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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE ACT
OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

[_]TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 001-13709

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ANWORTH MORTGAGE ASSET CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

MARYLAND 52-2059785
(State or Other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation Organization)

1299 OCEAN AVENUE, #200, 90401
SANTA MONICA, CALIFORNIA
(Address of Principal Executive Offices) (Zip Code)

Registrant's telephone number, including area code: (310) 394-0115

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, $0.01 PAR VALUE

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

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

The aggregate market value of the voting stock held by non-affiliates of the
registrant, computed by reference to the average closing bid and asked prices
of such stock, as of March 15, 2002 was approximately $110,516,081. (All
officers and directors of the registrant are considered affiliates.)

At March 18, 2002 the registrant had 11,803,327 shares of Common Stock
issued and outstanding.

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ANWORTH MORTGAGE ASSET CORPORATION

FORM 10-K ANNUAL REPORT

FISCAL YEAR ENDED DECEMBER 31, 2001

TABLE OF CONTENTS

Item Page
---- ----

PART I
1. Business.......................................................... 2
2. Property.......................................................... 18
3. Legal Proceedings................................................. 19
4. Submission of Matters to a Vote of Security Holders............... 19

PART II

5. Market for Registrant's Common Equity and Related Stockholder
Matters.......................................................... 20
6. Selected Financial Data........................................... 21
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 22
7A. Quantitative and Qualitative Disclosures About Market Risk........ 38
8. Financial Statements and Supplementary Information................ 41
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure............................................. 41

PART III

10. Directors and Executive Officers of the Registrant................ 42
11. Executive Compensation............................................ 44
12. Security Ownership of Certain Beneficial Owners and Management.... 47
13. Certain Relationships and Related Transactions.................... 48

PART IV

14. Exhibits, Financial Statement Schedules and Reports on Form 8-K... 50

CAUTIONARY STATEMENT

This Report contains or incorporates by reference certain forward-looking
statements. Forward-looking statements are those that predict or describe
future events or trends and that do not relate solely to historical matters.
You can generally identify forward-looking statements as statements containing
the words "will," "believe," "expect," "anticipate," "intend," "estimate,"
"assume" or other similar expressions. You should not rely on our forward-
looking statements because the matters they describe are subject to known and
unknown risks, uncertainties and other unpredictable factors, many of which
are beyond our control. These forward-looking statements are subject to
assumptions that are difficult to predict and various risks and uncertainties.
Therefore, our actual results could differ materially and adversely from those
expressed in any forward-looking statements as a result of various factors,
some of which are listed under the section "Risk Factors" at the end of Item 7
of this Report. We undertake no obligation to revise or update publicly any
forward-looking statements for any reason.

As used in this Form 10-K, "company," "we," "us," "our," "Anworth" and
"Anworth Mortgage" refer to Anworth Mortgage Asset Corporation.

PART I.

Item 1. BUSINESS

Overview

We are in the business of investing primarily in United States agency and
other highly rated single-family adjustable-rate and fixed-rate mortgage-
backed securities that we acquire in the secondary market. Our returns are
earned on the spread between the yield on our earning assets and the interest
cost of the funds we borrow. We have elected to be taxed as a real estate
investment trust, or REIT, under the United States Internal Revenue Code. As a
REIT, we routinely distribute substantially all of the income generated from
our operations to our stockholders. As long as we retain our REIT status, we
generally will not be subject to federal or state taxes on our income to the
extent that we distribute our net income to our stockholders.

We were incorporated in Maryland on October 20, 1997 and commenced our
operations on March 17, 1998.

Our Strategy

Investment Strategy

Our strategy is to invest primarily in United States agency and other highly
rated single-family adjustable-rate and fixed-rate mortgage-backed securities
that we acquire in the secondary market. We seek to acquire assets that will
produce competitive returns after considering the amount and nature of the
anticipated returns from the investment, our ability to pledge the investment
to secure collateralized borrowings and the costs associated with financing,
managing, securitizing and reserving for these investments. We do not
currently originate mortgage loans or provide other types of financing to the
owners of real estate.

At December 31, 2001, we had $424.6 million in total assets and all of our
mortgages assets were secured by single-family residential mortgage loans. As
of that date, approximately 99% of our assets consisted of mortgage-backed
securities guaranteed by Fannie Mae or Freddie Mac.

Financing Strategy

We finance the acquisition of mortgage-backed securities with short-term
borrowings and, to a lesser extent, equity capital. The amount of short-term
borrowings we employ depends on, among other factors, the amount of our equity
capital. We use leverage to attempt to increase potential returns to our
stockholders. Pursuant to our capital and leverage policy, we seek to strike a
balance between the under-utilization of leverage, which reduces

potential returns to stockholders, and the over-utilization of leverage, which
could reduce our ability to meet our obligations during adverse market
conditions.

We usually borrow at short-term rates using repurchase agreements.
Repurchase agreements are generally short-term in nature. We actively manage
the adjustment periods and the selection of the interest rate indices of our
borrowings against the adjustment periods and the selection of indices on our
mortgage-related assets in order to limit our liquidity and interest rate
related risks. We generally seek to diversify our exposure by entering into
repurchase agreements with multiple lenders. In addition, we enter into
repurchase agreements with institutions we believe are financially sound and
which meet credit standards approved by our board of directors.

Growth Strategy

In addition to the strategies described above, we intend to pursue other
strategies to further grow our earnings and our dividends per share, which may
include the following:

. increasing the size of our balance sheet at a rate faster than the rate
of increase in our operating expenses;

. issuing new common stock when market opportunities exist to profitably
increase the size of our balance sheet through the use of leverage; and

. lowering our effective borrowing costs over time by seeking direct
funding with collateralized lenders, rather than using financial
intermediaries, and possibly using commercial paper, medium term note
programs, preferred stock and other forms of capital.

Management

We are an externally managed REIT and have no employees. We have entered
into a management agreement with Anworth Mortgage Advisory Corporation, which
is owned by a trust controlled by Lloyd McAdams, our chairman and chief
executive officer, and Heather U. Baines, our executive vice president. Our
management company manages our investments and performs administrative
services for us. Our executive officers are employees of our management
company and Pacific Income Advisers, Inc., an investment advisory firm that
began operations in 1986. A majority of our board of directors is unaffiliated
with either our management company or Pacific Income Advisers. Pursuant to the
management agreement, the management company primarily provides:

. asset and liability management, including acquisition, financing,
management and disposition of mortgage-related assets, and credit and
prepayment risk management;

. capital management, including oversight of our structuring, analysis,
capital raising and investor relations activities; and

. administrative services, including secretarial, data processing,
operations and settlement, employee benefit and research services.

We pay our management company a management fee equal to 1% per year of the
first $300 million of stockholders' equity, plus 0.8% per year of the portion
of our stockholders' equity above $300 million. This management fee is paid on
a monthly basis. We also pay our management company, on a quarterly basis, an
incentive compensation fee of 20% of the amount by which our return on our
equity for each quarter exceeds a return based on the ten-year U.S. Treasury
Rate plus 1%.

Our agreement with our management company has a five-year term ending in
April 2003. This agreement will be extended automatically for additional one-
year terms unless terminated by our board of directors. If we elect to
terminate or not renew our agreement with our management company for reasons
other than our management company's breach of the agreement or due to
bankruptcy or similar proceedings affecting our management company, we must
pay our management company a termination fee. The amount of this fee will be
the fair value of the management agreement as determined by an appraisal from
an independent party and could be substantial.

Option To Become Internally Managed

As discussed above, our operations are managed externally by our management
company, Anworth Mortgage Advisory Corporation. We adopted this structure when
we began operations in 1998 because the size and scope of our business
operations at that time were not sufficient to support the overhead costs
associated with an internally managed structure. Our management company has
granted us an option, exercisable on or before April 30, 2003, to acquire our
management company by merger for consideration consisting of 240,000 shares of
our common stock. If exercised, we would become an internally managed company
and the employees of the management company would become our employees. The
closing of the merger would be subject to a number of conditions, including
the approval of our stockholders and receipt by our board of directors of a
fairness opinion regarding the fairness of the consideration payable by us in
the merger. We have agreed, as a condition to exercising the option, to enter
into direct employment contracts with Lloyd McAdams and other key executives
of the management company designated by Mr. McAdams, adopt an incentive
compensation plan for our employees and increase and maintain the size of our
1997 Stock Option and Awards Plan. If the merger is consummated, the
management agreement would be terminated.

Our board of directors has formed a special committee, made up solely of
independent members of the board, to consider the exercise of the option. We
will exercise the option only if the special committee determines that
consummating the merger and becoming internally managed would be fair to and
in the best interests of our stockholders.

Our Operating Policies and Programs

We have established the following four primary operating policies to
implement our business strategies:

. our Asset Acquisition Policy;

. our Capital and Leverage Policy;

. our Credit Risk Management Policy; and

. our Asset/Liability Management Policy.

Asset Acquisition Policy

Our asset acquisition policy provides guidelines for acquiring investments
and contemplates that we will acquire a portfolio of investments that can be
grouped into specific categories. Each category and our respective investment
guidelines are as follows:

. Category I--At least 60% of our total assets will generally be adjustable
or fixed-rate mortgage securities and short-term investments. Assets in
this category will be rated within one of the two highest rating
categories by at least one nationally recognized statistical rating
organization, or if not rated, will be obligations guaranteed by the
United States government or its agencies, Fannie Mae or Freddie Mac.

. Category II--At least 90% of our total assets will generally consist of
Category I investments plus unrated mortgage loans, mortgage securities
rated at least investment grade by at least one nationally recognized
statistical rating organization, or shares of other REITs or mortgage-
related companies.

. Category III--No more than 10% of our total assets may be of a type not
meeting any of the above criteria. Among the types of assets generally
assigned to this category are mortgage securities rated below investment
grade and leveraged mortgage derivative securities.

Under our Category III investment criteria, we may acquire other types of
mortgage derivative securities, including, but not limited to, interest only,
principal only or other mortgage-backed securities that receive a
disproportionate share of interest income or principal.

Capital and Leverage Policy

We employ a leverage strategy to increase our investment assets by borrowing
against existing mortgage-related assets and using the proceeds to acquire
additional mortgage-related assets. We generally borrow between eight to
twelve times the amount of our equity, although our borrowings may vary from
time to time depending on market conditions and other factors deemed relevant
by our management company and our board of directors. We believe that this
will leave an adequate capital base to protect against interest rate
environments in which our borrowing costs might exceed our interest income
from mortgage-related assets. We enter into collateralized borrowings with
institutions which meet credit standards approved by our board of directors.

Depending on the different cost of borrowing funds at different maturities,
we vary the maturities of our borrowed funds to attempt to produce lower
borrowing costs. Our borrowings are short-term and we manage actively, on an
aggregate basis, both the interest rate indices and interest rate adjustment
periods of our borrowings against the interest rate indices and interest rate
adjustment periods on our mortgage-related assets.

Our mortgage-related assets are financed primarily at short-term borrowing
rates through repurchase agreements and dollar-roll agreements. In the future
we may also employ borrowings under lines of credit and other collateralized
financings that we may establish with approved institutional lenders.

Credit Risk Management Policy

We review credit risk and other risks of loss associated with each of our
potential investments. In addition, we may diversify our portfolio of
mortgage-related assets to avoid undue geographic, insurer, industry and
certain other types of concentrations. We may reduce certain risks from
sellers and servicers through representations and warranties. Our board of
directors monitors the overall portfolio risk and determines appropriate
levels of provision for loss.

Compliance with our credit risk management policy guidelines is determined
at the time of purchase of mortgage assets, based upon the most recent
valuation utilized by us. Such compliance is not affected by events subsequent
to such purchase, including, without limitation, changes in characterization,
value or rating of any specific mortgage assets or economic conditions or
events generally affecting any mortgage-related assets of the type held by us.

Asset/Liability Management Policy

Interest-Rate Risk Management. To the extent consistent with our election to
qualify as a REIT, we follow an interest rate risk management program intended
to protect our portfolio of mortgage-related assets and related debt against
the effects of major interest rate changes. Specifically, our interest rate
management program is formulated with the intent to offset to some extent the
potential adverse effects resulting from rate adjustment limitations on our
mortgage-related assets and the differences between interest rate adjustment
indices and interest rate adjustment periods of our adjustable-rate mortgage-
related assets and related borrowings.

Our interest rate risk management program encompasses a number of
procedures, including the following:

. monitoring and adjusting, if necessary, the interest rate sensitivity of
our mortgage-related assets compared with the interest rate
sensitivities of our borrowings;

. attempting to structure our borrowing agreements relating to adjustable-
rate mortgage-related assets to have a range of different maturities and
interest rate adjustment periods (although substantially all will be
less than a year); and

. actively managing, on an aggregate basis, the interest rate indices and
interest rate adjustment periods of our mortgage-related assets compared
to the interest rate indices and adjustment periods of our borrowings.

As a result, we expect to be able to adjust the average maturity/adjustment
period of our borrowings on an ongoing basis by changing the mix of maturities
and interest rate adjustment periods as borrowings come due or are renewed.
Through the use of these procedures, we attempt to reduce the risk of
differences between interest rate adjustment periods of our adjustable-rate
mortgage-related assets and our related borrowings.

Depending on market conditions and the cost of the transactions, we may
conduct certain hedging activities in connection with the management of our
portfolio. To the extent consistent with our election to qualify as a REIT, we
may adopt a hedging strategy intended to lessen the effects of interest rate
changes and to enable us to earn net interest income in periods of generally
rising, as well as declining or static, interest rates. Specifically, hedging
programs are formulated with the intent to offset some of the potential
adverse effects of changes in interest rate levels relative to the interest
rates on the mortgage-related assets held in our investment portfolio, and
differences between the interest rate adjustment indices and periods of our
mortgage-related assets and our borrowings. We monitor carefully, and may have
to limit, our asset/liability management program to assure that we do not
realize excessive hedging income, or hold hedges having excess value in
relation to mortgage-related assets, which would result in our
disqualification as a REIT or, in the case of excess hedging income, if the
excess is due to reasonable cause and not willful neglect, the payment of a
penalty tax for failure to satisfy certain REIT income tests under the tax
code. In addition, asset/liability management involves transaction costs that
increase dramatically as the period covered by hedging protection increases
and that may increase during periods of fluctuating interest rates.

Prepayment Risk Management. We also seek to lessen the effects of prepayment
of mortgage loans underlying our securities at a faster or slower rate than
anticipated. We accomplish this by structuring a diversified portfolio with a
variety of prepayment characteristics, investing in mortgage-related assets
with prepayment prohibitions and penalties, investing in certain mortgage
security structures that have prepayment protections, and purchasing mortgage-
related assets at a premium and at a discount. We invest in mortgage-related
assets that on a portfolio basis do not have significant purchase price
premiums. Under normal market conditions, we seek to maintain the aggregate
capitalized purchase premium of the portfolio at 3% or less. In addition, we
can purchase principal only derivatives to a limited extent as a hedge against
prepayment risks. We monitor prepayment risk through periodic review of the
impact of a variety of prepayment scenarios on our revenues, net earnings,
dividends, cash flow and net balance sheet market value.

We believe that we have developed cost-effective asset/liability management
policies to mitigate prepayment risks. However, no strategy can completely
insulate us from prepayment risks. Further, as noted above, certain of the
federal income tax requirements that we must satisfy to qualify as a REIT
limit our ability to fully hedge our prepayment risks. Therefore, we could be
prevented from effectively hedging our interest rate and prepayment risks.

Our Investments

Mortgage-Backed Securities

Pass-Through Certificates. We principally invest in pass-through
certificates, which are securities representing interests in pools of mortgage
loans secured by residential real property in which payments of both interest
and principal on the securities are generally made monthly, in effect, passing
through monthly payments made by the individual borrowers on the mortgage
loans which underlie the securities, net of fees paid to the issuer or
guarantor of the securities. Early repayment of principal on some mortgage-
backed securities, arising from prepayments of principal due to sale of the
underlying property, refinancing or foreclosure, net of fees and costs which
may be incurred, may expose us to a lower rate of return upon reinvestment of
principal. This is generally referred to as prepayment risk. Additionally, if
a security subject to prepayment has been purchased at a premium, the value of
the premium would be lost in the event of prepayment. Like other fixed-income
securities, when interest rates rise, the value of a mortgage-backed security
generally will decline.

When interest rates are declining, however, the value of mortgage-backed
securities with prepayment features may not increase as much as other fixed-
income securities. The rate of prepayments on underlying

mortgages will affect the price and volatility of a mortgage-backed securities
and may have the effect of shortening or extending the effective maturity of
the security beyond what was anticipated at the time of purchase. When
interest rates rise, our holdings of mortgage-backed securities may experience
reduced returns if the owners of the underlying mortgages pay off their
mortgages later than anticipated. This is generally referred to as extension
risk.

Payment of principal and interest on some mortgage pass-through securities,
although not the market value of the securities themselves, may be guaranteed
by the full faith and credit of the federal government, including securities
backed by Ginnie Mae, or by agencies or instrumentalities of the federal
government, including Fannie Mae and Freddie Mac. Mortgage-backed securities
created by non-governmental issuers, including commercial banks, savings and
loan institutions, private mortgage insurance companies, mortgage bankers and
other secondary market issuers, may be supported by various forms of insurance
or guarantees, including individual loan, title, pool and hazard insurance and
letters of credit, which may be issued by governmental entities, private
insurers or the mortgage poolers.

Collateralized Mortgage Obligations. Collateralized mortgage obligations, or
CMOs, are hybrid mortgage-backed securities. Interest and principal on a CMO
are paid, in most cases, on a monthly basis. CMOs may be collateralized by
whole mortgage loans, but are more typically collateralized by portfolios of
mortgage pass-through securities guaranteed by Ginnie Mae, Freddie Mac or
Fannie Mae. CMOs are structured into multiple classes, with each class bearing
a different stated maturity. Monthly payments of principal, including
prepayments, are first returned to investors holding the shortest maturity
class; investors holding the longer maturity classes receive principal only
after the first class has been retired. We will consider CMOs that are issued
or guaranteed by the federal government or by any of its agencies or
instrumentalities to be United States government securities.

Other Mortgage-Backed Securities

Mortgage Derivative Securities. We may acquire mortgage derivative
securities in an amount not to exceed 10% of our total assets. Mortgage
derivative securities provide for the holder to receive interest only,
principal only, or interest and principal in amounts that are disproportionate
to those payable on the underlying mortgage loans. Payments on mortgage
derivative securities are highly sensitive to the rate of prepayments on the
underlying mortgage loans. In the event of faster or slower than anticipated
prepayments on these mortgage loans, the rates of return on interests in
mortgage derivative securities representing the right to receive interest only
or a disproportionately large amount of interest, or interest only
derivatives, would be likely to decline or increase, respectively. Conversely,
the rates of return on mortgage derivative securities representing the right
to receive principal only or a disproportionate amount of principal, or
principal only derivatives, would be likely to increase or decrease in the
event of faster or slower prepayments, respectively.

We may also invest in inverse floaters, a class of CMOs with a coupon rate
that resets in the opposite direction from the market rate of interest to
which it is indexed, including LIBOR or the 11th District Cost of Funds Index,
or COFI. Any rise in the index rate, which can be caused by an increase in
interest rates, causes a drop in the coupon rate of an inverse floater while
any drop in the index rate causes an increase in the coupon of an inverse
floater. An inverse floater may behave like a leveraged security since its
interest rate usually varies by a magnitude much greater than the magnitude of
the index rate of interest. The leverage-like characteristics inherent in
inverse floaters are associated with greater volatility in their market
prices.

We may also invest in other mortgage derivative securities that may be
developed in the future.

Subordinated Interests. We may also acquire subordinated interests, which
are classes of mortgage-backed securities that are junior to other classes of
the same series of mortgage-backed securities in the right to receive payments
from the underlying mortgage loans. The subordination may be for all payment
failures on the mortgage loans securing or underlying such series of mortgage
securities. The subordination will not be limited to those resulting from
particular types of risks, including those resulting from war, earthquake or
flood, or the

bankruptcy of a borrower. The subordination may be for the entire amount of
the series of mortgage-related securities or may be limited in amount.

Mortgage Warehouse Participations. We may also occasionally acquire mortgage
warehouse participations as an additional means of diversifying our sources of
income. We anticipate that these investments, together with our investments in
other Category III assets, will not in the aggregate exceed 10% of our total
mortgage-related assets. These investments are participations in lines of
credit to mortgage loan originators that are secured by recently originated
mortgage loans that are in the process of being sold to investors. Our
investments in mortgage warehouse participations are limited because they are
not qualified REIT assets under the tax code.

Other Mortgage-Related Assets

Mortgage Loans. We may acquire and accumulate mortgage loans as part of our
investment strategy until a sufficient quantity has been accumulated for
securitization into high-quality mortgage-backed securities in order to
enhance their value and liquidity. We anticipate that any mortgage loans that
we acquire and do not immediately securitize, together with our investments in
other mortgage-related assets that are not Category I assets, will not
constitute more than 30% of our total mortgage-related assets at any time. All
mortgage loans, if any, will be acquired with the intention of securitizing
them into high-credit quality mortgage securities. Despite our intentions,
however, we may not be successful in securitizing these mortgage loans. To
meet our investment criteria, mortgage loans acquired by us will generally
conform to the underwriting guidelines established by Fannie Mae, Freddie Mac
or other credit insurers. Applicable banking laws generally require that an
appraisal be obtained in connection with the original issuance of mortgage
loans by the lending institution. We do not intend to obtain additional
appraisals at the time of acquiring mortgage loans.

Mortgage loans may be originated by or purchased from various suppliers of
mortgage-related assets throughout the United States, including savings and
loans associations, banks, mortgage bankers and other mortgage lenders. We may
acquire mortgage loans directly from originators and from entities holding
mortgage loans originated by others. Our board of directors has not
established any limits upon the geographic concentration of mortgage loans
that we may acquire or the credit quality of suppliers of the mortgage-related
assets that we acquire.

Other Investments. We may acquire other investments that include equity and
debt securities issued by other primarily mortgage-related finance companies,
interests in mortgage-related collateralized bond obligations, other
subordinated interests in pools of mortgage-related assets, commercial
mortgage loans and securities, and residential mortgage loans other than high-
credit quality mortgage loans. Although we expect that our other investments
will be limited to less than 10% of total assets, we have no limit on how much
of our stockholders' equity will be allocated to other investments. There may
be periods in which other investments represent a large portion of our
stockholders' equity.

Competition

When we invest in mortgage-backed securities and other investment assets, we
compete with a variety of institutional investors including other REITs,
insurance companies, mutual funds, pension funds, investment banking firms,
banks and other financial institutions that invest in the same types of
assets. Many of these investors have greater financial resources and access to
lower costs of capital than we do.

Employees

As of December 31, 2001, we had no employees. Our manager, Anworth Mortgage
Advisory Corporation, carries out the day to day operations of Anworth,
subject to the supervision of our board of directors and under the terms of
the management agreement.

CERTAIN FEDERAL INCOME TAX CONSIDERATIONS

The following discussion summarizes particular United States federal income
tax considerations regarding our qualification and taxation as a REIT and
particular United States federal income tax consequences resulting from the
acquisition, ownership and disposition of our common stock. This discussion is
based on current law and assumes that we have qualified at all times
throughout our existence, and will continue to qualify, as a REIT for United
States federal income tax purposes. The tax law upon which this discussion is
based could be changed, and any such change could have retroactive effect. The
following discussion is not exhaustive of all possible tax considerations.
This summary neither gives a detailed discussion of any state, local or
foreign tax considerations nor discusses all of the aspects of United States
federal income taxation that may be relevant to you in light of your
particular circumstances or to particular types of stockholders which are
subject to special tax rules, such as insurance companies, tax-exempt
entities, financial institutions or broker-dealers, foreign corporations or
partnerships, and persons who are not citizens or residents of the United
States, stockholders that hold our stock as a hedge, part of a straddle,
conversion transaction or other arrangement involving more than one position,
or stockholders whose functional currency is not the United States dollar.
This discussion assumes that you will hold our common stock as a "capital
asset," generally property held for investment, under the tax code.

You are urged to consult with your own tax advisor regarding the specific
consequences to you of the purchase, ownership and sale of stock in an entity
electing to be taxed as a REIT, including the federal, state, local, foreign
and other tax considerations of such purchase, ownership, sale and election
and the potential changes in applicable tax laws.

General

Our qualification and taxation as a REIT depends upon our ability to
continue to meet the various qualification tests imposed under the tax code
and discussed below relating to our actual annual operating results, asset
diversification, distribution levels and diversity of stock ownership.
Accordingly, the actual results of our operations for any particular taxable
year may not satisfy these requirements.

We have made an election to be taxed as a REIT under the tax code commencing
with our taxable year ended December 31, 1998. We currently expect to continue
operating in a manner that will permit us to maintain our qualification as a
REIT. All qualification requirements for maintaining our REIT status, however,
may not have been or will not continue to be met.

So long as we qualify for taxation as a REIT, we generally will be permitted
a deduction for dividends we pay to our stockholders. As a result, we
generally will not be required to pay federal corporate income taxes on our
net income that is currently distributed to our stockholders. This treatment
substantially eliminates the "double taxation" that ordinarily results from
investment in a corporation. Double taxation means taxation once at the
corporate level when income is earned and once again at the stockholder level
when this income is distributed. We will be required to pay federal income
tax, however, as follows:

. we will be required to pay tax at regular corporate rates on any
undistributed "real estate investment trust taxable income," including
undistributed net capital gain;

. we may be required to pay the "alternative minimum tax" on our items of
tax preference; and

. if we have (a) 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 (b) other nonqualifying income from
foreclosure property, we will be required to pay tax at the highest
corporate rate on this income. Foreclosure property is generally defined
as property acquired through foreclosure or after a default on a loan
secured by the property or on a lease of the property.

We will be required to pay a 100% tax on any net income from prohibited
transactions. Prohibited transactions are, in general, sales or other taxable
dispositions of property, other than foreclosure property, held primarily for
sale to customers in the ordinary course of business. Under existing law,
whether property is held

as inventory or primarily for sale to customers in the ordinary course of a
trade or business depends on all the facts and circumstances surrounding the
particular transaction.

If we fail to satisfy the 75% gross income test or the 95% gross income test
discussed below, but nonetheless maintain our qualification as a REIT because
certain other requirements are met, we will be subject to a tax equal to:

. the greater of (i) the amount by which 75% of our gross income exceeds
the amount qualifying under the 75% gross income test described below,
and (ii) the amount by which 90% of our gross income exceeds the amount
qualifying under the 95% gross income test described below, multiplied
by

. a fraction intended to reflect our profitability.

We will be required to pay a 4% excise tax on the excess of the required
distribution over the amounts actually distributed if we fail to distribute
during each calendar year at least the sum of:

. 85% of our real estate investment trust ordinary income for the year;

. 95% of our real estate investment trust capital gain net income for the
year; and

. any undistributed taxable income from prior periods.

This distribution requirement is in addition to, and different from the
distribution requirements discussed below in the section entitled "Annual
Distribution Requirements."

If we acquire any asset from a corporation which is or has been taxed as a C
corporation under the tax code in a transaction in which the basis of the
asset in our hands is determined by reference to the basis of the asset in the
hands of the C corporation, and we subsequently recognize gain on the
disposition of the asset during the ten-year period beginning on the date on
which we acquired the asset, then we will be required to pay tax at the
highest regular corporate tax rate on this gain to the extent of the excess
of:

. the fair market value of the asset, over

. our adjusted basis in the asset, in each case determined as of the date
on which we acquired the asset.

A C corporation is generally defined as a corporation required to pay full
corporate-level tax. The results described in this paragraph with respect to
the recognition of gain will apply unless we make an election under Treasury
Regulation Section 1.337(d)-7T(c).

Finally, we could be subject to an excise tax if our dealings with any
taxable REIT subsidiaries (defined below) are not at arm's length.

Requirements for Qualification as a REIT

The tax code defines a REIT as a corporation, trust or association:

. that is managed by one or more trustees or directors;

. that issues transferable shares or transferable certificates to evidence
beneficial ownership;

. that would be taxable as a domestic corporation but for tax code
Sections 856 through 859;

. that is not a financial institution or an insurance company within the
meaning of the tax code;

. that is beneficially owned by 100 or more persons;

. not more than 50% in value of the outstanding stock of which is owned,
actually or constructively, by five or fewer individuals, including
specified entities, during the last half of each taxable year; and

. that meets other tests, described below, regarding the nature of its
income and assets and the amount of its distributions.

The tax code provides that all of the first four conditions stated above
must be met during the entire taxable year and that the fifth condition must
be met during at least 335 days of a taxable year of twelve months, or during
a proportionate part of a taxable year of less than twelve months. The fifth
and sixth conditions do not apply until after the first taxable year for which
an election is made to be taxed as a REIT.

For purposes of the sixth condition, pension trusts and other specified tax-
exempt entities generally are treated as individuals, except that a "look-
through" exception generally applies with respect to pension funds.

Stock Ownership Tests

Our stock must be beneficially held by at least 100 persons, the "100
Stockholder Rule," and no more than 50% of the value of our stock may be
owned, directly or indirectly, by five or fewer individuals at any time during
the last half of the taxable year, the "5/50 Rule." For purposes of the 100
Stockholder Rule only, trusts described in Section 401(a) of the tax code and
exempt under Section 501(a) of the tax code, are generally treated as persons.
These stock ownership requirements must be satisfied in each taxable year
other than the first taxable year for which an election is made to be taxed as
a REIT. We are required to solicit information from certain of our record
stockholders to verify actual stock ownership levels, and our charter provides
for restrictions regarding the transfer of our stock in order to aid in
meeting the stock ownership requirements. If we were to fail either of the
stock ownership tests, we would generally be disqualified from REIT status.

Income Tests

We must satisfy two gross income requirements annually to maintain our
qualification as a REIT:

. We must derive directly or indirectly at least 75% of our gross income,
excluding gross income from prohibited transactions, from specified real
estate sources, including rental income, interest on obligations secured
by mortgages on real property or on interests in real property, gain
from the disposition of "qualified real estate assets," i.e., interests
in real property, mortgages secured by real property or interests in
real property, and some other assets, and income from certain types of
temporary investments (the "75% gross income test"); and

. We must derive at least 95% of our gross income, excluding gross income
from prohibited transactions, from (a) the sources of income that
satisfy the 75% gross income test, (b) dividends, interest and gain from
the sale or disposition of stock or securities, including some interest
rate swap and cap agreements, options, futures and forward contracts
entered into to hedge variable rate debt incurred to acquire qualified
real estate assets, or (c) any combination of the foregoing (the "95%
gross income test").

For purposes of the 75% and 95% gross income tests, a REIT is deemed to have
earned a proportionate share of the income earned by any partnership, or any
limited liability company treated as a partnership for federal income tax
purposes, in which it owns an interest, which share is determined by reference
to its capital interest in such entity, and is deemed to have earned the
income earned by any qualified REIT subsidiary (in general, a 100% owned
corporate subsidiary of a REIT).

Interest earned by a REIT ordinarily does not qualify as income meeting the
75% or 95% gross income tests if the determination of all or some of the
amount of interest depends in any way on the income or profits of any person.
Interest will not be disqualified from meeting such tests, however, solely by
reason of being based on a fixed percentage or percentages of receipts or
sales.

If we fail to satisfy one or both of the 75% or 95% gross income tests for
any taxable year, we may nevertheless qualify as a REIT for the year if we are
entitled to relief under the tax code. Generally, we may avail ourselves of
the relief provisions if:

. our failure to meet these tests was due to reasonable cause and not due
to willful neglect;

. we attach a schedule of the sources of our income to our federal income
tax return; and

. any incorrect information on the schedule was not due to fraud with
intent to evade tax.

If we are entitled to avail ourselves of the relief provisions, we will
maintain our qualification as a REIT but will be subject to certain penalty
taxes as described above. We may not, however, be entitled to the benefit of
these relief provisions in all circumstances. If these relief provisions do
not apply to a particular set of circumstances, we will not qualify as a REIT.

Asset Tests

At the close of each quarter of our taxable year, we must satisfy four tests
relating to the nature and diversification of our assets:

. at least 75% of the value of our total assets must be represented by
qualified real estate assets (including mortgage loans), cash, cash
items and government securities;

. not more than 25% of our total assets may be represented by securities,
other than those securities included in the 75% asset test;

. of the investments included in the 25% asset class, the value of any one
issuer's securities may not exceed 5% of the value of our total assets,
and we generally may not own more than 10% by vote or value of any one
issuer's outstanding securities, in each case except with respect to
stock of any "taxable REIT subsidiaries"; and

. the value of the securities we own in any taxable REIT subsidiaries may
not exceed 20% of the value of our total assets.

A "taxable REIT subsidiary" is any corporation in which we own stock and as
to which we and such corporation jointly elect to treat such subsidiary as a
taxable REIT subsidiary. For purposes of the asset tests, we will be deemed to
own a proportionate share of the assets of any partnership, or any limited
liability company treated as a partnership for federal income tax purposes, in
which we own an interest, which share is determined by reference to our
capital interest in the entity, and will be deemed to own the assets owned by
any qualified REIT subsidiary and any other entity that is disregarded for
federal income tax purposes.

After initially meeting the asset tests at the close of any quarter, we will
not lose our status as a REIT for failure to satisfy the asset tests at the
end of a later quarter solely by reason of changes in asset values. If we fail
to satisfy the asset tests because we acquire securities or other property
during a quarter, we can cure this failure by disposing of sufficient
nonqualifying assets within 30 days after the close of that quarter. For this
purpose, an increase in our interests in any partnership or limited liability
company in which we own an interest will be treated as an acquisition of a
portion of the securities or other property owned by that partnership or
limited liability company.

Annual Distribution Requirements

To maintain our qualification as a REIT, we are required to distribute
dividends, other than capital gain dividends, to our stockholders in an amount
at least equal to the sum of:

. 90% of our "REIT taxable income," and

. 90% of our after tax net income, if any, from foreclosure property,
minus

. the excess of the sum of specified items of our non-cash income items
over 5% of "REIT taxable income," as described below.

For purposes of these distribution requirements, our "REIT taxable income"
is computed without regard to the dividends paid deduction (described below)
and net capital gain. In addition, for purposes of this test, non-cash income
means income attributable to leveled stepped rents, certain original issue
discount, certain like-kind exchanges that are later determined to be taxable
and income from cancellation of indebtedness. In addition, if we disposed of
any asset we acquired from a corporation which is or has been a C corporation
in a transaction in

which our basis in the asset is determined by reference to the basis of the
asset in the hands of that C corporation and we elected not to recognize gain
currently in connection with the acquisition of such asset, we would be
required to distribute at least 90% of the after-tax gain, if any, we
recognize on a disposition of the asset within the ten-year period following
our acquisition of such asset, to the extent that such gain does not exceed
the excess of:

. the fair market value of the asset on the date we acquired the asset,
over

. our adjusted basis in the asset on the date we acquired the asset.

Only distributions that qualify for the "dividends paid deduction" available
to REITs under the tax code are counted in determining whether the
distribution requirements are satisfied. We must make these distributions in
the taxable year to which they relate, or in the following taxable year if
they are declared before we timely file our tax return for that year, paid on
or before the first regular dividend payment following the declaration and we
elect on our tax return to have a specified dollar amount of such
distributions treated as if paid in the prior year. For these and other
purposes, dividends declared by us in October, November or December of one
taxable year and payable to a stockholder of record on a specific date in any
such month shall be treated as both paid by us and received by the stockholder
during such taxable year, provided that the dividend is actually paid by us by
January 31 of the following taxable year.

In addition, dividends distributed by us must not be preferential. If a
dividend is preferential, it will not qualify for the dividends paid
deduction. To avoid being preferential, every stockholder of the class of
stock to which a distribution is made must be treated the same as every other
stockholder of that class, and no class of stock may be treated other than
according to its dividend rights as a class.

To the extent that we do not distribute all of our net capital gain, or we
distribute at least 90%, but less than 100%, of our "REIT taxable income," as
adjusted, we will be required to pay tax on this undistributed income at
regular ordinary and capital gain corporate tax rates.

Failure to Qualify as a REIT

If we fail to qualify for taxation as a REIT in any taxable year, and the
relief provisions of the tax code do not apply, we will be required to pay
tax, including any applicable alternative minimum tax, on our taxable income
in that taxable year and all subsequent taxable years at regular corporate
rates. Distributions to stockholders in any year in which we fail to qualify
as a REIT will not be deductible by us and we will not be required to
distribute any amounts to our stockholders. As a result, we anticipate that
our failure to qualify as a REIT would reduce the cash available for
distribution to our stockholders. In addition, if we fail to qualify as a
REIT, all distributions to stockholders will be taxable at ordinary income
rates to the extent of our current and accumulated earnings and profits. In
this event, corporate distributees may be eligible for the dividends-received
deduction. Unless entitled to relief under specific statutory provisions, we
will also be disqualified from taxation as a REIT for the four taxable years
following the year in which we lose our qualification.

Taxation Of Taxable United States Stockholders

For purposes of the discussion in this Form 10-K, the term "United States
stockholder" means a holder of our stock that is, for United States federal
income tax purposes:

. a citizen or resident of the United States;

. a corporation, partnership, or other entity created or organized in or
under the laws of the United States or of any state thereof or in the
District of Columbia, unless Treasury regulations provide otherwise;

. an estate the income of which is subject to United States federal income
taxation regardless of its source; or

. a trust whose administration is subject to the primary supervision of a
United States court and which has one or more United States persons who
have the authority to control all substantial decisions of the trust.

Distributions Generally

Distributions out of our current or accumulated earnings and profits, other
than capital gain dividends, will be taxable to United States stockholders as
ordinary income. Provided that we continue to qualify as a REIT, dividends
paid by us will not be eligible for the dividends received deduction generally
available to United States stockholders that are corporations. To the extent
that we make distributions in excess of current and accumulated earnings and
profits, the distributions will be treated as a tax-free return of capital to
each United States stockholder, and will reduce the adjusted tax basis which
each United States stockholder has in our stock by the amount of the
distribution, but not below zero. Distributions in excess of a United States
stockholder's adjusted tax basis in its stock will be taxable as capital gain,
and will be taxable as long-term capital gain if the stock has been held for
more than one year. If we declare a dividend in October, November, or December
of any calendar year which is payable to stockholders of record on a specified
date in such a month and actually pay the dividend during January of the
following calendar year, the dividend is deemed to be paid by us and received
by the stockholder on December 31st of the previous year. Stockholders may not
include in their own income tax returns any of our net operating losses or
capital losses.

Capital Gain Distributions

Distributions designated by us as capital gain dividends will be taxable to
United States stockholders as capital gain income. We can designate
distributions as capital gain dividends to the extent of our net capital gain
for the taxable year of the distribution. This capital gain income will
generally be taxable to non-corporate United States stockholders at a 20% or
25% rate based on the characteristics of the asset we sold that produced the
gain. United States stockholders that are corporations may be required to
treat up to 20% of certain capital gain dividends as ordinary income.

A recently enacted 18% capital gains rate applies to certain assets acquired
after December 31, 2000, and to certain assets held on January 1, 2001, as to
which an election is made to treat such assets as having been sold and then
reacquired on the same date. If the election is made, the asset will be deemed
to be sold at its fair market value and any gain, but not loss, will be
recognized. Although the IRS has yet to issue any official guidance on how the
18% rate would apply to distributions made by us, the IRS has indicated in
income tax forms that the lower rate will apply to designated capital gain
distributions we make to the extent that the gain is derived from the
disposition of a capital asset acquired by us after December 31, 2000 and held
for more than five years at the time of disposition.

Retention of Net Capital Gains

We may elect to retain, rather than distribute as a capital gain dividend,
our net capital gains. If we were to make this election, we would pay tax on
such retained capital gains. In such a case, our stockholders would generally:

. include their proportionate share of our undistributed net capital gains
in their taxable income;

. receive a credit for their proportionate share of the tax paid by us in
respect of such net capital gain; and

. increase the adjusted basis of their stock by the difference between the
amount of their share of our undistributed net capital gain and their
share of the tax paid by us.

Passive Activity Losses, Investment Interest Limitations and Other
Considerations of Holding Our Stock

Distributions we make and gains arising from the sale or exchange of our
stock by a United States stockholder will not be treated as passive activity
income. As a result, United States stockholders will not be able to apply any
"passive losses" against income or gains relating to our stock. Distributions
by us, to the extent they do not constitute a return of capital, generally
will be treated as investment income for purposes of computing the investment
interest limitation under the tax code. Further, if we, or a portion of our
assets, were to be treated as a taxable mortgage pool, any excess inclusion
income that is allocated to you could not be offset by any losses or other
deductions you may have.

Dispositions of Stock

A United States stockholder that sells or disposes of our stock will
recognize gain or loss for federal income tax purposes in an amount equal to
the difference between the amount of cash or the fair market value of any
property the stockholder receives on the sale or other disposition and the
stockholder's adjusted tax basis in the stock. This gain or loss will be
capital gain or loss and will be long-term capital gain or loss if the
stockholder has held the stock for more than one year. In general, any loss
recognized by a United States stockholder upon the sale or other disposition
of our stock that the stockholder has held for six months or less will be
treated as long-term capital loss to the extent the stockholder received
distributions from us which were required to be treated as long-term capital
gains.

Information Reporting and Backup Withholding

We report to our United States stockholders and the IRS the amount of
dividends paid during each calendar year, and the amount of any tax withheld.
Under the backup withholding rules, a stockholder may be subject to backup
withholding with respect to dividends paid and redemption proceeds unless the
holder is a corporation or comes within other exempt categories and, when
required, demonstrates this fact, or provides a taxpayer identification number
or social security number, certifying as to no loss of exemption from backup
withholding, and otherwise complies with applicable requirements of the backup
withholding rules. A United States stockholder that does not provide us with
its correct taxpayer identification number or social security number may also
be subject to penalties imposed by the IRS. A United States stockholder can
meet this requirement by providing us with a correct, properly completed and
executed copy of IRS Form W-9 or a substantially similar form. Backup
withholding is not an additional tax. Any amount paid as backup withholding
will be creditable against the stockholder's income tax liability, if any, and
otherwise be refundable. In addition, we may be required to withhold a portion
of capital gain distributions made to any stockholders who fail to certify
their non-foreign status.

Pursuant to the Economic Growth and Tax Relief Reconciliation Act of 2001,
signed into law on June 7, 2001, the backup withholding tax rate is 30% for
amounts distributed after December 31, 2001 and on or before December 31,
2003. After 2003, the backup withholding tax rate will be gradually reduced
until 2006, when the backup-withholding rate will be 28%.

Taxation of Tax-Exempt Stockholders

The IRS has ruled that amounts distributed as a dividend by a REIT will be
treated as a dividend by the recipient and excluded from the calculation of
unrelated business taxable income when received by a tax-exempt entity. Based
on that ruling, provided that a tax-exempt stockholder has not held our stock
as "debt financed property" within the meaning of the tax code, i.e., property
the acquisition or holding of which is financed through a borrowing by the
tax-exempt United States stockholder, the stock is not otherwise used in an
unrelated trade or business, and we do not hold a residual interest in a real
estate mortgage investment conduit, REMIC, that gives rise to "excess
inclusion" income, as defined in Section 860E of the tax code, dividend income
on our stock and income from the sale of our stock should not be unrelated
business taxable income to a tax-exempt stockholder. However, if we were to
hold residual interests in a REMIC, or if we or a pool of our assets were to
be treated as a "taxable mortgage pool," a portion of the dividends paid to a
tax-exempt stockholder may be subject to tax as unrelated business taxable
income. Although we do not believe that we, or any portion of our assets, will
be treated as a taxable mortgage pool, no assurance can be given that the IRS
might not successfully maintain that such a taxable mortgage pool exists.

For tax-exempt stockholders that are social clubs, voluntary employee
benefit associations, supplemental unemployment benefit trusts, and qualified
group legal services plans exempt from federal income taxation under Sections
501(c)(7), (c)(9), (c)(17) and (c)(20) of the tax code, respectively, income
from an investment in our stock will constitute unrelated business taxable
income unless the organization is able to properly claim a deduction for
amounts set aside or placed in reserve for certain purposes so as to offset
the income generated by

its investment in our stock. Any prospective investors should consult their
tax advisors concerning these "set aside" and reserve requirements.

Notwithstanding the above, however, a substantial portion of the dividends
you receive may constitute unrelated business taxable income if we are treated
as a "pension-held REIT" and you are a pension trust which:

. is described in Section 401(a) of the tax code; and

. holds more than 10%, by value, of the interests in the REIT.

Tax-exempt pension funds that are described in Section 401(a) of the tax
code and exempt from tax under Section 501(a) of the tax code are referred to
below as "qualified trusts."

A REIT is a "pension-held REIT" if:

. it would not have qualified as a REIT but for the fact that Section
856(h)(3) of the tax code provides that stock owned by a qualified trust
shall be treated, for purposes of the 5/50 Rule, described above, as
owned by the beneficiaries of the trust, rather than by the trust
itself; and

. either at least one qualified trust holds more than 25%, by value, of
the interests in the REIT, or one or more qualified trusts, each of
which owns more than 10%, by value, of the interests in the REIT, holds
in the aggregate more than 50%, by value, of the interests in the REIT.

The percentage of any REIT dividend treated as unrelated business taxable
income is equal to the ratio of:

. the unrelated business taxable income earned by the REIT, less directly
related expenses, treating the REIT as if it were a qualified trust and
therefore subject to tax on unrelated business taxable income, to

. the total gross income, less directly related expenses, of the REIT.

A de minimis exception applies where the percentage is less than 5% for any
year. As a result of the limitations on the transfer and ownership of stock
contained in our charter, we do not expect to be classified as a "pension-held
REIT."

Taxation of Non-United States Stockholders

The rules governing federal income taxation of "non-United States
stockholders" are complex and no attempt will be made herein to provide more
than a summary of these rules. "Non-United States stockholders" mean
beneficial owners of shares of our stock that are not United States
stockholders (as such term is defined in the discussion above under the
heading entitled "Taxation of Taxable United States Stockholders").

PROSPECTIVE NON-UNITED STATES STOCKHOLDERS SHOULD CONSULT THEIR TAX ADVISORS
TO DETERMINE THE IMPACT OF FOREIGN, FEDERAL, STATE, AND LOCAL INCOME TAX LAWS
WITH REGARD TO AN INVESTMENT IN OUR STOCK AND OF OUR ELECTION TO BE TAXED AS A
REAL ESTATE INVESTMENT TRUST, INCLUDING ANY REPORTING REQUIREMENTS.

Distributions to non-United States stockholders that are not attributable to
gain from our sale or exchange of United States real property interests and
that are not designated by us as capital gain dividends or retained capital
gains will be treated as dividends of ordinary income to the extent that they
are made out of our current or accumulated earnings and profits. These
distributions will generally be subject to a withholding tax equal to 30% of
the distribution unless an applicable tax treaty reduces or eliminates that
tax. However, if income from an investment in our stock is treated as
effectively connected with the non-United States stockholder's conduct of a
United States trade or business, the non-United States stockholder generally
will be subject to federal income tax at graduated rates in the same manner as
United States stockholders are taxed with respect to those distributions, and
also may be subject to the 30% branch profits tax in the case of a non-United
States stockholder that is a corporation. We expect to withhold tax at the
rate of 30% on the gross amount of any distributions made to a non-United
States stockholder unless:

. a lower treaty rate applies and any required form, for example IRS Form
W-8BEN, evidencing eligibility for that reduced rate is filed by the
non-United States stockholder with us; or

. the non-United States stockholder files an IRS Form W-8ECI with us
claiming that the distribution is effectively connected income.

Any portion of the dividends paid to non-United States stockholders that is
treated as excess inclusion income will not be eligible for exemption from the
30% withholding tax or a reduced treaty rate.

Distributions in excess of our current and accumulated earnings and profits
will not be taxable to non-United States stockholders to the extent that these
distributions do not exceed the adjusted basis of the stockholder's stock, but
rather will reduce the adjusted basis of that stock. To the extent that
distributions in excess of current and accumulated earnings and profits exceed
the adjusted basis of a non-United States stockholder's stock, these
distributions will give rise to tax liability if the non-United States
stockholder would otherwise be subject to tax on any gain from the sale or
disposition of its stock, as described below. Because it generally cannot be
determined at the time a distribution is made whether or not such distribution
may be in excess of current and accumulated earnings and profits, the entire
amount of any distribution normally will be subject to withholding at the same
rate as a dividend. However, amounts so withheld are creditable against United
States tax liability, if any, or refundable by the IRS to the extent the
distribution is subsequently determined to be in excess of our current and
accumulated earnings and profits. We are also required to withhold 10% of any
distribution in excess of our current and accumulated earnings and profits if
our stock is a United States real property interest because we are not a
domestically controlled REIT, as discussed below. Consequently, although we
intend to withhold at a rate of 30% on the entire amount of any distribution,
to the extent that we do not do so, any portion of a distribution not subject
to withholding at a rate of 30% may be subject to withholding at a rate of
10%.

Distributions attributable to our capital gains which are not attributable
to gain from the sale or exchange of a United States real property interest
generally will not be subject to income taxation, unless (1) investment in our
stock is effectively connected with the non-United States stockholder's U.S.
trade or business (or, if an income tax treaty applies, is attributable to a
U.S. permanent establishment of the non-United States stockholder), in which
case the non-United States stockholder will be subject to the same treatment
as United States stockholders with respect to such gain (except that a
corporate non-United States stockholder may also be subject to the 30% branch
profits tax), or (2) the non-United States stockholder is a non-resident alien
individual who is present in the United States for 183 days or more during the
taxable year and certain other conditions are satisfied, in which case the
non-resident alien individual will be subject to a 30% tax on the individual's
capital gains.

For any year in which we qualify as a REIT, distributions that are
attributable to gain from the sale or exchange of a United States real
property interest, which includes some interests in real property, but
generally does not include an interest solely as a creditor in mortgage loans
or mortgage-backed securities, will be taxed to a non-United States
stockholder under the provisions of the Foreign Investment in Real Property
Tax Act of 1980, or FIRPTA. Under FIRPTA, distributions attributable to gain
from sales of United States real property interests are taxed to a non-United
States stockholder as if that gain were effectively connected with the
stockholder's conduct of a United States trade or business. Non-United States
stockholders thus would be taxed at the normal capital gain rates applicable
to stockholders, subject to applicable alternative minimum tax and a special
alternative minimum tax in the case of nonresident alien individuals.
Distributions subject to FIRPTA also may be subject to the 30% branch profits
tax in the hands of a non-United States corporate stockholder. We are required
to withhold 35% of any distribution that we designate (or, if greater, the
amount that we could designate) as a capital gains dividend. The amount
withheld is creditable against the non-United States stockholder's FIRPTA tax
liability.

Gains recognized by a non-United States stockholder upon a sale of our stock
generally will not be taxed under FIRPTA if we are a domestically controlled
REIT, which is a REIT in which at all times during a specified testing period
less than 50% in value of the stock was held directly or indirectly by non-
United States

stockholders. Because our stock is publicly traded, we cannot assure our
investors that we are or will remain a domestically controlled REIT. Even if
we are not a domestically-controlled REIT, however, a non-United States
stockholder that owns, actually or constructively, 5% or less of our stock
throughout a specified testing period will not recognize taxable gain on the
sale of our stock under FIRPTA if the shares are traded on an established
securities market.

If gain from the sale of the stock were subject to taxation under FIRPTA,
the non-United States stockholder would be subject to the same treatment as
United States stockholders with respect to that gain, subject to applicable
alternative minimum tax, a special alternative minimum tax in the case of
nonresident alien individuals, and the possible application of the 30% branch
profits tax in the case of non-United States corporations. In addition, the
purchaser of the stock could be required to withhold 10% of the purchase price
and remit such amount to the IRS.

Gains not subject to FIRPTA will be taxable to a non-United States
stockholder if:

. the non-United States stockholder's investment in the stock is
effectively connected with a trade or business in the United States, in
which case the non-United States stockholder will be subject to the same
treatment as United States stockholders with respect to that gain; or

. the non-United States stockholder is a nonresident alien individual who
was present in the United States for 183 days or more during the taxable
year and other conditions are met, in which case the nonresident alien
individual will be subject to a 30% tax on the individual's capital
gains.

Information Reporting and Backup Withholding

If the proceeds of a disposition of our stock are paid by or through a U.S.
office of a broker-dealer, the payment is generally subject to information
reporting and to backup withholding (currently at a rate of 30%, subject to
reduction in years after 2003) unless the disposing non-United States
stockholder certifies as to his name, address and non-U.S. status or otherwise
establishes an exemption. Generally, U.S. information reporting and backup
withholding will not apply to a payment of disposition proceeds if the payment
is made outside the U.S. through a foreign office of a foreign broker-dealer.
If the proceeds from a disposition of our stock are paid to or through a
foreign office of a U.S. broker-dealer or a non-U.S. office of a foreign
broker-dealer that is (i) a "controlled foreign corporation" for federal
income tax purposes, (ii) a foreign person 50% or more of whose gross income
from all sources for a three-year period was effectively connected with a U.S.
trade or business, (iii) a foreign partnership with one or more partners who
are U.S. persons and who in the aggregate hold more than 50% of the income or
capital interest in the partnership, or (iv) a foreign partnership engaged in
the conduct of a trade or business in the United States, then (i) backup
withholding will not apply unless the broker-dealer has actual knowledge that
the owner is not a foreign stockholder, and (ii) information reporting will
not apply if the non-United States stockholder satisfies certification
requirements regarding its status as a foreign stockholder.

State, Local and Foreign Taxation

We may be required to pay state, local and foreign taxes in various state,
local and foreign jurisdictions, including those in which we transact business
or make investments, and our stockholders may be required to pay state, local
and foreign taxes in various state, local and foreign jurisdictions, including
those in which they reside. Our state, local and foreign tax treatment may not
conform to the federal income tax consequences summarized above. In addition,
a stockholder's state, local and foreign tax treatment may not conform to the
federal income tax consequences summarized above. Consequently, prospective
investors should consult their tax advisors regarding the effect of state,
local and foreign tax laws on an investment in our stock.

Item 2. PROPERTY

Our office space is provided by our manager, Anworth Mortgage Advisory
Corporation. The office of the manager is located at 1299 Ocean Avenue, Second
Floor, Santa Monica, California.

Item 3. LEGAL PROCEEDINGS

We are not a party to any material pending legal proceedings.

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

No matters were submitted to a vote of security holders during the quarter
ended December 31, 2001.

PART II

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

Market Information

Our common stock began trading under the symbol ANH on the American Stock
Exchange on March 17, 1998. Preceding March 17, 1998, there had been no public
market for our common stock. The high and low sale prices for our common stock
as reported by the American Stock Exchange for the periods indicated are as
follows:

2000 2001
----------- -----------
High Low High Low
----- ----- ----- -----

First Quarter........................................ $4.69 $4.00 $5.35 $3.94
Second Quarter....................................... $4.50 $4.13 $6.90 $4.60
Third Quarter........................................ $5.06 $4.13 $8.08 $6.35
Fourth Quarter....................................... $5.00 $3.88 $9.85 $6.60

Holders

As of March 11, 2002 there were approximately 56 record holders of Anworth's
common stock. On March 12, 2002 the last reported sale price of the common
stock on the American Stock Exchange was $9.55 per share.

Recent Sales of Unregistered Securities

On December 27, 2001, we completed the sale of 500,000 unregistered shares
of our common stock. The securities were purchased by FBR Asset Investment
Corporation in a private placement exempted from registration by Section 4(2)
of the Securities Act of 1933, as amended. We received approximately $3.89
million in net proceeds after deducting expenses of the placement. The
securities were subsequently registered for future resale on a registration
statement on Form S-3, filed with the Securities and Exchange Commission on
January 30, 2002.

Dividends

We pay cash dividends on a quarterly basis. The following table lists the
cash dividends declared on each share of our common stock for our most recent
two fiscal years. The dividends listed below were based primarily on the board
of directors' evaluation of earnings for each listed quarter and were declared
on the date indicated.

Cash
Dividends Date Dividend
Per Share Declared
--------- -----------------

2000
First Quarter ended March 31, 2000............ $0.15 March 21, 2000
Second Quarter ended June 30, 2000............ $0.15 June 21, 2000
Third Quarter ended September 30, 2000(1)..... $0.10 October 13, 2000
Fourth Quarter ended December 31, 2000........ $0.11 January 19, 2001

2001
First Quarter ended March 31, 2001............ $0.20 April 20, 2001
Second Quarter ended June 30, 2001............ $0.24 July 23, 2001
Third Quarter ended September 30, 2001(2)..... $0.54 October 15, 2001
Fourth Quarter ended December 31, 2001(3)..... $0.25 October 15, 2001
Fourth Quarter ended December 31, 2001(4)..... $0.30 December 17, 2001

- --------
(1) On September 26, 2000, our board of directors announced that dividends on
common stock, in the future, would generally be declared after each
quarter-end rather than during the applicable quarter.
(2) The dividend of $0.54 was based on our retained earnings as of September
30, 2001, of which $0.42 was earned in the third quarter of 2001 and the
remaining $0.12 was earned in prior quarters.
(3) On October 15, 2001, our board of directors declared a dividend of $0.25,
paid on January 15, 2002, for purposes of year-end REIT compliance
requirements.
(4) The dividend of $0.30 was paid on January 22, 2002 to holders of record
as of the close of business on December 20, 2001.

Item 6. SELECTED FINANCIAL DATA

The selected financial data as of December 31, 2001, 2000 and 1999 and the
three years in the period ended December 31, 2001 are derived from our audited
financial statements incorporated by reference and included in this Form 10-K.
The selected financial data as of December 31, 1998 and for the period from
commencement of operations on March 17, 1998 to December 31, 1998 are derived
from audited financial statements not included in this Form 10-K. You should
read these selected financial data together with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our audited and
unaudited financial statements and notes thereto that are included in this
Form 10-K beginning on page F-1.

Period from
March 17 to Year Ended December 31,
December 31, ----------------------------
1998 1999 2000 2001
------------ -------- -------- --------

Statement of Operations Data:
Days in period..................... 290 365 366 365
Interest and dividend income....... $ 8,570 $ 9,501 $ 10,314 $ 10,768
Interest expense................... (7,378) (7,892) (8,674) (6,363)
-------- -------- -------- --------
Net interest income................ 1,192 1,609 1,640 4,405
Gain on sales...................... -- -- -- 430
Expenses........................... (307) (400) (379) (1,129)
-------- -------- -------- --------
Net income......................... $ 885 $ 1,209 $ 1,261 $ 3,706
======== ======== ======== ========
Basic net income per average
share............................. $ 0.38 $ 0.53 $ 0.54 $ 1.52
Diluted net income per average
share............................. $ 0.38 $ 0.53 $ 0.54 $ 1.50
Dividends declared per share (1)... $ 0.37 $ 0.53 $ 0.40 $ 1.64
Weighted average shares
outstanding....................... 2,316 2,290 2,331 2,467

At December 31,
-----------------------------------------
1998 1999 2000 2001
------------ -------- -------- --------

Statement of Operations Data:
Mortgage-backed securities, net.... $184,245 $161,488 $134,889 $420,214
Total assets....................... $199,458 $167,144 $141,834 $424,610
Repurchase agreements.............. $170,033 $147,690 $121,891 $325,307
Total liabilities.................. $182,216 $150,612 $123,633 $369,613
Stockholders' equity............... $ 17,242 $ 16,532 $ 18,201 $ 54,997
Number of common shares
outstanding....................... 2,328 2,307 2,350 6,951
Book value per share............... $ 7.41 $ 7.17 $ 7.75 $ 7.91

Period from
March 17 to Year Ended December 31,
December 31, ----------------------------
1998 1999 2000 2001
------------ -------- -------- --------

Other Data (unaudited):
Average earnings assets............ $181,445 $163,167 $152,289 $167,890
Average borrowings................. $165,496 $149,372 $135,631 $152,870
Average equity (2)................. $ 19,060 $ 18,931 $ 19,154 $ 20,279
Yield on interest earning assets
(3)............................... 5.94% 5.82% 6.77% 6.41%
Cost of funds on interest bearing
liabilities....................... 5.61% 5.28% 6.40% 4.16%
Annualized Financial Ratios
(unaudited) (2)(4):
Net interest margin (net interest
income/average assets)............ 0.83% 0.99% 1.08% 2.62%
G&A expenses as a percentage of
average assets (5)................ 0.21% 0.24% 0.25% 0.32%
Return on average assets (5)....... 0.61% 0.74% 0.83% 2.56%
Return on average equity........... 5.84% 6.38% 6.58% 18.28%

- --------
(1) On September 26, 2000, our board of directors announced that, beginning
with the third quarter of 2000, dividends would generally be declared
after each quarter-end rather than during the applicable quarter.
(2) Average equity excludes fair value adjustment for mortgage-backed
securities.
(3) Excludes gain on sale of $430,000 for the year ended December 31, 2001.
(4) Each ratio for 1998 has been computed by annualizing the results for the
290-day period ended December 31, 1998.
(5)Excludes incentive fees paid to our management company.

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

The following discussion should be read in conjunction with our financial
statements included elsewhere in this Form 10-K. This discussion contains
forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from those anticipated in these forward-
looking statements as a result of various factors including those set forth
under "Risk Factors" herein.

General

We were formed in October 1997 to invest primarily in mortgage-related
assets, including mortgage pass-through certificates, collateralized mortgage
obligations, mortgage loans and other securities representing interests in, or
obligations backed by, pools of mortgage loans which can be readily financed.
We commenced operations on March 17, 1998 upon the closing of our initial
public offering. Our principal business objective is to generate net income
for distribution to stockholders based upon the spread between the interest
income on our mortgage-backed securities and the costs of borrowing to finance
our acquisition of mortgage-backed securities.

Over the past year, the dramatic decline in the general level of interest
rates has had a materially positive impact on our financial results. As a
result of the interest rate reductions by the Federal Reserve Board, the one-
month treasury bill has declined from 5.37% as of December 31, 2000 to 1.68%
as of December 31, 2001. This decline has reduced the rates at which we borrow
funds to finance our portfolio holdings. Our cost of financing has declined
from 6.40% for the year ended December 31, 2000 to 4.16% for the year ended
December 31, 2001. This contrasts significantly with the much less substantial
decline of our asset yield from 6.77% for the year ended December 31, 2000 to
6.41% for the year ended December 31, 2001.

We are organized for tax purposes as a REIT. Accordingly, we generally
distribute substantially all of our earnings to stockholders without paying
federal or state income tax at the corporate level on the distributed
earnings. As of December 31, 2001, our qualified REIT assets (real estate
assets, as defined in the tax code, cash and cash items and government
securities) were greater than 90% of our total assets, as compared to the tax
code requirement that at least 75% of our total assets must be qualified REIT
assets. Greater than 99% of our 2001 revenue qualifies for both the 75% source
of income test and the 95% source of income test under the REIT rules. We
believe we met all REIT requirements regarding the ownership of our common
stock and the distributions of our net income. Therefore, we believe that we
continue to qualify as a REIT under the provisions of the tax code.

Results Of Operations

Years Ended December 31, 2001 and 2000

For the year ended December 31, 2001, our net income was $3,706,000, or
$1.50 per share diluted, based on an average of 2,466,817 shares outstanding.
Net interest income for that year totaled $4,405,000. Net interest income is
comprised of the interest income earned on mortgage investments less interest
expense from borrowings. During the year ended December 31, 2001, we incurred
general and administrative expenses of $1,129,000, consisting of operating
expense of $323,000, a base management fee of $208,000 and an incentive
management fee of $598,000.

By comparison, our net income was $1,261,000 for the year ended December 31,
2000. The increase in our profitability in 2001 over 2000 was due to the sharp
decline in the general level of interest rates, allowing us to decrease our
borrowing expense at a rate far greater than the rate at which the interest
income on our assets declined.

Our annual return on average equity was 18.28% for the year ended December
31, 2001. This return compares favorably to the 2000 figure of 6.58%.

For the year ended December 31, 2001, the yield on our average assets,
including the impact of the amortization of premiums and discounts, was 6.41%.
For 2000, this figure was 6.77%. Our weighted average cost of funds for the
year ended December 31, 2001 was 4.16% compared to 6.40% for the year ended
December 31, 2000.

During the year ended December 31, 2001, our return on common equity, as
calculated in accordance with the terms of our management agreement for the
purpose of calculating incentive fee, was 19.70%. The ten-year U.S. Treasury
rate for the corresponding period was 5.02%, which would dictate a 6.02%
hurdle rate. As a result, our management company earned an incentive fee of
$598,000 for the year ended December 31, 2001. In 2000, our management company
earned no incentive fee.

Years Ended December 31, 2000 and 1999

For the year ended December 31, 2000, our net income was $1,261,000, or
$0.54 per share (basic and diluted), based on an average of 2,330,987 shares
outstanding. Net interest income for that year totaled $1,640,000. Net
interest income is comprised of the interest income earned on mortgage
investments less interest expense from borrowings. During the year ended
December 31, 2000, we incurred general and administrative expenses of
$379,000, consisting of operating expense of $212,000, a base management fee
of $167,000 and no incentive management fee.

By comparison, our net income was $1,209,000 for the year ended December 31,
1999, our first full year of operation. The increase in our profitability in
2000 over 1999 was due to an increase in interest income, which rose faster
than interest expense due to the continued slowing of prepayment of our
mortgage assets in 2000, a trend which began in 1999. In addition, our
operating expenses decreased by $21,000.

Our annual return on average equity was 6.58% for the year ended December
31, 2000. This return compares favorably to the 1999 figure of 6.38%.

For the year ended December 31, 2000, the yield on our average assets,
including the impact of the amortization of premiums and discounts, was 6.77%.
For 1999, this figure was 5.82%. Our weighted average cost of funds for the
year ended December 31, 2000, was 6.40% compared to 5.28% for the year ended
December 31, 1999.

During the year ended December 31, 2000, our return on common equity, as
calculated in accordance with the terms of our management agreement for the
purpose of calculating incentive fee, was 6.03%. The ten-year U.S. Treasury
rate for the corresponding period was 6.03%, which would dictate a 7.03%
hurdle rate. As a result, our management company earned no incentive fee for
the year ended December 31, 2000. In 1999, our management company earned no
incentive fee.

The table below shows the components of return on average equity(1):

Net Interest G&A Net
Income/ Expense(2)/ Income(2)(3)/
Equity Equity Equity
------------ ----------- -------------

For the year ended December 31, 2001.... 21.72% 2.62% 19.10%
For the year ended December 31, 2000.... 8.56% 1.98% 6.58%
For the year ended December 31, 1999.... 8.49% 2.11% 6.38%

- --------
(1) Average equity excludes unrealized gain (loss) on available for sale
securities.
(2) Excludes incentive fees paid to our management company.
(3) Excludes gain on sales of $430,000 for the year ended December 31, 2001.

The table below shows our average balances of cash equivalents and mortgage
assets, the annualized yields earned on each type of earning assets, the yield
on average earning assets and interest income:

Yield on
Average Average
Amortized Yield on Amortized Yield on Dividend
Average Cost of Average Average Cost of Average and
Cash Mortgage Earning Cash Mortgage Earning Interest
Equivalents Assets Assets Equivalents Assets Assets Income
----------- --------- -------- ----------- --------- -------- --------
(dollars in thousands)

For the year ended
December 31, 2001...... $3,444 $164,446 $167,890 4.00% 6.46% 6.41% $10,768
For the year ended
December 31, 2000...... $2,122 $150,167 $152,289 5.88% 6.79% 6.77% $10,314
For the year ended
December 31, 1999...... $6,452 $156,715 $163,167 4.99% 5.86% 5.82% $ 9,501

The table below shows our average borrowed funds and annualized average cost
of funds as compared to average one- and average three-month LIBOR:

Average
One- Average Average
month Cost of Cost of
LIBOR Funds Funds
Relative Relative Relative
Average Average to Average to Average to Average
Average Average One- Three- Three- One- Three-
Borrowed Interest Cost of Month Month month month month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
-------- -------- ------- ------- ------- ---------- ---------- ----------
(dollars in thousands)

For the year ended Dec.
31, 2001............... $152,870 $6,363 4.16% 3.86% 3.75% 0.11 % 0.30 % 0.41 %
For the year ended Dec.
31, 2000............... $135,631 $8,674 6.40% 6.42% 6.54% (0.12)% (0.02)% (0.14)%
For the year ended Dec.
31, 1999............... $149,372 $7,892 5.28% 5.25% 5.42% (0.17)% 0.03 % (0.14)%

The following table shows operating expenses as a percent of total assets:

Management
Fee &
Other Total G&A
Expenses/ Performance Expenses/
Total Fee/Total Total
Assets Assets Assets
---------- ----------- ---------

For the year ended December 31, 2001........... 0.13% 0.14% 0.27%
For the year ended December 31, 2000........... 0.23% -- 0.23%
For the year ended December 31, 1999........... 0.24% -- 0.24%

Quarterly Results Of Operation

The following data was derived from unaudited financial information for each
of the eight quarters ending March 31, 2000 through December 31, 2001. This
data was prepared on the same basis as the audited financial statements
contained elsewhere in this Form 10-K and, in the opinion of management,
includes all adjustments necessary for the fair presentation of the
information for the periods presented. This information should be read in
conjunction with the financial statements and notes thereto. The operating
results in any quarter are not necessarily indicative of the results that may
be expected for any future period.

For the Three Months Ended
------------------------------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
2000 2000 2000 2000 2001 2001 2001 2001
--------- -------- --------- -------- --------- -------- --------- --------
(in thousands)

Statement of Operations
Data:
Interest and dividend
income................. $ 2,627 $ 2,646 $ 2,549 $ 2,493 $ 2,556 $ 2,518 $ 2,564 $ 3,130
Interest expense........ (2,132) (2,181) (2,241) (2,120) (1,921) (1,650) (1,403) (1,389)
------- ------- ------- ------- ------- ------- ------- -------
Net interest income..... 495 465 308 373 635 868 1,161 1,741
Gain on sales........... -- -- -- -- 71 81 166 113
Expenses................ (101) (97) (99) (83) (162) (255) (303) (410)
------- ------- ------- ------- ------- ------- ------- -------
Net Income.............. $ 394 $ 368 $ 209 $ 290 $ 544 $ 694 $ 1,024 $ 1,444
======= ======= ======= ======= ======= ======= ======= =======
Basic earnings per
share.................. $ 0.17 $ 0.16 $ 0.09 $ 0.12 $ 0.23 $ 0.29 $ 0.43 $ 0.54
Diluted earnings per
share.................. $ 0.17 $ 0.16 $ 0.09 $ 0.12 $ 0.23 $ 0.29 $ 0.42 $ 0.53
Dividends per share..... $ 0.15 $ 0.15 $ 0.10 $ 0.11 $ 0.20 $ 0.24 $ 0.54 $ 0.55
Weighted average common
shares outstanding
(diluted).............. 2,314 2,326 2,338 2,346 2,354 2,368 2,423 2,725

Financial Condition

At December 31, 2001, we held total assets of $425 million, consisting
primarily of $351 million of adjustable-rate mortgage-backed securities, $69
million of fixed-rate mortgage-backed securities and $1.8 million of preferred
stock issued by REITs. This balance sheet size represents an approximate 202%
increase over our balance sheet size at December 31, 2000. At December 31,
2001, we were well within our asset allocation guidelines, with 99% of total
assets consisting of mortgage-backed securities guaranteed by an agency of the
United States government such as Fannie Mae or Freddie Mac. Of the adjustable-
rate mortgage-backed securities owned by us, 75% were adjustable-rate pass-
through certificates that reset at least once a year. The remaining 25% were
3/1 and 5/1 hybrid adjustable-rate mortgage-backed securities. Hybrid
adjustable-rate mortgage-backed securities have an initial interest rate that
is fixed for a certain period, usually three to five years, and then adjust
annually for the remainder of the term of the loan.

The following table presents a schedule of mortgage-backed securities owned
at December 31, 2001 and December 31, 2000, classified by type of issuer:

At December 31, 2001 At December 31, 2000
-------------------- --------------------
Fair Portfolio Fair Portfolio
Agency Value Percentage Value Percentage
- ------ --------- ---------- --------- ----------
(dollar amounts in thousands)

FNMA.................................. $ 280,855 66.8% $ 110,415 81.8%
FHLMC................................. 139,359 33.2% 23,957 17.8%
Private Placement..................... -- -- % 517 0.4%
--------- ------ --------- ------
Total Portfolio..................... $ 420,214 100.0% $ 134,889 100.0%

The following table classifies our portfolio of mortgage-backed securities
owned at December 31, 2001 and December 31, 2000, by type of interest rate
index: (With respect to our hybrid ARMs, the fair value of these securities
appears on the line associated with the index based on which the security will
eventually reset, once the initial fixed interest rate period has expired.)

December 31, 2001 December 31, 2000
------------------- --------------------
Fair Portfolio Fair Portfolio
Index Value Percentage Value Percentage
- ----- -------- ---------- --------- ----------
(dollar amounts in thousands)

One-month LIBOR....................... $ 9,998 2.4% $ 1,249 0.9%
Six-month LIBOR....................... 4,218 1.0% 7,332 5.4%
One-year LIBOR........................ 39,689 9.5% -- -- %
Six-month Certificate of Deposit...... 2,059 0.5% 3,692 2.7%
One-year Constant Maturity Treasury... 291,606 69.3% 97,491 72.3%
Cost of Funds Index................... 3,895 0.9% 4,713 3.5%
Fixed rate............................ 68,749 16.4% 20,412 15.2%
-------- ------ --------- ------
Total Portfolio..................... $420,214 100.0% $ 134,889 100.0%

Our mortgage-backed securities portfolio had a weighted average coupon of
6.44% at December 31, 2001. The weighted average one-month constant prepayment
rates of our mortgage-backed securities portfolio were 17%, 30% and 34%,
respectively, for the months of October, November and December 2001. At
December 31, 2001, the unamortized net premium paid for our mortgage-backed
securities was $8.5 million.

We analyze our mortgage-backed securities and the extent to which
prepayments impact the yield of the securities. When actual prepayments exceed
expectations, we amortize the premiums paid on mortgage assets over a shorter
time period, resulting in a reduced yield to maturity on our mortgage assets.
Conversely, if actual prepayments are less than the assumed constant
prepayment rate, the premium would be amortized over a longer time period,
resulting in a higher yield to maturity. We monitor our prepayment
expectations versus our actual prepayment experience on a monthly basis in
order to adjust the amortization of the net premium.

As of December 31, 2001, the fair value of our portfolio of mortgage-related
assets classified as available for sale was $0.71 million, or 0.17%, greater
than the amortized cost of our portfolio.

Hedging

We have not entered into any hedging agreements to date. As part of our
asset/liability management policy, we may enter into hedging agreements such
as interest rate caps, floors or swaps. These agreements would be entered into
to try to reduce interest rate risk and would be designed to provide us with
income and capital appreciation in the event of certain changes in interest
rates. We review the need for hedging agreements on a regular basis consistent
with our capital investment policy.

Liquidity And Capital Resources

Our primary source of funds consists of repurchase agreements, which totaled
$325 million at December 31, 2001. Our other significant source of funds for
the year ended December 31, 2001 consisted of payments of principal and
interest from our mortgage securities portfolio in the amount of $51.7
million. As of December 31, 2001, we had raised approximately $0.8 million in
capital under our dividend reinvestment and direct stock purchase plan,
$491,000 of which was raised in 2001.

In the future, we expect that our primary sources of funds will consist of
borrowed funds under repurchase agreement transactions with one- to twelve-
month maturities and of monthly payments of principal and interest on our
mortgage-backed securities portfolio. Our liquid assets generally consist of
unpledged mortgage-backed securities, cash and cash equivalents.

Our borrowings had a weighted average interest cost during the year ended
December 31, 2001 of 4.16% compared with 6.40% for the year ended December 31,
2000. As of December 31, 2001, all of our repurchase agreements were fixed-
rate term repurchase agreements with original maturities ranging from three to
eighteen months. On December 31, 2001, we had borrowing arrangements with
eleven different financial institutions and had borrowed funds under
repurchase agreements with eight of these firms. Because we borrow money based
on the fair value of our mortgage-backed securities and because increases in
short-term interest rates can negatively impact the valuation of mortgage-
backed securities, our borrowing ability could be limited and lenders may
initiate margin calls in the event short-term interest rates increase or the
value of our mortgage-backed securities declines for other reasons. During the
year ended December 31, 2001, we had adequate cash flow, liquid assets and
unpledged collateral with which to meet our margin requirements during the
period.

From time to time, we raise additional equity dependent upon market
conditions and other factors. In that regard, we completed a public offering
and a private placement on December 27, 2001 that raised approximately $34.6
million in combined net proceeds, and we completed a public offering on
February 28, 2002 that raised approximately $40 million in net proceeds.

Stockholders' Equity

We use available for sale treatment for our mortgage-backed securities.
These assets are carried on the balance sheet at fair value rather than
historical amortized cost. Based upon such available for sale treatment, our
equity base at December 31, 2001 was $54.0 million, or $7.91 per share.

With our available for sale accounting treatment, unrealized fluctuations in
fair values of assets do not impact GAAP income or taxable income but rather
are reflected on the balance sheet by changing the carrying value of the asset
and reflecting the change in stockholders' equity under "Accumulated other
comprehensive income, unrealized gain (loss) on available for sale
securities."

As a result of this mark-to-market accounting treatment, our book value and
book value per share are likely to fluctuate far more than if we used
historical amortized cost accounting. As a result, comparisons with companies
that use historical cost accounting for some or all of their balance sheet may
not be meaningful.

Unrealized changes in the fair value of mortgage-backed securities have one
significant and direct effect on our potential earnings and dividends:
positive mark-to-market changes will increase our equity base and allow

us to increase our borrowing capacity while negative changes will tend to
limit borrowing capacity under our capital investment policy. A very large
negative change in the net market value of our mortgage-backed securities
might reduce our liquidity, requiring us to sell assets with the likely result
of realized losses upon sale. "Accumulated other comprehensive income,
unrealized gain (loss) on available for sale securities" was $0.71 million, or
0.17% of the amortized cost of mortgage-backed securities at December 31,
2001.

RISK FACTORS

Risks Related to Our Business

Interest rate mismatches between our adjustable-rate mortgage-backed
securities and our borrowings used to fund our purchases of the assets may
reduce our income during periods of changing interest rates.

We fund most of our acquisitions of adjustable-rate mortgage-backed
securities with borrowings that have interest rates based on indices and
repricing terms similar to, but of shorter maturities than, the interest rate
indices and repricing terms of our mortgage-backed securities. Accordingly, if
short-term interest rates increase, this may adversely affect our
profitability.

Most of the mortgage-backed securities we acquire are adjustable-rate
securities. This means that their interest rates may vary over time based upon
changes in a short-term interest rate index. Therefore, in most cases the
interest rate indices and repricing terms of the mortgage-backed securities
that we acquire and their funding sources will not be identical, thereby
creating an interest rate mismatch between assets and liabilities. While the
historical spread between relevant short-term interest rate indices has been
relatively stable, there have been periods when the spread between these
indices was volatile. During periods of changing interest rates, these
mismatches could reduce our net income, dividend yield and the market price of
our common stock.

The interest rates on our borrowings generally adjust more frequently than
the interest rates on our adjustable-rate mortgage-backed securities. For
example, on December 31, 2001, our adjustable-rate mortgage-backed securities
had a weighted average term to next rate adjustment of approximately 16
months, while our borrowings had a weighted average term to next rate
adjustment of 179 days. Accordingly, in a period of rising interest rates, we
could experience a decrease in net income or a net loss because the interest
rates on our borrowings adjust faster than the interest rates on our
adjustable-rate mortgage-backed securities.

We may experience reduced net interest income from holding fixed-rate
investments during periods of rising interest rates.

We generally fund our acquisition of fixed-rate mortgage-backed securities
with short-term borrowings. During periods of rising interest rates, our costs
associated with borrowings used to fund acquisition of fixed-rate assets are
subject to increases while the income we earn from these assets remains
substantially fixed. This reduces the net interest spread between the fixed-
rate mortgage-backed securities that we purchase and our borrowings used to
purchase them, which could lower our net interest income or cause us to suffer
a loss. On December 31, 2001, 16.4% of our mortgaged-backed securities were
fixed-rate securities.

Increased levels of prepayments from mortgage-backed securities may decrease
our net interest income.

Pools of mortgage loans underlie the mortgage-backed securities that we
acquire. We generally receive payments from the payments that are made on
these underlying mortgage loans. When borrowers prepay their mortgage loans
faster than expected, this results in prepayments that are faster than
expected on the mortgage-backed securities. Faster than expected prepayments
could adversely affect our profitability, including in the following ways:

. We often purchase mortgage-backed securities that have a higher interest
rate than the market interest rate at the time. In exchange for this
higher interest rate, we must pay a premium over the market value to
acquire the security. In accordance with accounting rules, we amortize
this premium over the term of the mortgage-backed security. If the
mortgage-backed security is prepaid in whole or in part prior to its
maturity date, however, we must expense the premium that was prepaid at
the time of the prepayment. On December 31, 2001, approximately 87.0% of
our mortgage-backed securities were acquired at a premium.

. We anticipate that a substantial portion of our adjustable-rate
mortgage-backed securities may bear interest rates that are lower than
their fully indexed rates, which are equivalent to the applicable index
rate plus a margin. If an adjustable-rate mortgage-backed security is
prepaid prior to or soon after the

time of adjustment to a fully indexed rate, we will have held that
mortgage-backed security while it was less profitable and lost the
opportunity to receive interest at the fully indexed rate over the
remainder of its expected life.

. If we are unable to acquire new mortgage-backed securities to replace
the prepaid mortgage-backed securities, our financial condition, results
of operation and cash flow would suffer.

Prepayment rates generally increase when interest rates fall and decrease
when interest rates rise, but changes in prepayment rates are difficult to
predict. Prepayment rates also may be affected by conditions in the housing
and financial markets, general economic conditions and the relative interest
rates on fixed-rate and adjustable-rate mortgage loans.

While we seek to minimize prepayment risk to the extent practical, in
selecting investments we must balance prepayment risk against other risks and
the potential returns of each investment. No strategy can completely insulate
us from prepayment risk.

We may incur increased borrowing costs related to repurchase agreements and
that would adversely affect our profitability.

Currently, all of our borrowings are collateralized borrowings in the form
of repurchase agreements. If the interest rates on these repurchase agreements
increase, that would adversely affect our profitability.

Our borrowing costs under repurchase agreements generally correspond to
short-term interest rates such as LIBOR or a short-term Treasury index, plus
or minus a margin. The margins on these borrowings over or under short-term
interest rates may vary depending upon:

. the movement of interest rates;

. the availability of financing in the market; and

. the value and liquidity of our mortgage-backed securities.

Interest rate caps on our adjustable-rate mortgage-backed securities may
reduce our income or cause us to suffer a loss during periods of rising
interest rates.

Our adjustable-rate mortgage-backed securities are typically subject to
periodic and lifetime interest rate caps. Periodic interest rate caps limit
the amount an interest rate can increase during any given period. Lifetime
interest rate caps limit the amount an interest rate can increase through
maturity of a mortgage-backed security. Our borrowings are not subject to
similar restrictions. Accordingly, in a period of rapidly increasing interest
rates, the interest rates paid on our borrowings could increase without
limitation while caps would limit the interest rates on our adjustable-rate
mortgage-backed securities. This problem is magnified for our adjustable-rate
mortgage-backed securities that are not fully indexed. Further, some
adjustable-rate mortgage-backed securities may be subject to periodic payment
caps that result in a portion of the interest being deferred and added to the
principal outstanding. As a result, we could receive less cash income on
adjustable-rate mortgage-backed securities than we need to pay interest on our
related borrowings. On December 31, 2001, approximately 83.6% of our mortgage-
backed securities were adjustable-rate securities. These factors could lower
our net interest income or cause us to suffer a net loss during periods of
rising interest rates.

Our leveraging strategy increases the risks of our operations.

We generally borrow between eight and twelve times the amount of our equity,
although our borrowings may at times be above or below this amount. We incur
this leverage by borrowing against a substantial portion of the market value
of our mortgage-backed securities. Use of leverage can enhance our investment
returns. However, leverage also increases risks. In the following ways, the
use of leverage increases our risk of loss and may reduce our net income by
increasing the risks associated with other risk factors, including a decline
in the market value of our mortgage-backed securities or a default of a
mortgage-related asset:

. The use of leverage increases our risk of loss resulting from various
factors, including rising interest rates, increased interest rate
volatility, downturns in the economy, reductions in the availability of
financing or deteriorations in the conditions of any of our mortgage-
related assets.

. A majority of our borrowings are secured by our mortgage-backed
securities, generally under repurchase agreements. A decline in the
market value of the mortgage-backed securities used to secure these debt
obligations could limit our ability to borrow or result in lenders
requiring us to pledge additional collateral to secure our borrowings.
In that situation, we could be required to sell mortgage-backed
securities under adverse market conditions in order to obtain the
additional collateral required by the lender. If these sales are made at
prices lower than the carrying value of the mortgage-backed securities,
we would experience losses.

. A default of a mortgage-related asset that constitutes collateral for a
loan could also result in an involuntary liquidation of the mortgage-
related asset, including any cross-collateralized mortgage-backed
securities. This would result in a loss to us of the difference between
the value of the mortgage-related asset upon liquidation and the amount
borrowed against the mortgage-related asset.

. To the extent we are compelled to liquidate qualified REIT assets to
repay debts, our compliance with the REIT rules regarding our assets and
our sources of income could be negatively affected, which would
jeopardize our status as a REIT. Losing our REIT status would cause us
to lose tax advantages applicable to REITs and may decrease our overall
profitability and distributions to our stockholders.

We have not used derivatives to mitigate our interest rate and prepayment
risks and this leaves us exposed to certain risks.

Our policies permit us to enter into interest rate swaps, caps and floors
and other derivative transactions to help us reduce our interest rate and
prepayment risks described above. However, so far we have determined that the
costs of these transactions outweigh their benefits. This strategy saves us
the additional costs of such hedging transactions, but it leaves us exposed to
the types of risks that such hedging transactions would be designed to reduce.
If we decide to enter into derivative transactions in the future, these
transactions may mitigate our interest rate and prepayment risks but cannot
eliminate these risks. Additionally, the use of derivative transactions could
have a negative impact on our earnings.

An increase in interest rates may adversely affect our book value.

Increases in interest rates may negatively affect the market value of our
mortgage-related assets. Our fixed-rate securities are generally more
negatively affected by these increases. In accordance with accounting rules,
we reduce our book value by the amount of any decrease in the market value of
our mortgage-related assets.

We may invest in leveraged mortgage derivative securities that generally
experience greater volatility in market prices, thus exposing us to greater
risk with respect to their rate of return.

We may acquire leveraged mortgage derivative securities that may expose us
to a high level of interest rate risk. The characteristics of leveraged
mortgage derivative securities result in greater volatility in their market
prices. Thus, acquisition of leveraged mortgage derivative securities would
expose us to the risk of greater volatility in our portfolio and that could
adversely affect our net income and overall profitability.

We depend on borrowings to purchase mortgage-related assets and reach our
desired amount of leverage. If we fail to obtain or renew sufficient funding
on favorable terms, we will be limited in our ability to acquire mortgage-
related assets and our earnings and profitability could decline.

We depend on short-term borrowings to fund acquisitions of mortgage-related
assets and reach our desired amount of leverage. Accordingly, our ability to
achieve our investment and leverage objectives depends on our ability to
borrow money in sufficient amounts and on favorable terms. In addition, we
must be able to renew or replace our maturing short-term borrowings on a
continuous basis. Moreover, we depend on a few lenders to provide the primary
credit facilities for our purchases of mortgage-related assets.

If we cannot renew or replace maturing borrowings, we may have to sell our
mortgage-related assets under adverse market conditions and may incur
permanent capital losses as a result. Any number of these factors in
combination may cause difficulties for us, including a possible liquidation of
a major portion of our portfolio at disadvantageous prices with consequent
losses, which may render us insolvent.

Possible market developments could cause our lenders to require us to pledge
additional assets as collateral. If our assets are insufficient to meet the
collateral requirements, then we may be compelled to liquidate particular
assets at an inopportune time.

Possible market developments, including a sharp rise in interest rates, a
change in prepayment rates or increasing market concern about the value or
liquidity of one or more types of mortgage-related assets in which our
portfolio is concentrated, may reduce the market value of our portfolio, which
may cause our lenders to require additional collateral. This requirement for
additional collateral may compel us to liquidate our assets at a
disadvantageous time, thus adversely affecting our operating results and net
profitability.

Our use of repurchase agreements to borrow funds may give our lenders greater
rights in the event that either we or a lender files for bankruptcy.

Our borrowings under repurchase agreements may qualify for special treatment
under the bankruptcy code, giving our lenders the ability to avoid the
automatic stay provisions of the bankruptcy code and to take possession of and
liquidate our collateral under the repurchase agreements without delay in the
event that we file for bankruptcy. Furthermore, the special treatment of
repurchase agreements under the bankruptcy code may make it difficult for us
to recover our pledged assets in the event that a lender files for bankruptcy.
Thus, the use of repurchase agreements exposes our pledged assets to risk in
the event of a bankruptcy filing by either a lender or us.

Because assets we acquire may experience periods of illiquidity, we may lose
profits or be prevented from earning capital gains if we cannot sell mortgage-
related assets at an opportune time.

We bear the risk of being unable to dispose of our mortgage-related assets
at advantageous times or in a timely manner because mortgage-related assets
generally experience periods of illiquidity. The lack of liquidity may result
from the absence of a willing buyer or an established market for these assets,
as well as legal or contractual restrictions on resale. As a result, the
illiquidity of mortgage-related assets may cause us to lose profits or the
ability to earn capital gains.

We depend on our key personnel and the loss of any of our key personnel could
severely and detrimentally affect our operations.

We depend on the diligence, experience and skill of our officers and the
people working on behalf of our management company for the selection,
structuring and monitoring of our mortgage-related assets and associated
borrowings. Our key officers include Lloyd McAdams, President, Chairman of our
board of directors and Chief Executive Officer, Pamela J. Watson, Chief
Financial Officer and Treasurer, Evangelos Karagiannis, Vice President and
Joseph McAdams, Vice President. We have not entered into employment agreements
with our senior officers, nor do we require the management company to employ
specific personnel or to dedicate employees solely to our business. These
individuals are free to engage in competitive activities in our industry. The
loss of any key person could harm our entire business, financial condition,
cash flow and results of operations.

Our board of directors may change our operating policies and strategies
without prior notice or stockholder approval and such changes could harm our
business, results of operation and stock price.

Our board of directors can modify or waive our current operating policies
and our strategies without prior notice and without stockholder approval. We
cannot predict the effect any changes to our current operating policies and
strategies may have on our business, operating results and stock price,
however, the effects may be adverse.

Competition may prevent us from acquiring mortgage-related assets at favorable
yields and that would negatively impact our profitability.

Our net income largely depends on our ability to acquire mortgage-related
assets at favorable spreads over our borrowing costs. In acquiring mortgage-
related assets, we compete with other REITs, investment banking firms, savings
and loan associations, banks, insurance companies, mutual funds, other lenders
and other entities that purchase mortgage-related assets, many of which have
greater financial resources than us. As a result we may not in the future be
able to acquire sufficient mortgage-related assets at favorable spreads over
our borrowing costs. If that occurs, our profitability will be harmed.

Our investment policy involves risks associated with the credit quality of our
investments. If the credit quality of our investments declines or if there are
defaults on the investments we make, our profitability may decline and we may
suffer losses.

Our mortgage-backed securities have primarily been agency certificates that,
although not rated, carry an implied "AAA" rating. Agency certificates are
mortgage-backed securities where either Freddie Mac or Fannie Mae guarantees
payments of principal or interest on the certificates. Our capital investment
policy, however, provides us with the ability to acquire a material amount of
lower credit quality mortgage-backed securities. If we acquire mortgage-backed
securities of lower credit quality, our profitability may decline and we may
incur losses if there are defaults on the mortgages backing those securities
or if the rating agencies downgrade the credit quality of those securities.

Risks Related to Our Management Company

Our management company and its affiliates may allocate mortgage-related
opportunities to other entities, and thus may divert attractive investment
opportunities away from us.

Our management company is Anworth Mortgage Advisory Corporation. Lloyd
McAdams, Joseph McAdams and Evangelos Karagiannis work on behalf of our
management company to manage our funds. Affiliates of our management company
and some of our officers manage mortgage-backed securities for other parties.
Messrs. L. McAdams, J. McAdams and Karagiannis are actively involved in
managing approximately $4 billion in mortgage-backed securities and other
fixed income assets for institutional clients and individual investors through
Pacific Income Advisers, which is under common control with our management
company. Messrs. L. McAdams, J. McAdams and Karagiannis intend to continue to
perform services for Pacific Income Advisers.

These multiple responsibilities may create conflicts of interest for these
officers if they are presented with opportunities that may benefit us and the
clients of Pacific Income Advisers. These officers allocate investments among
our portfolio and the clients of Pacific Income Advisers by determining the
entity or account for which the investment is most suitable. In making this
determination, these officers consider the investment strategy and guidelines
of each entity or account with respect to acquisition of assets, leverage,
liquidity and other factors that our officers determine appropriate. However,
our management company and those working on its behalf have no obligation to
make any specific investment opportunities available to us and the above
mentioned conflicts of interest may result in decisions or allocations of
securities that are not in our best interests.

The compensation structure for our management company creates an incentive for
our management company to increase the riskiness of our mortgage portfolio in
an attempt to increase its compensation.

In addition to its base management compensation, our management company
earns incentive compensation for each fiscal year equal to 20% of the amount
by which our return on equity each year exceeds a return based on the ten-year
United States treasury rate plus 1%. As a result, our management company
shares in our profits but not in our losses. Consequently, as our management
company evaluates different mortgage-backed securities for our investment and
other investments, there is a risk that our management company will cause us
to assume more risk than is prudent in an attempt to increase its incentive
compensation. Other key criteria related to determining appropriate
investments and investment strategies, including the preservation of capital,
may be unduly ignored at the expense of our management company's emphasis on
maximizing its income.

Since our management company may receive a significant fee if we terminate the
management agreement, we may not be able to economically terminate the
management agreement in the event that our management company fails to meet
our expectations.

If we terminate the management agreement, or if we decide not to renew it,
then we may have to pay a significant fee to our management company. The
actual amount of the fee is not known because the fair market value of the
management agreement cannot be determined in advance with certainty. Paying
this fee would reduce the cash available for distribution to stockholders and
may cause us to suffer a net operating loss. Consequently, we may not be able
to terminate the management agreement economically even if we are dissatisfied
with our management company's performance, or if we determine that it would be
more efficient to operate with an internal management structure.

We have recently entered into an option agreement with the stockholder of
our management company pursuant to which we have been granted an option to
acquire our management company, subject to several conditions being met,
including the negotiation of employment agreements with members of our
management, establishment of and increases to new and existing benefit plans
and extension of our services agreement with Pacific Income Advisors. Although
we have no obligation to exercise the option, as noted above, if we are
dissatisfied with the performance of our management company and desire to
terminate the management agreement, we could be forced to pay a termination
fee. Under such circumstances, it is highly unlikely we would desire to
fulfill the conditions necessary to exercise our option and, even if we
desired to do so, the termination fee relating to our management contract
could exceed the agreed-upon option price under the option agreement.
Consequently, investors in our common stock should not view our ability to
exercise the option to purchase our management company as providing any
economic advantage to us in the event we are dissatisfied with the performance
of our management company.

Because our management company may render services to other mortgage
investors, this could reduce the amount of time and effort that our management
company devotes to us and, consequently, our profitability and overall
management could suffer.

Our agreement with our management company does not restrict the right of our
management company, any persons working on its behalf or any of its affiliates
from doing business, including the rendering of advice in the purchase of
mortgage-backed securities that meet our investment criteria, with any other
person or entity. In addition to our management company's ability to do
business with any other third party, the management agreement does not specify
a minimum time period that our management company and its personnel must
devote to us. The ability of our management company to engage in these other
business activities could reduce the time and effort it spends managing us.

Prior to its association with us, our management company had not managed a
REIT.

Our management company has now managed us since our initial public offering
in March of 1998. Prior to its association with us, our management company had
not previously managed a REIT. In particular, our management company had not
managed a highly leveraged pool of mortgage assets or utilized hedging
instruments, nor did our management company have experience in complying with
the asset limitations imposed by the REIT provisions of the United States
Internal Revenue Code (referred to throughout this Form 10-K as the "tax
code"). Although our management company now has more than three years of
experience in managing our company, there can be no assurance that the
experience of our executive officers and our management company is appropriate
to our business. Further, the experience of the officers of our management
company should not be viewed as a reliable gauge of our continued success.

We may not become an internally managed REIT.

The option agreement that we entered into with our management company is
subject to several conditions, including the conditions that: (1) the
independent members of our board of directors have determined that a merger
with our management company is in the best interests of our stockholders; (2)
we have received a fairness opinion from a reputable investment banking firm
regarding the fairness of the consideration for the merger; and

(3) our stockholders have approved the merger. As a result, there cannot be
any assurance that a merger with our management company will be completed. If
a merger with our management company does not occur, we expect to continue to
operate as an externally-advised company under our existing management
agreement with our management company. This would prevent us from realizing
the possible benefits of internal management.

Our net income per share may decrease if we become internally managed.

If we become internally managed, we cannot guarantee that any anticipated
cost savings from no longer paying the base management fee to our management
company would offset the additional expenses that we would incur as an
internally managed REIT. These additional expenses would include all of the
salaries and benefits of our executive officers and the other employees that
we would need to operate as an internally managed company. In addition, we
have agreed to adopt an incentive compensation plan for key executives if we
become internally managed. Even if our earnings are not adversely affected,
our earnings per share may decrease because we would be issuing additional
shares of our common stock as merger consideration. These additional shares
would represent approximately 2.0% of the total number of shares outstanding
after the merger. If we remain externally managed, the amount of the base and
incentive management fees payable to our management company would depend on a
number of factors, including the amount of additional equity, if any, that we
are able to raise and the profitability of our business. Therefore, the exact
amount of future fees that we would pay to our management company cannot be
predicted with complete accuracy. If the expenses we assume as an internally
managed company are higher than we anticipate or the fees we would pay in the
future to our management company as an externally managed company would have
been lower than we anticipate, our net income per share may decrease as a
result of becoming internally managed.

The number of shares we issue in the merger with our management company will
not change to reflect changes in the relative value of our company and our
management company after the date the option agreement was signed.

The number of shares of our common stock that would be issued in a merger
with our management company is fixed. Therefore, it will not be reduced even
if the market price of our common stock increases after the date the option
agreement was signed. Likewise, it will not be reduced even if the value of
our management company goes down after that date. Our value may change because
of our financial results or other results of operations, changes in the
economic sector in which we operate, changes in economic conditions generally
and other factors that might affect our business, condition and prospects.

The merger with our management company may cause us to lose our REIT status
for tax purposes.

In order to maintain our status as a REIT for federal income tax purposes,
we are not permitted to have current or accumulated earnings and profits
carried over from our management company. If the IRS successfully asserts that
we acquired current or accumulated earnings and profits from our management
company and failed to distribute, during the taxable year in which the merger
occurs, all of such earnings and profits, we would lose our REIT qualification
for the year of the merger, as well as any other taxable years during which we
held such acquired earnings and profits, unless, in the year of such
determination, we make an additional distribution of the amount of earnings
and profits determined to be acquired from our management company. In order to
make such an additional distribution, we could be required to borrow funds or
sell assets even if prevailing market conditions were not generally favorable.
For any taxable year that we fail to qualify as a REIT, we would not be
entitled to a deduction for dividends paid to our stockholders in calculating
our taxable income. Consequently, our net assets and distributions to our
stockholders would be substantially reduced because of our increased tax
liability. Furthermore, to the extent that distributions have been made in
anticipation of our qualification as a REIT, we might also be required to
borrow additional funds or to liquidate certain of our investments in order to
pay the applicable tax on our income.

After a merger we would be subject to potential liability as an employer.

We do not directly employ any employees or maintain any benefit or
retirement plans. However, if we become internally managed, we expect to
directly employ the persons who are currently employees of our

management company. In addition to their salaries and other cash compensation,
we would need to establish certain health, retirement and other employee
benefit plans, and we would bear the costs of the establishment and
maintenance of these plans. As an employer, we would be subject to potential
liabilities that are commonly faced by employers, such as workers' disability
and compensation claims, potential labor disputes and other employee-related
liabilities and grievances.

Risks Related to REIT Compliance and Other Matters

If we are disqualified as a REIT, we will be subject to tax as a regular
corporation and face substantial tax liability.

We believe that since our initial public offering in 1998 we have operated
so as to qualify as a REIT under the tax code, and we intend to continue to
meet the requirements for taxation as a REIT. However, we may not remain
qualified as a REIT in the future. Qualification as a REIT involves the
application of highly technical and complex tax code provisions for which only
a limited number of judicial or administrative interpretations exist. Even a
technical or inadvertent mistake could jeopardize our REIT status.
Furthermore, Congress or the IRS might change tax laws or regulations and the
courts might issue new rulings, in each case potentially having retroactive
effect, that could make it more difficult or impossible for us to qualify as a
REIT. If we fail to qualify as a REIT in any tax year, then:

. we would be taxed as a regular domestic corporation, which, among other
things, means being unable to deduct distributions to stockholders in
computing taxable income and being subject to federal income tax on our
taxable income at regular corporate rates;

. any resulting tax liability could be substantial and would reduce the
amount of cash available for distribution to stockholders; and

. unless we were entitled to relief under applicable statutory provisions,
we would be disqualified from treatment as a REIT for the subsequent four
taxable years following the year during which we lost our qualification,
and thus, our cash available for distribution to stockholders would be
reduced for each of the years during which we do not qualify as a REIT.

Even if we remain qualified as a REIT, we may face other tax liabilities that
reduce our cash flow.

Even if we remain qualified for taxation as a REIT, we may be subject to
certain federal, state and local taxes on our income and property. Any of
these taxes would decrease cash available for distribution to our
stockholders.

Complying with REIT requirements may cause us to forego otherwise attractive
opportunities.

In order to qualify as a REIT for federal income tax purposes, we must
continually satisfy tests concerning, among other things, our sources of
income, the nature and diversification of our mortgage-backed securities, the
amounts we distribute to our stockholders and the ownership of our stock. We
may also be required to make distributions to stockholders at disadvantageous
times or when we do not have funds readily available for distribution. Thus,
compliance with REIT requirements may hinder our ability to operate solely on
the basis of maximizing profits.

Complying with REIT requirements may limit our ability to hedge effectively.

The REIT provisions of the tax code may substantially limit our ability to
hedge mortgage-backed securities and related borrowings by requiring us to
limit our income in each year from qualified hedges, together with any other
income not generated from qualified REIT real estate assets, to less than 25%
of our gross income. In addition, we must limit our aggregate income from
hedging and services from all sources, other than from qualified REIT real
estate assets or qualified hedges, to less than 5% of our annual gross income.
As a result, although we do not currently engage in hedging transactions, we
may in the future have to limit our use of advantageous hedging techniques.
This could result in greater risks associated with changes in interest rates
than we would otherwise want to incur. If we were to violate the 25% or 5%
limitations, we may have to pay a penalty

tax equal to the amount of income in excess of those limitations, multiplied
by a fraction intended to reflect our profitability. If we fail to satisfy the
25% and 5% limitations, unless our failure was due to reasonable cause and not
due to willful neglect, we could lose our REIT status for federal income tax
purposes.

Complying with REIT requirements may force us to liquidate otherwise
attractive investments.

In order to qualify as a REIT, we must also ensure that at the end of each
calendar quarter at least 75% of the value of our assets consists of cash,
cash items, government securities and qualified REIT real estate assets. The
remainder of our investment in securities generally cannot include more than
10% of the outstanding voting securities of any one issuer or more than 10% of
the total value of the outstanding securities of any one issuer. In addition,
in general, no more than 5% of the value of our assets can consist of the
securities of any one issuer. If we fail to comply with these requirements, we
must dispose of a portion of our assets within 30 days after the end of the
calendar quarter in order to avoid losing our REIT status and suffering
adverse tax consequences.

Complying with REIT requirements may force us to borrow to make distributions
to stockholders.

As a REIT, we must distribute 90% (95% with respect to taxable years
beginning before January 1, 2001) of our annual taxable income (subject to
certain adjustments) to our stockholders. From time to time, we may generate
taxable income greater than our net income for financial reporting purposes
from, among other things, amortization of capitalized purchase premiums, or
our taxable income may be greater than our cash flow available for
distribution to stockholders. If we do not have other funds available in these
situations, we may be unable to distribute substantially all of our taxable
income as required by the REIT provisions of the tax code. Thus, we could be
required to borrow funds, sell a portion of our mortgage-backed securities at
disadvantageous prices or find another alternative source of funds. These
alternatives could increase our costs or reduce our equity.

Failure to maintain an exemption from the Investment Company Act would
adversely affect our results of operations.

We believe that we conduct our business in a manner that allows us to avoid
being regulated as an investment company under the Investment Company Act of
1940, as amended. 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." Under the SEC's
current interpretation, qualification for this exemption generally requires us
to maintain at least 55% of our assets directly in qualifying real estate
interests. In order to constitute a qualifying real estate interest under this
55% requirement, a real estate interest must meet various criteria. If we fail
to continue to qualify for an exemption from registration as an investment
company, our ability to use leverage would be substantially reduced and we
would be unable to conduct our business as planned.

Additional Risk Factors

We have not established a minimum dividend payment level and there are no
assurances of our ability to pay dividends in the future.

We intend to pay quarterly dividends and to make distributions to our
stockholders in amounts such that all or substantially all of our taxable
income in each year, subject to certain adjustments, is distributed. This,
along with other factors, should enable us to qualify for the tax benefits
accorded to a REIT under the tax code. We have not established a minimum
dividend payment level and our ability to pay dividends may be adversely
affected by the risk factors described in this Form 10-K. All distributions
will be made at the discretion of our board of directors and will depend on
our earnings, our financial condition, maintenance of our REIT status and such
other factors as our board of directors may deem relevant from time to time.
There are no assurances of our ability to pay dividends in the future.

We intend to seek to raise additional capital from time to time if we
determine that it is in our best interests and the best interests of our
stockholders. If we raise additional capital, our earnings per share and
dividend may decline since we may not be able to invest all of the new capital
during the quarter in which additional shares are sold and possibly the entire
following calendar quarter.

We may incur excess inclusion income that would increase the tax liability of
our stockholders.

In general, dividend income that a tax-exempt entity receives from us should
not constitute unrelated business taxable income as defined in Section 512 of
the tax code. If we realize excess inclusion income and allocate it to
stockholders, this income cannot be offset by net operating losses. If the
stockholder is a tax-exempt entity, then this income would be fully taxable as
unrelated business taxable income under Section 512 of the tax code. If the
stockholder is foreign, then it would be subject to federal income tax
withholding on this income without reduction pursuant to any otherwise
applicable income-tax treaty.

Excess inclusion income could result if we held a residual interest in a
REMIC. Excess inclusion income also would be generated if we were to issue
debt obligations with two or more maturities and the terms of the payments on
these obligations bore a relationship to the payments that we received on our
mortgage-backed securities securing those debt obligations. We generally
structure our borrowing arrangements in a manner designed to avoid generating
significant amounts of excess inclusion income. We do, however, enter into
various repurchase agreements that have differing maturity dates and afford
the lender the right to sell any pledged mortgage securities if we default on
our obligations. The IRS may determine that these borrowings give rise to
excess inclusion income that should be allocated among stockholders.
Furthermore, some types of tax-exempt entities, including, without limitation,
voluntary employee benefit associations and entities that have borrowed funds
to acquire their shares of our common stock, may be required to treat a
portion of or all of the dividends they may receive from us as unrelated
business taxable income. We also invest in equity securities of other REITs.
If we were to receive excess inclusion income from another REIT, we may be
required to distribute the excess inclusion income to our shareholders, which
may result in the recognition of unrelated business taxable income.

Our charter does not permit ownership of over 9.8% of our common or preferred
stock and attempts to acquire our common or preferred stock in excess of the
9.8% limit are void without prior approval from our board of directors.

For the purpose of preserving our REIT qualification and for other reasons,
our charter prohibits direct or constructive ownership by any person of more
than 9.8% of the lesser of the total number or value of the outstanding shares
of our common stock or more than 9.8% of the outstanding shares of our
preferred stock. Our charter's constructive ownership rules are complex and
may cause the outstanding stock owned by a group of related individuals or
entities to be deemed to be constructively owned by one individual or entity.
As a result, the acquisition of less than 9.8% of the outstanding stock by an
individual or entity could cause that individual or entity to own
constructively in excess of 9.8% of the outstanding stock, and thus be subject
to our charter's ownership limit. Any attempt to own or transfer shares of our
common or preferred stock in excess of the ownership limit without the consent
of the board of directors shall be void, and will result in the shares being
transferred by operation of law to a charitable trust. Our board of directors
has granted Lloyd McAdams, our Chairman and Chief Executive Officer, and his
family members an exemption from the 9.8% ownership limitation as set forth in
our charter documents. This exemption permits Mr. McAdams, Heather Baines and
Joseph E. McAdams collectively to hold up to 19% of our outstanding shares.

Because provisions contained in Maryland law, our charter and our bylaws may
have an anti-takeover effect, investors may be prevented from receiving a
"control premium" for their shares.

Provisions contained in our charter and bylaws, as well as Maryland
corporate law, may have anti-takeover effects that delay, defer or prevent a
takeover attempt, which may prevent stockholders from receiving a "control
premium" for their shares. For example, these provisions may defer or prevent
tender offers for our common stock or purchases of large blocks of our common
stock, thereby limiting the opportunities for our stockholders to receive a
premium for their common stock over then-prevailing market prices. These
provisions include the following:

. Ownership limit. The ownership limit in our charter limits related
investors, including, among other things, any voting group, from
acquiring over 9.8% of our common stock without our permission.

. Preferred stock. Our charter authorizes our board of directors to issue
preferred stock in one or more classes and to establish the preferences
and rights of any class of preferred stock issued. These actions can be
taken without soliciting stockholder approval.

. Maryland business combination statute. Maryland law restricts the ability
of holders of more than 10% of the voting power of a corporation's shares
to engage in a business combination with the corporation.

. Maryland control share acquisition statute. Maryland law limits the
voting rights of "control shares" of a corporation in the event of a
"control share acquisition."

Future offerings of debt securities, which would be senior to our common stock
upon liquidation, or equity securities, which would dilute our existing
stockholders and may be senior to our common stock for the purposes of
dividend distributions, may adversely affect the market price of our common
stock.

In the future, we may attempt to increase our capital resources by making
additional offerings of debt or equity securities, including commercial paper,
medium-term notes, senior or subordinated notes and classes of preferred stock
or common stock. Upon liquidation, holders of our debt securities and shares
of preferred stock and lenders with respect to other borrowings will receive a
distribution of our available assets prior to the holders of our common stock.
Additional equity offerings by us may dilute the holdings of our existing
stockholders or reduce the market price of our common stock, or both. Our
preferred stock, if issued, would have a preference on dividend payments that
could limit our ability to make a dividend distribution to the holders of our
common stock. Because our decision to issue securities in any future offering
will depend on market conditions and other factors beyond our control, we
cannot predict or estimate the amount, timing or nature of our future
offerings. Thus, our stockholders bear the risk of our future offerings
reducing the market price of our common stock and diluting their stock
holdings in us.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We seek to manage the interest rate, market value, liquidity, prepayment and
credit risks inherent in all financial institutions in a prudent manner
designed to insure our longevity while, at the same time, seeking to provide
an opportunity for stockholders to realize attractive total rates of return
through ownership of our common stock. While we do not seek to avoid risk
completely, we do seek, to the best of our ability, to assume risk that can be
quantified from historical experience, to actively manage that risk, to earn
sufficient compensation to justify taking those risks and to maintain capital
levels consistent with the risks we undertake.

Interest Rate Risk

We primarily invest in adjustable-rate, hybrid and fixed-rate mortgage-
backed securities. Hybrid mortgages are adjustable-rate mortgages that have a
fixed interest rate for an initial period of time (typically three years or
greater) and then convert to a one-year adjustable-rate for the remaining loan
term. Our borrowings are generally repurchase agreements of limited duration
that are periodically refinanced at current market rates.

Adjustable-rate mortgage-backed assets are typically subject to periodic and
lifetime interest rate caps that limit the amount an adjustable-rate mortgage-
backed securities' interest rate can change during any given period.
Adjustable-rate mortgage securities are also typically subject to a minimum
interest rate payable. Our borrowings are not subject to similar restrictions.
Hence, in a period of increasing interest rates, interest rates on our
borrowings could increase without limitation, while the interest rates on our
mortgage-related assets could be limited. This problem would be magnified to
the extent we acquire mortgage-backed securities that are not fully indexed.
Further, some adjustable-rate mortgage-backed securities may be subject to
periodic payment caps that result in some portion of the interest being
deferred and added to the principal outstanding. These factors could lower our
net interest income or cause a net loss during periods of rising interest
rates, which would negatively impact our liquidity, net income and our ability
to make distributions to stockholders.

We fund the purchase of a substantial portion of our adjustable-rate
mortgage-backed debt securities with borrowings that have interest rates based
on indices and repricing terms similar to, but of somewhat shorter maturities
than, the interest rate indices and repricing terms of the mortgage assets.
Thus, we anticipate that in most cases the interest rate indices and repricing
terms of our mortgage assets and our funding sources will not be identical,
thereby creating an interest rate mismatch between assets and liabilities.
During periods of changing

interest rates, such interest rate mismatches could negatively impact our net
income, dividend yield and the market price of our common stock.

Most of our adjustable-rate assets are based on the one-year constant
maturity treasury rate and our debt obligations are generally based on LIBOR.
These indices generally move in parallel, but there can be no assurance that
this will continue to occur.

Our adjustable-rate mortgage-backed securities and borrowings reset at
various different dates for the specific asset or obligation. In general, the
repricing of our debt obligations occurs more quickly than on our assets.
Therefore, on average, our cost of funds may rise or fall more quickly than
does our earnings rate on the assets.

Further, our net income may vary somewhat as the spread between one-month
interest rates and six- and twelve-month interest rates varies.

As of December 31, 2001, our mortgage-backed securities and borrowings will
prospectively reprice based on the following time frames:

Assets Borrowings*
-------------------------- --------------------------
Percent of Total Percent of Total
Amount Investments Amount Borrowings
--------- ---------------- --------- ----------------
(amounts in thousands)

Investment Type/Rate
Reset Dates
Fixed-Rate Investments... $ 68,748 16.4% $ -- -- %
Adjustable Rate
Investments/Obligations:
Less than 3 months....... 11,740 2.8% 162,411 49.9%
Greater than 3 months and
less than 1 year........ 226,944 54.0% 127,146 39.1%
Greater than 1 year and
less than 2 years....... 11,833 2.8% 35,750 11.0%
Greater than 2 years and
less than 3 years....... 82,386 19.6% -- -- %
Greater than 3 years and
less than 5 years....... 18,563 4.4% -- -- %
--------- ------ --------- ------
Total.................. $ 420,214 100.0% $ 325,307 100.0%
========= ====== ========= ======

- --------
* Excludes borrowings incurred to settle open asset purchases at December 31,
2001, which will reprice in less than three months.

Market Value Risk

Substantially all of our mortgage-backed securities and equity securities
are classified as available for sale assets. As such, they are reflected at
fair value (i.e., market value) with the adjustment to fair value reflected as
part of accumulated other comprehensive income that is included in the equity
section of our balance sheet. The market value of our assets can fluctuate due
to changes in interest rates and other factors.

Liquidity Risk

Our primary liquidity risk arises from financing long-maturity mortgage-
backed securities with short-term debt. The interest rates on our borrowings
generally adjust more frequently than the interest rates on our adjustable-
rate mortgage-backed securities. For example, at December 31, 2001, our
adjustable-rate mortgage-backed securities had a weighted average term to next
rate adjustment of approximately 16 months, while our borrowings had a
weighted average term to next rate adjustment of 179 days. Accordingly, in a
period of rising interest rates, our borrowing costs will usually increase
faster than our interest earnings from mortgage-backed securities. As a
result, we could experience a decrease in net income or a net loss during
these periods. Our assets that are pledged to secure short-term borrowings are
high-quality, liquid assets. As a result, we have not had difficulty rolling
over our short-term debt as it matures. There can be no assurance that we will
always be able to roll over our short-term debt. At December 31, 2001, we had
$35.75 million of debt which could be considered long-term debt with a term
greater than one-year.

Prepayment Risk

Prepayments are the full or partial repayment of principal prior to the
original term to maturity of a mortgage loan and typically occur due to
refinancing of mortgage loans. Prepayment rates on mortgage-related

securities vary from time to time and may cause changes in the amount of our
net interest income. Prepayments of adjustable-rate mortgage loans usually can
be expected to increase when mortgage interest rates fall below the then-
current interest rates on such loans and decrease when mortgage interest rates
exceed the then-current interest rate on such loans, although such effects are
not predictable. Prepayment experience also may be affected by the conditions
in the housing and financial markets, general economic conditions and the
relative interest rates on fixed-rate and adjustable-rate mortgage loans
underlying mortgage-backed securities. The purchase prices of mortgage-backed
securities are generally based upon assumptions regarding the expected amounts
and rates of prepayments. Where slow prepayment assumptions are made, we may
pay a premium for mortgage-backed securities. To the extent such assumptions
differ from the actual amounts of prepayments, we could experience reduced
earnings or losses. The total prepayment of any mortgage-backed securities
purchased at a premium by us would result in the immediate write-off of any
remaining capitalized premium amount and a reduction of our net interest
income by such amount. Finally, in the event that we are unable to acquire new
mortgage-backed securities to replace the prepaid mortgage-backed securities,
our financial condition, cash flows and results of operations could be harmed.

We often purchase mortgage-backed securities that have a higher interest
rate than the market interest rate at the time. In exchange for this higher
interest rate, we must pay a premium over par value to acquire these
securities. In accordance with accounting rules, we amortize this premium over
the term of the mortgage-backed security. As we receive repayments of mortgage
principal, we amortize the premium balances as a reduction to our income. If
the mortgage loans underlying a mortgage-backed security are prepaid at a
faster rate than we anticipate, we would have to amortize the premium at a
faster rate. This would reduce our income. At December 31, 2001, unamortized
mortgage premium balances of mortgage-backed securities for financial
accounting purposes were $8.5 million, or 2.0% of total assets.

Tabular Presentation

The information presented in the table below projects the impact of changes
in interest rates on our 2002 projected net income and net assets as more
fully discussed below based on investments in place on December 31, 2001, and
includes all of our interest-rate sensitive assets and liabilities. We acquire
interest-rate sensitive assets and fund them with interest-rate sensitive
liabilities. We generally plan to retain such assets and the associated
interest rate risk to maturity.

The table below includes information about the possible future repayments
and interest rates of our assets and liabilities and constitutes a forward-
looking statement. This information is based on many assumptions and there can
be no assurance that assumed events will occur as assumed or that other events
will not occur that would affect the outcomes. Furthermore, future sales,
acquisitions, calls and restructuring could materially change our interest
rate risk profile. The table quantifies the potential changes in our net
income should interest rates go up or down (shocked) by 100 and 200 basis
points, assuming the yield curves of the rate shocks will be parallel to each
other.

When interest rates are shocked, these prepayment assumptions are further
adjusted based on our best estimate of the effects of changes on interest
rates or prepayment speeds. For example, under current market conditions, a
100 basis point decline in interest rates is estimated to result in a 87%
increase in the prepayment rate of our adjustable-rate mortgage-backed
securities. The base interest rate scenario assumes interest rates at December
31, 2001. Actual results could differ significantly from those estimated in
the table.

Change in Percentage Change Percentage Change
Interest Rate in Net Income in Net Assets
------------- ----------------- -----------------

(2.0)% (24)% 2 %
(1.0)% (18)% 1 %
0.0 % 0 % 0 %
1.0 % 1 % (2)%
2.0 % (2)% (4)%

Recently Issued Accounting Pronouncements

In June and August 2001, the Financial Accounting Standards Board, or FASB,
issued Statement of Financial Accounting Standards ("SFAS") No. 143,
"Accounting for Asset Retirement Obligations" and No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," respectively. Statement No. 143
requires that the fair value of a liability for an asset retirement obligation
be recognized in the period in which it is incurred if a reasonable estimate
of fair value can be made. The associated asset retirement costs are
capitalized as part of the carrying amount of the long-lived asset. Statement
No. 144 establishes a single accounting model for the accounting of a
discontinued segment of a business as well as addresses significant
implementation issues related to Statement 121. We do not expect that the
adoption of these standards will have a material impact on our financial
position, results of operations or cash flows.

In June 2001, the FASB, issued SFAS No. 141, "Business Combinations", and
No. 142, "Goodwill and Other Intangible Assets". Statement No. 141 requires
all business combinations initiated after June 30, 2001, to be accounted for
using the purchase method of accounting. With the adoption of Statement 142,
goodwill is no longer subject to amortization over its estimated useful life.
Rather, goodwill will be subject to at least an annual assessment for
impairment by applying a fair-value-based test. Similarly, goodwill associated
with equity method investments is no longer amortized. Equity method goodwill
is not, however, subject to the new impairment rules; the impairment guidance
in existing rules for equity method investments continues to apply. We do not
expect that the adoption of these standards will have a material impact on our
financial position, results of operations or cash flows. We currently do not
have any business combinations in progress; however, our board of directors
has formed a special committee to consider a merger with our management
company pursuant to an option agreement described more fully in Item 1 above.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION

The financial statements and related financial information required to be
filed hereunder are indexed under Item 14 of this report and are incorporated
herein by reference.

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Board of Directors

Biographical information regarding each director is set forth below:

Lloyd McAdams (age 56) has been the Chairman of the Board, President and
Chief Executive Officer of our company and of our management company, Anworth
Mortgage Advisory Corporation, since their formation in 1997. Mr. McAdams is
also the Chairman of the Board, Chief Investment Officer and co-founder of
Pacific Income Advisers, Inc., or PIA, an investment advisory firm organized
in 1986 that manages an investment portfolio for institutional and individual
clients. Mr. McAdams is the President of Syndicated Capital, Inc., a
registered broker-dealer. Mr. McAdams also serves as a director of Monterey
Mutual Fund. Before joining PIA, Mr. McAdams held the position of President of
Security Pacific Investment Managers, Inc. from 1981 to 1987, Senior Vice
President of Trust Company of the West from 1975 to 1981, and an Investment
Officer with the State of Tennessee from 1973 to 1975. In 1983, Mr. McAdams
served as a Board member of the California Public Employees Retirement System.
Mr. McAdams holds a Bachelor of Science in Statistics from Stanford University
and a Masters in Business Administration from the University of Tennessee. Mr.
McAdams is a Chartered Financial Analyst charterholder, Chartered Investment
Counselor and a Certified Employee Benefit Specialist.

Joe E. Davis (age 67) has been a director of our company since its
formation. Since 1982, Mr. Davis has been a private investor. From 1974 to
1982, Mr. Davis served as President and Chief Executive Officer of National
Health Enterprises, Inc. Mr. Davis also serves as a director of BMC
Industries, Inc., Wilshire Technologies, Inc., Natural Alternatives, Inc. and
American Funds Insurance Series.

Charles H. Black (age 75) has been a director of our company since its
formation. Since 1985, Mr. Black has been a private investor and financial
consultant. From 1985 to 1987, he served as Vice Chairman and Director of
Pertron Controls Corporation. From 1982 to 1985, Mr. Black served as the
Executive Vice President, Director, Chief Financial Officer and Chairman of
Investment Committee for Kaiser Steel Corporation. From 1980 to 1982, Mr.
Black served as Executive Vice President and Chief Financial Officer of Great
Western Financial Corporation. From 1957 to 1980, Mr. Black served at Litton
Industries, where he ultimately held the position of Corporate Vice President
and Treasurer. Mr. Black is a member of the Board of Governors of the Pacific
Exchange, Inc. Mr. Black serves as a director of Investment Company of
America, Orincon Industries, Inc. and Wilshire Technologies, Inc. and as an
advisory director of Windsor Capital Group, Inc.

Charles F. Smith (age 69) has been a director of our company since April
2001. Since 1984, Mr. Smith has served as Chief Executive Officer of Charles
F. Smith & Co., Inc., an investment banking firm specializing in mergers and
acquisitions. Mr. Smith serves as a Director of FirstFed Financial Corp.,
Grojean Transportation, Inc., Trans Ocean Distribution, Ltd. and Worldwide
Restaurant Concepts, Inc. Mr. Smith also serves as a Trustee and Vice Chairman
of Saint John's Health Center Foundation in Santa Monica, California.

Information Regarding Board of Directors

Our board of directors consists of four members. The size of our board was
increased from three to four members in April 2001 for the purpose of adding a
third independent director to serve as a member of our audit committee in
accordance with the rules of the American Stock Exchange. Directors are
elected annually to serve until the next annual meeting of stockholders and
until their successors are elected and qualified.

During 2001, our board of directors had an audit committee, but not a
compensation committee or a nominating committee. Our audit committee is
responsible for making recommendations concerning the engagement of
independent certified public accountants, approving professional services
provided by the independent public accountants and reviewing the adequacy of
the our internal accounting controls. Our audit committee is currently
comprised of Messrs. Davis, Black and Smith.

We do not have a compensation committee because we have no paid officers or
employees. However, our board of directors, which consists of a majority of
directors not affiliated with our management company, administers our 1997
Stock Option and Awards Plan. In addition, our independent directors review
from time to time the management agreement between us and our management
company to determine whether the contracted fee schedule is reasonable in
relation to the nature and quality of services performed by our management
company thereunder.

During 2001, our board of directors held five meetings and our audit
committee held one meeting. Each of our directors attended each of the
meetings of the board of directors and each member of our audit committee
attended the meeting held by the audit committee during 2001.

Our independent directors receive a fee of $6,000 per year, payable
semiannually, and $1,000 for each meeting of the board of directors attended
and each meeting of the audit committee attended not immediately preceding or
following a board meeting. Directors are reimbursed reasonable expenses
incurred in attending board and audit committee meetings. Concurrently upon
the initial public offering of our common stock in March 1998, we granted each
of our independent directors options to purchase 6,000 shares of common stock
at an exercise price of $9.00 per share. Such options vested 100% on September
17, 1998. In 1999, we granted each of our independent directors an option to
purchase 1,250 shares of our common stock at an exercise price of $4.60 per
share. Such options vest 100% on April 16, 2002, the third anniversary of the
date of grant. In 2000, we did not grant any options to any of our directors.
In 2001, we granted each of our independent directors a fully vested option to
purchase 3,000 shares of our common stock at an exercise price of $7.10 per
share. All of the options were granted under our 1997 Stock Option and Awards
Plan.

Our directors are required to devote only so much of their time to our
affairs as is necessary or required for the effective conduct and operation of
our business. Because our management agreement provides that our management
company will assume principal responsibility for managing our affairs, our
directors, in their capacities as such, are not expected to devote substantial
portions of their time to the affairs of the company. However, in their
capacities as officers or employees of our management company, or its
affiliates, they will devote such portion of their time to the affairs of our
management company as is required for the performance of the duties of our
management company under the management agreement.

No family relationships exist between any of our executive officers or
directors, except that Lloyd McAdams and Heather U. Baines are husband and
wife and Lloyd McAdams and Joseph E. McAdams are father and son.

Executive Officers

All officers serve at the discretion of our board of directors. Although we
may have salaried employees, we do not currently have any employees. The
persons listed below are the executive officers of the company:

Name Age Position(s) Held
---- --- ----------------

Lloyd McAdams........... 56 Chairman of the Board, President and Chief Executive Officer
Pamela J. Watson........ 47 Executive Vice President, Chief Financial Officer and Secretary
Heather U. Baines....... 60 Executive Vice President
Evangelos Karagiannis... 40 Vice President
Joseph E. McAdams....... 33 Vice President

Biographical information regarding each executive officer who is not a
director is set forth below:

Pamela J. Watson has been an Executive Vice President and the Chief
Financial Officer, Treasurer and Secretary of our company since its formation
and an Executive Vice President and the Chief Financial Officer and Secretary
of our management company since its formation. Ms. Watson joined PIA in 1996
and holds the position of Vice President. Prior to joining PIA, from 1990 to
1995, Ms. Watson was employed by Kleinwort Benson Cross Financing Inc. and
Kleinwort Benson Capital Management Inc., an interest rate swap dealer and

investment management firm owned by the British merchant bank Kleinwort Benson
Group plc., where Ms. Watson served as Chief Financial Officer from 1991 to
1995. From 1989 to 1990, Ms. Watson was employed by Security Pacific State
Trust Company as a Business Manager, and from 1986 to 1989, she held the
position of Vice President of Capital Research and Management Company, the
mutual fund arm of The Capital Group. Ms. Watson holds a Bachelor of Science
degree from Lehigh University and a Masters in Business Administration from
Claremont Graduate School.

Heather U. Baines has been an Executive Vice President our company and our
management company since their formation. Since 1987, she has held the
position of President and Chief Executive Officer of PIA. From 1978 to 1987,
Ms. Baines was employed by Security Pacific Investment Managers, Inc.,
ultimately holding the position of Senior Vice President and Director. Ms.
Baines holds a bachelors degree from Antioch College.

Evangelos Karagiannis has been a Vice President of our company and of our
management company since their formation. Mr. Karagiannis joined PIA in 1992
and holds the position of Vice President. Mr. Karagiannis serves as Fixed
Income Portfolio Manager with a specialty in mortgage-backed securities and is
also responsible for PIA's quantitative research. Mr. Karagiannis has been the
author, and co-author with Mr. McAdams, of articles on fixed income portfolio
management and for PIA's internal research. Mr. Karagiannis holds a Doctor of
Philosophy degree in physics from the University of California at Los Angeles
("UCLA") and, prior to joining PIA, was a postdoctoral fellow at UCLA, where
he was a Fulbright Scholar. Mr. Karagiannis is also a Chartered Financial
Analyst charterholder.

Joseph E. McAdams has been a Vice President of our company and of our
management company since June 19, 1998. Mr. McAdams joined PIA in 1998 and
holds the position of Vice President. Mr. McAdams serves as Fixed Income
Portfolio Manager with a specialty in mortgage-backed securities and is also
responsible for PIA's fixed income trading. Prior to joining PIA, from 1993 to
1998, Mr. McAdams was employed by Donaldson, Lufkin & Jenrette Securities
Corp. as a mortgage-backed security trader and analyst. Mr. McAdams holds a
Master of Arts degree in Economics from the University of Chicago and a
Bachelor of Science degree in Economics from the Wharton School of the
University of Pennsylvania. Mr. McAdams is also a Chartered Financial Analyst
charterholder.

Section 16(a) Beneficial Ownership Reporting Compliance

Under Section 16(a) of the Securities Exchange Act of 1934, as amended, our
directors, officers and persons holding more than 10% of our common stock are
required to file forms reporting their beneficial ownership of our common
stock and subsequent changes in that ownership with the Securities and
Exchange Commission. Such persons are also required to furnish us copies of
the forms so filed. Based solely upon a review of copies of such forms filed
with us, we believe that during 2001, our officers and directors complied with
the Section 16(a) filing requirements on a timely basis except for the
delinquent filing of a Form 3 on behalf of Charles F. Smith upon his election
as a director in April 2001.

Item 11. EXECUTIVE COMPENSATION

We have not paid, and do not intend to pay, any annual compensation to our
executive officers for their services as executive officers. From time to
time, in the discretion of our board of directors, we may grant options to
purchase shares of our common stock to our executive officers and directors
pursuant to our 1997 Stock Option and Awards Plan.

Options Granted in 2001

The following table sets forth information regarding stock options granted
to our executive officers during 2001.

Potential
Realizable
Value at
Assumed Annual
Rate of Stock
Price
Appreciation
for Option
Individual Grants Term(1)
----------------------------------------------- ---------------
Number of
Securities Percent of
Underlying Total Options
Options Granted to Exercise or
Granted Employees in Base Price Expiration
Name (#) Fiscal Year ($/Sh) Date 5%($) 10%($)
- ---- ---------- ------------- ----------- ---------- ------- -------

Lloyd McAdams........... 25,000 19 7.81 8/10/06 53,944 119,202
Pamela J. Watson........ 43,520 33 6.70 7/16/11 183,376 464,710
Heather U. Baines....... -- -- -- -- -- --
Evangelos Karagiannis... 43,520 33 6.70 7/16/11 183,376 464,710
Joseph E. McAdams....... 19,296 15 7.37 7/16/06 39,290 86,822

- --------
(1) The amounts under the columns labeled "5%" and "10%" are included pursuant
to certain rules promulgated by the Securities and Exchange Commission and
are not intended to forecast future appreciation, if any, in the price of
our common stock. The amounts are calculated by using the closing market
price of a share of common stock on the grant date as reported by the
American Stock Exchange and assuming annual compounded stock appreciation
rates of 5% and 10% over the full term of the option. The reported amounts
are based on the assumption that the named persons hold the options
granted for their full term. The actual value of the options will vary in
accordance with the market price of our common stock.

2001 Year-End Values

The following table sets forth the number and dollar value of unexercised
options held by our executive officers as of December 31, 2001.

Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money
Options at FY-End(#)(1) Options at FY-End ($)
Name Exercisable/Unexercisable Exercisable/Unexercisable
- ---- ------------------------- -------------------------

Lloyd McAdams............... 65,000/12,500 36,250/56,250
Pamela J. Watson............ 75,520/10,000 140,698/45,000
Heather U. Baines........... 32,000/5,000 36,250/22,500
Evangelos Karagiannis....... 75,520/10,000 140,698/45,000
Joseph E. McAdams........... 19,296/10,000 69,632/45,000

- --------
(1) Excludes shares issuable upon the exercise of options pursuant to accrued
dividend equivalent rights, or DERs, granted in conjunction with such
options, which shares are set forth below. Shares Accrued Pursuant to DERs
in 2001.

Shares Accrued in 2001 Pursuant to DERs

The following table sets forth the number of additional shares issuable upon
the exercise of stock options as a result of dividends paid by us in 2001 and
DERs granted to our executive officers.

Shares Accrued Shares Vested
Name Pursuant to DERs(1) Pursuant to DERs(2)
- ---- ------------------- -------------------

Lloyd McAdams........................... 1,845 15,819
Pamela J. Watson ....................... 1,476 12,655
Heather U. Baines....................... 1,435 12,655
Evangelos Karagiannis................... 1,476 12,655
Joseph E. McAdams....................... 80 0
Charles Black........................... 10 0
Joe E. Davis............................ 10 0
Charles F. Smith........................ 0 0

- --------
(1) Based upon DERs issued in conjunction with stock option grants. The shares
accrued pursuant to DERs represent shares issuable (assuming the
underlying options have vested) proportionately upon the exercise of the
related stock options at no additional consideration. The number of DERs
is derived from (a) the product of the dividend per share paid during 2001
multiplied by the number of shares subject to stock options granted to the
respective executive officer divided by (b) the fair market value of our
common stock on the dividend payment date.
(2) The additional shares vest 33.3% per year in accordance with the vesting
schedule for the related options that were granted in 1998 and 100% upon
the third anniversary of the date of the grant of options granted in 1999.
The DERs expire ten (10) years from the date of grant or earlier upon
termination of employment in accordance with the expiration and
termination of the related options.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

As of March 11, 2002, there were 11,803,327 shares of Anworth's Common Stock
outstanding. The following table sets forth certain information known to us
with respect to the beneficial ownership of our Common Stock as of March 15,
2002 by (i) each of our directors, (ii) each of our executive officers, (iii)
each person who is known to us to beneficially own more than 5% of Anworth's
Common Stock and (iv) all directors and executive officers of Anworth as a
group. The number of shares beneficially owned by each director or executive
officer is determined under rules of the Securities and Exchange Commission,
and the information is not necessarily indicative of beneficial ownership for
any other purpose. Under such rules, beneficial ownership includes any shares
as to which the individual has the sole or shared voting power or investment
power and also any shares which the individual has the right to acquire within
60 days of March 15, 2002 through the exercise of any stock option or other
right. Unless otherwise noted, we believe that each person has sole investment
and voting power (or shares such powers with his or her spouse) with respect
to the shares set forth in the following table.

Amount and
Nature of
Beneficial Percent of
Beneficial Owner Ownership Class
---------------- ---------- ----------

Wellington Management Company, LLP(1).................... 632,900 5.1%
Lloyd McAdams(2)......................................... 378,001 3.1%
Pamela J. Watson(3)...................................... 98,756 *
Heather U. Baines(4)..................................... 316,997 2.6%
Evangelos Karagiannis(5)................................. 98,756 *
Joe E. Davis(6).......................................... 14,583 *
Charles H. Black(7)...................................... 20,583 *
Joseph E. McAdams(8)..................................... 136,577 1.1%
Charles F. Smith(9)...................................... 3,000 *
All Directors and Officers as a Group (8 Persons)(10).... 813,282 6.6%

- --------
* Less than 1%
(1) This information was obtained from a Schedule 13G filed with the
Securities and Exchange Commission on February 12, 2002. According to
the Schedule 13G, Wellington Management Company, LLP, or WMC, is an
investment adviser and it may be deemed to beneficially own 632,900
shares of our common stock. Brian P. Hillary is Vice President of WMC.
The address for WMC is 75 State Street, Boston, Massachusetts, 02109.
(2) Includes (i) 147,575 shares held by Lloyd McAdams and Heather U. Baines
as community property, (ii) 123,771 shares subject to stock options
exercisable within 60 days of March 15, 2002 and (iii) 30,700 shares
owned by the McAdams Foundation of which Lloyd McAdams is a director.
Mr. McAdams shares voting and investment power over the shares held by
the Foundation and disclaims any beneficial interest in the shares held
by this entity.
(3) Includes 98,756 shares subject to stock options exercisable within 60
days of March 15, 2002.
(4) Includes (i) 147,575 shares held by Lloyd McAdams and Heather U. Baines
as community property and (ii) 93,466 shares subject to stock options
exercisable within 60 days of March 15, 2002.
(5) Includes 98,756 shares subject to stock options exercisable within 60
days of March 15, 2002.
(6) Includes 9,000 shares subject to stock options exercisable within 60
days of March 15, 2002.
(7) Includes 9,000 shares subject to stock options exercisable within 60
days of March 15, 2002.
(8) Includes 94,877 shares subject to stock options exercisable within 60
days of March 15, 2002. Includes 30,700 shares owned by the McAdams
Foundation of which Joseph McAdams is a director. Mr. McAdams shares
voting and investment power over the shares held by the Foundation and
disclaims any beneficial interest in the shares held by this entity.
(9) Includes 3,000 shares subject to stock options exercisable within 60
days of March 15, 2002.
(10) Anworth Mortgage Asset Corporation and each of its directors and
officers may be reached at 1299 Ocean Avenue, Suite 200, Santa Monica,
California 90401, telephone (310) 394-0115.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Management Agreement

We entered into a management agreement with our management company, Anworth
Mortgage Advisory Corporation, effective March 17, 1998 for an initial term of
five (5) years. The management agreement may be terminated by us without cause
at any time upon sixty (60) days written notice by a majority vote of the our
independent directors or by a vote of the holders of a majority of the
outstanding shares of capital stock having the right to vote. In addition, We
have the right to terminate the management agreement for "cause" upon a
material breach by our management company of any provision contained in the
management agreement or the bankruptcy or insolvency of our management
company. These events are not related to our performance.

Our manager receives a base management fee equal to 1% per year of the first
$300 million of our stockholders' equity, plus 0.8% per year of the portion of
our stockholders' equity above $300 million. For services performed during
2001, the base management fee was $208,000. We also pay our management company
an annual incentive compensation fee of 20% of the amount by which our return
on our equity, as defined in our management agreement, exceeds a return based
on the ten-year U.S. Treasury Rate plus 1%. For services performed during
2001, the incentive management fee was $598,000. Our board of directors
reviews and approves the calculation of the base and incentive compensation
paid to our management company quarterly, one quarter in arrears, during each
quarterly scheduled board of directors meeting.

The terms of the management agreement have not been negotiated on an arm's-
length basis and may not be as favorable as we could have obtained from an
unaffiliated third party.

Certain Relationships

Pursuant to the terms of our management agreement, our management company
and its affiliates, including Pacific Income Advisors, or PIA, agree on the
allocation of mortgage securities between us and other accounts over which our
management company and its affiliates have control. Pursuant to such
allocation, our management company bases allocation decisions on the
procedures our management company considers fair and equitable, including,
without limitation, such considerations as investment objectives, restrictions
and time horizon, availability of cash and the amount of existing holdings. In
some cases, some forms of pro rata allocations may be used and, in other
cases, random allocation processes may be used. In other cases, neither may be
used.

Notwithstanding the foregoing, the aforementioned conflict may result in
decisions or allocations of mortgage securities to affiliates of our
management company, including PIA, that are not in our best interests. In
particular, it is possible that asset allocations made by our management
company could favor its affiliates, and our operating income and distributions
to stockholders could be materially and adversely affected.

We are subject to additional conflicts of interest arising from our
relationships with PIA and its officers, directors and affiliates. Our
management company renders management services to us and is paid a management
fee on a quarterly basis, resulting in a direct benefit to its owner, who is
one of our officers and directors. Our management company oversees our day-to-
day operations pursuant to policies established by our board of directors and
the authority delegated to our manager under the management agreement. Our
management company entered into an administrative services agreement with PIA
upon the closing of our initial public offering, pursuant to which PIA renders
certain administrative services to our management company. Such services
include administrative, secretarial, data processing, operations and
settlement, employee benefit and research services. Our management company and
PIA determined the fee to be paid based upon what the parties believed such
services would be valued at if negotiated between unaffiliated third parties
on an arms-length basis. Lloyd McAdams, our Chairman of the Board, President
and Chief Executive Officer, and Heather Baines, our Executive Vice President,
beneficially own all of the outstanding common stock of our management
company. Additionally, Mr. McAdams and Ms. Baines beneficially own 5,550
shares, representing 92.5% of the outstanding

stock, of PIA, and Mr. McAdams and Ms. Baines are husband and wife.
Additionally, the officers and employees of our management company are also
officers of Anworth and officers and employees of PIA.

Option To Become Internally Managed

Our management company has granted us an option, exercisable on or before
April 30, 2003, to acquire our management company by merger for consideration
consisting of 240,000 shares of our common stock. If this option is exercised,
we would become an internally managed company and the employees of the
management company would become our employees. The closing of the merger would
be subject to a number of conditions, including the approval of our
stockholders and receipt by our board of directors of a fairness opinion
regarding the fairness of the consideration payable by us in the merger. We
have agreed, as a condition to exercising the option, to enter into direct
employment contracts with Lloyd McAdams and other key executives of the
management company designated by Mr. McAdams, adopt an incentive compensation
plan for our employees and increase and maintain the size of our 1997 Stock
Option and Awards Plan. If the merger is consummated, the management agreement
would be terminated with no termination fee payable by us.

PART IV

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)1. Financial Statements

Page
----

Report of Independent Accountants........................................ F-2
Balance Sheets as of December 31, 2001 and 2000.......................... F-3
Statements of Operations for the Years Ended December 31, 2001, 2000 and
1999.................................................................... F-4
Statements of Stockholders' Equity for the Years Ended December 31, 2001,
2000 and 1999........................................................... F-5
Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and
1999.................................................................... F-6
Notes to Financial Statements............................................ F-7

2. Financial Statement Schedules.

All other schedules are omitted because they are not applicable or
are not required.

3. Exhibits. The following exhibits are either filed herewith or
incorporated herein by reference:

Exhibit
Number Description
--------- -----------

2.1(1) Purchase Agreement dated December 20, 2001 between Anworth and FBR
Asset Corporation.
3.1(2) Charter
3.2(2) Bylaws
4.1(2) Specimen Class A Common Stock certificate
10.1(2) Management Agreement between Anworth and Anworth Mortgage Advisory
Corporation dated March 17, 1998
10.2(3) Dividend Reinvestment and Stock Purchase Plan
10.3(4) 1997 Stock Option and Awards Plan, as amended
10.4(5) Option Agreement between Anworth and the shareholder of Anworth
Mortgage Advisory Corporation dated October 29, 2001
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants

- --------
(1) Incorporated by reference from Anworth's Registration Statement on Form S-
3, Registration No. 333- 81698, filed on January 30, 2002.
(2) Incorporated by reference from Anworth's Registration Statement on Form S-
11, Registration No. 333-38641, which became effective under the
Securities Act of 1933, as amended, on March 12, 1998.
(3) Incorporated by reference from Anworth's Registration Statement on Form S-
3, Registration No. 333-87555, filed on September 22, 1999.
(4) Incorporated by reference from Anworth's Definitive Proxy Statement on
Schedule 14A, filed on April 30, 2001.
(5) Incorporated by reference to Anworth's Registration Statement on Form S-2,
Registration No. 333-71786, which became effective under the Securities
Act of 1933, as amended, on December 20, 2001.

(b) Reports on Form 8-K.

We filed the following current reports on Form 8-K during the quarter ended
December 31, 2001:

Form 8-K filed on December 17, 2001 to announce the issuance of our press
release that addressed the declaration of a dividend of $0.30 per share (Item
9).

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

DATED: March 19, 2002

Anworth Mortgage Asset Corporation

/s/ Joseph Lloyd McAdams
By: _________________________________
Joseph Lloyd McAdams
Chairman of the Board, President
and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

Signature Title Date
--------- ----- ----

/s/ Joseph Lloyd McAdams Chairman of the Board, March 19, 2002
______________________________________ President and Chief
Joseph Lloyd McAdams Executive Officer
(Principal Chief
Executive)

/s/ Pamela J. Watson Senior Vice President and March 19, 2002
______________________________________ Chief Financial Officer
Pamela J. Watson

/s/ Charles H. Black Director March 19, 2002
______________________________________
Charles H. Black

/s/ Joe E. Davis Director March 19, 2002
______________________________________
Joe E. Davis

/s/ Charles F. Smith Director March 19, 2002
______________________________________
Charles F. Smith

ANWORTH MORTGAGE ASSET CORPORATION

FINANCIAL STATEMENTS AND REPORTS OF INDEPENDENT ACCOUNTANTS

FOR INCLUSION IN FORM 10-K

ANNUAL REPORT FILED WITH

SECURITIES AND EXCHANGE COMMISSION

DECEMBER 31, 2001

ANWORTH MORTGAGE ASSET CORPORATION

INDEX TO FINANCIAL STATEMENTS

Page
----

F-1

Report of Independent Accountants

To the Board of Directors and Stockholders of
Anworth Mortgage Asset Corporation

In our opinion, the accompanying balance sheets and the related statements
of operations, stockholders' equity and cash flows present fairly, in all
material respects, the financial position of Anworth Mortgage Asset
Corporation at December 31, 2001 and December 31, 2000, and the results of its
operations and its cash flows for each of the three years in the period then
ended in conformity with accounting principles generally accepted in the
United States of America. 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 as of these
statements in accordance with auditing standards generally accepted in the
United States of America, which 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, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP

Los Angeles, California
January 25, 2002, except for
the last paragraph of Note
5 for which the date is
February 28, 2002

F-2

ANWORTH MORTGAGE ASSET CORPORATION

BALANCE SHEETS
(in thousands)

December 31, December 31,
2001 2000
------------ ------------

ASSETS
Mortgage backed securities......................... $420,214 $134,889
Other marketable securities........................ 1,803 1,948
Cash and cash equivalents.......................... 290 3,894
Accrued interest and dividend receivable........... 2,293 1,090
Prepaid expenses and other......................... 10 13
-------- --------
$424,610 $141,834
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Reverse repurchase agreements...................... $325,307 $121,891
Payable for purchase of mortgage-backed
securities........................................ 40,819 --
Accrued interest payable........................... 1,293 1,706
Dividends payable.................................. 1,329 --
Accrued expenses and other......................... 865 36
-------- --------
369,613 123,633
-------- --------
Stockholders' Equity
Preferred stock, par value $.01 per share;
authorized 20,000 shares; no shares issued and
outstanding....................................... -- --
Common stock; par value $.01 per share; authorized
100,000 shares; 7,001 and 2,400 issued and 6,951
and 2,350 outstanding respectively................ 70 24
Additional paid in capital......................... 54,324 19,243
Accumulated other comprehensive income, unrealized
gain (loss) on available for sale securities...... 705 (1,186)
Retained earnings.................................. 127 349
Treasury stock at cost (50 shares)................. (229) (229)
-------- --------
54,997 18,201
-------- --------
$424,610 $141,834
======== ========

See notes to financial statements.

F-3

ANWORTH MORTGAGE ASSET CORPORATION

STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

For the Year Ended For the Year Ended For the Year Ended
December 31, 2001 December 31, 2000 December 31, 1999
------------------ ------------------ ------------------

Interest and dividend
income net of
amortization of premium
and discount........... $10,768 $10,314 $ 9,501
Interest expense........ (6,363) (8,674) (7,892)
------- ------- -------
Net interest income..... 4,405 1,640 1,609
Gain on sale of
securities............. 430 -- --
Expenses: (Note 6)
Management fee........ (208) (167) (175)
Incentive fee......... (598) -- --
Other expense......... (323) (212) (225)
------- ------- -------
Net Income.............. $ 3,706 $ 1,261 $ 1,209
======= ======= =======
Basic earnings per
share.................. $ 1.52 $ 0.54 $ 0.53
======= ======= =======
Average number of shares
outstanding............ 2,442 2,331 2,290
======= ======= =======
Diluted earnings per
share.................. $ 1.50 $ 0.54 $ 0.53
======= ======= =======
Average number of
diluted shares
outstanding............ 2,467 2,331 2,290
======= ======= =======
Dividends declared per
share.................. $ 1.64 $ 0.40 $ 0.53
======= ======= =======

See notes to financial statements.

F-4

ANWORTH MORTGAGE ASSET CORPORATION

STATEMENTS OF STOCKHOLDERS' EQUITY

Years ended December 31, 1999, 2000 and 2001

Accum.
Other
Compre-
Common Common Additional hensive Treasury Compre-
Stock Stock Paid-in Income Retained Stock hensive
Shares Par Value Capital (Loss) Earnings at Cost Income Total
------ --------- ---------- ------- -------- -------- ------- -------
(in thousands except per share amounts)

Balance, December 31,
1998................... 2,328 $23 $18,971 $(1,775) $ 23 $ -- $17,242
Issuance of common
stock.................. 29 -- 99 99
Available-for-sale
securities,
Fair value adjustment.. (576) (576) (576)
Net income.............. 1,209 1,209 1,209
------
Comprehensive income.... $ 633
======
Repurchase of common
stock.................. (50) -- (229) (229)
Dividends declared -
$0.53 per share....... (1,213) (1,213)
----- --- ------- ------- ------ ----- -------
Balance, December 31,
1999................... 2,307 $23 $19,070 $(2,351) $ 19 $(229) $16,532
===== === ======= ======= ====== ===== =======
Issuance of common
stock.................. 43 1 173 174
Available-for-sale
securities,
Fair value adjustment.. 1,165 1,165 1,165
Net income.............. 1,261 1,261 1,261
------
Comprehensive income.... $2,426
======
Dividends declared -
$0.40 per share....... (931) (931)
----- --- ------- ------- ------ ----- -------
Balance, December 31,
2000................... 2,350 $24 $19,243 $(1,186) $ 349 $(229) $18,201
===== === ======= ======= ====== ===== =======
Issuance of common
stock.................. 4,601 46 35,081 35,127
Available-for-sale
securities,
Fair value adjustment.. 1,891 1,891 1,891
Net income.............. 3,706 3,706 3,706
------
Comprehensive income.... $5,597
======
Dividends declared -
$1.64 per share....... (3,928) (3,928)
----- --- ------- ------- ------ ----- -------
Balance, December 31,
2001................... 6,951 $70 $54,324 $ 705 $ 127 $(229) $54,997
===== === ======= ======= ====== ===== =======

See notes to financial statements.

F-5

ANWORTH MORTGAGE ASSET CORPORATION

STATEMENTS OF CASH FLOWS
(in thousands)

For the year ended For the year ended For the year ended
December 31, 2001 December 31, 2000 December 31, 1999
------------------ ------------------ ------------------

Operating Activities:
Net income.............. $ 3,706 $ 1,261 $ 1,209
Adjustments to reconcile
net income to
net cash provided by
operating activities:
Amortization............ 1,186 698 1,468
Gain on sale............ (430) -- --
Decrease (increase) in
accrued interest
receivable............. (1,203) 21 300
Decrease (increase) in
prepaid expenses and
other.................. 3 36 (34)
Increase (decrease) in
accrued interest
payable................ (413) (739) 646
Increase (decrease) in
accrued expenses and
other.................. 829 (118) 96
-------- ------- -------
Net cash provided by
operating activities... 3,678 1,159 3,685
Investing Activities:
Available-for-sale
securities:
Purchases............... (300,303) (2,618) (43,658)
Proceeds from sales..... 5,387 -- --
Principal payments...... 51,690 28,930 53,619
-------- ------- -------
Net cash provided by
(used in) investing
activities........... (243,226) 26,312 9,961
Financing Activities:
Net borrowings from
reverse repurchase
agreements............. 203,416 (25,799) (22,343)
Proceeds from common
stock issued, net...... 35,127 173 99
Repurchase of common
stock.................. -- -- (229)
Dividends paid.......... (2,599) (1,254) (1,169)
-------- ------- -------
Net cash provided by
(used in) financing
activities........... 235,944 (26,880) (23,642)
-------- ------- -------
Net increase (decrease)
in cash and cash
equivalents............ (3,604) 591 (9,996)
Cash and cash
equivalents at
beginning of period.... 3,894 3,303 13,299
-------- ------- -------
Cash and cash
equivalents at end of
period................. $ 290 $ 3,894 $ 3,303
======== ======= =======
Supplemental Disclosure
of Cash Flow
Information Cash paid
for interest........... $ 6,776 $ 9,413 $ 7,246
Supplemental Disclosure
of Investing and
Financing Activities
Mortgage securities
purchased, not yet
settled................. $ 40,819 $ -- $ --

See notes to financial statements.

F-6

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS

NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Anworth Mortgage Asset Corporation (the "Company") was incorporated in
Maryland on October 20, 1997. The Company commenced its operations of
purchasing and managing an investment portfolio of primarily adjustable-rate
mortgage-backed securities on March 17, 1998, upon completion of the initial
public offering of its common stock.

A summary of the Company's significant accounting policies follows:

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less. The carrying amount of cash
equivalents approximates their fair market value.

SECURITIES

The Company invests primarily in adjustable-rate mortgage pass-through
certificates and hybrid adjustable-rate mortgage-backed securities ("ARM"
securities). Hybrid ARM securities have an initial interest rate that is fixed
for a certain period, usually three to five years, and then adjusts annually
for the remainder of the term of the loan.

The Company classifies its investments as either trading investments,
available-for-sale investments or held-to-maturity investments. Management
determines the appropriate classification of the securities at the time they
are acquired and evaluates the appropriateness of such classifications at each
balance sheet date. The Company currently classifies all of its securities as
available-for-sale. All assets that are classified as available-for-sale are
carried at fair value and unrealized gains or losses are included in other
comprehensive income or loss as a component of stockholders' equity.

Interest income is accrued based on the outstanding principal amount of the
ARM securities and their contractual terms. Premiums and discounts associated
with the purchase of ARM securities are amortized into interest income over
the estimated lives of the assets adjusted for estimated prepayments using the
effective yield method.

Securities are recorded on the date the securities are purchased or sold.

CREDIT RISK

At December 31, 2001, the Company had limited its exposure to credit losses on
its portfolio of ARM securities by purchasing primarily securities from
Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage
Association ("FNMA"). The payment of principal and interest on the FHLMC and
FNMA mortgage backed securities are guaranteed by those respective agencies.
At December 31, 2001, because of the government agencies' guarantee, all of
the Company's mortgage backed securities have an implied "AAA" rating.

INCOME TAXES

The Company intends to elect to be taxed as a Real Estate Investment Trust
("REIT") and to comply with the provisions of the Internal Revenue Code with
respect thereto. Accordingly, the Company is not subject to Federal income tax
to the extent that its distributions to stockholders satisfy the REIT
requirements and certain asset, income and stock ownership tests are met.

F-7

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

EARNINGS PER SHARE (EPS)

Basic EPS is computed by dividing net income by the weighted average number of
common shares outstanding during the period. Diluted EPS assumes the
conversion, exercise or issuance of all potential common stock equivalents
unless the effect is to reduce a loss or increase in the income per share. For
the years ended December 31, 2000 and 1999, stock options that could
potentially dilute basic EPS in the future were not included in the
computation of diluted EPS because to do so would have been antidilutive. The
computation of EPS for the year ended December 31, 2001 is as follows:

Earnings
Income Shares Per Share
------ ------ ---------
(in thousands except
per share data)

For the year ended December 31, 2001
Basic EPS............................................... 3,706 2,442 $1.52
=====
Effect of dilutive securities:
Stock options........................................... 25
----- -----
Diluted EPS............................................. 3,706 2,467 $1.50
===== ===== =====

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is effective for all fiscal years
beginning after December 15, 2000. SFAS No. 133 established a framework of
accounting rules that standardize accounting for all derivative instruments.
The Statement requires that all derivative financial instruments be carried on
the balance sheet at fair value. The Company has not yet acquired any
derivative instruments.

NOTE 2. SECURITIES

The following table summarizes the Company's mortgage-backed securities
("MBS") classified as available-for-sale as of December 31, 2001 and 2000,
which are carried at their fair value (in thousands):

December 31, 2001

Federal Federal Other
Home Loan National Mortgage- Total
Mortgage Mortgage backed MBS
Corporation Association Securities Assets
----------- ----------- ---------- --------

Amortized Cost..................... $137,937 $280,458 $ -- $418,395
Paydowns receivable................ 1,426 -- -- 1,426
Unrealized gains................... 222 921 -- 1,143
Unrealized losses.................. (226) (524) -- (750)
-------- -------- ---- --------
Fair value......................... $139,359 $280,855 $ -- $420,214
======== ======== ==== ========

F-8

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

December 31, 2000

Federal Federal Other
Home Loan National Mortgage- Total
Mortgage Mortgage backed MBS
Corporation Association Securities Assets
----------- ----------- ---------- --------

Amortized Cost..................... $23,602 $111,379 $487 $135,468
Paydowns receivable................ 560 -- -- 560
Unrealized gains................... 28 189 29 246
Unrealized losses.................. (233) (1,152) -- (1,385)
------- -------- ---- --------
Fair value......................... $23,957 $110,416 $516 $134,889
======= ======== ==== ========

In addition, at December 31, 2001, the Company held positions in preferred
stock of another mortgage REIT, valued at $1,803,000. The following table
summarizes the Company's securities as of December 31, 2001 and 2000 at their
fair value (in thousands):
December 31, 2001

REIT
ARMS HYBRIDS FIXED Stock Total
-------- ------- ------- ------ --------

Amortized Cost..................... $250,525 $99,454 $68,416 $1,491 $419,886
Paydowns receivable................ 625 801 -- -- 1,426
Unrealized gains................... 658 57 428 312 1,455
Unrealized losses.................. (216) (439) (95) -- (750)
-------- ------- ------- ------ --------
Estimated fair value............... $251,592 $99,873 $68,749 $1,803 $422,017
======== ======= ======= ====== ========

December 31, 2000

REIT
ARMS HYBRIDS FIXED Stocks Total
------- ------- ------- ------ --------

Amortized Cost..................... $96,651 $18,270 $19,986 $1,995 $136,902
Paydowns receivable................ 553 7 -- -- 560
Unrealized gains................... 650 -- 157 -- 807
Unrealized losses.................. (1,000) (138) (247) (47) (1,432)
------- ------- ------- ------ --------
Estimated fair value............... $96,854 $18,139 $19,896 $1,948 $136,837
======= ======= ======= ====== ========

NOTE 3. REVERSE REPURCHASE AGREEMENTS

The Company has entered into reverse repurchase agreements to finance most of
its ARM securities. The reverse repurchase agreements are short-term
borrowings that bear interest rates that have historically moved in close
relationship to LIBOR (London Interbank Offer Rate). These agreements are
collateralized by mortgage backed securities with a fair value of
$370,564,000.

At December 31, 2001, the repurchase agreements had a weighted average
interest rate of 2.49%, an average maturity of 179 days and the following
remaining maturities (in thousands):

Within 59 days......................................................... $118,703
60 to 89 days.......................................................... 43,708
90 to 365 days......................................................... 127,146
Over one year.......................................................... 35,750
--------
$325,307
========

F-9

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

NOTE 4. FAIR VALUES OF FINANCIAL INSTRUMENTS

ARM securities and other marketable securities are reflected in the financial
statements at estimated fair value. Management bases its fair value estimates
for ARM securities and other marketable securities primarily on third-party
bid price indications provided by dealers who make markets in these financial
instruments when such indications are available. However, the fair value
reported reflects estimates and may not necessarily be indicative of the
amounts the Company could realize in a current market exchange. Cash and cash
equivalents, interest receivable, reverse repurchase agreements and payables
for securities purchased are reflected in the financial statements at their
costs, which approximates their fair value because of the short-term nature of
these instruments.

NOTE 5. PUBLIC OFFERINGS AND CAPITAL STOCK

On December 27, 2001 the Company completed a follow-on offering of common
stock, $0.01 par value. The Company issued 4,025,000 shares of common stock
pursuant to a public offering at a price of $8.30 per share and received net
proceeds of $31,320,000, net of underwriting discount of $0.51875 per share.
Offering costs in connection with the public offering, including the
underwriting discount and other expenses, which are estimated to total
$575,000, have been charged against the proceeds of the offering. Also on
December 27, 2001, the Company issued 500,000 shares of common stock pursuant
to a private placement; the Company received net proceeds of $3,891,000 as a
result of this transaction.

The Company's authorized capital includes 20 million shares of $.01 par value
preferred stock. The preferred stock may be issued in one or more classes or
series, with such distinctive designations, rights and preferences as
determined by the Board of Directors.

During the year ended December 31, 2001, the Company declared dividends to
stockholders totaling $1.64 per share, of which $1.09 has been paid, $0.25 is
payable on January 15, 2002 and $0.30 is payable on January 22, 2002. For
Federal income tax purposes such dividends are ordinary income and long-term
capital gains distributions to the Company's stockholders.

Late in 1998 the Board of Directors authorized the repurchase of 50,000 shares
of the Company's common stock. During 1999 the Company completed this
repurchase at an average cost of $4.58 per share.

In September of 1999, the Company filed with the Securities and Exchange
Commission its Dividend Reinvestment and Direct Stock Purchases Plan. The plan
allows shareholders and non-shareholders to purchase shares of the Company's
common stock and to reinvest dividends in additional shares of the Company's
common stock. Through December 31, 2001, the Company raised equity capital of
$803,000 as a result of this plan, $491,000 of which was raised in 2001.

On February 19, 2002, the Company completed another follow-on offering of
common stock, $0.01 par value. The Company issued 4,200,000 shares of common
stock pursuant to a public offering at a price of $8.85 per share and received
net proceeds of $34,847,000, net of underwriting discount of $0.553125 per
share. Offering costs in connection with the public offering, including the
underwriting discount and other expenses, which are expected to total
$319,000, will be charged against the proceeds of the offering. On February
28, 2002 the underwriters exercised their over-allotment option, purchasing an
additional 630,000 shares of common stock. As a result, the Company received
additional net proceeds of $5,227,0000, net of the underwriting discount of
$0.553125 per share.

F-10

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 6. TRANSACTIONS WITH AFFILIATES

The Company entered into a Management Agreement (the "Agreement") with Anworth
Mortgage Advisory Corporation (the "Manager"), effective March 12, 1998. Under
the terms of the Agreement, the Manager, subject to the supervision of the
Company's Board of Directors, is responsible for the management of the day-to-
day operations of the Company and provides all personnel and office space.

The Company pays the Manager an annual base management fee equal to 1% of the
first $300 million of Average Net Invested Assets (as defined in the
Agreement), plus 0.8% of the portion above $300 million (the "Base Management
Fee").

In addition to the Base Management Fee, the Manager receives as incentive
compensation for each fiscal quarter an amount equal to 20% of the Net Income
of the Company, before incentive compensation, for such fiscal quarter in
excess of the amount that would produce an annualized Return on Equity
(calculated by multiplying the Return on Equity for such fiscal quarter by
four) equal to the Ten-Year U.S. Treasury Rate for such fiscal quarter plus 1%
(the "Incentive Fee").

For the period ended December 31, 2001, the Company paid the Manager $208,000
in Base Management Fees and $598,000 in Incentive Fees; for the year ended
December 31, 2000, the Company paid the Manager $167,000 in Base Management
Fees and no Incentive Fees. For the year ended December 31, 1999 the Company
paid the Manager $175,000 in Base Management Fees and no Incentive Fee.

On October 29, 2001, the Manager granted the Company an option, exercisable on
or before April 30, 2003 to acquire the Manager by merger for consideration
consisting of 240,000 shares of common stock. The merger would be subject to a
number of conditions, including the approval of the Company's stockholders.

NOTE 7. STOCK OPTION PLAN

The Company has adopted the Anworth Mortgage Asset Corporation 1997 Stock
Option and Awards Plan (the "Stock Option Plan") which authorizes the grant of
options to purchase an aggregate of up to 300,000 of the outstanding shares of
the company's common stock. The plan authorizes the Board of Directors, or a
committee of the Board of Directors, to grant incentive stock options ("ISOs")
as defined under section 422 of the Internal Revenue Code of 1986, as amended,
options not so qualified ("NQSOs"), dividend equivalent rights ("DERs") and
stock appreciation rights ("SARs"). The exercise price for any option granted
under the Stock Option Plan may not be less than 100% of the fair market value
of the shares of common stock at the time the option is granted. During the
period ended December 31, 1998, the Company had granted 148,000 options at an
exercise price of $9 per share and 136,000 DERs. For these options, those
granted to officers become exercisable over a three year period following
their date of grant, while those granted to directors become exercisable six
months after their date of grant. During the year ended December 31, 1999, the
Company granted an additional 50,000 options at an exercise price of $4.60 and
12,500 DER's. These options become exercisable three years after the date of
grant. During the year ended December 31, 2001, the Company granted an
additional 140,856 options at exercise prices which range from $6.70 to $7.81.
These options became exercisable on the date of grant. All options granted
expire on March 11, 2008. The DER's are payable only when their associated
stock options are exercised, thereby reducing the effective strike price of
such options. The Company recognizes compensation expense at the time the
average market price of the stock exceeds the effective strike price of the
options. Since inception, the Company has recorded $73,000 in compensation
expense related to the DER's. During the quarter ended June 30, 2001, 114,000
of the outstanding DER's were truncated, and shortly after June 30, 2001 the
remaining 34,500 DER's were truncated. After the dividend declared on April
20, 2001, no more dividends accrued to the DER's, thereby fixing the effective
strike price of the options.

F-11

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

The Company adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation."
Accordingly, no compensation cost has been recognized for grants under the
Stock Option Plan. Had compensation cost for the Company's stock option plan
been determined based on the fair value at the grant date for awards
consistent with the provisions of SFAS No. 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
in the table below. The fair value of each option grant is estimated on the
date of grant using the Black-Scholes option-pricing model:

2001 2000 1999
------- -------- -------

Net income--as reported (in thousands)................. $3,706 $1,261 $1,209
Net income--pro forma (in thousands)................... $3,445 $1,167 $1,115
Basic earnings per share--as reported.................. $1.52 $0.54 $0.53
Basic earnings per share--pro forma.................... $1.41 $0.50 $0.49
Diluted earnings per share--as reported................ $1.50 $0.54 $0.53
Diluted earnings per share--pro forma.................. $1.40 $0.50 $0.49
Assumptions:
Dividend yield....................................... 10% n/a 10%
Expected volatility.................................. 41% n/a 35%
Risk-free interest rate.............................. 4.98 n/a 6.6%
Expected lives....................................... 7 years n/a 7 years

The fair value of the options granted in 2001 range from $1.13 to $1.77. The
fair value of options granted during 1999 was $1.75 per share.

2001 2000 1999
------------------------ ------------------------ ------------------------
Weighted Average Weighted Average Weighted Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
------- ---------------- ------- ---------------- ------- ----------------

Outstanding, beginning
of year................ 198,000 $7.889 198,000 $7.889 148,000 $9.000
Granted................. 140,856 7.014 -- -- 50,000 4.600
Exercised............... -- -- -- -- -- --
Expired................. -- -- -- -- -- --
------- ------ ------- ------ ------- ------
Outstanding, end of
year................... 338,856 $7.525 198,000 $7.889 198,000 $7.889
======= ====== ======= ====== ======= ======
Weighted average fair
value of options
granted during the
year................... $ 1.43 n/a $ 1.75
Options exercisable at
year end............... 288,856 98,568 49,284

The following table summarizes information about stock options outstanding at
December 31, 2001:

Effective
Exercise Price Remaining
Exercise After DER's Options Contractual Exercisable
Price are paid Outstanding Life (Yrs) at 12/31/01
-------- -------------- ----------- ----------- -----------

$4.60 $4.35 50,000 7.3 --
$6.70 $6.70 87,560 9.5 87,560
$7.10 $7.10 9,000 9.6 9,000
$7.37 $7.37 19,296 4.5 19,296
$7.81 $7.81 25,000 4.6 25,000
$9.00 $6.60 148,000 6.2 148,000
------- --- -------
338,856 7.1 288,856

F-12

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

NOTE 8. SUMMARIZED QUARTERLY RESULTS (UNAUDITED)

For the year ended December 31, 2001:

First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands except per share
data)

Interest and dividend income............... $2,556 $2,518 $2,564 $3,130
Interest expense........................... (1,921) (1,650) (1,403) (1,389)
Net interest income........................ 635 868 1,161 1,741
Gain on sale............................... 71 81 166 112
Expenses................................... (162) (255) (303) (409)
Net Income................................. $ 544 $ 694 $1,024 $1,444
Basic earnings per share................... $ 0.23 $ 0.29 $ 0.43 $ 0.54
Diluted earnings per share................. $ 0.23 $ 0.29 $ 0.42 $ 0.53
Average number of shares outstanding
(diluted)................................. 2,354 2,368 2,423 2,725

For the year ended December 31, 2000:

First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands except per share
data)

Interest and dividend income............... $2,627 $2,646 $2,549 $2,493
Interest expense........................... (2,132) (2,181) (2,241) (2,120)
Net interest income........................ 495 465 308 373
Expenses................................... (101) (97) (99) (83)
Net Income................................. $ 394 $ 368 $ 209 $ 290
Basic and diluted earnings per share....... $ 0.17 $ 0.16 $ 0.09 $ 0.12
Average number of shares outstanding....... 2,314 2,326 2,338 2,346

F-13

EXHIBIT INDEX

Exhibit
Number Description
------- -----------

- --------
(1) Incorporated by reference from Anworth's Registration Statement on Form S-
3, Registration No. 333-81698, filed on January 30, 2002.
(2) Incorporated by reference from Anworth's Registration Statement on Form S-
11, Registration No. 333-38641, which became effective under the Securities
Act of 1933, as amended, on March 12, 1998.
(3) Incorporated by reference from Anworth's Registration Statement on Form S-
3, Registration No. 333-87555, filed on September 22, 1999.
(4) Incorporated by reference from Anworth's Definitive Proxy Statement on
Schedule 14A, filed on April 30, 2001.
(5) Incorporated by reference to Anworth's Registration Statement on Form S-2,
Registration No. 333-71786, which became effective under the Securities Act
of 1933, as amended, on December 20, 2001.