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Filed pursuant to Rule 424(b)(3)

SEC File No. 333-111398

PROSPECTUS

 

 

Thornburg Mortgage, Inc.

 

$55,000,000

 

Offer to Exchange

Registered 8% Senior Notes due 2013

for

All Outstanding Unregistered 8% Senior Notes due 2013

 

The new notes:

 

 

 

 

 

The exchange offer:

 

 

 

In addition, you should note that:

 

 

 

 

 

 

You should consider carefully the Risk Factors beginning on page 16 of this prospectus before participating in the exchange offer.

 

 

YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO WHICH WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL TO SELL THESE SECURITIES. THE INFORMATION IN THIS DOCUMENT IS ONLY ACCURATE ON THE DATE OF THIS DOCUMENT OR ON SUCH OTHER DATE STATED HEREIN.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the new notes or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

Each broker-dealer that receives new notes for its own account pursuant to the exchange offer must acknowledge that it will deliver a prospectus in connection with any resale of such new notes. The letter of transmittal states that by so acknowledging and by delivering a prospectus, a broker-dealer will not be deemed to admit that it is an “underwriter” within the meaning of the Securities Act of 1933, as amended. This prospectus, as it may be amended or supplemented from time to time, may be used by a broker-dealer in connection with resales of new notes received in exchange for outstanding notes where such outstanding notes were acquired by such broker-dealer as a result of market-making activities or other trading activities. We have agreed that, for a period of 180 days after the consummation of the exchange offer (as described herein), we will make this prospectus available to any broker-dealer for use in connection with any such resale. See “Plan of Distribution.”

 

The date of this prospectus is January 12, 2004.                        

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This prospectus incorporates important business and financial information that is not included in or delivered with this document. This information is available without charge upon written or oral request. See “Incorporation of Certain Documents by Reference.” To obtain this information in a timely fashion, you must request such information no later than five business days before February 11, 2004, which is the date on which the exchange offer expires (unless we extend the exchange offer as described herein). See “The Exchange Offer—Extensions, Delay in Acceptance, Termination or Amendment.”

 

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FORWARD-LOOKING STATEMENTS

 

This prospectus contains or incorporates by reference certain “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the “Securities Act,” and Section 21E of the Securities Exchange Act of 1934, as amended, or the “Exchange Act,” 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,” 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. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors.” We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which we may make to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

 

WHERE YOU CAN FIND MORE INFORMATION

 

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission, or the “SEC.” You may inspect and copy such reports, proxy statements and other information at the public reference facilities maintained by the SEC in the Public Reference Room, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information. This material can also be obtained from the SEC’s internet web site at www.sec.gov. All reports, proxy statements and other information that we file with the New York Stock Exchange, or the “NYSE,” are also available at the offices of the NYSE (please call (212) 656-5060 for further information) or by visiting our website at www.thornburgmortgage.com. Information contained on our website is not, and should not be interpreted to be, a part of this prospectus.

 

We have filed a registration statement on Form S-4 with the SEC, of which this document forms a part, to register the new notes to be issued to holders whose outstanding notes are accepted for exchange pursuant to the exchange offer. This prospectus does not contain all of the information included in the registration statement.

 

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SUMMARY

 

This summary highlights information contained elsewhere in this prospectus or incorporated by reference into this prospectus. You should read the entire prospectus, including the information incorporated by reference into this prospectus, before making an investment decision. In this prospectus, (i) 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 and (ii) references to “the notes” include both the outstanding unregistered notes and the new notes unless the context indicates otherwise.

 

The Company

 

Overview

 

We commenced operations in 1993 and our common stock is listed on the New York Stock Exchange under the symbol “TMA.” As of December 17, 2003, we had a market capitalization of $2.0 billion. We are a single-family residential mortgage lender that originates, acquires and retains investments in adjustable and variable rate mortgage, or “ARM,” assets, thereby providing capital to the single-family residential housing market. Our ARM assets are comprised of traditional ARM securities and loans, which have interest rates that reprice in a year or less, and hybrid ARM securities and loans, which have a fixed interest rate for an initial period of three to ten years before converting to traditional ARM assets for their remaining terms to maturity. Like traditional banking organizations, 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 investments 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 and borrowings such as reverse repurchase agreements, whole loan financing facilities, floating rate long-term collateralized debt obligations, or “CDOs,” and other collateralized or unsecured financings that we may establish with approved institutional lenders. We have a policy to operate with an Adjusted Equity-to-Assets ratio of at least 8%. (See “The Company—Operating Policies and Strategies—Financing Strategies” below for a calculation of our Adjusted Equity-to-Assets ratio.) For purposes of applying this ratio, our Adjusted Equity-to-Assets ratio excludes other comprehensive income (loss) and assets financed with CDOs and the related equity and includes senior notes as an addition to equity. Since all of the assets we hold are ARM assets and we pursue a matched funding strategy, we believe our exposure to changes in interest rates can be prudently managed. Moreover, we focus on acquiring primarily high quality assets 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 over the last six years. Our low cost operating structure has resulted in operating costs well below those of other mortgage originators. We believe that our corporate structure differs from most lending institutions in that we are organized for tax purposes as a real estate investment trust, or “REIT,” and, therefore, pay substantially all of our earnings in the form of dividends to shareholders without paying federal or state income tax at the corporate level.

 

The 11 members of our management team have an average of 21 years experience in the fields of mortgage lending, investment advisory and management services, financial services, capital markets and financial reporting, providing us with significant expertise in the key disciplines required for success in our business. Since our inception, we have grown substantially as a result of consistent earnings and growth in equity capital. Our assets and earnings have grown on a compounded annual basis by 24.7% and 51.6%, respectively, from December 31, 1998 through December 31, 2002. As of September 30, 2003, we had assets of $17.3 billion, net

 

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income of $127.0 million (based on a nine-month period) and an equity base of $1.1 billion. We have reported 42 consecutive quarters of positive cash flow and earnings, including cash flow (earnings before amortization of $31.3 million) of $158.4 million for the nine months ended September 30, 2003. We can provide no assurance that these results and trends will be achieved or continue in the future.

 

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

 

Our principal executive offices are located at 150 Washington Avenue, Suite 302, Santa Fe, New Mexico 87501 and our telephone number is (505) 989-1900.

 

Our internet website address is www.thornburgmortgage.com. The information on our website is not considered part of this prospectus. We make available free of charge, through our 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 Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

 

You may also find our Code of Business Conduct and Ethics, Corporate Governance Guidelines and the charters of the Audit Committee, Nominating/Corporate Governance Committee and Compensation Committee of our Board of Directors at our website. These documents are also available in print to any shareholder who requests them by writing to us at the following address: 150 Washington Avenue, Suite 302, Santa Fe, New Mexico, 87501, or by phoning us at (505) 989-1900. To obtain timely delivery of any of our documents, you must make your request to us no later than five business days before February 11, 2004. The exchange offer will expire at 5:00 p.m., New York City time, on February 11, 2004, unless we extend the exchange offer, which we may do in our sole discretion. We currently do not intend to extend the expiration date. See “The Exchange Offer” for more detailed information.

 

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The table below shows our key financial highlights for the nine months ended September 30, 2003 and each of the five years ended December 31, 2002.

 

Summary of Financial Highlights

(in thousands)

 

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Competitive Strengths

 

We believe our competitive strengths distinguish our business model from those of other residential mortgage lenders and contribute to our ability to generate consistent returns on equity. We strive to maintain our financial performance through varied interest rate cycles by: (i) developing and expanding proprietary loan origination channels; (ii) employing a portfolio lending strategy, thereby maintaining borrower relationships; (iii) seeking direct funding from a wide array of lenders at attractive borrowing costs; (iv) applying our unique risk management approach to the management of interest rate and credit risks inherent in the mortgage lending business; and (v) using our low cost operating advantages.

 

Proprietary Loan Origination Channels

 

We acquire ARM assets for our portfolio through wholesale and proprietary origination channels. Our wholesale channels include the purchase of mortgage-backed securities, or “MBS,” and bulk loan packages. Our proprietary origination channels include loans that are originated through correspondent lenders or directly by us.

 

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Through the correspondent channel, we acquire loans from correspondent lenders or other loan originators with or without servicing rights, who generally originate the individual loans using our underwriting criteria and guidelines. Loans originated through our origination channels generally provide higher yields relative to our other channels, and generally can be originated at a lower cost. Thornburg Mortgage Home Loans, Inc., or “TMHL,” our wholly-owned mortgage banking subsidiary, conducts our mortgage loan acquisition, origination, processing, underwriting and securitization activities and also services mortgage loans that it acquires and originates. As of December 17, 2003, TMHL had authority to lend in 47 states and the District of Columbia.

 

In 2002, through our origination channels, we originated $1.9 billion of ARM loans through correspondent lenders and $379.8 million of ARM loans through our direct retail channel, up from $482.2 million and $108.1 million, respectively, in 2001. During the nine months ended September 30, 2003, we originated $2.2 billion of loans through correspondent lenders and $431.9 million of ARM loans through our direct retail channel. This represents an 84% increase over the same period last year. We also achieved our full year 2003 origination target of $2.6 to $2.8 billion in just nine months.

 

Over time, we would like to see originations account for 70% of our portfolio acquisitions, as we believe increasing this percentage will enhance both our earnings stability and earnings growth over time. Since we began originating loans for our portfolio, we have found that they generate consistently higher returns than purchased MBS. Furthermore, we continue to focus on hybrid ARM assets, which over the past five years, have increasingly become a larger portion of our portfolio mix and, at September 30, 2003, accounted for approximately 80.3% of our ARM assets. The increased level of hybrid ARM asset production has two compelling benefits: hybrid ARM assets can be acquired at a lower premium than traditional ARM assets and, after matched funding, we expect to earn a higher spread on hybrid ARM assets than on traditional ARM assets.

 

Portfolio Lending Strategy

 

As a portfolio lender, we generally hold in our portfolio all the ARM assets we acquire or originate until pay-off or maturity. This improves the economics of the lending transaction for a variety of reasons. First, our acquisition costs are capitalized and amortized over the life of the loan. Second, our cost to originate is typically less than our cost to purchase loans in the secondary market. Third, because we focus on the jumbo segment of the ARM market (loans in excess of $322,700), we can spread our loan origination expenses over a larger loan size, which improves the profitability of the mortgage asset.

 

Since we do not sell our ARM loans, we also are not constrained by secondary market loan purchase guidelines and our income is not dependent on cash and non-cash gain on sale. Further, this portfolio lending approach has great consumer appeal, because it enables us to offer innovative loan products and take a more practical approach to the loan underwriting process. Our ability to tailor each individual borrower’s loan gives us another advantage as we compete for mortgage loans. Additionally, because we do not sell our loans, we can offer a loan modification program that allows a borrower, for a modest fee and minimal paperwork, to change the rate and/or term of their loan at any time. Once a borrower obtains an ARM loan with us, we expect to retain that borrower relationship until their loan matures. Providing a quality customer experience and an attractive loan modification program helps us maintain customer relationships and a stable loan portfolio.

 

Diversified Funding Sources

 

We obtain funding from a variety of sources, including reverse repurchase agreements, whole loan financing facilities, long-term CDOs, proceeds from payments of principal and interest on our ARM assets portfolio and equity capital. This diversification enables us to insulate our business from potential fluctuations in the availability of funding. We have had consistent access to funding throughout our 10-year history and the terms of our funding have not varied significantly over this period.

 

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The table below provides selected financial data regarding the various sources of our funding for the nine months ended September 30, 2003 and each of the five years ended December 31, 2002.

 

History of Funding Sources

(in thousands)

 

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Risk Management

 

There are three key risks inherent in the mortgage lending business: credit risk, interest rate risk and prepayment risk. Our unique approach to risk management is predicated on three principal strategies: maintaining high credit standards, match funding our assets and liabilities, and diversifying our acquisitions. These strategies provide the foundation for our business model.

 

High Credit Quality Standards. In order to mitigate credit risk, our portfolio consists primarily of High Quality ARM MBS, which represent interests in ARM loans that are secured primarily by first liens on single-family (one-to-four units) residential properties, although we also may acquire ARM MBS secured by liens on other types of real estate-related properties. High Quality means that these assets are guaranteed by Ginnie Mae (a U.S. Government agency), Fannie Mae (a government-sponsored corporation) or Freddie Mac (a federally chartered corporation), or rated “AAA” or “AA” by Standard and Poor’s or Moody’s Investors Service, Inc., or the “Rating Agencies.” At September 30, 2003, 91.5% of the ARM assets we held in our ARM portfolio were High Quality ARM assets. An additional 7.4% of the ARM assets held in our ARM portfolio consisted of ARM loans that were pending securitization.

 

During the nine-month period ended September 30, 2003, we securitized $4.0 billion of our ARM loans into a series of multi-class ARM securities. The securitization process benefits us by creating highly liquid assets that can be readily financed in the reverse repurchase agreement market or by enabling us to enter into floating-rate CDOs that represent permanent financing and are not subject to margin calls. The securitizations of our loans are not accounted for as sales and we retain all of the economic interest and risk of the loans. Of the loans that we securitized during the first nine months of 2003, 99.9% of our resulting investment was rated “BBB,” “Baa” or better by one of the Rating Agencies, or “Investment Grade,” and 0.1% of our investment was rated below Investment Grade and provided credit support to the Investment Grade securities. At September 30, 2003, loans that we have securitized represented approximately 31% of our ARM portfolio.

 

We actively manage the credit risk inherent in acquiring and originating individual single-family residential mortgage loans by adhering to stringent loan underwriting criteria. Our borrowers generally have excellent credit profiles and our cumulative credit losses since we commenced acquiring loans in 1997, total just $174,000. In addition, at September 30, 2003, our 60-day plus delinquent loans and real estate-owned properties stood at 0.09% of total loans, compared to a 1.51% delinquent loan ratio for the industry as a whole as of September 30, 2003.

 

The table below shows our credit statistics for the nine months ended September 30, 2003 and each of the five years ended December 31, 2002.

 

Loan Delinquencies and Loss Statistics

(in thousands)

 

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Matched Funding Strategy. We actively manage interest rate risk by acquiring only ARM assets and pursuing a matched funding strategy. Because the yields on ARM assets move in similar fashion to changes in underlying interest rates, our exposure to interest rate fluctuations is, to a degree, limited. In addition, we borrow funds that have maturities that closely match the interest rate adjustment periods on our ARM assets. Our traditional ARM assets, which reprice in a year or less, are funded with short-term borrowings (also one year or less). The repricing mismatch on this portion of the portfolio was 63 days at September 30, 2003. Because our hybrid ARM assets have an initial fixed interest rate, we fund them with comparable duration fixed rate borrowings. A lower duration indicates a lower expected volatility of earnings given future changes in interest rates. At September 30, 2003, we had secured $11.2 billion of hedged borrowing such that the duration gap on the hybrid ARM portion of the portfolio was approximately 1.3 months. In essence, we have generally locked in our funding cost during the fixed rate period of the hybrid ARM assets, which will protect our earnings during a rising interest rate environment.

 

At September 30, 2003, based on our earnings simulation model, our potential earnings increase (decrease) from a parallel 100 and 200 basis point rise in market interest rates over the next twelve months and a commensurate slow down in prepayment speeds as interest rates rise, was 0.2% and (3.3%) of projected net income for the twelve months ended September 30, 2004, respectively, and (0.6%) and (3.5%) of projected net income for the twelve months ended September 30, 2005, respectively. All of these earnings projections result in earnings that are higher than the 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.

 

Diversified Acquisition Strategy. Diversifying our product mix and acquisition channels increases our sources for mortgage assets and gives us the flexibility to selectively acquire or originate ARM assets at prices much closer to par, thereby lowering the book price at which we hold our assets. This strategy minimizes our exposure to prepayment risk. The increased level of hybrid ARM assets in our portfolio over the past several years and the addition of our origination channels have positive profitability implications because the hybrid ARM assets that we purchased and all originated ARM assets have been acquired or originated at a lower average price. Since adding hybrid ARM assets and establishing our origination channels, we have significantly reduced the average price we pay to acquire assets over the past five years, which has improved our earnings stability. At September 30, 2003, the book price, excluding unrealized gains and losses, at which we were holding our ARM assets was 101.24% of par, down substantially from 102.77% of par at December 31, 1997. This is a non-GAAP measurement that provides the average amount of cash we have paid, net of amortization we have expensed, for the assets we hold in our ARM portfolio above par. We amortize all premiums and discounts over the expected life of the ARM assets. However, our ARM assets can be paid off at any time, which is why we provide this non-GAAP measurement. The corresponding GAAP measurement of book price, including unrealized gains and losses, was 101.07% at September 30, 2003, compared to 102.49% at December 31, 1997.

 

Operating Efficiencies

 

Low Cost Operating Structure. Unlike most mortgage bankers and lenders, we do not have an on-going high, fixed cost infrastructure. We do not have a nationwide retail branch network, commissioned loan officers or internal back office. We originate loans either through financial intermediaries or directly to borrowers over the internet or by telephone. We also outsource our back office functions to high-quality, third-party vendors who handle the majority of our processing, underwriting and loan closings in the Thornburg Mortgage name.

 

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Additionally, we use an outside party to service our loans. We generally pay these providers based on results; that is, closed or serviced loans. This method of operation keeps our fixed costs low, giving us a significant cost advantage in a highly competitive and cyclical business. We believe that our adherence to these principles has made us one of the most productive full-service mortgage lenders in the nation.

 

Tax Structure. Another cost advantage is our REIT tax structure. Since we qualify as a REIT, we do not pay federal or state income tax at the corporate level on income that we distribute. This tax-advantaged structure enables us to produce higher returns on our invested capital and use less leverage than taxable mortgage lending companies.

 

Recent Developments

 

On October 28, 2003, we completed a securitization of approximately $1.0 billion of loans from our ARM loans portfolio and 99.7% of the resulting securities were rated at least Investment Grade. We continue to retain all classes of the securitization in our ARM portfolio.

 

In October 2003, we entered into an additional whole loan financing facility with a committed borrowing capacity of $150 million. This facility matures in September 2004.

 

On November 20, 2003, Fitch Ratings Ltd. initiated coverage of our 8% Senior Notes due 2013 at BB.

 

On November 26, 2003, Moody’s Investors Service, Inc. downgraded its rating on our 8% Senior Notes due 2013 to Ba2 from Ba1.

 

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:

 

 

 

 

 

 

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Summary of the Exchange Offer

 

On December 2, 2003, we completed a private offering of the outstanding notes. We sold the outstanding notes in transactions that were exempt from or not subject to the registration requirements under the Securities Act. Accordingly, the outstanding notes are subject to transfer restrictions. In general, you may not offer or sell the outstanding notes unless either they are registered under the Securities Act or the offer or sale is exempt from or not subject to registration under the Securities Act and applicable state securities laws.

 

In connection with the sale of the outstanding notes, we entered into a registration rights agreement with the initial purchaser of the outstanding notes. We agreed to file with the SEC a registration statement not later than 45 days after the date we issued the outstanding notes, to use our best efforts to cause the registration statement to be declared effective under the Securities Act within 140 days after the date we issued the outstanding notes and to complete the exchange offer no later than 40 days after the date on which the registration statement is declared effective. In the exchange offer, you are entitled to exchange your outstanding notes for new notes with substantially identical terms, except that the existing transfer restrictions will be removed. This prospectus and the accompanying documents contain detailed information about us, the new notes and the exchange offer. See “The Exchange Offer” for further information regarding the exchange offer and resale of the new notes. You should read “Description of Notes” for further information regarding the new notes.

 

 

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The Exchange Agent

 

We have appointed Deutsche Bank Trust Company Americas as exchange agent for the exchange offer. You should direct questions and requests for assistance, requests for additional copies of this prospectus or of the letter of transmittal and requests for the notice of guaranteed delivery to the exchange agent addressed as follows:

 

 

By Hand:

Deutsche Bank Trust Company Americas

C/O The Depository Trust Clearing Corporation

55 Water Street, 1^st Floor

Jeanette Park Entrance

New York, NY 10041

 

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Summary of Terms of the New Notes

 

The summary below describes the principal terms of the new notes. Certain of the terms and conditions described below are subject to important limitations and exceptions. The “Description of Notes” section of this prospectus contains a more detailed description of the terms and conditions of the new notes.

 

 

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SELECTED SUMMARY FINANCIAL DATA

 

The following table sets forth selected summary financial data: (a) as of and for each of the five years in the period ended December 31, 2002 and (b) as of and for each of the nine month periods ended September 30, 2003 and 2002. The selected summary financial data as of and for each of the five years in the period ended December 31, 2002 have been derived from our audited consolidated financial statements. The selected summary financial data as of and for each of the nine months ended September 30, 2003 and 2002 have been derived from our unaudited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, which are, in our opinion, necessary for a fair presentation of our financial position at such dates and the results of operations for such periods. The results of operations for the nine months ended September 30, 2003 are not necessarily indicative of the results for the full year. You should read the following financial information with our audited consolidated financial statements and notes thereto incorporated by reference in this prospectus.

 

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RISK FACTORS

 

This section describes some, but not all, of the risks of acquiring notes in this offering and the risks associated with our business. You should carefully consider these risks, in addition to the other information contained or incorporated by reference in this document, before acquiring notes. In connection with the forward-looking statements that appear in this document, you should carefully review the factors discussed below and the cautionary statements referred to in “Forward-Looking Statements.”

 

Risks Related To This Exchange Offer

 

Failure to properly tender your outstanding notes for new notes could limit your ability to resell your outstanding notes.

 

We will only issue new notes in exchange for outstanding notes that are timely received by the exchange agent together with all required documents, including a properly completed and signed letter of transmittal, as described in this prospectus. Therefore, you should allow sufficient time to ensure timely delivery of your outstanding notes and you should carefully follow the instructions on how to tender your outstanding notes. Neither we nor the exchange agent are required to tell you of any defects or irregularities with respect to your tender of your outstanding notes. If you do not tender your outstanding notes or if we do not accept your outstanding notes because you did not tender your outstanding notes properly, then, after we complete the exchange offer, you will continue to hold outstanding notes that are subject to the existing transfer restrictions and you will no longer have any registration rights with respect to the outstanding notes. In addition:

 

 

 

We have agreed that, for a period of 180 days after the consummation of this exchange offer, we will make this prospectus available to any broker-dealer for use in connection with any resale of the new notes. We refer you to “Plan of Distribution.”

 

After the exchange offer is consummated, if you continue to hold any outstanding notes you may have difficulty selling them because there will be fewer such notes outstanding.

 

If a large principal amount of outstanding notes is not tendered or is tendered improperly, the limited principal amount of new notes that would be issued and outstanding after we consummate the exchange offer could adversely affect the liquidity and the market price of the new notes.

 

Risks Related To The Notes

 

We have other indebtedness.

 

As of September 30, 2003, on an as adjusted basis after giving effect to the issuance of the outstanding notes on December 2, 2003 and the use of proceeds as described in “Use of Proceeds,” our aggregate consolidated indebtedness would have been approximately $16.0 billion and our aggregate consolidated secured indebtedness would have been approximately $15.8 billion. We would not have had any aggregate consolidated subordinated indebtedness on a pro forma basis. Our ability to make scheduled payments of principal or interest on, or to refinance, our indebtedness depends on our future performance, which, to a certain extent, is subject to general economic, financial, competitive and other factors beyond our control.

 

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The new notes will be unsecured and will be subordinate to all of our existing and future secured indebtedness, and structurally subordinated to subsidiary debt.

 

All of our existing indebtedness, with the exception of the 8% Senior Notes due 2013, is secured by our assets. Creditors of our existing and future secured debt will have priority in right of payment over holders of the new notes with respect to our assets that secure such indebtedness. The indenture provides limited restrictions on our ability to incur additional secured indebtedness.

 

The new notes are not guaranteed by any of our subsidiaries. Our subsidiaries hold a portion of our assets. Our subsidiaries had approximately $1.0 billion of indebtedness outstanding at September 30, 2003. Creditors of a subsidiary are entitled to be paid what is due to them before assets of the subsidiary become available for creditors of its parent. Therefore, liabilities of our subsidiaries will, in effect, be prior in right of payment to the new notes with regard to the assets of those subsidiaries. This can substantially reduce the portion of our consolidated assets which are available for payment of the new notes. Also, any agreements of our subsidiaries which prohibit or limit the subsidiaries’ payment of dividends will eliminate or reduce our access to cash flows of those subsidiaries to pay interest or principal with regard to the new notes.

 

Our ability to repurchase notes upon a change of control may be limited.

 

Upon a change of control, each holder of notes will have the right to require us to repurchase such holder’s notes. If there were a change of control, but we did not have sufficient funds to pay the repurchase price for all of the notes which were tendered, that failure would constitute an event of default under the indenture. Therefore, a change of control at a time when we could not pay for notes which were tendered as a result of the change of control could result in the holders of notes receiving substantially less than the principal amount of the notes.

 

As a REIT, we must distribute a portion of our income to our shareholders.

 

We must distribute at least 90% of our taxable net income to our shareholders to maintain our REIT status. As a result, those earnings will not be available to pay principal on the notes. In addition, the indenture governing the notes permits us to distribute up to 95% of our Adjusted Earnings (as defined under “Description of Notes - Certain Definitions”).

 

There is no current public market for the new notes and there may never be one.

 

The new notes are a new issue of securities for which there is currently no trading market. We cannot guarantee:

 

 

 

 

Liquidity of any market for the new notes and future trading prices of the new notes will depend on many factors, including:

 

 

 

 

We do not intend to apply for listing of the new notes on any securities exchange or for inclusion of the new notes in any automated quotation system.

 

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Risks Related To Our Business

 

ARM yields change as short-term interest rates change.

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

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

 

 

 

 

We acquire hybrid ARM assets that have fixed interest rate periods.

 

 

 

 

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

 

 

 

 

 

 

Our expansion into mortgage loan origination may not be successful.

 

 

 

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Our REIT tax status creates certain risks.

 

 

 

 

 

 

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

 

 

We are dependent on certain key personnel.

 

 

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

 

 

We may change our policies without shareholder approval.

 

 

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USE OF PROCEEDS

 

The exchange offer is intended to satisfy our obligations under the registration rights agreement that we entered into in connection with the private offering of the outstanding notes. We will not receive any cash proceeds from the issuance of the new notes. In consideration for issuing the new notes, we will receive in exchange a like principal amount of the outstanding notes. The outstanding notes surrendered in exchange for the new notes will be retired and canceled, and cannot be reissued. Accordingly, issuance of the new notes will not result in any change in our capitalization. No underwriter is being used in connection with the exchange offer.

 

RATIO OF EARNINGS TO FIXED CHARGES

 

The following table sets forth our ratios of earnings to fixed charges and to combined fixed charges and preferred stock dividends for the periods shown:

 

 

The ratios of earnings to fixed charges were computed by dividing earnings as adjusted by fixed charges. The ratios of earnings to combined fixed charges and preferred stock dividends were computed by dividing earnings as adjusted by fixed charges and preferred stock dividends. For these purposes, earnings consist of net income from continuing operations and fixed charges. Fixed charges consist of interest expense, including the amortization of capitalized issuance costs relating to indebtedness.

 

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CAPITALIZATION

 

The following table sets forth our capitalization as of September 30, 2003 on an actual basis and on an as adjusted basis to give effect to the issuance of the outstanding notes on December 2, 2003.

 

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DESCRIPTION OF FINANCING ARRANGEMENTS

 

We finance our purchased or securitized ARM assets using equity capital, borrowings such as reverse repurchase agreements, lines of credit, and other secured or unsecured financings that we may establish with approved institutional lenders. We generally expect to maintain an Adjusted Equity-to-Assets ratio of at least 8%. For purposes of applying this ratio, our Adjusted Equity-to-Assets ratio excludes accumulated other comprehensive income (loss) and assets financed with non-recourse debt and the related equity and includes senior unsecured debt as an addition to equity. This ratio may vary from time to time depending upon market conditions and other factors that our management deems relevant, but cannot fall below 8% without the approval of our Board of Directors. The following paragraphs summarize our current financing arrangements.

 

Reverse Repurchase Agreements

 

We have arrangements to enter into reverse repurchase agreements, a form of collateralized short-term borrowing, with 24 different financial institutions, and as of September 30, 2003, had borrowed funds from 17 of these firms. Because we borrow money under these 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 could be limited and lenders could initiate margin calls in the event interest rates change or the value of our ARM assets declines for other reasons.

 

As of September 30, 2003, we had $12.6 billion of reverse repurchase agreements outstanding with a weighted average borrowing rate of 1.22% and a weighted average remaining maturity of 6.4 months. As of December 31, 2002, we had $8.4 billion of reverse repurchase agreements outstanding with a weighted average borrowing rate of 1.59% and a weighted average remaining maturity of 4.6 months. As of September 30, 2003, $11.8 billion of our borrowings were variable-rate term reverse repurchase agreements with original maturities that range from two months to twenty-five months. The interest rates of these term reverse repurchase agreements are indexed to either the one-month or three-month LIBOR rate and reprice accordingly. ARM assets with a carrying value of $12.9 billion, including accrued interest and cash totaling $464.5 million, collateralized the reverse repurchase agreements at September 30, 2003.

 

At September 30, 2003, the reverse repurchase agreements had the following remaining maturities:

 

 

CDOs

 

On April 3, 2003, $1.1 billion of mortgage loans from our ARM loan portfolio were transferred to Thornburg Mortgage Securities Trust 2003-2 and were securitized. On August 28, 2003, $1.4 billion of mortgage loans from our ARM loan portfolio were transferred to Thornburg Mortgage Securities Trust 2003-4 and were securitized. Approximately $2.4 billion of the securities created by these securitizations were issued to third-party investors in the form of AAA-rated floating rate pass-through certificates, or CDOs. In connection with the issuance of the CDOs, we incurred costs of $7.3 million, which were deducted from the proceeds of the transactions and are being amortized over the expected life of the CDOs. These transactions were accounted for as financings of the loans and represent permanent financing that is not subject to margin calls. We retained the AA and A certificates totaling $63.1 million. The structure of these transactions also includes overcollateralization certificates that provide $6.1 million of credit support based on the estimated exposure to

 

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credit losses on the loans collateralizing the debt. As of September 30, 2003, the CDOs had a net balance of $2.2 billion and an effective interest cost of 1.55%, which changes each month at a spread to one-month LIBOR. As of September 30, 2003, the CDOs were collateralized by ARM loans with a principal balance of $2.2 billion. The debt matures between 2033 and 2043 and is callable by us 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 three to four years.

 

Whole Loan Financing Facilities

 

As of September 30, 2003, we had entered into three whole loan financing facilities. The interest rates on these facilities are indexed to one-month LIBOR and reprice accordingly. The first whole loan financing facility has a committed borrowing capacity of $600 million and an uncommitted capacity of $100 million and matures in November 2004. The second financing facility has a committed borrowing capacity of $300 million and matures in March 2004. The third financing facility has a committed borrowing capacity of $300 million and an uncommitted capacity of $250 million and matures in December 2003. We expect this facility to be renewed. In October 2003, we entered into an additional whole loan financing facility with a committed borrowing capacity of $150 million. This facility matures in September 2004. As of September 30, 2003, we had $1.0 billion borrowed against these whole loan financing facilities at an effective cost of 1.85%. As of December 31, 2002, we had $589.1 million borrowed against whole loan financing facilities at an effective cost of 2.11%. The amount borrowed on the whole loan financing agreements at September 30, 2003 was collateralized by ARM loans with a carrying value of $1.0 billion, including accrued interest. These facilities have covenants that are standard for industry practice. We are in compliance with all such covenants as of September 30, 2003.

 

The $300 million whole loan financing facility discussed above is a securitization transaction in which we transfer 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 works like a secured line of credit whereby we can deliver loans into the facility and take loans out of the facility at our discretion subject to the terms and conditions of the facility. This securitization transaction is accounted for as a structured financing.

 

Senior Notes

 

On May 15, 2003, we entered into an indenture and a supplemental indenture with Deutsche Bank Trust Company Americas as Trustee, relating to the issuance of $200.0 million of 8% senior unsecured notes due 2013. On December 2, 2003, we issued an additional $55.0 million of notes pursuant to these indentures. Interest on the notes is payable each May 15 and November 15. The notes mature on May 15, 2013, but 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 notes may also be redeemed under limited circumstances on or before May 15, 2006. In connection with the issuance of the notes, we incurred net costs of $4.3 million, which are being amortized to interest expense over the expected life of the notes.

 

Our senior note obligations contain both financial and non-financial covenants. Significant financial covenants include limitations on our ability to incur indebtedness beyond specified levels, restrictions on our ability to incur liens on assets and limitations on the amount and type of restricted payments, such as repurchases of our own equity securities, that we make. As of September 30, 2003, we are in compliance with all financial and non-financial covenants on our senior note obligations.

 

All notes issued on May 15, 2003 were exchanged in the third quarter of 2003 for new registered notes with terms substantially identical to the original notes, pursuant to an exchange offer that we concluded. At September 30, 2003, the balance of the notes outstanding, net of unamortized issuance costs, was $194.5 million. The balance of the notes outstanding, net of unamortized issuance costs, as of December 2, 2003 was $251.0 million.

 

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THE COMPANY

 

General

 

We are a single-family residential mortgage lender that originates, acquires and retains investments in ARM assets comprised of traditional ARM securities and loans and hybrid ARM securities and loans, thereby providing capital to the single-family residential housing market. Traditional ARM securities and loans have interest rates that reprice in a year or less (“Traditional ARMs”) and hybrid ARM securities and loans have a fixed interest rate for an initial period of three to ten years and then convert to Traditional ARMs for their remaining terms to maturity (“Hybrid ARMs”). ARM securities represent interests in pools of ARM loans, which are publicly rated and include guarantees or other credit enhancements against losses from loan defaults. “ARM Loans” consist of securitized ARM loans, ARM loans collateralizing long-term debt and ARM loans held for securitization.

 

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 and borrowings such as reverse repurchase agreements, whole loan financing facilities, floating-rate long-term collateralized debt obligations (“CDOs”) and other collateralized or unsecured financings that we may establish with approved institutional lenders. We have a policy to operate with an Adjusted Equity-to-Assets ratio of at least 8%. (See “Operating Policies and Strategies—Financing Strategies” below for a calculation of our Adjusted Equity-to-Assets ratio.) For purposes of applying this ratio, our Adjusted Equity-to-Assets ratio excludes other comprehensive income (loss) and assets financed with CDOs and the related equity and includes senior notes as an addition to equity. Since all of the assets we hold are ARM assets and we pursue a matched funding strategy, we believe our exposure to changes in interest rates can be prudently managed. Moreover, we focus on acquiring primarily high quality assets 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 over the last six years. Our low cost 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 real estate investment trust (“REIT”) and, therefore, substantially all of our earnings are paid in the form of dividends to shareholders, without paying federal or state income tax at the corporate level.

 

We have five qualified REIT subsidiaries, all of which are consolidated in our financial statements and federal and state income tax returns. Two of these subsidiaries, Thornburg Mortgage Funding Corporation and Thornburg Mortgage Acceptance Corporation, were created to facilitate financing of our mortgage loan assets. Thornburg Mortgage Home Loans, Inc. (“TMHL”), our wholly owned mortgage-banking subsidiary, conducts our mortgage loan acquisition, origination, processing, underwriting, securitization, and servicing activities. TMHL’s two wholly owned special purpose subsidiaries, Thornburg Mortgage Funding Corporation II and Thornburg Mortgage Acceptance Corporation II, facilitate the financing of loans by TMHL.

 

We are an externally advised REIT and are managed under a management agreement (the “Management Agreement”) with Thornburg Mortgage Advisory Corporation (the “Manager”), which manages our operations, subject to the supervision of our Board of Directors.

 

Operating Policies and Strategies

 

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 borrowing. We originate ARM loans for our portfolio through our correspondent lending program, which currently includes approximately 120 approved correspondents, and we originate loans direct to consumers through TMHL. Currently, TMHL is authorized to lend in 47 states and the District of Columbia. Our authorization to lend in these jurisdictions depends on our compliance with the applicable licensing and other regulatory requirements of each jurisdiction, and it is our intention to operate in compliance with those

 

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requirements. In addition, we are subject to examination by each jurisdiction, and if it is determined that we are not in compliance with the applicable requirements, we may be fined and our license to lend may be suspended or revoked. Additionally, we acquire ARM assets by purchasing ARM securities or large packages of ARM loans that other mortgage lending institutions have originated and serviced. 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 also acquire ARM assets from investment banking firms, broker-dealers and similar financial institutions that regularly make markets in these assets. We also acquire ARM assets from other mortgage suppliers, including mortgage bankers, banks, savings and loan institutions, investment banking firms, home builders and other firms involved in originating, packaging and selling mortgage loans. We believe we have a competitive advantage in the acquisition and investment of these mortgage securities and loans due to the low cost of our operations relative to traditional mortgage investors, such as banks and savings and loan institutions.

 

We have a focused portfolio lending investment policy designed to minimize credit risk and interest rate risk. Our mortgage assets portfolio may consist of ARM pass-through securities guaranteed by an agency of the federal government (“Ginnie Mae”), a government-sponsored corporation or federally-chartered corporation (“Fannie Mae” or “Freddie Mac”) (collectively, “Agency Securities”), or privately issued (generally publicly registered) ARM pass-through securities, multi-class pass-through securities, floating rate classes of collateralized mortgage obligations (“CMOs”), ARM loans, fixed rate mortgage-backed securities (“MBS”) with an expected duration of one year or less or short-term investments that either mature within one year or have an interest rate that reprices within one year.

 

Our ARM assets also include investments in Hybrid ARM assets, which are typically 30-year loans with a fixed rate of interest for an initial period, generally 3 to 10 years, and then convert to an adjustable rate for the balance of their term. In April 2003, our Board of Directors increased the limitation on our ownership of Hybrid ARM assets with fixed rate periods of greater than five years from 10% to 20% of our total assets. We also have a policy to maintain a net duration of one year or less on our Hybrid ARM assets (including commitments to purchase Hybrid ARM assets), related borrowings and Hybrid Hedging Instruments. We use Swap Agreements, Cap Agreements and Eurodollar Transactions (collectively, “Hybrid Hedging Instruments”) as hedges to fix the maximum interest rates on our short-term borrowing costs and to manage our interest rate risk exposure on our CDOs.

 

Our investment policy requires that we invest at least 70% of total assets in High Quality ARM assets and short-term investments. High Quality means:

 

 

 

 

 

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

 

 

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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 mortgage interest rates fall below the interest rates on ARM loans. To the extent there is an increase in prepayment rates, resulting in a shortening of the expected lives of our ARM assets, our net income and, therefore, the amount available for dividends could be adversely affected. Our portfolio of ARM assets is held at a book price, excluding unrealized gains and losses, of 101.24% of par at September 30, 2003, compared to 101.01% at December 31, 2002. This is a non-GAAP measurement that provides the average amount of cash we have paid, net of amortization we have expensed, for the assets we hold in our ARM portfolio above par. We amortize all premiums and discounts over the expected life of the ARM assets. However, our ARM assets can be paid off at any time, which is why we provide this non-GAAP measurement. The corresponding GAAP measurement of book price, including unrealized gains and losses, was 101.07% at September 30, 2003, compared to 101.45% at December 31, 2002.

 

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

 

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

 

We acquire and originate High Quality mortgage loans through TMHL from three sources: (i) correspondent lending, (ii) direct retail loan originations, and (iii) bulk acquisitions. Correspondent lending involves acquiring individual loans from correspondent lenders who are approved by us and who originate the individual loans using our underwriting criteria and guidelines, or criteria and guidelines that we have approved. We also perform an underwriting review of each correspondent loan prior to purchase. Direct retail loan originations are loans we originate through retail channels. Bulk acquisitions involve acquiring pools of whole loans, which are originated using the seller’s guidelines and underwriting criteria. Prior to purchasing a bulk pool, we review the underwriting of a selected sample of the loans in the pool. The loans we acquire or originate are financed through warehouse borrowing arrangements and securitized 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 up to ten years, and fully amortizing thereafter. Interest-only loans acquired or originated during the first nine months of 2003 represented 89.1% of total loan production during that period. We believe interest-only loans do not pose additional credit risk due to original effective loan-to-value ratios averaging 66.9% and the credit strength of our borrowers.

 

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All ARM loans that we acquire 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 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 long-term debt financings. In order to facilitate the securitization or financing of our loans, we generally create subordinate certificates, which provide a specified amount of credit enhancement. Upon securitization, we retain the securitized ARM loans, including the subordinate certificates, and either finance them in the repurchase agreement market or through the issuance of collateralized long-term debt in the capital markets. Our investment policy limits the amount we may retain of these below Investment Grade subordinate certificates 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 the acquisition and origination of ARM loans for securitization benefits us by providing: (i) greater control over the quality and types of ARM assets acquired; (ii) the ability to acquire ARM assets at lower prices, so that the amount of the premium to be amortized will be reduced in the event of prepayment; (iii) additional sources of new whole-pool ARM assets; and (iv) generally higher yielding investments in our portfolio.

 

We offer a loan modification program on all loans we originate and certain loans we acquire. 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 adjustable-rate product that we offer at the offered retail interest rate, plus  ¹/8%. During the quarter ended September 30, 2003, we modified 635 loans with balances totaling $343.7 million. At September 30, 2003, the pipeline of loans to be modified totaled $22.6 million, which represents a significant decline from recent levels of modification activity due to the recent increase in interest rates.

 

Bulk Acquisitions

 

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

 

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Correspondent Lending

 

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

 

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

 

Direct Retail Loan Origination

 

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

 

We originate mortgage loans through TMHL. As of December 17, 2003, TMHL was authorized to originate loans in the following 47 states and the District of Columbia:

 

 

Our direct retail lending origination model is built upon strategic partnerships with third-party providers of traditional “back office” processing and underwriting and other services, such as appraisals, title and settlement

 

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services. We have entered into agreements with two Company-approved third-party, private label fulfillment vendors for the processing, underwriting and closing of our retail loans. In addition, we work with nationally recognized providers of appraisal, credit, title insurance and settlement services. We oversee the activities of these service providers through on-site visits, report monitoring, customer service surveys, post-closing quality control, and periodic direct participation in the customer experience.

 

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

 

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

 

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

 

Mortgage Loan Servicing

 

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

 

Underwriting Guidelines

 

Our underwriting guidelines are intended to determine the collateral value of the mortgaged property and to consider the borrower’s credit standing and repayment ability. Each prospective borrower completes an application that includes information with respect to the applicant’s assets, liabilities, income and employment history, as well as certain other personal information. A credit report is required for each applicant from at least one credit reporting company. The report typically contains information relating to matters such as credit history with local and national merchants and lenders, installment debt payments and any record of default, bankruptcy, repossession, suit or judgment. At September 30, 2003, our borrowers had a weighted average credit score, called a FICO (which is a credit score, ranging from 300 to 850, based upon the credit evaluation methodology developed by Fair, Isaac and Company, a consulting firm specializing in creating credit evaluation models) of 738. On a case-by-case basis, we

 

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may determine that, based upon compensating factors, a prospective borrower not strictly qualifying under the applicable underwriting guidelines warrants an underwriting exception. Compensating factors may include, but are not limited to, low loan-to-value ratios, low debt-to-income ratios, good credit history, stable employment, financial reserves, and time in residence at the applicant’s current address.

 

Our underwriting guidelines for both the correspondent lending and direct retail loan origination channels are applied in accordance with a procedure that generally requires (1) one appraisal report for loan amounts up to $650 thousand, one appraisal report and one field review for loan amounts between $650 thousand and $1 million, and two appraisal reports for loan amounts greater than $1 million, (2) a review of such appraisal by a third-party appraisal review firm for loans over $650 thousand, if deemed necessary, and (3) an internal review by us of all appraisal reports. Our underwriting guidelines permit single-family mortgage loans with loan-to-value ratios at origination of up to 95% (or, with respect to additional collateral mortgage loans, up to 100%) for the highest credit grading category, depending on the creditworthiness of the borrower, the type and use of the property, the purpose of the loan application and the loan amount. All loans with loan-to-value ratios greater than 80% must either have mortgage insurance or additional collateral securing the loan.

 

Financing Strategies

 

We finance our ARM assets using equity capital, borrowings such as reverse repurchase agreements, lines of credit, and other collateralized or unsecured financings that we may establish with approved institutional lenders. We have established lines of credit and collateralized financing agreements with 24 different financial institutions. Our Board policy requires that we maintain an Adjusted Equity-to-Assets ratio, as described below, of a minimum of 8%. This ratio may vary from time to time depending upon market conditions and other factors that our management deems relevant, but cannot fall below 8%. Our Adjusted Equity-to-Assets ratio represents the long-term capital supporting our recourse or marginable debt.

 

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

 

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We borrow primarily at short-term interest rates and in the form of reverse repurchase agreements using our ARM securities and securitized ARM loans as collateral. Reverse repurchase agreements involve a simultaneous sale of pledged assets to a lender at an agreed-upon price in return for the lender’s agreement to resell the same assets back to us at a future date (the maturity of the borrowing) at a higher price. The price difference is the cost of borrowing under these agreements. We generally enter into two types of reverse repurchase agreements: variable rate term reverse repurchase agreements and fixed rate reverse repurchase agreements. Variable rate term reverse repurchase agreements are financings with original maturities ranging from two to 25 months. The interest rates on these variable rate term reverse repurchase agreements are 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 have also financed the purchase of ARM assets by issuing floating-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 required to support the same amount of financings in the reverse repurchase agreement market and these transactions represent permanent financing of these loans and are not subject to margin calls.

 

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

 

Hedging Strategies

 

We attempt to mitigate our interest rate risk by funding our ARM assets with borrowings whose maturities approximately match the interest rate adjustment periods on our ARM assets. Accordingly, some of our borrowings have variable interest rates or short term fixed maturities (one year or less) because, as of September 30, 2003, 19.7% of our ARM assets were Traditional ARMs, which had interest rates that adjust within one year. However, the majority of our portfolio is comprised of Hybrid ARM assets, which have fixed interest rate periods of 3 to 10 years and, as of September 30, 2003, averaged a 4.5-year fixed rate period. We utilize Hybrid Hedging Instruments to, in effect, fix the interest rate on our borrowings such that the net duration of our Hybrid ARM assets, related borrowings and Hybrid Hedging Instruments is no more than one year. A lower duration indicates a lower expected volatility of earnings given future changes in interest rates. 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. 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 level specified by the Cap Agreement. The notional balances of the Hybrid Hedging Instruments generally decline over the life of these instruments. As of September 30, 2003, our Hybrid Hedging Instruments had a remaining average term to maturity of 3.8 years and when combined with our Hybrid ARM assets and related borrowings had a net duration of approximately 1.3 months.

 

In general, our Traditional ARM assets have a maximum lifetime interest rate cap, or ceiling, meaning that each ARM asset contains a contractual maximum interest rate. Since our borrowings are not subject to equivalent interest rate caps, we have also entered into Cap Agreements, so that the net margin on our Traditional ARM assets with maximum lifetime interest rate caps will be protected in high interest rate environments. These Cap Agreements are referred to as “Life Cap Hedging Instruments.” Pursuant to the terms of these Life Cap Hedging Instruments owned as of September 30, 2003, we will receive cash payments if the applicable index, generally

 

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the three-month or six-month LIBOR index, increases above contractually specified levels. The fair value of these Cap Agreements generally increases when general market interest rates increase and decreases when market interest rates decrease, helping to partially offset changes in the fair value of our ARM assets related to the effect of the lifetime interest rate cap. We are not currently purchasing Life Cap Hedging Instruments because the current interest rate environment is significantly lower than the contractual life caps on our ARM assets.

 

In addition, some Traditional ARM assets are subject to periodic caps. Periodic caps generally limit the maximum interest rate coupon change on any interest rate coupon adjustment date to either a maximum of 1.00% per semiannual adjustment or 2.00% per annual adjustment. The borrowings that we incur do not have similar periodic caps. However, we believe the impact of the periodic caps is somewhat mitigated because we own our ARM assets at a net price above par and, therefore, the yield on our ARM assets can change by an amount greater than the associated periodic cap due to changes in the amortization of the net price above par. Further, the contractual future interest rate adjustments on the ARM assets will cause their interest rates to increase over time and reestablish the ARM assets’ interest rate to a spread over the then current index rate. As of September 30, 2003, $1.3 billion of our Traditional ARM assets have periodic caps, representing 8.2% of total ARM assets.

 

We may enter into other hedging-type transactions designed to protect our borrowing costs or portfolio yields from interest rate changes. We may also purchase “interest-only” mortgage derivative assets or other mortgage derivative products for purposes of mitigating risk from interest rate changes, although we have not, to date, entered into these types of transactions. We may also use, from time to time, futures contracts and options on futures contracts on the Eurodollar, Federal Funds, Treasury bills and Treasury notes and similar financial instruments to mitigate risk from changing interest rates.

 

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

 

Operating Restrictions

 

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

 

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

 

We closely monitor our purchases of ARM assets and the income from such assets, including from our hedging strategies, so that we maintain our qualification as a REIT at all times. We developed certain accounting systems and testing procedures with the help of qualified accountants and tax experts to facilitate our ongoing compliance with the REIT 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 of 1940, as amended. If we were to become regulated as an investment company, our use of leverage would be substantially reduced. The Investment Company Act exempts entities that are

 

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“primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate,” or “Qualifying Interests.” Under current interpretation of the staff of the SEC, we must maintain at least 55% of our assets directly in Qualifying Interests as defined in the Code. We closely monitor our compliance with this requirement and we intend to maintain our exempt status. We have been able to maintain our exemption so far through the purchase of whole pool Agency Securities and privately issued ARM securities and loans that qualify for the exemption.

 

The Manager

 

As of December 17, 2003, we had no employees. Rather, the Manager provides our management and employees, subject to the supervision of our Board of Directors and under the terms of the Management Agreement discussed below.

 

The Management Agreement

 

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

 

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

 

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

 

Subject to the limitations set forth below, we pay all our operating expenses except those that the Manager is specifically required to pay under the Management Agreement. The operating expenses that the Manager is required to pay include the compensation of personnel who are performing management services for the Manager and the cost of office space, equipment and other personnel required for the management of our day-to-day operations. The expenses that we are required to pay include costs incident to the acquisition, disposition, securitization and financing of mortgage loans, the compensation and expenses of operating personnel, marketing expenses, regular legal and auditing fees and expenses, the fees and expenses of our directors, the costs of printing and mailing proxies and reports to shareholders, the fees and expenses of our custodian and transfer agent, if any, and the reimbursement of any obligation of the Manager for any New Mexico Gross Receipts Tax

 

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liability. The expenses we are required to pay, which are attributable to our operations, are limited to an amount per year equal to the greater of 2% of our Average Net Invested Assets or 25% of our Net Income for that year. The determination of Net Income for purposes of calculating the expense limitation is the same as for calculating the Manager’s incentive compensation except that it includes any incentive compensation payable for such period. The Manager must pay expenses in excess of such amount, unless the unaffiliated directors determine that, based upon unusual or non-recurring factors, a higher level of expenses is justified for such fiscal year. In that event, the Manager may recover such expenses in succeeding years to the extent that expenses in succeeding quarters are below the limitation of expenses. We are also required to pay expenses associated with litigation and other extraordinary or non-recurring expenses. Expense reimbursement is made monthly, subject to adjustment at the end of each year.

 

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

 

Management

 

The following table sets forth the names and positions of our senior officers:

 

 

Mr. Thornburg has over 22 years of experience in the investment advisory industry and currently holds positions in the following entities (all of which are independent from the Company): sole Director and Treasurer of Thornburg Investment Management, Inc., or “TIM,” an investment advisory firm organized in 1982 which is advisor to the twelve Thornburg Mutual Funds, and Thornburg Securities Corporation, a registered broker-dealer that acts as a distributor of mutual funds managed by TIM; Trustee and Chairman of Trustees of Thornburg Investment Trust, a regulated investment company that is the issuer of nine of the twelve Thornburg Mutual Funds; and Director, Chairman and Treasurer of Thornburg Limited Term Municipal Fund, Inc., a regulated investment company. Mr. Thornburg is currently a member of the Board of Governors of the National Association of Real Estate Investment Trusts.

 

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Mr. Goldstone has over 20 years of experience in the mortgage lending industry, working principally for savings and loan institutions, where, in various capacities, he has managed portfolios of MBS, utilized hedging techniques to mitigate interest rate risk within such portfolios, and overseen and participated in related mortgage management efforts. Mr. Story has over 29 years of experience in the mortgage lending industry, working primarily for savings and loan institutions, where he served in a variety of senior accounting and treasury management functions and, prior to 1993, served as Controller for San Diego’s largest health care provider. Mr. Badal has over 33 years of experience in the finance industry, mortgage banking, commercial banking and corporate finance, and, prior to 2001, served as Senior Vice President of Residential Loan Production with Charter Mortgage Company in Albuquerque, New Mexico. Mr. Chicaferro has over 23 years of experience in the mortgage industry, having held a variety of positions involving mortgage lending, mortgage finance, correspondent lending and secondary marketing. Ms. Swisa has over 18 years of experience in the information technology profession, working mainly in the financial services industry, and, prior to joining us, was Director of Information Technology at a privately controlled real estate investment trust. Ms. Beckett has over 24 years of experience in the mortgage industry, working with savings and loans institutions, commercial banks, and a state housing agency, and has held a variety of positions in single and multifamily loan origination, secondary marketing, and loan portfolio management. Ms. Burns has over 22 years of experience in the securities investment industry and, prior to 1998, served as Director of the Securities Division of TIAA-CREF, a private pension fund, where she worked for 10 years. Mr. Fellers, Chartered Financial Analyst, has over six years of experience in the mortgage industry and, prior to joining us, served as Investment Officer at the Federal Home Loan Bank of Seattle. Ms. Gallagher has over 11 years of shareholder relations and capital markets experience and, prior to joining us in 2000, was a Vice President in the Capital Markets Group of a leading international real estate operating and investment management company. Ms. Starrett has over 20 years of accounting and financial reporting experience and, prior to joining us, was Vice President and Controller of a family of publicly-held venture capital funds.

 

Non-Employee Directors

 

The following table sets forth the names and current affiliations of our non-employee directors:

 

 

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SUMMARY OF OUR FINANCIAL CONDITION

 

Critical Accounting Policies

 

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

 

 

 

 

 

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Financial Condition

 

At September 30, 2003, we held total assets of $17.3 billion, $16.5 billion of which consisted of ARM assets, as compared to $10.5 billion of total assets and $10.3 billion of ARM assets at December 31, 2002. Since commencing operations, we have primarily purchased either ARM securities or ARM loans. At September 30, 2003, 61.7% of our ARM assets were ARM securities, 17.7% were securitized ARM loans, 13.2% were ARM loans collateralizing long-term debt and 7.4% were ARM loans held for securitization. At September 30, 2003, 91.6% of our assets, including cash and cash equivalents, restricted cash and accrued interest receivable on High Quality assets, 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 table presents a schedule of ARM assets owned at September 30, 2003 and December 31, 2002 classified by High Quality and Other Investment assets and further classified by type of issuer and by ratings categories. The securitized ARM loans are stratified in the table below based on the credit rating determined by the Rating Agency on the related securities:

 

ARM Assets by Issuer and Credit Rating

(Dollar amounts in thousands)

 

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As of September 30, 2003, 12 of the 14,557 loans in our ARM loan portfolio were considered seriously delinquent (60 days or more delinquent) and had an aggregate balance of $4.4 million. The average original effective loan-to-value ratio on the delinquent loans was approximately 71%. We believe that our current level of allowance for loan losses is adequate to cover estimated losses from these loans.

 

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At September 30, 2003, the ARM loan portfolio included two real estate-owned properties totaling $1.1 million that we acquired as a result of foreclosure procedures.

 

The following table classifies our portfolio of ARM assets by type of interest rate index:

 

ARM Assets by Index

(Dollar amounts in thousands)

 

 

The ARM portfolio had a current weighted average coupon of 4.43% at September 30, 2003. This consisted of an average coupon of 4.57% on the Hybrid ARM portion of the portfolio and an average coupon of 3.67% on the Traditional ARM portion of the portfolio. If the portfolio had been “fully indexed,” the weighted average coupon of the portfolio would have been approximately 4.20%, based upon the current composition of the portfolio and the applicable indices. 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 approximately 3.12%, also based upon the current composition of the portfolio and the applicable indices. The term “fully indexed” refers to an ARM asset that has an interest rate that is currently equal to its applicable index plus a margin to the index that is specified by the terms of the ARM asset.

 

As of December 31, 2002, the ARM portfolio had a current weighted average coupon of 4.99%. This consisted of an average coupon of 5.23% on the Hybrid ARM portion of the portfolio and an average coupon of 4.27% on the Traditional ARM portion of the portfolio. If the Traditional ARM portion of the portfolio had been “fully indexed,” the weighted average coupon of the ARM portfolio would have been approximately 4.82%, based upon the composition of the portfolio and the applicable indices at that time.

 

At September 30, 2003, the current yield of the ARM assets portfolio was 3.96%, compared to 4.63% as of December 31, 2002. The decrease in the yield of 67 basis points is due primarily to the decreased weighted average interest rate coupon, which decreased by 56 basis points, due to the reinvestment of principal prepayments and new assets purchased with the equity offering proceeds in a declining interest rate environment. The higher level of net premium amortization had the effect of decreasing the yield by 2 basis points, increased loan loss reserves decreased the yield by 1 basis point and the relative level of non-interest earning principal payments receivables also decreased the portfolio yield by 8 basis points.

 

The ARM asset portfolio had an average term to the next repricing date of 3.8 years as of September 30, 2003, compared to 2.8 years as of December 31, 2002. The Traditional ARM asset portion of the portfolio had an

 

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average term to the next repricing date of 83 days and the Hybrid ARM asset portion had an average term to the next repricing date of 4.5 years at September 30, 2003. As of September 30, 2003, Hybrid ARM assets comprised 80.3% of the total ARM asset portfolio, compared to 72.3% as of the end of 2002.

 

The following table presents various characteristics of our ARM loan portfolio as of September 30, 2003. This information pertains to loans held for securitization, loans held as collateral for notes payable and loans securitized for our own portfolio for which we retained credit loss exposure. The combined amount of the loans included in this table is $6.3 billion.

 

ARM Loan Portfolio Characteristics

 

 

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As of September 30, 2003 and December 31, 2002, we serviced $3.8 billion and $2.0 billion of our loans, respectively, and had 8,358 and 4,778 customer relationships, respectively. We hold all of the loans that we service in our portfolio in the form of securitized ARM loans, loans collateralizing long-term debt or ARM loans held for securitization.

 

During the nine months ended September 30, 2003, we purchased $7.4 billion of ARM securities, 99.6% of which were High Quality assets, and $4.0 billion of ARM loans, generally originated to “A” quality underwriting standards. Of the ARM assets acquired during the nine months ended September 30, 2003, 92.9% were Hybrid ARM assets, and 7.1% were Traditional ARM assets.

 

The following table compares our ARM asset acquisition and origination activity for the nine-month periods ended September 30, 2003 and September 30, 2002 (dollar amounts in thousands):

 

 

Since 1997, we have emphasized purchasing ARM assets, high quality, floating rate collateralized mortgages and short term, fixed rate securities at substantially lower prices relative to par in order to reduce the potential impact of rapid prepayments. In doing so, the average premium/(discount) that we paid for ARM assets acquired in the first nine months of 2003 and for the year 2002 was 1.14% and 0.78% of par, respectively, as compared to 3.29% of par in 1997 when we emphasized the purchase of seasoned ARM assets. In part, as a result of this strategy, the book price of our ARM assets, excluding unrealized gains and losses, was 101.24% of par as of September 30, 2003, down from 102.77% of par as of the end of 1997. This is a non-GAAP measurement that provides the average amount of cash we have paid, net of amortization we have expensed, for the assets we hold in our ARM portfolio above par. We amortize all premiums and discounts over the expected life of the ARM assets. However, our ARM assets can be paid off at any time, which is why we provide this non-GAAP measurement. The corresponding GAAP measurement of book price, including unrealized gains and losses, was 101.07% at September 30, 2003, compared to 102.49% at December 31, 1997.

 

During the nine-month period ended September 30, 2003, we securitized $4.0 billion of our ARM loans into a series of multi-class ARM securities. The securitization process benefits us by creating highly liquid assets that can be readily financed in the reverse repurchase agreement market or by enabling us to enter into floating-rate CDOs that represent permanent financing and are not subject to margin calls. The securitizations of the Company’s loans are not accounted for as sales and we retain all of the economic interest and risk of the loans. Of the loans that we securitized during the first nine months of 2003, 99.9% of our resulting investment was rated at least Investment Grade and 0.1% of our investment was rated below Investment Grade and provided credit support to the Investment Grade securities.

 

As of September 30, 2003, we had commitments to purchase $1.4 billion of ARM securities, $63.0 million of ARM loans through wholesale channels and $821.4 million of ARM loans through origination channels.

 

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During the nine months ended September 30, 2003, there were no sales of ARM assets. We sold $72.9 million of ARM securities for a gain of $113.5 thousand during the nine months ended September 30, 2002.

 

For the quarter ended September 30, 2003, our mortgage assets paid down at an approximate average annualized Constant Paydown Rate (“CPR”) of 39%, compared to 30% for the quarter ended September 30, 2002 and 31% for the quarter ended June 30, 2003. When prepayments increase, we have to amortize the premium at which we own our ARM assets over a shorter time period, which reduces the yield to maturity on our ARM assets. Conversely, if actual prepayments 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 in order to adjust the amortization of the net premium, as appropriate.

 

The amount of the adjustment to the fair value on the purchased ARM securities classified as available-for-sale declined from a positive adjustment of $44.7 million as of December 31, 2002, to a negative adjustment of $28.7 million as of September 30, 2003. All of our ARM securities are classified as available-for-sale and are carried at their fair value.

 

Our Traditional ARM assets generally have a maximum lifetime interest rate cap or ceiling (“Life Cap”), meaning that each Traditional ARM asset contains a contractual maximum interest rate. Since our borrowings are not subject to equivalent interest rate caps, we have entered into Cap Agreements that have the effect of offsetting a portion of our borrowing costs above a level specified by the Cap Agreement so that the net margin on our Traditional ARM assets will be protected in high interest rate environments. As of September 30, 2003, our Traditional ARM assets had an average lifetime interest rate cap of 11.14%, far exceeding the current level of interest rates. At September 30, 2003, these Cap Agreements had a remaining notional balance of $1.0 billion with an average final maturity of ten months, compared to a remaining notional balance of $1.8 billion with an average final maturity of one year at December 31, 2002. At September 30, 2003, the fair value of these Cap Agreements was $10.7 thousand compared to a fair value of $84.7 thousand as of December 31, 2002. Pursuant to the terms of the Cap Agreements, we will receive cash payments if the one month or three month LIBOR indices increase above contractually specified levels, which range from 6.00% to 12.00% and average approximately 9.91%. Due to the current low level of interest rates, we have decided not to purchase additional Cap Agreements for Traditional ARM assets at this time, but will reevaluate this policy on an ongoing basis. We do not currently apply hedge accounting to our Cap Agreements which are used to manage the interest rate risk on our assets with contractual Life Caps and, as a result, we record the change in fair value of these Cap Agreements as hedging expense in current earnings.

 

We enter into Hybrid Hedging Instruments in order to manage our interest rate exposure when financing our Hybrid ARM assets. We generally borrow money based on short-term interest rates. Our Hybrid ARM assets generally have an initial fixed interest rate period of three to ten years. As a result, our existing and forecasted borrowings reprice to a new interest rate on a more frequent basis than our Hybrid ARM assets. Both Swap Agreements and Eurodollar Transactions have the effect of converting our variable rate debt into fixed rate debt over the life of the Swap Agreements and Eurodollar Transactions. We use Swap Agreements and Eurodollar Transactions as a cost-effective way to lengthen the average repricing period of our variable rate and short-term borrowings such that the duration of our borrowings more closely matches the duration of our ARM assets. We use Cap Agreements to protect the net margin on our Hybrid ARM assets in higher interest rate environments by establishing a maximum fixed interest rate on a portion of our borrowings funding Hybrid ARM assets. We generally enter into Swap Agreements, Eurodollar Transactions and Cap Agreements that have notional balances that decline over time in approximate relation to the expected paydown of our Hybrid ARM assets. The relative balances and duration of our Hybrid ARM assets and our Hybrid Hedging Instruments are monitored on a continual basis in order to manage the net duration within our policy limits.

 

As of September 30, 2003, we were counterparty to Swap Agreements and Eurodollar Transactions having an aggregate current notional balance of $9.6 billion. In addition, we entered into five delayed Swap Agreements, three of which have a total notional balance of $915 million and became effective in October 2003, one with a

 

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notional balance of $180 million which became effective in November 2003 and the last with a notional balance of $270 million becoming effective in February 2004. These Swap Agreements and Eurodollar Transactions fix the interest rate on the financing of our Hybrid ARM assets during their fixed rate term (generally three to ten years). As of September 30, 2003, these Swap Agreements and Eurodollar Transactions had a weighted average maturity of 3.5 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 3.05% and 3.74% at September 30, 2003 and December 31, 2002, respectively. As of September 30, 2003, ARM assets with a carrying value of $84.1 million, including accrued interest, and cash totaling $43.6 million collateralized the Swap Agreements. The net fair value of Swap Agreements at September 30, 2003 of $150.8 million included Swap Agreements with gross unrealized gains of $4.7 million and gross unrealized losses of $155.5 million and is included in “Hedging instruments” on the balance sheet. As of September 30, 2003, the net unrealized loss on Swap Agreements, deferred gains from terminated Swap Agreements and deferred gains and losses on Eurodollar Transactions recorded in “Accumulated other comprehensive income (loss)” was a net loss of $167.4 million.

 

In April and August 2003, we purchased Cap Agreements with notional balances of $576.7 million and $995.3 million, respectively, at a cost of $8.9 million and $20.2 million, respectively, in order to manage our interest rate risk exposure on the financing of the Hybrid ARM loans collateralizing our CDOs. These Cap Agreements had a remaining notional amount of $1.5 billion as of September 20, 2003. The fair value of these Cap Agreements at September 30, 2003 was $21.5 million and is included in “Hedging instruments” on the balance sheet. The unrealized loss on these Cap Agreements of $7.6 million is included in “Accumulated other comprehensive income (loss).” 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 4.61% and average 3.81%. The Cap Agreements had an average maturity of 5.4 years as of September 30, 2003. The initial aggregate notional amount of the Cap Agreements declines over the period of the agreements, which expire between 2006 and 2012.

 

As a result of entering into these Hybrid Hedging Instruments, we have reduced the interest rate variability of our cost to finance Hybrid ARM assets. The average remaining fixed rate term of our Hybrid ARM assets as of September 30, 2003 was 4.5 years. We hedge the funding of our Hybrid ARM assets such that the weighted average net duration of borrowed funds, Hybrid Hedging Instruments and Hybrid ARM assets is less than one year. At September 30, 2003, the financing and hedging of our Hybrid ARM assets resulted in a net duration of approximately 1.3 months.

 

In accordance with Financial Accounting Standards No. 133 (“FAS 133”), we designate all of these Swap Agreements as cash flow hedges. The Swap Agreements and the short-term borrowings they hedge have nearly identical terms and characteristics with respect to the applicable index and interest rate repricing dates, and we have calculated the effectiveness of this cash flow hedge to be approximately 100%. As a result, we have recorded all changes in the unrealized gains and losses on Swap Agreements in “Accumulated other comprehensive income (loss)” and we have reclassified all such changes to earnings as interest expense is recognized on our hedged borrowings.

 

Also, in accordance with FAS 133, we designate all of the Eurodollar Transactions as cash flow hedges. The Eurodollar Transactions hedge the change in the three-month LIBOR interest rate index and we have also entered into short-term borrowings indexed to three-month LIBOR with re-pricing dates that correspond to the valuation dates of the Eurodollar Transactions. As a result, there has not been any measurable ineffectiveness from this activity and, therefore, the gains and losses from this activity have been recorded in “Accumulated other comprehensive income (loss)” and will be reclassified to earnings as interest expense is recognized on our hedged short-term borrowings.

 

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We designate the Cap Agreements used as Hybrid Hedging Instruments as cash flow hedges. We assess hedging effectiveness in accordance with the provisions of FAS 133 Implementation Issue No. G20 and have calculated such effectiveness at approximately 100%. All changes in the unrealized gains and losses on these Cap Agreements 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.

 

Results of Operations For the Nine Months Ended September 30, 2003

 

For the nine months ended September 30, 2003, our net income was $127.0 million, or $2.04 basic earnings per share, and $2.02 diluted EPS, based on weighted average basic and diluted shares outstanding of 60,572,000 and 62,887,000, respectively. That compares to $84.8 million, or $1.93 and $1.92 per share, basic and diluted EPS, respectively, for the same period in 2002, based on weighted average basic and diluted shares outstanding of 41,401,000 and 44,161,000, respectively, a 5.2% increase in our diluted earnings per share.

 

Our return on average common equity was 17.55% for the nine months ended September 30, 2003 compared to 17.60% for the nine months ended September 30, 2002.

 

The following table presents the components of our net interest income:

 

Comparative Net Interest Income Components

(Dollar amounts in thousands)

 

 

As presented in the table above, our net interest income increased by $55.6 million in the first nine months of 2003 compared to the same period of 2002. The change was attributable to a $125.7 million increase in interest income primarily due to an increased asset base, partially offset by a $70.2 million increase in interest expense. Included in this increase in interest expense is a $44.8 million increase resulting from the impact of Swap Agreements and Eurodollar Transactions which is commensurate with the increase in borrowings financing our Hybrid ARM assets. Hybrid ARM assets totaled $13.3 billion and $6.6 billion at September 30, 2003 and 2002, respectively.

 

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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, Interest Income and Interest Expense Table

(Dollar amounts in thousands)

 

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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):

 

 

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As presented in the table above, net interest income increased by $55.6 million. This increase in net interest income included a favorable volume variance partially offset by an unfavorable rate variance. As a result of the yield on our interest-earning assets decreasing to 4.12% during the first nine months of 2003 from 4.86% during the same period of 2002, a decrease of 74 basis points, while our cost of funds decreased to 2.68% from 3.27% during the same time period, a decrease of 59 basis points, there was a net unfavorable rate variance of $9.2 million. This was due to an unfavorable rate variance on our ARM assets portfolio and other interest-earning assets that decreased net interest income by $42.0 million, partially offset by a favorable rate variance on our borrowings in the amount of $32.7 million. The potential volatility in the rate variance is reduced through our use of Hedging Instruments and the net improvement in interest income is primarily a result of the benefits resulting from the issuance of additional common equity and the investment opportunities we have pursued in our ARM assets portfolio as a result of this growth. The increased average size of our portfolio during the first nine months of 2003 compared to the same period in 2002 increased net interest income in the amount of $64.8 million. The average balance of our interest-earning assets was $13.3 billion during the first nine months of 2003, compared to $7.8 billion during the same period of 2002 — an increase of 69.9%.

 

During the nine months ended September 30, 2003, we realized a net gain on ARM assets of $5.4 million. This gain consists of a $2.7 million net release of previously recorded credit losses, a $910.5 thousand gain upon the maturity of a collateralized bond obligation and a net unrealized gain of $1.8 million on ARM loan purchase commitments to correspondent lenders at September 30, 2003.

 

We did not sell any ARM assets during the nine months ended September 30, 2003. During the nine months ended September 30, 2002, we sold $72.9 million of ARM securities for a gain of $113.5 thousand. The ARM securities sold were classified as “available-for-sale.” In addition, we sold $4.1 million of loans and realized a net loss of $8.1 thousand.

 

During the nine months ended September 30, 2003, we recorded loan loss provisions totaling $2.0 million to reserve for estimated credit losses on loans.

 

For the nine months ended September 30, 2003, our ratio of operating expenses to average assets was 0.44%, compared to 0.44% for the same period in 2002. Total operating expenses for the nine-month period ended September 30, 2003 were $43.9 million, compared to $25.6 million for the same period in 2002. The most significant single increase to our operating expenses was the $8.2 million increase in the performance-based fee that the Manager earned during the first nine months of 2003 as a result of our achieving a return on shareholders’ equity in excess of the threshold as defined in the Management Agreement with the Manager. Our return on equity prior to the effect of the performance-based fee was 18.31%, whereas the threshold, the average 10-year treasury rate plus 1%, was 4.92%. This is a non-GAAP measurement that we believe to be more meaningful for comparing 2003 and 2002 because it excludes the volatility caused by unrealized gains (losses) on available-for-sale ARM assets and Hedging Instruments. Our return on equity on a GAAP basis was 20.42% and is based on the inclusion of average accumulated other comprehensive loss of $108.0 million in the computation.

 

The remaining $10.0 million increase in operating expenses from the first nine months of 2002 to the same period of 2003 related primarily to increased base management fees, expanded operations of TMHL, expenses associated with our issuance of Dividend Equivalent Rights (“DERs”) and Phantom Stock Rights (“PSRs”), and other corporate matters. The base management fee paid to the Manager increased $2.6 million due to our increased average shareholders’ equity, TMHL’s operations increased $1.6 million, and our issuance of DERs and PSRs together with our improved stock price accounted for $4.8 million of the increase.

 

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 September 30, 2003, we had

 

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operating liquidity of $393.3 million, consisting of unpledged ARM assets and cash and cash equivalents. Our principal sources of liquidity are the reverse repurchase market, the issuance of CDOs, whole loan financing facilities as well as principal and interest payments from ARM assets. The reverse repurchase market is a $6 trillion market that has been a readily available source of financing for mortgage assets, particularly those rated AA or better. There is also a robust market for AAA-rated long-term debt of the type that we issue and this type of financing effectively eliminates liquidity 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 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.

 

Our primary sources of funds for the quarter ended September 30, 2003 consisted of reverse repurchase agreements, floating-rate CDOs and whole loan financing facilities. Our other significant sources of funds for the quarter ended September 30, 2003 consisted primarily of payments of principal and interest from our ARM assets. In the future, we expect our primary sources of funds to remain the same.

 

Total borrowings outstanding at September 30, 2003 had a weighted average effective cost of 1.32%. The reverse repurchase agreements had a weighted average remaining term to maturity of 6.4 months, although we utilize Swap Agreements and Eurodollar Transactions to extend the re-pricing characteristic of total borrowings to 2.2 years. The CDOs mature between 2033 and 2043, although they are callable by us at par once the total balance of the loans collateralizing the debt is reduced to 20% of the original balance of the debt. The whole loan financing facilities are committed facilities that mature in December 2003, March 2004, September 2004 and November 2004. As of September 30, 2003, $11.8 billion of our borrowings were variable rate term reverse repurchase agreements. Term reverse repurchase agreements are committed financings with original maturities that range from two to 25 months. The interest rates on these term reverse repurchase agreements are indexed to either the one-month or three-month LIBOR rate, and reprice accordingly. The interest rates on the CDOs and whole loan financing facilities are indexed to one-month LIBOR and are subject to either daily or monthly adjustments.

 

We have arrangements to enter into reverse repurchase agreements with 24 different financial institutions and on September 30, 2003, had uncommitted financing facilities of approximately $20.4 billion. At September 30, 2003, we had borrowed funds totaling $12.6 billion from 17 of these firms. Because we borrow money under these 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 decline 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. We had adequate liquidity throughout the quarter ended September 30, 2003. 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.

 

On August 28, 2003, approximately $1.4 billion of mortgage loans from our ARM loan portfolio were transferred to Thornburg Mortgage Securities Trust 2003-4 and were securitized. Approximately $1.4 billion of the securities created by this securitization were issued to third-party investors in the form of AAA-rated floating rate pass-through certificates. Using such a structure enables us to make more efficient use of our capital because the capital required to support these financings is less than the amount required to support the same amount of financings in the reverse repurchase agreement market and these transactions represent permanent financing of these loans and are not subject to margin calls. At September 30, 2003, we had $2.2 billion of collateralized long-term debt outstanding.

 

As of September 30, 2003, we had entered into three whole loan financing facilities. We borrow money under these facilities based on the fair value of the ARM loans pledged to secure these facilities. Therefore, the

 

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amount of money available to us under these facilities is subject to margin call based on changes in fair value, which can be negatively affected by changes in interest rates and other factors, including the delinquency status of individual loans. The first whole loan financing facility has a committed borrowing capacity of $600 million and an uncommitted capacity of $100 million and matures in November 2004. The second financing facility has a committed borrowing capacity of $300 million and matures in March 2004. The third financing facility has a committed borrowing capacity of $300 million and an uncommitted capacity of $250 million and matures in December 2003. We expect to renew this facility. In October 2003, we entered into a fourth financing facility that has a committed borrowing capacity of $150 million and matures in September 2004. As of September 30, 2003, we had $1.0 billion borrowed against these whole loan financing facilities, at an effective cost of 1.85%.

 

During the quarter ended September 30, 2003, we issued 974,655 shares of common stock through “at-market” transactions under controlled equity offering programs under the August 2002 shelf registration statement and received net proceeds of $24.4 million. As of September 30, 2003, $25.1 million and $86.6 million of our registered securities remained available for future issuance and sale under our currently effective July 2001 and August 2002 shelf registration statements, respectively.

 

On August 5, 2003, we completed a public offering of 4,000,000 shares of common stock under the August 2002 shelf registration statement and received net proceeds of $104.6 million.

 

We have a Dividend Reinvestment and Stock Purchase Plan (the “DRSPP”) designed to provide a convenient and economical way for existing shareholders to automatically reinvest their dividends in additional shares of our common stock, and for new and existing shareholders to purchase shares at a discount to the current market price of the common stock, as defined in the DRSPP. During the quarter ended September 30, 2003, we issued 1,209,463 shares of common stock under the DRSPP and received net proceeds of $30.2 million.

 

Our senior note obligations contain both financial and non-financial covenants. Significant financial covenants include limitations on our ability to incur indebtedness beyond specified levels, restrictions on our ability to incur liens on assets and limitations on the amount and type of restricted payments, such as repurchases of our own equity securities, that we make. As of September 30, 2003, we are in compliance with all financial and non-financial covenants on our senior note obligations.

 

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THE EXCHANGE OFFER

 

Participation in the exchange offer is voluntary, and you should carefully consider whether to accept. You are urged to consult your financial and tax advisors in making your own decision on what action to take.

 

We are offering to issue new registered 8% senior notes due 2013 in exchange for a like principal amount of our outstanding unregistered 8% senior notes due 2013. We may extend, delay or terminate the exchange offer. Holders of outstanding notes who wish to exchange their notes will need to complete the exchange offer documentation related to the exchange.

 

Purpose and Effect of the Exchange Offer

 

We sold the outstanding notes in transactions that were exempt from or not subject to the registration requirements under the Securities Act. Accordingly, the outstanding notes are subject to transfer restrictions. In general, you may not offer or sell the outstanding notes unless either they are registered under the Securities Act or the offer or sale is exempt from or not subject to registration under the Securities Act and applicable state securities laws.

 

In connection with the sale of the outstanding notes, we entered into a registration rights agreement with the initial purchaser of the outstanding notes. In that agreement, we agreed to file a registration statement relating to an offer to exchange the outstanding notes for new notes not later than 45 days after the date we issued the outstanding notes and to use our best efforts to have it declared effective within 140 days after the date we issued the outstanding notes. We also agreed to complete the exchange offer no later than 40 days following the date on which the registration statement is declared effective. We are offering the new notes under this prospectus to satisfy those obligations under the registration rights agreement.

 

If we fail to comply with deadlines for completion of the exchange offer, we will be required to pay additional interest to holders of the outstanding notes.

 

Based on interpretations of the SEC staff in “no action letters” issued to third parties, we believe that each new note issued under the exchange offer may be offered for resale, resold and otherwise transferred by you, the holder of that new note, without compliance with the registration and prospectus delivery provisions of the Securities Act if:

 

 

 

 

However, the SEC has not considered the legality of our exchange offer in the context of a “no action letter,” and there can be no assurance that the staff of the SEC would make a similar determination with respect to our exchange offer as it has in other interpretations to other parties.

 

If you tender outstanding notes in the exchange offer with the intention of participating in any manner in a distribution of the new notes, you:

 

 

 

Unless an exemption from registration is otherwise available, the resale by any holder intending to distribute new notes should be covered by an effective registration statement under the Securities Act containing the

 

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holder’s information required by Item 507 or Item 508, as applicable, of Regulation S-K under the Securities Act. This prospectus may be used for an offer to resell, resale or other retransfer of new notes only as specifically described in this prospectus. Failure to comply with the registration and prospectus delivery requirements by a holder subject to these requirements could result in that holder incurring liability for which it is not indemnified by us. With respect to broker-dealers, only those that acquired the outstanding notes for their own account as a result of market-making activities or other trading activities may participate in the exchange offer. Each broker-dealer that receives new notes for its own account in exchange for outstanding notes acquired as a result of market-making activities or other trading activities may be deemed to be an “underwriter” within the meaning of the Securities Act and must acknowledge that it will deliver a prospectus in connection with any resale of such notes. We have agreed to make this prospectus available in connection with resales of the new notes by broker-dealers for 180 days after the consummation of the exchange offer. Please see “Plan of Distribution” for more details regarding the transfer of new notes.

 

Under the terms of the registration rights agreement, we may be required to file a shelf registration statement to permit specified holders of outstanding notes to resell their notes periodically without being limited by transfer restrictions applicable to the outstanding notes. We may be required to file a shelf registration statement to cover resales of the outstanding notes only if:

 

 

 

 

 

 

If we are obligated to file the shelf registration statement, we will:

 

 

 

 

The shelf registration statement will permit only certain holders to resell their notes from time to time. In particular, these holders must:

 

 

 

A holder who sells notes under the shelf registration statement will be required to be named as a selling securityholder in the prospectus and to deliver a copy of the prospectus to purchasers. If we are required to file a shelf registration statement, we will provide to each holder of the notes covered thereby copies of the prospectus

 

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that is a part of the shelf registration statement and notify each of these holders when the shelf registration statement becomes effective. These holders will be subject to civil liability provisions under the Securities Act in connection with those sales.

 

Under the registration rights agreement, we may suspend the availability of an exchange offer or shelf registration statement and, in each case, the use of the related prospectus if:

 

 

 

 

 

Holders of notes registered under a registration statement are required to discontinue disposition of those notes under the registration statement and use of the prospectus upon notice of any of the events described in the preceding paragraph.

 

If any of the following “registration defaults” occurs, we will be required to pay additional interest on the notes:

 

 

 

 

 

If a registration default occurs, then we will pay to each affected holder of the notes additional interest that will accrue and be payable on the regular interest payment dates (in addition to the stated interest on the notes) from and including the date on which such registration default occurs up to but excluding the date on which all such registration defaults are cured. During the time that additional interest is accruing, the rate of additional interest will be 0.50% per annum during the first 90 day period and will increase by 0.50% per annum for each subsequent 90 day period, but in no event will the rate exceed 2.0% per annum in the aggregate.

 

Terms of the Exchange Offer

 

Upon the terms and subject to the conditions described in this prospectus and in the letter of transmittal, we will accept for exchange any outstanding notes properly tendered and not withdrawn before the expiration date of the exchange offer. We will issue $1,000 principal amount of new notes in exchange for each $1,000 principal amount of outstanding notes surrendered under the exchange offer. Outstanding notes may be tendered only in integral multiples of $1,000. The exchange offer is not conditioned upon any minimum aggregate principal amount of outstanding notes being tendered for exchange.

 

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As of the date of this prospectus, $55 million principal amount of unregistered notes are outstanding. This prospectus and the letter of transmittal included with this prospectus are being sent to all registered holders of outstanding unregistered notes. There will be no fixed record date for determining registered holders of outstanding notes entitled to participate in the exchange offer.

 

We intend to conduct the exchange offer according to the provisions of the registration rights agreement, the applicable requirements of the Securities Act and the Exchange Act and the rules and regulations of the SEC. Outstanding notes that are not tendered for exchange in the exchange offer will remain outstanding and continue to accrue interest and will be entitled to the rights and benefits the holders have under the indenture and, if applicable, the registration rights agreement. However, these outstanding notes will not be freely tradable. See “—Consequences of Failure to Exchange” below.

 

We will be deemed to have accepted for exchange properly tendered outstanding notes when we have given oral or written notice of the acceptance to the exchange agent and complied with the applicable provisions of the registration rights agreement. The exchange agent will act as agent for the tendering holders for the purpose of receiving the new notes from us.

 

If you tender outstanding notes in the exchange offer, you will not be required to pay brokerage commissions or fees or, subject to the instructions in the letter of transmittal, transfer taxes with respect to the exchange of outstanding notes. We will pay all charges and expenses, other than certain applicable taxes described below, in connection with the exchange offer. It is important that you read “—Fees and Expenses” for more details regarding fees and expenses incurred in the exchange offer.

 

We will return any outstanding notes that we do not accept for exchange for any reason without expense to the tendering holder as promptly as practicable after the expiration or termination of the exchange offer.

 

Expiration Date

 

The exchange offer will expire at 5:00 p.m., New York City time, on February 11, 2004 unless, in our sole discretion, we extend the exchange offer.

 

Extensions, Delay in Acceptance, Termination or Amendment

 

We expressly reserve the right, at any time or from time to time, to extend the period of time during which the exchange offer is open. During any extensions, all outstanding notes previously tendered will remain subject to the exchange offer, and we may accept them for exchange.

 

To extend the exchange offer, we will notify the exchange agent orally or in writing of any extension. We will also make a public announcement of the extension no later than 9:00 a.m., New York City time, on the next business day after the previously scheduled expiration date.

 

If any of the conditions described below under “—Conditions to the Exchange Offer” have not been satisfied, we reserve the right, in our sole discretion:

 

 

 

 

We will give oral or written notice of a delay, extension or termination to the exchange agent. Subject to the terms of the registration rights agreement, we also reserve the right to amend the terms of the exchange offer in any manner.

 

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Any delay in acceptance, extension, termination or amendment will be followed as promptly as practicable by oral or written notice to the registered holders of the outstanding notes. If we amend the exchange offer in a manner we determine to constitute a material change, we will promptly disclose the amendment by means of a prospectus supplement. The supplement will be distributed to the registered holders of the outstanding notes. Depending upon the significance of the amendment and the manner of disclosure to the registered holders, we will extend the exchange offer if the exchange offer would otherwise expire during that period.

 

Without limiting the manner in which we may choose to make public announcements of any delay in acceptance, extension, termination or amendment of the exchange offer, we will have no obligation to publish, advertise or otherwise communicate any public announcement, other than by making a timely release to an appropriate news agency.

 

Conditions to the Exchange Offer

 

Despite any other term of the exchange offer, if in our reasonable judgment the exchange offer, or the making of any exchange by a holder of outstanding notes, would violate applicable law or any applicable interpretation of the staff of the SEC or would be impaired by any action or proceeding that has been instituted or threatened in any court or by or before any governmental agency with respect to the exchange offer:

 

 

 

In addition, we will not be obligated to accept for exchange the outstanding notes of any holder that has not made or been deemed to have made to us:

 

 

 

We expressly reserve the right to amend or terminate the exchange offer, and to reject for exchange any outstanding notes not previously accepted for exchange, upon the occurrence of any of the conditions to the exchange offer specified above. We will give oral or written notice of any extension, amendment, nonacceptance or termination to the holders of the outstanding notes as promptly as practicable.

 

These conditions are for our sole benefit, and we may assert them or waive them in whole or in part at any time or at various times in our sole discretion. If we fail at any time to exercise any of these rights, this failure will not mean that we have waived our rights. Each right will be deemed an ongoing right that we may assert at any time or at various times. In addition, we will not accept for exchange any outstanding notes tendered and will not issue new notes in exchange for any outstanding note, if at that time any stop order has been threatened or is in effect with respect to the registration statement of which this prospectus constitutes a part or the qualification of the indenture under the Trust Indenture Act of 1939.

 

Procedures for Tendering

 

How to Tender Generally

 

Only a registered holder of outstanding notes may tender its outstanding notes in the exchange offer. If you are a beneficial owner of outstanding notes and wish to have the registered owner tender on your behalf, please see “—How to Tender if You Are a Beneficial Owner” below. To tender in the exchange offer, a registered

 

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holder must either comply with the procedures for manual tender or comply with the automated tender offer program procedures of DTC described below under “—Tendering Through DTC’s Automated Tender Offer Program.”

 

To complete a manual tender, you must:

 

 

 

 

 

 

If you wish to tender your outstanding notes and cannot comply with the requirement to deliver the letter of transmittal and your outstanding notes (including by book-entry transfer) or use the automated tender offer program of DTC before the expiration date, you must tender your outstanding notes according to the guaranteed delivery procedures described below under “—Guaranteed Delivery Procedures.”

 

For a tender to be effective, the exchange agent must receive any physical delivery of the letter of transmittal and other required documents at its address provided above under “Summary—The Exchange Agent” before the expiration date. To complete a tender through DTC’s automated tender offer program, the exchange agent must receive, prior to the expiration date, a timely confirmation of book-entry transfer of such outstanding notes into the exchange agent’s account at DTC according to the procedure for book-entry transfer described below and a properly transmitted agent’s message.

 

Any tender by a holder that is not withdrawn before the expiration date will constitute a legally binding agreement between the holder and us according to the terms and subject to the conditions described in this prospectus and in the letter of transmittal.

 

The method of delivery of outstanding notes, the letter of transmittal and all other required documents to the exchange agent is at your election and risk. Rather than mail these items, we recommend that you use an overnight or hand delivery service. In all cases, you should allow sufficient time to ensure delivery to the exchange agent before the expiration date. You should not send the letter of transmittal or outstanding notes to us. You may request your broker, dealer, commercial bank, trust company or other nominee to effect the above transactions on your behalf.

 

Book-Entry Transfer

 

The exchange agent will make a request to establish an account with respect to the outstanding notes at DTC for purposes of the exchange offer promptly after the date of this prospectus. Any financial institution participating in DTC’s system may make book-entry delivery of outstanding notes by causing DTC to transfer the outstanding notes into the exchange agent’s account at DTC according to DTC’s procedures for transfer. If you are unable to deliver confirmation of the book-entry tender of your outstanding notes into the exchange agent’s account at DTC or all other documents required by the letter of transmittal to the exchange agent on or before the expiration date, you must tender your outstanding notes according to the guaranteed delivery procedures described below under “—Guaranteed Delivery Procedures.”

 

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Tendering Through DTC’s Automated Tender Offer Program

 

The exchange agent and DTC have confirmed that any financial institution that is a participant in DTC’s system may use DTC’s automated tender offer program to tender its outstanding notes. Participants in the program may transmit their acceptance of the exchange offer electronically instead of physically completing and signing the letter of transmittal and delivering it to the exchange agent. Tendering through the automated tender offer program causes DTC to transfer the outstanding notes to the exchange agent according to its procedures for transfer. DTC will then send an agent’s message to the exchange agent.

 

The term “agent’s message” means a message transmitted by DTC to and received by the exchange agent and forming part of the book-entry confirmation, stating that:

 

 

 

 

How to Tender if You Are a Beneficial Owner

 

If you beneficially own outstanding notes that are registered in the name of a broker, dealer, commercial bank, trust company or other nominee and you wish to tender those notes, you should contact the registered holder promptly and instruct the registered holder to tender on your behalf. If you are a beneficial owner and wish to tender on your own behalf, you must, before completing and executing the letter of transmittal and delivering your outstanding notes, either:

 

 

 

The transfer of registered ownership may take considerable time and may not be completed before the expiration date.

 

Signatures and Signature Guarantees

 

You must have signatures on a letter of transmittal or a notice of withdrawal described below guaranteed by an “eligible guarantor institution” unless the outstanding notes are tendered:

 

 

 

An “eligible institution” is:

 

 

 

 

 

An “eligible guarantor institution” is an eligible institution that is also a member in good standing of a recognized “medallion” signature guarantee program.

 

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When Endorsements or Bond Powers are Needed

 

If the letter of transmittal is signed by a person other than the registered holder of any outstanding notes, the outstanding notes must be endorsed or accompanied by a properly completed bond power. The bond power must be signed by the registered holder as the registered holder’s name appears on the outstanding notes and an eligible guarantor institution must guarantee the signature on the bond power.

 

If the letter of transmittal or any outstanding notes or bond powers are signed by trustees, executors, administrators, guardians, attorneys-in-fact, officers of corporations or others acting in a fiduciary or representative capacity, those persons should so indicate when signing. They should also submit evidence of their authority to deliver the letter of transmittal satisfactory to us unless we waive this requirement.

 

Determinations Under the Exchange Offer

 

We will determine in our sole discretion all questions as to the validity, form, eligibility, time of receipt, acceptance of tendered outstanding notes and withdrawal of tendered outstanding notes. Our determination will be final and binding. We reserve the absolute right to reject any outstanding notes not properly tendered or any outstanding notes our acceptance of which would, in the opinion of our counsel, be unlawful. We also reserve the absolute right to waive any defects, irregularities or conditions of tender as to particular outstanding notes. Our interpretation of the terms and conditions of the exchange offer, including the letter of transmittal and the instructions thereto, will be final and binding on all parties.

 

Unless waived, any defects or irregularities in connection with tenders of outstanding notes must be cured within the time we determine. Neither we, the exchange agent nor any other person will be under any duty to give notification of defects or irregularities with respect to tenders of outstanding notes, nor will we or those persons incur any liability for failure to give such notification. Tenders of outstanding notes will not be deemed made until any defects or irregularities have been cured or waived. Any outstanding notes received by the exchange agent that are not properly tendered and as to which the defects or irregularities have not been cured or waived will be returned by the exchange agent to the tendering holder, unless otherwise provided in the letter of transmittal, as soon as practicable following the expiration date.

 

When We Will Issue New Notes

 

In all cases, we will issue new notes for outstanding notes that we have accepted for exchange in the exchange offer only after the exchange agent timely receives:

 

 

 

Return of Outstanding Notes Not Accepted or Exchanged

 

If we do not accept any tendered outstanding notes for exchange for any reason described in the terms and conditions of the exchange offer or if outstanding notes are submitted for a greater principal amount than the holder desires to exchange, the unaccepted or nonexchanged outstanding notes will be returned without expense to their tendering holder. In the case of outstanding notes tendered by book-entry transfer into the exchange agent’s account at DTC according to the procedures described above, the nonexchanged outstanding notes will be credited to an account maintained with DTC. These actions will occur as promptly as practicable after the rejection of tender or the expiration or termination of the exchange offer.

 

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Your Representations to Us

 

By signing or agreeing to be bound by the letter of transmittal, you will represent to us that, among other things:

 

 

 

 

 

 

 

 

Guaranteed Delivery Procedures

 

If you wish to tender your outstanding notes but your outstanding notes are not immediately available or you cannot deliver your outstanding notes (including by book-entry transfer), the letter of transmittal or any other required documents to the exchange agent or comply with the applicable procedures under DTC’s automated tender offer program before the expiration date, you may tender if:

 

 

 

 

 

 

 

Upon request to the exchange agent, the exchange agent will send you a notice of guaranteed delivery if you wish to tender your outstanding notes using the guaranteed delivery procedures described above.

 

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Withdrawal of Tenders

 

Except as otherwise provided in this prospectus, you may withdraw your tender at any time before 5:00 p.m., New York City time, on the expiration date. For a withdrawal to be effective:

 

 

 

Any notice of withdrawal must:

 

 

 

 

 

If outstanding notes have been tendered under the procedure for book-entry transfer described above, any notice of withdrawal must specify the name and number of the account at DTC to be credited with the withdrawn outstanding notes and otherwise comply with the procedures of DTC.

 

We will determine, in our sole discretion, all questions as to the validity, form, eligibility and time of receipt of notice of withdrawal. Our determination will be final and binding on all parties. We will deem any outstanding notes so withdrawn not to have been validly tendered for exchange for purposes of the exchange offer.

 

Any outstanding notes that have been tendered for exchange but that are not exchanged for any reason will be returned to their holder without cost to the holder or, in the case of outstanding notes tendered by book-entry transfer into the exchange agent’s account at DTC according to the procedures described above, the outstanding notes will be credited to an account maintained with DTC for the outstanding notes. This return or crediting will take place as soon as practicable after withdrawal, rejection of tender or termination of the exchange offer. At any time on or before the expiration date, holders may re-tender properly withdrawn outstanding notes by following one of the procedures described under “—Procedures for Tendering” above.

 

Fees and Expenses

 

We will bear the expenses of soliciting tenders. The principal solicitation is being made by mail, but we may make additional solicitation by telephone, electronically or in person by our officers and regular employees and those of our affiliates.

 

We have not retained any dealer-manager in connection with the exchange offer and will not make any payments to broker-dealers or others soliciting acceptances of the exchange offer. We will, however, pay the exchange agent reasonable and customary fees for its services and reimburse it for its related reasonable out-of-pocket expenses. We may also pay brokerage houses and other custodians, nominees and fiduciaries the reasonable out-of-pocket expenses incurred by them in forwarding copies of this prospectus, letters of transmittal and related documents to the beneficial owners of the outstanding notes and in handling or forwarding tenders for exchange.

 

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We will pay the cash expenses to be incurred in connection with the exchange offer, including:

 

 

 

 

 

Transfer Taxes

 

We will pay all transfer taxes, if any, applicable to the exchange of outstanding notes under the exchange offer. A tendering holder, however, will be required to pay any transfer taxes, whether imposed on the registered holder or any other person, if:

 

 

 

 

If satisfactory evidence of payment of any transfer taxes payable by a holder is not submitted with the letter of transmittal, the amount of the transfer taxes will be billed directly to that tendering holder. The exchange agent will retain possession of the new notes with a face amount equal to the amount of the transfer taxes due until it receives payment of the taxes.

 

Consequences of Failure to Exchange

 

If you do not exchange your outstanding notes for new notes in the exchange offer, or if you tender your outstanding notes but subsequently withdraw them, your outstanding notes will remain outstanding and continue to accrue interest, but will not retain any rights under the registration rights agreement (except in limited circumstances generally involving only the initial purchaser and specified broker-dealers) or accrue additional interest under that agreement. In addition, your notes will remain subject to the existing restrictions on transfer of the outstanding notes. In general, you may not offer or sell the outstanding notes unless they are registered under the Securities Act or the offer or sale is exempt from or not subject to registration under the Securities Act and applicable state securities laws. Except as required by the registration rights agreement, we do not intend to register resales of the outstanding notes under the Securities Act. Consummation of the exchange offer will fulfill substantially all of our registration obligations with respect to the outstanding notes under the registration rights agreement.

 

Accounting Treatment

 

We will not recognize a gain or loss for accounting purposes upon the consummation of the exchange offer. We will amortize expenses of the exchange offer over the term of the new notes under accounting principles generally accepted in the United States of America.

 

Other

 

Participation in the exchange offer is voluntary, and you should carefully consider whether to accept. You are urged to consult your financial and tax advisors in making your decision on what action to take. In the future, we may seek to acquire untendered outstanding notes in open market or privately negotiated transactions, through subsequent exchange offers or otherwise. We have no present plan to acquire any outstanding notes that are not tendered in the exchange offer or to file a registration statement to permit resales of any untendered outstanding notes, except as required by the registration rights agreement.

 

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DESCRIPTION OF NOTES

 

We issued the outstanding notes and will issue the new notes under an indenture, or the “Indenture,” between the Company and Deutsche Bank Trust Company Americas, as Trustee, or the “Trustee.” The following is a summary of the material provisions of the Indenture. We urge you to read the Indenture and the form and terms of the new notes because they define your rights. The terms of the new notes include those stated in the Indenture and those made part of the Indenture by reference to the Trust Indenture Act of 1939, as amended, or the “TIA.” You may request a copy of the Indenture at our address as shown under “Incorporation of Certain Documents by Reference” below. You can find definitions of certain capitalized terms used in this section under “—Certain Definitions.” For purposes of this section, references to the “Company” or “our” include only Thornburg Mortgage, Inc. and not its Subsidiaries.

 

The new notes will be senior unsecured obligations of the Company, ranking pari passu in right of payment with all other senior unsecured obligations of the Company.

 

The Company will issue the new notes in fully registered form in denominations of $1,000 and integral multiples thereof. The Trustee will initially act as the paying agent, or the “Paying Agent,” and the registrar, or the “Registrar,” for the new notes. The Company may change any Paying Agent and Registrar without notice to holders of the notes, or the “Holders.” The Company will pay principal (and premium, if any) on the notes at the Trustee’s corporate office in New York, New York. At the Company’s option, interest may be paid at the Trustee’s corporate trust office or by check mailed to the registered address of Holders.

 

Principal, Maturity and Interest

 

The new notes are initially being offered up to the principal amount of $55 million. The Company may, without the consent of the Holders, increase the principal amount of the notes in the future on the same terms and conditions and with the same CUSIP number as the new notes being offered hereby. The new notes will mature on May 15, 2013. Interest on the new notes will accrue at the rate of 8% per annum and will be payable semiannually in cash on each May 15 and November 15, commencing on May 15, 2004, to the persons who are registered Holders at the close of business on the May 1 and November 1 immediately preceding the applicable interest payment date. Interest on the new notes will accrue from the most recent date to which interest has been paid or, if no interest has been paid, from and including November 15, 2003.

 

The notes will not be entitled to the benefit of any mandatory sinking fund.

 

Redemption

 

Optional Redemption. At any time on or after May 15, 2008, the notes may be redeemed or purchased in whole or in part at the Company’s option at a price equal to 100% of the principal amount thereof plus the Applicable Premium as of, and accrued but unpaid interest, if any, to, the date of redemption or purchase, or the “Redemption Date,” (subject to the right of Holders of record on the relevant record date to receive interest due on the relevant interest payment date). Such redemption or purchase may be made upon notice mailed by first-class mail to each Holder’s registered address, not less than 30 nor more than 60 days prior to the Redemption Date.

 

“Applicable Premium” means, with respect to a note: (1) 104% of the principal amount of such note if the Redemption Date is on or after May 15, 2008 and before May 15, 2009; (2) 102.667% of the principal amount of such note if the Redemption Date is on or after May 15, 2009 and before May 15, 2010; (3) 101.333% of the principal amount of such note if the Redemption Date is on or after May 15, 2010 and before May 15, 2011; and (4) 0% of the principal amount of such note if the Redemption Date is on or after May 15, 2011. Calculation of the Applicable Premium will be made by the Company or on behalf of the Company by such Person as the Company shall designate; provided, however, that such calculation shall not be a duty or obligation of the Trustee.

 

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Optional Redemption Upon Equity Offerings. At any time, or from time to time, on or prior to May 15, 2006, the Company may, at its option, use the net cash proceeds of one or more Equity Offerings (as defined below) to redeem up to 35% of the principal amount of all notes issued under the Indenture at a redemption price of 108.0% of the principal amount thereof plus accrued and unpaid interest thereon, if any, to the date of redemption; provided that:

 

 

 

“Equity Offering” means an underwritten public offering of Qualified Capital Stock of the Company pursuant to a registration statement filed with the SEC in accordance with the Securities Act or a private placement of Qualified Capital Stock of the Company generating gross proceeds of at least $25.0 million.

 

Selection and Notice of Redemption

 

In the event that the Company chooses to redeem less than all of the notes, selection of the notes for redemption will be made by the Trustee either:

 

 

 

No notes of a principal amount of $1,000 or less shall be redeemed in part. If a partial redemption is made with the proceeds of an Equity Offering, the Trustee will select the notes only on a pro rata basis or on as nearly a pro rata basis as is practicable (subject to DTC procedures). Notice of redemption will be mailed by first-class mail at least 30 but not more than 60 days before the redemption date to each Holder of notes to be redeemed at its registered address. On and after the redemption date, interest will cease to accrue on notes or portions thereof called for redemption as long as the Company has deposited with the Paying Agent funds in satisfaction of the applicable redemption price.

 

Change of Control

 

Upon the occurrence of a Change of Control, each Holder will have the right to require that the Company purchase all or a portion of such Holder’s notes pursuant to the offer described below (the “Change of Control Offer”), at a purchase price equal to 101% of the principal amount thereof plus accrued interest to the date of purchase.

 

Within 30 days following the date upon which the Change of Control occurred, the Company must send, by first class mail, a notice to each Holder, with a copy to the Trustee, which notice shall govern the terms of the Change of Control Offer. Such notice shall state, among other things, the purchase date, which must be no earlier than 30 days nor later than 60 days from the date such notice is mailed, other than as may be required by law (the “Change of Control Payment Date”). Holders electing to have a note purchased pursuant to a Change of Control Offer will be required to surrender the note, with the form entitled “Option of Holder to Elect Purchase” on the reverse of the note completed, to the Paying Agent at the address specified in the notice prior to the close of business on the third business day prior to the Change of Control Payment Date.

 

If a Change of Control Offer is made, we cannot assure you that the Company will have available funds sufficient to pay the Change of Control purchase price for all the notes that might be delivered by Holders seeking to accept the Change of Control Offer. In the event the Company is required to purchase notes pursuant to a Change of Control Offer, the Company expects that it would seek third-party financing to the extent it does not have available funds to meet its purchase obligations. However, we cannot assure you that the Company would be able to obtain such financing.

 

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Neither the Board of Directors of the Company nor the Trustee may waive the covenant relating to a Holder’s right to redemption upon a Change of Control. Restrictions in the Indenture described herein on the ability of the Company and its Subsidiaries to incur additional Senior Unsecured Indebtedness, to grant liens on its property and to make Restricted Payments (as defined below) may also make more difficult or discourage a takeover of the Company, whether favored or opposed by the management of the Company. Consummation of any such transaction in certain circumstances may require redemption or repurchase of the notes, and we cannot assure you that the Company or the acquiring party will have sufficient financial resources to effect such redemption or repurchase. Such restrictions and the restrictions on transactions with Affiliates may, in certain circumstances, make more difficult or discourage any leveraged buyout of the Company or any of its Subsidiaries by the management of the Company. While such restrictions cover a wide variety of arrangements that have traditionally been used to effect highly leveraged transactions, the Indenture may not afford the Holders protection in all circumstances from the adverse aspects of a highly leveraged transaction, reorganization, restructuring, merger or similar transaction.

 

The Company will comply with the requirements of Rule 14e-1 under the Exchange Act and any other securities laws and regulations thereunder to the extent such laws and regulations are applicable in connection with the repurchase of notes pursuant to a Change of Control Offer. To the extent that the provisions of any securities laws or regulations conflict with the “Change of Control” provisions of the Indenture, the Company shall comply with the applicable securities laws and regulations and shall not be deemed to have breached its obligations under the “Change of Control” provisions of the Indenture by virtue thereof.

 

Certain Covenants

 

The Indenture contains, among others, the following covenants; but the Indenture also provides that the “Limitation on Liens,” “Limitation Based Upon Total Unencumbered Assets,” “Limitation on Restricted Payments,” “Limitation on Dividend and Other Payment Restrictions Affecting Subsidiaries,” “Limitation on Preferred Stock of Subsidiaries,” “Limitation of Guarantees by Subsidiaries,” “Conduct of Business” and “Limitations on Transactions with Affiliates” covenants will not be applicable in the event, and only for so long as, the notes are rated Investment Grade and no Default or Event of Default has occurred and is continuing.

 

Limitation on Incurrence of Additional Senior Unsecured Indebtedness. The Company will not, and will not permit any of its Subsidiaries to, directly or indirectly, create, incur, assume, guarantee, become liable, contingently or otherwise, with respect to, or otherwise become responsible for payment of (collectively, “incur”) any Senior Unsecured Indebtedness (including, without limitation, Acquired Indebtedness) other than Permitted Indebtedness.

 

Notwithstanding the foregoing, if no Default or Event of Default shall have occurred and be continuing at the time of or as a consequence of the incurrence of any such Senior Unsecured Indebtedness, the Company or any of its Subsidiaries may incur Senior Unsecured Indebtedness (including, without limitation, Acquired Indebtedness), in each case if on the date of the incurrence of such Senior Unsecured Indebtedness, after giving effect to the incurrence thereof and the use of proceeds thereof:

 

 

 

Limitation on Incurrence of Additional Consolidated Indebtedness. The Company will not, and will not permit any of its Subsidiaries to, directly or indirectly, incur any Indebtedness (including, without limitation, Acquired Indebtedness) other than Permitted Indebtedness.

 

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Notwithstanding the foregoing, if no Default or Event of Default shall have occurred and be continuing at the time of or as a consequence of the incurrence of any such Indebtedness, the Company or any of its Subsidiaries may incur Indebtedness (including, without limitation, Acquired Indebtedness), in each case if on the date of the incurrence of such Indebtedness, after giving effect to the incurrence thereof and the use of proceeds thereof:

 

 

Limitation Based Upon Total Unencumbered Assets. If the Total Unencumbered Assets of the Company and its Consolidated Subsidiaries is less than 125% of the aggregate principal amount of the Unsecured Indebtedness of the Company and its Consolidated Subsidiaries, in each case as of the last day of any fiscal quarter of the Company during the term of the notes (the “Quarter End Date”), then from and after the Quarter End Date until such time as the Total Unencumbered Assets of the Company and its Consolidated Subsidiaries is at least 125% of the aggregate principal amount of the Unsecured Indebtedness of the Company and its Consolidated Subsidiaries, the Company will maintain a ratio of Adjusted Debt to Adjusted Net Worth, that is no higher than the calculation of such ratio at the Quarter End Date.

 

Limitation on Restricted Payments. The Company will not, and will not cause or permit any of its Subsidiaries to, directly or indirectly:

 

 

 

 

if at the time of such action (each, a “Restricted Payment”) or immediately after giving effect thereto,

 

 

 

 

 

 

 

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The foregoing provisions do not prohibit:

 

 

 

 

 

 

 

 

 

In determining the aggregate amount of Restricted Payments made subsequent to the Measurement Date in accordance with clause (iii) above, amounts expended pursuant to clauses (1), (2) (ii), (3), (4) and (6) shall be included in such calculation.

 

Limitation on Dividend and Other Payment Restrictions Affecting Subsidiaries. The Company will not, and will not cause or permit any of its Subsidiaries to, directly or indirectly, create or otherwise cause or permit to exist or become effective any encumbrance or restriction on the ability of any Subsidiary of the Company to:

 

 

 

 

 

 

 

 

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Limitation on Preferred Stock of Subsidiaries. The Company will not permit any of its Subsidiaries to issue any Preferred Stock (other than to the Company or to a Wholly Owned Subsidiary of the Company) or permit any Person (other than the Company or a Wholly Owned Subsidiary of the Company) to own any Preferred Stock of any Subsidiary of the Company, other than Preferred Stock outstanding on the Measurement Date of Subsidiaries formed to facilitate maintaining the Company’s REIT status.

 

Limitation on Liens. The Company will not, and will not cause or permit any of its Subsidiaries to, directly or indirectly, create, incur, assume or permit or suffer to exist any Liens of any kind on the assets of the Company securing Indebtedness of the Company unless:

 

 

 

 

 

 

 

 

Merger, Consolidation and Sale of Assets. The Company will not, in a single transaction or series of related transactions, consolidate or merge with or into any Person, or sell, assign, transfer, lease, convey or otherwise dispose of (or cause or permit any Subsidiary of the Company to sell, assign, transfer, lease, convey or otherwise dispose of) all or substantially all of the Company’s assets (determined on a consolidated basis for the Company and the Company’s Subsidiaries) whether as an entirety or substantially as an entirety to any Person unless:

 

 

 

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For purposes of the foregoing, the transfer (by lease, assignment, sale or otherwise, in a single transaction or series of transactions) of all or substantially all of the properties or assets of one or more Subsidiaries of the Company the Capital Stock of which constitutes all or substantially all of the properties and assets of the Company, shall be deemed to be the transfer of all or substantially all of the properties and assets of the Company.

 

The Indenture provides that upon any consolidation, combination or merger or any transfer of all or substantially all of the assets of the Company in accordance with the foregoing, in which the Company is not the continuing corporation, the successor Person formed by such consolidation or into which the Company is merged or to which such conveyance, lease or transfer is made shall succeed to, and be substituted for, and may exercise every right and power of, the Company under the Indenture and the notes with the same effect as if such surviving entity had been named as such.

 

Limitations on Transactions with Affiliates. The Company will not, and will not permit any of its Subsidiaries to, directly or indirectly, enter into or permit to exist any transaction or series of related transactions (including, without limitation, the purchase, sale, lease or exchange of any property or the rendering of any service) with, or for the benefit of, any of its Affiliates (each an “Affiliate Transaction”), other than: (1) Affiliate Transactions permitted as described below; and (2) Affiliate Transactions on terms that are no less favorable than those that might reasonably have been obtained in a comparable transaction at such time on an arm’s-length basis from a Person that is not an Affiliate of the Company or such Subsidiary.

 

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All Affiliate Transactions (and each series of related Affiliate Transactions which are similar or part of a common plan) involving aggregate payments or other property with a fair market value in excess of $5.0 million shall be approved by the Board of Directors of the Company or such Subsidiary, as the case may be, such approval to be evidenced by a Board Resolution stating that such Board of Directors has determined that such transaction complies with the foregoing provisions. If the Company or any Subsidiary of the Company enters into an Affiliate Transaction (or a series of related Affiliate Transactions related to a common plan) that involves an aggregate fair market value of more than $10.0 million, the Company or such Subsidiary, as the case may be, shall, prior to the consummation thereof, obtain a favorable opinion as to the fairness of such transaction or series of related transactions to the Company or the relevant Subsidiary, as the case may be, from a financial point of view, from an Independent Financial Advisor and file the same with the Trustee.

 

The restrictions set forth in the first paragraph of this covenant shall not apply to:

 

 

 

 

 

 

 

 

Limitation of Guarantees by Subsidiaries. The Company will not permit any of its Subsidiaries, directly or indirectly, by way of the pledge of any intercompany note or otherwise, to assume, guarantee or in any other manner become liable with respect to any Indebtedness of the Company, unless, in any such case:

 

 

 

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Notwithstanding the foregoing, any such Guarantee by a Subsidiary of the notes shall provide by its terms that it shall be automatically and unconditionally released and discharged, without any further action required on the part of the Trustee or any Holder, upon:

 

 

 

Conduct of Business. The Company and its Subsidiaries will engage primarily in the business of acquiring and originating adjustable rate mortgages and assets comprised of adjustable rate mortgage securities and other activities related to or arising out of those activities.

 

Reports to Holders. Whether or not required by the rules and regulations of the SEC, so long as any notes are outstanding, the Company will furnish the Holders of notes:

 

 

 

In addition, whether or not required by the rules and regulations of the SEC, the Company will file a copy of all such information and reports with the SEC for public availability within the time periods specified in the SEC’s rules and regulations (unless the SEC will not accept such a filing) and make such information available to securities analysts and prospective investors upon request. In addition, the Company has agreed that, for so long as any notes remain outstanding, it will furnish to the Holders and to securities analysts and prospective investors, upon their request, the information required to be delivered pursuant to Rule 144A(d)(4) under the Securities Act.

 

Compliance Certificate. The Company will deliver to the Trustee within 90 days after the end of each fiscal year, an officer’s certificate stating that a review of the activities of the Company and its Subsidiaries during the preceding fiscal year has been made with a view to determining whether the Company has fulfilled its obligations and covenants under the Indenture and indicating whether any Event of Default has occurred.

 

Events of Default

 

The following events are defined in the Indenture as “Events of Default”:

 

 

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If an Event of Default (other than an Event of Default specified in clause (6) above with respect to the Company) shall occur and be continuing, the Trustee or the Holders of at least 25% in principal amount of the then outstanding notes issued under the Indenture may declare the principal of and accrued interest on all the notes issued under the Indenture to be due and payable by notice in writing to the Company and the Trustee specifying the respective Event of Default and that it is a “notice of acceleration,” or the “Acceleration Notice,” and the same shall become immediately due and payable.

 

If an Event of Default specified in clause (6) above with respect to the Company occurs and is continuing, then all unpaid principal of, and premium, if any, and accrued and unpaid interest on all of the then outstanding notes issued under the Indenture shall ipso facto become and be immediately due and payable without any declaration or other act on the part of the Trustee or any Holder.

 

The Indenture provides that, at any time after a declaration of acceleration with respect to the notes as described in the preceding paragraph, the Holders of a majority in principal amount of all notes issued under the Indenture may rescind and cancel such declaration and its consequences:

 

 

 

 

 

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The Holders of a majority in aggregate principal amount of the then outstanding notes issued under the Indenture may waive any existing Default or Event of Default under the Indenture, and its consequences, except a default in the payment of the principal of or interest on any notes.

 

Holders of the notes may not enforce the Indenture or the notes except as provided in the Indenture and under the TIA. Subject to the provisions of the Indenture relating to the duties of the Trustee, the Trustee is under no obligation to exercise any of its rights or powers under the Indenture at the request, order or direction of any of the Holders, unless such Holders have offered to the Trustee indemnity satisfactory to it. Subject to all provisions of the Indenture and applicable law, the Holders of a majority in principal amount of the then outstanding notes issued under the Indenture have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee or exercising any trust or power conferred on the Trustee.

 

Under the Indenture, the Company is required to provide an officers’ certificate to the Trustee promptly upon any such officer obtaining knowledge of any Default or Event of Default (provided that such officers shall provide such certification at least annually whether or not they know of any Default or Event of Default) that has occurred and, if applicable, describe such Default or Event of Default and the status thereof.

 

Legal Defeasance and Covenant Defeasance

 

The Company may, at its option and at any time, elect to have its obligations discharged with respect to the notes (“Legal Defeasance”). Such Legal Defeasance means that the Company shall be deemed to have paid and discharged the entire indebtedness represented by the notes, except for:

 

 

 

 

 

In addition, the Company may, at its option and at any time, elect to have the obligations of the Company released with respect to certain covenants that are described in the Indenture (“Covenant Defeasance”) and thereafter any omission to comply with such obligations shall not constitute a Default or Event of Default with respect to the notes. In the event Covenant Defeasance occurs, certain events (not including non-payment, bankruptcy, receivership, reorganization and insolvency events) described under “Events of Default” will no longer constitute an Event of Default with respect to the notes.

 

In order to exercise either Legal Defeasance or Covenant Defeasance:

 

 

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Notwithstanding the foregoing, the opinion of counsel required by clause (2) above with respect to a Legal Defeasance need not be delivered if all notes not theretofore delivered to the Trustee for cancellation (1) have become due and payable or (2) will become due and payable on the maturity date within one year under arrangements satisfactory to the Trustee for the giving of notice of redemption by the Trustee in the name, and at the expense, of the Company.

 

Satisfaction and Discharge

 

The Indenture will be discharged and will cease to be of further effect (except as to surviving rights or registration of transfer or exchange of the notes, as expressly provided for in the Indenture) as to all notes when:

 

 

 

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Modification of the Indenture

 

From time to time, the Company and the Trustee, without the consent of the Holders, may amend the Indenture for certain specified purposes, including curing ambiguities, defects or inconsistencies, so long as such change does not adversely affect the rights of any of the Holders in any material respect. In formulating its opinion on such matters, the Trustee will be entitled to conclusively rely, and shall be fully protected in acting upon, such evidence as it deems appropriate, including, without limitation, solely on an opinion of counsel. Other modifications and amendments of the Indenture may be made with the consent of the Holders of a majority in principal amount of the then outstanding notes issued under the Indenture, except that, without the consent of each Holder affected thereby, no amendment may:

 

 

 

 

 

 

 

 

Governing Law

 

The Indenture provides that it and the notes will be governed by, and construed in accordance with, the laws of the State of New York but without giving effect to applicable principles of conflicts of law to the extent that the application of the law of another jurisdiction would be required thereby.

 

The Trustee

 

The Indenture provides that, except during the continuance of an Event of Default, the Trustee will perform only such duties as are specifically set forth in the Indenture. During the existence of an Event of Default, the Trustee will exercise such rights and powers vested in it by the Indenture, and use the same degree of care and skill in its exercise as a prudent man would exercise or use under the circumstances in the conduct of his own affairs.

 

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The Indenture and the provisions of the TIA contain certain limitations on the rights of the Trustee, should it become a creditor of the Company, to obtain payments of claims in certain cases or to realize on certain property received in respect of any such claim as security or otherwise. Subject to the TIA, the Trustee will be permitted to engage in other transactions; provided that if the Trustee acquires any conflicting interest as described in the TIA, it must eliminate such conflict or resign.

 

Form of Security

 

Generally. We will issue the new notes in the form of one or more global notes in fully registered form initially registered in the name of Cede & Co., as nominee of DTC. DTC will act as securities depository for the global notes, or “Global Notes.” The Global Notes will be deposited with the Trustee as custodian for DTC and may not be transferred except as a whole by DTC to a nominee of DTC or by a nominee of DTC to DTC or another nominee of DTC or by DTC or a nominee of DTC to a successor of DTC or a nominee of such successor.

 

Depository Procedures. The following description of the operations and procedures of DTC is provided solely as a matter of convenience. These operations and procedures are solely within the control of DTC’s settlement system and are subject to changes by it. We take no responsibility for these operations and procedures and urge investors to contact DTC or its participants to discuss these matters. DTC has advised us that DTC is a limited-purpose trust company organized under the New York Banking Law, a “banking organization” within the meaning of the New York Banking Law, a member of the Federal Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code, and a “clearing agency” registered pursuant to the provisions of Section 17A of the Exchange Act. DTC holds securities that its participants, or “Participants,” deposit with DTC. DTC also facilitates the post-trade settlement among Participants of sales and other securities transactions, such as transfers and pledges, in deposited securities through electronic computerized book-entry changes in Participants’ accounts, thereby eliminating the need for physical movement of securities certificates. Participants include both U.S. and non-U.S. securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations. DTC is a wholly-owned subsidiary of The Depository Trust & Clearing Corporation, or “DTCC.” DTCC, in turn, is owned by a number of Participants and members of the National Securities Clearing Corporation, Government Securities Clearing Corporation, MBS Clearing Corporation, and Emerging Markets Clearing Corporation (also subsidiaries of DTCC), as well as by the New York Stock Exchange, Inc., the American Stock Exchange LLC, and the National Association of Securities Dealers, Inc. Access to the DTC system is also available to others such as both U.S. and non-U.S. securities brokers and dealers, banks, trust companies and clearing corporations that clear through or maintain a custodial relationship with a Participant, either directly or indirectly (“Indirect Participants”). The rules applicable to DTC and its Participants and Indirect Participants are on file with the SEC.

 

DTC has also advised us that purchases of Global Notes under the DTC system must be made by or through Participants, which will receive a credit for the Global Notes on DTC’s records. The ownership interest of each actual purchaser of each Global Note (“Beneficial Owner”) is in turn to be recorded on the Participants’ and Indirect Participants’ records. Beneficial Owners will not receive written confirmation from DTC of their purchase, but Beneficial Owners are expected to receive written confirmations providing details of the transaction, as well as periodic statements of their holdings, from the Participant or Indirect Participant through which the Beneficial Owner entered into the transaction. Transfers of ownership interests in the Global Notes are to be accomplished by entries made on the books of Participants and Indirect Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in Global Notes, except in the event that use of the book-entry system for the Global Notes is discontinued. To facilitate subsequent transfers, all Global Notes deposited by Participants with DTC are registered in the name of DTC’s partnership nominee, Cede & Co. or such other name as may be requested by an authorized representative of DTC. The deposit of Global Notes with DTC and their registration in the name of Cede & Co. or such other nominee do not effect any change in beneficial ownership. DTC has no knowledge of the actual Beneficial Owners of the Global Notes. DTC’s records reflect only the identity of the Participants to whose accounts such Global Notes are credited, which may or may not be the Beneficial Owners. The Participants and Indirect Participants will remain responsible for keeping account of their holdings on behalf of their customers.

 

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The laws of some states require that certain persons take physical delivery in definitive form of securities that they own. Consequently, the ability to transfer beneficial interests in a Global Note to such persons may be limited to that extent. Because DTC can act only on behalf of Participants, which in turn act on behalf of Indirect Participants and certain banks, the ability of a person having beneficial interests in a Global Note to pledge such interests to persons or entities that do not participate in the DTC System, or otherwise take actions in respect of such interests, may be affected by the lack of a physical certificate evidencing such interests. For certain other restrictions on the transferability of the notes, see “—Exchange of Book-Entry Notes for Certificated Notes.”

 

Redemption proceeds and payments in respect of the principal of (and premium, if any) and interest on the Global Notes will be made to Cede & Co., or such other nominee as may be requested by an authorized representative of DTC, in its capacity as the registered holder under the Indenture. DTC’s practice is to credit Participants’ accounts, upon DTC’s receipt of funds and corresponding detail information from us or the Trustee, on the payable date in accordance with their respective holdings shown on DTC’s records. Payments by Participants to Beneficial Owners will be governed by standing instructions and customary practices, as is the case with securities held for the accounts of customers in bearer form or registered in “street name,” and will be the responsibility of such Participant and not of DTC, the Company or the Trustee, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of redemption proceeds and payments in respect of the principal of (and premium, if any) and interest on the Global Notes to Cede & Co. (or such other nominee as may be requested by an authorized representative of DTC) is the responsibility of the Trustee, disbursement of such payments to Participants shall be the responsibility of DTC, and disbursement of such payments to the Beneficial Owners shall be the responsibility of Participants and Indirect Participants. Under the terms of the Indenture, the Trustee will treat the persons in whose names the notes, including the Global Notes, are registered as the owners thereof for the purpose of receiving such payments and for any and all other purposes whatsoever. Consequently, neither the Trustee nor any agent of the Trustee has or will have any responsibility or liability for (i) any aspect of DTC’s records or any Participant’s or Indirect Participant’s records relating to or payments made on account of beneficial ownership interests in the Global Notes, or for maintaining, supervising or reviewing any of DTC’s records or any Participant’s or Indirect Participant’s records relating to the beneficial ownership interests in the Global Notes, or (ii) any other matter relating to the actions and practices of DTC or any of its Participants or Indirect Participants. The Trustee will not be liable for any delay by DTC or any of its Participants in identifying the Beneficial Owners of the notes, and the Trustee may conclusively rely on and will be protected in relying on instructions from DTC or its nominee as the registered owner of the notes for all purposes.

 

Interests in the Global Notes will trade in DTC’s Same-Day Funds Settlement System and secondary market trading activity in such interests will therefore settle in immediately available funds, subject in all cases to the rules and procedures of DTC and its Participants.

 

Transfers between Participants in DTC will be effected in accordance with DTC’s procedures, and, if applicable, those of Euroclear and Clearstream Banking.

 

DTC has advised us that conveyance of notices and other communications by DTC to Participants, by Participants to Indirect Participants, and by Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time. DTC has also advised us that it will take any action permitted to be taken by a holder of notes only at the direction of one or more Participants to whose account an interest in the Global Notes is credited and only in respect of such portion of the aggregate principal amount of the notes as to which such Participant or Participants has or have given such direction. However, if there is an Event of Default under the notes, DTC reserves the right to exchange the Global Notes for legended notes in certificated form, and to distribute such notes to its Participants.

 

The information in this section concerning DTC and its book-entry system has been obtained from sources that we believe to be reliable, but we take no responsibility for the accuracy thereof.

 

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Exchange of Book-Entry Notes for Certificated Notes. DTC may discontinue providing its services as securities depository with respect to the Global Notes at any time by giving reasonable notice to us or the Trustee. If DTC is at any time unwilling or unable to continue as depository or ceases to be a clearing agency registered under the Exchange Act and a successor depository or clearing agency is not appointed by us within 90 days, or if we decide to discontinue use of the system of book-entry transfers through DTC (or a successor securities depository), we will issue individual, fully registered, definitive notes in exchange for the Global Note. Upon the exchange of a Global Note for individual notes, such Global Note shall be canceled by the Trustee and the definitive notes shall be registered in such names and in such authorized denominations as DTC, pursuant to instructions from its Participants, any Indirect Participants or otherwise, shall instruct the Trustee. The Trustee shall deliver such notes to the persons in whose names such notes are so registered and shall recognize the holders thereof as noteholders.

 

Certain Definitions

 

Set forth below is a summary of certain of the defined terms used in the Indenture. Reference is made to the Indenture for the full definition of all such terms, as well as any other terms used herein for which no definition is provided.

 

“Acquired Indebtedness” means Indebtedness of a Person or any of its Subsidiaries existing at the time such Person becomes a Subsidiary of the Company or at the time it merges or consolidates with the Company or any of its Subsidiaries or assumed in connection with the acquisition of assets from such Person and in each case whether or not incurred by such Person in connection with, or in anticipation or contemplation of, such Person becoming a Subsidiary of the Company or such acquisition, merger or consolidation.

 

“Adjusted Debt” means aggregate Indebtedness of the Company and its Consolidated Subsidiaries, net of Non-Marginable Indebtedness and fair value adjustments to hedging instruments.

 

“Adjusted Earnings” means with respect to any Person, for any period, the sum (without duplication) of: Consolidated Net Income and, to the extent Consolidated Net Income has already been reduced thereby, depreciation and amortization.

 

“Adjusted Net Worth” means Consolidated Adjusted Tangible Net Worth plus Senior Unsecured Indebtedness less NMI Equity.

 

“Affiliate” means, with respect to any specified Person, any other Person who directly or indirectly through one or more intermediaries controls, or is controlled by, or is under common control with, such specified Person. The term “control” means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise; and the terms “controlling” and “controlled” have meanings correlative of the foregoing.

 

“Asset Acquisition” means: (1) an Investment by the Company or any Subsidiary of the Company in any other Person pursuant to which such Person shall become a Subsidiary of the Company or any Subsidiary of the Company, or shall be merged with or into the Company or any Subsidiary of the Company; or (2) the acquisition by the Company or any Subsidiary of the Company of the assets of any Person (other than a Subsidiary of the Company) that constitute all or substantially all of the assets of such Person or comprises any division or line of business of such Person or any other properties or assets of such Person other than in the ordinary course of business.

 

“Asset Sale” means any direct or indirect sale, issuance, conveyance, transfer, lease (other than operating leases entered into in the ordinary course of business), assignment or other transfer for value by the Company or any of its Subsidiaries (including any sale and leaseback transaction) to any Person other than the Company or its Wholly Owned Subsidiaries of:

 

 

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“Board of Directors” means, as to any Person, the Board of Directors of such Person or any duly authorized committee thereof.

 

“Board Resolution” means, with respect to any Person, a copy of a resolution certified by the Secretary or an Assistant Secretary of such Person to have been duly adopted by the Board of Directors of such Person and to be in full force and effect on the date of such certification, and delivered to the Trustee.

 

“Capitalized Lease Obligation” means, as to any Person, the obligations of such Person under a lease that are required to be classified and accounted for as capital lease obligations under GAAP and, for purposes of this definition, the amount of such obligations at any date shall be the capitalized amount of such obligations at such date, determined in accordance with GAAP.

 

“Capital Stock” means:

 

 

 

“Change of Control” means the occurrence of one or more of the following events:

 

 

 

 

 

“Common Stock” of any Person means any and all shares, interests or other participations in, and other equivalents (however designated and whether voting or non-voting) of such Person’s common stock, whether outstanding on the Measurement Date or issued after the Measurement Date, and includes, without limitation, all series and classes of such common stock.

 

“Consolidated Adjusted Tangible Net Worth” of any Person means the excess of such Person’s total assets over its total liabilities determined on a consolidated basis in accordance with GAAP, plus the principal amount of any Subordinated Indebtedness, excluding (1) Other Comprehensive Income or Loss, (2) goodwill and (3) other intangibles, in each case as of the end of the last completed fiscal quarter ending on or prior to the date of the transaction giving rise to the need to calculate Consolidated Adjusted Tangible Net Worth.

 

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“Consolidated EBITDA” means, with respect to any Person, for any period, the sum (without duplication) of:

 

 

 

 

 

 

all as determined on a consolidated basis for such Person and its Subsidiaries in accordance with GAAP.

 

“Consolidated Net Income” means, with respect to any Person, for any period, the aggregate net income (or loss) of such Person and its Subsidiaries before the payment of dividends on Preferred Stock for such period on a consolidated basis, determined in accordance with GAAP; provided that there shall be excluded therefrom:

 

 

 

 

 

 

 

 

 

 

 

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“Consolidated Net Worth” of any Person means the consolidated stockholders’ equity of such Person, as of the end of the last completed fiscal quarter ending on or prior to the date of the transaction giving rise to the need to calculate Consolidated Net Worth determined on a consolidated basis in accordance with GAAP, less (without duplication) amounts attributable to Disqualified Capital Stock of such Person and interests in such Person’s Consolidated Subsidiaries not owned, directly or indirectly, by such Person.

 

“Consolidated Senior Unsecured Indebtedness Interest Coverage Ratio” means, with respect to any Person, the ratio of Consolidated EBITDA of such Person during the four full fiscal quarters (the “Four Quarter Period”) ending prior to the date of the transaction giving rise to the need to calculate the Consolidated Senior Unsecured Indebtedness Interest Coverage Ratio for which financial statements are available (the “Transaction Date”) to Consolidated Senior Unsecured Indebtedness Interest Expense of such Person for the Four Quarter Period. In addition to and without limitation of the foregoing, for purposes of this definition, “Consolidated EBITDA” and “Consolidated Senior Unsecured Indebtedness Interest Expense” shall be calculated after giving effect on a pro forma basis for the period of such calculation to:

 

 

 

“Consolidated Senior Unsecured Indebtedness Interest Expense” means, with respect to any Person for any period, the sum of, without duplication:

 

 

 

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“Consolidated Subsidiary” means, with respect to any Person, a Subsidiary of such Person, the financial statements of which are consolidated with the financial statements of such Person in accordance with GAAP.

 

“Currency Agreement” means any foreign exchange contract, currency swap agreement or other similar agreement or arrangement designed to protect the Company or any Subsidiary of the Company against fluctuations in currency values.

 

“Default” means an event or condition the occurrence of which is, or with the lapse of time or the giving of notice or both would be, an Event of Default.

 

“Disqualified Capital Stock” means that portion of any Capital Stock that, by its terms (or by the terms of any security into which it is convertible or for which it is exchangeable at the option of the holder thereof), or upon the happening of any event (other than an event which would constitute a Change of Control), matures or is mandatorily redeemable, pursuant to a sinking fund obligation or otherwise, or is redeemable at the sole option of the holder thereof (except, in each case, upon the occurrence of a Change of Control) on or prior to the final maturity date of the notes.

 

“Exchange Act” means the Securities Exchange Act of 1934, as amended, or any successor statute or statutes thereto.

 

“Existing Warehouse Facilities” mean: (1) the Master Repurchase Agreement dated as of November 20, 2001, as amended November 14, 2002, between UBS Warburg Real Estate Securities Inc. and TMHL; (2) the Master Loan and Security Agreement dated as of November 20, 2001, as amended November 19, 2002, between Greenwich Capital Financial Products, Inc. and TMHL; (3) the TMA Mortgage Funding Trust II Collateralized Asset-Backed Notes, Series 2000-1 and Master Repurchase Agreement dated as of December 1, 2000 and March 22, 2000, respectively, as amended March 24, 2003 and February 28, 2003, respectively, between Wachovia Bank National Association and TMHL and Thornburg Mortgage Acceptance Corp. II and Real Estate Asset Funding Corporation and Wilmington Trust Company and Deutsche Bank National Trust Company and Ambac Assurance Corporation; and (4) the Master Repurchase Agreement currently in its final stages of negotiation, between CDC Mortgage Capital Inc. and TMHL, in each case, together with the related documents thereto (including, without limitation, any security documents), in each case as such agreements may be amended (including any amendment and restatement thereof), supplemented or otherwise modified from time to time, including any agreement extending the maturity of, refinancing, replacing or otherwise restructuring (including increasing the amount of available borrowings thereunder (provided that such increase in borrowings is permitted by the “Limitation on Incurrence of Additional Senior Unsecured Indebtedness,” “Limitation Based Upon Total Unencumbered Assets,” and “Limitation on Incurrence of Additional Consolidated Indebtedness” covenants above) or adding Subsidiaries of the Company as additional borrowers or guarantors thereunder) all or any portion of the Indebtedness under such agreement or any successor or replacement agreement and whether by the same or any other agent, lender or group of lenders.

 

“fair market value” means, with respect to any asset or property, the price which could be negotiated in an arm’s-length, free market transaction, for cash, between a willing seller and a willing and able buyer, neither of whom is under undue pressure or compulsion to complete the transaction. Fair market value shall be determined by the Board of Directors of the Company acting reasonably and in good faith and shall be evidenced by a Board Resolution of the Board of Directors of the Company delivered to the Trustee.

 

“GAAP” means generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board 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, which are in effect as of the Measurement Date.

 

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“Guarantor” means: each of the Company’s Subsidiaries that in the future executes a supplemental indenture in which such Subsidiary agrees to be bound by the terms of the Indenture as a Guarantor; provided that any Person constituting a Guarantor as described above shall cease to constitute a Guarantor when its respective Guarantee is released in accordance with the terms of the Indenture.

 

“Indebtedness” means with respect to any Person, without duplication:

 

 

 

 

 

 

 

 

 

 

For purposes hereof, the “maximum fixed repurchase price” of any Disqualified Capital Stock which does not have a fixed repurchase price shall be calculated in accordance with the terms of such Disqualified Capital Stock as if such Disqualified Capital Stock were purchased on any date on which Indebtedness shall be required to be determined pursuant to the Indenture, and if such price is based upon, or measured by, the fair market value of such Disqualified Capital Stock, such fair market value shall be determined reasonably and in good faith by the Board of Directors of the issuer of such Disqualified Capital Stock.

 

“Independent Financial Advisor” means a firm: (1) that does not, and whose directors, officers and employees or Affiliates do not, have a direct or indirect financial interest in the Company; and (2) that, in the judgment of the Board of Directors of the Company, is otherwise independent and qualified to perform the task for which it is to be engaged.

 

“Investment” means, with respect to any Person, any direct or indirect loan or other extension of credit (including, without limitation, a guarantee), or corporate tenant lease to or capital contribution to (by means of any transfer of cash or other property to others or any payment for property or services for the account or use of others), or any purchase or acquisition by such Person of any Capital Stock, bonds, notes, debentures or other securities or evidences or Indebtedness issued by, any Person. “Investment” shall exclude extensions of trade credit by the Company and its Subsidiaries on commercially reasonable terms in accordance with the Company’s or its Subsidiaries’ normal trade practices, as the case may be.

 

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“Investment Grade” means a rating of the notes by both S&P and Moody’s, each such rating being one of such agency’s four highest generic rating categories that signifies investment grade (i.e. BBB- (or the equivalent) or higher by S&P and Baa3 (or the equivalent) or higher by Moody’s); provided, in each case, such ratings are publicly available; provided, further, that in the event Moody’s or S&P is no longer in existence for purposes of determining whether the notes are rated “Investment Grade,” such organization may be replaced by a nationally recognized statistical rating organization (as defined in Rule 436 under the Securities Act) designated by the Company, notice of which shall be given to the Trustee.

 

“Lien” means any lien, mortgage, deed of trust, pledge, security interest, charge or encumbrance of any kind (including any conditional sale or other title retention agreement, any lease in the nature thereof and any agreement to give any security interest).

 

“Measurement Date” means May 15, 2003.

 

“NMI Equity” means the excess of the value of the assets collateralizing Non-Marginable Indebtedness over the amount of Non-Marginable Indebtedness, as reported in accordance with GAAP.

 

“Non-Marginable Indebtedness” means all Non-Recourse Indebtedness that is secured by assets that are not subject to requirements that the borrower or any third party provide additional margin collateralization in the event of a change in value of the assets.

 

“Non-Recourse Indebtedness” means any of the Company’s or any of its Subsidiaries’ Indebtedness that is:

 

 

 

 

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“Obligations” means all obligations for principal, premium, interest, penalties, fees, indemnification, reimbursements, damages and other liabilities payable under the documentation governing any Indebtedness.

 

“Other Comprehensive Income or Loss” shall mean the accumulated other comprehensive income or loss of the Company and its Consolidated Subsidiaries as determined in accordance with GAAP.

 

“Permitted Hedging Transactions” means entering into instruments and contracts and making margin calls thereon, covering Indebtedness of the Company or any of its Subsidiaries and of any Subsidiary covering Indebtedness of such Subsidiary that are entered into to protect the Company and its Subsidiaries from fluctuations in interest rates on Indebtedness incurred in accordance with the Indenture; and shall include, without limitation, interest rate swaps, caps, floors, collars and similar instruments, “interest only” mortgage derivative assets or other mortgage derivative products, future contracts and options on futures contracts on the Eurodollar, Federal Funds, Treasury bills and Treasury rates and similar financial instruments.

 

“Permitted Indebtedness” means, without duplication, each of the following:

 

 

 

 

 

 

 

 

 

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For purposes of determining compliance with the “Limitation on Incurrence of Additional Senior Unsecured Indebtedness,” “Limitation Based Upon Total Unencumbered Assets,” and “Limitation on Incurrence of Additional Consolidated Indebtedness” covenants, in the event that an item of Senior Unsecured Indebtedness or Indebtedness, as the case may be, meets the criteria of more than one of the categories of Permitted Indebtedness described in clauses (1) through (12) above or is entitled to be incurred pursuant to the second paragraph of each such covenant, the Company shall, in its sole discretion, classify (or later reclassify) such item of Senior Unsecured Indebtedness or Indebtedness, as the case may be, in any manner that complies with this covenant. Accrual of interest, accretion or amortization of original issue discount, the payment of interest on any Senior Unsecured Indebtedness or Indebtedness, as the case may be, in the form of additional Senior Unsecured Indebtedness or Indebtedness, as the case may be, with the same terms, and the payment of dividends on Disqualified Capital Stock in the form of additional shares of the same class of Disqualified Capital Stock will not be deemed to be an incurrence of Senior Unsecured Indebtedness or Indebtedness, as the case may be, or an issuance of Disqualified Capital Stock for purposes of the “Limitations on Incurrence of Additional Senior Unsecured Indebtedness,” “Limitation Based Upon Total Unencumbered Assets,” and “Limitation on Incurrence of Additional Consolidated Indebtedness” covenants.

 

“Permitted Liens” means the following types of Liens:

 

 

 

 

 

 

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“Person” means an individual, partnership, corporation, unincorporated organization, trust or joint venture, or a governmental agency or political subdivision thereof.

 

“Preferred Stock” of any Person means any Capital Stock of such Person that has preferential rights to any other Capital Stock of such Person with respect to dividends or redemptions or upon liquidation.

 

“Principal and Interest Facilities” means any principal and interest facilities in aggregate borrowing capacity amount at any one time of up to $50 million, together with the related documents thereto (including, without limitation, any security documents), in each case as such agreements may be amended (including any amendment and restatement thereof), supplemented or otherwise modified from time to time, including any agreement extending the maturity of, refinancing, replacing or otherwise restructuring or adding Subsidiaries of the Company as additional borrowers or guarantors thereunder) all or any portion of the Indebtedness under such agreement or any successor or replacement agreement and whether by the same or any other agent, lender or group of lenders.

 

“Qualified Capital Stock” means any Capital Stock that is not Disqualified Capital Stock.

 

“Refinance” means, in respect of any security or Indebtedness, to refinance, extend, renew, refund, repay, prepay, redeem, defease or retire, or to issue a security or Indebtedness in exchange or replacement for, such security or Indebtedness in whole or in part. “Refinanced” and “Refinancing” shall have correlative meanings.

 

“Refinancing Indebtedness” means any Refinancing by the Company or any Subsidiary of the Company of Senior Unsecured Indebtedness incurred in accordance with the “Limitation on Incurrence of Additional Senior Unsecured Indebtedness,” “Limitation on Incurrence of Additional Consolidated Indebtedness” and “Limitation Based Upon Total Unencumbered Assets” covenants (other than pursuant to clauses (2), (4), (5), (6), (7), (8), (9), (10) or (12) of the definition of Permitted Indebtedness), and in each case that does not:

 

 

 

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“REIT” means Real Estate Investment Trust.

 

“Secured Indebtedness” means any Indebtedness secured by a Lien upon the property of the Company or any of its Subsidiaries.

 

“Securities Act” means the Securities Act of 1933, as amended, or any successor statute or statutes thereto.

 

“Senior Unsecured Indebtedness” means all Indebtedness of the Company and its Subsidiaries other than (1) Indebtedness that is secured by a Lien on property or assets of the Company or its Subsidiaries and (2) Subordinated Indebtedness.

 

“Significant Subsidiary,” with respect to any Person, means any Subsidiary of such Person that satisfies the criteria for a “significant subsidiary” set forth in Rule 1.02(w) of Regulation S-X under the Exchange Act.

 

“Subordinated Indebtedness” means all of the Company’s and its Subsidiaries’ Indebtedness that expressly provides that such Indebtedness shall be subordinated in right of payment to any other Indebtedness and matures or is mandatorily redeemable pursuant to a sinking fund obligation or otherwise, or is redeemable at the sole option of the holder thereof (except, in each case, upon the occurrence of a Change of Control) on or after the final maturity date of the notes.

 

“Subsidiary,” with respect to any Person, means:

 

 

 

“Total Unencumbered Assets” as of any date means all assets (but excluding intangibles and accounts receivable other than principal and interest receivables on ARM assets) of the Company and its Subsidiaries not securing any portion of Secured Indebtedness determined on a consolidated basis in accordance with GAAP.

 

“Unsecured Indebtedness” means any Indebtedness of the Company or any of its subsidiaries that is not Secured Indebtedness.

 

“Weighted Average Life to Maturity” means, when applied to any Indebtedness at any date, the number of years obtained by dividing: (1) the then outstanding aggregate principal amount of such Indebtedness into; (2) the sum of the total of the products obtained by multiplying (i) the amount of each then remaining installment, sinking fund, serial maturity or other required payment of principal, including payment at final maturity, in respect thereof, by (ii) the number of years (calculated to the nearest one-twelfth) which will elapse between such date and the making of such payment.

 

“Wholly Owned Subsidiary” of any Person means any Subsidiary of such Person of which all the outstanding voting securities (other than in the case of a foreign Subsidiary, directors’ qualifying shares or an immaterial amount of shares required to be owned by other Persons pursuant to applicable law) are owned by such Person or any Wholly Owned Subsidiary of such Person.

 

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FEDERAL INCOME TAX CONSIDERATIONS

 

The following discussion is a summary of certain United States federal income tax consequences expected to result from the purchase, ownership and disposition of the new notes by holders who acquire the new notes on the issue date (as discussed below) at the issue price (as discussed below) and who hold the new notes as “capital assets” (generally, property held for investment) within the meaning of Section 1221 of the Code. This summary is based upon current provisions of the Code, applicable Treasury regulations, judicial authority and administrative rulings and practice, any of which may be altered with retroactive effect thereby changing the U.S. federal income tax consequences discussed below. There can be no assurance that the Internal Revenue Service, or the “IRS,” will not take a contrary view, and no ruling from the IRS has been or will be sought.

 

The U.S. federal income tax treatment of a holder of notes may vary depending upon such holder’s particular situation. Certain holders (including, but not limited to, certain financial institutions, partnerships or other entities treated as “passthrough” entities for U.S. federal income tax purposes, insurance companies, broker-dealers, expatriates and persons holding the notes as part of a “straddle,” “hedge” or “conversion transaction”) may be subject to special rules not discussed below.

 

PROSPECTIVE INVESTORS SHOULD CONSULT THEIR TAX ADVISORS AS TO THE PARTICULAR TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE NOTES, INCLUDING THE APPLICABILITY AND EFFECT OF ANY UNITED STATES FEDERAL, STATE, LOCAL, FOREIGN OR OTHER TAX LAWS.

 

As used herein, the term “U.S. Holder” means a beneficial owner of the notes that is for U.S. federal income tax purposes:

 

 

 

 

 

 

As used herein, the term “Non-U.S. Holder” means a beneficial owner of the notes that is not a U.S. Holder.

 

Issue Date and Issue Price

 

Although the new notes will be part of a series of notes issued initially on May 15, 2003 (the “Initial Notes”), because the Initial Notes were not “publicly traded” (within the meaning of the Treasury regulations), the new notes will not be treated as issued in a “qualified reopening” (within the meaning of the Treasury regulations). Therefore, the new notes will be treated as issued on the first closing date on which a substantial amount of the new notes are sold for money, and the issue price will be the first price at which a substantial amount of the new notes are sold for money (excluding sales bonds houses, brokers, or similar persons or organizations acting in the capacity of underwriters, placement agents or wholesalers). If the new notes were treated as issued in a qualified reopening, then the new notes would be treated as having the same issue date and the same issue price as the Initial Notes for U.S. federal income tax purposes. The remainder of this discussion assumes that the new notes are not issued in a qualified reopening.

 

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Registered Exchange Offer

 

The exchange of the outstanding notes for identical debt securities registered under the Securities Act should not constitute a taxable exchange. See “The Exchange Offer.” As a result, (i) holders should not recognize a taxable gain or loss as a result of exchanging the outstanding notes; (ii) the holding period of the new notes received should include the holding period of the outstanding notes exchanged therefor; and (iii) the adjusted tax basis of the new notes received should be the same as the adjusted tax basis of the outstanding notes exchanged therefor determined immediately before the registered exchange.

 

We believe that the likelihood that additional interest will become payable due to a registration default is remote. Accordingly, we intend to take the position that if such additional interest becomes payable, such amounts will be taxable to a U.S. Holder, generally, as ordinary income in accordance with such holder’s regular method of accounting for U.S. federal income tax purposes. However, the IRS may take a different position, which could affect the timing of a U.S. Holder’s recognition of income. We believe that a Non-U.S. Holder generally will not be subject to U.S. federal withholding on such amounts. The IRS may also take a different position, which could affect the amount of the payment such holder receives.

 

U.S. Holders

 

Payments of Interest. In general, interest on a note will be taxable to a U.S. Holder as ordinary income at the time it accrues or is received, in accordance with the U.S. Holder’s regular method of accounting for U.S. federal income tax purposes. In general, if the terms of a debt instrument entitle a holder to receive payments other than “qualified stated interest” (generally, stated interest that is unconditionally payable in cash or in property (other than debt instruments of the issuer) at least annually at a single fixed or qualifying floating rate), such holder might be required to recognize additional interest as “original issue discount” over the term of the instrument. The notes will not be issued with original issue discount.

 

Pre-Issuance Accrual of Interest. The notes will start accruing interest before their issue date. To the extent that a portion of the initial purchase price of the notes is allocable to interest that has accrued prior to the issue date, a U.S. Holder may compute the issue price of the notes by subtracting from the issue price the amount of such pre-issuance accrued interest. In such case, the U.S. Holder must treat an equivalent amount of the payment of stated interest on the first interest payment date as a return of principal.

 

Amortizable Bond Premium. A U.S. Holder that purchases a note for an amount greater than the note’s stated principal amount will be considered to have purchased the note with “amortizable bond premium” equal to the excess of the purchase price over the stated principal amount. Such U.S. Holder may elect to amortize such premium as an offset to payments of interest on the note, effectively reducing the amount of interest income in the hands of such U.S. Holder.

 

If a U.S. Holder makes this election, the U.S. Holder must amortize the premium using a “constant yield method” (i.e., a fixed yield-to-maturity) to determine the amount of premium that offsets its interest income each year. This results in the amount of deductible premium steadily growing over the term of the note. Because we may redeem the notes under certain circumstances, an electing U.S. Holder must amortize the premium based on the expected term of the notes assuming that we will exercise or not exercise our right to redeem the notes in a manner that will minimize the yield on the notes. Based on the terms of the notes, we believe that it is significantly more likely than not that the notes will not be redeemed prior to their maturity. Accordingly, an electing U.S. Holder should use the entire scheduled term of the notes as the expected term of the notes for purposes of amortizing the premium. Each time a portion of the premium reduces an electing U.S. Holder’s taxable income, the holder must decrease its tax basis in the note by the amount of such portion of the premium.

 

A U.S. Holder makes this election by claiming a deduction (or interest offset) for the premium on its U.S. federal income tax return for the first taxable year to which the U.S. Holder wishes to make the election to apply,

 

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and by attaching a statement to the return to the effect that the holder is making the election under Treasury regulation section 1.171-4. Once made, the election applies to all taxable debt obligations held by the U.S. Holder during or after the taxable year for which the election is made and may be revoked only with the consent of the IRS.

 

Sale, Retirement or Other Taxable Disposition. In general, a U.S. Holder of a note will recognize gain or loss upon the sale, retirement or other taxable disposition of such note in an amount equal to the difference between:

 

 

 

A U.S. Holder’s adjusted tax basis in a note generally will be equal to the price paid for such note as adjusted under “Amortizable Bond Premium” above. A U.S. Holder’s gain or loss will be capital gain or loss and will be long-term capital gain or loss if the U.S. Holder held the note for more than one year. For the years 2003 through 2008, long-term capital gain recognized by a non-corporate U.S. Holder generally will be subject to tax at a rate not to exceed 15%, whereas short-term capital gain recognized by a non-corporate U.S. Holder generally will be subject to tax at ordinary income tax rates. Capital gain recognized by a corporate U.S. Holder will be subject to tax at the ordinary income tax rates applicable to corporations regardless of the corporation’s holding period. The deductibility of capital losses is subject to certain limitations. A U.S. Holder who sells a note between record dates for payments of interest will be required to include part of the sales proceeds representing accrued but unpaid interest or original issue discount on the note through the date of disposition as ordinary income and to add the amount of the original issue discount to its adjusted tax basis in the note.

 

Non-U.S. Holders

 

A Non-U.S. Holder generally will not be subject to U.S. federal income or withholding tax on payments of interest (including original issue discount, if any) on a note if such payments are not effectively connected with the conduct of a U.S. trade or business, unless such Non-U.S. Holder owns directly, or by attribution, 10% or more of the total combined voting power of all classes of our stock entitled to vote or is a controlled foreign corporation related to us.

 

In addition, a Non-U.S. Holder generally will not be subject to U.S. federal income or withholding tax on any amount which constitutes gain upon retirement or disposition of a note, unless the gain is effectively connected with the conduct of a trade or business in the U.S. by the Non-U.S. Holder or, in the case of a Non-U.S. Holder who is an individual, the Non-U.S. Holder is present in the U.S. for 183 days or more in the taxable year of the sale and certain other conditions are met. Certain other exceptions may be applicable, and a Non-U.S. Holder should consult its tax advisor in this regard.

 

If interest and other payments received by a Non-U.S. Holder with respect to the notes (including proceeds from a sale, retirement or other disposition of the notes) are effectively connected with the conduct by the Non-U.S. Holder of a trade or business within the U.S. (or the Non-U.S. Holder is otherwise subject to U.S. federal income taxation on a net basis with respect to such holder’s ownership of the notes), such Non-U.S. Holder will generally be subject to the rules described above for a U.S. Holder (subject to any modification provided under an applicable income tax treaty). Such Non-U.S. Holder may also be subject to the “branch profits tax” if such holder is a corporation.

 

If the exemptions discussed above do not apply and interest (including original issue discount, if any) or, in the case of an individual Non-U.S. Holder, gain upon retirement or disposition of a note, is not effectively connected with the conduct of a U.S. trade or business, such interest or gain will be subject to a 30% gross withholding tax (unless reduced or eliminated by an applicable treaty). To qualify for the exemption from

 

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taxation (or the elimination or reduction of the applicable withholding tax under a treaty), the last U.S. payor in the chain of payment prior to payment to a Non-U.S. Holder, or the “Withholding Agent,” must have received, before payment, a withholding certificate that:

 

 

 

 

The statement may be made on an IRS Form W-8BEN or a substantially similar form, and the Non-U.S. Holder must inform the Withholding Agent of any change in the information on the statement within 30 days of such change.

 

The value of a note will not be includable in the estate of an individual Non-U.S. Holder unless the individual owns directly, or by attribution, 10% or more of the total combined voting power of all classes of our stock entitled to vote or, at the time of such individual’s death, payments in respect of the note would have been effectively connected with the conduct by such individual of a trade or business in the U.S.

 

Backup Withholding and Information Reporting

 

Certain non-corporate U.S. Holders may be subject to backup withholding on payments of principal and interest on, and the proceeds of the sale or other disposition of, the notes, if the U.S. Holder:

 

 

 

 

 

In addition, payments of principal, interest and disposition proceeds to such U.S. Holders will generally be subject to information reporting. U.S. Holders should consult their tax advisors regarding their qualification for exemption from backup withholding and information reporting and the procedure for obtaining such an exemption, if applicable.

 

We must report annually to the IRS and to each Non-U.S. Holder any amount in respect of the notes that is subject to withholding or that is exempt from U.S. withholding tax pursuant to an income tax treaty or the “portfolio interest” exemption. Copies of these information returns may also be made available under the provisions of a specific treaty or agreement to the tax authorities of the country in which the Non-U.S. Holder resides.

 

Backup withholding and other information reporting generally will not apply to payments of interest made to a Non-U.S. Holder of a note who provides a properly completed IRS Form W-8BEN (or a substantially similar form) or otherwise establishes an exemption from backup withholding. Payments of principal or the proceeds of a disposition of the notes by or through a U.S. office of a broker generally will be subject to backup withholding and information reporting unless the Non-U.S. Holder certifies its status as a Non-U.S. Holder under penalties of perjury (and certain other conditions are met) or otherwise establishes an exemption. Payments of principal or the proceeds of a disposition of the notes by or through a foreign office of a U.S. broker or foreign broker with certain relationships to the U.S. generally will be subject to information reporting (but not backup withholding) unless the broker has documentary evidence in its records that the holder is not a U.S. person and certain other conditions are met or the holder otherwise establishes an exemption.

 

Any amounts withheld under the backup withholding rules from a payment to a beneficial owner would be allowed as a refund or a credit against such beneficial owner’s federal income tax liability provided the required information is furnished to the IRS.

 

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PLAN OF DISTRIBUTION

 

Each broker-dealer that receives new notes for its own account pursuant to the exchange offer must acknowledge that it will deliver a prospectus in connection with any resale of the new notes. This prospectus, as it may be amended or supplemented from time to time, may be used by a broker-dealer in connection with resales of new notes received in exchange for outstanding notes where the outstanding notes were acquired as a result of market-making activities or other trading activities. We have agreed that, for a period of 180 days after the consummation of the exchange offer, we will make this prospectus, as amended or supplemented, available to any broker-dealer for use in connection with any such resale. In addition, dealers will have prospectus delivery obligations when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

We will not receive any proceeds from any sale of new notes by broker-dealers. New notes received by broker-dealers for their own account pursuant to the exchange offer may be sold from time to time in one or more transactions in the over-the-counter market, in negotiated transactions, through the writing of options on the new notes or a combination of those methods of resale, at market prices prevailing at the time of resale, at prices related to prevailing market prices or negotiated prices. Any such resale may be made directly to purchasers or to or through brokers or dealers who may receive compensation in the form of commissions or concessions from any such broker-dealer or the purchasers of any of the new notes. Any broker-dealer that resells new notes that were received by it for its own account pursuant to the exchange offer and any broker or dealer that participates in a distribution of the new notes may be deemed to be an “underwriter” within the meaning of the Securities Act and any profit on any such resale of new notes and any commissions or concessions received by any such persons may be deemed to be underwriting compensation under the Securities Act. The Letter of Transmittal states that, by acknowledging that it will deliver and by delivering a prospectus, a broker-dealer will not be deemed to admit that it is an “underwriter” within the meaning of the Securities Act.

 

For a period of 180 days after the expiration date of the exchange offer, we will promptly send additional copies of this prospectus and any amendment or supplement to this prospectus to any broker-dealer that requests such documents in the Letter of Transmittal. We have agreed to pay all expenses incident to the exchange offer (including the expenses of one counsel for the holders of the notes) other than commissions or concessions of any brokers or dealers and will indemnify the holders of the securities (including any broker-dealers) against certain liabilities, including liabilities under the Securities Act.

 

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LEGAL MATTERS

 

Certain legal matters in connection with the issuance of the new notes will be passed upon for us by Dechert LLP, Newport Beach, California. Michael Jeffers, our Secretary, is counsel to that firm and, as of December 17, 2003, owns 51,572 shares of our common stock, dividend equivalent rights for 63,671 shares and phantom stock rights for 22,101 shares and owns a 1% equity interest in the Manager.

 

EXPERTS

 

The financial statements incorporated in this prospectus by reference to the Annual Report on Form 10-K for the year ended December 31, 2002 have been so incorporated in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting.

 

INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE

 

We are “incorporating by reference” information into this prospectus, which means that we are disclosing important information to you by referring you to another document filed separately with the SEC. The information incorporated by reference is deemed to be part of this prospectus, except for any information superseded by information in this prospectus. We have filed the documents listed below with the SEC under the Exchange Act and these documents are incorporated herein by reference:

 

 

 

 

 

 

Any documents we file pursuant to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this prospectus and prior to the termination of the offering of the securities to which this prospectus relates will automatically be deemed to be incorporated by reference in this prospectus and to be part hereof from the date of filing those documents.

 

Any statement contained in this prospectus or in a document incorporated by reference shall be deemed to be modified or superseded for all purposes to the extent that a statement contained in this prospectus or in any other document which is also incorporated by reference modifies or supersedes that statement.

 

You may obtain copies of any documents which are incorporated in this prospectus by reference (other than the exhibits to such documents which are not specifically incorporated by reference herein) without charge upon written or oral request to Investor Relations, at Thornburg Mortgage, Inc., 150 Washington Avenue, Suite 302, Santa Fe, New Mexico 87501, telephone number (505) 989-1900 or by visiting our website at www.thornburgmortgage.com.

 

To obtain timely delivery of any of our documents, you must make your request to us no later than five business days before February 11, 2004. The exchange offer will expire at 5:00 p.m., New York City time, on February 11, 2004, unless we extend the exchange offer, which we may do in our sole discretion. We currently do not intend to extend the expiration date. See “The Exchange Offer” for more detailed information.

 

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