10-K 1 b38159hce10-k.txt FORM 10-K DATED 12/31/00 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the year ended December 31, 2000 OR [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to -------------- ------------- Commission file number: 001-13417 HANOVER CAPITAL MORTGAGE HOLDINGS, INC. (Exact name of registrant as specified in its charter) MARYLAND 13-3950486 (State or other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 90 WEST STREET, SUITE 2210, NEW YORK, NY 10006 (Address of principal executive offices) (Zip Code) (212) 732-5086 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Common Stock, $.01 Par Value per Share - American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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 The aggregate market value of common stock held by nonaffiliates of the registrant as of March 1, 2001 was approximately $26,586,000 (based on closing sales price of $6.15 per share of common stock as reported for the American Stock Exchange) on March 1, 2001. The registrant had 4,322,944 shares of common stock outstanding as of March 1, 2001. DOCUMENTS INCORPORATED BY REFERENCE Portions of the notice of Annual Stockholder's Meeting and Proxy Statement, to be filed within 120 days after the end of registrant's fiscal year, are incorporated by reference into Part III. 2 HANOVER CAPITAL MORTGAGE HOLDINGS, INC. FORM 10-K ANNUAL REPORT FOR THE YEAR ENDED DECEMBER 31, 2000 INDEX PART I PAGE Item 1. Business............................................................ 2 Item 2. Properties.......................................................... 23 Item 3. Legal Proceedings................................................... 23 Item 4. Submission of Matters to a Vote of Security Holders................. 23 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............................................................. 24 Item 6. Selected Financial Data............................................. 27 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................... 28 Item 7a. Quantitative and Qualitative Disclosure About Market Risk.......... 49 Item 8. Financial Statements and Supplementary Data......................... 51 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................................ 51 PART III Item 10. Directors and Executive Officers of the Registrant................. 52 Item 11. Executive Compensation............................................. 52 Item 12. Security Ownership of Certain Beneficial Owners and Management..... 52 Item 13. Certain Relationships and Related Transactions..................... 52 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.... 53 Signatures ................................................................. 54 3 PART I ITEM 1: BUSINESS This Annual Report on Form 10-K contains, in addition to historical information, forward-looking statements that involve risks and uncertainty. The Company's actual results could differ significantly from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include those discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as those discussed elsewhere in this Annual Report on Form 10-K. GENERAL Hanover Capital Mortgage Holdings, Inc. ("Hanover") was incorporated in Maryland on June 10, 1997. Hanover is a real estate investment trust ("REIT"), formed to operate as a specialty finance company. Hanover has two primary unconsolidated subsidiaries: Hanover Capital Partners Ltd. ("HCP") and HanoverTrade.com, Inc. ("HTC"). When we refer to the "Company," we mean Hanover together with its consolidated and unconsolidated subsidiaries. The Company is engaged in three principal businesses, which are conducted through its three primary operating units: Hanover, HCP and HTC. The principal business strategy of Hanover is to invest in mortgage backed securities ("MBS") and, to a lesser extent, in mortgage loans. The principal business strategy of HCP is to generate consulting and other fee income by performing loan file and operational due diligence reviews for third parties, performing advisory services for third parties, and preparing and or processing documentation (primarily assignments of mortgage loans) for third parties on a contract basis. The principal business activity of HTC is to generate fee income by operating an online world-wide web-based exchange for trading loan pools (primarily mortgage loan pools) and by performing loan sale advisory services for third parties. The Company's principal business objective is to generate net interest income on its portfolio of mortgage loans and mortgage securities and to generate fee income through HCP and HTC. The Company's principal executive offices are located at 90 West Street, Suite 2210, New York, New York 10006. 2 4 INVESTMENT PORTFOLIO General Hanover's primary business is investing in mortgage backed securities which are secured by single family mortgage loans. Hanover generally targets so-called "subordinate" mortgage backed securities. The subordinate mortgage backed securities bear all of the credit losses on the related pool of mortgage loans. Because of this feature, these securities are generally rated below investment grade by the major statistical rating organizations, such as Moody's Investors Service, Standard & Poor's Ratings Group, or Fitch Investor Service. Hanover has in the past, and may in the future, invest directly in mortgage loans. Hanover has issued mortgage backed securities collateralized by these loans, and has retained the subordinate securities from these transactions. While the Company has not done so to date, it may in the future also invest in multifamily mortgage loans and commercial mortgage loans (single-family mortgage loans, mortgage securities, multifamily mortgage loans and commercial mortgage loans collectively referred to as the "Investment Portfolio"). The percentage of the Company's mortgage-related assets which is invested in various sectors of the Investment Portfolio may vary significantly from time to time depending upon the availability of mortgage loans and mortgage securities. The Company believes that its sales and due diligence organization and its mortgage industry expertise gives it certain advantages over other mortgage market participants. The Company uses its sales force to source mortgage loan pools, and uses its due diligence organization to analyze the credit risk characteristics of those pools. In addition, the Company acquires subordinate mortgage backed securities that bear the credit risk of specific mortgage loan pools. The Company uses its due diligence organization and industry expertise to analyze the credit risk characteristics of these mortgage loan pools in order to price these securities efficiently. Trends and Recent Developments PURCHASE OF SUBORDINATE MBS. As a result of the continued evolution of the mortgage loan and MBS markets in which the Company operates, market conditions in 1999 dictated a shift in the Company's strategy of acquiring mortgage loans and mortgage-backed securities, as compared to 1997 and 1998. Whereas the Company had previously focused primarily on acquiring seasoned mortgage loans, in 1999 and 2000 the Company focused primarily on acquiring subordinate MBS with characteristics similar to the subordinate MBS that the Company created in its securitizations. Prior to 1999, the Company had primarily invested its funds in mortgage whole loans, which were subsequently securitized. When the mortgage whole loans were securitized, the Company retained a subordinate interest in the loans. These subordinate interests are referred to as subordinate MBS. Other issuers also create subordinate MBS, and these subordinate MBS trade in organized markets. The market for subordinate MBS changed dramatically at the end of 1998 and in early 1999, resulting in a substantial buying opportunity for the Company. The pricing shifts experienced in early 1999 have remained consistent to-date. As a result of the change in relative pricing, the Company found that it could purchase subordinate MBS created by third party securitizers at very attractive yields. Additionally, the Company's costs to acquire subordinate MBS created by other issuers is substantially lower than the cost of creating its own subordinate MBS. As a result of these changes in the market, the Company took advantage of the new market conditions by curtailing its purchase of mortgage whole loans and purchasing existing MBS instead. In 2000, the Company purchased ten subordinate MBS with an aggregate principal balance of $9,273,000, 3 5 at a net purchase price of $5,941,000. The Company also purchased three MBS issued by agencies of the Federal government ("Agency") with an aggregate principal balance of $4,257,000 at a net purchase price of $4,626,000. In addition, the Company's affiliate, HCP, purchased twenty-seven subordinate MBS with an aggregate principal balance of $15,191,000, at a net purchase price of $8,451,000. All of the MBS purchased by HCP were either sold or transferred to Hanover in June 2000. The Company receives 97% of the income attributable to the subordinate MBS purchased by its affiliate. Portfolio Composition At December 31, 2000, the Company had invested $222,124,000 or 81.4% of the Company's total assets in single-family mortgage loans classified as held for sale, held to maturity or collateral for collateralized mortgage obligations ("CMOs"), and $25,846,000 or 9.5% of its total assets in single-family mortgage-backed securities classified as available for sale, held to maturity or held for trading. The composition of the investment portfolio is described in detail in Notes 3 and 4 to the Company's audited financial statements included in this Annual Report on Form 10-K. The revenues, operating profit and loss from the Company's investing activity is reflected on the Company's consolidated statement of operations. In 2000, the Company experienced $16,000 of mortgage loan losses on its mortgage loan portfolio (held for sale, held to maturity and collateral for CMOs), and $70,000 of losses on its mortgage-backed securities portfolio (available for sale, held to maturity and trading). The Company experienced $58,000 of mortgage loan losses during 1999 on its mortgage loan portfolio and no losses on its mortgage-backed securities portfolio. Notwithstanding the low level of losses actually incurred, the Company recorded a provision for anticipated credit losses of $875,000 and $446,000 in 2000 and 1999. The mortgage loans and created mortgage securities held in the Investment Portfolio generally will be held on a long-term basis, so that the returns will be earned over the lives of the mortgage loans and mortgage securities rather than from sales of the investments. The mortgage securities that the Company purchased may be held or sold from time to time depending on market conditions Securitization Activity In June 2000, the Company issued $13,222,000 of CMO borrowings at a discount of $2,013,000 for net proceeds before expenses of $11,209,000. The "Hanover 2000-A" CMO securities carry a fixed interest rate of 6.50%. The Hanover 2000-A securities are collateralized by $25,588,000 principal balance of the retained portions of Hanover's previous CMO borrowings, Hanover 98-A, Hanover 99-A and Hanover 99-B and certain retained mortgage backed securities from Hanover 98-B. In March 1999, the Company completed its third securitization transaction, the "1999-A" securitization, and thereby transferred $138,357,000 (par value) of mortgage loans to CMO collateral. In August 1999, the Company completed its fourth securitization transaction, the "1999-B" securitization, and thereby transferred $111,575,000 (par value) of mortgage loans to CMO collateral. In April 1998, the Company completed its first securitization, the "1998-A" securitization, and thereby transferred $103 million (par value) of mortgage loans to CMO collateral. In August 1998, the Company converted approximately $17 million (par value) of adjustable rate mortgage loans into FNMA mortgage securities, and in October and December the Company converted $56 million and $55 million (par value) of fixed rate mortgage loans into FNMA mortgage securities. In October 1998, the Company completed a $318 million (par value) securitization accomplished as a real estate mortgage investment conduit ("REMIC") structure through a taxable subsidiary of the Company, HCP-2. Simultaneously, the Company acquired from HCP-2 in exchange for all of the preferred stock of HCP-2, through two newly 4 6 created REIT qualified subsidiaries, all of the investment grade securities, (except for the "AAA" rated securities), the unrated securities, the interest-only securities and the principal only securities from the security transaction. The table below summarizes the Company's securitization transactions (dollars in thousands):

SECURITIZATION TRANSACTIONS Collateral Principal Mortgage Month Balance on Transaction Security Completed Transaction Date Type Created --------- ---------------- ---- ------- April 1998 $102,977 CMO structured as a REMIC Private Placement August 1998 17,404 Swap FNMA October 1998 317,764 REMIC Private Placement October 1998 55,650 Swap FNMA December 1998 55,208 Swap FNMA March 1999 138,357 CMO Private Placement August 1999 111,575 CMO Private Placement June 2000 25,588 CMO Private Placement

Subordinate Mortgage Backed Securities Purchases In analyzing subordinate MBS for purchase, the Company focuses primarily on subordinated interests ("tranches") in pools of whole single-family mortgage loans that do not fit into the large government-sponsored (FNMA, FHLMC or GNMA) conduits, typically because the principal balance of the mortgages exceeds the maximum amount permissible in a government-agency guaranteed MBS. The Company generally purchases subordinate MBS collateralized by "A" quality mortgages originated by several of the largest non-government mortgage conduits in the market. All of the Company's acquisitions of subordinate MBS to date have been fixed rate. The subordinate tranches that the Company purchases are generally structured so that they will absorb the credit losses resulting from a specified pool of mortgages. Since these tranches could potentially absorb credit losses, the tranches of securities the Company purchases are generally either not rated or are rated below investment grade (generally "BB" or "B"). These tranches are generally purchased at a substantial discount to their principal balance. This discount provides a cushion against potential future losses, and, to the extent that losses on the mortgage loans are less than the discount, the discount provides a yield enhancement. The Company primarily purchases subordinate MBS from "Wall Street" dealer firms, although the Company also is attempting to develop direct relationships with the larger issuers of subordinate MBS. For the foreseeable future, the Company believes that there will be an adequate supply of subordinate MBS available in the market. As of December 31, 2000, the Company and its affiliates had purchased since inception approximately $64,317,000 (principal balance) of subordinate MBS from third parties at an aggregate purchase price of $32,174,000. As of the same date, the Company had sold approximately $28,192,000 (principal balance) of such securities. At December 31, 2000 the Company owned $35,212,000 (principal balance) of subordinate MBS purchased from third parties, representing a subordinate interest in $5,401,000,000 of 5 7 single-family mortgage loan pools. The aggregate carrying value of these MBS at December 31, 2000 was $19,518,000. Because there are a number of regular issuers of subordinate MBS, the Company is not dependent upon any one source. Note 5 to the financial statements describes the concentration of the Company's portfolio by issuer. Management believes that the loss of any single financial institution from which the Company purchases subordinate MBS would not have any detrimental effect on the Company. One of the Company's unconsolidated subsidiaries, HCP, has a due diligence and consulting staff, located in Edison, New Jersey, consisting of approximately 33 full-time employees and access to a part-time pool of employees in excess of 500. The due diligence staff contributes to the subordinate MBS acquisition process by providing expertise in the analysis of many characteristics of the underlying single-family mortgage loans. Prior to making an offer to purchase a subordinate MBS, HCP employees conduct an extensive investigation and evaluation of the loans collateralizing the security. This examination typically consists of analyzing the information made available by the seller (generally, an outline of the portfolio with the information for each loan in the pool), reviewing other relevant material that may be available, analyzing the underlying collateral (including reviewing the Company's single-family mortgage loan database which contains, among other things, listings of property values and loan loss experience in local markets for similar assets), and in certain instances obtaining property specific opinions of value from third parties. The Company's senior management determines the amount to be offered for the security using a proprietary stratification and pricing system which focuses on, among other things, rate, term, location, credit scores and types of the loans. The Company also reviews information on the local economy and real estate markets (including the amount of time and procedures legally required to foreclose on real property) where the loan collateral is located. By examining the mortgage pool loan data, a prepayment speed is selected based primarily upon the gross coupons and seasoning of the subject pool. The Company also determines a "base case" default scenario and several alternative scenarios based on the Public Securities Association's standard default assumption ("SDA"). The default scenarios reflect the Company's estimate of the most likely range of potential losses on the underlying mortgage loans, taking into consideration the credit analysis described above. After determination of a prepayment speed and a base case SDA assumption, the pools' cash flow stream is modeled. The proposed purchase price is calculated as the present value of the base case cash flow stream, discounted by the current market rate for securities with similar product type and credit characteristics. The Company then examines the yield of the security under various alternative SDA and prepayment assumptions, and if necessary, adjusts the proposed purchase price so that it will receive an acceptable yield under a variety of possible scenarios. Single Family Mortgage Operations SINGLE-FAMILY MORTGAGE LOANS. In 2000, the Company did not purchase any mortgage whole loans. However, the Company continues to monitor the relative value available in the mortgage whole loan market vis-a-vis the subordinate MBS market. To the extent that the Company is able to purchase and securitize mortgage whole loans at attractive prices, the Company would attempt to do so, creating attractive yields on the resulting subordinate MBS. 6 8 In analyzing potential whole loan pools for purchase, the Company focuses on pools of whole single-family mortgage loans that do not fit into the large government-sponsored (FNMA, FHLMC or GNMA) or private conduit programs. Single-family mortgage loans generally are acquired in pools from a wide variety of sources, including private sellers such as banks, thrifts, finance companies, mortgage companies and governmental agencies. At December 31, 2000, the Company had purchased since inception in excess of $1 billion of single-family mortgage loan pools. Also, at December 31, 2000 the Company did not have any commitments outstanding to purchase single-family mortgage pools. Single-family mortgage loan pools are usually acquired through competitive bids or negotiated transactions. The competition for larger single-family mortgage loan portfolios is generally more intense, while there is less competition for smaller single-family mortgage loan portfolios. Management believes that the Company's funding flexibility, personnel, proprietary due diligence software and single-family mortgage loan trading relationships provide it with certain advantages over competitors in pricing and purchasing certain single-family mortgage loan portfolios. The Company purchases mortgages in bulk, after its bid has been accepted, subject to the Company's due diligence work. Prior to making an offer to purchase a single-family mortgage loan portfolio, HCP employees conduct an extensive investigation and evaluation of the loans in the portfolio. This examination typically consists of analyzing the information made available by the portfolio seller (generally, an outline of the portfolio with the credit and collateral files for each loan in the pool), reviewing other relevant material that may be available, analyzing the underlying collateral (including reviewing the Company's single-family mortgage loan database which contains, among other things, listings of property values and loan loss experience in local markets for similar assets), and obtaining opinions of value from third parties (and, in some cases, conducting site inspections). The Company's senior management determines the amount to be offered for the portfolio using a proprietary stratification and pricing system which focuses on, among other things, rate, term, location, credit scores and types of the loans. The proprietary stratification and pricing system identifies pool characteristics and segments loans by product type (i.e., fixed or adjustable rate, interest rate change frequency, ARM index, etc.). The segments are then further divided by credit quality using a logic program, which uses credit bureau scores and other criteria to grade loans within numerous categories. These categories include subdivisions such as loans eligible for sale/securitization to Fannie Mae or Freddie Mac (the "Agencies"), and further subdivisions of loans that only meet some Agency requirements, loans without mortgage insurance, loans with certain LTV and delinquency characteristics, etc. Upon completion of the product segmentation and loan grading phase, the resulting pools are individually priced and totaled to determine an overall portfolio value. The effective pricing would require information on gross weighted average coupon, servicing fee, original term, weighted average maturity, remittance data, settlement data and ARM data (i.e., index, margin, rate and payment reset frequency, etc.). By examining the mortgage pool loan data, a prepayment speed is selected based primarily upon the gross coupons and seasoning of the subject pool. After determination of a prepayment speed, the pool's cash flow stream is modeled. The present value of the cash flow stream is determined by discounting the cash flow by the current market rate for loans with similar product type and credit characteristics. 7 9 The Company also reviews information on the local economy and real estate markets (including the amount of time and procedures legally required to foreclose on real property) where the loan collateral is located. HCP's due diligence staff contributes to the single-family mortgage loan acquisition process by providing expertise in the analysis of many characteristics of the single-family mortgage loans. It has been Management's experience that buyers generally discount the price of a single-family mortgage loan if there is a lack of information. By accumulating additional information on loan pools through its due diligence operations, the Company believes it is better able to assess the value of loan pools. In conducting due diligence operations, HCP often discovers non-conforming elements of single-family mortgage loans, such as: (i) problems with documents, including missing or lost documentation, errors on documents, nonstandard forms of documents and inconsistent dates between documents, (ii) problems with the real estate, including inadequate initial appraisals, deterioration in property values or economic decline in the general geographic area, and (iii) miscellaneous problems, including poor servicing, poor credit history of the borrower, poor payment history by the borrower and current delinquency status. The price paid for such loans is adjusted to compensate for these non-conforming elements. The Company maintains a process to improve the value of its single-family mortgage loan portfolio, including updating data, obtaining lost note affidavits in the event that a note has been misplaced, updating property values with new appraisals, assembling historical records, obtaining mortgage insurance if the value of a loan is in question, grouping similar loans in packages for securitization, and segmenting portfolios for different buyers. However, Management believes that in most cases, any value created will be extracted by financing or securitizing the single-family mortgage loans and then realizing the enhanced spread on the retained pool, as opposed to recognizing a gain on sale of the single-family mortgage loan portfolio. SINGLE-FAMILY UNDERWRITING GUIDELINES. The Company has developed an underwriting approval policy to maintain uniform control over the quality of the single-family mortgage loans it purchases. This policy sets forth a three step review process: (i) collateral valuation, (ii) credit review, and (iii) property valuation. Prior to final purchase of a portfolio, a senior manager of the Company reviews the results of all three underwriting evaluations. The collateral valuation entails a check on the collateral documents (i.e., the note, mortgage, title policy and assignment chain). The documents are examined for conformity among the documents and adherence to secondary market standards. The credit review involves an analysis of the credit of the borrower, including an examination of the origination and credit documents, credit report and payment history. For more seasoned single-family mortgage loans, the analysis may be more directed at payment histories and credit scores. The property valuation involves an analysis of the loan-to-value of the collateral, including an examination of the original appraisal in the context of the current regional property market conditions and often a drive-by valuation of the subject property and review of recent comparable sales. SINGLE-FAMILY SERVICING. Pools of single-family mortgage loans are purchased with servicing retained or released by the seller. In the case of pools purchased with servicing retained by the seller, the Company considers the reputation and the servicing capabilities of the servicer. In some instances, the Company requires a master servicer to provide the assurance of quality required. A master servicer provides oversight of its subservicers and stands ready, and is contractually obligated, to take over the servicing if there is a problem with the subservicer. In the case of pools purchased with servicing released, the Company places the servicing with a qualified servicer. In some cases, the Company may retain the servicing and contract with a qualified servicer to provide subservicing. In this case, the Company keeps the risk of ownership of the servicing with respect to any change in value as a result of prepayment of the 8 10 underlying single-family mortgage loans or other factors. If the Company contracts out to a servicer the servicing of a mortgage loan pool, the servicer's responsibilities would include collection of the borrower's remittances, proper application of the borrower's remittances to principal, interest and escrow, remitting collections to the master servicer and remitting advances to the master servicer on delinquent loans (for principal and interest only). The master servicer would then remit funds and loan level documentation to the Company, or if the loan is securitized - to the trustee. The trustee would then distribute the funds to the certificate holders. Neither the Company nor any of its affiliates are involved in any single-family servicing operations. Commercial Mortgage Loans and Multifamily Mortgage Loans The Company discontinued its commercial and multifamily mortgage origination business in the second quarter of 1999. HCP's wholly-owned subsidiary, Hanover Capital Mortgage Corporation ("HCMC"), has retained the relevant licenses necessary to originate these mortgages, and may at some point decide to re-enter this market. HCMC was one of the first commercial mortgage banking operations to originate multifamily mortgage loans for sale to conduits, which are financial firms (generally "Wall Street" firms) that purchase loans on real estate with the specific intention to convert the underlying mortgages to securities in the form of bonds. COMMERCIAL AND MULTIFAMILY MORTGAGE LOAN SERVICING. The Company continues to service a very limited number of multifamily and commercial mortgages. HCMC, as servicer, will have the risks associated with operating a mortgage servicing business as well as the risk of ownership of the servicing. HCMC serviced approximately $10 million and $13 million of multifamily mortgage loans at December 31, 2000 and December 31, 1999. The servicing of mortgage loans involves processing and administering the mortgage loan payments for a fee. It involves collecting mortgage payments on behalf of investors, reporting information to investors and maintaining escrow accounts for the payment of principal and interest to investors and property taxes and insurance premiums on behalf of borrowers. The primary risk of operating a servicing business is failing to service the loans in accordance with the servicing contracts, which exposes the servicer to liability for possible losses suffered by the owner of the loans. The operational requirements include proper handling and accounting for all payment and escrow amounts, proper borrower and periodic credit reviews, proper value and property reviews and proper payment of all monies due to third parties, such as real estate taxing authorities and insurance companies. The primary risks of ownership of servicing rights include the loss of value through faster than anticipated loan prepayments (even though there may be prepayment penalties) or improper servicing as outlined above. 9 11 HANOVER CAPITAL PARTNERS LTD. The Company conducts due diligence and consulting operations through HCP for commercial banks, government agencies, mortgage banks, credit unions and insurance companies. The operations consist of loan sale advisory assignments, the underwriting of credit, analysis of loan documentation and collateral, analysis of the accuracy of the accounting for mortgage loans serviced by third party servicers, and the preparation of documentation to facilitate the transfer of mortgage loan. The due diligence analyses are performed on a loan by loan basis. Consulting services include loan sale advisory work for government agencies such as the Small Business Administration and Federal Deposit Insurance Corporation as well as private sector financial institutions. HCP also performs due diligence on mortgage loans acquired by the Company. HCP owns a licensed mortgage banker, HCMC, and a licensed broker-dealer, Hanover Capital Securities, Inc. ("HCS"). Although HCP maintains these companies' licenses in good standing, neither of these companies currently conduct any material ongoing business. As noted above, HCMC originated multifamily mortgage loans until June 1999, when this activity was discontinued, and continues to service a small number of multifamily loans. In January 2000, HCP hired all of the former management of Document Management Network, Inc. and is continuing DMN's business as the Assignment Division of HCP. The Assignment Division provides mortgage assignment services for many of the same customers serviced by HCP. Whenever an institution purchases a mortgage loan in the secondary market, the purchaser is required to submit paperwork (called an "assignment of mortgage") to the local county or city jurisdiction in which the mortgaged property is located in order to record the new institution's interest in the mortgaged property. The Assignment Division employees prepare and process this paperwork for third party institutions. HANOVERTRADE.COM, INC. The Company conducts loan brokering and trading, and loan sale advisory services through HTC. HTC operates an online world wide web-based exchange for trading loan pools (primarily mortgage loan pools) and performs loan sale advisory services for third parties. HTC was incorporated on May 28, 1999. In the third quarter of 2000, the loan brokering and trading activities of HCP were combined with the HTC activities. HTC officially launched its web-site on October 29, 2000. In January of 2000, HTC hired all of the former employees and acquired all of the assets of Pamex Capital Partners, LLC. (We refer to this as "Pamex.") Prior to its acquisition, Pamex was a traditional broker of pools of mortgage loans and consumer loans. With the acquisition of Pamex and subsequent reassignments, HTC has 9 full-time salespeople. These salespeople attempt to maintain regular contact with all of the major buyers and sellers of mortgage and consumer whole loans. As of January 31, 2001, registered members of the site accounted for approximately 51% of the domestic US mortgage origination market. HTC arranges for the sale of pools of mortgage loans, consumer loans and commercial mortgage loans to institutional purchasers. HTC arranges for such sales through its web site as well as through traditional channels, including telephone contact and e-mail. Typically, HTC attempts to utilize its web site to assist in the process of selling larger pools of mortgage loans that conform to industry recognized underwriting standards. For smaller pools, or pools that do not conform to industry recognized standards, HTC will attempt to sell these pools using more traditional means. To assist in the sales process of these pools, HTC may prepare marketing materials and marketing analyses for sellers of pools. FINANCING General The Company's purchases of mortgage related assets are initially financed primarily with equity and short-term borrowings through reverse repurchase agreements until long-term financing is arranged or the assets are securitized. Generally, upon repayment of each borrowing in the form of a reverse repurchase agreement, the mortgage asset used to collateralize the financing will immediately be pledged to secure a new reverse repurchase agreement or some form of long term financing. The Company had established committed and uncommitted mortgage asset financing agreements from various financial institutions at December 31, 2000. 10 12 Reverse Repurchase Agreements A reverse repurchase agreement ("repo"), although structured as a sale and repurchase obligation, is a financing transaction in which the Company pledges its mortgage assets as collateral to secure a short-term loan. Generally, the other party to the agreement will loan an amount equal to a percentage of the market value of the pledged collateral, ranging from 50% to 97% depending on the credit quality of the collateral pledged. At the maturity of the reverse repurchase agreement, the Company is required to repay the loan and correspondingly receives back its collateral. Under reverse repurchase agreements, the Company generally retains the incidents of beneficial ownership, including the right to distributions on the collateral and the right to vote on matters as to which certificate holders vote. If the Company defaults in a payment obligation under such agreements, the lending party may liquidate the collateral. In the event of the insolvency or bankruptcy of the Company, certain reverse repurchase agreements may qualify for special treatment under the United States Bankruptcy Code, which permits the creditor to avoid the automatic stay provisions of the Bankruptcy Code and to foreclose on the collateral without delay. In the event of the insolvency or bankruptcy of a lender during the term of a reverse repurchase agreement, the lender may be permitted, under the Bankruptcy Code, to repudiate the contract, and the Company's claim against the lender for damages therefrom may be treated simply as that of an unsecured creditor. In addition, if the lender is a broker or dealer subject to the Securities Investor Protection Act of 1970 or an insured depository institution subject to the Federal Deposit Insurance Act, the Company's ability to exercise its rights to recover its mortgage assets under a reverse repurchase agreement or to be compensated for damages resulting from the lender's insolvency may be limited by those laws. The effect of these various statutes is, among other things, that a bankrupt lender, or its conservator or receiver, may be permitted to repudiate or disaffirm its reverse repurchase agreements, and the Company's claims against the bankrupt lender may be treated as an unsecured claim. Should this occur, the Company's claims would be subject to significant delay and, if and when paid, could be in an amount substantially less than the damages actually suffered by the Company. To reduce its exposure to the credit risk of reverse repurchase agreements, the Company enters into such arrangements with several different parties. The Company monitors its exposure to the financial condition of its reverse repurchase agreement lenders on a regular basis, including the percentage of its mortgage loans that are the subject of reverse repurchase agreements with a single lender. Notwithstanding these measures, no assurance can be given that the Company will be able to avoid such third party risks. The reverse repurchase borrowings bear short-term (one year or less) fixed interest rates varying from LIBOR to LIBOR plus 288 basis points depending on the credit of the related mortgage assets. Generally, the borrowing agreements require the Company to deposit additional collateral in the event the market value of existing collateral declines, which, in rising interest-rate markets, could require the Company to sell assets to reduce the borrowings. There exists a risk during the initial holding of the mortgage loan assets, when the mortgage loan assets are financed with repo agreements, that adverse developments in the mortgage market could cause the repo lenders to reduce the mark to market on the mortgage loans collateralizing the repo agreements. A reduction in the repo lender's market value calculations could result in margin calls that could be in excess of the Company's liquid assets. In this situation, the Company might be forced to sell other portfolio assets to meet the repo lender's margin call. There also exists a risk during the initial holding period of the mortgage loan assets that there might be no demand or very limited demand for the creation of new mortgage securitizations. If this situation were to exist for an extended time period, the Company might be forced to maintain repo financing on its mortgage assets for a longer than intended period, 11 13 which might cause repo financing availability to become more scarce and might cause repo financing terms to become more onerous for the Company. SECURITIZATION AND SALE PROCESS General During periods when the Company is acquiring mortgage whole loans, the Company normally securitizes the mortgage loans through the issuance of mortgage-backed securities after acquiring a sufficient volume of mortgage loans with similar characteristics, generally $50 million to $100 million or more. Such securitization generally will be in the form of collateralized mortgage obligations but may also be in the form of REMICs. Alternatively, to a lesser extent and to the extent consistent with the Company's qualification as a REIT, the Company may resell loans in bulk whole loan sales. The length of time from when the Company commits to purchase a mortgage loan to when it sells or securitizes the loan will generally range from 30 days to one year or more, depending on several factors, including the length of the purchase commitment period, the amount and type of the mortgage loan, and the securitization process. For accounting and tax purposes, mortgage loans financed through the issuance of CMOs are treated as assets of the Company, and the CMOs are treated as debt of the Company. The Company earns the net interest spread between the interest income on the mortgage loans and the interest and other expenses associated with the CMO financing. The net interest spread will be directly affected by prepayments of the underlying mortgage loans and, to the extent the CMOs have variable interest, may be affected by changes in short-term interest rates. The Company may from time to time issue REMICs. REMIC transactions are generally accounted for as sales of the mortgage loans for tax purposes and can be accounted for as sales or financings for accounting purposes depending upon various criteria. REMIC securities consist of one or more classes of "regular interests" and a single "residual interest". The regular interests are tailored to the needs of investors and may be issued in multiple classes with varying maturities, average lives and interest rates. These regular interests are predominantly senior securities but, in conjunction with providing credit enhancement, may be subordinated to the rights of other regular interests. The residual interest represents the remainder of the cash flows from the underlying mortgage loans over the amounts required to be distributed on the regular interests. In some cases, the regular interests may be structured so that there is no significant residual cash flow. In such a REMIC transaction, the Company sells its entire interest in the mortgage loans, and all of the capital originally invested in the mortgage loans may be reinvested. The Company may retain regular and residual interests on a short-term or long-term basis. Gain on sale income from the issuance of REMICs may not qualify as acceptable REIT income for tax purposes. Accordingly, REMIC issuances will generally be undertaken through the taxable subsidiaries. The Company expects that its retained interests in securitizations will be subordinated to the securities issued to third party investors with respect to losses of principal and interest on the underlying mortgage loans. Accordingly, any such losses on underlying mortgage loans will be applied first to reduce the remaining amount of the Company's retained interest, until reduced to zero. Any retained regular interest may include "principal only" or "interest only" securities or other interest rate or prepayment sensitive securities or investments. Any retained securities may subject the Company to credit, interest rate and/or prepayment risks. The Company anticipates it will retain securities only on terms which it believes are sufficiently attractive to compensate it for assuming the associated risks. 12 14 The Company may also retain subordinated mortgage backed securities, with ratings ranging from AA to unrated, generally fixed-rate. The fixed-rate securities generally evidence interests in 30-year single-family mortgage loans. Securities backed by multifamily mortgage loans and commercial loans are generally interests in 7 or 10 year balloon loans with 25 or 30 year amortization schedules. In general, subordinated classes bear all losses prior to the related senior classes. Losses in excess of losses anticipated at the time subordinated securities are purchased would adversely affect the Company's yield on the securities and, in extreme circumstances, could result in the failure of the Company to recoup its initial investment. Except in the case of breach of the representations and warranties made by the Company when mortgage loans are securitized, the securitization of mortgage loans will be non-recourse to the Company. As a result, the Company is able to maintain the economic benefit of financing the mortgage assets and earning a positive net interest spread, while limiting its potential risk of credit loss to its investment in the subordinated or residual securities (generally approximately 5% to 10% of the loan pool amount). A second advantage to the CMO structure is that it is permanent financing and, therefore, not subject to margin calls during periods in which the value of the pool assets is declining due to increases in interest rates. The Company may also pay a monoline bond insurer a monthly fee to assume a portion of the credit risk in a pool of mortgage loans. The monoline insurer would generally require the issuer to retain a portion of the credit risk and over-collateralize a particular pool of mortgage loans. Proceeds from securitizations will be available to support new loan originations and acquisitions. In addition to providing relatively less expensive long-term financing, Management believes that the Company's securitizations will reduce the Company's interest rate risk on mortgage assets held for long-term investment. Credit Enhancement CMOs or REMICs created by the Company are structured so that one or more of the classes of the securities are rated investment grade by at least one nationally recognized rating agency. The ratings for the Company's mortgage assets will be based on the rating agency's view of the perceived credit risk of the underlying mortgage loans, the structure of the mortgage assets and the associated level of credit enhancement. Credit enhancement is designed to provide protection to the holders of the securities in the event of borrower defaults and other losses, including reductions in the principal or interest as required by law or a bankruptcy court. The Company can utilize multiple forms of credit enhancement, including special hazard insurance, monoline insurance, reserve funds, letters of credit, surety bonds and subordination or any combination thereof. A decline in the credit quality of the mortgage loans backing any mortgage securities or of any third party providing credit enhancement, or adverse developments in general economic trends affecting real estate values or the mortgage industry, could result in ratings being downgraded. In determining whether to provide credit enhancement, the Company takes into consideration the costs associated with each method. The Company generally provides credit enhancement through the issuance of mortgage-backed securities in senior/subordinated structures or by over-collaterization of its mortgage assets. The need for additional collateral or other credit enhancements will depend upon factors such as the type of collateral provided and the interest rates paid thereon, the geographic concentration of the mortgaged property and other criteria established by the rating agency. The pledge of additional collateral would reduce the capacity of the Company to raise additional funds through short-term secured borrowings or additional CMOs and diminish the potential expansion of the Investment Portfolio. 13 15 Accordingly, collateral would be pledged for CMOs only in the amount required to obtain the highest rating category of a nationally-recognized rating agency. The subordinated mortgage securities may be sold, retained by the Company or accumulated for sale in subsequent transactions. Other Mortgage-Backed Securities As an additional alternative for the financing of the Investment Portfolio, the Company may cause to be issued other mortgage-backed securities if the issuance of such other securities is advantageous and consistent with the Company's qualification as a REIT. In particular, mortgage pass-through certificates representing undivided interests in pools of mortgage loans formed by the Company may prove to be attractive vehicles for raising funds. The holders of mortgage pass-through certificates receive their pro rata share of the principal payments made on a pool of mortgage loans and interest at a pass-through interest rate that is fixed at the time of the offering. The Company intends to retain significant portions of the undivided interests in the mortgage loans underlying pass-through certificates. The retained interest may also be subordinated so that, in the event of a loss, payments to certificate holders will be made before the Company receives its payments. Unlike the issuance of CMOs, the issuance of mortgage pass-through certificates will not create an obligation of the Company to security holders in the event of a borrower default. However, as in the case of CMOs, the Company may be required to obtain credit enhancement in order to obtain a rating for the mortgage pass-through certificates in one of the top two rating categories established by a nationally-recognized rating agency. CAPITAL ALLOCATION GUIDELINES (CAG) The Company has adopted capital allocation guidelines ("CAG") in order to strike a balance between the under-utilization of leverage and excess dependence on leverage, which could reduce the Company's ability to meet its obligations during adverse market conditions. Modifications to the CAG require the approval of a majority of the Company's Board of Directors. The CAG are intended to keep the Company's leverage balanced by (i) matching the amount of leverage to the riskiness (return and liquidity) of each investment, and (ii) monitoring the credit and prepayment performance of each investment to adjust the required capital. This analysis takes into account the Company's various hedging and other risk containment programs discussed below. The minimum amount of equity the lender requires with a mortgage asset is generally referred to as the lender haircut. There is some variation in haircut levels among lenders from time to time. From the lender's perspective, the haircut is a "cushion" to provide additional protection if the value of or cash flow from an asset pool declines. The size of the haircut depends on the liquidity and price volatility of each investment. Agency securities are very liquid, with price volatility in line with the fixed income markets, which means a lender requires a smaller haircut, typically 3%. On the other extreme, securities rated below "AAA" and securities not registered with the Securities and Exchange Commission are substantially less liquid, and have more price volatility than Agency securities, which results in a lender requiring a larger haircut (5% to 50% depending on the rating). Particular securities that are performing below expectations would also typically require a larger haircut. The haircut for residential whole loan pools will generally range between 3% and 5% depending on the documentation and delinquency characteristics of the pool. Certain whole loan pools may have haircuts which may be negotiated with lenders in excess of 5% due to other attributes of the pool (delinquencies, aging, liens etc.). 14 16 Implementation of the CAG -- Mark to Market Accounting Each quarter, for financial management purposes, the Company marks its investments to market. This process consists of (i) valuing the Company's investments acquired in the secondary market, and (ii) valuing the Company's non-security investments, such as retained interests in securitizations. For the first category, the Company obtains benchmark market quotes from traders who make markets in securities similar in nature to the Company's investments. The Company then adjusts for the difference in pricing between securities and whole loan pools. Market values for the Company's retained interests in securitizations are calculated internally using market assumptions for losses, prepayments and discount rates. The face amount of the financing used for the securities and retained interests is subtracted from the current market value of the investments. This is the current market value of the Company's equity positions. This value is compared to the required capital as determined by the CAG. If the actual equity of the Company falls below the capital required by the CAG, the Company must prepare a plan to bring the actual capital above the level required by the CAG. Periodically, management presents to the Board of Directors the results of the CAG compared to actual equity. Management may propose changing the capital required for a class of investments or for an individual investment based on its prepayment and credit performance relative to the market and the ability of the Company to predict or hedge the risk of the investments. As a result of these procedures, the leverage of the balance sheet will change with the performance of the Company's investments. Good credit or prepayment performance may release equity for purchase of additional investments. Poor credit or prepayment performance may cause additional equity to be allocated to existing investments, forcing a reduction in investments on the balance sheet. In either case, the periodic investments performance evaluation, along with the corresponding leverage adjustments, is intended to help to maintain the maximum acceptable leverage (and earnings) while protecting the capital base of the Company. RISK MANAGEMENT The Company believes that its portfolio income is subject to three primary risks: credit risk, interest rate risk and prepayment risk. Credit Risk Management The Company seeks to reduce credit risk through (i) the review of each mortgage-backed security or mortgage loan prior to purchase to ensure that it meets the guidelines established by the Company, (ii) use of early intervention, aggressive collection and loss mitigation techniques in the servicing process, (iii) use of insurance in the securitization process, (iv) maintenance of appropriate capital and reserve levels, and (v) obtaining representations and warranties, to the extent possible, from originators. Although the Company does not set specific geographic diversification requirements, the Company monitors the geographic dispersion of the mortgage loans and makes decisions on a portfolio by portfolio basis about adding to specific concentrations. Single-family mortgage loans are generally purchased in bulk pools of $2 million to $100 million. The credit underwriting process varies depending on the pool characteristics, including seasoning, loan-to-value ratios and payment histories. For a new pool of single-family mortgage loans, a full due diligence review is undertaken, including a review of the documentation, appraisal reports and credit underwriting. 15 17 Where required, an updated property valuation is obtained. The bulk of the work is performed by employees in the due diligence operations of HCP. Interest Rate Risk Management For accounting purposes, the Company has three basic types of mortgage loans and four basic types of MBS. Mortgage loans are classified as (i) mortgage loans held for sale, (ii) mortgage loans held to maturity, or (iii) collateral for CMOs. MBS are classified as (i) available for sale, (ii) held to maturity, (iii) held for trading or (iv) collateral for CMOs. Fixed rate mortgage loans and MBS held for sale, available for sale or held for trading are generally hedged. A variety of hedging instruments may be used, depending on the asset or liability to be hedged and the relative price of the various hedging instruments. Possible hedging instruments include forward sales of mortgage securities, and may also include interest rate futures or options, interest rate swaps, and caps and floor agreements. Mortgage loans held in securitized form are generally financed in a manner intended to maintain a consistent spread in a variety of interest rate environments and therefore are not hedged. The Company may purchase interest rate caps, interest rate swaps and similar instruments to attempt to mitigate the risk of the cost of its variable rate liabilities increasing at a faster rate than the earnings on its mortgage assets during a period of rising interest rates. The Company generally hedges as much of the interest rate risk as management determines is reasonable, given the cost of such hedging transactions and the need to maintain the Company's status as a REIT, among other factors. The Company may also, to the extent consistent with its qualification as a REIT and Maryland law, utilize financial futures contracts, options and forward contracts and other instruments as a hedge against future interest rate changes. See "Business - Hedging." Prepayment Risk Management Prepayment risk is monitored by senior management and through periodic review of the impact of a variety of prepayment scenarios on the Company's revenues, net earnings, dividends, cash flow and net balance sheet market value. Although the Company believes it has developed a cost-effective asset/liability management program to provide a level of protection against credit, interest rate and prepayment risks, no strategy can completely insulate the Company from the effects of credit risk, interest rate changes, prepayments and defaults by counterparties. Further, certain of the Federal income tax requirements that the Company must satisfy to qualify as a REIT limit the Company's ability to fully hedge its interest rate and prepayment risks. HEDGING Investment Portfolio The Company's primary method of addressing interest rate risk on its mortgage loans is through its strategy of securitizing mortgage loans with collateralized mortgage obligation ("CMO") borrowings or REMIC financing, which are designed to provide long term financing while maintaining a consistent spread in a variety of interest rate environments. The Company believes that its primary interest rate risk relates to MBS and mortgage loans that are financed with reverse repurchase agreements. The Company uses certain hedging strategies in connection with the management of the Investment Portfolio. To the extent consistent with the Company's REIT status, the Company follows a hedging 16 18 program intended to protect against interest rate changes and to enable the Company to earn net interest income in periods of generally rising, as well as declining or static, interest rates. Specifically, the goal of the hedging program is to offset the potential adverse effects of changes in interest rates relative to the interest rates of the mortgage assets held in the Investment Portfolio. As part of its hedging program, the Company also monitors prepayment risks that arise in fluctuating interest rate environments. The Company may use a variety of instruments in its hedging program. Two examples currently used are interest rate caps and short sales of so called "TBA" securities. In a typical interest rate cap agreement, the cap purchaser makes an initial lump sum cash payment to the cap seller in exchange for the seller's promise to make cash payments to the purchaser on fixed dates during the contract term if prevailing interest rates exceed the rate specified in the contract. The Company enters into interest rate hedge mechanisms (interest rate caps) to manage its interest rate exposure on certain reverse repurchase agreement financing. The cost of the interest rate caps is amortized over the life of the interest rate cap and is reflected as a portion of interest expense in the consolidated statement of operations. "TBA" securities (which stands for "to be announced") are commitments to deliver mortgage securities which have not yet been created. When the Company short sells a TBA security, it ordinarily covers the short sale within a month by agreeing to buy a similar TBA security. The Company would then sell another TBA security and cover that sale in the following month and so on. The changes in market prices from such short sales are intended to offset changes in interest rates that could offset either the market price or the net interest margin earned on the Company's investment portfolio. The Company may also use, but as yet has not used, mortgage derivative securities. Mortgage derivative securities can be used as effective hedging instruments in certain situations as the value and yields of some of these instruments tend to increase as interest rates rise and to decrease as interest rates decline, while the experience for others is the converse. The Company will limit its purchases of mortgage derivative securities to investments that meet REIT requirements. To a lesser extent, the Company may also enter into, but again has not entered into, interest rate swap agreements, financial futures contracts and options on financial futures contracts, and forward contracts. However, the Company will not invest in these instruments unless the Company is exempt from the registration requirements of the Commodity Exchange Act or otherwise complies with the provisions of that Act. The REIT rules may restrict the Company's ability to purchase certain instruments and may restrict the Company's ability to employ other strategies. In all its hedging transactions, the Company deals only with counterparties that the Company believes are sound credit risks. In connection with securitizations of mortgage loans, the Company is subject to the risk of rising mortgage interest rates between the time it commits to a fixed price purchase and the time it sells or securitizes the mortgage loans. To mitigate this risk, the Company currently utilizes interest rate caps and forward sales of Agency mortgage securities and may utilize other hedging strategies, including mandatory and optional forward selling of mortgage loans or mortgage-backed securities, interest rate floors, and buying and selling of futures and options on futures. The nature and quantity of these hedging transactions is determined by the management of the Company based on various factors, including market conditions and expected volume of mortgage loan purchases. Costs and Limitations The Company believes that it has implemented a cost-effective hedging policy to provide an adequate level of protection against interest rate risks. However, maintaining an effective hedging strategy is complex, and no hedging strategy can completely insulate the Company from interest rate risks. Moreover, as noted above, certain of the REIT rules limit the Company's ability to fully hedge its interest rate risks. The Company monitors carefully, and may have to limit, its hedging strategies to 17 19 assure that it does not violate the REIT rules, which could result in disqualification and/or payment of penalties. In addition, hedging involves transaction and other costs, which can increase dramatically as the period covered by the hedge increases and also increase in periods of rising and fluctuating interest rates. Therefore, the Company may be prevented from effectively hedging its interest rate risks without significantly reducing the Company's return on equity. SERVICING RIGHTS Whether servicing is purchased by the Company (along with purchased single-family mortgage loans or purchased multifamily mortgage loans and commercial mortgage loans) or created by HCMC (by the origination of multifamily mortgage loans and commercial mortgage loans), a value is placed on the servicing as a purchased mortgage servicing right ("PMSR") or an originated mortgage servicing right ("OMSR"), as the case may be, and recorded as an asset on the books of the respective entity. The valuation of a PMSR and an OMSR includes an analysis of the characteristics of the size, rate, escrow amounts, type, maturity, etc. of the loan, as well as an estimate of the mortgage loan's remaining life. To the extent the characteristics change or the estimate of remaining life changes, the value of the PMSR or OMSR will be adjusted. For example, if mortgage loans are repaid more quickly than originally forecasted (increased speed), the value of the OMSR or PMSR will be reduced. REGULATION Although HCMC does not currently originate mortgage loans, HCMC continues to service a small number of loans and has retained its mortgage-banking licenses in several states. In addition, the Company's activities are subject to the rules and regulations of HUD. Mortgage operations also may be subject to applicable state usury and collection statutes. HCP's wholly owned subsidiary, Hanover Capital Securities, Inc., is a registered broker/dealer with the Securities and Exchange Commission. COMPETITION The Company participates on a national level in the mortgage market, which is estimated at $5 trillion for single-family mortgage loans. In purchasing mortgage loans and MBS and issuing mortgage-backed securities, the Company competes with other REITs, established mortgage conduit programs, investment banking firms, savings and loan associations, banks, thrift and loan associations, finance companies, mortgage bankers, insurance companies, other lenders and other entities purchasing mortgage assets. In addition, there are several mortgage REITs similar to the Company and others may be organized in the future. Continued consolidation in the mortgage banking industry may reduce the number of sellers of mortgage loans, which would reduce the Company's potential customer base and result in the Company purchasing a larger percentage of mortgage loans from a smaller number of sellers. These changes could negatively impact the Company. As an issuer of mortgage securities, the Company will face competition for investors from other investment opportunities. Increasingly, mortgage lending is being conducted by mortgage lenders who specialize in the origination and servicing of mortgage loans and then sell these loans to other mortgage investment institutions, such as the Company. The Company believes it has a competitive advantage because of the low cost of its operations relative to traditional mortgage investors such as banks and savings and loans. Like 18 20 traditional financial institutions, the Company seeks to generate income for distribution to its shareholders primarily from the difference between the interest income on its mortgage assets and the financing costs associated with carrying the mortgage assets. EMPLOYEES Hanover had five employees (the "Principals") at December 31, 2000. Hanover engages the services of HCP to provide management expertise, product sourcing, due diligence support, and general and administrative services to assist Hanover in accomplishing its business objectives. At December 31, 2000, HCP employed 33 people on a full-time basis and 31 people on a part-time basis. HCP periodically hires additional employees on a temporary basis to perform due diligence and consulting service work on specific engagements. Nine of these 33 people devote substantially all their time to HTC. HTC does not have a separate payroll. HCP maintains a database of approximately 500 individuals that can be employed for due diligence and consulting engagements. To date, the Company and its subsidiaries believe they have been successful in their efforts to recruit qualified employees, but there is no assurance that it will continue to be successful in the future. None of the employees are subject to collective bargaining agreements. TRADEMARKS HCP owns two registered trademarks that have been registered with the United States Patent and Trademark Office, each of which expires in the year 2003. HTC is in the process of registering one trademark with the United States Patent and Trademark office. FUTURE REVISIONS IN POLICIES AND STRATEGIES The Board of Directors has established the Company's investment and operating policies, which can be revised only with the approval of the Board of Directors, including a majority of the unaffiliated directors. Except as otherwise restricted, the Board of Directors may revise the policies without the consent of stockholders if the Board of Directors determines that the change is in the best interests of stockholders. Developments in the market which affect the policies and strategies mentioned herein or which change the Company's assessment of the market may cause the Board of Directors to revise the Company's policies and financing strategies. The Company has elected to qualify as a REIT for tax purposes (see "Federal Income Tax Considerations"). The Company has adopted certain compliance guidelines which include restrictions on the acquisition, holding and sale of assets. Prior to the acquisition of any asset, the Company determines whether the asset meets REIT requirements. Substantially all of the assets that the Company has acquired and will acquire for investment are expected to qualify as REIT assets. This requirement limits the Company's investment strategies. The Company closely monitors its purchases of mortgage assets and the sources of its income, including from its hedging strategies, to ensure at all times that it maintains its qualifications as a REIT. The Company has developed certain accounting systems and testing procedures to facilitate its ongoing compliance with the REIT provisions of the Code. No changes in the Company's investment policies and operating strategies, including credit criteria for mortgage asset investments, may be made without the approval of the Company's Board of Directors, including a majority of the unaffiliated directors. The Company intends to conduct its business so as not to become regulated as an investment company under the Investment Company Act of 1940. The Investment Company Act exempts entities that are "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on 19 21 and interests in real estate" ("Qualifying Interests"). Under current interpretation of the staff of the Securities and Exchange Commission, in order to qualify for this exemption, the Company must maintain at least 55% of its assets directly in Qualifying Interests. In addition, unless certain mortgage securities represent all the securities issued with respect to an underlying pool of mortgages, the securities may be treated as securities separate from the underlying mortgage pool and, thus, may not be considered Qualifying Interests for purposes of the 55% requirement. The Company closely monitors its compliance with this requirement and intends to maintain its exempt status. As of this date, the Company has been able to maintain its exemption through the purchase of mortgage loan pools and certain whole pool government Agency securities that qualify for the exemption. A REIT is subject to a 100% tax on the net income from prohibited transactions. The only "prohibited transaction" is the sale or disposition of property, that is not foreclosure property, held primarily for sale to customers in the ordinary course of a trade or business. Management believes that none of the 1999 or 2000 sales transactions would be classified as prohibited transactions. 22 FEDERAL INCOME TAX CONSIDERATIONS General Hanover has elected to be treated as a REIT for income tax purposes, pursuant to the Internal Revenue Code of 1986, as amended (sometimes referred to as the "Code"). In brief, if certain detailed conditions imposed by the REIT provisions of the Code are met, entities that invest primarily in real estate investments and mortgage loans, and that otherwise would be taxed as corporations are, with certain limited exceptions, not taxed at the corporate level on their taxable income that is currently distributed to their shareholders. This treatment eliminates most of the "double taxation" (at the corporate level and then again at the shareholder level when the income is distributed) that typically results from the use of corporate investment vehicles. In the event that Hanover does not qualify as a REIT in any year, it would be subject to Federal income tax as a domestic corporation and the amount of Hanover's after-tax cash available for distribution to its shareholders would be reduced. Hanover believes it has satisfied the requirements for qualification as a REIT since commencement of its operations in September 1997. Hanover intends at all times to continue to comply with the requirements for qualification as a REIT under the Code, as described below. Requirements for Qualification as a REIT To qualify for tax treatment as a REIT under the Code, Hanover must meet certain tests which are described briefly below. Ownership of Common Stock For all taxable years after its first taxable year, Hanover's shares of capital stock must be held by a minimum of 100 persons for at least 335 days of a 12 month year (or a proportionate part of a short tax 20 23 year). In addition, at any time during the second half of each taxable year, no more than 50% in value of the capital stock of Hanover may be owned directly or indirectly by five or fewer individuals. Hanover is required to maintain records regarding the actual and constructive ownership of its shares, and other information, and to demand statements from persons owning above a specified level of the REIT's shares (if Hanover has 200 or fewer shareholders of record, from persons holding 0.5% or more of Hanover's outstanding shares of capital stock) regarding their ownership of shares. Hanover must keep a list of those shareholders who fail to reply to such a demand. Hanover is required to use (and does use) the calendar year as its taxable year for income tax reporting purposes. Nature of Assets On the last day of each calendar quarter, Hanover must satisfy three tests relating to the nature of its assets. First, at least 75% of the value of Hanover's assets must consist of mortgage loans, certain interests in mortgage loans, real estate, certain interests in real estate (the foregoing, "Qualified REIT Assets"), government securities, cash and cash items. Hanover expects that substantially all of its assets will continue to be Qualified REIT Assets. Second, not more than 25% of Hanover's assets may consist of securities that do not qualify under the 75% asset test. Third, of the investments in securities not included in the 75% asset test, the value of any one issuer's securities may not exceed 5% by value of Hanover's total assets, and Hanover may not own more than 10% of any one issuer's outstanding voting securities. On December 17, 1999, as part of a larger bill, the President signed into law the REIT Modernization Act ("RMA"). Effective January 1, 2001, the RMA amended tax rules relating to the composition of REITs assets. Under prior law, a REIT was precluded from owning more than 10% of the outstanding voting securities of any one issuer, other than a wholly owned subsidiary or another REIT. Beginning in 2001, a REIT will remain subject to the current restriction and be precluded from owning more than 10% of the value of all classes of securities of any one issuer. There is an exception to this prohibition. A REIT will be allowed to own up to 100% of the securities of a taxable REIT subsidiary ("TRS"). However, no more than 20% of the value of a REIT's total assets may be represented by securities of one or more TRSs. The amount of debt and rental payments from a TRS to a REIT will be limited to ensure that a TRS is subject to an appropriate level of corporate tax. The new 10% asset test will not apply to certain arrangements (including third party subsidiaries) in place on July 12, 1999, provided that the subsidiary does not engage in a "substantial" new line of business, its existing business does not increase, and a REIT does not acquire any new securities in the subsidiary. Under the RMA, a third party subsidiary will be able to convert tax free into a TRS. Pursuant to its compliance guidelines, Hanover intends to monitor closely the purchase and holding of its assets in order to comply with the above asset tests. Sources of Income Hanover must meet the following two separate income-based tests each year: 1. 75% INCOME TEST. At least 75% of Hanover's gross income for the taxable year must be derived from Qualified REIT Assets including interest on obligations secured by mortgages on real property or interests in real property. During the first year of operations certain temporary investment income will also qualify under the 75% income test. The investments that Hanover has made and expects to continue to make will give rise primarily to mortgage interest qualifying under the 75% income test. 21 24 2. 95% INCOME TEST. In addition to deriving 75% of its gross income from the sources listed above, at least an additional 20% of Hanover's gross income for the taxable year must be derived from those sources, or from dividends, interest or gains from the sale or disposition of stock or other securities that are not dealer property. Hanover intends to limit substantially all of the assets that it acquires to Qualified REIT Assets. The policy of Hanover to maintain REIT status may limit the types of assets, including hedging contracts and other securities, that Hanover otherwise might acquire. Distributions Hanover must distribute to its shareholders on a pro rata basis each year an amount equal to at least (i) 90% of its taxable income before deduction of dividends paid and excluding net capital gains, plus (ii) 90% of the excess of the net income from foreclosure property over the tax imposed on such income by the Code, less (iii) certain "excess noncash income". Hanover intends to make distributions to its shareholders in sufficient amounts to meet this 90% distribution requirement. Taxation of Hanover's Shareholders For any taxable year in which Hanover is treated as a REIT for Federal income tax purposes, amounts distributed by Hanover to its shareholders out of current or accumulated earnings and profits will be includable by the shareholders as ordinary income for Federal income tax purposes unless properly designated by Hanover as capital gain dividends. Distributions of Hanover will not be eligible for the dividends received deduction for corporations. Shareholders may not deduct any net operating losses or capital losses of Hanover. Any loss on the sale or exchange of shares of the common stock of Hanover held by a shareholder for six months or less will be treated as a long-term capital loss to the extent of any capital gain dividends received on the common stock held by such shareholder. If Hanover makes distributions to its shareholders in excess of its current and accumulated earnings and profits, those distributions will be considered first a tax-free return of capital, reducing the tax basis of a shareholder's shares until the tax basis is zero. Such distributions in excess of the tax basis will be taxable as gain realized from the sale of Hanover's shares. Hanover will withhold 30% of dividend distributions to shareholders that Hanover knows to be foreign persons unless the shareholder provides Hanover with a properly completed IRS form claiming a reduced withholding rate under an applicable income tax treaty. Under the Code, if a portion of Hanover's assets were treated as a taxable mortgage pool or if Hanover were to hold REMIC residual interests, a portion of Hanover's dividends would be treated as unrelated business taxable income ("UBTI") for pension plans and other tax exempt entities. Hanover believes that it has not engaged in activities that would cause any portion of Hanover's income to be taxable as UBTI for pension plans and similar tax exempt shareholders. Hanover believes that its shares of stock will be treated as publicly offered securities under the plan asset rules of the Employment Retirement Income Security Act ("ERISA") for Qualified Plans. The provisions of the Code are highly technical and complex and are subject to amendment and interpretation from time to time. This summary is not intended to be a detailed discussion of all applicable provisions of the Code, the rules and regulations promulgated thereunder, or the administrative and judicial interpretations thereof. Hanover has not obtained a ruling from the Internal Revenue Service with respect to tax considerations relevant to its organization or operations. 22 25 ITEM 2: PROPERTIES The Company's and its unconsolidated subsidiaries operations are conducted in several leased office facilities throughout the United States. A summary of the office leases is shown below:

OFFICE MINIMUM SPACE ANNUAL EXPIRATION LOCATION (SQ. FT.) RENTAL DATE OFFICE USE -------- --------- ------ ---- ---------- New York, New York 7,863 $216,233 February 2010 Executive, Administration, Accounting, Investment Operations Edison, New Jersey 5,834 78,874 June 2002 Accounting, Administration, Due Diligence Operations, Mortgage Loan Servicing, Investment Operations Edison, NJ(1) 5,200 137,800 April 2005 Executive, Administration, Accounting Operations Chicago, Illinois 1,151 22,397 January 2004 Marketing Rockland, Massachusetts 300 6,000 Month to Month Marketing St. Paul, Minnesota 150 9,060 Month to Month Marketing ------ -------- Total: 20,498 $470,364 ====== ========

(1) This office lease will be assumed by HanoverTrade.com, Inc., in connection with it's acquisition of all of the assets of Pamex Capital Partners, L.L.C. Management of the Company believes that these facilities are adequate for the Company's and its unconsolidated subsidiaries foreseeable office space needs and that lease renewals and/or alternate space at comparable rental rates is available, if necessary. ITEM 3: LEGAL PROCEEDINGS The Company is not engaged in any material legal proceeding. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable 23 26 PART II ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS In September 1997, Hanover raised net proceeds of approximately $79 million in its initial public offering (the "IPO"). In the IPO, Hanover sold 5,750,000 units (each unit consists of one share of common stock, par value $.01 and one stock warrant) including 750,000 units sold pursuant to the underwriters' over-allotment option, which was exercised in full. Each warrant entitled the holder to purchase one share of common stock at the original issue price - $15.00. The strike price of the warrant was subsequently reset to $14.56. The warrants became exercisable on March 19, 1998 and expired on September 15, 2000. On September 19, 1997, the units began trading on the American Stock Exchange under the trading symbol HCM.U or HCM/U. Commencing March 19, 1998, the warrants became detachable from the common stock, and commencing March 20, 1998, the common stock and warrants began trading separately on the American Stock Exchange under the trading symbols HCM and HCM.WS, respectively. With the expiration of the warrants on September 15, 2000 the units and warrants stopped trading on September 14, 2000. As of March 1, 2001, Hanover had 4,322,944 shares of common stock issued and outstanding, which was held by 108 holders of record and approximately 1,500 beneficial owners. The following tables set forth, for the periods indicated, the high, low and closing sales price of Hanover's securities as reported on the American Stock Exchange in 1998, 1999 and 2000.

COMMON STOCK ------------ High Low Close ---- --- ----- Quarter Ended March 31, 1998 (a) 16 1/2 16 1/8 16 1/4 Quarter Ended June 30, 1998 17 3/8 9 1/2 9 1/2 Quarter Ended September 30, 1998 10 3/8 6 7/8 6 7/8 Quarter Ended December 31, 1998 6 7/8 3 1/2 4 Quarter Ended March 31, 1999 5 7/16 4 1/4 4 7/16 Quarter Ended June 30, 1999 6 4 1/8 5 3/8 Quarter Ended September 30, 1999 5 3/8 4 4 Quarter Ended December 31, 1999 4 3/8 3 1/4 3 5/8 Quarter Ended March 31, 2000 3 7/8 3 5/16 3 11/16 Quarter Ended June 30, 2000 4 1/2 3 5/8 4 1/2 Quarter Ended September 30, 2000 5 7/16 4 3/8 5 Quarter Ended December 31, 2000 5 9/16 4 9/16 5 1/4 UNIT PRICES ----------- High Low Close ---- --- ----- Quarter Ended March 31, 1998 21 7/8 16 1/4 19 1/16 Quarter Ended June 30, 1998 20 13/16 10 5/8 10 5/8 Quarter Ended September 30, 1998 11 3/4 7 1/4 7 1/4 Quarter Ended December 31, 1998 7 1/4 3 1/2 4 3/16 Quarter Ended March 31, 1999 5 1/4 4 1/4 4 1/2 Quarter Ended June 30, 1999 5 5/8 4 3/8 5 1/4 Quarter Ended September 30, 1999 5 1/4 4 3/8 4 3/8 Quarter Ended December 31, 1999 4 3/8 3 3 1/8 Quarter Ended March 31, 2000 3 7/8 3 1/8 3 3/8 Quarter Ended June 30, 2000 4 3/16 3 1/4 4 1/8 Quarter Ended September 30, 2000 4 3/4 4 (1) Quarter Ended December 31, 2000 (1) (1) (1)

24 27

WARRANTS -------- High Low Close ---- --- ----- Quarter Ended March 31, 1998 (a) 3 7/8 3 1/8 3 1/8 Quarter Ended June 30, 1998 3 1/4 1 1/8 1 1/8 Quarter Ended September 30, 1998 1 3/8 3/16 3/16 Quarter Ended December 31, 1998 3/8 5/16 1/8 Quarter Ended March 31, 1999 1/4 1/16 1/8 Quarter Ended June 30, 1999 3/16 1/16 1/8 Quarter Ended September 30, 1999 1/8 1/32 1/16 Quarter Ended December 31, 1999 3/64 1/64 1/64 Quarter Ended March 31, 2000 1/16 .252/64 1/16 Quarter Ended June 30, 2000 1/16 .252/64 1/64 Quarter Ended September 30, 2000 1/64 1/64 (1) Quarter Ended December 31, 2000 (1) (1) (1)

(1) The warrants expired on September 15, 2000 and the warrants and units stopped trading on September 14, 2000. The following table sets forth, for the periods indicated, Hanover's dividends declared for each quarter for the two most recent fiscal years:

DIVIDENDS DECLARED -------- Quarter Ended March 31, 1998 $0.21 Quarter Ended June 30, 1998 $0.21 Quarter Ended September 30, 1998 $0.17 Quarter Ended December 31, 1998 $0.11 Quarter Ended March 31, 1999 $0.20 Quarter Ended June 30, 1999 $0.10 Quarter Ended September 30, 1999 $0.10 Quarter Ended December 31, 1999 $0.10 Quarter Ended March 31, 2000 $0.12 Quarter Ended June 30, 2000 $0.14 Quarter Ended September 30, 2000 $0.20 Quarter Ended December 31, 2000 $0.20

(a) Common stock and warrants were first listed on the American Stock Exchange on March 20, 1998. 25 28 Hanover intends to pay quarterly dividends and other distributions to its shareholders of all or substantially all of its taxable income in each year in order to qualify for the tax benefits accorded to a REIT under the Code. To the extent that Hanover records capital gain income in future years, this income does not need to be distributed as dividends to shareholders to the extent of unutilized capital losses recorded (more than $8,944,000 as of December 31, 2000). All distributions will be made by Hanover at the discretion of the Board of Directors and will depend on the earnings of Hanover, financial condition of Hanover, maintenance of REIT status and such other factors as the Board of Directors deems relevant. 26 29 ITEM 6: SELECTED FINANCIAL DATA The following selected financial data are derived from audited consolidated financial statements of Hanover for the years ended December 31, 2000, December 31, 1999, December 31, 1998 and for the period from June 10, 1997 (inception) to December 31, 1997. The selected financial data should be read in conjunction with the more detailed information contained in the Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Form 10-K (dollars in thousands, except per share data):

Period from June 10 STATEMENT OF OPERATIONS HIGHLIGHTS Year Ended Year Ended Year Ended (inception) to December 31, December 31, December 31, December 31, 2000 1999 1998 1997 ---- ---- ---- ---- Net interest income $ 6,663 $ 4,408 $ 6,623 $ 1,676 Loan loss provision (875) (446) (356) (18) Gain (loss) on sale and mark-to-market 1,250 (5,831) (5,704) 35 Provision for loss on unconsolidated subsidiary -- (4,793) -- -- ---------- ---------- ---------- ---------- Total revenues (loss) 7,038 (6,662) 563 1,693 Expenses 3,136 4,191 4,064 940 ---------- ---------- ---------- ---------- Operating income (loss) 3,902 (10,853) (3,501) 753 Equity in income (loss) of unconsolidated subsidiaries Hanover Capital Partners Ltd. 455 (443) (1,039) (254) Hanover Capital Partners 2, Inc. -- (1,300) (394) -- HanoverTrade.com, Inc. (1,495) (31) -- -- ---------- ---------- ---------- ---------- (1,040) (1,774) (1,433) (254) ---------- ---------- ---------- ---------- Net income (loss) $ 2,862 $ (12,627) $ (4,934) $ 499 ========== ========== ========== ========== Basic earnings (loss) per share $ .56 $ (2.12) $ (0.77) $ 0.15 ========== ========== ========== ========== Diluted earnings (loss) per share $ .56 $ (2.12) $ (0.77) $ 0.14 ========== ========== ========== ========== Dividends declared per share $ .66 $ 0.50 $ 0.70 $ 0.16 ========== ========== ========== ========== BALANCE SHEET HIGHLIGHTS December 31, December 31, December 31, December 31, 2000 1999 1998 1997 ---- ---- ---- ---- Mortgage loans $ 212,247 $ 270,084 $ 407,994 $ 160,970 Mortgage securities 35,723 62,686 78,478 348,131 Cash and cash equivalents 9,958 18,022 11,837 4,022 Other assets 14,880 14,694 17,861 4,420 ---------- ---------- ---------- ---------- Total assets $ 272,808 $ 365,486 $ 516,170 $ 517,543 ========== ========== ========== ========== Reverse repurchase agreements $ 14,760 $ 55,722 $ 370,090 $ 435,138 CMO Borrowings 210,374 254,963 77,305 -- Other liabilities 3,650 4,443 2,995 4,307 ---------- ---------- ---------- ---------- Total liabilities 228,784 315,128 450,390 439,445 ---------- ---------- ---------- ---------- Stockholders' equity 44,024 50,358 65,780 78,098 ---------- ---------- ---------- ---------- Total liabilities and stockholders' equity $ 272,808 $ 365,486 $ 516,170 $ 517,543 ========== ========== ========== ========== Number of common shares outstanding 4,322,944 5,826,899 6,321,899 6,466,677 ========== ========== ========== ========== Book value per common share $ 10.18 $ 8.64 $ 10.41 $ 12.08 ========== ========== ========== ==========

27 30 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Hanover is a real estate investment trust ("REIT"), formed to operate as a specialty finance company. The principal business strategy of Hanover is to invest in mortgage backed securities and to a lesser extent mortgage loans and to earn net interest income on these investments. The Company has two principal unconsolidated subsidiaries, HCP and HTC. The principal business strategy of HCP is to generate consulting and other fee income by performing loan file and operational due diligence reviews for third parties, performing advisory services for third parties, and preparing and/or processing documentation (primarily assignments of mortgage loans) for third parties on a contract basis. The principal business activity of HTC is to generate fee income by operating an online world-wide web-based exchange for trading loan pools (primarily mortgage loan pools) and by performing loan sale advisory services for third parties. Hanover operates as a tax-advantaged REIT and is generally not subject to Federal and state income tax to the extent that it distributes its earnings to its stockholders and maintains its qualification as a REIT. Taxable affiliates of Hanover, however, are subject to Federal and state income tax. Hanover has engaged HCP to render due diligence, asset management and administrative services pursuant to a Management Agreement. The Company's generation of net income is dependent upon (i) the spread between interest earned on its investment portfolio and the cost of borrowed funds to finance the investment portfolio; and (ii) the aggregate amount of the investment portfolio on the Company's balance sheet. The Company strives to create a diversified portfolio of investments that in the aggregate generates increasing net income in a variety of interest rate and prepayment rate environments and preserves the equity base of the Company. The Company's primary strategy for its investment portfolio entails (1) efficient acquisition pricing of mortgage loans and securities, (2) financing securities and loans by reverse repurchase agreements or lines of credit, (3) hedging in the short term to offset potential adverse effects of changes in interest rates, and (4) for mortgage loans, stratifying and segregating them in securitizations to replace short term financing with collateralized mortgage obligations (CMO), real estate mortgage investment conduits (REMIC) or other types of long term debt financing, thereby eliminating the majority of refinancing and interest rate risk and retaining certain residual interests of the securitization resulting in increased yields. 28 31 RESULTS OF OPERATIONS (dollars in thousands, except per share data)

Quarter Ended -------------------------------------------------- Year Ended Mar 31 Jun 30 Sept 30 Dec 31 Dec 31 2000 2000 2000 2000 2000 ---- ---- ---- ---- ---- Net interest income $ 1,484 $ 1,425 $ 2,081 $ 1,673 $ 6,663 Loan loss provision (103) (99) (385) (288) (875) Gain on sale of mortgage assets -- -- -- 819 819 Gain on mark to market of mortgage securities and mortgage loans, net of associated hedge 199 316 -- (84) 431 -------- -------- -------- -------- -------- Total revenues 1,580 1,642 1,696 2,120 7,038 Expenses 980 959 502 695 3,136 -------- -------- -------- -------- -------- Operating income 600 683 1,194 1,425 3,902 Equity in income (loss) of unconsolidated subsidiaries Hanover Capital Partners Ltd 114 98 125 118 455 Hanover Capital Partners 2, Inc. -- -- -- -- -- HanoverTrade.com, Inc. (24) (46) (592) (833) (1,495) -------- -------- -------- -------- -------- Net income $ 690 $ 735 $ 727 $ 710 $ 2,862 ======== ======== ======== ======== ======== Basic earnings per share $ 0.12 $ 0.14 $ 0.15 $ 0.16 $ 0.56 ======== ======== ======== ======== ======== Dividends declared per share (a) $ 0.12 $ 0.14 $ 0.20 $ 0.20 $ 0.66 ======== ======== ======== ======== ========

Quarter Ended -------------------------------------------------- Year Ended Mar 31 Jun 30 Sept 30 Dec 31 Dec 31 1999 1999 1999 1999 1999 ---- ---- ---- ---- ---- Net interest income (expense) $ 2,051 $ 1,733 $ (884) $ 1,509 $ 4,409 Loan loss provision (119) (113) (107) (108) (447) Gain on sale of servicing rights 342 2 196 -- 540 Gain (loss) on sale of mortgage assets 163 -- (17) -- 146 Gain (loss) on mark to market of mortgage securities and mortgage loans, net of associated hedge -- -- (6,534) 17 (6,517) Provision for (loss) on disposition of unconsolidated subsidiary -- -- (4,793) -- (4,793) -------- -------- -------- -------- -------- Total revenues (loss) 2,437 1,622 (12,139) 1,418 (6,662) Expenses 825 860 1,304 1,203 4,192 -------- -------- -------- -------- -------- Operating income (loss) 1,612 762 (13,443) 215 (10,854) Equity in income(loss) of unconsolidated subsidiaries Hanover Capital Partners Ltd. (407) (276) (142) 383 (442) Hanover Capital Partners 2, Inc. (469) (428) (403) -- (1,300) HanoverTrade.com, Inc. -- -- (6) (25) (31) -------- -------- -------- -------- -------- Net income (loss) $ 736 $ 58 $(13,994) $ 573 $(12,627) ======== ======== ======== ======== ======== Basic earnings (loss) per share $ 0.12 $ 0.01 $ (2.40) $ 0.10 $ (2.12) ======== ======== ======== ======== ======== Dividends declared per share (a) $ 0.20 $ 0.10 $ 0.10 $ 0.10 $ 0.50 ======== ======== ======== ======== ========

(a) The dividends relating to the three months ended December 31, 2000 were declared on December 22, 2000. The dividends relating to the three months ended December 31, 1999 were declared on December 21, 1999. 29 32 YEARS ENDED DECEMBER 31, 2000 AND 1999. The Company recorded net income of $2,862,000 or $0.56 per share based on 5,102,563 weighted shares of common stock outstanding for the year ended December 31, 2000 compared to a net loss of $12,627,000 or $2.12 per share based on 5,942,403 weighted shares of common stock outstanding for 1999. Total revenues for the year ended December 31, 2000 were $7,038,000 compared to a negative $6,662,000 in 1999. The 1999 revenues were negatively impacted by charges in the third quarter for (1) provision for loss on the disposition of an unconsolidated subsidiary, Hanover Capital Partners 2, Inc. ("HCP-2") of $4,793,000, (2) mark to market adjustments on mortgage securities acquired from the Hanover 1998-B securitization of $3,537,000, (3) mark to market adjustments on mortgage loans securitized in the August 1999 Hanover 1999-B securitization of $2,997,000 and (4) adjustments to the investment portfolio's net interest income resulting primarily from cumulative prepayment speed adjustments affecting amortization totaling $2,178,000. The 1999 revenues before these charges were $6,844,000. Net interest income increased to $6,663,000 in 2000 compared to $4,408,000 in 1999. Net interest income in 1999 was $6,587,000 before giving effect to the third quarter amortization expense described above. Net interest income in the first and second quarter of 2000 of $1,484,000 and $1,425,000 was significantly lower than in the comparable quarters of 1999 ($2,051,000 and $1,733,000.) Net interest income declined for these periods as a result of (1) an increase in amortization expense for whole loans as a result of increases in assumed prepayment speeds and (2) a reduction in the principal balance of the company-sponsored securitizations of whole loans partially offset by a corresponding reduction in the principal balance of CMO borrowings against such whole loans. Net interest income in the third quarter of 2000 was $2,081,000 compared to a negative $884,000 in the third quarter of 1999. The 2000 figure includes a positive $205,000 of amortization adjustment reflecting a slowing of assumed prepayment speeds, and also includes $306,000 of net revenue from subordinate MBS that were transferred from HCP to the Company on July 1, 2000. The 1999 figure includes a negative $2,178,000 reflecting an increase in assumed prepayment speeds. Net interest income for the fourth quarter of 2000 was $1,673,000 compared to $1,509,000 for the same period in 1999. The increase resulted from the repositioning of the Company's investment portfolio during 2000 towards more high yielding subordinate mortgage-backed securities purchased from third parties. At December 31, 1999 the Company's direct investment in such securities totaled $3,640,000 as compared to $19,518,000 at December 31, 2000. At December 31, 1999 the Company's unconsolidated subsidiary, HCP, owned $14,180,000 of such securities and recorded the net interest income earned thereon. All of these securities were either sold or transferred to the Company on July 1, 2000. The Company's provision for loan losses increased from $447,000 in 1999 to $875,000 in 2000, primarily as a result of the Company's increased investment in subordinate mortgaged-backed securities. Provision for losses on Hanover sponsored securitizations decreased from $331,000 for the year ended December 31, 1999 to $319,000 for 2000. Provision for loan losses on subordinate securities purchased from third parties increased from $39,000 for the year ended December 31, 1999 to $555,000 for the similar 2000 period. The average balance of subordinate securities purchased from third parties in 1999 was $2,133,000, compared to $11,973,000 in 2000. The Company sold nine subordinate mortgage-backed MBS with proceeds of $5,882,000 and a gain of $1,248,000 and 32 Agency MBS with proceeds of $39,881,000 and a loss of $429,000 during 2000. The 30 33 Company sold six subordinate MBS created in the Hanover 1998B securitization for proceeds of $2,232,000 and a gain of $146,000 during 1999. The Company held subordinate mortgage-backed securities from Hanover 1998B classified as trading during the year ended December 31, 2000 and recorded mark to market gains totaling $515,000 net of the associated hedge. These securities were transferred to CMO collateral as part of the Hanover 2000A securitization in June 2000. In addition, net hedging activity on subordinate MBS available for sale, net of related realized marks of the hedged securities totaled a loss of $84,000 in the fourth quarter of 2000. The Company's equity in income (losses) of HCP, its consulting subsidiary, improved from a loss of $443,000 in 1999 to income of $455,000 in 2000. Total revenue at HCP increased $1,654,000 or 23% to $8,713,000 in 2000 from $7,059,000 in 1999. Due diligence fees increased $1,486,000 or 27% from $5,530,000 in 1999 to $7,016,000 in 2000. Assignment fees contributed $631,000 of revenue in 2000, the first year of activity in this area. The portfolio of subordinate mortgage backed securities contributed $954,000 of net interest income and gains on sale in 2000 compared to $385,000 of net interest income in 1999. This portfolio was transferred from HCP to the Company in July of 2000. Loan brokering and asset management fees declined to $30,000 in 2000 from $789,000 in 1999. This activity was transferred to HTC in July of 2000. During 1999, the Company reflected equity in losses of HCP-2 of $1,300,000 compared to $394,000 in 1998. As noted above, the Company took a provision of $4,793,000 in the quarter ended September 30, 1999 and recorded certain other operating expenses in connection with its decision to sell HCP-2. HCP-2 is an unconsolidated mortgage finance subsidiary that was organized in October 1998 to execute a REMIC financing securitization for the Company. The financing structure required certain costs of the securitization (net premiums, hedging and deferred financing costs) to be capitalized in this subsidiary. Substantially all of HCP-2's net equity ($4,473,000 at September 30, 1999) consisted of these capitalized expenses. These deferred financing costs were being amortized through net interest income (expense) over the anticipated life of the respective mortgage loans and recorded by the Company in its economic ownership percentage (99%) of this net loss through September 30, 1999. As a result of the provision for the expected sale of HCP-2, the Company believes it will not record future losses from HCP-2. The Company recognized equity in losses of HTC, its world wide web based exchange for loan pool trading and loan sale advisory, of $1,495,000 for 2000 and $31,000 for 1999. HTC was organized in May 1999 to develop an E-commerce business to broker mortgage loan pools to financial institutions and other finance companies via the internet. HTC recorded revenue of $141,000 for the year ended December 31, 2000 and $0 for 1999. HTC operating expenses for the year ended December 31, 2000 totaled $1,683,000 and $32,000 for the similar period in 1999. The 2000 expenses included personnel expense of $790,000, technology expense for web hosting and web graphics of $230,000 and premises expense of $130,000. Depreciation and amortization of $151,000 for 2000 includes $149,000 of amortization of capitalized software costs. Travel and entertainment expense of $175,000 includes $42,000 to introduce the HTC web site at the Mortgage Bankers Association Conference. Operating expenses for the year ended December 31, 2000 were $3,136,000, compared to $4,191,000 in 1999, a reduction of $1,055,000. Legal and professional fees declined to $555,000 in 2000 from $1,201,000 in 1999 as a result of decreases in legal and other professional fees. Financing fees declined to $281,000 in 2000 from $404,000 in 1999 reflecting reduced committed lines of credit and lower levels of activity. Due diligence expenses in 1999 resulted from the Company's two 1999 securitizations. There were no similar expenses in 2000. Management and administrative expenses included office overhead in 1999 but do not in 2000 resulting in a decrease of $135,000. Office expenses are paid directly in 2000 31 34 and recorded in the other expense category causing an increase of $186,000 from the prior year. In addition, $103,000 of premises related expenses were billed to HTC in 2000 to reflect activity on behalf of HTC. There were no similar billings in 1999. The Company also billed personnel related expenses totaling $369,000 to HTC and $136,000 to HCP during 2000. These billings reduce personnel related expenses of the Company and similar billings are expected in future periods. There were no similar billings to HTC in 1999 and HCP was billed $180,000 in 1999. The Company's 2000 and 1999 operating expenses did not include any incentive bonus compensation pursuant to the Company's incentive bonus plan. In order for the eligible participants to earn incentive bonus compensation, the rate of return on shareholders' investment must exceed the average ten-year U.S. Treasury rate during the year plus 4.0%. YEARS ENDED DECEMBER 31, 1999 AND 1998 The Company recorded a net loss of $12,627,000 or $2.12 per share based on 5,942,403 weighted shares of common stock outstanding for the year ended December 31, 1999 compared to a net loss of $4,934,000 or $0.77 per share based on 6,418,305 weighted shares of common stock outstanding for 1998. Total revenues for the year ended December 31, 1999 were negative $6,662,000 compared to a positive $563,000 in 1998. The 1999 revenues were negatively impacted by charges for (1) provision for loss on the disposition of an unconsolidated subsidiary, Hanover Capital Partners 2, Inc. ("HCP-2") of $4,793,000, (2) mark to market adjustments on mortgage securities acquired from the Hanover 1998-B securitization of $3,537,000, (3) mark to market adjustments on mortgage loans securitized in the August 1999 Hanover 1999-B securitization of $2,997,000 and (4) adjustments to the investment portfolio's net interest income resulting primarily from cumulative prepayment speed adjustments affecting amortization totaling $2,178,000. The 1999 revenues before these charges were $6,844,000. By comparison, 1998 revenues of $563,000 included a loss of $5,989,000 on the sale of adjustable rate mortgage securities in October, 1998. Revenues for 1998 before this loss were $6,552,000. The Company's equity in losses of HCP, its consulting subsidiary, declined from a loss of $1,039,000 in 1998 to a loss of $443,000 in 1999. Third party consulting and loan brokering revenues at HCP increased from $3,500,000 in 1998 to $5,036,000 in 1999, and the Company recorded a profit of $383,000 from its equity in HCP in the fourth quarter of 1999. During 1999, the Company reflected equity in losses of HCP-2 of $1,300,000 compared to $394,000 in 1998. As noted above, the Company took a provision of $4,793,000 in the quarter ended September 30, 1999 and recorded certain other operating expenses in connection with its decision to sell HCP-2. HCP-2 is an unconsolidated mortgage finance subsidiary that was organized in October 1998 to execute a REMIC financing securitization for the Company. The financing structure required certain costs of the securitization (net premiums, hedging and deferred financing costs) to be capitalized in this subsidiary. Substantially all of HCP-2's net equity, $4,473,000 at September 30, 1999, consisted of these capitalized expenses. These deferred financing costs were being amortized through net interest income (expense) over the anticipated life of the respective mortgage loans and recorded by the Company in its economic ownership percentage (99%) of this net loss through September 30, 1999. As a result of the provision for the expected sale of HCP-2, the Company believes it will not record future losses from HCP-2. 32 35 Also included in the equity in loss of unconsolidated subsidiaries in 1999 is a $31,000 loss from a newly organized subsidiary -- HanoverTrade.com, Inc. HTC was organized in May 1999 to develop an E-commerce business to broker mortgage loan pools to financial institutions and other finance companies via the internet. Operating expenses for the year ended December 31, 1999 were $4,191,000, compared to $4,064,000 in 1998. The Company did not purchase any mortgage loans during 1999, compared to 1998 when the Company purchased in excess of $749,000,000 of mortgage loan pools. Accordingly, the Company incurred only a fraction of the due diligence and commission expenses in 1999, $124,000, as compared to $973,000 in 1998 and experienced significantly lower financing and commitment fees, $404,000 in 1999 compared to $836,000 in 1998. Offsetting these cost savings were substantial increases in legal and professional expenses, $1,201,000 for 1999 compared to $545,000 in 1998, and personnel expenses of $1,230,000 in 1999 compared to $712,000 for 1998. Legal and professional expenses increased substantially in 1999 compared to 1998 as a result of increased regulatory filings and the negotiation of credit lines to replace lines that were wound down during the liquidity crunch at the end of 1998. The increase in personnel expenses results primarily from the reallocation of certain personnel expenses from HCP to the Company to better reflect the proper allocation of the affected individuals' time, and from the addition of a new chief financial officer in 1999. The Management Agreement by and between Hanover and HCP, whereby HCP provides Hanover due diligence, asset management and administrative services, was amended in September 1999 (retroactive to July 1, 1999). The amendment reallocated certain asset management and administrative service expenses between Hanover and HCP to more accurately reflect current top management personnel expense and certain other occupancy related charges. As a result of this amendment, the Company recorded additional personnel and occupancy expenses that were previously allocated to HCP. Hanover will continue to record similar expenses in future periods. Also included in personnel expense in the third quarter of 1999 is approximately $103,000 of additional compensation expense paid to certain employees of Hanover, relating to the provision for the forgiveness of certain of their loans in connection with the write-off of HCP-2. 33 36 The table below highlights the Company's historical trends and components of return on average equity. COMPONENTS OF ANNUALIZED RETURN ON AVERAGE EQUITY (1)

Gain (loss) on Other Equity in Net Interest Sale of Gains or Operating Earnings (Loss) Annualized For the Income/ Assets/ (Losses)/ Expenses/ Of Subsidiaries/ Return on Quarter Ended Equity Equity Equity Equity Equity Equity ------------- ------ ------ ------ ------ ------ ------ June 30, 1997 (2) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% September 30, 1997 (3) 4.85% 0.00% 0.00% 3.59% 0.97% 2.23% December 31, 1997 7.71% 0.18% 0.00% 4.26% (1.41%) 2.22% March 31, 1998 10.78% 0.00% 0.00% 4.37% (0.03%) 6.38% June 30, 1998 3.47% (0.25%) 0.00% 5.00% (1.50%) (3.28%) September 30, 1998 8.23% 0.00% 0.00% 4.89% (1.52%) 1.82% December 31, 1998 11.12% (32.76%) 0.00% 7.55% (4.89%) (34.08%) March 31, 1999 11.36% 2.97% 0.00% 4.85% (5.15%) 4.33% June 30, 1999 9.89% 0.01% 0.00% 5.25% (4.30%) 0.35% September 30, 1999 (6.57%) 1.19% (75.10%) 8.65% (3.65%) (92.78%) December 31, 1999 11.01% 0.00% 0.13% 9.46% 2.81% 4.51% March 31, 2000 10.91% 1.57% 0.00% 7.74% .71% 5.45% June 30, 2000 10.99% 2.62% 0.00% 7.95% .43% 6.09% September 30, 2000 13.40% 0.00% 1.16% 4.31% (4.01)% 6.24% December 31, 2000 12.435 6.61% 0.00% 6.24% (6.41) 6.39%

(1) Average equity excludes unrealized loss on investments available for sale. (2) The Company was organized on June 10, 1997, but did not begin operations until September 19, 1997. (3) Average equity for this period is based on the equity balance at September 19, 1997 (IPO date) and the equity balance at September 30, 1997, excluding unrealized loss on investments available for sale. 34 37 The following table reflects the average balances for each major category of the Company's interest earning assets as well as the Company's interest bearing liabilities with the corresponding effective rate of interest annualized for the periods shown below (dollars in thousands):

INTEREST EARNING ASSETS AND RELATED LIABILITIES Quarter Ended Quarter Ended Quarter Ended Quarter Ended March 31, 2000 June 30, 2000 September 30, 2000 December 31, 2000 Average Effective Average Effective Average Effective Average Effective Balance Rate (1) Balance Rate (1) Balance Rate (1) Balance Rate (1) ------- -------- ------- -------- ------- -------- ------- -------- Interest earning assets: Mortgage loans $ 334 251.64% $ 354 4.10% $ 282 21.17% $ 231 60.32% CMO collateral 262,909 7.13% 251,775 7.47% 246,268 7.82% 230,449 7.45% Agency MBS 44,515 7.04% 42,500 7.19% 40,911 7.78% 36,361 7.11% Private placement notes 17,390 15.97% 16,313 17.13% 24,513 16.86% 22,849 17.26% -------- ----- -------- ------- -------- ----- -------- ----- 325,148 7.84% 310,942 7.94% 311,974 8.56% 289,890 8.22% -------- ------ -------- ------- -------- ----- -------- ----- Interest bearing liabilities: Reverse repurchase borrowings on mortgage loans - - - - - - - - CMO borrowings 247,655 7.36% 236,373 7.49% 233,548 7.52% 217,796 7.61% Reverse repurchase borrowings on: CMO collateral 3,346 7.43% 3,335 8.31% 3,622 8.05% 3,758 6.12% Agency MBS 33,957 5.93% 33,522 5.99% 25,695 5.53% 22,908 5.19% Private placement notes 4,292 6.54% 2,463 6.98% 12,653 8.01% 10,770 8.27% -------- ------ -------- ------- -------- ----- -------- ----- 289,250 7.18% 275,693 7.31% 275,518 7.36% 255,232 7.40% -------- ------ -------- ------- -------- ----- -------- ----- Net interest earning assets $ 35,898 $ 35,249 $ 36,456 $ 34,658 ======== ======== ======== ======== Net interest spread 0.66% 0.62% 1.17% 0.82% ====== ====== ===== ===== Yield on net interest earning assets (2) 13.17% 12.80% 17.40% 14.29% ====== ====== ===== =====

Quarter Ended Quarter Ended Quarter Ended Quarter Ended March 31, 1999 June 30, 1999 September 30, 1999 December 31, 1999 Average Effective Average Effective Average Effective Average Effective Balance Rate (1) Balance Rate (1) Balance Rate (1) Balance Rate (1) ------- -------- ------- -------- ------- -------- ------- -------- Interest earning assets: Mortgage loans $246,329 7.02% $123,945 6.93% $ 41,034 2.64% $ 251 (9.56%) CMO collateral 124,784 6.75% 204,469 7.00% 262,666 6.72% 279,928 7.13% Agency MBS 57,552 6.78% 53,619 6.93% 49,968 6.72% 46,930 6.97% Private placement notes 18,334 13.98% 17,261 13.21% 18,643 (24.22%) 16,401 16.13% -------- ------ -------- ----- -------- ------ -------- ------ 446,999 7.20% 399,294 7.23% 372,311 4.71% 343,510 7.53% -------- ------ -------- ------ -------- ------ -------- ------ Interest bearing liabilities: Reverse repurchase borrowings on mortgage loans 225,835 6.43% 113,125 6.15% 37,031 6.32% - - CMO borrowings 98,357 6.88% 191,858 6.79% 232,132 7.22% 262,354 6.96% Reverse repurchase borrowings on: CMO collateral 18,194 5.96% 1,518 6.32% 15,361 7.05% 3,366 8.08% Agency MBS 56,420 5.07% 52,559 5.39% 47,888 5.82% 38,534 5.89% Private placement notes 4,037 5.45% 5,836 5.83% 4,243 5.85% 4,605 6.69% -------- ------ -------- ----- -------- ------ -------- ------ 402,843 6.32% 364,896 6.37% 336,655 6.70% 308,859 6.86% -------- ------ -------- ----- -------- ------ -------- ------ Net interest earning assets $ 44,156 $ 34,398 $ 35,656 $ 34,651 ======== ======== ======== ======== Net interest spread 0.99% 0.98% (1.87%) 0.80% ====== ===== ====== ====== Yield on net interest earning assets (2) 16.30% 17.52% (12.60%) 15.18% ====== ===== ====== ======

(1) Loan loss provisions are included in the above calculations. (2) Yield on net interest earning assets is computed by dividing the applicable net interest income after loan loss provision by the average daily balance of net interest earning assets. 35 38 NET INTEREST INCOME (EXPENSE) Net interest income for the year ended December 31, 2000 was $6,663,000 compared to net interest income of $4,408,000 for 1999. The following table reflects net interest income (expense) generated for each period (dollars in thousands):

NET INTEREST INCOME (EXPENSE) IN 2000 Quarter Ended --------------------------------------------------------------------------------- March 31, 2000 June 30, 2000 September 30, 2000 December 31, 2000 Total -------------- ------------- ------------------ ----------------- ----- Net Loan Net Loan Net Loan Net Loan Loan Interest Loss Interest Loss Interest Loss Interest Loss Interest Loss Income Provision Income Provision Income Provision Income Provision Income Provision Mortgage Loans $ 210 $ -- $ 4 $ -- $ 15 $ -- $ 35 $ -- $ 264 $ -- CMO Collateral 119 (48) 253 (50) 427 (78) 164 (73) 963 (249) Agency MBS 280 -- 261 -- 440 -- 349 -- 1,330 -- Private placement MBS 679 (54) 705 (49) 1,088 (308) 978 (215) 3,450 (626) Other 196 -- 202 -- 111 -- 147 -- 656 -- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total net interest income $1,484 $ (102) $1,425 $ (99) $2,081 $ (386) $1,673 $ (288) $6,663 $ (875) ====== ====== ====== ====== ====== ====== ====== ====== ====== ======

NET INTEREST INCOME (EXPENSE) IN 1999 Quarter Ended --------------------------------------------------------------------------------- March 31, 1999 June 30, 1999 September 30, 1999 December 31, 1999 Total -------------- ------------- ------------------ ----------------- ----- Net Loan Net Loan Net Loan Net Loan Loan Interest Loss Interest Loss Interest Loss Interest Loss Interest Loss Income Provision Income Provision Income Provision Income Provision Income Provision Mortgage Loans $ 736 $ (45) $ 413 $ (24) $ (314) $ (7) $ (6) $ -- $ 829 $ (76) CMO Collateral 166 (23) 335 (37) 181 (41) 396 (51) 1,078 (152) Agency MBS 261 -- 221 -- 143 -- 251 -- 876 -- Private placement MBS 637 (51) 537 (52) (1,132) (59) 640 (56) 682 (218) Other 251 -- 227 -- 238 -- 227 -- 943 -- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total net interest income $ 2,051 $ (119) $ 1,733 $ (113) $ (884) $ (107) $ 1,508 $ (107) $ 4,408 $ (446) ======= ======= ======= ======= ======= ======= ======= ======= ======= =======

MORTGAGE LOANS HELD FOR SALE Net interest income generated from investments in mortgage loans (classified as held for sale and held to maturity) during the years ended December 31, 2000 and 1999, respectively, is detailed below (dollars in thousands): 36 39

Mortgage Loans Held for Sale Quarter Ended -------------------------------------------------- March 31, June 30, September 30, December 31, 2000 2000 2000 2000 ---- ---- ---- ---- Average asset balance $ 334 $ 354 $ 282 $ 231 Average repo borrowing balance -- -- -- -- ------- ------- ------- ------- Net interest earning assets $ 334 $ 354 $ 282 $ 231 Average leverage ratio 0.00% 0.00% 0.00% 0.00% Effective interest income rate 251.64% 4.10% 21.17% 60.32% Effective interest expense rate 0.00% 0.00% 0.00% 0.00% ------- ------- ------- ------- Net interest spread 251.64% 4.10% 21.17% 60.32% Interest income $ 210 $ 4 $ 15 $ 35 Interest expense -- -- -- -- ------- ------- ------- ------- Net interest income before loan loss provision 210 4 15 35 Loan loss provision -- -- -- -- ------- ------- ------- ------- Net interest income after loan loss provision $ 210 $ 4 $ 15 $ 35 ======= ======= ======= ======= Yield on net interest earning assets after loan loss provision 251.64% 4.10% 21.17% 60.32% ======= ======= ======= =======

Mortgage Loans Held for Sale Quarter Ended -------------------------------------------------- March 31, June 30, September 30, December 31, 1999 1999 1999 1999 ---- ---- ---- ---- Average asset balance $246,329 $123,945 $41,034 $ 251 Average repo borrowing balance 225,835 113,125 37,031 -- ------- -------- ------- ------- Net interest earning assets $20,494 $ 10,820 $ 4,003 $ 251 Average leverage ratio 91.68% 91.27% 90.25% -- Effective interest income rate 7.09% 7.01% 2.70% (9.24%) Effective interest expense rate 6.43% 6.23% 6.39% -- ------- -------- ------- ------- Net interest spread 0.66% 0.79% (3.69%) (9.24%) Interest income $ 4,367 $ 2,172 $ 278 $ (6) Interest expense 3,631 1,759 592 -- ------- -------- ------- ------- Net interest income before loan loss provision 736 413 (314) (6) Loan loss provision (45) (24) (7) -- ------- -------- ------- ------- Net interest income after loan loss provision $ 691 $ 389 $ (321) $ (6) ======= ======== ======= ======= Yield on net interest earning assets after loan loss provision 13.49% 14.39% (32.10%) (9.56%) ======= ======== ======= =======

The Company did not purchase any mortgage loans in 2000 or 1999. In 1999, the Company securitized substantially all of its remaining inventory of mortgage loans. These loans were transferred from the held for sale category to the CMO collateral category. 37 40 CMO COLLATERAL Net interest income generated from the CMO collateral (including mortgage loans and mortgage-backed securities pledged to CMOs) during 2000 and 1999 is detailed below (dollars in thousands):

CMO Collateral Quarter Ended --------------------------------------------------------------- March 31, June 30, September 30, December 31, 2000 2000 2000 2000 ---- ---- ---- ---- Average asset balance $ 262,909 $ 251,775 $246,268 $230,449 Average CMO borrowing balance 247,655 236,373 233,548 217,796 Average repo balance 3,346 3,335 3,621 3,758 --------- --------- -------- -------- Net interest earning assets $ 11,908 $ 12,067 $ 9,099 $ 8,895 Average leverage ratio 95.47% 95.21% 96.31% 96.14% Effective interest income rate 7.21% 7.55% 7.95% 7.58% Effective interest expense rate 7.36% 7.49% 7.52% 7.61% Effective interest expense rate - Repo 7.43% 8.31% 8.05% 6.12% --------- --------- -------- -------- Net interest spread (0.15%) 0.06% 0.43% (0.03%) Interest income $ 4,736 $ 4,749 $ 4,892 $ 4,368 Interest expense 4,556 4,427 4,392 4,146 Interest expense - Repo 62 69 73 57 --------- --------- -------- -------- Net interest income before loan loss provision 118 253 427 165 Loan loss provision (48) (50) (78) (73) --------- --------- -------- -------- Net interest income after loan loss provision $ 70 $ 203 $ 349 $ 92 ========= ========= ======== ======== Yield on net interest earning assets after loan loss provision 2.34% 6.75% 15.36% 4.09% ========= ========= ======== ========

CMO Collateral Quarter Ended --------------------------------------------------------------- March 31, June 30, September 30, December 31, 1999 1999 1999 1999 ---- ---- ---- ---- Average asset balance $ 124,784 $ 204,469 $262,666 $279,298 Average CMO borrowing balance 98,357 191,858 232,132 262,354 Average repo balance 18,194 1,518 15,361 3,366 --------- --------- -------- -------- Net interest earning assets $ 8,233 $ 11,093 $ 15,173 $ 13,578 Average leverage ratio 93.40% 94.58% 94.22% 95.14% Effective interest income rate 6.83% 7.08% 6.78% 7.20% Effective interest expense rate 6.88% 6.79% 7.29% 6.97% Effective interest expense rate - Repo 5.96% 6.32% 1.93% 8.08% --------- --------- -------- -------- Net interest spread (0.05%) 0.29% (0.51%) 0.23% Interest income $ 2,129 $ 3,617 $ 4,453 $ 5,029 Interest expense 1,692 3,258 4,230 4,565 Interest expense - Repo 271 24 42 68 --------- --------- -------- -------- Net interest income before loan loss provision 166 335 181 396 Loan loss provision (23) (37) (41) (51) --------- --------- -------- -------- Net interest income after loan loss provision $ 143 $ 298 $ 140 $ 345 ========= ========= ======== ======== Yield on net interest earning assets after loan loss provision 6.95% 10.75% 3.69% 10.16% ========= ========= ======== ========

38 41 In 2000, the Company issued $13,222,000 of CMO borrowings at a discount of $2,013,000 for net proceeds before expenses of $11,209,000. The "Hanover 2000-A" CMO securities carry a fixed interest rate of 6.50%. The Hanover 2000-A securities are collateralized by $25,588,000 principal balance of the retained portions of Hanover's previous CMO borrowings, Hanover 98-A, Hanover 99-A and Hanover 99-B and certain retained mortgage-backed securities from Hanover 98-B. In 1999, the Company securitized $249,932,000 (par value) of mortgage loans in two securitizations. The securitizations were accomplished in a grantor/owner trust format (CMO) through a wholly-owned subsidiary, Hanover SPC-A, Inc. The transactions were accounted for as financings for both GAAP and tax accounting purposes. In a GAAP financing, the Company continues to record 100% of the interest income, net of servicing and other fees, generated by the mortgage loans. The primary source of financing for these mortgage loans was the CMO borrowing. These financings represent the liability for certain investment grade mortgage notes issued by the Company. The interest expense on this financing represents the coupon interest amount to be paid to those note holders. The Company's net equity in these transactions was leveraged through reverse repurchase financing. At December 31, 2000 the Company had $3,627,000 of reverse repurchase financing against its net equity in these transactions. Interest expense includes the interest on CMO borrowings, interest on the related reverse repurchase agreements and amortization of certain deferred financing costs and interest rate caps. AGENCY MORTGAGE SECURITIES Net interest income in 2000 and 1999 generated from investments in Agency mortgage securities is detailed below (dollars in thousands):

Agency Mortgage Securities Quarter Ended --------------------------------------------------------------- March 31, June 30, September 30, December 31, 2000 2000 2000 2000 ---- ---- ---- ---- Average asset balance $ 44,515 $ 42,500 $ 40,911 $ 36,361 Average repo borrowing balance 33,957 33,522 25,695 22,908 --------- --------- -------- -------- Net interest earning assets $ 10,558 $ 8,978 $ 15,216 $ 13,453 Average leverage ratio 76.28% 78.88% 62.81% 63.00% Effective interest income rate 7.04% 7.19% 7.78% 7.11% Effective interest expense rate 5.93% 5.99% 5.53% 5.19% --------- --------- -------- -------- Net interest spread 1.11% 1.20% 2.25% 1.92% Interest income $ 783 $ 764 $ 796 $ 646 Interest expense 503 503 356 297 --------- --------- -------- -------- Net interest income before loan loss provision 280 261 440 349 Loan loss provision -- -- -- -- --------- --------- -------- -------- Net interest income after loan loss provision $ 280 $ 261 $ 440 $ 349 ========= ========= ======== ======== Yield on net interest earning assets after loan loss provision 10.62% 11.64% 11.58% 10.37% ========= ========= ======== ========

39 42

Agency Mortgage Securities Quarter Ended --------------------------------------------------------------- March 31, June 30, September 30, December 31, 1999 1999 1999 1999 ---- ---- ---- ---- Average asset balance $ 57,552 $ 53,618 $ 49,968 $ 46,930 Average repo borrowing balance 56,420 52,559 47,888 38,534 --------- --------- -------- -------- Net interest earning assets $ 1,132 $ 1,060 $ 2,080 $ 8,396 Average leverage ratio 98.03% 98.02% 95.84% 82.11% Effective interest income rate 6.78% 6.93% 6.72% 6.98% Effective interest expense rate 5.07% 5.39% 5.82% 5.89% --------- --------- -------- -------- Net interest spread 1.71% 1.54% 0.90% 1.09% Interest income $ 976 $ 929 $ 840 $ 819 Interest expense 715 708 697 568 --------- --------- -------- -------- Net interest income before loan loss provision 261 221 143 251 Loan loss provision -- -- -- -- Net interest income after loan loss provision $ 261 $ 221 $ 143 $ 251 ========= ========= ======== ======== Yield on net interest earning assets after loan loss provision 92.23% 83.40% 27.50% 11.97% ========= ========= ======== ========

In November 2000, the Company purchased $1.9 million of GNMA securities. In December 2000, the Company sold 31 FNMA Certificates, totaling $36.9 million of principal. In August 1998, the Company exchanged $17.4 million of adjustable rate mortgage loans for a like amount of mortgage securities in the form of five FNMA certificates. All of these mortgage certificates were subsequently sold with recourse in October 1998. In December 1998, the Company exchanged $55.2 million of fixed rate mortgage loans (without recourse) for a like amount of mortgage securities in the form of 31 FNMA certificates. In March 1998, the Company purchased $4,122,000 of FNMA passthrough certificates. Interest expense includes the interest on the related reverse repurchase agreements and amortization of deferred financing costs and interest rate caps. 40 43 PRIVATE PLACEMENT MBS Net interest income (expense) generated from private placement mortgage-backed securities excluding securities pledged as collateral for CMO is detailed below (dollars in thousands):

Private Placement MBS Quarter Ended --------------------------------------------------------------- March 31, June 30, September 30, December 31, 2000 2000 2000 2000 Average asset balance $ 17,390 $ 16,313 $ 24,513 $ 22,849 Average repo borrowing balance 4,292 2,463 12,653 10,770 --------- --------- -------- -------- Net interest earning assets $ 13,098 $ 13,850 $ 11,860 $ 12,079 Average leverage ratio 24.68% 15.10% 51.62% 47.13% Effective interest income rate 17.23% 18.33% 21.88% 21.02% Effective interest expense rate 6.54% 6.98% 8.01% 8.27% --------- --------- -------- -------- Net interest spread 10.69% 11.35% 13.87% 12.75% Interest income (expense) $ 749 $ 748 $ 1,341 $ 1,201 Interest expense 70 43 253 223 --------- --------- -------- -------- Net interest income before loan loss provision 679 705 1,088 978 Loan loss provision (54) (49) (308) (215) --------- --------- -------- -------- Net interest income after loan loss provision $ 625 $ 656 $ 780 $ 763 ========= ========= ======== ======== Yield on net interest earning assets after loan loss provision 19.06% 18.94% 26.30% 25.28% ========= ========= ======== ========

Private Placement MBS Quarter Ended --------------------------------------------------------------- March 31, June 30, September 30, December 31, 1999 1999 1999 1999 ---- ---- ---- ---- Average asset balance $ 18,334 $ 17,261 $ 18,643 $ 16,401 Average repo borrowing balance 4,037 5,836 4,243 4,605 --------- --------- -------- -------- Net interest earning assets $ 14,297 $ 11,425 $ 14,400 $ 11,796 Average leverage ratio 22.02% 33.81% 22.76% 28.08% Effective interest income rate 15.10% 14.41% (22.96%) 17.49% Effective interest expense rate 5.45% 5.82% 5.84% 6.69% --------- --------- -------- -------- Net interest spread 9.65% 8.59% (28.80%) 10.80% Interest income (expense) $ 692 $ 622 $ (1,070) $ 717 Interest expense 55 85 62 77 --------- --------- -------- -------- Net interest income before loan loss provision 637 537 (1,132) 640 Loan loss provision (51) (52) (59) (56) --------- --------- -------- -------- Net interest income after loan loss provision $ 586 $ 485 $ (1,191) $ 584 ========= ========= ======== ======== Yield on net interest earning assets after loan loss provision 16.40% 16.98% (33.08%) 19.81% ========= ========= ======== ========

41 44 The Private Placement MBS category includes (1) interest only notes, and principal only notes that the Company created in its second securitization, 1998-B, and (2) starting in June 1999, subordinate MBS that the company purchased in the open market. In October 1998, the Company completed its second private placement REMIC securitization transaction, the 1998-B securitization. Hanover contributed certain mortgage loan collateral to its newly organized unconsolidated subsidiary, HCP-2. This had the effect of removing the mortgage loan collateral from Hanover's balance sheet for GAAP and tax accounting purposes. HCP-2 accounted for the transaction as a financing for GAAP and as a sale for tax accounting purposes. The Company's investment in 1998-B private placement MBS at December 31, 2000 includes a $12,345,000 investment in six investment grade ("AA", "A" and "BBB"), six interest only notes, six below investment grade notes and three principal only notes. The 1998-B interest only notes will be adversely affected more than other notes by higher than expected prepayment speeds on underlying mortgage loans with interest rates in excess of the pass through rate on the Securitization. In all likelihood, mortgages with higher interest rates will be repaid more rapidly than mortgages with lower interest rates. The Company's investment in private placement MBS at December 31, 2000 includes an investment of $1.6 million carrying value in 1998-B interest only notes, an investment of $0.9 million carrying value in 1998-B principal only notes and an investment of $19.5 million carrying value in below investment grade subordinate MBS classified as held to maturity, available for sale or trading. During 2000 the Company purchased $6.0 million of below investment grade MBS from third parties, sold $5.9 million of below investment grade MBS to third parties, purchased $13.8 million of below investment grade subordinate MBS from HCP, and transferred $9.9 million of investment grade and below investment grade subordinate MBS from the Company's 1998-B CMO to Collateral for the 2000-A CMO. During 1999, the Company purchased twelve below investment grade subordinate MBS from third parties. At December 31, 1999, these securities had an aggregate book of value of $3,640,000. 42 45 OTHER INTEREST INCOME Interest income generated during 2000 and 1999 from non-mortgage assets is detailed below (dollars in thousands):

QUARTER ENDED Year --------------------------------------------------- Ended Mar 31, Jun 30, Sept 30, Dec 31, Dec 31, 2000 2000 2000 2000 2000 ---- ---- ---- ---- ---- Overnight investing $ 52 $ 28 $ 14 $ 29 123 Related party notes 144 174 97 117 532 ---- ---- ---- ---- ---- $196 $202 $111 $146 $655 ==== ==== ==== ==== ====

QUARTER ENDED Year --------------------------------------------------- Ended Mar 31, Jun 30, Sept 30, Dec 31, Dec 31, 1999 1999 1999 1999 1999 ---- ---- ---- ---- ---- Overnight investing $199 $169 $146 $ 84 $598 Related party notes 52 58 92 143 345 ---- ---- ---- ---- ---- $251 $227 $238 $227 $943 ==== ==== ==== ==== ====

Interest income recorded on overnight investing was generated for the most part from investing excess cash in Federal Agency Discount Notes, mutual funds of Treasury and Agency securities and, to a lesser extent, investments in the highest rated commercial paper and savings accounts. Interest rates on overnight investments ranged from 4.80% to 6.29%. The Company applied excess cash to reduce borrowing against Agency Collateral during 2000 and the fourth quarter of 1999. Notes receivable due from HCP and HTC earn interest at the prime rate less one percent. The balance due from HCP at December 31, 2000 and 1999 was $1,704,000 and $4,896,000, respectively. The balance due from HTC at December 31, 2000 and December 31, 1999 was $2,904,000 and $0 respectively. Notes receivable due from Principals earn interest at the lowest applicable Federal rate in effect at the time of the loan. The balance due from Principals at December 31, 2000 and 1999 was $3,279,000 and $3,050,000, respectively. In September 1999 Hanover advanced $3,041,000 to HCP to fund the purchase of certain third party private placement notes by HCP. This advance is included in the notes receivable due from HCP at December 31, 1999. The outstanding balance of this advance was repaid when the private placement notes were transferred to the Company in July of 2000. 43 46 TAXABLE INCOME Hanover's taxable income for the year ended December 31, 2000 is estimated at $2,732,000. Taxable income differs from GAAP net income for the year ended December 31, 2000 due to various recurring and one time book/tax differences. The following table details the major book/tax differences in arriving at the estimated taxable income for the year ended December 31, 2000 (dollars in thousands): GAAP NET INCOME $2,862 RECURRING ADJUSTMENTS: Add: Equity in loss of unconsolidated subsidiaries 1,041 Loan loss provision, net of realized losses 789 Less: Tax amortization of net premiums on mortgages, CMO collateral and mortgage securities and interest accrual in excess of GAAP amortization and interest accrual (1,197) Difference in recognition on sales of mortgage securities (697) Other (66) ---------- ESTIMATED TAXABLE INCOME $ 2,732 ========== As a REIT, Hanover is required to pay dividends amounting to 85% of each year's taxable income by the end of each calendar year and to have declared dividends amounting to 90% of Hanover's taxable income for each year by the time Hanover files its Federal tax return. Therefore, a REIT generally passes through substantially all of its earnings to shareholders without paying Federal income tax at the corporate level. LIQUIDITY With the completion of the 2000-A securitization in June 2000, the Company believes it has substantially reduced its exposure to liquidity events. The Company expects to meet its future short-term and long-term liquidity requirements generally from its existing working capital, cash flow provided by operations, reverse repurchase agreements and other possible sources of financing, including CMOs and REMICs. The Company considers its ability to generate cash to be adequate to meet operating requirements both short-term and long-term. The Company's remaining exposure to market-driven liquidity events is limited to the short-term reverse repurchase financing it has in place against its mortgage-backed securities. If a significant decline in the market value of the Company's mortgage-backed securities portfolio should occur, the Company's available liquidity from existing sources and ability to access additional sources of credit may be reduced. As a result of such a reduction in liquidity, the Company may be forced to sell certain investments in order to maintain liquidity. If required, these sales could be made at prices lower than the carrying value of such assets, which could result in losses. The Company had two committed reverse repurchase agreement lines of credit in place at December 31, 2000 and seven uncommitted lines of credit. At December 31, 2000 the Company had available capacity to borrow $21 million under the first committed line and $50 million under the second. Management may add additional committed and uncommitted lines of credit in the future. 44 47 Net cash used in operating activities for the year ended December 31, 2000 was $3,906,000 compared to net income of $2,682,000 for the year. Significant non-cash charges and expenses included $1,041,000 of equity in income and loss of unconsolidated subsidiaries and loan loss provision of $875,000, partially offset by gain on mark to market of mortgage securities of $816,000. Purchase of trading securities used $7,634,000, partially offset by sale of trading securities of $2,709,000. Net cash provided by investing activities amounted to $91,551,000 during the year ended December 31, 2000. The majority of cash proceeds from investing activities was generated from (1) principal payments received on collateral for CMOs of $57,254,000, (2) proceeds from the sale of mortgage assets of $43,054,000 and (3) principal payments received on mortgage securities of $8,001,000. These were offset by cash payments to purchase mortgage securities from third parties of $2,934,000 and cash used to purchase mortgage securities from HCP of $13,845,000. Cash flows from financing activities used $95,709,000 during the year ended December 31, 2000. The Company made net repayments to its reverse repurchase lenders of $40,962,000 and had net repayment on CMO borrowings (net of borrowings of $11,209,000) of $45,685,000. The Company also paid dividends of $2,822,000 and purchased an additional 1,503,955 shares of its common stock for $7,309,000 during this period. CAPITAL RESOURCES The Company regularly invests its capital in mortgage backed securities through Hanover, its primary investment vehicle. Hanover has also invested a limited amount of its capital in HTC. From the inception of HTC in May 1999 until December 31, 2000, Hanover advanced $2,904,000 in the form of a loan, and $390,000 in the form of an inter-company advance, to HTC. The Company believes that HTC will continue to have significant capital needs for the remainder of 2001. The Company is attempting to raise outside capital to address HTC's capital budget. However, if the Company is unable to raise outside capital on acceptable terms, the Company expects to continue to advance funds from Hanover to HTC for the remainder of 2001. HTC has a limited operating history and has not been profitable to date. Although the Company currently expects that HTC will not need substantial capital investments after the end of 2001, there can be no assurances that HTC will generate sufficient revenues to cover its own capital costs and operating costs at that time. If future revenues are insufficient to cover such costs, HTC would require additional advances from Hanover in order to remain as a going concern. YEAR 2000 (Y2K) DISCLOSURE The Company did not experience any material Y2K issues. Nevertheless, there still remain some future dates that could potentially cause computer systems problems. The Y2K issue is the result of computer systems that use two digits rather than four to define the applicable year, which may prevent such systems from accurately processing dates ending in the year 2000 and thereafter. This could result in system failures or in miscalculations causing disruption of operations, including, but not limited to, an inability to process transactions, to send and receive electronic data, or to engage in routine activities and operations. RISK FACTORS REIT Requirements Hanover has elected to be taxed as a REIT under the Code. Hanover believes that it was in full compliance with the REIT tax rules as of December 31, 2000 and intends to remain in compliance with all REIT tax rules. If Hanover fails to qualify as a REIT in any taxable year and certain relief provisions of the Code do not apply, Hanover will be subject to Federal income tax as a regular, domestic corporation, and its stockholders will be subject to tax in the same manner as stockholders of a regular corporation. Distributions to its stockholders in any year in which Hanover fails to qualify as a REIT would not be deductible by Hanover in computing its taxable income. As a result, Hanover could be subject to income tax liability, thereby significantly reducing or eliminating the amount of cash available for distribution to its stockholders. Further, Hanover could also be disqualified from re-electing REIT status for the four taxable years following the year during which it became disqualified. 45 48 Investments in Certain Mortgage Assets The Company takes certain risks in investing in non-standard single-family mortgage loans and securities collateralized by such loans. If these mortgage loans are missing relevant documents, such as the original note, they may be difficult to enforce. These mortgage loans may also have inadequate property valuations. In addition, if a single-family mortgage loan has a poor payment history, it is more likely to have future delinquencies because of poor borrower payment habits or a continuing cash flow problem. Defaults on Mortgage Assets The Company makes long-term investments in mortgage assets and securities. During the time it holds mortgage assets for investment, the Company is subject to the risks of borrower defaults and bankruptcies and hazard losses (such as those occurring from earthquakes or floods) that are not covered by insurance. If a default occurs on any mortgage loan held by the Company or on any mortgage loan collateralizing below investment grade in MBS held by the Company, the Company will bear the risk of loss of principal to the extent of any deficiency between the value of the mortgaged property, plus any payments from an insurer or guarantor, and the amount owing on the mortgage loan. If the Company were to invest in commercial mortgage loans, the Company may be subject to certain additional risks. Commercial properties tend to be unique and more difficult to value than single-family residential properties. Commercial mortgage loans often have shorter maturities than single-family mortgage loans and often have a significant principal balance or "balloon" due on maturity. A balloon payment creates a greater risk for the lender because the ability of a borrower to make a balloon payment normally depends on its ability to refinance the loan or sell the related property at a price sufficient to permit the borrower to make the payment. Commercial mortgage lending is generally viewed as exposing the lender to a relatively greater risk of loss than single-family mortgage lending because it usually involves larger mortgage loans to single borrowers or groups of related borrowers and the repayment of the loans is typically dependent upon the successful operation of the related properties. As of December 31, 2000, the Company did not have any commercial mortgage loan investments. However, the Company may elect to make such investments in the future. Negative Effects of Fluctuating Interest Rates Changes in interest rates may impact the Company's earnings in various ways. Approximately one third of the Company's mortgage loans held as collateral for CMOs are adjustable rate mortgages ("ARMs"). Therefore, rising short term interest rates may negatively affect the Company's earnings in the short term. Increases in the interest rate on an ARM loan are generally limited to either 1% or 2% per adjustment period. ARM loans owned by the Company are subject to such limitations, while adjustments in the interest rate on the Company's borrowings are not correspondingly limited. As a result, in periods of rising interest rates, the Company's net interest income could decline. The rate of prepayment on the Company's mortgage loans may increase if interest rates decline, or if the difference between long-term and short-term interest rates diminishes. Increased prepayments would cause the Company to amortize any premiums paid on the acquisition of its mortgage loans faster than currently anticipated, resulting in a reduced yield on its mortgage loans. Additionally, to the extent proceeds of prepayments cannot be reinvested at a rate of interest at least equal to the rate previously earned on the prepaid mortgage loans, the Company's earnings may be adversely affected. 46 49 Insufficient Demand for Mortgage Loans and the Company's Loan Products The availability of mortgage loans that meet the Company's criteria depends on, among other things, the size of and level of activity in the residential, multifamily and commercial real estate lending markets. The size and level of activity in these markets, in turn, depends on the level of interest rates, regional and national economic conditions, inflation and deflation in property values and the general regulatory and tax environment as it relates to mortgage lending. If the Company can not obtain sufficient mortgage loans or mortgage securities that meet its criteria, its business will be adversely affected. Investment in Subsidiary As of Dec. 31, 2000, Hanover had provided $2,904,000 to HTC in the form of loans, and Hanover anticipates that HTC will continue to borrow substantial amounts of money from Hanover in the future. Since its inception, HTC has not generated revenues, and there can be no assurance that in the future HTC will generate sufficient revenues or be successful enough to repay such loans to Hanover or provide Hanover with any other returns on its investment. Investment Company Act The Company at all times intends to conduct its business so as not to become regulated as an investment company under the Investment Company Act. If the Company were to become regulated as an investment company, the Company's use of leverage would be substantially reduced. The Investment Company Act exempts entities that are "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on interest in real estate" ("Qualifying Interests"). Under current interpretation of the staff of the Securities and Exchange Commission, in order to qualify for this exemption, the Company must maintain at least 55% of its assets directly in Qualifying Interests. As of December 31, 2000, the Company believes that it is in compliance with this requirement. State and Local Taxes Hanover and its shareholders may be subject to state or local taxation in various jurisdictions, including those in which it or they transact business or reside. The state and local tax treatment of Hanover and its shareholders may not conform to federal income tax consequences discussed above. Consequently, prospective shareholders should consult their own tax advisors regarding the effect of state and local tax laws on an investment in Hanover shares. 47 50 IMPORTANT FACTORS RELATED TO FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS The preceding section, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and other sections of this Annual Report on Form 10K contain various "forward-looking statements" within the meaning of Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent the Company's current expectations, intent or beliefs concerning future events, including, without limitation, statements containing the words "believes," "anticipates," "expects" and words of similar import; and also including, without limitation, the following: statements regarding the Company's continuing ability to target and acquire mortgage loans; expected availability of the master reverse repurchase agreement financing; the sufficiency of the Company's working capital, cash flows and financing to support the Company's future operating and capital requirements; results of operations and overall financial performance; the expected dividend distribution rate; and the expected tax treatment of the Company's operations. Such forward-looking statements relate to future events and the future financial performance of the Company and the industry and involve known and unknown risks, uncertainties and other important factors which could cause actual results, performance or achievements of the Company or industry to differ materially from the future results, performance or achievements expressed or implied by such forward-looking statements. Investors should carefully consider the various factors identified in "Management's Discussion and Analysis of Financial Condition and Results of Operation - Risk Factors," and elsewhere in this Annual Report on Form 10K that could cause actual results to differ materially from the results predicted in the forward-looking statements. Further, the Company specifically cautions investors to consider the following important factors in conjunction with the forward-looking statements: the possible decline in the Company's ability to locate and acquire mortgage loans or mortgage backed securities; the possible adverse effect of changing economic conditions, including fluctuations in interest rates and changes in the real estate market both locally and nationally; the effect of severe weather or natural disasters; the effect of competitive pressures from other financial institutions, including other mortgage REIT's; and the possible changes, if any, in the REIT rules. Because of the foregoing factors, the actual results achieved by the Company in the future may differ materially from the expected results described in the forward-looking statements. The Company undertakes no obligation to update or revise the information contained herein, whether as a result of new information, future events or circumstances, or otherwise. 48 51 ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK During 2000 the Company used certain derivative financial instruments (for purposes other than trading) as hedges of anticipated transactions relating to its investment portfolio. The Company from time to time enters into interest rate hedge mechanisms (forward sales of Agency mortgage securities) to manage its exposure to market pricing changes in connection with the purchase, holding of, securitization and sale of its fixed rate mortgage loan portfolio and certain mortgage securities. The Company generally closes out the hedge position to coincide with the related sale or securitization transactions and recognizes the results of the hedge transaction in determining the amount of the related gain or loss for loans or securities sold, or as a basis adjustment to loans held to maturity. At December 31, 2000 the Company had forward commitments to sell $11.3 million (par value) of Agency mortgage securities that had not yet settled. Of this amount, $4.5 million was entered into to hedge the expected sale of approximately $3,921,000 million principal balance of subordinate mortgage-backed securities held in a trading account. The balance of $6.8 million was entered into as a partial hedge for the Company's mortgage securities available for sale The primary risk associated with selling short Agency securities relates to changes in interest rates. Generally, as market interest rates increase, the market value of the hedged asset (fixed rate mortgage loans) will decrease. The net effect of increasing interest rates will generally be a favorable or gain settlement on the forward sale of the Agency security; this gain should offset a corresponding decline in the value of the hedged assets. Conversely, if interest rates decrease, the market value of the hedged asset will generally increase. The net effect of decreasing interest rates will generally be an unfavorable or loss settlement on the forward sale of the Agency security; this loss should be offset by a corresponding gain in value of the hedged assets. To mitigate interest rate risk an effective matching of Agency securities with the hedged assets needs to be monitored closely. Senior Management monitors the changes in weighted average duration and coupons of the hedged assets and will appropriately adjust the amount, duration and coupon of future forward sales of Agency securities. The Company also enters into interest rate hedge mechanisms (interest rate caps) to manage its interest rate exposure on certain reverse repurchase agreement financing and floating rate CMOs. The cost of the interest rate caps is amortized over the life of the interest rate cap and is reflected as a portion of interest expense in the consolidated statement of operations. At December 31, 2000 the Company had the following interest rate caps in effect (dollars in thousands):

NOTIONAL AMOUNT INDEX STRIKE % MATURITY DATE ---------------------------- -------------------------- -------------------------- -------------------------- $ 23,922 3 Month LIBOR 5.75% March, 2001 23,097 3 Month LIBOR 5.75% April, 2001 11,000 3 Month LIBOR 7.70% October 2003 50,000 1 Month LIBOR 7.25% August, 2002 25,000 1 Month LIBOR 7.75% August, 2004 -------- $133,019 ========

The primary risk associated with interest rate caps relates to interest rate increases. The interest rate caps provide a cost of funds hedge against interest rates that exceed the strike rate, subject to the limitation of the notional amount of financing. 49 52 INTEREST RATE SENSITIVITY Interest Rate Mismatch Risk - Reverse Repo Financing At December 31, 2000, the Company owned a de minimus amount of mortgage loans held for sale. If the Company resumes its strategy of purchasing mortgage loans, it would finance these assets during the initial period (the time period during which management analyzes the loans in detail and corrects deficiencies where possible before securitizing the loans) with reverse repurchase agreement ("repo") financing or with equity alone in certain instances. In this scenario, the Company would be exposed to the mismatch between the cost of funds on its repo financing and the yield on the mortgage loans. The Company's repo financing agreements at December 31, 2000 were indexed to LIBOR plus a spread of 0 to 288 basis points. This financing generally is rolled and matures every 30 to 90 days. Accordingly, any increases in LIBOR will tend to reduce net interest income and any decreases in LIBOR will tend to increase net interest income. The Company also has floating rate reverse repurchase financing for certain fixed-rate mortgage backed securities. At December 31, 2000, the Company had a total of $11,134,000 of floating rate reverse repo financing compared to $35,723,000 of fixed rate mortgage-backed securities investments. The Company has attempted to hedge this exposure by using the interest rate caps described above. Price Risk The market value of mortgage loans and mortgage securities will fluctuate with changes in interest rates. In the case of mortgage loans held for sale and mortgage securities available for sale or held for trading, the Company will be required to record changes in the market value of such assets. In the case of mortgage loans held for sale and mortgage securities held for trading, the Company generally attempts to hedge these changes through the short sale of mortgage securities, described above. At December 31, 2000, the Company did not have any significant mortgage loans held for sale. The mortgage securities held for trading were hedged with the short sale of mortgage securities described above. In the case of mortgage loans held for sale, hedging gains and losses and other related hedging costs are deferred and are recorded as an adjustment of the hedged assets or liabilities. The hedging gains ("Hedging Gains") and losses ("Hedging Costs") along with the other related hedging costs are amortized over the estimated life of the asset or liability. This hedging of mortgage assets should, if properly executed, adjust the carrying value of the fixed mortgage loan pools to reflect current market pricing. The costs of the individual hedging transactions can vary greatly depending upon the market conditions. Prepayment Risk Interest income on the mortgage loan and mortgage securities portfolio is also negatively affected by prepayments on mortgage loan pools or MBS purchased at a premium and positively impacted by prepayments on mortgage loan pools or MBS purchased at a discount. The Company assigns an anticipated prepayment speed to each mortgage pool and MBS at the time of purchase and records the appropriate amortization of the premium or discount over the estimated life of the mortgage loan pool or MBS. To the extent the actual prepayment speeds vary significantly from the anticipated prepayment speeds for an extended period of time, the Company will adjust the anticipated prepayment speeds and amortization of the premium or discount accordingly. This will negatively (in the case of accelerated amortization of premiums or decelerated amortization of discounts) or positively (in the case of 50 53 decelerated amortization of premiums or accelerated amortization of discounts) impact net interest income. Delinquency and Default Risk Increases in delinquency rates and defaults by borrowers on their mortgages can also negatively impact the Company's net interest income. The Company monitors delinquencies and defaults in its mortgage loan portfolio in three categories: government, conventional insured and conventional uninsured. It adjusts its loan loss provision policy and interest non-accrual policy in accordance with changes in the delinquency and default trends. Securitized Mortgage Loan Assets With respect to the match funding of assets and liabilities, the CMO collateral relating to the 1998-A, 1999-A, 1999-B and 2000-A securitizations reflect $142,330,000 of fixed rate mortgage loans and $69,687,000 of adjustable rate mortgage loans and $9,877,000 of mortgage securities at December 31, 2000. The primary financing for this asset category is the CMO debt of $210,374,000 and to a much lesser extent repo agreements of $3,627,000. The repo financing, which is indexed to LIBOR, is subject to interest rate volatility as the repo agreement matures and is extended. The financing provided by the CMOs for the 1998-A, 1999-A and 2000-A securitizations lock in long-term fixed financing and thereby eliminates most interest rate risk. The financing for the 1999-B securitization is indexed to LIBOR. Accordingly, the Company has hedged this interest rate risk through the purchase of interest rate caps. The Company purchased amortizing interest rate caps with notional balances of $110 million in August 1999 to hedge the 1999-B securitization. The remaining notional balance of these caps is $75 million at December 31, 2000. Mortgage Securities At December 31, 2000 the Company owned certain fixed rate Agency and private placement mortgage securities and certain interest only and principal only private placement mortgage securities with an aggregate carrying value of $25,846,000. The coupon interest rates on the fixed rate mortgage securities would not be affected by changes in interest rates. The interest only notes remit monthly interest generated from the underlying mortgages after deducting all service fees and the coupon interest rate on the applicable notes. The interest rate on each of the interest only notes is based on a notional amount (the principal balance of those mortgage loans with an interest rate in excess of the related note coupon interest rate). The notional amounts decline each month to reflect the related normal principal amortization, curtailments and prepayments for the related underlying mortgage loans. Accordingly, net interest income on the mortgage securities portfolio would be negatively affected by prepayments on mortgage loans underlying the mortgage securities and would further be negatively affected to the extent that higher rated coupon mortgage loans paid off more rapidly than lower rated coupon mortgage loans. ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements of the Company and the related notes, together with the Independent Auditors' Report thereon beginning on page F-1 of this Form 10-K. ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 51 54 PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated herein by reference to the Company's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year. ITEM 11: EXECUTIVE COMPENSATION Incorporated herein by reference to the Company's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year. ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated herein by reference to the Company's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated herein by reference to the Company's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year. 52 55 PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) Financial Statements See Part II, Item 8 hereof. (2) Financial Statements and Auditors' Reports All schedules omitted are inapplicable or the information required is shown in the Financial Statements or notes thereto. The auditors' reports of Deloitte & Touche LLP with respect to the Financial Statements begin on page F-1 of this Form 10-K. (3) Exhibits Exhibits required to be attached by Item 601 of Regulation S-K are listed in the Exhibit Index attached hereto, which is incorporated herein by this reference. (b) Reports on Form 8-K The Company did not file any current reports on Form 8-K during the last quarter of 2000. 53 56 EXHIBIT INDEX 3.1(1) Articles of Incorporation of the Company, as amended 3.2(1) By-Laws of the Company 4.1(1) Specimen Common Stock Certificate 4.2(1) Warrant Agreement pursuant to which Warrants were issued (including form of Warrant) 4.3(1) Representatives' Warrant Agreement pursuant to which the Representatives' Warrants were issued 4.4(1) Specimen Unit Certificate 10.3*(1) Registration Rights Agreement 10.4*(1) Shareholders' Agreement of Hanover Capital Partners Ltd. 10.4.1*(6) Termination of Shareholders' Agreement of Hanover Capital Partners Ltd. 10.5*(1) Agreement and Plan of Recapitalization 10.6*(1) Bonus Incentive Compensation Plan 10.7*(1) 1997 Executive and Non-Employee Director Stock Option Plan 10.7.1*(3) 1999 Equity Incentive Plan 10.8*(1) Employment Agreement by and between the Company and John A. Burchett 10.8.1* First Amendment to Employment Agreement by and between the Company and John A. Burchett 10.9*(1) Employment Agreement by and between the Company and Irma N. Tavares 10.9.1* First Amendment to Employment Agreement by and between the Company and Irma N. Tavares 10.10*(1) Employment Agreement by and between the Company and Joyce S. Mizerak 10.10.1* First Amendment to Employment Agreement by and between the Company and Joyce S. Mizerak 10.11*(1) Employment Agreement by and between the Company and George J. Ostendorf 10.11.1* First Amendment to Employment Agreement by and between the Company and George J. Ostendorf 10.11.2* Employment Agreement by and between the Company and Thomas P. Kaplan 10.12(1) Standard Form of Office Lease, dated as of May 6, 1991, by and between Irwin Kahn and HCP, as amended by the First Amendment of Lease, dated as of July 1, 1996 10.12.1(3) Second Amendment of lease, dated as of December 22, 1998, by and between FGP 90 West Street, Inc., successor to Irwin Kahn, and HCP. 10.13(1) Office Lease Agreement, dated as of March 1, 1994, by and between Metroplex Associates and HCMC, as amended by the First Modification and Extension of Lease Amendment, dated as of February 28, 1997. 10.14(3) Office Lease Agreement, dated as of February 1, 1999, between La Salle-Adams, LLC and HCP. 57 10.16(1) Office Lease and Service Agreement, dated as of August 28, 1995 by and between Federal Deposit Insurance Receiver for Merchants Bank and HCP 10.25*(1) Contribution Agreement 10.26*(1) Participation Agreement 10.27*(1) Loan Agreement 10.29(2) Management Agreement, dated as of January 1, 1998, by and between the Company and HCP 10.30(3) Amendment Number One to Management Agreement, dated as of September 30, 1999 10.31(4) Amended and Restated Master Loan and Security Agreement by and between Greenwich Capital Financial Products, Inc. and Hanover Capital Mortgage Holdings, Inc. and Hanover Capital Partners Ltd., dated March 27, 2000 10.32(3) Warehousing Credit and Security Agreement, dated as of April 30, 1999, by and between Bank United and the Company, as amended by the First Amendment and Second 10.32.1(4) Third Amendment to Warehousing Credit and Security Agreement dated as of April 30, 1999 by and between Bank United and the Company 10.32.2(6) Fourth Amendment to Warehousing Credit and Security Agreement dated as of May 31, 2000 by and between Bank United and the Company 10.33(5) Stockholder Protection Rights Agreement 10.34 Asset Purchase Agreement dated as of January 19, 2001 by and among HanoverTrade.com, Inc., Hanover Capital Mortgage Holdings, Inc., Pamex Capital Partners, L.L.C. and the Members of Pamex Capital Partners, L.L.C. 21 Subsidiaries of the Company -------------------------------------------------------------------------------- (1) Incorporated herein by reference to the Company's Registration Statement No. 333-29261, as amended, as filed with the Securities and Exchange Commission. (2) Incorporated herein by reference to the Company's Form 10-K for the year ended December 31, 1997, as filed with the Securities and Exchange Commission. (3) Incorporated herein by reference to the Company's Form 10-K for the year ended December 31, 1999, as filed with the Securities and Exchange Commission. (4) Incorporated herein by reference to the Company's Form 10-Q for the quarter ended March 31, 2000, as filed with the Securities and Exchange Commission. (5) Incorporated herein by reference to the Company's Report on Form 8-K filed with the Securities and Exchange Commission on April 29, 2000. (6) Incorporated herein by reference to the Company's Form 10-Q for the quarter ended June 30, 2000, as filed with the Securities and Exchange Commission. * Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 601 of Regulation S-K. 58 TABLE OF CONTENTS TO FINANCIAL STATEMENTS

PAGE HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES Independent Auditors' Report .................................................................... F-2 Consolidated Financial Statements as of December 31, 2000 and December 31, 1999 and for the Years Ended December 31, 2000, 1999 and 1998: Balance Sheets ........................................................................ F-3 Statements of Operations .............................................................. F-4 Statements of Stockholders' Equity .................................................... F-5 Statements of Cash Flows .............................................................. F-6 Notes to Consolidated Financial Statements ............................................ F-7 HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES Independent Auditors' Report .................................................................... F-40 Consolidated Financial Statements as of December 31, 2000 and December 31, 1999 and the Years Ended December 31, 2000, 1999 and 1998: Balance Sheets ........................................................................ F-41 Statements of Operations .............................................................. F-42 Statements of Stockholders' Equity .................................................... F-43 Statements of Cash Flows .............................................................. F-44 Notes to Consolidated Financial Statements ............................................ F-45 HANOVERTRADE.COM, Inc. Independent Auditors' Report .................................................................... F-59 Consolidated Financial Statements as of December 31, 2000 and December 31, 1999 and for the Year Ended December 31, 2000 and for the Period from May 28, 1999 (inception) through December 31, 1999: Balance Sheets ........................................................................ F-60 Statements of Operations .............................................................. F-61 Statements of Stockholders' Equity .................................................... F-62 Statements of Cash Flows .............................................................. F-63 Notes to Consolidated Financial Statements ............................................ F-64

F-1 59 INDEPENDENT AUDITORS' REPORT To the Board of Directors of Hanover Capital Mortgage Holdings, Inc. and Subsidiaries New York, New York We have audited the accompanying consolidated balance sheets of Hanover Capital Mortgage Holdings, Inc. and Subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. 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 generally 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 misstatement. An audit includes examining, on a test basis, evidence supporting 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hanover Capital Mortgage Holdings, Inc. and Subsidiaries as of December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP Parsippany, New Jersey March 27, 2001 F-2 60 HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except as noted) DECEMBER 31, DECEMBER 31, ASSETS 2000 1999 --------- --------- Mortgage loans: Held for sale $ 230 $ 251 Collateral for CMOs 212,017 269,833 Mortgage securities pledged as collateral for reverse repurchase agreements: Available for sale 11,785 48,529 Held to maturity 1,384 3,618 Trading 1,743 5,919 Mortgage securities pledged as collateral for CMOs 9,877 -- Mortgage securities, not pledged: Available for sale 4,744 -- Held to maturity 3,133 4,620 Trading 3,057 -- Cash and cash equivalents 9,958 18,022 Accrued interest receivable 2,466 2,926 Equity investments Hanover Capital Partners Ltd. 1,765 1,466 HanoverTrade.com, Inc. (1,526) (30) Notes receivable from related parties 7,887 8,187 Due from related parties 237 232 Other receivables 911 151 Prepaid expenses and other assets 3,140 1,910 --------- --------- TOTAL ASSETS $ 272,808 $ 365,634 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Reverse repurchase agreements $ 14,760 $ 55,722 CMO borrowing 210,374 254,963 Accrued interest payable 1,796 2,433 Dividends payable 865 583 Due to related party -- 88 Accrued expenses and other liabilities 989 1,339 --------- --------- TOTAL LIABILITIES 228,784 315,128 --------- --------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, par value $.01, 10 million shares authorized, -0- issued and outstanding Common stock, par value $.01, 90 million shares authorized, 4,322,944 and 5,826,899 shares outstanding at December 31, 2000 and December 31, 1999, respectively 43 58 Additional paid-in capital 68,546 75,840 Retained earnings (deficit) (25,737) (25,496) Accumulated other comprehensive income 1,172 104 --------- TOTAL STOCKHOLDERS' EQUITY 44,024 50,506 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 272,808 $ 365,634 ========= ========= See notes to consolidated financial statements F-3 61 HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)

YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 2000 1999 1998 ------------ ------------ ------------ REVENUES: Interest income $ 26,692 $ 27,505 $ 47,799 Interest expense 20,029 23,097 41,176 -------- -------- -------- Net interest income 6,663 4,408 6,623 Loan loss provision 875 446 356 -------- -------- -------- Net interest income after loan loss provision 5,788 3,962 6,267 Gain on sale of servicing rights -- 540 -- Gain (loss) on sale of mortgage assets 819 146 (5,704) Gain (loss) on mark to market of mortgage assets, net of associated hedge 431 (4,292) -- Impairment charge on mortgage securities -- (2,225) Provision for (loss) on unconsolidated subsidiary -- (4,793) -- -------- -------- -------- Total revenue (loss) 7,038 (6,662) 563 EXPENSES: Personnel 1,013 1,230 712 Management and administrative 759 894 733 Due diligence -- 119 687 Commissions 4 5 286 Legal and professional 555 1,201 545 Financing/commitment fees 281 404 836 Other 524 338 265 -------- -------- -------- Total expenses 3,136 4,191 4,064 -------- -------- -------- Operating income (loss) 3,902 (10,853) (3,501) Equity in income (loss) of unconsolidated subsidiaries Hanover Capital Partners Ltd. 455 (443) (1,039) Hanover Capital Partners 2, Inc. -- (1,300) (394) HanoverTrade.com, Inc. (1,495) (31) -- -------- -------- -------- NET INCOME (LOSS) $ 2,862 $(12,627) $ (4,934) ======== ======== ======== BASIC EARNINGS (LOSS) PER SHARE $ 0.56 $ (2.12) $ (0.77) ======== ======== ======== DILUTED EARNINGS (LOSS) PER SHARE $ 0.56 $ (2.12) $ (0.77) ======== ======== ========

See notes to consolidated financial statements F-4 62 HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (in thousands except share data)

ACCUMULATED COMMON STOCK ADDITIONAL COMPREHENSIVE RETAINED OTHER ------------ PAID-IN INCOME EARNINGS COMPREHENSIVE SHARES AMOUNT CAPITAL (LOSS) (DEFICIT) INCOME (LOSS) TOTAL ---------- ------ ------- ------------- ---------- ------------- ------- BALANCE, DECEMBER 31,1997 6,466,677 $65 $79,411 $(536) $(842) $78,098 Adjustment of initial public offering expenses 11 11 Exercise of warrants 2,122 32 32 Costs associated with registration of warrants (40) (40) Repurchase of common stock (146,900) (1,345) (1,345) Comprehensive (loss): Net (loss) $(4,934) (4,934) (4,934) Other comprehensive (loss): Change in net unrealized gain (loss) on securities available for sale (1,557) (1,557) (1,557) --------- Comprehensive (loss) $ (6,491) ========= Dividends declared (4,485) (4,485) ---------- ------ ------- --------- ------------- ------- BALANCE DECEMBER 13, 1998 6,321,899 65 78,069 (9,955) (2,399) 65,780 Repurchase of common stock (495,000) (2,236) (2,236) Treasury stock par value re-class (7) 7 -- Comprehensive (loss): Net (loss) (12,627) (12,627) (12,627) Other comprehensive income Change in net unrealized gain on securities available for sale, net of reclassification adjustments 2,355 2,355 2,355 Equity in other comprehensive income of unconsolidated subsidiary 148 148 148 --------- Comprehensive (loss) $ (10,124) ========= Dividends declared (2,914) (2,914) ---------- ------ ------- --------- ------------- ------- BALANCE, DECEMBER 31, 1999 5,826,899 58 75,840 (25,496) 104 50,506 Repurchase of common stock (1,503,955) (15) (7,294) (7,309) Comprehensive income: Net income 2,862 2,862 2,862 Other comprehensive income: Change in net unrealized gain on securities available for sale 1,216 1,216 1,216 Equity in other comprehensive loss of unconsolidated subsidiary (148) (148) (148) ------- Comprehensive income: $ 3,930 ======= Dividends declared (3,103) (3,103) ---------- ------ ------- --------- ------------- ------- BALANCE, DECEMBER 31, 2000 4,322,944 $ 43 $ 68,546 $ (25,737) $ 1,172 $44,024 ========== ====== ======= ========= ============= =======

See notes to consolidated financial statements F-5 63 HANOVER CAPITAL MORTGAGE HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)

YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998 ----------------- ----------------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 2,862 $ (12,627) $ (4,934) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Amortization of net premium and deferred costs 203 4,300 6,594 Loan loss provision 875 446 356 (Gain) on sale of servicing rights -- (540) -- (Gain) loss on sale of mortgage assets (873) (146) 5,705 (Gain) loss on mark to market of mortgage assets (816) 4,292 -- Impairment charge on mortgage securities -- 2,225 -- Provision for loss on sale of unconsolidated subsidiary -- 4,793 -- Equity in loss of unconsolidated subsidiaries 1,041 1,774 1,433 Purchase of Trading Securities (7,634) -- -- Sales of Trading Securities 2,709 -- -- (Increase) decrease in accrued interest receivable 460 1,014 (343) (Increase) decrease in loans to related parties 300 (4,294) (3,411) (Increase) decrease in other receivables (761) 1,104 (1,621) (Increase) in prepaid expenses and other assets (1,230) (1,305) (364) Increase (decrease) in accrued interest payable (637) 1,039 842 Increase (decrease) in due to related parties (93) 169 (782) Increase (decrease) in accrued expenses and other liabilities (312) 432 423 --------- --------- --------- Net cash provided by (used in) operating activities (3,906) 2,676 3,898 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of mortgage loans -- (1,449) (863,324) Purchase of mortgage securities (2,934) (3,668) (25,856) Purchase of mortgage securities from affiliate (13,845) -- -- Principal payments received on mortgage securities 8,001 12,895 150,543 Principal payments received on collateral for CMOs 57,254 61,613 23,165 Principal payments received on mortgage loans held for sale and held to maturity 21 44,429 123,098 Proceeds from sale of mortgage assets 43,054 30,909 276,582 Proceeds from sale of servicing rights -- 786 -- --------- --------- --------- Net cash provided by (used in) investing activities 91,551 145,515 (315,792) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings from (repayment of) reverse repurchase agreements (40,962) (314,368) 243,218 Net (repayment of) borrowing from CMOs (45,685) 177,624 77,305 Increase in CMO discount 1,069 Net proceeds of initial public offering -- 11 Exercise of stock warrants - net -- (8) Equity investments in subsidiaries (1) (2,700) Dividends received - unconsolidated subsidiary -- 8,054 Payment of dividends (2,822) (3,026) (4,826) Repurchase of common stock (7,309) (2,235) (1,345) --------- --------- --------- Net cash provided by (used in) financing activities (95,709) (142,006) 319,709 --------- --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (8,064) 6,185 7,815 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 18,022 11,837 4,022 --------- --------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 9,958 $ 18,022 $ 11,837 ========= ========= =========

See notes to consolidated financial statements F-6 64 HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 1. ORGANIZATION AND BASIS OF PRESENTATION GENERAL Hanover Capital Mortgage Holdings, Inc. ("Hanover") was incorporated in Maryland on June 10, 1997. Hanover is a real estate investment trust ("REIT"), formed to operate as a specialty finance company. Hanover has two primary unconsolidated subsidiaries: Hanover Capital Partners Ltd. ("HCP") and HanoverTrade.com, Inc. ("HTC"). When we refer to the "Company," we mean Hanover together with its consolidated and unconsolidated subsidiaries. The Company is engaged in three principal businesses, which are conducted through its three primary operating units: Hanover, HCP and HTC. The principal business strategy of Hanover is to invest in mortgage backed securities ("MBS") and, to a lesser extent, in mortgage loans. The principal business strategy of HCP is to generate consulting and other fee income by performing loan file and operational due diligence reviews for third parties, performing advisory services for third parties, and preparing and or processing documentation (primarily assignments of mortgage loans) for third parties on a contract basis. The principal business activity of HTC is to generate fee income by operating an online worldwide web-based exchange for trading loan pools (primarily mortgage loan pools) and by performing loan sale advisory services for third parties. The Company's principal business objective is to generate net interest income on its portfolio of mortgage loans and mortgage securities and to generate fee income through HCP and HTC. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Hanover Capital Mortgage Holdings, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. BASIS OF PRESENTATION The consolidated financial statements of the Company are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles ("GAAP") and in conformity with the rules and regulations of the Securities and Exchange Commission. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. When necessary, reclassifications have been made to conform to current period presentation. USE OF ESTIMATES; RISKS AND UNCERTAINTIES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the F-7 65 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's estimates and assumptions primarily arise from risks and uncertainties associated with interest rate volatility, credit exposure and regulatory changes. Although management is not currently aware of any factors that would significantly change its estimates and assumptions in the near term, future changes in market trends and conditions may occur which could cause actual results to differ materially. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, overnight investments deposited with banks and government securities with maturities less than 30 days. MORTGAGE LOANS The Company's policy is to classify each of its mortgage loans as held for sale as they are purchased and each asset is monitored for a period of time, generally four to nine months, prior to making a determination as to whether the asset will be classified as held to maturity. Mortgage loans that are securitized in a collateralized mortgage obligation ("CMO") are classified as collateral for CMOs as of the closing date of the CMO. All mortgage loans designated as held for sale are reported at the lower of cost or market, with unrealized losses reported as a charge to earnings in the current period. Mortgage loans designated as held to maturity and CMO collateral are reported at the lower of the original cost of the mortgaged loans or the market value of the mortgage loans as of the date they were designated as CMO collateral or held to maturity. Premiums, discounts and certain deferred costs associated with the purchase of mortgage loans are amortized into interest income over the lives of the mortgage loans using the effective yield method adjusted for the effects of estimated prepayments. Mortgage loan transactions are recorded on the date the mortgage loans are purchased or sold. Purchases of new mortgage loans are recorded when all significant uncertainties regarding the characteristics of the mortgage loans are removed, generally on or shortly before settlement date. Realized gains and losses on mortgage loan transactions are determined on the specific identification basis. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest income is reversed. Interest income is subsequently recognized only to the extent cash payments are received. The Company has limited its exposure to credit losses on its portfolio of mortgage loans by performing an in-depth due diligence on every loan purchased. The due diligence encompasses the borrower's credit, the enforceability of the documents, and the value of the mortgage property. In addition, many mortgage loans are guaranteed by an agency of the federal government or private mortgage insurance. The Company monitors the delinquencies and losses on the underlying mortgages and makes a provision for known losses as well as unidentified potential losses in its mortgage loan portfolio if the impairment is deemed to be other than temporary. The provision is based on management's assessment of numerous factors affecting its portfolio of mortgage loans including, but not limited to, current and projected economic conditions, delinquency status, losses to date on mortgages and remaining credit protection. F-8 66 MORTGAGE SECURITIES The Company's policy is to generally classify mortgage securities as available for sale as they are acquired. Each available for sale mortgage security is monitored for a period of time prior to making a determination whether the asset will be classified as held to maturity or trading. Management reevaluates the classification of the mortgage securities on a quarterly basis. Mortgage securities designated as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Mortgage securities designated as trading are reported at fair value. Gains and losses resulting from changes in fair value are recorded as income or expense and included in earnings. Mortgage securities classified as held to maturity are carried at the fair value of the security at the time the designation is made. Any fair value adjustment is reflected as a separate component of stockholders' equity and as a cost adjustment of the mortgage security as of the date of the classification and is amortized into interest income as a yield adjustment. The Company makes periodic evaluations of all mortgage securities to determine whether an other than temporary impairment is considered to have occurred. If a decline in the fair value is judged to be other than temporary, the cost basis of the mortgage security will be marked to fair value, resulting in a current period loss in the consolidated statement of operations. The new cost basis shall not be changed for further increases in market value; however, further increases in market value will be reflected separately in the equity section of the Company's balance sheet. In the quarter ended September 30, 1999, the Company determined that six interest only notes were impaired. See Note 16, "Certain Charges and Expenses in the Quarter Ended September 30, 1999". Premiums, discounts and certain deferred costs associated with the acquisition of mortgage securities are amortized into interest income over the lives of the securities using the effective yield method adjusted for the effects of estimated prepayments. Mortgage securities transactions are recorded on the date the mortgage securities are purchased or sold. Purchases of new issue mortgage securities are recorded when all significant uncertainties regarding the characteristics of the mortgage securities are removed, generally on or shortly before settlement date. Realized gains and losses on mortgage securities transactions are determined on the specific identification basis. The Company purchases both investment grade and below investment grade mortgage backed securities. Below investment grade MBS have the potential to absorb credit losses caused by delinquencies and defaults on the underlying mortgage loans. When purchasing below investment grade MBS, the Company leverages HCP's due diligence operations and management's substantial mortgage credit expertise to make a thorough evaluation of the underlying mortgage loan collateral. The Company monitors the delinquencies and defaults on the underlying mortgages of its mortgage securities and, if an impairment is deemed to be other than temporary, makes a provision for known losses as well as unidentified potential losses. The provision is based on management's assessment of numerous factors affecting its portfolio of mortgage securities including, but not limited to, current and projected economic conditions, delinquency status, credit losses to date on underlying mortgages and remaining credit protection. The provision is made by reducing the cost basis of the individual security and the amount of such write-down is recorded as a realized loss, thereby reducing earnings. Provisions for credit losses do not reduce taxable income and therefore do not affect the dividends paid by the Company to stockholders in the period the provisions are taken. Actual losses realized by the Company reduce F-9 67 taxable income in the period the actual loss is realized and may affect the dividends paid to stockholders for that tax year. EQUITY INVESTMENTS Hanover records its investment in HCP, Hanover Capital Partners 2, Inc. ("HCP-2"), and HTC on the equity method. Accordingly, Hanover records 97% of the earnings or losses of HCP and HTC, and, until September 30, 1999, 99% of the earnings or losses of HCP-2 through its ownership of all of the non-voting preferred stock of HCP, HTC and HCP-2, respectively. After writing off its investment in HCP-2 in September, 1999, Hanover stopped recording earnings or losses of HCP-2. Hanover believes that HCP-2 has no value. Hanover generally has no right to control the affairs of HCP, HCP-2 or HTC because Hanover's investment in those companies is based solely on ownership of non-voting preferred stock. Even though Hanover has no right to control the affairs of these companies, management believes that Hanover has the ability to exert significant influence over these companies and therefore these investments are accounted for on the equity method. REVERSE REPURCHASE AGREEMENTS Reverse repurchase agreements are accounted for as collateralized financing transactions and recorded at their contractual amounts, plus accrued interest. FINANCIAL INSTRUMENTS The Company from time to time enters into interest rate hedge mechanisms (forward sales of Agency mortgage securities) to manage its exposure to changes in interest rates in connection with the purchase, holding of, securitization and sale of its mortgage loan and mortgage securities portfolio. The Company generally closes out the hedge position to coincide with the long-term securitization financing transaction or with any sale. Gains and losses on hedge positions are either (i) deferred as an adjustment to the carrying value of the related loans until the loan has been funded and securitized, after which the gains or losses will be amortized into income over the remaining life of the loan using a method that approximates the effective yield method, or (ii) deferred until such time as the related loans are sold. Gains or losses on hedge positions associated with mortgage securities held in a trading account are recognized as income or loss in each period. The Company also enters into interest rate caps to manage its interest rate exposure on certain reverse repurchase agreement and CMO financing. The cost of the interest rate caps is amortized over the life of the interest rate cap and is reflected as a portion of interest expense in the consolidated statement of operations. Any payments received under the interest rate cap agreements are recorded as a reduction of interest expense on the reverse repurchase agreement financing. For derivative financial instruments designated as hedge instruments, the Company periodically evaluates the effectiveness of these hedges against the financial instrument being hedged under various interest rate scenarios. The Company utilizes hedge deferral accounting procedures in accounting for its hedging program so long as there is adequate correlation between the hedged results and the change in value of the hedged financial instrument. If the hedge instrument performance does not result in adequate correlation between the changes in value of the hedge instrument and the related hedged financial instrument, the Company will terminate hedge deferral accounting and mark the carrying value of the hedge instrument to market. If a hedge instrument is sold or matures, or the criteria that was F-10 68 anticipated at the time the hedge instrument was entered into no longer exists, the hedge instrument is no longer accounted for as a hedge. Under these circumstances, the accumulated change in the market value of the hedge is recognized in current period income or loss to the extent that the effects of interest rate or price changes of the hedged item have not offset the hedged results. In accordance with SFAS No.107, Disclosure about Derivative Financial Instruments, and SFAS No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments, the Company has provided fair value estimates and information about valuation methodologies. The estimated fair value amounts have been determined using available market information or appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value, so the estimates are not necessarily indicative of the amounts that would be realized in a current market exchange. The effect of using different market assumptions and/or estimation methodologies may materially impact the estimated fair value amounts. INCOME TAXES Hanover 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, Hanover will not be subject to Federal or state income tax to the extent that its annual distributions to stockholders are equal to at least 90% of its taxable income and as long as certain asset, income and stock ownership tests are met. During 1998, Hanover distributed dividends in excess of its accumulated and current taxable income. Consequently, the distributions in excess of accumulated and current taxable income were treated as a return of capital to the stockholders. EARNINGS PER SHARE Basic earnings or loss per share excludes dilution and is computed by dividing income or loss available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings or loss per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock that then shared in earnings and losses. Shares issued during the period and shares reacquired during the period are weighted for the period they were outstanding. COMPREHENSIVE INCOME Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the consolidated balance sheets, such items, along with net income, are components of comprehensive income. RECLASSIFICATION The 1999 financial statements were reclassified to conform to the 2000 financial statement presentation. F-11 69 RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") 133, Accounting for Derivative Instruments and Hedging Activities in June 1998. SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities. SFAS 137, issued in June 1999, delayed the effective date of SFAS 133 to make it effective for quarters in fiscal years beginning after June 15, 2000. SFAS 138, issued in June 2000, amends certain technical provisions of SFAS 133. The Company implemented SFAS 133, SFAS 137 and SFAS 138 on January 1, 2001. See Note 20, "Subsequent Events". RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 - Revenue Recognition in Financial Statements. The Staff Accounting Bulletin summarizes certain of the staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. The staff is providing this guidance, due, in part, to the large number of revenue recognition issues that registrants encounter. Implementation of Staff Accounting Bulletin No. 101 must occur no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. The Company adopted SAB 101 effective October 1, 2000. The adoption of SAB 101 did not have an impact on the Company's financial statements. In September 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a Replacement of FASB Statement No. 125 ("SFAS 140"). SFAS 140 replaces FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS 125"). It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS 125's provisions without reconsideration. SFAS 140 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Those standards are based on consistent application of a financial components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. SFAS 140 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. SFAS 140 is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of SFAS 140 did not have an impact on the Company's financial statements, except for the requirement of additional disclosure with respect to certain mortgage-backed securities retained in connection with one of the Company's securitization transactions. This disclosure is displayed in Note 10. CMO Borrowing and Securitized Sale. 3. MORTGAGE LOANS At December 31, 2000 management had made the determination that $230,000 of mortgage loans were held for sale. No mortgage loans were designated as held to maturity and $212,017,000 of mortgage loans were held as collateralized mortgage obligation ("CMO") collateral. F-12 70 HELD FOR SALE The following table summarizes certain characteristics of the Company's single-family mortgage loan pools, held for sale portfolio which are carried at the lower of cost or market (dollars in thousands):

DECEMBER 31, 2000 DECEMBER 31, 1999 --------------------------------- --------------------------------- FIXED ADJUSTABLE FIXED ADJUSTABLE RATE RATE TOTAL RATE RATE TOTAL ----- ---------- ----- ----- ---------- ----- Principal amount of mortgage loans $ 31 $199 $230 $ 45 $206 $251 Net premium and deferred cost -- -- -- -- -- -- Loan loss allowance -- -- -- -- -- -- ---- ---- ---- ---- ---- ---- Carrying cost of mortgage loans $ 31 $199 $230 $ 45 $206 $251 ==== ==== ==== ==== ==== ====

COLLATERAL FOR CMOs In April 1998, the Company issued its first CMO securitization transaction, Hanover Capital SPC, Inc. Series 1998-A ("1998-A"). $102,977,000 (par value) of single family fixed rate residential mortgage loans were assigned as collateral for the 1998-A securitization. In March 1999, the Company completed its second CMO securitization transaction, Hanover Grantor Trust 1999-A ("1999-A"). $138,357,000 (par value) of single family fixed and adjustable rate residential loans were assigned as collateral for the 1999-A securitization. In August 1999, the Company completed its third CMO securitization transaction, Hanover Capital Trust 1999-B ("1999-B"). $111,575,000 (par value) of single-family fixed and adjustable rate residential loans were assigned as collateral for the 1999-B securitization. In June 2000, the Company completed its fourth CMO securitization transaction, Hanover Capital Trust 2000-A ("2000-A"). The Company assigned all of its interests in 1999-A and 1999-B securitizations and certain mortgage securities from its 1998-A and 1998-B securitizations as collateral for the 2000-A securitization. The Company has limited exposure to credit risk retained on loans it has securitized through the issuance of CMOs. The following table summarizes the Company's single-family fixed and adjustable rate mortgage loan pools held as CMO collateral (dollars in thousands):

DECEMBER 31, 2000 DECEMBER 31, 1999 --------------------------------------- --------------------------------------- FIXED ADJUSTABLE FIXED ADJUSTABLE RATE RATE TOTAL RATE RATE TOTAL --------- ---------- --------- --------- ---------- --------- Principal amount of mortgage loans $ 140,867 $ 70,059 $ 210,926 $ 174,761 $ 93,419 $ 268,180 Net premium (discount) and deferred costs 1,952 (159) 1,793 2,361 (165) 2,196 Loan loss allowance (489) (213) (702) (371) (172) (543) --------- --------- --------- --------- --------- --------- Carrying cost of mortgage loans $ 142,330 $ 69,687 $ 212,017 $ 176,751 $ 93,082 $ 269,833 ========= ========= ========= ========= ========= =========

4. MORTGAGE SECURITIES At December 31, 2000, the Company had $3,860,000 of fixed rate Agency mortgage-backed securities, $19,519,000 of fixed rate subordinate mortgage-backed securities, and $2,467,000 of interest only and principal only derivatives, created in the Company's 1998-B securitization. These securities are freely marketable and are classified as available for sale, held to maturity, or trading, as shown in the tables below. F-13 71 In addition, the Company had $9,877,000 of fixed-rate subordinate mortgage-backed securities which have been permanently pledged to support CMO borrowings. The Company is prohibited by the terms of the CMO from selling or otherwise transferring these securities. The following tables summarize the Company's Agency mortgage-backed securities, fixed rate subordinate mortgage-backed securities, and derivatives (dollars in thousands):

FIXED RATE AGENCY MORTGAGE-BACKED SECURITIES DECEMBER 31, 2000 DECEMBER 31, 1999 ------------------ ----------------- AVAILABLE HELD AVAILABLE HELD FOR TO FOR TO SALE MATURITY TRADING TOTAL SALE MATURITY TRADING TOTAL --------- -------- ------- -------- --------- -------- ------- -------- Principal balance of mortgage securities $ 2,047 $-- $ 1,681 $ 3,728 $ 46,156 $-- $-- $ 46,156 Net premium and deferred costs 105 -- 65 170 863 -- -- 863 -------- --- -------- -------- -------- -------- Total amortized cost of mortgage securities 2,152 -- 1,746 3,898 47,019 -- -- 47,019 Gross unrealized loss (35) -- (3) (38) (1,540) -- -- (1,540) -------- --- -------- -------- -------- --- --- -------- Carrying cost of mortgage securities $ 2,117 $-- $ 1,743 $ 3,860 $ 45,479 $-- $-- $ 45,479 ======== === ======== ======== ======== === === ========

FIXED RATE SUBORDINATE MORTGAGE-BACKED SECURITIES DECEMBER 31, 2000 ----------------- AVAILABLE HELD COLLATERAL FOR TO FOR SALE MATURITY TRADING CMOS TOTAL --------- -------- -------- ---------- -------- Principal balance of mortgage securities $ 25,305 $ 5,986 $ 3,921 $ 13,234 $ 48,446 Net (discount) and deferred costs (12,857) (2,281) (913) (3,035) (19,086) -------- -------- -------- -------- -------- Total amortized cost of mortgage securities 12,448 3,705 3,008 10,199 29,360 Loan loss allowance (595) (105) -- (322) (1,022) Gross unrealized gain (loss) 1,009 -- 49 -- 1,058 -------- -------- -------- -------- -------- Carrying cost of mortgage securities $ 12,862 $ 3,600 $ 3,057 $ 9,877 $ 29,396 ======== ======== ======== ======== ========

DECEMBER 31, 1999 ----------------- AVAILABLE HELD FOR TO SALE MATURITY TRADING TOTAL --------- -------- -------- -------- Principal balance of mortgage securities $-- $ 12,454 $ 7,105 $ 19,559 Net (discount) and deferred costs -- (5,012) (1,135) (6,147) --- -------- -------- -------- Total amortized cost of mortgage securities -- 7,442 5,970 13,412 Loan loss allowance -- (256) -- (256) Gross unrealized gain (loss) -- -- (51) (51) --- -------- -------- -------- Carrying cost of mortgage securities -- $ 7,186 $ 5,919 $ 13,105 === ======== ======== ========

DERIVATIVE MORTGAGE-BACKED SECURITIES DECEMBER 31, 2000 DECEMBER 31, 1999 ----------------- ----------------- INTEREST PRINCIPAL INTEREST PRINCIPAL ONLY STRIPS ONLY STRIPS ONLY STRIPS ONLY STRIPS AVAILABLE HELD AVAILABLE HELD FOR TO FOR TO SALE MATURITY TRADING TOTAL SALE MATURITY TRADING TOTAL -------- -------- ------- ------- -------- -------- ------- ------- Principal balance of mortgage securities $ -- $ 1,111 $-- $ 1,111 $ -- $ 1,281 $-- $ 1,281 Net premium (discount) and deferred costs 1,170 (194) -- 976 1,553 (229) -- 1,324 ------- ------- --- ------- ------- ------- --- ------- Total amortized cost of mortgage securities 1,170 917 -- 2,087 1,553 1,052 -- 2,605 Loan loss allowance -- -- -- -- -- -- -- -- Gross unrealized gain 380 -- -- 380 1,496 -- -- 1,496 ------- ------- --- ------- ------- ------- --- ------- Carrying cost of mortgage securities $ 1,550 $ 917 $-- $ 2,467 $ 3,049 $ 1,052 $-- $ 4,101 ======= ======= === ======= ======= ======= === =======

December 31, 1999 the Company also had substantially all of the economic benefit and risks associated with $14,180,000 of fixed rate private-placement subordinate mortgage backed securities held by its affiliate, HCP. The securities were transferred to the Company on June 30, 2000. F-14 72

FIXED RATE SUBORDINATE MORTGAGE-BACKED SECURITIES (HELD BY AFFILIATE) DECEMBER 31, 1999 AVAILABLE HELD FOR TO SALE MATURITY TRADING TOTAL -------- --------- -------- -------- Principal balance of mortgage securities $ 33,401 $ -- $ -- $ 33,401 Net (discount) and deferred costs (19,175) -- -- (19,175) -------- --------- -------- -------- Total amortized cost of mortgage securities 14,226 -- -- 14,226 Loan loss allowance (285) -- -- (285) Gross unrealized gain 239 -- -- 239 -------- --------- -------- -------- Carrying cost of mortgage securities $ 14,180 $ -- $ -- $ 14,180 ======== ========= ======== ========

The carrying value at December 31, 2000 of the Company's mortgage securities by average life dates are presented below (dollars in thousands):

AVAILABLE FOR SALE HELD TO MATURITY TRADING COLLATERAL AVERAGE LIFE CARRYING VALUE CARRYING VALUE CARRYING VALUE FOR CMOs ------------ ------------------ ---------------- -------------- ---------- One to five years $ 1,551 $ 613 -- -- Five to ten years 4,753 2,721 $1,743 -- More than ten years 10,226 1,183 3,057 $9,877 -------- ------ ------ ------ $ 16,529 $4,517 $4,800 $9,877 ======== ====== ====== ======

As mentioned above, actual maturities may differ from stated maturities because borrowers usually have the right to prepay certain obligations, often times without penalties. Maturities of mortgage securities depend on the repayment characteristics and experience of the underlying mortgage loans. The proceeds, gross realized gains and losses from sales of available for sale mortgage securities in 2000, 1999 and 1998 were as follows (dollars in thousands): 2000 REALIZED PROCEEDS GAIN (LOSS) --------- ----------- Sale of Subordinate MBS $ 5,882 $ 1,248 Sale of Agency Pass-Through MBS 39,881 (429) --------- -------- $ 45,763 $ 819 ========= ======== 1999 REALIZED PROCEEDS GAIN (LOSS) --------- ----------- Hanover Capital 1998-B Subordinate MBS $ 2,232 $ 146 F-15 73 1998 REALIZED PROCEEDS GAIN (LOSS) --------- ----------- Adjustable rate FNMA and FHLMC Certificates $ 189,057 $ (5,989) Adjustable rate FNMA certificates 17,172 (161) Fixed rate FNMA certificates 56,740 495 --------- ---------- $ 262,969 $ (5,655) ========= ========== 5. CONCENTRATION OF CREDIT RISK MORTGAGE LOANS The Company's exposure to credit risk associated with its investment activities is measured on an individual customer basis as well as by groups of customers that share similar attributes. In the normal course of its business, the Company has concentrations of credit risk in its mortgage portfolio for the loans in certain geographic areas. At December 31, 2000 and 1999, the percent of total principal amount of loans outstanding in any one state, exceeding 5% of the principal amount of mortgage loans are as follows: AT DECEMBER 31, 2000 AT DECEMBER 31, 1999 MORTGAGE LOANS MORTGAGE LOANS ---------------------- ---------------------- COLLATERAL FOR COLLATERAL FOR CMOs CMOs ---- ---- Florida 16% 15% California 13 13 Texas 9 9 Ohio 5 6 Maryland 5 5 --- --- Total 48% 48% === === The Company did not have any material concentrations of credit risk in its held for sale and held to maturity categories at December 31, 2000. The Company did not purchase any mortgage loans in 2000 or 1999. During 1998 the Company purchased approximately 75.2% of its total principal amount of mortgage loans from six financial institutions, the largest of which represented approximately 21.7% of the total principal amount of mortgage loans purchased in 1998. Management believes that the loss of any single financial institution from which the Company purchased mortgage loans would not have any material detrimental effect on the Company. F-16 74 MORTGAGE SECURITIES The Company's exposure to credit risk associated with its investment activities is measured on an individual security basis as well as by groups of securities that share similar attributes. In certain instances, the Company has concentrations of credit risk in its mortgage securities portfolio for the securities of certain issuers. Management believes exposure to credit risk associated with purchased Agency mortgage securities is minimal due to the guarantees provided by the Agency. CONCENTRATION OF CREDIT RISK BY ISSUER DECEMBER 31, 2000 HANOVER CAPITAL MORTGAGE HOLDINGS, INC. --------------------------------------------- AVAILABLE HELD COLLATERAL FOR TO FOR ISSUER SALE MATURITY TRADING CMOs TOTAL ------ --------- -------- ------- ---------- ------- FNMA $ 2,117 $ -- $ -- $ -- $ 2,117 GNMA -- -- 1,743 -- 1,743 Hanover Capital 1998-B 1,550 917 -- 9,877 12,344 Issuer 1 3,428 -- -- -- 3,428 Issuer 2 1,946 -- -- -- 1,946 Issuer 3 2,407 2,216 -- -- 4,623 Issuer 4 -- 712 -- -- 712 Issuer 5 3,580 672 -- -- 4,252 Issuer 6 1,501 -- -- -- 1,501 Issuer 7 -- -- 3,057 -- 3,057 ------- ------- ------- ------- ------- Total $16,529 $ 4,517 $ 4,800 $ 9,877 $35,723 ======= ======= ======= ======= ======= CONCENTRATION OF CREDIT RISK BY ISSUER DECEMBER 31, 1999

HANOVER CAPITAL HANOVER CAPITAL MORTGAGE HOLDINGS, INC. PARTNERS LTD. TOTAL -------------------------------------------- ------------- ------- AVAILABLE HELD AVAILABLE FOR TO FOR ISSUER SALE MATURITY TRADING TOTAL SALE ------ --------- -------- ------- ------- --------- FNMA $45,479 $ -- $ -- $45,479 $ -- $45,479 Hanover Capital 1998-B 3,050 4,597 5,919 13,566 -- 13,566 Issuer 1 -- -- -- -- 7,387 7,387 Issuer 2 -- -- -- -- 6,793 6,793 Issuer 3 -- 2,220 -- 2,220 -- 2,220 Issuer 4 -- 706 -- 706 -- 706 Issuer 5 -- 715 -- 715 -- 715 ------- ------- ------- ------- ------- ------- Total $48,529 $ 8,238 $ 5,919 $62,686 $14,180 $76,866 ======= ======= ======= ======= ======= =======

F-17 75 CASH AND OVERNIGHT INVESTMENTS The Company has cash and cash equivalents in a major financial institution which is insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000. At December 31, 2000, the Company had amounts on deposit with the financial institution in excess of FDIC limits. At December 31, 2000, the Company had overnight investments of $9,796,000 in mutual funds of treasury securities. The Company limits its risk by placing its cash and cash equivalents in a high quality financial institution, Federal Agency notes, mutual funds of treasury securities or in the highest rated commercial paper. 6. LOAN LOSS ALLOWANCE The provision for loan loss charged to expense is based upon actual credit loss experience and management's estimate and evaluation of potential losses in the existing mortgage loan and mortgage securities portfolio, including the evaluation of impaired loans. The following table summarizes the activity in the loan loss allowance for the following periods (dollars in thousands): YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 2000 1999 1998 ------------ ------------ ------------ Balance, beginning of period $ 799 $ 372 $ 18 Loan loss provision 875 446 356 Transfers from related company 729 39 (2) Sales (593) -- -- Charge-offs (92) (110) -- Recoveries 6 52 -- ------- ------- ------- Balance, end of period $ 1,724 $ 799 $ 372 ======= ======= ======= 7. EQUITY INVESTMENTS Hanover owns 100% of the non-voting preferred stock of HCP, which entitles Hanover to receive 97% of the earnings or losses of HCP and its wholly owned subsidiaries. Hanover also owns 100% of the non-voting preferred stock of HCP-2, which entitles Hanover to receive 99% of the earnings or losses of HCP-2 and its wholly owned subsidiary. In June 1999, the Company acquired 100% of the non-voting preferred stock of HTC which entitles Hanover to receive 97% of the earnings or losses of HTC. Hanover currently conducts substantially all of its taxable consulting operations (i.e. due diligence consulting, loan sale advisory, and loan brokering and trading) through HCP and HTC. HCP-2 was organized in October 1998 to facilitate the securitization of $318 million of fixed and adjustable rate residential mortgage loans in connection with the issuance of the 1998-B security. HCP-2 does not conduct any ongoing business. The Company wrote off its remaining investment in HCP-2 in September, 1999. HTC was organized in June 1999 to develop an E-commerce business to broker mortgage loan pools to financial institutions via the internet. HCP and its subsidiaries operate as a specialty finance company which is principally engaged in performing due diligence, consulting and mortgage investment banking services. A wholly-owned subsidiary of HCP, Hanover Capital Mortgage Corporation, is a servicer of multifamily mortgage loans and, prior to June 1999, was an originator of multifamily and commercial loans. HCMC's origination operations were discontinued in June 1999. Another wholly-owned subsidiary of HCP, Hanover Capital Securities, Inc. is a registered broker/dealer with the Securities and Exchange Commission. F-18 76 The principal business activity of HTC is to generate fee income by operating an online world-wide web-based exchange for trading loan pools (primarily mortgage loan pools) and by performing loan sale advisory services for third parties. HCP-2 was organized in October, 1998 to acquire single-family residential mortgage loans from Hanover pursuant to its formation transaction and to finance the purchase of these mortgage loans through a REMIC securitization, 1998-B. The table below reflects the activity recorded in Hanover's equity investments for the following periods (dollars in thousands):

YEAR ENDED YEAR ENDED DECEMBER 31, 2000 DECEMBER 31, 1999 ------------------- ------------------- HCP HCP-2 HTC TOTAL HCP HCP-2 HTC TOTAL ------- ------- ------- ------- ------- ------- ------- ------- Beginning balance $ 1,466 $ -- $ (30) $ 1,436 $ 1,761 $ 5,728 $ -- $ 7,489 Applicable % of net (loss) 455 -- (1,496) (1,041) (443) (1,300) (31) (1,774) Applicable % of comprehensive gain (156) -- -- (156) 148 -- -- 148 Capital contribution -- -- -- -- -- -- 1 1 Formation transaction -- -- -- -- -- -- -- -- Dividends received (a) -- -- -- -- -- -- -- -- Write off of investment -- -- -- -- -- (4,428) -- (4,428) ------- ------- ------- ------- ------- ------- ------- ------- Ending Balance $ 1,765 $ -- $(1,526) $ 239 $ 1,466 $ -- $ (30) $ 1,436 ======= ======= ======= ======= ======= ======= ======= =======

YEAR ENDED DECEMBER 31, 1998 ------------------------------------ HCP HCP-2 TOTAL -------- -------- -------- Beginning balance $ 100 $ -- $ 100 Applicable % of net (loss) (1,039) (394) (1,433) Applicable % of comprehensive gain -- -- -- Capital contribution 2,700 -- 2,700 Formation transaction -- 14,176 14,176 Dividends received (a) -- (8,054) (8,054) -------- -------- -------- Ending Balance $ 1,761 $ 5,728 $ 7,489 ======== ======== ======== (a) represents a return of capital 8. NOTES RECEIVABLE AND DUE FROM RELATED PARTIES In connection with Hanover's original formation transactions in September 1997, Hanover agreed to lend a maximum of $1,750,000 collectively, to four officer/stockholders (collectively referred to as the "Principals") to enable the Principals to pay personal income taxes on the gains they must recognize upon contributing their HCP preferred stock to the Company for shares of Hanover's common stock. The loans are secured solely by 116,667 shares of Hanover's common stock owned by the Principals, collectively. The loans bear interest at the lowest applicable Federal tax rate during the month the loans are made. At December 31, 2000 Hanover had loaned the Principals the full $1,750,000. These loans bear interest at 6.02% on $482,600 of loans and 5.70% on $1,267,400 of loans at December 31, 2000. F-19 77 In March 1998, Hanover agreed to lend up to an additional $1,500,000 in unsecured loans to the Principals, in lieu of incurring the costs and expenses Hanover was required to pay associated with the registration of 100,000 shares of Hanover's common stock owned by the Principals. Pursuant to such agreement, Hanover loaned the Principals an additional $1,203,880 in April 1998. These additional loans are due and payable on March 31, 2001 and bear interest at 5.51%. In November 1998, Hanover agreed to lend an additional $226,693 in unsecured loans to the Principals. These loans are due and payable in November 2002 and bear interest at 4.47% (the lowest applicable Federal tax rate in November 1999). A portion of these loans, $69,149, was repaid in February 1999, another portion, $61,837, was forgiven on January 28, 2000 and $12,202 was repaid in April 2000. The Company reserved for this forgiveness on September 30, 1999. At December 31, 2000, the balance of these loans, was $83,505. During 2000 Hanover advanced funds to HCP and HTC pursuant to unsecured loan agreements. These loans to HCP and HTC bear interest at 1.00% below the prime rate. At December 31, 2000 the loan outstanding to HCP totaled $1,704,342 and the loan outstanding to HTC totaled $2,903,758. Accrued interest receivable from related parties was $172,000 at December 31, 2000 and $121,000 at December 31, 1999. Amounts due from related parties and due to related parties are detailed below (dollars in thousands): INTERCOMPANY BALANCES DECEMBER 31, DECEMBER 31, 2000 1999 ---- ---- Due from HTC $ 51 $121 Due from HCP 14 6 ---- ---- $ 65 $127 ==== ==== Due to HCP $ -- $ 88 ==== ==== NOTES RECEIVABLE DECEMBER 31, DECEMBER 31, 2000 1999 ---- ---- Principals (a) (b) (c) (e) (f) $3,279 $3,049 Hanover Capital Partners (d) 1,704 4,869 HanoverTrade.com 2,904 -- (a) Amounts reported for 2000 include John A. Burchett, George J. Ostendorf, Irma N. Tavares, Joyce S. Mizerak and Tom Kaplan, the five most senior officers/stockholders of Hanover. Amounts reported for 1999 include loans to John A. Burchett, George J. Ostendorf, Irma N. Tavares and Joyce S. Mizerak. (b) In March 1999, Hanover agreed to amend certain notes receivable aggregating $1,203,880, from the Principals that had a scheduled maturity date of March 31, 1999, by extending the maturity date for two additional years. The notes were also modified to provide for accelerated repayment by a Principal in the event of such Principals' voluntary termination of employment. F-20 78 (c) Pursuant to the note agreements, the Company loaned the Principals $143,000 to purchase common stock in HCP-2 in order to complete the 1998-B securitization transaction. The Principals subsequently made payments on the loans totaling $81,000. In September 1999, the Company reserved for an expected forgiveness of $62,000 of these loans. This amount was subsequently forgiven on January 28, 2000. Summarized below is the change in Principals loans during 2000: Balance at January 1, 2000 $3,291 Loan repayments (12) --------- Balance at December 31, 2000 $3,279 ========= (d) In September 1999 the Company advanced $3,041,000 to HCP to fund the purchase of certain subordinated mortgage securities pursuant to an unsecured loan agreement. An additional advance of $2,847,000 was made during the first six months of 2000 to fund the purchase of certain subordinated securities. The advances were repaid when the subordinated securities were sold to the Company in July 2000. (e) In September 1999 the Company loaned Mr. Kaplan $242,000 to purchase stock in the Company. The loan bears interest at 5.29% and is secured by the stock purchased. Mr. Kaplan's loan was re-classed to principal loans January 1, 2000. (f) In March 2000, the Company amended the terms of the notes due from Mr. Burchett, Ms. Mizerak, Mr. Ostendorf and Ms. Tavares to provide that the notes would be forgiven in the event of certain changes in control. 9. REVERSE REPURCHASE AGREEMENTS At December 31, 2000 the Company had a total of $75 million of committed and uncommitted mortgage asset reverse repurchase agreement financing available pursuant to master reverse repurchase agreements with two lenders. All borrowings pursuant to the master reverse repurchase agreements are secured by mortgage loans or other securities. The reverse repurchase agreements collateralized by mortgage loans are short term borrowings with interest rates that vary from LIBOR plus 125 basis points to LIBOR plus 238 basis points. The lender will typically finance an amount equal to 80% to 95% of the market value of the pledged collateral (mortgage loans) depending on certain characteristics of the collateral (delinquencies, liens, aging, etc.). The reverse repurchase agreement financing rates for mortgage securities, accomplished through individual Public Securities Association (PSA) agreements and through existing reverse repurchase agreements, bear interest rates that vary from LIBOR to LIBOR plus 288 basis points. The lender will typically finance an amount equal to 50% to 97% of the market value of the mortgage securities, depending on the nature of the collateral. At December 31, 2000 the Company had no outstanding borrowings on mortgage loans under the above mentioned reverse repurchase agreements. At December 31, 2000, the Company had outstanding borrowings on retained CMO securities of $3,627,000 with a weighted average borrowing rate of 7.47% and a weighted average remaining maturity of three months. Retained CMO securities represent the Company's net investment in the CMOs issued by the Company. The reverse repurchase financing agreements at December 31, 2000 were collateralized by securities with a cost basis of $11,545,000. F-21 79 At December 31, 2000, the Company had outstanding reverse repurchase agreement financing for mortgage securities (other than retained CMO securities) of $11,134,000 with a weighted average borrowing rate of 6.14% and a remaining maturity of less than one month. These mortgage securities are mortgage securities that the Company has purchased or created in transactions other than CMOs. The repurchase agreement financing at December 31, 2000 was collateralized by securities with a cost basis of $14,912,000. The table below details the scheduled maturities of the Company's committed and uncommitted master reverse repurchase agreements at December 31, 2000: COMMITTED MATURITY DATE ---------- ------------- $50 million May 2001 $25 million March 2001 Information pertaining to reverse repurchase agreement financing as of and for the years ended December 31, 2000 and 1999 is summarized as follows (dollars in thousands): YEAR ENDED DECEMBER 31, 2000

OTHER MORTGAGE RETAINED CMO MORTGAGE LOANS SECURITIES SECURITIES REVERSE REPURCHASE AGREEMENTS -------- ------------ ---------- Balance of borrowing at end of period -- $ 3,627 $11,134 Average borrowing balance during the period -- $ 3,515 $36,565 Average interest rate during the period -- 7.47% 6.14% Maximum month-end borrowing balance during the period -- $ 3,815 $39,177 COLLATERAL UNDERLYING THE AGREEMENTS Balance at end of period - carrying value -- $11,545 $14,912

REVERSE REPO FINANCING YEAR ENDED DECEMBER 31, 1999

OTHER MORTGAGE RETAINED CMO MORTGAGE LOANS SECURITIES SECURITIES -------- ------------ ---------- REVERSE REPURCHASE AGREEMENTS Balance of borrowing at end of period -- $ 3,366 $ 52,356 Average borrowing balance during the Period $ 93,998 $ 2,244 $ 53,638 Average interest rate during the period 6.364% 7.164% 5.510% Maximum month-end borrowing balance during the period $283,837 $ 3,393 $ 61,559 COLLATERAL UNDERLYING THE AGREEMENTS Balance at end of period - carrying value -- $ 7,201 $ 60,465

F-22 80 Additional information pertaining to individual reverse repurchase agreement lenders at December 31, 2000 is summarized as follows (dollars in thousands):

REVERSE WEIGHTED AVERAGE REPURCHASE UNDERLYING MATURITY LENDER TYPE OF COLLATERAL FINANCING COLLATERAL DATE ------ ----------------------- --------- ----------- -------------------- Lender A (committed) Retained CMO Securities $3,627 $11,545 March 28, 2001 (a) Lender A Mortgage Securities 952 1,486 January 4, 2001 (b) Lender B Mortgage Securities 2,940 3,892 January 5, 2001 (b) Lender C Mortgage Securities 1,672 1,743 January 8, 2001 (b) Lender D Mortgage Securities 3,691 5,297 January 31, 2001 (b) Lender E Mortgage Securities 1,034 1,331 January 29, 2001 (b) Lender F Mortgage Securities 516 712 January 30, 2001 (b) Lender G Mortgage Securities 328 454 January 16, 2001 (b) --------- ----------- Total $14,760 $26,460 ========= ===========

(a) The Company does not intend to renew this facility. (b) These borrowings are pursuant to uncommitted lines of credit which are typically renewed monthly. 10. CMO BORROWING AND SECURITIZED SALE The Company has executed five securitization transactions since April 1998. Four of these transactions were structured as financings, and one of these transactions ("Hanover 1998-B") was structured as a sale transaction. In the financing transactions, the company pledged mortgage loans to secure collateralized mortgage obligations ("CMOs"). These mortgage loans are treated as assets of the Company and the CMOs are treated as debt of the Company. In contrast, the mortgage loans financed through the issuance of Hanover 1998-B were treated as having been sold, and the corresponding debt is not treated as debt of the Company. COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) Borrower remittances received on the CMO collateral are used to make payments on the CMOs. The obligations of the CMO are payable solely from the underlying mortgage loans collateralizing the debt and otherwise are non-recourse to the Company. The maturity of each class of CMO is directly affected by principal prepayments on the related CMO collateral. Each class of CMO is also subject to redemption according to specific terms of the respective indenture agreements. As a result, the actual maturity of any class of CMO is likely to occur earlier than its stated maturity. The Company issued its first CMO (also referred to as mortgage-backed bonds borrowing) secured by fixed rate mortgage loans in April 1998, and issued subsequent CMO borrowings secured by fixed rate and adjustable rate mortgage loans in March 1999 and August 1999. In June 2000, the Company issued $13,222,000 of CMO borrowings at a discount of $2,013,000 for net proceeds before expenses of $11,209,000 (the "Hanover 2000-A" CMO). The Hanover 2000-A CMO securities carry a fixed interest rate of the 6.50%. The Hanover 2000-A securities are collateralized by $25,588,000 principal balance of the retained portions of Hanover's previous CMO borrowings, Hanover 98-A, Hanover 99-A and Hanover 99-B, and by certain retained mortgage backed securities from Hanover 98-B. Information pertaining to the CMOs as of and for the year ended December 31, 2000 is summarized as follows (dollars in thousands): F-23 81

2000-A 1999-B 1999-A 1998-A SECURITIZATION SECURITIZATION SECURITIZATION SECURITIZATION TOTAL -------------- -------------- -------------- -------------- -------- Balance of borrowing at end of period $11,095 $71,462 $85,843 $41,974 $210,374 Average borrowing balance during the period 5,894 83,207 96,388 48,354 233,843 Average interest rate during the period 9.76% 7.96% 7.18% 6.89% 7.49% Interest rate at end of period 9.48% 8.37% 7.32% 6.95% 7.72% Maximum month-end borrowing balance during the period 11,183 91,795 103,997 53,365 260,340 CMO COLLATERAL Balance at end of period - carrying balance $10,839 $75,221 $91,824 $44,972 $222,856

Aggregate annual repayments of mortgage backed bonds based upon the expected amortization of the underlying mortgage loan collateral at December 31, 2000 were as follows (dollars in thousands): YEAR AMOUNT ---- -------- 2001 $ 57,321 2002 42,457 2003 30,946 2004 22,135 2005 15,955 Thereafter 42,534 -------- Total $211,348 ======== SECURITIZED SALE In October 1998, the Company completed the Hanover 1998-B securitization. The Company sold mortgage loans to an unconsolidated affiliate, HCP-2, which simultaneously issued a Real Estate Mortgage Investment Conduit (REMIC) structured as a CMO. The mortgage loans were transferred to HCP-2 at cost. HCP-2 recorded the transaction as a financing. HCP-2 sold the most highly rated securities and transferred the remaining securities to the Company. The purchase of the retained REMIC securities was recorded at cost. No gain or loss was recognized in connection with the transaction. The Company does not service any of the loans in the Hanover 1998-B securitization. At the time of the transaction, the Company was not subject to any restrictions that would limit its ability to transfer the securities retained in the securitization. However, certain of these securities were later pledged to support borrowings under the Hanover 2000-A CMO transaction. The Company did not provide any recourse in the 1998-B securitization. However, the securities initially retained by the Company will bear all of the losses incurred on the related mortgage loans. At December 31, 2000, the Company had a remaining investment of $12,344,000 in securities retained from Hanover 1998-B. Of this amount, $9,877,000 were subordinate mortgage backed securities classified as collateral for CMOs, $1,550,000 were interest only strips classified as available for sale, and $917,000 were principal only strips classified as held to maturity. These securities had a fair value of $11,716,000. The Company determines the fair value of these securities by obtaining market quotes from a third party dealer firm. In providing these quotes, the dealer firm used the following assumptions for the Hanover 1998-B securities: F-24 82

TYPE OF CREDIT DISCOUNT PREPAYMENT AVERAGE SECURITY RATING SPREAD RATE SPEED LIFE -------- ------ ------ ---- ----- ---- Subordinate AA/AAA 300 bp 8.12% 175 PSA 10 years Subordinate A/AA+ 400 9.12 175 PSA 10 Subordinate BBB/A+ 675 11.87 175 PSA 10 Subordinate BB/BB+ 1125 16.37 175 PSA 10 Subordinate B/B 1875 23.87 175 PSA 10 Subordinate unrated -- 60.00 175 PSA 10 Interest only AAA/AAA -- 0.00 40 CPR 1 Principal only AAA/AAA 200 7.00 6 CPR 3-8

Discount rates in the market for subordinate securities are typically quoted based on the assumption that the securities will not incur any losses, notwithstanding the fact that market makers expect that these securities will incur losses. The exposure of these securities to credit losses is reflected in the quoted discount rates. Although dealer firms do not typically quote credit loss assumptions, the Company monitors and projects the credit losses on its portfolio. The Company assumes that the mortgage loans in the Hanover 1998-B securitization will default at an annual rate of 0.30% per year, and the Company will recover 75% of the principal balance of the defaulted mortgage loans. Using these assumptions, the quoted prices for the unrated subordinate securities result in an annualized yield of 49% - 57%. This default rate assumption results in projected cumulative losses of $743,000, or 0.23% of the original principal balance of the mortgage loans in the Hanover 1998-B securitization. The following tables shows the impact of a change of each of the foregoing assumptions on the fair value of the related securities: SENSITIVITY TO DISCOUNT RATE CHANGE IN DECLINE TYPE OF DISCOUNT IN SECURITY RATE VALUE -------------- -------- --------- Subordinate +100 bp $ 518,000 +200 bp 992,000 Interest Only +500 bp $ 230,000 +1000 bp 421,000 Principal Only +25 bp $ 8,000 +50 bp 16,000 SENSITIVITY TO PREPAYMENT SPEED DECLINE TYPE OF PREPAYMENT IN SECURITY SPEED VALUE -------------- ---------- --------- Subordinate 175 PSA $ -- 150 PSA 60,000 100 PSA 196,000 Interest Only 40 CPR $ -- 50 CPR 668,000 60 CPR 1,146,000 Principal Only 6 CPR $ -- 4 CPR 30,000 2 CPR 63,000 F-25 83 SENSITIVITY TO LOSS ASSUMPTION ANNUAL DECLINE TYPE OF DEFAULT CUMULATIVE IN SECURITY RATE LOSSES VALUE ----------- ------- ---------- --------- Subordinate 0.30% 0.23% $ -- 0.90% 0.66% 81,000 3.00% 1.99% 979,000 The foregoing sensitivity analysis is designed to assist the reader in evaluating the impact that changes in interest rates, prepayment speeds or default rates would have on the value of the securities retained in the Hanover 1998-B securitization. This analysis is based on projected cashflows. The projections were prepared based on a number of simplifying assumptions, including but not limited to the following: (i) all of the loans will prepay at the indicated speeds; (ii) all borrowers pay a full month's interest if they prepay their loans; (iii) there are no delinquencies on the underlying mortgage loans; and (iv) the securities are not called. Actual results will differ from projected results. Managed Mortgage Whole Loans The following table presents certain information relating to all mortgage loans securitized by the Company or owned by the Company at December 31, 2000. MANAGED ASSETS PRINCIPAL BALANCE OF MANAGED ASSETS PRINCIPAL BALANCE ----------------------------------- ----------------- Mortgage loans held for sale $ 230,000 Mortgage loans collateralizing on-balance sheet CMOs 210,926,000 Mortgage loans collateralizing off-balance sheet securitization executed by the Company 172,947,000 --------------- Total mortgage loans purchased and managed by the Company $ 384,103,000 =============== DELINQUENCY RATES OF MANAGED ASSETS ----------------------------------- 30-59 days delinquent 6.73% 60-89 days delinquent 1.33% 90 or more days delinquent 1.88% Loans in foreclosure 0.75% Real estate owned 0.42% The Company realized credit losses of $56,000 on the foregoing assets during the year ended December 31, 2000. 11. EMPLOYEE BENEFIT PLANS 401(K) PLAN The Company participates in the HCP non-contributory retirement plan ("401(k) Plan"). The 401(k) plan is available to all full-time company employees with at least 3 months of service. The 401(k) Plan is designed to be tax deferred in accordance with provisions of Section 401(k) of the Internal Revenue Code. The 401(k) Plan provides that each participant may contribute 15.0% of his or her salary subject to the maximum allowable each fiscal year ($10,500 in 2000 and $10,000 in 1999). Under the 401(k) Plan, an employee may elect to enroll on the first of the month, provided that the employee has met the 3 F-26 84 month employment service requirement. The Company can, at its option, make a discretionary matching contribution to the plan. In January 2001 the Company made a matching contribution of 1/2 of the employee's contribution up to a maximum of 2% of the employee's 2000 base salary COMPANY STOCK OPTION PLANS The Company has adopted two stock option plans: (1) the 1997 Executive and Non-Employee Director 1997 Stock Option Plan (the "1997 Stock Option Plan"); and (2) the 1999 Equity Incentive Plan (the "1999 Equity Incentive Plan", together with the 1997 Stock Option Plan, "the Stock Option Plans"). The purpose of the Stock Option Plans is to provide a means of performance-based compensation in order to attract and retain qualified personnel and to afford additional incentive to others to increase their efforts in providing significant services to the Company. 1997 Stock Option Plan The 1997 Stock Option Plan provides for the grant of qualified incentive stock options ("ISOs") which meet the requirements of Section 422 of the Internal Revenue Code, stock options not so qualified ("NQSOs"), deferred stock, restricted stock, performance shares, stock appreciation and limited stock awards ("Awards"), and dividend equivalent rights ("DERs"). The 1997 Stock Option Plan authorizes the grant of options to purchase, and Awards of, an aggregate of up to 325,333 shares of the Company's Common Stock. If an option granted under the Stock Option Plan expires or terminates, or an Award is forfeited, the shares subject to any unexercised portion of such option or Award will again become available for issuance under the Stock Option Plan. Unless previously terminated by the Board of Directors, the 1997 Stock Option Plan will terminate ten years from the date of approval (or five years in the case of ISOs granted to an employee who owns in excess of 10% of the combined voting power of the Company's outstanding equity stock) and no options or Awards may be granted under the 1997 Stock Option Plan thereafter, but existing options or Awards remain in effect until the options are exercised or the options or the Awards are terminated by their terms. The aggregate fair market value (determined as of the time of grant) of the shares with respect to which ISOs are exercisable for the first time by an employee during any calendar year may not exceed $100,000. All stock options granted by the Compensation Committee pursuant to the Stock Option Plan are contingent and may vest, subject to other vesting requirements imposed by the Compensation Committee, in full or in part on any September 30 beginning with September 30, 1998 and ending with September 30, 2002 (each, an "Earn-Out Measuring Date"). No vesting occurred on the first Earn-Out Measuring Date (September 30, 1998) and the second Earn-Out Measuring Date (September 30, 1999) because the Company did not meet or exceed the vesting requirements. Vesting occurs when the return on a unit (a unit is composed of one common stock certificate and one warrant certificate) is at least equal to the initial public offering price of the unit. In addition, subject to any other vesting restrictions, one-third of any outstanding stock options will vest as of any Earn-Out Measuring Date through which the return on a unit is at least equal to a 20% annualized return on the initial public offering price of the unit. The return on a unit is determined by adding (i) the appreciation in the value of the unit since the closing of the initial public offering and (ii) the amount of distributions made by the Company on the share of Common Stock included in the unit since the closing of the initial public offering. The appreciation in the value of a unit as of any Earn-Out Measuring Date is the average difference, during the 30 day period that ends on the Earn-Out Measuring Date, between the market price of the shares of Common Stock F-27 85 included in the unit and the initial public offering price of the unit multiplied by two to take into account the value of the warrant included in the unit. In determining whether such stock options have vested, appropriate adjustments will be made for stock splits, recapitalizations, stock dividends and transactions having similar effects. 1999 STOCK OPTION PLAN The Company adopted the 1999 Equity Incentive Plan (the "1999 Stock Option Plan"), which provides for the grant of stock options which are not intended to be "qualified incentive stock options" pursuant to Section 422 of the Internal Revenue Code. The 1999 Stock Option Plan authorizes the grant of options of up to 550,710 shares of the Company's Common Stock. If an option granted under the 1999 Stock Option Plan expires or terminates, or an Award is forfeited, the shares subject to any unexercised portion of such option or Award will again become available for the issuance of further options or Awards under the 1999 Equity Incentive Plan. The maximum number of Common Stock that any eligible participant may receive under the 1999 Stock Option Plan for any year may not exceed 50,000. Unless terminated earlier by the Board of Directors, the 1999 Stock Option Plan will terminate ten years from its approval date. When the 1999 Stock Option Plan ends, no options or Awards may be granted under the 1999 Stock Option Plan, but existing options or Awards remain in effect until they are exercised or terminated. Each option must terminate no more than ten years from the date it is granted. Options may be granted on terms providing for exercise either in whole or in part at any time or times during their restrictive terms, or only in specified percentages at stated time periods or intervals during the term of the option. One third of the option vests one year after the grant of the option, another third of the option vests two years after the grant, and after three years the option may be exercised in full. F-28 86 A summary of the status of the Company's 1997 and 1999 Stock Option Plans as of December 31, 2000 and changes during the periods from September 19, 1997 to December 31, 1997 and for the years ended December 31, 1998, 1999 and 2000 is presented below:

1997 PLAN 1999 PLAN # OF # OF WEIGHTED OPTIONS FOR OPTIONS FOR AVERAGE STOCK OPTION ACTIVITY - 1997 SHARES SHARES EXERCISE PRICE EXERCISE PRICE ---------------------------- ----------- ----------- -------------- -------------- Granted - September 19, 1997 162,664 $15.00 Granted - September 28, 1997 160,660 15.75 Cancelled (3,000) 15.75 -------- Outstanding at Dec. 31, 1997 320,324 $15.37 -------- ====== STOCK OPTION ACTIVITY - 1998 Granted - January 14, 1998 2,000 $15.94 Granted - March 9, 1998 2,000 18.13 Cancelled (1,750) 15.75 ------- Outstanding at Dec. 31, 1998 322,574 $15.39 ------- ====== STOCK OPTION ACTIVITY - 1999 Granted - July 29, 1999 282,750 $4.625 Cancelled (27,250) 15.75 Cancelled (12,500) 4.625 ------- ------- ------ Outstanding at Dec. 31,1999 295,324 $15.35 ------- ====== 270,250 $4.625 ------- ====== STOCK OPTION ACTIVITY - 2000 Granted - May 18, 2000 282,210 $3.875 Cancelled (6,250) 15.75 Cancelled (2,000) 15.94 Cancelled (13,750) 3.875 Cancelled (17,500) 4.625 ------- Outstanding at Dec. 31, 2000 287,074 $15.34 ======= ------- ====== 521,210 $ 4.24 ======= ======

No shares were exercisable at December 31, 1998 and 1997. At December 31, 2000, 90,250 shares were exercisable at a weighted exercise price of $4.58. At December 31, 1999, 2000 shares were exercisable at a weighted exercise price of $4.625. The per share weighted average fair value of stock options granted during the period ended December 31, 2000 and 1999 was $0.17 and $0.49, respectively at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: F-29 87 2000 1999 ---- ---- Expected life (years) 10 10 Risk-free interest rate 6.54% 6.27% Volatility 42.1% 61.4% Expected dividend yield 12.6% 12.3% The Company applies APB opinion No. 25 in accounting for its 1997 and 1999 Stock Option Plans and, accordingly, no compensation cost has been recognized for its stock options in the financial statements for 2000, 1999, 1998 and 1997. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under Statements of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, the Company's net income would have been reduced to the pro forma amounts for the period indicated below (dollars in thousands, except per share data):

YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998 ----------------- ----------------- ----------------- Net earnings (loss): As reported $2,862 ($12,627) ($4,934) Pro forma $2,814 ($12,766) ($4,938) Earnings (loss) per share - basic: As reported $ 0.56 ($2.12) ($0.77) Pro forma $ 0.55 ($2.15) ($0.77) Earnings (loss) per share - diluted : As reported $ 0.56 ($2.12) ($0.77) Pro forma $ 0.55 ($2.14) ($0.77)

BONUS INCENTIVE COMPENSATION PLAN A bonus incentive compensation plan was established in 1997, whereby an annual bonus will be accrued for eligible participants of the Company. The annual bonus will be paid one-half in cash and (subject to ownership limits) one-half in shares of common stock in the following year. The Company must generate annual net income before bonus accruals that allows for a return of equity to stockholders in excess of the average weekly ten-year U.S. Treasury rate plus 4.0% before any bonus accrual is recorded. No such accrual was recorded in 2000, 1999 and 1998. 12. AFFILIATED PARTY TRANSACTIONS The Company engaged HCP pursuant to a Management Agreement to render among other things, due diligence, asset management and administrative services. F-30 88 The 2000 consolidated statement of operations of the Company includes management and administrative expenses of $634,000 and commission expense of $4,000 relating to billings from HCP. The 1999 consolidated statement of operations of the Company includes management and administrative expenses of $809,000, due diligence expenses of $119,000 and commission expenses of $5,000 relating to billings from HCP. The 1998 consolidated statement of operations of the Company includes management and administrative expenses of $733,000, due diligence expenses of $687,000 and commission expenses of $286,000 relating to billings from HCP. The 2000, 1999 and 1998 consolidated statement of operations also reflects a reduction in personnel expenses for a portion of salaries allocated (and billed) to HCP. During 2000, 1999 and 1998 the Company recorded $185,000, $175,000 and $129,000 of interest income generated from loans to the Principals, $265,000, $168,000 and $126,000 of interest income from loans to HCP and $81,000, $0, and $0 of interest income from loans to HTC. The term of the Management Agreement continues until December 31, 2001 with subsequent renewal. 13. EARNINGS PER SHARE Calculations for earnings (loss) per share are shown below (dollars in thousands, except per share data):

YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 2000 1999 1998 ----------- ----------- ----------- EARNINGS (LOSS) PER SHARE BASIC: Net income (loss) (numerator) $ 2,862 $ (12,627) $ (4,934) =========== =========== =========== Average common shares outstanding (denominator) 5,102,563 5,942,403 6,418,305 =========== =========== =========== Per share $ 0.56 $ (2.12) $ (0.77) =========== =========== =========== EARNINGS (LOSS) PER SHARE DILUTED: Net income (loss) (numerator) $ 2,862 $ (12,627) $ (4,934) =========== =========== =========== Average common shares outstanding 5,102,563 5,942,403 6,418,305 =========== =========== =========== Add: Incremental shares from assumed conversion of warrants and exercise of options 24,577 27,016 -0- ----------- ----------- ----------- Dilutive potential common shares 24,577 27,016 -0- ----------- ----------- ----------- Adjusted weighted average shares outstanding (denominator) 5,127,140 5,969,419 6,418,305 =========== =========== =========== Per share $ 0.56 $ (2.12) $ (0.77) =========== =========== ===========

F-31 89 14. STOCKHOLDERS' EQUITY In September 1997, Hanover raised net proceeds of approximately $79 million in its initial public offering (the "IPO"). In the IPO, Hanover sold 5,750,000 units (each unit consisting of one share of common stock, par value $.01 and one stock warrant) at $15.00 per unit including 750,000 units sold pursuant to the underwriters' over-allotment option, which was exercised in full. The warrants became exercisable on March 19, 1998 and expired on September 15, 2000. The Company utilized substantially all of the net proceeds of the IPO to fund leveraged purchases of mortgage loans and mortgage backed securities. In July 1998, the Board of Directors of the Company authorized a share repurchase program pursuant to which the Company was authorized to repurchase up to 646,880 shares of the Company's outstanding common stock. During the year ended December 31, 1998, the Company repurchased a total of 146,900 shares of its common stock at an average price of $9.16 per share for a total cost of $1,345,000. In November 1998 Hanover entered into a short term financing agreement (that has since terminated) with Residential Funding Corporation ("RFC"). In connection with that financing arrangement, Hanover in April 1999 executed a Warrant Agreement to issue to RFC warrants to purchase 299,999 shares of Hanover's common stock. The warrants are exercisable at a price per share equal to the closing price of Hanover's common stock on the American Stock Exchange on the date of the November agreement, which was $4.00 per share. The warrants expire in April 2004. During the year ended December 31, 1999, the Company repurchased a total of 495,000 shares at an average price of $4.51 per share for a total cost of $2,236,000. In October 1999, the Board of Directors of the Company authorized a second share repurchase program pursuant to which the Company was authorized to repurchase up to 1,000,000 shares of its outstanding common stock from time to time in open market transactions. In August 2000, the Board of Directors of the Company authorized a third share repurchase program pursuant to which the Company is authorized to repurchase up to 1,000,000 shares of its outstanding common stock from time to time in open market transactions at a total cost not to exceed $3,000,000. During the year ended December 31, 2000, the Company repurchased 1,503,955 shares at an average price of $4.86 per share for a total cost of $7,309,055 pursuant to the share repurchase programs. As of December 31, 2000, the Company has repurchased 646,880 shares pursuant to the 1998 share repurchase program, 1,000,000 shares pursuant to the 1999 share repurchase program, and 498,975 shares at an average price of $5.74 for a total cost of $2,863,000 pursuant to the 2000 share repurchase program. As of such date, the Company had remaining authority to purchase up to 501,025 shares for not more than $137,000. 15. GAIN ON SALE OF SERVICING RIGHTS On March 31, 1999 Hanover entered into an agreement to sell the servicing rights on $148 million of single-family mortgage loans. The total income from the sale of mortgage servicing rights was $566,000. The gain on sale of mortgage servicing rights was $540,000 and the balance of the income ($26,000) relating to mortgage loans classified as held for sale, was deferred and was amortized into interest income in 1999 over the lives of the mortgage loans using the effective yield method until the mortgage loans were securitized in August 1999. F-32 90 16. CERTAIN CHARGES AND EXPENSES IN THE THREE MONTHS ENDED SEPTEMBER 30, 1999 For the three-month period ended September 30, 1999 the Company recorded certain charges and expenses totaling $14,061,000. These charges and expenses are summarized as detailed below (dollars in thousands): Realized (loss) on mark to market of mortgage securities $ 1,312 (a) Impairment charge on mortgage securities 2,225 (b) Realized (loss) on mark to market of mortgage loans 2,997 (c) Provision for (loss) on disposition of unconsolidated subsidiary (HCP-2) 4,793 (d) Additional operating expenses relating to the provision for (loss) on sale of unconsolidated subsidiary (HCP-2) 153 (d) Loss from unconsolidated subsidiary (HCP-2) 403 (d) Catch-up premium, (discount), deferred financing adjustments on certain CMOs and mortgage securities 1,821 (e) Mortgage loan net interest income adjustment 357 (f) -------- $14,061 (a) The realized (loss) on mark to market of mortgage securities resulted from the September 30, 1999 mark to market adjustment recorded on six 1998-B notes transferred from the available for sale category to the held to maturity and the trading categories. (b) The impairment charge on mortgage securities resulted from the mark down of six 1998-B interest only notes to market value. (c) The realized (loss) from mark to market resulted from a mark to market adjustment of $2,997,000 at the time of transfer of mortgage loans from the held for sale category to the collateral for CMOs category (in connection with the 1999-B securitization transaction). (d) The financing structure for the 1998-B securitization resulted in the organization of HCP-2 in October 1998. HCP-2 was capitalized with a non-cash contribution from Hanover in the form of mortgage pools net of related reverse repurchase agreement financing in exchange for 100% of the non-voting preferred stock of HCP-2 (99% economic interest in HCP-2) and cash contributions from the Principals (which were loaned to the Principals from Hanover) in exchange for all of the common stock of HCP-2 (1% economic interest in HCP-2). The financing structure required certain costs of the securitization (net premium, hedging and deferred financing costs) to be capitalized in the subsidiary, HCP-2. Substantially all of Hanover's investment in HCP-2 consists of these capitalized costs. The capitalized costs are amortized on HCP-2's books over the anticipated life of the respective mortgage loans and passed through to Hanover each period as Hanover's equity ownership (99%) in HCP-2. HCP-2 will continue to generate losses as these capitalized costs are amortized. F-33 91 In September 1999, the Company decided to sell HCP-2. A provision for a loss on the disposition of this investment has been reflected as follows: 100% of the balance of the investment in HCP-2 $4,428,000 Advances to HCP-2 365,000 ---------- Total provision $4,793,000 ========== The Company reserved for the expected forgiveness of $62,000 of loans that Hanover advanced to the Principals in October 1998 that the Principals used to invest in HCP-2. These loans were forgiven on January 28, 2000. In addition, the Company reserved for additional compensation ($41,000) to the Principals equal to the anticipated income tax consequences attributable to the forgiveness of the notes. The total compensation costs related to the provision for forgiveness of Principals' notes ($103,000) and an estimate of costs relating to the disposition of HCP-2 (legal and other) of $50,000 are reflected as additional operating expenses in the consolidated statement of operations for 1999. Also reflected in the above is the $403,000 loss for the three month period ended September 30, 1999 from an unconsolidated subsidiary (HCP-2). Because the Company has no basis in its investment in HCP-2 at September 30, 1999 the Company does not expect to record any future losses from HCP-2. (e) At September 30, 1999 management reviewed the actual prepayment speeds as compared to the projected prepayment speeds on all of its investment portfolios. The review resulted in a cumulative adjustment of premiums, (discount), deferred costs and deferred financing amortization of $1,821,000 on certain of the Company's investment portfolio. The following cumulative income adjustments were recorded in the three month period ended September 30, 1999: Mortgage securities - 1998-B $1,606,000 Collateral for CMO - 1998-A 138,000 Collateral for CMO - 1999-A 58,000 Mortgage securities - swapped FNMA certificates 19,000 ---------- $1,821,000 ========== (f) An adjustment to mortgage loan net interest income of $357,000 was reflected in the three month period ended September 30, 1999 in connection with the 1999-B securitization. This adjustment reduced the Company's outstanding accrued interest receivable on loans included in the securitization to the amount specified in the securitization documentation. F-34 92 17. SUPPLEMENTAL DISCLOSURES FOR STATEMENTS OF CASH FLOWS (in thousands except share data): YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998 ----------------- ----------------- ----------------- Cash paid during the period for interest $3,234 $22,058 $39,876 ====== ======= ======= SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES Dividends of $865,000, $583,000 and $695,000 were declared in December 2000, December 1999 and December 1998 but not paid until February 2001, February 2000 and January 1999, respectively. Acquisition of a 99% economic ownership in Hanover Capital Partners 2, Inc. in October 1998 from the contribution of $324,210 (book value) of mortgage loans net of $309,963 of reverse repurchase agreement financing less funds to be returned to Hanover of $71. 18. COMMITMENTS AND CONTINGENCIES Hanover entered into employment agreements with the Principals in 1997 and Mr. Kaplan in August 2000. The terms of the agreements were amended in August 2000. Such agreements are for five year terms, and provide for initial aggregate annual base salaries of $1,200,000 (subject to cost of living increases). Pursuant to the amendments, the term of each contract is automatically extended on its anniversary, unless either party gives notice to the contrary. A portion of the aggregate base salaries was allocated to Hanover's principal taxable subsidiaries, HCP and HTC, based on management's actual and estimated time involved with the subsidiary's activities. As additional consideration to the Principals for their contribution of their HCP preferred stock to Hanover, Hanover has agreed to (1) issue to the Principals up to 216,667 additional shares of Hanover's common stock and (2) forgive a maximum of $1,750,000 in loans made to the Principals if certain financial returns to stockholders are met, at certain Earn-Out Measuring Dates as described in Hanover's IPO Prospectus dated September 15, 1997. Hanover has guaranteed the obligations of HCP with respect to an amendment to an office lease entered into by HCP. At December 31, 2000 the remaining term of the lease is 9 years and 2 months and obligates HCP for $1,982,000 of base rental expense plus escalation, electric and other billings over the lease term. Pursuant to a short-term (3 month) reverse repurchase financing agreement entered into in November 1998, Hanover agreed to issue and deliver to the lender warrants to purchase 299,999 shares of Hanover's common stock. The warrants are exercisable at $4.00 per share. In October 1998, the Company sold 15 adjustable rate FNMA certificates and 19 fixed rate FNMA certificates that the Company received in a swap for certain adjustable rate and fixed rate mortgage loans. These securities were sold with recourse. Accordingly, the Company retains credit risk with respect to the principal amount of these mortgage securities. At December 31, 2000 the Company had forward commitments to sell $11.3 million (par value) of Agency mortgage securities that had not yet settled. This forward sale was entered into to hedge the F-35 93 expected sale of approximately $19.6 million, principal balance, of purchased subordinate mortgage-backed securities held in a trading account and classified as available for sale. 19. FINANCIAL INSTRUMENTS The estimated fair value of the Company's assets and liabilities classified as financial instruments and off-balance sheet financial instruments at December 31, 2000 and 1999 are as follows (dollars in thousands):

DECEMBER 31, 2000 DECEMBER 31, 1999 ------------------ ----------------- CARRYING NOTIONAL FAIR CARRYING NOTIONAL FAIR AMOUNT AMOUNT VALUE AMOUNT AMOUNT VALUE --------- --------- --------- -------- -------- -------- Assets: Mortgage loans Held for sale $ 230 $ 230 $ 251 $ 251 Collateral for CMOs 212,017 207,741 269,833 263,373 Mortgage securities pledged as collateral for reverse repurchase agreements: Available for sale 11,785 11,785 48,529 48,529 Held to maturity 1,384 1,392 3,618 3,345 Trading 1,743 1,743 5,919 5,919 Mortgage securities pledged as collateral for CMOs 9,877 9,340 -- -- Mortgage securities not pledged: Available for sale 4,744 4,744 -- - Held to maturity 3,133 3,033 4,620 4,034 Trading 3,057 3,057 -- -- Interest rate caps 619 134,362 206 1,072 166,266 1,139 Forward commitments to sell mortgage securities (103) 11,300 (103) 68 6,000 68 Cash and cash equivalents 9,958 9,958 18,022 18,022 Accrued interest receivable 2,466 2,466 3,015 3,015 Notes receivable 7,887 7,887 7,946 7,946 --------- --------- --------- --------- -------- -------- Total $ 268,797 $ 145,662 $ 263,479 $ 362,893 $172,266 $355,641 ========= ========= ========= ========= ======== ======== Liabilities: Reverse repurchase agreements $ 14,760 $ 14,760 $ 55,722 $ 55,722 CMO borrowing 210,374 209,331 254,963 250,906 Accrued interest payable 1,796 1,796 2,433 2,433 Other liabilities 989 989 2,513 2,513 --------- --------- --------- -------- Total $ 227,919 $ 226,876 $ 315,631 $311,574 ========= ========= ========= ========

The following methods and assumptions were used to estimate the fair value of the Company's financial instruments: Mortgage loans - The fair values of these financial instruments are based upon actual prices received upon recent sales of loans and securities to investors and projected prices which could be obtained through investors considering interest rates, loan type, and credit quality. Mortgage securities - The fair values of these financial instruments are based upon either or all of the following: actual prices received upon recent sales of securities to investors, projected prices which could be obtained through investors, estimates considering interest rates, loan type, quality and F-36 94 discounted cash flow analysis based on prepayment and interest rate assumptions used in the market place for similar securities with similar credit ratings. Cash and cash equivalents, accrued interest receivable, notes receivable, reverse repurchase agreements, accrued interest payable, other liabilities - The fair value of these financial instruments was determined to be their carrying value due to their short-term nature. CMO Borrowing - The fair values of these financial instruments are based upon either or all of the following: actual prices received upon recent sales of securities to investors, projected prices which could be obtained through investor estimates considering interest rates, loan type, quality and discounted cash flow analysis based on prepayment and interest rate assumptions used in the market place for similar securities with similar credit ratings. Forward commitments to sell securities - The Company has outstanding forward commitments to sell mortgage securities into mandatory delivery contracts with investment bankers, private investors and agency-backed securities. The fair value of these financial instruments was determined through review of published market information associated with similar instruments. These commitment obligations are considered in conjunction with the Company's lower of cost or market valuation of its loans held for sale. Interest rate caps - The fair values of these financial instruments are estimated based on dealer quotes and is the estimated amount the Company would pay to execute a new agreement with similar terms. 20. SUBSEQUENT EVENTS On January 1, 2001, the Company implemented Statements of Financial Accounting Standards ("SFAS") 133, 137 and 138. SFAS 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, issued in June 1998, establishes accounting and reporting standards for derivative instruments and hedging activities. SFAS 137, issued in June 1999, delayed the effective date of SFAS 133 to make it effective for quarters in fiscal years beginning after June 15, 2000. SFAS 138, issued in June 2000, amends certain technical provisions of SFAS 133. The impact of this implementation will be reflected in the Company's quarterly financial statements for the period ending March 31, 2001. In connection with the implementation of these financial standards, the Company adopted a hedging policy on January 1, 2001. Certain of the hedges that the Company had in place as of December 31, 2000 were designated as Fair Value Hedges, and certain of the hedges that the Company had in place were designated as Cash Flow Hedges. In future financial statements, changes in the values of Fair Value Hedges will be reflected in income, and an offsetting amount reflecting changes in value of the related hedged assets will also be reflected in income. The effect of this treatment will be to reflect in income any ineffective portion of such hedges. The Company's Fair Value Hedges as of December 31, 2000 consisted of short sales of $11.3 million of FNMA agency mortgage-backed securities. As of December 31, 2000, both the hedge and the hedged assets were carried at fair value. This treatment will not materially change as a result of the adoption of SFAS 133, 137 and 138. Changes in the value of Cash Flow Hedges will be reflected as other comprehensive income or loss, but only to the extent that the hedging relationship is expected to be highly effective. The Company's Cash Flow Hedges at December 31, 2000 consisted of five interest rate caps in effect at December 31, 2000 with an aggregate book value of $619,000 and an aggregate market value of $206,000. F-37 95 Two of these hedges with an aggregate book value of $480,000 were designated as hedges for floating rate borrowings. The Company expects that these Cash Flow Hedges will be highly effective. These hedges had a fair value at January 1, 2001 of $72,000. The carrying value of these hedges was adjusted to fair value at January 1, 2001. The difference between the carrying value and the fair value of these hedges, or $408,000, was recorded as an unrealized loss, and will be reported as a component of "other comprehensive income" in the Company's financial statements for the period ending March 31, 2001. The Company considers this loss to be part of the cumulative effect of the adoption of SFAS 133. Two of these hedges with an aggregate book value of $40,000 had been designated as hedges for floating rate borrowings that were repaid in the fourth quarter of 2000. These hedges had a fair value at January 1, 2001 of $123,000. The carrying value of these hedges was adjusted to fair value at January 1, 2001. The difference between the carrying value and the fair value of these hedges, or $83,000, was recorded as a realized gain, and will be reported as a component of income in the Company's financial statements for the period ending March 31, 2001. The Company considers this gain to be part of the cumulative effect of the adoption of SFAS 133. On January 1, 2001, the Company reclassified $1,874,000 of mortgage securities from "held to maturity" to "trading" in connection with the adoption of SFAS 133. These securities were sold on January 31, 2001 for $2,047,000, resulting in a gain on sale of $173,000. The Company considers this gain to be part of the cumulative effect of the adoption of SFAS 133. Also on January 1, 2001, the Company reclassified $1,725,000 of mortgage securities from "held to maturity" to "available for sale" in connection with the adoption of SFAS 133. In connection with this transfer, the carrying value of these securities was adjusted to fair value. These securities had a fair value of $1,681,000 as of January 1, 2001. The $44,000 difference between the carrying value at December 31, 2000 and the fair value at January 1, 2001 was recorded as an unrealized loss, and will be reported as a component of "other comprehensive income" in the Company's financial statements for the period ending March 31, 2001. The Company considers this loss to be part of the cumulative effect of the adoption of SFAS 133. On February 1, 2001 a $0.20 cash dividend previously declared by the Board of Directors was paid to stockholders of record as of December 31, 2000. On January 19, 2001 the Company's affiliate, HanoverTrade.com, Inc. purchased all the assets of Pamex Capital Partners, L.L.C. ("Pamex") a whole loan mortgage broker and hired 18 Pamex employees. The purchase price consisted of $850,000 in cash paid at closing plus an earn out of between $1,250,000 and $1,500,000, payable over three years in shares of Hanover. Included in the purchase was Pamex Securities, L.L.C. a licensed securities broker dealer registered with the Securities Exchange Commission and the National Association of Securities Dealers. The combined sales force will market HanoverTrade.com product and continue to broker whole loans through traditional channels. At the February 2, 2001 meeting of the board of directors, the loans to the principals totaling $3,279,000 due on March 31, 2001 were extended to March 31, 2003. F-38 96 21. QUARTERLY FINANCIAL DATA - UNAUDITED Selected quarterly financial data are as follows (dollars in thousands, except per share data):

Three Months Three Months Three Months Three Months Ended Ended Ended Ended December 31, September 30, June 30, March 31, 2000 2000 2000 2000 ------------------- ------------------ ------------------- ------------------ Net interest income $1,673 $2,081 $1,425 $1,484 =================== ================== =================== ================== Net income $ 710 $ 727 $ 735 $ 690 =================== ================== =================== ================== Basic earnings per share (2) $ .16 $ .15 $ .14 $ .12 =================== ================== =================== ================== Diluted earnings per share $ .15 $ .15 $ .14 $ .12 (2) =================== ================== =================== ================== Dividends declared $ .20 $ .20 $ .14 $ .12 =================== ================== =================== ================== Three Months Three Months Three Months Three Months Ended Ended Ended Ended December 31, September 30, June 30, March 31, 1999 1999 1999 1999 ------------------- ------------------ ------------------- ------------------ Net interest income $1,509 $ (884) $1,733 $2,051 =================== ================== =================== ================== Net income (loss) $ 573 $(13,994) $ 58 $ 736 =================== ================== =================== ================== Basic earnings (loss) per share (2) $ 0.10 $ (2.40) $ 0.01 $ 0.12 =================== ================== =================== ================== Diluted earnings (loss) per share $ 0.10 $ (2.38) $ 0.01 $ 0.11 (2) =================== ================== =================== ================== Dividends declared $ 0.10 $ 0.10 $ 0.10 $ 0.10 =================== ================== =================== ================== Three Months Three Months Three Months Three Months Ended Ended Ended Ended December 31, September 30, June 30, March 31, 1998 1998 1998 1998 ------------------- ------------------ ------------------- ------------------ Net interest income $ 1,998 $1,692 $ 774 $2,159 =================== ================== =================== ================== Net income (loss) $(5,884) $ 346 $ (644) $1,248 =================== ================== =================== ================== Basic earnings (loss) per share (2) $ (0.93) $ 0.05 $(0.10) $ 0.19 =================== ================== =================== ================== Diluted earnings (loss) per share (2) $ (0.93) $ 0.05 $(0.10) $ 0.17 =================== ================== =================== ================== Dividends declared $ 0.11 $ 0.17 $ 0.21 $ 0.21 =================== ================== =================== ================== Three Months Three Months June 10, 1997 Ended Ended Through December 31, September 30, June 30, 1997 1997 (1) 1997 (1) ------------------- ------------------ ------------------ Net interest income $1,548 $ 128 $ 0 =================== ================== ================== Net income $ 440 $ 59 $ 0 =================== ================== ================== Basic earnings per share (2) $ 0.07 $0.07 $0.00 =================== ================== ================== Diluted earnings per share $ 0.07 $0.07 $0.00 (2) =================== ================== ================== Dividends declared $ 0.16 $0.00 $0.00 =================== ================== ==================

(1) The Company was organized on June 10, 1997, however operations did not begin until the IPO date - September 19, 1997 (2) Earnings per share are computed independently for each of the quarters presented; therefore the sum of the quarterly earnings per share does not equal the earnings per share total for the year. ****** F-39 97 INDEPENDENT AUDITORS' REPORT To the Board of Directors of Hanover Capital Partners Ltd. New York, New York We have audited the accompanying consolidated balance sheets of Hanover Capital Partners Ltd. and Subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. 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 generally 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 misstatement. An audit includes examining, on a test basis, evidence supporting 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 consolidated financial statements present fairly, in all material respects, the consolidated financial position of Hanover Capital Partners Ltd. and Subsidiaries at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP Parsippany, New Jersey March 27, 2001 F-40 98 HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS

DECEMBER 31, DECEMBER 31, ASSETS 2000 1999 ---- ---- CURRENT ASSETS: Cash $ 493,711 $ 514,804 Investment in marketable securities 3,300 19,055 Accounts receivable 2,302,211 668,993 Receivables from related parties 532,115 186,969 Accrued interest receivable -- 181,471 Accrued revenue on contracts in progress 1,347,566 761,923 Prepaid expenses and other current assets 26,556 170,201 ------------ ------------ Total current assets 4,705,459 2,503,416 PROPERTY AND EQUIPMENT - Net 86,717 56,601 NET INVESTMENT IN MORTGAGE SECURITIES AVAILABLE FOR SALE -- 14,180,184 DEFERRED TAX ASSET 340,731 856,143 OTHER ASSETS 13,730 175,633 ------------ ------------ TOTAL ASSETS $ 5,146,637 $ 17,771,977 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Reverse repurchase agreement $ -- $ 10,842,000 Accrued appraisal and subcontractor costs 36,779 13,582 Accounts payable and accrued expenses 1,541,328 508,975 Deferred revenue 5,276 -- Notes payable to related parties 1,704,342 4,896,046 Income tax payable 21,508 -- ------------ ------------ Total current liabilities 3,309,233 16,260,603 ------------ ------------ TOTAL LIABILITIES 3,309,233 16,260,603 ------------ ------------ COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock: $.01 par value, 100,000 shares authorized, 97,000 shares outstanding at December 31, 2000 and 1999 970 970 Common stock: Class A: $.01 par value, 5,000 authorized, 3,000 shares outstanding at December 31, 2000 and 1999 30 30 Additional paid-in capital 2,839,947 2,839,947 Retained earnings (deficit) (1,003,543) (1,471,884) Accumulated other comprehensive income -- 142,311 ------------ ------------ TOTAL STOCKHOLDERS' EQUITY: 1,837,404 1,511,374 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,146,637 $ 17,771,977 ============ ============

See notes to consolidated financial statements F-41 99 HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS

YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 2000 1999 1998 ----------- ----------- ----------- REVENUES: Due diligence fees $ 7,016,435 $ 5,530,307 $ 5,001,047 Mortgage sales and servicing 27,825 229,557 701,574 Assignment fees 631,093 -- -- Loan brokering/asset management fees 30,234 789,003 654,748 Interest income on mortgage backed securities, net of interest expense of $962,485 and $547,636 in 2000 and 1999 respectively 513,391 384,642 -- Gain on sale of mortgage securities 440,639 -- -- Other income (loss) 54,041 125,809 (12,609) ----------- ----------- ----------- Total revenues 8,713,658 7,059,318 6,344,760 ----------- ----------- ----------- EXPENSES: Personnel expense 3,309,860 3,954,622 4,364,725 Subcontractor expense 2,924,021 1,950,946 1,537,294 Occupancy expense 453,372 477,937 578,512 Travel and subsistence 215,959 390,318 555,382 General and administrative expense 309,926 378,407 532,006 Appraisal, inspection and other professional fees 257,495 155,609 223,262 Interest expense 90,054 252,144 155,128 Depreciation and amortization 52,908 107,583 107,971 ----------- ----------- ----------- Total revenues 7,613,595 7,667,566 8,054,280 ----------- ----------- ----------- INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT) 1,100,063 (608,248) (1,709,520) INCOME TAX PROVISION (BENEFIT) 631,722 (152,062) (661,524) ----------- ----------- ----------- NET INCOME (LOSS) $ 468,341 $ (456,186) $(1,047,996) =========== =========== =========== BASIC EARNINGS (LOSS) PER SHARE $ 156.12 $ (152.07) $ (349.33) =========== =========== ===========

See notes to consolidated financial statements F-42 100 HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998

Preferred Stock Common Stock ---------------- ---------------- Shares Amount Shares Amount ------ ------ ------ ------ BALANCE, DECEMBER 31, 1997 97,000 $ 970 3,000 $ 30 Capital Contributions Comprehensive (loss): Net (loss) Comprehensive (loss) ------ ----- ------ ----- BALANCE, DECEMBER 31, 1998 97,000 970 3,000 30 Comprehensive (loss): Net (loss) Other comprehensive income: Change in net unrealized gain on securities available for sale, net of income tax effect Comprehensive (loss) ------ ----- ------ ----- BALANCE, DECEMBER 31, 1999 97,000 970 3,000 30 Comprehensive income: Net income Other comprehensive income (loss): Change in net unrealized gain on securities available for sale, net of income tax effect Comprehensive income ------ ----- ------ ----- BALANCE, DECEMBER 31, 2000 97,000 $ 970 3,000 $ 30 ====== ===== ====== =====

Accumulated Additional Comprehensive Retained Other Paid-In Income Earnings Comprehensive Capital (Loss) (Deficit) Gain Total ------- ------ --------- ---- ----- BALANCE, DECEMBER 31, 1997 $ 56,442 $ 32,298 -- $ 89,740 Capital Contributions 2,783,505 2,783,505 Comprehensive (loss): Net (loss) $(1,047,996) (1,047,996) (1,047,996) ---------- Comprehensive (loss) $(1,047,996) ---------- ========== ----------- --------- ----------- BALANCE, DECEMBER 31, 1998 2,839,947 (1,015,698) -- 1,825,249 Comprehensive (loss): Net (loss) $ (456,186) (456,186) (456,186) Other comprehensive income: Change in net unrealized gain on securities available for sale, net of income tax effect 142,311 $ 142,311 142,311 ---------- Comprehensive (loss) $ (313,875) ---------- ========== ----------- --------- ----------- BALANCE, DECEMBER 31, 1999 2,839,947 (1,471,884) 142,311 1,511,374 Comprehensive income: Net income $ 468,341 468,341 468,341 Other comprehensive income (loss): Change in net unrealized gain on securities available for sale, net of income tax effect (142,311) (142,311) (142,311) ---------- Comprehensive income $ 326,030 ---------- ========== ----------- --------- ----------- BALANCE, DECEMBER 31, 2000 $2,839,947 $(1,003,543) $ -- $ 1,837,404 ========== =========== ========= ===========

See notes to consolidated financial statements F-43 101 HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS CASH FLOWS

YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 2000 1999 1998 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 468,341 $ (456,186) $ (1,047,996) Adjustments to reconcile net income (loss) to net cash (used in) operating activities: Amortization of net premium (374,961) (204,010) -- Loan loss provision 478,330 289,297 -- Depreciation and amortization 42,798 107,583 107,971 Gain on sale of mortgage servicing rights -- -- (371,977) Gain on sale of mortgage backed securities (440,639) -- -- (Gain) Loss on disposal of property and equipment (2,700) 14,588 -- Loss on disposal of securities -- -- 100,750 Sale (Purchase) of trading securities 15,755 (1,063) (598) Changes in assets - (increase) decrease: Accounts receivable (1,633,218) (151,748) (383,416) Receivables from related parties (345,146) 26,810 597,371 Accrued interest receivable 181,471 (181,471) -- Accrued revenue on contracts in progress (585,643) (514,823) (211,687) Income tax receivable -- 219,563 73,322 Prepaid expenses and other current assets 143,645 22,379 (74,028) Deferred tax assets 612,682 -- (781,270) Other assets 161,903 (47,062) 37,348 Changes in liabilities - increase (decrease): Accrued appraisal and subcontractor costs 23,197 (7,148) (111,248) Accounts payable and accrued expenses 1,032,353 42,278 132,106 Income tax payable 21,508 -- -- Deferred income taxes -- (152,062) -- Deferred revenue 5,276 (89,625) (15,325) Minority interest -- -- (616) ------------ ------------ ------------ Net cash (used in) operating activities (195,048) (1,082,700) (1,949,293) ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (72,914) (38,598) (33,841) Sale of property and equipment 2,700 1,285 -- Proceeds from sale of mortgage servicing rights -- -- 418,974 Purchase of securities -- -- (100,000) Purchase of mortgage securities (8,450,259) (14,110,858) -- Proceeds from sale of mortgage securities to third parties 8,667,260 -- -- Proceeds from sale of mortgage securities to related party 13,844,223 -- -- Principal payments received on mortgage securities 216,649 84,969 -- ------------ ------------ ------------ Net cash (used in) provided by investing activities 14,207,659 (14,063,202) 285,133 ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of note payable to bank -- -- (1,405,000) Net proceeds from (repayment of) note payable to related party (3,191,704) 4,183,222 712,824 Capital contributions -- -- 2,783,505 Net borrowings from (repayment of) reverse repurchase agreements (10,842,000) 10,842,000 -- ------------ ------------ ------------ Net cash provided by (used in) financing activities (14,033,704) 15,025,222 2,091,329 ------------ ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (21,093) (120,680) 427,169 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 514,804 635,484 208,315 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS, END OF YEAR $ 493,711 $ 514,804 $ 635,484 ============ ============ ============ SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES: Loans of $7,165,000, and $13,930,000, were originated by HCMC and funded by investors in 1999 and 1998, respectively SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the year for: Income taxes $ 3,435 $ 5,350 $ 5,671 ============ ============ ============ Interest $ 830,930 $ 323,851 $ 689,779 ============ ============ ============

See notes to consolidated financial statements F-44 102 HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 1. BUSINESS DESCRIPTION Hanover Capital Partners Ltd. ("HCP") and its subsidiaries operate as a specialty finance company which is principally engaged in performing due diligence services, asset management services, mortgage loan assignment preparation services and mortgage and investment banking services for third parties and for its affiliate, Hanover Capital Mortgage Holdings, Inc. A wholly-owned subsidiary of HCP, Hanover Capital Mortgage Corporation ("HCMC"), is a servicer of multifamily mortgage loans and until June 30, 1999 was an originator of multifamily mortgage loans. HCMC is approved by the U.S. Department of Housing and Urban Development (HUD) as a Title II Nonsupervised Mortgagee under the National Housing Act. Another wholly-owned subsidiary of HCP, Hanover Capital Securities, Inc. ("HCS") is a registered broker/dealer with the Securities and Exchange Commission. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of HCP and its wholly-owned subsidiaries (the "Company"). The wholly-owned subsidiaries include HCMC and HCS. All significant intercompany accounts and transactions have been eliminated. 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 at the date of the financial statements and the required amounts of revenues and expenses during the reporting period. INVESTMENTS IN LIMITED LIABILITY COMPANIES Minority ownership interests in limited liability companies are accounted for by the equity method of accounting. HCP's investments in limited liability companies are classified as other assets in the accompanying consolidated balance sheets. During the year ended December 31, 2000 HCP's investment in the limited liability companies was liquidated. The ownership of each limited liability company at December 31, 2000 and 1999 is detailed below: 2000 1999 ---- ---- Alpine/Hanover, LLC 0.0% 1.0% ABH-I, LLC 0.0% 1.0% REVENUE RECOGNITION Revenues from due diligence contracts in progress and assignment preparation services are recognized for the services provided as they are earned and billed. F-45 103 LOAN ORIGINATION FEES AND COSTS Loan origination fees and costs are deferred until the sale of the loan. The Company sells all originated loans to investors at the time of origination, and accordingly, recognizes loan origination fees at that time. Direct loan origination costs and loan origination fees are offset and included in mortgage sales and servicing. LOAN SERVICING FEES Loan servicing fees consist of fees paid by investors for the collection of monthly mortgage payments, maintenance of required escrow accounts, remittance to investors, and ancillary income associated with those activities. The Company recognizes loan servicing fees as payments are collected. DEFERRED REVENUE Cash advances received for certain service contracts are recorded in the accompanying consolidated balance sheets as deferred revenue and are recognized during the period the services are provided and the related revenue is earned. INCOME TAXES The Company files a consolidated Federal income tax return. The Company has not been subject to an examination of its income tax returns by the Internal Revenue Service. The Company's tax sharing policy provides that each member of the Federal consolidated group receive an allocation of income taxes as if each member filed a separate Federal income tax return. HCP, HCMC and HCS generally file their state income tax returns on a separate company basis. Deferred income taxes are provided for the effect of temporary differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements. PROPERTY AND EQUIPMENT Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets, generally three to seven years. Leasehold improvements are depreciated over the terms of the respective leases or their estimated useful lives, whichever is shorter. INVESTMENT IN MARKETABLE SECURITIES Investment in marketable securities which the Company has classified as trading securities are reported in the accompanying consolidated balance sheets at market value at December 31, 2000 and 1999. CASH AND CASH EQUIVALENTS For cash flow purposes, the Company considers highly liquid investments, purchased with an original maturity of three months or less, to be cash equivalents. F-46 104 MORTGAGE SERVICING RIGHTS After the transfer of a financial asset, the Company recognizes the financial assets it controls and the liabilities it has incurred. Furthermore, the Company no longer recognizes the financial assets for which control has been surrendered and liabilities have been extinguished. For purposes of assessing impairment, the lower of carrying value or fair value of servicing rights is determined on an individual loan basis. Capitalized servicing rights are amortized in proportion to projected net servicing revenue. The fair value of servicing rights is determined using a discounted cash flow method. MORTGAGE SECURITIES The Company's policy is to generally classify mortgage securities as available for sale as they are acquired. Each available for sale mortgage security is monitored for a period of time prior to making a determination whether the asset will be classified as held to maturity or trading. Management reevaluates the classification of the mortgage securities on a quarterly basis. Mortgage securities designated as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Mortgage securities designated as trading are reported at fair value. Gains and losses resulting from changes in fair value are recorded as income or expense and included in earnings. Mortgage securities classified as held to maturity are carried at the fair value of the security at the time the designation is made. Any fair value adjustment is reflected as a separate component of stockholders' equity and as a cost adjustment of the mortgage security as of the date of the classification and is amortized into interest income as a yield adjustment. The Company makes periodic evaluations of all mortgage securities to determine whether an other than temporary impairment is considered to have occurred. If a decline in the fair value is judged to be other than temporary, the cost basis of the mortgage security will be marked to fair value, resulting in a current period loss in the consolidated statement of operations. The new cost basis is not changed for further increases in market value; however, further increases in market value are reflected separately in the equity section of the Company's consolidated balance sheet. Premiums, discounts and certain deferred costs associated with the acquisition of mortgage securities are amortized into interest income over the lives of the securities using the effective yield method adjusted for the effects of estimated prepayments. Mortgage securities transactions are recorded on the date the mortgage securities are purchased or sold. Purchases of new issue mortgage securities are recorded when all significant uncertainties regarding the characteristics of the mortgage securities are removed, generally on or shortly before settlement date. Realized gains and losses on mortgage securities transactions are determined on the specific identification basis. F-47 105 The Company purchases both investment grade and below investment grade mortgage backed securities ("MBS"). Below investment grade MBS have the potential to absorb credit losses caused by delinquencies and defaults on the underlying mortgage loans. When purchasing below investment grade MBS, the Company leverages off of its due diligence operations and management's substantial mortgage credit expertise to make a thorough evaluation of the underlying mortgage loan collateral. The Company monitors the delinquencies and defaults on the underlying mortgages of its mortgage securities and, if an impairment is deemed to be other than temporary, makes a provision for known losses as well as unidentified potential losses. The provision is based on management's assessment of numerous factors affecting its portfolio of mortgage securities including, but not limited to, current and projected economic conditions, delinquency status, credit losses to date on underlying mortgages and remaining credit protection. The provision is made by reducing the cost basis of the individual security and the amount of such write-down is recorded as a realized loss, thereby reducing earnings. Provisions for credit losses do not reduce taxable income and therefore do not affect the dividends paid by the Company to stockholders in the period the provisions are taken. Actual losses realized by the Company reduce taxable income in the period the actual loss is realized and would affect the dividends paid to stockholders for that tax year. REVERSE REPURCHASE AGREEMENTS Reverse repurchase agreements are accounted for as collateralized financing transactions and recorded at their contractual amounts, plus accrued interest. FINANCIAL INSTRUMENTS The Company from time to time enters into interest rate hedge mechanisms including short sales and interest rate caps to manage its exposure to market pricing changes and/or changes in costs of match funded liabilities in connection with the purchase, holding, permanent financing or sale of its mortgage securities portfolio. The Company generally closes out the hedge position to coincide with the related sale or permanent financing transactions. Gains and losses on hedge positions are either (i) deferred as an adjustment to the carrying value of the related securities until the security has been sold or permanently financed, after which the gains or losses will be amortized into income over the remaining life of the security or financing using a method that approximates the effective yield method, or (ii) deferred until such time as the related securities are sold. Gains or losses on hedge positions associated with mortgage securities held in a trading account are recognized as income or loss in each period. The Company also enters into interest rate caps to manage its interest rate exposure on certain reverse repurchase agreement and CMO financing. The cost of the interest rate caps is amortized over the life of the interest rate cap and is reflected as a portion of interest expense in the consolidated statement of operations. Any payments received under the interest rate cap agreements are recorded as a reduction of interest expense on the reverse repurchase agreement financing. For derivative financial instruments designated as hedge instruments, the Company periodically evaluates the effectiveness of these hedges against the financial instrument being hedged under various interest rate scenarios. The Company utilizes hedge deferral accounting procedures in accounting for its hedging program so long as there is adequate correlation between the hedged results and the change in value of the hedged financial instrument. If the hedge instrument performance does not result in adequate correlation between the changes in value of the hedge instrument and the related hedged financial instrument, the Company will terminate hedge deferral accounting and mark the carrying value of the hedge instrument to market. If a hedge instrument is sold or matures, or the criteria that was F-48 106 anticipated at the time the hedge instrument was entered into no longer exists, the hedge instrument is no longer accounted for as a hedge. Under these circumstances, the accumulated change in the market value of the hedge is recognized in current period income or loss to the extent that the effects of interest rate or price changes of the hedged item have not offset the hedged results. Estimated fair value amounts have been determined using available market information or appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value, so the estimates are not necessarily indicative of the amounts that would be realized in a current market exchange. The effect of using different market assumptions and/or estimation methodologies may materially impact the estimated fair value amounts. BASIC EARNINGS PER SHARE Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Shares issued during the period and shares reacquired during the period are weighted for the portion of time they were outstanding. COMPREHENSIVE INCOME Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the consolidated balance sheets, such items, along with net income, are components of comprehensive income. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, is effective for all fiscal years beginning after June 15, 2000. SFAS 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The Company adopted SFAS 133 effective January 1, 2001. The adoption of SFAS 133 did not have a significant impact on the financial position, results of operations, or cash flows of the Company. 3. CONCENTRATION RISK REVENUES FROM CERTAIN CUSTOMERS For the years ended December 31, 2000, 1999 and 1998, the Company received revenues from certain customers, which are subject to change annually, which exceeded 10% of total revenues as follows: F-49 107

DECEMBER 31, DECEMBER 31, DECEMBER 31, 2000 1999 1998 ---- ---- ---- Major Customer # 1 30% 22% 28% Major Customer # 2 22% 13% 13%

MORTGAGE SECURITIES The Company's exposure to credit risk associated with its investment activities is measured on an individual security basis as well as by groups of securities that share similar attributes. In certain instances, the Company has concentrations of credit risk in its mortgage securities portfolio for the securities of certain issuers. The Company did not own any mortgage securities at December 31, 2000. The following table sets forth the concentrations of the Company's credit risk by issuer at December 31, 1999. CONCENTRATION OF CREDIT RISK BY ISSUER DECEMBER 31, 1999 Carrying Value of Mortgage Issuer Securities ------ ---------- Private Issuer 1 $ 7,386,525 Private Issuer 2 6,793,659 ----------- Total $14,180,184 =========== 4. MORTGAGE SERVICING The Company, through its wholly-owned subsidiary, HCMC, services multifamily mortgage loans on behalf of others. Loan servicing consists of the collection of monthly mortgage payments on behalf of investors, reporting information to those investors on a monthly basis and maintaining custodial escrow accounts for the payment of principal and interest to investors and property taxes and insurance premiums on behalf of borrowers. As of December 31, 2000 and 1999, HCMC was servicing 5 and 6 loans, respectively, with unpaid principal balances of $10,227,119 and $13,388,037 including loans subserviced for others of $7,584,236 and $10,690,537 respectively. Escrow balances maintained by HCMC were $170,830 and $212,528 at December 31, 2000 and 1999, respectively. The aforementioned servicing portfolio and related escrow accounts are not included in the accompanying consolidated balance sheets as of December 31, 2000 and 1999. 5. MORTGAGE OPERATIONS In September 1998, the Company purchased a portfolio of single family mortgage loans with a principal balance of $101,586,036. This balance was comprised of fixed rate loans ($22,752,341) and adjustable rate loans ($78,833,695). The mortgage loan portfolio was purchased at 101.395% of par value. The F-50 108 Company sold this portfolio of loans at book value to Hanover Capital Mortgage Holdings, Inc. During the period in which the Company owned the loan portfolio, net interest income of $121,585 was recognized and is reported as a component of other income (loss) in the 1998 consolidated statement of operations. 6. RELATED PARTY TRANSACTIONS Receivables from related parties at December 31, 2000 and 1999 consist of the following:

DECEMBER 31, DECEMBER 31, 2000 1999 ---- ---- Due from Hanover Capital Mortgage Holdings, Inc. (1) $185,381 $150,027 Due from ABH-I, LLC -- 9,005 Due from Hanover Mortgage Capital Corporation (2) 6,661 6,727 Due from Hanover Investment Fund (2) -- 125 Due from HanoverTrade.com (3) 339,444 14,274 -------- -------- Due from related entities 531,486 180,158 Due from officers (4) 629 6,811 -------- -------- Receivables from related parties $532,115 $186,969 ======== ========

(1) The Company entered into a Management Agreement in 1998 to provide, among other services, due diligence, asset management and administrative services to Hanover Capital Mortgage Holdings, Inc. ("HCHI") in connection with acquiring single-family mortgage loan pools and managing and servicing HCHI's investment portfolio. The term of the Management Agreement continues until December 31, 2000 with automatic annual renewal. (2) Amounts due from entities that are owned by certain of the Company's officers/owners represent receivables resulting primarily from accounting fees and out-of-pocket expenses. (3) Amounts due reflect certain costs that the Company paid for HanoverTrade.com ("HTC"). Beginning July 1, 2000, normal recurring operating expenses paid on behalf of HTC were billed to HTC. The expenses billed include personnel expense, occupancy expense, travel, entertainment and trade show expense and general and administrative expenses. During 1999 the expenses incurred relate to start-up costs of HTC. (4) Amounts due from officers are mostly miscellaneous travel related advances. F-51 109 7. PROPERTY AND EQUIPMENT Property and equipment at December 31, 2000 and 1999 consists of the following:

DECEMBER, 31 DECEMBER, 31 2000 1999 ---- ---- Office machinery and computer equipment $ 302,047 $ 229,133 Furniture and fixtures 4,745 4,745 --------- --------- 306,792 233,878 Less accumulated depreciation (220,075) (177,277) --------- --------- Property and equipment - net $ 86,717 $ 56,601 ========= =========

Depreciation expense for the years ended December 31, 2000, 1999 and 1998 was $42,798, $107,583, and $105,519, respectively. 8. MORTGAGE SECURITIES On July 1, 2000 the Company sold the mortgage-backed securities at book value net of loan loss reserve and reverse repurchase debt to Hanover Capital Mortgage Holdings, Inc. At December 31, 1999, the Company had $14,180,184 of fixed rate private-placement mortgage-backed securities, classified as available for sale, as shown on the table below.

FIXED RATE PRIVATE PLACEMENT MORTGAGE-BACKED SECURITIES DECEMBER 31, 1999 ----------------------------------------------------------------------------- Available Held For to Sale (a) Maturity Trading Total --------------- --------------- --------------- --------------- Principal balance of mortgage securities $ 33,400,795 $ -- $ -- $ 33,400,795 Net (discount) and deferred costs (19,174,902) -- -- (19,174,902) --------------- --------------- --------------- --------------- Total amortized cost of mortgage securities 14,225,893 -- -- 14,225,893 Loan loss allowance (285,290) -- (285,290) Gross unrealized gain 239,581 -- -- 239,581 --------------- --------------- --------------- --------------- Carrying cost of mortgage securities $ 14,180,184 $ -- $ -- $ 14,180,184 Mix 100% -- -- 100% Principal balance of mortgage loans $ 5,171,979,000 -- -- $ 5,171,979,000 Weighted average net coupon 6.520% -- -- 6.520% Weighted average maturity 345 -- -- 345

(a) At December 31, 1999, represents seventeen below investment grade subordinate MBS purchased from third parties in the third quarter of 1999. The coupon interest rates on these notes are fixed and range from 6.25% to 6.75%. These notes generate normal principal and interest remittances to the Company on a monthly basis. These notes represented a $33,400,795 (principal balance) subordinated interest in $5,171,979,000 of mortgage loans at December 31, 1999. These notes were carried at $14,180,184 at December 31, 1999. F-52 110 The carrying value at December 31, 1999 of the Company's mortgage securities by contractual maturity dates are presented below:

Available for Sale Held to Maturity Trading Carrying Value Carrying Value Carrying Value -------------- -------------- -------------- Due after ten years $14,180,184 - -

As mentioned above, actual maturities may differ from stated maturities because borrowers usually have the right to prepay certain obligations, often times without penalties. Maturities of mortgage securities depend on the repayment characteristics and experience of the underlying mortgage loans. The average effective yield, which includes amortization of net premiums, (discounts) and deferred costs, for the periods shown below on the combined available for sale, held to maturity and trading mortgage securities portfolio were as follows: 1999 ---- Quarter ended March 31 - Quarter ended June 30 - Quarter ended September 30 20.218% Quarter ended December 31 19.696% ------ 22.527% ====== 9. LOAN LOSS ALLOWANCE The provision for loan loss charged to expense is based upon actual credit loss experience and management's estimate and evaluation of potential losses in the existing mortgage securities portfolio, including the evaluation of impaired loans. There was no loan loss reserve at December 31, 2000. On July 1, 2000 the mortgage-backed securities were sold at book value net of loan loss reserve to Hanover Capital Mortgage Holdings, Inc. The following table summarizes the activity in the loan loss allowance for the years ended December 31, 2000 and 1999.

YEAR ENDED YEAR ENDED DECEMBER 31, 2000 DECEMBER 31, 1999 ----------------- ----------------- Balance beginning of period $ 285,291 $ - Loan loss provision 478,330 289,297 Transfers/sales (729,366) - Charge-offs (34,255) (4,006) -------- -------- Balance end of period $ - $285,291 ======== ========

F-53 111 10. REVERSE REPURCHASE AGREEMENTS At December 31, 2000 there were no reverse repurchase agreements. The borrowings pursuant to the reverse repurchase agreement were sold along with the mortgage-backed securities to Hanover Capital Mortgage Holdings, Inc. on July 1, 2000. At December 31, 1999 the Company had a total of $10,842,000 of uncommitted borrowings pursuant to a master reverse repurchase agreement with one lender. All borrowings pursuant to the master reverse repurchase agreement are secured by mortgage securities. The reverse repurchase agreements bear interest rates that vary from LIBOR plus 90 to LIBOR plus 130 basis points. The lender will typically finance an amount equal to 60% to 80% of the market value of the mortgage securities, depending on the nature of the collateral. The weighted average borrowing rate under the agreement was 7.111% at December 31, 1999. The weighted average maturity was eight months. The reverse repurchase financing agreements at December 31, 1999 were collateralized by securities with a cost basis of $14,180,184. Information pertaining to reverse repurchase agreement financing as of and for the years ended December 31, 2000 and 1999 is summarized as follows: REVERSE REPO FINANCING FOR YEARS ENDED: --------------------------

REVERSE REPURCHASE AGREEMENTS DECEMBER 31, 2000 DECEMBER 31, 1999 ----------------------------- ----------------- ----------------- Balance of borrowing at end of period $ 0 $10,842,000 Accrued interest at end of period $ 0 $ 66,572 Average borrowing balance during the period $ 6,356,000 $11,022,000 Average interest rate during the period 7.617% 6.874% Maximum month-end borrowing balance during the period $15,079,000 $11,082,000 COLLATERAL UNDERLYING THE AGREEMENTS ------------------------------------ Balance at end of period - carrying value $ 0 $14,180,184

F-54 112 11. INCOME TAXES The components of deferred income taxes as of December 31, 2000 and 1999 are as follows:

DECEMBER 31, DECEMBER 31, 2000 1999 ---- ---- DEFERRED TAX ASSETS Temporary differences $ 112,849 $ 223,643 Federal net operating loss carryforward 374,411 638,950 State/Local net operating loss carryforward 73,481 124,032 Amt credit 16,830 -- --------- --------- Total deferred tax assets 577,571 986,625 DEFERRED TAX LIABILITIES Temporary differences (25,127) (33,212) Tax liability for other comprehensive income -- (97,270) --------- --------- Total deferred tax liabilities (25,127) (130,482) Valuation allowance (211,713) -- --------- --------- Net deferred tax assets $ 340,731 $ 856,143 ========= =========

The items resulting in significant temporary differences for the years ended December 31, 2000 and 1999 that generate deferred tax assets and liabilities relate primarily to the recognition of revenue and accrued liabilities for financial reporting purposes. The components of the income tax provision (benefit) for the years ended December 31, 2000, 1999 and 1998 consist of the following:

DECEMBER, 31 DECEMBER, 31 DECEMBER, 31 2000 1999 1998 ---- ---- ---- Current - Federal, state and local $ 19,040 $ -- $ -- Deferred - Federal, state and local 612,682 (152,062) (661,524) --------- --------- --------- Total $ 631,722 $(152,062) $(661,524) ========= ========= =========

F-55 113 The income tax (benefit) differs from amounts computed at statutory rates, as follows:

DECEMBER, 31 DECEMBER, 31 DECEMBER, 31 2000 1999 1998 ---- ---- ---- Federal income taxes (benefit) at statutory rate $ 374,021 $ (206,804) $ (595,554) State and local income taxes (benefit) 72,052 (40,145) (76,256) Meals and entertainment 4,065 6,486 6,002 Officer's life insurance 268 -- 4,273 Penalties 1,702 -- -- Realized loss on hedge transaction (14,089) -- -- Sale of assets (18,010) -- -- Provision for valuation allowance 211,713 -- -- Adjustment of deferred tax asset -- 88,401 -- Other, net -- -- 11 ---------- ----------- ---------- Total $ 631,722 $ (152,062) $ (661,524) ========== =========== ==========

The Company has a Federal tax net operating loss carryforward of approximately $1.1 million which begins to expire in the year 2012. 12. STOCKHOLDERS' EQUITY On September 19, 1997, the Company entered into an Agreement and Plan of Recapitalization ("Agreement") with its four stockholders to recapitalize the Company. The Agreement provided for the tax-free exchange of the stockholders' 166.424 Class A "old" common stock shares for 3,000 shares of "new" Class A common stock shares, $0.01 par value (representing a 3% economic interest in the Company) and 97,000 shares of Series A preferred stock, $0.01 par value (representing a 97% economic interest in the Company). The preferred stock has no dividend rate or preference over the common stock. Dividend distributions will be made in the same amount on a per share basis of the common stock as for the preferred stock. Dividend distributions will be made to the common stockholders and the preferred stockholders in proportion to the number of outstanding shares. The preferred stockholder has the right to receive $10,750,005 upon liquidation of the Company before common stockholders receive any liquidating distributions. 13. NOTE PAYABLE TO BANK HCP had a $2.0 million Line of Credit Facility Agreement with a bank that expired December 31, 1999 and was not renewed. There was no outstanding balance at December 31, 1999. 14. NOTE PAYABLE TO RELATED PARTY At December 31, 2000 and 1999 the Company had a principal balance outstanding on a note payable to Hanover Capital Mortgage Holdings, Inc. in the amount of $1,704,342 and $4,896,046 respectively. The note bears interest at the prime rate minus 1% and interest is calculated on the daily principal balance outstanding. At December 31, 2000, and 1999 the interest rate in effect was 8.5% and 7.5% respectively. Included in the 2000 and 1999 consolidated statement of operations is interest expense in the amount of $265,062 and $167,955 respectively related to this note payable. The entire unpaid principal balance on the note is due in full on the maturity date, March 31, 2002. F-56 114 15. COMMITMENTS AND CONTINGENCIES The Company has noncancelable operating lease agreements for office space. Future minimum rental payments for such leases are as follows: YEAR AMOUNT ---- ------ 2001 $ 324,901 2002 283,045 2003 241,189 2004 218,312 2005 216,233 Thereafter 774,835 ---------- Total $2,058,515 ========== Rent expense for the years ended December 31, 2000, 1999 and 1998 amounted to $144,731 and $217,413, $250,684, respectively. HCHI has guaranteed the obligations of the Company with respect to an amendment to an office lease entered into by the Company. The office lease (beginning November 4, 1999) is for a period of 10 years and 3 months and obligates the Company for $2,162,300 of base rental expense plus escalation, electric and other billings over the lease term. 16. FINANCIAL INSTRUMENTS The estimated fair value of the Company's assets and liabilities classified as financial instruments and off-balance sheet financial instruments at December 31, 2000 and 1999 are as follows:

DECEMBER 31, 2000 DECEMBER 31, 1999 --------------------------- --------------------------- Carrying Fair Carrying Fair Amount Value Amount Value Assets: Mortgage securities, available -- -- $14,180,184 $14,180,184 for sale Interest rate caps -- -- 135,609 245,000 Cash and cash equivalents $ 493,711 $ 493,711 515,804 514,804 Marketable Securities 3,300 3,300 19,055 19,055 Accrued interest receivable -- -- 181,471 181,471 ----------- ----------- ----------- ----------- Total $ 497,011 $ 497,011 $15,032,123 $15,140,514 =========== =========== =========== =========== Liabilities: Reverse repurchase agreements -- -- $10,842,000 $10,842,000 Note Payable to related party $ 1,704,342 $ 1,704,342 4,896,046 4,896,046 ----------- ----------- ----------- ----------- Total $ 1,704,342 $ 1,704,342 $15,738,046 $15,738,046 =========== =========== =========== ===========

F-57 115 The following methods and assumptions were used to estimate the fair value of the Company's financial instruments: Mortgage securities - The fair values of these financial instruments are based upon either or all of the following: actual prices received upon recent sales of securities to investors, projected prices which could be obtained through investors, estimates considering interest rates, loan type, quality and discounted cash flow analysis based on prepayment and interest rate assumptions used in the market place for similar securities with similar credit ratings. Cash and cash equivalents, accrued interest receivable, reverse repurchase agreements, note payable to related party - The fair value of these financial instruments was determined to be their carrying value due to their short-term nature. Marketable securities - The fair values of these financial instruments are based on quotes obtained from third parties. Interest rate caps - The fair values of these financial instruments are estimated based on dealer quotes and is the estimated amount the Company would pay to execute a new agreement with similar terms. ****** F-58 116 INDEPENDENT AUDITORS' REPORT To the Board of Directors of HanoverTrade.com, Inc. New York, New York We have audited the accompanying balance sheets of HanoverTrade.com, Inc. (the "Company") as of December 31, 2000 and 1999, and the related statements of operations, stockholders' equity, and cash flows for the year ended December 31, 2000 and the period from May 28, 1999 (inception) to December 31, 1999. 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 generally 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 misstatement. An audit includes examining, on a test basis, evidence supporting 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 HanoverTrade.com, Inc. at December 31, 2000 and 1999, and the results of its operations and cash flows for the year ended December 31, 2000 and the period from May 28, 1999 (inception) to December 31, 1999 in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP Parsippany, New Jersey March 27, 2001 F-59 117 HANOVERTRADE.COM, INC. BALANCE SHEETS

DECEMBER 31, DECEMBER 31, ASSETS 2000 1999 ---- ---- CURRENT ASSETS: Cash $ 32,573 $ 929 Accounts receivable 10,000 26 ----------- ----------- Total Current Assets 42,573 955 PROPERTY AND EQUIPMENT - Net 19,681 -- COMPUTER SOFTWARE - Net 2,702,266 103,540 DEFERRED INCOME TAX BENEFIT -- -- ----------- ----------- TOTAL ASSETS $ 2,764,520 $ 104,495 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued expenses $ 1,008,403 $ -- Accrued interest due to related parties 35,864 -- Due to related parties 390,138 135,626 ----------- ----------- Total current liabilities 1,434,405 135,626 ----------- ----------- Notes payable to related parties 2,903,758 -- ----------- ----------- TOTAL LIABILITIES 4,338,163 135,626 ----------- ----------- COMMITMENTS AND CONTINGENCIES -- -- STOCKHOLDERS' EQUITY: Series A Preferred stock: $0.01 par value, 100,000 shares Authorized, 97,000 shares outstanding at December 31, 2000 and 1999 970 970 Common Stock: $0.01 par value, 5,000 shares authorized, 3,000 shares outstanding at December 31, 2000 and 1999 30 30 Retained earnings (deficit) (1,574,643) (32,131) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY: (1,573,643) (31,131) ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,764,520 $ 104,495 =========== ===========

See notes to financial statements. F-60 118 HANOVERTRADE.COM, INC. STATEMENTS OF OPERATIONS

PERIOD FROM MAY 28, 1999 YEAR ENDED (INCEPTION) TO DECEMBER 31, DECEMBER 31, 2000 1999 ----------- ----------- REVENUES: Loan brokering/Trading $ 140,781 $ -- ----------- ----------- Total revenues 140,781 -- ----------- ----------- EXPENSES: Personnel expense 789,646 -- Technology 230,520 4,450 Occupancy expense 130,278 -- Travel and entertainment 174,821 11,892 General and administrative expense 93,471 676 Professional fees 32,143 15,113 Interest expense 81,479 -- Depreciation and amortization 150,935 -- ----------- ----------- Total expenses 1,683,293 32,131 ----------- ----------- (LOSS) BEFORE INCOME TAX (1,542,512) (32,131) INCOME TAX BENEFIT -- -- ----------- ----------- NET (LOSS) $(1,542,512) $ (32,131) =========== =========== BASIC (LOSS) PER SHARE $ (514.17) $ (10.71) =========== ===========

See notes to financial statements F-61 119 HANOVERTRADE.COM, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEAR ENDED DECEMBER 31, 2000 AND PERIOD FROM MAY 28, 1999 (INCEPTION) TO DECEMBER 31, 1999

Series A Accumulated Preferred Stock Common Stock Additional Retained Other --------------- -------------- Paid-In Comprehensive Earnings Comprehensive Shares Amount Shares Amount Capital (Loss) (Deficit) Gain Total ------ ------ ------ ------ ------- ------ --------- ---- ----- Capital Contribution 97,000 $ 970 3,000 $ 30 -- $ 1,000 Comprehensive (loss): Net (loss) $ (32,131) $ (32,131) (32,131) ----------- Comprehensive (loss) $ (32,131) -- -- ------ ----- ------ ----- ------ =========== ----------- ----------- ----------- BALANCE, DECEMBER 31, 1999 97,000 970 3,000 30 -- (32,131) -- (31,131) Comprehensive (loss): Net (loss) $(1,542,512) (1,542,512) (1,542,512) ----------- Comprehensive (loss) $(1,542,512) ------ ----- ------ ----- ------ =========== ----------- ----------- ----------- BALANCE, DECEMBER 31, 2000 97,000 $ 970 3,000 $ 30 -- $(1,574,643) -- $(1,573,643) ====== ===== ====== ===== =========== ===========

See notes to financial statements F-62 120 HANOVERTRADE.COM, INC. STATEMENTS OF CASH FLOWS

PERIOD FROM MAY 28 YEAR ENDED (INCEPTION) TO DECEMBER 31, DECEMBER 31, 2000 1999 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) $(1,542,512) $ (32,131) Adjustments to reconcile net (loss) to net cash (used in) provided by operating activities: Depreciation and amortization 150,935 -- Changes in assets - (increase) decrease: Accounts receivable (9,974) (26) Changes in liabilities - increase (decrease): Accounts payable and accrued expenses 1,008,403 -- Payable to related party 254,512 135,626 Accrued interest due to related party 35,864 -- ----------- ----------- Net cash (used in) provided by operating activities (102,772) 103,469 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (21,695) -- Investment in web-site software (2,747,647) (103,540) ----------- ----------- Net cash (used in) investing activities (2,769,342) (103,540) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from notes payable to related party 2,903,758 -- Capital contributions -- 1,000 ----------- ----------- Net cash provided by financing activities 2,903,758 1,000 ----------- ----------- NET INCREASE IN CASH AND CASH EQUIVALENTS 31,644 929 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 929 -- ----------- ----------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 32,573 $ 929 =========== =========== SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the year for: Income taxes $ 680 $ -- =========== =========== Interest to related party $ 45,615 $ -- =========== ===========

See notes to financial statements F-63 121 HANOVERTRADE.COM, INC. NOTES TO FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2000 AND THE PERIOD MAY 28, 1999 (INCEPTION) TO DECEMBER 31, 1999 1. BUSINESS DESCRIPTION HanoverTrade.com, Inc. ("HTC"), a Delaware corporation, is principally engaged in operating an online world wide web-based exchange for trading loan pools (primarily mortgage loan pools) and performing loan sale advisory services for third parties. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES REVENUE RECOGNITION Revenues from loan sale advisory and trading are recognized when the transactions close and fees are earned and billed. At the time of closing a transaction, the number of loans, loan principal balance and purchase price in the transaction are agreed upon, documentation is signed and the sale is funded. HTC billing of fees relating to a transaction occurs concurrently with the closing and funding. INCOME TAXES A deferred income tax asset is recorded to reflect the effect of temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements and to reflect the future tax benefit of net operating losses. PROPERTY AND EQUIPMENT Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets, generally three to seven years. Leasehold improvements are depreciated over the terms of the respective leases or their estimated useful lives, whichever is shorter. TECHNOLOGY EXPENSES Professional fees for technology are included in technology expenses. Capitalized software includes internal and external application development stage costs incurred to develop the Company's online world wide web based exchange for trading loan pools. Capitalized software costs are stated at cost less accumulated amortization. Amortization is computed on the straight-line method over the estimated useful life of the asset, generally three years. Expenses for web page design are expensed as incurred. CASH AND CASH EQUIVALENTS For cash flow purposes, the Company considers highly liquid investments, purchased with an original maturity of three months or less, to be cash equivalents. BASIC EARNINGS PER SHARE Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Shares issued F-64 122 during the period and shares reacquired during the period are weighted for the portion of time they were outstanding. RELATED PARTY TRANSACTIONS The results of operations may not necessarily be indicative of those that would have occurred on a stand alone basis. ESTIMATE FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, due to related parties and note payable to affiliate were determined to be their carrying value due to their short-term nature. 3. CONCENTRATION RISK REVENUES FROM CERTAIN CUSTOMERS For the year ended December 31, 2000 and the Period May 28, 1999 (inception) to December 31, 1999, the Company received revenues from certain customers, which are subject to change annually, which exceeded 10% of total revenues as follows:

DECEMBER 31, DECEMBER 31, 2000 1999 ---- ---- Major Customer # 1 29% - Major Customer # 2 16% - Major Customer # 3 14% - Major Customer # 4 11% -

4. RELATED PARTY TRANSACTIONS Payables due to related parties at December 31, 2000 and 1999 consist of the following:

DECEMBER 31, DECEMBER 31, 2000 1999 ---- ---- Due to Hanover Capital Partners Ltd $339,443 $ 14,274 Due to Hanover Capital Mortgage Holdings, Inc 50,695 121,352 -------- -------- Payables to related parties $390,138 $135,626 ======== ========

For the year ended December 31, 2000 and the period from May 28, 1999 (inception) to December 31, 1999, Hanover Capital Partners Ltd. ("HCP") and Hanover Capital Mortgage Holdings, Inc., ("Hanover") billed certain expenses to HTC. The expenses billed included personnel expense, occupancy expense, travel and trade show expense and general and administrative expenses and were billed to reflect activity on behalf of HTC. HTC expects similar billings from HCP and Hanover in future periods. HCP billed a total of $464,000 of net expenses to HTC for the year ended December 31, 2000. The billing included $441,000 of personnel expense, $26,000 of occupancy expense, $57,000 of travel and trade show expense, and $51,000 of general and administrative expense offset by $111,000 of trading and brokering revenue. HCP billed a total of $14,000 of expenses to HTC for the period May 28, 1999 (inception) to December 31, 1999. The billings included $12,000 of travel and tradeshow expenses and $2,000 of technology expenses. F-65 123 Hanover billed a total of $488,000 of expenses to HTC during the year ended December 31, 2000. The billing included $369,000 of personnel expense, $103,000 of occupancy expense, and $16,000 of general and administrative expenses. Hanover billed a total of $18,000 of expenses to HTC for the period May 28, 1999 (inception) to December 31, 1999. The billings included $15,000 of professional fees and $3,000 of technology expense. At December 31, 2000 HTC had a principal balance on a note payable to Hanover in the amount of $2,904,000. The maximum loan amount under this note is $10 million. The note bears interest daily at the prime rate minus 1% and interest is calculated on the daily principal balance outstanding. At December 31, 2000 the interest rate in effect was 8.5%. The entire unpaid principal balance on the note is due in full on the maturity date, March 31, 2002. 5. PROPERTY AND EQUIPMENT Property and equipment at December 31, 2000 consists of the following:

DECEMBER 31, 2000 ---- Office machinery and computer equipment $ 21,695 Less accumulated depreciation (2,014) -------- Property and equipment - net $ 19,681 ========

Depreciation expense for the year ended December 31, 2000 was $2,014. 6. CAPITALIZED SOFTWARE COSTS Capitalized software costs at December 31, 2000 and December 31, 1999 consists of the following:

DECEMBER 31, DECEMBER 31, 2000 1999 ---- ---- Capitalized Software $ 2,851,187 $ 103,540 Less accumulated amortization (148,921) -- ----------- ----------- Capitalized Software Costs - net $ 2,702,266 $ 103,540 =========== ===========

Amortization expense for the year ended December 31, 2000 and the period May 28, 1999 (inception) to December 31, 1999 was $148,921 and $0 respectively. 7. INCOME TAXES The components of deferred income taxes as of December 31, 2000 and 1999 are as follows: F-66 124

DECEMBER 31, DECEMBER 31, 2000 1999 ---- ---- Deferred tax assets $ 620,824 $ 12,429 Valuation allowance (620,824) (12,429) --------- --------- Net deferred tax assets $ 0 $ 0 ========= =========

The items resulting in significant temporary differences for the year ended December 31, 2000 and the Period May 28, 1999 (inception) to December 31, 1999 that generate deferred tax assets relate primarily to the benefit of net operating losses. The Company has established a valuation allowance for the full amount of the benefit. The income tax (benefit) differs from amounts computed at statutory rates, as follows:

DECEMBER 31, DECEMBER 31, 2000 1999 ---- ---- Federal income taxes (benefit) at statutory rate $(524,454) $ (10,925) State and local income taxes (benefit) (97,050) (2,036) Meals and entertainment 11,228 522 Officer's life insurance 1,881 -- Adjustment of deferred tax asset -- -- Other, net -- -- --------- --------- Total tax benefit (608,395) (12,429) Valuation allowance 608,395 12,429 --------- --------- Net tax benefit $ 0 $ 0 ========= =========

The Company has a Federal tax net operating loss carryforward of approximately $1,548,000 that begins to expire in 2014. 8. STOCKHOLDERS' EQUITY On May 28, 1999 (inception) HTC was incorporated in Delaware with 5,000 authorized shares of Common Stock (par value $0.01) and 100,000 authorized shares of Series A Preferred Stock (par value $0.01). F-67 125 HTC issued 3000 shares to the principals, John A. Burchett, Joyce Mizerak, George Ostendorf and Irma Tavares, giving them a 3% economic interest. HTC issued 97,000 shares of Series A Preferred Stock to Hanover Capital Mortgage Holdings, Inc. giving it a 97% economic interest. The Preferred Stock has no dividend rate or preference over the Common Stock. Dividend distributions will be made in the same amount on a per share basis for the common stock as for the Preferred Stock. All voting power is held by the Common Stock except for certain situations involving merger, dissolution, sale of substantially all the assets of HTC, and amendments to the certificate of incorporation adversely affecting the Preferred Stockholders. In these situations, the Preferred stockholders shall be entitled to vote. 9. SUBSEQUENT EVENTS On January 24, 2001, the Company hired 18 employees of Pamex Capital Partners L.L.C. ("Pamex") and purchased all of Pamex's assets. The Company entered into employment agreements with 5 of the 18 employees hired. The purchase price consisted of $850,000 in cash paid at closing plus an earn out of between $1,250,000 and $1,500,000, payable over three years in shares of Hanover. Included in the assets purchased was Pamex Securities, L.L.C. a securities broker dealer registered with the Securities Exchange Commission and National Association of Securities Dealers. On February 13, 2001, the Certificate of Incorporation was amended to authorize an additional 100,000 shares of Common Stock. The note payable due Hanover on March 31, 2001 was extended to March 31, 2002. 126 On March 30, 2001, we entered into a loan agreement with VerticalCrossings.com, Inc. (which we refer to as "Vcross"). Vcross is a world-wide web based exchange for mortgage-backed securities, asset-backed securities, and other structured securities. We lent Vcross $200,000 for a 120 day term at an interest rate of 12%, and we agreed to lend them an additional $100,000 upon the completion of a project to integrate our technology. Our loan was collateralized by all of Vcross's assets. As additional consideration for the loan, we received a lifetime license to use Vcross' proprietary software technology to conduct online auctions of mortgage loans. We also received warrants to purchase 3.67% of Vcross's common stock, and we will receive warrants to purchase an additional 1.33% of Vcross's common stock when we fund the final $100,000. ****** F-68 127 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 30, 2001. HANOVER CAPITAL MORTGAGE HOLDINGS, INC. By /s/ Thomas P. Kaplan ------------------------------------- Thomas P. Kaplan Managing Director and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Registrant and the capacities indicated on March 30, 2001. SIGNATURE TITLE /s/ John A. Burchett Chairman of the Board of Directors -------------------------------------- and Chief Executive Officer John A. Burchett /s/ Irma N. Tavares Senior Managing Director and a Director -------------------------------------- Irma N. Tavares /s/ Joyce S. Mizerak Senior Managing Director, Secretary and -------------------------------------- a Director Joyce S. Mizerak /s/ George J. Ostendorf Senior Managing Director and a Director -------------------------------------- George J. Ostendorf /s/ John A. Clymer Director -------------------------------------- John A. Clymer /s/ Joseph J. Freeman Director -------------------------------------- Joseph J. Freeman /s/ James F. Stone Director -------------------------------------- James F. Stone /s/ Saiyid T. Naqvi Director -------------------------------------- Saiyid T. Naqvi /s/ John N. Rees Director -------------------------------------- John N. Rees /s/ Thomas P. Kaplan Managing Director and Chief Financial -------------------------------------- Officer (Principal Financial and Thomas P. Kaplan Accounting Officer) 54