ANTHRACITE CAPITAL INC - 10-K Annual Report

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

FORM 10-K

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

For the fiscal year ended December 31, 2002

OR

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

For the transition period from: ________ to ________

Commission File No. 001-13937

ANTHRACITE CAPITAL, INC.
(Exact name of Registrant as specified in its charter)

MARYLAND 13-3978906
------------------------------------- ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

40 East 52nd Street
New York, New York 10022
- ---------------------------------------- -----------------------
(Address of principal executive office) (Zip Code)

(212) 409-3333
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(g) of the Act: Not Applicable
Securities registered pursuant to Section 12(b) of the Act:

COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE
(Title of each class) (Name of each exchange on which registered)

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

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

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |X| No |_|

The aggregate market value of the registrant's Common Stock, $.001 par value,
held by non-affiliates of the registrant, computed by reference to the closing
sale price of $13.25 as reported on the New York Stock Exchange on June 28,
2002, was $602,514,269 (for purposes of this calculation affiliates include
only directors and executive officers of the registrant).

The number of shares of the registrant's Common Stock, $.001 par value,
outstanding as of March 21, 2003 was 47,681,985 shares.

Documents Incorporated by Reference: The registrant's Definitive Proxy
Statement for the 2003 Annual Meeting of Stockholders is incorporated by
reference into Part III.

2

ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS

3

Cautionary Statement Regarding Forward-Looking Statements

Certain statements contained herein are not, and certain statements contained
in future filings by Anthracite Capital, Inc. (the "Company") with the
Securities and Exchange Commission (the "SEC") in the Company's press releases
or in the Company's other public or stockholder 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 the Company's control) may be identified by reference to a
future period or periods, or by the use of forward-looking terminology, such
as "believe," "expect," "anticipate," "intend," "estimate," "position,"
"target," "mission," "assume," "achievable," "potential," "strategy," "goal,"
"objective," "plan," "aspiration," "outlook," "outcome," "continue," "remain,"
"maintain," "strive," "trend," and variations of such words and similar
expressions, or future or conditional verbs such as "will," "would," "should,"
"could," "may," 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 and future results could differ materially from historical
performance due to a variety of factors, including, but not limited to: (1)
the introduction, withdrawal, success and timing of business initiatives and
strategies; (2) changes in political, economic or industry conditions, the
interest rate environment or financial and capital markets, which could result
in deterioration in credit performance; (3) the performance and operations of
the Manager; (4) the impact of increased competition; (5) the impact of
capital improvement projects; (6) the impact of future acquisitions; (7) the
unfavorable resolution of legal proceedings; (8) the extent and timing of any
share repurchases; (9) the impact, extent and timing of technological changes
and the adequacy of intellectual property protection; (10) the impact of
legislative and regulatory actions and reforms; (11) terrorist activities,
which may adversely affect the general economy, financial and capital markets,
the real estate industry and the Company; and (12) the ability of the Manager
to attract and retain highly talented professionals. Forward-looking
statements speak only as of the date they are made. The Company does not
undertake, and specifically disclaims 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.

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PART I

ITEM 1. BUSINESS

All dollar figures expressed herein are expressed in thousands, except share
or per share amounts.

General

Anthracite Capital, Inc. (the "Company"), a Maryland corporation, is a real
estate finance company that generates income based on the spread between the
interest income on its mortgage loans and securities investments and the
interest expense from borrowings to finance its investments. The Company's
primary activity is investing in high yielding commercial real estate debt.
The Company focuses on acquiring pools of performing loans in the form of
Commercial Mortgage Backed Securities ("CMBS"), issuing secured debt backed by
CMBS and providing strategic capital for the commercial real estate industry
in the form of mezzanine loan financing. The Company commenced operations on
March 24, 1998.

The Company's stock is traded on the New York Stock Exchange under the symbol
"AHR". The Company's goal is to provide a consistent quarterly dividend
supported by earnings that are sustainable over the long term. The Company
seeks to achieve this consistent performance through pro-active credit risk
management and the application of value-added capital markets strategies to
traditional commercial real estate finance activities.

The Company establishes its dividend by analyzing the long-term sustainability
of earnings given existing market conditions and the current composition of
its portfolio. This includes an analysis of the Company's credit loss
assumptions, general level of interest rates and projected hedging costs.
During the year ended December 31, 2002, the Company's total distributions to
stockholders were $1.40 per share paid quarterly.

The Company is managed by BlackRock Financial Management, Inc. (the
"Manager"), a subsidiary of BlackRock, Inc., a publicly traded (NYSE: BLK)
asset management company with over $273 billion of global assets under
management as of December 31, 2002. The Manager provides an operating platform
that incorporates significant asset origination, risk management and
operational capabilities.

The Company's investment activities encompass three distinct lines of
business:
1) Commercial Real Estate Securities
2) Commercial Real Estate Loans
3) Residential Mortgage Backed Securities

The Company believes that these three investment activities represent an
integrated strategy where each line of business supports the others and
creates value over and above operating each line in isolation. The commercial
real estate securities portfolio provides diversification and high yields that
are adjusted for anticipated losses over a long period of time (typically, a
ten year weighted average life) and can be financed through the issuance of
secured debt that matches the life of the investment. Commercial real estate
loans provide attractive risk adjusted returns over shorter periods of time
through strategic investments in specific property types or regions. The
residential mortgage backed securities ("RMBS") portfolio is a highly liquid
portfolio that supports the liquidity needs of the Company while earning

5

attractive returns after hedging costs. The Company believes the risks of
these portfolios are not highly correlated and thus can serve to provide
stable earnings over long periods of time.

Commercial Real Estate Securities

The Company's principal activity is to underwrite and acquire high yielding
CMBS that are rated below investment grade. The Company's CMBS are securities
backed by pools of loans secured by first mortgages on commercial real estate
throughout the United States. The commercial real estate securing the first
mortgages consist of income producing properties including office buildings,
shopping centers, apartment buildings, industrial properties, healthcare
properties and hotels, amongst others. The terms of a typical loan include a
fixed rate of interest, thirty year amortization, some form of prepayment
protection, and a large interest rate increase if not paid off after ten
years. The loans are originated by various lenders and pooled together in a
trust that issues securities in the form of various classes of fixed rate debt
secured by the cash flows from the underlying loans. The securities issued by
the trust are rated by one or more nationally recognized credit rating
organization and are rated AAA down to CCC. Additionally, the security which
is affected first by loan losses is not rated. Generally, the Company does not
acquire the investment grade rated securities from newly formed trusts. The
principal amount of the pools of loans securing the CMBS securities varies.

Each trust will also have a designated special servicer. Special servicers are
responsible for carrying out the loan loss mitigation strategies. A special
servicer will also advance funds to a trust to maintain principal and interest
cash flows on the bonds so long as it believes there is a significant
probability of recovering those advances from the underlying borrowers. The
special servicer is paid a fee for advancing funds and for its efforts in
carrying out loss mitigation strategies.

The Company focuses on acquiring the securities rated below investment grade
and therefore that are rated BB+ or lower. The lowest rated securities are the
first to absorb realized losses in the loan pools. If a loss of par is
experienced in the underlying loans, a corresponding reduction in the par of
the lowest rated security occurs, reducing cash flow. The majority owner of
the first loss position has the right to control the workout process and
therefore designate the special servicer. The Company will generally seek to
be in the control position by purchasing the majority of the non-rated
securities and sequentially rated securities as high as BB+. Typically, the
par amount of all securities that are rated below investment grade represents
4.5% - 6.5% of the par of the underlying loans of newly issued CMBS
transactions. This is known as the subordination level because 4.5% - 6.5% of
the loan balance is subordinated to the senior, investment grade rated
securities.

The Company does not typically purchase a BB- rated security without having
the right to control the workout process on the underlying loans. The Company
purchases BB+ and BB rated securities at their original issue or in the
secondary market without necessarily having control of the workout process.
These other below investment grade CMBS do not absorb losses until the BB- and
lower rated securities have experienced losses of their entire principal
amounts. The Company believes the 4.0% - 4.5% subordination levels of these
securities provide additional credit protection and diversification with an
attractive risk return profile.

As of December 31, 2002, the Company owns seven different trusts ("Controlling
Class") where it is in the

6

first loss position and as a result controls the workout process on $9,616,797
of underlying loans. The total par amount owned of these Controlling Class
securities is $690,052. The Company does not own the senior securities that
represent the remaining par amount of the underlying mortgage loans. The
special servicer on five of the seven trusts is Midland Loan Services, Inc.;
the special servicer on the remaining two trusts is GMAC Commercial Mortgage
Management, Inc.

The Company also purchases investment grade commercial real estate related
securities in the form of CMBS and unsecured debt of commercial real estate
companies. The addition of these higher rated securities is intended to add
greater stability to the long-term performance of the Company's portfolios as
a whole and to provide greater diversification to optimize secured financing
alternatives. The Company generally seeks to assemble a portfolio of high
quality issues that will maintain consistent performance over the life of the
security.

The Company also acquires CMBS interest only securities ("IOs"). These
securities represent a portion of the interest coupons paid by the underlying
loans. The Company views this portfolio as an attractive relative value versus
other alternatives. These securities do not have significant prepayment risk
because the underlying loans generally have prepayment restrictions.
Furthermore, the credit risk is also mitigated because the IO represents a
portion of all underlying loans, not solely the first loss.

The following table indicates the amounts of each category of commercial real
estate asset the Company owns as of December 31, 2002.

The Company finances the majority of these portfolios with match funded,
secured term debt through Collateralized Debt Obligation ("CDO") offerings. To
accomplish this, the Company forms a special purpose entity ("SPE") and
contributes a portfolio of mostly below investment grade CMBS, investment
grade CMBS, and unsecured debt of commercial real estate companies. As this
transaction is considered a financing, the SPE is fully consolidated on the
Company's consolidated financial statements. The SPE will then issue fixed and
floating rate debt secured by the cash flows of the securities in the
portfolio. The SPE will enter into an interest rate swap agreement to convert
all floating rate debt issued to a fixed rate, thus matching the cash flow
profile of the underlying portfolio. The structure of the debt also eliminates
the mark to market requirement of other types of financing, thus eliminating
the need to provide additional collateral if the value of the portfolio
declines. The debt issued by the SPE is generally rated AAA down to BB; the
Company will keep the equity of the portfolio and continue to manage the
credit risk as it did prior

7

to the assets being contributed to the CDOs. The CDO provides an optimal
capital structure to maximize returns on these types of portfolios on a
non-recourse basis. Other forms of financing used for these types of assets
include multi-year committed financing facilities and 30-day reverse
repurchase agreements.

Owning commercial real estate loans in this form allows the Company to earn
its loss-adjusted returns over a long period of time while achieving
significant diversification across geographic areas and property types.

The following table indicates the par values of each category of commercial
real estate asset being used to secure the different types of borrowings as of
December 31, 2002:

Prior to acquiring Controlling Class securities, the Company performs a
significant amount of due diligence on the underlying loans to ensure their
risk profiles fit the Company's criteria. Loans that do not fit the Company's
criteria are removed from the pool. The debt service coverage ratios are
evaluated to determine if they are appropriate for each asset class. The
average loan to value ratio ("LTV") of the underlying loans is generally 70%
at origination. Due to its greater levels of credit protection, other below
investment grade CMBS are subject to comprehensive diligence though less
detailed than Controlling Class securities.

As part of the underwriting process, the Company assumes a certain amount of
loans will incur losses over time. In performing its due diligence on the
seven trusts, at the time of acquisition, the Company estimated that $180,638
of principal on the underlying loans would not ultimately be recoverable. This
amount represents approximately 1.9% of the underlying loan pools and 26.2% of
the par amount of the Controlling Class securities owned by the Company. This
loss assumption is used to compute a loss adjusted yield, which is then used
to report income on the Company's consolidated financial statements. The
weighted average loss adjusted yield for all Controlling Class securities is
10.36% and the weighted average yield if no losses occur is 11.72%. For all
Controlling Class securities with a rating of BB- and below the weighted
average loss adjusted yield is 10.84%. If the loss assumptions prove to be
consistent with actual loss experience, the Company will maintain that level
of income for the life of the security. If actual losses differ from the
original loss assumptions, a change in the original assumptions will be made
to restate the yields accordingly. A write down or write up of the adjusted
purchase price of the security may also be required. (See Item 7A
- -"Quantitative and Qualitative Disclosures About Market Risk" for more
information on the sensitivity of the Company's income and adjusted purchase
price to changes in credit experience.)

Once acquired, the Company uses a performance monitoring system to track the
credit experience of the

8

mortgages in the pools securing both the Controlling Class and the other below
investment grade CMBS. The Company receives remittance reports monthly from
the trustees and closely monitors any delinquent loans or other issues that
may affect the performance of the loans. The special servicer of a loan pool
also assists in this process. The Company also reviews its loss assumptions
every quarter using updated payment and debt service coverage information on
each loan in the context of economic trends on both a national and regional
level.

The Company's anticipated yields to maturity on its investments are based upon
a number of assumptions that are subject to certain business and economic
uncertainties and contingencies. Examples of such contingencies include, among
other things, the timing and severity of expected credit losses, the rate and
timing of principal payments (including prepayments, repurchases, defaults,
liquidations, special servicer fees and other related expenses), the
pass-through or coupon rate and interest rate fluctuations. Additional factors
that may affect the Company's anticipated yields to maturity on its
subordinated CMBS include interest payment shortfalls due to delinquencies on
the underlying mortgage loans and the timing and magnitude of credit losses on
the mortgage loans underlying the subordinated CMBS that are a result of the
general condition of the real estate market (including competition for tenants
and their related credit quality) and changes in market rental rates. As these
uncertainties and contingencies are difficult to predict and are subject to
future events, which may alter these assumptions, no assurance can be given
that the Company's anticipated yields to maturity will be achieved.

Commercial Real Estate Loans

The Company's loan activity is focused on providing mezzanine capital to the
commercial real estate industry. The Company targets well capitalized real
estate operators with strong track records and compelling business plans
designed to enhance the value of their real estate. These loans are generally
subordinated to a senior lender or first mortgage and are priced to reflect a
higher return. The Company has significant experience in closing large,
complex loan transactions and can deliver a timely and competitive financing
package to an underserved part of the real estate industry.

The types of investments in this class include subordinated participations in
first mortgages, loans secured by partnership interests, preferred equity
interests in real estate limited partnerships and loans secured by second
mortgages. The weighted average life of these investments is generally two to
three years and average leverage is 1:1 debt to equity generally funded with
committed financing facilities. These investments have fixed or floating rate
coupons and some provide additional earnings through an internal rate of
return ("IRR") look back or gross revenue participation.

The Company performs significant due diligence before making investments to
evaluate risks and opportunities in this sector. The Company generally focuses
on strong sponsorship, attractive real estate fundamentals, and pricing and
structural characteristics that provide significant control over the
underlying asset.

Since 2001, the Company's activity in this sector has generally been conducted
through Carbon Capital, Inc. ("Carbon"), a private Real Estate Investment
Trust. As of December 31, 2002, the Company owns 18.8% of Carbon and the
remainder is owned by various institutional investors. The Manager also
manages Carbon. The Company believes the use of Carbon allows it to invest in
larger institutional quality assets with greater diversification. The
Company's consolidated financial statements include, on a consolidated basis,
its share of assets and income of Carbon.

9

On December 31, 2002, the Company owned commercial real estate loans with a
carrying value $107,474. The average yield of this portfolio at December 31,
2002 was 9.4%. The majority of these loans pay interest based on one month
LIBOR. Commercial real estate loans with a carrying value of $33,545 were held
in Carbon and $73,929 were held directly. The Company and Carbon each have
committed financing facilities used to finance the acquisition of these
assets.

During the year ended December 31, 2002, the Company invested $3,370 in new
loans and received par payoffs of $82,865. Additionally, the Company invested
$6,100 in Carbon.

Investment Grade Residential Mortgage Backed Securities

The Company also invests a portion of its equity in RMBS with the strategic
objective of providing enhanced earnings and liquidity risk management. A key
element in managing the risk of owning a portfolio of below investment grade
CMBS and commercial real estate loans is to maintain sufficient liquid assets
to support these investments during periods of reduced liquidity in the
financial markets. RMBS can generally be sold quickly to raise cash to meet
margin calls required by lenders that provide secured financing for CMBS and
commercial real estate loans. As the Company continues to exploit the
opportunities available to it in the secured debt markets, such as CDO
offerings, the need for excess liquidity will be reduced. The size of this
investment portfolio can be expected to diminish over time as the Company
continues to match fund its commercial real estate portfolios.

The Company's investments in residential mortgage assets are currently and
expected to be concentrated in Pass-Through Certificates. The Pass-Through
Certificates to be acquired by the Company will consist primarily of
pass-through certificates issued by Federal National Mortgage Association
("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") and Government
National Mortgage Association ("GNMA"), as well as privately issued
adjustable-rate and fixed-rate mortgage pass-through certificates.

FNMA is a federally chartered and privately owned corporation. FNMA provides
funds to the mortgage market primarily by purchasing mortgage loans on homes
from local lenders. FNMA guarantees to the registered holder of an FNMA
Certificate that it will distribute amounts representing scheduled principal
and interest (at the rate provided by the FNMA Certificate) on the mortgage
loans in the pool underlying the FNMA Certificate, whether or not received,
and the full principal amount of any such Mortgage loan foreclosed or
otherwise finally liquidated, whether or not the principal amount is actually
received. The obligations of FNMA under its guarantees are solely those of
FNMA and are not backed by the full faith and credit of the United States. If
FNMA were unable to satisfy such obligations, distributions to holders of FNMA
Certificates would consist solely of payments and other recoveries on the
underlying Mortgage loans and, accordingly, monthly distributions to holders
of FNMA Certificates would be affected by delinquent payments and defaults on
such Mortgage loans.

FHLMC is a privately owned corporate instrumentality of the United States
created pursuant to an Act of Congress. The principal activity of FHLMC
currently consists of the purchase of conforming Mortgage loans or
participation interests therein and the resale of the loans and participations
so purchased in the form of guaranteed MBS. FHLMC guarantees to each holder of
its certificates the timely payment of interest at the applicable pass-through
rate and ultimate collection of all principal on the holder's pro rata share
of the unpaid principal balance of the related Mortgage loans, but does not
guarantee the timely

10

payment of scheduled principal of the underlying Mortgage loans. The
obligations of FHLMC under its guarantees are solely those of FHLMC and are
not backed by the full faith and credit of the United States. If FHLMC were
unable to satisfy such obligations, distributions to holders of FHLMC
Certificates would consist solely of payments and other recoveries on the
underlying Mortgage loans and, accordingly, monthly distributions to holders
of FHLMC Certificates would be affected by delinquent payments and defaults on
such Mortgage loans.

GNMA is a wholly owned corporate instrumentality of the United States within
the U.S. Housing and Urban Development Department ("HUD"). GNMA guarantees the
timely payment of the principal of and interest on certificates that represent
an interest in a pool of Mortgage loans insured by the Federal Housing
Administration ("FHA") and other loans eligible for inclusion in mortgage
pools underlying GNMA Certificates. GNMA Certificates constitute general
obligations of the United States backed by its full faith and credit.

Privately Issued Pass-Through Certificates are structured similar to the FNMA,
FHLMC and GNMA pass-through certificates discussed above and are issued by
originators of and investors in Mortgage loans, including savings and loan
associations, savings banks, commercial banks, mortgage banks, investment
banks and special purpose subsidiaries of such institutions. Privately Issued
Pass-Through Certificates are usually backed by a pool of conventional
Mortgage loans and are generally structured with credit enhancements such as
pool insurance or subordination. However, Privately Issued Pass-Through
Certificates are typically not guaranteed by an entity having the credit
status of FNMA, FHLMC or GNMA guaranteed obligations.

The Pass-Through Certificates to be acquired by the Company represent
interests in mortgages that are secured by liens on single-family (one-
to-four-units) residential properties, multifamily residential properties and
commercial properties. Pass-Through Certificates backed by adjustable-rate
Mortgage loans are subject to lifetime interest rate caps and to periodic
interest rate caps that limit the amount an interest rate can change during
any given period. The Company's borrowings are generally not subject to
similar restrictions. In a period of increasing interest rates, the Company
could experience a decrease in net income or incur losses because the interest
rates on its borrowings could exceed the interest rates on adjustable-rate
Pass-Through Certificates owned by the Company. The impact on net income of
such interest rate changes will depend on the adjustment features of the
mortgage assets owned by the Company, the maturity schedules of the Company's
borrowings and related hedging.

The majority of these securities are classified for accounting purposes as
held for trading so the change in their value is marked to market through the
income statement at the end of each quarter. Several factors influence the
value of RMBS including interests rates, interest spreads and paydowns.
Paydowns affect the value of the portfolio because a homeowner can payoff a
mortgage at par, and if the value of the portfolio is marked at a premium due
to falling interest rates, the par paydown generates a loss in the amount of
the premium. Alternatively, if the value of the portfolio is marked at a
discount, a paydown will generate a gain. Prepayments generally occur when
interest rates fall. The low interest rates in the third and fourth quarter of
2002 caused unprecedented levels of prepayments. The portfolio is marked to
market on the last day of each quarter and any change from the end of the
prior quarter is reported on the income statement. The portfolio is actively
hedged to mitigate the effects of interest rate movements.

As of December 31, 2002, the Company's classification of RMBS as either held
for trading or available for

11

sale is detailed below.

At year-end, the RMBS portfolio represented approximately 57% of the Company's
total assets. The equity committed to this portfolio provides a ready source
of cash that can be used to support the Company's other investment operations,
if needed. This allows the Company to earn attractive returns on equity while
maintaining significant liquidity. The leverage on this portfolio varies based
upon the short-term cash needs of the Company.

At December 31, 2002, the Company's assets were allocated among the following
categories:

At December 31, 2002, the Company had $42,796 of excess borrowing capacity in
the CMBS and commercial real estate loans portfolio.

12

Hedging Activities

The Company enters into hedging transactions to protect its investment
portfolio and related borrowings from interest rate fluctuations and other
changes in market conditions. These transactions may include interest rate
swaps, the purchase or sale of interest rate collars, caps or floors, options
and other hedging instruments. These instruments may be used to hedge as much
of the interest rate risk as the Manager determines is in the best interest of
the Company's stockholders, given the cost of such hedges. The Manager may
elect to have the Company bear a level of interest rate risk that could
otherwise be hedged when the Manager believes, based on all relevant facts,
that bearing such risk is advisable. The Manager has extensive experience in
hedging mortgages, mortgage-related assets and related borrowings with these
types of instruments.

Hedging instruments often are not traded on regulated exchanges, guaranteed by
an exchange or its clearinghouse, or regulated by any U.S. or foreign
governmental authorities. Consequently, there may be no requirements with
respect to record keeping, financial responsibility or segregation of customer
funds and positions. The Company will enter into these transactions only with
counterparties with long-term debt rated "A" or better by at least one
nationally recognized statistical rating organization. The business failure of
a counterparty with which the Company has entered into a hedging transaction
will most likely result in a default, which may result in the loss of
unrealized profits and force the Company to cover its resale commitments, if
any, at the then current market price. Although the Company generally will
seek to reserve for itself the right to terminate its hedging positions, it
may not always be possible to dispose of or close out a hedging position
without the consent of the counterparty, and the Company may not be able to
enter into an offsetting contract in order to cover its risk. There can be no
assurance that a liquid secondary market will exist for hedging instruments
purchased or sold, and the Company may be required to maintain a position
until exercise or expiration, which could result in losses.

The Company's hedging activities are intended to address both income and
capital preservation. Income preservation refers to maintaining a stable
spread between yields from mortgage assets and the Company's borrowing costs
across a reasonable range of adverse interest rate environments. Capital
preservation refers to maintaining a relatively steady level in the market
value of the Company's capital across a reasonable range of adverse interest
rate scenarios. However, no strategy can insulate the Company completely from
changes in interest rates.

From time to time, the Company may reduce its exposure to market interest
rates by entering into various financial instruments that adjust portfolio
duration. These financial instruments are intended to mitigate the effect of
interest rates on the value of certain assets in the Company's portfolio.

Interest rate swap agreements as of December 31, 2002 and 2001 consisted of
the following:

The counterparties for all of the Company's swaps are Deutsche Bank AG and
Merrill Lynch Capital Services, Inc., with ratings of AA- and A+,
respectively.

Futures contracts as of December 31, 2002 and 2001 consisted of the following:

Financing and Leverage

The Company has financed its assets with the net proceeds of its initial
public offering, follow-on offerings, the issuance of common stock under the
Company's Dividend Reinvestment and Stock Purchase Plan, the issuance of
preferred stock, long-term secured borrowings, short-term borrowings under
repurchase agreements and the lines of credit discussed below. In the future,
operations may be financed by future offerings of equity securities, as well
as unsecured and secured borrowings. The Company expects that, in general, it
will employ leverage consistent with the type of assets acquired and the
desired level of risk in various investment environments. The Company's
governing documents do not explicitly limit the amount of leverage that the
Company may employ. Instead, the Board of Directors has adopted an
indebtedness policy for the Company that limits total leverage to a maximum
6.0 to 1 debt to equity ratio. At December 31, 2002 and 2001, the Company's
debt-to-equity ratio was approximately 5.3 to 1 and 4.8 to 1, respectively.
The Company anticipates that it will maintain debt-to-equity ratios between
2.5 to 1 and 5.5 to 1 in the foreseeable future, although this ratio may be
higher or lower at any time. The Company's indebtedness policy may be changed
by the Board of Directors at any time in the future.

On May 29, 2002, the Company issued ten tranches of secured debt through CDO
I. In this transaction, a

14

wholly-owned subsidiary of the Company issued secured debt in the par amount of
$419,185 secured by the subsidiary's assets. The adjusted issue price of the
CDO I debt, as of December 31, 2002, is $403,983. Five tranches were issued at
a fixed rate coupon and five tranches were issued at a floating rate coupon
with a combined weighted average remaining maturity of 9.29 years. All
floating rate coupons were swapped to fixed resulting in a total fixed rate
cost of funds for CDO I of approximately 7.21%.

On December 10, 2002, the Company issued seven tranches of secured debt
through CDO II. In this transaction, a wholly-owned subsidiary of the Company
issued secured debt in the par amount of $280,783 secured by the subsidiary's
assets. The adjusted issue price of the CDO II debt as of December 31, 2002 is
$280,607. Four tranches were issued at a fixed rate coupon and three tranches
were issued at a floating rate coupon with a combined weighted average
remaining maturity of 9.34 years. All floating rate coupons were swapped to
fixed resulting in a total fixed rate cost of funds for CDO II of
approximately 5.73%.

Included in CDO II was a ramp facility that will be utilized to fund the
purchase of additional $50,000 of par of below investment grade CMBS by
September 30, 2003. Use of the ramp will permit the Company to increase the
net interest spread of the transaction by adding high yielding CMBS to the
asset portfolio.

On July 19, 1999, the Company entered into a $185,000 committed credit
facility with Deutsche Bank AG (the "Deutsche Bank Facility"). The Deutsche
Bank Facility has a two-year term and provides for extensions at the Company's
option. The Deutsche Bank Facility was extended for a one-year term through
July 19, 2002. The facility was extended a second time through July 15, 2005.
The Deutsche Bank Facility can be used to replace existing reverse repurchase
agreement borrowings and to finance the acquisition of mortgage-backed
securities, loan investments and investments in real estate joint ventures. As
of December 31, 2002 and December 31, 2001, the outstanding borrowings under
this facility were $19,189 and $43,409, respectively. Outstanding borrowings
under the Deutsche Bank Facility bear interest at a LIBOR based variable rate.

On January 15, 2002, the Company renewed a credit facility with Merrill Lynch
Mortgage Capital, Inc. for a twelve-month period, which permits the Company to
borrow up to $200,000. As of December 31, 2002, there were no outstanding
borrowings under this facility. As of December 31, 2001, the outstanding
borrowings under this line of credit were $57,113. The agreement requires
assets to be pledged as collateral, which may consist of rated CMBS, rated
RMBS, residential and commercial mortgage loans, and certain other assets.
Outstanding borrowings under this line of credit bear interest at a LIBOR
based variable rate. The facility expired pursuant to its terms in January
2003.

On July 18, 2002, the Company entered into a $75,000 committed credit facility
with Greenwich Capital, Inc. This facility provides the Company with the
ability to borrow only in the first year with repayment of principal not due
for three years. Outstanding borrowings under this line of credit bear
interest at a LIBOR based variable rate. As of December 31, 2002, there were
no borrowings under this facility.

The Company is subject to various covenants in its lines of credit, including
maintaining a minimum net worth of $305,000 as determined under generally
accepted accounting principles in the United States of America ("GAAP"), a
debt-to-equity ratio not to exceed 5.5 to 1, a minimum cash requirement based
upon certain debt-to-equity ratios, a minimum debt service coverage ratio of
1.5 and a minimum liquidity reserve of $10,000. As of December 31, 2002, the
Company was in compliance with all such

15

covenants.

On December 2, 1999, the Company authorized and issued 1,200,000 shares of
Series A Preferred Stock for aggregate proceeds of $30,000. The Series A
Preferred Stock carries a 10.5% coupon and is convertible into shares of
Common Stock at a price of $7.35 per share. The Series A Preferred Stock has a
seven-year maturity at which time, at the option of the holders, the shares of
preferred stock may be converted into shares of common stock or liquidated for
$28.50 per share. On December 21, 2001, the sole Series A Preferred
shareholder converted 1,190,000 shares of the Series A Preferred Stock into
4,096,854 shares of Common Stock at a conversion price of $7.26 per share
pursuant to the terms of such Preferred Stock, which was $0.09 per share lower
than the original conversion price due to the effects of anti-dilution
provisions in the Series A Preferred Stock. The remaining 10,000 shares of
Series A Preferred Stock were converted into 34,427 shares of the Company's
Common Stock in March 2002 at a conversion price of $7.26 per share.

On February 14, 2001, the Company completed a follow-on offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $33,300. The Company had granted the underwriters an
option, exercisable for 30 days, to purchase up to 600,000 additional shares
of Common Stock to cover over-allotments. This option was exercised on March
13, 2001 and resulted in additional net proceeds to the Company of
approximately $5,000.

On May 11, 2001, the Company completed a follow-on offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $37,800. The Company had granted the underwriters an
option, exercisable for 30 days, to purchase up to 600,000 additional shares
of Common Stock to cover over-allotments. This option was exercised on June 6,
2001 and resulted in additional net proceeds to the Company of approximately
$5,675.

On November 7, 2001, the Company completed a follow-on offering of 4,400,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $39,400. On November 13, 2001, the underwriters exercised
an option to purchase an additional 90,000 shares of Common Stock available
through an over-allotment granted to the underwriters and resulted in
additional net proceeds to the Company of approximately $810.

For the year ended December 31, 2002, the Company issued 1,455,725 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company
were approximately $15,920. For the year ended December 31, 2001, the Company
issued 2,228,566 shares of Common Stock under its Dividend Reinvestment Plan
with net proceeds to the Company of approximately $22,945.

The Company has entered into reverse repurchase agreements to finance most of
its securities available for sale which are not financed under its lines of
credit. The reverse repurchase agreements are collateralized by most of the
Company's securities available for sale and bear interest at rates that have
historically moved in close relationship to LIBOR.

16

Certain information with respect to the Company's collateralized borrowings at
December 31, 2002 is summarized as follows:

At December 31, 2002, the Company's collateralized borrowings had the
following remaining maturities:

As of December 31, 2002, $165,811 of the Company's $185,000 Deutsche Bank
Facility was available for future borrowings. Additionally, as of December 31,
2002, all of the Company's $75,000 committed credit facility with Greenwich
Capital, Inc. was available.

Under the lines of credit and the reverse repurchase agreements, the lender
retains the right to mark the underlying collateral to estimated market value.
A reduction in the value of its pledged assets will require

17

the Company to provide additional collateral or fund cash margin calls. From
time to time, the Company expects that it will be required to provide such
additional collateral or fund margin calls. The Company maintains adequate
liquidity to meet such calls.

Operating Policies

The Company has adopted compliance guidelines, including restrictions on
acquiring, holding and selling assets, to ensure that the Company meets the
requirements for qualification as a Real Estate Investment Trust ("REIT")
under the Internal Revenue Code of 1986 (the "Code") and is excluded from
regulation as an investment company. Before acquiring any asset, the Manager
determines whether such asset would constitute a "Real Estate Asset" under the
REIT Provisions of the Code, as amended. The Company regularly monitors
purchases of mortgage assets and the income generated from such assets,
including income from its hedging activities, in an effort to ensure that at
all times the Company's assets and income meet the requirements for
qualification as a REIT and exclusion under the Investment Company Act of 1940
(the "Investment Company Act").

The Company's unaffiliated directors review all transactions of the Company on
a quarterly basis to ensure compliance with the operating policies and to
ratify all transactions with PNC Bank (an affiliate of the Manager) and its
affiliates, except that the purchase of securities from PNC Bank and its
affiliates require prior approval. The unaffiliated directors rely
substantially on information and analysis provided by the Manager to evaluate
the Company's operating policies, compliance therewith and other matters
relating to the Company's investments.

In order to maintain the Company's REIT status, the Company generally intends
to distribute to its stockholders aggregate dividends equaling at least 90% of
its taxable income each year. The Code permits the Company to fulfill this
distribution requirement by the end of the year following the year in which
the taxable income was earned.

Regulation

The Company intends to continue to conduct its business so as not to become
regulated as an investment company under the Investment Company Act. Under the
Investment Company Act, a non-exempt entity that is an investment company is
required to register with the SEC and is subject to extensive, restrictive and
potentially adverse regulation relating to, among other things, operating
methods, management, capital structure, dividends and transactions with
affiliates. The Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and
other liens on and interests in real estate" ("Qualifying Interests"). Under
current interpretation by the staff of the SEC, to qualify for this exemption,
the Company, among other things, must maintain at least 55% of its assets in
Qualifying Interests. Pursuant to such SEC staff interpretations, certain of
the Company's interests in agency pass-through and mortgage-backed securities
and agency insured project loans are Qualifying Interests.

A portion of the CMBS acquired by the Company are collateralized by pools of
first mortgage loans where the Company can monitor the performance of the
underlying mortgage loans through loan management and servicing rights and
when the Company has appropriate workout/foreclosure rights with respect to
the underlying mortgage loans. When such arrangements exist, the Company
believes that the related

18

subordinated CMBS constitute Qualifying Interests for purposes of the
Investment Company Act. Therefore, the Company believes that it should not be
required to register as an "investment company" under the Investment Company
Act as long as it continues to invest in a sufficient amount of such
subordinated CMBS and/or in other Qualifying Interests.

If the SEC or its staff were to take a different position with respect to
whether the Company's subordinated CMBS constitute Qualifying Interests, the
Company could be required to modify its business plan so that either (i) it
would not be required to register as an investment company or (ii) it would
comply with the Investment Company Act and be able to register as an
investment company. In such event, modification of (i) the Company's business
plan so that it would not be required to register as an investment company
would likely entail a disposition of a significant portion of the Company's
subordinated CMBS or the acquisition of significant additional assets, such as
agency pass-through and mortgage-backed securities, which are Qualifying
Interests or (ii) the Company's business plan to register as an investment
company would result in significantly increased operating expenses and would
likely entail significantly reducing the Company's indebtedness (including the
possible prepayment of the Company's short-term borrowings), which could also
require it to sell a significant portion of its assets. No assurances can be
given that any such dispositions or acquisitions of assets, or deleveraging,
could be accomplished on favorable terms. Consequently, any such modification
of the Company's business plan could have a material adverse effect on the
Company. Further, if it were established that the Company were an unregistered
investment company, there would be a risk that the Company would be subject to
monetary penalties and injunctive relief in an action brought by the SEC, that
the Company would be unable to enforce contracts with third parties and that
third parties could seek to obtain recession of transactions undertaken during
the period it was established that the Company was an unregistered investment
company. Any such results would be likely to have a material adverse effect on
the Company.

Competition

The Company's net income depends, in large part, on the Company's ability to
acquire mortgage assets at favorable spreads over the Company's borrowing
costs. In acquiring mortgage assets, the Company competes with other mortgage
REITs, specialty finance companies, savings and loan associations, banks,
mortgage bankers, insurance companies, mutual funds, institutional investors,
investment banking firms, other lenders, governmental bodies and other
entities. In addition, there are numerous mortgage REITs with asset
acquisition objectives similar to the Company's, and others may be organized
in the future. The effect of the existence of additional REITs may be to
increase competition for the available supply of mortgage assets suitable for
purchase by the Company. Some of the Company's anticipated competitors are
significantly larger than the Company, have access to greater capital and
other resources and may have other advantages over the Company. In addition to
existing companies, other companies may be organized for purposes similar to
that of the Company, including companies organized as REITs focused on
purchasing mortgage assets. A proliferation of such companies may increase the
competition for equity capital and thereby adversely affect the market price
of the Company's Common Stock.

Employees

The Company does not have any employees. The Company's officers, each of whom
is a full-time employee of the Manager, perform the duties required pursuant
to the Management Agreement (as defined below) with the Manager and the
Company's bylaws.

19

Management Agreement

The Company is managed pursuant to a management agreement, dated March 27,
1998, between the Company and the Manager (the "Management Agreement"),
pursuant to which the Manager is responsible for the day-to-day operations of
the Company and performs such services and activities relating to the assets
and operations of the Company as may be appropriate. The initial two-year term
of the Management Agreement was to expire on March 27, 2000; on March 16,
2000, the Management Agreement was extended for an additional two years, with
the approval of the unaffiliated directors, on terms similar to the original
agreement. On March 25, 2002, the Management Agreement was extended for one
year through March 27, 2003, with the approval of the unaffiliated directors,
on terms similar to the prior agreement with the following changes: (i) the
incentive fee calculation would be based upon GAAP earnings instead of funds
from operations, (ii) the removal of the four-year period to value the
Management Agreement in the event of termination and (iii) subsequent renewal
periods of the Management Agreement would be for one year instead of two
years. The Board was advised by Houlihan Lokey Howard & Zukin Financial
Advisors, Inc., a national investment banking and financial advisory firm, in
the renewal process.

On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement are similar to the
prior agreement except for the incentive fee calculation which would provide
for a rolling four-quarter high watermark rather than a quarterly calculation.
In determining the rolling four-quarter high watermark, the Manager would
calculate the incentive fee based upon the current and prior three quarters'
net income ("Yearly Incentive Fee"). The Manager would be paid an incentive
fee in the current quarter if the Yearly Incentive Fee is greater than what
was paid to the Manager in the prior three quarters cumulatively. The Company
will phase in the rolling four-quarter high watermark commencing with the
second quarter of 2003. Calculation of the incentive fee will be based on GAAP
and adjusted to exclude special one-time events pursuant to changes in GAAP
accounting pronouncements after discussion between the Manager and the
unaffiliated directors. The incentive fee threshold did not change. The high
watermark will be based on the existing incentive fee hurdle, which provides
for the Manager to be paid 25% of the amount of earnings (calculated in
accordance with GAAP) per share that exceeds the product of the adjusted issue
price of the Company's common stock per share ($11.39 as of December 31, 2002)
and the greater of 9.5% or 350 basis points over the ten-year Treasury note.

The Manager primarily engages in four activities on behalf of the Company: (i)
acquiring and originating mortgage loans and other real estate related assets;
(ii) asset/liability and risk management, hedging of floating rate
liabilities, and financing, management and disposition of assets, including
credit and prepayment risk management; (iii) surveillance and restructuring of
real estate loans and (iv) capital management, structuring, analysis, capital
raising and investor relations activities. In conducting these activities, the
Manager formulates operating strategies for the Company, arranges for the
acquisition of assets by the Company, arranges for various types of financing
and hedging strategies for the Company, monitors the performance of the
Company's assets and provides certain administrative and managerial services
in connection with the operation of the Company. At all times, the Manager is
subject to the direction and oversight of the Company's Board of Directors.

The Company may terminate, or decline to renew the term of, the Management
Agreement without cause at any time upon 60 days' written notice by a majority
vote of the unaffiliated directors. Although no

20

termination fee is payable in connection with a termination for cause, in
connection with a termination without cause, the Company must pay the Manager
a termination fee, which could be substantial. The amount of the termination
fee will be determined by independent appraisal of the value of the Management
Agreement. Such appraisal is to be conducted by a nationally-recognized
appraisal firm mutually agreed upon by the Company and the Manager.

On May 15, 2000, the Company completed the acquisition of CORE Cap, Inc. The
merger was a stock for stock acquisition where the Company issued 4,180,552
shares of its common stock and 2,261,000 shares of its series B preferred
stock. At the time of the CORE Cap acquisition, the Manager agreed to pay GMAC
(CORE Cap, Inc's external advisor) $12,500 over a ten-year period
("Installment Payment") to purchase the right to manage the assets under the
existing management contract ("GMAC Contract"). The GMAC Contract had to be
terminated in order to allow for the Company to complete the merger, as the
Company's management agreement with the Manager did not provide for multiple
managers. As a result the Manager offered to buy-out the GMAC contract as the
Manager estimated it would receive incremental fees above and beyond the
Installment Payment, and thus was willing to pay for, and separately
negotiate, the termination of the GMAC Contract. Accordingly, the value of the
Installment Payment was not considered in the Company's allocation of its
purchase price to the net assets acquired in the acquisition of CORE Cap, Inc.
The Company agreed that should the Management Agreement with its Manager be
terminated, not renewed or not extended for any reason other than for cause,
the Company would pay to the Manager an amount equal to the Installment
Payment less the sum of all payments made by the Manager to GMAC. As of
December 31, 2002, the Installment Payment would be $9,500 payable over eight
years. The Company does not accrue for this contingent liability.

In addition, the Company has the right at any time during the term of the
Management Agreement to terminate the Management Agreement without the payment
of any termination fee upon, among other things, a material breach by the
Manager of any provision contained in the Management Agreement that remains
uncured at the end of the applicable cure period.

To coincide with the increased size of the Company, effective July 1, 2001,
the Manager reduced the base management fee payable under the Management
Agreement to 0.20% of average invested assets rated above BB+ from 0.35%.
Additionally, effective July 1, 2001, the Manager revised the hurdle rate
applicable to the incentive fee from 3.5% over the ten-year U.S. Treasury Rate
to the greater of 3.5% over the ten-year U.S. Treasury Rate or 9.5% on the
adjusted issue price of shares of Common Stock. This revision resulted in
savings of $3,278 and $1,689 to the Company during 2002 and 2001,
respectively. For purposes of calculating the incentive fee during 2002, the
cumulative transition adjustment of $6,327 resulting from the Company's
adoption of SFAS 142 was excluded from earnings in its entirety and included
using an amortization period of three years. This revision saved the Company
$1,314 of incentive fee during 2002.

Taxation of the Company

The Company has elected to be taxed as a REIT under the Code, commencing with
its taxable year ended December 31, 1998, and the Company intends to continue
to operate in a manner consistent with the REIT provisions of the Code. The
Company's qualification as a REIT depends on its ability to meet the various
requirements imposed by the Code, through actual operating results, asset
holdings, distribution levels and diversity of stock ownership.

Provided the Company continues to qualify for taxation as a REIT, it generally
will not be subject to Federal corporate income tax on its net income that is
currently distributed to stockholders. This treatment substantially eliminates
the "double taxation" (at the corporate and stockholder levels) that generally
results from an investment in a corporation. If the Company fails to qualify
as a REIT in any taxable year, its

21

taxable income would be subject to Federal income tax at regular corporate
rates (including any applicable alternative minimum tax). Even if the Company
qualifies as a REIT, it will be subject to Federal income and excise taxes on
its undistributed income.

If in any taxable year the Company fails to qualify as a REIT and, as a
result, incurs additional tax liability, the Company may need to borrow funds
or liquidate certain investments in order to pay the applicable tax, and the
Company would not be compelled to make distributions under the Code. Unless
entitled to relief under certain statutory provisions, the Company would also
be disqualified from treatment as a REIT for the four taxable years following
the year during which qualification is lost. Although the Company currently
intends to operate in a manner designated to qualify as a REIT, it is possible
that future economic, market, legal, tax or other considerations may cause the
Company to fail to qualify as a REIT or may cause the Board of Directors to
revoke the Company's REIT election.

The Company and its stockholders may be subject to foreign, state and local
taxation in various foreign, state and local jurisdictions, including those in
which it or they transact business or reside. The state and local tax
treatment of the Company and its stockholders may not conform to the Company's
Federal income tax treatment.

Website

The Company's website address is www.anthracitecapital.com. The Company makes
available free of charge through its website its Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments
to those reports as soon as reasonably practicable after such material is
electronically filed with or furnished to the SEC.

22

ITEM 2. PROPERTIES

The Company does not maintain an office and owns no real property. It utilizes
the offices of the Manager, located at 40 East 52nd Street, New York, New York
10022.

ITEM 3. LEGAL PROCEEDINGS

The Company is not a party to any material legal proceedings.

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

No matters were submitted to a vote of the Company's security holders during
the fourth quarter of 2002 through the solicitation of proxies or otherwise.

23

PART II

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

The Company's Common Stock has been listed and is traded on the New York Stock
Exchange under the symbol "AHR" since the initial public offering in March
1998. The following table sets forth, for the periods indicated, the high, low
and last sale prices in dollars on the New York Stock Exchange for the
Company's Common Stock and the dividends declared by the Company with respect
to the periods indicated as were traded during these respective time periods.

On March 21, 2003, the closing sale price for the Company's Common Stock, as
reported on the New York Stock Exchange, was $11.98. As of March 21, 2003,
there were approximately 877 record holders of the Common Stock. This figure
does not reflect beneficial ownership of shares held in nominee name.

24

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data set forth below as of and for the years ended
December 31, 2002, 2001, 2000, and 1999 and the period from March 24, 1998
(Commencement of Operations) through December 31, 1998 has been derived from
the Company's audited financial statements. This information should be read in
conjunction with "Item 1. Business" and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations", as well as the
audited financial statements and notes thereto included in "Item 8. Financial
Statements and Supplementary Data".

25

The Company's ratio of management fee, incentive fee, and general and
administrative expenses to net income before such fees is 21.7%, 21.2%, 23.2%
and 21.9% for the years ended December 31, 2002, 2001, 2000 and 1999,
respectively. This ratio is not meaningful for the Company's initial year of
operations in 1998.

26

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

All dollar figures expressed herein are expressed in thousands, except share
or per share amounts.

General

The Company's primary long-term objective is to distribute consistent
dividends supported by operating earnings. The Company considers its operating
earnings ("Operating Earnings") to be net income available to common
stockholders as determined under GAAP before gains and losses, changes in
accounting pronouncements and Statement of Financial Accounting Standard
(SFAS) 133 hedging adjustments.

Operating Earnings are primarily maintained by consistent credit performance
on the Company's investments and stability of the Company's liability
structure. In 2002, the Company established a strong long-term secured debt
issuance platform through two Collateralized Debt Obligation ("CDO")
offerings. These transactions effectively match funded a significant part of
the Company's long-term credit sensitive CMBS and REIT portfolios at
attractive terms. In 2003 the Company expects to redeploy capital raised from
these transactions combined with additional equity capital raised from the
Company's strategic common stock issuance program. This is expected to lead to
the accretion of both earnings and book value per share as well as to increase
diversification of credit exposure.

The Company establishes its dividend by analyzing the long-term sustainability
of Operating Earnings given existing market conditions and the current
composition of its portfolio. This includes an analysis of the Company's
credit loss assumptions, general level of interest rates, realized gains and
losses and projected hedging costs. These factors are generally beyond the
Company's control so there is no certainty that dividends will remain at
current levels. During calendar year 2002, the Company distributed $1.40 per
share in the form of fully taxable dividends on a quarterly basis.

For the year ended December 31, 2002, the Company recorded $1.18 of GAAP
earnings per share and $1.67 of Operating Earnings per share. For the year
ended December 31, 2001, the Company recorded $1.35 of GAAP earnings per share
and $1.44 of Operating Earnings per share. The table below reconciles GAAP
earnings per share with Operating Earnings per share for the four years ended
December 31, 2002:

27

Commercial Real Estate Securities Portfolio Activity

The Company continues to increase its investments in commercial real estate
securities. Commercial real estate securities include CMBS and investment
grade REIT debt. During the year ended December 31, 2002, the Company
increased total assets in this sector by 97% from $453,953 to $894,345. This
increase was attributable to the execution of the two CDO offerings that
provided an attractive match funding financing platform for these assets.

The table below is a summary of the Company's investments by asset class since
inception:

The Company's first CDO transaction was issued as Anthracite CDO 2002 CIBC-1
and closed on May 15, 2002 ("CDO I"). The Company issued $403,633 of debt
secured by a portfolio of commercial real estate securities with a total par
of $515,880 and an adjusted purchase price of $431,995. On December 10, 2002,
the Company issued another $280,607 of debt through Anthracite CDO 2002-2
("CDO II") secured by a separate portfolio of commercial real estate
securities with a par of $313,444 and an average adjusted purchase price of
$289,197. Included in CDO II was a ramp facility that will be utilized to fund
the purchase of an additional $50,000 of par of below investment grade CMBS by
September 30, 2003. Use of the ramp facility will permit the Company to
increase the net interest spread of the transaction by adding high yielding
CMBS to the asset portfolio. The Company retained 100% of the equity of both
CDOs and is recording the transaction on its books as a financing.

28

* Weighted Average cost of funds is the current cost of funds plus hedging
expenses.

** The total market value of the assets contributed to the two CDOs at
December 31, 2002 was $726,769, an additional $50,000 of par can be
contributed through the ramp facility. Securities contributed at a
discounted market value would generate excess cash in the amount of the
discount.

*** The company did not sell $22,850 of par of CDO II debt rated BBB- and BB

Assets contributed to the CDOs were a combination of below investment grade
CMBS (rated below BBB-), investment grade CMBS (rated BBB- to BB+) and
investment grade unsecured REIT debt. CMBS securities rated B- or lower were
not contributed into either CDO. The Company did not contribute certain other
below investment grade CMBS rated BB+ down to B. Other securities that were
not contributed to either CDO include a portfolio of AAA rated CMBS IO
securities and other CMBS related securities.

The following table details the par, fair market value, adjusted purchase
price and loss adjusted yield of the Company's commercial real estate
securities outside of the CDOs as of December 31, 2002:

Below Investment Grade CMBS and Underlying Loan Performance

The Company divides its below investment grade CMBS investment activity into
two portfolios, Controlling Class CMBS and other below investment grade CMBS.
The distinction between the two is in the controlling class rights.
Controlling class rights allow the Company to control the workout and/or
disposition of defaults that occur in the underlying loans. These securities
absorb the first losses realized in the underlying loan pools. Other below
investment grade CMBS have no right to control the workout and/or disposition
of underlying loan defaults, however they are not the first to absorb losses
in the underlying pools.

During 2002, the Company acquired $199,840 of par of other below investment
grade CMBS and did not acquire any new Controlling Class securities. The
Company continues to take a cautious approach to the real estate credit
markets and favored CMBS with greater credit protection rather than being in a
first loss position. The total par of the Company's other below investment
grade CMBS at December 31, 2002 was $261,157; the total credit protection, or
subordination level, of this portfolio is 6.50%. The total par of the
Company's Controlling Class CMBS at December 31, 2002 was $690,052 and the
total par of the loans underlying these securities was $9,616,797. The
non-rated security is the first to absorb underlying loan losses until its par
is completely written off. The coupon payment on the non-rated security can
also be reduced for special servicer fees charged to the trust. The next
highest rated security in the structure will then generally be downgraded to
non-rated and becomes the first to absorb losses and expenses from that point
on.

29

The Company's investment in its Controlling Class CMBS by credit rating
category at December 31, 2002 is as follows:

The Company's investment in its Controlling Class CMBS by credit rating
category at December 31, 2001 is as follows:

During 2002, the par for one of the Company's Controlling Class CMBS was
written down by the servicer in the amount of $2,388. This reduction in par
does not affect the Company's loss adjusted yield on this asset. During the
year ended 2002 certain delinquent loans in CMAC 98-C2 caused a temporary
shortfall of interest available to pay the non-rated security which shortfall
may not be recoverable. The Company expects the coupon to resume during the
first half of 2003. These types of shortfalls are expected to occur in
non-rated CMBS classes and therefore the Company currently does not believe
this is an impairment that requires a change in loss assumptions. Further
delinquencies and losses may cause the shortfall to continue and cause the
Company to conclude that a change in loss adjusted yield is required along
with a significant write down of the adjusted purchase price through the
income statement according to EITF 99-20. Also during 2002, the loan pools
were paid down by $128,344. Pay down proceeds are distributed to the highest
rated CMBS class first and reduce the percent of total underlying collateral
represented by each rating category.

For all of the Company's Controlling Class securities, the Company assumes
that 1.88% of the remaining current aggregate loan balance will not be
recoverable. This has not changed from the year ended 2001. This estimate was
developed based on an analysis of individual loan characteristics and
prevailing market conditions at the time of origination. This loss estimate
equates to cumulative expected defaults of

30

approximately 5% over the life of the portfolio and an average assumed loss
severity of 37.6% of the defaulted loan balance. All estimated workout
expenses including special servicer fees are included in these assumptions.
Actual results could differ materially from these estimated results. See Item
7A -"Quantitative and Qualitative Disclosures About Market Risk" for a
discussion of how differences between estimated and actual losses could affect
Company earnings.

The Company monitors credit performance on a monthly basis and debt service
coverage ratios on a quarterly basis. Using these and other statistics, the
Company maintains watch lists for loans that are delinquent thirty days or
more and for loans that are not delinquent but have issues that the Company
feels require close monitoring. The Company plans to perform a detailed
re-underwriting of a substantial number of the underlying loans supporting its
Controlling Class CMBS within the next 18 months. Upon completion, the
Company may determine that its GAAP yields and book values need to be
adjusted.

The Company considers delinquency information from the Lehman Brothers Conduit
Guide to be the most relevant measure of credit performance and market
conditions applicable to its Controlling Class CMBS holdings. The year of
issuance, or vintage year, is important, as older loan pools will tend to have
more delinquencies than newly underwritten loans. The Company owns Controlling
Class CMBS issued in 1998, 1999 and 2001. Comparable delinquency statistics
referenced by vintage year as a percentage of par outstanding as of December
31, 2002 are shown in the table below:

Morgan Stanley also tracks CMBS loan delinquencies for the specific CMBS
transactions with more than $200,000 of collateral and that have been seasoned
for at least one year. This seasoning criterion will generally adjust for the
lower delinquencies that occur in newly originated collateral. As of December
31, 2001, the Morgan Stanley index indicated that delinquencies on 174
securitizations was 1.85%, and as of December 31, 2002, this same index
indicated that delinquencies on 204 securitizations was 2.01%. See Item 7A -
"Quantitative and Qualitative Disclosures About Market Risks" for a detailed
discussion of how delinquencies and loan losses affect the Company.

Delinquencies on the Company's CMBS collateral as a percent of principal
increased in line with expectations. The Company's aggregate delinquency
experience is consistent with comparable data provided in the Lehman Brothers
Conduit Guide.

Of the 36 delinquent loans shown on the chart in Note 2 of the consolidated
financial statements, one was delinquent due to technical reasons, six were
Real Estate Owned (REO) and being marketed for sale, three were in
foreclosure, and the remaining 26 loans were in some form of workout
negotiations. Aggregate realized losses of $6,141 were realized in the fourth
quarter of 2002. This brings cumulative net losses

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realized to $9,149, which is 5.1% of total estimated losses. These losses
include special servicer and other workout expenses. This experience to date
is in line with the Company's loss expectations. Realized losses are expected
to increase on the underlying loans as the portfolio ages. Special servicer
expenses are also expected to increase as portfolios mature and US economic
activity remains weak.

The Company manages its credit risk through disciplined underwriting,
diversification, active monitoring of loan performance and exercise of its
right to control the workout process as early as possible. The Company
maintains diversification of credit exposures through its underwriting process
and can shift its focus in future investments by adjusting the mix of loans in
subsequent acquisitions. The comparative profiles of the loans underlying the
Company's CMBS by property type as of December 31, 2002 and for the two prior
years is as follows:

As of December 31, 2002, the fair market value of the Company's holdings of
CMBS is $60,738 lower than the adjusted cost for these securities. Except for
the writedown of the FMACT bond, this decline in the value of the investment
portfolio represents market valuation changes and is not due to actual credit
experience or credit expectations. The adjusted purchase price of the
Company's Controlling Class CMBS portfolio as of December 31, 2002 represents
approximately 64% of its par amount. The market value of the Company's
Controlling Class CMBS portfolio as of December 31, 2002 represents
approximately 54% of its par amount. As the portfolio matures, the Company
expects to recoup the unrealized loss, provided that the credit losses
experienced are not greater than the credit losses assumed in the purchase
analysis. As of December 31, 2002, the Company believes there has been no
material deterioration in the credit quality of its portfolio below original
expectations.

As the portfolio matures and expected losses occur, subordination levels of
the lower rated classes of a CMBS investment will be reduced. This may cause
the lower rated classes to be downgraded which would negatively affect their
market value and therefore the Company's net asset value. Reduced market value
will negatively affect the Company's ability to finance any such securities
that are not financed through a CDO or similar matched funding vehicle. In
some cases, securities held by the Company may be upgraded to reflect
seasoning of the underlying collateral and thus would increase the market
value of the securities.

The Company's GAAP income for its CMBS securities is computed based upon a
yield which assumes credit losses would occur. The yield to compute the
Company's taxable income does not assume there would be credit losses, as a
loss can only be deducted for tax purposes when it has occurred. As a result,
for the years 1998 through December 31, 2002, the Company's GAAP income
accrued on its CMBS assets

32

was approximately $19,650 lower than the taxable income accrued on the CMBS
assets.

The FMACT 1998-BA class B security continues to perform poorly. Based on the
information provided by the trustee, as of December 16, 2002, of the 71
borrowers in the loan pool underlying this security, there are 8 borrowers
with loans in the amount of $36,741 which are in default, 10 borrowers with
loans in the amount of $23,722 which are delinquent, and 53 borrowers with
loans in the amount of $135,292 which are current. During the fourth quarter
of 2002, the servicer of the underlying loans recouped principal and interest
advances made in prior years. This action resulted, at least temporarily, in
insufficient cash being available to make the payments required on the
Company's class B security.

Based on the delinquencies and defaults in the underlying pools, and the
missed payments during the fourth quarter of 2002 as described above, the
Company revised its estimated future cash flows from this investment.
Accordingly, in accordance with EITF 99-20, the Company determined that its
investment was impaired and wrote down the adjusted purchase price of this
security by $10,273 to its estimated fair value and increased the GAAP yield
from 7.69% to a market yield for a security of this credit quality, estimated
to be 20%. These figures incorporate the assumption that an additional $31,203
of losses will be experienced by the underlying pools and an estimate of
another 1.0% of losses per year over the remaining life of the trust. This
security was part of the CORE Cap acquisition in May of 2000 and was rated AA
at that time. This security is currently rated D by Standard & Poors and CC by
Fitch Ratings.

Commercial Real Estate Loan Activity

The Company's commercial real estate loan portfolio generally emphasizes
larger transactions located in metropolitan markets, as compared to the
typical loan in the CMBS portfolio. There are no delinquencies in the
Company's commercial real estate loan portfolio which is relatively small and
heterogeneous. The Company has determined it is not necessary to establish a
loan loss reserve.

The following table summarizes the Company's commercial real estate loan
portfolio by property type as of December 31, 2002, 2001 and 2000:

Recent Events

Included in CDO II was a ramp facility that will be utilized to fund the
purchase of $50,000 of par of below investment grade CMBS. On March 14, 2003,
the Company purchased $78,027 par of securities in

33

CSFB 2003-CPN1. Of this purchase, $30,000 par will be contributed into the
ramp facility for CDO II, and $48,027 will be held outside of CDO II.

On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement are similar to the
prior agreement except for the incentive fee calculation which would provide
for a rolling four-quarter high watermark rather than a quarterly calculation.
In determining the rolling four-quarter high watermark, the Company would
calculate the incentive fee based upon the current and prior three quarters'
net income. The Manager would be paid an incentive fee in the current quarter
if the Yearly Incentive Fee is greater than what was paid to the Manager in
the prior three quarters cumulatively. The Company will phase in the rolling
four-quarter high watermark commencing with the second quarter of 2003.
Calculation of the incentive fee will be based on GAAP and adjusted to exclude
special one-time events pursuant to changes in GAAP accounting pronouncements
after discussion between the Manager and the unaffiliated directors. The
incentive fee threshold did not change. The high watermark will be based on
the existing incentive fee hurdle, which provides for the Manager to be paid
25% of the amount of earnings (calculated in accordance with GAAP) per share
that exceeds the product of the adjusted issue price of the Company's common
stock per share ($11.39 as of December 31, 2002) and the greater of 9.5% or
350 basis points over the ten-year Treasury note.

On February 6, 2003, the Company funded a capital call notice from Carbon in
the amount of $2,680. This was used by Carbon to acquire a mezzanine loan
secured by ownership interests in an entity that owns a mixed-use development.

In January 2003, the par for two of the Company's Controlling Class CMBS was
written down by the servicer in the aggregate amount of $4,284. This reduction
in par does not affect the Company's loss adjusted yield on this asset.

In January 2003, the Company's $200,000 financing facility with Merrill Lynch
Mortgage Capital, Inc. expired pursuant to its terms. There was no balance
owing at the expiration.

Critical Accounting Policies

Management's discussion and analysis of financial condition and results of
operations is based on the amounts reported in the Company's consolidated
financial statements. These financial statements are prepared in accordance
with GAAP. In preparing the financial statements, management is required to
make various judgments, estimates and assumptions that affect the reported
amounts. Changes in these estimates and assumptions could have a material
effect on the Company's consolidated financial statements. The following is a
summary of the Company's accounting policies that are the most affected by
management judgments, estimates and assumptions:

Securities Available for Sale

The Company has designated its investments in mortgage-backed securities,
mortgage-related securities and certain other securities as available for
sale. Securities available for sale are carried at estimated fair value with
the net unrealized gains or losses reported as a component of accumulated
other

34

comprehensive income (loss) in stockholders' equity. Many of these investments
are relatively illiquid, and their values must be estimated by management. In
making these estimates, management generally utilizes market prices provided
by dealers who make markets in these securities, but may, under certain
circumstances, adjust these valuations based on management's judgment. Changes
in the valuations do not affect the Company's reported income or cash flo