the chapter) is not contained herein, and will
not be contained, to the best of the registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. |_|

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 |_|

The aggregate market value of the voting common stock held by
non-affiliates of the registrant based on the final closing price of the
Company's common stock on the New York Stock Exchange on February 5, 2003 was
$384,937,254.

The number of shares of the registrant's common stock outstanding on
February 5, 2003, was 46,279,605.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's proxy statement for the 2003 Annual Meeting of
Stockholders scheduled to be held on May 20, 2003 are incorporated by reference
into Part III of this Annual Report on Form 10-K.


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TABLE OF CONTENTS

PART I

Item 1. Business......................................................... 1
Item 2. Properties....................................................... 14
Item 3. Legal Proceedings................................................ 14
Item 4. Submission of Matters to a Vote of Security Holders.............. 14
Item 4A. Executive Officers of the Company................................ 14

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.......................................................... 16
Item 6. Selected Financial Data.......................................... 17
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....... 26
Item 8. Financial Statements and Supplementary Data...................... 29
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure............................................. 51

PART III

Item 10. Directors and Executive Officers of the Registrant............... 51
Item 11. Executive Compensation........................................... 51
Item 12. Security Ownership of Certain Beneficial Owners and Management... 51
Item 13. Certain Relationships and Related Transactions................... 51
Item 14. Controls and Procedures.......................................... 51

PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 51

SIGNATURES................................................................. 54
CERTIFICATIONS ............................................................ 55


PART I

Item 1. Business.

THE COMPANY

MFA Mortgage Investments, Inc. (the "Company") is a self-advised mortgage
real estate investment trust ("REIT"), which is primarily engaged in the
business of investing in adjustable rate mortgage-backed securities and hybrid
mortgage-backed securities (collectively, "ARM-MBS"). The Company's investment
portfolio consists primarily of ARM-MBS issued or guaranteed by an agency of the
U.S. Government, such as Ginnie Mae, Fannie Mae or Freddie Mac (collectively
referred to as "Agency MBS"), and, to a lesser extent, high quality ARM-MBS,
rated in one of the two highest rating categories by at least one nationally
recognized rating agency, which include, Moody's Investors Services, Inc.,
Standard & Poor's Corporation or Fitch, Inc. (collectively, the "Rating
Agencies"). The Company's principal business objective is to generate net income
for distribution to its stockholders resulting from the spread between the
interest and other income it earns on its investments and the cost of financing
such investments.

As of December 31, 2002, the Company held total assets on its balance
sheet valued at $3.604 billion, of which 98.5% consisted of Agency MBS, other
high quality mortgage-backed securities ("MBS") and cash. The Company also held
controlling and non-controlling interests in corporate and partnership entities
that own six apartment properties, containing a total of 1,473 rental units.
Four of these apartment properties are located in Georgia, one in North Carolina
and one in Nebraska.

The Company has elected to be taxed as a REIT for federal income tax
purposes. Pursuant to the current federal tax regulations, one of the
requirements of maintaining its status as a REIT is that the Company must
distribute at least 90% of its annual taxable net income to its stockholders,
subject to certain adjustments. For additional information, see "Certain Federal
Income Tax Considerations."

The Company was incorporated in Maryland on July 24, 1997, and began its
business operations on April 10, 1998, when the Company consummated a merger
transaction (the "1998 Merger") with America First Participating/Preferred
Equity Mortgage Fund Limited Partnership ("PREP Fund 1" or the "Predecessor"),
America First PREP Fund 2 Limited Partnership ("PREP Fund 2") and America First
PREP Fund 2 Pension Series Limited Partnership ("Pension Fund" and, together
with PREP Fund 1 and PREP Fund 2, the "PREP Funds"). As a result of the 1998
Merger, PREP Fund 1 and PREP Fund 2 were merged directly into the Company and
Pension Fund became a partnership subsidiary of the Company. In December 1999,
Pension Fund was liquidated and dissolved, and, as a result, the Company
acquired 99% of the assets of Pension Fund. The remaining assets, consisting
solely of cash, were distributed to the holders of Pension Fund securities who
elected to remain in place following the 1998 Merger. As a result of the 1998
Merger, the Company issued a total of 9,035,084 shares of its $.01 par value
common stock ("Common Stock") to the former partners of the PREP Funds.

Following the completion of the 1998 Merger through December 31, 2001, the
Company was an externally advised and managed REIT. As such, the Company had no
employees and relied entirely on America First Mortgage Advisory Corporation
(the "Advisor") to perform all of the duties that are generally performed by
internal management. Pursuant to an agreement between the Company and the
Advisor (the "Advisory Agreement"), the Advisor provided the day-to-day
management of the Company's operations for a fee, which was calculated on a
quarterly basis. The Advisor was a subsidiary of America First Companies L.L.C.
("AFC").

On December 12, 2001, the Company's stockholders approved the terms of an
Agreement and Plan of Merger, dated September 24, 2001, among the Company, the
Advisor, AFC and the stockholders of the Advisor (the "Advisor Merger
Agreement"), which provided for the merger of the Advisor into the Company (the
"Advisor Merger"). Subsequent to the Advisor Merger, effective January 1, 2002,
the Company became a self-advised REIT. As a self-advised REIT, the Company no
longer pays a fee to the Advisor under the Advisory Agreement, but instead
directly incurs all of the costs of operating the Company. Accordingly, the
employees of the Advisor became employees of the Company. The Company also
acquired all of the tangible and intangible business assets of the Advisor. (For
additional information regarding the Advisor and the Advisor Merger, see Note 3a
to the accompanying consolidated financial statements included under Item 8.)

On August 13, 2002, the Company changed its name from America First
Mortgage Investments, Inc. to MFA Mortgage Investments, Inc.


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BUSINESS AND INVESTMENT STRATEGY

The Company is primarily engaged in the business of investing in
high-grade ARM-MBS, which are secured by pools of adjustable rate and hybrid
mortgage loans ("ARMs") primarily on single family residences. The Company's
investment strategy also provides for the acquisition and ownership of
multifamily housing properties. The Company does not currently originate
mortgage loans or provide other types of financing to the owners of real estate.

The Company's investment policy requires that at least 50% of its
investment portfolio consist of ARM-MBS that are either (i) Agency MBS or (ii)
rated in one of the two highest rating categories by one of the Rating Agencies.
The remainder of the Company's assets may consist of (a) direct investments
(mezzanine or equity) in multifamily apartment properties, (b) investments in
limited partnerships or REITs or (c) other fixed-income instruments. At December
31, 2002, 98.5% of the Company's assets consisted of Agency MBS, high quality
"AAA" rated MBS and cash. The Company's other investments, primarily consisting
of direct and indirect investments in limited partnerships owning real estate,
comprised less than 1.0% of its remaining assets at December 31, 2002.

The Company's ARM-MBS are generally indexed to the one-year constant
maturity treasury ("CMT") rate with interest rates that adjust on an interim
basis, generally annually, however, the hybrid MBS have an initial fixed rate
period, which does not exceed 36 months and thereafter reprice on an interim
basis. Other ARM-MBS are indexed to the London Interbank Offered Rate ("LIBOR")
or the 11th District Cost of Funds Index. ARM-MBS are generally subject to a
limitation on the amount of the interim interest rate change, which is usually
100 to 200 basis points (i.e. one basis point is equal to 1/100 of 1%) per
annum. ARMs also have lifetime caps on interest rate changes from the initial
interest rate, which typically do not exceed 600 basis points from the initial
interest rate.

FINANCING STRATEGY

The Company utilizes repurchase agreements to finance the acquisition of
ARM-MBS and other assets by borrowing against its portfolio of assets. In
addition, the Company may also finance the acquisition of additional assets with
the proceeds from capital market transactions. When fully invested, the
Company's policy is to maintain an assets-to-equity ratio of less than 11:1. As
of December 31, 2002, the Company's assets-to-equity ratio was 9.7:1 and its
debt-to-equity ratio was 8.6:1.

A repurchase agreement, although structured as a sale and repurchase
obligation, operates as a financing (i.e., borrowing) under which the Company
pledges its investment securities as collateral to secure a short-term loan with
a counterparty. The borrowed amount is limited to a specified percentage,
generally not more than 97%, of the estimated market value of the pledged
collateral. Repurchase agreements take the form of a sale of the pledged
collateral to a lender at an agreed upon price in return for such lender's
simultaneous agreement to resell the same securities back to the borrower at a
future date (i.e., the maturity of the borrowing) at a higher price. The
difference between the sale and repurchase price is the cost, or interest
expense, of borrowing under the repurchase agreements. The Company retains
beneficial ownership of the pledged collateral, including the right to
distributions, while the counterparty maintains custody of the collateral
securities. At the maturity of a repurchase agreement, the Company is required
to repay the loan and concurrently receive back its pledged collateral from the
lender or, may rollover (i.e., extend) such agreement at the then prevailing
financing rate. The repurchase agreements may require the Company to pledge
additional assets to the lender in the event the market value of existing
pledged collateral declines below a specified percentage. The pledged collateral
may fluctuate in value due to, among other things, principal repayments, market
changes in interest rates and credit quality. As of December 31, 2002, the
Company did not have any margin calls on its repurchase agreements that it was
not able to satisfy with either cash or additional pledged collateral.

The Company's repurchase agreements generally have maturities ranging from
one to 18 months at inception of the loan; however, the Company may decide to
enter into repurchase agreements with longer maturities in the future. Should
the counterparty to a repurchase agreement decide not to renew the agreement at
maturity, the Company would be required to either refinance elsewhere or be in a
position to retire the obligation. If, during the term of a repurchase
agreement, a lender should file for bankruptcy, the Company might experience
difficulty recovering its pledged assets and may have an unsecured claim against
the lender's assets for the difference between


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the amount loaned to the Company and the fair value of the security pledged by
the Company as collateral.

To reduce its exposure, the Company enters into repurchase agreements only
with financially sound institutions whose holding or parent company's long-term
debt rating is "A" or better as determined by at least one of the Rating
Agencies, where applicable. If this minimum criterion is not met, the Company
will not enter into repurchase agreements with that lender without the specific
approval of its Board of Directors. The Company generally seeks to diversify its
exposure by entering into repurchase agreements with at least four separate
lenders with a maximum loan from any lender of no more than three times the
Company's stockholders' equity. As of December 31, 2002, the Company had
repurchase agreements with 12 separate lenders, all of which were rated "A" or
better, with a maximum exposure (the difference between the amount loaned to the
Company and the fair value of the security pledged by the Company as collateral)
to a single lender of $54.3 million.

The Company may use derivatives and other hedging strategies to help
mitigate its prepayment and interest rate risks if it is determined that the
cost of these transactions is justified by their potential benefit. Through
December 31, 2002, the Company's use of hedge instruments has been limited to
purchased interest rate caps ("Cap Agreements"). A Cap Agreement is a contract,
whereby the purchaser pays a fee in exchange for the right to receive payments
equal to the principal (i.e., notional amount) times the difference between a
specified interest rate and a future interest rate during a defined "active"
period of time. As of December 31, 2002, the Company had 11 Cap Agreements, with
a total notional amount of $310.0 million. The Cap Agreements, which had an
amortized cost of $4.0 million were carried at their estimated fair value of
$1.1 million, with unrealized losses of $2.9 million reflected in accumulated
other comprehensive income. Management expects to enter into additional Cap
Agreements to hedge against increases in interest rates on its anticipated
future LIBOR-based repurchase agreements. However, the timing and amount of
future hedging transactions, if any, will depend on numerous market conditions,
including, but not limited to, the interest rate environment, management's
assessment of the future changes in interest rates and the market availability
and cost of entering into such hedge transactions.

Each of the multifamily apartment properties in which the Company holds an
interest is financed with a long-term fixed rate mortgage loan. The borrowers on
these mortgage loans are separate corporations, limited partnerships or limited
liability companies. Each of these mortgage loans is made to the applicable
ownership entity, generally on a nonrecourse basis, which means that the
lender's source of payment in the event of a default is generally foreclosure of
the underlying property securing the mortgage loan. As of December 31, 2002, the
aggregate mortgage indebtedness secured by the six multifamily apartment
properties in which the Company owns an interest was $47.7 million.

RISK FACTORS

The results of the Company's operations are affected by various factors,
many of which are beyond the control of the Company. The results of the
Company's operations primarily depend on, among other things, the level of its
net interest income, the market value of its assets and the supply of and demand
for such assets. The Company's net interest income varies primarily as a result
of changes in short-term interest rates, borrowing costs and prepayment rates,
the behavior of which involves various risks and uncertainties as set forth
below. Prepayment rates and interest rates vary according to the type of
investment, conditions in financial markets, competition and other factors, none
of which can be predicted with any certainty. In addition to these factors,
borrowing costs are further affected by the creditworthiness of the borrower.
Since changes in interest rates may significantly affect the Company's
activities, the operating results of the Company depend, in large part, upon the
ability of the Company to effectively manage its interest rate and prepayment
risks while maintaining its status as a REIT. The Company also has risks
inherent with its investments in real estate and hedging instruments. Because
these investments represented less than 1.0% of its total assets at December 31,
2002, the Company's risk relating to these assets is limited, but nonetheless
these investment have the potential of causing a material impact on the
Company's operating results. These risks, the Company's strategies to mitigate
the risks and the limitations of such strategies are discussed in further detail
below.

Interest Rate Risks

While management believes that there is no strategy that would completely
insulate the Company from interest rate changes and related prepayments on
investments, while achieving targeted profitability, the Company undertakes
certain strategies aimed at mitigating the potential negative effects of
interest rate changes. In order to limit interest rate risk on its assets, the
Company invests predominantly in ARM-MBS, which include hybrid MBS


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with generally less than 36 months to reprice at the time of acquisition, and
enters into interest rate Cap Agreements on the cash flows of anticipated
LIBOR-based repurchase agreements. The Company's hybrid MBS have a fixed rate
for an initial number of years, typically not greater than three years, and
thereafter convert to an adjustable rate coupon, which typically resets
annually. These strategies and related assets carry certain inherent risks other
than interest rate risk and/or costs. The Company finances the acquisition of
MBS through borrowings under repurchase agreements, which subjects the Company
to interest rate risk in relationship to the corresponding assets.

The cost of the Company's borrowings under its repurchase agreements is
based on the prevailing short-term market rates. The term of the Company's
repurchase agreements range from one to 18 months at inception of the loan;
however, the Company may decide to enter into repurchase agreements with longer
maturities in the future. The Company's ARM-MBS have interest rates that reset
every 12 months, after an initial fixed rate period for the hybrid MBS. At
December 31, 2002, the weighted average term to repricing for the ARM-MBS
portfolio was 19.6 months, while the weighted average term to repricing for the
Company's repurchase agreements was 5.8 months. The Company's policy is to
maintain an asset/borrowings repricing gap (i.e., the weighted average time
period for ARM-MBS to reprice, less the weighted average time period for
liabilities to reprice) of less than 18 months. At December 31, 2002, the
Company had a repricing gap of 13.8 months. However, it should be noted that a
significant portion, 31.9%, of the Company's repurchase agreements were
scheduled to mature in the first quarter of 2003.

The market determines the interest rates that the Company pays on its
borrowings (i.e., its repurchase agreements) to finance its MBS assets. The
Company has control over the cost of borrowings only to the extent of the
Company's credit standing and competitive bargaining ability. However, the level
of increase in rates on the Company's interest earning assets is limited. At
December 31, 2002, ARM-MBS comprised 96.5% of the Company's total assets and
99.8% of total MBS. The amount by which the interest rate on ARM-MBS can adjust
is limited by the interim and lifetime caps on the underlying ARMs. Generally,
interest rates on ARM-MBS can adjust by a maximum of 100 to 200 basis points per
annum (i.e., an interim cap) and 600 basis points from the initial interest rate
over the term of the ARMs (i.e., a lifetime cap). Lifetime and interim interest
rate caps on ARM-MBS could limit the change in the coupon (i.e., the stated
interest rated) on such assets. At December 31, 2002, $656.9 million, or 18.9%
of the Company's ARM-MBS (18.2% of the total assets), had a 1% interim cap and
the remainder had a 2% interim cap. As of December 31, 2002, the ARM-MBS had a
weighted average term to repricing of 19.6 months.

The cost of the Company's borrowings is generally LIBOR-based while
interest rates on ARM-MBS are primarily based on one-year CMT rates. Therefore,
any increase in the LIBOR relative to the CMT rates will generally result in an
increase in the Company's borrowing cost that is not matched by a corresponding
increase in the interest earnings on its ARM-MBS portfolio. At December 31,
2002, the one-year LIBOR was 1.44% and the one-year CMT was 1.32%. At December
31, 2002, the Company had 71.8% of its ARM-MBS portfolio repricing from the
one-year CMT index; 26.1% repricing from the one-year LIBOR index and 2.1%
repricing from the 11th District Cost of Funds Index (i.e., COFI).

In order to mitigate its interest rate risks, the Company intends to
continue to keep a substantial majority of its assets invested in ARM-MBS,
rather than fixed rate securities. These assets allow the Company's interest
income to generally move with changes in corresponding interest rates. However,
given the lag in interest rate resets along with the interim and lifetime
interest rate limitations on adjustments on its ARM-MBS portfolio, relative to
changes in the interest rates it pays on its liabilities, net interest income
could be negatively affected over the short term in a rising interest rate
environment. The ability of ARM-MBS to adjust based on changes in interest rates
helps to mitigate interest rate risk more effectively over a longer time period
than over the short term; however, interest rate risk is not eliminated under
either scenario. The general trend of declining interest rates experienced
during 2002 significantly reduced the Company's average cost of borrowings, to
2.32% for 2002 from 3.96% for 2001, which benefited the Company. However, as
interest rates declined, the prepayment speeds on the Company's MBS portfolio
increased, causing an increase in principal prepayments and corresponding
acceleration of amortization of premiums paid on the ARM-MBS portfolio.
Consequently, the increased amortization of purchase premiums decreased the
yield on the portfolio. In addition, coupons on ARM-MBS scheduled to reset
declined to lower interest rates and principal repayments were reinvested at the
lower prevailing market rates. For 2002, the weighted average coupon (i.e., the
weighted average stated rate) on the Company's MBS portfolio was 5.44%, while
the net yield on the MBS portfolio was 4.25%. The differential between the
coupon and net yield on the Company's MBS portfolio reflect the cost of premium
amortization, the cost of delay and difference between the coupon and gross
yield. The Company's cost of delay reflects the cost associated with the delay
in receiving the cash for principal


4

repayments, during which time such receivable is non-interest bearing. The gross
yield reflects the coupon interest income divided by the amortized cost, which
includes purchase premiums, of the MBS, and thus is lower than the coupon.

In accordance with the Company's investment guidelines, it may enter into
Cap Agreements to hedge against anticipated future increases in interest rates
on the Company's anticipated repurchase agreements. The Company only enters into
interest rate Cap Agreements with financial institutions which have a debt
rating of "A" or better by one of the Rating Agencies, thereby securing, to the
greatest extent possible, receipt of payments under the Cap Agreements. In the
unlikely event that a counterparty is unable to make required payments pursuant
to a Cap Agreement, the Company's loss would be limited to any remaining
unamortized premium paid for the specific Cap Agreement. Management monitors the
ratings of all of its counterparties on a regular basis; however, no assurance
can be given that the Company can eliminate risks related to third parties. As
of December 31, 2002, the Company had (i) ten interest rate Cap Agreements, with
a total notional amount of $260.0 million, that will become active during the
next 18 months, with strike prices ranging from 3.00% to 5.00% and (ii) a $50.0
million notional amount Cap Agreement which became active during the fourth
quarter of 2002, with a strike price of 5.75% that will run through October
2004. The Company's active Cap Agreement did not result in the Company receiving
any payments during 2002, as the 30-day LIBOR did not exceed the strike rate of
5.75% during the active period. Cap Agreements are extremely sensitive to
changes in interest rates and therefore their values are quite volatile;
however, the Company's maximum exposure is limited to the premium paid to
purchase the Cap Agreement. Because the Company utilizes Cap Agreements solely
to mitigate interest rate risk, in the form of a liability hedge, changes in the
market value are reflected in other comprehensive income and the premium is
amortized over the active period of the Cap Agreement, provided that the hedge
remains effective. As of December 31, 2002, the Company had unrealized losses of
$2.9 million on its Cap Agreements.

As a part of its hedging strategy, the Company may engage in limited
amounts of the buying and/or selling of mortgage derivative securities or other
derivative products, including interest rate swap agreements, financial futures
contracts and options. Although the Company has not historically used such
instruments, it is not precluded by its operating policies from doing so. In the
future, management may use such instruments as hedges against interest rate
risk. Management does not anticipate entering into derivatives for speculative
or trading purposes. Any use of derivatives and contemplated derivative
strategies are addressed with the investment committee of the Board of Directors
of the Company. It should be noted that no cost beneficial hedging strategy can
completely insulate the Company against interest rate risks. In addition, there
can be no assurance that any such hedging activities will have the desired
impact on the Company's results of operations or financial condition. Hedging
typically involves transaction costs, which increase dramatically as the period
covered by the hedge increases and which also increase during periods of rising
or volatile interest rates. Such hedging costs may cause the Company to conclude
that a particular hedging transaction is not appropriate for the Company,
thereby affecting the Company's ability to mitigate interest rate risk. As of
December 31, 2002, the Company's only hedge instruments were comprised of the
Cap Agreements previously discussed.

Increases in short-term interest rates may cause the Company's financing
costs to increase faster than rates increase on its ARM-MBS. As a result, the
Company's net interest spread and net interest margin could decline during such
periods, the severity of which would depend on the asset/liability structure at
the time as well as the magnitude and duration of the interest rate increase. In
the case of a sudden and sustained increase in interest rates, the net interest
income could become negative. Accordingly, in such a period, the Company could
incur a net loss from operations. In addition, such an interest rate environment
could decrease the market value of the ARM-MBS, to a level that additional
collateral could be required to secure the borrowings under the Company's
repurchase agreements. If such additional collateral were not available, the
lender could liquidate the securities collateralizing the repurchase agreements,
resulting in a loss to the Company. Further, such a decrease in the Company's
net interest income could negatively impact dividend distributions made by the
Company, which, in turn could reduce the market price of the Company's Common
Stock. The Company could also react to such a scenario by reducing borrowings
and assets, by selling assets or not replacing securities as they amortize
and/or prepay, thereby "shrinking the balance sheet." Such an action would
likely reduce interest income, interest expense and net income, the extent of
which would be dependent on the level of reduction in assets and liabilities as
well as the sale price of the assets sold.

Prepayment Risks

In general, residential borrowers of the mortgage loans securing the MBS
in the Company's portfolio may prepay such mortgage loans at any time without
penalty. Prepayments result when a homeowner sells his home or


5

decides to either satisfy or refinance his existing mortgage loan. In addition,
defaults and foreclosures have the same effect as prepayments. Prepayments
usually can be expected to increase when mortgage interest rates decrease
significantly, as was the case in 2001 and 2002, and decrease when mortgage
interest rates increase, although such effects are not entirely predictable.
Prepayment experience also may be affected by the conditions in the housing and
financial markets, general economic conditions and the relative interest rates
on fixed rate and adjustable rate mortgage loans. During 2002, prepayments rates
increased, particularly in the last quarter of 2002. During 2002, the constant
prepayment rate ("CPR"), which is a measure of prepayment speeds, ranged from a
low of 23% to high of 38%; during 2001, the CPR ranged from a low of 17% to a
high of 31%.

Prepayments are the primary feature of MBS that distinguishes them from
other types of bonds. While a certain percentage of the pool of mortgage loans
underlying MBS are expected to prepay during a given period of time, the
prepayment rate can, and often does, vary significantly from the anticipated
rate of prepayment. Prepayments generally have a negative impact on the
Company's financial results, the effects of which depends on, among other
things, the amount of unamortized premium on the securities, the reinvestment
lag and the reinvestment opportunities.

The Company limits its exposure to the impact of accelerated premium
amortization caused by prepayments, by limiting the premium paid on its MBS
portfolio. MBS securities can trade at significantly different prices depending
on, among other things, seasoning (i.e., age of the security) and the interest
rate. According to the Company's current policy, the average purchase price of
the MBS portfolio must be less than 103.5% of the securities par value. The
Company's gross premium as a percentage of current par value of the total MBS
portfolio was 2.26% and 1.99% at December 31, 2002 and 2001, respectively. In
addition, the Company maintains a diversified MBS portfolio with a variety of
prepayment characteristics and may reduce leverage in less advantageous market
environments. While these strategies may not maximize earnings potential in the
short term, the Company's objective is aimed at obtaining more predictable
earnings with less potential risk to capital.

Risks Associated with Leverage

The Company's financing strategy is designed to increase the size of its
mortgage investment portfolio by borrowing against a substantial portion of the
market value of its MBS. If interest income on the MBS purchased with borrowed
funds fails to cover the cost of the borrowings, the Company will experience net
interest losses and may experience net losses from operations. Such losses could
be significant as a result of the Company's leveraged structure.

The ability of the Company to achieve its investment objectives depends on
its ability to borrow money in sufficient amounts and on favorable terms
compared to the assets that the borrowings fund. Currently, the Company's direct
borrowings are comprised of collateralized borrowings in the form of repurchase
agreements. The ability of the Company to enter into repurchase agreements in
the future will depend on the market value of the MBS pledged to secure the
specific borrowings, the availability of financing and other conditions existing
in the lending market at that time. The cost of borrowings under repurchase
agreements generally corresponds to LIBOR plus or minus a margin, although such
agreements may not expressly incorporate a LIBOR index. Future increases in
haircuts (i.e., the about by which the collateral value exceeds the repurchase
agreement loan amount), decreases in the market value of the Company's MBS,
increases in interest rate volatility, and changes in the availability of
financing in the market, could cause the Company to be unable to achieve the
degree of leverage it believes to be optimal. As a result, the Company may be
less profitable than it would be otherwise.

In the future, the Company may also use other sources of funding, that
generally bear interest rates that correspond to a short-term benchmark, such as
other types of collateralized borrowings, loan agreements, lines of credit,
dollar-roll agreements or through the issuance of debt securities.

The Company's wholly-owned subsidiary, Retirement Centers Corporation
("RCC"), has non-recourse mortgage loans secured by two real estate properties,
which had an aggregate balance of $16.3 million and a weighted average interest
rate of 7.3%. In addition, the Company had investments in four limited
partnerships, which had an aggregate of $31.4 million of non-recourse mortgage
loans secured by the underlying properties, with a weighted average interest
rate of 7.7%.

Risks of Decline in Market Value

The value of interest-bearing obligations such as mortgages and MBS
typically move inversely with interest rates. Accordingly, in a rising interest
rate environment, the value of such instruments may decline. Because the
interest earned on ARM-MBS may increase as interest rates increase subject to a
delay until each such security's


6

next reset date, the values of these assets are generally less sensitive to
changes in interest rates than are fixed rate instruments. Therefore, in order
to mitigate this risk, the Company intends to maintain a substantial majority of
its portfolio in ARM-MBS. At December 31, 2002, ARM-MBS constituted 96.5% of
total assets and 99.8% of the Company's total MBS.

A decline in the market value of the Company's MBS assets may limit the
Company's ability to borrow or result in lenders initiating margin calls, which
require a pledge of additional collateral or cash to re-establish the required
ratio of borrowing to collateral value. The Company could be required to sell
some of its MBS under adverse market conditions in order to maintain liquidity.
If such sales were to be made at prices lower than the amortized cost (i.e., the
carrying value) of the securities, the Company would incur losses. A default by
the Company under its collateralized borrowings could also result in a
liquidation of the collateral, and a resulting loss of the difference between
the value of the collateral and the amount borrowed.

Credit Risks Associated with Investments

The holder of a mortgage or MBS assumes a risk that the borrowers may
default on their obligations to make full and timely payments of principal and
interest. The Company significantly mitigates this credit risk by requiring that
at least 50% of its investment portfolio consist of ARM-MBS that are either (i)
Agency MBS or (ii) rated in one of the two highest rating categories by one of
the Rating Agencies. The remainder of the Company's assets may be either (a)
direct investment (mezzanine or equity) in multifamily apartment properties, (b)
investments in limited partnerships or REITs or (c) other fixed-income
instruments. As of December 31, 2002, 93.2% of the Company's assets consisted of
Agency MBS, 3.5% were high quality MBS rated "AAA" and 1.8% were of cash and
cash equivalents; combined these assets comprised 98.5% of the Company's total
assets. During 2002, the Company sold all of its remaining investments in
corporate debt and equity securities. (See Notes 5 and 6 to the accompanying
consolidated financial statements, included under Item 8.)

Investment Company Act

The Company at all times intends to conduct its business so as to not
become regulated as an investment company under the Investment Company Act of
1940 (the "Investment Company Act"). If the Company were to become regulated as
an investment company, then, among other things, the Company's ability to use
leverage would be substantially reduced. The Investment Company Act exempts
entities that are "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interests in real estate" (i.e.,
"Qualifying Interests"). Under the current interpretation of the staff of the
Securities and Exchange Commission, in order to qualify for this exemption, the
Company must maintain at least 55% of its assets directly in Qualifying
Interests. In addition, unless certain MBS represent an undivided interest in
the entire pool backing such MBS (i.e., whole pools), such MBS may be treated as
securities separate from the underlying mortgage loan, thus, may not be
considered Qualifying Interests for purposes of the 55% exemption requirement.
Accordingly, the Company monitors its compliance with this requirement in order
to maintain its exempt status. As of December 31, 2002, the Company determined
that it was in and has maintained compliance with this requirement.

CERTAIN FEDERAL INCOME TAX CONSIDERATIONS

The following is a description of certain U.S. federal income tax
consequences relating to the Company's taxation as a REIT.

The information in this section is based on the Internal Revenue Code of
1986, as amended (the "Code"), current, temporary and proposed regulations
promulgated under the Code, the legislative history of the Code, current
administrative interpretations and practices of the Internal Revenue Service
(the "IRS") and court decisions, all as of the date hereof. The administrative
interpretations and practices of the IRS upon which this summary is based
include its practices and policies as expressed in private letter rulings which
are not binding on the IRS, except with respect to the taxpayers who requested
and received such rulings. In each case, these sources are relied upon as of the
date hereof. No assurance can be given that future legislation, regulations
administrative interpretations and practices and court decisions will not
significantly change current law, or adversely affect certain existing
interpretations of existing law, on which the information in this section is
based. Even if there is no change in applicable law, no assurance can be
provided that the statements made in the following discussion will not be
challenged by the IRS or will be sustained by a court if so challenged.


7

General

The Company has elected to be taxed as a REIT under Sections 856 through
860 of the Code, commencing with the Company's taxable year ended December 31,
1998. Management believes that the Company is organized and has operated in a
manner so as to qualify as a REIT under the Code and intends to continue to
operate in such a manner. No assurance, however, can be given that the Company
in fact has qualified or will remain qualified as a REIT.

The sections of the Code that relate to the qualification and taxation of
REITs are highly technical and complex. The following describes the material
aspects of the sections of the Code that govern the federal income tax treatment
of a REIT. This summary is qualified in its entirety by the applicable Code
provisions, rules and regulations promulgated under the Code, and administrative
and judicial interpretations of the Code.

Qualification and taxation as a REIT depend upon the Company's ability to
meet on a continuing basis, through actual annual operating results, the various
requirements under the Code and, as described in this Form 10-K, with regard to,
among other things, the Company's; (i) source of gross income, (ii) composition
of assets, (iii) distribution levels and (iv) diversity of stock ownership.
While the Company intends to operate so that the Company qualifies as a REIT,
given the highly complex nature of the rules governing REITs, the ongoing
importance of factual determinations and the possibility of future changes in
the Company's circumstances or in the law, no assurance can be given that the
Company so qualifies or will continue to so qualify.

Provided the Company qualifies for taxation as a REIT, it generally will
not be subject to federal corporate income tax on net income that is currently
distributed to the Company's stockholders. This treatment substantially
eliminates the "double taxation" that generally results from an investment in a
corporation. Double taxation means taxation once at the corporate level, when
income is earned, and once again at the stockholder level when such income is
distributed through dividends. However, even as a REIT, the Company will be
subject to federal income taxation under the following circumstances:

o The Company will be required to pay tax at regular corporate
rates on any undistributed REIT taxable income, including
undistributed net capital gains;

o The Company may be subject to the "alternative minimum tax"
on items of tax preference, if any;

o If the Company has (i) net income from the sale or other
disposition of "foreclosure property" which is held primarily for
sale to customers in the ordinary course of business or (ii) other
nonqualifying income from foreclosure property, the Company will be
required to pay tax at the highest corporate rate on this income. In
general, foreclosure property is property acquired through
foreclosure after a default on a loan secured by the property or on
a lease of the property;

o The Company will be required to pay a 100% tax on any net
income from prohibited transactions. In general, prohibited
transactions are sales or other taxable dispositions of assets,
other than foreclosure property, held for sale to customers in the
ordinary course of business;

o If the Company fails to satisfy the 75% or 95% gross income
tests, as described below, but has, nevertheless, maintained its
qualification as a REIT, the Company will be subject to a tax equal
to the gross income attributable to the greater of either (i) the
amount by which 75% of the Company's gross income exceeds the amount
qualifying under the 75% test for the taxable year or (ii) the
amount by which 90% of the Company's gross income exceeds the amount
of its income qualifying under the 95% test for the taxable year
multiplied in either case by a fraction intended to reflect the
Company's profitability;

o The Company will be required to pay a 4% excise tax on the
amount by which its annual distributions to stockholders is less
than the sum of (i) 85% of the Company's ordinary income for the
year, (ii) 95% of the Company's REIT capital gain net income for the
year, and (iii) any undistributed taxable income from prior periods;

o If the Company acquires an asset from a corporation which is
not a REIT in a transaction in which the basis of the asset in the
Company's hands is determined by reference to the basis of the asset
in the hands of the transferor corporation and the Company
subsequently sells or otherwise disposes of the asset within ten
years, then under existing treasury regulations, the Company would
be required to pay tax at the highest regular corporate tax rate on
this gain to the extent the fair market value of the asset exceeds
the Company's adjusted tax basis in the asset, in each case,
determined as of the date on which the


8

Company acquired the asset. The results described in this paragraph
assume that the Company will not elect in lieu of this treatment to
be subject to an immediate tax when the asset is acquired; and

o The Company will generally be subject to tax on the portion
of any "excess inclusion income" derived from an investment in
residual interests in real estate mortgage investment conduits to
the extent the Company's stock is held by specified tax exempt
organizations not subject to tax on unrelated business taxable
income.

Requirements for Qualification as a REIT

General. The Code defines a REIT as a corporation, trust or association:

(1) that is managed by one or more trustees or directors;

(2) that issues transferable shares or transferable
certificates to its owners;

(3) that would be taxable as a regular corporation, but for
its election to be taxed as a REIT;

(4) that is not a financial institution or an insurance
company under the Code;

(5) that is owned by 100 or more persons;

(6) that has not more than 50% of the value of its outstanding
stock that is owned, actually or constructively, by five or fewer
individuals (as defined in the Code to include certain entities)
during the last half of each year (the "5/50 Rule"); and

(7) that meets other tests, described below, regarding the
nature of its income and assets, and the amount of its
distributions.

The Code provides that conditions (1) through (4) must be met during the
entire year and that condition (5) must be met during at least 335 days of a
year of twelve months or during a proportionate part of a shorter taxable year.
Conditions (5) and (6) do not apply to the first taxable year for which an
election is made to be taxed as a REIT.

The Company's amended and restated articles of incorporation provide for
restrictions regarding ownership and transfer of the Company's stock. These
restrictions are intended to assist the Company in satisfying the share
ownership requirements described in conditions (5) and (6) above. These
restrictions, however, may not ensure that the Company will, in all cases, be
able to satisfy the share ownership requirements described in conditions (5) and
(6) above. If the Company fails to satisfy these share ownership requirements,
the Company's status as a REIT may terminate. If, however, the Company complied
with the rules contained in applicable regulations that require a REIT to
determine the actual ownership of its shares and the Company does not know, or
would not have known through the exercise of reasonable diligence, that the
Company failed to meet the requirement described in condition (6) above, the
Company would not be disqualified as a REIT.

In addition, a corporation may not qualify as a REIT unless its taxable
year is the calendar year. The Company has a calendar taxable year.

Qualified REIT Subsidiaries. A "qualified REIT subsidiary" is a
corporation, all of the stock of which is owned by a REIT. Under the Code, a
qualified REIT subsidiary is not treated as a separate corporation from the
REIT. Rather, all of the assets, liabilities and items of income, deduction and
credit of the qualified REIT subsidiary are treated as the assets, liabilities
and items of income, deduction and credit of the REIT for purposes of the REIT
income and asset tests described below.

Taxable REIT Subsidiaries. A "taxable REIT subsidiary" is a corporation
which, together with a REIT, which owns an interest in such corporation, makes
an election to be treated as a taxable REIT subsidiary. A taxable REIT
subsidiary may earn income that would be nonqualifying income if earned directly
by a REIT and is generally subject to full corporate level tax. A REIT may own
up to 100% of the stock of a taxable REIT subsidiary.

Certain restrictions imposed on taxable REIT subsidiaries are intended to
ensure that such entities will be subject to appropriate levels of federal
income taxation. First, a taxable REIT subsidiary may not deduct interest
payments made in any year to an affiliated REIT to the extent that such payments
exceed, generally, 50% of the taxable REIT subsidiary's adjusted taxable income
for that year (although the taxable REIT subsidiary may carry forward to, and
deduct in, a succeeding year the disallowed interest amount if the 50% test is
satisfied in that year). In addition, if a taxable REIT subsidiary pays
interest, rent or another amount to a REIT that exceeds the amount that would be
paid to an unrelated party in an arm's length transaction, the REIT generally
will be subject to an


9

excise tax equal to 100% of such excess. The Company, together with RCC, had
made a taxable REIT subsidiary election with respect to its ownership interest
in RCC, which election was effective, for federal income tax purposes, as of
March 30, 2002; however, the Company and RCC revoked this election in January of
2003. As a result, effective January 2003, RCC became a qualified REIT
subsidiary of the Company. During its time as a TRS, RCC made interest and other
payments to the Company.

Income Tests. The Company must meet two annual gross income requirements
to qualify as a REIT. First, each year the Company must derive, directly or
indirectly, at least 75% of its gross income, excluding gross income from
prohibited transactions, from investments relating to real property or mortgages
on real property, including "rents from real property" and mortgage interest, or
from specified temporary investments. Second, each year the Company must derive
at least 95% of its gross income, excluding gross income from prohibited
transactions, from investments meeting the 75% test described above, or from
dividends, interest and gain from the sale or disposition of stock or
securities. For these purposes, the term "interest" generally does not include
any interest of which the amount received depends on the income or profits of
any person. An amount will generally not be excluded from the term "interest;"
however, if such amount is based on a fixed percentage of gross receipts or
sales.

Any amount includable in the Company's gross income with respect to a
regular or residual interest in a real estate mortgage investment conduit is
generally treated as interest on an obligation secured by a mortgage on real
property for purposes of the 75% gross income test. If, however, less than 95%
of the assets of a real estate mortgage investment conduit consist of real
estate assets, the Company will be treated as receiving directly its
proportionate share of the income of the real estate mortgage investment
conduit, which would generally include non-qualifying income for purposes of the
75% gross income test. In addition, if the Company receives interest income with
respect to a mortgage loan that is secured by both real property and other
property and the principal amount of the loan exceeds the fair market value of
the real property on the date the mortgage loan was made by the Company,
interest income on the loan will be apportioned between the real property and
the other property, which apportionment would cause the Company to recognize
income that is not qualifying income for purposes of the 75% gross income test.

To the extent interest on a loan is based on the cash proceeds from the
sale or value of property, such income would be treated as gain from the sale of
the secured property, which generally should qualify for purposes of the 75% and
95% gross income tests.

The Company inevitably may have some gross income from various sources
that fails to constitute qualifying income for purposes of one or both of the
gross income tests, such as qualified hedging income, which would constitute
qualifying income for purposes of the 95% gross income test, but not the 75%
gross income test. However, the Company intends to maintain its status as a REIT
by carefully monitoring any such potential nonqualifying income.

If the Company fails to satisfy one or both of the 75% or 95% gross income
tests for any year, the Company may still qualify as a REIT if it is entitled to
relief under the Code. Generally, the Company may be entitled to relief if:

o the failure to meet the gross income tests was due to
reasonable cause and not due to willful neglect;

o a schedule of the sources of the Company's income is
attached to its federal income tax return; and

o any incorrect information on the schedule was not due to
fraud with the intent to evade tax.

It is not possible to state whether in all circumstances the Company would
be entitled to rely on these relief provisions. If these relief provisions do
not apply to a particular set of circumstances, the Company would fail to
qualify as a REIT. As discussed above in "General," even if these relief
provisions apply and the Company retains its status as a REIT, a tax would be
imposed with respect to the Company's income that does not meet the gross income
tests. The Company may not always be able to maintain compliance with the gross
income tests for REIT qualification despite periodically monitoring the
Company's income.

Foreclosure Property. Net income realized by the Company from foreclosure
property would generally be subject to tax at the maximum federal corporate tax
rate (currently 35%). Foreclosure property means real property and related
personal property that is acquired through foreclosure following a default on a
lease of such property or a default on indebtedness that is secured by the
property and for which an election is made to treat the property as foreclosure
property.


10

Prohibited Transaction Income. Any gain realized by the Company on the
sale of any asset other than foreclosure property, held as inventory or
otherwise held primarily for sale to customers in the ordinary course of
business will be prohibited transaction income and subject to a 100% penalty
tax. Prohibited transaction income may also adversely affect the Company's
ability to satisfy the gross income tests for qualification as a REIT. Whether
an asset is held as inventory or primarily for sale to customers in the ordinary
course of a trade or business depends on all the facts and circumstances
surrounding the particular transaction. While the regulations provide standards
which, if met, would not cause a sale of an asset to result in prohibited
transaction income, the Company may not be able to meet these standards in all
circumstances.

Asset Tests. At the close of each calendar quarter, the Company also must
satisfy four tests relating to the nature of its assets. First, at least 75% of
the value of the Company's total assets must be real estate assets, cash, cash
items and government securities. For purposes of this test, real estate assets
include real estate mortgages, real property, interests in other REITs and stock
or debt instruments held for one year or less that are purchased with the
proceeds of a stock offering or a long-term public debt offering. Second, not
more than 25% of the Company's total assets may be represented by securities,
other than those securities includable in the 75% asset class. Third, not more
than 20% of the value of the Company's total assets may be represented by
securities in one or more taxable REIT subsidiaries. Fourth, of the investments
included in the 25% asset class, the value of any one issuer's securities may
not exceed 5% of the value of the Company's total assets, and the Company may
not own more than 10% of the total vote or value of the outstanding securities
of any one issuer (other than securities of a qualified REIT subsidiary, a
taxable REIT subsidiary and, with respect to the 10% value test, certain
"straight debt" securities).

The Company currently owns 100% of RCC. RCC elected to be taxed as a REIT
for its taxable year ended December 31, 2001 and jointly elected, together with
the Company, to be treated as a taxable REIT subsidiary effective as of March
30, 2002. The Company believes that RCC met all of the requirements for taxation
as a REIT with respect to its taxable year ended December 31, 2001 and as a
taxable REIT subsidiary commencing as of March 30, 2002; however, the sections
of the Code that relate to qualification as a REIT are highly technical and
complex and there are certain requirements that must be met in order for RCC to
have qualified as a taxable REIT subsidiary effective March 30, 2002. Since RCC
has been subject to taxation as a REIT or a taxable REIT subsidiary, as the case
may be, at the close of each quarter of the Company's taxable years beginning
with the year ended December 31, 2001, the Company believes that its ownership
interest in RCC has not caused the Company to fail to satisfy the 10% value
test. In addition, the Company believes that it has, at all times prior to
October 1, 2002, owned less than 10% of the voting securities of RCC. No
assurance, however, can be given that RCC in fact qualified as a REIT for its
taxable year ended December 31, 2001 or as a taxable REIT subsidiary as of March
30, 2002, that the nonvoting preferred stock of RCC owned by the Company would
not be deemed to be "voting stock" for purposes of the asset tests or, as a
result of any of the foregoing, that the Company has qualified or will continue
to qualify as a REIT. Effective January 2003, the Company and RCC revoked their
election to treat RCC as a taxable REIT subsidiary. As a result, effective as of
such date, RCC became a qualified REIT subsidiary of the Company.

After meeting the asset tests at the close of any quarter, the Company
will not lose its status as a REIT if it fails to satisfy the asset tests at the
end of a later quarter solely by reason of changes in asset values. In addition,
if the Company fails to satisfy the asset tests because it acquires assets
during a quarter, the Company can cure this failure by disposing of sufficient
nonqualifying assets within 30 days after the close of that quarter.

The Company intends to monitor the status of the assets that the Company
owns for purposes of the various asset tests and manage its portfolio in order
to comply with such tests.

Annual Distribution Requirements. To qualify as a REIT, the Company is
required to distribute dividends, other than capital gain dividends, to its
stockholders in an amount at least equal to the sum of (i) 90% of the Company's
"REIT taxable income" and (ii) 90% of the Company's after-tax net income, if
any, from foreclosure property, minus (iii) the sum of certain items of non-cash
income. In general, "REIT taxable income" means taxable ordinary income without
regard to the dividends paid deduction.

The Company is generally required to distribute income in the taxable year
in which it is earned, or in the following taxable year before the Company
timely files its tax return if such dividend distributions are declared and paid
on or before the Company's first regular dividend payment. Generally, these
distributions are taxable to holders of common stock in the year in which paid,
even though these distributions relate to the prior year for purposes of the
Company's 90% distribution requirement. To the extent that the Company does not
distribute all of


11

its net capital gain or distribute at least 90% of its "REIT taxable income,"
the Company will be subject to tax at regular corporate tax rates on such
under-distributed amount.

From time to time, the Company may not have sufficient cash or other
liquid assets to meet the above distribution requirement due to timing
differences between the actual receipt of cash and payment of expenses and the
inclusion of income and deduction of expenses in arriving at the Company's
taxable income. If these timing differences occur, in order to meet the REIT
distribution requirements, the Company may need to arrange for short-term, or
possibly long-term, borrowings, or to pay dividends in the form of taxable stock
dividends.

Under certain circumstances, the Company may be able to rectify a failure
to meet a distribution requirement for a year by paying "deficiency dividends"
to its stockholders in a later year, which may be included in the Company's
deduction for dividends paid for the earlier year. Thus, the Company may be able
to avoid being subject to tax on amounts distributed as deficiency dividends.
The Company will be required, however, to pay interest based upon the amount of
any deduction claimed for deficiency dividends. In addition, the Company will be
subject to a 4% excise tax on the excess of the required distribution over the
amounts actually distributed if the Company should fail to distribute each year
at least the sum of 85% of its ordinary income for the year, 90% of its capital
gain income for the year and any undistributed taxable income from prior
periods.

Recordkeeping Requirements. The Company is required to maintain records
and request on an annual basis information from specified stockholders. This
requirement is designed to disclose the actual ownership of the Company's
outstanding stock.

Excess Inclusion Income. If the Company is deemed to have issued debt
obligations having two or more maturities, the payments on which correspond to
payments on mortgage loans owned by the Company, such arrangement will be
treated as a "taxable mortgage pool" for federal income tax purposes. If all or
a portion of the Company is considered a taxable mortgage pool, its status as a
REIT generally should not be impaired; however, a portion of its taxable income
may be characterized as "excess inclusion income" and allocated to its
stockholders. Any excess inclusion income:

o could not be offset by unrelated net operating losses of a
stockholder;

o would be subject to tax as "unrelated business taxable
income" to a tax-exempt stockholder;

o would be subject to the application of federal income tax
withholding (without reduction pursuant to any otherwise applicable
income tax treaty) with respect to amounts allocable to foreign
stockholders; and

o would be taxable (at the highest corporate tax rate) to the
Company, rather than its stockholders, to the extent allocable to
the Company's stock held by disqualified organizations (generally,
tax-exempt entities not subject to unrelated business income tax,
including governmental organizations).

Failure to Qualify. If the Company fails to qualify for taxation as a REIT
in any taxable year and the relief provisions of the Code described above do not
apply, the Company will be subject to tax, including any applicable alternative
minimum tax, and possibly increased state and local taxes, on its taxable income
at regular corporate rates. Such taxation would reduce the cash available for
distribution by the Company to its stockholders. Distributions to the Company's
stockholders in any year in which the Company fails to qualify as a REIT will
not be deductible by the Company and the Company will not be required to
distribute any amounts to its stockholders. Additionally, if the Company fails
to qualify as a REIT, distributions to its stockholders will be subject to tax
as ordinary income to the extent of the Company's current and accumulated
earnings and profits and, subject to certain limitations of the Code, corporate
stockholders may be eligible for the dividends received deduction. Unless
entitled to relief under specific statutory provisions, the Company would also
be disqualified from taxation as a REIT for the four taxable years following the
year during which the Company lost its qualification. It is not possible to
state whether in all circumstances the Company would be entitled to statutory
relief.

State, Local and Foreign Taxation

The Company may be required to pay state, local and foreign taxes in
various state, local and foreign jurisdictions, including those in which the
Company transacts business or make investments, and its stockholders may be
required to pay state, local and foreign taxes in various state, local and
foreign jurisdictions, including those in which they reside. The Company's
state, local and foreign tax treatment may not conform to the federal income tax
consequences summarized above.


12

Proposed Legislative or Other Actions Affecting REITs

On January 7, 2003, the Bush Administration released a proposal intended
to eliminate one level of the federal "double taxation" that is currently
imposed on corporate income for regular C corporations. Under this proposal,
dividends from a regular C corporation will be excluded from a stockholder's
federal taxable income to the extent that corporate income tax has been paid on
the earnings from which the dividends are paid. If a REIT receives a dividend
from a regular C corporation that has been subject to corporate income tax, the
REIT could distribute or retain the dividend amount without any additional
federal income tax being imposed on the REIT or its stockholders.

REITs currently are tax-advantaged relative to regular C corporations
because they are not subject to corporate-level federal income tax on income
that they distribute to stockholders. The Bush Administration's proposal, if
enacted, could decrease the tax advantage of a REIT relative to a regular C
corporation, because part or all of the dividends received by a stockholder from
the regular C corporation would be exempt from federal income tax. It is not
possible to predict whether the Bush Administration's proposal ultimately will
be enacted, the form which it might take, and, if enacted, the effects it may
have on the value of REIT shares.

The rules dealing with federal income taxation are constantly under review
by persons involved in the legislative process and by the IRS and the U.S.
Treasury Department. Changes to the tax law, which may have retroactive
application, could adversely affect the Company and its stockholders. It cannot
be predicted whether, when, in what forms or with what effective dates, the tax
law applicable to the Company or its stockholders will be changed.

COMPETITION

The Company believes that its principal competitors in the business of
acquiring and holding MBS of the types in which it invests are financial
institutions, such as banks, savings and loan institutions, life insurance
companies, institutional investors, including mutual funds and pension funds and
other mortgage REITs. Such investors may not be subject to similar regulatory
constraints (i.e., REIT tax compliance or maintaining an exemption under the
Investment Company Act). In addition, many of the other entities purchasing
mortgages and MBS have greater financial resources and access to capital than
the Company. The existence of these competitive entities, as well as the
possibility of additional entities forming in the future, may increase the
competition for the acquisition of MBS and other REIT qualifying investments
that the Company may invest in, resulting in higher prices and lower yields on
such assets.

AVAILABLE INFORMATION

The Company maintains a website on the World Wide Web at www.mfa-reit.com.
The Company makes available, free of charge, on its website its annual report on
the Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended (the "1934 Act"), as
soon as reasonable practicable after such reports are electronically filed with,
or furnished to, the SEC. The Company's reports filed with, or furnished to, the
SEC are also available at the SEC's website at www.sec.gov.


13

Item 2. Properties.

Executive Office

During the second quarter of 2002, the Company entered into a lease
through 2012 for its corporate headquarters, located at 350 Park Avenue, New
York, New York. The lease provides for, among other things, annual rent of (i)
$338,000 though July 31 2005; (ii) $348,000 from August 1, 2005 through November
30, 2008 and (iii) $357,000 from December 1, 2008 through August 31, 2012. The
Company believes that the leased space is adequate to meet the Company's
foreseeable operating needs.

Property Owned Through Subsidiary Corporation

On October 1, 2002, the Company acquired 100% of the voting common stock
of RCC Corporation, representing 5% economic interest, for $260,000. (See Note 3
to the consolidated financial statements, included under Item 8). As a result of
the purchase of RCC common shares, the Company indirectly owns the controlling
interest the properties known as "The Greenhouse" and "Lealand Place". The
Greenhouse is a 127-unit high-rise rental apartment building located at 900
Farnam on the Mall in Omaha, Nebraska. Lealand Place is a 192-unit three and
four-story garden-style apartment rental complex located at 2945 Cruse Road,
Lawrenceville, Georgia.

Item 3. Legal Proceedings.

There are no material pending legal proceedings to which the Company is a
party or any of its assets are subject.

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

None.

Item 4A Executive Officers of the Company.

The following table sets forth certain information with respect to each
executive officer of the Company. The Board of Directors appoints or annually
reaffirms the appointment of all of the Company's executive officers.

Name Age* Position held with the Company
- ------------------- ---- ----------------------------------------------------
Stewart Zimmerman 58 President and Chief Executive Officer and Director
William S. Gorin 44 Executive Vice President and Chief Financial Officer
Ronald A. Freydberg 42 Executive Vice President and Secretary
Teresa D. Covello 37 Senior Vice President and Controller

* As of December 31, 2002

Stewart Zimmerman has served as President and Chief Executive Officer of
the Company since 1997. From 1989 through 1997, he initially served as a
consultant to The America First Companies and then became Executive Vice of
America First Companies, L.L.C. During this time he held a number of positions:
President and Chief Operating Officer of America First REIT, Inc., and President
of several America First Mortgage funds, including America First
Participating/Preferred Equity Mortgage Fund, America First PREP Fund 2, America
First PREP Fund II Pension Series Limited Partnership, Capital Source L.P.,
Capital Source II L.P.-A, America First Tax Exempt Mortgage Fund Limited
Partnership and America First Tax Exempt Fund 2-Limited Partnership. From 1986
through 1989, Mr. Zimmerman served as a Managing Director and Director of
Security Pacific Merchant Bank. From 1982 through 1986 Mr. Zimmerman served as
First Vice President of EF Hutton & Company, Inc. From 1980 through 1982, Mr.
Zimmerman was employed by First Pennco Securities and Cralin & Company. From
1977 to 1980, he served as Vice President of Lehmann Brothers. Prior to that
time, Mr. Zimmerman was an officer of Bankers Trust Company as well as Vice
President of Zenith Mortgage Company. Mr. Zimmerman holds a Bachelors of Arts
degree from Michigan State University.


14

William S. Gorin serves as Executive Vice President, Chief Financial
Officer and Treasurer of the Company. He has served as Executive Vice President
since 1997 and was appointed Chief Financial Officer and Treasurer in 2001. From
1998 to 2001, Mr. Gorin served as Executive Vice President and Secretary of the
Company. From 1989 to 1997, Mr. Gorin held various positions with PaineWebber
Incorporated/Kidder, Peabody & Co. Incorporated, New York, New York, serving as
a First Vice President in the Research Department. Prior to that position, Mr.
Gorin was Senior Vice President in the Special Products Group. From 1982 to
1988, Mr. Gorin was employed by Shearson Lehman Hutton, Inc./E.F. Hutton &
Company, Inc., New York, New York, in various positions in corporate finance and
direct investments. Mr. Gorin has a Masters of Business Administration degree
from Stanford University and a Bachelor of Arts in Economics from Brandeis
University.

Ronald A. Freydberg serves as Executive Vice President and Secretary of
the Company, which positions he was appointed to in 2001. From 1998 to 2001, he
served as Senior Vice President of the Company. From 1995 to 1997, Mr. Freydberg
served as a Vice President of Pentalpha Capital, in Greenwich, Connecticut,
where he was a fixed-income quantitative analysis and structuring specialist. In
addition, he worked with various financial institutions on the acquisition and
sale of residential, commercial and asset-backed securities. From 1988 to 1995,
Mr. Freydberg held various positions with J.P. Morgan & Co. in New York, New
York. From 1994 to 1995, he was with the Global Markets Group. In that position,
he was involved in all aspects of commercial mortgage-backed securitization and
sale of distressed commercial real estate, including structuring, due diligence
and marketing. From 1985 to 1988, Mr. Freydberg was employed by Citicorp in New
York, New York. Mr. Freydberg holds a Masters of Business Administration degree
in Finance from George Washington University and a Bachelor of Arts degree from
Muhlenberg College.

Teresa D. Covello has served as Senior Vice President and Controller of
the Company since October 2001. From 2000 up to joining the Company, Ms. Covello
was a self-employed financial consultant, concentrating in investment banking
within the financial services sector. From 1990 to 2000, she held progressive
positions, was the Director of Financial Reporting and served on the Strategic
Planning Team for JSB Financial, Inc., where her key responsibilities included;
Securities and Exchange Commission ("SEC") reporting, implementing accounting
standards, establishing policies and procedures, managing asset/liability and
interest rate risk policy and reporting, and investor and regulatory
communications. Ms. Covello began her career in public accounting in 1987 with
KPMG Peat Marwick (predecessor to KPMG LLP), participating in and supervising
financial statement audits, compliance examinations, public debt and equity
offerings. Ms. Covello is a Certified Public Accountant and has a Bachelor of
Science degree in Public Accounting from Hofstra University.


15

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.

(a) Market Information The Company's Common Stock began trading on the New
York Stock Exchange on April 10, 1998, under the symbol "MFA." As of February 5,
2003, the last sales price for the Company's Common Stock on the New York Stock
Exchange was $8.55. The following table sets forth the high and low sale prices
per share for the Company's Common Stock during the 12 months ending December
31, 2002 and 2001.

2002 2001
-------------------- -------------------
Quarter Ended High Low High Low
------------------- ------- ------ ------ ------
March 31 $9.590 $8.200 $7.500 $5.063
June 30 $10.740 $8.300 $8.250 $6.750
September 30 $10.180 $7.210 $8.850 $7.250
December 31 $9.160 $7.100 $9.400 $7.650

(b) Investors

The approximate number of record holders of the Company's Common Stock as
of December 31, 2002 was 492; the total number of beneficial owners was
estimated at 16,500.

(c) Dividends

The Company currently pays cash dividends on a quarterly basis. Total cash
dividends declared by the Company to stockholders during the years ended
December 31, 2002 and 2001, were $54.8 million ($1.24 per share) and $17.0
million ($0.845 per share), respectively. In general, consistent with the
Company's underlying operational strategy, the Company's dividends will for the
most part be characterized as ordinary income to its stockholders for federal
tax purposes. However, a portion of the Company's dividends may be characterized
as capital gains or return of capital. All of the Company's dividends for 2002
and 2001 were characterized as ordinary income. (For additional dividend
information, see Note 11 to the accompanying consolidated financial statements,
included under Item 8.)

The Company elected to be treated as a REIT for federal income tax
purposes beginning with its 1998 taxable year and, as such, has distributed and
anticipates distributing annually at least 90% (95% prior to January 1, 2001) of
its taxable income, subject to certain adjustments. Although the Company may
borrow funds to make distributions; cash for such distributions has generally
been and is expected to continue to be largely generated from the Company's
results of operations.

The Company declared the following dividends during the years ended
December 31, 2002 and 2001:

Dividend
Declaration Date Record Date Payment Date per Share
- ------------------ ------------------ ---------------- -----------
2002
- ----
March 12, 2002 March 28, 2002 April 30, 2002 $ 0.30 (1)
June 12, 2002 June 28, 2002 July 30, 2002 0.30 (1)
September 12, 2002 September 30, 2002 October 30, 2002 0.32 (2)
December 19, 2002 December 30, 2002 January 24, 2003 0.32 (2)

2001
- ----
February 12, 2001 April 16, 2001 April 30, 2001 $ 0.165
April 9, 2001 June 30, 2001 July 16, 2001 0.175
September 19, 2001 October 2, 2001 October 18, 2001 0.225
December 12, 2001 December 28, 2001 January 30, 2002 0.280

(1) Included a special dividend of $0.02 per share.
(2) Included a special dividend of $0.04 per share.
Note: For tax purposes, a portion of each of the dividends declared on
December 19, 2002 and December 12, 2001 were treated as a dividend for
stockholders in the subsequent year.

Dividends are declared by the Company's Board of Directors after
considering the Company's available cash for distribution, financial condition,
ability to maintain its REIT status, and such other factors that may be deemed
relevant. See Item 7, Management's Discussion and Analysis of Financial
Conditions and Results of Operations, for information regarding the sources of
funds used for dividends and for a discussion of factors, if any, which may
adversely affect the Company's ability to pay dividends at the same levels in
2003 and thereafter.


16

Item 6. Selected Financial Data.

Set forth below is selected financial data for the Company (for periods
after April 9, 1998) and the Predecessor (for periods up to April 9, 1998). The
information set forth below should be read in conjunction with the consolidated
financial statements and notes to the consolidated financial statements.