proceed without fear Annaly Mortgage Management, Inc. ANNUAL REPORT 2001 Earnings Per Share $2.23 $1.41 $1.18 2001 2000 1999 Stockholders’ Equity (dollars in thousands) $667,357 $135,642 $103,272 2001 2000 1999 Corporate Profile Annaly Mortgage Management, Inc. owns and manages a portfolio of mortgage- backed securities. Our principal business objective is to generate net income for dis- tribution to our stockholders from the spread between the interest income on our mortgage-backed securities and the costs of borrowing to finance our acquisition of mortgage-backed securities. We have elected to be taxed as a real estate investment trust (or REIT) under the Internal Revenue Code. We commenced operations on February 18, 1997. We are self-advised and self-managed. Annaly Mortgage Managment, Inc. Earnings Per Share increased by 89% 392% Stockholders’ Equity increased by 1 Annaly Mortgage Managment, Inc. To Our Fellow Shareholders: In last year’s letter, I outlined the path of the Company against the background of my family history. The closing sentence in the letter read, "The best is yet to come." In fact, these words were an under- statement. In 2001, the Company grew in dramatic leaps and bounds. Our shareholder base grew from 14.5 million shares to 59.8 million shares. We tapped the capital markets relentlessly in accretive sec- ondary transactions, increased the Company’s market capitalization from $130 million to $957 million at year end, became a member of the Russell 2000 Index and grew earnings per share by 89% from 2000’s results. But this letter is not about the Company’s growth, the financial markets or our plans for next year. It is a letter of reflection and a tale of two brothers. As a result of our successful secondary transactions, we earned the right to celebrate by "ringing the bell" at the open of the New York Stock Exchange on February 22nd. This was a seminal moment for the Company and its management. Because of the success of the deal, the cyclical return of the capital mar- kets to choose value stocks and yield over growth multiples and after four years of exceptional results against the most challenging market environment of the past 100 years, it was a moment of triumph. As I stood on the balcony that morning, I was surrounded by my immediate family, and my second family, the management of your Company. I consider them among my closest and best colleagues and friends, hand picked over the years to form the top performing management team in the sector. I don’t understand what power in the universe has graced me with the privilege of spending my workdays with them. I am grate- ful for the opportunity. In last year’s letter, I discussed how my parents immigrated to this country and brought my older brother over from Dublin, Ireland to start their lives in America. Our family crest and its motto "Prodesse non Nocere" are the trademarks of the Company. Like many Northeastern families, my brothers and sis- 2 ters cover a wide range of professions and their networks of friends and associates reflect the neighbor- hood structure of the region. My older brother, Tom stood on the very same balcony at the NYSE later this year, but for a very different reason. You see, Tom is a Chief of Police for the Port Authority of New York and New Jersey. He stood with his "extended family" to commemorate the lives of those lost in the attacks on the World Trade Center, including men and women he worked with every day of his profes- sional life. These people put their lives on the line for others. There is no greater tribute to their legacy. As I write this letter, I reflect on the losses and gains inherent in our lives, and on the Company’s motto, Prodesse non Nocere. In our third secondary offering of the year, we priced the deal three days after the NYSE resumed operations following the attacks. In the ensuing chaos of the markets, we held the underwriters and investors together and were the first to complete a transaction after the tragedy, val- idating the liquidity of the markets and the strength of our Company. Other deals followed. A Swiss firm, a Dutch firm, a Canadian firm and an American firm whose offices overlook the Pentagon in Arlington, Virginia underwrote the September deal. There is no stronger statement of the phrase, world trade center. It is not represented by buildings, but by the people who inhabit those buildings and the commerce they create. The Company’s Latin motto, Prodesse non Nocere is literally translated as "to do good, not harm". Its figurative translation is the one we have always used in our lives: "Proceed without fear". In honor and memory of those who have gone before us, it is what we intend to do. Michael A.J. Farrell March 17, 2002 3 Annaly has Seamless Execution Powerful Earnings Model High Quality Assets Transparency Annaly’s senior management is experienced in Wall Street trading, management and operations, with a specialization in mortgage securities. This group founded and capitalized Annaly Mortgage Management, Inc., in November 1996. Successfully completing a private placement in February 1997, an IPO in October 1997 and three secondary offerings in 2001, Annaly has consistently generated double-digit returns for its shareholders. Annaly Mortgage Management’s success and future growth prospects are based on the proven ability of its strong and seasoned management team to deliver excellent results in volatile markets. Annaly Mortgage Managment, Inc. “ We identified the market trend early in the cycle, successfully communicated it to investors and then seamlessly executed the strategic pieces to the benefit of all shareholders. This was all accomplished against the background of extremely volatile debt and equity markets. ” Michael Farrell Chairman, President & CEO “ The Power of our earnings model has been proven time and again over the past year. The Strength of our team has been proven over the past five years and will con- tinue to be the greatest asset our shareholders own. ” Wellington Denahan Vice Chairman and Chief Portfolio Manager “ With the three secondary offerings during the year, we were able to effectively deploy the capital and provide exceptional returns to exist- ing and new shareholders. These returns were achieved while main- taining our core business strategy of acquiring only high quality assets. Kathryn Fagan Chief Financial Officer & Treasurer ” “ We are committed to a strategy focused on discipline, attention to detail, and transparency. Investors have recognized that commitment as evidenced in the growth achieved over the last year and the price appreciation in the stock. In the current market environment, I believe, they will come to value it even more. Jennifer Stephens Secretary and Portfolio Manager ” 5 Annaly Mortgage Managment, Inc. Financial Highlights (dollars in thousands, except for per share data) Statement of Operations Data: Days in period Interest income Interest expense Net interest income Gain on sale of mortgage-backed securities General and administrative expenses (G&A expense) Net income Basic net income per average share Diluted net income per average share Dividends declared per share Balance Sheet Data: For the Year Ended December 31, 2001 365 263,058 168,055 95,003 4,586 7,311 92,278 2.23 2.21 1.75 $ $ $ $ $ $ February 18, 1997 (commencement of operations) through December 31, 2000 December 31, 1999 December 31, 1998 December 31, 1997(1) For the Year Ended For the Year Ended For the Year Ended 366 109,750 92,902 16,848 2,025 2,286 16,587 1.18 1.15 1.15 $ $ $ $ $ $ 365 $ 89,812 69,846 $ 19,966 454 2,281 18,139 1.41 1.35 1.38 $ $ $ $ 365 89,986 75,735 14,251 3,344 2,106 15,489 1.22 1.19 1.21 $ $ $ $ $ $ 317 24,713 19,677 5,036 735 852 4,919 0.83 0.80 0.79 $ $ $ $ $ $ Mortgage-backed securities, net $ 7,575,379 $ 1,978,219 $ 1,437,793 $ 1,520,289 $ 1,161,779 Total assets Repurchase agreements Total liabilities Stockholders’ equity Number of common shares outstanding 7,717,314 6,367,710 7,049,957 667,357 2,035,029 1,628,359 1,899,386 135,642 1,491,322 1,338,296 1,388,050 103,272 1,527,352 1,280,510 1,401,481 125,871 1,167,740 918,869 1,032,654 135,086 59,826,975 14,522,978 13,581,316 12,648,424 12,713,900 Other Data: Average total assets Average earning assets Average borrowings Average equity Yield on interest-earning assets Cost of funds on interest-bearing liabilities Interest rate spread Annualized Financial Ratios: Net interest margin (net interest income/average total assets) G&A expense as a percentage of average assets G&A expense as a percentage of average equity Return on average assets Return on average equity (1) Ratios for the 317-day period ended December 31, 1997 have been annualized. $ 5,082,852 $ 1,652,459 $ 1,473,765 $ 1,499,875 $ 476,855 4,682,780 4,388,900 437,376 5.62% 3.83% 1.79% 1.87% 0.14% 1.67% 1.82% 21.10% 1,564,491 1,449,999 117,727 7.02% 6.41% 0.61% 1.02% 0.14% 1.94% 1.00% 14.09% 1,461,254 1,350,230 117,685 6.15% 5.17% 0.98% 1.35% 0.15% 1.94% 1.23% 15.41% 1,461,791 1,360,040 131,265 6.16% 5.57% 0.59% 0.95% 0.14% 1.60% 1.03% 11.80% 448,306 404,140 61,096 6.34% 5.61% 0.73% 1.22% 0.21% 1.61% 1.19% 9.27% 6 Financial Review 8 Management’s Discussion and Analysis of Financial Condition and Result of Operations 17 Statements of Financial Condition 18 19 Statements of Operations Statements of Stockholders’ Equity 20 Statements of Cash Flows 21 Notes to Financial Statements 26 Independent Auditors Report 27 Common Stock and Market Information 28 Corporate Information Annaly Mortgage Managment, Inc. Annaly Mortgage Managment, Inc. Management’s Discussion and Analysis of Financial Condition and Result of Operations Overview We are a real estate investment trust that owns and manages a portfolio of mortgage-backed securities. Our principal business objective is to generate net income for distribution to our stockholders from the spread between the interest income on our mortgage-backed securities and the costs of bor- rowing to finance our acquisition of mortgage-backed securities. We commenced operations on February 18, 1997 upon the consummation of a private placement. We completed our initial public offering on October 14, 1997. The 317-day period ended December 31, 1997 was a short oper- ating period and not a full twelve months. Result of Operations Net Income Summary For the year ended December 31, 2001 our GAAP net income was $92.3 million or $2.23 basic earnings per average share, as compared to $16.6 mil- lion or $1.18 basic earnings per average share for the year ended December 31, 2000. For the year ended December 31, 1999 our GAAP net income was $18.1 million, or $1.41 basic earnings per average share. The increase in 2001 GAAP net income is attributable to our acquisition of additional mortgage-backed securities using proceeds raised in three public offerings in 2001 and the increase in the interest rate spread on our interest-earning assets and our interest-bearing liabilities. We compute our GAAP net income per share by dividing net income by the weighted average number of shares of outstanding common stock during the period, which was 41,439,631 for the year ended December 31, 2001, 14,089,436 for the year ended December 31, 2000, and 12,889,510 for the year ended December 31, 1999. Dividends per share for the year ended December 31, 2001 was $1.75, or an aggregate of $88.4 million. Dividends per share for the year ended December 31, 2000 was $1.15 per share, or $16.3 million in total. Dividends per share for the year ended December 31, 1999 was $1.38 per share, or $18.0 million in total. Our return on average equity was 21.10% for the year ended December 31, 2001, 14.09% for the year ended December 31, 2000, and 15.41% for the year ended December 31, 1999. The increase in return on equity in 2001 is primarily due to the favorable interest rate environment. The table below presents the net income sum- mary for the years ended December 31, 2001, 2000, 1999, 1998, and the period ended December 31, 1997. Net Income Summary (dollars in thousands, except for per share data) Interest Income Interest Expense Net Interest Income Gain on Sale of Mortgage-Backed Securities General and Administrative Expenses Net Income Year ended December 31, 2001 Year Ended December 31, 2000 Year Ended December 31, 1999 Year Ended December 31, 1998 Period Ended December 31, 1997 $ 263,058 168,055 $ 95,003 4,586 7,311 $ 92,278 $ 109,750 92,902 $ 16,802 2,025 2,286 $ 16,587 $ 89,812 69,846 $ 19,966 454 2,281 $ 18,139 $ 89,986 75,735 $ 14,251 3,344 2,106 $ 15,489 $ 24,713 19,677 $ 5,036 735 852 $ 4,919 Average Number of Basic Shares Outstanding Average Number of Diluted Shares Outstanding 41,439,631 41,857,498 14,089,436 14,377,459 12,889,510 13,454,007 12,709,116 13,020,648 5,952,126 6,300,623 Basic Net Income Per Share Diluted Net Income Per Share Average Total Assets Average Equity 2.23 $ $ 2.21 1.18 $ $ 1.15 $ 1.41 $ 1.35 $ 1.22 $ 1.19 0.83 $ $ 0.80 $ 5,082,852 437,376 $ 1,652,459 117,727 $ 1,473,765 117,685 $ 1,499,875 131,265 $ 476,855 61,096 Annualized Return on Average Assets Annualized Return on Average Equity 1.82% 21.10% 1.00% 14.09% 1.23% 15.41% 1.03% 11.80% 1.19% 9.27% Interest Income and Average Earning Asset Yield We had average earning assets of $4.7 billion for the year ended December 31, 2001. We had average earning assets of $1.6 billion for the year ended December 31, 2000. We had average earning assets of $1.5 billion for the year ended December 31, 1999. Our primary source of income for the years ended December 31 2001, 2000, and 1999 was interest income. A portion of our income was generated by gains on the sales of our mortgage- backed securities. Our interest income was $263.1 million for the year ended December 31, 2001, $109.8 million for the year ended December 31, 2000, and $89.8 million for the year ended December 31, 1999. Our yield on average earning assets was 5.62%, 7.02%, and 6.15% for the same respec- tive periods. Our yield on average earning assets decreased by 1.40% and our average earning asset balance increased by $3.1 billion for the year ended December 31, 2001, when compared to the prior year. Due to the substantial increase in the asset base resulting from the inflow of capital dur- ing the year ended December 31, 2001, interest income increased by $153.3 million. Our yield on average earning assets increased by 0.87% and our average earning asset balance increased by $103.2 million for the year 8 Annaly Mortgage Managment, Inc. ended December 31, 2000 as compared to the year ended December 31, 1999. This equates to a $20.0 million increase in interest income. The table below shows our average balance of cash equivalents and mortgage-backed securities, the yields we earned on each type of earning assets, our yield on average earning assets and our interest income for the years ended December 31, 2001, 2000, 1999 and 1998, and the period ended December 31, 1997, and the four quarters in 2001. Average Earning Asset Yield (dollars in thousands) For the Year Ended December 31, 2001 For the Year Ended December 31, 2000 For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 For the Quarter Ended December 31, 2001 For the Quarter Ended September 30, 2001 For the Quarter Ended June 30, 2001 For the Quarter Ended March 31, 2001 Average Cash Equivalents $ 2 $263 $221 $ 2 $ 30 $ 2 $ 2 $ 2 $ 2 Average Mortgage- Backed Securities $4,682,778 $ 1,564,228 $ 1,461,033 $ 1,461,789 $ 448,276 $6,708,928 $5,263,231 $4,256,864 $2,502,088 Average Earning Assets Yield on Average Cash Equivalents $4,682,780 $ 1,564,491 $ 1,461,254 $ 1,461,791 $ 448,306 $6,708,930 $5,263,233 $4,256,866 $2,502,090 3.25% 4.18% 4.10% 4.32% 4.20% 1.56% 2.77% 3.72% 4.93% Yield on Average Mortgage- Backed Securities 5.62% 7.02% 6.15% 6.16% 6.34% 4.77% 5.76% 6.09% 6.78% Yield on Average Earning Assets 5.62% 7.02% 6.15% 6.16% 6.34% 4.77% 5.76% 6.09% 6.78% Interest Income $263,058 $109,750 $ 89,812 $ 89,986 $ 24,713 $ 80,060 $ 75,774 $ 64,790 $ 42,434 Ratios for the period ended December 31, 1997 and the four quarters in 2001 have been annualized. The constant prepayment rate (or CPR) on our mortgage-backed securities for the year ended December 31, 2001 was 26%, for the year ended December 31, 2000 was 11%, and for the year ended December 31, 1999 was 18%. CPR is an assumed rate of prepayment for our mortgage-backed securities, expressed as an annual rate of prepayment relative to the out- standing principal balance of our mortgage-backed securities. CPR does not purport to be either a historical description of the prepayment experience of our mortgage-backed securities or a prediction of the anticipated rate of pre- payment of our mortgage-backed securities. the year ended December 31, 2001 increased $75.2 million. We increased our asset base by raising approximately $474.2 million of additional capital in 2001. As a result, we increased the repurchase agreements we are party to. Consequently, the increased interest expense for the year is the result of our growth. The cost of funds rate increased by 1.24% and the average bor- rowed funds increased by $99.8 million for the year ended December 31, 2000, when compared to the year ended December 31, 1999. As a result of the increased funding cost and the average balance, interest expense increased by $23.1 million in 2000. Principal prepayments had a negative effect on our earning asset yield for the years ended December 31, 2001, 2000, and 1999 because we adjust our rates of premium amortization and discount accretion monthly based upon the effective yield method, which takes into consideration changes in prepayment speeds. Interest Expense and the Cost of Funds Our largest expense is the cost of borrowed funds. We had average bor- rowed funds of $4.4 billion for the year ended December 31, 2001, $1.4 billion for the year ended December 31, 2000, and $1.4 billion for the year ended December 31,1999. Interest expense totaled $168.1 million, $92.9 million, and $69.8 million for the years ended December 31, 2001, 2000, and 1999, respectively. Our average cost of funds was 3.83% for the year ended December 31, 2001, 6.41% for the year ended December 31, 2000, and 5.17% for the year ended December 31, 1999. The cost of funds rate decreased by 2.58% and the average borrowed funds increased by $3.0 billion for the year ended December 31, 2001. Interest expense for With our current asset/liability management strategy, changes in our cost of funds are expected to be closely correlated with changes in short-term LIBOR, although we may choose to extend the maturity of our liabilities at any time. During the year ended December 31, 2001, we entered into three-year repurchase agreements. Our average cost of funds was 0.05% less than average one-month LIBOR for the year ended December 31, 2001, and 0.10% greater than to average six-month LIBOR Our average cost of funds was equal to average one-month LIBOR for the year ended December 31, 2000, and 0.25% less than average six-month LIBOR. Our cost of funds was 0.08% below average one-month LIBOR for the year ended December 31, 1999, and 0.36% less than average six-month LIBOR. During the year ended December 31, 2001, average one-month LIBOR, which was 3.88%, was 0.15% greater than average six-month LIBOR, which was 3.73%. During the year ended December 31, 2000, average one- month LIBOR, which was 6.41%, was 0.25% lower than average six-month LIBOR, which was 6.66%. During the year ended December 31, 1999, aver- age one-month LIBOR, which was 5.25%, was 0.28% lower than average 9 Annaly Mortgage Managment, Inc. six-month LIBOR, which was 5.53%. The table below shows our average borrowed funds and average cost of funds as compared to average one- month and average six-month LIBOR for the years ended December 31, 2001, 2000, 1999, 1998, the period ended December 31, 1997 and the four quarters in 2001. Average Cost of Funds (dollars in thousands) For the Year Ended December 31, 2001 For the Year Ended December 31, 2000 For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 For the Quarter Ended December 31, 2001 For the Quarter Ended September 30, 2001 For the Quarter Ended June 30, 2001 For the Quarter Ended March 31, 2001 Average Borrowed Funds Interest Expense Average Cost of Funds Average One- Month LIBOR Average Six-Month LIBOR Average One- Month LIBOR Relative to Average Six- Month LIBOR Average Cost of Funds Relative to Average One- Month LIBOR Average Cost of Funds Relative to Average Six- Month LIBOR $4,388,900 $168,055 3.83% 3.88% 3.73% 0.15% (0.05%) 0.10% $ 1,449,999 $ 92,902 6.41% 6.41% 6.66% (0.25%) — (0.25%) $ 1,350,230 $ 69,846 5.17% 5.25% 5.53% (0.28%) (0.08%) (0.36%) $ 1,360,040 $ 75,735 5.57% 5.57% 5.54% 0.03% — 0.03% $ 404,140 $ 19,677 5.61% 5.67% 5.87% (0.20%) (0.06%) (0.26%) $6,166,998 $ 40,698 2.64% 2.20% 2.16% 0.04% 0.44% 0.48% $4,997,922 $ 48,620 3.89% 3.55% 3.47% 0.08% 0.34% 0.42% $4,035,022 $ 45,284 4.49% 4.27% 4.12% 0.15% 0.22% 0.37% $2,355,658 $ 33,453 5.68% 5.51% 5.18% 0.33% 0.17% 0.50% Ratios for the period ended December 31, 1997 and the four quarters in 2001 have been annualized. Net Interest Rate Agreement Expense We have not entered into any interest rate agreements to date. As part of our asset/liability management process, we may enter into interest rate agreements such as interest rate caps, floors or swaps. These agreements would be entered into with the intent to reduce interest rate or prepayment risk and would be designed to provide us income and capital appreciation in the event of certain changes in interest rates. However, even after enter- ing into these agreements, we would still be exposed to interest rate and prepayment risks. We review the need for interest rate agreements on a reg- ular basis consistent with our capital investment policy. Net Interest Income Our net interest income, which equals interest income less interest expense totaled $95.0 million for the year ended December 31, 2001, $16.8 million for the year ended December 31, 2000, and $20.0 million for the year ended December 31, 1999. Our net interest income increased by $78.2 million for the year ended December 31, 2001 over the prior year. The increase in our balance sheet which resulted from our raising addition- al capital in 2001, along with the 1.18% increase in the interest rate spread, caused the significant increase in the net interest income for the year. Our net interest income decreased for the year ended December 31, 2000 because of higher funding costs for the year. The substantial increase in interest expense for the year ended December 31, 2000 was only partially offset by the increase in interest income. Our net interest spread, which equals the yield on our average assets for the period less the average cost of funds for the period, was 1.79% for the year ended December 31, 2001, which is a 1.18% increase over the prior year. The net interest spread for the year ended December 31, 2000 was 0.61%, as compared to 0.98% for the year ended December 31, 1999. This 0.37% decrease in spread income is reflected in the $3.2 million decrease in net interest income. Net interest margin, which equals net interest income divided by average interest earn- ing assets, was 1.87% for the year ended December 31, 2001, 1.02% for 10 Annaly Mortgage Managment, Inc. the year ended December 31, 2000, and 1.35% for the year ended December 31, 1999. The principal reason that net interest margin exceed- ed net interest spread is that average interest earning assets exceeded aver- age interest bearing liabilities. A portion of our assets is funded with equity rather than borrowings. We did not have any interest rate agreement expens- es to date. The table below shows our interest income by earning asset type, average earning assets by type, total interest income, interest expense, average repurchase agreements, average cost of funds, and net interest income for the years ended December 31, 2001, 2000, 1999, 1998 and the period ended December 31, 1997, and the four quarters in 2001. GAAP Net Interest Income (dollars in thousands) For the Year Ended Average Mortgage- Backed Securities Held Interest Income on Mortgage- Backed Securities Average Cash Equivalents Total Interest Income Yield on Average Interest Earning Assets Average Balance of Repurchase Agreements Interest Expense Average Cost of Funds Net Interest Income December 31, 2001 $ 4,682,778 $263,058 $ 2 $263,058 5.62% $4,388,900 $168,055 3.83% $95,003 For the Year Ended December 31, 2000 $ 1,564,228 $ 109,739 $263 $ 109,750 7.02% $1,449,999 $ 92,902 6.41% $ 16,848 For the Year Ended December 31, 1999 $ 1,461,033 $ 89,801 $221 $ 89,812 6.15% $1,350,230 $ 69,846 5.17% $ 19,966 For the Year Ended December 31, 1998 $ 1,461,789 $ 89,986 $ 2 $ 89,986 6.16% $1,360,040 $ 75,735 5.57% $ 14,251 For the Period Ended December 31, 1997 $ 448,276 $ 24,682 $ 31 $ 24,713 6.34% $ 404,140 $ 19,677 5.61% $ 5,036 For the Quarter Ended December 31, 2001 For the Quarter Ended September 30, 2001 For the Quarter Ended $6,708,928 $ 80,060 $ 2 $ 80,060 4.77% $6,166,998 $ 40,698 2.64% $39,361 $5,263,231 $ 75,774 $ 2 $ 75,774 5.76% $4,997,922 $ 48,620 3.89% $ 27,154 June 30, 2001 $4,256,864 $ 64,790 $ 2 $ 64,790 6.09% $4,035,022 $ 45,284 4.49% $19,506 For the Quarter Ended March 31, 2001 $2,502,088 $ 42,434 $ 2 $ 42,434 6.78% $2,355,658 $ 33,453 5.68% $ 8,981 Ratios for the period ended December 31, 1997 and the four quarters in 2001 have been annualized. Gains and Losses on Sales of Mortgage-Backed Securities For the year ended December 31, 2001, we sold mortgage-backed securi- ties with an aggregate historical amortized cost of $1.2 billion for an aggre- gate gain of $4.6 million. For the year ended December 31, 2000, we sold mortgage-backed securities with an aggregate historical amortized cost of $487.8 million for an aggregate gain of $2.0 million. For the year ended December 31, 1999, we sold mortgage-backed securities with an aggregate historical amortized cost of $122.1 million for an aggregate gain of $455,000. The gain on sale of assets for the year ended December 31, 2001 increased by $2.6 million over the prior year. Even though the gain for the year 2001 increased over the prior year, as a percentage of total income it declined. Our gain on the sale of assets increased substantially for the year ended December 31, 2000, when compared to the year ended December 31, 1999. For the year ended December 31, 1999, there was a greater emphasis on spread income and not gains. The difference between the sale price and the historical amortized cost of our mortgage-backed securities is a realized gain and increases income accordingly. We do not expect to sell assets on a frequent basis, but may from time to time sell existing assets to move into new assets, which our management believes might have higher risk-adjusted returns, or to manage our balance sheet as part of our asset/lia- bility management strategy. Credit Losses We have not experienced credit losses on our mortgage-backed securities to date. We have limited our exposure to credit losses on our mortgage-backed securities by purchasing only securities issued or guaranteed by FNMA, FHLMC or GNMA, which, although not rated, carry an implied “AAA” rating. Under our capital investment policy, however, up to 25% of our securities could be rated “BBB” or better or if unrated, securities we deem to be of a quality “BBB” or better. General and Administrative Expenses General and administrative expenses (“G&A”) were $7.3 million for the year ended December 31, 2001, $2.3 million for the year ended December 31, 2000, and $2.3 million for the year ended December 31, 1999. G&A expenses as a percentage of average assets was 0.14%, 0.14%, and 0.15% for the years ended December 31, 2001, 2000, and 1999, respectively. G&A expense has increased proportionately with our increased capital base. Increases in salaries were the primary reason for the overall increase in G&A. G&A expenses in total were materially unchanged for the years ended December 31, 2000 and 1999. The table below shows our total G&A expenses as compared to average assets and average equity for the years ended December 31, 2001, 2000, 1999, 1998, the period ended December 31, 1997, and the four quarters in 2001. 11 Annaly Mortgage Managment, Inc. GAAP G&A Expenses and Operating Expense Ratios (dollars in thousands) For the Year Ended December 31, 2001 For the Year Ended December 31, 2000 For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 For the Quarter Ended December 31, 2001 For the Quarter Ended September 30, 2001 For the Quarter Ended June 30, 2001 For the Quarter Ended March 31, 2001 Total G&A Expenses $ 7,311 $2,286 $2,281 $2,106 $ 852 $3,004 $1,993 $1,393 $ 921 Total G&A Expenses/ Average Assets 0.14% 0.14% 0.15% 0.14% 0.21% 0.17% 0.13% 0.12% 0.13% Total G&A Expenses/ Average Equity 1.67% 1.94% 1.94% 1.60% 1.61% 1.78% 1.76% 1.44% 1.90% Ratios for the period ended December 31, 1997 and the four quarters in 2001 have been annualized. Net Income and Return on Average Equity Our net income was $92.3 million for the year ended December 31, 2001, $16.6 million for the year ended December 31, 2000, and $18.1 million for the year ended December 31, 1999. Our return on average equity was 21.1% for the year ended December 31, 2001, 14.1% for the year ended December 31, 2000, and 15.4% for the year ended December 31, 1999. The increase in net income for the year ended December 2001, as com- pared to the year ended December 31, 2000, is a direct result of growth in our balance sheet following our three pubic offerings in 2001, as well as the favorable interest rate environment during the year 2001. primary reason that our earnings decreased, when compared to the year ended December 31, 1999. We were, however, able to take advantage of appreciation in asset value in 2001. The gain on sale of securities increased by $2.6 million for the year ended December 31, 2001, as compared to the prior year. The G&A expenses remained relatively constant during the years ended December 31, 2000 and 1999. The table below shows our net inter- est income, gain on sale of mortgage-backed securities and G&A expenses each as a percentage of average equity, and the return on average equity for the years ended December 31, 2001, 2000, 1999, 1998, and period ended December 31, 1997, and for the four quarters in 2001. The substantial increase in interest expense, resulting from an overall increase in interest rates, for the year ended December 31, 2000 was the Components of Return on Average Equity For the Year Ended December 31, 2001 For the Year Ended December 31, 2000 For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 For the Quarter Ended December 30, 2001 For the Quarter Ended September 30, 2001 For the Quarter Ended June 30, 2001 For the Quarter Ended March 31, 2001 Net Interest Income/Average Equity 21.72% 14.31% 16.97% 10.85% 9.49% 23.34% 23.97% 20.37% 18.54% Gain on Sale of Mortgage-Backed Securities/Average Equity G&A Expenses/Average Equity 1.05% 1.72% 0.38% 2.55% 1.39% 1.57% 1.05% 0.50% 0.56% 1.67% 1.94% 1.94% 1.60% 1.61% 1.78% 1.76% 1.45% 1.90% Return on Average Equity 21.10% 14.09% 15.41% 11.80% 9.27% 23.13% 23.26% 19.42% 17.20% Ratios for the period ended December 31, 1997 and the four quarters in 2001 have been annualized. Financial Condition Mortgage-Backed Securities All of our mortgage-backed securities at December 31, 2001, 2000, and 1999 were adjustable-rate or fixed-rate mortgage-backed securities backed by single-family mortgage loans. All of the mortgage assets underlying these mortgage-backed securities were secured with a first lien position on the underlying single-family properties. All our mortgage-backed securities were FHLMC, FNMA or GNMA mortgage pass-through certificates or CMOs, which carry an implied “AAA” rating. We mark-to-market all of our earning assets at liquidation value. We accrete discount balances as an increase in interest income over the life of discount mortgage-backed securities and we amortize premium balances as a decrease in interest income over the life of premium mortgage-backed securities. At December 31, 2001, 2000, and 1999 we had on our balance sheet a total of $2.1 million, $989,000, and $1.1 million, respectively, of unamortized discount (which is the difference between the remaining prin- cipal value and current historical amortized cost of our mortgage-backed securities acquired at a price below principal value) and a total of $139.4 million, $24.3 million, and $23.6 million, respectively, of unamortized pre- mium (which is the difference between the remaining principal value and the current historical amortized cost of our mortgage-backed securities acquired at a price above principal value). 12 Annaly Mortgage Managment, Inc. We received mortgage principal repayments of $1.7 billion for the year ended December 31, 2001, $168.5 million for the year ended December 31, 2000, and $362.7 million for the year ended December 31, 1999. The increase in prepayments in 2001 from 2000 was primarily because we acquired more mortgage-backed securities following our three public offerings. The decrease in 2000 compared to 1999 was due to higher interest rates during the year. Given our current portfolio composition, if mortgage principal prepayment rates were to increase over the life of our mortgage-backed securities, all other factors being equal, our net interest income would decrease during the life of these mortgage-backed securities as we would be required to amortize our net premium balance into income over a shorter time period. Similarly, if mortgage principal prepayment rates were to decrease over the life of our mortgage-backed securities, all other factors being equal, our net interest income would increase during the life of these mortgage-backed securities as we would amortize our net premium balance over a longer time period. The table below summarizes our mortgage-backed securities at December 31, 2001, 2000, 1999, 1998 and 1997, September 30, 2001, June 30, 2001, and March 31, 2001. Mortgage-Backed Securities (dollars in thousands) Principal Value At December 31, 2001 At December 31, 2000 At December 31, 1999 At December 31, 1998 At December 31, 1997 At September 30, 2001 At June 30, 2001 At March 31, 2001 $7,399,941 $ 1,967,967 $ 1,452,917 $ 1,502,414 $ 1,138,365 $6,275,501 $5,498,235 $3,455,436 Net Premium $137,269 $ 23,296 $ 22,444 $ 24,278 $ 21,390 $ 96,674 $ 69,193 $ 42,023 Amortized Cost $ 7,537,210 $ 1,991,263 $ 1,475,361 $ 1,526,692 $ 1,159,755 $6,372,175 $5,567,428 $3,497,459 Amortized Cost/Principal Value 101.86% 101.18% 101.54% 101.62% 101.88% 101.54% 101.26% 101.22% Estimated Fair Value $ 7,575,379 $ 1,978,219 $ 1,437,793 $ 1,520,289 $ 1,161,779 $6,428,853 $5,572,288 $3,500,610 Estimated Fair Value/ Principal Value 102.37% 100.52% 98.96% 101.19% 102.06% 102.44% 101.34% 101.31% Weighted Average Yield 4.41% 7.09% 6.77% 6.43% 6.57% 5.17% 5.75% 6.43% The tables below set forth certain characteristics of our mortgage-backed securities. The index level for adjustable-rate mortgage-backed securities is the weighted average rate of the various short-term interest rate indices, which determine the coupon rate. Adjustable-Rate Mortgage-Backed Security Characteristics (dollars in thousands) At December 31, 2001 At December 31, 2000 At December 31, 1999 At December 31, 1998 At December 31, 1997 At September 30, 2001 At June 30, 2001 At March 31, 2001 Principal Value $5,793,250 $ 1,454,356 $ 951,839 $ 1,030,654 $ 994,653 $ 4,789,570 $ 3,997,580 $2,495,296 Weighted Average Coupon Rate 5.90% 7.61% 7.33% 6.84% 7.13% 6.24% 6.47% 7.01% Weighted Average Index Level Weighted Average Net Margin 3.95% 5.76% 5.84% 5.18% 5.52% 4.31% 4.60% 5.14% 1.95% 1.85% 1.49% 1.66% 1.61% 1.93% 1.87% 1.87% Weighted Average Term to Next Adjustment 24 months 15 months 11 months 12 months 22 months 27 months 26 months 26 months Fixed-Rate Mortgage-Backed Security Characteristics (dollars in thousands) At December 31, 2001 At December 31, 2000 At December 31, 1999 At December 31, 1998 At December 31, 1997 At September 30, 2001 At June 30, 2001 At March 31, 2001 Principal Value $1,606,691 $ 513,611 $ 501,078 $ 471,760 $ 143,712 $1,485,931 $1,500,655 $ 960,140 Weighted Average Coupon Rate 6.92% 6.62% 6.58% 6.55% 7.50% 6.88% 6.83% 6.79% 13 Weighted Average Lifetime Cap Weighted Average Asset Yield Principal Value at Period End as % of Total Mortgage-Backed Securities 11.49% 11.47% 10.30% 10.63% 10.78% 11.46% 11.37% 11.57% Weighted Average Asset Yield 6.33% 6.68% 7.01% 6.47% 7.08% 6.48% 6.71% 6.69% 3.87% 7.24% 7.64% 6.42% 6.50% 4.76% 5.38% 6.35% 78.29% 73.90% 65.51% 68.60% 87.38% 76.32% 72.71% 72.21% Principal Value as % of Total Mortgage-Backed Securities 21.71% 26.10% 34.49% 31.40% 12.62% 23.68% 27.29% 27.79% Annaly Mortgage Managment, Inc. At December 31, 2001 we held mortgage-backed securities with coupons linked to the one-year, three-year, and five-year Treasury indices, one-month and six-month LIBOR, six-month Auction Average, twelve-month moving average and the six-month CD rate. At December 31, 2000 and 1999 we held mort- gage-backed securities with coupons linked to the one-year, three-year, and five-year Treasury indices, one-month LIBOR and the six-month CD rate. Adjustable-Rate Mortgage-Backed Securities by Index December 31, 2001 Weighted Average Adjustment Frequency Weighted Average Term to Next Adjustment Weighted Average Annual Period Cap Weighted Average Lifetime Cap at December 31, 2001 Mortgage Principal Value as Percentage of Mortgage- Backed Securities at December 31, 2001 One-Month LIBOR Six-Month LIBOR Six-Month Auction Average 12-Month Moving Average Six-Month CD Rate 1-Year Treasury Index 3-Year Treasury Index 5-Year Treasury Index 1mo. 60 mo. 6 mo. 12 mo. 6 mo. 6 mo. 36 mo. 60 mo. 1mo. 55 mo. 2 mo. 11 mo. 2 mo. 33 mo. 16 mo. 33 mo. None 2.00% 0.50% None 1.00% 1.98% 2.00% 1.96% 9.09% 11.50% 12.53% 10.63% 11.40% 12.22% 13.08% 12.92% 18.32% 0.13% 0.12% 1.06% 0.22% 56.20% 1.35% 0.89% Adjustable-Rate Mortgage-Backed Securities by Index December 31, 2000 Weighted Average Adjustment Frequency Weighted Average Term to Next Adjustment Weighted Average Annual Period Cap Weighted Average Lifetime Cap at December 31, 2000 Mortgage Principal Value as Percentage of Mortgage-Backed Securities at One-Month LIBOR 1 mo. 1 mo. None 9.11% Six-Month CD Rate 6 mo. 2 mo. 1.00% 11.37% 1-Year Treasury Index 12 mo. 23 mo. 1.98% 12.61% 3-Year Treasury Index 36 mo. 20 mo. 2.00% 13.24% 5-Year Treasury Index 60 mo. 40 mo. 1.76% 12.42% December 31, 2000 24.08% 1.21% 44.52% 2.97% 1.12% Adjustable-Rate Mortgage-Backed Securities by Index December 31, 1999 Weighted Average Adjustment Frequency Weighted Average Term to Next Adjustment Weighted Average Annual Period Cap Weighted Average Lifetime Cap at December 31, 1999 Mortgage Principal Value as Percentage of Mortgage-Backed Securities at One-Month LIBOR 1 mo. 1 mo. None 9.20% Six-Month CD Rate 6 mo. 2 mo. 1.00% 11.36% 1-Year Treasury Index 12 mo. 25 mo. 1.93% 11.19% 3-Year Treasury Index 36 mo. 16 mo. 1.57% 13.23% 5-Year Treasury Index 60 mo. 36 mo. 1.35% 11.68% December 31, 1999 34.89% 2.12% 22.62% 5.22% 0.66% Interest Rate Agreements Interest rate agreements are assets that are carried on a balance sheet at estimated liquidation value. We have not entered into any interest rate agreements since our inception. Borrowings To date, our debt has consisted entirely of borrowings collateralized by a pledge of our mortgage-backed securities. These borrowings appear on our balance sheet as repurchase agreements. At December 31, 2001, we had established uncommitted borrowing facilities in this market with 22 lenders in amounts, which we believe, are in excess of our needs. We believe that we have used approximately 52% of our uncommitted borrowing line. All of our mortgage-backed securities are currently accepted as collateral for these borrowings. However, we limit our borrowings, and thus our potential asset growth, in order to maintain unused borrowing capacity and thus increase the liquidity and strength of our balance sheet. At December 31, 2001, we had collateral in excess of the required haircut on our repurchase agree- ments in the amount of $452.3 million. For the year ended December 31, 2001, the term to maturity of our bor- rowings ranged from one day to three years, with a weighted average origi- nal term to maturity of 119 days at December 31, 2001. For the years ended December 31, 2000 and 1999, the term to maturity of our borrow- ings ranged from one day to one year, with a weighted average original term to maturity of 56 days at December 31, 2000, and 50 days at December 31, 1999. At December 31, 2001, the weighted average cost of funds for all of our borrowings was 2.18% and the weighted average term to next rate adjustment was 85 days. At December 31, 2000, the weighted average cost of funds for all of our borrowings was 6.55% and the weighted average term to next rate adjustment was 29 days. At December 31, 1999, the weighted average cost of funds for all of our borrowings was 5.26% and the weight- ed average term to next rate adjustment was 20 days. At December 31, 2001, the weighted average original term increased because of the use of three year repurchase agreements. 14 Annaly Mortgage Managment, Inc. Liquidity Liquidity, which is our ability to turn non-cash assets into cash, allows us to purchase additional mortgage-backed securities and to pledge additional assets to secure existing borrowings should the value of our pledged assets decline. Potential immediate sources of liquidity for us include cash balances and unused borrowing capacity. Unused borrowing capacity will vary over time as the market value of our mortgage-backed securities varies. Our bal- ance sheet also generates liquidity on an on-going basis through mortgage principal repayments and net earnings held prior to payment as dividends. Should our needs ever exceed these on-going sources of liquidity plus the immediate sources of liquidity discussed above, we believe that our mort- gage-backed securities could in most circumstances be sold to raise cash. The maintenance of liquidity is one of the goals of our capital investment policy. Under this policy, we limit asset growth in order to preserve unused borrowing capacity for liquidity management purposes. Stockholders’ Equity We use “available-for-sale” treatment for our mortgage-backed securities; we carry these assets on our balance sheet at estimated market value rather than historical amortized cost. Based upon this “available-for-sale” treatment, our equity base at December 31, 2001 was $667.4 million, or $11.15 per share. If we had used historical amortized cost accounting, our equity base at December 31, 2001 would have been $629.2 million, or $10.52 per share. Our equity base at December 31, 2000 was $135.6 million, or $9.34 per share. If we had used historical amortized cost accounting, our equity base at December 31, 2000 would have been $148.6 million, or $10.24 per share. Our equity base at December 31, 1999 was $103.3 million, or $7.60 per share. If we had used historical amortized cost accounting, our equity base at December 31, 1999 would have been $140.8 million, or $10.37 per share. We completed three public offerings during the year ended December 31, 2001 in which we issued a total of 45,060,100 shares of common stock, and received aggregate net proceeds of $474.2 million. Subsequently, we completed a secondary offering of 23,000,000 shares of common stock in January 2002. Our aggregate net proceeds for this offer- ing was $347.4 million. With our “available-for-sale” accounting treatment, unrealized fluctuations in market values of assets do not impact our GAAP or taxable income but rather are reflected on our balance sheet by changing the carrying value of the asset and stockholders’ equity under “Accumulated Other Comprehensive Income (Loss).” By accounting for our assets in this manner, we hope to provide useful information to stockholders and creditors and to preserve flexibility to sell assets in the future without having to change accounting methods. As a result of this mark-to-market accounting treatment, our book value and book value per share are likely to fluctuate far more than if we used histori- cal amortized cost accounting. As a result, comparisons with companies that use historical cost accounting for some or all of their balance sheet may not be meaningful. The table below shows unrealized gains and losses on the mortgage-backed securities in our portfolio. Unrealized Gains and Losses (dollars in thousands) Unrealized Gain Unrealized Loss Net Unrealized Gain (Loss) Net Unrealized Gain (Loss) as % of Mortgage- Backed Securities Principal Value Net Unrealized Gain (Loss) as % of Mortgage- Backed Securities Amortized Cost 2001 $ 53,935 (15,766) $ 38,169 0.52% 0.51% 2000 $ 3,020 (16,064) $(13,044) At December 31, 1999 $ 1,531 (39,100) $ (37,569) 1998 $ 3,302 (9,706) $(6,404) (0.66%) (2.59%) (0.43%) (0.66%) (2.54%) (0.42%) 1997 $ 3,253 (1,229) $ 2,024 0.18% 0.17% Unrealized changes in the estimated net market value of mortgage-backed securities have one direct effect on our potential earnings and dividends: positive mark-to-market changes increase our equity base and allow us to increase our borrowing capacity while negative changes tend to limit bor- rowing capacity under our capital investment policy. A very large negative change in the net market value of our mortgage-backed securities might impair our liquidity position, requiring us to sell assets with the likely result of realized losses upon sale. “Unrealized Gains on Available-for-Sale Securities” was $38.2 million, or 0.51% or the amortized cost of our mort- gage-backed securities as of December 31, 2001. “ Unrealized Losses on Available-for-Sale Securities” was $13.0 million, or 0.66% of the amortized cost of our mortgage-backed securities at December 31, 2000. “Unrealized Losses on Available-for-Sale Securities” was $37.6 million or 2.54% of the amortized cost of our mortgage-backed securities at December 31, 1999. The table below shows our equity capital base as reported and on a his- torical amortized cost basis at December 31, 2001, 2000, 1999, 1998, and 1997, and September 30, 2001, June 30, 2001 and March 31, 2001. Issuances of common stock, the level of GAAP earnings as compared to dividends declared, and other factors influence our historical cost equity capital base. The GAAP reported equity capital base is influenced by these factors plus changes in the “Net Unrealized Losses on Assets Available for Sale” account. 15 Annaly Mortgage Managment, Inc. Stockholders’ Equity (dollars in thousands, except per share data) At December 31, 2001 At December 31, 2000 At December 31, 1999 At December 31, 1998 At December 31, 1997 At September 30, 2001 At June 30, 2001 At March 31, 2001 Historical Amortized Cost Equity Base $629,188 $148,686 $140,841 $132,275 $133,062 $625,368 $445,091 $248,732 Net Unrealized Gains on Assets Available for Sale $ 38,169 $(13,044) $ (37,569) $ (6,404) 2,024 $ $ 56,677 $ 4,860 3,151 $ GAAP Reported Equity Base (Book Value) $ 667,357 $ 135,642 $ 103,272 $ 125,871 $ 135,086 $682,045 $449,951 $251,883 Historical Amortized Cost Equity Per Share $10.52 $ 10.24 $ 10.37 $ 10.46 $ 10.47 $10.47 $ 9.96 $ 9.67 GAAP Reported Equity (Book Value) Per Share $11.15 $ 9.34 $ 7.60 $ 9.95 $10.62 $11.41 $10.07 $ 9.80 Leverage Our debt-to-GAAP reported equity ratio at December 31, 2001, 2000, and 1999 was 9.5:1, 12.0:1, and 12.9:1, respectively. We generally expect to maintain a ratio of debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this range from time to time based upon various factors, including management’s opinion of the level of risk of our assets and liabil- ities, our liquidity position, our level of unused borrowing capacity and over- collateralization levels required by lenders when we pledge assets to secure borrowings. Inflation Virtually all of our assets and liabilities are financial in nature. As a result, interest rates and other factors drive our performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our dividends based upon our net income as cal- culated for tax purposes; in each case, our activities and balance sheet are measured with reference to historical cost or fair market value without con- sidering inflation. Our target debt-to-GAAP reported equity ratio is determined under our cap- ital investment policy. Should our actual debt-to-equity ratio increase above the target level due to asset acquisition or market value fluctuations in assets, we will cease to acquire new assets. Our management will, at that time, present a plan to our Board of Directors to bring us back to our target debt- to-equity ratio; in many circumstances, this would be accomplished in time by the monthly reduction of the balance of our mortgage-backed securities through principal repayments. Asset/Liability Management and Effect of Changes in Interest Rates We continually review our asset/liability management strategy with respect to interest rate risk, mortgage prepayment risk, credit risk and the related issues of capital adequacy and liquidity. We seek attractive risk-adjusted stockholder returns while maintaining a strong balance sheet. We seek to manage the extent to which our net income changes as a func- tion of changes in interest rates by matching adjustable-rate assets with vari- able-rate borrowings. In addition, although we have not done so to date, we may seek to mitigate the potential impact on net income of periodic and life- time coupon adjustment restrictions in our portfolio of mortgage-backed securities by entering into interest rate agreements such as interest rate caps and interest rate swaps. Changes in interest rates may affect the rate of mortgage principal prepay- ments and, as a result, prepayments on mortgage-backed securities. We will seek to mitigate the effect of changes in the mortgage principal repayment rate by balancing assets we purchase at a premium with assets we purchase at a discount. To date, the aggregate premium exceeds the aggregate discount on our mortgage-backed securities. As a result, prepayments, which result in the expensing of unamortized premium, will reduce our net income compared to what net income would be absent such prepayments. Other Matters We calculate that our qualified REIT assets, as defined in the Internal Revenue Code, are 98.2% of our total assets at December 31, 2001, 99.9% of our total assets at December 31, 2000 and 1999, as compared to the Internal Revenue Code requirement that at least 75% of our total assets be qualified REIT assets. We also calculate that 100% of our revenue qualifies for the 75% source of income test, and 100% of its revenue qualifies for the 95% source of income test, under the REIT rules for the years ended December 31, 2001, 2000, and 1999. We also met all REIT requirements regarding the ownership of our common stock and the distribution of our net income. Therefore, as of December 31, 2001, 2000, and 1999 we believe that we qualified as a REIT under the Internal Revenue Code. We at all times intend to conduct our business so as not to become regu- lated as an investment company under the Investment Company Act. If we were to become regulated as an investment company, then our use of lever- age would be substantially reduced. The Investment Company Act exempts entities that are “primarily engaged in the business of purchasing or other- wise acquiring mortgages and other liens on and interests in real estate” (qualifying interests). Under current interpretation of the staff of the SEC, in order to qualify for this exemption, we must maintain at least 55% of our assets directly in qualifying interests. In addition, unless certain mortgage securities represent all the certificates issued with respect to an underlying pool of mortgages, the mortgage-backed securities may be treated as secu- rities separate from the underlying mortgage loans and, thus, may not be considered qualifying interests for purposes of the 55% requirement. We calculate that as of December 31, 2001, 2000, and 1999 we were in com- pliance with this requirement. 16 Annaly Mortgage Managment, Inc. Statements of Financial Condition December 31, Assets Cash and Cash Equivalents Mortgage-Backed Securities—At fair value Receivable for Mortgage-Backed Securities Sold Accrued Interest Receivable Other Assets Total Assets Liabilities and Stockholders’ Equity Liabilities: Repurchase agreements Payable for Mortgage-Backed Securities purchased Accrued interest payable Dividends payable Other liabilities Accounts payable Total liabilities Stockholders’ Equity: Common stock: par value $.01 per share; 100,000,000 authorized, 59,826,975 and 14,522,978 shares issued and outstanding, respectively Additional paid-in capital Accumulated other comprehensive income (loss) Retained earnings Total stockholders’ equity 2001 2000 $ 429,247 7,575,379,313 94,502,807 46,803,644 198,888 $ 113,061 1,978,219,376 44,933,631 11,502,482 260,238 $ 7,717,313,899 $ 2,035,028,788 $6,367,710,186 627,063,523 16,043,004 35,896,185 2,009,533 1,234,463 7,049,956,894 598,270 623,985,662 38,169,285 4,603,788 667,357,005 $1,628,359,000 258,798,138 8,314,414 3,630,745 284,105 1,899,386,402 145,230 147,844,861 (13,044,259) 696,554 135,642,386 Total Liabilities and Stockholders’ Equity $ 7,717,313,899 $ 2,035,028,788 See notes to financial statements. 17 Annaly Mortgage Managment, Inc. Statements of Operations Years Ended December 31, Interest Income: 2001 2000 1999 Mortgage-Backed Securities and cash equivalents $ 263,057,732 $109,750,406 $ 89,811,994 Interest Expense: Repurchase agreements 168,055,304 92,901,697 69,846,206 Net Interest Income 95,002,428 16,848,709 19,965,788 Gain on sale of Mortgage-Backed Securities 4,586,465 2,025,205 454,782 General and Administrative Expenses 7,311,208 2,286,626 2,281,290 Net Income 92,277,685 16,587,288 18,139,280 Other Comprehensive Income (Loss): Unrealized gain (loss) on available-for-sale securities Less reclassification adjustment for gains included in net income Other comprehensive income (loss) 55,800,009 (4,586,465) 51,213,544 26,549,456 (2,025,205) 24,524,251 (30,709,453) (454,782) (31,164,235) Total Comprehensive Income (Loss) $143,491,229 $ 41,111,539 $(13,024,955) Net Income Per Share: Basic Diluted Average Number of Shares Outstanding: Basic Diluted See notes to financial statements. $ $ 2.23 2.21 $ $ 1.18 1.15 $ $ 1.41 1.35 41,439,631 41,857,498 14,089,436 14,377,459 12,889,510 13,454,007 18 Annaly Mortgage Managment, Inc. Statements of Stockholders’ Equity Balance, December 31, 1998 $ 126,484 $ 131,868,108 $ 280,992 $ (6,404,275) $ 125,871,309 Common Stock Par Value Additional Paid-in Capital Comprehensive Income Retained Earnings Accumulated Other Comprehensive Income (Loss) Total — $ 18,139,280 18,139,280 — Net income Other comprehensive income: Unrealized net losses on securities, net of reclassification adjustment Comprehensive loss Exercise of stock options Proceeds from direct purchase Dividends declared for the year ended 572 8,757 232,704 8,161,845 December 31, 1999, $1.38 per share — — Balance, December 31, 1999 135,813 140,262,657 Net income Other comprehensive income: Unrealized net gains on securities, net of reclassification adjustment Comprehensive income Exercise of stock options Proceeds from direct purchase Dividends declared for the year ended — — — — — — 475 8,942 198,287 7,383,917 December 31, 2000, $1.15 per share — — Balance, December 31, 2000 145,230 147,844,861 — — (31,164,235) $(13,024,955) (31,164,235) — — — — (17,977,754) — — — — (13,024,955) 233,276 8,170,602 (17,977,754) 442,518 (37,568,510) 103,272,478 $16,587,288 16,587,288 — — 24,524,251 $ 41,111,539 — — — — — — — — (16,333,252) 24,524,251 — — — — 41,111,539 198,762 7,392,859 (16,333,252) 696,554 (13,044,259) 135,642,386 — $ 92,277,685 92,277,685 — — — — — — — — — — — 2,747 2,971,919 (416) 108 (587,652) 142,348 — — 51,213,544 $ 143,491,229 51,213,544 — — — — — — (88,370,451) — — — — — — 143,491,229 2,974,666 (588,068) 142,456 474,064,787 (88,370,451) $ 4,603,788 $ 38,169,285 $ 667,357,005 — — — — — — — — — — Net income Other comprehensive income: Unrealized net gains on securities, net of reclassification adjustment Comprehensive income Exercise of stock options Shares exchanged upon exercise of stock options Proceeds from direct purchase Proceeds from secondary offerings 450,601 473,614,186 Dividends declared for the year ended December 31, 2001, $1.75 per share — — Balance, December 31, 2001 $ 598,270 $623,985,662 See notes to financial statements. 19 Annaly Mortgage Managment, Inc. Statements of Cash Flows Years Ended December 31, 2001 2000 1999 Cash Flows from Operating Activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: $ 92,277,685 $ 16,587,288 $ 18,139,280 Amortization of mortgage premiums and discounts, net 36,865,112 2,646,753 6,103,239 Market value adjustment on long term repurchase agreement Gain on sale of Mortgage-Backed Securities Stock option expense Increase in accrued interest receivable (Increase) decrease in other assets Increase in accrued interest payable Increase in other liabilities and accounts payable Net cash provided by operating activities Cash Flows from Investing Activities: Purchase of Mortgage-Backed Securities Proceeds from sale of Mortgage-Backed Securities Principal payments on Mortgage-Backed Securities Net cash used in investing activities Cash Flows from Financing Activities: Proceeds from repurchase agreements Principal payments on repurchase agreements Proceeds from exercise of stock options Proceeds from direct equity offering Proceeds from secondary offerings Dividends paid Net cash provided by financing activities Net Increase in Cash and Cash Equvalents Cash and Cash Equvalents, Beginning of Year 985,719 (4,586,465) 789,889 (35,301,162) 61,350 7,728,590 950,358 99,771,076 (8,194,215,283) 1,248,811,946 1,685,874,506 (5,259,528,831) 49,773,649,527 (45,033,274,527) 1,596,709 142,456 474,064,787 (56,105,011) 5,160,073,941 316,186 113,061 Cash and Cash Equvalents, End of Year $ 429,247 Supplemental Disclosure of Cash Flow Information: Interest paid $ 160,326,714 Noncash Financing Activities: Net change in unrealized loss on available-for-sale securities Dividends declared, not yet paid See notes to financial statements. $ $ 51,213,544 35,896,185 (2,025,205) (454,782) (4,644,799) (62,342) 1,631,727 120,005 14,253,427 (952,737,643) 489,809,698 168,516,759 (294,411,186) (98,310) 36,988 1,630,061 24,864 25,381,340 (559,695,956) 122,552,293 362,657,549 (74,486,114) 14,196,953,221 (13,906,889,971) 11,202,660,000 (11,144,874,250) 198,762 7,392,859 — (17,455,969) 280,198,902 41,143 71,918 113,061 91,269,970 24,524,251 3,630,745 $ $ $ $ 233,276 8,170,602 — (17,081,956) 49,107,672 2,898 69,020 71,918 68,216,145 (31,164,235) 4,753,461 $ $ $ $ 20 Annaly Mortgage Managment, Inc. Notes to Financial Statements 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Annaly Mortgage Management, Inc. (the “Company”) was incorporated in Maryland on November 25, 1996. The Company commenced its operations of purchasing and managing an investment portfolio of Mortgage-Backed Securities on February 18, 1997, upon receipt of the net proceeds from the private placement of equity capital. An initial public offering was completed on October 14, 1997. A summary of the Company’s significant accounting policies follows: Cash and Cash Equivalents—Cash and cash equivalents includes cash on hand and money market funds. The carrying amounts of cash equivalents approximates their value. Mortgage-Backed Securities—The Company invests primarily in mort- gage pass-through certificates, collateralized mortgage obligations and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans (collectively, “Mortgage-Backed Securities”). Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires the Company to classify its investments as either trading investments, available-for-sale investments or held-to-maturity investments. Although the Company generally intends to hold most of its Mortgage-Backed Securities until maturity, it may, from time to time, sell any of its Mortgage-Backed Securities as part of its overall man- agement of its balance sheet. Accordingly, this flexibility requires the Company to classify all of its Mortgage-Backed Securities as available-for- sale. All assets classified as available-for-sale are reported at fair value, based on market prices provided by certain dealers who make markets in these financial instruments, with unrealized gains and losses excluded from earn- ings and reported as a separate component of stockholders’ equity. Unrealized losses on Mortgage-Backed Securities that are considered other than temporary, as measured by the amount of decline in fair value attrib- utable to factors other than temporary, are recognized in income and the cost basis of the Mortgage-Backed Securities is adjusted. There were no such adjustments for the years ended December 31, 2001, 2000, and 1999. Interest income is accrued based on the outstanding principal amount of the Mortgage-Backed Securities and their contractual terms. Premiums and discounts associated with the purchase of the Mortgage-Backed Securities are amortized into interest income over the lives of the securities using the interest method. Mortgage-Backed Securities transactions are recorded on the trade date. Purchases of newly issued securities are recorded when all significant uncer- tainties regarding the characteristics of the securities are removed, generally shortly before settlement date. Realized gains and losses on Mortgage-Backed Securities transactions are determined on the specific identification basis. Credit Risk—At December 31, 2001 and 2000, the Company has limited its exposure to credit losses on its portfolio of Mortgage-Backed Securities by only purchasing securities issued by Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”), or Government National Mortgage Association (“GNMA”). The payment of prin- cipal and interest on the FHLMC and FNMA Mortgage-Backed Securities are guaranteed by those respective agencies and the payment of principal and interest on the GNMA Mortgage-Backed Securities are backed by the full- faith-and-credit of the U.S. government. At December 31, 2001 and 2000, all of the Company’s Mortgage-Backed Securities have an implied “AAA” rating. Income Taxes—The Company has elected to be taxed as a Real Estate Investment Trust (“REIT”) and intends to comply with the provisions of the Internal Revenue Code of 1986, as amended (the “Code”) with respect thereto. Accordingly, the Company will not be subjected to Federal income tax to the extent of its distributions to shareholders and as long as certain asset, income and stock ownership tests are met. Use of Estimates—The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Recent Accounting Pronouncements—The Company adopted the pro- visions of Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities -Deferral of the Effective Date for FASB Statement No. 133, and No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, and as interpreted by the FASB and the Derivatives Implementation Group through Statement No. 133, Implementation Issues, as of January 1, 2001. As of January 1, 2001, the Company had not entered into any derivative agreements; therefore, there were no transition adjustments. 2. MORTGAGE-BACKED SECURITIES The following table pertains to the Company’s Mortgage-Backed Securities classified as available-for-sale as of December 31, 2001, which are carried at their fair value: Mortgage-Backed Securities, gross Unamortized discount Unamortized premium Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Adjustable Rate Fixed Rate Total Federal Home Loan Mortgage Corporation $4,426,194,568 (1,345,955) 83,775,464 4,508,624,077 32,636,111 (7,985,994) $4,533,274,194 Federal National Mortgage Association $2,894,026,227 (755,106) 54,118,304 2,947,389,425 21,223,896 (7,313,534) $2,961,299,787 Government National Mortgage Association $ 79,719,749 — 1,476,777 81,196,526 75,100 (466,294) Total Mortgage- Backed Securities $7,399,940,544 (2,101,061) 139,370,545 7,537,210,028 53,935,107 (15,765,822) $ 80,805,332 $ 7,575,379,313 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair Value $5,908,236,449 1,628,973,579 $ 7,537,210,028 $ $ 44,469,272 9,465,834 53,935,106 $(10,049,070) (5,716,751) $(15,765,821) $5,942,656,651 1,632,722,662 $ 7,575,379,313 21 Annaly Mortgage Managment, Inc. The following table pertains to the Company’s Mortgage-Backed Securities classified as available-for-sale as of December 31, 2000, which are carried at their fair value: Mortgage-Backed Securities, gross Unamortized discount Unamortized premium Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Adjustable Rate Fixed Rate Total Federal Home Loan Mortgage Corporation $1,029,045,622 (221,944) 11,203,043 1,040,026,721 2,220,525 (5,426,076) $1,036,821,170 Federal National Mortgage Association $ 853,777,836 (767,116) 11,569,619 864,580,339 798,984 (9,503,333) $855,875,990 Government National Mortgage Association $ 85,143,889 — 1,512,687 86,656,576 — (1,134,360) $ 85,522,216 Total Mortgage- Backed Securities $ 1,967,967,347 (989,060) 24,285,349 1,991,263,636 3,019,509 (16,063,769) $1,978,219,376 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair Value $1,475,409,337 515,854,299 $1,991,263,636 $ 12,565 3,006,944 $ 3,019,509 $ (7,819,597) (8,244,172) $(16,063,769) $1,467,602,305 510,617,071 $1,978,219,376 The adjustable rate Mortgage-Backed Securities are limited by periodic caps (generally interest rate adjustments are limited to no more than 1% every six months) and lifetime caps. The weighted average lifetime cap was 11.5% at December 31, 2001 and 2000. During the year ended December 31, 2001, the Company realized $6,770,754 in gains from sales of Mortgage-Backed Securities. Losses totaled $2,184,289 for the year ended December 31, 2001. During the year ended December 31, 2000, the Company realized $2,025,205 in gains from sales of Mortgage-Backed Securities. During the year ended December 31, 1999, the Company realized $563,259 in gains from sales of Mortgage-Backed Securities. Losses totaled $108,477 for the year ended December 31, 1999. 3. REPURCHASE AGREEMENTS The Company had outstanding $6,367,710,186 and $1,628,359,000 of repurchase agreements with a weighted average borrowing rate of 2.18% and 6.55% and a weighted average remaining maturity of 85 days and 29 days as of December 31, 2001 and 2000, respectively. At December 31, 2001 and 2000, Mortgage-Backed Securities actually pledged had an esti- mated fair value of $6,564,249,752 and $1,668,161,860, respectively. At December 31, 2001 and 2000, the repurchase agreements had the following remaining maturities: Within 30 days 30 to 59 days 60 to 89 days 90 to 119 days Over 120 days 4. OTHER LIABILITIES In 2001, the Company entered into a repurchase agreement maturing in July 2004, at which time, the repurchase agreement gives the buyer the right to extend, in whole or in part, in three-month increments up to July 2006. The repurchase agreement has a principal value of $100,000,000. The Company accounts for the extension option as a separate interest rate floor liability carried at fair value. The initial fair value of $1,200,000 allocat- ed to the interest rate floor resulted in a similar discount on the repurchase agreement borrowings that is being amortized over the initial term of 3 years using the effective yield method. At December 31, 2001, the fair value of this interest rate floor was a $2,009,533 and was classified as other liabilities. The aggregate charge of $985,719 is included in interest expense for 2001. 5. COMMON STOCK During the Company’s year ending December 31, 2001, the Company declared dividends to shareholders totaling $88,370,451, or $1.75 per share, of which $52,474,266 was paid during the year and $35,896,185 was paid on January 30, 2002. 2001 $5,380,006,000 206,947,000 66,202,000 65,037,000 649,518,186 $ 6,367,710,186 2000 $1,135,886,000 363,810,000 48,845,000 — 79,818,000 $1,628,359,000 During the year ended December 31, 2001, 274,231 options were exercised at $2,974,666. Total shares exchanged upon exercise of the stock options were 41,620 at a value of $588,068. Also, 10,856 shares were purchased in dividend reinvestment and share purchase plan, totaling $142,456. The Company completed an offering of common stock in the third quarter issu- ing 14,991,600 shares, with aggregate net proceeds of $179.6 million. An offering of common stock during the second quarter of 2001 was complet- ed issuing 18,918,500 shares, with aggregate net proceeds of $195.3 million. Additional offerings for 11,150,000 shares were completed during the first quarter for aggregate net proceeds of $99.3 million. During the Company’s year ending December 31, 2000, the Company declared dividends to shareholders totaling $16,333,252, or $1.15 per share, of which $12,702,507 was paid during the year and $3,630,745 was paid on January 30, 2001. During the year ended December 31, 2000, 47,499 options were exercised at $198,762. Also, 894,163 shares were purchased in direct offerings, total- ing $7,392,859. During the year ended December 31, 1999, 57,204 options were exercised at $233,276. Also, 875,688 shares were purchased in the dividend reinvestment and share purchase plan, totaling $8,170,602. 22 Annaly Mortgage Managment, Inc. 6. EARNINGS PER SHARE (EPS) In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting No. 128, Earnings Per Share (SFAS No. 128), which requires dual presentation of basic EPS and diluted EPS on the face of the income statement for all entities with complex capital structures. SFAS No. 128 also requires a reconciliation of the numerator and denomi- nator of basic EPS and diluted EPS computation. For the year ended December 31, 2001, the reconciliation is as follows: For the Year Ended December 31, 2001 Net income Basic EPS Effect of dilutive securities: Dilutive stock options Diluted EPS Income (Numerator) $92,277,685 92,277,685 — $92,277,685 Shares (Denominator) Per-Share Amount 41,439,631 $2.23 417,867 41,857,498 $2.21 Options to purchase 629,576 shares were outstanding during the year and were dilutive as the exercise price of between $4.00 and $11.25 was less than the average stock price for the year of $12.70. Options to purchase 6,250 shares of stock were outstanding and not considered dilutive. The exercise price of $13.69 was greater than the average stock price for the year of $12.70. For the year ended December 31, 2000, the reconciliation is as follows: For the Year Ended December 31, 2000 Net income Basic EPS Effect of dilutive securities: Dilutive stock options Diluted EPS Income (Numerator) $16,587,288 16,587,288 — $16,587,288 Shares (Denominator) Per-Share Amount 14,089,436 $1.18 288,023 14,377,459 $1.15 Options to purchase 334,881 shares were outstanding during the year and were dilutive as the exercise price of between $4.00 and $8.13 was less than the average stock price for the year of $8.51. Options to purchase 568,926 shares of stock were outstanding and not considered dilutive. The exercise price of between $8.63 and $11.25 was greater than the average stock price for the year of $8.51. For the year ended December 31, 1999, the reconciliation is as follows: For the Year Ended December 31, 1999 Net income Basic EPS Effect of dilutive securities: Dilutive stock options Diluted EPS Income (Numerator) $18,139,280 18,139,280 — $18,139,280 Shares (Denominator) Per-Share Amount 12,889,510 $1.41 564,497 13,454,007 $1.35 Options to purchase 708,380 shares were outstanding during the year and were dilutive as the exercise price (between $4.00 and $8.94) was less than the average stock price for the year for the Company of $9.58. Options to purchase 135,676 shares of stock were outstanding and not considered dilutive. The exercise price (between $10.00 and $11.25) was greater than the average stock price for the year of $9.58. 7. LONG-TERM STOCK INCENTIVE PLAN The Company has adopted a long term stock incentive plan for executive officers, key employees and nonemployee directors (the “Incentive Plan”). The Incentive Plan authorizes the Compensation Committee of the Board of Directors to grant awards, including incentive stock options as defined under Section 422 of the Code (“ISOs”) and options not so qualified (“NQSOs”). The Incentive Plan authorizes the granting of options or other awards for an aggregate of the greater of 500,000 shares or 9.95% of the outstanding shares of the Company’s common stock. The Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. Accordingly, no compensation cost for the Incentive Plan has been determined based on the fair value at the grant date for awards con- sistent with the provisions of SFAS No. 123. For the Company’s pro forma net earnings, the compensation cost will be amortized over the vesting peri- od of the options. The Company’s net earnings per share would have been reduced to the pro forma amounts indicated below: Net earnings—as reported Net earnings—pro forma Earnings per share—as reported Earnings per share—pro forma 2001 $92,277,685 92,012,080 2.23 $ 2.22 $ 2000 $16,587,288 16,468,550 1.18 $ 1.17 $ 1999 $18,139,280 18,010,908 1.41 1.40 $ $ 23 Annaly Mortgage Managment, Inc. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in the year ended December 31, 2001: divi- dend yield of 15.32%; expected volatility of 28%; risk-free interest rate of 4.21%; and the weighted average expected lives of five years. For the year ended December 31, 2000: dividend yield of 12.69%; expected volatility of 28.33%; risk-free interest rate of 5.16%; and the weighted average expect- ed lives of nine years. For the year ended December 31, 1999, dividend yield of 15%; expected volatility of 32%; risk-free interest rate of 5.61%; and the weighted average expected lives of seven years. Information regarding options at December 31, 2001 is as follows: Outstanding, January 1, 2001 Granted (6,250 NQSOs) Exercised Outstanding, December 31, 2001 Weighted average fair value of options granted during the year (per share) Information regarding options at December 31, 2000 is as follows: Outstanding, January 1, 2000 Granted (36,500 ISOs, 86,000 NQSOs) Exercised Expired Outstanding, December 31, 2000 Weighted average fair value of options granted during the year (per share) Information regarding options at December 31, 1999 is as follows: Outstanding, January 1, 1999 Granted (289,068 ISOs, 545,988 NQSOs) Exercised Expired Outstanding, December 31, 1999 Weighted average fair value of options granted during the year (per share) Weighted Average Exercise Price $ 8.28 13.69 7.95 $ 8.48 Weighted Average Exercise Price $8.03 8.00 9.17 4.18 $8.28 Weighted Average Exercise Price $7.42 8.63 4.08 — $8.03 Shares 903,807 6,250 (274,231) 635,826 $ 0.33 Shares 844,056 122,500 (15,250) (47,499) 903,807 $ 0.43 Shares 593,760 307,500 (57,204) — 844,056 $ 0.63 The following table summarizes information about stock options outstanding at December 31, 2001: Exercise Price Outstanding Life (Yrs.) $ 7.94 8.13 8.63 8.94 9.06 10.00 10.75 11.25 13.69 110,362 213,381 264,705 2,500 3,438 27,000 6,250 1,940 6,250 635,826 9 7 8 1 2 1 1 1 5 7.4 At December 31, 2001, 2000, and 1999 297,018, 341,013, and 162,389 options were vested and not exercised, respectively. 24 Annaly Mortgage Managment, Inc. 8. COMPREHENSIVE INCOME The Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income. Statement No. 130 requires the reporting of comprehensive income in addition to net income from operations. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. The Company at December 31, 2001 and 2000 held securities classified as available-for-sale. At December 31, 2001, the net unrealized gains totaled $38,169,285 and at December 31, 2000, the net unrealized losses totaled $13,044,259. 9. LEASE COMMITMENTS The Corporation has a noncancelable lease for office space, which com- menced in April 1998 and expires in December 2007. The Corporation’s aggregate future minimum lease payments are as follows: 2002 2003 2004 2005 2006 2007 Total remaining lease payments 100,515 110,261 113,279 116,388 119,590 122,888 $682,921 10. RELATED PARTY TRANSACTION Included in “Other Assets” on the Balance sheet is an investment in Annaly International Money Management, Inc. On June 24, 1998, the Company acquired 99,960 nonvoting shares, at a cost of $49,980. The officers and directors of Annaly International Money Management Inc. are also officers and directors of the Company. Officers and employees of the Company are actively involved in managing mortgage-backed securities and other fixed income assets for institutional clients through Fixed Income Discount Advisory Company (“FIDAC”). FIDAC is a registered investment advisor, which is 100%-owned by the Chief Executive Officer of Annaly Mortgage Management, Inc. Our management currently allocates rent and other gen- eral and administrative expenses 90% to Annaly and 10% to FIDAC. 11. INTEREST RATE RISK The primary market risk to the Company is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Company’s control. Changes in the general level of interest rates can affect net interest income, which is the difference between the interest income earned on interest-earning assets and the inter- est expense incurred in connection with the interest-bearing liabilities, by affecting the spread between the interest-earning assets and interest-bear- ing liabilities. Changes in the level of interest rates also can affect the value of the mortgage-backed securities and the Company’s ability to realize gains from the sale of these assets. The Company seeks to manage the extent to which net income changes as a function of changes in interest rates by matching adjustable-rate assets with variable-rate borrowings. In addition, although the Company has not done so to date, the Company may seek to mitigate the potential impact on net income of periodic and lifetime coupon adjustment restrictions in the portfolio of mortgage-backed securities by entering into interest rate agree- ments such as interest rate caps and interest rate swaps. Changes in interest rates may also have an effect on the rate of mortgage principal prepayments and, as a result, prepayments on mortgage-backed securities. The Company will seek to mitigate the effect of changes in the mortgage principal repayment rate by balancing assets purchased at a pre- mium with assets purchased at a discount. To date, the aggregate premium exceeds the aggregate discount on the mortgage-backed securities. As a result, prepayments, which result in the expensing of unamortized premium, will reduce net income compared to what net income would be absent such prepayments. 12. SUBSEQUENT EVENT The Company completed a secondary offering of 20,000,000 shares of company common stock on January 24, 2002. The aggregate net proceeds to the Company after deducting expenses are estimated to be $302.1 mil- lion. The underwriters exercised an option to purchase 3,000,000 addition- al shares of common stock to cover over-allotments on January 31, 2002, providing the Company with additional net proceeds of $45.4 million. 13. SUMMARIZED QUARTERLY RESULTS (UNAUDITED) The following is a presentation of the quarterly results of operations for the year ended December 31, 2001. Quarters Ending Interest income from Mortgage- Backed Securities and cash Interest expense on repurchase agreements Net interest income Gain on sale of Mortgage-Backed Securities General and administrative expenses Net income Net income per share: Basic Dilutive Average number of shares outstanding: Basic Dilutive March 31, 2001 June 30, 2001 September 30, 2001 December 31, 2001 $42,434,421 33,453,077 8,981,344 269,478 920,549 $64,789,651 45,283,966 19,505,685 481,936 1,392,778 $75,774,532 48,620,332 27,154,200 1,184,399 1,993,431 $80,059,128 40,697,929 39,361,199 2,650,651 3,004,450 $ 8,330,273 $18,594,843 $26,345,168 $ 39,007,400 $ $ 0.38 0.37 $ $ 0.48 0.48 $ $ 0.58 0.57 $ $ 0.65 0.65 21,851,481 22,535,210 38,473,928 39,054,488 45,503,179 45,959,693 59,776,777 60,155,994 25 Annaly Mortgage Managment, Inc. The following is a presentation of the quarterly results of operations for the year ended December 31, 2000. Quarters Ending Interest income from Mortgage- Backed Securities and cash Interest expense on repurchase agreements Net interest income Gain on sale of Mortgage-Backed Securities General and administrative expenses Net income Net income per share: Basic Dilutive Average number of shares outstanding: Basic Dilutive March 31, 2000 June 30, 2000 September 30, 2000 December 31, 2000 $24,616,782 19,292,954 5,323,828 106,853 582,319 $25,734,520 21,453,016 4,281,504 64,774 507,322 $28,239,125 24,779,096 3,460,029 872,949 526,881 $31,159,979 27,376,631 3,783,348 980,629 670,104 $ 4,848,362 $ 3,838,956 $ 3,806,097 $ 4,093,873 $ $ 0.35 0.35 13,660,539 13,971,112 $ $ 0.27 0.26 14,039,741 14,631,940 $ $ 0.27 0.26 14,238,680 14,529,142 $ $ 0.28 0.28 14,413,578 14,702,189 Independent Auditors’ Report To the Board of Directors and Stockholders of Annaly Mortgage Management, Inc. We have audited the accompanying statements of financial condition of Annaly Mortgage Management, Inc. (the “Company”) as of December 31, 2001 and 2000, and the related statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards gener- ally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstate- ment. An audit includes examining, on a test basis, evidence support- ing the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. New York, New York February 15, 2002 26 Annaly Mortgage Managment, Inc. Common Stock and Market Data The following table sets forth, for the periods indicated, the high, low, and closing sales prices per share of common stock as reported on the New York Stock Exchange composite tape and the cash dividends declared per share of our common stock. Stock Prices First Quarter ended March 31, 2001 Second Quarter ended June 30, 2001 Third Quarter ended September 30, 2001 Fourth Quarter ended December 31, 2001 First Quarter ended March 31, 2000 Second Quarter ended June 30, 2000 Third Quarter ended September 30, 2000 Fourth Quarter ended December 31, 2000 First Quarter ended March 31, 1999 Second Quarter ended June 30, 1999 Third Quarter ended September 30, 1999 Fourth Quarter ended December 31, 1999 First Quarter ended March 31, 2001 Second Quarter ended June 30, 2001 Third Quarter ended September 30, 2001 Fourth Quarter ended December 31, 2001 First Quarter ended March 31, 2000 Second Quarter ended June 30, 2000 Third Quarter ended September 30, 2000 Fourth Quarter ended December 31, 2000 First Quarter ended March 31, 1999 Second Quarter ended June 30, 1999 Third Quarter ended September 30, 1999 Fourth Quarter ended December 31, 1999 High $ 11.50 $ 13.76 $ 14.93 $ 17.01 $ 9.25 $ 9.38 $ 9.50 $ 9.50 $ 10.25 $ 11.38 $ 11.50 $ 9.44 Low $ 8.75 $ 10.50 $ 12.70 $ 13.20 $ 7.19 $ 8.19 $ 8.06 $ 7.88 $ 7.94 $ 9.31 $ 9.19 $ 8.06 Close $ 11.26 $ 13.71 $ 14.45 $ 16.00 $ 8.88 $ 8.88 $ 9.13 $ 9.06 $ 10.25 $ 11.25 $ 9.31 $ 8.75 Cash Dividends Declared Per Share $ 0.30 $ 0.40 $ 0.45 $ 0.60 $ 0.35 $ 0.30 $ 0.25 $ 0.25 $ 0.33 $ 0.35 $ 0.35 $ 0.35 We intend to pay quarterly dividends and to make distributions to our stockholders in amounts that all or substantially all of our taxable income in each year (subject to certain adjustments) is distributed. This will enable us to qualify for the tax benefits accorded to a REIT under the Code. We have not established a minimum dividend payment level and our ability to pay dividends may be adversely affected for the reasons described under the caption "Risk Factors" in the 2001 Form 10-K. All distributions will be made at the discretion of our Board of Directors and will depend on our earnings, our financial condition, maintenance of our REIT status and such other factors as our Board of Directors may deem relevant from time to time. 27 Annaly Mortgage Managment, Inc. Corporate Information Corporate Officers Board of Directors Corporate Headquarters Michael A.J. Farrell Chairman of the Board, President & Chief Executive Officer Michael A.J. Farrell Chairman of the Board, President & Chief Executive Officer Wellington J. Denahan Vice Chairman & Chief Investment Officer Kathryn F. Fagan Chief Financial Officer & Treasurer Jennifer A. Stephens Executive Vice President & Corporate Secretary James P. Fortescue Senior Vice President Kristopher R. Konrad Senior Vice President Rose-Marie Lyght Vice President Wellington J. Denahan Vice Chairman & Chief Investment Officer Kevin P. Brady Founder & Principal KPB Associates Spencer I. Browne Former President & Chief Executive Officer Asset Investors Corporation Jonathan D. Green President & Chief Executive Officer Rockefeller Group Development Corporation John A. Lambiase Former Managing Director Salomon Brothers, Inc. Donnell A. Segalas Phoenix Investment Partners, Ltd. Annaly Mortgage Management, Inc. 12 East 41st Street, Suite 700 New York, New York 10017 (888) 8ANNALY Legal Counsel McKee Nelson LLP 1919 M. Street, NW Suite 800 Washington, D.C. 20036 Auditors Deloitte & Touche L.L.P. Two World Financial Center New York, New York 10281-1434 Stock Transfer Agent Shareholder inquiries concerning dividend payments, lost certificates, change of address: Mellon Investor Services, L.L.C PO Box 3315 South Hackensack, New Jersey 07606-1915 (800) 370-1163 www.mellon-investor.com Stock Exchange Listing The common stock is listed on the New York Stock Exchange (symbol: NLY) Annual Meeting The Annual Meeting of Stockholders will be held Friday, May 17th, 2002 at 10 a.m. at: The Union League Club Library 38 East 37th Street New York, New York Shareholder Communications Copies of the Company’s Annual Report and Financials may be obtained by writing the Corporate Secretary, by calling the investor rela- tions hot line at 888 - 8ANNALY, or by visiting our website at www.annaly.com 28 ) i . m o c n g s e d w r ( i I W R : i n g s e D SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained herein are not, and certain statements contained in our future filings with the Securities and Exchange Commission (the "SEC" or the "Commission"), in our press releases or in our other public or shareholder communications may not be, based on historical facts and are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements which are based on various assumptions, (some of which are beyond our control) may be identified by ref- erence to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "anticipate," "continue," or similar terms or variations on those terms, or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, changes in interest rates, changes in yield curve, changes in prepayment rates, the availability of mortgage-backed securities for purchase, the availability of financing and, if avail- able, the terms of any financing. For a discussion of the risks and uncertainties which could cause actual results to differ from those con- tained in the forward-looking statements, see the information described under the caption "Risk Factors" in the 2001 Form 10-K. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward- looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Annaly Mortgage Management, Inc. 12 East 41st Street, Suite 700 New York, New York 10017 1.888.8ANNALY annaly.com