Edgar Filing: ANWORTH MORTGAGE ASSET CORP

Filed Pursuant To Rule 424(B)1
File Number 333-76642

PROSPECTUS

4,200,000 Shares

[LOGO] LOGO OF ANWORTH MORTGAGE ASSET CORPORATION

Anworth Mortgage Asset Corporation

Common Stock

We are selling 4,200,000 shares of our common stock and we will receive all
of the net proceeds from the sale. Our common stock is traded on the American
Stock Exchange under the symbol "ANH." On February 12, 2002, the last reported
sale price of our common stock was $9.12 per share.

Investing in our common stock involves a high degree of risk. You should
carefully consider the information under the heading "Risk Factors" beginning
on page 6 of this prospectus before buying shares of our common stock.

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

Per Share Total
--------- -----------

Public offering price............................ $ 8.85 $37,170,000
Underwriting discounts and commissions........... $0.553125 $ 2,323,125
Proceeds, before expenses, to us................. $8.296875 $34,846,875

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

Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities, or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.

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

We have granted the underwriters a 30-day option to purchase up to an
additional 630,000 shares of our common stock to cover over-allotments, if any,
at the public offering price per share.

The underwriters expect the shares of our common stock will be ready for
delivery to purchasers on or about February 19, 2002.

FRIEDMAN BILLINGS RAMSEY

ADVEST, INC.

WEDBUSH MORGAN SECURITIES INC.

The date of this prospectus is February 13, 2002

You should rely only on the information contained in or incorporated by
reference into this prospectus. Neither the underwriters nor we have authorized
any other person to provide you with different information. If anyone provides
you with different or inconsistent information, you should not rely on it. The
information in this prospectus is current as of the date of this prospectus.
Our business, financial condition, results of operations and prospects may have
changed since that date.

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

TABLE OF CONTENTS

Page
----

Forward-Looking Statements................................................ ii
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 6
Market Price and Dividends on Our Common Stock............................ 17
Capitalization............................................................ 18
Selected Financial Data................................................... 19
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 20
Our Company............................................................... 32
Description of Securities................................................. 39
Certain Federal Income Tax Considerations................................. 44
Underwriting.............................................................. 55
Experts................................................................... 56
Legal Matters............................................................. 56
Where You Can Find More Information....................................... 57
Information Incorporated by Reference..................................... 57
Financial Information..................................................... F-1

FORWARD-LOOKING STATEMENTS

This prospectus 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. Statements regarding the following subjects are
forward-looking by their nature:

. our business strategy;

. market trends and risks;

. assumptions regarding interest rates; and

. assumptions regarding prepayment rates on the mortgage loans securing our
mortgage-backed securities.

These forward-looking statements are subject to various risks and
uncertainties, including those relating to:

. increases in the prepayment rates on the mortgage loans securing our
mortgage-backed securities;

. our ability to use borrowings to finance our assets;

. risks associated with investing in mortgage-related assets, including
changes in business conditions and the general economy;

. our ability to maintain our qualification as a real estate investment
trust for federal income tax purposes; and

. management's ability to manage our growth and planned expansion.

Other risks, uncertainties and factors, including those discussed under
"Risk Factors" in this prospectus or described in reports that we file from
time to time with the Securities and Exchange Commission, such as our Forms
10-K and 10-Q, could cause our actual results to differ materially from those
projected in any forward-looking statements we make. We are not obligated to
publicly update or revise any forward-looking statements, whether as a result
of new information, future events or otherwise.

PROSPECTUS SUMMARY

This summary highlights selected information in this prospectus. The summary
is not complete and does not contain all of the information you should consider
before investing in our common stock. We urge you to carefully read this entire
prospectus, including the financial statements, along with the information that
is incorporated by reference into this prospectus. You should carefully
consider the information discussed under "Risk Factors" before you decide to
purchase our common stock. All references to "we," "us" or the "Company" mean
Anworth Mortgage Asset Corporation. Unless otherwise indicated, we have assumed
that the underwriters do not exercise their over-allotment option.

Our Business

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. We seek attractive
long-term investment returns by investing our equity capital and borrowed funds
in such securities. 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.

At September 30, 2001, we had total assets of $223.7 million and equity of
$22.0 million, or $9.16 book value per share. As of that date, approximately
94% of our assets consisted of mortgage-backed securities guaranteed by an
agency of the United States government such as Fannie Mae or Freddie Mac. For
the quarter ended September 30, 2001, we reported net income of $1.02 million,
or $0.42 per diluted share and for the nine months ended September 30, 2001, we
reported net income of $2.26 million, or $0.95 per diluted share.

Our Strategy

Our strategy is to acquire mortgage-related assets, finance our purchases in
the capital markets and use leverage to increase our return on stockholders'
equity. Through this strategy we expect to earn income that will enable us to
generate dividends for our stockholders.

We intend to acquire mortgage-related assets that we believe will generate
attractive returns on capital invested. Before making these investments, we
consider the amount and nature of the anticipated returns from the assets, our
ability to pledge the assets to secure collateralized borrowings, and the costs
associated with financing, managing, securitizing and reserving for the assets.
We have also established a written asset acquisition policy that provides the
following investment guidelines:

. 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.

We finance our acquisition of mortgage-related assets through borrowing at
short-term rates using repurchase agreements. We generally borrow between eight
and twelve times the amount of our equity. At September 30, 2001, we had
$179.6 million of repurchase agreements outstanding with a weighted average
current borrowing rate of 3.45% and an average maturity of 68 days. 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 also seek to lessen the effects on our income if mortgage loans
underlying our securities prepay at a rate materially different than
anticipated. We do this by structuring a diversified portfolio with a variety
of prepayment characteristics, investing in mortgage assets or structures with
prepayment protections and purchasing mortgage assets at a premium and at a
discount. Although we have not yet done so, we may choose to engage in various
hedging activities designed to mitigate our exposure to changes in interest
rates and prepayment rates.

We review credit risk and other risks of loss associated with each potential
investment and may diversify our portfolio to avoid undue geographic, insurer,
industry and other types of concentrations. Given the fact that we maintain
such a large percentage of our assets in high quality or highly rated assets,
many of which include an implied guarantee of the federal government as to
payment of principal and interest, we believe we have limited exposure to
losses from credit risk.

In addition to the strategies described above, we intend to pursue other
strategies to 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,
possibly using commercial paper, medium term note programs, preferred
stock and other forms of capital.

Our Manager and Executive Officers

Our day-to-day operations are conducted by our management company, Anworth
Mortgage Advisory Corporation, through the authority delegated to it under a
management agreement and pursuant to the policies established by our board of
directors. We have currently elected to be managed by our management company as
a result of the efficiencies and economies of scale that can be achieved by
utilizing the resources presently available to our management company. A trust
controlled by our Chairman and Chief Executive Officer, Lloyd McAdams, and our
Executive Vice President, Heather U. Baines, is the principal stockholder of
our management company and Pacific Income Advisers, Inc., an investment
advisory firm that began operations in 1986. As of September 30, 2001, Pacific
Income Advisers and its affiliates managed approximately $4 billion for
institutional and individual investors. Our executive officers also serve as
members of the management teams of our management company and Pacific Income
Advisers. A majority of our board of directors is unaffiliated with either our
management company or Pacific Income Advisers. We have no ownership interest in
our management company or Pacific Income Advisers.

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. We also pay our management company
an annual incentive compensation fee of 20% of the amount by which our return
on our equity exceeds a return based on the ten-year U.S. Treasury Rate plus 1%.

Our executive officers are as follows:

Lloyd McAdams. Mr. McAdams is Chairman of the Board, President and Chief
Executive Officer of our company and our management company. Mr. McAdams is
also the Chairman of the Board, Chief Investment Officer and co-founder of
Pacific Income Advisers and is the President of Syndicated Capital, Inc., a
registered broker-dealer. Mr. McAdams also serves as a director of Monterey
Mutual Fund. Before joining Pacific Income Advisers, Mr. McAdams was President
of Security Pacific Investment Managers, Inc. and served as Senior Vice
President of Trust Company of the West. Mr. McAdams is a Chartered Financial
Analyst, Chartered Investment Counselor and a Certified Employee Benefit
Specialist.

Pamela J. Watson. Ms. Watson is Executive Vice President and the Chief
Financial Officer, Treasurer and Secretary of our company and an Executive Vice
President and the Chief Financial Officer and Secretary of our management
company. Ms. Watson is also Vice President of Pacific Income Advisers. Prior to
joining Pacific Income Advisers, Ms. Watson was Chief Financial Officer of
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.

Heather U. Baines. Ms. Baines is Executive Vice President of our company
and our management company. Ms. Baines is also the President, Chief Executive
Officer and co-founder of Pacific Income Advisers. Prior to joining Pacific
Income Advisers, Ms. Baines was employed by Security Pacific Investment
Managers, Inc., ultimately holding the position of Senior Vice President and
Director.

Evangelos Karagiannis. Mr. Karagiannis is Vice President of our company and
our management company with responsibility for managing our portfolio. Mr.
Karagiannis is also Vice President of Pacific Income Advisers where he serves
as Fixed Income Portfolio Manager with a specialty in mortgage securities and
is responsible for Pacific Income Advisers' quantitative research. Mr.
Karagiannis is a Chartered Financial Analyst and holds a Ph.D. in physics.

Joseph E. McAdams. Mr. McAdams is Vice President of our company and our
management company with responsibility for managing our portfolio. Mr. McAdams
is Vice President of Pacific Income Advisers where he serves as Fixed Income
Portfolio Manager with a specialty in mortgage securities and is responsible
for Pacific Income Advisers' fixed income trading. Prior to joining Pacific
Income Advisers, Mr. McAdams was a mortgage security trader and analyst at
Donaldson, Lufkin & Jenrette Securities Corp. in New York. Mr. McAdams is also
a Chartered Financial Analyst.

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 the other key employees of the
management company, adopt an incentive compensation plan for our key executives
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.

General Information

We were incorporated on October 20, 1997 under Maryland law. Our office is
located at 1299 Ocean Avenue, 2nd Floor, Santa Monica, California 90401. Our
telephone number is (310) 394-0115.

The Offering

Common stock offered....................................... 4,200,000 shares(1)
Common stock outstanding after the offering................ 11,173,327 shares(2)
American Stock Exchange trading symbol..................... ANH

--------
(1)4,830,000 shares of common stock if the underwriters exercise their
over-allotment option in full.
(2)11,803,327 shares of common stock if the underwriters exercise their
over-allotment option in full. Includes 4,025,000 shares of common stock
issued in a public offering completed on December 27, 2001 and 500,000
shares of common stock issued in a private placement completed on that same
date. Also includes 50,968 shares of common stock issued after September 30,
2001 pursuant to our Direct Stock Purchase Plan and our Dividend
Reinvestment Plan. Does not include 477,361 shares of common stock that may
be issued upon the exercise of outstanding options granted under our 1997
Stock Option and Awards Plan at exercise prices ranging from $4.60 to $9.45
per share or 56,690 shares of common stock that may be acquired pursuant to
outstanding dividend equivalent rights. A total of 600,000 shares of our
common stock are currently authorized for issuance under our 1997 Stock
Option and Awards Plan.

Use Of Proceeds

We are conducting this offering to increase our equity capital base which
will allow us to grow our balance sheet through the deployment of the equity
and the use of leverage. We will use the net proceeds from this offering to
acquire mortgage-related assets consistent with our investment policy. We then
intend to increase our investment assets by borrowing against these
mortgage-related assets and using the proceeds of such borrowings to acquire
additional mortgage-related assets. The net proceeds from the sale of 4,200,000
shares of our common stock, based on an offering price of $8.85, will be
approximately $34.6 million after deducting underwriting discounts and
commissions and estimated expenses of the offering. Pending such investment, we
will place the net proceeds in interest-bearing bank accounts or in readily
marketable, interest-bearing securities.

Recent Developments

For the fourth quarter of 2001, we declared dividends totaling $0.55 per
share. The fourth quarter 2001 dividends consist of a dividend of $0.25 per
share declared on October 25, 2001 and a dividend of $0.30 per share declared
on December 17, 2001. Shares purchased in this offering will not participate in
either of those fourth quarter 2001 dividends.

On December 27, 2001, we completed a public offering of 4,025,000 shares of
our common stock and received approximately $30.7 million in net proceeds after
deducting underwriting discounts and commissions and expenses of that offering.
On December 27, 2001, we also completed a private placement of 500,000 shares
of our common stock and received approximately $3.85 million in net proceeds
after deducting expenses of that offering.

On January 23, 2002, we reported our unaudited results of operations for the
quarter and year ended December 31, 2001. For the quarter ended December 31,
2001, we reported earnings of $1,444,000 or $0.54 per share based on 2,658,427
weighted average common shares outstanding and $0.53 per share on a fully
diluted basis. For the year ended December 31, 2001, our earnings were
$3,706,000 or $1.50 per share based on the weighted average common shares
outstanding for 2001 on a fully diluted basis.

At December 31, 2001, we held total assets of $424.6 million and our
mortgage assets included 63% in adjustable-rate mortgage-backed securities, 21%
in hybrid adjustable-rate mortgage-backed securities, 13% in fixed-rate
mortgage-backed securities and 2% in collateralized mortgage obligations. Our
total assets at December 31, 2001 included $216.9 million in mortgage-backed
securities purchased since the closings of our public offering and private
placement on December 27, 2001. At December 31, 2001, approximately 99.6% of
our mortgage assets were guaranteed by an agency of the United States
government such as Fannie Mae or Freddie Mac. The weighted average maturity of
our outstanding repurchase agreements increased from 68 days as of September
30, 2001 to 179 days as of December 31, 2001.

Between January 1, 2002 and January 18, 2002 we purchased $112.1 million in
mortgage-backed securities guaranteed by an agency of the United States
government.

Summary Financial Data

You should read these summary 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 prospectus beginning on page F-1.

Nine Months Three Months
Period from Ended Ended
March 17 to Year Ended September 30, September 30,
December 31, December 31, (unaudited) (unaudited)
------------ ---------------- ---------------- ----------------
1998 1999 2000 2000 2001 2000 2001
------------ ------- ------- ------- ------- ------- -------
(amounts in thousands, except per share data)

Statement of Operations Data:
Interest and dividend income................ $ 8,570 $ 9,501 $10,314 $ 7,822 $ 7,639 $ 2,549 $ 2,564
Interest expense............................ (7,378) (7,892) (8,674) (6,654) (4,974) (2,241) (1,403)
------- ------- ------- ------- ------- ------- -------
Net interest income......................... 1,192 1,609 1,640 1,268 2,665 308 1,161
Gain on sales............................... -- -- -- -- 318 -- 166
Expenses.................................... (307) (400) (379) (297) (720) (99) (303)
------- ------- ------- ------- ------- ------- -------
Net Income.................................. $ 885 $ 1,209 $ 1,261 $ 971 $ 2,263 $ 209 $ 1,024
======= ======= ======= ======= ======= ======= =======
Diluted net income per share................ $ 0.38 $ 0.53 $ 0.54 $ 0.42 $ 0.95 $ 0.09 $ 0.42
Dividends declared per share (1)............ $ 0.37 $ 0.53 $ 0.51 $ 0.40 $ 0.98 $ 0.10 $ 0.54
Weighted average common shares outstanding.. 2,316 2,290 2,331 2,326 2,381 2,338 2,423

At September 30,
At December 31, (unaudited)
--------------------------- -----------------
1998 1999 2000 2000 2001
-------- -------- -------- -------- --------
(amounts in thousands, except per share data)

Balance Sheet Data:
Mortgage-backed securities, net.. $184,245 $161,488 $134,889 $140,494 $210,159
Total assets..................... $199,458 $167,144 $141,834 $144,771 $223,681
Repurchase agreements............ $170,033 $147,690 $121,891 $126,524 $179,567
Total liabilities................ $182,216 $150,612 $123,633 $127,703 $201,730
Stockholders' equity............. $ 17,242 $ 16,532 $ 18,201 $ 17,068 $ 21,951
Book value per share............. $ 7.41 $ 7.17 $ 7.75 $ 7.29 $ 9.16

Nine Months Three Months
Period from Ended Ended
March 17 to Year Ended September 30, September 30,
December 31, December 31, (unaudited) (unaudited)
------------ ----------------- ----------------- -----------------
1998 1999 2000 2000 2001 2000 2001
------------ -------- -------- -------- -------- -------- --------
(dollar amounts in thousands)

Annualized Financial Ratios (unaudited) (2)(5):
Net interest margin (net interest income/average assets).. 0.83% 0.99% 1.08% 1.10% 2.32% 0.83% 2.89%
G&A expenses as a percentage of average assets (6)........ 0.21% 0.24% 0.25% 0.25% 0.35% 0.27% 0.32%
Return on average assets (6).............................. 0.61% 0.74% 0.83% 0.83% 2.24% 0.56% 2.99%
Return on average equity.................................. 5.84% 6.38% 6.58% 6.77% 15.20% 4.36% 20.27%

--------
(1)On September 26, 2000, our board of directors announced that, beginning with
the third quarter of 2000, dividends would 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 $166,000 and $318,000, respectively, for the three
and nine months ended September 30, 2001.
(4)Annualized.
(5)Each ratio for 1998 has been computed by annualizing the results for the
290-day period ended December 31, 1998. Each ratio for the nine months and
three months ended September 30, 2000 has been computed by annualizing the
results for the 274 days and 92 days in those respective periods. Each ratio
for the nine months and three months ended September 30, 2001 has been
computed by annualizing the results for the 273 days and 92 days in those
respective periods.
(6)Excludes incentive fees paid to our management company.

RISK FACTORS

An investment in our common stock involves various risks. You should
carefully consider the following risk factors in conjunction with the other
information contained and incorporated by reference in this prospectus before
purchasing our common stock. If any of the risks discussed in this prospectus
actually occur, our business, operating results, prospects and financial
condition could be harmed. This could cause the market price of our common
stock to decline and could cause you to lose all or part of your investment.

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 September 30, 2001, our adjustable-rate mortgage-backed securities
had a weighted average term to next rate adjustment of approximately 18 months,
while our borrowings had a weighted average term to next rate adjustment of 68
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 September 30, 2001, 16.6% 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 September 30, 2001, approximately 87.5% 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 September 30, 2001, approximately 83.4%

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 prospectus 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 assure you 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 1.5% 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 will 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 may not be able to use the money we raise to acquire investments at
favorable prices.

The net proceeds of this offering will represent a significant increase in
our equity. Depending on the amount of leverage that we use, the full
investment of the net proceeds of this offering will result in a substantial
increase in our total assets. There can be no assurance that we will be able to
invest all of these additional funds in mortgage-backed securities at favorable
prices. As a result, we may not be able to acquire enough mortgage-backed
securities in order to become fully invested after the offering, or we may have
to pay more for mortgage-backed securities than we have historically. In either
case, the return that we earn on stockholders' equity may be reduced.

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 prospectus. 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 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. See page 41 for
a description of these provisions.

. 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." See page 42 for a description of these
provisions.

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.

MARKET PRICE AND DIVIDENDS ON OUR COMMON STOCK

Our stock began trading on March 17, 1998 on the American Stock Exchange and
is traded under the symbol "ANH". As of December 31, 2001, we had 6,950,765
shares of common stock outstanding which were held by 26 holders of record. The
last reported sale price of our common stock on February 12, 2002 was $9.12 per
share. The following table sets forth, for the periods indicated, the high and
low sales prices per share of our common stock.

1999 2000 2001 2002
----------- ----------- ----------- ------------
High Low High Low High Low High Low
----- ----- ----- ----- ----- ----- ------ -----

First Quarter.......................... $5.00 $3.75 $4.69 $4.00 $5.35 $3.94 $10.12 $8.10(1)
Second Quarter......................... $5.00 $4.13 $4.50 $4.13 $6.90 $4.60 -- --
Third Quarter.......................... $5.50 $4.50 $5.06 $4.13 $8.08 $6.35 -- --
Fourth Quarter......................... $5.50 $4.44 $5.00 $3.88 $9.85 $6.60 -- --

--------
(1)The information for the first quarter of 2002 is for January 1, 2002 through
February 12, 2002.

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
16 fiscal quarters. 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
-------------- ------------------

1998
First Quarter ended March 31, 1998......... -- (1)
Second Quarter ended June 30, 1998......... $0.15 June 19, 1998
Third Quarter ended September 30, 1998..... $0.10 September 28, 1998
Fourth Quarter ended December 31, 1998..... $0.12 December 17, 1998

1999
First Quarter ended March 31, 1999......... $0.12 March 17, 1999
Second Quarter ended June 30, 1999......... $0.13 June 17, 1999
Third Quarter ended September 30, 1999..... $0.14 September 20, 1999
Fourth Quarter ended December 31, 1999..... $0.14 December 17, 1999

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 (2). $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 (3). $0.54 October 15, 2001
Fourth Quarter ended December 31, 2001(4).. $0.25 October 25, 2001
Fourth Quarter ended December 31, 2001 (5). $0.30 December 17, 2001

--------
(1) First quarter 1998 was a partial period consisting of 15 days for which
approximately $0.01 per share was earned and no dividend was declared.
(2) 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.
(3) 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.
(4) 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.
(5) 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.

We intend to pay quarterly dividends and to make distributions to our
stockholders of all or substantially all of our taxable income each year,
subject to some adjustments, so as to qualify for the tax benefits accorded to
a REIT under the tax code. All distributions will be made by us at the
discretion of our board of directors and will depend on our taxable 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.

CAPITALIZATION

The following table sets forth our actual capitalization at September 30,
2001, our pro forma capitalization as of September 30, 2001 to reflect our
December 27, 2001 public sale of 4,025,000 shares of our common stock and our
private placement of 500,000 shares of our common stock on that same date for
combined net proceeds of approximately $34.6 million, and our pro forma
capitalization as adjusted to give effect to the issuance of 4,200,000 shares
of our common stock in this offering at a price of $8.85 per share for net
proceeds of approximately $34.6 million, assuming that the underwriters do not
exercise their over-allotment option.

September 30, 2001
----------------------------------
Pro Pro Forma
Actual Forma(1) As Adjusted(1)(2)
------- -------- -----------------
(amounts in thousands)

Stockholders' Equity:
Preferred stock, par value $0.01 per share; 20,000,000
shares authorized; no shares outstanding................. $ -- $ -- $ --
Common stock, par value $0.01 per share; 100,000,000
authorized; 2,397,359 shares issued and outstanding;
6,922,359 issued and outstanding, pro forma; 11,122,359
shares issued and outstanding, as adjusted............... 24 69 111
Additional paid-in capital................................. 19,531 54,081 88,636
Retained earnings.......................................... 1,310 1,310 1,310
Accumulated other comprehensive income (loss) (3).......... 1,315 1,315 1,315
Treasury stock............................................. (229) (229) (229)
------- ------- -------
Total stockholders' equity.............................. $21,951 $56,546 $91,143
======= ======= =======

--------
(1) Does not include 50,968 shares of our common stock issued subsequent to
September 30, 2001 pursuant to our Direct Stock Purchase Plan and our
Dividend Reinvestment Plan, dividend payments of $1,187,113 for the fourth
quarter of 2001 net of dividend reinvestments, a mark-to-market reduction
in the value of our portfolio by $609,538 for the fourth quarter of 2001
and does not reflect any other events or transactions after September 30,
2001.
(2) After deducting estimated underwriting discounts and commissions and
estimated offering expenses payable by us, and assuming no exercise of the
underwriters' over-allotment option to purchase up to an additional 630,000
shares of our common stock.
(3) Represents unrealized gains (losses) resulting from mark-to-market
adjustments on our available for sale securities.

SELECTED FINANCIAL DATA

The selected financial data as of December 31, 2000 and 1999 and the two
years in the period ended December 31, 2000 and the period from commencement of
operations on March 17, 1998 to December 31, 1998 are derived from our audited
financial statements incorporated by reference and included in this prospectus.
The selected financial data as of December 31, 1998 are derived from audited
financial statements not included in this prospectus. The selected financial
data for the three months and nine months ended September 30, 2000 and 2001 are
derived from our unaudited financial statements for these periods. 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
prospectus beginning on page F-1.

Statement of Operations Data:
Days in period.............................. 290 365 366 274 273 92 92
Interest and dividend income................ $ 8,570 $ 9,501 $10,314 $ 7,822 $ 7,639 $ 2,549 $ 2,564
Interest expense............................ (7,378) (7,892) (8,674) (6,554) (4,974) (2,241) (1,403)
------- ------- ------- ------- ------- ------- -------
Net interest income......................... 1,192 1,609 1,640 1,268 2,665 308 1,161
Gain on sales............................... -- -- -- -- 318 -- 166
Expenses.................................... (307) (400) (379) (297) (720) (99) (303)
------- ------- ------- ------- ------- ------- -------
Net Income.................................. $ 885 $ 1,209 $ 1,261 $ 971 $ 2,263 $ 209 $ 1,024
======= ======= ======= ======= ======= ======= =======
Basic net income per average share.......... $ 0.38 $ 0.53 $ 0.54 $ 0.42 $ 0.95 $ 0.09 $ 0.42
Diluted net income per average share........ $ 0.38 $ 0.53 $ 0.54 $ 0.42 $ 0.95 $ 0.09 $ 0.42
Dividends declared per share (1)............ $ 0.37 $ 0.53 $ 0.51 $ 0.40 $ 0.98 $ 0.10 $ 0.54
Weighted average common shares outstanding.. 2,316 2,290 2,331 2,326 2,381 2,338 2,423

Balance Sheet Data:
Mortgage-backed securities, net...... $184,245 $161,488 $134,889 $140,494 $210,159
Total assets......................... $199,458 $167,144 $141,834 $144,771 $223,681
Repurchase agreements................ $170,033 $147,690 $121,891 $126,524 $179,567
Total liabilities.................... $182,216 $150,612 $123,633 $127,703 $201,730
Stockholders' equity................. $ 17,242 $ 16,532 $ 18,201 $ 17,068 $ 21,951
Number of common shares outstanding.. 2,328 2,307 2,350 2,342 2,397
Book value per share................. $ 7.41 $ 7.17 $ 7.75 $ 7.29 $ 9.16

Three Months
Period from Nine Months Ended
March 17 to Year Ended Ended September September 30,
December 31, December 31, 30, (unaudited) (unaudited)
------------ ----------------- ----------------- -----------------
1998 1999 2000 2000 2001 2000 2001
------------ -------- -------- -------- -------- -------- --------
(dollar amounts in thousands)

Other Data (unaudited):
Average earnings assets................................... $181,445 $163,167 $152,289 $155,885 $153,423 $148,340 $160,350
Average borrowings........................................ $165,496 $149,372 $135,631 $138,458 $137,956 $131,880 $145,316
Average equity (2)........................................ $ 19,060 $ 18,931 $ 19,154 $ 19,122 $ 19,848 $ 19,185 $ 20,206
Yield on interest earning assets (3)(4)................... 5.94% 5.82% 6.77% 6.69% 6.64% 6.87% 6.40%
Cost of funds on interest bearing liabilities (4)......... 5.61% 5.28% 6.40% 6.31% 4.81% 6.89% 3.86%
Annualized Financial Ratios (unaudited) (2)(5):
Net interest margin (net interest income/average assets).. 0.83% 0.99% 1.08% 1.10% 2.32% 0.83% 2.89%
G&A expenses as a percentage of average assets (6)........ 0.21% 0.24% 0.25% 0.25% 0.35% 0.27% 0.32%
Return on average assets (6).............................. 0.61% 0.74% 0.83% 0.83% 2.24% 0.56% 2.99%
Return on average equity.................................. 5.84% 6.38% 6.58% 6.77% 15.20% 4.36% 20.27%

--------
(1) On September 26, 2000, our board of directors announced that, beginning
with the third quarter of 2000, dividends would 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 $166,000 and $318,000, respectively, for the three
months and nine months ended September 30, 2001.
(4) Annualized.
(5) Each ratio for 1998 has been computed by annualizing the results for the
290-day period ended December 31, 1998. Each ratio for the nine months and
three months ended September 30, 2000 has been computed by annualizing the
results for the 274 days and 92 days in those respective periods. Each
ratio for the nine months and three months ended September 30, 2001 has
been computed by annualizing the results for the 273 and 92 days in those
respective periods.
(6) Excludes incentive fees paid to our management company.

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

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 several months, 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
2.28% as of September 30, 2001. This decline has reduced the rates at which we
borrow funds to finance our portfolio holdings. Our cost of financing has
declined from 6.76% for the quarter ended December 31, 2000 to 3.86% for the
quarter ended September 30, 2001. This contrasts significantly with the much
less substantial decline of our asset yield from 7.05% for the quarter ended
December 31, 2000 to 6.40% for the quarter ended September 30, 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 September 30, 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

Three Months Ended September 30, 2001 Compared to September 30, 2000

For the quarter ended September 30, 2001, our net income was $1,024,000, or
$0.42 per diluted share based on an average of 2,423,000 shares outstanding.
Net interest income for this quarter totaled $1,161,000 compared to $308,000
for the quarter ended September 30, 2000. Net interest income is comprised of
the interest income earned on mortgage investments, net of premium
amortization, less interest expense from borrowings. For the quarter ended
September 30, 2000, our net income was $209,000. The increase in our net
interest income was due primarily to short-term interest rates paid on our
borrowings decreasing more than the interest rates earned on our
mortgage-related assets. Also, during the third quarter of 2001, we realized a
$166,000 gain on the sale of assets.

For the quarter ended September 30, 2001, our operating expenses increased
to $303,000 from $99,000 for the quarter ended September 30, 2000. This
increase was due primarily to an increase in the incentive compensation earned
by our management company as a result of our improved financial performance.

Our adjusted return on average equity, excluding incentive management fees
and gain or loss on sales, was 5.11%, or 22.05% on an annualized compounded
basis, for the quarter ended September 30, 2001 compared to 1.09%, or 4.43%
annualized, for the quarter ended September 30, 2000. The table below shows the
components of return on average equity:

Net
Interest G&A Net
Income/ Expense(2)/ Income(2)(3)/
Equity Equity Equity
For the Quarter Ended (1): -------- ----------- -------------

September 30, 2001....... 5.75% 0.64% 5.11%
June 30, 2001............ 4.39% 0.85% 3.55%
March 31, 2001........... 3.24% 0.54% 2.70%
December 31, 2000........ 1.93% 0.43% 1.50%
September 30, 2000....... 1.61% 0.52% 1.09%
June 30, 2000............ 2.43% 0.50% 1.93%
March 31, 2000........... 2.59% 0.53% 2.06%

--------
(1)Average equity excludes unrealized gain (loss) on available for sale
mortgage-backed securities.
(2)Excludes incentive fees paid to our management company.
(3)Excludes gain on sale of $71,000 for the quarter ended March 31, 2001,
$81,000 for the quarter ended June 30, 2001 and $166,000 for the quarter
ended September 30, 2001.

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

Annualized
Yield on
Average Average Annualized
Daily Annualized Daily Yield on
Amortized Average Yield on Amortized Average Dividend
Average Cost of Daily Average Cost of Daily and
Daily Cash Mortgage Earning Daily Cash Mortgage Earning Interest
Equivalents Assets Assets Equivalents Assets Assets Income
----------- --------- -------- ----------- ---------- ---------- --------
For the quarter ended: (dollars in thousands)

September 30, 2001.. $4,045 $156,305 $160,350 3.31% 6.48% 6.40% $2,564
June 30, 2001....... $4,706 $148,362 $153,069 4.14% 6.66% 6.58% $2,518
March 31, 2001...... $3,542 $143,408 $146,951 5.39% 7.00% 6.96% $2,556
December 31, 2000... $1,912 $139,590 $141,502 5.86% 7.06% 7.05% $2,493
September 30, 2000.. $2,075 $146,265 $148,340 6.60% 6.88% 6.87% $2,549
June 30, 2000....... $2,186 $154,130 $156,317 6.30% 6.78% 6.77% $2,646
March 31, 2000...... $2,316 $160,684 $163,000 4.86% 6.47% 6.45% $2,627

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

Average Average Average
One-month Cost of Cost of
LIBOR Funds Funds
Average Annualized Relative to Relative to Relative to
Daily Average Average Average Average Average Average
Borrowed Interest Daily Cost One-Month Three-Month Three-month One-month Three-month
Funds Expense of Funds LIBOR LIBOR LIBOR LIBOR LIBOR
-------- -------- ---------- --------- ----------- ----------- ----------- -----------
For the quarter ended: (dollars in thousands)

September 30, 2001.. $145,316 $1,403 3.86% 3.55% 3.46% 0.09% 0.31% 0.40%
June 30, 2001....... $138,275 $1,650 4.84% 4.27% 4.17% 0.10% 0.57% 0.67%
March 31, 2001...... $130,279 $1,921 5.98% 5.47% 5.29% 0.18% 0.51% 0.69%
December 31, 2000... $127,150 $2,120 6.76% 6.64% 6.67% (0.03)% 0.12% 0.09%
September 30, 2000.. $131,880 $2,240 6.89% 6.62% 6.70% (0.08)% 0.17% 0.19%
June 30, 2000....... $138,799 $2,181 6.37% 6.47% 6.65% (0.18)% (0.10)% (0.28)%
March 31, 2000...... $144,696 $2,132 5.98% 5.93% 6.12% (0.19)% (0.05)% (0.14)%

In general, our operating margin can be estimated from the tables above by
comparing the yield on average daily amortized cost of mortgage assets to the
average daily cost of funds. The table below summarizes this operating margin:

Annualized
Yield on Average Annualized
Daily Amortized Average Average
Cost of Daily Cost Operating
Mortgage Assets of Funds Margin
For the quarter ended: ---------------- ---------- ---------

September 30, 2001.. 6.48% 3.86% 2.62%
June 30, 2001....... 6.66% 4.84% 1.82%
March 31, 2001...... 7.00% 5.98% 1.02%
December 31, 2000... 7.06% 6.76% 0.30%
September 30, 2000.. 6.88% 6.89% (0.01)%
June 30, 2000....... 6.78% 6.37% 0.41%
March 31, 2000...... 6.47% 5.98% 0.49%

We pay our management company an annual base management fee, generally based
on average net invested assets, as defined in the management agreement, payable
monthly in arrears as follows: 1% of the first $300 million of average net
invested assets, plus 0.8% of the portion above $300 million.

In order for our management company to earn an incentive fee, the rate of
return on stockholders' investment, as defined in the management agreement,
must exceed the average ten-year U.S. Treasury rate during the quarter plus 1%.
During the third quarter of 2001, our management company earned $174,000 in
incentive fees. During the third quarter of 2001, our return on stockholder's
investment, excluding incentive fees, was 5.45% or, on an annualized basis,
21.81%. The ten-year U.S. Treasury rate for the corresponding period was 4.99%.

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

Management
Fee & Other Incentive Total G&A
Expenses/ Fee/Total Expenses/Total
Total Assets Assets Assets
For the quarter ended: ------------ --------- --------------

September 30, 2001.. 0.23% 0.31% 0.54%
June 30, 2001....... 0.41% 0.21% 0.62%
March 31, 2001...... 0.26% 0.14% 0.40%
December 31, 2000... 0.23% --% 0.23%
September 30, 2000.. 0.27% --% 0.27%
June 30, 2000....... 0.25% --% 0.25%
March 31, 2000...... 0.25% --% 0.25%

Nine Months Ended September 30, 2001 Compared to September 30, 2000

For the nine months ended September 30, 2001, our net income was $2,263,000,
or $0.95 per diluted share, based on an average of 2,423,000 shares
outstanding, compared to $971,000 for the nine months ended September 30, 2000.
Net interest income for this nine-month period totaled $2,665,000 compared to
$1,268,000 for the nine months ended September 30, 2000. Net interest income is
comprised of the interest income earned on mortgage investments, net of premium
amortization, less interest expense from borrowings. The increase in our net
interest income was due primarily to short-term interest rates paid on our
borrowings decreasing more than the interest rates of our mortgage-related
assets. Also, during the first nine months of 2001, we realized a gain on the
sale of assets of $318,000.

For the nine months ended September 30, 2001, our operating expenses
increased to $720,000 from $297,000 for the nine months ended September 30,
2000. This increase was due primarily to a $318,000 incentive management fee
for the nine months ended September 30, 2001 compared to $1,000 for the nine

months ended September 30, 2000 and increases in other operating expenses for
the nine months ended September 30, 2001. The increase in other operating
expenses was due primarily to an increase in compensation expenses associated
with our 1997 Stock Option and Awards Plan.

Our adjusted return on average equity, excluding incentive management fees
and gain or loss on sales, was 11.40%, or 15.20% on an annualized compounded
basis, for the nine months ended September 30, 2001, compared to 5.08%, or
6.77% on an annualized basis, for the nine months ended September 30, 2000. The
table below shows the components of return on average equity:

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

For the nine months ended:(1)
September 30, 2001......... 17.90% 2.70% 15.20%
September 30, 2000......... 8.84% 2.07% 6.77%

--------
(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 sale of $318,000 for the nine months ended September 30,
2001.

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

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

For the nine months ended:
September 30, 2001...... $4,098 $149,325 $153,423 4.23% 6.70% 6.64% $7,639
September 30, 2000...... $2,192 $153,693 $155,885 5.89% 6.70% 6.69% $7,822

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

For the nine months ended:
September 30, 2001...... $137,956 $4,974 4.81% 4.45% 4.33% 0.12% 0.36% 0.48%
September 30, 2000...... $138,458 $6,554 6.31% 6.33% 6.48% (0.15)% (0.02)% (0.17)%

For the nine months ended September 30, 2001, the yield on our average daily
earning assets, including the impact of the amortized premiums and discounts,
was 6.64%. Our weighted average cost of funds at September 30, 2001 was 3.45%.

Annualized
Yield on Average
Daily Amortized Annualized Average
Cost of Average Daily Operating
Mortgage Assets Cost of Funds Margin
---------------- ------------- ---------

For the nine months ended:
September 30, 2001...... 6.70% 4.81% 1.89%
September 30, 2000...... 6.70% 6.31% 0.39%

During the first nine months of 2001, our management company earned $318,000
in incentive fees. During the first nine months of 2001, our return on
stockholder's investment, excluding incentive management fees, was 11.97% or,
on an annualized compounded basis, 15.95%. The ten-year U.S. Treasury rate for
the corresponding period was 5.11%.

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

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

For the nine months ended:
September 30, 2001...... 0.24% 0.19% 0.43%
September 30, 2000...... 0.27% 0.00% 0.27%

Year Ended December 31, 2000 Compared to 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 $211,000, 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 total 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 annualized return on common
equity was 6.58%. 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.

Year Ended December 31, 1999 Compared to the Period from March 17, 1998 to
December 31, 1998

For the year ended December 31, 1999, our net income was $1,209,000, or
$0.53 per share (basic and diluted), based on an average of 2,289,790 shares
outstanding. Net interest income for that year totaled $1,609,000. Net interest
income is comprised of the interest income earned on mortgage investments less
interest expense from borrowings. During the year ended December 31, 1999, we
incurred general and administrative expenses of $400,000, consisting of
operating expense of $225,000, a base management fee of $175,000 and no
incentive management fee.

By comparison, our net income was $885,000 during our initial 290-day period
of operation in 1998. On an annualized basis, our 1998 net income was
$1,114,000. The primary reason for the increase in our profitability in 1999
over 1998 was the relatively stable interest rate environment resulting in
decreased refinancing activity which in turn led to slower prepayments of our
mortgage assets.

Our annual return on average equity was 6.38% for the year ended December
31, 1999. This return compares favorably to the 1998 figure of 5.84%.

For the year ended December 31, 1999, the yield on our total assets,
including the impact of the amortization of premiums and discounts, was 5.82%.
For 1998, this figure was 5.94% on an annualized basis. Our weighted average
cost of funds for the year ended December 31, 1999, was 5.28% compared to 5.61%
for the period ended December 31, 1998.

Beginning in 1999, the incentive fee became subject to an annual
reconciliation so that the incentive fee is based on our management company's
performance for a calendar year rather than a quarter-by-quarter basis. During
the year ended December 31, 1999, our annualized return on common equity was
6.38%. The ten-year U.S. Treasury rate for the corresponding period was 5.63%,
which would dictate a 6.63% hurdle rate. As a result, our management company
earned no performance fee for the year ended December 31, 1999. In 1998, our
management company earned $2,000 of incentive management fee. The incentive
management fee for 1998 was calculated on a quarterly basis because 1998 was
not a full operating year.

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

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

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%
For the period ended December 31, 1998 7.86% 2.02% 5.84%

--------
(1)Average equity excludes unrealized gain (loss) on available for sale
securities.
(2)Excludes incentive fees paid to our management company.

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 Yield
Amortized Yield on Amortized 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, 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
For the period ended December 31, 1998 $6,647 $174,798 $181,445 5.65% 6.04% 5.94% $ 8,570

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
to to to
Average Average Average Average 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
December 31, 2000..................... $135,631 $8,674 6.40% 6.42% 6.54% (0.12)% (0.02)% (0.14)%
For the year ended
December 31, 1999..................... $149,372 $7,892 5.28% 5.25% 5.42% (0.17)% 0.03% (0.14)%
For the period ended
December 31, 1998..................... $165,496 $7,378 5.61% 5.55% 5.54% 0.01% 0.06% 0.07%

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

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

For the year ended December 31, 2000........ 0.23% -- % 0.23%
For the year ended December 31, 1999........ 0.24% -- % 0.24%
For the period ended December 31, 1998...... 0.21% -- % 0.21%

Quarterly Results of Operation

The following data was derived from unaudited consolidated financial
information for each of the eleven quarters ending March 31, 1999 through
September 30, 2001. These data have been prepared on the same basis as the
audited financial statements contained elsewhere in this prospectus and, in the
opinion of management, include 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, March 31,
1999 1999 1999 1999 2000 2000 2000 2000 2001
--------- -------- --------- -------- --------- -------- --------- -------- ---------

Statement of Operations Data: (amounts in thousands, except per share data)
Interest and dividend income........... $ 2,404 $ 2,211 $ 2,349 $ 2,537 $ 2,627 $ 2,646 $ 2,549 $ 2,493 $ 2,556
Interest expense....................... (2,036) (1,816) (1,921) (2,119) (2,132) (2,181) (2,241) (2,120) (1,921)
------- ------- ------- ------- ------- ------- ------- ------- -------
Net interest income.................... 368 395 428 418 495 465 308 373 635
Gain on sales.......................... -- -- -- -- -- -- -- -- 71
Expenses............................... (90) (94) (114) (102) (101) (97) (99) (83) (162)
------- ------- ------- ------- ------- ------- ------- ------- -------
Net Income............................. $ 278 $ 301 $ 314 $ 316 $ 394 $ 368 $ 209 $ 290 $ 544
======= ======= ======= ======= ======= ======= ======= ======= =======
Basic earnings per share............... $ 0.12 $ 0.13 $ 0.14 $ 0.14 $ 0.17 $ 0.16 $ 0.09 $ 0.12 $ 0.23
Diluted earnings per share............. $ 0.12 $ 0.13 $ 0.14 $ 0.14 $ 0.17 $ 0.16 $ 0.09 $ 0.12 $ 0.23
Dividends per share.................... $ 0.12 $ 0.13 $ 0.14 $ 0.14 $ 0.15 $ 0.15 $ 0.10 $ 0.11 $ 0.20
Weighted average common shares
outstanding........................... 2,320 2,279 2,278 2,283 2,314 2,326 2,338 2,346 2,354

June 30, Sept. 30,
2001 2001
-------- ---------

Statement of Operations Data:
Interest and dividend income........... $ 2,518 $ 2,564
Interest expense....................... (1,650) (1,403)
------- -------
Net interest income.................... 868 1,161
Gain on sales.......................... 81 166
Expenses............................... (255) (303)
------- -------
Net Income............................. $ 694 $ 1,024
======= =======
Basic earnings per share............... $ 0.29 $ 0.43
Diluted earnings per share............. $ 0.29 $ 0.42
Dividends per share.................... $ 0.24 $ 0.54
Weighted average common shares
outstanding........................... 2,368 2,423

Financial Condition

At September 30, 2001, we held total assets of $224 million, consisting of
$175 million of adjustable-rate mortgage-backed securities, $35 million of
fixed-rate mortgage-backed securities and $1.7 million of preferred stock
issued by REITs. This balance sheet size represents an approximate 58% increase
over our balance sheet size at December 31, 2000. At September 30, 2001, we
were well within our asset allocation guidelines, with 94% 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, 59% were adjustable-rate pass-through
certificates that reset at least once a year. The remaining 41% 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 September 30, 2001 and December 31, 2000, classified by type of issuer:

At September 30, 2001 At December 31, 2000
--------------------- --------------------
Fair Portfolio Fair Portfolio
Value Percentage Value Percentage
-------- ---------- -------- ----------
(dollars in thousands)

Agency
FNMA........................................ $156,869 74.6% $110,415 81.9%
FHLMC....................................... 53,289 25.4% 23,957 17.8%
Private Placement........................... -- --% 517 0.4%
-------- ----- -------- -----
Total Portfolio.......................... $210,159 100.0% $134,889 100.0%

The following table classifies our portfolio of mortgage-backed securities
owned at September 30, 2001 and December 31, 2000, by type of interest rate
index:

At September 30, 2001 At December 31, 2000
-------------------- -------------------
Fair Portfolio Fair Portfolio
Value Percentage Value Percentage
-------- ---------- -------- ----------
(dollars in thousands)

Index
One-month LIBOR.................... $ 501 0.2% $ 1,249 0.9%
Six-month LIBOR.................... 4,893 2.3% 7,332 5.4%
One year LIBOR..................... 6,036 2.9% -- --%
Six-month Certificate of Deposit... 2,148 1.0% 3,692 2.7%
One-year Constant Maturity Treasury 157,500 75.0% 97,491 72.3%
Cost of Funds Index................ 4,107 2.0% 4,713 3.5%
Fixed rate......................... 34,974 16.6% 20,412 15.2%
-------- ----- -------- -----
Total Portfolio................. $210,159 100.0% $134,889 100.0%

Our mortgage-backed securities portfolio had a weighted average yield of
6.86% at September 30, 2001. The weighted average one-month constant prepayment
rates of our mortgage-backed securities portfolio were 34%, 26% and 31%,
respectively, for the months of July, August and September 2001. At September
30, 2001 the unamortized net premium paid for our mortgage-backed securities
was $4.3 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 September 30, 2001, the fair value of our portfolio of
mortgage-related assets classified as available for sale was $1.32 million, or
0.62% 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
$180 million at September 30, 2001. Our other significant source of funds for
the quarter ended September 30, 2001 consisted of payments of principal and
interest from our mortgage securities portfolio in the amount of $17.1 million.
Additionally, as of September 30, 2001, we had raised approximately $600,000 in
capital under our dividend reinvestment plan.

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 quarter ended
September 30, 2001 of 3.86% compared with 6.89% for the quarter ended September
30, 2000. As of September 30, 2001, all of our repurchase agreements were
fixed-rate term repurchase agreements with original maturities ranging from
three months to one

year. On September 30, 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 quarter
ended September 30, 2001, we had adequate cash flow, liquid assets and
unpledged collateral with which to meet our margin requirements during the
period. Further, we believe we will continue to have sufficient liquidity to
meet our future cash requirements from our primary sources of funds for the
foreseeable future without needing to sell assets.

We may 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 intend to raise approximately $34.6 million in net proceeds
through the issuance of common stock as described in this prospectus.

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 September 30, 2001 was $21.95 million, or $9.16 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 1.32 million, or 0.62% of the
amortized cost of mortgage-backed securities at September 30, 2001.

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 debt obligations 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 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 debt obligations 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 September 30, 2001, our mortgage-backed securities and debt
obligations will prospectively reprice based on the following time frames:

Assets Debt Obligations
------------------------ ------------------------
Percent of Total Percent of Total
Amount Investments Amount Investments
-------- ---------------- -------- ----------------
Investment Type/Rate Reset Dates (dollars in thousands)

Fixed-Rate Investments........................... $ 34,974 16.6% $ -- --%

Adjustable Rate Investments/ Obligations:
Less than 3 months............................... 2,665 1.3% 112,860 63.0%
Greater than 3 months and less than 1 year....... 102,157 48.6% 66,707 37.0%
Greater than 1 year and less than 2 years........ 11,260 5.4% -- --%
Greater than 2 years and less than 3 years....... 46,234 22.0% -- --%
Greater than 3 years and less than 5 years....... 12,869 6.2% -- --%
-------- ----- -------- -----
Total......................................... $210,159 100.0% $179,567 100.0%

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 September 30, 2001,
our adjustable-rate mortgage-backed securities had a weighted average term to
next rate adjustment of approximately 18 months, while our borrowings had a
weighted average term to next rate adjustment of 68 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. We had no long-term debt at
September 30, 2001.

At September 30, 2001, we had unrestricted cash of $140,000 available to
meet margin calls on short-term debt that could be caused by asset value
declines or changes in lender collateralization requirements. Such unrestricted
cash is approximately 0.08% of our short-term debt.

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 September 30, 2001, unamortized
mortgage premium balances of mortgage-backed securities for financial
accounting purposes were $4.3 million, or 1.9% of total assets.

Tabular Presentation

The information presented in the table below projects the impact of changes
in interest rates on our 2001 projected net income and net assets as more fully
discussed below based on investments in place on September 30, 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 33% increase in the
prepayment rate of our adjustable-rate mortgage-backed securities. The base
interest rate scenario assumes interest rates at September 30, 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% 6.9% 1.1%
-1.0% (1.0)% 0.7%
0.0% 0.0% 0.0%
1.0% 3.3% (1.5)%
2.0% (13.3)% (3.5)%

OUR COMPANY

Overview

We were incorporated in Maryland on October 20, 1997 and commenced our
operations on March 17, 1998. We acquire various types of mortgage-related
assets and seek to generate income based on the difference between the yield on
our assets and the cost of our borrowings. We utilize leverage to seek an
attractive rate of return on stockholders' equity. We finance our asset
purchases in the capital markets. We have elected to be taxed as a REIT under
the tax code and, thus, will not generally be subject to federal or state taxes
on our income to the extent that we distribute substantially all of our net
income to our stockholders.

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. For a description
of our Asset Acquisition Policy see "Our Operating Policies and Programs--Asset
Acquisition Policy" on page 34 below. We do not currently originate mortgage
loans or provide other types of financing to the owners of real estate.

At September 30, 2001, we had $223.7 million in total assets and all of our
mortgages assets were secured by single-family residential mortgage loans. As
of that date, approximately 94% 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 only 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 and Heather U. Baines. Our
management company manages our investments and performs administrative services
for us. Our executive officers are employees of our management company. 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.

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

Option To Become Internally Managed

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 the other key employees of the
management company, adopt an incentive compensation plan for our key executives
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 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:

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, but only on a limited
basis due to the greater risk of loss associated with mortgage derivative
securities. However, we have not acquired and generally will not acquire
inverse floaters, REMIC residuals or first loss subordinated bonds.

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 only with institutions we
believe are financially sound and 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, although we have not yet done so. 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, if we implement a hedging program, it would be
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. If we implement a hedging strategy,
we must 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 keep the
aggregate capitalized purchase premium of the portfolio to 3% or less. In
addition, we may in the future 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.

Legal Proceedings

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

DESCRIPTION OF SECURITIES

The description of our capital stock set forth below does not purport to be
complete and is qualified in its entirety by reference to our charter, as
amended and restated, and our bylaws, copies of which are exhibits to the
registration statement of which this prospectus is a part.

General

Our authorized capital stock consists of 100 million shares of common stock,
$0.01 par value, and 20 million shares of preferred stock, $0.01 par value,
issuable in one or more series. Each share of common stock is entitled to
participate equally in dividends when and as declared by our board of directors
and in the distribution of our assets upon liquidation. Each share of common
stock is entitled to one vote and will be fully paid and non-assessable by us
upon issuance. Shares of our common stock have no preference, conversion,
exchange, preemptive, or cumulative voting rights. Our authorized capital stock
may be increased and altered from time to time as permitted by Maryland law.

Our preferred stock may be issued from time to time in one or more classes
or series, with such distinctive designations, rights and preferences as shall
be determined by our board of directors. Preferred stock would be available for
possible future financing of, or acquisitions by, us and for general corporate
purposes without any legal requirement that further stockholder authorization
for issuance is obtained. The issuance of preferred stock could have the effect
of making an attempt to gain control more difficult by means of a merger,
tender offer or proxy contest. The preferred stock, if issued, could have a
preference on dividend payments that could affect our ability to make dividend
distributions to the common stockholders.

Meetings of our stockholders are to be held annually and special meetings
may be called by a majority of our board of directors, our Chairman of the
board or our President. Special meetings shall be called by the Secretary at
the written request of our stockholders entitled to cast at least a majority of
all the votes entitled to be cast at the meeting. Our charter reserves to us
the right to amend any provision thereof in the manner prescribed by law.

Restrictions on Transfer

Two of the requirements of qualification for the tax benefits accorded by
the REIT provisions of the tax code are that (1) during the last half of each
taxable year not more than 50% in value of the outstanding shares may be owned
directly or indirectly by five or fewer individuals, and (2) there must be at
least 100 stockholders on 335 days of each taxable year of 12 months.

In order that we may meet these requirements at all times, our charter
prohibits any person from owning, acquiring or holding, directly or indirectly,
without prior approval by our board of directors, shares of common stock in
excess of 9.8% in value of the aggregate of the outstanding shares of common
stock or in excess of 9.8% (in value or in number of shares, whichever is more
restrictive) of the aggregate of the outstanding shares of our common stock.
For this purpose, ownership includes both beneficial ownership and constructive
ownership. Beneficial ownership is defined in our charter to include interests
that would be treated as owned through the application of Section 544 of the
tax code, as modified by Section 856(h)(1)(B) of the tax code. Constructive
ownership is defined in our charter to include interests that would be treated
as owned through the application of Section 318(a) of the tax code, as modified
by Section 856(d)(5) of the tax code. Subject to certain limitations, our board
of directors may increase or decrease the ownership limitations or waive the
limitations for individual investors.

For purposes of the 50% stockholder test discussed above, the constructive
ownership provisions applicable under Section 544 of the tax code attribute
ownership of securities owned by a corporation, partnership, estate or trust
proportionately to its stockholders, partners or beneficiaries, attribute
ownership of securities owned by

family members to other members of the same family, treat securities with
respect to which a person has an option to purchase as actually owned by that
person, and set forth rules for application of such attribution provisions
(e.g., reattribution of stock that is constructively owned). Thus, for purposes
of determining whether a person holds shares of common stock in violation of
the ownership limitations set forth in our charter, many types of entities may
own directly more than the 9.8% limit because such entities' shares are
attributed to its individual stockholders. On the other hand, a person will be
treated as owning not only shares of common stock actually or beneficially
owned, but also any shares of common stock attributed to such person under the
attribution rules described above. Accordingly, under certain circumstances,
shares of common stock owned by a person who individually owns less than 9.8%
of the shares outstanding may nevertheless be in violation of the ownership
limitations set forth in our charter. Ownership of shares of common stock
through such attribution is generally referred to as constructive ownership.

If any transfer of shares of common stock would result in any person
beneficially or constructively owning capital stock in violation of our
transfer or ownership limitations, then the number of shares of capital stock
causing the violation (rounded to the nearest whole shares) shall be
automatically transferred to a trustee of a trust for the exclusive benefit of
one or more charitable beneficiaries. The intended transferee shall not acquire
any rights in such shares. Shares of common stock held by the trustee shall be
issued and outstanding shares of common stock. The intended transferee shall
not benefit economically from ownership of any shares held in the trust, shall
have no rights to dividends, and shall not possess any rights to vote or other
rights attributable to the shares held in the trust. The trustee shall have all
voting rights and rights to dividends or other distributions with respect to
shares held in the trust, which rights shall be exercised for the exclusive
benefit of the charitable beneficiary. Any dividend or other distribution paid
to the intended transferee prior to the discovery by us that shares of common
stock have been transferred to the trustee shall be paid with respect to such
shares to the trustee by the intended transferee upon demand and any dividend
or other distribution authorized but unpaid shall be paid when due to the
trustee. Our board of directors may, in its discretion, waive these
requirements on owning shares in excess of the ownership limitations.

Within 20 days of receiving notice from us that shares of common stock have
been transferred to the trust, the trustee shall sell the shares held in the
trust to a person, designated by the trustee, whose ownership of the shares
will not violate the ownership limitations set forth in our charter. Upon such
sale, the interest of the charitable beneficiary in the shares sold shall
terminate and the trustee shall distribute the net proceeds of the sale to the
intended transferee and to the charitable beneficiary as follows. The intended
transferee shall receive the lesser of (1) the price paid by the intended
transferee for the shares or, if the intended transferee did not give value for
the shares in connection with the event causing the shares to be held in the
trust (e.g., in the case of a gift, devise or other such transaction), the
market price (as defined below) of the shares on the day of the event causing
the shares to be held in the trust, and (2) the price per share received by the
trustee from the sale or other disposition of the shares held in the trust. Any
net sales proceeds in excess of the amount payable to the intended transferee
shall be immediately paid to the charitable beneficiary. In addition, shares of
common stock transferred to the trustee shall be deemed to have been offered
for sale to us, or our designee. This offer shall be at a price per share equal
to the lesser of (1) the price per share in the transaction that resulted in
such transfer to the trust (or, in the case of a devise or gift, the market
price at the time of such devise or gift), and (2) the market price on the date
we, or our designee, accepts such offer. We shall have the right to accept such
offer until the trustee has sold shares held in the trust. Upon such a sale to
us, the interest of the charitable beneficiary in the shares sold shall
terminate and the trustee shall distribute the net proceeds of the sale to the
intended transferee.

The market price shall mean the last sale price for such shares. In case no
such sale takes place on such day, the market price shall be the average of the
closing bid and asked prices on the American Stock Exchange. In the event that
no trading price is available for such shares, the fair market value of the
shares shall be as determined in good faith by our board of directors.

Under the REIT provisions of the tax code, every owner of 5% or more in the
case of 2,000 or more stockholders of record, of 1% or more in the case of more
than 200 but fewer than 2,000 stockholders of record

and of 0.5% or more in the case of 200 or fewer stockholders of record, of all
classes or series of our stock, is required to give written notice to us in
response to our written demand for such notice, which request must be made
within 30 days after the end of each taxable year. They shall state their name
and address, the number of shares of each class and series of our stock
beneficially owned and a description of the manner in which such shares are
held. Each such owner shall provide to us such additional information as we may
request in order to determine the effect, if any, of such beneficial ownership
on our status as a REIT and to ensure compliance with the ownership limitations.

Removal of Directors

Our charter provides that a director may be removed from office at any time
for cause but only by the affirmative vote of the holders of at least
two-thirds of the votes of the shares entitled to be cast in the election of
directors.

Indemnification

As permitted by Maryland law, our charter obligates us to indemnify our
present and former directors and officers to the maximum extent permitted by
Maryland law. Maryland law permits a corporation to indemnify its present and
former directors and officers, among others, against judgments, penalties,
fines, settlements and reasonable expenses actually incurred by them in
connection with any proceeding to which they may be made a party by reason of
their service in those or other capacities, unless it is established that:

. the act or omission of the director or officer was material to the matter
giving rise to such proceeding and was committed in bad faith or was the
result of active and deliberate dishonesty;

. the director or officer actually received an improper personal benefit in
money, property or services;

. in the case of any criminal proceeding, the director or officer had
reasonable cause to believe that the act or omission was unlawful; or

. the proceeding, other than a proceeding brought to enforce
indemnification, is brought by the director or officer against us.

Limitation of Liability

As permitted by Maryland law, our charter limits the liability of our
directors and officers to us and our stockholders for money damages, except to
the extent that:

. the person actually received an improper benefit or profit in money,
property or services; or

. a judgment or other final adjudication is entered in a proceeding based on
a finding that the person's action, or failure to act, was the result of
active and deliberate dishonesty and was material to the cause of action
adjudicated in the proceeding.

As a result of these provisions, we and our stockholders may be unable to
obtain monetary damages from a director or officer for breach of his or her
duty of care.

Maryland Business Combination Act

Maryland law prohibits specified "business combinations" between a Maryland
corporation and an "interested stockholder." These business combinations
include a merger, consolidation, share exchange, an asset transfer or issuance
or reclassification of equity securities. Interested stockholders are either:

. anyone who beneficially owns 10% or more of the voting power of the
corporation's shares; or

. an affiliate or associate of the corporation who was an interested
stockholder or an affiliate or an associate of the interested stockholder
at any time within the two-year period prior to the date in question.

Business combinations with a past interested stockholder are prohibited for
five years after the most recent date on which the stockholder became an
interested stockholder. Thereafter, any business combinations with the
interested stockholder must be recommended by the board of directors of the
corporation and approved by the vote of:

. at least 80% of the votes entitled to be cast by all holders of voting
shares of the corporation's voting shares; and

. at least 66 2/3% of the votes entitled to be cast by all holders of the
corporation's voting other than voting shares held by the interested
stockholder or an affiliate or associate of the interested stockholder.

However, these special voting requirements do not apply if the corporation's
stockholders receive a minimum price for their shares, as specified in the
statute, and the consideration is received in cash or in the same form
previously paid by the interested stockholder for its shares.

This business combination statute does not apply to business combinations
that are approved or exempted by the corporation's board of directors prior to
the time that the interested stockholder becomes an interested stockholder. The
statute also does not apply to stockholders that acquired 10% or more of the
corporation's voting shares in a transaction approved by the corporation's
board of directors. A Maryland corporation may adopt an amendment to its
charter electing not to be subject to these special voting requirements. Any
amendment would have to be approved by at least 80% of the votes entitled to be
cast by all holders of outstanding shares of voting stock and 66 2/3% of the
votes entitled to be cast by holders of outstanding shares of voting stock who
are not interested stockholders.

The business combination statute could have the effect of discouraging
offers to acquire us and of increasing the difficulty of consummating such
offers, even if our acquisition would be in our stockholders' best interests.

Maryland Control Share Acquisition Act

Maryland law provides that "control shares" of a Maryland corporation
acquired in a "control share acquisition" have no voting rights unless approved
by a vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares owned by the acquirer or by the corporation's officers or
directors who are employees of the corporation. Control shares are shares of
voting stock which, if aggregated with all other shares of stock previously
acquired, would entitle the acquirer to exercise voting power in electing
directors within one of the following ranges of voting power:

. 10% or more but less than 33 1/3%;

. 33 1/3% or more but less than a majority; or

. a majority of all voting power.

Control shares do not include shares of stock an acquiring person is
entitled to vote as a result of having previously obtained stockholder
approval. A control share acquisition generally means the acquisition of,
ownership of or the power to direct the exercise of voting power with respect
to, control shares.

A person who has made or proposes to make a "control share acquisition,"
under specified conditions, including an undertaking to pay expenses, may
require the board of directors to call a special stockholders' meeting to
consider the voting rights of the shares. The meeting must be held within 50
days of the demand. If no request for a meeting is made, the corporation may
itself present the question at any stockholders' meeting.

If voting rights are not approved at the meeting or if the acquiring person
does not deliver an acquiring person statement as permitted by the statute, the
corporation generally may redeem any or all of the control shares, except those
for which voting rights have previously been approved. This redemption of
shares must be

for fair value, determined without regard to voting rights as of the date of
the last control share acquisition or of any stockholders' meeting at which the
voting rights of the shares are considered and not approved. If voting rights
for "control shares" are approved at a stockholders' meeting and the acquirer
becomes entitled to vote a majority of the shares entitled to vote, all other
stockholders may exercise appraisal rights. The fair value of the stock
determined for purposes of appraisal rights may not be less than the highest
price per share paid in the control share acquisition. The limitations and
restrictions otherwise applicable to the exercise of dissenters' rights do not
apply in the context of a "control share acquisition."

The control share acquisition statute would not apply to stock acquired in a
merger, consolidation or share exchange if we were a party to the transaction,
or to acquisitions previously approved or exempted by a provision in our
charter or bylaws.

Presently our bylaws contain a provision exempting from the control share
acquisition statute any and all acquisitions by any person of our common stock.
However, our board of directors may decide to amend or eliminate this provision
at any time in the future.

Amendment to Our Charter

We reserve the right from time to time to make any amendment to our charter
including any amendment that alters the contract rights as expressly set forth
in our charter of any shares of outstanding stock, subject to certain
limitations. Our charter may be amended only by the affirmative vote of holders
of shares entitled to cast not less than a majority of all the votes entitled
to be cast on the matter. The provisions in our charter on removal of directors
may be amended only by the affirmative vote of holders of shares entitled to
cast not less than two-thirds of all the votes entitled to be cast in the
election of directors.

Transfer Agent and Registrar

Our transfer agent and registrar is Continental Stock Transfer & Trust
Company.

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 prospectus, 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 UBTI, 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.

UNDERWRITING

Friedman, Billings, Ramsey & Co., Inc. ("FBR"), Advest, Inc. and Wedbush
Morgan Securities, Inc. are acting as representatives of the underwriters named
below. Subject to the terms and conditions contained in the underwriting
agreement, we have agreed to sell to each underwriter, and each underwriter has
agreed to purchase from us, the number of shares set forth opposite its name
below. The underwriting agreement provides that the obligation of the
underwriters to pay for and accept delivery of our common stock is subject to
approval of certain legal matters by their counsel and to certain other
conditions. The underwriters are obligated to take and pay for all shares of
our common stock offered (other than those covered by the over-allotment option
described below) if any of the shares are taken.

Number of
Underwriter Shares
----------- ---------

Friedman, Billings, Ramsey & Co., Inc...................... 1,940,400
Advest, Inc................................................ 1,058,400
Wedbush Morgan Securities, Inc............................. 529,200
BB&T Capital Markets, a division of Scott & Stringfellow,
Inc...................................................... 84,000
Crowell, Weedon & Co....................................... 84,000
Fahnestock & Co. Inc....................................... 84,000
Flagstone Securities, LLC.................................. 84,000
J.J.B. Hilliard, W.L. Lyons, Inc........................... 84,000
Howe Barnes Investments, Inc............................... 84,000
Stifel, Nicolaus & Company, Incorporated................... 84,000
Wells Fargo Securities, LLC................................ 84,000
---------
Total............................................... 4,200,000
=========

We have granted the underwriters an option exercisable for 30 days after the
date of this prospectus to purchase up to 630,000 additional shares of common
stock to cover over-allotments, if any, at the public offering price less the
underwriting discounts and commissions set forth on the cover page of this
prospectus. If the underwriters exercise this option, the underwriters will
have a firm commitment, subject to certain conditions, to purchase all of the
shares for which the option is exercised.

The following table shows the amount per share and total underwriting
discounts and commissions we will pay to the underwriters. The amounts are
shown assuming both no exercise and full exercise of the underwriters' option
to purchase up to 630,000 additional shares of our common stock to cover
over-allotments.

Total
-----
Per Share No Exercise Full Exercise
--------- ----------- -------------

Public offering price...................................... $ 8.85 $37,170,000 $42,745,500
Underwriting discounts and commissions to be paid by us.... $0.553125 $ 2,323,125 $ 2,671,594
Proceeds, before expenses, to us........................... $8.296875 $34,846,875 $40,073,906

Each of our officers and directors has agreed with FBR, for a period of 90
days after the date of this prospectus, subject to certain exceptions, not to
sell any shares of common stock or any securities convertible into or
exchangeable for shares of common stock owned by them, without the prior
written consent of FBR. However, FBR may, in its sole discretion and at any
time without notice, release all or any portion of the securities subject to
these agreements.

The underwriters propose to offer our common stock directly to the public at
$8.85 per share and to certain dealers at this price less a concession not in
excess of $0.33 per share. The underwriters may allow, and the dealers may
reallow, a concession not in excess of $0.10 per share to certain dealers. We
expect to incur expenses of approximately $250,000 in connection with this
offering.

We have agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act of 1933, as amended, or to
contribute to payments the underwriters may be required to make in respect
thereof.

In connection with this offering, the underwriters are permitted to engage
in certain transactions that stabilize the price of our common stock. These
transactions consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of our common stock. If the underwriters create a short
position in our common stock in connection with this offering by selling more
than 4,200,000 shares of common stock, the underwriters may reduce that short
position by purchasing our common stock in the open market. In general,
purchases of a security for the purpose of stabilization or to reduce a short
position could cause the price of the security to be higher than it might be in
the absence of those purchases. Neither the underwriters nor we make any
representation or prediction as to the direction or magnitude of any effect
that the transactions described above may have on the price of our common
stock. In addition, neither the underwriters nor we make any representation
that the underwriters will engage in those transactions or that those
transactions, once commenced, will not be discontinued without notice.

The underwriters or their affiliates may provide us with investment banking,
financial advisory, or commercial banking services in the future, for which
they may receive customary compensation.

The underwriters have informed us that they do not intend to confirm sales
of the common stock offered by this prospectus to any accounts over which they
exercise discretionary authority.

On December 27, 2001, we completed a public offering of 4,025,000 shares of
our common stock and received approximately $30.7 million in net proceeds after
deducting underwriting discounts and commissions and expenses of that offering.
FBR was the lead managing underwriter and Advest, Inc. was the co-manager for
that offering. The underwriting commission for that offering was 6.25%, or
$0.51875 per share, for a total underwriting commission of approximately $2.1
million.

EXPERTS

The financial statements as of December 31, 2000 and 1999, and for each of
the two years in the period ended December 31, 2000, included in this
prospectus and incorporated in this prospectus by reference to the Annual
Report on our Form 10-K, have been so included and incorporated in reliance on
the report of PricewaterhouseCoopers LLP, independent accountants, given on the
authority of said firm as experts in accounting and auditing.

Our financial statements for the period from March 17, 1998 to December 31,
1998, included and incorporated by reference in this prospectus have been
audited by McGladrey & Pullen LLP, independent auditors, as stated in that
firm's report included and incorporated by reference herein, and have been so
included and incorporated in reliance upon that firm's report given on its
authority as experts in accounting and auditing.

LEGAL MATTERS

The validity of our securities offered in this prospectus and selected
federal tax matters will be passed upon for us by Allen Matkins Leck Gamble &
Mallory LLP, Century City, California. Selected legal matters related to
Maryland law will be passed upon for us by Piper Marbury Rudnick & Wolfe LLP.
Selected legal matters will be passed upon for the underwriters by Morrison &
Foerster LLP, Los Angeles, California.

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and special reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
the materials we file at the Commission's Public Reference Room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Please call the Commission at
1-800-SEC-0330 for further information on the operation of the Public Reference
Rooms. Our Commission filings are also available to the public from the
Commission's World Wide Web site on the Internet at http://www.sec.gov. This
site contains reports, proxy and information statements and other information
regarding issuers that file electronically with the Commission. You may also
read and copy this information at the National Association of Securities
Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.

We maintain a site on the Internet at http://www.anworth.com. The
information contained in our website is not part of this prospectus and you
should not rely on it in deciding whether to invest in our common stock.

We have filed a registration statement, of which this prospectus is a part,
covering the offered securities. As allowed by Commission rules, this
prospectus does not include all of the information contained in the
registration statement and the included exhibits, financial statements and
schedules. We refer you to the registration statement, the included exhibits,
financial statements and schedules for further information. This prospectus is
qualified in its entirety by such other information.

INFORMATION INCORPORATED BY REFERENCE

The SEC allows us to "incorporate by reference" the information that we file
with the SEC. This means that we can disclose important information to you by
referring you to another document filed separately with the SEC under the
Securities Exchange Act of 1934 (the "Exchange Act"). The information
incorporated by reference is deemed to be part of this prospectus, except for
any information superseded by information in this prospectus. We have filed
with the SEC and incorporate by reference our annual report on Form 10-K for
the fiscal year ended December 31, 2000 and our quarterly reports on Form 10-Q
for the quarters ended March 31, June 30 and September 30, 2001.

Any documents we file pursuant to Section 13(a) or 15(d) of the Exchange Act
after the date of this prospectus and prior to the termination of the offering
of the securities to which this prospectus relates will automatically be deemed
to be incorporated by reference in this prospectus and to be part hereof from
the date of filing those documents. Any statement contained in this prospectus
or in a document incorporated by reference shall be deemed to be modified or
superseded for all purposes to the extent that a statement contained in this
prospectus or in any other document which is also incorporated by reference
modifies or supersedes that statement.

You may obtain copies of all documents which are incorporated in this
prospectus by reference (other than the exhibits to those documents which are
not specifically incorporated by reference herein) without charge by writing or
calling Ms. Pamela Watson, at Anworth Mortgage Asset Corporation, 1299 Ocean
Avenue, 2nd Floor, Santa Monica, CA 90401, telephone: (310) 394-0115.

FINANCIAL INFORMATION

Index to Financial Statements

Page
----

Unaudited Financial Statements:
Balance Sheets as of September 30, 2001 (unaudited) and December 31, 2000............................ F-2
Statements of Operations (unaudited) for the Three and Nine Month Periods Ended September 30, 2001
and 2000........................................................................................... F-3
Statements of Stockholders' Equity (unaudited) for the Three Months Ended March 31, June 30 and
September 30, 2001................................................................................. F-4
Statements of Cash Flows (unaudited) for the Three and Nine Month Periods Ended September 30, 2001
and 2000........................................................................................... F-5
Notes to Financial Statements........................................................................ F-6

Audited Financial Statements:
Report of Independent Accountants.................................................................... F-11
Balance Sheets as of December 31, 2000, and December 31, 1999........................................ F-12
Statements of Operations for the years ended December 31, 2000 and 1999, and for the period from
March 17, 1998 (commencement of operations) through December 31, 1998.............................. F-13
Statements of Stockholders' Equity for the years ended December 31, 2000 and 1999, and for the period
from March 17, 1998 (commencement of operations) through December 31, 1998......................... F-14
Statements of Cash Flows for the years ended December 31, 2000 and 1999, and for the period from
March 17, 1998 (commencement of operations) through December 31, 1998.............................. F-15
Notes to Financial Statements........................................................................ F-16

F-1

ANWORTH MORTGAGE ASSET CORPORATION

BALANCE SHEETS
(Amounts in thousands)

September 30, December 31,
2001 2000
------------- ------------
(unaudited)

ASSETS
Mortgage backed securities..................................................... $210,159 $134,889
Other marketable securities.................................................... 1,745 1,948
Cash and cash equivalents...................................................... 141 3,894
Accrued interest and dividends receivable...................................... 1,306 1,090
Prepaid expenses and other..................................................... 24 13
Receivable for security sold................................................... 10,306 --
-------- --------
$223,681 $141,834
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Reverse repurchase agreements............................................... $179,567 $121,891
Payable for securities purchased............................................ 20,730 --
Accrued interest payable.................................................... 915 1,706
Dividends payable........................................................... -- --
Accrued expenses and other.................................................. 518 36
-------- --------
201,730 123,633
-------- --------
Stockholders' Equity
Preferred stock, par value $.01 per share; authorized 20,000,000 shares; no
shares issued and outstanding............................................. -- --
Common stock; par value $.01 per share; authorized 100,000,000 shares;
2,447,359 and 2,400,016 issued and 2,397,359 and 2,350,016 outstanding
respectively.............................................................. 24 24
Additional paid in capital.................................................. 19,531 19,243
Accumulated other comprehensive income, unrealized gain (loss) on available
for sale securities....................................................... 1,315 (1,186)
Retained earnings........................................................... 1,310 349
Treasury stock at cost (50,000 shares)...................................... (229) (229)
-------- --------
21,951 18,201
-------- --------
$223,681 $141,834
======== ========

See notes to financial statements.

F-2

STATEMENTS OF OPERATIONS (unaudited)
(Amounts in thousands, except per share data)

Three months ended Nine months ended
September 30, September 30,
----------------- ----------------
2001 2000 2001 2000
------- ------- ------- -------

Interest and dividend income net of amortization of premium $ 2,564 $ 2,549 $ 7,639 $ 7,822
Interest expense........................................... (1,403) (2,241) (4,974) (6,554)
------- ------- ------- -------
Net interest income........................................ $ 1,161 $ 308 $ 2,665 $ 1,268
Gain on sale of assets.................................. 166 -- 318 --
Less:
Management fee.......................................... (52) (41) (148) (123)
Incentive fee........................................... (174) -- (318) (1)
Other expense........................................... (77) (58) (254) (173)
------- ------- ------- -------
Net income................................................. $ 1,024 $ 209 $ 2,263 $ 971
======= ======= ======= =======
Basic earnings per share................................... $ 0.43 $ 0.09 $ 0.96 $ 0.42
======= ======= ======= =======
Diluted earnings per share................................. $ 0.42 $ 0.09 $ 0.95 $ 0.42
======= ======= ======= =======
Dividends per share (Note A)............................... $ 0.54 $ 0.10 $ 0.98 $ 0.40
======= ======= ======= =======
Average number of shares outstanding (diluted)............. 2,423 2,338 2,381 2,326
======= ======= ======= =======

Note A: Effective as of the third quarter of 2000, dividends are declared after
the close of the quarter. For the three months ended September 30,
2001, the dividend includes the dividend declared and to be paid in the
fourth quarter of 2001. For the three months ended September 30, 2000,
the dividend includes the dividend declared and paid in the fourth
quarter of 2000. For the nine months ended September 30, 2001, the
dividends include dividends declared and paid in the second and third
quarters of 2001 and the dividend declared and to be paid in the fourth
quarter of 2001. For the nine months ended September 30, 2000, the
dividends include dividends declared and paid in the second, third and
fourth quarters of 2000.

See notes to financial statements.

F-3

STATEMENTS OF STOCKHOLDERS' EQUITY (unaudited)

For the three months ended March 31, June 30 and September 30, 2001
(Amounts in thousands)

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

Balance, December 31, 2000......... 2,350 $24 $19,243 $(1,186) $ 349 $(229) $18,201
Issuance of common stock........... 10 0 45 45
Available-for-sale securities, Fair
value adjustment................. 437 437 437
Net income......................... 545 545 545
------
Other comprehensive income
(loss)........................... $ 982
======
Dividends declared--$0.11 per
share............................ (259) (259)
----- --- ------- ------- ------ ----- -------
Balance, March 31, 2001............ 2,360 $24 $19,288 $ (749) $ 635 $(229) $18,969
===== === ======= ======= ====== ===== =======
Issuance of common stock........... 16 0 91 91
Available-for-sale securities,
Fair value adjustment............ 98 98 98
Net income......................... 694 694 694
------
Other comprehensive income
(loss)........................... $ 792
======
Dividends declared--$0.20 per
share............................ (472) (472)
----- --- ------- ------- ------ ----- -------
Balance, June 30, 2001............. 2,376 $24 $19,379 $ (651) $ 857 $(229) $19,380
===== === ======= ======= ====== ===== =======
Issuance of common stock........... 21 0 152 152
Available-for-sale securities,
Fair value adjustment............ 1,965 1,965 1,965
Net income......................... 1,024 1,024 1,024
------
Other comprehensive income
(loss)........................... 2,989
======
Dividends declared--$0.24 per
share............................ (570) (570)
----- --- ------- ------- ------ ----- -------
Balance, September 30, 2001........ 2,397 $24 $19,531 $ 1,315 $1,310 $(229) $21,951
===== === ======= ======= ====== ===== =======

See notes to financial statements.

F-4

STATEMENTS OF CASH FLOWS (unaudited)
(Amounts in thousands)

Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2001 2000 2001 2000
-------- -------- -------- --------

Operating Activities:
Net income........................................................... $ 1,024 $ 209 $ 2,262 $ 971
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization.................................................. 308 158 514 514
Gain on sales of assets....................................... (166) -- (318) --
Decrease (increase) in accrued interest and dividends
receivable.................................................. (62) (25) 49 6
Increase (decrease) in accrued interest payable............... 32 (282) (791) (1,395)
Increase (decrease) in accrued expenses and other............. 311 49 525 (40)
-------- -------- -------- --------
Net cash provided by operating activities.................. 1,447 109 2,241 56
Investing Activities:
Available-for-sale securities:....................................
Purchases......................................................... (61,538) (6) (99,542) (676)
Proceeds from sale................................................ -- -- 1,095 --
Principal payments................................................ 14,380 8,482 35,790 21,043
-------- -------- -------- --------
Net cash provided by (used in) investing activities........ (47,158) 8,476 (62,657) 20,367
Financing Activities:
Net borrowings from reverse repurchase agreements................. 45,130 (10,176) 57,676 (21,166)
Proceeds from common stock issued, net............................ 152 59 288 142
Dividends paid.................................................... (570) (349) (1,301) (1,020)
-------- -------- -------- --------
Net cash provided by (used in) financing activities........ 44,712 (10,466) 56,663 (22,044)
-------- -------- -------- --------
Net increase (decrease) in cash and cash equivalents................. (999) (1,881) (3,753) (1,621)
Cash and cash equivalents at beginning of period..................... 1,140 3,562 3,894 3,302
-------- -------- -------- --------
Cash and cash equivalents at end of period........................... $ 141 $ 1,681 $ 141 $ 1,681
======== ======== ======== ========
Supplemental Disclosure of Cash Flow Information.....................
Cash paid for interest............................................ $ 1,371 $ 2,524 $ 5,765 $ 7,950
Supplemental Disclosure of Noncash Investing and Financing...........
Mortgage securities purchased, not yet settled.................... $ 10,306 $ -- $ 10,306 $ --
Mortgage securities sold, not yet settled......................... $ 20,730 $ -- $ 20,730 $ --

See notes to financial statements.

F-5

NOTES TO FINANCIAL STATEMENTS

September 30, 2001

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 mortgage-backed securities
("MBS") on March 17, 1998, upon completion of its initial public offering of
the Company's common stock.

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

BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Therefore, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.

In the opinion of management, all material adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation have been
included. The operating results for the quarter ended September 30, 2001 are
not necessarily indicative of the results that may be expected for the calendar
year ending December 31, 2001.

CASH AND CASH EQUIVALENTS

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

MORTGAGE BACKED SECURITIES

The Company has invested primarily in fixed- and adjustable-rate mortgage
pass-through certificates ("MBSs") and hybrid ARMs. 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.

Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"), requires the Company to
classify its investments as either trading investments, available-for-sale
investments or held-to-maturity investments. It is the Company's policy to
classify each of its MBS as available-for-sale and then to monitor the
security's performance over time before making a final determination as to the
permanent classification. At this time all of the Company's MBS are classified
as available-for-sale. All assets that are classified as available-for-sale are
carried at fair value.

Interest income is accrued based on the outstanding principal amount of the
MBS and their contractual terms. Premiums associated with the purchase of MBS
are amortized into interest income over the estimated lives of the asset using
the effective yield method.

MBS transactions are recorded on the date the securities are purchased or
sold.

CREDIT RISK

At September 30, 2001 the Company has limited its exposure to credit losses
on its portfolio of mortgage backed 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 ARM securities are guaranteed by those respective
agencies. At September 30, 2001, over 99% of the Company's mortgage backed
securities have an implied "AAA" rating.

F-6

ANWORTH MORTGAGE

NOTES TO FINANCIAL STATEMENTS--(Continued)

INCOME TAXES

The Company intends to elect to be taxed as a Real Estate Investment Trust
and to comply with the provisions of the Internal Revenue Code with respect
thereto. Accordingly, the Company will not be 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.

EARNINGS PER SHARE

Basic earnings per share ("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 the income per
share.

The following table provides a reconciliation of the numerator and
denominator of the earning per share computation:

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

Three Months Ended September 30, 2001
Basic EPS............................ 1,024 2,384 $0.43
=====
Effect of dilutive securities:
Stock options........................ -- 39
----- -----
Diluted EPS.......................... 1,024 2,423 $0.42
===== ===== =====
Three Months Ended September 30, 2000
Basic EPS............................ 209 2,338 $0.09
=====
Effect of dilutive securities:
Stock options........................ -- --
----- -----
Diluted EPS.......................... 209 2,338 $0.09
===== ===== =====
Nine Months Ended September 30, 2001
Basic EPS............................ 2,263 2,369 $0.96
=====
Effect of dilutive securities:
Stock options........................ -- 12
----- -----
Diluted EPS.......................... 2,263 2,381 $0.95
===== ===== =====
Nine Months Ended September 30, 2000
Basic EPS............................ 971 2,326 $0.42
===== ===== =====
Effect of dilutive securities:
Stock options........................ -- --
----- -----
Diluted EPS.......................... 971 2,326 $0.42
===== ===== =====

USE OF ESTIMATES

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

F-7

ANWORTH MORTGAGE

NOTES TO FINANCIAL STATEMENTS -- (Continued)

NOTE 2. MORTGAGE BACKED SECURITIES

The following table pertains to the Company's mortgage backed securities
classified as available-for-sale as of September 30, 2001, which are carried at
their fair value (amounts in thousands):

Federal Federal
Home Loan National Other Total
Mortgage Mortgage Mortgage MBS
($000's) Corporation Association Securities Assets
-------- ----------- ----------- ---------- --------

Amortized Cost.................... $52,037 $156,177 $-- $208,214
Paydown Receivable................ 885 -- -- 885
Unrealized gains.................. 462 1,083 -- 1,545
Unrealized losses................. (103) (382) -- (485)
------- -------- --- --------
Fair value........................ $53,281 $156,878 $-- $210,159
------- -------- --- --------

In addition, at September 30, 2001 the Company held a position in a
preferred stock issued by Thornburg Mortgage Inc. which had a fair value of
$1,745,000.

The following table summarizes the Company's securities as of September 30,
2001 at their fair value (amounts in thousands):

Fixed
Rate REIT
($000's) ARMS MBS Stock Total
-------- -------- ------- ------ --------

Amortized Cost.................... $174,066 $34,148 $1,491 $209,704
Paydown Receivable................ 885 -- -- 885
Unrealized gains.................. 719 827 255 1,800
Unrealized losses................. (485) -- -- (485)
-------- ------- ------ --------
Fair value........................ $175,185 $34,975 $1,746 $211,905
-------- ------- ------ --------

NOTE 3. REVERSE REPURCHASE AGREEMENTS

The Company has entered into reverse repurchase agreements to finance most
of its MBS. The reverse repurchase agreements are short-term borrowings that
are secured by the market value of the Company's MBS and bear interest rates
that have historically moved in close relationship to London Interbank Offer
Rate ("LIBOR"). At September 30, 2001 the Company's reverse repurchase
agreements had an average term to maturity of 68 days.

At September 30, 2001, the repurchase agreements had the following remaining
maturities (amounts in thousands):

Within 59 days............................................. $112,860
60 to 89 days.............................................. --
90 to 119 days............................................. 18,103
Over 120 days.............................................. 48,604
--------
$179,567
========

NOTE 4. 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.

F-8

ANWORTH MORTGAGE

NOTES TO FINANCIAL STATEMENTS--(Continued)

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
Compensation").

In addition to the Base Management Compensation, the Manager shall receive
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 Management Compensation").

The Manager has 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 the Company's common stock. If this option is exercised,
the Company would become internally managed, the employees of the Manager would
become employees of the Company and the Agreement would be terminated.

For the quarters ended September 30, 2001 and September 30, 2000, the
Company paid the Manager $52,000 and $41,000, respectively, in base management
fees. The Company paid the Manager $174,000 in incentive compensation for the
quarter ended September 30, 2001 and no incentive compensation for the quarter
ended September 30, 2000.

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 600,000 of the outstanding shares of
the Company's common stock. The Stock Option 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. As of June 30, 2001, the Company had granted a total of 198,000
options, with strike prices of either $9 per share or $4.60 per share, and
148,500 DER's. Options granted to officers either become exercisable at a rate
of 33.3% each year following their date of grant or become exercisable three
years after their date of grant. Options granted to directors either became
exercisable six months after their date of grant or become exercisable three
years after their date of grant. All options must expire with a maximum of ten
years after their date of grant. 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 market price of the stock exceeds the effective strike price.

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
will accrue to the DER's. For the quarter ended June 30, 2001, the Company
recorded $61,000 in operating expense associated with the Stock Option Plan.

For the quarter ended September 30, 2001, the Company recorded no operating
expense associated with the Stock Option Plan.

At its meeting on July 23, 2001 the board of directors granted 87,560
options with a strike price of $6.70 and 10,000 options with a strike price of
$7.37 per share. At a special meeting held on August 10, 2001, the board
granted 25,000 options at a strike price of $7.81 and 9,000 options with a
strike price $7.10.

F-9

NOTE 5. COMMON STOCK

In December of 1998, the board of directors authorized the repurchase of
50,000 shares of the Company's common stock. As of September 30, 2000, the
entire 50,000 shares had been repurchased at an average cost of $4.58 per share.

NOTE 6. RECENT DEVELOPMENTS

On December 27, 2001, the Company completed a public offering of 4,025,000
shares of its common stock and a private placement of 500,000 shares of its
common stock. The Company received approximately $34.6 million in combined net
proceeds from the sales of these shares.

F-10

Report of Independent Accountants

To the Board of Directors and Stockholders
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, 2000 and December 31, 1999, and the results of its operations
and its cash flows for each of the two 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 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 15, 2001

Report of Independent Accountants

To the Board of Directors and Stockholders
Anworth Mortgage Asset Corporation

We have audited the accompanying statements of operations, stockholders'
equity and cash flows of Anworth Mortgage Asset Corporation for the period from
March 17, 1998 (commencement of operations) to December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.

In our opinion, the financial statements of Anworth Mortgage Asset
Corporation referred to above present fairly, in all material respects, the
results of its operations and its cash flows for the period from March 17, 1998
(commencement of operations) to December 31, 1998 in conformity with generally
accepted accounting principles.

MCGLADREY & PULLEN, LLP

New York, New York
January 9, 1999

F-11

ANWORTH MORTGAGE ASSET CORPORATION

BALANCE SHEETS
(Amounts in thousands)

December 31,
------------------
2000 1999
-------- --------
ASSETS
------

Assets
Mortgage backed securities (Notes 2, 3, and 4)....................................... $134,889 $161,488
Other marketable securities (Note 2)................................................. 1,948 1,193
Cash and cash equivalents (Note 1)................................................... 3,894 3,303
Accrued interest and dividends receivable............................................ 1,090 1,111
Prepaid expenses and other........................................................... 13 49
-------- --------
$141,834 $167,144
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------

Liabilities
Reverse repurchase agreements (Note 3)............................................... $121,891 $147,690
Accrued interest payable............................................................. 1,706 2,445
Dividends payable.................................................................... -- 323
Accrued expenses and other........................................................... 36 154
-------- --------
123,633 150,612
-------- --------

Stockholders' Equity
Preferred stock, par value $.01 per share; authorized 20,000,000 shares; no shares
issued and outstanding............................................................... -- --
Common stock; par value $.01 per share; authorized 100,000,000 shares;
2,400,016 and 2,356,669 issued and 2,350,016 and 2,306,669 outstanding,
respectively......................................................................... 24 23
Additional paid in capital........................................................... 19,243 19,070
Accumulated other comprehensive income, unrealized gain (loss) on available for
sale securities (Note 2)............................................................. (1,186) (2,351)
Retained earnings.................................................................... 349 19
Treasury stock at cost (50,000 shares)............................................... (229) (229)
-------- --------
18,201 16,532
-------- --------
$141,834 $167,144
======== ========

See notes to financial statements.

F-12

ANWORTH MORTGAGE ASSET CORPORATION

STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)

Period from
March 17, 1998
For the year ended (commencement
December 31, of operations) to
------------------ December 31,
2000 1999 1998
------- ------ -----------------

Interest and dividend income net of amortization
of premium and discount.......................... $10,314 $9,501 $8,570
Interest expense................................. 8,674 7,892 7,378
------- ------ ------
Net interest income.............................. $ 1,640 $1,609 $1,192

Expenses: (Note 6)
Management fee................................ 167 175 144
Incentive fee................................. -- -- 2
Other expense................................. 211 225 161
------- ------ ------
Net Income....................................... $ 1,261 $1,209 $ 885
======= ====== ======
Basic and diluted earnings per share............. $ 0.54 $ 0.53 $ 0.38
======= ====== ======
Dividends declared per share..................... $ 0.40 $ 0.53 $ 0.37
======= ====== ======
Weighted average number of shares outstanding.... 2,331 2,290 2,316
======= ====== ======

See notes to financial statements.

F-13

ANWORTH MORTGAGE ASSET CORPORATION

STATEMENTS OF STOCKHOLDERS' EQUITY

Period from March 17, 1998 (commencement of operations) to December 31, 1998
and years ended December 31, 1999 and December 31, 2000
(Amounts in thousands)

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

Balance, March 17, 1998.................... 0 $-- $ 1 $ -- $ 1
Issuance of common stock.................. 2,328 23 18,970 18,993
Available-for-sale securities, fair value
adjustment................................ $(1,775) $(1,775) (1,775)
Net income................................ 884 884 884
-------
Other comprehensive income (loss).......... $ (891)
=======
Dividends declared--$0.37 per share....... (861) (861)
----- --- ------- ------- ------- ----- -------
Balance, December 31, 1998................. 2,328 $23 $18,971 $(1,775) $ 23 $ -- $17,242
===== === ======= ======= ======= ===== =======

Issuance of common stock.................. 29 0 99 99
Available-for-sale securities, fair value
adjustment................................ (576) (576) (576)
Net income................................ 1,209 1,209 1,209
-------
Other comprehensive income (loss).......... $ 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
-------
Other comprehensive income (loss).......... $ 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
===== === ======= ======= ======= ===== =======

See notes to financial statements.

F-14

ANWORTH MORTGAGE ASSET CORPORATION

STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)

Period from
March 17, 1998
For the year ended (commencement
December 31, of operations) to
------------------ December 31,
2000 1999 1998
-------- -------- -----------------

Operating Activities:
Net income.......................................................... $ 1,261 $ 1,209 $ 885
Adjustments to reconcile net income to net cash provided by operating
activities:
Amortization.................................................... 698 1,468 1,489
Decrease (increase) in accrued interest receivable.............. 21 300 (1,411)
Decrease (increase) in prepaid expenses and other............... 36 (34) (15)
Increase (decrease) in accrued interest payable................. (739) 646 1,799
Increase (decrease) in accrued expenses and other............... (118) 96 58
-------- -------- ---------
Net cash provided by operating activities.................... 1,159 3,685 2,805

Investing Activities:
Available-for-sale securities:
Purchases....................................................... (2,618) (43,658) (231,361)
Principal payments.............................................. 28,930 53,619 53,409
-------- -------- ---------
Net cash provided by investing activities.................... 26,312 9,961 (177,952)

Financing Activities:
Net borrowings from (repayments of) reverse repurchase agreements... (25,799) (22,343) 170,033
Proceeds from common stock issued, net.............................. 173 99 18,994
Repurchase of common stock.......................................... -- (229) --
Dividends paid...................................................... (1,254) (1,169) (582)
-------- -------- ---------
Net cash provided by (used in) financing activities.......... (26,880) (23,642) 188,445
-------- -------- ---------
Net increase (decrease) in cash and cash equivalents................ 591 (9,996) 13,298
Cash and cash equivalents at beginning of period.................... 3,303 13,299 1
-------- -------- ---------
Cash and cash equivalents at end of period.......................... $ 3,894 $ 3,303 $ 13,299
======== ======== =========

Supplemental Disclosure of Cash Flow Information
Cash paid for interest.............................................. $ 9,413 $ 7,246 $ 5,579

Supplemental Disclosure of Investing and Financing Activities
Mortgage securities purchased, not yet settled...................... $ -- $ -- $ 10,047

See notes to financial statements.

F-15

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 its initial
public offering of the Company's 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 associated with the
purchase of ARM securities are amortized into interest income over the
estimated lives of the asset 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, 2000 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 ("MBS") are guaranteed by those respective
agencies. At December 31, 2000, because of the government agencies' guarantee,
substantially 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
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.

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

F-16

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

stock equivalents unless the effect is to reduce a loss or increase in the
income per share. 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.

USE OF 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.

In September of 2000, the Financial Accounting Standards Board issued SFAS
No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. The provisions of this standard will be applied
prospectively in the Company's fiscal quarter starting April 1, 2001. The
Company does not expect the implementation of this standard to materially
affect the Company's reported results of operations and financial position.

NOTE 2. SECURITIES

The following table summarizes the Company's mortgage backed securities
classified as available-for-sale as of December 31, 2000 and 1999, which are
carried at their fair value (amounts in thousands):

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

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

Amortized cost.......... $24,162 $111,379 $487 $136,028
Unrealized gains........ 28 189 29 246
Unrealized losses....... (233) (1,152) -- (1,385)
------- -------- ---- --------
Fair value.............. $23,957 $110,416 $516 $134,889
======= ======== ==== ========

December 31, 1999
------------------------------------------------
Federal Federal
Home Loan National Other Total
Mortgage Mortgage Mortgage-backed MBS
Corporation Association Securities Assets
----------- ----------- --------------- --------

Amortized cost.......... $30,066 $133,612 $ -- $163,678
Unrealized gains........ 41 101 -- 142
Unrealized losses....... (377) (1,955) -- (2,332)
------- -------- ---- --------
Fair value.............. $29,730 $131,758 $ -- $161,488
======= ======== ==== ========

F-17

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

In addition, at December 31, 2000 the Company held positions in preferred
and common stock of other mortgage REITs, valued at $1,948,000. The following
table summarizes the Company's securities as of December 31, 2000 and 1999 at
their fair value (amounts in thousands):

December 31, 2000
--------------------------
REIT
MBS Stocks Total
-------- ------ --------

Amortized Cost............. $135,467 $1,995 $137,462
Unrealized gains........... 807 -- 807
Unrealized losses.......... (1,385) (47) (1,432)
-------- ------ --------
Estimated fair value....... $134,889 $1,948 $136,837
======== ====== ========

December 31, 1999
--------------------------
REIT
MBS Stocks Total
-------- ------ --------

Amortized Cost............. $163,353 $1,355 $164,708
Unrealized gains........... 142 -- 142
Unrealized losses.......... (2,332) (162) (2,494)
-------- ------ --------
Estimated fair value....... $161,163 $1,193 $162,356
======== ====== ========

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). At December 31, 2000,
these agreements are collateralized by mortgage backed securities with a fair
value of $133,896,000.

At December 31, 2000, the repurchase agreements had a weighted average
interest rate of 6.68%, an average maturity of 32 days and the following
remaining maturities (amounts in thousands):

Within 59 days....... $101,103
60 to 89 days........ 20,788
--------
$121,891
========

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. INITIAL PUBLIC OFFERING AND CAPITAL STOCK

On March 17, 1998 the Company completed its initial public offering of
common stock, $0.01 par value. The Company issued 2,200,000 shares of common
stock at a price of $9 per share and received net proceeds of

F-18

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

$18,414,000, net of underwriting discount of $0.63 per share. Offering costs in
connection with the public offering, including the underwriting discount and
other expenses, which total $491,182, have been charged against the proceeds of
the offering. Prior to March 17, 1998, the Company had no operations other than
activities relating to its organization, registration under the Securities Act
of 1933 and the issuance of 100 shares of its common stock to its initial
shareholder.

The Company granted the underwriters of the initial public offering of the
Company's common stock a 30-day option to purchase additional shares of common
stock solely to cover over-allotments, if any, at the public offering price of
$9 per share. On April 14, 1998, the underwriters purchased an additional
127,900 shares under the terms of this option. As a result, the Company
received additional net proceeds of $1,070,523, net of the underwriting
discount of $0.63 per share.

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.

For the year ended December 31, 2000, the Company declared dividends to
stockholders totaling $0.51 per share, of which $0.40 was paid in 2000 and
$0.11 was declared in January 2001 and is payable on February 16, 2001. For the
year ended December 31, 1999 and the period ended December 31, 1998 the Company
declared dividends of $0.53 and $0.37, respectively. For Federal income tax
purposes such dividends are ordinary income 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 Purchase 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. The Company raised equity capital of $174,000 in 2000 and $99,000
in 1999 as a result of this plan.

NOTE 6. TRANSACTIONS WITH AFFILIATES

For the year ended December 31, 2000, the Company paid the Manager $167,000
in base management fees and no incentive management fees; for the year ended
December 31, 1999, the Company paid the Manager

F-19

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

$175,000 in base management fees and no incentive fees and for the period ended
December 31, 1998 the Manager was paid a base management fee of $144,000 and an
incentive management fee of $2,000.

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 600,000 of the outstanding shares of
the Company's common stock. The Stock Option 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. 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 $10,000 in compensation expense related to the DER's.

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:

2000 1999 1998
---------- ---------- --------

Net income--as reported................................. $1,261,000 $1,209,000 $885,000
Net income--pro forma................................... $1,167,000 $1,115,000 $811,000
Basic and diluted earnings per share--as reported....... $ 0.54 $ 0.53 $ 0.38
Basic and diluted earnings per share--pro forma......... $ 0.50 $ 0.49 $ 0.35
Assumptions:
Dividend yield....................................... n/a 10% 10%
Expected volatility.................................. n/a 35% 35%
Risk-free interest rate.............................. n/a 6.6% 5.5%
Expected lives....................................... n/a 7 years 7 years

The fair value of options granted during 1999 was $1.75 per share. The fair
value of the options granted during 1998 was $1.90. There were no options
granted in 2000.

F-20

ANWORTH MORTGAGE ASSET CORPORATION

NOTES TO FINANCIAL STATEMENTS--(Continued)

NOTE 8. SUMMARIZED QUARTERLY RESULTS (UNAUDITED)

For the year ended December 31, 2000:
--------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(amounts 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
====== ====== ====== ======

For the year ended December 31, 1999:
--------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(amounts in thousands except per share data)

Interest and dividend income..................... $2,404 $2,211 $2,349 $2,537
Interest expense................................. 2,036 1,816 1,921 2,119
------ ------ ------ ------
Net interest income.............................. 368 395 428 418
Expenses......................................... 90 94 114 102
------ ------ ------ ------
Net Income....................................... $ 278 $ 301 $ 314 $ 316
====== ====== ====== ======
Basic and diluted earnings per share............. $ 0.12 $ 0.13 $ 0.14 $ 0.14
====== ====== ====== ======
Average number of shares outstanding............. 2,320 2,279 2,278 2,283
====== ====== ====== ======

F-21

================================================================================

4,200,000 Shares

[LOGO] LOGO OF ANWORTH MORTGAGE ASSET CORPORATION

Anworth Mortgage Asset Corporation

Common Stock

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

PROSPECTUS

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

FRIEDMAN BILLINGS RAMSEY

ADVEST, INC.

WEDBUSH MORGAN SECURITIES INC.

February 13, 2002

================================================================================