HANOVER CAPITAL MORTGAGE HOLDINGS INC, POS AM, 1998-07-20

HANOVER CAPITAL MORTGAGE HOLDINGS INC
POS AM, 1998-07-20
MORTGAGE BANKERS & LOAN CORRESPONDENTS

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 20, 1998
REGISTRATION NO. 333-29261
================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------

POST EFFECTIVE AMENDMENT NO. 1
TO
FORM S-11
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES
---------------

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
---------------

90 WEST STREET, SUITE 1508
NEW YORK, NEW YORK 10006
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
---------------

JOHN A. BURCHETT
CHIEF EXECUTIVE OFFICER
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
90 WEST STREET, SUITE 1508
NEW YORK, NEW YORK 10006
(212) 732-5086
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF AGENT FOR SERVICE)
---------------

COPIES TO:
CHARLES A. WRY, JR., ESQ.
MORSE, BARNES-BROWN & PENDLETON, P.C.
1601 TRAPELO ROAD
WALTHAM, MA 02451
TELEPHONE: (781) 622-5930
FACSIMILE: (781) 622-5933
---------------

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration number of the earlier effective
registration statement for the same offering.

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [X] 333-29261

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following.

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.

================================================================================
<PAGE> 2

PROSPECTUS

5,920,378 Shares of Common Stock Issuable Upon Exercise of Certain Stock
Purchase Warrants

Hanover Capital Mortgage Holdings, Inc.

July 20, 1998

This Prospectus covers the offer and sale by Hanover Capital Mortgage
Holdings, Inc. (the "Company") of up to 5,920,378 shares of the Company's common
stock, $.01 par value per share (the "Common Stock"), 5,747,878 of which are
issuable from time to time upon the exercise of Stock Purchase Warrants (the
"Warrants") included in the Units issued by the Company in its initial public
offering which closed on September 19, 1997 and 172,500 of which are issuable
from time to time upon the exercise of Stock Purchase Warrants (the
"Representatives' Warrants") issued to Stifel, Nicolaus & Company Incorporated
and Nationsbank Montgomery Securities, underwriters of the initial public
offering of the Company at the closing of such offering. Each Unit included one
share of the Company's Common Stock and a Stock Purchase Warrant initially
exercisable for one share of the Company's Common Stock. The current exercise
price of a Warrant is $15.00 for one share of Common Stock. The Warrants became
exercisable on the opening of business on March 19, 1998 and will continue to be
exercisable through the close of business on September 15, 2000. The exercise
price and the number of shares of Common Stock issuable upon the exercise of the
Warrants is subject to adjustment in certain events. Each Representative Warrant
is initially exercisable for one share of the Company's Common Stock. The
current exercise price of a Representative Warrant is $15.00 for one share of
Common Stock. The exercise price and the number of shares of Common Stock
issuable upon the exercise of the Representatives' Warrants is subject to
adjustment in certain events. The proceeds to the Company from the sale of
Common Stock upon the exercise of the Warrants and the Representatives' Warrants
will be $88,805,670 (assuming all of the Warrants are exercised), which will be
used by the Company for general working capital and corporate purposes. The
exercise of a Warrant or a Representative's Warrant is optional with the owner
of the warrant, and the Company cannot predict whether or when any of the
warrants will be exercised. See "Description of Securities--Warrants."

SEE "RISK FACTORS" COMMENCING ON PAGE 10 FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS. THESE RISKS INCLUDE:

- - - Total dependence upon Principals and other key personnel.

- - - Inability of the Company to control the operations of the Company's taxable
subsidiaries (which are controlled by the Principals), which could result in
decisions by such subsidiaries that do not reflect the Company's best
interests.

- - - Adverse general economic conditions, which generally cause decreasing demand
for consumer credit and declining real estate values, either of which would
negatively impact the Company's net income.

- - - Acceleration of prepayments on Mortgage Assets purchased by the Company at a
premium will result in a corresponding write-off of unamortized premiums
which could negatively impact the Company's net income, if any.

- - - Significant increases in short-term interest rates, which would adversely
affect the Company's borrowing costs and could negatively impact the
Company's net income.

- - - Difficulty of acquiring Mortgage Assets (as defined herein) at favorable
spreads relative to borrowing costs in an environment of increasing
competition.

- - - Consequences of failing to maintain REIT status which would result in the
Company being subject to tax as a regular corporation.

- - - Failure of a public market to develop or be sustained for the Units, Common
Stock or Warrants.

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<PAGE> 3

<TABLE>
<CAPTION>
================================================================================
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT COMPANY(1)
- - --------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share....................... $ 15.00 $0.00 $ 15.00
- - --------------------------------------------------------------------------------
Total........................... $88,805,670 $0.00 $88,805,670
================================================================================
</TABLE>

(1) Before deducting expenses of this offering of shares of Common Stock
issuable upon exercise of the Warrants and the Representatives' Warrants payable
by the Company, estimated to be $75,000.

<PAGE> 4

TABLE OF CONTENTS

PAGE

PROSPECTUS SUMMARY......................................................... 4
The Company.............................................................. 4
General................................................................. 4
Management.............................................................. 5
The Company's Operations................................................ 5
Competitive Advantages.................................................. 6
Structure of the Company................................................ 7
Structure of Company..................................................... 7
Principals' Conflicts of Interest........................................ 9
Dividend Policy and Distributions........................................ 9
Summary Risk Factors..................................................... 1
RISK FACTORS............................................................... 1
Dependence Upon Principals and Other Key Personnel....................... 1
Recent Formation and Lack of Relevant Experience......................... 1
Benefits to the Principals............................................... 2
Negative Effect on Financial Condition Due to Board of
Director's Ability to Change Policies of the Company.................... 2
Absence of Independent Valuation for Allocation of Equity
Interest in HCHI........................................................ 2
Principals' Conflicts of Interest........................................ 2
Recent Negative Trends in Revenue and Income............................. 3
Mortgage Assets with Poor Documentation and Poor Payment
Histories............................................................... 3
Defaults on Mortgage Assets.............................................. 3
Defaults on Commercial Mortgages........................................ 3
Effect of Adverse Economic Conditions on Multifamily
Properties............................................................. 4
Decreases in Value of Retail, Office and Industrial
Properties............................................................. 4
Environmental Liabilities Associated with Contaminated
Properties............................................................. 5
Risks Related to Operations.............................................. 5
Negative Effects of Fluctuating Interest Rates.......................... 5
Reduction of Income Due to Prepayment................................... 7
Defaults by Borrowers under Mortgage Assets............................. 8
Losses Related to Investing in Subordinated Classes of
Mortgage-Backed Securities.............................................. 8
Losses Related to Borrowings and Substantial Leverage by the
Company................................................................ 9
Insufficient Demand for Mortgage Loans and the Company's
Loan Products.......................................................... 10
Lack of Geographic Diversification...................................... 11
Ability to Acquire Mortgage Assets at Favorable Spreads
Relative to Borrowing Costs; Competition and Supply.................... 11
Failure to Maintain REIT Status; Company Subject to Tax
as a Regular Corporation................................................ 11
Potential Characterization of Distribution as UBTI; Taxation
of Tax-Exempt Investors................................................. 12
Taxable Mortgage Pool Risk; Increased Taxation........................... 13
Market Considerations.................................................... 13
Investment Company Act Risk.............................................. 13
Legislative and Regulatory Risk.......................................... 14
Shares Eligible for Future Sale.......................................... 15
Preferred Stock; Restrictions on Ownership of Common
Stock; Anti-takeover Measures........................................... 16
THE COMPANY................................................................ 17
USE OF PROCEEDS............................................................ 17
DIVIDEND POLICY AND DISTRIBUTIONS.......................................... 17
DIVIDEND REINVESTMENT PLAN................................................. 19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................ 20
Overview................................................................ 20
Results of Operations................................................... 20
Three Months Ended March 31, 1998 Compared to Three Months
Ended March 31, 1996................................................... 20
Year Ended December 31, 1997 Compared to Year
Ended December 31, 1996................................................ 24
Financial Condition..................................................... 26
Liquidity and Capital Resources......................................... 26
BUSINESS................................................................... 29
General................................................................. 29
Background............................................................. 29
Business Strategy...................................................... 30
Investment Portfolio.................................................... 30
General................................................................ 30
Single-Family Mortgage Operations...................................... 30
Commercial Mortgage Loans and Multifamily Mortgage Loans
Accumulation Period Acquisitions........................................ 34
Federal National Mortgage Association (FNMA)
Securities............................................................. 36
Due Diligence Operations................................................ 37
Financing............................................................... 37
General................................................................ 37
Reverse Repurchase Agreements.......................................... 37
Securitization and Sale Process......................................... 38
General................................................................ 38
Credit Enhancement..................................................... 40
Other Mortgage-Backed Securities....................................... 40
Capital Allocation Guidelines (CAG).................................... 41
Implementation of the CAG -- Mark to Market Accounting................. 41
Risk Management......................................................... 42
Credit Risk Management................................................. 42
Interest Rate Risk Management.......................................... 43
Prepayment Risk Management............................................. 43
Hedging................................................................. 43
Investment Portfolio................................................... 43
Costs and Limitations.................................................. 44
Servicing Rights........................................................ 45
Regulation.............................................................. 45
Competition............................................................. 45
Employees............................................................... 46
Service Marks........................................................... 46
Future Revisions in Policies and Strategies............................. 46
Relationship with Affiliates and Prior Business
HCHI ORGANIZATIONAL CHART.................................................. 47
MANAGEMENT................................................................. 50
Directors and Executive Officers........................................ 50
Terms of Directors and Officers......................................... 53
Committees of the Board................................................. 54
Compensation of Directors............................................... 54
Compensation Committee Interlocks....................................... 55
Executive Compensation.................................................. 55
Bonus Incentive Compensation Plan....................................... 56
Option Grants in Fiscal Year Ended December 31, 1997....................... 57
Aggregated Option Exercises in Fiscal Year Ended December 31,
1997 and Fiscal Year End Option Values..................................... 58
Employment Agreements................................................... 58
401(k) Plan............................................................. 59
1997 Stock Option Plan.................................................. 59
CERTAIN TRANSACTIONS....................................................... 62
Management Agreement.................................................... 62
The HCP Shareholders' Agreement......................................... 64
The Formation Transactions.............................................. 62
Employment Agreements................................................... 63
The HCP Shareholders' Agreement......................................... 64
Loans to the Principals................................................. 65
PRINCIPAL STOCKHOLDERS..................................................... 66
DESCRIPTION OF SECURITIES.................................................. 67
Common Stock............................................................ 67
Preferred Stock......................................................... 67
Warrants................................................................ 68
Repurchase of Shares and Restrictions on Transfer....................... 69
Transfer Agent.......................................................... 71
SHARES ELIGIBLE FOR FUTURE SALE............................................ 71
General................................................................. 71
Registration Rights..................................................... 72
CERTAIN PROVISIONS OF MARYLAND LAW AND OF

<PAGE> 5

THE COMPANY'S CHARTER AND BYLAWS......................................... 73
Removal of Directors.................................................... 73
Business Combinations................................................... 73
Control Share Acquisitions.............................................. 73
Amendment to the Charter................................................ 74
Dissolution of the Company.............................................. 74
Advance Notice of Director Nominations and New Business................. 74
Anti-takeover Effect of Certain Provisions of Maryland.................. 75
Law and the Charter and Bylaws......................................... 75
Limitation of Liability and Indemnification............................. 75
FEDERAL INCOME TAX CONSIDERATIONS.......................................... 77
General................................................................. 77
Opinion of Counsel...................................................... 78
Requirements for Qualification as a REIT................................ 78
Record Keeping Requirements............................................. 83
Termination or Revocation of REIT Status................................ 83
Taxation of HCHI........................................................ 83
Taxation of Taxable Affiliates.......................................... 84
Taxation of Taxable U.S. Stockholders................................... 85
Withholding............................................................. 86
Taxation of Tax-Exempt Stockholders..................................... 87
Certain United States Federal Income Tax Considerations
Applicable to Foreign Holders.......................................... 87
Information Reporting and Backup Withholding............................ 88
Special Considerations.................................................. 89
Other Tax Consequences.................................................. 89
ERISA INVESTORS............................................................ 90
LEGAL MATTERS.............................................................. 91
EXPERTS
ADDITIONAL INFORMATION..................................................... 91
GLOSSARY................................................................... 92
TABLE OF CONTENTS TO FINANCIAL STATEMENTS.................................. F-1

3
<PAGE> 6
PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information appearing elsewhere in this Prospectus. Certain capitalized terms
not otherwise defined herein have the meanings assigned to them in the Glossary,
which begins on page 92. The "Company" means either (i) Hanover Capital
Mortgage Holdings, Inc., a Maryland corporation ("HCHI"), or (ii) HCHI, Hanover
Capital Partners Ltd., a New York corporation ("HCP"), Hanover Capital Mortgage
Corporation, a Missouri corporation ("HCMC"), and Hanover Capital Securities,
Inc., a New York corporation ("HCS"), collectively, as the context may require.

THE COMPANY

GENERAL

The Company is a specialty finance company, the activities of which include
(i) acquiring primarily Single-Family Mortgage Loans that are at least twelve
months old ("seasoned" Single-Family Mortgage Loans) or that were intended to be
of certain credit quality but that do not meet the originally intended market
parameters due to errors or credit deterioration ("fall-out" Single-Family
Mortgage Loans and, together with seasoned Single-Family Mortgage Loans,
"subprime" Single-Family Mortgage Loans), (ii) originating, holding, selling and
servicing Multifamily Mortgage Loans and Commercial Mortgage Loans, (iii)
securitizing Mortgage Loans and retaining interests therein, (iv) purchasing
Mortgage Assets in the secondary mortgage market, (v) managing the resulting
combined portfolio in a tax-advantaged REIT structure, and (vi) offering due
diligence services to buyers, sellers and holders of Mortgage Loans. The
Company's principal business objective is to generate increasing earnings and
dividends for distribution to stockholders. The Company acquires Single-Family
Mortgage Loans through a network of sales representatives targeting financial
institutions throughout the United States. The Company originates Multifamily
Mortgage Loans and Commercial Mortgage Loans through HCMC. The Company has
elected to be taxed as a real estate investment trust under the Internal Revenue
Code of 1986, as amended. The Company will generally not be subject to Federal
income tax to the extent it distributes its earnings to its stockholders and
maintains its qualification as a REIT. Taxable affiliates of the Company,
however, including HCP, HCMC and HCS, will be subject to Federal income tax. See
"Federal Income Tax Considerations -- Requirements for Qualification as a REIT,"
" -- Taxation of HCHI" and " -- Taxation of Taxable Affiliates." The Company is
self-advised and self-managed.

The Company determined to elect REIT status primarily for the tax
advantages. Management believes that the REIT structure is the most desirable
structure for owning Mortgage Assets because it generally eliminates
corporate-level Federal income taxation. In addition, as the Company is not a
traditional lender which accepts deposits, it is subject to substantially less
regulatory oversight and incurs lower compliance expenses than banks, thrifts
and many other originators of Mortgage Assets. The Principals believe that the
Company will generate attractive earnings and dividends per share for
stockholders through the combination of (i) purchasing subprime Single-Family
Mortgage Loans which generally have higher yields than newly originated,
conforming Single-Family Mortgage Loans, (ii) its focus on originating
Multifamily Mortgage Loans and Commercial Mortgage Loans, which generally have
higher yields than conforming Single-Family Mortgage Loans, and (iii) using
long-term financing that allows the Company to realize net interest income over
time as REIT-qualified income, as opposed to fully taxable gain-on-sale income.
In general, "subprime" Single-Family Mortgage Loans are Single-Family Mortgage
Loans that are either twelve months or older (also referred to as "seasoned"
Single-Family Mortgage Loans) or were intended to be of a certain credit quality
but do not meet the originally intended market parameters due to documentation
errors or credit deterioration (also referred to as "fall-out" Single-Family
Mortgage Loans). "Conforming" Single-Family Mortgage Loans are newly originated
Single-

<PAGE> 7

Family Mortgage Loans of top quality and of a size acceptable to the Agencies.
See "Business -- Single-Family Mortgage Operations-Single-Family Market Trends."
See also "Risk Factors -- Defaults on Mortgage Assets."

MANAGEMENT

The business of the Company is managed by John A. Burchett, Joyce S.
Mizerak, Irma N. Tavares and George J. Ostendorf. Prior to founding HCP in
February 1989, these four individuals (each, a "Principal" and collectively, the
"Principals") were employed in the mortgage trading operations of Bankers Trust
Company. Prior to that time, the Principals were employed by Citicorp Investment
Bank, where they supervised trades of Mortgage Assets and were responsible for
the management and hedging of portfolios of Mortgage Assets. At Citicorp
Investment Bank, Mr. Burchett co-managed the mortgage finance department, which
included responsibilities for the trading of mortgage assets, and led the
development of its residential conduit, Citimae. At Citicorp Investment Bank,
Ms. Tavares was responsible initially for mortgage operations and eventually for
trading of whole loan packages and adjustable rate mortgage securities. While
employed at Citicorp Investment Bank, Ms. Mizerak originally was responsible for
contract finance and securitization and later for whole loan trading. Mr.
Ostendorf was responsible for marketing, sales and customer relations for the
Chicago mortgage finance office. Ms. Tavares, Ms. Mizerak and Mr. Ostendorf had
similar responsibilities at Bankers Trust Company. See "Management -- Directors
and Executive Officers."

THE COMPANY'S OPERATIONS

General. HCHI was incorporated in the state of Maryland on June 10, 1997 and
has conducted business operations since the closing of the Company's initial
public offering on September 19, 1997. Since its incorporation in 1989, HCP has
managed short-term trading (generally involving holding periods of eighteen
months or less) of Single-Family Mortgage Loans for Alpine Associates, A Limited
Partnership, and for BT Realty Resources, Inc., a subsidiary of Bankers Trust
New York Corp. In managing trading activities, HCP has typically targeted pools
containing subprime Single-Family Mortgage Loans with deficiencies that could be
corrected to permit resales on favorable terms. In addition, HCP provides
Mortgage Loan due diligence services. After the closing of the Company's initial
public offering in September 1997, HCP ceased to manage trading activities for
Alpine Associates and BT Realty Resources but has continued to provide due
diligence services. HCMC, which was incorporated in 1992, originates, sells and
services Multifamily Mortgage Loans and, since the closing of the Company's
initial public offering has also originated, sold and serviced Commercial
Mortgage Loans. HCS, which was incorporated in 1989, is a broker/dealer.

Investment Portfolio. The primary business of the Company is investing in
first lien Single-Family Mortgage Loans, Multifamily Mortgage Loans and
Commercial Mortgage Loans and Mortgage Securities secured by or representing an
interest in Mortgage Loans (the "Investment Portfolio). HCHI's focus in
acquiring Single-Family Mortgage Loans for the Investment Portfolio is on pools
that contain subprime Single-Family Mortgage Loans. HCHI, however, also invests
in Multifamily Mortgage Loans and Commercial Mortgage Loans. In addition,
Mortgage Loans and Mortgage Securities in the Investment Portfolio generally
will be held on a long-term basis, so that returns will be earned over the lives
of Mortgage Loans and Mortgage Securities rather than from their sales. Although
HCMC has originated and sold Multifamily Mortgage Loans, neither HCP nor any of
the Principals has significant experience in managing investments in Multifamily
Mortgage Loans or Commercial Loans or in managing long-term investments in any
Mortgage Loans or Mortgage Securities. See "Risk Factors -- Limited Experience
of Principals."

HCMC has originated Multifamily Mortgage Loans since its inception in 1992.
The Principals believe HCMC was one of the first commercial mortgage banking
operations to originate Multifamily Mortgage Loans

<PAGE> 8

for sale to conduits and, from direct borrower originations and its network of
third party brokers, can provide Multifamily Mortgage Loans and Commercial
Mortgage Loans of sufficient credit quality to meet the requirements for
securitization and sales to third party investors and into the Investment
Portfolio. Subsequent to the closing of the Company's initial public offering,
the Company has primarily originated, through HCMC, Multifamily Mortgage Loans
and Commercial Mortgage Loans, including Mortgage Loans secured by
income-producing commercial properties such as office, retail, warehouse and
mini-storage facilities, and has subsequently sold the Mortgage Loans to
investors. It is not anticipated that the Company will originate Single-Family
Mortgage Loans. The Principals believe that the Company has certain competitive
advantages over other entities in the commercial mortgage market due to the
speed, consistency and flexibility it seeks to achieve by being a vertically
integrated company (i.e., acting as originator, servicer and owner of Commercial
Mortgage Loans).

The Company acquires and securitizes Single-Family Mortgage Loans and
Commercial Mortgage Loans so as to earn higher returns than could generally be
earned from purchasing Mortgage Securities in the marketplace. However, there
can be no assurance that the Company will be able to earn such higher returns.
In addition, although HCP has rendered advisory services in connection with
securitization transactions, neither it nor HCMC has securitized any significant
amount of Mortgage Loans.

Accumulation Period Acquisitions. The Company initially allocated a majority
of the net proceeds raised in the Company's initial public offering to build a
portfolio of Mortgage Assets, primarily comprised of adjustable rate mortgage
pass-through securities of high investment quality (i.e., Agency, "AAA" or
"AA"-rated), to provide income during the initial period required to acquire
Mortgage Loans. The Principals intend that the Company will earn an acceptable
level of return on the initial Investment Portfolio until the net proceeds from
the Company's initial public offering can be fully invested in higher yielding
Mortgage Assets. However, there can be no assurance that the Company will be
able to earn such a level of return or any return at all. A similar portfolio
acquisition strategy will be employed whenever the Company must invest the net
proceeds of a new issuance of debt or equity securities.

Due Diligence Operations. The Company continues to conduct the Due Diligence
Operations, which have been historically performed for commercial banks,
government agencies, private mortgage banks, credit unions and insurance
companies. The Due Diligence Operations consist of the underwriting of credit,
the analysis of loan documentation and collateral, and the analysis of the
accuracy of the servicing accounting for Mortgage Loans. Such due diligence
analysis is performed on a loan by loan basis. Audits of the accuracy of the
interest charged on adjustable rate Mortgage Loans are frequently a part of the
due diligence services provided to customers. The Company performs due diligence
on the Mortgage Loans it acquires and for third parties. The Principals of the
Company believe that the Due Diligence Operations will provide a source of
revenue and a competitive advantage to the Company through the underwriting and
pricing expertise gained through this business. However, there is no assurance
that the Due Diligence Operations will in fact provide such revenue or
competitive advantage.

<PAGE> 9

STRUCTURE OF THE COMPANY

The Structure. The following diagram depicts the structure of the Company.
The structure was designed primarily to (i) permit the Company to acquire the
ownership of a majority of the stock in HCP while preserving HCHI's
qualification as a REIT, and (ii) permit certain activities of HCP to be wound
down before and after the closing of the Company's initial public offering. See
"Federal Income Tax Considerations -- Requirements for Qualification as a REIT."

STRUCTURE OF COMPANY

[GRAPH]

- - ----------
(1) The Principals own 716,677 shares of Common Stock, representing 11.08% of
the outstanding shares of Common Stock. The Principals may also be issued up
to 216,667 additional shares of Common Stock, increasing their percentage
ownership of the outstanding shares of Common Stock to up to 13.96%, if the
Earn-Out vests. In addition, the Principals may acquire additional shares of
Common Stock upon the exercise of stock options granted to them under the
Company's 1997 Executive and Non-Employee Director Stock Option Plan or
pursuant to the Company's Bonus Incentive Compensation Plan. See "Management
-- Bonus Incentive Compensation Plan" and "Management -- 1997 Stock Option
Plan."

(2) HCHI owns 100% of the HCP Preferred representing the right to receive 97% of
dividend distributions from HCP, and the Principals own 100% of the common
stock of HCP representing the right to receive 3% of dividend distributions
from HCP.

The Principals currently own 716,677 shares of Common Stock of HCHI, or
11.08% of the outstanding shares of Common Stock. If the Earn-Out vests, HCHI
will issue up to 216,667 additional shares of Common Stock to the Principals as
an additional payment for their contribution of the HCP Preferred to HCHI. The
Earn-Out may vest 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"). The Earn-Out will vest in full as of any Earn-Out Measuring
Date through which the return on a Unit is at least equal to the initial public
offering price of the Unit. One-third of the Earn-Out 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 Company's initial public offering on September
19, 1997, 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 Company's 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 share of Common
Stock 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. The Principals may acquire additional shares of Common Stock upon

<PAGE> 10

the exercise of stock options granted to them under the Company's 1997 Executive
and Non-Employee Director Stock Option Plan or pursuant to the Company's Bonus
Incentive Compensation Plan. See "Management -- 1997 Stock Option Plan;" and
"Management -- Bonus Incentive Compensation Plan."

It is anticipated that HCHI will earn substantially all of its revenue from
the net cash flow from the Investment Portfolio and the operations of HCP, HCMC
and HCS. The amounts that HCHI may in turn distribute to its stockholders will
be reduced by the operating expenses of HCHI, including any Federal income tax
that HCHI must pay if it fails to qualify as a REIT. See "Federal Income Tax
Considerations -- Requirements for Qualification as a REIT" and " -- Taxation of
HCHI."

Except as described below, HCP, HCMC and HCS continue to own their
pre-initial public offering assets and conduct their pre-initial public offering
activities as taxable, non-controlled subsidiaries of HCHI. HCP conducts the Due
Diligence Operations and supports HCHI's acquisition and investment activities
by providing due diligence services. HCMC originates, sells and services
Multifamily Mortgage Loans and Commercial Mortgage Loans and serves as a source
of Multifamily Mortgage Loans and Commercial Mortgage Loans for HCHI. HCS
facilitates the Company's trading activities by acting as a broker/dealer. See
"Risk Factors -- Principals' Conflicts of Interest."

HCHI owns all of the HCP Preferred, but generally has no right to
participate in the operations of HCP, HCMC and HCS (other than to approve
certain fundamental transactions such as mergers, consolidations, sales of all
or substantially all assets, and any voluntary liquidation) because the HCP
Preferred is nonvoting. Instead, as the holders of all of the HCP Common, the
Principals generally control the operations of HCP, HCMC and HCS. This ownership
structure is required because as a REIT, HCHI generally may not own more than
10% of the voting securities of any other issuer. See "Federal Income Tax
Considerations -- Requirements for Qualification as a REIT -- Nature of Assets."
Accordingly, the purchasers of the Company's Common Stock will not own an
interest in any entity that controls HCP, HCMC or HCS.

As the directors of HCP, the Principals intend to cause HCP to distribute
its net cash from operations as dividends on a quarterly basis to the extent
consistent with HCHI's REIT qualification. For purposes of receiving dividends,
there is no difference between a share of the HCP Preferred and a share of the
HCP Common, so that the HCP Preferred has no dividend rate or preference over
the HCP Common. Instead, dividend distributions by HCP will be made in the same
amount per share of HCP Preferred and HCP Common. Accordingly, each dividend
distribution by HCP will be made to HCHI and the Principals in proportion to the
numbers of shares held by them (so that, initially, each dividend distribution
will be made 97% to HCHI and 3% to the Principals). As the holder of the HCP
Preferred, however, based on a price of the Common Stock in the Company's
initial public offering of $15.00 per share, HCHI will have the right to receive
$10,750,005 (up to $15,750,010 if the Earn-Out vests, including the forgiveness
of loans from HCHI of up to $1,750,000 (all of which has been loaned to date),
but without regard to any salaries or other compensation for services, any
additional shares of Common Stock that may be issued as compensation for
services and any releases of personal guarantees) in HCP's liquidation before
any other shareholders receive anything. See "Certain Transactions Loans to the
Principals." Thus, the Principals control the operations of HCP, HCMC and HCS,
but have the right to receive only 3% of the dividend distributions made by HCP.
See "Risk Factors -- Principals' Conflicts of Interest." Shares of HCP Common
held by a Principal may be repurchased if, among other things, the Principal
ceases to be employed by the Company or to own an interest in HCHI. See "Certain
Transactions -- The HCP Shareholders' Agreement."

The Principals received 716,667 shares of Common Stock (representing 11.08%
of the outstanding shares of Common Stock) in exchange for the HCP Preferred
(which represents 97% of the book value of HCP at June

<PAGE> 11

30, 1997, or $688,854). HCHI will record the carrying value of its investment in
HCP at cost (which has been determined to be the net book value of the HCP
Preferred) and account for the investment under the equity method. Upon the full
vesting of the Earn-Out, up to 216,667 additional shares of Common Stock may be
issued to the Principals, giving the Principals up to 13.96% of the outstanding
Common Stock (taking into account the issuance of such additional shares of
Common Stock). HCHI will receive no additional consideration in exchange for the
216,667 additional shares of Common Stock. In addition, up to $1,750,000 in
loans made by HCHI to the Principals to enable the Principals to pay taxes (all
of which has been loaned to date) will be forgiven to the extent that the
Earn-Out vests. See "Risk Factors -- Benefits to the Principals" and "Certain
Transactions - The Formation Transactions."

In connection with the contribution by the Principals of the HCP Preferred
to HCHI, no third-party appraisals or fairness opinions have been or will be
obtained. There can be no assurance that the value of the Common Stock received
by the Principals and the amount of any forgiven loans will be equivalent to the
fair market value of the HCP Preferred contributed by them to HCHI. See "Risk
Factors -- Benefits to the Principals" and " -- Absence of Independent Valuation
for Allocation of Equity Interests in HCHI" and "Certain Transactions - The
Formation Transactions."

PRINCIPALS' CONFLICTS OF INTEREST

The Principals' interests might conflict with those of the purchasers of the
Company's Common Stock in certain respects, particularly as follows:

- The terms of the agreements by which the Principals acquired their
shares of Common Stock and their loans to pay taxes were not
determined through arm's-length negotiation. The Principals'
obligations to enforce those agreements as directors and officers of
HCHI may conflict with their interests as stockholders, directors and
officers of HCHI.

- The Principals continue to own the HCP Common. As the owners of the
HCP Common, the Principals are entitled to receive only 3% of the
dividend distributions made by HCP but control the operations of HCP,
HCMC and HCS. HCP Common held by a Principal may be repurchased if,
among other things, the Principal ceases to be employed by the
Company or to own an interest in HCHI.

DIVIDEND POLICY AND DISTRIBUTIONS

The Company intends to distribute 95% or more of its net taxable income
(which does not necessarily equal net income as calculated in accordance with
GAAP) to its stockholders on a quarterly basis each year so as to comply with
the REIT provisions of the Code. Any taxable income remaining after the
distribution of the regular quarterly dividends will be distributed annually in
a special dividend on or prior to the date of the first regular quarterly
dividend payment date of the following taxable year. The dividend policy is
subject to revision in the discretion of the Board of Directors of the Company.
All distributions will be made based upon such factors as the Board of Directors
of the Company deems relevant. The Board of Directors of the Company has not
established a minimum distribution level. To date, the Company has made the
following quarterly dividend distributions. On January 12, 1998, the Company
paid a dividend of $0.16 on each share of Common Stock and on April 13, 1998,
the Company paid a dividend of $0.21 on each share of Common Stock. In addition,
the Company has declared a dividend of $0.21 on each share of Common Stock,
payable on July 13, 1998 to holders of record of the Company's Common Stock on
June 30, 1998. See "Federal Income Tax Considerations."

<PAGE> 12
SUMMARY RISK FACTORS

An investment in the Company's Common Stock involves various risks, and
prospective investors should consider carefully the matters discussed under
"Risk Factors" prior to an investment in the Company's Common Stock. Among such
risks are the following:

- The Company's success will depend heavily upon the efforts of the
Principals, each of whom would be difficult to replace.

- HCHI was formed in June 1997 and has conducted operations for less
than one year. The earnings of HCHI depend primarily upon the
Principals' ability to acquire and manage the Investment Portfolio.
Although HCP has managed the short-term trading of Single-Family
Mortgage Loans and HCMC has originated Multifamily Mortgage Loans,
the Principals have limited experience in managing investments in
Multifamily Mortgage Loans and Commercial Mortgage Loans and in
managing long-term investments in any Mortgage Loans or Mortgage
Securities. In addition, the officers and directors of HCHI have
limited experience in managing a public company or a REIT.

- The investment and financing policies of the Company and its
policies with respect to certain other activities, including growth,
debt capitalization, distributions, REIT status and operating
policies, will be determined by the Board of Directors.

- Acceleration of prepayments on Mortgage Assets purchased by the
Company at a premium will result in a corresponding write-off of
unamortized premiums which could negatively impact the Company's net
income, if any.

- There can be no assurance that the exercise price of the Warrants
reflects the fair market value of the interest in the Company
represented by the shares of Common Stock received upon exercise
thereof.

- The Company will not control the operations of the Company's taxable
subsidiaries (which are controlled by the Principals), which could
result in decisions by such subsidiaries that do not reflect the
Company's best interests.

- The Principals may have conflicts of interest with respect to their
obligations as officers and directors of the Company, in connection
with the operations of the Company and the enforcement of the terms
of the agreements pursuant to which such individuals acquired their
Common Stock in HCHI and loans from HCHI.

- Adverse general economic conditions, which generally cause
decreasing demand for consumer credit and declining real estate
values, could negatively impact the Company's net income, if any.

- Significant increases in short-term interest rates could adversely
affect the Company's borrowing costs and could negatively impact the
Company's net income.

- The Company may experience difficulty in acquiring Mortgage Assets
at favorable spreads relative to borrowing costs in an environment
of increasing competition.

- If the Company fails to maintain its qualification as a REIT, the
Company will be subject to Federal income tax as a regular
corporation.

<PAGE> 13
- The failure of a public market to develop or be sustained for the
Units, the Common Stock or the Warrants may occur.

<PAGE> 14

RISK FACTORS

In addition to the other information contained in this Prospectus, the
following risk factors should be carefully considered in evaluating the Company
and its business before purchasing any of the shares of Common Stock offered
hereby.

This Prospectus contains forward-looking statements within the meaning of
the Federal securities laws. Discussions containing such forward-looking
statements may be found in the material set forth under "Prospectus Summary,"
"Use of Proceeds," "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and "Business" as well as within the Prospectus
generally. Actual results could differ materially from those described in the
forward-looking statements as a result of the risks and uncertainties set forth
below and within the Prospectus generally.

DEPENDENCE UPON PRINCIPALS AND OTHER KEY PERSONNEL

The Company's operations will depend heavily upon the efforts of John A.
Burchett, Joyce S. Mizerak, Irma N. Tavares and George J. Ostendorf, each of
whom would be difficult to replace. Mr. Burchett, Ms. Mizerak, Ms. Tavares and
Mr. Ostendorf have signed employment and non-competition agreements with the
Company. See "Management -- Employment Agreements." There can be no assurance,
however, that any of these individuals will remain in the Company's employ. The
loss of any one of these individuals could have a material adverse effect upon
the Company's business and results of operations. See "Management -- Directors
and Executive Officers."

RECENT FORMATION AND LACK OF RELEVANT EXPERIENCE

HCHI was formed in June 1997 and has conducted operations for less than
one year. The earnings of HCHI will depend primarily upon the Principals'
ability to acquire and manage the Investment Portfolio. Although HCP has managed
the short-term trading of Single-Family Mortgage Loans and HCMC has originated
Multifamily Mortgage Loans, the Principals have limited experience in managing
investments in Multifamily Mortgage Loans and Commercial Mortgage Loans and in
managing long-term investments in any Mortgage Loans or Mortgage Securities. In
addition, the officers and directors of HCHI have limited experience in managing
a public company or a REIT. See "Management - Directors and Executive Officers."
Although HCP has previously rendered advisory services in connection with
securitization transactions, neither it nor HCMC has securitized any significant
amount of Mortgage Loans. There can be no assurance that the Company will be
able to successfully operate its business as described in this Prospectus. If
the Company does not originate and acquire a sufficient number of Mortgage
Loans, or securitize its Mortgage Loans as planned, the Company's business and
results of operations will be materially adversely affected.

Historical financial information presented in this Prospectus and in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" should be regarded solely as background information and may not be
indicative of future results, which may vary substantially and adversely from
historical results.

12
<PAGE> 15

NEGATIVE EFFECT ON FINANCIAL CONDITION DUE TO BOARD OF DIRECTOR'S ABILITY TO
CHANGE POLICIES OF THE COMPANY

The investment and financing policies of the Company and its policies with
respect to certain other activities, including growth, debt capitalization,
distributions, REIT status and operating policies, are determined by the Board
of Directors. The Board of Directors has no present intention to amend or revise
these policies. However, the Board of Directors may do so at any time without a
vote of the Company's stockholders. A change in these policies could adversely
affect the Company's financial condition or results of operations.

ABSENCE OF INDEPENDENT VALUATION FOR ALLOCATION OF EQUITY INTERESTS IN HCHI

The capitalization of HCHI and the amounts and terms of the loans of up to
$1,750,000 (all of which has been loaned to date; See "Certain Transactions -
Loans to the Principals") made to the Principals were not determined by
arm's-length negotiations. The Company did not obtain an independent valuation
of the businesses of the Company or a fairness opinion in connection with the
capitalization and valuation of HCHI. No third-party appraisals or fairness
opinions have been or will be obtained in connection with the contributions of
the HCP Preferred to HCHI.

PRINCIPALS' CONFLICTS OF INTEREST

The terms of the agreements pursuant to which the Principals acquired their
Common Stock, and were made loans to pay taxes on their acquisitions of Common
Stock, were not determined through arms-length negotiation. The Principals may
have a conflict of interest with respect to their obligations as officers and
directors of the Company to enforce the terms of such agreements. Certain
aspects of the businesses of the Company will be carried on through HCP, HCMC
and HCS because income from the businesses might jeopardize HCHI's status as a
REIT if such operations were carried on directly by HCHI. The Principals own all
of the voting common stock of HCP, and HCHI owns all of the non-voting HCP
Preferred. As the holder of the HCP Preferred, HCHI receives 97% of the dividend
distributions generated by the operations of HCP, HCMC and HCS (and, based on a
public offering price of $15.00 per Unit, has a liquidation preference that is
initially equal to $10,750,005 and that may increase to up to $15,750,010 if the
Earn-Out vests). However, HCHI's investment in HCP, through non-voting preferred
stock, is subject to the risk that the Principals might have interests which are
inconsistent with the interests of HCHI.

The Principals are parties to a shareholders' agreement that provides for,
among other things, (i) rights of first refusal in the event any Principal
proposes to sell his or her shares of HCP Common, and (ii) rights to redeem or
purchase the shares of HCP Common held by any Principal who dies, becomes
incompetent, suffers a bankruptcy, ceases to hold shares of Common Stock or is
no longer employed by HCHI, HCP, HCMC or HCS. There can be no assurance,
however, that the HCP Common will be held at all times by persons who also hold
shares of Common Stock. In addition, there can be no assurance that the current
relationship between HCHI, on the one hand, and HCP, HCMC and HCS, on the other
hand, will continue indefinitely. See "Certain Transactions -- The HCP
Shareholders' Agreement."

The Principals currently serve as directors and officers of each of HCHI,
HCP, HCMC and HCS. In addition, certain other officers and employees of HCP,
HCMC and HCS will serve as officers and employees of HCHI. Each of the
Principals has entered into an employment agreement with the Company. See
"Management -- Employment Agreements." There can be no

<PAGE> 16

assurance that disputes among the Principals, as shareholders, which may delay
decisions of the Principals as directors and officers, will not occur, or that
if they occur they will not adversely effect the operation of the Company.

RECENT NEGATIVE TRENDS IN REVENUE AND INCOME

Prepayment speeds on adjustable rate Mortgage Securities purchased by the
Company in December 1997 accelerated significantly in the second quarter of
1998. As a result, the Company will reflect an additional write-off of
unamortized mortgage security premiums of approximately $1,169,000 for the
period April 1 to June 30, 1998. Although the prepayment speeds have declined
slightly from the highest levels experienced in April, management expects the
prepayment speeds on Mortgage Securities to remain at higher than normal levels
(45% to 50%) through the remainder of 1998. The higher than expected prepayment
speeds are expected to reduce the Company's effective yield on the overall
Mortgage Securities which would generate a loss from its investment in Mortgage
Securities in the second half of 1998. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Recent Events."

MORTGAGE ASSETS WITH POOR DOCUMENTATION AND POOR PAYMENT HISTORIES

The Company invests in Single-Family Mortgage Loans that are at least twelve
months old ("seasoned Single-Family Mortgage Loans") or that were intended to be
of certain credit quality but that do not meet the originally intended market
parameters due to errors or credit deterioration ("fall-out Single-Family
Mortgage Loans" and, together with seasoned Single-Family Mortgage Loans,
"subprime Single-Family Mortgage Loans"). Single-Family Mortgage Loans that are
missing applicable documents, such as the original note, mortgage or title
policy, may be difficult to enforce. Single-Family Mortgage Loans that are
missing origination documents, such as the original appraisal, application or
disclosure documents, risk having inadequate property valuations. Such Mortgage
Loans also risk exposure to consumer protection relief in the event of a loss of
disclosure documents which limit the ability of the Company to audit origination
disclosure procedures. In addition, Single-Family Mortgage Loans with poor
payment histories are subject to increased future delinquencies due to poor
borrower payment habits or a continuous cash flow problem.

DEFAULTS ON MORTGAGE ASSETS

Defaults on Commercial Mortgages

Commercial Mortgage Loans have certain distinct risk characteristics.
Commercial properties tend to be unique and more difficult to value than
single-family residential properties. Commercial Mortgage Loans also tend to
have shorter maturities than Single-Family Mortgage Loans and may have a
significant principal balance or "balloon" due on maturity. The Company expects
that a majority of its Commercial Mortgage Loans will have a balloon payment due
at maturity. Commercial Mortgage Loans with balloon payments involve a greater
risk to a lender than self-amortizing Commercial Mortgage Loans, because the
ability of a borrower to pay such amount will normally depend on its ability to
fully refinance the Commercial Mortgage Loan or sell the related property at a
price sufficient to permit the borrower to make the balloon payment. The Company
is not under any obligation to refinance any Commercial Mortgage Loans.
Commercial mortgage lending is generally viewed as exposing the lender to a
relatively greater risk of loss than single-family mortgage lending, in part
because it typically involves larger Mortgage Loans to single borrowers or
groups of related borrowers than Single-Family

<PAGE> 17
Mortgage Loans. Further, the repayment of Commercial Mortgage Loans secured by
income producing properties is typically dependent upon the successful operation
of the related properties. The successful operation of a commercial property is
dependent upon the performance and viability of the property manager of the
applicable project. There can be no assurance regarding the performance of any
operators or managers or persons who may become operators or managers of the
applicable commercial properties. See "Business -- Investment Portfolio --
Commercial Mortgage Loans and Multifamily Mortgage Loans."

Commercial Mortgage Loans generally are nonrecourse to the borrower. In the
event of foreclosure on a Commercial Mortgage Loan, the value of the property
and other collateral securing the Commercial Mortgage Loan may be less than the
amounts due on the Commercial Mortgage Loan. There may also be costs and delays
involved in enforcing rights of a property owner against tenants in default
under the terms of leases with respect to commercial properties, who may seek
the protection of the bankruptcy laws which can result in termination of lease
contracts.

Effect of Adverse Economic Conditions on Multifamily Properties

Adverse economic conditions, either local, regional or national, may limit
the rent that can be charged by a multifamily borrower and may result in a
reduction in timely rent payments or a reduction in occupancy levels. Further,
the costs of operating a multifamily property may increase, including the costs
of utilities and the costs of required capital expenditures. Occupancy and rent
levels may also be affected by construction of additional housing units, local
military base closings and national and local politics, including current or
future rent stabilization and rent control laws and agreements. In addition, the
level of mortgage interest rates may encourage tenants to purchase single-family
housing. All of these conditions and events may increase the possibility that a
borrower may default on its obligations under its Multifamily Mortgage Loan. See
"Business Investment Portfolio -- Commercial Mortgage Loans and Multifamily
Mortgage Loans."

Decreases in Value of Retail, Office and Industrial Properties

Income from, and the market value of, retail, office or industrial
properties would be adversely affected if space in such properties could not be
leased, if tenants were unable to pay rent, if a significant tenant were to
become a debtor in a case under the United States Bankruptcy Code and its lease
were rejected, or if for any other reason rental payments could not be
collected.

If sales of retail tenants were to decline, percentage rents may decline,
tenants could be unable to pay their base rent, or delays in enforcing the
lessor's rights could be experienced. Repayment of the related Commercial
Mortgage Loans may also be affected by the expiration of tenant leases and the
ability of the borrowers to renew leases or to release the space on favorable
terms. Even if vacated space is successfully released, the associated costs,
including tenant improvements and leasing commissions (to the extent not
reserved), could be substantial and could reduce cash flow from the properties.
Retail properties are, in general, affected by the health of the retail
industry, which is currently undergoing a consolidation and is experiencing
changes due to the growing market share of "off-price" and direct mail
retailing. A particular retail property may be adversely affected by the
bankruptcy, decline in drawing power, departure or cessation of operations of an
anchor tenant, a shift in consumer demand due to demographic

<PAGE> 18
changes (for example, population decreases or changes in average age or income)
and/or changes in consumer preference.

An office property may be adversely affected if there is an economic decline
in the businesses operated by the tenant of the property. The risk of such an
adverse effect is increased if rental revenue is dependent on a single tenant or
if there is a significant concentration of tenants in a particular business or
industry. Owners of office properties are generally required to expend
significant amounts of cash for general capital improvements, tenant
improvements and costs of re-leasing space, including commissions. Office
properties that are not equipped to accommodate the needs of modern businesses
may become functionally obsolete and, thus, non-competitive.

Industrial and warehouse properties may be adversely affected by reduced
demand for industrial space occasioned by a general economic decline in a
particular industry (for example, a decline in defense spending), and a
particular industrial or warehouse property that suited the needs of its
original tenant may be difficult to re-lease to another tenant or may become
functionally obsolete relative to newer industrial properties.

Environmental Liabilities Associated with Contaminated Properties

Certain properties securing Mortgage Loans may be contaminated by hazardous
substances resulting in reduced property values. If the Company forecloses on a
defaulted Mortgage Loan on such property, the Company may be subject to
environmental liabilities regardless of whether the Company was responsible for
the contamination. The Company intends to exercise due diligence to discover
potential environmental liabilities before purchasing any property through
foreclosure. However, hazardous substances or waste, contaminants and pollutants
may be discovered on properties during the Company's ownership or after a sale
to a third party. If such substances are discovered on a property, the Company
may be subject to liability for clean-up. The Company may also be liable to
tenants and owners of neighboring properties. In addition, the Company may find
it difficult or impossible to sell the property during or following any such
clean-up. Further, under certain circumstances, such as if the Company were
found to have participated in the management or operation of a property, the
Company may be subject to environmental liabilities with respect to such
property absent a foreclosure on the property. See "Business -- Investment
Portfolio -- Commercial Mortgage Loans and Multifamily Mortgage Loans."

RISKS RELATED TO OPERATIONS

Negative Effects of Fluctuating Interest Rates

Impact on Profitability of Mortgage Loans. The Company's earnings will be
affected by changes in interest rates. The Company will be subject to the risk
of rising mortgage interest rates (including changes in interest rates between
the time it commits to purchase Mortgage Loans at a fixed price and the time it
sells or securitizes those Mortgage Loans), which will adversely affect the
value of the Investment Portfolio. While hedging techniques will be used to
reduce these risks, there still may be changes in income due to changes in
interest rates. In addition, hedging involves transaction and other costs, and
such costs increase dramatically as the period covered by the hedging protection
increases and also increase in periods of rising and fluctuating interest rates.
See "Business -- Risk Management -- Interest Rate Risk Management" and " --
Hedging -- Costs and Limitations."

<PAGE> 19

Impact on Overall Operations. Higher interest rates may discourage borrowers
from refinancing Mortgage Loans, borrowing to purchase a single-family residence
or commercial property, or seeking a second Mortgage Loan, thus decreasing the
volume of Mortgage Loans originated by third-parties. This could have an adverse
effect on the Company's net interest spread during the accumulation of Mortgage
Loans held for sale and on the net interest spread on Mortgage Loans held for
long-term investment which are financed through reverse repurchase agreements.
If short-term interest rates exceed long-term interest rates, there could also
be a negative effect on the Company's net interest spread. See "Business -- Risk
Management -- Interest Rate Risk Management."

Financial Impact on Net Interest Income. Some Mortgage Assets held by the
Company for long-term investment may have adjustable interest rates or
pass-through rates based on short-term interest rates. The Company's short-term
borrowings generally will bear interest at fixed rates and have maturities of
less than one year. However, certain of these borrowings will include variable
rates. Consequently, changes in short-term interest rates may affect the
Company's net interest income. ARMs owned by the Company or mortgage-backed
securities backed by ARMs will be subject to periodic interest rate adjustments
based on an index such as the CMT Index or LIBOR. Interest rates on the
Company's borrowings may also be based on short-term indices. If any of the
Company's Mortgage Assets are financed with borrowings that bear interest based
on an index different from that used for the related Mortgage Assets, so-called
"basis" interest rate risk will arise. In that event, if the index used for the
Mortgage Assets is a "lagging" index that reflects market interest rate changes
on a delayed basis, and the rate on the related borrowings reflects market rate
changes more rapidly, the Company's net interest income will be adversely
affected in periods of increasing market interest rates. If the Company utilizes
short-term debt financing to originate or acquire fixed rate mortgages or
mortgage-backed securities or issues adjustable rate mortgage-backed securities
backed by fixed rate mortgages, the Company may also be subject to interest rate
risks. See "Business -- Risk Management -- Interest Rate Risk Management."

Impact of Periodic and Life Caps on Net Interest Margin. Some Mortgage
Assets will also be subject to periodic rate adjustments that may be less
frequent than the adjustments in rates on the borrowings or financings utilized
by the Company. Accordingly, in a period of increasing interest rates, the
Company could experience a decrease in net interest income or a net loss because
the interest rates on the Company's borrowings could adjust faster than the
interest rates on the ARMs or mortgage-backed securities backed by ARMs held in
the Investment Portfolio. Moreover, ARMs are typically subject to periodic and
lifetime interest rate caps, which limit the amount the interest rate can change
during a given period. The Company's short-term borrowings will not be subject
to similar restrictions. Hence, in a period of increasing interest rates, the
Company could also experience a decrease in net interest income or a net loss in
the absence of effective hedging because the interest rates on borrowings could
increase without limitation, while the interest rates on the Company's ARMs and
mortgage-backed securities backed by ARMs would be limited by caps. Further,
some ARMs may be subject to periodic payment caps that result in some portion of
the interest accruing on the ARMs being deferred and added to the principal
outstanding. This could result in receipt by the Company of less cash on its
ARMs than is required to pay interest on the related borrowings, which will not
have such payment caps. The Company expects that the net effect of these factors
will be to lower the Company's net interest income or cause a net loss during
periods of rising interest rates. No assurance can be given as to the amount or
timing of changes in interest rates or their effect on the Company's Mortgage
Assets held for long-term investment or net interest income. If the Company
utilizes short-term debt financing to originate or acquire fixed rate mortgages
or

<PAGE> 20
mortgage-backed securities or issues adjustable rate mortgage-backed securities
backed by fixed rate mortgages, the Company may also be subject to interest rate
risks.

Impact on Derivative Securities Held For Investment. Rising interest rates
may have a negative effect, in particular, on the yield of any mortgage-backed
securities in the Investment Portfolio purchased at a premium in connection with
the Company's hedging activities. If the Company were required to dispose of any
such mortgage-backed securities during a period of rising interest rates, a loss
could be incurred. Lower long-term rates of interest may negatively affect the
yield on servicing fees receivable and on Mortgage Assets purchased at a premium
in connection with the Company's hedging activities. In certain low interest
rate environments, the Company may not fully recoup any initial investment in
such securities or investments.

Impact on Origination Volume. Higher interest rates may also negatively
impact the conduit operations by reducing originations of Multifamily Mortgage
Loans and Commercial Mortgage Loans, since high interest rates will limit the
ability of borrowers to incur new debt or to refinance existing mortgages.

Reduction of Income Due to Prepayments on Mortgage Assets

Mortgage prepayment rates vary from time to time and may cause changes in
the amount of the Company's net interest income or net losses. Prepayments on
Mortgage Assets generally increase when mortgage interest rates fall below the
then-current interest rates on such Mortgage Assets. Conversely, prepayments of
the Mortgage Assets generally decrease when mortgage interest rates exceed the
then-current interest rate on the Mortgage Assets. Prepayment experience also
may be affected by the geographic location of the property securing the Mortgage
Loans, the assumability of the Mortgage Loans, the ability of an ARM Mortgage
loan to convert to a fixed-rate Mortgage Loan, conditions in the housing and
financial markets, and general economic conditions. In addition, prepayments on
ARMs are affected by conditions in the fixed-rate mortgage market. If the
interest rates on ARMs increase at a rate greater than the interest rates on
fixed-rate Mortgage Loans, prepayments on ARMs will tend to increase. In periods
of fluctuating interest rates, interest rates on ARMs may exceed interest rates
on fixed-rate Mortgage Loans, which may tend to cause prepayments on ARMs to
increase at a greater rate than anticipated. In addition, any future limitations
on the rights of borrowers to deduct interest payments on Mortgage Loans for
Federal income tax purposes may result in a higher rate of prepayment of
Mortgage Loans. See "Business -- Risk Management -- Prepayment Risk Management."

Prepayments of Mortgage Loans could affect the Company in several adverse
ways. The prepayment of any Mortgage Loan that had been purchased at a premium
by the Company (or backing a Mortgage Security that had been purchased by the
Company at a premium) would result in the immediate write-off of any remaining
capitalized premium amount and a consequent increase of the Company's
amortization of purchased mortgage servicing rights (to the extent it has
retained servicing) by such amount. See "Business -- PMSR/OMSR."

Substantially all of the Commercial Mortgage Loans originated by the Company
will contain provisions restricting prepayment. The restrictions may prohibit
prepayments in whole or in part during a specified period of time and/or require
the payment of a prepayment charge or fee. Prepayment restrictions may, but do
not necessarily, deter prepayments. Prepayment charges or fees may be less than
the amount which would fully compensate for the difference between the yield on
the reinvestment of the prepayment proceeds and the expected yield to maturity
of the

<PAGE> 21
prepaid Commercial Mortgage Loan. There can be no assurance that the borrower on
a Commercial Mortgage Loan which is being prepaid will have sufficient financial
resources to pay all or any required prepayment charges, particularly where the
prepayment results from acceleration of the Commercial Mortgage Loan following a
payment default. No assurance can be given that foreclosure proceeds will be
sufficient to make any prepayment charges required in connection with a
defaulted Commercial Mortgage Loan. No representation or warranty is made as to
the effect of prepayment charges on the rate of prepayment of the related
Commercial Mortgage Loan.

The laws of a number of states are unclear whether provisions requiring
payment of prepayment charges upon a voluntary or involuntary prepayment are
enforceable. In particular, no assurance can be given that prepayment charges
required in connection with an involuntary prepayment will be enforceable under
applicable law or, if enforceable, that foreclosure proceeds will be sufficient
to make the payment. Proceeds recovered in respect of any defaulted Commercial
Mortgage Loans will, in general, be applied to cover outstanding property
protection expenses, servicing expenses and unpaid principal and interest before
being applied to any prepayment charges.

Defaults by Borrowers under Mortgage Assets

The Company makes long-term investments in Mortgage Assets. Accordingly,
during the time it holds Mortgage Assets for investment, the Company will be
subject to the risks of borrower defaults and bankruptcies and special hazard
losses (such as those occurring from earthquakes or floods) that are not covered
by standard hazard insurance. If a default occurs on any Mortgage Loan 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. In
addition, Mortgage Loans in default are not eligible collateral for borrowings,
and will have to be financed by the Company from other funds until ultimately
liquidated.

With respect to second Mortgage Loans, the Company's security interest in
the property is subordinated to the interest of the first mortgage holder. If
the value of the property securing the second Mortgage Loan is not sufficient to
repay the borrower's obligation to the first Mortgage Loan holder upon
foreclosure or if there is no additional value in such property after satisfying
the borrower's obligation to the first Mortgage Loan holder, the borrower's
obligation to the Company may not be satisfied. See "Business -- Risk Management
- - -- Credit Risk Management."

Losses Related to Investing in Subordinated Classes of Mortgage-Backed
Securities

The Company will bear the risk of loss on any mortgage-backed securities it
purchases in the secondary mortgage market or otherwise. The Company has not
previously insured mortgage-backed securities through monoline insurers.
However, if monoline insurers are contracted to insure against these types of
losses, the Company would be dependent in part upon the creditworthiness and
claims-paying ability of the insurer and the timeliness of reimbursement in the
event of a default on the underlying obligations. Further, the insurance
coverage for various types of losses is limited, and losses in excess of the
limitations would be borne by the Company.

The yield derived from certain classes of mortgage-backed securities, which
may be created in connection with securitizations by the Company and
subsequently retained by the Company, is

<PAGE> 22
particularly sensitive to interest rate, prepayment and credit risks. The
Investment Portfolio will include subordinated securities and investments in
servicing fees receivables. See "Risk Factors -- Risks Related to Operations;" "
- - -- Negative Effects of Fluctuating Interest Rates; " -- Reduction of Income Due
to Prepayment." Because subordinated securities, in general, bear all losses
prior to the applicable senior securities, the amount of credit risk associated
with any investment in subordinated securities would be significantly greater
than the risk associated with a comparable investment in the related senior
securities and, on a percentage basis, the risk would be greater than holding
the underlying Mortgage Loans directly. See "Business -- Investment Portfolio;"
- - -- "Securitization and Sale Process."

Losses Related to Borrowings and Substantial Leverage by the Company

General. The Company intends to leverage the Investment Portfolio by borrowing
a substantial portion (up to approximately 92%, depending on the nature of the
underlying Mortgage Asset) of the market value of substantially all of its
investments in Mortgage Assets. The Company expects generally to maintain a
ratio of equity capital (book value of stockholders' equity) to book value of
total assets of approximately 10%-12%, although the percentage may vary from
time to time depending upon market conditions and other factors. The Company is
not limited by its charter or bylaws as to the amount it may borrow, whether
secured or unsecured, and the ratio of equity capital could at times be lower. A
majority of the Company's borrowings are expected to be collateralized
borrowings, primarily in the form of reverse repurchase agreements, which are
based on the market value of the Company's Mortgage Assets pledged to secure the
specific borrowings. The cost of borrowing under a reverse repurchase agreement
corresponds to the referenced interest rate (e.g., the CMT Index or LIBOR) plus
or minus a margin. The margin over or under the referenced interest rate varies
depending upon the lender, the nature and liquidity of the underlying
collateral, the movement of interest rates, the availability of financing in the
market and other factors. If the returns on the Mortgage Assets purchased with
borrowed funds fail to cover the cost of the borrowings, the Company will
experience net interest losses and may experience net losses. See "Business --
Investment Portfolio."

Failure to Refinance Outstanding Borrowings. The Company's ability to achieve
its investment objectives will depend not only on its ability to borrow money in
sufficient amounts and on favorable terms but also on its ability to renew or
replace its maturing short-term borrowings on a continuous basis. The Company's
business strategy relies on short-term borrowings to fund long-term Mortgage
Loans at certain times. If the Company is not able to renew or replace maturing
borrowings, it could be required to sell, under adverse market conditions, all
or a portion of its Mortgage Assets, and could incur losses as a result. In such
event the Company may be required to terminate hedge positions, which could
result in further losses. These events could have a material adverse effect on
the Company, and could jeopardize the Company's qualification as a REIT by,
among other things, causing the value of the HCP Preferred to exceed 5% of the
value of the Company's total assets. See "Risk Factors -- Consequences of
Failure to Maintain REIT Status; Company Subject to Tax as a Regular
Corporation."

Initiation of Margin Calls. Certain of the Company's borrowings may be
cross-collateralized to secure multiple borrowings from a single lender. A
decline in the market value of the collateral could limit the Company's ability
to borrow or result in lenders initiating margin calls (i.e., requiring a pledge
of cash or additional assets to reestablish the ratio of the amount of the
borrowing to the value of the collateral). The Company could be required to sell
Mortgage

<PAGE> 23
Assets under adverse market conditions to maintain liquidity. If these sales
were made at prices lower than the carrying value of the Mortgage Assets, the
Company would experience losses. A default by the Company under its
collateralized borrowings could also result in a liquidation of the collateral,
including any cross-collateralized Mortgage Assets, and a resulting loss of the
difference between the value of the collateral and the amount borrowed.

Liquidation of Collateral Upon Bankruptcy. In the event of a bankruptcy of the
Company, certain reverse repurchase agreements may qualify for special treatment
under the Bankruptcy Code, the effect of which is, among other things, to allow
the creditors under such agreements to avoid the automatic stay provisions of
the Bankruptcy Code and to liquidate the collateral under the agreements without
delay. Conversely, in the event of a bankruptcy of a party with whom the Company
had a reverse repurchase agreement, the Company might experience difficulty
repurchasing the collateral under the agreement if it were to be repudiated and
the Company's claim against the bankrupt lender for the resulting damages were
to be treated as an unsecured claim. In this event, payment of the Company's
claim would be subject to significant delay and, if and when paid, the amount
paid might be substantially less than the damages actually suffered by the
Company. Although the Company intends to enter into reverse repurchase
agreements with several different parties and has developed procedures to reduce
its exposure to such risks, no assurance can be given that the Company will be
able to avoid such risks. See "Business -- Financing."

Need for Additional Debt or Equity Financing. The Company's liquidity is also
affected by its ability to access the debt and equity capital markets. To the
extent that the Company is unable regularly to access such markets, the Company
could be forced to sell Mortgage Assets at unfavorable prices or discontinue
various business activities in order to meet its liquidity needs. Any such
inability to access the capital markets could have a negative impact on the
Company's earnings. In addition, the REIT provisions of the Code require the
Company to distribute to its holders of Common Stock substantially all of its
net earnings, thereby restricting the Company's ability to retain earnings and
replenish the capital necessary or advisable for its business activities.

Insufficient Demand for Mortgage Loans and the Company's Loan Products

The availability of Mortgage Loans meeting 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 the residential real estate lending markets depends on various
factors, including the level of interest rates, regional and national economic
conditions, inflation and deflation in property values, as well as the general
regulatory and tax environment as it relates to mortgage lending. See " --
Legislative and Regulatory Risk." To the extent the Company is unable to obtain
sufficient Mortgage Loans meeting its criteria, the Company's business will be
adversely affected.

In general, lower interest rates generate greater demand for Mortgage Loans,
because more individuals can afford to purchase single-family and commercial
properties. However, if low interest rates are accompanied by a weak economy and
high unemployment, demand for Mortgage Loans may decline. Conversely, higher
interest rates often result in lower levels of real estate finance and refinance
activity, which may decrease Mortgage Loan purchase volume levels, resulting in
decreased economies of scale and higher costs per unit, reduced fee income,
smaller gains on the sale of Mortgage Loans and lower net income during the
accumulation phase.

<PAGE> 24
FNMA and FHLMC are not currently permitted to purchase Single-Family Mortgage
Loans with original principal balances above $214,600, with certain exceptions.
If this dollar limitation were increased without a commensurate increase in home
prices, the Company's ability to maintain or increase its current acquisition
levels could be adversely affected as the size of the non-conforming
Single-Family Mortgage Loan market may be reduced, and FNMA and FHLMC may be in
a position to purchase a greater percentage of the Single-Family Mortgage Loans
in the secondary market than they currently acquire.

Lack of Geographic Diversification

Although the Company intends to seek geographic diversification of the
properties underlying the Company's Mortgage Assets, it does not intend to set
specific diversification requirements (whether by state, zip code or other
geographic measure). Concentration in any one area will increase exposure of the
Company's Investment Portfolio to the economic and natural hazard risks
associated with that area. See "Business -- Risk Management -- Credit Risk
Management."

Ability to Acquire Mortgage Assets at Favorable Spreads Relative to Borrowing
Costs; Competition and Supply

The Company's net income depends on the Company's ability to acquire Mortgage
Assets at favorable spreads over the Company's borrowing costs. In acquiring
Mortgage Assets, the Company competes with other REITs, investment banking
firms, savings and loan associations, banks, mortgage bankers, insurance
companies, mutual funds, other lenders, GNMA, FNMA, FHLMC, and other entities
purchasing Mortgage Assets, many of which have greater financial resources than
the Company and more experience in securitizations. In addition, there are
several mortgage REITs similar to the Company, and others may be organized in
the future. The effect of the existence of additional REITs may be to increase
competition for the available supply of Mortgage Assets suitable for purchase by
the Company. There can be no assurance that the Company will be able to acquire
sufficient Mortgage Assets at spreads above the Company's cost of funds. The
Company will also face competition for financing, and the effect of the
existence of additional mortgage REITs may be to reduce the Company's access to
sufficient funds to carry out its business strategy and/or to increase the costs
of funds to the Company. Continued consolidation in the financial services
industry may also reduce the number of current sellers of Mortgage Assets to the
Investment Portfolio, thus reducing the Company's potential customer base,
resulting in the Company's purchasing a larger percentage of Mortgage Loans from
a smaller number of sellers. Such changes could negatively impact the Investment
Portfolio. See "Business -- Competition."

The Company will face competition in its Due Diligence Operations from
financial institutions, including, but not limited to, banks and investment
banks. Many of the institutions with which the Company will compete in this area
have significantly greater financial resources than the Company. Increased
competition in the Due Diligence Operations could adversely affect the Company's
profitability. See "Business -- Competition."

FAILURE TO MAINTAIN REIT STATUS; COMPANY SUBJECT TO TAX AS A REGULAR CORPORATION

The Company has elected to be taxed as a REIT and intends to at all times
conduct its business operations so as to continue to qualify as a REIT for
Federal income tax purposes. To

<PAGE> 25

qualify as a REIT, the Company must satisfy a series of complicated tests
related to, among other things, the nature of its assets and income, the
ownership of its Common Stock, and the amount and timing of distributions to its
stockholders. The REIT election covers only HCHI and not any of the Company's
taxable subsidiaries, including HCP, HCMC and HCS, which are subject to Federal
income tax. See "Federal Income Tax Considerations -- Requirements for
Qualification as a REIT;" -- "Taxation of Taxable Affiliates."

The continued qualification of the Company as a REIT could be jeopardized by,
among other things, (i) the hedging of interest rate and prepayment risks with
instruments that are not Qualified REIT Assets or Qualified Hedges, (ii) the
payment by HCP of excessive amounts of dividends, and (iii) the failure of the
Company to distribute sufficient amounts of its income to its stockholders. In
addition, it is anticipated that the Mortgage Assets will be highly leveraged.
Borrowings could result in the termination of the Company's qualification as a
REIT if required payments on borrowings leave the Company with insufficient
amounts to distribute to its stockholders. An inability of the Company to fund
acquisitions of Mortgage Assets with borrowings, on the other hand, could result
in the termination of the Company's qualification as a REIT if the value of the
HCP Preferred exceeds 5% of the value of the Company's total assets. See
"Business -- Hedging" and "Federal Income Tax Considerations -- Requirements for
Qualification as a REIT."

If the Company fails to qualify as a REIT in any taxable year and certain
relief provisions of the Code do not apply, the Company 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 the Company fails to
qualify as a REIT would not be deductible by the Company in computing its
taxable income. As a result, the Company could be subject to income tax
liability, thereby significantly reducing or eliminating the amount of cash
available for distribution to its stockholders. Further, the Company could also
be disqualified from re-electing REIT status for the four taxable years
following the year during which it became disqualified. See "Federal Income Tax
Considerations -- Termination of Revocation of REIT Status."

The Principals have limited experience in managing a REIT. No assurance can be
given that future legislation, regulations, administrative interpretations or
court decisions will not significantly change the tax laws with respect to REIT
qualification or the Federal income tax consequences of such qualification. See
"Federal Income Tax Considerations -- Requirements for Qualification as a REIT."

POTENTIAL CHARACTERIZATION OF DISTRIBUTIONS AS UBTI; TAXATION OF TAX-EXEMPT
INVESTORS

In the event that (i) the Company is subject to the rules relating to taxable
mortgage pools (discussed below) or if a pension trust owns more than 10% of the
Common Stock and (a) at least one pension trust owns more than 25% of the Common
Stock, or (b) one or more pension trusts, each owning more than 10% of the
Common Stock, own in the aggregate more than 50% of the Common Stock, (ii) a
tax-exempt stockholder has incurred indebtedness to purchase or hold Common
Stock or is not exempt from Federal income taxation under certain special
sections of the Code, or (iii) any residual REMIC interests generate "excess
inclusion income," distributions to and, in the case of a stockholder described
in (ii), gains realized on the sale of Common Stock by, such tax-exempt
stockholder may be subject to Federal income tax as unrelated business taxable
income as defined in section 512 of the Code ("UBTI"). See "Federal Income Tax
Considerations -- Taxation of Tax-Exempt Stockholders."

<PAGE> 26
TAXABLE MORTGAGE POOL RISK; INCREASED TAXATION

The Company intends to enter into reverse repurchase agreements and CMO and
other secured lending transactions pursuant to which it may borrow funds with
differing maturity dates which are cross- collateralized by specific Mortgage
Loans. Some financing activities may create taxable mortgage pools. A REIT that
incurs debt obligations with two or more maturities, which are supported by
Mortgage Loans or mortgage-backed securities, may be classified as a "taxable
mortgage pool" under the Code if payments required to be made on the debt
obligations bear a specified relationship to the payments received on such
Mortgage Loans. If all or a portion of the Company were treated as a taxable
mortgage pool, the Company's status as a REIT would not be impaired, but a
portion of the Company's taxable income may, under proposed regulations, be
characterized as "excess inclusion" income and allocated to the stockholders.
Any excess inclusion income (i) could not be offset by the net operating losses
of a stockholder, (ii) would be subject to tax as UBTI to a tax-exempt
stockholder, (iii) would be subject to the application of Federal income tax
withholding at the maximum rate (without reduction for any otherwise applicable
income tax treaty) with respect to amounts allocable to foreign stockholders,
and (iv) would be taxable (at the highest corporate tax rate) to a REIT, rather
than its stockholders, to the extent allocable to shares of stock held by
disqualified organizations (generally, tax-exempt entities not subject to tax on
unrelated business income, including governmental organizations). See "Federal
Income Tax Considerations -- Taxation of Taxable U.S. Stockholders; -- Taxation
of Tax-Exempt Stockholders; -- Taxation of Non-U.S. Stockholders; -- Special
Considerations."

MARKET CONSIDERATIONS

Fluctuation in Market Price. The market price of the Company's Common Stock
will be influenced by any variation between the net yield on the Company's
Mortgage Assets and prevailing market interest rates. Earnings will not
necessarily be greater in high interest rate environments than in low interest
rate environments. Moreover, in periods of high interest rates, the net income
of the Company, and, therefore, the dividend yield on the Common Stock, may be
less attractive compared with alternative investments, which could negatively
impact the price of the Common Stock. If the anticipated or actual net yield on
the Company's Mortgage Assets declines or if prevailing market interest rates
rise, thereby decreasing the positive spread between the net yield on such
investments and the cost of the Company's borrowings, the market price of the
Common Stock may be adversely affected.

Effects of Future Offerings. The Company in the future may increase its
capital resources through private or public offerings of its Common Stock,
securities convertible into its Common Stock, preferred stock or debt
securities. All debt securities and preferred stock will be senior to the Common
Stock in the event of a liquidation of the Company. The actual or perceived
effect of such offerings, the timing of which cannot be predicted, may be the
dilution of the book value or earnings per share of the Common Stock
outstanding, which may result in the reduction of the market price of the Common
Stock.

INVESTMENT COMPANY ACT RISK

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.
Accordingly, the Company does not expect to be subject to the restrictive
provisions of the Investment Company Act. The Investment

24
<PAGE> 27

Company Act exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate ("Qualifying Interests")." Under the current interpretation of the
staff of the Commission, in order to qualify for this exemption, the Company
must maintain at least 55% of its assets directly in mortgage loans, qualifying
pass-through certificates and certain other Qualifying Interests in real estate.
Unless certain mortgage securities represent all of the securities issued with
respect to an underlying pool of mortgages, the mortgage securities may be
treated as securities separate from the underlying Mortgage Loans and, thus, may
not qualify as Qualifying Interests for purposes of the 55% requirement.
Therefore, the Company's ability to invest in certain mortgage securities may be
limited by considerations of the provisions of the Investment Company Act. In
addition, in order to meet the 55% requirement under the Investment Company Act,
the Company intends to consider privately issued certificates issued with
respect to an underlying pool as to which the Company holds all issued
certificates as Qualifying Interests. If the Commission, or its staff, adopts a
contrary interpretation with respect to such securities, the Company could be
required to restructure its activities to the extent its holding of such
privately issued certificates did not comply with the new interpretation. Such a
restructuring could require the sale of a substantial amount of privately issued
certificates at an inopportune time. Further, in order to insure that the
Company at all times continues to qualify for exemption from the Investment
Company Act, the Company may be required at times to adopt less efficient
methods of financing certain of its Mortgage Loans and investments in
mortgage-backed securities than would otherwise be the case and may be precluded
from acquiring certain types of Mortgage Assets whose yield may be higher than
the yield on Mortgage Assets that are consistent with the exemption. The net
effect of these factors will be to reduce at times the Company's net interest
income, although the Company does not expect the effect to be material. If the
Company fails to qualify for exemption from registration as an investment
company, its ability to use leverage would be substantially reduced, and it
would be unable to conduct its business as described in this Prospectus. Any
failure to qualify for the exemption could have a material adverse effect on the
Company.

LEGISLATIVE AND REGULATORY RISK

Members of Congress and government officials from time to time have suggested
the elimination of the mortgage interest deduction for Federal income tax
purposes, either entirely or in part, based on borrower income, type of Mortgage
Loan or principal amount. The reduction or elimination of these tax benefits
could have a material adverse effect on the demand for the Company's Mortgage
Loans.

In addition, a budget proposal recently made by President Clinton included a
provision that would have required income of a taxable subsidiary of a REIT to
be taken into account in determining whether the REIT satisfies the tests for
continued qualification as a REIT relating to the nature of its income. Although
HCP, HCMC and HCS would have been eligible for a grandfather exemption, the
exemption with respect to any of those entities would have been lost if the
entity engaged in new activities or acquired a substantial amount of new assets.
See "Federal Income Tax Considerations - Requirements for Qualification as a
REIT."

The Company's business is subject to regulation, supervision and licensing by
Federal, state and local governmental authorities. It is also subject to various
laws and judicial and administrative decisions imposing requirements and
restrictions on part or all of its operations. Regulated matters include,
without limitation, collection and foreclosure procedures, qualification and
licensing requirements for mortgage banking and otherwise doing business in
various jurisdictions and other trade practices. In addition, the Company's
activities are subject

<PAGE> 28
to the rules and regulations of the Department of Housing and Urban Development.
Failure to comply with these rules and regulations can lead to loss of approved
status, termination or suspension of servicing contracts without compensation to
the servicer, demands for indemnification or Mortgage Loan repurchases, certain
rights of rescission for Mortgage Loans, class action lawsuits and
administrative enforcement actions. There can be no assurance that the Company
will maintain compliance with these requirements in the future without
additional expense, or that more restrictive local, state or Federal laws, rules
and regulations will not be adopted or that existing laws and regulations will
not be interpreted in a more restrictive manner, which would make compliance
more difficult for the Company.

The laws and regulations described above are subject to legislative,
administrative and judicial interpretation, and certain of these laws and
regulations have been infrequently interpreted or only recently enacted.
Infrequent interpretations of these laws and regulations or an insignificant
number of interpretations of recently enacted regulations can result in
ambiguity with respect to permitted conduct under these laws and regulations.
Any ambiguity under the regulations to which the Company is subject may lead to
regulatory investigations or enforcement actions and private causes of action,
such as class action lawsuits, with respect to the Company's compliance with the
applicable laws and regulations. As a mortgage lender, the Company will be
subject to regulatory enforcement actions and private causes of action from time
to time with respect to its compliance with applicable laws and regulations. See
"Business -- Regulation."

SHARES ELIGIBLE FOR FUTURE SALE

Sales of substantial amounts of the Common Stock in the public market or the
prospect of such sales could materially and adversely affect the market price of
the Common Stock. The 5,750,000 shares of Common Stock offered as part of the
Units pursuant to the Company's initial public offering became eligible for sale
independent of the Units in the public market without restriction beginning on
March 19, 1998, the date that the Warrants became detachable. 2,122 shares of
Common Stock which have been issued pursuant to the exercise of Warrants are
also currently eligible for sale without restriction in the public market. The
[5,920,378] shares of Common Stock issuable upon exercise of the Warrants and
the Representatives' Warrants will be immediately eligible for sale in the
public market without restriction beginning on the date that they are issued
upon exercise of the Warrants or the Representatives' Warrants, as applicable,
assuming that a current prospectus is then in effect covering the issuance of
such shares. The 716,667 shares of Common Stock issued to the Principals, and
the 216,667 shares of Common Stock that may be issued to the Principals if the
Earn-Out vests, are and will be restricted and are not and will not be salable
pursuant to Rule 144 or otherwise sooner than the date which is one year from
the date of issue of such shares (except pursuant to registration rights). The
Company and the Principals have agreed with the underwriters of the Company's
initial public offering that, for a period of one year following the closing of
the initial public offering (i.e., until September 15, 1998), and except for up
to 100,000 shares of Common Stock that may now be registered and sold, the
Principals will not sell, contract to sell or otherwise dispose of shares of
Common Stock or rights to acquire such shares (other than pursuant to employee
plans) without the prior written consent of the Representatives. See "Shares
Eligible for Future Sale" Additionally, (i) stock options for 325,333 shares of
Common Stock may be granted to the Principals and other employees of the Company
at a per share exercise price equal to the initial public offering price
pursuant to the Company's 1997 Stock Option Plan, (ii) 5,747,878 shares of
Common Stock may be issued upon the exercise of the Warrants, and (iii) up to
172,500 shares of Common Stock may be issued upon exercise of the
Representatives' Warrants. The Principals

<PAGE> 29

have registration rights which will permit them to sell, free of the Rule 144
volume limitation, up to 100,000 shares of Common Stock in the aggregate at any
time and the remainder of their shares of Common Stock at any time after the one
year lock-up period expires. See "Shares Eligible for Future Sale --
Registration Rights."

PREFERRED STOCK; RESTRICTIONS ON OWNERSHIP OF COMMON STOCK; ANTI-TAKEOVER
MEASURES

The charter authorizes the Board of Directors to issue shares of Preferred
Stock designated in one or more classes or series. The Preferred Stock may be
issued from time to time with such designations, rights and preferences as shall
be determined by the Board of Directors. Preferred Stock would be available for
possible future financing of, or acquisitions by, the Company and for general
corporate purposes without any legal requirement that further stockholder
authorization for issuance be obtained. The issuance of Preferred Stock could
have the effect of making an attempt to gain control of the Company more
difficult by means of a merger, tender offer, proxy contest or otherwise. The
Preferred Stock, if issued, may have a preference on dividend payments which
could affect the ability of the Company to make dividend distributions to the
holders of Common Stock. As of the date of this Prospectus, no shares of
Preferred Stock have been issued and the Company does not intend to issue any
Preferred Stock prior to the closing of the Offering. Certain provisions of the
Company's charter may also have the effect of delaying, deferring or preventing
a change in control of the Company. See "Certain Provisions of Maryland Law and
of the Company's Charter and Bylaws;" and "Description of Securities."

To meet the requirements for qualification as a REIT at all times, the
Company's charter prohibits any person other than John A. Burchett from
acquiring or holding, directly or constructively, shares of Common Stock in
excess of 9.5% of the value of the aggregate of the outstanding shares of Common
Stock (the "Ownership Limit"). Mr. Burchett's ownership percentage may not
exceed 11.99%. For this purpose, the term "ownership" is defined in accordance
with the REIT provisions of the Code, the constructive ownership provisions of
Section 544 of the Code, as modified by Section 856(h)(1)(B) of the Code, and
the term "person" is defined to include a "group" so as to have the same meaning
as for purposes of Section 13(d)(3) of the Exchange Act apply. Accordingly,
shares of Common Stock owned or deemed to be owned by a person who individually
owns less than 9.5% (or 11.99% in the case of Mr. Burchett) of the outstanding
shares of Common Stock may nevertheless be in violation of the ownership
limitations set forth in the Company's charter. The Company's charter further
prohibits (1) any person from beneficially or constructively owning shares of
Common Stock that would result in the Company being "closely held" under Section
856(h) of the Code or otherwise cause the Company to fail to qualify as a REIT,
and (2) any person from transferring shares of Common Stock if such transfer
would result in shares of Common Stock being owned by fewer than 100 persons.

YEAR 2000 COMPLIANCE

The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process data fields containing a two
digit year is commonly referred to as the Year 2000 Compliance issue. As the
year 2000 approaches, such systems may be unable to accurately process certain
date-based information.

The Company has identified all significant applications that will require
modification to ensure Year 2000 Compliance. Internal resources are primarily
being used to make the required modifications and test Year 2000 Compliance. The
modification process of all significant

27
<PAGE> 30

applications is substantially complete. The Company plans to complete the
testing process of all significant applications by December 31, 1998.

In addition, the Company has communicated with others with whom it does
significant business to determine their Year 2000 readiness and the extent to
which the Company may be vulnerable to any third party Year 2000 issues.
However, there can be no guarantee that the systems of other companies on which
the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company.

The total cost to the Company of these Year 2000 Compliance activities has not
been and is not anticipated to be material to the Company's financial position
or results of operations in any year. These costs and the date on which the
Company plans to complete the Year 2000 modification and testing processes are
based on management's best estimates, which were derived utilizing numerous
assumptions of future events including the continued availability of certain
resources, third party modification plans and other factors. However, there can
be no guarantee that these estimates will be achieved and actual results could
differ from those plans.

THE COMPANY

The Company was incorporated in the state of Maryland on June 10, 1997. The
Company generally will not be subject to Federal income tax to the extent that
certain REIT qualification requirements are met. See "Federal Income Tax
Considerations -- Requirements for Qualification as a REIT." HCP (and its
subsidiaries) will not be consolidated with the Company for accounting purposes
because the Company will not own any of HCP's voting common stock and the
Company will not control HCP. All taxable income of HCP, HCMC and HCS is subject
to Federal and state income taxes, where applicable. See "Federal Income Tax
Considerations -- Taxation of Taxable Affiliates."

The principal executive office of the Company is located at 90 West Street,
Suite 1508, New York, New York 10006, telephone (212) 732-5086.

USE OF PROCEEDS

The net proceeds of the issuance of the shares of the Company's Common Stock
upon exercise of the Warrants are estimated to be approximately $88,805,670. The
Company expects to use such net proceeds for working capital and general
corporate purposes. Pending these uses, the net proceeds may be invested in
short-term CDs, overnight agency paper and money-market accounts temporarily to
the extent consistent with the REIT provisions of the Code.

DIVIDEND POLICY AND DISTRIBUTIONS

The Company intends to distribute 95% or more of its taxable income (which may
not necessarily equal net income as calculated in accordance with GAAP) to its
stockholders on a quarterly basis each year so as to comply with the REIT
provisions of the Code. Any taxable income remaining after distribution of the
regular quarterly dividends will be distributed annually in a special dividend
on or prior to the date of the first regular quarterly dividend payment date of
the following taxable year. The dividend policy is subject to revision at the
discretion of the Board of Directors. All distributions in excess of those
required for the

<PAGE> 31

Company to maintain REIT status will be made by the Company in the discretion of
the Board of Directors and will depend on the taxable earnings of the Company,
the financial condition of the Company and such other factors as the Board of
Directors deems relevant. The Board of Directors has not established a minimum
distribution level. See "The Company -- Directors and Executive Officers;" and
"Federal Income Tax Considerations -- Requirements for Qualifications as a REIT
- - -- Distributions."

The Company intends to operate in a manner that permits it to elect, and it
intends to elect, to be a REIT for Federal income tax purposes. The Company
expects to generate income for distribution to the stockholders primarily from
the net interest income derived from its investments classified as Qualified
REIT Assets and from dividends generated by the Due Diligence Operations and the
conduit operations. As a result of its REIT status, the Company will be
permitted to deduct dividend distributions to its stockholders in calculating
its taxable income, thereby effectively eliminating the "double taxation" that
generally results when a corporation earns income and distributes that income to
stockholders in the form of dividends. The Principals intend to cause HCP to
distribute its net cash from operations as dividends on a quarterly basis to the
extent consistent with HCHI's REIT qualification. For purposes of receiving
dividend distributions, there is no difference between a share of the HCP
Preferred and a share of the HCP Common, so that the HCP Preferred will have no
dividend rate or preference over the HCP Common. Since HCP, HCMC and HCS will
not be covered by the REIT election, dividend distributions made by HCP, HCMC
and HCS will not be deductible by them for Federal income tax purposes.

Distributions to stockholders will generally be taxable as ordinary income,
although a portion of such distributions may be designated by the Company as
capital gain or may constitute a tax-free return of capital. The Company will
annually furnish to each of its stockholders a statement setting forth
distributions paid during the preceding year and their characterization as
ordinary income, capital gains or return of capital. For a discussion of the
Federal income tax treatment of distributions by the Company, see "Federal
Income Tax Considerations -- Taxation of Taxable U.S. Stockholders;" " --
Taxation of Tax-Exempt Stockholders;" and " -- Certain United States Federal
Income Tax Considerations Applicable to Foreign Holders."

If (i) the Company is subject to the rules relating to taxable mortgage pools
or the Company is a "pension-held REIT" within the meaning of Section
856(h)(3)(D) of the Code, (ii) a tax-exempt stockholder has incurred
indebtedness to purchase or hold its Common Stock or is not exempt from Federal
income taxation under certain special sections of the Code, or (iii) the
residual REMIC interests acquired by the Company generate "excess inclusion
income," distributions to and, in the case of a stockholder described in (ii),
gains realized on the sale of Common Stock by, such tax-exempt stockholder may
be subject to federal income tax as unrelated business taxable income as defined
in section 512 of the Code ("UBTI"). See "Federal Income Tax Considerations --
Special Considerations."

To date, the Company has made the following quarterly dividend distributions.
On January 12, 1998, the Company paid a dividend of $0.16 on each share of
Common Stock and on April 13, 1998, the Company paid a dividend of $0.21 on each
share of Common Stock. In addition the Company has declared a dividend of $0.21
on each share of Common Stock, payable on July 13, 1998 to holders of record of
the Company's Common Stock on June 30, 1998.

<PAGE> 32
DIVIDEND REINVESTMENT PLAN

The Company intends to adopt a Dividend Reinvestment Plan ("DRP") for
stockholders who wish to reinvest their dividend distributions in additional
shares of Common Stock. All stockholders will be eligible to participate in the
DRP. The DRP will be administered by a plan administrator who will keep records,
send statements of accounts to each stockholder who participates in the DRP,
provide safe-keeping for the shares and perform other duties related to the DRP.
The DRP will provide for dividend reinvestments and optional cash purchases.
Discounts will be made available to the extent determined by the Board of
Directors and to the extent consistent with the Company's qualification as a
REIT.

SELECTED FINANCIAL DATA

The following selected financial data are derived from audited financial
statements of the Company for the period from inception (June 10, 1997) through
December 31, 1997 and unaudited financial information for the period from
January 1, 1998 through March 31, 1998. The selected financial data should be
read in conjunction with the more detailed information contained in the
Financial Statements and Notes thereto and "Management's Discussion and Analysis
of Financial Conditions and Results of Operations" included elsewhere in this
Prospectus.

OPERATIONS STATEMENT HIGHLIGHTS

<TABLE>
<CAPTION>
Period from January 1, 1998 Period from June 10, 1997
through (inception) through
March 31, 1998 December 31, 1997
<S> <C> <C>
Net interest income $2,159,000 $1,676,000
Net income $1,248,000 $499,000
Basic earnings per share $0.19 $0.15
Diluted earnings per share $0.17 $0.14
Dividends declared per share $0.21 $0.16
</TABLE>

BALANCE SHEET HIGHLIGHTS

<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
<S> <C> <C>
Mortgage loans $419,627,000 $160,970,000
Mortgage securities $312,390,000 $348,131,000
Total assets $766,823,000 $517,543,000
Shareholders' equity $77,169,000 $78,098,000
Number of common shares outstanding 6,466,677 6,466,677
</TABLE>

<PAGE> 33

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with
"Selected Consolidated Financial Data" and the Company's consolidated financial
statements, and the notes thereto, appearing elsewhere in this Prospectus.

RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 1998

(dollars in thousands, except per share data)

<TABLE>
<CAPTION>
Three Months
Ended
March 31, 1998
<S> <C>
Net interest income $2,159
Loan loss provision (51)
General and administrative (854)
expenses
Equity in (loss) of
unconsolidated subsidiary (6)
------
Net income $1,248
======

Basic earnings per share $0.19
=====

Dividends declared per share $0.21
=====
</TABLE>

Net interest income for the three months ended March 31, 1998 totaled
$2,159,000. The majority of the net interest income was generated by the
Company's investment in mortgage loans (63.5%) and mortgage securities (26.9%).
The balance of net interest income was generated from overnight agency paper
investments, cash collateral on deposit with certain mortgage security lenders,
a savings account, loans to certain Principals and a loan to HCP. Management
anticipates that the net interest income generated by mortgage loans will
continue to reflect an increasing percentage of total net interest income as the
Company continues to grow its mortgage loan investment portfolio. The Company's
mortgage loans increased from $160,970,000 at December 31, 1997 to $419,627,000
at March 31, 1998.

<PAGE> 34

The following table reflects the average balances for the Company's investment
portfolio as well as the Company's interest bearing liabilities with the
corresponding effective rate of interest annualized for the period January 1,
1998 through March 31, 1998 (dollars in thousands):

<TABLE>
<CAPTION>
Effective
Average Interest
Balance Rate
<S> <C> <C>
Interest Earning Assets
Mortgage loans (1) $216,275 7.410%
Mortgage securities 334,722 6.116%
------- ------
$550,997 6.624%

Interest Bearing Liabilities
Reverse repurchase
borrowings on
mortgage loans $166,881 6.318%
Reverse repurchase
borrowings on
mortgage securities 324,305 5.597%
$491,186 5.842%
------- ------

Net Interest Earning Assets $59,811
=======
Net Interest Spread 0.782%
======
Yield on Net Interest Earning Assets (2) 13.046%
=======
</TABLE>

(1) Loan loss provisions are excluded in the above calculations.
(2) Yield on Net Interest Earning Assets is computed by dividing the
applicable net interest income by the average daily balance of Net
Interest Earning Assets.

The effective rate for interest earning assets has been adjusted to reflect
amortization of premiums paid or discounts received on the acquisition of
mortgage loans and mortgage securities. By engaging HCP to perform due diligence
on mortgage loans the Company acquires, management believes that premium amounts
paid for the purchase of mortgage loan are less than if they were acquired in
the market. Net unamortized premiums on the Company's mortgage loans, and
mortgage securities were $6,905,000 and $11,519,000 at March 31, 1998 or
approximately 1.68% and 3.81% of the respective par value investments in
mortgage loans and mortgage securities.

The Company's largest expense is the interest cost on borrowed funds. Funds to
finance the investment portfolio in the first quarter of 1998 were borrowed in
the form of reverse repurchase agreements, which is indexed to LIBOR. The
Company may also use interest rate swaps, caps and financial futures to manage
its interest rate risk. The net cost of those instruments will be included in
the cost of funds as a component of interest expense for the period to which it
relates.

At March 31, 1998 the Company's mortgage loan investment portfolio comprised
54.7% of total assets in the following types of single family mortgage loans:

<PAGE> 35

Mortgage Loan Summary

Fixed Rate Mortgage Loans

<TABLE>
<CAPTION>
<S> <C>
Face or principal amount $297,382,000
Carrying value $304,595,000
Weighted average net coupon 8.83%
Weighted average maturity (in months) 229
Number of loans 9,891
Average loan size $ 30,071

Adjustable Rate Mortgage (Arm) Loans

Face or principal amount $113,932,000
Carrying value $115,032,000
Weighted average net coupon 8.05%
Weighted average maturity (in months) 273
Number of loans 1,359
Average loan size $ 83,792
</TABLE>

At March 31, 1998 the Company's mortgage securities investment portfolio
comprised 40.7% of total assets in the following categories (dollars in
thousands):

Federal National Mortgage Association

(FNMA) Securities

<TABLE>
<CAPTION>
Adjustable
Rate Fixed Rate Total
---- ---------- -----
<S> <C> <C> <C>
Par value at purchase date $200,524 $4,122 $204,646
March 31, 1998 adjusted principal $174,141 $4,122 $178,263
Amortized cost basis $180,968 $4,330 $185,298
Market Value $180,093 $4,322 $184,415
Weighted average net coupon 7.73% 9.47% 7.77%
Weighted average maturity (in months) 285 303 285
</TABLE>

<PAGE> 36

Federal Home Loan Mortgage Corp

(FHLMC) Securities

<TABLE>
<CAPTION>
Adjustable Fixed
Rate Rate Total
---- ---- -----
<S> <C> <C> <C>
Par value at purchase date $136,237 -- $136,237
March 31, 1998 adjusted principal $124,280 -- $124,280
Amortized cost basis $128,764 -- $128,764
Market Value $127,975 -- $127,975
Weighted average net coupon 7.88% 7.88%
Weighted average maturity (in months) 300 300
</TABLE>

General and administrative expenses (G & A expenses) amounted to $854,000 for
the first quarter of 1998. G & A expenses consist substantially of expenses
relating to the acquisition of and managing the Company's investment portfolio,
as well as various other corporate expenses. Most of the G & A expenses will
remain relatively stable on a quarterly basis with the possible exception of the
following: (1) due diligence, (2) commissions and (3) legal and professional.
The due diligence acquisitions will vary based upon various factors, including
but not limited to the number of loans purchased, complexity of documentation
problems encountered, type of mortgage loans, ease of converting data to the
Company's proprietary software system, geographic location, and creditworthiness
of the borrower. Commission expense is also directly related to mortgage loans
acquired. Commissions are paid on all mortgage loan acquisitions initiated by
HCP's sales representatives. However, certain mortgage loan acquisitions are
also initiated by the Principals. No commission expense is recorded when the
mortgage loan acquisitions are originated by the Principals. Legal and
professional fees will also vary based on the usage of various professional
firms from time to time.

The Company recorded a loss from its investment in HCP and subsidiaries of
$6,000 for the period January 1, 1998 through March 31, 1998. Summarized
operating results for Hanover Capital Partners and Subsidiaries is shown in the
table below (dollars in thousands):

<TABLE>
<CAPTION>
<S> <C>
Revenues $1,791
Expenses 1,797
------
Net Loss 6
======
</TABLE>

The Company's net income for the period January 1, 1998 through March 31, 1998
was $1,248,000 or a 6.39% annualized return on equity. The table below
highlights the Company's brief historical trends and components of annualized
return on average equity.

<PAGE> 37

COMPONENTS OF ANNUALIZED RETURN ON AVERAGE EQUITY (1)

<TABLE>
<CAPTION>
Net Gain on Sale G & A1 Equity in Earnings Annualized
For the Quarter Ended Interest of Expense / (Loss) of Return on
Income / Securities Equity Subsidiary / Equity
Equity Equity Equity
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
June 30, 1997 0.00% 0.00% 0.00% 0.00% 0.00%
September, 30, 1997 4.85% 0.00% 3.59% 0.97% 2.23%
December 31, 1997 7.71% 0.18% 4.26% (1.41%) 2.22%
March 31, 1998 10.78% 0.00% 4.37% (0.03%) 6.38%
</TABLE>

(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 is based on equity balances at September 19, 1997 (IPO date),
and equity balances at September 30, 1997, excluding unrealized loss on
investments available for sale.

PERIOD FROM INCEPTION ON JUNE 10, 1997 THROUGH DECEMBER 31, 1997

The Company was organized on June 10, 1997, but did not commence operations
until September 19, 1997 (the date of the closing of the Company's initial
public offering). For the period from June 10, 1997 to December 31, 1997, the
Company's net income was $499,000 or $0.15 per share based on a weighted average
of 3,296,742 shares of common stock outstanding. The Company's net income for
the period September 19, 1997 to December 31, 1997 was $499,000 or $.08 per
share based on a weighted average of 6,466,677 shares of common stock
outstanding.

Net interest income for 1997 totaled $1,676,000. Net interest income is
interest income earned on mortgage securities, fixed rate and adjustable rate
mortgage loans, and other temporary investments less interest expense from
borrowings related to the investments.

General and administration expenses for 1997 totaled $940,000. The majority of
general and administrative expenses relate to management and administrative
expenses, due diligence acquisition costs, commission expenses, and legal and
professional fees. Due diligence acquisition costs averaged .156% of the
principal balance of the mortgage loans purchased in 1997.

On September 19, 1997 (the IPO date), the Company acquired 100% of the
nonvoting preferred stock of HCP, which represents a 97% ownership interest in
HCP and its wholly owned subsidiaries. While the Company will generally have no
right to control the affairs of HCP because the Company owns only the preferred
stock of HCP, management believes that the Company has the ability to exert
significant influence over HCP and therefore the investment in HCP is accounted
for on the equity method. The Company recorded a loss of $254,000 in 1997 for
its equity investment in HCP. The HCP loss was a result of a decline in
consulting (due diligence/ARMS audit) revenues and a slowdown in the mortgage
originations division during the fourth quarter of 1997.

The table below highlights the Company's brief historical trends and
components of return on average equity.

<PAGE> 38

COMPONENTS OF ANNUALIZED RETURN ON AVERAGE EQUITY (1)

<TABLE>
<CAPTION>
Net Gain on Equity in
Interest Sale of G & A Earnings (Loss) Annualized
For the Income/ Securities/ Expense/ of Subsidiary/ Return on
Quarter Ended Equity Equity Equity Equity Equity
- - ------------- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
June 30, 1997 (2) 0.00% 0.00% 0.00% 0.00% 0.00%
September 30, 4.85% 0.00% 3.59% 0.97% 2.23%
1997(3)
December 31, 1997 7.71% 0.18% 4.26% (1.41%) 2.22%
</TABLE>

For the period from inception through December 31, 1997, the Company's taxable
income was $1,077,000 or $0.167 per weighted average share outstanding. Taxable
income is higher than GAAP net income primarily because taxable income does not
include the equity in the loss of HCP ($254,000), and due diligence costs and
commission expenses incurred to acquire mortgage loan pools ($324,000) that are
expensed under GAAP, but capitalized and amortized for tax purposes.

As a REIT, the Company is required to declare dividends amounting to 85% of
each years taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of the Company's taxable income for each year by the
time the Company 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. The Company paid a fourth quarter
dividend of $0.16 per share, which was equivalent to a dividend of approximately
96% of taxable income.

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
period September 30, 1997 (initial purchase of mortgage assets) through December
31, 1997:

<TABLE>
<CAPTION>
Average Effective
Balance Rate
------- ----
<S> <C> <C>
Interest Earning Assets:
Mortgage Loans (1) $83,776,000 7.317%
Mortgage Securities 116,375,000 6.268%
----------- -----
$200,151,000 6.707%
============ =====
Interest Bearing Liabilities
Reverse repurchase borrowings on mortgage loans $32,674,000 6.313%
Reverse repurchase borrowings on mortgage securities 113,803,000 5.723%
----------- -----
$146,477,000 5.855%
============ =====

Net Interest Earning Assets $53,674,000
===========
Net Interest Spread 0.852%
=====
Yield on Net Interest Earnings Assets (2) 9.034%
=====
</TABLE>

(1) Loan loss reserves are excluded in above calculations.
(2) Yield on Net Interest Earning Assets is computed by dividing annualized net
interest by the average daily balance of net interest earnings assets.

<PAGE> 39

For the year ended December 31, 1997, the Company's ratio of operating
expenses to average assets was 1.59%. The Company's 1997 operating expense did
not include any incentive bonus compensation. 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%.

Financial Condition

At December 31, 1997, the Company had total assets of $517,543,000. Mortgage
loans totaled $160,970,000 or 31.1% of total assets, while mortgage securities
totaled $348,131,000 or 67.3% of total assets.

The following table presents a schedule of mortgage loans at December 31,
1997, classified by fixed rate mortgages and adjustable rate mortgages:

<TABLE>
<CAPTION>
Carrying Portfolio
Value Mix
----- ---
<S> <C> <C>
Fixed rate mortgages $107,953,000 67.1%
Adjustable rate mortgages 53,017,000 32.9%
---------- -----
$160,970,000 100.0%
============ =====
</TABLE>

The following table presents a schedule of mortgage securities at December 31,
1997, classified by type of issue:

<TABLE>
<CAPTION>
Carrying Portfolio
Value Mix
----- ---
<S> <C> <C>
FNMA $207,397,000 59.6%
FHLMC 140,734,000 40.4%
----------- -----
$348,131,000 100.0%
============ =====
</TABLE>

LIQUIDITY AND CAPITAL RESOURCES

The Company expects to meet its 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 CMO's and REMICs, additional equity generated by the
exercise of some or all of the Company's outstanding warrants and additional
equity offerings. The Company considers its ability to generate cash to be
adequate to meet operating requirements both in the short-term and long-term.
However, if a significant decline in the market value of the Company's
investment portfolio should occur, the Company's available liquidity from these
other borrowings 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.

Period From January 1, 1998 through March 31, 1998

Net cash provided by operating activities for the first quarter of 1998 was
$1,894,000. Cash flows from operating activities were generated by net income of
$1,248,000, adjusted for certain non-cash

<PAGE> 40

expenses ($1,093,000) and normal recurring changes in other assets and
liabilities ($453,000) and reduced by a loan to HCP of $900,000.

Net cash used in investing activities amounted to $188,774,000 during the
period January 1, 1998 through March 31, 1998. The majority of the cash used in
investing activities related to the purchase of assets for the Company's
investment portfolio. Mortgage loans were purchased at an average price of
102.25% of par and mortgage securities were purchased at an average price of
101.12% of par during the first quarter of 1998.

Cash flows from financing activities generated $207,847,000 for the period
January 1, 1998 through March 31, 1998. The cash flows from financing activities
resulted from net borrowing on reverse repurchase agreements ($208,882,000)
reduced by dividends paid in January 1998 ($1,035,000).

Management anticipates that the Company will continue to purchase
single-family mortgage loan pools and will finance the purchase of the mortgage
loan pools through existing equity, reverse repurchase agreements, and other
sources of financing including CMOs and REMICs. The Company may also realize
additional liquidity if the Company's stock warrants are exercised. In order to
grow its equity base, the Company may also issue additional capital stock.
Management intends to issue such additional shares when it believes that
existing stockholders are likely to benefit from such offerings through higher
earnings and dividends per share than as compared to the level of earnings and
dividends the Company would likely generate without such offerings.

Period From Inception on June 10, 1997 through December 31, 1997.

Net cash provided by operating activities for the period June 10, 1997 to
December 31, 1997 was $49,000. The cash flows generated from operating
activities (mainly from net income ($499,000), non cash expense items such as
amortization of mortgage loans and mortgage security premiums, and the increase
of certain liability accounts) were reduced by amounts expended for the purchase
of accrued interest on mortgage loan pools and by loans ($482,000) made to the
Principals.

Net cash used in investing activities for the period from June 10, 1997 to
December 31, 1997 was $510,287,000. The majority of the cash used in investing
activities related to the purchase of FNMA securities and FHLMC securities
($349,287,000) and mortgage loan pools ($163,030,000).

Cash flows from financing activities generated $514,260,000 during the period
from June 10, 1997 to December 31, 1997. The cash flows from financing
activities represent net proceeds from reverse repurchase agreements used to
finance the purchase of mortgage securities ($341,407,000), pools of
single-family mortgage loans ($93,731,000), and the net proceeds of the IPO
($79,122,000).

Management anticipates that the Company will continue to purchase single
family mortgage loan pools and will finance the purchase of the mortgage loan
pools through existing equity, reverse repurchase agreements, and other sources
of financing including CMO's and REMICs. The Company may also realize additional
liquidity after March 1998 from the warrants which became exercisable.

The Company is obligated to make additional loans to the Principals
($1,268,000) at their request. It is anticipated that the Principals will
request additional loans in April 1998 for tax purposes. Further, in lieu of
their exercise of certain registration rights, the Principals have also
requested additional loans in the aggregate amount of $1,500,000, which was
approved by the

<PAGE> 41

Board of Directors. The Company has guaranteed HCP's line of credit facility.
The Company has advanced $900,000 to HCP in February 1998 for working capital
purposes and Management anticipates that the Company may advance additional
funds in 1998 to HCP.

RECENT EVENTS

On April 7, 1998, the Company issued approximately $103 Million in REMIC
interests in a private placement offering that was structured as a financing
transaction. The Company has retained interests in the REMIC, including the
non-rated credit support interests, which totaled approximately $513,000.

In April 1998 the Company loaned $1,268,000 to the Principals, resulting in
total loans to the Principals of $1,750,000, the maximum loan amount permitted
pursuant to the original formation transactions of the Company.

Pursuant to the Registration Rights Agreement among the Company and the
Principals, the Principals have the right to request on any one occasion on or
after January 1, 1998 that the Company file one registration statement with the
Securities and Exchange Commission, at the Company's expense, with respect to a
maximum of 100,000 shares of the Common Stock owned by the Principals in order
to pay tax on gains the Principals recognized relating to the Company's original
formation transactions. In March 1998, the Board of Directors agreed to lend up
to $1,500,000 in unsecured loans to the Principals, in lieu of incurring at that
time the costs and expenses associated with the registration of 100,000 shares
of the Company's Common Stock. The Company loaned the Principals an additional
$1,203,880 in April 1998. The additional loans are due and payable on March 31,
1999 and bear interest at the rate of 5.51% per annum.

Although the prepayment speeds have declined slightly from the highest levels
experienced in April, management expects the prepayment speeds on Mortgage
Securities to remain at higher than normal levels (45% to 50%) through the
remainder of 1998. The higher than expected prepayment speeds are expected to
reduce the Company's effective yield on overall Mortgage Securities which will
generate a loss from its investment in Mortgage Securities in the second half of
1998.

Management anticipates that the third and fourth quarters of 1998 will
reflect net income as the Company's main focus continues to be the purchase of
fixed rate residential whole loans. As the Company continues to grow its asset
base through the purchase of residential whole loans, a significantly increasing
percentage of net interest income will be generated by the Company's investment
in whole loans and a decreasing percentage of revenues will be dependent on
Mortgage Securities.

<PAGE> 42
BUSINESS

GENERAL

Background

In September 1997, Hanover Capital Mortgage Holdings, Inc. (the "Company")
raised net proceeds of approximately $79.1 million in its initial public
offering, pursuant to which the Company sold 5,750,000 Units at $15.00 per Unit.
Each Unit consisted of one share of the Company's Common Stock and one Warrant.
Each Warrant entitles the holder to purchase one share of Common Stock at $15.00
per share (subject to adjustment in certain events). The Warrants became
exerciseable on March 19, 1998 and remain exerciseable until September 15, 2000.

In connection with the initial public offering, the Company acquired a 97%
ownership interest (representing a 100% ownership of the non-voting preferred
stock) in Hanover Capital Partners Ltd. ("HCP") and its wholly-owned
subsidiaries, Hanover Capital Mortgage Corporation ("HCMC") and Hanover Capital
Securities, Inc. ("HCS"), in exchange for 716,667 shares of the Company's Common
Stock.

The Company is a specialty finance company the activities of which include (i)
acquiring primarily single-family "subprime" mortgage loans (as defined below),
(ii) securitizing mortgage loans and retaining interests therein, (iii) offering
due diligence services to buyers, sellers and holders of mortgage loans, and
(iv) originating, holding, selling and servicing multifamily mortgage loans and
commercial mortgage loans. The Company's principal business objective is to
generate increasing earnings and dividends for distribution to stockholders. The
Company acquires single-family mortgage loans through a network of sales
representatives targeting financial institutions throughout the United States.
The Company originates multifamily mortgage loans and commercial mortgage loans
through HCMC. The Company operates as a tax-advantaged REIT. The Company is
generally not subject to Federal income tax to the extent that it distributes
its earnings to its stockholders and maintains its qualification as a REIT.
Taxable affiliates of the Company, however, including HCP, HCMC and HCS, are
subject to Federal income tax. The Company has engaged HCP to render due
diligence, asset management and administrative services pursuant to a Management
Agreement.

The Company elected REIT status primarily for the tax advantages.
Management believes that the REIT structure is the most desirable structure for
owning mortgage assets because it eliminates corporate-level Federal income
taxation. In addition, as the Company is not a traditional lender which accepts
deposits, it is subject to substantially less regulatory oversight and incurs
lower operating expenses than banks, thrifts and many other originators of
mortgage assets. Management believes that the Company will generate attractive
earnings and dividends per share for stockholders through the combination of (i)
purchasing subprime single-family mortgage loans which generally have higher
yields than newly originated mortgage loans, (ii) using long-term financing that
allows the Company to realize net interest income over time as REIT-qualified
income, as opposed to fully taxable gain-on-sale income, and (iii) its focus on
originating multifamily mortgage loans and commercial mortgage loans, which
generally have higher yields than conforming single-family mortgage loans. As
used herein, the term "subprime single-family mortgage loan" means a
single-family mortgage loan that is either twelve months or older or that does
not meet the originally intended credit quality due to documentation errors

<PAGE> 43

or credit deterioration. Although HCP has previously rendered advisory services
in connection with securitization transactions, neither it nor HCMC has
securitized any significant amount of mortgage loans.

Business Strategy

The Company's strategy is to pursue acquisitions and originations of mortgage
loans where it believes it can receive acceptable rates of return on invested
capital and effectively utilize leverage. Key elements of this strategy include:

- growing the Company's investment portfolio by utilizing the Company's
single-family mortgage loan acquisition network and multifamily and
commercial origination operation to create attractive investment
opportunities;

- financing the Company's investments in a manner that limits the Company's
interest rate risk while earning an attractive return on equity; and

- owning mortgage assets in the REIT structure and thereby eliminating a
layer of taxes relative to most traditional real estate lenders.

The Company's principal executive offices are located at 90 West Street,
Suite 1508, New York, New York 10006.

INVESTMENT PORTFOLIO

General

The primary business of the Company is investing, generally on a long-term
basis, in first lien single-family mortgage loans, multifamily mortgage loans
and commercial mortgage loans and mortgage securities secured by or representing
an interest in mortgage loans (the "Investment Portfolio"). The percentage of
the Company's mortgage 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 utilizes its
organization to acquire and securitize single-family mortgage loans and
originate commercial mortgage loans to earn higher returns than could generally
be earned from purchasing mortgage securities in the marketplace.

Single Family Mortgage Operations

Single-Family Mortgage Loans. The Company focuses on the purchase of pools of
whole single-family mortgage loans that do not fit into the large
government-sponsored 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. The majority (65% - 70%) of the Company's acquisition
of single-family mortgage loan pools to date have been fixed rate loans, with
the balance made up of adjustable rate mortgage ("ARM") loans. At March 31,
1998, the Company had an investment in mortgage securities of $312 million. The
Company intends to liquidate these investments over the next twelve months as it
identifies and purchases additional single-family mortgage loan pools.

<PAGE> 44

The Company uses seven sales representatives from HCP, located in Illinois,
Minnesota, California, Massachusetts and New York, to source single-family
mortgage loan products. For the foreseeable future, the Company believes that
there will be an adequate supply of mortgage loan product that can be sourced by
the existing HCP sales force.

At March 31, 1998, the Company had invested $419,627,000 or 54.7% of the
Company's total assets in the following types of single-family mortgage loans in
accordance with the operating policies established by the Board of Directors.

<TABLE>
<CAPTION>
Whole Loan Mortgage Loan Summary
Fixed Rate Mortgage Loans
-------------------------
<S> <C>
Face or principal amount $297,382,000
Carrying value $304,595,000
Weighted average net coupon 8.83%
Weighted average maturity (in months) 229
Number of loans 9,891
Average loan size $ 30,071

Adjustable Rate Mortgage (ARM) Loans

Face or principal amount $113,932,000
Carrying value $115,032,000
Weighted average net coupon 8.05%
Weighted average maturity
(in months) 273
Number of loans 1,359
Average loan size $ 83,792
</TABLE>

At July 1, 1998, the Company had purchased since inception in excess of $695
million of single-family mortgage loan pools and had committed to purchase an
additional $74 million of single-family mortgage loan pools.

In addition, HCP has a due diligence and underwriting staff, located in
Edison, New Jersey, consisting of approximately ten full-time employees. The 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 having additional information on loan pools through its due
diligence operations, the Company is better able to assess the value of loan
pools.

Because mortgage loan pools can be purchased from virtually any bank,
insurance company or financial institution, the Company is not dependent upon
any one source. At June 30, 1998, the Company had purchased approximately 30.5%
of the Company's single-family mortgage loan portfolio from one source.
Management does not believe this concentration of purchases is indicative of
future trends. The Company does not service its single-family mortgage loans.
The servicing is outsourced to unrelated third parties specializing in loan
servicing.

<PAGE> 45

The Company purchases ARM securities from broker-dealers and financial
institutions that regularly make markets in these securities. The Company can
also purchase mortgage-backed securities from other mortgage suppliers,
including mortgage bankers, banks, savings and loans, investment banking firms,
home builders and other firms involved in originating, packaging and selling
mortgage loans.

The mortgage loans and to a lesser extent the 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.

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.

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 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.

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 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 upon sale of the
single-family mortgage loan portfolio.

<PAGE> 46

Single-Family Market Trends. The Company focuses on subprime mortgage loans
which are generally available in bulk from loan originators such as mortgage
bankers, banks and thrifts that originate primarily for sale and from mortgage
portfolio holders as they restructure their holdings.

Single-Family Acquisition Strategy. The Company believes that it can continue
to acquire single-family mortgage loans that have a relatively high yield when
compared to the applicable risk of loss. In many cases, portions of a pool may
be made eligible for inclusion in agency pools, which will raise the credit
level of the Investment Portfolio, while preserving the higher yield obtained at
the time of purchase. In addition, the Company may securitize a single-family
mortgage loan pool. In structuring a securitization, the Company retains
subordinated or other interests.

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 pricing a bid or 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 underlying single-family mortgage loans or other factors. No
single-family mortgage loans are currently serviced by the Company.

Commercial Mortgage Loans and Multifamily Mortgage Loans

The Company's affiliate HCMC was one of the first commercial mortgage banking
operations to originate multifamily mortgage loans for sale to conduits. From
direct borrower originations and its network of third party brokers, it can
provide multifamily mortgage loans and commercial mortgage loans of sufficient
credit quality to meet the requirements for securitization, as well as sales to
third party investors and purchases by the Company for the Investment Portfolio.
Due to low interest spreads, no multifamily mortgage loans or commercial
mortgage loans have been purchased by the Company to date. However, in the
future, the Company may originate

<PAGE> 47

multifamily mortgage loans and commercial mortgage loans, including mortgage
loans secured by income-producing commercial properties such as office, retail,
warehouse and mini-storage facilities, through HCMC and subsequently either sell
the mortgage loans to investors or hold them in the Investment Portfolio.
Management of the Company believes that the Company has certain competitive
advantages in the commercial mortgage market due to the speed, consistency and
flexibility with which it can act as a vertically integrated company (acting as
originator, servicer, and owner of commercial mortgage loans).

Commercial Production Process. The commercial process differs from the
single-family mortgage loan acquisition process because HCMC operates as a
direct originator of loans. HCMC has been engaged in this process since 1992 and
has been an active supplier to the Wall Street conduit/securitization firms,
which are Wall Street dealer firms that have set up a conduit to purchase
multifamily mortgage loans and commercial mortgage loans from national brokers
and mortgage bankers for the purpose of issuing commercial mortgage-backed
securities. HCMC has the ability to source new commercial mortgage loans
directly and through brokers, to process and underwrite the loans to the
Company's standards and to service the loans.

Commercial and Multifamily Loan Acquisition/Production Strategies. The
Company adheres to specified underwriting and due diligence requirements for the
origination of multifamily and commercial mortgage loans, such that they will
qualify for sale to third party conduits or for inclusion in securitizations.
The Company continually monitors the underwriting criteria by contacting rating
agencies and the third party conduit purchasers. In addition to the underwriting
and due diligence completed at the origination level, a separate credit
committee approves all multifamily mortgage loans and commercial mortgage loans
purchased for the Investment Portfolio. The Company intends that, with prudent
underwriting and due diligence, combined with the securitization option, it will
achieve a satisfactory reward/risk ratio; however, there are no assurances that
it will be able to do so.

HCMC originates new multifamily and commercial mortgage loans through
originators that call on brokers, real estate developers and owners. While the
Company's sales force concentrates primarily on sourcing pools of single-family
mortgage loans, it also can find leads for the multifamily and commercial
mortgage loan origination business of HCMC and the due diligence operations of
HCP.

Commercial and Multifamily Underwriting Guidelines. The Company's
underwriting guidelines for commercial and multifamily mortgage loans focus on
the origination of loans eligible for securitization. The due diligence process
focuses on four main areas: (i) a property level review, (ii) borrower credit
issues, (iii) cash flow structures, and (iv) adequacy of legal documentation.
The property level review begins with a review of the on-site inspection report
and includes an analysis of the third party reports, including the appraisal,
engineering report and environmental report. The borrower credit issues include
an analysis of the borrower's legal structure, a review of financial statements,
past credit history of principals, management's ability and experience and
prior/existing relationships. The cash flow structures include an analysis of
the loan-to-value ratio, the expense ratio, the debt service coverage, the value
per unit, the occupancy levels and the historical expense records. The legal
documentation review includes a review of any changes to the approved program
loan documents, including the note, mortgage, reserve agreements, assignments of
leases and any borrower certifications. The program loan documents will be
structured in order to meet the requirements of securitization with respect to
such matters as prepayment penalties, recourse carve-outs and the overall
soundness of the documents. In addition, the Company obtains a "Phase I"
environmental site assessment (i.e.,

<PAGE> 48

generally a record search with no invasive testing) of the property that will
secure a commercial or multifamily mortgage loan. Depending on the results of
the Phase I assessment, the Company may require a Phase II assessment. The
Company's loan servicing guidelines require that the Company obtain a Phase II
assessment (which includes invasive testing) of any mortgaged property prior to
the Company acquiring title to or assuming operation of the mortgaged property.
This requirement effectively precludes the Company from enforcing the rights
under the mortgage loan until a satisfactory Phase I environmental site
assessment is obtained or until any required remedial action is thereafter
taken, but also decreases the likelihood that the Company will become liable for
any material environmental condition at a mortgaged property.

Commercial and Multifamily Mortgage Loan Servicing. To control the credit
risk of retained interests in securitized loans, HCMC will retain the servicing
rights on any commercial mortgage loans and multifamily mortgage loans held in
the Investment Portfolio. HCMC may also retain the servicing rights on loans
originated and sold to third party conduits. HCMC, as servicer, will have the
risks associated with operating a mortgage servicing business as well as the
risk of ownership of the servicing.

At March 31, 1998, HCMC serviced approximately $56 million of multifamily
mortgage loans. 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.

Commercial Market Trends. The market for commercial and multifamily mortgage
loans has undergone dramatic changes in recent years with the advent of
securitizations. Financing of income-producing property has evolved from a
traditional two-party lending relationship, with the borrower obtaining funding
from a traditional lending institution, to a market in which lenders with
expertise in the creation of mortgage-backed securities offer borrowers an
alternative source of competitive financing. Securitization involves multiple
parties, each with specialized roles and responsibilities creating profitable
lending opportunities for those with experience in commercial mortgage finance
and the capital markets. Securitizations of commercial and multifamily mortgage
loans have grown rapidly during the 1990s.

The growth in securitization has been the result of two market forces. First,
during the recession of the early 1990s, traditional lenders withdrew from the
real estate credit market. Securitization filled the resulting void. Second,
Congress established the Resolution Trust Corporation ("RTC") in 1989 in order
to liquidate the commercial and single-family mortgage assets of failed
financial institutions. After unsuccessfully trying to sell the mortgages, the
RTC began securitizing commercial mortgages. The RTC's enormous securitization
program

<PAGE> 49

stimulated the growth of the private sector securitization market by providing
experience and knowledge to participants such as investment bankers, rating
agencies, mortgage companies, attorneys, accountants and loan servicers. These
participants have applied the experience and knowledge gained in the
securitization of RTC assets to the securitization of non-governmental,
private-label securities. The RTC's program also helped create an informed and
active investor base for the securities created from the securitization of
commercial mortgage assets.

The Company believes that success in the commercial market depends on a
vertically integrated strategy, which includes origination of commercial and
multifamily mortgage loans, servicing, securitization and investment in the
residual security after securitization. The Company is structured to take
advantage of efficiencies in the vertically integrated strategy, which it
anticipates will result in attractive returns to equity. However, there can be
no assurance that such returns will be achieved.

ACCUMULATION PERIOD ACQUISITIONS

At March 31, 1998, the Company had invested $312,390,000 or 40.7% of the
Company's total assets in the following types of mortgage securities in
accordance with the operating policies established by the Board of Directors.

(dollars in thousands)

Federal National Mortgage Association

(FNMA) Securities

<TABLE>
<CAPTION>
Adjustable
Rate Fixed Rate Total
-------- ---------- --------
<S> <C> <C> <C>
Par value at purchase date $200,524 $4,122 $204,646
March 31, 1998 adjusted $174,141 $4,122 $178,263
principal
Amortized cost basis $180,968 $4,330 $185,298
Market Value $180,093 $4,322 $184,415
Weighted average net coupon 7.73% 9.47% 7.77%
Weighted average maturity (in 285 303 285
months)
</TABLE>

<PAGE> 50

Federal Home Loan Mortgage Corp

(FHLMC) Securities

<TABLE>
<CAPTION>
Adjustable
Rate Fixed Rate Total
-------- ---------- --------
<S> <C> <C> <C>

Par value at purchase date $136,237 -- $136,237
March 31, 1998 adjusted $124,280 -- $124,280
principal
Amortized cost basis $128,764 -- $128,764
Market Value $127,975 -- $127,975
Weighted average net coupon 7.88% 7.88%

Weighted average maturity (in 300 300
months)
</TABLE>

DUE DILIGENCE OPERATIONS

The Company conducts due diligence operations through HCP for commercial
banks, government agencies, mortgage banks, credit unions and insurance
companies. The operations consist of the underwriting of credit, analysis of
loan documentation and collateral, and analysis of the accuracy of the
accounting for mortgage loan servicing by third party servicers. The due
diligence analyses are performed on a loan by loan basis. Audits of the accuracy
of the interest charged on adjustable rate mortgage loans are frequently a part
of the due diligence services provided to customers. HCP performs due diligence
on mortgage loans acquired by the Company and by unrelated third parties.

FINANCING

General

The Company's purchases of mortgage 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 long term financing. The
Company had established mortgage asset financing agreements with various
financial institutions at March 31, 1998 and is currently negotiating a back-up
line of credit agreement with several major financial institutions.

Reverse Repurchase Agreements

A reverse repurchase agreement, 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, typically 80% to 98%. 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

<PAGE> 51

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 the arrangements with several different parties. The
Company monitors 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 fixed (one year or less)
interest rates varying from LIBOR to LIBOR plus 125 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 dramatically rising
interest-rate markets, could require the Company to sell assets to reduce the
borrowings.

SECURITIZATION AND SALE PROCESS

General

When the Company acquires a sufficient volume of mortgage loans with similar
characteristics, generally $50 million to $100 million or more, the Company
plans to securitize them through the issuance of mortgage-backed securities in
the form of REMICs or CMOs. 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 certain factors,
including the length of the purchase commitment period, the amount and type of
the mortgage loan, and the securitization process. Any decision by the Company
to issue CMOs or REMICs or to sell mortgage loans in bulk will be influenced by
a variety of factors.

<PAGE> 52

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.

As an alternative to CMOs, the Company may issue REMICs. REMIC transactions
are generally accounted for as sales of the mortgage loans. 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 redeployed. The Company may retain regular and residual interests on a
short-term or long-term basis. Since gains on REMIC issuances by a REIT may be
subject to a 100% prohibited transaction tax if made to "customers" of the REIT,
the Company may issue REMICs through its 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.

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 are declining
due to increases in interest rates.

<PAGE> 53

The Company typically pays 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

REMICs or CMOs 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
will diminish the potential expansion of the Investment Portfolio. 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

<PAGE> 54

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 of 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 mortgage asset, and (ii) monitoring the
credit and prepayment performance of each mortgage asset to adjust the required
capital. This analysis takes into account the Company's various hedging and
other risk containment programs discussed below. In this way, the use of balance
sheet leverage is optimized through the implementation of the CAG controls. The
lender haircut indicates the minimum amount of equity the lender requires with a
mortgage asset. There is some variation in haircut levels among lenders from
time to time. From the lender's perspective, the haircut is a "cushion" to
protect capital in case the borrower is unable to meet a margin call. The size
of the haircut depends on the liquidity and price volatility of each mortgage
asset. 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, "B" rated securities 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. 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.

Implementation of the CAG -- Mark to Market Accounting

Each quarter, for financial management purposes, the Company marks its
mortgage assets to market. This process consists of (i) valuing the Company's
mortgage assets acquired in the secondary market, and (ii) valuing the Company's
non-security investments, such as retained interests in securitizations. For the
purchased mortgage assets, the Company obtains benchmark market quotes from
traders who make markets in securities similar in nature to the mortgage assets.
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 mortgage assets
(and hedges). This is the current market value of the Company's equity
positions. This value is compared to the required capital as

<PAGE> 55

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 mortgage asset.

As a result of these procedures, the leverage of the balance sheet will
change with the performance of the Company's mortgage assets. Good credit or
prepayment performance may release equity for purchase of additional mortgage
assets, leading to increased earnings. Poor credit or prepayment performance may
cause additional equity to be allocated to existing investments, forcing a
reduction in mortgage assets on the balance sheet and lower future earnings. In
either case, the constant mortgage asset performance evaluation, along with the
corresponding leverage adjustments, helps 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 reduces credit risk through (i) the review of each 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 closely monitors the
geographic dispersion of the mortgage loans and makes decisions on a portfolio
by portfolio basis about adding to specific concentrations.

Commercial mortgage loans held by the Company generally are originated by
HCMC to underwriting standards established by the Company. These underwriting
standards reflect the experience of HCMC in its past originations as well as the
requirements of the rating agencies for commercial mortgage loans. The credit
underwriting includes a financial and credit check of the borrower, technical
reports including appraisal, engineering and environmental reports, as well as a
review of the economic status of the geographic area where the mortgaged
property is located. In addition, a separate credit sign-off is required before
commercial mortgage loans are transferred to the Investment Portfolio from HCMC.
The commercial mortgage loans in the Investment Portfolio will be monitored by
the servicing department of HCMC, which includes a periodic review of financial
statements of the mortgaged property as well as property inspections.

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

<PAGE> 56

loans, a full due diligence review is undertaken, including a review of the
documentation, appraisal reports and credit underwriting. 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

There are two basic types of mortgage loans held by the Company: mortgage
loans held for securitization or sale and mortgage loans held in securitized
form. Mortgage loans held for securitization or sale are generally hedged. A
variety of hedging instruments may be used, depending on the asset to be hedged
and the relative price of the various hedging instruments. Hedging instruments
include forward sales of mortgage securities, and may also include interest rate
futures or options, interest rate swaps, and cap and floor agreements. Mortgage
loans held in securitized form are generally financed in a manner designed to
maintain a consistent spread in a variety of interest rate environments and
therefore do not require any hedging.

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

With respect to commercial and multifamily mortgage loans, the Company will
seek to minimize the effects of faster or slower than anticipated prepayment
rates by originating mortgage loans with prepayment penalties and utilizing
various financial hedging instruments. With respect to single-family mortgage
loans, the Company utilizes various financial instruments as a hedge against
prepayment risk. 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
interest rate and prepayment risks, no strategy can completely insulate the
Company from the effects of 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 may 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
assets is through its strategy of securitizing mortgage loans with
collateralized mortgage obligation ("CMO") borrowings, 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

<PAGE> 57

primary interest rate risk relates to mortgage assets that are financed with
reverse repurchase agreements and are held for securitization.

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 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. One
example is an interest rate cap. 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 may also purchase mortgage
derivative securities. Mortgage derivative securities can be 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 must
meet REIT requirements. To a lesser extent, the Company may also enter 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 may utilize hedging strategies, including
mandatory and optional forward selling of mortgage loans or mortgage-backed
securities, interest rate caps and 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 may 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 assure that it does not violate the REIT rules, which
could result in disqualification and/or payment of penalties.

<PAGE> 58

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 (along with purchased single-family mortgage
loans) or created (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
Company.

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

There are various state and local laws and regulations affecting the
Investment Portfolio. HCMC has mortgage-banking licenses in Arizona, Illinois,
New Jersey, Vermont and Wisconsin. 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. The Company believes
that it is currently in compliance with all material rules and regulations to
which it is subject and has all required licenses.

COMPETITION

The Company participates on a national level in the mortgage market, which is
estimated at $3.8 trillion for single-family mortgage loans and $1.0 trillion
for multifamily mortgage loans and commercial loans. In purchasing mortgage
loans 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 traditional financial institutions, the Company seeks to

<PAGE> 59

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

The Company had no employees at December 31, 1997. The Principals became
employees of the Company as of January 1, 1998. The Company engages the services
of HCP to provide management expertise, product sourcing, due diligence support,
and general and administrative services to assist the Company in accomplishing
its business objectives. At March 31, 1998, HCP employed 44 people on a
full-time basis and 31 people on a temporary basis. To date, HCP believes it has
been successful in its efforts to recruit qualified employees, but there is no
assurance that it will continue to be successful in the future. None of HCP's
employees are subject to collective bargaining agreements.

SERVICE MARKS

HCP owns two service marks that have been registered with the United States
Patent and Trademark Office, each of which expires in the year 2003.

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 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

<PAGE> 60

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.

RELATIONSHIPS WITH AFFILIATES AND PRIOR BUSINESS

HCP has rendered asset management services in connection with the short-term
trading of seasoned (more than one year since origination) single-family
mortgage loans since 1995. In managing mortgage activities, HCP typically
targeted mortgage loan pools containing subprime single-family mortgage loans
with deficiencies that could be corrected so as to permit resales on favorable
terms. In managing sale activities, HCP generally has pursued a strategy of
selling single-family mortgage loans within eighteen months after their
acquisition. The Company, on the other hand, generally holds mortgage loans on a
long-term basis, so that returns are earned over the lives of mortgage loans
rather than from their sales.

In the past, HCP has engaged in single-family mortgage loan acquisition,
financing, hedging and sale activities pursuant to private management
arrangements with (i) Alpine Associates, a Limited Partnership ("Alpine
Associates"), (ii) a limited liability company formed by HCP, Alpine Associates
and an affiliate of Bankers Trust New York Corp. and (iii) certain affiliates of
Bankers Trust New York Corp. The objective in each of those arrangements was to
profit from purchasing and reselling mortgage loans rather than, as in the case
of the Company, from holding, financing and securitizing mortgage loans.

Alpine Associates and HCP formed Alpine/Hanover LLC in May of 1996, as a
successor to a partnership formed by them in February of 1994, to trade in
portfolios of subprime single-family mortgage loans. In October of 1995, HCP,
Alpine/Hanover LLC and BAHT 1995-1 Corp., an affiliate of Bankers Trust New York
Corp., formed ABH-I LLC to trade in subprime single-family mortgage loans.
Pursuant to separate asset management contracts with BT Realty Resources, Inc.,
HCP has rendered management services similar to those it has rendered for ABH-I
LLC. HCP intends to wind down and terminate Alpine/Hanover LLC and ABH-I LLC at
such time as all of the ABH-I LLC assets have been sold. As of February 28,
1998, the remaining assets of ABH-I LLC had an aggregate principal amount of
approximately $300,000. HCP intends to wind down and terminate its management
arrangement with BT Realty Resources, Inc. at such time as all of the assets
under management have been sold. As of February 28, 1998, the remaining assets
under management had an aggregate principal amount of approximately $100,000.

The Company continues to acquire and hold the Investment Portfolio. HCP has
continued to conduct the due diligence operations and, in addition, support the
Company's acquisition and investment activities by providing due diligence
services to the Company. HCMC has continued to originate, sell and service
multifamily mortgage loans and commercial mortgage loans and, in addition, may
in the future support the Company's acquisition and investment activities by
serving as a source of multifamily mortgage loans and commercial mortgage loans.
HCS facilitates the Company's trading activities by acting as a broker/dealer.

<PAGE> 61

Properties

The Company's operations are conducted in several leased office facilities
throughout the United States. A summary of the office leases is shown below:

<TABLE>
<CAPTION>
LOCATION OFFICE MINIMUM EXPIRATION
SPACE ANNUAL DATE
(SQ. FT) RENTAL
<S> <C> <C> <C>
New York, New York 2,300 $ 42,800 November 2001

Edison, New Jersey 5,850 75,400 June 2002

Chicago, Illinois 3,900 58,900 June 1999

St. Louis, Missouri 1,007 26,800 August 1998

Rockland, Massachusetts 300 6,000 Month to Month

Sacramento, California 150 5,600 July 1998

St. Paul, Minnesota 150 5,600 July 1998
------ -------- --------------
Total: 13,657 $222,900
------ --------
</TABLE>

Management of the Company believes that these facilities are adequate for the
Company's foreseeable needs and that lease renewals and/or alternate space at
comparable rental rates is available, if necessary.

LEGAL PROCEEDINGS

The Company is not engaged in any material legal proceedings. However, two
affiliates have been parties to certain proceedings describe below. To the
extent that the results of these proceedings are adverse to the affiliates, the
proceedings could also adversely affect the Company.

On or about January 15, 1997, Quarters on Melody Lane Partnership ("Quarters")
brought suit against HCMC in the District Court in Dallas County, Texas (titled
Quarters on Melody Lane Partnership v. Hanover Capital Mortgage Corporation et
al.) In a letter dated December 17, 1996, Quarters threatened to sue HCMC and
others unless Quarters was permitted to prepay a multifamily mortgage loan,
which had been originated by HCMC, without pre-payment penalties. The initial
principal balance of the multifamily mortgage loan, which closed on June 28,
1994, was approximately $1.76 million. A portion of the proceeds of the loan
were retained in an escrow account to fund the cost of repairs, replacements and
improvements. Quarters alleged that HCMC personnel orally represented before the
closing that funds would be disbursed from the escrow account other (and more
favorably to the obligor) than as provided in the loan documents. Disbursements
have not been made in accordance with such alleged representations. HCMC sold
the loan on the day of closing and sold the servicing rights to the loan in
December 1994. In a written response to the letter, HCMC denied that its
representatives made any misrepresentations to Quarters. Thereafter, Quarters
filed suit against HCMC and

<PAGE> 62

others as defendants in District Court in Dallas County, Texas. The complaint
alleges that HCMC is guilty of fraudulent misrepresentations, breach of
contract, fraudulent withholding of funds, breach of fiduciary duty and
conversion. On July 17, 1997, Quarters filed an amended petition, alleging
actual damages in the amount $300,000.00 and seeking punitive damages in the
amount $1,000,000.00. On August 29, 1997, a court-ordered mediation between all
parties was held, at which time it was believed that a settlement had been
reached. In exchange for a complete release, HCMC agreed to pay Quarters
$20,000.00. However, as of this date, a final settlement agreement has not yet
been executed and one of the other defendants has not yet agreed to the
settlement. In early January, 1998, Quarters requested certain defendants,
including HCMC, to settle separately. However, HCMC elected not to settle
separately. HCMC has retained counsel and is defending itself in such action.
Management of the Company does not believe that this claim will have a material
adverse effect of the Company's financial condition and results of operations.

<PAGE> 63
MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The Company was incorporated in the state of Maryland on June 10, 1997. The
following table sets forth certain information with respect to the directors and
executive officers of the Company:

<TABLE>
<CAPTION>
NAME AGE POSITION
- - ---- --- --------
<S> <C> <C>
John A. Burchett...................... 55 Chairman of the Board, Chief Executive
Officer and President
Irma N. Tavares....................... 43 Managing Director and a Director
Joyce S. Mizerak...................... 42 Managing Director, Secretary and a Director
George J. Ostendorf................... 53 Managing Director and a Director
Ralph F. Laughlin..................... 44 Senior Vice President, Chief Financial Officer, Treasurer
and Assistant Secretary
Julia M. Curran....................... 36 Senior Vice President
James C. Strickler.................... 41 Senior Vice President
Robert E. Campbell.................... 64 Director
John A. Clymer........................ 50 Director
Joseph J. Freeman..................... 66 Director
Saiyid T. Naqvi....................... 48 Director
John Nicholas Rees.................... 64 Director
</TABLE>

- - ----------

John A. Burchett has been the Chairman of the Board, President and Chief
Executive Officer of the Company since its inception in June 1997. Mr. Burchett
has also been the Chairman of the Board, President and Chief Executive Officer
of each of HCP and Hanover Capital Mortgage Corporation, a subsidiary of HCP,
since each of their formations in 1989 and 1992, respectively. Prior to the
founding of HCP, Mr. Burchett held executive positions in the national mortgage
finance operations of two global financial institutions: Citicorp Investment
Bank ("Citicorp") from 1980 to 1987 and Bankers Trust Company ("Bankers Trust")
from 1987 to 1989. Mr. Burchett was also Senior Vice President and Chief
Financial Officer from 1976 to 1980 for City Federal Savings, which was one of
the largest thrift institutions in the United States at the time he left. Mr.
Burchett has an MBA in Finance from Columbia University and a BSME in Mechanical
and Aerospace Sciences from the University of Rochester.

While at Citicorp, Mr. Burchett served as co-head of Global Mortgage Finance,
managing a seven office national institutional sales force, the New York
mortgage trading desk, mortgage trading operations, the Citimae mortgage
conduit, mortgage pipeline hedging, mortgage research, contracts and private
label securities structuring and rating. During Mr. Burchett's tenure, Citicorp
bought and sold Mortgage Loans and mortgage-backed securities and operated the
Citimae mortgage conduit, a single-family residential mortgage conduit created
during his tenure. During that period, Citimae issued fixed rate and adjustable
rate, AA rated, pass-through certificates and multi-tranche CMOs. Mr. Burchett's
duties also included the management of sales and trading of Agency
mortgage-backed securities.

While at Bankers Trust, Mr. Burchett managed its then newly formed
Mortgage Finance group, which included the retail mortgage banking operations
as well as origination, sales and trading of mortgage loans and
mortgage-backed securities. During Mr. Burchett's tenure,

<PAGE> 64
Bankers Trust became a member of FNMA's dealer group, issued its first CMOs and
participated in the securitization of mortgage loans for several state pension
funds.

Irma N. Tavares, has been a Director and Managing Director of the Company
since its inception in June 1997. Ms. Tavares has also been a Managing Director
and Director of HCP since its formation in 1989. At HCP, Ms. Tavares was
responsible for HCP's whole loan trading and related hedging activities and
oversaw the purchase of Single Family Mortgage Loans by entities for which HCP
rendered management services. Ms. Tavares has valued, purchased and re-sold
whole loans through a six member sales force on behalf of Alpine/Hanover LLC and
ABH-I LLC. Ms. Tavares has managed the purchase of a wide variety of performing
and semi-performing pools of primarily Single-Family Mortgage Loans ranging from
heterogeneous pools purchased from RTC and the FDIC to highly structured pools
of performing newly originated Mortgage Loans sold by banks, thrift institutions
and mortgage companies throughout the U.S.

While at HCP, Ms. Tavares also served for three years as investment manager
for a publicly-traded mutual fund, Midwest Income Trust's Adjustable Rate U.S.
Government Securities Fund. That Fund, designed by HCP, was one of the first of
its kind to be rated AAAf by Standard and Poor's Corporation. For the twelve
month period ending October 31, 1996, its performance was ranked 16th of 53 such
funds by Lipper Analytical Services. The Fund invests in Agency adjustable rate
mortgage backed securities with the objective of high current income while
maintaining stable net asset values.

Prior to joining HCP, Ms. Tavares held similar trading positions at both
Citicorp from 1983 to 1987 and Bankers Trust from 1987 to 1989 working with
Mr. Burchett. Ms. Tavares holds a BS in Accounting from Seton Hall University.

Joyce S. Mizerak, has been a Director, Managing Director and Secretary of the
Company since its inception in June 1997. Ms. Mizerak has also been a Managing
Director of HCP since its formation in 1989. At HCP, Ms. Mizerak's duties
included the approval of Multifamily Mortgage Loans and Commercial Mortgage
Loans originated by HCMC, the establishment of investor relationships with
purchasers of such Mortgage Loans, as well as oversight of the mortgage
operations group which provides transactional due diligence and contractual
review services for HCP's mortgage trading activities. Ms. Mizerak has
negotiated various investor relationships with entities that have been
securitizing HCMC's Mortgage Loan production.

Prior to joining HCP, Ms. Mizerak had responsibilities at Bankers Trust from
1988 to 1989 for mortgage transaction contracts. Before joining Bankers Trust,
Ms. Mizerak held a variety of positions at Citicorp from 1984 to 1988 including
the trading of whole Mortgage Loans for Citicorp's Citimae residential mortgage
conduit. Prior to joining Citicorp, Ms. Mizerak was a mortgage-backed securities
rating analyst at Standard and Poor's Corporation. Ms. Mizerak holds a BA from
the University of Scranton and an MBA in Finance from Temple University.

George J. Ostendorf, has served as a Director of the Company since its
inception in June 1997. Mr. Ostendorf also serves as a Managing Director of
the Company. Mr. Ostendorf has also been a Managing Director of HCP since
its formation in 1989. Mr. Ostendorf's duties at HCP included senior
relationship management of HCP's clients which ranged from small depository
institutions to the largest mortgage lenders in the country. Mr. Ostendorf
caused HCP to enter a number of businesses including mortgage securitization
advisory services, due diligence and ARM auditing. In 1992, Mr. Ostendorf
finalized the initial conduit structure which led to HCP's entry into the
Multifamily Mortgage Loan and Commercial Mortgage Loan

<PAGE> 65

origination business and the formation of HCMC. A frequent speaker at mortgage
industry events, Mr. Ostendorf has written several articles for mortgage
industry publications.

Prior to joining HCP, Mr. Ostendorf was responsible for origination and
distribution of mortgage securities transactions by Chicago based sales forces
that he managed for Citicorp and later for Bankers Trust. Mr. Ostendorf was
Chief Lending Officer for Horizon Federal Savings, one of Illinois's largest
thrift institutions at the time, prior to joining Citicorp. Mr. Ostendorf holds
an MBA in Finance and a BS degree from DePaul University.

Ralph F. Laughlin, has been a Senior Vice President, Chief Financial
Officer, Treasurer and Assistant Secretary of the Company since its inception in
June 1997. Mr. Laughlin has also been Chief Financial Officer of HCP since May
1996. Prior to 1996, Mr. Laughlin was Vice President of Finance for Middex
Development Corporation ("Middex"), a New York based owner and operator of
office buildings, shopping centers and hotels, and the holder of a controlling
interest in Hodgson Houses, Inc., a publicly traded modular home builder. Mr.
Laughlin is responsible for HCP's accounting and financial reporting. As Vice
President of Finance and Chief Financial Officer of Middex, Mr. Laughlin was
responsible for the development and management of all financial and
administrative functions, including strategic planning, budgeting, accounting
and procedures. Prior to joining Middex, Mr. Laughlin was employed as a
Certified Public Accountant at Deloitte & Touche LLP. Mr. Laughlin has a BBA in
Accounting from Kent State University.

Julia M. Curran, has been Senior Vice President of the Company since its
inception in June 1997. Ms. Curran is also a Senior Vice President of HCP and
has been employed by HCP since 1990. At HCP Ms. Curran had primary
responsibility for the Commercial Mortgage Loan delivery and servicing operation
of HCP. She was also responsible for day-to-day management of HCP's due
diligence and ARM auditing operations. Prior to joining HCP, Ms. Curran held
various mortgage servicing positions at Bankers Trust Company and mortgage loan
delivery and servicing at City Federal Savings. Ms. Curran holds a BA in
Economics and Business from Lafayette College.

James C. Strickler, Jr., has been Senior Vice President of the Company since
its inception in June 1997. Mr. Strickler is also a Senior Vice President of HCP
and has been employed by HCP since 1995. Mr. Strickler's responsibilities at HCP
included day-to-day trading and hedging of the firms' whole loan portfolio held
for sale. Mr. Strickler has developed several models to evaluate performing,
non-performing and poorly documented fixed and ARM portfolios. Prior to
purchase, Mr. Strickler analyzes the Mortgage Loan pools to obtain sufficient
demographic, geographic, credit and empirical information to evaluate
prospective Mortgage Loan pool pricing. After purchase, Mr. Strickler provides
the sales force with various methods of comparing the characteristics of
portfolios held for sale to other opportunities available to prospective buyers
in the mortgage marketplace and structures pools of Mortgage Loans to appeal to
various types of buyers so as to seek to optimize the return to HCP.

Prior to joining HCP, Mr. Strickler held positions as a trader of whole
loans, asset backed securities, non-Agency mortgage backed securities, and asset
backed securities at Morgan Stanley & Co., Incorporated from 1984 to 1988,
Chemical Bank from 1988 to 1992, and most recently, Lehman Brothers Inc. from
1992 to 1995. Mr. Strickler received an MBA with a concentration in Finance from
the University of Chicago and an A.B. from Duke University.

<PAGE> 66

Robert E. Campbell has served as a Director of the Company since January
1998. Mr. Campbell is a retired former Vice Chairman of the Board of Directors
of Johnson & Johnson. Mr. Campbell had assumed this position in April 1989.
Among his professional affiliations, Mr. Campbell is a Chairman of the Board of
The Cancer Institute of New Jersey and Chairman of the Board of The Trustees of
Fordham University. He is also a member of the Board of The Robert Wood Johnson
Foundation, ARGO Med, Inc. and The Parker Memorial Home, is a member of the
Advisory Council for the College of Science of the University of Notre Dame, is
Chairman of the Board of New Brunswick Affiliated Hospitals and is Chairman of
the Board of the Family Practice Center of St. Peter's Medical Center.

John A. Clymer has served as a Director of the Company since the
consummation of the Company's initial public offering in September 1997. Since
September 1994, Mr. Clymer has been the President and Chief Investment Officer
of Resource Capital Advisers, Inc. From 1972 until January 1994, Mr. Clymer was
the President of Minnesota Mutual Life Insurance and for the period from 1991 to
1994 was the President of Minnesota Mutual Life Insurance. Among his
professional affiliations, Mr. Clymer is a member of the Board of Hudson Medical
Center, Inc., Hudson Hospital Corporation, Inc., Resources Companies, Inc. and
WTC Industries, Inc. He has an MBA in Finance and a B.S. in Engineering from the
University of Wisconsin.

Joseph J. Freeman has served as a Director of the Company since October
1997. Since 1986, Mr. Freeman has been the President of LRF Investments, Inc., a
privately held venture capital firm. Mr. Freeman is currently on the Board of
Directors of LRF Investments, Inc., Newton Group, Inc. and Work Management
Solutions, Inc.

Saiyid T. Naqvi has served as a Director of the Company since March
1998. Mr. Naqvi is the President and Chief Executive Officer of PNC Mortgage
(formerly Sears Mortgage Corporation). He joined PNC Mortgage in 1993 with the
acquisition of Sears Mortgage Corporation, which he had joined in 1985 as senior
vice president of secondary marketing.

John Nicholas Rees has served as a director of the Company since the
consummation of the Company's initial public offering. Since 1985, Mr. Rees has
been President of Pilot Management, a privately held investor/consultant firm.
From 1974 to 1985, Mr. Rees was Vice Chairman of the Bank of New England
Corporation where he was responsible for its finance, strategic planning, money
market, government banking and data processing operations. He has an MBA from
Harvard University and a B.A. in Economics from the University of Virginia. Mr.
Rees also serves as a director of various private corporations.

TERMS OF DIRECTORS AND OFFICERS

The Company's Board of Directors consists of such number of persons as shall
be fixed by the Board of Directors from time to time by resolution to be divided
into three classes, designated Class I, Class II and Class III, with each class
to be as nearly equal in number of directors as possible. Currently there are
nine directors. George J. Ostendorf, John Nicholas Rees and Joseph J. Freeman
are Class I directors, Irma N. Tavares, Robert E. Campbell and Joyce S. Mizerak
are Class II directors and John A. Burchett, John A. Clymer and Saiyid T. Naqvi
are Class III directors. Class I, Class II and Class III directors will stand
for reelection at the annual meetings of stockholders of the Company held in
2001, 1999 and 2000, respectively. At each annual meeting, the successors to the
class of directors whose term expires at that time are to be elected to hold
office for a term of three years, and until their respective successors are
elected and qualified, so that the term of one class of directors expires at
each such annual meeting. The

<PAGE> 67

Company intends to maintain the composition of the Board so that there will
be no more than nine directors, with a majority of independent directors at all
times after the initial issuance of the Units, at least two of whom shall serve
on the Audit and/or Compensation Committees. In the case of any vacancy on the
Board of Directors, including a vacancy created by an increase in the number of
directors, the vacancy may be filled by election of the Board of Directors or
the stockholders, with the director so elected to serve until the next annual
meeting of stockholders (if elected by the Board of Directors) or for the
remainder of the term of the director being replaced (if elected by the
stockholders); any newly-created directorships or decreases in directorships are
to be assigned by the Board of Directors so as to make all classes as nearly
equal in number as possible. Directors may be removed only for cause and then
only by the affirmative vote of two-thirds of the combined voting power of
stockholders entitled to vote in the election for directors. Subject to the
voting rights of the holders of any Preferred Stock, the charter may be amended
by the affirmative vote of two-thirds of the combined voting power of
stockholders, provided that amendments to the charter dealing with directors may
only be amended if it is advised by at least two-thirds of the Board of
Directors and approved by vote of at least two-thirds of the combined voting
power of stockholders. The effect of the foregoing as well as other provisions
of the Company's charter and bylaws may discourage takeover attempts and make
more difficult attempts by stockholders to change management. Prospective
investors are encouraged to review the charter and bylaws in their entirety. See
"Risk Factors -- Preferred Stock; Restrictions on Ownership of Common Stock;
Antitakeover Risk."

COMMITTEES OF THE BOARD

Audit Committee. The Company has an Audit Committee whose present members
are Mr. Burchett, Ms. Tavares, Mr. Clymer, Mr. Rees and Mr. Freeman. The Audit
Committee recommends to the Board of Directors the selection of independent
public accountants to serve as the Company's auditors and reviews the scope of
their audit, their audit report and any recommendations made by them. The Audit
Committee also conducts reviews of any related-party transactions or potential
conflict of interest situations.

Compensation Committee. The Board of Directors has a Compensation Committee
whose members are Mr. Clymer, Mr. Rees and Mr. Freeman. The Compensation
Committee annually reviews the Company's compensation policy for executive
officers and makes recommendations to the Board of Directors with respect to
that policy, as well as making compensation decisions for executive officers,
and it administers the Company's Bonus Incentive Compensation Plan and the
Company's 1997 Stock Option Plan.

Other Committees. The Board of Directors may establish other committees as
deemed necessary or appropriate from time to time, including, but not limited
to, an Executive Committee of the Board of Directors.

COMPENSATION OF DIRECTORS

The Company pays independent directors $15,000 per year, $500 for each
meeting attended in person and stock options pursuant to the 1997 Stock Option
Plan. See "Management -- 1997 Stock Option Plan." All directors receive
reimbursement of reasonable out-of-pocket expenses incurred in connection with
meetings of the Board of Directors. No director who is an employee of the
Company receives separate compensation for services rendered as a director.

<PAGE> 68
COMPENSATION COMMITTEE INTERLOCKS

No interlocking relationship exists between the Company's Board of Directors
or officers responsible for compensation decisions and the board of directors or
compensation committee of any other company, nor has any such interlocking
relationship existed in the past.

EXECUTIVE COMPENSATION

The Company had no employees in 1997 and as such had no executive
compensation. The executive officers of the Company are also the executive
officers of HCP and as such received all of their compensation from HCP; a
portion of which was billed to the Company pursuant to the Management Agreement.
See "Certain Relationships Management Agreement" John A. Burchett, Irma N.
Tavares, Joyce S. Mizerak and George J. Ostendorf (collectively, the
"Principals") became employees of the Company as of January 1, 1998.

The following table contains information concerning compensation earned in
the years ended December 31, 1997 and December 31, 1996 by HCP's Chief Executive
Officer and its four other most senior executive officers who received total
salary and bonus in excess of $100,000 during the fiscal years ended December
31, 1997 and 1996 (the "Named Executive Officers"):

<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
Other Securities LTIP
Name and Principal Position Year Salary(1) Bonus(1) Compensation Underlying Options Payouts
- - --------------------------- ------ ----------- ------------ ------------- ------------------ -----------

<S> <C> <C> <C> <C> <C> <C>
John A. Burchett(2) 1997 $287,500(3) $545,715 $22,633(4) $113,737 $4,537,510
Chairman of the Board, 1996 250,000 110,000 25,195(5)
Chief Executive Officer
and President

Irma N. Tavares(2) 1997 213,750(6) 372,245 9,122(7) 43,029 1,237,500
Managing Director and a 1996 180,000 150,000 9,054(8)
Director

Joyce S. Mizerak(2) 1997 213,750(9) 372,245 7,959(10) 43,029 1,237,500
Managing Director and a 1996 180,000 150,000 7,515(11)
Director

George J. Ostendorf(2) 1997 225,000 141,271 16,728(12) 43,029 1,237,500
Managing Director and a 1996 225,000 35,000 16,972(13)
Director

James C. Strickler 1997 130,000 50,000 12,500
Senior Vice President 1996 129,583 5,000
</TABLE>

(1) Salary and bonus amounts are presented in the period earned; however,
the payment of such amounts may have occurred in other periods.
(2) Each of these persons entered into a five year Employment Agreement
with the Company on September 19, 1997. During 1997, this compensation
was paid by HCP. Beginning January 1, 1998, the compensation is paid by
the Company.
(3) Pursuant to his Employment Agreement, Mr. Burchett receives a base
annual salary of $300,000.
(4) Includes $6,908 for an automobile allowance, $13,385 for life insurance
premiums and $2,340 for club membership dues.
(5) Includes $6,609 for an automobile allowance, $16,246 for life insurance
premiums and $2,340 for club membership dues.
(6) Pursuant to her Employment Agreement, Ms. Tavares receives a base
annual salary of $225,000.
(7) Includes $7,200 for personal use of a company leased automobile and
$1,992 life insurance premiums.
(8) Includes $6,800 for personal use of a company leased automobile and
$2,254 life insurance premiums.
(9) Pursuant to her Employment Agreement, Ms. Mizerak receives a base
annual salary of $225,000.
(10) Includes $6,299 for an automobile allowance and $1,660 for life
insurance premiums.
(11) Includes $5,541 for an automobile allowance and $1,974 for life
insurance premiums.

<PAGE> 69

(12) Includes $7,200 for an automobile allowance, $7,368 for life insurance
premiums and $2,160 for club membership dues.
(13) Includes $6,516 for an automobile allowance, $8,656 for life insurance
premiums and $1,800 for club membership dues.

BONUS INCENTIVE COMPENSATION PLAN

The Company established a Bonus Incentive Compensation Plan for eligible
participants. The annual bonus pursuant to the Bonus Incentive Compensation Plan
will be paid one-half in cash and, subject to certain ownership limitations,
one-half in shares of common stock, annually, following receipt of the Company's
audit from its independent public accountants for the related fiscal year (or
prorated fiscal year). This Bonus Incentive Compensation Plan will award bonuses
annually to those eligible participants out of a total pool based upon annual
net income before bonus incentive compensation as follows:

<TABLE>
<CAPTION>
ACTUAL ROE(1)
IN EXCESS
OF BASE PLUS FIXED
BROE(2) BY: BONUS % MULTIPLIED BY MINIMUM BONUS
----------- ------- ------------- ----------------------
<S> <C> <C> <C>
Zero or less 0% Bonus Base (4) 0%
Zero to 6% 12.00% Bonus Base (4) 0%
Greater
than 6% 15.00% Incremental Bonus Base (5) Average Net Worth multiplied by .72%
</TABLE>

(1) "Actual ROE" means the Company's return on equity and is determined on
an annual basis by dividing (a) the Company's annual Net Income before
bonus incentive compensation, by (b) the Average Net Worth for the same
fiscal year. For such calculations "Net Income" of the Company means
the net income or net loss of the Company determined according to GAAP.
(2) "Base BROE" is the average weekly Ten-Year U.S. Treasury Rate, plus
4.0% for each fiscal year.
(3) "Average Net Worth" is the annual average of the end of the month Net
Worth of the Company (as determined in accordance with GAAP); without
regard to earnings or losses generated in the current fiscal year.
(4) "Bonus Base" is equal to (a) the annual Net Income before bonus
incentive compensation minus (b) (i) the Average Net Worth multiplied
by (ii) the Base BROE.
(5) "Incremental Bonus Base" is equal to (a) the annual Net Income before
bonus incentive compensation minus (b) (i) the Average Net Worth
multiplied by (ii) the Base BROE, minus (c) (i) the Average Net Worth
multiplied by (ii) 6%.

Of the amount so determined, one-half will be deemed contributed to the
total pool in cash and the other half will be deemed contributed to the total
pool in the form of shares of common stock with the number of shares of common
stock to be calculated based on the average price per share of the common stock
during the twenty day period that ends on the date of such determination.

No incentive compensation bonuses were earned for the year ended December
31, 1997.

<PAGE> 70

OPTION GRANTS IN FISCAL YEAR ENDED DECEMBER 31, 1997

The following table sets forth certain information regarding stock options
granted in 1997 to the Named Executive Officers:

<TABLE>
<CAPTION>
Potential Realized Value at
Assumed Annual Rates of
Stock Appreciation for
Individual Option Term(2)
Grants
Percent of
Number of Total
Securities Options
Underlying Granted to Exercise
Options Employees Price Expiration
Name Granted (#)(1) In 1997 ($/Share) Date 5%($) 10%($)
---- -------------- --------- ------- ----- ------ --------

<S> <C> <C> <C> <C> <C> <C>
John A. Burchett 89,467 28.37% $15.00 Sept. 2007 $1,062,578 $2,486,892
24,270 7.70% $15.75 Sept. 2007 270,046 656,425

Irma N. Tavares 24,399 7.74% $15.00 Sept. 2007 289,781 678,213
18,630 5.91% $15.75 Sept. 2007 207,292 503,881

Joyce S. Mizerak 24,399 7.74% $15.00 Sept. 2007 289,781 678,213
18,630 5.91% $15.75 Sept. 2007 207,292 503,881

George J. Ostendorf 24,399 7.74% $15.00 Sept. 2007 289,781 678,213
18,630 5.91% $15.75 Sept. 2007 207,292 503,881

James C. Strickler 12,500 3.96% $15.75 Sept. 2007 139,085 338,084
</TABLE>

(1) All options listed were granted pursuant to the 1997 Stock Option Plan.
Option exercise prices were at the market price when granted. The
options have a term of 10 years and vest over a three year period if
certain returns on the Company's securities are met. See " -- 1997
Stock Option Plan." The exercise price must be paid in cash or its
equivalent as determined by the Compensation Committee.
(2) The potential realizable value of the options, if any, granted in 1997
to each of the Named Executive Officers was calculated by multiplying
those options by the excess of (a) the assumed market value, at
September 2007, of common stock if the market value of the common stock
were to increase 5% or 10% in each year of the option's 10-year term
over (b) the base price shown. This calculation does not take into
account any taxes or other expenses which might be owed. The assumed
market value at a 5% assumed annual appreciation rate over the 10-year
term is $26.88 and such value at a 10% assumed annual appreciation rate
over that term is $42.80. At $26.88, the total market value of the
shares of common stock outstanding on March 31, 1998 would be
$173,824,277 which would be an increase of $67,124,107 from market
value of such shares at the close of business on December 31, 1997. At
$42.80, the total market value of shares of common stock outstanding on
March 31, 1998 would be $276,773,776 which would be an increase of
$170,073,605 from market value of such shares at close of business on
December 31, 1997. The 5% and 10% appreciation rates are set forth in
the Securities and Exchange Commission rules and no representation is,
of course, made that the common stock will appreciate at these assumed
rates or at all.

68
<PAGE> 71

AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED DECEMBER 31, 1997
AND FISCAL YEAR END OPTION VALUES

The following table sets forth certain information concerning the value of
stock options held at December 31, 1997 by the Named Executive Officers of the
Company. None of the Named Executive Officers exercised any stock options during
the year ended December 31, 1997.

<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money
Options at Options at
December 31, 1997 December 31, 1997
----------------- -----------------
Shares Acquired Value
Name on Exercise(#) Realized($) Exercisable Unexercisable Exercisable Unexercisable
--------- --------------- ----------- ----------- -------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
John A. Burchett 0 $0 0 89,467 0 $67,100
24,270 0 0

Irma N. Tavares 0 0 0 24,399 0 18,299
18,630 0 0

Joyce S. Mizerak 0 0 0 24,399 0 18,299
18,630 0 0

George J. Ostendorf 0 0 0 24,399 0 18,299
18,630 0 0

James C. Strickler 0 0 0 12,500 0 0
</TABLE>

(1) The value of unexercised options is based on the fair market value of
the underlying securities at December 31, 1997 ($15.75) minus the
exercise price. The fair market value of the underlying securities was
determined by allocating a portion of the increase in the fair market
value of a unit to the warrant by subtracting from the closing price of
the Company's units at December 31, 1997 ($16.50) one-half of the
difference between the closing price of the Company's units at December
31, 1997 and the initial public offering price per unit ($15.00).

EMPLOYMENT AGREEMENTS

On September 19, 1997, the Company entered into employment agreements with
the Company's Chief Executive Officer, John A. Burchett, and the Company's other
three most senior executive officers (Irma N. Tavares, Joyce S. Mizerak and
George J. Ostendorf). Each employment agreement provides for an initial term of
five years and will be automatically extended for an additional year at the end
of each year of the employment agreement, unless either party provides prior
written notice to the contrary or the employee has been terminated pursuant to
the terms thereof. The employment agreements provide for an initial annual base
salary of $300,000, $225,000, $225,000 and $225,000 for Mr. Burchett, Ms.
Mizerak, Ms. Tavares and Mr. Ostendorf, respectively. Each employment agreement
also provides for participation by the executive officer in the Company's Bonus
Incentive Compensation Plan and the Company's 1997 Stock Option Plan. See
"Management -- Bonus Incentive Compensation Plan;" " -- 1997 Stock Option Plan."
Each employment agreement also contains a covenant not to compete provision
which prohibits the executive officer from competing with the Company for a
certain period of time following the Company's termination of the executive
officer with good cause or termination by the executive officer without cause.
The Company may terminate each executive officer pursuant to each employment
agreement for "good cause" upon (i) the conviction of the executive officer of
(or the plea by the executive officer of nolo contendere to) a felony; (ii) the
good faith determination by the Board of Directors that the executive officer
has

<PAGE> 72

willfully and deliberately failed to perform a material amount of executive
officer's duties pursuant to the employment agreement (other than a failure to
perform duties resulting from the executive officer's incapacity due to physical
or mental illness), which failure to perform duties shall not have been cured
within thirty (30) days after the receipt by the executive officer of written
notice thereof from the Board of Directors specifying with reasonable
particularity such alleged failure; (iii) any absence from the Company's regular
full-time employment in excess of three consecutive days that is not due to a
vacation, participation in a permitted activity, bona fide illness, disability,
death or other reason expressly authorized by the Board of Directors in advance;
or (iv) any act or acts of personal dishonesty (including, without limitation,
any insider trading or unauthorized trading in the Company's securities) by the
executive officer which have a material adverse effect on the Company or any of
its subsidiaries.

In addition, in the event the executive officer is terminated by the Company
without good cause or the executive officer resigns from the Company within
ninety days after being removed from, or not re-elected to the Board of
Directors, despite the executive officer's efforts to remain on the Board of
Directors, the executive officer will be entitled to receive his or her base
salary then in effect until the later of one year from the date of termination
or the end of the term of the employment agreement. In the event that the
executive officer is terminated without good cause within ninety days after a
change of control (as defined in the employment agreement), then the executive
officer will be entitled to receive his or her base salary then in effect until
the later of two years from the date of termination or the end of the term of
the employment agreement. The employment agreements also provide each of such
executive officers with specified amounts of term life and disability insurance
coverage, a monthly automobile allowance and payment of club dues.

401(K) PLAN

The 401(k) Plan is available to all full-time Company employees with at
least six months of service. The 401(k) Plan is designed to be tax deferred in
accordance with provisions of Section 401(k) of the 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 ($9,500 in 1997). Under the 401(k)
Plan, an employee may elect to enroll on January 1, or July 1, provided that the
employee has met the six month employment service requirement.

1997 STOCK OPTION PLAN

General. The Company has adopted the 1997 Executive and Non-Employee
Director Stock Option Plan (the "Stock Option Plan"), which 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 Stock Option Plan is intended 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. The Stock Option Plan is
administered by the Compensation Committee. Members of the Compensation
Committee are eligible to receive only NQSOs.

Purpose. The 1997 Stock Option Plan is intended 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.

<PAGE> 73
Administration. The 1997 Stock Option Plan will be administered by the
Compensation Committee, which shall at all times be composed solely of
"non-employee directors" as required by Rule 16b-3 under the Exchange Act.
Members of the Compensation Committee are eligible to receive only NQSOs
pursuant to automatic grants of stock options discussed below.

Options and Awards. Options granted under the 1997 Stock Option Plan will
become exercisable in accordance with the terms of grant made by the
Compensation Committee. Awards will be subject to the terms and restrictions of
the Awards made by the Compensation Committee. Option and Award recipients shall
enter into a written stock option agreement with the Company. The Compensation
Committee has discretionary authority to select participants from among eligible
persons and to determine at the time an option or Award is granted when and in
what increments shares covered by the option or Award may be purchased or will
vest and, in the case of options, whether it is intended to be an ISO or a NQSO,
provided, however, that certain restrictions applicable to ISOs are mandatory,
including a requirement that ISOs not be issued for less than 100% of the then
fair market value of the Common Stock (110% in the case of a grantee who holds
more than 10% of the outstanding Common Stock) and a maximum term of ten years
(five years in the case of a grantee who holds more than 10% of the outstanding
Common Stock). Fair market value means as of any given date, with respect to any
option or Award granted, at the discretion of the Board of Directors or the
Compensation Committee, (i) the closing sale price of the Common Stock on such
date as reported in the Wall Street Journal, or (ii) the average of the closing
price of the Common Stock on each day of which it was traded over a period of up
to twenty trading days immediately prior to such date, or (iii) if the Common
Stock is not publicly traded, the fair market value of the Common Stock as
otherwise determined by the Board of Directors or the Compensation Committee in
the good faith exercise of its discretion.

Eligible Persons. Officers, directors and employees of the Company or
subsidiaries of the Company, and other persons expected to provide significant
services to the Company, are eligible to participate in the 1997 Stock Option
Plan. ISOs may be granted to the officers and key employees of the Company and
certain subsidiaries of the Company (but, because HCHI does not own voting stock
of HCP, not to employees of HCP, HCMC or HCS). NQSOs and Awards may be granted
to the directors, officers, key employees, agents and consultants of the Company
or any of its subsidiaries (and may be granted by HCHI to HCP for services
rendered by HCP to HCHI).

Shares Subject to the Plan. Subject to anti-dilution provisions for stock
splits, stock dividends and similar events, 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 Common Stock. If an option granted under the 1997 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 1997 Stock Option Plan.

Term of the Plan. Unless previously terminated by the Board of Directors,
the 1997 Stock Option Plan will terminate ten years from the date of approval
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.

Term of Options. Each option must terminate no more than ten years from the
date it is granted (or five years in the case of ISOs granted to an employee who
is deemed to own in

<PAGE> 74
excess of 10% of the combined voting power of the Company's outstanding equity
stock). 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.

Number of Options. The aggregate fair market value (determined as of the
time of grant) of the shares of the Common Stock with respect to which ISOs are
exercisable for the first time by an employee during any calendar year may not
exceed $100,000.

Option Exercise. The exercise price of any option granted under the 1997
Stock Option Plan is payable in full in cash, or its equivalent as determined by
the Compensation Committee. The Company may make loans available to option
holders to permit them to exercise options. Any such loan will be evidenced by a
promissory note executed by the option holder and secured by a pledge of Common
Stock of the Company with fair value at least equal to the principal of the
promissory note unless otherwise determined by the Compensation Committee.

Amendment and Termination of Stock Option Plan. The Board of Directors may,
without affecting any outstanding options or Awards, from time to time revise or
amend the 1997 Stock Option Plan, and may suspend or discontinue it at any time.
However, no such revision or amendment may, without approval by stockholders of
the Company, increase the number of shares of Common Stock subject to the 1997
Stock Option Plan, modify the class of participants eligible to receive options
or Awards granted under the 1997 Stock Option Plan or extend the maximum option
term under the 1997 Stock Option Plan.

Contingent Options. All stock options granted by the Compensation Committee
pursuant to the 1997 Stock Option Plan will be 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"). Subject to any other
applicable vesting restrictions, any outstanding stock options will vest in full
as of any Earn-Out Measuring Date through which the return on a Unit is at least
equal to the initial public offering price of the Unit. In addition, subject to
any other applicable 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 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 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 share of Common Stock 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.

Pursuant to the Management Agreement, the Company intends to cancel
options to purchase 72,509 shares of Common Stock of the Company that were
issued to employees of HCP in 1997 and reissue such options directly to HCP. HCP
will then grant its employees the right to exercise these options. See "Certain
Relationships and Related Transactions - Management Agreement."

<PAGE> 75

CERTAIN TRANSACTIONS

MANAGEMENT AGREEMENT

Effective as of January 1, 1998, the Company entered into a Management
Agreement (the "Management Agreement") with HCP. Under this agreement, HCP,
subject to the direction and control of the Company's Board of Directors,
provides certain services for the Company, including, among other things: (i)
serving as the Company's consultant with respect to formulation of investment
criteria and preparation of policy guidelines by the Board of Directors; (ii)
assisting the Company in developing criteria for the purchase of mortgage assets
that are specifically tailored to the Company's investment objectives; (iii)
representing the Company in connection with the purchase and commitment to
purchase or sell mortgage assets; (iv) arranging for the issuance of mortgage
securities from a pool of mortgage loans; (v) furnishing reports and statistical
and economic research to the Company regarding the Company's activities and the
services performed for the Company by HCP; (vi) monitoring and providing to the
Board of Directors on an ongoing basis price information and other data; (vii)
investing or reinvesting any money of the Company in accordance with its
policies and procedures and the terms and conditions of the Management
Agreement; (viii) providing the executive and administrative personnel office
space and services required in rendering such services to the Company; and (ix)
administering the day-to-day operations of the Company. For these services, the
Company pays HCP for each month an amount equal to the sum of (a) the wages and
salaries of the personnel employed by HCP and/or its affiliates (other than
independent contractors and other third parties rendering due diligence services
in connection with the acquisition of any mortgage assets) apportioned to the
Company for such month, plus (b) twenty-five percent (25%) of (a). The Company
also is required to pay HCP for each month an amount equal to the sum of (c) the
expenses of HCP for any due diligence services provided by independent
contractors and other third parties in connection with the acquisition of any
mortgage assets during such month plus (d) three percent (3%) of (c). Any amount
that may become payable by HCP to the Company for any services provided by the
Company to HCP, including the services of the Principals, is offset against
amounts payable to HCP.

Subject to other contractual limitations, the Management Agreement does not
prevent HCP from acting as an investment advisor or manager for any other
person, firm or corporation. The term of the Management Agreement continues
until December 31, 1999 and thereafter is automatically renewed for successive
one-year periods unless the Unaffiliated Directors (as defined therein) resolve
to terminate the Management Agreement.

Pursuant to the Management Agreement, the Company intends to cancel options
to purchase 72,509 shares of the Company's Common Stock that were issued to
employees of HCP in 1997 and reissue such options directly to HCP.
HCP will then grant its employees the right to exercise these options.

THE FORMATION TRANSACTIONS

In connection with the Company's initial public offering in September 1997,
the Company acquired a 97% ownership interest (representing 100% of the
non-voting preferred stock) in HCP and its wholly-owned subsidiaries, Hanover
Capital Mortgage Corporation ("HCMC") and Hanover Capital Securities, Inc.
("HCS") in exchange for an aggregate of 716,667 shares of the Company's Common
Stock issued to the Principals. The Principals may also be issued up to

<PAGE> 76

216,667 additional shares of Common Stock as additional payment for their
contribution of the preferred stock of HCP to the Company (the "Earn-Out"). The
Earn-Out may vest 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"). The Earn-Out will vest in full as of any Earn-Out Measuring
Date through which the return on a Unit offered in the Company's initial public
offering is at least equal to the initial public offering price of the Unit.
One-third of the Earn-Out 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 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 the Earn-Out has vested, appropriate
adjustments will be made for stock splits, recapitalizations, stock dividends
and transactions having similar effects.

In addition, up to $1,750,000 in loans made by the Company to the Principals
to enable the Principals to pay taxes will be forgiven to the extent that the
Earn-Out vests. These loans are secured by 116,667 shares of the Principal's
Common Stock but are otherwise nonrecourse to the Principals.

The shares of Common Stock acquired by the Principals (including any
additional shares to be issued upon the vesting of the Earn-Out) and the
forgiveness of any loans to the Principals upon the vesting of the Earn-Out
represent the consideration given to the Principals in exchange for their
contribution of the preferred stock of HCP to the Company.

Although the Company owns all of the preferred stock of HCP, the Company
generally has no right to control the affairs of HCP, HCMC and HCS (other than
to approve certain fundamental transactions such as mergers, consolidations,
sales of substantially all assets, and voluntary liquidations) because the
preferred stock of HCP is nonvoting. Instead, as the holders of all of the
Common Stock of HCP, the Principals control the operations and affairs of HCP,
HCMC and HCS. This ownership is required because, as a real estate investment
trust, the Company generally may not own more than ten percent of the voting
securities of any other issuer.

EMPLOYMENT AGREEMENTS

On September 19, 1997, the Company entered into employment agreements with
the CEO, John A. Burchett, and the other three of the Company's most senior
executive officers (Irma N. Tavares, Joyce S. Mizerak, and George J. Ostendorf).
Each employment agreement provides for an initial term of five years and will be
automatically extended for an additional year at the end of each year of the
employment agreement, unless either party provides prior written notice to the
contrary or the employee has been terminated pursuant to the terms thereof. The
employment agreements provide for an initial annual base salary of $300,000,
$225,000, $225,000, and $225,000 for Mr. Burchett, Ms. Mizerak, Ms. Tavares and
Mr. Ostendorf (each, a "Principal"), respectively. Each employment agreement
also provides for participation by the executive officer in the Company's Bonus
Incentive Compensation Plan and the Company's Stock Option Plan. Each employment
agreement also contains a not to compete provision which prohibits the executive
officer from competing with the Company for a certain period of time

<PAGE> 77

following the Company's termination of the executive officer pursuant to each
employment agreement for "good cause" or the executive officer's resignation of
his or her employment other than as a result of a change in control or within
ninety days after being removed from, or not elected to the Board of Directors,
despite the executive officer's efforts to remain on the Board of Directors.
"Good cause" means (i) the conviction of the executive officer of (or the plea
by the executive officer of nolo contendere to) a felony; (ii) the good faith
determination by the Board of Directors that the executive officer has willfully
and deliberately failed to perform a material amount of his or her executive
officer's duties pursuant to the employment agreement (other than a failure to
perform duties from the executive officer's incapacity due to physical or mental
illness), which failure to perform such duties shall not have been cured within
thirty (30) days after the receipt by the executive officer of written notice
thereof from the Board of Directors specifying with reasonable particularity
such alleged failure; (iii) any absence from the Company's regular full-time
employment in excess of three consecutive days that is not due to a vacation,
participation in a permitted activity, bona fide illness, disability, death or
other reason expressly authorized by the Board of Directors in advance; or (iv)
any act or acts of personal dishonesty (including, without limitation, insider
trading or unauthorized trading in the Company's securities) by the executive
officer which may have a material adverse effect on the Company or any of its
subsidiaries.

In addition, in the event the executive officer is terminated by the Company
without good cause or the executive officer resigns from the Company within
ninety days after being removed from, or not re-elected to the Board of
Directors, despite the executive officer's efforts to remain on the Board of
Directors, the executive officer will be entitled to receive his or her base
salary then in effect until the later of one year from the date of termination
or to the end of the term of the employment agreement. In the event that the
executive officer is terminated without good cause within ninety days after a
change of control (as defined in the employment agreement), then the executive
officer will be entitled to receive his or her base salary then in effect until
the later or two years from the date of termination or to the end of the term of
the employment agreement. The employment agreement also provides each executive
officer specified amounts of term life and disability insurance coverage, a
monthly automobile allowance and payment of club dues.

THE HCP SHAREHOLDERS' AGREEMENT

HCP and the Principals entered into a shareholders' agreement (the "HCP
Shareholders' Agreement") that governs, among other things, (i) the rights of
the Principals to transfer their shares of common stock of HCP, and (ii) the
purchase of shares of common stock of HCP from the Principals by HCP, the
Company and the other Principals. Under the HCP Shareholders' Agreement, a
Principal may not transfer his or her shares of common stock of HCP, other than
to a family member, an affiliate or another HCP stockholder without first
offering such common stock of HCP to HCP, the other holders of common stock of
HCP, and the holders of preferred stock of HCP (in that order) on the same terms
and conditions. In addition, HCP, the other holders of common stock of HCP, and
holders of preferred stock of HCP, will have the right to purchase the shares of
common stock of HCP of a Principal (or of a permitted transferee of a Principal)
if such Principal (a) ceases to be employed by the Company (including by death,
disability or voluntary or involuntary termination), (b) ceases to own any
equity interest in the Company, (c) becomes bankrupt, or (d) transfers any
shares of common stock of HCP, in connection with a divorce or by operation of
law. The amount payable to a Principal who suffers any of the foregoing events
is based upon the valuation of HCP. To avoid the loss of the Company's REIT
status, the Company is permitted to assign its rights to purchase common stock

<PAGE> 78

of HCP, and to exchange any common stock of HCP it purchases for shares of
nonvoting common stock of HCP.

LOANS TO THE PRINCIPALS

In connection with the Company's initial public offering, the Company has
agreed to make up to $1,750,000 in loans available to the Principals to enable
them to pay their personal income taxes. Each loan has a term of five years and
bears interest at the lowest "applicable federal rate" in effect for the month
in which the loan is made. No payments of principal on the loans is due before
maturity unless the borrowing Principal is terminated for "good cause" under his
or her employment agreement with the Company, in which case the loan will become
immediately due and payable. Interest, however, is payable on a quarterly basis
in arrears. The loans to the Principals are secured by a maximum of 116,667 of
their shares of the Company's Common Stock (if the entire $1,750,00 were to be
borrowed) but are otherwise be nonrecourse to them. A Principal will not be able
to sell the shares of common stock that are pledged to secure his or her loan.
Accordingly, if a Principal defaults in repaying his or her loan, the Company
will be able to look only to the shares of common stock the Principal pledged to
secure his or her loan and not to any personal assets of the Principal. Thus, a
decline in the value of the common stock could result in a Principal's failure
to repay his or her loan. As additional consideration to the Principals for
their contribution of the preferred stock of HCP to the Company, the outstanding
balance of the loans will be forgiven to the extent that the Earn-Out vests. The
terms of the loans were not determined through arm's-length negotiations and may
be more favorable to the Principals than would otherwise be available to them.

Pursuant to the Registration Rights Agreement among the Company and the
Principals, the Principals have the right to request on any one occasion on or
after January 1, 1998 that the Company file one registration statement with the
Securities and Exchange Commission, at the Company's expense, with respect to a
maximum of 100,000 shares of the Common Stock owned by the Principals in order
to pay tax on gains the Principals recognized relating to the Company's original
formation transactions. In March 1998, the Board of Directors agreed to lend up
to $1,500,000 in unsecured loans to the Principals, in lieu of incurring the
costs and expenses associated with the registration of 100,000 shares of the
Company's Common Stock at that time. The Company loaned the Principals an
additional $1,203,880 in April 1998. The additional loans are due and payable on
March 31, 1999 and bear interest at the rate of 5.51% per annum.

At June 30, 1998 the following Principals had received loans from the
Company:

Name (a) (b) Total
- - -------------------- ---------- ---------- ----------
John A Burchett $962,500 $696,280 $1,658,780

Irma N. Tavares 262,500 207,100 469,600

Joyce S. Mizerak 262,500 170,500 433,000

George J. Ostendorf 262,500 130,000 392,500

$1,750,000 $1,203,880 $2,953,880

(a) Loans made to the Principals pursuant to the Formation Transactions.

(b) Additional loans made to the Principals in April 1998.

<PAGE> 79

PRINCIPAL STOCKHOLDERS

The following table sets forth certain information known to the Company
respecting the beneficial ownership of the Company's Common Stock as of March
31, 1998 by (1) each person known to the Company to beneficially own more than
5% of the Company's Common Stock, (2) each Director of the Company, (3) the
Company's Named Executive Officers, and (4) all Directors and executive officers
as a group. Unless otherwise indicated in the footnotes to the table, the
beneficial owners named have, to the knowledge of the Company, sole voting and
investment power with respect to the shares beneficially owned, subject to
community property laws where applicable.

<TABLE>
<CAPTION>
Number of Shares Percentage of Shares
Name of Beneficial Owner Beneficially Owned Beneficially Owned
- - --------------------------------- ------------------ --------------------
<S> <C> <C>
Ryback Management Corporation(1) 400,000(2) 6.19%
Lawrence M. Blau(3) 471,500(4) 7.30%
Mark Metzger(5) 483,500(6) 7.50%
John A. Burchett(7) 397,177(8) 6.14%
Irma N. Tavares(9) 107,500 1.66%
Joyce S. Mizerak(9) 107,500 1.66%
George J. Ostendorf(10) 107,500 1.66%
John A. Clymer(11) 2,000(12) *
John Nicholas Rees(13) 2,000(12) *
Joseph Freeman(14) 2,000(12) *
Robert E. Campbell(15) 2,000(12) *
Saiyid Naqvi(16) 2,000(12) *
Ralph F. Laughlin(9) 800(17) *
James C. Strickler(7) -- --
Julia Curran(7) -- --
All executive officers and directors as a
group (12 persons) 730,477 11.28%
</TABLE>

* Less than one percent.

(1) Address is 7711 Carondelet Avenue, Box 16900, St. Louis, Missouri
63105.
(2) According to a Schedule 13G filed with the Securities and Exchange
Commission on or before February 14, 1998.
(3) Address is c/o BEM Management, Inc., 520 Madison Avenue, 32nd Floor,
New York, NY 10022.
(4) According to a Schedule 13G filed with the Securities and Exchange
Commission on or before March 16, 1998. Includes 30,000 shares of
common stock held by Mr. Blau's Individual Retirement Account and
441,500 shares of common stock owned by BEM Partners, L.P. of which Mr.
Blau is a managing partner.
(5) Address is c/o BEM Management, Inc., 520 Madison Avenue, 32nd Floor,
New York, NY 10022.
(6) According to a Schedule 13G filed with the Securities and Exchange
Commission on or before March 16, 1998. Includes 41,000 shares of
common stock owned by Mr. Metzger's's Individual Retirement Account,
1,000 shares held by an individual account over which he has investment
discretion and 441,500 shares of common stock owned by BEM Partners,
L.P. of which Mr. Metzger is a managing partner.
(7) Address is 90 West Street, Suite 1508, New York, New York 10006.
(8) Includes 3,000 shares of Common Stock held by his children to which he
disclaims beneficial ownership. (9) Address is 100 Metroplex Drive,
Suite 301, Edison, New Jersey 08817.
(10) Address is 7140 West Higgins Avenue, Chicago, Illinois 60656.

<PAGE> 80

(11) Address is 900 Second Avenue, S., Suite 300, Minneapolis, Minnesota
55402.
(12) Includes 2,000 shares of Common Stock which each of Mr. Clymer, Mr.
Rees, Mr. Freeman, Mr. Campbell and Mr. Naqvi has the right to acquire
within sixty days pursuant to the 1997 Executive and Non-Employee
Director Stock Option Plan.
(13) Address is 101 Granite Street, Rockport, Massachusetts 01966.
(14) Address is 60 Wells Avenue, Newton, Massachusetts 02159.
(15) Address is 100 Albany Street, Suite 200, New Brunswick, New Jersey
08901.
(16) Address is 75 North Fairway Drive, Vernon Hills, Illinois 60061.
(17) Includes 400 shares of Common Stock which Mr. Laughlin has the right to
acquire within sixty days pursuant to the exercise of warrants.

DESCRIPTION OF SECURITIES

The authorized stock of the Company consists of 90,000,000 shares of Common
Stock, $.01 par value, and (ii) 10,000,000 shares of Preferred Stock, $.01 par
value. The following description of the capital stock of the Company does not
purport to be complete or to give full effect to the provisions of statutory or
common law and is subject in all respects to the provisions of the Company's
charter as in effect from time to time. The authorized stock of the Company may
be increased and altered from time to time as permitted by Maryland law. The
charter authorizes the Board of Directors to reclassify any unissued shares of
its capital stock in one or more classes or series.

COMMON STOCK

Voting. Each holder of Common Stock is entitled to one vote for each share
of record on each matter submitted to a vote of holders of capital stock of the
Company. The Company's charter does not provide for cumulative voting and,
accordingly, the holders of a majority of the outstanding shares of Common Stock
have the power to elect all directors to be elected each year.

Annual Meeting. Annual meetings of the stockholders of the Company will be
held commencing in 1998, and special meetings may be called by the Chairman of
the Board of Directors, by the President, by a majority of the Board of
Directors, or by stockholders holding at least a majority of the outstanding
shares of capital stock entitled to be voted at the meeting. The charter of the
Company may be amended in accordance with Maryland law, subject to certain
limitations set forth in the charter.

PREFERRED STOCK

The Company's Board of Directors is authorized by the charter to fix or
alter the rights, preferences, privileges and restrictions of any series of
Preferred Stock, including the dividend rights, original issue price, conversion
rights, voting rights, terms of redemption, liquidation preferences and sinking
fund terms thereof, and the number of shares constituting any such series and
designating thereof, and to increase or decrease the number of shares of such
series subsequent to the issuance of shares of such series (but not below the
number of shares outstanding). As the terms of the Preferred Stock can be fixed
by the Board of Directors without shareholder action, the Board of Directors may
issue Preferred Stock with terms calculated to defeat a proposed takeover of the
Company or to make the removal of management more difficult. The Board of
Directors, without shareholder approval, could issue Preferred Stock with
dividend, voting, conversion and other rights which could adversely affect the
rights of the holders of Common Stock. The Company's Board of Directors
currently has no plans to issue

<PAGE> 81
shares of Preferred Stock in the Company. See "Risk Factors -- Preferred Stock;
Restrictions on Ownership of Common Stock; Anti-takeover Risk."

WARRANTS

The Warrants were issued pursuant to a warrant agreement (the "Warrant
Agreement") dated as of September 19, 1997 between the Company and the warrant
agent (the "Warrant Agent"). State Street Bank & Trust Company is currently
acting as Warrant Agent. The following is a brief summary of certain provisions
of the Warrant Agreement and does not purport to be complete and is qualified in
its entirety by reference to the Warrant Agreement including the definitions
therein of certain terms used below. A copy of the proposed form of Warrant
Agreement to be filed as an exhibit to the Registration Statement of which this
Prospectus is a part. See "Additional Information."

Each Unit consists of one share of Common Stock and one Warrant. The
Warrants became detachable from shares of Common Stock on March 19, 1998. The
Warrants are exercisable until 5:00 p.m. Eastern Time on September 19, 2000 (the
"Expiration Date") at the initial public offering price and are subject to
certain anti-dilution protection. Each Warrant, when exercised, will entitle the
holder thereof to receive one share of Common Stock.

The Warrants may be exercised by surrendering to the Warrant Agent the
definitive Warrant Certificates evidencing such Warrants, with the accompanying
form of election to purchase properly completed and executed, together with
payment of the exercise price. Payment of the exercise price may be made (a) in
the form of cash or by certified or official bank check payable to the order of
the Company, or (b) by surrendering additional Warrants or shares of Common
Stock for cancellation to the extent the Company may lawfully accept shares of
Common Stock, with the value of such shares of Common Stock for such purpose to
equal the average trading price of the Common Stock during the 20 trading days
preceding the date surrendered and the value of the Warrants to equal the
difference between such value of a share of Common Stock and the exercise price.
Upon surrender of the Warrant Certificate and payment of the exercise price and
any other applicable amounts, the Warrant Agent will deliver or cause to be
delivered, to or upon the written order of such holder, stock certificates
representing the number of whole shares of Common Stock or other securities or
property to which such holder is entitled. If less than all of the Warrants
evidenced by a Warrant certificate are to be exercised, a new Warrant
Certificate will be issued for the remaining number of Warrants.

The Warrants are in registered form and may be presented to the Warrant
Agent for transfer, exchange or exercise at any time on or prior to 5:00 p.m.
Eastern Time on the Expiration Date, at which time the Warrants become wholly
void and of no value. Since March 20, 1998 the Warrants have traded on the
American Stock Exchange under the symbol "HCM.W." If a market for the Warrants
develops, the holder may sell the Warrants instead of exercising them. There can
be no assurance, however, that a market for the Warrants will develop or
continue.

For a holder to exercise the Warrants, there must be a current prospectus
covering the shares of Common Stock issuable upon the exercise of the Warrants,
and such shares must be registered, qualified or deemed to be exempt under
federal and state securities laws. Although the Company will use its best
efforts to have all of the shares of Common Stock issuable upon the exercise of
the Warrants registered or qualified on or before the Exercise Date and to
maintain a current prospectus relating thereto until the Expiration Date of the
Warrants, there can be no assurance that it will be able to do so.

<PAGE> 82
No fractional shares of Common Stock will be issued upon exercise of the
Warrants. The holders of the Warrants have no right to vote on matters submitted
to the stockholders of the Company and have no right to receive dividends. The
holders of the Warrants not yet exercised are not entitled to share in the
assets of the Company in the event of liquidation, dissolution or the winding up
of the affairs of the Company.

The exercise price of the Warrants will be appropriately adjusted if the
Company (i) pays a dividend or makes a distribution on its Common Stock in
shares of its Common Stock or makes certain other dividends or distributions on
its Common Stock (other than cash dividends out of funds legally available
therefor), (ii) subdivides its outstanding shares of Common Stock into a greater
number of shares, (iii) combines its outstanding shares of Common Stock into a
smaller number of shares, (iv) issues by reclassification of its Common Stock
any shares of its capital stock.

In case of certain consolidations or mergers of the Company, or the
liquidation of the Company or the sale of all or substantially all of the assets
of the Company to another corporation, each Warrant will thereafter be deemed
exercised for the right to receive the kind and amount of shares of stock or
other securities or property to which such holder would have been entitled as a
result of such consolidation, merger or sale had the Warrants been exercised
immediately prior thereto, less the exercise price.

REPURCHASE OF SHARES AND RESTRICTIONS ON TRANSFER

Two of the requirements of qualification for the tax benefits accorded by
the REIT provisions of the Code are that (i) during the last half of each
taxable year not more than 50% in value of the outstanding shares may be owned
directly or indirectly by five or fewer individuals, and (ii) there must be at
least 100 stockholders on 335 days of each taxable year of 12 months.

For the Company to meet these requirements at all times, the charter
prohibits any person or group of persons from acquiring or holding, directly or
indirectly, shares of Common Stock in excess of 9.5% of the value of the
aggregate of the outstanding shares of Common Stock, provided that John A.
Burchett will be permitted to hold up to 11.99%. For this purpose, the term
"ownership" is defined in accordance with the REIT provisions of the Code, the
constructive ownership provisions of Section 544 of the Code, as modified by
Section 856(h)(1)(B) of the Code, and the term "person" is defined to include a
"group," which is defined to have the same meaning as that term has for purposes
of Section 13(d)(3) of the Exchange Act. Accordingly, shares of Common Stock
owned or deemed to be owned by a person who individually owns less than 9.5% (or
11.99% in the case of Mr. Burchett) of the shares of Common Stock outstanding
may nevertheless be in violation of the ownership limitations set forth in the
Company's charter.

The constructive ownership provisions applicable under Section 544 of the
Code attribute ownership of securities owned by a corporation, partnership,
estate or trust proportionately to its stockholders, partners or beneficiaries,
attribute ownership of securities owned by family members to other members of
the same family and by partners to other partners of the same partnership, treat
securities with respect to which a person has an option to purchase as actually
owned by that person, and set forth rules as to when securities constructively
owned by a person are considered to be actually owned for the application of
such attribution provisions (i.e., "reattribution"). For purposes of determining
whether a person holds shares of Common Stock in violation of the Ownership
Limitation set forth in the Company's charter, a person or group will

<PAGE> 83

thus be treated as owning not only shares of Common Stock actually or
beneficially owned, but also any shares of Common Stock attributed to such
person or group under the attribution rules described above. Ownership of shares
of the Common Stock through such attribution is generally referred to as
constructive ownership.

The Company's charter further prohibits (a) any person from beneficially or
constructively owning shares of Common Stock that would result in the Company's
being "closely held" under Section 856(h) of the Code or otherwise cause the
Company to fail to qualify as a REIT, and (b) any person from transferring
shares of Common Stock if such transfer would result in shares of Common Stock
being owned by fewer than 100 persons. If any transfer of shares of Common Stock
occurs which, if effective, would result in any person beneficially or
constructively owning shares of Common Stock in excess or in violation of the
above transfer or ownership limitations, then that number of shares of Common
Stock the beneficial or constructive ownership of which otherwise would cause
such person to violate such limitations (rounded to the nearest whole shares)
shall be automatically transferred to a trustee (the "Trustee") as trustee of a
trust (the "Trust") for the exclusive benefit of one or more charitable
beneficiaries (the "Charitable Beneficiary"), and the intended transferee shall
not acquire any rights in such shares. Shares held by the Trustee shall be
issued and outstanding shares of Common Stock. The intended transferee shall not
benefit economically from ownership of any shares held in the Trust, shall have
no rights to dividends and shall not possess any rights to vote or other rights
to the shares held in the Trust. The Trustee shall have all voting rights and
rights to dividends or other distributions with respect to shares held in the
Trust, which rights shall be exercised for the exclusive benefit of the
Charitable Beneficiary. Any dividend or other distribution paid prior to the
discovery by the Company that shares of Common Stock have been transferred to
the Trustee shall be paid with respect to such shares to the Trustee upon demand
and any dividend or other distribution authorized but unpaid shall be paid when
due to the Trustee. Any dividends or distributions so paid over to the Trustee
shall be held in trust for the Charitable Beneficiary. The Board of Directors of
the Company may, in their discretion, waive these requirements on owning shares
in excess of the Ownership Limit.

Within 20 days of receiving notice from the Company that shares of Common
Stock have been transferred to the Trust, the Trustee shall sell the shares held
in the Trust to a person, designated by the trustee, whose ownership of the
shares will not violate the ownership limitations set forth in the Company's
charter. Upon such sale, the interest of the Charitable Beneficiary in the
shares sold shall terminate and the Trustee shall distribute the net proceeds of
the sale to the intended transferee and to the Charitable Beneficiary as
follows. The intended transferee shall receive the lesser of (i) the price paid
by the intended transferee for the shares or, if the intended transferee did not
give value for the shares in connection with the event causing the shares to be
held in the trust (e.g., in the case of a gift, devise or other such
transaction), the Market Price (as defined below) of the shares on the day of
the event causing the shares to be held in the Trust, and (ii) the price per
share received by the Trustee from the sale or other disposition of the shares
held in the Trust. Any net sale proceeds in excess of the amount payable to the
intended transferee shall be immediately paid to the Charitable Beneficiary.

The term "Market Price" on any date shall mean, with respect to any class or
series of outstanding shares of the Company's stock, the Closing Price (as
defined below) for such shares on such date. The "Closing Price" on any date
shall mean the last sale price for such shares, regular way, or, in case no such
sale takes place on such day, the average of the closing bid and asked prices,
regular way, for such shares, in either case as reported in the principal
consolidated transaction reporting system with respect to securities listed on
the principal national securities

<PAGE> 84
exchange on which such shares are listed or admitted to trading or, if such
shares are not listed or admitted to trading on any national securities
exchange, the last quoted price, or, if not so quoted, the average of the high
bid and low asked prices in the over-the-counter market, as reported by the
National Association of Securities Dealers, Inc. Automated Quotation System or,
if such system is no longer in use, the principal other automated quotation
system that may be in use or, if such shares are not quoted by any such
organization, the average of the closing bid and asked prices as furnished by a
professional market maker making a market in such shares elected by the Board of
Directors or, in the event that no trading price is available for such shares,
the fair market value of the shares, as determined in good faith by the Board of
Directors.

Every owner of 5% or more (or such lower percentage as required by the Code
or the regulations promulgated thereunder) of all classes or series of the
Company's capital stock, including shares of Common Stock, within 30 days after
the end of each taxable year, is required to give written notice to the Company
stating the name and address of such owner, the number of shares of each class
and series of stock of the Company beneficially owned and a description of the
manner in which such shares are held. Each such owner shall provide to the
Company such additional information as the Company may request in order to
determine the effect, if any, of such beneficial ownership on the Company's
status as a REIT and to ensure compliance with the Ownership Limit. See "Federal
Income Tax Considerations -- Record Keeping Requirements."

TRANSFER AGENT

The transfer agent and registrar for the Common Stock is Boston EquiServe,
L.P., Canton, Massachusetts.

SHARES ELIGIBLE FOR FUTURE SALE

GENERAL

The Company has outstanding 6,468,799 shares of Common Stock (including
716,677 shares issued to the Principals), 5,747,878 shares of Common Stock
reserved for the Warrants, 172,500 shares of Common Stock reserved for the
Representatives' Warrants and 216,667 shares reserved for the issuance to the
Principals that will be issued to them upon the vesting of the Earn-Out. The
Units issued in the Company's initial public offering were freely tradable
immediately after the offering, and the Warrants and Common Stock issued in the
Offering became freely tradeable on March 19, 1998, the date that the Warrants
became detachable from the Common Stock and 2,122 shares of Common Stock which
have been issued pursuant to the excersis of Warrants are also currently
eligible for sale without restriction in the public market, in each case by
persons other than "affiliates" of the Company without restriction under the
Securities Act, subject to the limitations on ownership set forth in the
charter. See "Description of Securities." The Units, Warrants and Common Stock
owned by the Company's directors, executive officers and employees
(collectively, the "Restricted Stock"), will be "restricted securities" within
the meaning of Rule 144 promulgated under the Securities Act ("Rule 144") and
may not be sold except pursuant to registration under the Securities Act or
pursuant to an exemption from registration, including exemptions contained in
Rule 144. As described below under "Registration Rights," the Company has
granted certain holders registration rights with respect to their Common Stock.
See " -- Registration Rights."

<PAGE> 85
In general, under Rule 144 as currently in effect, if one year has elapsed
since the later of the date of acquisition of Restricted Stock from the Company
or any "affiliate" of the Company, as that term is defined under the Securities
Act, the acquirer or subsequent holder thereof is entitled to sell within any
three-month period a number of shares of Common Stock that does not exceed the
greater of 1% of the then outstanding Common Stock or the average weekly trading
volume of the Common Stock during the four calendar weeks preceding the date on
which notice of the sale is filed with the Commission. Sales under Rule 144 are
also subject to certain manner of sale provisions, public information
requirements and notice requirements. After one year has elapsed since the date
of acquisition of Restricted Stock from the Company or from any "affiliate" of
the Company, and the acquirer or subsequent holder thereof is deemed not to have
been an "affiliate" of the Company at any time during the 90 days preceding a
sale, such person would be entitled to sell such shares in the public market
under Rule 144(k) without regard to the volume limitation, manner of sale,
public information or notice requirements.

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 symbols HCM and HCM.WS, respectively. Sales of substantial
amounts of Common Stock or Warrants (including shares issued upon the exercise
of stock options), or the perception that such sales occur, could adversely
affect prevailing market prices of the Common Stock and Warrants. See "Risk
Factors -- Shares Available for Future Sale."

The Company has reserved for issuance an aggregate of 325,333 shares of
Common Stock to be issued pursuant to the exercise of stock options to be
granted under the 1997 Stock Option Plan. All stock options granted pursuant to
the 1997 Stock Option Plan will be contingent, with vesting based upon the
financial performance of the Company and such other criteria as the Compensation
Committee determines to be appropriate. See "Management -- 1997 Stock Option
Plan."

REGISTRATION RIGHTS

Pursuant to a Registration Rights Agreement, the Company has granted the
Principals certain "demand" and "piggyback" registration rights with respect to
the Common Stock owned by them.

Pursuant to the Registration Rights Agreement, Principals who do not own
less than 30% of the Registrable Securities (as defined therein) may request,
(i) on any one occasion on or after January 1, 1998, that the Company file one
registration on Form S-11 or other form (including Form S-3) that may be
available, at the Company's expense, with respect to up to 100,000 of the
Registrable Shares of the Principals to pay tax on the gains they must recognize
upon contributing the HCP Preferred to HCHI for shares of Common Stock and (ii)
on any two occasions on or after September 19, 1998, that the Company file a
shelf registration on Form S-3 with respect to the number of Registrable Shares
requested by the Principals, with the Company paying all registration expenses
in connection with the first such shelf registration and the Principals paying
all registration expenses in connection with the second such shelf registration.
In addition, in the event that the Company proposes to register any of its
Securities under the Securities Act, whether for its own account or otherwise,
the Principals are entitled to notice of such registration and are entitled to
include their Registrable Shares, subject to certain conditions and limitations.

<PAGE> 86

CERTAIN PROVISIONS OF MARYLAND LAW AND
OF THE COMPANY'S CHARTER AND BYLAWS

The following summary of certain provisions of the MGCL and of the charter
and the bylaws of the Company does not purport to be complete and is subject to
and qualified in its entirety by reference to Maryland law and the charter and
the bylaws of the Company.

REMOVAL OF DIRECTORS

The charter provides that a director may be removed at any time but only by
the affirmative vote of at least a majority of the votes entitled to be cast in
the election of directors.

BUSINESS COMBINATIONS

Under the MGCL, certain "business combinations" (including a merger,
consolidation, share exchange or, in certain circumstances, as asset transfer or
issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns 10% or more of the outstanding
voting stock of the corporation's shares or an affiliate of the corporation who,
at any time within the two-year period prior to the date in question was the
beneficial owner of 10% or more of the voting power of the then outstanding
voting stock of the corporation (an "Interested Stockholder") or an affiliate of
such an Interested Stockholder are prohibited for five years after the most
recent date on which the Interested Stockholder becomes an Interested
Stockholder. Thereafter, any such business combination must be recommended by
the board of directors of such corporation and approved by the affirmative vote
of at least (a) 80% of the votes entitled to be cast by holders of voting stock
of the corporation and (b) 66 2/3% of the votes entitled to be cast by holders
of voting stock other than shares held by the Interested Stockholder with whom
(or with whose affiliate) the business combination is to be effected, unless,
among other conditions, the corporation's common stockholders receive a minimum
price (as defined in the MGCL) for their shares and their consideration is
received in cash or in the same form as previously paid by the Interested
Stockholder for its shares. These provisions of Maryland law do not apply,
however, to business combinations that are approved or exempted by the board of
directors of the corporation prior to the time that the Interested Stockholder
becomes an Interested Stockholder.

CONTROL SHARE ACQUISITIONS

The MGCL provides that "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares of stock owned by the acquirer, by officers or by directors who
are employees of the corporation. "Control shares" are voting shares of stock
which, if aggregated with all other such shares of stock, previously acquired by
the acquirer or in respect of which the acquirer is able to exercise or direct
the exercise of voting power (except solely by virtue of a revocable proxy),
would entitle the acquirer to exercise voting power in electing directors within
one of the following ranges of voting power: (1) one-fifth or more but less than
one-third, (2) one-third or more but less than a majority or (3) a majority or
more of all voting power. Control shares do not include shares the acquiring
person is entitled to vote as a result of having previously obtained stockholder
approval. A "control share acquisition" means the acquisition of control shares,
subject to certain exceptions.

<PAGE> 87

A person who has made or proposed to make a control share acquisition, upon
satisfaction of certain conditions (including an undertaking to pay expenses)
may compel the board of directors of the corporation to call a special meeting
of stockholders to be held within 50 days of demand to consider the voting
rights of the shares. If no request for a meeting is made, the corporation may
itself present the question at any stockholders meeting.

If voting rights are not approved at the meeting or if the acquiring person
does not deliver an acquiring person statement as required by the statute, then,
subject to certain conditions and limitations, the corporation may redeem any or
all of the control shares (except those for whom voting rights have previously
been approved) for fair value determined, without regard to the absence of
voting rights for the control shares, as of the date of the last control share
acquisition by the acquirer or of any meeting of stockholders at which the
voting rights of such shares are considered and not approved. If voting rights
for control shares are approved at a stockholders meeting and the acquirer
becomes entitled to vote a majority of the shares entitled to vote, all other
stockholders may exercise appraisal rights. The fair value of the shares as
determined for purposes of such appraisal rights may not be less than the
highest price per share paid by the acquirer in the control share acquisition.

The control share acquisition statute does not apply (a) to shares acquired
in a merger, consolidation or share exchange if the corporation is a party to
the transaction or (b) to acquisitions approved or exempted by the charter or
bylaws of the corporation.

The bylaws of the Company contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of the
Company's shares of stock. There can be no assurance that such provision will
not be amended or eliminated at any time in the future.

AMENDMENT TO THE CHARTER

The Company reserves the right from time to time to make any amendment to
its charter, now or hereafter authorized by law. Provisions on removal of
directors may be amended only by the affirmative vote of the holders of not less
than two-thirds of all of the votes entitled to be cast on the matter.

DISSOLUTION OF THE COMPANY

The dissolution of the Company must be proposed by the Board of Directors
and approved by the affirmative vote of the holders of not less than two-thirds
of all of the votes entitled to be cast on the matter.

ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS

The bylaws provide that (a) with respect to an annual meeting of
stockholders, nominations of persons for election to the Board of Directors and
the proposal of business to be considered by stockholders may be made only (1)
pursuant to the Company's notice of the meeting, (2) by the Board of Directors
or (3) by a stockholder who is entitled to vote at the meeting and has complied
with the advance notice procedures set forth in the bylaws and (b) with respect
to special meetings of stockholders, only the business specified in the
Company's notice of meeting may be brought before the meeting of stockholders
and nominations of persons for election to the Board of Directors may be made
only (1) pursuant to the Company's notice of the meeting, (2) by the Board of
Directors or (3) provided that the Board of Directors has determined that

<PAGE> 88

directors shall be elected at such meeting, by a stockholder who is entitled to
vote at the meeting and has complied with the advance notice provisions set
forth in the bylaws.

ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE CHARTER
AND BYLAWS

The business combination provisions and, if the applicable provision in the
bylaws is rescinded, the control share acquisition provisions of the MGCL, the
provisions of the charter on removal of directors and the advance notice
provisions of the bylaws could delay, defer or prevent a transaction or a change
in control of the Company that might involve a premium price for stockholders or
otherwise be in their best interest.

LIMITATION OF LIABILITY AND INDEMNIFICATION

The MGCL permits a Maryland corporation to include in its charter a
provision limiting the liability of its directors and officers to the
corporation and its stockholders for money damages except for liability
resulting form (a) actual receipt of an improper benefit or profit in money,
property or services or (b) active and deliberate dishonesty established by a
final judgment as being material to the cause of action. The Company's charter
contains such a provision, which eliminates such liability to the maximum extent
permitted by the MGCL.

The Company's charter obligates the Company, to the maximum extent permitted
by Maryland law, to indemnify and to pay or reimburse reasonable expenses in
advance of final disposition of a proceeding to (a) any present or former
director or officer who is made a party to the proceeding by reason of his
service in that capacity or (b) any individual who, at the request of the
Company, serves or has served another entity and who is made a party to the
proceeding by reason of his service in that capacity. The MGCL also permits the
Company to indemnify and advance expenses to any person who served a predecessor
of the Company in any of the capacities described above and to any employee or
agent of the Company or a predecessor of the Company.

The MGCL requires a corporation (unless its charter provides otherwise,
which the Company's charter does not) to indemnify a director or officer who has
been successful, on the merits or otherwise, in the defense of any proceeding to
which he is made a party by reason of his service in that capacity. The MGCL
permits a corporation to indemnify its present and former directors and
officers, among others, against judgments, penalties, fines, settlements and
reasonable expenses actually incurred by them in connection with any proceeding
to which they may be made a party by reason of their service in those or other
capacities unless it is established that (a) the act or omission of the director
or officer was material to the matter giving rise to the proceeding and (1) was
committed in bad faith or (2) was the result of active and deliberate
dishonesty, (b) the director or officer actually received an improper personal
benefit in money, property or services or (c) in the case of any criminal
proceeding, the director or officer had reasonable cause to believe that the act
or omission was unlawful. However, a Maryland corporation may not indemnify for
an adverse judgment in a suit by or in the right of the corporation. In
addition, the MGCL requires the Company, as a condition to advancing expenses,
to obtain (a) a written affirmation by the director or officer of his good faith
belief that he has met the standard of conduct necessary for indemnification by
the Company as authorized by the bylaws and (b) a written undertaking by or on
his behalf to repay the amount paid or reimbursed by the Company if it shall
ultimately be determined that the standard of conduct was not met. The Company
will enter into indemnification agreements with all of its officers and
directors

<PAGE> 89

which provide for the indemnification of such officers and directors to the
fullest extent permitted under Maryland law. Insofar as indemnification by the
Company for liabilities arising under the Securities Act may be permitted to
directors, officers and controlling persons of the Company pursuant to the
indemnity agreements referenced herein or otherwise, the Company has been
advised that in the opinion of the Commission such indemnification is against
public policy as expressed in the Securities Act, and is, therefore,
unenforceable.

<PAGE> 90

FEDERAL INCOME TAX CONSIDERATIONS

THE FOLLOWING DISCUSSION SUMMARIZES THE MATERIAL FEDERAL INCOME TAX
CONSEQUENCES THAT MAY BE RELEVANT TO A PURCHASER OF COMMON STOCK. THIS
DISCUSSION IS BASED ON CURRENT LAW. THE FOLLOWING DISCUSSION IS NOT EXHAUSTIVE
OF ALL POSSIBLE TAX CONSIDERATIONS. IT DOES NOT GIVE A DETAILED DISCUSSION OF
ANY STATE, LOCAL OR FOREIGN TAX CONSIDERATIONS, NOR DOES IT DISCUSS ALL OF THE
ASPECTS OF FEDERAL INCOME TAXATION THAT MAY BE RELEVANT TO AN INVESTOR IN LIGHT
OF SUCH INVESTOR'S PARTICULAR CIRCUMSTANCES OR TO CERTAIN TYPES OF INVESTORS
(INCLUDING INSURANCE COMPANIES, CERTAIN TAX-EXEMPT ENTITIES, FINANCIAL
INSTITUTIONS, BROKER/DEALERS, FOREIGN CORPORATIONS AND PERSONS WHO ARE NOT
CITIZENS OR RESIDENTS OF THE UNITED STATES) SUBJECT TO SPECIAL TREATMENT UNDER
THE FEDERAL INCOME TAX LAWS.

PROSPECTIVE PURCHASERS OF COMMON STOCK ARE URGED TO CONSULT WITH THEIR
OWN TAX ADVISORS REGARDING THE SPECIFIC CONSEQUENCES TO THEM OF THE PURCHASE,
OWNERSHIP AND SALE OF COMMON STOCK, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN
AND OTHER TAX CONSIDERATIONS OF SUCH PURCHASE, OWNERSHIP AND SALE AND THE
POTENTIAL CHANGES IN APPLICABLE TAX LAWS.

GENERAL

The Code provides special tax treatment for organizations that qualify
and elect to be taxed as REITs. The discussion below summarizes the material
provisions applicable to the Company as a REIT for Federal income tax purposes
and to its stockholders in connection with their ownership of Units, Common
Stock or Warrants, as the case may be. However, it is impractical to set forth
in this Prospectus all aspects of Federal, state, local and foreign tax law that
apply to an investor. The discussion of various aspects of Federal taxation
contained herein is based on the Code, rules and regulations promulgated
thereunder and judicial and administrative interpretations thereof, all of which
are subject to change on a prospective or retroactive basis. Generally, if
certain detailed conditions imposed by the Code are met, and with certain
limited exceptions, entities that invest primarily in real estate assets and
mortgage loans, and that otherwise would be taxed as corporations, are not taxed
at the corporate level on their taxable income that is currently distributed to
their stockholders. This treatment eliminates most of the "double taxation" (at
the corporate level and then again at the stockholder level when the income is
distributed) that typically results from the use of corporate investment
vehicles. A qualifying REIT, however, may be subject to certain excise and other
taxes, including normal corporate tax on taxable income that is not currently
distributed to its stockholders. See " -- Taxation of HCHI."

HCHI elected to be taxed as a REIT under the Code commencing with its
taxable year ending December 31, 1997. The election will not cover HCP, HCMC,
HCS or any other taxable affiliate of HCHI.

<PAGE> 91

Opinion of Counsel

Morse, Barnes-Brown & Pendleton, P.C. ("Counsel"), counsel to the
Company, gave an opinion upon the closing of the Company's initial public
offering of Units that, based upon certain assumptions and representations, HCHI
has been organized in conformity with the requirements for qualification as a
REIT under the Code, and HCHI's proposed methods of operation described in this
Prospectus and as represented by the Company to Counsel will enable HCHI to
qualify as a REIT. Whether HCHI in fact so qualifies, however, depends on actual
operating results and compliance with the various tests for qualification as a
REIT relating to its income, assets, distributions, ownership and certain
administrative matters, the results of which have not been and will not be
reviewed by Counsel. Counsel's opinions were based on various assumptions and on
the factual representations of HCHI concerning its business and assets. There
can be no assurance that the courts or the IRS will agree with this opinion. In
addition, qualification as a REIT depends on future transactions and events that
cannot be known at this time. Accordingly, Counsel was and is unable to opine
whether HCHI will in fact qualify as a REIT under the Code in all events.
Counsel has also given its opinion that the section of the Prospectus entitled
"Federal Income Tax Considerations" identifies and fairly summarizes the Federal
income tax considerations that are likely to be material to a holder of Common
Stock and that, to the extent such summaries involve matters of law, such
statements of law are correct under the Code. The anticipated income tax
treatment described in the Prospectus may be changed, perhaps retroactively, by
legislative, administrative or judicial action at any time. Counsel's opinions
also were based in part on the opinion of special Maryland counsel, Piper &
Marbury L.L.P., that HCHI is duly organized and existing under Maryland law.
Counsel's opinion was filed as an exhibit to the Registration Statement of which
the Prospectus was a part. See " -- Requirements for Qualification as a REIT;"
"-- Termination or Revocation of REIT Status." See "Additional Information."

In the event that HCHI does not qualify as a REIT in any year, it will
subject to Federal income tax as a domestic corporation, and its stockholders
will be taxed in the same manner as stockholders of ordinary corporations. To
the extent that the Company would, as a consequence, be subject to potentially
significant tax liabilities, the amount of earnings and cash available for
distribution to its stockholders would be reduced. See " -- Termination or
Revocation of REIT Status."

REQUIREMENTS FOR QUALIFICATION AS A REIT

To qualify for tax treatment as a REIT under the Code, HCHI must be
managed by one or more trustees or directors and use the calendar year as its
taxable year (which requirements will be satisfied by HCHI). In addition, HCHI
must meet certain tests which are described immediately below.

Ownership of Common Stock. HCHI's shares of Common Stock must be
transferable for all taxable years for which a REIT election is made. After the
first taxable year for which a REIT election is made, HCHI's shares 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 year). In addition, at all times during the
second half of each taxable year, no more than 50% in value of the shares of
Common Stock may be owned directly or indirectly by five or fewer individuals.
In determining whether HCHI's shares are held by five or fewer individuals, the
attribution rules of Section 544 of the Code apply. For a description of these
attribution rules and of Rule 13d-3 promulgated under the Exchange Act, see
"Description of Securities." HCHI believes that it will have outstanding

<PAGE> 92

sufficient shares of Common Stock with sufficient diversity to allow it to
satisfy the ownership requirements. In addition, the charter of HCHI imposes
certain repurchase and transfer restrictions intended to prevent the shares of
Common Stock from being held by fewer than 100 persons and to prevent more than
50% in value of the Common Stock from being held by five or fewer individuals
(directly or constructively) at any time during the last half of any taxable
year. Such repurchase and transfer restrictions, however, may not ensure that
HCHI will, in all cases, be able to satisfy the ownership requirements. If HCHI
fails to satisfy the ownership requirements, its status as a REIT will
terminate, although HCHI will be treated as having satisfied the requirement
that no more than 50% in value of the shares of Common Stock be owned directly
or indirectly by five or fewer individuals during the second half of any taxable
year if it complied with regulations requiring the maintenance of records to
ascertain ownership and did not know (and would not know using reasonable
diligence) that it was a personal holding company for the year. See
"-- Termination or Revocation of REIT Status."

Nature of Assets. On the last day of each calendar quarter, HCHI must
satisfy three tests relating to the nature of its assets. First, at least 75% of
the value of HCHI's assets must consist of Qualified REIT Assets, government
securities, cash and cash items (the "75% of assets test"). Qualified REIT
Assets include interests in real property, interests in Mortgage Loans secured
by real property and interests in REMICs and other REITs. Second, not more than
25% of the value of HCHI's total assets may be represented by securities that do
not qualify under the 75% of assets test (the "25% of assets limit"). Third, of
securities that do not qualify under the 75% of assets test, the value of any
one issuer's securities owned by HCHI may not exceed 5% of the value of HCHI's
total assets (the "5% of assets limit"), and HCHI may not own more than 10% of
any one issuer's voting securities (the "10% of voting securities limit").

It is anticipated that, for purposes of applying the asset tests,
substantially all of HCHI's assets will consist of Qualified REIT Assets, cash,
cash items and HCP Preferred (which will be nonvoting). Hedging contracts (other
than those which are Qualified REIT Assets) and certain other types of Mortgage
Assets may be treated as securities of the entities issuing them. HCHI does not
expect the value of such contracts, interests or assets issued by any one issuer
ever to exceed 5% of the value of its assets. Moreover, HCHI intends to closely
monitor (on not less than a quarterly basis) the purchase and holding of the
assets of HCHI to ensure compliance with the asset tests.

Since HCHI will not own any voting securities of HCP, the ownership of
the HCP Preferred by HCHI will not cause HCHI to violate the 10% of voting
securities limit. If the value of the HCP Preferred exceeds 5% of the value of
HCHI's total assets, however, HCHI will violate the 5% of assets limit. See " --
Termination or Revocation of REIT Status." In that regard, the HCP Preferred was
initially valued at $10,750,005 and may be revalued at $15,750,010 (based on the
public offering price of the Units at $15.00 per Unit) if additional shares of
Common Stock are issued to the Principals upon the vesting of the Earn-Out. HCHI
intends to monitor the value of the HCP Preferred and believes that the value of
the HCP Preferred will not exceed 5% of the total value of its assets. Counsel
relied on the representation of HCHI to such effect, which representation was
based on the assumption that the Company will own sufficient assets purchased
with borrowing proceeds (by the close of each quarter beginning with the third
quarter of 1997) to cause the value of the HCP Preferred to be less than 5% of
the value of HCHI's total assets. No independent appraisals have been obtained
to support this conclusion. There can be no assurance that the Company will be
able to maintain sufficient levels of borrowings to avoid a violation of the 5%
of assets limit or that the IRS will agree with the Company's determination of
the value of the HCP Preferred.

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When purchasing mortgage-related securities, HCHI may rely on opinions
of counsel for the issuer or sponsor of such securities given in connection with
the offering of such securities, or statements made in related offering
documents, for purposes of determining whether and to what extent those
securities (and the income therefrom) constitute Qualified REIT Assets (and
income) for purposes of the 75% of assets test (and the source of income tests
discussed below). A regular or residual interest in a REMIC will be treated as a
Qualified REIT Asset for purposes of the REIT asset tests (and income derived
with respect to such interest will be treated as interest on obligations secured
by mortgages on real property) if at least 95% of the assets of the REMIC are
Qualified REIT Assets. If less than 95% of the assets of the REMIC are Qualified
REIT Assets, only a proportionate share of the assets of and income derived from
the REMIC will qualify under the REIT asset and income tests.

If a failure to satisfy any of the asset tests discussed above results
from an acquisition of securities or other property during a quarter, the
failure may be cured by the disposition of sufficient nonqualifying assets
within 30 days after the close of such quarter. HCHI intends to maintain
adequate records of, and closely monitor the value of its assets to determine
its compliance with the asset tests, and intends to take such actions as may be
required to cure any failure to satisfy the test within 30 days after the close
of any quarter.

Sources of Income. HCHI must satisfy two separate income-based tests
for each year in order to qualify as a REIT.

Under the first test (the "75% of income test"), at least 75% of HCHI's
gross income (excluding gross income from "prohibited transactions;" see " --
Taxation of HCHI") for the taxable year must be derived directly or indirectly
from the following sources: (i) rents from real property; (ii) interest (other
than interest based in whole or in part on the income or profits of any person)
on obligations secured by mortgages on real property or on interests in real
property; (iii) gains from the sale or other disposition of interests in real
property and real estate mortgages not held primarily for sale to customers in
the ordinary course of business ("dealer property"); (iv) dividends or other
distributions on shares in REITs and, provided such shares are not dealer
property, gain from the sale of such shares; (v) abatements and refunds of real
property taxes; (vi) income from the operation, and gain from the sale, of
property acquired at or in lieu of a foreclosure of the mortgage secured by such
property (or as a result of a default under a lease of such property) and which
is not held after the close of the third taxable year following the year of
acquisition ("foreclosure property"); (vii) amounts (other than amounts the
determination of which depend in whole or in part on the income or profits of
any person) received or accrued as consideration for entering into agreements
(a) to make loans secured by mortgages on real property or on interests in real
property or (b) to purchase or lease real property (including interests in real
property and interests in mortgages on real property (for example, commitment
fees); and (viii) income attributable to stock or debt instruments acquired with
the proceeds from the sale of stock or certain debt obligations ("new capital")
of HCHI, received during the one-year period beginning on the day such proceeds
were received ("qualified temporary investment income").

Under the second test (the "95% of income test"), in addition to
deriving 75% of its gross income from the sources qualifying under the 75% of
income test, at least an additional 20% of HCHI's gross income for the taxable
year (excluding gross income from "prohibited transactions;" see " -- Taxation
of HCHI") must be derived from the sources qualifying under the

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75% of income test, dividends, interest and gains from the sale or disposition
of stock or other securities that are not dealer property.

HCHI anticipates that the investments it will make will give rise
primarily to mortgage interest qualifying under the 75% of income test. Interest
on mortgage backed securities (other than Qualified REIT Assets), dividends on
stock (including any dividends from HCP), interest on any other obligations not
secured by real property, and gains from the sale or disposition of stock or
other securities that are not Qualified REIT Assets will be qualified income for
purposes of the 95% of income test but will not be qualified income for purposes
of the 75% of income test. Loan guarantee fees and income from mortgage
servicing and other service contracts will not qualify for either the 95% or 75%
of income tests if such income constitutes fees for services rendered by HCHI or
HCLP or is not treated as interest on obligations secured by mortgages on real
property or on interests in real property for purposes of the 75% of income
test. Similarly, income of HCHI from hedging, including from the sale of hedges,
will not qualify under the 75% or 95% of income tests unless the hedges
constitute Qualified Hedges, in which case such income will qualify under the
95% of income test.

It is anticipated that HCP and HCMC will recognize income that, if
recognized by HCHI, would fail to qualify under the 75% and 95% of income tests.
Such non-qualifying income will include income from HCP's due diligence
operations and from HCMC's servicing operations. Income of HCP or HCMC is not
treated as income of HCHI for purposes of the income-based tests except to the
extent that such income is distributed as a dividend. As described above, HCHI's
share of dividends paid by HCP are qualified income for purposes of the 95% of
income test but are not qualified income for purposes of the 75% of income test.

HCHI intends to maintain its REIT status by carefully monitoring its
income, including income from dividends, hedging transactions, services and
sales of Mortgage Assets to comply with the 75% of income test and the 95% of
income test. See " -- Taxation of HCHI" for a discussion of the potential tax
cost of HCHI's selling certain mortgage securities on a regular basis. In order
to help insure its compliance with the REIT requirements of the Code, HCHI has
adopted guidelines the effect of which will be to limit HCHI's ability to earn
certain types of income, including income from hedging, other than income from
Qualified Hedges. See "Business -- Hedging." The policy of HCHI to maintain REIT
status may limit the type of assets, including hedging contracts, that might
otherwise be acquired.

If HCHI fails to satisfy one or both of the 75% of income test or 95%
of income test for any year, it may nevertheless qualify as a REIT for such year
if it is entitled to relief under certain provisions of the Code. These relief
provisions will generally be available if HCHI's failure to meet such tests was
due to reasonable cause and not due to willful neglect, HCHI attaches a schedule
of the sources of its income to its federal income tax return, and any incorrect
income on the schedule was not due to fraud with intent to evade tax. It is not
possible to state whether in all circumstances HCHI would be entitled to the
benefit of the relief provisions. Even if the relief provisions apply and HCHI
retains its status as a REIT, a 100% tax would be imposed on an amount equal to
(i) the gross income attributable to the greater of the amount by which HCHI
failed to comply with the 75% of income test or the 95% of income test
multiplied by (ii) a fraction intended to reflect HCHI's profitability. There
can be no assurance that HCHI will always be able to maintain compliance with
the gross income tests for REIT qualification despite its periodic monitoring
procedures. See " -- Termination or Revocation of REIT Status."

<PAGE> 95

Distributions. HCHI must distribute dividends (other than capital gain
dividends) to its stockholders each year in an amount at least equal to (i) the
sum of (a) 95% of its "REIT taxable income" determined without regard to the
dividends paid deduction and by excluding its net capital gain (see " --
Taxation of HCHI") and (b) 95% of the excess of the net income, if any, from
foreclosure property over the tax imposed on such income by the Code, minus (ii)
the excess of the sum of certain "excess non-cash income" over 5% of its "REIT
taxable income" (the "95% distribution test"). In addition, if HCHI recognizes
any Built-In Gain upon the disposition of any Built-In Gain Asset during its
Recognition Period (see " -- Taxation of HCHI"), HCHI will be required, pursuant
to Treasury Regulations which have not yet been promulgated, to distribute at
least 95% of the Built-In Gain (after tax), if any, it recognizes on the
disposition of such asset. Such distributions must be made in the taxable year
to which they relate (although a dividend that is declared in October, November
or December of any calendar year and payable to shareholders of record on a
specified date in such a month will be deemed to be paid not later than December
31 of such year if actually paid during January of the following year) or, at
the election of HCHI if declared before the timely filing of HCHI's tax return
for such year (specifying the dollar amount of such distribution) and paid not
later than the first regular dividend payment after such declaration, in the
following taxable year. See "Dividend Policy and Distributions." Distributions
declared with respect to a prior year before the timely filing of HCHI's tax
return for such year and paid not later than the first regular dividend payment
date after such declaration are taxable to holders of Common Stock (other than
certain tax-exempt entities, as discussed below) in the year in which paid, even
if such distributions relate to the prior year for purposes of the 95%
distribution test. The amount distributed must not be preferential (e.g., each
holder of shares of Common Stock must receive the same distribution per share).
To the extent that HCHI does not distribute all of its net capital gain or
distributes at least 95%, but less than 100%, of its "REIT taxable income," as
adjusted, it will be subject to tax on the undistributed portion at ordinary and
capital gain corporate tax rates. Furthermore, if HCHI should fail to distribute
during each calendar year at least the sum of (i) 85% of its REIT ordinary
income for such year, (ii) 95% of its REIT capital gain net income for such year
and (iii) any undistributed taxable income from prior periods, it would be
subject to a 4% excise tax on the excess of such required distributions over the
amounts actually distributed.

HCHI intends to make timely distributions to its stockholders in
amounts sufficient to meet the 95% distribution requirement. It is possible,
however, that HCHI from time to time may not have sufficient cash or other
liquid assets to meet these distribution requirements due to timing differences
between (i) the actual receipt of income and actual payment of deductible
expenses and (ii) the inclusion of such income and deduction of such expenses in
arriving at its taxable income. For instance, HCHI may realize income without a
corresponding cash payment, as in the case of original issue discount on a loan
or REMIC interest or accrued interest on a defaulted loan. In the event that
HCHI recognizes income without the corresponding cash payment, HCHI may have to
sell assets, borrow (or cause HCP or HCMC to sell assets or borrow) or declare a
taxable stock dividend in order to comply with the 95% distribution test.

The IRS has ruled that if a REIT's dividend reinvestment plan ("DRP")
allows stockholders of the REIT to elect to have cash distributions reinvested
in shares of the REIT at a purchase price equal to at least 95% of fair market
value on the distribution date, then such cash distributions qualify under the
95% distribution test. The terms of HCHI's DRP will comply with the ruling. See
"Dividend Reinvestment Plan."

Under certain circumstances, HCHI may be able to rectify a failure to
meet the 95% distribution test for a year by paying "deficiency dividends" to
stockholders in a later year, which

<PAGE> 96

may be included in HCHI's deduction for dividends paid for the earlier year.
HCHI would be liable for interest based on the amount of any deduction taken for
the deficiency dividends. A deficiency dividend is not permitted if the
deficiency is due to fraud with intent to evade tax or a willful failure to file
timely tax returns.

RECORD KEEPING REQUIREMENTS

A REIT is required to maintain records, including records regarding the
actual and constructive ownership of its shares, and, within 30 days after the
end of its taxable year, to demand statements from persons owning above a
specified level of the REIT's share (e.g., if HCHI has 2,000 or more
stockholders of record, from persons holding 5% or more of HCHI's outstanding
shares of stock; if HCHI has over 200 but fewer than 2,000 stockholders of
record, from persons holding 1% or more of HCHI's outstanding shares of stock;
and if HCHI has 200 or fewer shareholders of record, from persons holding 1/2%
or more of HCHI's outstanding shares of stock) regarding their ownership of
shares. In addition, HCHI must maintain, as part of its records, a list of those
persons failing or refusing to comply with this demand. Shareholders who fail or
refuse to comply with the demand must submit a statement with their tax returns
setting forth their actual stock ownership and other information. The failure of
HCHI to comply with the record keeping requirements for any taxable year will
subject HCHI to a penalty of $25,000 ($50,000 if the failure is due to
intentional disregard of the requirements). HCHI intends to maintain the records
and demand statements as required by these regulations.

TERMINATION OR REVOCATION OF REIT STATUS

If HCHI fails to qualify for taxation as a REIT in any taxable year and
the relief provisions do not apply, HCHI will be subject to tax (including any
applicable alternative minimum tax) at regular corporate rates. Distributions to
stockholders in any year in which HCHI fails to qualify will not be deductible
by HCHI and will not be required to be made. As a result, HCHI's failure to
qualify as a REIT would substantially reduce the cash available for distribution
to its stockholders. In addition, if HCHI fails to qualify as a REIT,
distributions to stockholders will be taxable as ordinary income to the extent
of HCHI's current or accumulated earnings and profits (although, subject to
certain limitations, would be eligible for the dividends received deduction in
the hands of corporate distributees). Unless entitled to relief under specific
statutory provisions, HCHI will also be disqualified from taxation as a REIT for
the four taxable years following the year during which qualification is lost. It
is not possible to state whether in all circumstances HCHI would be entitled to
such statutory relief. Failure to qualify for even one year could result in
HCHI's incurring substantial indebtedness (to the extent borrowings are
feasible) or liquidating substantial investments in order to pay the resulting
taxes.

TAXATION OF HCHI

For as long as HCHI qualifies for taxation as a REIT, it generally will
not be subject to federal income tax on that portion of its net income that is
currently distributed to its stockholders. HCHI will, however, be subject to
federal income tax as follows. First, HCHI will be taxed at regular corporate
rates on any undistributed "REIT taxable income," including undistributed net
capital gains. Generally, REIT taxable income is taxable income adjusted by
disallowing any dividends received deduction, allowing a deduction for dividends
paid, excluding any net income from foreclosure property (see " -- Requirements
for Qualification as a REIT -- Sources of Income") and excluding any net income
from "prohibited transactions" (as described below). Second, under certain
circumstances, HCHI may be subject to the "alternative

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minimum tax" on its items of tax preference. Third, HCHI will be taxed at the
highest corporate rate on (i) net income from the sale or other disposition of
foreclosure property which is held primarily for sale to customers in the
ordinary course of business or (ii) other nonqualifying net income from
foreclosure property. Fourth, HCHI will be subject to a 100% tax on any net
income from prohibited transactions (which are, in general, certain sales or
other dispositions of property, other than foreclosure property, held primarily
for sale to customers in the ordinary course of business). Fifth, if HCHI should
fail to satisfy the 75% of income test or the 95% of income test (discussed
above under "-- Requirements for Qualification as a REIT -- Sources of Income")
but has nonetheless maintained its qualification as a REIT because certain other
requirements have been met, it will be subject to a 100% tax on an amount equal
to (a) the gross income attributable to the greater of the amount by which HCHI
fails the 75% or 95% test multiplied by (b) a fraction intended to reflect
HCHI's profitability. Sixth, if HCHI should fail to distribute during each
calendar year at least the sum of (i) 85% of its REIT ordinary income for such
year, (ii) 95% of its REIT capital gain net income for such year and (iii) any
undistributed taxable income from prior periods, it would be subject to a 4%
excise tax on the excess of such required distribution over the amounts actually
distributed. Seventh, if HCHI has excess inclusion income (attributable to any
residual interest in a REMIC or any interest in a taxable mortgage pool) and a
disqualified organization (generally, tax-exempt entities not subject to tax on
unrelated business income, including governmental organizations) holds shares of
stock in HCHI, HCHI will be taxed at the highest corporate tax rate on the
amount of excess inclusion income for the taxable year allocable to the shares
held by such disqualified organization. Eighth, with respect to any asset (a
"Built-In Gain Asset") acquired by HCHI from a corporation which is or has been
a regular corporation in a transaction in which the basis of the Built-In Gain
Asset in the hands of HCHI is determined by reference to the basis of the asset
in the hands of the corporation, if HCHI recognizes gain on the disposition of
such asset during the ten-year period (the "Recognition Period") beginning on
the date on which such asset was acquired by HCHI, then, to the extent of the
Built-In Gain recognized by HCHI (i.e., the excess of the fair market value of
the asset over the adjusted basis of HCHI in the asset as of the beginning of
the Recognition Period), such gain will be subject to tax at the highest regular
corporate rate pursuant to Treasury Regulations that have not yet been
promulgated. The results described above with respect to the recognition of
Built-In Gain assume that HCHI will make an election pursuant to IRS Notice
88-19 and that such treatment is not modified by subsequently enacted tax
legislation.

It is intended that the Company will be operated so as to minimize any
taxes that will be payable by HCHI. In addition, HCHI intends to distribute
substantially all of its taxable income to its stockholders on a pro rata basis
in each year. There can be no assurance, however, that HCHI will not have to pay
tax as a result of, among other things, HCHI's failure to distribute all of its
taxable income as a result of differences in the timing between the recognition
of income and the deduction of expenses, dispositions of loans and other assets,
the management and dispositions of foreclosure properties and excused failures
to meet REIT qualification tests. In addition, it is anticipated that CMO
issuances will cause HCHI to own interests in taxable mortgage pools, as a
result of which HCHI will have excess inclusion income. See " -- Special
Considerations."

TAXATION OF TAXABLE AFFILIATES

HCP, HCMC and HCS (and any other corporate subsidiaries of HCP) are
fully taxable at regular corporate rates on their net income. Such income is
expected to include all of the income earned by HCP, HCMC and HCS (and any other
subsidiaries of HCP) from origination and

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conduit operations, loan securitizations and due diligence and other activities.
As a result, HCP is able to distribute only its net after-tax earnings as
dividend distributions, thereby reducing the cash available for distribution by
HCHI to its stockholders.

TAXATION OF TAXABLE U.S. STOCKHOLDERS

The Units. The $15.00 purchase price of a Unit in HCHI's initial public
offering was allocable to the share of Common Stock and to the Warrant included
in the Unit in proportion to their relevant fair market values on the date the
Unit was issued. HCHI has notified purchasers of Units in its initial public
offering that the $15.00 public offering price for a Unit was allocable $14.67
to the share of Common Stock included in the Unit and $.33 to the Warrant
included in the Unit. Although HCHI believes that such allocation was
reasonable, there can be no assurance that the IRS will respect such allocation.

The Common Stock. As used herein, the term "U.S. Stockholder" means a
holder of shares of Common Stock who (for United States Federal income tax
purposes) (i) is a citizen or resident of the United States, (ii) is a
corporation, partnership, or other entity created or organized in or under the
laws of the United States or of any political subdivision thereof, or (iii) is
an estate or trust the income of which is subject to United States Federal
income taxation regardless of its source.

As long as HCHI qualifies as a REIT, distributions made by HCHI out of
its current or accumulated earnings and profits (and not designated as capital
gain dividends) will constitute dividends taxable to its taxable U.S.
Stockholders as ordinary income. Such distributions will not be eligible for the
dividends received deduction in the case of U.S. Stockholders that are
corporations. Distributions made by HCHI that are properly designated by HCHI as
capital gain dividends will be taxable to taxable U.S. Stockholders as long-
term capital gains (to the extent that they do not exceed HCHI's actual net
capital gain for the taxable year) without regard to the period for which a U.S.
Stockholder has held his shares of Common Stock. U.S. Stockholders that are
corporations may, however, be required to treat up to 20% of certain capital
gain dividends as ordinary income. To the extent that HCHI makes distributions
(not designated as capital gain dividends) in excess of its current and
accumulated earnings and profits, such distributions will be treated first as a
tax-free return of capital to each U.S. Stockholder, reducing the adjusted basis
which such U.S. Stockholder has in his shares of Common Stock for tax purposes
by the amount of such distribution (but not below zero), with distributions in
excess of a U.S. Stockholder's adjusted basis in his shares taxable as long-
term capital gains (or short-term capital gains if the shares have been held for
one year or less), provided that the shares have been held as a capital asset.
HCHI will notify stockholders at the end of each year as to the portions of the
distributions which constitute ordinary income, net capital gain or return of
capital. Dividends declared by HCHI in October, November or December of any year
and payable to a stockholder of record on a specified date in any such month
will be treated as both paid by HCHI and received by the stockholder on December
31 of such year, provided that the dividend is actually paid by HCHI on or
before January 31 of the following calendar year out of current or accumulated
earnings and profits. Stockholders may not include in their own income tax
returns any net operating losses or capital losses of HCHI. For taxable years
beginning after August 5, 1997, a REIT may retain and pay tax on its long-term
capital gains and pass credits on to its stockholders for the amounts of such
tax payments

Distributions made by HCHI and gain arising from the sale or exchange
by a U.S. Stockholder of shares of Common Stock will not be treated as passive
activity income, and, as a

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result, U.S. Stockholders generally will not be able to apply any "passive
losses" against such income or gain. Distributions made by HCHI (to the extent
they do not constitute a return of capital) generally will be treated as
investment income for purposes of computing the net investment income limitation
applicable to deductions of investment interest. Gain arising from the sale or
other disposition of Common Stock, however, will not be treated as investment
income unless the U.S. Stockholder elects to reduce the amount of such U.S.
Stockholder's total net capital gain eligible for reporting at capital gain
rates by the amount of such gain with respect to such Common Stock.

Upon any sale or other disposition of Common Stock, a U.S. Stockholder
will recognize gain or loss for federal income tax purposes in an amount equal
to the difference between (i) the amount of cash and the fair market value of
any other property received on such sale or other disposition and (ii) the
holder's adjusted basis in such shares of Common Stock for tax purposes. Such
gain or loss will be capital gain or loss if the shares have been held by the
U.S. Stockholder as a capital asset, and will be long-term gain or loss if such
shares have been held for more than one year. A long-term gain on a sale or
other taxable disposition of shares of Common Stock by an individual U.S.
Stockholder is taxable at a maximum federal rate of 28% unless the shares have
been held by the U.S. Stockholder for more than 18 months, in which case the
maximum federal rate is 20%. In general, any loss recognized by a U.S.
Stockholder upon the sale or other disposition of shares of Common Stock that
have been held for six months or less (after applying certain holding period
rules) will be treated as a long-term capital loss, to the extent of
distributions received by such U.S. Stockholder from HCHI which were required to
be treated as long-term capital gains.

The Warrants. Upon the exercise of a Warrant, the holder will not
recognize gain or loss and will have a tax basis in the Common Stock of the
Company received equal to the holder's tax basis in the Warrant plus the
exercise price of the Warrant. The holding period for the Common Stock purchased
by exercising a Warrant will begin on the day following the date of exercise and
will not include the period during which the holder held the Warrant.

Upon the sale or other disposition of a Warrant, the holder will
recognize capital gain or loss in an amount equal to the difference between the
amount realized and the holder's tax basis in the Warrant. Such a gain or loss
will be long-term if the holder's holding period is more than one year (and
eligible for the maximum federal rate of 20% if the holder's holding period is
more than 18 months). In the event a Warrant lapses unexercised, the holder will
recognize a capital loss in an amount equal to his tax basis in the Warrant.
Such loss will be long-term if the Warrant has been held for more than one year.

WITHHOLDING

HCHI will report to its U.S. Stockholders and the Service the amount of
dividends paid during each calendar year, and the amount of tax withheld, if
any. Under the backup withholding rules, a stockholder may be subject to backup
withholding at the rate of 31% with respect to dividends paid unless such holder
(a) is a corporation or comes within certain other exempt categories and, when
required, demonstrates this fact, or (b) provides a taxpayer identification
number, certifies as to no loss of exemption from backup withholding, and
otherwise complies with applicable requirements of the backup withholding rules.
A U.S. Stockholder that does not provide HCHI with his correct taxpayer
identification number may also be subject to penalties imposed by the Service.
Any amount paid as backup withholding will be creditable against the

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stockholder's income tax liability. In addition, HCHI may be required to
withhold a portion of capital gain distributions to any stockholders who fail to
certify their non-foreign status to HCHI.

TAXATION OF TAX-EXEMPT STOCKHOLDERS

Generally, a tax-exempt investor that is exempt from tax on its
investment income, such as an individual retirement account (IRA) or a pension,
profit-sharing or stock bonus plan which is "qualified" under the Code, that
holds Common Stock as an investment will not be subject to tax on dividends paid
by HCHI. However, if such tax-exempt investor is treated as having purchased its
Common Stock with borrowed funds, some or all of its dividends from the Common
Stock will be subject to tax. In addition, under some circumstances certain
pension plans (including "qualified" plans but not including IRAs) that own more
than 10% (by value) of HCHI's outstanding stock, including Common Stock, could
be subject to tax on a portion of their Common Stock dividends even if their
Common Stock is held for investment and is not treated as acquired with borrowed
funds. The ownership limit (see "Description of Capital Stock -- Repurchase of
Shares and Restrictions on Transfer"), however, should reduce the likelihood of
this result. Tax-exempt investors may also be subject to tax on distributions
from HCHI to the extent HCHI has excess inclusion income. See " -- Special
Considerations."

CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO FOREIGN
HOLDERS

The following discussion summarizes certain United States Federal tax
consequences of the acquisition, ownership and disposition of the Common Stock
in the Company by an initial purchaser of the Common Stock that, for United
States Federal income tax purposes, is not a "U.S. Stockholder" as defined above
under " -- Taxation of Taxable U.S. Stockholders -- The Common Stock." This
discussion does not consider any specific facts or circumstances that may apply
to a particular Non-United States Holder. Prospective investors are urged to
consult their tax advisors regarding the United States Federal tax consequences
of acquiring, holding and disposing of Common Stock, as well as any tax
consequences that may arise under the laws of any foreign, state, local or other
taxing jurisdiction.

Dividends. Dividends paid by HCHI out of earnings and profits, as
determined for United States Federal income tax purposes, to a Non-United States
Holder will generally be subject to withholding of United States Federal income
tax at the rate of 30%, unless reduced or eliminated by an applicable tax treaty
or unless such dividends are treated as effectively connected with a United
States trade or business. Distributions paid by HCHI in excess of its earnings
and profits will be treated as a tax-free return of capital to the extent of the
holder's adjusted basis in his Common Stock, and thereafter as gain from the
sale or exchange of a capital asset as described below. If it cannot be
determined at the time a distribution is made whether such distribution will
exceed the earnings and profits of HCHI, the distribution will be subject to
withholding at the same rate as dividends. Amounts so withheld, however, will be
refundable or creditable against the Non-United States Holder's United States
Federal tax liability if it is subsequently determined that such distribution
was, in fact, in excess of the earnings and profits of HCHI. If the receipt of
the dividend is treated as being effectively connected with the conduct of a
trade or business within the United States by a Non-United States Holder, the
dividend received by such holder will be subject to the United States Federal
income tax on net income that applies to U.S. Stockholders generally (and, with
respect to corporate holders and under certain circumstances, the branch profits
tax).

<PAGE> 101

For any year in which HCHI qualifies as a REIT, distributions to a
Non-United States Holder that are attributable to gain from sales or exchanges
by HCHI of "United States real property interests" will be treated as if such
gain were effectively connected with a United States business and will thus be
subject to tax at the normal capital gain rates applicable to U.S. Stockholders
(subject to applicable alternative minimum tax) under the provisions of the
Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"). Also,
distributions subject to FIRPTA may be subject to a 30% branch profits tax in
the hands of a foreign corporate stockholder not entitled to a treaty exemption.
HCHI is required to withhold 35% of any distribution that could be designated by
HCHI as a capital gains dividend. This amount may be credited against the Non-
United States Holder's FIRPTA tax liability.

Gain on Disposition. A Non-United States Holder will generally not be
subject to United States Federal income tax on gain recognized on a sale or
other disposition of the Common Stock unless (i) the gain is effectively
connected with the conduct of a trade or business within the United States by
the Non-United States Holder, (ii) in the case of a Non-United States Holder who
is a nonresident alien individual and holds the Common Stock as a capital asset,
such holder is present in the United States for 183 or more days in the taxable
year and certain other requirements are met, or (iii) the Non-United States
Holder is subject to tax under the FIRPTA rules discussed below. Gain that is
effectively connected with the conduct of a United States trade or business will
be subject to the United States Federal income tax on net income that applies to
U.S. Stockholders generally (and, with respect to corporate holders and under
certain circumstances, the branch profits tax) but will not be subject to
withholding. Non-United States Holders should consult applicable treaties, which
may provide for different rules.

Gain recognized by a Non-United States Holder upon a sale of its Common
Stock will generally not be subject to tax under FIRPTA if HCHI is a
"domestically controlled REIT," which is defined generally as a REIT in which at
all times during a specified testing period less than 50% in value of its shares
were held directly or indirectly by Non-United States Holders. Because only a
minority of HCHI's stockholders are expected to be Non-United States Holders,
HCHI anticipates that it will qualify as a "domestically controlled REIT."
Accordingly, a Non-United States Holder should not be subject to U.S. tax from
gains recognized upon disposition of the Common Stock.

INFORMATION REPORTING AND BACKUP WITHHOLDING

Under temporary United States Treasury regulations, United States
information reporting requirements and backup withholding tax will generally not
apply to dividends paid on the Common Stock to a Non-United States Holder at an
address outside the United States. Payments by a United States office of a
broker of the proceeds of a sale of the Common Stock is subject to both backup
withholding at a rate of 31% and information reporting unless the holder
certifies its Non-United States Holder status under penalties of perjury or
otherwise establishes an exemption. Information reporting requirements (but not
backup withholding) will also apply to payments of the proceeds of sales of the
Common Stock by foreign offices of United States brokers, or foreign brokers
with certain types of relationships to the United States, unless the broker has
documentary evidence in its records that the holder is a Non-United States
Holder and certain other conditions are met, or the holder otherwise establishes
an exemption.

Backup withholding is not an additional tax. Any amounts withheld under
the backup withholding rules will be refunded or credited against the Non-United
States Holder's United

<PAGE> 102
States Federal income tax liability, provided that the required information is
furnished to the Internal Revenue Service.

These information reporting and backup withholding rules are under
review by the United States Treasury and their application to the Common Stock
of the Company could be changed by future regulations.

SPECIAL CONSIDERATIONS

HCHI may invest in or otherwise acquire residual interests in REMICs.
In general, a REMIC is a fixed pool of mortgage instruments in which investors
hold multiple classes of interests and for which a REMIC election has been made.
Part or all of any income derived by HCHI from a REMIC residual interest may be
excess inclusion income. Excess inclusion income is generally taxable income
with respect to a residual interest in excess of a specified return on
investment in the residual interest. In some cases, substantially all taxable
income with respect to a residual interest may be considered excess inclusion
income. Pursuant to regulations not yet published, if HCHI pays any dividends to
its stockholders that are attributable to such excess inclusion income, the
stockholders who receive such dividends would be subject to certain special
rules including (i) the characterization of excess inclusion income as UBTI for
tax-exempt stockholders (including employee benefit plans and individual
retirement accounts), (ii) the application of Federal income tax withholding at
the maximum rate (without reduction for any otherwise applicable income tax
treaty) on any excess inclusion income allocable to Non-United States Holders,
(iii) the inability of a stockholder generally to offset excess inclusion income
with net operating losses, and (iv) the taxation (at the highest corporate tax
rate) of a REIT, rather than its stockholders, on the amount of excess inclusion
income for the taxable year allocable to shares of stock held by disqualified
organizations (generally, tax-exempt entities not subject to tax on unrelated
business taxable income, including governmental organizations). Until
regulations or other guidance are issued, HCHI will use methods it believes are
appropriate for calculating the amount of any excess inclusion income it
recognizes from REMICs, and allocating any excess inclusion income to its
stockholders. Because gains from REMIC issuances may be taxed at a 100% rate as
income from prohibited transactions, REMIC issuances may be effected by HCP,
HCMC and one or more other taxable subsidiaries.

HCHI intends to finance the acquisition of Mortgage Assets by entering
into reverse repurchase agreements (which are essentially loans secured by
Mortgage Assets), CMOs or other secured lending transactions. Such transactions
may result in the existence of debt instruments (i.e., reverse repurchase
agreements, CMOs or other secured loans) with differing maturity dates secured
by a pool of loans. Accordingly, HCHI may be treated, in whole or in part, as a
taxable mortgage pool. If HCHI is treated in whole or in part as a taxable
mortgage pool, a portion of its income will be characterized as excess inclusion
income, thereby subjecting stockholders (or HCHI, to the extent Common Stock is
held by disqualified organizations) to the tax treatment described above with
respect to residual interests in REMICs. There can be no assurance that reverse
repurchase agreements, CMOs or other secured loans will not cause HCHI to
realize excess inclusion income.

OTHER TAX CONSEQUENCES

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

100

<PAGE> 103

consequences discussed above. Consequently, prospective stockholders should
consult their own tax advisors regarding the effect of state and local tax laws
on an investment in HCHI.

ERISA INVESTORS

A fiduciary of a pension, profit-sharing, stock bonus plan or
individual retirement account, including a plan for self-employed individuals
and their employees or any other employee benefit plan (collectively, a "Plan")
subject to the prohibited transaction provisions of the Code or the fiduciary
responsibility provisions of the Employee Retirement Income Security Act of 1974
("ERISA"), should consider (1) whether the ownership of the Common Stock is in
accordance with the documents and instruments governing the Plan, (2) whether
the ownership of Common Stock in the Company is consistent with the fiduciary's
responsibilities and satisfies the requirements of Part 4 of Subtitle A of Title
I of ERISA (if applicable) and, in particular, the diversification, prudence and
liquidity requirements of Section 404 of ERISA, (3) the prohibitions under ERISA
on improper delegation of control over, or responsibility for "plan assets" and
ERISA's imposition of co-fiduciary liability on a fiduciary who participates in,
or permits (by action or inaction) the occurrence of, or fails to remedy a known
breach of duty by another fiduciary with respect to plan assets, and (4) the
need to value the assets of the Plan annually.

In regard to the "plan assets" issue noted in clause (3) above, the
Company believes that the Common Stock should qualify as a "publicly-offered
security," and therefore the acquisition of such Common Stock by Plans should
not cause the Company's assets to be treated as assets of such investing Plans
for purposes of the fiduciary responsibility provisions of ERISA or the
prohibited transaction provisions of the Code. The Department of Labor has
issued final regulations (the "DOL Regulations") as to what constitutes an asset
of a Plan. Under the DOL Regulations, if a Plan acquires an equity interest in
an entity, which interest is neither a "publicly-offered security" nor a
security issued by an investment company registered under the Investment Company
Act of 1940, as amended, the Plan's assets would include, for purposes of the
fiduciary responsibility provisions of ERISA and the prohibited transaction
provisions of the Code, both the equity interest and an undivided interest in
each of the entity's underlying assets, unless certain specified exemptions
apply. The DOL Regulations define a publicly-offered security as a security that
is "widely held," "freely transferable" and either part of a class of securities
registered under the Exchange Act, or sold pursuant to an effective registration
statement under the Securities Act (provided the securities are registered under
the Exchange Act within 120 days after the end of the fiscal year of the issuer
during which the offering occurred). The Common Stock offered hereby is being
sold in an offering registered under the Securities Act and has been registered
under the Exchange Act.

The DOL Regulations provide that a security is "widely held" only if it
is part of a class of securities that is owned by 100 or more investors
independent of the issuer and of one another. A security will not fail to be
"widely held" because the number of independent investors falls below 100
subsequent to the initial public offering as a result of events beyond the
issuer's control. The Company expects the outstanding shares of its Common Stock
to be "widely held" upon the closing of the Offering.

The DOL Regulations provide that whether a security is "freely
transferable" is a factual question to be determined on the basis of all
relevant facts and circumstances. The DOL Regulations further provide that when
a security is part of an offering in which the minimum investment is $10,000 or
less, as is the case with the Offering, certain restrictions ordinarily will

101

<PAGE> 104

not, alone or in combination, affect the finding that such securities are freely
transferable. The Company believes that the restrictions imposed under the
Company's charter on the transfer of the Common Stock are limited to the
restrictions on transfer generally permitted under the DOL Regulations and are
not likely to result in the failure of the Common Stock to be "freely
transferable." The DOL Regulations only establish a presumption in favor of the
finding of free transferability, and therefore, no assurance can be given that
the Department of Labor and the Treasury Department will not reach a contrary
conclusion.

Fiduciaries of ERISA Plans and IRA's should consult with and rely upon
their own advisors in evaluating the consequences under the fiduciary provisions
of ERISA and the Code of an investment in Common Stock in light of their own
circumstances.

LEGAL MATTERS

Certain legal matters in connection with the Common Stock offered
hereby have been passed upon for the Company by Morse, Barnes-Brown & Pendleton,
P.C., Waltham, Massachusetts. Certain legal matters have been passed upon by
Piper & Marbury L.L.P., Baltimore, Maryland, with respect to Maryland law.

EXPERTS

The financial statements of Hanover Capital Mortgage Holdings, Inc. as
of December 31, 1997 and for the period from June 10, 1997 (inception) through
December 31, 1997 and of Hanover Capital Partners Ltd. as of December 31, 1997
and 1996 and for each of the three years in the period ended December 31, 1997
included in this Prospectus have been audited by Deloitte & Touche LLP,
independent auditors, as stated in their reports appearing herein and have been
so included in reliance upon reports of such firm given their authority as
experts in accounting and auditing.

ADDITIONAL INFORMATION

The Company has filed with the Commission, Washington, D.C. 20549, a
Registration Statement on Form S-11 (the "Registration Statement") under the
Securities Act of 1933, as amended (the "Securities Act"), with respect to the
shares of Common Stock offered hereby. Copies of the Registration Statement and
the exhibits thereto are on file at the offices of the Commission in Washington,
D.C. and may be obtained at rates prescribed by the Commission upon request to
the Commission and inspected, without charge, at the offices of the Commission.
The Company is required to file reports and other information with the
Commission pursuant to the requirements of the Securities Exchange Act of 1934,
as amended (the "Exchange Act"). The Company's Exchange Act filing number is
001-13417. Such reports and other information can be inspected and copied at the
public reference facilities maintained by the Commission at 450 Fifth Street,
NW, Washington, D.C. 20549, and at the Commission's regional offices at
Northwest Atrium Center, 500 West Madison Street (Suite 1400), Chicago, Illinois
60661 and 7 World Trade Center, New York, New York 10048. Copies of such
material can also be obtained from the Commission at prescribed rates through
its Public Reference Section at 450 Fifth Street, NW, Washington, D.C. 20549.
The Commission maintains a Web site that contains reports, proxy, and
information statements and other information regarding registrants that file
electronically with the Commission. The Web site is located at
http:///www.sec.gov. Statements contained in this Prospectus as to the contents
of any contract or any other document are not necessarily complete, and in each
instance reference is made to the copy of such contract or other

102

<PAGE> 105

document filed as an exhibit to the Registration Statement, each such statement
being qualified in all respects by such reference.

GLOSSARY

As used in this Prospectus, the capitalized and other terms listed below
have the meanings indicated.

"Agency" means FNMA, FHLMC or GNMA.

"Agency Certificates" means Pass-Through Certificates guaranteed by FNMA,
FHLMC or GNMA.

"ARM" means a Mortgage Loan, or any Mortgage Loan underlying a Mortgage
Security, that features adjustments of the underlying interest rate at
predetermined times based on an agreed margin to an established index. An ARM is
usually subject to periodic interest rate and/or payment caps and a lifetime
interest rate cap.

"Average Net Worth" means the arithmetic average of the sum of the gross
proceeds from any sale of equity securities by the Company, before deducting any
underwriting discounts and commissions and other expenses and costs relating to
the Offering, plus the Company's retained earnings (without taking into account
any losses incurred in prior periods) computed by taking the daily average of
such values during such period.

"Bankruptcy Code" means Title 11, United States Code, as amended.

"CAG" means the Company's capital allocation guidelines.

"CMO" means an adjustable or fixed-rate debt obligation (bond) that is
collateralized by Mortgage Loans or mortgage certificates and issued by private
institutions or issued or guaranteed by FNMA, FHLMC or GNMA.

"CMT Index" means constant maturity Treasury index.

"Code" means the Internal Revenue Code of 1986, as amended.

"Commission" means the Securities and Exchange Commission.

"Company" means either (i) HCHI or (ii) HCHI, HCP, HCMC and HCS
collectively, as the context may require.

"Commercial Mortgage Assets" means Commercial Mortgage Loans and Commercial
Mortgage Securities.

"Commercial Mortgage Loans" means Mortgage Loans secured by commercial
property.

"Commercial Mortgage Securities" means Mortgage Securities representing an
interest in, or secured by, Commercial Mortgage Loans.

"Due Diligence Operations" means the due diligence operations conducted by
the Company.

103

<PAGE> 106

"Earn-Out" means 216,667 additional shares of Common Stock that will be
issued to the Principals if (i) as of any Earn-Out Measuring Date, the return on
a Unit is at least equal to the initial public offering price of the Unit or
(ii) as of any three Earn-Out Measuring Dates, the total return on a Unit is at
least equal to a 20% annualized return on the public offering price of the Unit.
One-third of the Earn-Out 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 (a) the appreciation in the value of the Unit since the closing of the
Offering and (b) the amount of distributions made by the Company on the share of
Common Stock included in the Unit since the closing of the Offering. The
appreciation in the value of a Unit as of any Earn-Out Measuring Date is two
times the average difference, during the 30 day period that ends on the Earn-Out
Measuring Date, between the market price of the share of Common Stock included
in the Unit and the initial public offering price of the Unit.

"Earn-Out Measuring Date" means each September 30, beginning with September
30, 1998 and ending with September 30, 2002.

"ERISA" means the Employee Retirement Income Security Act of 1974.

"ERISA Plan" or "Plan" means a pension, profit-sharing, retirement or other
employee benefit plan which is subject to ERISA.

"Exchange Act" means the Securities Exchange Act of 1934, as amended.

"FHA" means the United States Federal Housing Administration.

"FHLMC" means the Federal Home Loan Mortgage Corporation.

"FNMA" means the Federal National Mortgage Association.

"GAAP" means Generally Accepted Accounting Principles.

"GNMA" means Government National Mortgage Association.

"HCHI" means Hanover Capital Mortgage Holdings, Inc., a Maryland
corporation.

"HCMC" means Hanover Capital Mortgage Corporation, a Missouri corporation.

"HCP" means Hanover Capital Partners Ltd., a New York corporation.

"HCP Common" means voting common stock of HCP.

"HCP Preferred" means nonvoting preferred stock of HCP.

"HCS" means Hanover Capital Securities, Inc., a New York corporation.

"HJV" means Hanover Joint Ventures, Inc., a New York corporation.

"HUD" means the Department of Housing and Urban Development.

104

<PAGE> 107

"Investment Company Act" means the Investment Company Act of 1940, as
amended.

"IRAs" means Individual Retirement Accounts.

"IRS" means the United States Internal Revenue Service.

"ISOs" means qualified incentive stock options granted under the Company's
1997 Stock Option Plan, which meet the requirements of Section 422 of the Code.

"LIBOR" means the London interbank offered rate.

"MGCL" means the Maryland General Corporation Law, as amended from time to
time.

"Mortgage Assets" means Single-Family Mortgage Assets, Multifamily Mortgage
Assets, Commercial Mortgage Assets and Mortgage Securities.

"Mortgage Loans" means Single-Family Mortgage Loans, Multifamily Mortgage
Loans and Commercial Mortgage Loans.

"Mortgage Securities" means (1) Pass-Through Certificates, (2) CMOs and (3)
REMICs.

"Multifamily Mortgage Assets" means Multifamily Mortgage Loans and
Multifamily Mortgage Securities.

"Multifamily Mortgage Loans" means Mortgage Loans secured by multifamily (in
excess of four units) residential property.

"Multifamily Mortgage Securities" means Mortgage Securities representing an
interest in, or secured by, Multifamily Mortgage Loans.

"Net Income" means the net income of the Company determined in accordance
with GAAP before the deduction for dividends paid, and any net operating loss
deductions arising from losses in prior periods. The Company's interest expenses
for borrowed money shall be deducted in calculating Net Income.

"Ownership Limit" means, with respect to all stockholders other than John A.
Burchett for which such Ownership Limit shall be 11.99%, 9.5% (in value or in
number of shares, whichever is more restrictive) of the aggregate of the
outstanding shares of Common Stock, as may be increased or reduced by the Board
of Directors of HCHI.

"Pass-Through Certificates" means securities (or interests therein) which
are Qualified REIT Assets evidencing undivided ownership interests in a pool of
Single-Family Mortgage Loans, the holders of which receive a "pass-through" of
the principal and interest paid in connection with the underlying Single-Family
Mortgage Loans in accordance with the holders' respective, undivided interests
in the pool.

"Principals" mean John A. Burchett, Joyce S. Mizerak, Irma N. Tavares and
George J. Ostendorf.

105

<PAGE> 108

"Privately-Issued Certificates" means privately-issued Pass-Through
Certificates issued by the Company or an affiliate of the Company or other
non-Agency third party issuer.

"Qualified Hedge" means an interest rate swap or cap agreement, option,
futures contract, forward rate agreement or similar financial instrument entered
into to reduce the interest rate risks with respect to indebtedness incurred or
to be incurred to acquire or carry Real Estate Assets and the payments on (or
gain on the disposition of) which qualify under Section 856(c)(2) of the Code.

"Qualified REIT Assets" means Pass-Through Certificates, Mortgage Loans,
Agency Certificates and other assets qualifying as "real estate assets" under
Code Section 856(c)(5)(B).

"Qualified REIT Subsidiary" means a corporation whose stock is entirely
owned by a REIT.

"Qualifying Interests" means "mortgages and other liens on and interests in
real estate," as defined in Section 3(c)(5)(c) under the Investment Company Act.

"Real Estate Assets" means interests in real property, interests in
mortgages on real property, regular and residual interests in REMICs and stock
in qualifying REITs.

"REIT" means Real Estate Investment Trust as defined under Section 856 of
the Code.

"REMIC" means serially maturing debt securities secured by a pool of
Mortgage Loans, the payments on which bear a relationship to the debt securities
and the issuer of which qualifies as a Real Estate Mortgage Investment Conduit
as defined under section 860D of the Code.

"Representatives" means Stifel, Nicolaus & Company, Incorporated and
Montgomery Securities.

"Representatives' Warrants" means the Warrants to be issued to the
Representatives to purchase 172,500 shares of Common Stock at an exercise price
of $15.00.

"Reverse Repurchase Agreement" means a borrowing device by an agreement to
sell securities or other assets to a third party and a simultaneous agreement to
repurchase them at a specified future date and price, the price difference
constituting the interest on the borrowing.

"RTC" means Resolution Trust Corporation.

"Securities Act" means the Securities Act of 1933, as amended.

"Single-Family Mortgage Assets" means Single-Family Mortgage Loans and
Single-Family Mortgage Securities.

"Single-Family Mortgage Loans" means Mortgage Loans secured by single-family
(one to four unit) residential property.

"Single-Family Mortgage Securities" means Mortgage Securities representing
an interest in, or secured by, Single-Family Mortgage Loans.

106

<PAGE> 109

"Tax-Exempt Entity" means a qualified pension, profit-sharing or other
employee retirement benefit plan, Keogh Plan, bank commingled trust fund for
such plans, and IRA or other similar entity intended to be exempt from Federal
income taxation.

"Ten Year U.S. Treasury Rate" means the average of the weekly average yield
to maturity for U.S. Treasury securities (adjusted to a constant maturity of 10
years) as published weekly by the Federal Reserve Board during a quarter.

"UBTI" means "unrelated trade or business taxable income" as defined in
Section 512 of the Code.

107

<PAGE> 110
TABLE OF CONTENTS TO FINANCIAL STATEMENTS

PAGE
----
<S> <C>
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
Independent Auditors' Report....................................................................F-2
Financial Statements as of December 31, 1997 and for the Period from June 10, 1997
(inception) through December 31, 1997:
Balance Sheet.................................................................................F-3
Statement of Operations.......................................................................F-4
Statement of Stockholders' Equity.............................................................F-5
Statement of Cash Flows.......................................................................F-6
Notes to Financial Statements.................................................................F-7
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
Independent Auditors' Report....................................................................F-22
Consolidated Financial Statements as of December 31, 1997 and December 31, 1996 and for each F-22
of the Three Years in the Period Ended December 31, 1997:
Balance Sheets................................................................................F-23
Statements of Operations......................................................................F-24
Statements of Stockholders' Equity............................................................F-25
Statements of Cash Flows......................................................................F-26
Notes to Consolidated Financial Statements....................................................F-27
Financial Statements as of March 31, 1998 and for the Three Months Ended March
31, 1998 (unaudited):
Condensed Balance Sheets as of March 31, 1998 and December 31, 1997...........................F-35
Condensed Statement of Operations for the Three Months Ended March 31, 1998...................F-36
Condensed Statement of Cash Flows for the Three Months Ended March 31, 1998...................F-37
Notes to Condensed Financial Statements.......................................................F-38
</TABLE>

F-1
<PAGE> 111

INDEPENDENT AUDITORS' REPORT

To the Board of Directors of
Hanover Capital Mortgage Holdings, Inc.
New York, New York

We have audited the accompanying balance sheet of Hanover Capital Mortgage
Holdings, Inc. (the "Company") as of December 31, 1997 and the related
statements of operations, stockholders' equity and cash flows for the period
June 10, 1997 (inception) through December 31, 1997. 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 audit.

We conducted our audit in accordance with generally accepted auditing
standards. 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 audit provides a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Hanover Capital Mortgage
Holdings, Inc. as of December 31, 1997 and the results of its operations and
its cash flows for the period June 10, 1997 (inception) through December 31,
1997, in conformity with generally accepted accounting principles.

DELOITTE & TOUCHE LLP

Parsippany, New Jersey
March 20, 1998

F-2
<PAGE> 112
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

BALANCE SHEET

(in thousands, except as noted)

<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
ASSETS

ARM securities, available for sale $ 348,131
Mortgage loans, held for sale 160,970
Cash and cash equivalents 4,022
Accrued interest receivable 3,597
Equity investment 100
Notes receivable from related parties 482
Prepaid expenses and other assets 241
---------

TOTAL ASSETS $ 517,543
=========

LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES:
Reverse repurchase agreements $ 435,138
Accrued interest payable 2,250
Dividends payable 1,035
Due to related party 540
Accrued expenses and other liabilities 482
---------

Total liabilities 439,445
---------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
Preferred stock, par value $.01
authorized, 10 million shares, issued
and outstanding, -0- shares --
Common stock, par value $.01
authorized, 90 million shares, issued
and outstanding, 6,466,677 shares 65
Additional paid-in-capital 79,411
Available for sale securities:
Unrealized (loss) on investments available
for sale (842)
Retained earnings (deficit) (536)
---------

Total stockholders' equity 78,098
---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 517,543
=========
</TABLE>

See notes to financial statements

F-3
<PAGE> 113
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

STATEMENT OF OPERATIONS

PERIOD FROM JUNE 10 (INCEPTION) TO DECEMBER 31, 1997
(in thousands, except per share data)

<TABLE>
<S> <C>
REVENUES:
Interest income $ 4,880
Interest expense 3,204
-----------
Net interest income 1,676
Loan loss provision 18
-----------
Net interest income after loan loss
provision 1,658
-----------
Gain on sale of securities 35
-----------
Total revenues 1,693
-----------

EXPENSES:
General and administrative expenses
Management and administrative 400
Due diligence 266
Commissions 61
Legal and professional 170
Other 43
-----------
Total expenses 940
-----------

Operating income 753

Equity in (loss) of unconsolidated subsidiary (254)
-----------

NET INCOME $ 499
===========

BASIC EARNINGS PER SHARE $ 0.15
===========

DILUTED EARNINGS PER SHARE $ 0.14
===========
</TABLE>

See notes to financial statements

F-4

<PAGE> 114

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

STATEMENT OF STOCKHOLDERS' EQUITY

PERIOD FROM JUNE 10 (INCEPTION) TO DECEMBER 31, 1997
(in thousands)

<TABLE>
<CAPTION>
AVAILABLE
FOR SALE
ADDITIONAL SECURITIES RETAINED
COMMON STOCK PAID-IN UNREALIZED EARNINGS
SHARES AMOUNT CAPITAL (LOSS) (DEFICIT) TOTAL
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock 6,466,677 $ 65 $ 79,411 $ 79,476

Unrealized (loss) on available-for-sale $(842) (842)
securities
Net income $499 499

Dividends declared (1,035) (1,035)
-----------------------------------------------------------------------------------

BALANCE, DECEMBER 31, 1997 6,466,677 $ 65 $ 79,411 $(842) $(536) $78,098
===================================================================================
</TABLE>

See notes to financial statements

F-5

<PAGE> 115

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

STATEMENT OF CASH FLOWS

PERIOD FROM JUNE 10 (INCEPTION) TO DECEMBER 31, 1997
(in thousands)

<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 499
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of net premium - ARM securities 314
Amortization of net premium - mortgage loans 47
Loan loss provision 18
Gain on sale of securities (35)
Equity in loss of unconsolidated subsidiary 254
Increase in accrued interest receivable (3,597)
Loans to officers/stockholders (482)
Increase in prepaid expenses and other assets (241)
Increase in accrued interest payable 2,250
Increase in due to related party 540
Increase in accrued expenses and other liabilities 482
---------

Net cash provided by operating activities 49
---------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of ARM securities (349,287)
Purchase of mortgage loans (163,030)
Principal payments on mortgage loans 1,995
Proceeds from sale of securities 35
---------

Net cash (used in) investing activities (510,287)
---------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from reverse repurchase agreements 435,138
Net proceeds of initial public offering 79,122
---------

Net cash provided by financing activities 514,260
---------

NET INCREASE IN CASH AND CASH EQUIVALENTS 4,022

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 0
---------

CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,022
=========
</TABLE>

SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES

Operating activity - increase in dividends payable ($1,035,000) relating to the
declaration of dividends in December 1997.

Investing activity - acquisition of a 97% ownership interest in Hanover Capital
Partners Ltd ($354,000).

Financing activities - issuance of 716,667 shares of the Company's common stock
used to acquire an equity investment in HCP ($354,000), and the declaration of
$1,035,000 of dividends in December 1997 that was paid in January 1998.

SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid during the period for:

<TABLE>
<S> <C>
Income taxes $ -0-
==========
Interest $ 884
==========
</TABLE>

See notes to financial statements

F-6

<PAGE> 116

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997

1. BUSINESS DESCRIPTION

GENERAL

Hanover Capital Mortgage Holdings, Inc. (the "Company") was incorporated in
Maryland on June 10, 1997. The Company is a self-managed real estate investment
trust ("REIT"), formed to operate as a specialty finance company. The principal
business strategy of the company is to (i) acquire primarily single-family
mortgage loans that are at least twelve months old or that were intended to be
of certain credit quality but that do not meet the originally intended market
parameters due to errors or credit deterioration, (ii) securitize the mortgage
loans and retain interests therein, (iii) originate, hold, sell and service
multifamily mortgage loans and commercial mortgage loans and (iv) acquire
multifamily mortgage loans. The Company's principal business objective is to
generate increasing earnings and dividends for distribution to its stockholders.
The Company acquires single-family mortgage loans through a network of sales
representatives targeting financial institutions throughout the United States.
The Company may also acquire multifamily mortgage loans from a taxable
subsidiary of the Company.

CAPITALIZATION

In September 1997, the Company raised net proceeds of approximately $79 million
in its initial public offering (the "IPO"). In the IPO, the Company sold
5,750,000 units (each unit consists 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' overallotment option, which was exercised in
full. Each warrant entitles the holder to purchase one share of common stock at
the original issue price - $15.00. The warrants became exercisable on March 19,
1998 and remain exercisable until September 15, 2000. The Company will utilize
substantially all of the net proceeds of the IPO to fund leveraged purchases of
mortgage assets.

In connection with the closing of the IPO the Company acquired a 97% ownership
interest (representing a 100% ownership of the non-voting preferred stock) in
Hanover Capital Partners Ltd. and its wholly-owned subsidiaries: Hanover Capital
Mortgage Corporation and Hanover Capital Securities, Inc., in exchange for
716,667 shares of the Company's common stock. Hanover Capital Partners Ltd. and
its wholly-owned subsidiaries offer due diligence services to buyers, sellers
and holders of mortgage loans and originate, sell and service multifamily
mortgage loans and commercial loans.

F-7

<PAGE> 117

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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 reported amounts of revenues and expenses during the reporting period. 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.

ADJUSTABLE RATE MORTGAGE SECURITIES

The Company's policy is to classify its adjustable rate mortgage ("ARM")
securities as available-for-sale as they are purchased and each asset is
monitored for a period of time, generally three to six months, prior to making a
determination whether the asset will be classified as held-to-maturity. At
December 31, 1997 management has made the determination that all ARM securities
are available-for-sale in order to be prepared to respond to potential future
opportunities in the market, to sell ARM securities in order to optimize the
portfolio's total return and to retain its ability to respond to economic
conditions that require the Company to sell assets in order to maintain an
appropriate level of liquidity. Management re-evaluates the classification of
the ARM securities on a quarterly basis. ARM securities classified as
held-to-maturity are carried at the fair value of the security at the time the
designation is made and any fair value adjustment to the cost basis as of the
date of the classification is amortized into interest income as a yield
adjustment. All ARM 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.

Premiums and discounts associated with the purchase of ARM securities are
amortized into interest income over the lives of the securities using the
effective yield method adjusted for the effects of estimated prepayments. ARM
securities transactions are recorded on the date the ARM securities are
purchased or sold. Purchases of new issue ARM securities are recorded when all
significant uncertainties regarding the characteristics of the securities are
removed, generally on or shortly before settlement date. Realized gains and
losses on ARM securities transactions are determined on the specific
identification basis.

F-8

<PAGE> 118

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

The Company has limited its exposure to credit losses on its portfolio of ARM
securities by only purchasing ARM securities that have some form of credit
enhancement and that are either guaranteed by an agency of the federal
government or have an investment grade rating at the time of purchase, or the
equivalent, by at least one of two nationally recognized rating agencies,
Moody's or Standard & Poor's (the "Rating Agencies"). The Company monitors the
delinquencies and losses on the underlying mortgages of its ARM securities and,
if the credit performance of the underlying mortgage loans is not as good as
expected, makes a provision for possible credit losses as well as unidentified
potential future losses in its ARM securities portfolio. The provision is based
on management's assessment of numerous factors affecting its portfolio of ARM
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.

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. At December 31, 1997 management
has made the determination that all mortgage loans are held for sale in order to
be prepared to respond to potential future opportunities in the market, to sell
mortgage loans in order to optimize the portfolio's total return and to retain
its ability to respond to economic conditions that require the Company to sell
mortgage loans in order to maintain an appropriate level of liquidity.
Management re-evaluates the classification of mortgage loans on a quarterly
basis. 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.

Premiums and discounts 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.

F-9

<PAGE> 119

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

The accrual of interest on impaired loans is discounted 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 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 borrowers 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.

FINANCIAL INSTRUMENTS

The Company from time to time enters into interest rate hedge mechanisms to
manage its exposure to interest rate changes in connection with the purchase,
securitization and sale of its mortgage loans. The Company closes out the hedge
position to coincide with the related mortgage loan sale and securitization
transactions and recognizes the results of the hedge transaction in determining
the amount of the related mortgage loan sale gain for loans sold or, as a basis
adjustment to mortgage loans held to maturity.

EQUITY INVESTMENT

The Company's 97% ownership investment in Hanover Capital Partners Ltd. ("HCP")
is accounted for by the equity method of accounting. The Company generally has
no right to control the affairs of HCP because the Company's investment in HCP
is based solely on a 100% ownership of HCP's non-voting preferred stock. Even
though the Company has no right to control the affairs of HCP, management
believes that the Company has the ability to exert significant influence over
HCP and therefore the investment in HCP is accounted for by the equity method of
accounting.

REVERSE REPURCHASE AGREEMENTS

Reverse repurchase agreements are accounted for as collateralized financing
transactions and recorded at their contractual amounts, plus accrued interest.

F-10

<PAGE> 120

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

INCOME TAXES

The Company has elected to be taxed as a real estate investment trust ("REIT")
and intends to comply with the provisions of the Internal Revenue Code of 1986,
as amended (the "Code") with respect thereto. Accordingly, the Company will not
be subject to Federal income tax to the extent of its distributions to
stockholders as long as certain asset, income and stock ownership tests are met.

EARNINGS PER SHARE

At December 31, 1997 the Company adopted Statement of Financial Accounting
Standards No. 128 "Earnings per Share"("SFAS 128"). Under SFAS 128 basic
earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings 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.
Shares issued during the period and shares reacquired during the period are
weighted for the period they were outstanding.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income
("SFAS 130"). SFAS 130 establishes standards for reporting and displaying of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general purpose financial statements. SFAS 130 requires that
all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. SFAS 130 is
effective for fiscal years beginning after December 15, 1997. Reclassification
of financial statements for earlier periods provided for comparative purposes is
required.

The FASB issued SFAS No.131 Disclosures About Segments of an Enterprise and
Related Information ("SFAS 131") in June 1997. SFAS 131 establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to stockholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
SFAS 131 is effective for financial statements for periods beginning after
December 15, 1997. Management has not yet determined what effect, if any,
adoption will have on the Company's financial condition and results of
operations.

3. ADJUSTABLE RATE MORTGAGE SECURITIES

ARM securities consist of FNMA and FHLMC mortgage certificates secured by ARM
loans on single-family residential housing. The following table summarizes the
Company's ARM

F-11

<PAGE> 121

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

securities classified as available-for-sale as of December 31, 1997, which are
carried at their fair value (dollars in thousands):

<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE PORTFOLIO MIX
------------------ -------------
<S> <C> <C>
Amortized cost :
FNMA certificates $ 207,898 59.6%
FHLMC certificates 141,075 40.4%
--------- -----
Total amortized cost 348,973 100.0%
=====
Gross unrealized (losses) (842)
---------
Fair value $ 348,131
=========
</TABLE>

The scheduled maturities of ARM securities available for sale at December 31,
1997, were as follows:

<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
--------- ---------
<S> <C> <C>
Due in one year or less $ -0- $ -0-
Due from one to five years -0- -0-
Due from five to ten years -0- -0-
Due after ten years 348,973 348,131
--------- ---------
Total $ 348,973 $ 348,131
========= =========
</TABLE>

As mentioned above, actual maturities may differ from scheduled maturities
because borrowers may 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 obligations.

As of December 31, 1997, the average effective yield on the ARM securities
including the amortization of the net premiums paid for the ARM securities, was
6.268%.

4. MORTGAGE LOANS HELD FOR SALE

Investments in single-family mortgage loans held for sale consist of fixed rate
mortgages and adjustable rate mortgages. The following table summarizes the
Company's single-family mortgage loan pools as of December 31, 1997, which are
carried at the lower of cost or market (dollars in thousands):

F-12

<PAGE> 122

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

<TABLE>
<CAPTION>
COST MIX
---- ---
<S> <C> <C>
Fixed rate $ 106,397 67.1%
Adjustable rate 52,392 32.9%
--------- -----
Subtotal 158,789 100.0%
=====
Net deferred loan fees,
Premiums and discounts 2,199
Loan loss provision (18)
---------
Total $ 160,970
=========
</TABLE>

An analysis of the change in the loan loss provision is as follows:

<TABLE>
<S> <C>
Balance beginning of period $ 0

Loan loss provision 18
---
Balance at December 31, 1997 $18
===
</TABLE>

The following table summarizes certain characteristics of the Company's
single-family fixed rate and adjustable rate mortgage loan portfolios as of
December 31, 1997 (dollars in thousands):

<TABLE>
<CAPTION>
CARRYING VALUE PRINCIPAL WEIGHTED WEIGHTED
OF MORTGAGE AMOUNT OF AVERAGE NET AVERAGE
LOANS MORTGAGE LOANS COUPON MATURITY (1)
----- -------------- ------ ------------
<S> <C> <C> <C> <C>
Fixed Rate $107,953 $106,424 8.265% 242
Adjustable Rate 53,017 52,365 7.925% 319
-------- -------- ----- --------
$160,970 $158,789 8.153% 267
======== ======== ===== ========
</TABLE>

(1) weighted average maturity reflects the number of months remaining until
maturity

As of December 31, 1997 the average effective yield on the mortgage loan
portfolio, including the amortization of the net premiums paid for the mortgage
loans, was 7.317%.

5. CONCENTRATION OF CREDIT RISK

The Company's exposure to credit risk associated with its lending 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 portfolio for the mortgage loans in certain
geographic areas. At December 31, 1997, the percent of total principal amount of
mortgage loans outstanding in any one state, exceeding 5% of the principal
amount of mortgage loans held for sale, are as follows:

F-13

<PAGE> 123

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

<TABLE>
<CAPTION>
STATE PERCENT
----- -------
<S> <C>
Florida 25%
South Carolina 13%
California 10%
Ohio 9%
Texas 6%
</TABLE>

The Company's management believes exposure to credit risk associated with agency
ARM securities is minimal due to the guarantees provided by FNMA and FHLMC.

During 1997 the Company purchased approximately 61.9% of its total outstanding
principal amount of mortgage loans from three financial institutions (the
largest of which represented approximately 29.1% of the total outstanding
principal amount of mortgage loans). Management attributes the high
concentration of purchases from these three financial institutions to the
initial ramp up phase of mortgage loan acquisitions and does not foresee that
this is a trend that will continue into the future.

ARM securities were purchased from six securities firms in 1997. The largest
concentration of ARM purchases from one firm represented approximately 22.8% of
the total principal amount of ARM securities outstanding at December 31, 1997.

The company has cash and cash equivalents in a financial institution which is
insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000 per
institution. As of December 31, 1997, the Company had amounts on deposit with
the financial institution in excess of FDIC limits. The Company limits its risk
by placing its cash and cash equivalents in a high quality financial
institution.

6. REVERSE REPURCHASE AGREEMENTS

In September 1997, the Company entered into a master repurchase agreement with a
lender in an amount up to $200 million ($100 million committed and $100 million
uncommitted) for a period of one year. Any borrowings under this facility will
be secured by mortgage loans, or other securities, and will bear interest at the
six-month LIBOR, plus a spread ranging from 0.70% to 1.25%.

In December 1997 the Company entered into a second master repurchase agreement
with another lender in an amount up to $125 million ($100 million committed and
$25 million uncommitted) for a period of one year. Any borrowings under this
facility will be secured by mortgage loans, or other securities and will bear
interest at the six-month LIBOR, plus a spread of 60 basis points.

At December 31, 1997 the Company had outstanding borrowings of $93,731,000 under
the above mentioned reverse repurchase agreements with a weighted average
borrowing rate of 6.313% and a weighted average remaining maturity of
approximately one month. The reverse

F-14

<PAGE> 124

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

repurchase agreements at December 31, 1997 were collateralized by mortgage loans
with a cost basis of $160,970,000 (which approximates market value).

In November 1997 the Company entered into six separate reverse repurchase
agreements to finance all of its ARM securities purchases. Each of the reverse
repurchase agreements are secured by the market value of the Company's ARM
securities ($348,131,000) at December 31, 1997 and bear interest at LIBOR.

As of December 31, 1997, the Company had outstanding ARMS securities reverse
repurchase agreements of $341,407,000 with a weighted average borrowing rate of
5.723 % and a weighted average remaining maturity of less than one month.

Information concerning the reverse repurchase agreements and the pledged
collateral at December 31, 1997 is summarized as follows: (dollars in
thousands):

<TABLE>
<CAPTION>
Collateral (dollars in thousands)
---------------------------------
ARM Mortgage
Reverse Repurchase Agreements Securities Loans
- - ----------------------------- ---------- -----
<S> <C> <C>
Average balance during the period (1) $113,803 $ 32,674
Average interest rate during period (1) 5.723% 6.313%
Maximum month-end balance during
the period $341,407 $ 93,731

Collateral Underlying the Agreements
- - ------------------------------------
Carrying balance $348,131 $160,970
Estimated fair value $348,131 $160,970
</TABLE>

(1) above table reflects the period beginning September 30, 1997 (the date
of the first mortgage asset purchase) through December 31, 1997.

7. 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 six 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 ($9,500 in 1997). Under
the 401(k) Plan, an employee may elect to enroll on January 1, or July 1,
provided that the employee has met the six month employment service requirement.

F-15

<PAGE> 125

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

1997 STOCK OPTION PLAN

The Company's 1997 Executive and Non-Employee Director 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 rights and limited
stock awards ("Awards") and dividend equivalent rights ("DERs").

Subject to anti-dilution provisions of stock splits, stock dividends and similar
events, 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 common stock. If an
option granted under the 1997 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 1997 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 ISO's granted to an employee who is deemed to own in excess of 10% of
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 of the common
stock 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 1997
Stock Option Plan will be 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"). Subject to any other applicable
vesting restrictions, any outstanding stock options will vest in full as of any
Earn-Out Measuring Date through which 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 applicable 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 share of common stock
included in the unit and the initial public offering price of the unit
multiplied by two to take into account the value of the stock 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.

F-16

<PAGE> 126

\ HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

A summary of the status of the Company's 1997 Stock Option Plan as of December
31, 1997 and changes during the period from September 19, 1997 through December
31, 1997 is presented below:

<TABLE>
<CAPTION>
STOCK OPTION SHARES EXERCISE PRICE
- - ------------ ------ --------------
<S> <C> <C>
Granted - September 19, 1997 162,664 $15.00
Granted - September 28, 1997 160,660 15.75
Cancelled (3,000) 15.75
-------- ------
Outstanding at December 31, 1997 320,324 $15.37
======== ======
</TABLE>

No shares were exercisable at December 31, 1997.

The per share weighted average fair value of stock options granted during the
period ended December 31, 1997 was $0.27 at the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:

<TABLE>
<CAPTION>
1997
----
<S> <C>
Expected life (years) 5
Risk-free interest rate 5.77%
Volatility 12.0%
Expected dividend yield 10.0%
</TABLE>

The Company applies APB opinion No. 25 in accounting for its 1997 Stock Option
Plan and, accordingly, no compensation cost has been recognized for its stock
options in the financial statements. 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 indicated below (in thousands, except per share data):

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1997
-----------------
<S> <C>
Net earnings:
As reported $ 499
Pro forma 417

Earnings per share - basic:
As reported $0.15
Pro forma 0.13

Earnings per share - diluted
As reported $0.14
Pro forma 0.11
</TABLE>

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

F-17

<PAGE> 127

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

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 allow 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 1997.

8. AFFILIATED PARTY TRANSACTIONS

The Company has engaged HCP pursuant to a Management Agreement to render, among
other things, due diligence, asset management and administrative services. The
1997 statement of operations of the Company includes management and
administrative expenses of $400,000, due diligence expenses of $266,000 and
commission expenses of $61,000 relating to billings from HCP. At December 31,
1997 the balance sheet of the Company included an amount due HCP of $540,000.
The term of the Management Agreement continues until December 31, 1999 with
subsequent renewal provisions.

The Company has 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 tax on the gains they must recognize upon contributing
their HCP preferred stock to the Company for shares of the Company's common
stock. The loans will be secured solely by 116,667 shares of the Company'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, 1997 loans outstanding to three of the Principals totaled $482,000.

9. EARNINGS PER SHARE

On December 31, 1997 the Company adopted SFAS 128 for calculating earnings per
share as shown below: (dollars in thousands, except per share data)

<TABLE>
<S> <C>
Earnings per share - basic:
Net income (numerator) $ 499
==========

Average common shares
outstanding (denominator) 3,296,742
==========
Per share $ 0.15
==========

Earnings per share - diluted:
Net income (numerator) $ 499
==========

Average common shares outstanding 3,296,742
Add: Incremental shares from
assumed conversion of
warrants 374,943
----------
Dilutive potential common shares 374,943
----------
Adjusted weighted average shares
(denominator) 3,671,685
==========

Per share $ 0.14
==========
</TABLE>

F-18

<PAGE> 128

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

10. COMMITMENTS AND CONTINGENCIES

At December 31, 1997 the Company had committed to purchase approximately
$111,092,000 of fixed and ARM loans.

The Company entered into employment agreements with the Principals. Such
agreements are for five year terms which expire in 2002, and provide for
aggregate annual base salaries of $975,000. A portion of the aggregate base
salaries is allocated to the Company's taxable subsidiary 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 the Company, the Company has agreed to (1) issue to the
Principals up to 216,667 additional shares of the Company'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 the Company's IPO Prospectus dated September 15, 1997.

The Company has guaranteed the line-of-credit of its majority owned subsidiary,
Hanover Capital Partners Ltd. The maximum line-of-credit obligation and the
actual line-of-credit obligation at December 31, 1997 was $1,700,000 and
$1,405,000, respectively.

11. FINANCIAL INSTRUMENTS

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.

The estimated fair value of the Company's assets and liabilities classified as
financial instruments and off-balance sheet financial instruments at December
31, 1997 are as follows (dollars in thousands):

F-19

<PAGE> 129

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

<TABLE>
<CAPTION>
CARRYING FAIR
AMOUNT VALUE
-------- --------
<S> <C> <C>
Assets:
ARM securities $348,131 $348,131
Mortgage loans 160,970 160,970
Cash and cash equivalents 4,022 4,022
Accrued interest receivable 3,597 3,597
Notes receivable 482 482
-------- --------
Total $517,202 $517,202
======== ========

Liabilities:
Reverse repurchase agreements 435,138 435,138
Accrued interest payable 2,250 2,250
Other liabilities 2,057 2,057
-------- --------
Total $439,445 $439,445
======== ========

Off-Balance Sheet: Notional
--------
Commitments to purchase loans $111,092 $111,132
======== ========

Forward commitments to sell
mortgage securities $122,650 $122,378
======== ========
</TABLE>

The following methods and assumptions were used to estimate the fair value of
the Company's financial instruments:

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.

ARM securities - The fair values of these financial instruments are based upon
either or all of the following: actual prices received upon recent sales of
mortgage securities to investors, projected prices which could be obtained
through investor estimates considering interest rates, mortgage 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.

Mortgage loans held for sale - The fair values of these financial instruments
are based upon actual prices received upon recent sales of mortgage loans and
securities to investors and projected prices which could be obtained through
investors considering interest rates, mortgage loan type, an credit quality.

Commitments to purchase/originate mortgages - The Company has outstanding
commitments to purchase mortgage loans at market terms at the time of
commitment. The fair value of these financial instruments was determined through
a 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 mortgage loans held for sale.

F-20

<PAGE> 130

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM JUNE 10, 1997 (INCEPTION) TO DECEMBER 31, 1997 - (CONTINUED)

Forward commitments to sell mortgage securities - The Company has outstanding
forward commitments to sell mortgages and/or mortgage securities into mandatory
delivery contracts with investment bankers, private mortgage investors and
agency mortgage-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 mortgage loans held
for sale.

12. SUBSEQUENT EVENT

On January 12, 1998 a $0.16 cash dividend previously declared by the Board of
Directors was paid to stockholders of record as of December 31, 1997.

13. QUARTERLY FINANCIAL DATA - UNAUDITED

Selected quarterly financial data are as follows (dollars in thousands, except
per share data):

Period from June 10, 1997 (inception)
through December 31, 1997

<TABLE>
<CAPTION>
(1) (1)
THREE MONTHS THREE MONTHS JUNE 10, 1997
ENDED ENDED THROUGH
DECEMBER 31, 1997 SEPTEMBER 30, 1997 JUNE 30, 1997
---------------------------------------------------------------------------
<S> <C> <C> <C>
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(2) 0.07 0.07 0.00
=================================================================

Dividends declared 0.16 0.00 0.00
=================================================================
</TABLE>

(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 do not equal
the earnings per share total for the year

F-21

<PAGE> 131
INDEPENDENT AUDITORS' REPORT

To the Board of Directors of
Hanover Capital Partners Ltd.

We have audited the accompanying consolidated balance sheets of Hanover Capital
Partners Ltd. and Subsidiaries (the "Company") as of December 31, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1997.
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 generally accepted auditing
standards. 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 financial position of Hanover Capital Partners Ltd. and
Subsidiaries at December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles.

DELOITTE & TOUCHE LLP

Parsippany, New Jersey
March 20, 1998

F-22

<PAGE> 132
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
- - --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
ASSETS 1997 1996
---- ----

<S> <C> <C>
CURRENT ASSETS:
Cash $ 208,315 $ 161,546
Investment in marketable securities 17,394 16,443
Accounts receivable 133,829 3,683,865
Receivables from related parties 757,384 521,539
Accrued revenue on contracts in progress 35,413 549,781
Prepaid expenses and other current assets 118,552 143,026
---------- ----------
Total current assets 1,270,887 5,076,200

PROPERTY AND EQUIPMENT - Net 213,137 316,057
MORTGAGE SERVICING RIGHTS 49,449 30,587
DEFERRED TAX ASSET 20,081 --
OTHER ASSETS 166,670 227,548
INCOME TAX RECEIVABLE 292,885 --
DUE FROM OFFICER 53,766 107,532
---------- ----------
TOTAL ASSETS $2,066,875 $5,757,924
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Accrued appraisal and subcontractor costs $ 131,978 $2,807,172
Accounts payable and accrued expenses 334,591 678,390
Income taxes payable -- 89,477
Deferred revenue 104,950 194,334
Notes payable to related parties -- 133,018
Deferred income taxes -- 12,993
Other liabilities -- 122,400
---------- ----------
Total current liabilities 571,519 4,037,784
---------- ----------
LONG-TERM LIABILITIES
Note payable to bank 1,405,000 1,045,000
Minority interest 616 250
---------- ----------
Total long-term liabilities 1,405,616 1,045,250
---------- ----------
Total liabilities 1,977,135 5,083,034
---------- ----------
COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
Preferred stock: $.01 par value, 100,000
shares authorized, 97,000 shares
outstanding at December 31, 1997 970 --
Common stock: Class A: $.01 par value,
5,000 and 1,000 shares authorized at
December 31, 1997 and 1996, 3,000
and 166.424 shares outstanding at
December 31, 1997 and 1996 30 2
Additional paid-in capital 56,442 57,440
Retained earnings 32,298 617,448
---------- ----------
Total stockholders' equity 89,740 674,890
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,066,875 $5,757,924
========== ==========
</TABLE>

See notes to consolidated financial statements.

F-23

<PAGE> 133
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- - --------------------------------------------------------------------------------

1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Due diligence fees $ 4,058,609 $ 8,323,789 $ 7,525,620
Loan brokering/asset management
fees 3,027,319 2,469,378 1,770,665
Mortgage sales and servicing 826,486 970,757 2,289,440
Other income 58,151 355,715 295,944
----------- ----------- -----------
Total revenues 7,970,565 12,119,639 11,881,669
----------- ----------- -----------
EXPENSES:
Personnel expense 5,373,331 4,227,226 3,831,426
Appraisal, inspection and other
professional fees 618,059 3,128,225 2,593,001
Subcontractor expense 1,386,979 2,919,509 2,738,903
Travel and subsistence 302,936 616,795 860,253
Occupancy expense 495,285 536,520 437,830
General and administrative expense 419,543 525,143 1,066,220
Reversal of reserve for IRS
assessment (23,160) (277,600) --
Interest expense 117,894 134,393 160,439
Depreciation and amortization 117,675 125,928 114,174
----------- ----------- -----------
Total expenses 8,808,542 11,936,139 11,802,246
----------- ----------- -----------

INCOME (LOSS) BEFORE INCOME TAX
PROVISION (BENEFIT) (837,977) 183,500 79,423

INCOME TAX (BENEFIT) PROVISION (325,959) 73,870 51,165
----------- ----------- -----------

NET INCOME (LOSS) $ (512,018) $ 109,630 $ 28,258
=========== =========== ===========

BASIC EARNINGS (LOSS) PER SHARE $ (525.79) $ 658.74 $ 169.80
=========== =========== ===========
</TABLE>

See notes to consolidated financial statements.

F-24

<PAGE> 134
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 1997 AND 1996
- - --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
Common Stock Common Stock Common Stock Additional
Preferred Stock New Class A Old Class A Class B Paid-in Retained
Shares Amount Shares Amount Shares Amount Shares Amount Capital Earnings Total
--------- ------ ------------- ------------- ------------- ------- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 $165.800 $1 41,600 $1 $165,999 $500,846 $666,847
-------- -- ------ -- -------- -------- --------
Net income 109,630 109,630
Distribution of subsidiary to stockholders 6,972 6,972
Shareholders' Exchange Agreement:
Redemption of Class A shares (40.836) (108,559) (108,559)
Exchange of Class B shares for Class A shares 41.460 1 (41,600) (1) -- -- --
-------- -- ------ -- -------- -------- --------

BALANCE, DECEMBER 31, 1996 166.424 2 57,440 617,448 674,890

Net(loss) (512,018) (512,018)

Dividends (noncash) (73,132) (73,132)

Agreement and Plan of Recapitalization:
Exchange of "old" Class A shares
for "new" Class A shares and
Series A preferred Stock 97,000 $970 3,000 $30 (166.474) (2) (998) -- --
------ ---- ----- --- -------- -- -------- -------- --------

BALANCE, DECEMBER 31, 1997 97,000 $970 3,000 $30 -- -- $ 56,442 $ 32,298 $ 89,740
====== ==== ===== === ======== == ======== ======== ========
</TABLE>

See notes to consolidated financial statements.

F-25

<PAGE> 135
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- - --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (512,018) $ 109,630 $ 28,258
Adjustments to reconcile net income (loss)
to net cash (used in) provided by
operating activities:
Depreciation and amortization 117,675 125,928 114,174
Gain on sale of mortgage servicing rights (16,916) (52,318) (232,587)
Reversal of reserve for IRS assessment (23,160) (277,600) --
IRS payroll tax settlement (99,240) -- --
Loss on disposal of property and equipment 35,696 -- 10,261
Loss on sale of trading securities -- 1,360 753
Purchase of trading securities (951) (1,931) (29,951)
Sale of trading securities -- 26,593 100,016
Distribution of subsidiary to stockholders -- 6,972 --
Changes in assets - (increase) decrease:
Accounts receivable 3,550,036 (2,150,117) 862,364
Receivables from related parties (315,097) (308,808) 22,582
Accrued revenue on contracts in progress 514,368 (384,880) 1,011,785
Income tax receivable (292,885) -- --
Prepaid expenses and other current assets 24,474 (49,871) (39,169)
Deferred tax asset (20,081) -- --
Other assets (12,254) (22,914) (154,108)
Changes in liabilities - increase (decrease):
Accrued appraisal and subcontractor costs (2,675,194) 2,741,014 21,931
Accounts payable and accrued expenses (343,799) 104,018 (913,692)
Income taxes payable (89,477) (90,490) 15,634
Deferred income taxes (12,993) (17,222) (114,326)
Deferred revenue (89,384) (14,946) 113,855
Minority interest 366 (26,935) (147,057)
---------- ---------- ----------
Net cash (used in) provided by
operating activities (260,834) (282,517) 670,723
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (43,060) (133,317) (43,421)
Sale of property and equipment -- 4,592 1,704
Proceeds from sale of mortgage servicing rights 34,446 94,043 423,563
Capitalization of mortgage servicing rights (43,783) (37,451) (264,141)
---------- ---------- ----------
Net cash (used in) provided
by investing activities (52,397) (72,133) 117,705
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (repayment of) note
payable to bank 360,000 (330,000) (125,000)
Redemption of Class A common stock -- (66,000) --
Repayment of subordinated debt -- -- (51,299)
---------- ---------- ----------
Net cash provided by (used in)
financing activities 360,000 (396,000) (176,299)
---------- ---------- ----------

NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 46,769 (750,650) 612,129

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 161,546 912,196 300,067
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 208,315 $ 161,546 $ 912,196
========== ========== ==========

SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES:
Loans of $25,649,378 and $35,831,617 were
originated by HCMC and funded by investors
in 1997 and 1996, respectively.
Noncash dividends of $73,132, were distributed
to the Company's stockholders on
September 19, 1997.

SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Income taxes $ 129,359 $ 205,075 $ 176,119
========== ========== ==========

Interest $ 116,993 $ 125,748 $ 164,420
========== ========== ==========
</TABLE>

See notes to consolidated financial statements.

F-26

<PAGE> 136
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- - --------------------------------------------------------------------------------

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, mortgage and investment banking services and, prior to
September 1997, asset management services. A wholly-owned subsidiary of
HCP, Hanover Capital Mortgage Corporation ("HCMC"), is an originator and
servicer of multifamily mortgage loans. HCMC's operations are conducted
from multiple branches located throughout the United States. 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

a. Principles of Consolidation - The consolidated financial statements
include the accounts of HCP and its majority and wholly-owned
subsidiaries (the "Company"). The wholly owned subsidiaries include
HCMC, HCS, Hanover Capital Advisors, Inc. (through September 1997)
and Hanover Capital Mortgage Fund, Inc. (through September 1997).
Majority owned subsidiaries include Hanover Joint Ventures, Inc.
(75% owned) and Hanover On-Line Mortgage Edge, LLC (50% owned,
through September 1997). 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 amount of assets and
liabilities at the date of the financial statements and the required
amounts of revenues and expenses during the reporting period.

b. Investments in Limited Liability Companies - Minority ownership
interests in limited liability companies are accounted for by the
equity method of accounting. HCP's investment in limited liability
companies are classified as other assets in the accompanying
consolidated balance sheets. The ownership of each limited liability
company at December 31, 1997 and 1996 is detailed below:

1997 1996
---- ----
AGR Financial, LLC - 25.0%
Alpine/Hanover, LLC 1.0% 1.0%
ABH-I, LLC 1.0% 1.0%
Alpine/Hanover II, LLC - 1.0%

c. Minority Interests - Minority interests, representing other
stockholders' interests in majority-owned companies are consolidated
in the accompanying balance sheets.

F-27

<PAGE> 137

HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- - --------------------------------------------------------------------------------

d. Revenue Recognition - Revenues from due diligence contracts in
progress are recognized for the services provided as they are earned
and billed.

e. 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 revenue.

f. 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.

g. 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.

h. Income Taxes - The Company records deferred taxes in accordance with
Statement of Financial Accounting Standards No. 109, Accounting for
Income Taxes ("SFAS 109"). Under SFAS 109 a current or deferred tax
liability or asset is recognized for the current or deferred tax
effects of all events recognized in the financial statements. Those
effects are measured based on provisions of current tax law to
determine the amount of taxes payable or refundable currently or in
future years. The tax effects of earning income or incurring
expenses in future years or the future enactment of a change in tax
laws or rates are not anticipated in determining deferred tax assets
or liabilities.

The Company files a consolidated Federal income tax return. The
Company has not been subject to an examination of their income tax
returns by the Internal Revenue Service.

i. 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.

j. 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, 1997 and 1996.

k. 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. There were
no cash equivalents at December 31, 1997 and 1996.

l. Mortgage Servicing Rights - Effective January 1, 1997, the Company
adopted Statement of Financial Accounting Standards No. 125,
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities ("SFAS 125"). SFAS 125 supersedes
Statement of Financial Accounting Standards No. 122, Accounting for
Mortgage Servicing Rights, an amendment of FASB Statement No. 65.
Under SFAS 125, 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

F-28

<PAGE> 138

HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- - --------------------------------------------------------------------------------

surrendered and liabilities have been extinguished. The adoption of
SFAS 125 did not have an effect on the financial position or results
of operations of the Company.

In December 1996, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 127, Deferral of the
Effective Date of Certain Provisions of FASB Statement No. 125
("SFAS 127"). SFAS 127 defers for one year the effective date of
certain sections of SFAS 125, including those relating to repurchase
agreement, dollar-roll, securities lending and similar transactions,
as prescribed by SFAS 125. The adoption of SFAS 127 will not have a
material effect on the Company's financial position or results of
operations.

Prior to January 1, 1997, the Company accounted for mortgage
servicing rights in accordance with SFAS 122. 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.

m. Basic Earnings per Share - The Company computes earnings per share
in accordance with statement of Financial Accounting Standards No.
128, Earnings per Share ("SFAS 128"). 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.

3. PAYROLL TAX SETTLEMENT

In 1994, the Internal Revenue Service ("IRS") began an examination of the
Company's payroll tax withholding practices with respect to independent
contractors who provided services to HCP's due diligence business.

Pursuant to the IRS Classification Settlement Program ("CSP"), HCP settled
all disputed payroll taxes relating to the IRS examination of HCP's
payroll withholding practices with respect to independent contractors. In
October 1997, management agreed to the terms of the CSP which required HCP
to pay the United States Government $99,240 in full discharge of any
federal employment tax liability and to further treat the workers as
employees (rather than independent contractors) on a prospective basis
effective April 1, 1998.

At December 31, 1995, HCP had recorded an accrual of $400,000 for payroll
withholding tax for independent contractors. HCP recorded a reversal of
reserve of $23,160 and $277,600 for the payroll tax matter in the
accompanying consolidated statements of operations for the years ended
December 31, 1997 and 1996, respectively, to adjust the previously
established reserve to the actual and expected settlement amounts.

F-29

<PAGE> 139

HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- - --------------------------------------------------------------------------------

4. CONCENTRATION RISK

For the years ended December 31, 1997, 1996 and 1995, the Company received
revenues from certain customers, which are subject to change annually,
which exceeded 10% of total revenues as follows:

1997 1996 1995
---- ---- ----

24% 46% 32%
18% 26% 16%

5. 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, 1997 and 1996, HCMC was servicing 43 and
46 loans, respectively, with unpaid principal balances of $120,736,400 and
$129,315,400, including loans subserviced for others of $40,055,200 and
$44,241,919, respectively. Escrow balances maintained by HCMC were
$3,087,400 and $4,352,400 at December 31, 1997 and 1996, respectively. The
aforementioned servicing portfolio and related escrow accounts are not
included in the accompanying consolidated balance sheets as of December
31, 1997 and 1996.

Activity in mortgage servicing rights for the years ended December 31,
1997 and 1996 was as follows:

1997 1996
-------- --------

Beginning balance $ 30,587 $ 46,904
Capitalization 43,783 37,451
Sales (17,530) (41,725)
Scheduled amortization (7,391) (12,043)
-------- --------

$ 49,449 $ 30,587
======== ========

The fair value of the Company's servicing rights at December 31, 1997 and
1996 was $79,504 and $46,606, respectively.

F-30

<PAGE> 140

HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- - --------------------------------------------------------------------------------

6. RELATED PARTY TRANSACTIONS

Receivables from related parties at December 31, 1997 and 1996 consist of
the following:

1997 1996
-------- --------

Due from Hanover Capital Mortgage Holdings, Inc. (1) $540,044 $ --
Due from ABH-I, LLC (includes $28,984 and
$431,118 of asset management fees at
December 31, 1997 and 1996, respectively) (2) 51,321 451,604
Due from Hanover Asset Services, Inc. (3) 8,070 6,420
Due from Alpine/Hanover, LLC (2) 9,273 4,361
Due from Alpine/Hanover II, LLC (3) 5,000 --
Due from Hanover Mortgage Capital Corporation (3) 5,962 --
Due from AGR Financial, LLC (4) 80,813 --
-------- --------
Due from related entities 700,483 462,385
Due from officers (5) 110,667 166,686
-------- --------
Receivables from related parties $811,150 $629,071
======== ========

(1) The Company entered into a Management Agreement in 1998 to provide,
among other things, 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, 1999
with subsequent renewal provisions.

(2) Amounts due from entities that the Company had a minority ownership
percentage in for all of 1997 represent receivables resulting
primarily from fees generated from asset management services and
out-of-pocket expenses. The Company ceased providing asset
management services to these entities in September 1997. Asset
management fees are recognized in the period earned and amounted to
$2,446,000, $1,370,000 and $1,362,000 for the years ended December
31, 1997, 1996 and 1995, respectively.

(3) Amounts due from entities that are owned by certain of the Company's
officers/owners at December 31, 1997 represent receivables resulting
primarily from accounting fees and out-of-pocket expenses.

(4) Amounts due from AGR Financial, LLC represent unpaid billings for
services that the Company provides to AGR Financial, LLC pursuant to
an agreement dated August 1996. The services include but are not
limited to providing AGR Financial, LLC with office space, office
equipment, software operating systems, processing capabilities and
accounting services.

(5) Amounts due from officers in 1997 include $107,532 from the
Company's President which will be repaid in annual amounts of
$53,766 in August 1998 and August 1999.

F-31

<PAGE> 141
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- - --------------------------------------------------------------------------------

Notes payable to related parties at December 31, 1996 consisted of the
following:

1996
----

Note payable to officer $ 42,559
Notes payable to ABH-I, LLC 90,459
--------
Notes payable to related parties $133,018
========

On January 1, 1996, HCP and its stockholders entered into an Exchange
Agreement (see Note 9) whereby HCP redeemed 40.836 shares of Class A
common stock from one of its stockholders in exchange for cash ($66,000)
and a term note in the amount of $42,559. The note was paid in full, with
interest at the prime rate plus 2.0% in January 1997.

Notes payable to ABH-I, LLC at December 31, 1996 consisted of three (3)
promissory notes totaling $90,459. All of the promissory notes bear
interest at the prime rate (8.25% at December 31, 1996). The promissory
notes were paid in full in 1997.

7. PROPERTY AND EQUIPMENT

Property and equipment at December 31, 1997 and 1996 consists of the
following:

1997 1996
--------- ---------

Office machinery and equipment $ 381,189 $ 388,123
Furniture and fixtures 111,246 111,246
Leasehold improvements 68,553 68,553
--------- ---------

560,988 567,922
Less accumulated depreciation and
amortization (347,851) (251,865)
--------- ---------

Property and equipment - net $ 213,137 $ 316,057
========= =========

Depreciation expense for the years ended December 31, 1997, 1996 and 1995
was $110,284, $113,885 and $87,913, respectively.

8. INCOME TAXES

The components of deferred income taxes as of December 31, 1997 and 1996
are as follows:

1997 1996
--------- ---------

Deferred tax assets $ 44,499 $ 52,409
Deferred tax liabilities (24,418) (65,402)
--------- ---------
Net deferred tax assets (liabilities) $ 20,081 $ (12,993)
========= =========

The items resulting in significant temporary differences for the years
ended December 31, 1997 and 1996 that generate deferred tax assets relate
primarily to the recognition of deferred revenue, accounts payable and
accrued liabilities for financial reporting purposes. Temporary
differences that generate

F-32

<PAGE> 142

HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- - --------------------------------------------------------------------------------

deferred tax liabilities relate primarily to the Company's change from the
cash method to the accrual method of accounting for income tax reporting
purposes.

The components of the income tax provision (benefit) for the years ended
December 31, 1997, 1996 and 1995 consist of the following:

1997 1996 1995
--------- --------- ---------

Current - Federal, state and local $(292,885) $ 91,092 $ 165,491
Deferred - Federal, state and local (33,074) (17,222) (114,326)
--------- --------- ---------
Total $(325,959) $ 73,870 $ 51,165
========= ========= =========

The income tax provision (benefit) differs from amounts computed at
statutory rates, as follows:

1997 1996 1995
--------- --------- ---------
Federal income taxes at statutory rate $(285,167) $ 56,518 $ 27,006
State and local income taxes net
of Federal benefit (59,486) 14,836 9,417
Unconsolidated subsidiary's net income (12,793) -- 1,177
Meals and entertainment 4,052 3,719 6,291
Officer's life insurance 9,613 8,576 9,114
Other, net 3,852 3,014 (663)
--------- --------- ---------
Total $(325,959) $ 73,870 $ 51,165
========= ========= =========

9. 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.

On January 1, 1996, HCP entered into an exchange agreement ("Exchange
Agreement") with its stockholders in order to restructure the ownership of
HCP so that HCP had only 166.424 Class A shares of common stock
outstanding. The terms of the Exchange Agreement required HCP to: (1)
redeem 40.836 shares of Class A common stock; (2) exchange 41.460 shares
of Class B common stock for Class A common stock; (3) effect an exchange
of 8.468 shares of Class A common stock among certain stockholders; and
(4) transfer the ownership of Hanover Mortgage Capital Corporation
(formerly a wholly-owned subsidiary of HCP) to HCP's stockholders.

F-33

<PAGE> 143

HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (CONTINUED)
- - --------------------------------------------------------------------------------

On January 1, 1996, pursuant to the Exchange Agreement, HCP transferred
its total ownership interests in its wholly-owned subsidiary, Hanover
Mortgage Capital Corporation to HCP's stockholders. Hanover Mortgage
Capital Corporation had a retained earnings deficiency at the time of
transfer.

10. NOTE PAYABLE TO BANK

In December 1996, HCP entered into a $2.0 million Line of Credit Facility
Agreement ("Line") with a bank that extends through December 31, 1999. The
note payable to the bank at December 31, 1997 and 1996 consisted of a
short-term note of $1,405,000 and $1,045,000, respectively, with an annual
interest rate at the prime rate as of December 31, 1997. In October 1997,
the terms of the Line were amended to decrease the interest rate on the
Line from the prime rate plus 1.5% to the prime rate. The interest rate in
effect at December 31, 1997 and 1996 was 8.50% and 9.75%, respectively.
The maximum borrowing capacity under the terms of the Line reduce every
six (6) months, beginning at June 30, 1997, by $150,000. The line is
collateralized by all of the assets of HCHI and guaranteed by HCHI. Prior
to September 1997, the line was collateralized by all of the assets of the
Company and guaranteed by the President and all of the wholly-owned
subsidiaries of HCP.

At December 31, 1997, the Company was in violation of certain financial
debt covenants of the Line that required the Company (on a stand-alone
basis) to: (1) maintain a maximum debt to net worth ratio of 3 to 1 at
December 31, 1997 and (2) to maintain a minimum debt service coverage
ratio of 1.25 to 1.00 at December 31, 1997. To mitigate the above
violations, the Company agreed to make a voluntary paydown on the Line of
$860,000 on February 17, 1998, thereby reducing the outstanding borrowings
on the line to $505,000.

11. COMMITMENTS AND CONTINGENCIES

The Company is involved in ongoing litigation regarding a mortgage loan
and a related reserve agreement. The Company has retained the services of
outside counsel. As of the date of this report, an evaluation of the
likelihood of success or an unfavorable outcome could not be performed. As
such, no amount has been provided for in the accompanying financial
statements. The Company intends to attempt to achieve final settlement of
the matter and if for any reason, the final settlement cannot be
effectuated, the Company intends to respond vigorously and will evaluate
the progress of the litigation as information becomes available.

The Company has noncancelable operating lease agreements for office space.
Future minimum rental payments for such leases are as follows:

YEAR AMOUNT
---- ------

1998 $187,414
1999 104,882
2000 37,714
--------
Total $330,010
========

Rent expense for the years ended December 31, 1997, 1996 and 1995 amounted
to $310,814, $339,421, and $345,716 respectively.

******

F-34

<PAGE> 144

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

CONDENSED BALANCE SHEETS

(in thousands, except as noted)

ASSETS MARCH 31, DECEMBER 31,
1998 1997
---- ----
(unaudited)

<S> <C> <C>
Mortgage loans, held for sale $ 419,627 $ 160,970
Mortgage securities, available for sale 312,390 348,131
Cash and cash equivalents 24,989 4,022
Accrued interest receivable 7,346 3,597
Equity investment 94 100
Notes receivable from related parties 1,383 482
Prepaid expenses and other assets 995 241
--------- ---------

TOTAL ASSETS $ 766,824 $ 517,543
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES:

Reverse repurchase agreements $ 644,020 $ 435,138
Purchased mortgage loans payable 36,058 --
Accrued interest payable 3,942 2,250
Dividends payable 1,358 1,035
Due to related party 51 540
Accrued expenses and other liabilities 4,226 482
--------- ---------

Total liabilities 689,655 439,445
--------- ---------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY

Preferred stock, par value $.01
authorized, 10 million shares, issued
and outstanding, -0- shares
Common stock, par value $.01
authorized, 90 million shares,
issued and outstanding 6,466,677 shares 65 65
Additional paid-in-capital 79,422 79,411
Available for sale securities:
Unrealized (loss) on investments
available for sale (1,672) (842)
Retained earnings (deficit) (646) (536)
--------- ---------

Total stockholders' equity 77,169 78,098
--------- ---------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 766,824 $ 517,543
========= =========
</TABLE>

See accompanying notes to financial statements

F-35

<PAGE> 145

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

CONDENSED STATEMENT OF OPERATIONS
(in thousands, except per share data)
(unaudited)

Three Months Ended
March 31,
1998
----
REVENUES:
<S> <C>
Interest income $ 9,332
Interest expense 7,173
-------

Net interest income 2,159
Loan loss provision 51
-------
Net interest income after loan loss
provision 2,108
-------

Total revenues 2,108
-------

EXPENSES:
General and administrative expenses
Personnel 189
Management and administrative 161
Due diligence 175
Commissions 125
Legal and professional 141
Other 63
-------
Total expenses 854
-------

Operating income 1,254

Equity in (loss) of unconsolidated subsidiary (6)
-------

NET INCOME $ 1,248
=======
BASIC EARNINGS PER SHARE $ 0.19
=======

DILUTED EARNINGS PER SHARE $ 0.17
=======
</TABLE>

See accompanying notes to financial statements

F-36

<PAGE> 146

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

CONDENSED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)

Three Months
Ended March 31, 1998
--------------------

CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C>
Net income $ 1,248
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of net premium - mortgage securities 903
Amortization of net premium - mortgage loans 133
Loan loss provision 51
Equity in loss of unconsolidated subsidiary 6
(Increase) in accrued interest receivable (3,749)
(Increase) in loans to related parties (901)
(Increase) in prepaid expenses and other assets (754)
Increase in accrued interest payable 1,692
(Decrease) in due to related party (489)
Increase in accrued expenses and other liabilities 3,754
---------

Net cash provided by operating activities 1,894
---------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage loans (232,587)
Purchase of mortgage securities (4,333)
Principal payments on mortgage securities 38,340
Principal payments on mortgage loans 9,806
---------

Net cash (used in) investing activities (188,774)
---------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from reverse repurchase agreements 208,882
Payment of dividends (1,035)
---------

Net cash provided by investing activities 207,847
---------

NET INCREASE IN CASH AND CASH EQUIVALENTS 20,967

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 4,022
---------

CASH AND CASH EQUIVALENTS, END OF PERIOD $ 24,989
=========

SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES

Operating activity- increase in dividends payable ($1,358) relating to the
declaration of dividends in March 1998.

Investing activity and financing activity- funds for the purchase of $36,058
of mortgage loans were not disbursed until April 1998.

SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid during the period for:

Income taxes $ 1
=========

Interest $ 5,190
=========
</TABLE>

See accompanying notes to financial statements.

F-37

<PAGE> 147

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)

1. ORGANIZATION AND BASIS OF PRESENTATION

GENERAL

Hanover Capital Mortgage Holdings, Inc. (the "Company") was incorporated in
Maryland on June 10, 1997. The Company is a real estate investment trust
("REIT"), formed to operate as a specialty finance company. The principal
business strategy of the Company is to (i) acquire primarily single-family
mortgage loans that are at least twelve months old or that were intended to be
of certain credit quality but that do not meet the originally intended market
parameters due to errors or credit deterioration, (ii) securitize the mortgage
loans and retain interests therein, (iii) originate, hold, sell and service
multifamily loans and commercial loans and (iv) acquire multifamily loans. The
Company's principal business objective is to generate increasing earnings and
dividends for distribution to its stockholders. The Company acquires
single-family mortgage loans through a network of sales representatives
targeting financial institutions throughout the United States. The Company may
also acquire multifamily mortgage loans from a taxable subsidiary of the
Company.

CAPITALIZATION

In September 1997, the Company raised net proceeds of approximately $79 million
in its initial public offering (the "IPO"). In the IPO, the Company sold
5,750,000 units (each unit consists 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' overallotment option, which was exercised in full. Each
warrant entitles the holder to purchase one share of common stock at the
original issue price - $15.00. The warrants became exercisable on March 19, 1998
and remain exercisable until September 15, 2000. The Company utilizes
substantially all of the net proceeds of the IPO to fund leveraged purchases of
mortgage loans.

F-38

<PAGE> 148

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements have been prepared by
the management of the Company in accordance with generally accepted accounting
principles for interim financial information and in conformity with the rules
and regulations of the Securities and Exchange Commission. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring adjustments)
considered necessary for a fair presentation have been included. The results of
operations for the three months ended March 31, 1998 are not necessarily
indicative of the results that may be expected for the full year. For further
information, refer to the audited financial statements and footnotes included in
the Company's Form 10-K for the period from June 10, 1997 (inception) to
December 31, 1997.

Because the Company was incorporated on June 10, 1997, there is no comparable
statement of operations.

METHOD OF ACCOUNTING

The condensed financial statements of the Company are prepared on the accrual
basis of accounting in accordance with generally accepted accounting principles.
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 reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.

INCOME TAXES

EARNINGS PER SHARE

In 1997 the Company adopted Statement of Financial Accounting Standards No. 128
"Earnings per Share"("SFAS 128"). Under SFAS 128 basic earnings per share
excludes dilution and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding during
the period. Diluted earnings 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. Shares
issued during the period and shares reacquired during the period are weighted
for the period they were outstanding.

F-39

<PAGE> 149

Calculations for earnings per share are shown below (dollars in thousands,
except per share data):

Basic earnings per share:
<S> <C>
Net income (numerator) $ 1,248
==========

Average common shares
outstanding (denominator) 6,466,677
==========

Per share $ 0.19
==========

Diluted earnings per share:
Net income (numerator) $ 1,248
==========

Average common shares outstanding 6,466,677
Add: Incremental shares from
assumed conversion of
warrants 767,059
----------
Dilutive potential common shares 767,059
----------

Adjusted weighted average shares
(denominator) 7,233,736
==========

Per share $ 0.17
==========
</TABLE>

3. MORTGAGE LOANS

F-40

<PAGE> 150

The following table summarizes the Company's single-family mortgage loan pools,
which are carried at the lower of cost or market (dollars in thousands):

<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
----------------- -----------------
Cost Mix Cost Mix
---- --- ---- ---
<S> <C> <C> <C> <C>
Mortgage Loans
Fixed rate $297,382 72.3% $106,397 67.1%
Adjustable rate 113,932 27.7% 52,392 32.9%
-------- ----- -------- -----
Subtotal 411,314 100.0% 158,789 100.0%
===== =====
Net deferred loan fees,
premiums and discounts 8,382 2,199
Loan loss reserve (69) (18)
-------- --------
Carrying value $419,627 $160,970
======== ========
</TABLE>

An analysis of the change in the loan loss reserve for the three months ended
March 31, 1998 is as follows (dollars in thousands):

<S> <C>
Balance beginning of period $18
Loan loss provision 51
---

Balance at March 31, 1998 $69
===
</TABLE>

The following table summarizes certain characteristics of the Company's
single-family fixed rate and adjustable rate mortgage loan portfolio
(dollars in thousands):

<TABLE>
<CAPTION>
March 31, 1998
------------------------------------------------------------------------------
Carrying Value Principal Weighted Weighted
of Mortgage Amount of Average Net Average
Loans Mortgage Loans Coupon Maturity (1)
-------------- -------------- ----------- ------------
<S> <C> <C> <C> <C>
Fixed Rate $304,595 $297,382 8.829% 229
Adjustable Rate 115,032 113,932 8.054% 273
-------- -------- ------ ------
$419,627 $411,314 8.615% 241
======== ======== ====== ======
</TABLE>

<TABLE>
<CAPTION>
December 31, 1997
------------------------------------------------------------------------------
Carrying Value Principal Weighted Weighted
of Mortgage Amount of Average Net Average
Loans Mortgage Loans Coupon Maturity (1)
-------------- -------------- ----------- ------------
<S> <C> <C> <C> <C>
Fixed Rate $107,953 $106,424 8.265% 242
Adjustable Rate 53,017 52,365 7.925% 319
-------- -------- ----- ---
$160,970 $158,789 8.153% 267
======== ======== ===== ===
</TABLE>

(1) weighted average maturity reflects the number of months remaining until
maturity

The average effective yield for the three months ended March 31, 1998 on the
mortgage loan portfolio, including the amortization of the net premiums paid for
the mortgage loans, was 7.410%.

4. MORTGAGE SECURITIES

The Company's policy is to classify its mortgage securities as
available-for-sale as they are purchased and each asset is monitored for a
period of time, generally three to six months, prior to making a determination
whether the asset will be classified as held-to-maturity. All 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.

Premiums and discounts associated with the purchase 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
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-41

<PAGE> 151

The following table summarizes the Company's amortized cost basis and fair value
of mortgage securities available for sale (dollars in thousands):

<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
-------------------------- -------------------
Available Available
for Sale Mix for Sale Mix
--------- --- --------- ---
<S> <C> <C> <C> <C>
Mortgage Securities
Adjustable - rate
FNMA certificate $180,968 57.6% $207,898 59.6%
FHLMC certificates 128,764 41.0% 141,075 40.4%
-------- ----- -------- -----
309,732 98.6% 348,973 100.0%
Fixed rate
FNMA certificate 4,330 1.4% -- --
-------- ----- -------- -----
Total amoritized cost 314,062 100.0% 348,973 100.0%
-------- ===== -------- =====
Gross unrealized (losses) (1,672) (842)
-------- --------
Fair value $312,390 $348,131
======== ========
</TABLE>

5. REVERSE REPURCHASE AGREEMENTS

Reverse repurchase agreements are accounted for as collateralized financing
transactions and recorded at their contractual amounts, plus accrued interest.

In March 1998, the Company entered into a third master repurchase agreement with
a lender in an amount up to $100 million for a period of one year. Any
borrowings under this facility will be secured by mortgage loans, or other
securities, and will bear interest at the comparable LIBOR plus a spread of
0.70% to 1.25%.

At March 31, 1998 the Company had a total of $500 million of mortgage loan
reverse repurchase agreement financing available pursuant to master repurchase
agreements with three lenders. At March 31, 1998 the Company had outstanding
borrowings of $330,062,000 under the above mentioned reverse repurchase
agreements with a weighted average borrowing rate of 6.318% for the first
quarter of 1998 and a weighted average remaining maturity of less than three
months. The reverse repurchase agreements at March 31, 1998 were collateralized
by mortgage loans with a cost basis of $345,585,000 (which approximates market
value).

As of March 31, 1998, the Company had outstanding mortgage securities reverse
repurchase agreements of $313,958,000 with a weighted average borrowing rate of
5.597% and a weighted average remaining maturity of less than one month.

Information concerning the reverse repurchase agreements and the pledged
collateral at March 31, 1998 is summarized as follows (dollars in thousands):

Mortgage Mortgage
Reverse Repurchase Agreements Securities Loans
---------- -----
<S> <C> <C>
Average balance during the period (1) $324,305 $166,881
Average interest rate during period (1) 5.597% 6.318%
Maximum month-end balance during the
period $331,793 $330,062

Collateral Underlying the Agreements
Carrying balance $314,062 $345,585
</TABLE>

(1) above table reflects the period beginning January 1, 1998 through March 31,
1998.

F-42

<PAGE> 152

6. PURCHASED MORTGAGE LOANS PAYABLE

At March 31, 1998 the Company held back approximately $36,058,000 from the
original purchase price of $54,016,000 from mortgage pools purchased in February
and March 1998 due to documentation and logistical problems. Substantially all
of the holdback amounts were paid in April 1998.

7. AFFILIATED PARTY TRANSACTIONS

The Company has engaged HCP pursuant to a Management Agreement to render among
other things, due diligence, asset management and administrative services. The
statement of operations of the Company includes management and administrative
expenses of $161,000, due diligence expenses of $175,000 and commission expenses
of $125,000 relating to billings from HCP. At March 31, 1998 the balance sheet
of the Company included an amount due HCP of $51,000. During the first three
months of 1998 the Company recorded a loss from its investment in HCP and
Subsidiaries of $6,000 (generated from revenues of $1,791,000 and expenses of
$1,797,000).

In connection with the original formation transactions in September 1997, the
Company 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 the
Company's common stock. The loans are secured solely by 116,667 shares of the
Company'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 March 31, 1998 loans outstanding to three of the Principals totaled
$482,000. The loans bear interest at 6.02%.

In February 1998 the Company advanced $900,000 to HCP pursuant to an unsecured
loan agreement. The loan to HCP bears interest at 1.00% below the prime rate. At
March 31, 1998 the loans outstanding to HCP totaled $900,000.

8. COMMITMENTS AND CONTINGENCIES

At March 31, 1998 the Company had committed to purchase approximately
$104,051,000 of fixed and adjustable rate mortgage loans.

9. ADOPTION OF FINANCIAL ACCOUNTING STANDARDS

In June 1997 the Financial Accounting Standards Board issued Statement of
Financial Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130").
Effective January 1, 1998 the Company adopted SFAS No. 130 which established
disclosure standards for reporting comprehensive income in a full set of general
purpose financial statements. Comprehensive income for three months ended March
31, 1998 was $418,000, which included an unrealized loss on investments
available for sale of $830,000.

10. SUBSEQUENT EVENTS

On April 7, 1998 the Company issued approximately $103 million in Real Estate
Mortgage Investment Conduit (REMIC) interests in a private placement offering
that was structured as a financing transaction. The Company will retain
interests in the REMIC, including the non-rated credit support interests, which
totaled approximately $513,000.

On April 13, 1998 a $0.21 cash dividend previously declared by the Board of
Directors was paid to stockholders of record as of March 31, 1998.

In April 1998 the Company loaned $1,268,000 to the Principals resulting in
total loans to the Principals of $1,750,000, the maximum loan amount permitted
pursuant to the original formation transaction.

Pursuant to the Registration Rights Agreement by and between the Company and the
Principals, the Principals have the right to request on any one occasion on or
after January 1, 1998 that the

F-43

<PAGE> 153

Company file one registration statement with the Securities and Exchange
Commission, at the Company's expense, with respect to a maximum of 100,000
shares of common stock owned by the Principals in order to pay tax on gains the
principals must recognize relating the Company's original formation transaction.
In March 1998 the Board of Directors agreed to lend up to an additional
$1,500,000 in unsecured loans to the Principals, in lieu of incurring the costs
and expenses associated with the registration of 100,000 shares of the Company's
common stock owned by the Principals. The Company loaned the Principals an
additional $1,298,000 in April 1998. These additional loans are due and payable
on March 31, 1999 and bear interest of 5.51%. No additional loans are expected
to be made to the Principals.

F-44

<PAGE> 154

NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE,
SUCH OTHER INFORMATION AND REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF
ANY TIME SUBSEQUENT TO ITS DATE. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE
REGISTERED SECURITIES TO WHICH IT RELATES. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY SUCH SECURITIES IN ANY
CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.

TABLE OF CONTENTS

PAGE
----
Prospectus Summary . . . . . . . . . . . . . . . . . . 4
Risk Factors . . . . . . . . . . . . . . . . . . . . . 1
The Company. . . . . . . . . . . . . . . . . . . . . . 17
Use of Proceeds. . . . . . . . . . . . . . . . . . . . 17
Dividend Policy and Distributions. . . . . . . . . . . 17
Dividend Reinvestment Plan. .. . . . . . . . . . . . . 19
Management's Discussion and Analysis of
Financial Condition and Results of Operations. . . . . 20
Business . . . . . . . . . . . . . . . . . . . . . . . 29
Management . . . . . . . . . . . . . . . . . . . . . . 50
Certain Transactions . . . . . . . . . . . . . . . . . 62
Principal Stockholders . . . . . . . . . . . . . . . . 66
Description of Capital Stock . . . . . . . . . . . . . 67
Shares Eligible for Future Sale. . . . . . . . . . . . 71
Certain Provisions of Maryland Law and the
Company's charter and By-Laws. . . . . . . . . . . . . 73
Federal Income Tax Considerations. . . . . . . . . . . 77
ERISA Investors. . . . . . . . . . . . . . . . . . . . 90
Legal Matters. . . . . . . . . . . . . . . . . . . . . 91
Experts. . . . . . . . . . . . . . . . . . . . . . . . 91
Additional Information . . . . . . . . . . . . . . . . 91
Glossary . . . . . . . . . . . . . . . . . . . . . . . 92
Index to Financial Statements. . . . . . . . . . . . . F-1

5,920,378 SHARES
OF COMMON STOCK
HANOVER CAPITAL HOLDINGS, INC.
ISSUABLE UPON EXERCISE OF
STOCK PURCHASE WARRANTS

PROSPECTUS

July 20, 1998

<PAGE> 155

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Registrant in connection
with the registration of the securities of the Registrant registered pursuant to
the Registrant's Registration Statement on Form S-11 to which this
Post-Effective Amendment No. 1 relates (including the sale of Common Stock being
registered hereby).

<TABLE>
<CAPTION>
<S> <C>
Securities and Exchange Commission registration fee.................................$ 56,594.46
NASD filing fee........................................................................19,176.18
American Stock Exchange filing fee.....................................................50,000.00
Printing and engraving expenses.......................................................289,000.00
Legal fees and expenses...............................................................287,051.58
Accounting fees and expenses..........................................................275,000.00
Transfer agent and custodian fees.......................................................1,500.00
Miscellaneous..........................................................................13,226.25
Total.....................................................................$ 991,548.47
</TABLE>

ITEM 32. SALES TO SPECIAL PARTIES.

Not applicable.

ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.

On or about June 11, 1997, the Company sold 10 shares of Common Stock to
John A. Burchett in a private placement.

In connection with the Formation Transactions, the Principals sold the HCP
Preferred to HCHI.

ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS

The MGCL permits a Maryland corporation to include in its charter a
provision limiting the liability of its directors and officers to the
corporation and its stockholders for money damages except for liability
resulting from (a) actual receipt of an improper benefit or profit in money,
property or services or (b) active and deliberate dishonesty established by a
final judgment as being material to the cause of action. The charter of the
Company contains such a provision which eliminates such liability to the maximum
extent permitted by Maryland law.

The charter of the Company authorizes it, to the maximum extent permitted by
Maryland law, to obligate itself to indemnify and to pay or reimburse reasonable
expenses in advance of final disposition of a proceeding to (1) any present or
former Director or officer or (2) any individual who, while a Director of the
Company and at the

II-1
<PAGE> 156

request of the Company, serves or has served another corporation, partnership,
joint venture, trust, employee benefit plan or any other enterprise from and
against any claims or liability to which such person may become subject or which
such person may incur by reason of his status as a present or former Director or
officer of the Company. The Bylaws of the Company obligate it, to the maximum
extent permitted by Maryland law, to indemnify and to pay or reimburse
reasonable expenses in advance of final disposition of a proceeding to (1) any
present or former Director or officer who is made a party to the proceeding by
reason of his service in that capacity or (2) any individual who, while a
Director of the Company and at the request of the Company, serves or has served
another corporation, partnership, director, officer, partner or trustee of such
corporation, partnership, joint venture, trust, employee benefit plan or other
enterprise and who is made a party to the proceeding by reason of his service in
that capacity. The charter and Bylaws also permit the Company to indemnify and
advance expenses to any person who served a predecessor of the Company in any of
the capacities described above and to any employee or agent of the Company or a
predecessor of the Company.

The MGCL requires a corporation (unless its charter provides otherwise,
which the Company's charter does not) to indemnify a director or officer who has
been successful, on the merits or otherwise, in the defense of any proceeding to
which he is made a party by reason of his service in that capacity. The MGCL
permits a corporation to indemnify its present and former directors and
officers, among others, against judgments, penalties, fines, settlements and
reasonable expenses actually incurred by them in connection with any proceeding
to which they may be made a party by reason of their service in those or other
capacities unless it is established that (1) the act or omission of the director
or officer was material to the matter giving rise to the proceeding and (i) was
committed in bad faith or (ii) was the result of active and deliberate
dishonesty, (2) the director or officer actually received an improper personal
benefit in money, property or services or (3) in the case of any criminal
proceeding, the director or officer had reasonable cause to believe that the act
or omission was unlawful. However, a Maryland corporation may not indemnify for
an adverse judgment in a suit by or in the right of the corporation. In
addition, the MGCL requires the Company, as a condition to advancing expenses,
to obtain (1) a written affirmation by the director or officer of his good faith
belief that he has met the standard of conduct necessary for indemnification by
the Company as authorized by the Bylaws and (2) a written statement by or on his
behalf to repay the amount paid or reimbursed by the Company if it shall
ultimately be determined that the standard of conduct was not met.

ITEM 36.L FINANCIAL STATEMENTS AND EXHIBITS

(a) Financial Statements, all of which are in the Prospectus:

(b) Exhibits.

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<PAGE> 157

EXHIBIT INDEX

**1.1 Form of Underwriting Agreement

**3.1 Articles of Incorporation of HCHI, as amended

**3.2 By-Laws of HCHI

**4.1 Specimen Common Stock Certificate

**4.2 Warrant Agreement pursuant to which Warrants were issued (including
form of Warrant)

**4.3 Representatives' Warrant Agreement pursuant to which the
Representatives' Warrants were issued

**4.4 Specimen Unit Certificate

**5.1 Opinion of Piper & Marbury with respect to legality of the Securities
being registered

**8.1 Opinion of Morse, Barnes-Brown & Pendleton, P.C. with respect to
certain Federal income tax matters

**10.3 Registration Rights Agreement

**10.4 Shareholders' Agreement of HCP

**10.5 Agreement and Plan of Recapitalization

**10.6 Bonus Incentive Compensation Plan

**10.7 1997 Executive and Non-Employee Director Stock Option Plan

**10.8 Employment Agreement by and between HCHI and John A. Burchett

**10.9 Employment Agreement by and between HCHI and Irma N. Tavares

**10.10 Employment Agreement by and between HCHI and Joyce S. Mizerak

**10.11 Employment Agreement by and between HCHI and George J. Ostendorf

**10.12 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

**10.13 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 Agreement, dated as of February 28, 1997

**10.14 Indenture, dated as of June 28, 1993, by and between LaSalle National
Bank, N.A., as Trustee, and HCP, as amended by the Lease Amendment
dated as of August 23, 1995

**10.15 Office building space, dated as of February 5, 1993, by and between
Bonhomme Place Associates, Inc. and HCMC, as amended by Lease
Amendment #1, dated as of December 1, 1993 and as further amended by
Second Amendment and Extension of Lease, dated as of March 1, 1996

**10.16 Office Lease and Service Agreement, dated as of August 28, 1995 by
and between Federal Deposit Insurance Receiver for Merchants Bank and
HCP

**10.17 Agreement of Lease, dated as of January 8, 1997 by and between Saint
Paul Executive Office Suites, Inc., d.b.a. LesWork Inc. and HCP

**10.18 Revolving Credit Agreement, dated as of December 10, 1996 between
Fleet National Bank and HCP

**10.19 Guaranty, dated as of December 10, 1996, by John A. Burchett to Fleet
National Bank

**10.20 Guaranty, dated as of December 10, 1996, by HCMC to Fleet National
Bank

**10.21 Guaranty, dated as of December 10, 1996, by HCMF to Fleet National
Bank

**10.22 Guaranty, dated as of December 10, 1996, by HCA to Fleet National Bank

**10.23 Guaranty, dated as of December 10, 1996, by HCS to Fleet National Bank

**10.24 Modification Agreement, dated as of June , 1997, between Fleet
National Bank, HCP, HCMC, HCMF, HCS, HCA and John A. Burchett

**10.25 Contribution Agreement

**10.26 Participation Agreement

**10.27 Loan Agreement

%10.28 Master Repurchase Agreement Governing Purchases and Sales of
Mortgage Loans, between Nomura Asset Capital Corporation and

HCHI, dated September 29, 1997

#10.29 Management Agreement, dated as of January 1, 1998, by and between
HCHI and HCP

#10.30 Master Loan and Security Agreement between HCHI and Morgan Stanley
Mortgage Capital Inc., dated as of December 8, 1997

+10.31 Master Loan and Security Agreement by and between Greenwich Capital
Financial Products, Inc. and HCHI, dated March 30, 1998

**21 Subsidiaries of HCHI

23.1 Consents of Deloitte & Touche, LLP

23.2 Consent of Piper & Marbury (included in Exhibit 5.1 hereof)

23.3 Consent of Morse, Barnes-Brown & Pendleton, P.C. (included in Exhibit
6.1 hereof)

**24 Power of Attorney (included on signature page)

- - ----------

** Previously filed.

% Incorporated herein by reference to the Registrant's Form 10-Q, as amended,
for the quarter ended September 30, 1997, as filed with the Securities and
Exchange Commission.

# Incorporated herein by reference to the Registrant's Form 10-K for the year
ended December 31, 1997, as filed with the Securities and Exchange Commission.

+ Incorporated by reference herein to the Registrant's Form 10-Q for the quarter
ended March 31, 1998, as filed with the Securities

II-3
<PAGE> 158

and Exchange Commission.

ITEM 37. UNDERTAKINGS

Insofar as indemnification by the registrant for liabilities arising under
the Securities Act of 1933, as amended may be permitted to directors, officers
and controlling persons of the registrant pursuant to the provisions described
in Item 34 above or otherwise, the registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the registrant of expenses incurred or paid by a director,
officer or controlling person of the registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or controlling
person against the registrant in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.

The undersigned registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities Act
of 1993, as amended, the information omitted from the form of prospectus
filed as part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrant pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be
part of this registration statement as of the time it was declared
effective.

(2) For the purpose of determining any liability under the Securities
Act of 1933, as amended, each post-effective amendment that contains a form
of prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be initial bona fide offering thereof.

II-4
<PAGE> 159

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form S-11 and has duly caused this
Post-Effective Amendment No. 1 to Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of New York
City, State of New York, on the 14th day of July, 1998.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

By: /s/ John A. Burchett
------------------------------------
John A. Burchett
Chairman of the Board, Chief
Executive Officer and President

Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment No. 1 to Registration Statement has been signed by the
following persons in the capacities and on the dates indicated.

SIGNATURE TITLE DATE
--------- ----- ----

/s/ John A. Burchett Chairman of the Board, July 14, 1998
--------------------- Chief Executive Officer,
John A. Burchett and President (Principal
Executive Officer)

/s/ Ralph F. Laughlin Senior Vice President, Chief July 14, 1998
--------------------- Financial Officer,
Ralph F. Laughlin Treasurer and Assistant
Secretary (Principal
Financial and Accounting
Officer)

/s/ Irma N. Tavares Managing Director and July 14, 1998
--------------------- Director
Irma N. Tavares

* Managing Director, July 14, 1998
--------------------- Secretary
Joyce S. Mizerak and Director

* Managing Director and July 14 1998
--------------------- Director
George J. Ostendorf

* By: /s/ John A. Burchett
--------------------
John A. Burchett
Attorney-in-Fact

We, the undersigned directors of Hanover Capital Holdings, Inc., do hereby
constitute and appoint John A. Burchett and Joyce S. Mizerak or either of them,
our true and lawful attorneys and agents, to do any and all acts and things in
our name and behalf in our capacities as directors and to execute any and all
instruments for us and in our names in the capacities indicated below, which
said attorneys and agents, or either of them, may deem necessary or advisable to
enable said corporation to comply with the Securities Act of 1933, as amended,
and any rules, regulations, and requirements of the Securities and Exchange
Commission, in connection with this Registration Statement, including
specifically, but without limitation, power and authority to sign for us or any
of us in our names and in the capacities indicated below, any and all amendments
(including post-effective amendments) to this Registration Statement, or any
related registration statement that is to be effective upon filing pursuant to
Rule 462(b) under the Securities Act of 1933, as amended; and we do hereby
ratify and confirm all that the said attorneys and agents, or either of them,
shall do or cause to be done by virtue hereof.

II-5

<PAGE> 160

SIGNATURE TITLE DATE
--------- ----- ----

Director July __,1998
------------------
John Nicholas Rees

/s/ Joseph Freeman Director July 13,1998
------------------
Joseph Freeman

/s/ Robert Campbell Director July 9, 1998
------------------
Robert Campbell

/s/ John A. Clymer Director July 10,1998
------------------
John A. Clymer

/s/ Saiyid Naqvi Director July 10,1998
------------------
Saiyid Naqvi

II-6

<PAGE> 1

Exhibit 23.1

INDEPENDENT AUDITORS' CONSENT

We consent to the incorporation by reference in this Post-Effective Amendment
No. 1 to Registration Statement No. 333-29261 of Hanover Capital Mortgage
Holdings, Inc. on Form S-11 of our reports on Hanover Capital Mortgage
Holdings, Inc. and Hanover Capital Partners Ltd. and Subsidiaries dated March
20, 1998, appearing and incorporated by reference in the Annual Report on Form
10-K of Hanover Capital Mortgage Holdings, Inc. for the year ended December 31,
1997, and to the reference to us under the heading "Experts" in the Prospectus,
which is part of such Registration Statement.

/s/ Deloitte & Touche LLP

DELOITTE & TOUCHE LLP

Parsippany, New Jersey
July 17, 1998