<PAGE>

    As filed with the Securities and Exchange Commission on March 30, 2000

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

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

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

                                   FORM 10-K
(Mark One)
[X]ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
   1934

  For the year ended December 31, 1999; or

[_]TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
   OF 1934

  For the transition period from                 to

                         Commission File No. 001-13709

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

                      ANWORTH MORTGAGE ASSET CORPORATION
            (Exact name of Registrant as specified in its charter)

<TABLE>
<S>                                            <C>
                  Maryland                                       52-2059785
       (State or Other Jurisdiction of                        (I.R.S. Employer
       Incorporation or Organization)                        Identification No.)
</TABLE>

            1299 Ocean Avenue, #200, Santa Monica, California 90401
                   (Address of principal executive offices)

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

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

<TABLE>
<CAPTION>
   Title of each class                            Name of exchange on which registered
   -------------------                            ------------------------------------
   <S>                                            <C>
   Common stock, par value $0.01 per share        American Stock Exchange
</TABLE>

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

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

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

   At March 17, 2000 the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $9,402,916, based on the closing price of
the common stock on the American Stock Exchange.

   As of March 17, 2000, 2,316,067 shares of Common Stock, $0.01 par value per
share were outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

   Portions of the Registrant's definitive Proxy Statement which the Company
intends to issue within 120 days of the end of the fiscal year, are
incorporated by reference into Part III.

-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<PAGE>

                       ANWORTH MORTGAGE ASSET CORPORATION

                          1999 FORM 10-K ANNUAL REPORT

                               TABLE OF CONTENTS

<TABLE>
 <C>         <S>                                                            <C>
 PART 1...................................................................    1

    ITEM 1.  BUSINESS....................................................     1

    ITEM 2.  PROPERTIES..................................................    32

    ITEM 3.  LEGAL PROCEEDINGS...........................................    32

    ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........    32

 PART II..................................................................   33

    ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
             SHAREHOLDER MATTERS.........................................    33

    ITEM 6.  SELECTED FINANCIAL DATA.....................................    34

    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
             AND RESULTS OF OPERATIONS...................................    35

    ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..    41

    ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................    41

    ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
             AND FINANCIAL DISCLOSURE....................................    41

 PART III.................................................................   43

    ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..........    43

    ITEM 11. EXECUTIVE COMPENSATION......................................    43

    ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
             MANAGEMENT..................................................    43

    ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............    43

 PART IV..................................................................   44

    ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
             FORM 8-K....................................................    44

 SIGNATURES

 FINANCIAL STATEMENTS

 EXHIBITS
</TABLE>

                                       i
<PAGE>

                               INTRODUCTORY NOTE

   Certain statements contained herein are not, and certain statements
contained in future filings by the Company with the Securities and Exchange
Commission (the "Commission") in the Company's press releases or in the
Company's other public or shareholder communications may not be, based on
historical facts and are "forward-looking statements" within the meaning of
applicable federal securities laws. Forward looking statements which are based
on various assumptions (some of which are beyond the Company's control) may be
identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may", "will," "intend," "should,"
"expect," "anticipate," "estimate" or "continue" or the negatives thereof or
other comparable terminology. Forward-looking statements included herein
regarding the actual results, performance and achievements of the Company are
dependent on a number of factors. The Company's actual results could differ
materially from those anticipated in such forward-looking statements as a
result of certain factors, including but not limited to, changes in interest
rates, changes in yield curve, changes in prepayment rates, the availability
of mortgage-backed securities for purchase, the availability of financing and,
if available, the terms of any such financing. For a discussion of the risks
and uncertainties which could cause actual results to differ from those
contained in the forward-looking statements, see "Risk Factors" commencing on
page 27 of this Annual Report on Form 10-K. The Company does not undertake,
and specifically disclaims any obligation, to publicly release the result of
any revisions which may be made to any forward-looking statements to reflect
the occurrence of anticipated or unanticipated events or circumstances after
the date of such statements.

   Reference is made to the Glossary commencing on page 45 of the report for
definitions of terms used in the following description of the Company's
business and elsewhere in this report.

                                    PART 1

ITEM 1. BUSINESS

                            SUMMARY OF THE COMPANY

General

   The Company was formed in October 1997 to invest in mortgage 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
and short-term investments. On March 17, 1998, the Company completed its
initial public offering of 2,200,000 shares raising $18,414,000 in proceeds.
In connection with the underwriters' over-allotment allowance, approximately
one month later, an additional 127,900 shares of Common Stock were sold
raising $1,071,000 in proceeds. The Company utilized the equity capital raised
in its offering and short term borrowings to generate income based on the
difference between the yield on its mortgage assets and the cost of its
borrowings. In October of 1999 the Company implemented a Dividend Reinvestment
and Direct Stock Purchase Plan. Through the plan, the Company has raised an
additional $99,000 in equity capital through December 31, 1999. The Company
has elected to be taxed as a REIT under the Code, and therefore is not
generally subject to federal taxes on its income to the extent it distributes
its net income to its stockholders and maintains its qualification as a REIT.
See "Federal Income Tax Considerations--Requirements for Qualification as a
REIT--Distribution Requirement."

   The goal of the Company is to generate a competitive yield through its use
of leverage and active management of the asset/liability yield spread.

   The Company acquires mortgage assets primarily in the secondary mortgage
market through its manager, Anworth Mortgage Advisory Corporation (the
"Manager"). The Manager manages the day-to-day operations of the Company,
pursuant to the policies established by the Company's Board of Directors and
the authority delegated to the Manager under the Management Agreement. The
Manager is under common control with Pacific Income Advisers, Inc. ("PIA"), an
investment advisory firm, which began operations in 1986. The Manager's

                                       1
<PAGE>

management team is comprised of selected members of PIA's management. The
Company is externally managed by the Manager, taking advantage of the
economies of scale associated with the Manager while avoiding duplicate
administrative functions and incurring the costs of creating a new
administrative infrastructure. The Company has no ownership interest in the
Manager.

   The Company's mortgage assets consist primarily of mortgage securities
("Mortgage Securities") bearing interest rates that adjust periodically based
on changes in short-term interest rates. The Company uses short-term
borrowings utilizing its Mortgage Assets as collateral to acquire additional
Mortgage Assets, while generally maintaining a debt-to-equity ratio of between
8:1 and 12:1, although the ratio may vary from time to time based upon market
conditions and other factors deemed relevant by the Manager and the Company's
Board of Directors. The Company manages actively, on an aggregate basis, both
the interest rate indices and interest rate adjustment periods of its
borrowings against the interest rate indices and interest rate adjustment
periods on its Mortgage Assets.

   At least 60% of the Company's total assets are expected to be what the
Company refers to as Category I securities, which are adjustable or fixed rate
Mortgage Securities and Short-Term Investments. In addition, the Mortgage
Securities in this category will either be rated within one of the two highest
rating categories by at least one nationally recognized statistical rating
organization (such as Moody's, Fitch or Standard & Poors), or if not rated
will be obligations guaranteed by the United States government, its agencies,
Fannie Mae or Freddie Mac. At least 90% of the Company's assets (Category II)
are expected to be investments that qualify for Category I or Mortgage Assets
including (i) unrated Mortgage Loans and, (ii) Mortgage Securities rated at
least Investment Grade by at least one nationally recognized statistical
rating organization. Together Category I and Category II securities are
referred to as Primary assets.

   All other assets (Category III) will be less than 10% of the Company's
assets. Among the types of asset which generally will be assigned to this
category are: (i) Mortgage Securities rated below Investment Grade,
(ii) leveraged Mortgage Derivative Securities, and (iii) shares of other REITS
or mortgage related companies.

Summary of Strategy

   The principal business objective of the Company is to generate a
competitive yield through its use of leverage and active management of the
asset/liability yield spread. Following is the Company's strategy to achieve
its business objective:

 Investment Strategy

   The Company applies a disciplined approach to managing its investments in
an attempt to achieve competitive yields while managing portfolio risk. The
Company utilized the proceeds of its initial public offering, operating cash
flow and short-term borrowings to generate income based on the difference
between the yield on its Mortgage Assets and the cost of its borrowings. The
Company seeks to minimize prepayment risk by structuring a diversified
portfolio with a variety of prepayment characteristics and by analyzing the
prepayment risk of the Mortgage Assets, as well as the deviations between
projected and realized prepayment rates.

 Financing Strategy

   The Company employs a strategy of attempting to increase profitability
through growth in Mortgage Asset volume achieved by leverage based upon short-
term borrowings, primarily reverse repurchase agreements and dollar-roll
agreements. The Company generally maintains a debt-to-equity ratio of between
8:1 and 12:1, although the ratio varies from time to time depending on market
conditions and other factors deemed relevant by the Manager and the Company's
Board of Directors. Depending on the different cost of borrowing funds at
different maturities, the Company varies the maturities of its borrowed funds
to attempt to produce lower borrowing costs. The Company's borrowings are
short-term and the Company attempts to actively manage, on

                                       2
<PAGE>

an aggregate basis, the interest rate indices and interest rate adjustment
periods of its borrowings against the interest rate indices and interest rate
adjustment periods on its Mortgage Assets.

   Although it has not yet done so, over time, to the extent the Company
believes it can lower its cost of funds or increase its return to investors,
it may seek to raise additional capital through accessing the capital markets.
In addition, to the extent the Company develops appropriate infrastructure, it
may access the securitization market to raise additional funds for operations.

 Risk Management Strategy

   Interest Rate and Volatility Risk. If the general level of interest rates
increases or the expected level of volatility of interest rates increases, the
Company's assets are likely to decline in value. The Company uses mathematical
modeling and quantitative analysis to monitor the interest rate sensitivity of
its Mortgage Asset portfolio. The analysis includes the use of mathematical
assumptions regarding the effect of mortgage loan prepayments and interest
rate caps incorporated in most adjustable-rate mortgage securities, as well as
interest rate volatility on its portfolio of Mortgage Assets. Comparison of
interest rate sensitivity factors to the quantitative and qualitative nature
of the Company's borrowings provides the Company with a qualitative measure of
the impact that interest rate movements could have on the Company's net
interest income. Management evaluates continually these mathematical
assumptions and, if necessary, adjusts its Mortgage Asset portfolio
accordingly.

   Credit Risk. The Company has invested in Mortgage Assets, primarily
mortgage pass-through certificates and short-term investments. Although it has
not yet done so, the Company may also invest in collateralized mortgage
obligations, mortgage loans and other securities representing interests in or
obligations backed by pools of mortgage loans which can be readily financed.
If an issuer of a security owned by the Company defaults, the value of the
security is likely to decline, either temporarily or permanently. The Company
continually monitors the credit quality of its Mortgage Assets and maintains
appropriate capital levels for allowances and possible credit losses. The
Company manages the credit risk of its Mortgage Assets through, among other
activities, (i) complying with the Company's policies with respect to credit
risk concentration, (ii) actively monitoring the ongoing credit quality and
servicing of its Mortgage Assets and (iii) maintaining appropriate capital
levels and allowances for possible credit losses.

   Hedging. Although it has not yet done so, the Company may enter into
hedging transactions designed to protect itself to varying degrees against
interest rate changes. The Company may purchase interest rate caps and
interest rate swaps to mitigate the risk of its short-term borrowings
increasing at a greater rate than the yields on its Mortgage Assets during a
period of rising interest rates. The Company may also, to the extent
consistent with its qualifications as a REIT and Maryland law, utilize
financial futures contracts and put and call options on financial futures
contracts and trade forward contracts as a hedge against future interest rate
changes. However, no hedging strategy can completely insulate the Company from
interest rate risks and market movement, and the federal tax laws applicable
to REITs may substantially limit the Company's ability to engage in hedging
transactions. Additionally, hedging strategies have significant transaction
costs and the Company will not be able to significantly reduce or eliminate
the risk associated with its investment portfolio without reducing or perhaps
even eliminating the return on its investments.

   There can be no assurance that the Company will successfully implement its
strategies. See "Risk Factors" for a discussion of factors that could affect
the Company's ability to successfully implement its strategy.

The Manager

   The Manager implements the Company's business strategy on a day-to-day
basis and performs certain services for the Company, pursuant to policies
established by the Company's Board of Directors and the authority delegated to
the Manager under the Management Agreement. The Manager is responsible
primarily for two areas of activity: (i) asset/liability management, which
consists of the acquisition, disposition, financing, hedging and management of
Mortgage Assets and includes credit and prepayment risk management; and (ii)
capital

                                       3
<PAGE>

management, which consists of structuring, analysis, capital raising and
investor relations activities. With respect to the Company's investment
strategy, the Manager employs mortgage analytical tools to generally construct
a diversified Mortgage Asset portfolio. With respect to the Company's
financing strategy, the Manager arranges for various types of financing for
the Company and manages actively the interest rate structure of the Company's
assets and liabilities and monitors the Company's portfolio leverage. With
respect to the Company's risk management strategy, the Manager monitors the
projected change in the portfolio's value based upon assumed changes in
interest rates and, if necessary, attempts to adjust the portfolio
accordingly. The Manager monitors the credit quality of each asset in the
Company's portfolio and seeks to ensure that the overall credit quality of the
portfolio is in keeping with the Company's credit policies as adopted by the
Company's Board of Directors. The Manager evaluates the Company's interest
rate risk levels and performs such analyses as may be required to determine
what types and amounts of hedging transactions are advisable for the Company
given the configuration of its portfolio and seeks to execute trades to
maintain hedges. The Manager is also be required to perform the following
services for the Company: (i) providing regular reports regarding the Company
to the Board of Directors, (ii) monitoring the Company's status as a REIT from
tax and compliance standpoints and (iii) providing managerial, administrative
and management information systems support for the Company.

   The Manager has now managed the Company since its inception in March of
1998. Prior to its association with the Company, the Manager had not
previously managed a REIT. In particular, the Manager had not previously
managed a highly-leveraged pool of Mortgage Assets or utilized hedging
instruments, nor did the Manager have experience in complying with the asset
limitations imposed by the REIT provisions of the Code. Although management
now has nearly two years of experience in managing the Company, there can be
no assurance that the experience of the executive officers of the Company and
the Manager is appropriate to the business of the Company. Further, the
experience of the officers of the Manager and PIA should not be viewed as a
reliable gauge of the continued success of the Company.

   The Company has entered into a management agreement (the "Management
Agreement") between the Company and the Manager for an initial term of five
years from the date of the closing of the Company's initial public offering.
Pursuant to the Management Agreement with the Manager, the Company pays the
Manager an annual base management fee based on Average Net Invested Assets,
payable monthly in arrears, equal to 1% of the first $300 million of Average
Net Invested Assets, plus 0.8% of the portion above $300 million of Average
Net Invested Assets. Average Net Invested Assets is generally defined as total
assets less total debt incurred to finance assets; accordingly, incurring debt
to finance asset purchases does not necessarily increase Average Net Invested
Assets.

   The Company also pays the Manager, as incentive compensation for each
fiscal quarter, an amount equal to 20% of the Net Income of the Company,
before incentive compensation, in excess of the amount that would produce an
annualized Return on Equity equal to the Ten Year U.S. Treasury Rate (average
of weekly average yield to maturity for U.S. Treasury securities (adjusted to
a constant maturity of 10 years), as published weekly by the Federal Reserve
Board during a quarter) plus 1%. A deduction for the Company's interest
expenses for borrowed money is taken in calculating Net Income. "Return on
Equity" is computed on Average Net Worth and has no necessary correlation with
the actual distributions received by stockholders. The incentive compensation
calculation and payment to the Manager is made quarterly in arrears before any
income distributions are made to stockholders for the corresponding period.
Beginning in calendar year 1999, the quarterly Incentive Management
Compensation will be subject to annual reconciliation so that the incentive
management compensation is based on the Manager's performance for a calendar
year rather than on a quarter-by-quarter basis. Such reconciliation shall be
determined as part of the Company's annual audit.

   After the expiration of the initial five-year term, the Management
Agreement will be automatically renewed for additional one-year terms unless
terminated by the Company or the Manager upon written notice. Except in the
case of a termination or non-renewal by the Company for cause, upon
termination or non-renewal of the Management Agreement by the Company, the
Company is obligated to pay the Manager a termination or non-renewal fee equal
to the fair market value of the Management Agreement without regard to the
Company's

                                       4
<PAGE>

termination or non-renewal right as determined by an independent appraisal.
The selection of the independent appraiser shall be subject to the approval of
the Unaffiliated Directors. The payment of such a termination or non-renewal
fee by the Company would adversely affect the cash available for distribution
to the Company's stockholders and may have a material adverse effect on the
Company's operations.

                        OPERATING POLICIES AND PROGRAMS

Asset Acquisition Policy

   The principal business objective of the Company is to earn a competitive
yield through the management of Mortgage Assets and their risks, the use of
leverage, the active management of the asset/liability yield spread, and the
employment of the Company's risk management strategies. In addition, the
Company's structure provides investors with a vehicle to participate in the
mortgage securities market. The Company's Mortgage Assets are held primarily
for investment. The Company generally buys and holds Mortgage Assets to
maturity and, therefore, has a low portfolio turnover rate. The Company's
ability to sell Mortgage Assets for gain is restricted by the REIT Provisions
of the Code and the rules, regulations and interpretations of the Service
thereunder. See "Federal Income Tax Considerations--Requirements for
Qualification as a REIT--Gross Income Tests."

   At least 60% of the Company's total assets are expected to be what the
Company refers to as Category I securities, which are adjustable or fixed rate
Mortgage Securities and Short-Term Investments. In addition, the Mortgage
Securities in this category will either be rated within one of the two highest
rating categories by at least one nationally recognized statistical rating
organization (such as Moody's, Fitch or Standard & Poors), or if not rated
will be obligations guaranteed by the United States government, its agencies,
Fannie Mae or Freddie Mac. At least 90% of the Company's assets (Category II)
are expected to be investments that qualify for Category I are Mortgage Assets
including (i) unrated Mortgage Loans and, (ii) Mortgage Securities rated at
least Investment Grade by at least one nationally recognized statistical
rating organization.

   All other assets (Category III) will be less than 10% of the Company's
assets. Among the types of asset which generally will be assigned to this
category are: (i) Mortgage Securities rated below Investment Grade,
(ii) leveraged Mortgage Derivative Securities, and (iii) shares of other REITS
or mortgage related companies.

   The Company has not acquired and generally will not acquire Inverse
Floaters, Remic Residuals or First Loss Subordinated Bonds. The Company may
acquire mortgage derivative securities, including, but not limited to,
interest only, principal only or other Mortgage Securities that receive a
disproportionate share of interest income or principal, either as an
independent stand-alone investment opportunity or to assist in the management
of prepayment and other risks (collectively, "Mortgage Derivative
Securities"), but only on a limited basis due to the greater risk of loss
associated with Mortgage Derivative Securities. See "Risk Factors--Failure to
Successfully Manage Interest Rate Risks May Adversely Affect Results of
Operations."

   The Company's Board of Directors adopted the investment policies set forth
in the Company's Prospectus as its initial investment policies. The policies
were changed effective June 17, 1999 to allow the Company to better respond to
market conditions. The policies may be changed at any time by the Board of
Directors (subject to approval by a majority of Unaffiliated Directors)
without the consent of stockholders. The Company's Board of Directors will
establish and approve (including approval by a majority of Unaffiliated
Directors) at least annually the investment policies of the company, which
will include investment criteria that each Mortgage Asset must satisfy to be
eligible for investment by the Company. The Company will not purchase any
Mortgage Assets from its Affiliates other than Mortgage Securities that may be
purchased from a taxable subsidiary of the Company that may be formed in
connection with the securitization of Mortgage Loans.

Capital and Leverage Policy

   The Company finances its purchases of Mortgage Assets through equity from
the proceeds of its initial public offering and thereafter primarily by
borrowing against existing Mortgage Assets and using the proceeds

                                       5
<PAGE>

to acquire additional Mortgage Assets. The borrowings are in the form of
reverse repurchase agreements and dollar-roll agreements and may, in the
future, be in the form of loan agreements, lines of credit and other credit
facilities. The Company's borrowings are secured by Mortgage Assets owned by
the Company.

   The Company employs a leveraging strategy to increase its investment assets
by borrowing against existing Mortgage Assets and using the proceeds to
acquire additional Mortgage Assets. The Company generally maintains a debt-to-
equity ratio of between 8:1 and 12:1, although the ratio may vary from time to
time depending on market conditions and other factors deemed relevant by the
Manager and Company's Board of Directors. The Company believes that this will
leave an adequate capital base to protect against interest rate environments
in which the Company's borrowing costs might exceed its interest income from
Mortgage Assets. For example, these conditions could occur when the interest
adjustments on Mortgage Assets lag behind interest rate increases in the
Company's short-term borrowings or when the interest rate of the Company's
short-term borrowings are mismatched with the interest rate indices of the
Company's Mortgage Assets. See "Risk Factors--Failure to Successfully Manage
Interest Rate Risks May Adversely Affect Results of Operations" and "Risk
Factors--Interest Rate Fluctuations May Decrease Net Interest Income." The
Company enters into the collateralized borrowings described herein only with
financially sound institutions meeting credit standards approved by the
Company's Board of Directors, including approval by a majority of Unaffiliated
Directors and monitors the financial condition of such institutions on a
regular, periodic basis.

   Depending on the different cost of borrowing funds at different maturities,
the Company varies the maturities of its borrowed funds to attempt to produce
lower borrowing costs. The Company's borrowings are short-term and the Company
manages actively, on an aggregate basis, both the interest rate indices and
interest rate adjustment periods of its borrowings against the interest rate
indices and interest rate adjustment periods on its Mortgage Assets.

   Mortgage Assets are financed primarily at short-term borrowing rates
through reverse repurchase agreements (a borrowing device evidenced by an
agreement to sell securities to a third party and a simultaneous agreement to
repurchase them at a specified future date and price, the difference
constituting the borrowing rate) and dollar-roll agreements (an agreement to
sell a security for delivery on a specified future date and simultaneous
agreement to repurchase the same or substantially similar security on a
specified future date). In the future the Company may also employ borrowings
under lines of credit and other collateralized financings which the Company
may establish with approved institutional lenders. Currently reverse
repurchase agreements and dollar-roll agreements are the principal financing
devices utilized by the Company to leverage its Mortgage Assets portfolio.
Generally, upon repayment of each reverse repurchase agreement, or repurchase
pursuant to a dollar-roll agreement, the collateral is immediately pledged to
secure a new reverse repurchase agreement or is sold pursuant to a new dollar-
roll agreement.

   A reverse repurchase agreement, although structured as a sale and
repurchase obligation, effects a financing under which the Company pledges its
Mortgage Assets as collateral to secure a short term loan. Generally, the
creditor will make the loan pursuant to the repurchase agreement in an amount
equal to a percentage of the market value of the collateral, typically 80% to
98%. Given the Company's investing activities since inception, this percentage
has ranged from 94% to 97% during the reporting period, a slight improvement
over the 93% to 97% range experienced by the Company during its initial period
of operation, reflecting the Company's improved position with its borrowers.
At the maturity of the reverse repurchase agreement, the Company is required
to repay the loan pursuant to the agreement and correspondingly receives back
its collateral. Under reverse repurchase agreements, the Company generally
retains the incidents of beneficial ownership, including the right to
distributions on the collateral and the right to vote on matters as to which
certificate holders are entitled to vote. Upon a payment default under a
repurchase agreement, the lending party may liquidate the collateral.

   Similar to a reverse repurchase agreement as a method of financing Mortgage
Securities, a dollar-roll is a transaction in which the Company sells Mortgage
Securities for delivery on a specified future date and simultaneously
contracts to repurchase the same or substantially the same type of security on
a specified future date. During the roll period, the Company forgoes the
principal and interest payments on the Mortgage Securities.

                                       6
<PAGE>

The Company, however, is compensated by the interest earned on the cash
proceeds of the initial sale and by the typically lower repurchase price at
the future date. Because the roll provides funds to the Company for the period
of the roll, its value can be expressed in terms of an "implied financing
rate." This method of financing is favorable to the Company when the
repurchase price is low enough in comparison to the initial sale price so that
the implied financing rate is below other alternative short-term borrowing
rates (e.g., the rate for reverse repurchase agreements or other short-term
borrowings). The Company's ability to enter into dollar-roll agreements may be
limited in order to maintain the Company's status as a REIT and to avoid the
imposition of tax on the Company. See "Federal Income Tax Considerations--
Requirements for Qualification as a REIT" and "--Taxation of the Company."

   Reverse repurchase agreements take the form of a sale of pledged securities
to the lender at a discounted price in return for the lender's agreement to
resell the same or similar securities to the borrower at a future date (the
maturity of the borrowing) at an agreed price. In the event of the insolvency
or bankruptcy of a lender during the term of a reverse repurchase agreement,
provisions of the Federal Bankruptcy Code, if applicable, may permit the
lender to consider the agreement to resell the securities to be an executory
contract that, at the lender's option, may be either assumed or rejected by
the lender. If a bankrupt lender rejects its obligation to resell pledged
securities to the Company, the Company's claim against the lender for the
damages resulting therefrom may be treated as simply one of many unsecured
claims against the lender's assets. These claims would be subject to
significant delay and, if and when received, may be substantially less than
the damages actually suffered by the Company.

Credit Risk Management Policy

   The Company reviews credit risk and other risks of loss associated with
each investment. In addition, the Company seeks to diversify the Company's
portfolio of Mortgage Assets to avoid undue geographic, insurer, industry and
certain other types of concentrations. The Company seeks to reduce certain
risks from sellers and servicers through representations and warranties. The
Company's Board of Directors monitors the overall portfolio risk and
determines appropriate levels of provision for loss.

   With respect to its Mortgage Securities, the Company is exposed to various
levels of credit and special hazard risk, depending on the nature of the
underlying Mortgage Assets and the nature and level of credit enhancements
supporting such securities. Agency Certificates are covered by credit
protection in the form of a 100% guarantee from a government entity (GNMA) or
government sponsored entity (Fannie Mae or Freddie Mac). Privately Issued
Certificates represent interests in pools of residential mortgage loans with
partial credit enhancement. Credit loss protection for Privately Issued
Certificates is achieved through the subordination of other interests in the
pool to the interest held by the Company, through pool insurance or through
other means. The degree of credit protection varies substantially among
Privately Issued Certificates.

   The Company reviews the quality of Mortgage Loans at the time of
acquisition and on an ongoing basis. During the time it holds Mortgage Loans,
the Company is subject to risks of borrower defaults and bankruptcies and
special hazard losses (such as those occurring from earthquakes or floods)
that are not covered by standard hazard insurance. However, individual
Mortgage Loans may be covered by FHA insurance, VA guarantees or private
mortgage insurance and, to the extent securitized into Agency Certificates, by
such government sponsored entity obligations or guarantees.

   Compliance with the Company's credit risk management policy guidelines is
determined at the time of purchase of Mortgage Assets (based upon the most
recent valuation utilized by the Company) and will not be 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 Assets of the type held
by the Company.

Asset/Liability Management Policy

   Interest-Rate Risk Management. To the extent consistent with its election
to qualify as a REIT, the Company follows an interest rate risk management
program intended to protect its portfolio of Mortgage Assets

                                       7
<PAGE>

and related debt against the effects of major interest rate changes.
Specifically, the Company's interest rate management program is formulated
with the intent to offset to some extent the potential adverse effects
resulting from rate adjustment limitations on its Mortgage Assets and the
differences between interest rate adjustment indices and interest rate
adjustment periods of its adjustable-rate Mortgage Assets and related
borrowings. The Company's interest rate risk management program encompasses a
number of procedures, including the following: (i) monitoring and adjusting,
if necessary, the interest rate sensitivity of its Mortgage Assets compared
with the interest rate sensitivities of its borrowings; and (ii) attempting to
structure its borrowing agreements relating to adjustable-rate Mortgage Assets
to have a range of different maturities and interest rate adjustment periods
(although substantially all will be less than a year). As a result, the
Company expects to be able to adjust the average maturity/adjustment period of
such borrowings on an ongoing basis by changing the mix of maturities and
interest rate adjustment periods as borrowings come due or are renewed.
Through use of these procedures, the Company attempts to reduce the risk of
differences between interest rate adjustment periods of adjustable-rate
Mortgage Assets and related borrowings.

   Depending on market conditions and the cost of the transactions, the
Company may conduct certain hedging activities in connection with the
management of its Mortgage Asset portfolio, although it has not done so since
inception. To the extent consistent with the Company's election to qualify as
a REIT, the Company follows a hedging strategy intended to mitigate the
effects of interest rate changes and to enable the Company to earn net
interest income in periods of generally rising, as well as declining or
static, interest rates. Specifically, the Company's hedging program is
formulated with the intent to offset to some extent the potential adverse
effects of (i) changes in interest rate levels relative to the interest rates
on the Mortgage Assets held in the Company's investment portfolio, and (ii)
differences between the interest rate adjustment indices and periods of the
Company's Mortgage Assets and the borrowings of the Company. As part of its
hedging strategy, the Company also monitors on an ongoing basis the prepayment
risks that arise in fluctuating interest rate environments.

   The Company's hedging policy encompasses a number of procedures. First, the
Company attempts to actively manage, on an aggregate basis, the interest rate
indices and interest rate adjustment periods of its borrowings against the
interest rate indices and interest rate adjustment periods on its Mortgage
Assets. In addition, the Company structures its reverse repurchase borrowing
agreements and dollar-roll agreements to have a range of different maturities
(although substantially all have maturities of less than one year). As a
result, the Company is able to adjust the average maturity of its borrowings
on an ongoing basis by changing the mix of maturities as borrowings come due
and are renewed. In this way, the Company reduces differences between the
interest rate adjustment periods of its Mortgage Assets and related borrowings
that may occur due to prepayments of Mortgage Loans or other factors.

   The Company may hedge to some extent against the short-term indebtedness
incurred by the Company to finance its acquisition of Mortgage Assets to
mitigate the effects of interest rate fluctuations or other market movements.
With respect to assets, hedging can be used either to increase the liquidity
or decrease the risk of holding an asset by guaranteeing, in whole or in part,
the price at which such asset may be disposed of prior to its maturity and may
also be used to receive interest income in excess of specified interest rate
caps. With respect to indebtedness, hedging can be used to limit, fix, or cap
the interest rate on short-term indebtedness.

   In a typical interest rate cap agreement, the cap purchaser makes an
initial lump sum cash payment to the cap seller in exchange for the seller's
promise to make cash payments to the purchaser on fixed dates during the
contract term if prevailing interest rates exceed the rate specified in the
contract. Financial futures contracts are the sale of a futures contract,
typically on Treasury Bills or Eurodollar contracts, creating a firm
obligation to deliver a specific financial instrument at a specified future
date and price. Options on financial futures contracts are similar to options
on securities except that a futures option gives the purchaser the right, in
return for the premium paid, to assume a position in a futures contract and
obligates the seller to deliver that position. Financial futures contracts and
options on financial futures contracts are classified as "commodities" under
the federal Commodity Exchange Act and may also be classified as "securities"
for securities law purposes. The Company does not intend to invest in any
other types of commodities and will not engage in commodities trading. The
purchase of Mortgage Derivative Securities and Excess Servicing Rights can be
effective hedging instruments in

                                       8
<PAGE>

certain situations as these investments tend to increase in value and their
yields tend to increase as interest rates rise. The Company intends to limit
its purchases of Mortgage Derivative Securities and Excess Servicing Rights to
those investments qualifying as Qualified REIT Real Estate Assets. Income from
such investments qualifies for purposes of the 95% and 75% sources of income
tests applicable to REITs. See "Federal Income Tax Considerations--
Requirements for Qualification as a REIT--Gross Income Tests."

   The Company may acquire Excess Servicing Rights, but only to the extent
such rights constitute a Qualified REIT Real Estate Asset. Excess Servicing
Rights would entitle the Company to receive the interest portion of monthly
mortgage payments not already allocated to either a pass-through certificate
or the administration of mortgage servicing. Because Excess Servicing Rights
represent interest only cash flows from mortgage loans, they behave in a
fashion similar to "interest only" Mortgage Derivative Securities. The Excess
Servicing Rights also will be subject to the general credit of the Servicer
(the entity performing the loan servicing function on Mortgage Loans or Excess
Servicing Rights owned by the Company) and the risk that the Servicer could be
terminated. As part of its loan servicing function, the Servicer collects and
is responsible for distributing the interest payments attributable to the
Excess Servicing Rights.

   Fixed-rate Mortgage Assets may also be acquired for the purpose of being
combined with hedging instruments to obtain investment characteristics similar
to adjustable-rate Mortgage Assets.

   These hedging transactions are designed to reduce the fluctuation in the
value of the Company's portfolio in changing interest rate environments. No
hedging strategy can completely insulate the Company from such risks, and
certain of the federal income tax requirements that the Company must satisfy
to qualify as a REIT limit the Company's ability to hedge. The Company intends
to carefully monitor and may have to limit its hedging strategies to assure
that it does not realize excessive hedging income, or hold hedging assets
having excess value in relation to total assets, which would result in the
Company's disqualification as a REIT or, in the case of excess hedging income,
the payment of a penalty tax for failure to satisfy certain REIT income tests
under the Code, provided such failure was for reasonable cause. See "Federal
Income Tax Considerations--Requirements for Qualification as a REIT."

   In addition, hedging involves transaction costs, and such costs increase
dramatically as the period covered by the hedging protection increases and
that may also increase during periods of rising and fluctuating interest
rates. Therefore, the Company may be prevented from effectively hedging or may
determine it is not advantageous to hedge its short-term indebtedness incurred
to acquire Mortgage Assets. Certain losses incurred in connection with hedging
activities may be capital losses that would not be deductible to offset
ordinary REIT income. In such a situation, the Company would have incurred an
economic loss of capital that would not be deductible to offset the ordinary
income from which dividends must be paid.

   Prepayment Risk Management. The Company seeks to minimize the risk that
borrowers of mortgage loans underlying Mortgage Assets may prepay such loans
at a faster or slower than anticipated rate and the effects caused by such
prepayments by attempting to structure a diversified portfolio with a variety
of prepayment characteristics, investing in Mortgage Assets with prepayment
prohibitions and penalties, investing in certain Mortgage Security structures
that have prepayment protections, and balancing Mortgage Assets purchased at a
premium with Mortgage Assets purchased at a discount. The Company invests in
Mortgage Assets that on a portfolio basis do not have significant purchase
price premiums. Under normal market conditions, the Company seeks to keep the
aggregate capitalized purchase premium of the portfolio to 3% or less. In
addition, the Company may in the future purchase Principal Only Derivatives to
a limited extent as a hedge against prepayment risks. Prepayment risk is
monitored by Management and the Company's Board of Directors through periodic
review of the impact of a variety of prepayment scenarios on the Company's
revenues, net earnings, dividends, cash flow and net balance sheet market
value.

   The Company believes that it has developed cost-effective asset/liability
management policies to mitigate interest rate and prepayment risks. However,
no strategy can completely insulate the Company from interest rate changes,
prepayment risks and defaults by counter-parties. Further, as noted above,
certain of the federal income

                                       9
<PAGE>

tax requirements that the Company must satisfy to qualify as a REIT limit the
Company's ability to fully hedge its interest and prepayment risks. Management
monitors carefully, and may have to limit, its asset/liability management
program to assure that the Company does not realize excessive hedging income,
or hold hedging Mortgage Assets having excess value in relation Mortgage
Assets, which would result in the Company's disqualification as a REIT or, in
the case of excess hedging income, the payment of a penalty tax for failure to
satisfy certain REIT income tests under the Code, provided such failure was
for reasonable cause. See "Federal Income Tax Considerations--Requirements for
Qualification as a REIT." In addition, asset/liability management involves
transaction costs that increase dramatically as the period covered by the
hedging protection increases and that may increase during periods of
fluctuating interest rates. Therefore, the Company may be prevented from
effectively hedging its interest rate and prepayment risks.

Description of Mortgage Assets

   The Company invests principally in the following types of Mortgage Assets
subject to the operating restrictions described in "--Operating Policies and
Programs" above. Within such operating restrictions there are no limitations
on the amount of each of the following Mortgage Assets the Company can
acquire.

 Pass-Through Certificates

   General. The Company's investments in Mortgage Assets are expected to be
concentrated in Pass-Through Certificates. The Pass-Through Certificates to be
acquired by the Company will consist primarily of pass-through certificates
issued by Fannie Mae, FHLMC and GNMA, as well as Primary privately issued
adjustable-rate mortgage pass-through certificates. The Pass-Through
Certificates acquired by the Company represent interests in mortgages that
will be secured primarily by liens on single-family (one-to-four units)
residential properties, or on multi-family, commercial or other real estate-
related properties.

   The ARM Pass-Through Certificates acquired by the Company are subject to
periodic interest rate adjustments which may be less frequent than the
increases or decreases in the borrowings or financings utilized by the
Company. In a period of increasing interest rates, the Company could
experience a decrease in Net Cash Flow because the interest rates on its
borrowings could increase faster than the interest rates on ARM Pass-Through
Certificates owned by the Company. Additionally, ARMs backed by loans secured
by liens on single-family (one-to-four) residences are subject to periodic and
lifetime interest rate caps which limit the amount an ARM interest rate can
change during any given period. The Company's borrowings are generally not
subject to similar restrictions. The impact on Net Cash Flows of such interest
rate changes depends on the adjustment features of the Mortgage Assets owned
by the Company and the maturity schedules of the Company's borrowings.

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

   Existing Fannie Mae ARM Programs. Fannie Mae is a federally chartered and
privately owned corporation organized and existing under the Federal National
Mortgage Association Charter Act (12 U.S.C. (S) 1716 et seq.). Fannie Mae
provides funds to the mortgage market primarily by purchasing Mortgage Loans
on homes from local lenders, thereby replenishing their funds for additional
lending. Fannie Mae established its first ARM programs in 1982 and currently
has several ARM programs under which ARM certificates may be issued, including
programs for the issuance of securities through REMICs under the Code.

                                      10
<PAGE>

   Each Fannie Mae ARM Pass-Through Certificate issued to date has been issued
in the form of a Pass-Through Certificate representing a fractional undivided
interest in a pool of ARMs formed by Fannie Mae. The ARMs included in each
pool are fully amortizing conventional Mortgage Loans secured by a first lien
on either one-to-four family residential properties or multifamily properties.
The original terms to maturities of the Mortgage Loans generally do not exceed
40 years. Currently, Fannie Mae has issued several different series of ARMs.
All of Fannie Mae's series of ARMs are in its lender (or Swaps) mortgage-
backed securities program where individual lenders swap pools of Mortgage
Loans that they originated or purchased for a Fannie Mae security backed by
those same Mortgage Loans. Each series bears an initial interest rate and a
margin tied to an index based on all Mortgage Loans in the related pool, less
a fixed percentage representing servicing compensation and Fannie Mae's
guarantee fee. The specified index used in each series has included the One-
Year U.S. Treasury Rate published by the Federal Reserve Board, the 11th
District Cost of Funds Index published by the Federal Home Loan Bank of San
Francisco and other indices. In addition, the majority of series of Fannie Mae
ARMs issued to date have had a monthly, semi-annual or annual interest rate
adjustment.

   Adjustments to the interest rates on Fannie Mae ARMs are typically subject
to lifetime caps. In addition, some pools contain ARMs that are subject to
semi-annual or annual interest rate change limitations, frequently 1% to 2%,
respectively. Some pools contain ARMs that provide for limitations on the
amount by which monthly payments may be increased but have no limitation on
the frequency or magnitude of changes to the mortgage interest rate of the ARM
except for the lifetime cap. In cases where an increase in the rate cannot be
covered by the amount of the scheduled payment, the uncollected portion of
interest is deferred and added to the principal amount of the ARM. In such
cases, interest paid on the Fannie Mae Certificates is a monthly pass-through
of the amount of interest on each ARM rather than a weighted average pass-
through rate of interest.

   Fannie Mae guarantees to the registered holder of a Fannie Mae Certificate
that it will distribute amounts representing scheduled principal and interest
(at the rate provided by the Fannie Mae Certificate) on the Mortgage Loans in
the pool underlying the Fannie Mae Certificate, whether or not received, and
the full principal amount of any such Mortgage Loan foreclosed or otherwise
finally liquidated, whether or not the principal amount is actually received.
The obligations of Fannie Mae under its guarantees are solely those of Fannie
Mae and are not backed by the full faith and credit of the United States. If
Fannie Mae were unable to satisfy such obligations, distributions to holders
of Fannie Mae Certificates would consist solely of payments and other
recoveries on the underlying Mortgage Loans and, accordingly, monthly
distributions to holders of Fannie Mae Certificates would be affected by
delinquent payments and defaults on such Mortgage Loans.

   Existing FHLMC ARM Programs. The Federal Home Loan Mortgage Corporation is
a corporate instrumentality of the United States created pursuant to an Act of
Congress (Title III of the Emergency Home Finance Act of 1970, as amended, 12
U.S.C. (S) 1451-1459), on July 24, 1970. The principal activity of FHLMC
currently consists of the purchase of Conforming Mortgage Loans or
participation interests therein and the resale of the loans and participations
so purchased in the form of guaranteed Mortgage Securities. FHLMC established
its first regular ARM program in 1986 and currently has several regular ARM
programs available for the issuance of ARM certificates and a number of
special programs that may be offered to Mortgage Loan sellers. All of the
Mortgage Loans evidenced by FHLMC Certificates are conventional Mortgage
Loans, and are not guaranteed or insured by, and are not obligations of, the
United States or any agency or instrumentality thereof, other than FHLMC.

   Each FHLMC Certificate issued to date has been issued in the form of a
Pass-Through Certificate representing an undivided interest in a pool of ARMs
purchased by FHLMC. The ARMs included in each pool are fully amortizing,
conventional Mortgage Loans with original terms to maturity of up to 40 years
secured by first liens on one-to-four unit family residential properties or
multi-family properties. An ARM certificate issued by FHLMC may be issued
under one of two cash programs (comprised of Mortgage Loans purchased from a
number of sellers) or guarantor programs (comprised of Mortgage Loans
purchased from one seller in exchange for participation certificates
representing interests in the Mortgage Loans purchased). The interest rate
paid on FHLMC Certificates adjusts on the first day of the month following the
month in which the interest rates on the underlying Mortgage Loans adjust. The
interest rates paid on ARM certificates issued under FHLMC's standard

                                      11
<PAGE>

ARM programs adjust annually in relation to the One-Year U.S. Treasury Rate as
published by the Federal Reserve Board. The specified index used in each FHLMC
series has also included the 11th District Cost of Funds Index published by
the Federal Home Loan Bank of San Francisco and other indices. Interest rates
paid on FHLMC Certificates equal the applicable index rate plus a specified
number of basis points ranging typically from 125 to 250 basis points. In
addition, the majority of series of FHLMC Mortgage Securities issued to date
have had a monthly, semi-annual or annual interest adjustment. Adjustments in
the interest rates paid are generally limited to an annual increase or
decrease of either 1% or 2% and to a lifetime cap of 5% or 6% over the initial
interest rate. Certain FHLMC programs include Mortgage Loans that allow the
borrower to convert the adjustable mortgage interest rate of his ARM to a
fixed rate. ARMs that are converted into fixed-rate Mortgage Loans are
repurchased by FHLMC or by the seller of such Mortgage Loans to FHLMC, at the
unpaid principal balance thereof, plus accrued interest to the due date of the
last adjustable rate interest payment.

   Some FHLMC pools contain ARMs that provide for limitations on the amount by
which monthly payments may be increased but have no limitation on the
frequency or magnitude of changes to the mortgage interest rate of the ARM
except for the lifetime cap. In cases where an increase in the rate cannot be
covered by the amount of the scheduled payment, the uncollected portion of
interest is deferred and added to the principal amount of the ARM. In such
cases, interest paid on the FHLMC Certificates is a monthly pass-through of
the amount of interest on each ARM rather than a weighted average pass-through
rate of interest.

   FHLMC guarantees to each holder of its ARM certificates the timely payment
of interest at the applicable pass-through rate and ultimate collection of all
principal on the holder's pro rata share of the unpaid principal balance of
the related ARMs, but does not guarantee the timely payment of scheduled
principal of the underlying Mortgage Loans. The obligations of FHLMC under its
guarantees are solely those of FHLMC and are not backed by the full faith and
credit of the United States. If FHLMC were unable to satisfy such obligations,
distributions to holders of FHLMC Certificates would consist solely of
payments and other recoveries on the underlying Mortgage Loans and,
accordingly, monthly distributions to holders of FHLMC Certificates would be
affected by delinquent payments and defaults on such Mortgage Loans.

   Existing GNMA ARM Programs. GNMA is a wholly owned corporate
instrumentality of the United States within the Department of Housing and
Urban Development ("HUD"). Section 306(g) of Title III of the National Housing
Act of 1934, as amended (the "Housing Act"), authorizes GNMA to guarantee the
timely payment of the principal of and interest on certificates that represent
an interest in a pool of Mortgage Loans insured by the FHA under the Housing
Act or Title V of the Housing Act of 1949, or partially guaranteed by the VA
under the Servicemen's Readjustment Act of 1944, as amended, or Chapter 37 of
Title 38, United States Code and other loans eligible for inclusion in
mortgage pools underlying GNMA Certificates. Section 306(g) of the Housing Act
provides that "the full faith and credit of the United States is pledged to
the payment of all amounts which may be required to be paid under any guaranty
under this subsection." An opinion, dated December 12, 1969, of an Assistant
Attorney General of the United States, states that such guarantees under
Section 306(g) of mortgage-backed certificates of the type that may be
purchased by the Company or pledged as security for a series of Mortgage
Securities are authorized to be made by GNMA and "would constitute general
obligations of the United States backed by its full faith and credit."

   The interest rate paid on the certificates issued under GNMA's standard ARM
program adjusts annually in relation to the One-Year U.S. Treasury Rate as
published by the Federal Reserve Board. Interest rates paid on GNMA
Certificates typically equal the index rate plus 150 basis points. Adjustments
in the interest rate are generally limited to an annual increase or decrease
of 1% and to a lifetime cap of 5%.

 CMOs

   The Company may, from time to time, invest in variable-rate and short-term
fixed-rate CMOs. "CMOs" as used herein means variable-rate debt obligations
(bonds) that are collateralized by mortgage loans or mortgage certificates
other than Mortgage Derivative Securities and Subordinated Interests. CMOs are
structured so that principal and interest payments received on the collateral
are sufficient to make principal and interest payments

                                      12
<PAGE>

on the bonds. Such bonds may be issued by United States government agencies or
private issuers in one or more classes with fixed or variable interest rates,
maturities and degrees of subordination which are characteristics designed for
the investment objectives of different bond purchasers. The Company will only
acquire CMOs that constitute beneficial interests in grantor trusts holding
Mortgage Loans, or regular interests issued by REMICs, or that otherwise
constitute Qualified REIT Real Estate Assets (provided that the Company has
obtained a favorable opinion of counsel or a ruling from the Service to that
effect).

   CMOs ordinarily are issued in series, each of which consists of several
serially maturing classes ratably secured by a single pool of Mortgage Loans
or Pass-Through Certificates. Generally, principal payments received on the
mortgage-related assets securing a series of CMOs, including prepayments on
such mortgage-related assets, are applied to principal payments on one or more
classes of the CMOs of such series on each principal payment date for such
CMOs. Scheduled payments of principal of and interest on the mortgage-related
assets and other collateral securing a series of CMOs are intended to be
sufficient to make timely payments of interest on such CMOs and to retire each
class of such CMOs by its stated maturity.

   CMOs may be subject to certain rights of issuers thereof to redeem such
CMOs prior to their stated maturity dates, which may have the effect of
diminishing the Company's anticipated return on its investment. The Company
will not acquire any CMOs that do not qualify as Qualified REIT Real Estate
Assets.

 Mortgage Warehouse Participations

   The Company also may from time to time acquire Mortgage Warehouse
Participations as an additional means of diversifying its sources of income,
provided that such investments, together with the Company's investments in
Limited Investment Assets, will not in the aggregate exceed 30% of its total
Mortgage 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. Mortgage Warehouse
Participations do not qualify as Qualified REIT Real Estate Assets.
Accordingly, this activity will be limited by the REIT Provisions of the Code.
See "Federal Income Tax Considerations--Requirements for Qualification as a
REIT."

 Other Mortgage Securities

   General. The Company may acquire Other Mortgage Securities or interests
therein if it determines that it will be beneficial to do so and it will not
adversely affect qualification of the Company as a REIT. Such Other Mortgage
Securities may include non-Primary Mortgage Assets and other Mortgage
Securities collateralized by single-family Mortgage Loans, Mortgage Warehouse
Participations, Mortgage Derivative Securities, Subordinated Interests and
other mortgage-backed and mortgage-collateralized obligations, other than
Pass-Through Certificates and CMOs.

   Mortgage Derivative Securities. The Company may acquire Mortgage Derivative
Securities on a limited basis as market conditions warrant, either as an
independent stand-alone investment opportunity or to assist in the management
of prepayment and other risks. 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 more
rapid than anticipated prepayments on such 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
("Interest Only Derivatives") would be likely to decline. Conversely, the
rates of return on Mortgage Derivative Securities representing the right to
receive principal only or a disproportionate amount of principal ("Principal
Only Derivatives") would be likely to increase in the event of rapid
prepayments.

   The Company presently intends to acquire Mortgage Derivative Securities,
including Principal and Interest Only Derivatives. Interest Only Derivatives
may be an effective hedging device since they generally increase in value as
Mortgage Securities representing interests in adjustable-rate mortgages
decrease in value. The Company also may invest in other types of floating-rate
derivatives that are currently available in the market. The Company

                                      13
<PAGE>

also may invest in other Mortgage Derivative Securities that may in the future
be developed if the Board of Directors, including a majority of Unaffiliated
Directors, determines that such investments would be advantageous to the
Company. The Company will generally not acquire Inverse Floaters, Remic
Residuals or First Loss Subordinated Bonds. However, the Company may retain
residual interests in its own securitizations of Mortgage Loans. Moreover, the
Company will not purchase any Mortgage Derivative Securities that do not
qualify as Qualified REIT Real Estate Assets.

   Subordinated Interests. The Company also may acquire Subordinated
Interests, which are classes of Mortgage Securities that are junior to other
classes of such series of Mortgage 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
certain types of risks, such as 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 Securities or may be limited in amount.

   Any Subordinated Interests acquired by the Company will be limited in
amount and bear yields that the Company believes are commensurate with the
risks involved. The market for Subordinated Interests is not extensive and may
be illiquid. In addition, the Company's ability to sell Subordinated Interests
will be limited by the REIT Provisions of the Code. Accordingly, the Company
intends to purchase Subordinated Interests for investment purposes only.
Although publicly offered Subordinated Interests generally will be rated, the
risks of ownership will be substantially the same as the ownership of unrated
Subordinated Interests because the rating does not address the possibility
that the Company might suffer a lower than anticipated yield or fail to
recover its initial investment. The Company will only purchase Subordinated
Interests that are consistent with its credit risk management policy and will
not purchase any Subordinated Interests that do not qualify as Qualified REIT
Real Estate Assets.

 Mortgage Loans

   General. In the future, following the development of an appropriate
infrastructure, the Company intends to acquire and accumulate Mortgage Loans
as part of its investment strategy until a sufficient quantity has been
accumulated for securitization into Primary Mortgage Securities. The Mortgage
Loans acquired by the Company and not yet securitized, together with the
Company's investments in Limited Investment Assets, will not constitute more
than 30% of its total Mortgage Assets at any time. All Mortgage Loans will be
acquired with the intention of securitizing them into Primary Mortgage
Securities. However, there can be no assurance that the Company will be
successful in securitizing the Mortgage Loans. After a pool of Mortgage Loans
has been securitized, the Mortgage Loans will no longer be considered Limited
Investment Assets. To meet the Company's investment criteria, the Mortgage
Loans to be acquired by the Company will generally conform to the underwriting
guidelines established by Fannie Mae, FHLMC 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. The Company does not intend to obtain additional appraisals at
the time of acquiring Mortgage Loans.

   The Mortgage Loans may be originated by or purchased from various Suppliers
of Mortgage Assets throughout the United States, such as savings and loan
associations, banks, mortgage bankers, home builders, insurance companies and
other mortgage lenders. The Company may acquire Mortgage Loans directly from
originators and from entities holding Mortgage Loans originated by others. The
Board of Directors of the Company has not established any limits upon the
geographic concentration of Mortgage Loans to be acquired by the Company or
the credit quality of Suppliers of Mortgage Assets. See "Risk Factors--
Interest Rate Fluctuations May Decrease Net Interest Income."

   The Company will acquire ARMs. The interest rate on ARMs is typically tied
to an index (such as the One-Year U.S. Treasury Rate published by the Federal
Reserve Board, the 11th District Cost of Funds Index published by the Federal
Home Loan Bank of San Francisco or LIBOR) and is adjustable periodically at
various intervals. Such Mortgage Loans may be subject to lifetime or periodic
interest rate or payment caps.


                                      14
<PAGE>

   Conforming and Nonconforming Mortgage Loans. In the future, the Company may
acquire both Conforming and Nonconforming Mortgage Loans for securitization.
Conforming Mortgage Loans comply with the requirements for inclusion in a loan
guarantee program sponsored by GNMA, FHLMC or Fannie Mae. Under current
regulations, the maximum principal balance allowed on Conforming Mortgage
Loans ranges from $214,600 for one-unit residential loans ($321,000 for such
residential loans secured by mortgage properties located in either Alaska or
Hawaii) to $412,450 for four-unit residential loans ($618,875 for such
residential loans secured by mortgaged properties located in either Alaska or
Hawaii). Nonconforming Mortgage Loans are Mortgage Loans that do not qualify
in one or more respects for purchase by Fannie Mae or FHLMC under their
standard programs. The Company expects that a majority of Nonconforming
Mortgage Loans it purchases will be nonconforming primarily because they have
original principal balances which exceed the requirements for FHLMC or Fannie
Mae programs.

   Commitments to Mortgage Loan Sellers. The Company may issue commitments
("Commitments") to originators and other sellers of Mortgage Loans who follow
policies and procedures that generally comply with Fannie Mae and FHLMC
regulations and guidelines and that comply with all applicable federal and
state laws and regulations for Mortgage Loans secured by single-family (one-
to-four units) residential properties. In addition, Commitments may be issued
for Agency Certificates as well as privately issued Pass-Through Certificates
and Mortgage Loans. Commitments will obligate the Company to purchase Mortgage
Assets from the holders of the Commitments for a specific period of time, in a
specific aggregate principal amount and at a specified price and margin over
an index. Although the Company may commit to acquire Mortgage Loans prior to
funding, all Mortgage Loans are to be fully funded prior to their acquisition
by the Company. Following the issuance of Commitments, the Company will be
exposed to risks of interest rate fluctuations similar to those risks on
adjustable-rate Mortgage Assets.

   Securitization of Mortgage Loans. The Company anticipates that in the
future, if it obtains personnel with the appropriate expertise, it may create,
through securitization, Primary Mortgage Securities with all Mortgage Loans it
acquires. Such Securities would be structured as collateralized borrowing and
not as a sale for accounting purposes. The Company's decision at any time to
acquire Mortgage Loans for securitization will be based on the Company's
determination that it can earn a higher yield on the Mortgage Securities
created through securitization than on comparable Mortgage Securities
purchased in the market. In making this determination, the Company will
consider the demand for the Mortgage Securities to be created from such
Mortgage Loans, the cost of securitization, the relative strength of issuers
and other market participants active in such securities, Rating Agency
requirements and other factors affecting the structure, cost, rating and
benefits of such securities relative to each other and to other investment
alternatives.

   The Company may elect to conduct its operations of acquiring and
securitizing Mortgage Loans through one or more taxable subsidiaries formed
for such purpose.

   In connection with the creation of a new Mortgage Security through
securitization of Mortgage Loans, the issuer generally will be required to
enter into a master servicing agreement with respect to such series of
Mortgage Securities with an entity acceptable to the rating agency that
regularly engages in this activity (the "Master Servicer"). At the present
time, the Company does not engage in this business and no Affiliates of the
Company or the Manager will be appointed as a Master Servicer for any issue of
Mortgage Securities created by the Company.

   To the extent that Management determines that it is not in the best
interests of the Company to securitize mortgage loans, it may engage in whole
loan sale transactions with respect to loans accumulated in its portfolio.

   Protection Against Mortgage Loan Risks. It is anticipated that any Mortgage
Loan purchased will have a commitment for mortgage pool insurance from a
mortgage insurance company with a claims-paying ability in one of the two
highest rating categories by either of the Rating Agencies. Mortgage pool
insurance insures the payment of certain portions of the principal and
interest on Mortgage Loans. In lieu of mortgage pool insurance, the Company
may arrange for other forms of credit enhancement such as letters of credit,
subordination of cash

                                      15
<PAGE>

flows, corporate guaranties, establishment of reserve accounts or over-
collateralization. The Company expects that any Mortgage Loans acquired will
be reviewed by a mortgage pool insurer or other qualified Mortgage Loan
underwriter to ensure that the credit quality of the Mortgage Loans meets the
insurer's guidelines. The Company intends to rely primarily upon the credit
evaluation of such third-party mortgage pool insurer or underwriter issuing
the commitment rather than make its own independent credit review in
determining whether to purchase a Mortgage Loan. Credit losses covered by the
pool insurance policies or other forms of credit enhancement are restricted to
the limits of their contractual obligations and may be lower than the
principal amount of the Mortgage Loan. The pool insurance or credit
enhancement will be issued when the Mortgage Loan is subsequently securitized,
and the Company will be at risk for credit losses on that loan prior to its
securitization.

   In addition to credit enhancement, the Company anticipates that it will
also obtain a commitment for special hazard insurance on the Mortgage Loans,
if available at reasonable cost, to mitigate casualty losses that are not
usually covered by standard hazard insurance, such as vandalism, war,
earthquake and floods. This special hazard insurance is not in force during
the accumulation period, but is activated instead at the time the Mortgage
Loans are pledged as collateral for the Mortgage Securities. Accordingly, the
risks associated with such special hazard losses exist primarily between the
times the Company purchases a Mortgage Loan and the inclusion of such Mortgage
Loan within a newly created issue of Mortgage Securities.

   It is expected that when the Company acquires Mortgage Loans, the seller
will generally represent and warrant to the Company that there has been no
fraud or misrepresentation during the origination of the Mortgage Loans and
generally agree to repurchase any loan with respect to which there is fraud or
misrepresentation. The Company will provide similar representations and
warranties when the Company sells or pledges the Mortgage Loans as collateral
for Mortgage Securities. If a Mortgage Loan becomes delinquent and the pool
insurer is able to prove that there was fraud or misrepresentation in
connection with the origination of the Mortgage Loan, the pool insurer will
not be liable for the portion of the loss attributable to such fraud or
misrepresentation. Although the Company will generally have recourse to the
seller based on the seller's representations and warranties to the Company,
the Company will be at risk for loss to the extent the seller does not perform
its repurchase obligations.

Other Policies

   The Company may purchase stock in other mortgage REITs or stock in similar
companies when the Company believes that such purchases will yield fairly
attractive returns on capital employed. When the stock market valuations of
such companies are low in relation to the market value of their assets, the
Company believes that such stock purchases provide a method for the Company to
acquire an interest in a pool of Mortgage Assets at an attractive price. The
Company does not, however, presently intend to invest in the securities of
other issuers for the purpose of exercising control or to underwrite the
securities of other issuers. As of December 31, 1999 the Company acquired an
approximately $1,200,000 position in Thornburg Mortgage Asset Corporation
preferred stock.

   The Company intends to operate in a manner that will not subject it to
regulation under the Investment Company Act. The Company does not currently
intend to (i) originate loans, or (ii) offer securities in exchange for real
property.

Future Revisions in Policies and Strategies

   The Board of Directors has established the investment policies, operating
policies and strategies set forth in the Company's Prospectus. The Board of
Directors has the power to modify or waive such policies and strategies
without the consent of the stockholders to the extent that the Board of
Directors (including a majority of the Unaffiliated Directors) determines that
such modification or waiver is in the best interests of stockholders. Among
other factors, developments in the market that affect the policies and
strategies mentioned herein or which change the Company's assessment of the
market may cause the Company's Board of Directors to revise its policies and
strategies. However, if such modification or waiver relates to the
relationship of, or any transaction between, the Company and the Manager or
any Affiliate of the Manager, the approval of a majority of the Unaffiliated
Directors is also required.

                                      16
<PAGE>

   The Company monitors closely its purchases of Mortgage Assets and the
income from such assets, including from its hedging strategies, so as to
ensure at all times that it maintains its qualification as a REIT and its
exemption under the Investment Company Act. The Company has engaged qualified
accountants and tax experts to assist in developing accounting systems and
testing procedures and to conduct quarterly compliance reviews designed to
determine compliance with the REIT Provisions of the Code and the Company's
exempt status under the Investment Company Act. See "Federal Income Tax
Considerations--Requirements for Qualification as a REIT" and "Risk Factors--
Failure to Maintain Exemption from the Investment Company Act Would Adversely
Affect Results of Operations" and "--Failure to Maintain REIT Status Would
Result in the Company Being Subject to Tax as a Regular Corporation and
Substantially Reduce Cash Flow Available for Distribution to Stockholders." No
changes in the Company's investment and operating policies, including credit
criteria for Mortgage Asset investments, may be made without the approval of
the Company's Board of Directors, including by a majority of the Unaffiliated
Directors.

                              DISTRIBUTION POLICY

   The Company distributes substantially all of its taxable income to
stockholders in each year (which does not ordinarily equal net income as
calculated in accordance with GAAP). The Company declares four regular
quarterly distributions. In addition, taxable income, if any, not distributed
through regular quarterly dividends may be distributed annually, at or near
year end, in a special dividend. The distribution policy is subject to
revision at the discretion of the Board of Directors. All distributions will
be made by the Company at the discretion of the Board of Directors and will
depend on the earnings of the Company, the financial condition of the Company,
maintenance of REIT status and such other factors as the Board of Directors
deems relevant. See "Federal Income Tax Considerations--Requirements for
Qualification as a REIT--Distribution Requirement."

   In order to qualify as a REIT under the Code, the Company must make
distributions to its stockholders each year in an amount at least equal to (i)
95% of its Taxable Income before deduction of dividends paid (less any net
capital gain), plus (ii) 95% of the excess of the net income from Foreclosure
Property over the tax imposed on such income by the Code, minus (iii) any
excess noncash income. The "Taxable Income" of the Company for any year means
the taxable income of the Company for such year (excluding any net income
derived either from property held primarily for sale to customers or from
foreclosure property) subject to certain adjustments provided in the REIT
Provisions of the Code.

   It is anticipated that distributions generally will be taxable as ordinary
income to stockholders of the Company, although a portion of such
distributions may be designated by the Company as capital gain or may
constitute a return of capital. The Company will furnish annually to each of
its stockholders a statement setting forth distributions paid during the
preceding year and their characterization as ordinary income, return of
capital or capital gains. For a discussion of the federal income tax treatment
of distributions by the Company, see "Federal Income Tax Considerations--
Taxation of Stockholders."

                        COMPETITION FOR MORTGAGE ASSETS

   In acquiring Mortgage Assets, the Company competes with other REITs,
investment banking firms, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, other lenders, GNMA, Fannie Mae,
FHLMC and other entities purchasing Mortgage Assets, most of which have
greater financial resources than the Company. In addition, there are several
REITs similar to the Company, and others may be organized in the future. The
effect of the existence of additional REITs may be to increase competition for
the available supply of Mortgage Assets suitable for purchase by the Company.
Increased competition for the acquisition of eligible Mortgage Assets or a
diminution in the supply could result in higher prices and, thus, lower yields
on such Mortgage Assets that could further narrow the yield spread over
borrowing costs.

   The Company has been able to compete effectively and generate competitive
rates of return for stockholders by utilizing leverage through accessing
wholesale markets for collateralized borrowings and as a result of its
exemption from certain forms of regulation and the tax advantages of its REIT
status.

                                      17
<PAGE>

                                   EMPLOYEES

   As of December 31, 1999 the Company had no employees. The Manager carries
out the day to day operations of the Company, subject to the supervision of
the Board of Directors and under the terms of the Management Agreement.

                       FEDERAL INCOME TAX CONSIDERATIONS

General

   The following discussion summarizes the material federal income tax
considerations that may be relevant to a holder of shares of common stock of
the company. This discussion is based on current law. The following discussion
is not exhaustive of all possible tax considerations. It does not discuss any
state, local or foreign tax considerations, nor does it discuss all of the
aspects of federal income taxation that may be relevant to a prospective
stockholder in light of such stockholder's particular circumstances or to
certain types of stockholders (including insurance companies, certain tax-
exempt entities, financial institutions, broker/dealers, foreign corporations
and persons who are not citizens or residents of the United States) subject to
special treatment under federal income tax laws.

   Each stockholder and prospective stockholder of common stock of the Company
is urged to consult with his own tax advisor regarding the specific
consequences to him 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.

   The Code provides special tax treatment for organizations that qualify and
elect to be taxed as REITs. The discussion below summarizes the material
provisions applicable to the Company as a REIT for federal income tax purposes
and to its stockholders in connection with their ownership of shares of Common
Stock. However, it is impractical to set forth in this Annual Report on Form
10-K all aspects of federal, state, local and foreign tax law that may have
tax consequences with respect to an investor's purchase of the Common Stock.
The discussion of various aspects of federal taxation contained herein is
based on the Code, administrative regulations, judicial decisions,
administrative rulings and practice, all of which are subject to change. In
brief, if certain detailed conditions imposed by the Code are met, entities
that invest primarily in real estate assets, including Mortgage Loans, and
that otherwise would be taxed as corporations are, with certain limited
exceptions, not subject to tax on income that is currently distributed to
their stockholders. This treatment eliminates most of the "double taxation"
(at the corporate level and then again at the stockholder level when the
income is distributed) that typically results from the use of corporate
investment vehicles. A qualifying REIT, however, may be subject to certain
excise and other taxes, as well as normal corporate tax, on Taxable Income
that is not currently distributed to its stockholders. See "--Taxation of the
Company" below.

   The Company elected to become subject to tax as a REIT, for Federal income
tax purposes, commencing with the taxable year ending December 31, 1998. The
Board of Directors of the Company currently expects that the company will
continue to operate in a manner that will permit the Company to maintain its
qualification as a REIT for the taxable year ended December 31, 1999, and in
each taxable year thereafter. This treatment will permit the Company to deduct
dividend distributions to its stockholders for Federal income tax purposes,
thus effectively eliminating the "double taxation" that generally results when
a corporation earns income and distributes that income to its stockholders in
the form of dividends.

Requirements for Qualification as a REIT

   To qualify for tax treatment as a REIT under the Code, the Company must
meet certain tests which are described immediately below.

   Stock Ownership Tests. For all taxable years after the first taxable year
for which a REIT election is made, the Company's shares of Common Stock must
be transferable and must be held by a minimum of 100 persons

                                      18
<PAGE>

for at least 335 days of a 12 month year (or a proportionate part of a short
tax year). The Company must also use the calendar year as its taxable year. In
addition, at all times during the second half of each taxable year, no more
than 50% in value of the shares of the stock of the Company may be owned
directly or indirectly by five or fewer individuals. If, for any taxable year,
the Company complies with regulations requiring the maintenance of records to
ascertain ownership of its outstanding stock and the Company does not know or
have reason to know that it failed to satisfy this test, it will be treated as
satisfying this test for any such taxable year. In determining whether the
Company's shares are held by five or fewer individuals, the attribution rules
of Section 544 of the Code (as modified by Section 856(h)(1)(B)) apply. For a
description of these attribution rules, see "Description of Capital Stock."
The Company's Charter impose certain repurchase provisions and transfer
restrictions to avoid more than 50% by value of any class of the Company's
stock being held by five or fewer individuals (directly or constructively) at
any time during the last half of any taxable year. Such repurchase and
transfer restrictions will not cause the stock not to be treated as
"transferable" for purposes of qualification as a REIT. The Company intends to
satisfy both the 100 stockholder and 50%/5 stockholder individual ownership
limitations described above for as long as it seeks qualification as a REIT.
The Company will use the calendar year as its taxable year for income tax
purposes.

   Asset Tests. On the last day of each calendar quarter at least 75% of the
value of the Company's assets must consist of Qualified REIT Real Estate
Assets, government securities, cash and cash items (the "75% of Assets Test").
The Company expects that substantially all of its assets will be Qualified
REIT Real Estate Assets. Qualified REIT Real Estate Assets include interests
in real property, interests in Mortgage Loans secured by real property and
interests in REMICs.

   On the last day of each calendar quarter, of the investments in securities
not included in the 75% of Assets Test, the value of any one issuer's
securities may not exceed 5% by value of the Company's total assets (for an
exception to this limitation beginning after December 31, 2000, see "New Tax
Legislation" below) and the Company may not own more than 10% of any one
issuer's outstanding voting securities (for an additional value restriction
beginning December 31, 2000, see "New Tax Legislation" below). Hedging
contracts (other than those which are Qualified REIT Real Estate Assets) and
certain types of other Mortgage Assets may be treated as securities of the
entity issuing such agreements or interests. The Company will take measures to
prevent the value of such contracts, interests or assets issued by any one
entity to exceed 5% of the value of the Company's assets as of the end of each
calendar quarter. Moreover, pursuant to its compliance guidelines, the Company
intends to monitor closely (on not less than a quarterly basis) the purchase
and holding of the Company's assets in order to comply with the above assets
tests. In particular, as of the end of each calendar quarter the Company
intends to limit and diversify its ownership of hedging contracts and other
Mortgage Securities that do not constitute Qualified REIT Real Estate Assets
to less than 25%, in the aggregate, by value of its portfolio, to less than 5%
by value as to any single issuer, and to less than 10% of the voting stock and
beginning after July 12, 1999, 10% of the value of any single issuer
(collectively the "25% of Assets Test"). If such limits are ever exceeded, the
Company intends to take appropriate remedial action to dispose of such excess
assets within the 30-day period after the end of the calendar quarter, as
permitted under the Code.

   When purchasing Mortgage Securities, the Company may rely on certain
opinions of counsel for the issuer or sponsor of such securities given in
connection with the offering of such securities, or statements made in related
offering documents, for purposes of determining whether and to what extent
those securities (and the income therefrom) constitute Qualified REIT Real
Estate Assets (and income) for purposes of the 75% of Assets Test (and the
source of income tests discussed below). If the Company invests in a
partnership, it will be treated as receiving its share of the income and loss
of the partnership and owning a proportionate share of the assets of the
partnership and any income from the partnership will retain the character that
it had in the hands of the partnership. If the Company forms a taxable
affiliate to conduct mortgage origination and other activities, it will obtain
an opinion of counsel that the proposed organization and ownership of an
interest in the taxable affiliate will not adversely affect the Company's
status as a REIT.

                                      19
<PAGE>

   Where a failure to satisfy any of the asset tests discussed above results
from an acquisition of securities or other property during a quarter, the
failure can be cured by a disposition of sufficient non-qualifying assets
within 30 days after the close of such quarter. The Company intends to
maintain adequate records of the value of its assets to determine its
compliance with the asset tests, and intends to take such action as may be
required to cure any failure to satisfy the test within 30 days after the
close of any quarter.

   Gross Income Tests. The Company must meet two separate income-based tests
for each year in order to qualify as a REIT.

   1. The 75% Test. At least 75% of the Company's gross income (the "75% of
Income Test") for the taxable year must be derived from the following sources:
(i) rents from real property, (ii) interest (other than interest based in
whole or in part on the income or profits of any person) on obligations
secured by mortgages of real property or on interests in real property; (iii)
gains from the sale or other disposition of interests in real property and
real estate mortgages other than gain from stock in trade, inventory or
property held primarily for sale to customers in the ordinary course of the
Company's trade or business ("Dealer Property"); (iv) dividends or other
distributions on shares in other REITs and, provided such shares are not
Dealer Property, gain from the sale of such shares; (v) abatements and refunds
of real property taxes; (vi) income from the operation, and gain from the
sale, of property acquired at or in lieu of a foreclosure of the mortgage
secured by such property or as a result of a default under a lease of such
property ("Foreclosure Property"); (vii) income received as consideration for
entering into agreements to make loans secured by real property or to purchase
or lease real property (including interests in real property and interests in
mortgages on real property) (for example, commitment fees); (viii) gain from
the sale of other disposition of a real estate asset which is not a prohibited
transaction; and (ix) income attributable to stock or debt instruments
acquired with the proceeds from the sale of stock or certain debt obligations
("New Capital") of the Company received during the one-year period beginning
on the day such proceeds were received ("Qualified Temporary Investment
Income").

   2. The 95% Test. In addition to deriving 75% of its gross income from the
sources listed above, at least an additional 20% of the Company's gross income
for the taxable year must be derived from those sources, or from dividends,
interest or gains from the sale or disposition of stock or other securities
that are not Dealer Property (the "95% of Income Test"). Income attributable
to Mortgage Warehouse Participations. Mortgage Securities (other than
Qualified REIT Real Estate Assets) that the Company holds directly, dividends
on stock interest on any other obligations not secured by real property, and
gains from the sale or disposition of stock or other securities that are not
Qualified REIT Real Estate Assets will constitute qualified income for
purposes of the 95% of Income Test only, but will not be qualified income for
purposes of the 75% of Income Test. Income from mortgage servicing contracts,
loan guarantee fees (or other contracts under which the Company would earn
fees for performing services) and hedging (other than with respect to debt
that was or will be incurred to acquire Qualified REIT Real Estate Assets)
will not qualify for either the 95% or 75% of Income Tests. The Company
intends to severely limit such income and its acquisition of any assets or
investments the income from which does not qualify for purposes of the 95% of
Income Test. Moreover, in order to help ensure compliance with the 95% of
Income Test and the 75% of Income Test, the Company limits substantially all
of the assets that it acquires to Qualified REIT Real Estate Assets. The
policy of the Company to maintain REIT status may limit the type of assets,
including hedging contracts, that the Company otherwise might acquire. At
December 31, 1999, over 95% of the Company's assets were Qualified REIT Real
Estate Assets.

   For purposes of determining whether the Company complies with the 75% of
Income Test and the 95% of Income Test detailed above, gross income does not
include gross income from "Prohibited Transactions." A "Prohibited
Transaction" is one involving a sale of Dealer Property, other than
Foreclosure Property. Net income from Prohibited Transactions is subject to a
100% tax. See "--Taxation of the Company" below.

   The Company maintains its REIT status by carefully monitoring its income,
including income from hedging transactions, futures contracts and sales of
Mortgage Assets to comply with the 75% of Income Test and the 95% of Income
Test. In order to help assure its compliance with the REIT Provisions of the
Code, the Company will adopt guidelines the effect of which will be to limit
its ability to earn certain types of income. See

                                      20
<PAGE>

"Operating Policies and Policies." If the Company fails to satisfy one or both
of the 75% or 95% of Income Tests for any year, it may face either (a) assuming
such failure was for reasonable cause and not willful neglect, a 100% tax on
the greater of the amounts of income by which it failed to comply with the 75%
of Income Test or the 95% of Income Test, reduced by estimated related expenses
or (b) loss of REIT status. There can be no assurance that the Company will
always be able to maintain compliance with the gross income tests for REIT
qualification despite its periodic monitoring procedures. Moreover, there is no
assurance that the relief provisions for a failure to satisfy either the 95% or
the 75% of Income Tests will be available in any particular circumstance.

   Distribution Requirement. The Company must distribute to its stockholders on
a pro rata basis each year an amount equal to (i) 95% (90% in taxable years
beginning after December 31, 2000, See--"New Tax Legislation" below) of its
Taxable Income before deduction of dividends paid and excluding net capital
gain, plus (ii) 95% (90% in taxable years beginning after December 31, 2000,
See--"New Tax Legislation" below) of the excess of the net income from
Foreclosure Property over the tax imposed on such income by the Code, less
(iii) any excess noncash income (the "95% Distribution Test"). See
"Distribution Policy." The Company intends to make distributions to its
stockholders in amounts sufficient to meet this 95% distribution requirement.
Such distributions must be made in the taxable year to which they relate or, if
declared before the timely filing of the Company's tax return for such year and
paid not later than the first regular dividend payment after such declaration,
in the following taxable year. A nondeductible excise tax, equal to 4% of the
excess of such required distributions over the amounts actually distributed
will be imposed on the Company for each calendar year to the extent that
dividends paid during the year (or declared during the last quarter of the year
and paid during January of the succeeding year) are less than the sum of (i)
85% of the Company's "ordinary income," (ii) 95% of the Company's capital gain
net income, and (iii) income not distributed in earlier years.

   The Service has ruled that if a REIT's dividend reinvestment plan allows
stockholders of the REIT to elect to have cash distributions reinvested in
shares of the REIT at a purchase price equal to at least 95% of fair market
value on the distribution date, then such cash distributions qualify under the
95% distribution test.

   If the Company fails to meet the 95% Distribution Test as a result of an
adjustment to the Company's tax returns by the Service, the Company by
following certain requirements set forth in the Code, may pay a deficiency
dividend within a specified period that will be permitted as a deduction in the
taxable year to which the adjustment is made. The Company would be liable for
interest based on the amount of the deficiency dividend. A deficiency dividend
is not permitted if the deficiency is due to fraud with intent to evade tax or
to a willful failure to file a timely tax return.

   Recordkeeping Requirements. A REIT is required to maintain records regarding
the actual and constructive ownership of its shares, and other information, and
within 30 days after the end of its taxable year, to demand statements from
persons owning above a specified level of the REIT's shares (e.g., if the
Company has over 200 but fewer than 2,000 stockholders of record, from persons
holding 1% or more of the Company's outstanding shares of stock and if the
Company has 200 or fewer stockholders of record, from persons holding 1/2% or
more of the stock) regarding their ownership of shares. The Company must
maintain, as part of its records, a list of those persons failing or refusing
to comply with this demand. Stockholders who fail or refuse to comply with the
demand must submit a statement with their tax returns setting forth the actual
stock ownership and other information. The Company also is required to maintain
permanent records of its assets as of the last day of each calendar quarter.
The Company intends to maintain the records and demand statements as required
by these Treasury Regulations.

Termination or Revocation of REIT Status

   The Company's election to be treated as a REIT will be terminated
automatically if it fails to meet the requirements described above. In that
event, the Company will not be eligible again to elect REIT status until the
fifth taxable year that begins after the year for which its election was
terminated unless all of the following relief provisions apply: (i) the Company
did not willfully fail to file a timely return with respect to the termination
taxable year, (ii) inclusion of incorrect information in such return was not
due to fraud with intent to evade tax,

                                       21
<PAGE>

and (iii) the Company establishes that failure to meet the requirements was
due to reasonable cause and not willful neglect. The Company may also
voluntarily revoke its election, although it has no intention of doing so, in
which event it will be prohibited, without exception, from electing REIT
status for the year to which the revocation relates and the following four
taxable years.

   If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Company would be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to stockholders of the Company with
respect to any year in which it fails to qualify as a REIT would not be
deductible by the Company nor would such distributions be required to be made.
Failure to qualify as a REIT would result in a reduction of the Company's
distributions to stockholders in order to pay the resulting taxes. If, after
forfeiting REIT status, the Company later qualifies and elects to be taxed as
a REIT again, the Company could face significant adverse tax consequences.

Taxation of the Company

   In any year in which the Company qualifies as a REIT, it generally will not
be subject to federal income tax on that portion of its Taxable Income or net
capital gain which is distributed to its stockholders. The Company will,
however, be subject to tax at normal corporate rates upon any Net Income or
net capital gain not distributed. The Company intends to distribute the
percentage of its Taxable Income to its stockholders on a pro rata basis in
each year required under applicable law to maintain its REIT qualification.
See "Distribution Policy."

   In addition, the Company will also be subject to a tax of 100% of net
income from any prohibited transaction and will be subject to a 100% tax on
the greater of the amount by which it fails either the 75% or 95% of Income
Tests, reduced by estimated related expenses, if the failure to satisfy such
tests is due to reasonable cause and not willful neglect and if certain other
requirements are met. The Company may be subject to the alternative minimum
tax on certain items of tax preference.

   If the Company acquires any real property as a result of foreclosure, or by
a deed in lieu of foreclosure, it may elect to treat such real property as
Foreclosure Property. Net income from the sale of Foreclosure Property is
taxable at the maximum federal corporate rate, currently 35%. Accordingly,
income from Foreclosure Property may not be subject to the 100% tax on
prohibited transactions. The Company has the right to determine whether to
treat such real properly as Foreclosure Property on the tax return for the
fiscal year in which such property is acquired.

   The Company may elect to retain and pay income tax on all or a portion of
its net long-term capital gains for any taxable year, in which case the
Company's stockholders would include in their income as long-term capital
gains their proportionate share of such undistributed capital gains. The
stockholders would be treated as having paid their proportionate share of the
capital gains tax paid by the Company, which amounts would be credited or
refunded to the stockholders.

   The Company will also be subject to a nondeductible 4% excise tax if it
fails to make timely dividend distributions for each calendar year. See "--
Requirements for Qualification as a REIT--Distribution Requirement" above. The
Company intends to declare its fourth regular annual dividend, as well as a
fifth special dividend, if any, during the final quarter of the year and to
make such dividend distribution no later than 31 days after the end of the
year in order to avoid imposition of the excise tax. Such a distribution would
be taxed to the stockholders in the year that the distributions were declared,
not in the year paid. Imposition of the excise tax on the Company would reduce
the amount of cash available for distribution to its stockholders.

Taxation of Stockholders

   For any taxable year in which the Company is treated as a REIT for federal
income tax purposes, amounts distributed by the Company to its stockholders
out of current or accumulated earnings and profits will be includable by the
stockholders as ordinary income for federal income tax purposes unless such
distributions are

                                      22
<PAGE>

properly designated by the Company as capital gain dividends. In the latter
case, the distributions will be taxable to the stockholders as long-term
capital gains. Any loss on the sale or exchange of shares of the Common Stock
held by a stockholder for six months or less will be treated as a long-term
capital loss to the extent of any capital gain dividend received on the Common
Stock by such stockholders.

   Distributions by the Company will not be eligible for the dividends received
deduction for corporations. Stockholders may not deduct any net operating
losses or capital losses of the Company. If the Company makes distributions to
its stockholders in excess of its current and accumulated earnings and profits,
those distributions will be considered first as a tax-free return of capital,
reducing the tax basis of a stockholder's shares until the tax basis in such
shares is zero. Thereafter, distributions in excess of the tax basis will be
taxable as gain realized from the sale of the Company's stock.

   The Company will notify stockholders after the close of the Company's
taxable year as to the portions of the distributions which constitute ordinary
income and the portions that constitute either return of capital or capital
gain. Dividends and distributions declared in the last quarter of any year
payable to stockholders of record on a specified date in such month will be
deemed to have been received by the stockholders and paid by the Company on
December 31 of the record year, provided that such dividends are in fact paid
before February 1 of the following year.

   The Company will notify stockholders after the close of the Company's
taxable year as to the portions of the distributions which constitute ordinary
income and the portions that constitute either return of capital or capital
gain. Dividends and distributions declared in the last quarter of any year
payable to stockholders of record on a specified date in such month will be
deemed to have been received by the stockholders and paid by the Company on
December 31 of the record year, provided that such dividends are in fact paid
before February 1 of the following year.

   The Company does not expect to acquire residual interests issued by REMICs.
Such residual interests, if acquired by a REIT, may generate excess inclusion
income. Excess inclusion income cannot be offset by net operating losses of a
stockholder. If the stockholder is a Tax-Exempt Entity, the excess inclusion
income is fully taxable as UBTI. If allocated to a foreign stockholder, the
excess inclusion income is subject to federal income tax withholding without
reduction pursuant to any otherwise applicable tax treaty. Potential investors,
and in particular Tax-Exempt Entities, are urged to consult with their tax
advisors concerning this issue.

   The Company intends to finance the acquisition of Mortgage Assets by
entering into, among other things, reverse repurchase agreements, which are
essentially loans secured by the Company's Mortgage Assets. The Company may
enter into master repurchase agreements with secured lenders known as "Counter-
parties." Typically, such master repurchase agreements have cross-
collateralization provisions that afford the counter-party the right to
foreclose on the Mortgage Assets pledged as collateral. If the Service were to
successfully take the position that the cross-collateralization provisions of
the master repurchase agreements result in the Company having issued debt
instruments (the reverse repurchase agreements) with differing maturity dates
secured by a pool of Mortgage Loans, a portion of its income could be
characterized as "excess inclusion income."

Taxation of Tax-Exempt Entities

   In general, a Tax-Exempt Entity that is a stockholder of the Company is not
subject to tax on distributions. The Service has ruled that amounts distributed
by a REIT to an exempt employees' pension trust do not constitute UBTI and thus
should be nontaxable to such a Tax-Exempt Entity. Based on that ruling, but
subject to the discussion of excess inclusion income set forth under "--
Taxation of Stockholders" above, indebtedness incurred by the Company in
connection with the acquisition of real estate assets such as Mortgage Loans
will not cause dividends of the Company paid to a stockholder that is a Tax-
Exempt Entity to be UBTI. However, if a Tax-Exempt Entity has financed the
acquisition of any of its stock in the Company with "acquisition indebtedness,"
within the meaning of the Code, distributions on such stock could be treated as
UBTI. Under certain conditions, if a tax-exempt employee pension or profit
sharing trust were to acquire more than 10% of the Company's stock, a portion
of the dividends on such stock could be treated as UBTI.

                                       23
<PAGE>

   For social clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts, and qualified group legal services plans exempt
from federal income taxation under Code Sections 501(c)(7), (c)(9), (c)(17) and
(c)(20), respectively, income from an investment in the Company will constitute
UBTI unless the organization is able to properly deduct amounts set aside or
placed in reserve for certain purposes so as to offset the UBTI generated by
its investment in the Company. Such entities should review Code Section
512(a)(3) and should consult their own tax advisors concerning these "set
aside" and reserve requirements.

State and Local Taxes

   The Company and its stockholders may be subject to state or local taxation
in various jurisdictions, including those in which it or they transact business
or reside. The state and local tax treatment of the Company and its
stockholders may not conform to the federal income tax consequences discussed
above. Consequently, prospective stockholders should consult their own tax
advisors regarding the effect of state and local tax laws on an investment in
the Common Stock.

Certain United States Federal Income Tax Considerations Applicable to Foreign
Holders

   The following discussion summarizes certain United States tax consequences
of the acquisition, ownership and disposition of the Common Stock by an initial
purchaser of the Common Stock that, for United Stares income tax purposes, is
not a "United States person" (a "Foreign Holder"). For purposes of discussion,
a United States persons means: a citizen or resident of the United States; a
corporation, partnership, or other entity created or organized in the United
States or under the laws of the United States or of any political subdivision
thereof (unless, in the case of a partnership, the Service provides otherwise
by regulations); an estate whose income is includable in gross income for
United States income tax purposes regardless of its source; or, a trust if a
court within the United States is able to exercise primary supervision over the
administration of the trust and one or more United States persons have the
authority to control all substantial decisions of the trust. This discussion
does not consider any specific facts or circumstances that may apply to a
particular Foreign Holder. Prospective investors are urged to consult their tax
advisors regarding the United States tax consequences of acquiring, holding and
disposing of the Common Stock, as well as any tax consequences that may arise
under the laws of any foreign, state, local or other taxing jurisdiction.

   Dividends. Dividends paid by the Company out of earnings and profits, as
determined for United States income tax purposes, to a Foreign Holder will
generally be subject to withholding of United States federal income tax at the
rate of 30%, unless reduced or eliminated by an applicable tax treaty or unless
such dividends are treated as effectively connected with a United States trade
or business conducted by the Foreign Holder. A Foreign Holder eligible for a
reduction in withholding under an applicable treaty must so notify the Company
by completing the appropriate IRS form. Distributions paid by the Company in
excess of its earnings and profits will be treated as a tax-free return of
capital to the extent of the holder's adjusted basis in his Common Stock, and
any additional amounts distributed are treated as amounts received in exchange
for a Foreign Holder's interest in the Company. These additional amounts will
not be subject to U.S. tax provided that (i) the REIT is "domestically
controlled" or (ii) the stock of the REIT is regularly traded on an established
securities market, and the recipient of the additional amounts does not, after
application of certain attribution rules, own more than 5% of the stock of the
REIT. If it cannot be determined at the time a distribution is made whether
such distribution will exceed the Company's earnings and profits, the
distribution will be subject to withholding at the same rate as dividends.
Amounts so withheld, however, will be refundable or creditable against the
Foreign Holder's United States tax liability if the Company subsequently
determines that such distribution was, in fact, in excess of the earnings and
profits of the Company. If the receipt of the dividend is treated as being
effectively connected with the conduct of a trade or business within the United
States by a Foreign Holder, the dividend received by such holder will be
subject to the same United States federal income tax on net income that applies
to United States persons generally (and, with respect to foreign corporate
holders and under certain circumstances, the 30% branch profits tax).

                                       24
<PAGE>

   For any year in which the Company qualifies as a REIT, distributions to a
Foreign Holder that are attributable to gain from the sales or exchanges by
the Company of "United States real property interests" will be treated as if
such gain were effectively connected with a United States business and will
thus be subject to tax at the graduated rates applicable to United States
stockholders (subject to applicable alternative minimum tax) under the
provisions of the Foreign Investment in Real Property Tax Act of 1980
("FIRPTA"). Also, distributions subject to FIRPTA may be subject to a 30%
branch profits tax in the hands of a foreign corporate stockholder not
entitled to a treaty exemption. The Company is required to withhold 35% of any
distribution that could be designated by the Company as a capital gains
dividend. This amount may be credited against the Foreign Holder's FIRPTA tax
liability. In addition, the Company must withhold 10% of a distribution to a
Foreign Holder which is attributable to a return of capital or to the sale of
the Company's shares (i.e. the distribution is not a capital gain dividend but
is in excess of the Foreign Holder's basis in its stock).

   Gain on Disposition. A Foreign Holder will generally not be subject to
United States federal income tax on gain recognized on a sale or other
disposition of the Common Stock unless (i) the gain is effectively connected
with the conduct of a trade or business within the United States by the
Foreign Holder, (ii) in the case of a Foreign Holder who is a nonresident
alien individual and holds the Common Stock as a capital asset, such holder is
present in the United States for 183 or more days (computed in part by
reference to days present in the 2 prior years) in the taxable year and
certain other requirements are met, or (iii) the Foreign Holder is subject to
tax under the FIRPTA rules discussed below. Gain that is effectively connected
with the conduct of a United States business will be subject to the United
States federal income tax on net income that applies to United States persons
generally (and, with respect to corporate holders and under certain
circumstances, the branch profits tax) but will not be subject to withholding.
Foreign Holders should consult applicable treaties, which may provide for
different rules.

   Gain recognized by a Foreign Holder upon a sale of its Common Stock will
generally not be subject to tax under FIRPTA if the Company is a "domestically
controlled REIT," which is defined generally as a REIT in which at all tines
during a specified testing period less than 50% in value of its shares were
held directly or indirectly by non-U.S. persons. Because only a minority of
the Company's stockholders are expected to be Foreign Holders, the Company
anticipates that it will qualify as a "domestically controlled REIT."
Accordingly, a Foreign Holder should not be subject to U.S. tax from gains
recognized upon disposition of the Common Stock. However, because the Common
Stock will be publicly traded, no assurance can be given that the Company will
continue to be a "domestically controlled REIT."

   Information Reporting and Backup Withholding. Under temporary United States
Treasury regulations (which remain effective after 1996 for international
transactions), United States information reporting requirements and backup
withholding tax will generally not apply to dividends paid on the Common Stock
to a Foreign Holder at an address outside the United States. Payments by a
United States office of a broker of the proceeds of a sale of the Common Stock
is subject to both backup withholding at a rate of 31% and information
reporting unless the holder certifies its Foreign Holder status under
penalties of perjury or otherwise establishes an exemption. Information
reporting requirements (but not backup withholding) will also apply to
payments of the proceeds of sales of the Common Stock by foreign offices of
United States brokers, or foreign brokers with certain types of relationships
to the United States, unless the broker has documentary evidence in its
records that establishes that the holder is a Foreign Holder and certain other
conditions are met, or the holder otherwise establishes an exemption.

   Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be refunded or credited against the Foreign
Holder's United States federal income tax liability, provided that the
required information is furnished to the Service.

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

                                      25
<PAGE>

New Tax Legislation

   In December 1999, President Clinton signed into law the Tax Relief
Extension Act of 1999, which contains all but one of the provisions of the so-
called REIT Modernization Act (the "Act"). The Act contains several provisions
which, when effective, will (i) permit a REIT to own up to one hundred percent
(100%) of the stock of a new type of entity known as the "Taxable REIT
Subsidiary", (ii) prohibit a REIT from owning more than ten percent (10%) of
the vote or value of the securities of a non-REIT subchapter C Corporation
(other than securities of a Taxable REIT Subsidiary, certain debt securities,
and securities of grandfathered entities described below), (iii) reduce the
REIT distribution requirement from ninety-five percent (95%) to ninety percent
(90%), and (iv) change the measurement of the REIT fifteen percent (15%)
personal property rule from adjusted tax basis to fair market value. The new
provisions will be effective in taxable years beginning after December 31,
2000.

  (i) The Taxable REIT Subsidiary.

   Effective in taxable years beginning after December 31, 2000, REITs will be
permitted to own as much as 100% of the stock of "Taxable REIT Subsidiaries"
("TRS"). A TRS is a taxable subchapter C Corporation which elects to be
subject to the TRS rules. A subchapter C Corporation making a TRS election
will be permitted to provide services to REIT tenants, including non-customary
services, and other third parties without tainting the rents a REIT receives
from such tenants (and will be permitted to undertake any other activity
which, under existing law, the so-called "preferred stock taxable subsidiary"
is permitted to undertake).

   Under the Act, no more than twenty percent (20%) of the fair market value
of a REIT's gross assets may be securities of a TRS. In addition, the stock of
a TRS, like stock of any other subchapter C Corporation, will not constitute a
qualified asset under the existing 75% of Assets Test and dividends a REIT
receives from a TRS will not qualify for the 75% of Income Test (but will
qualify for the 95% of Income Test). Current law restricts a REIT from owning
more than five percent (5%) of its assets in the securities of a single issuer
but, under the Act, this five percent (5%) limitation will not apply to a
REIT's ownership of a TRS. Further, the 10% vote or value restriction (as
described below) will not apply to a REIT's interest in a TRS.

   Payments from a TRS for space rented from a REIT will qualify under the 75%
and 95% of Income Tests if (i) the TRS rents no more than ten percent (10%) of
the leased space of the property, and (ii) the TRS pays substantially the same
rents for similar space as the non-related parties leasing the same property.
A TRS will be permitted to deduct interest payments made to its affiliated
REIT but only if (i) the TRS has a debt to equity ratio (defined as the
aggregate tax basis of its assets reduced by such debt) of less than 1.5 to 1,
or (ii) half of the TRS' net income (before deducting interest, net operating
losses and depreciation) is greater than its net interest expense. The Act
will impose a 100% excise tax to the extent any transaction between a TRS and
its affiliated REIT (or that REITs tenants) is not conducted on an arms-length
basis.

  (ii) 10% Vote or Value Restriction.

   The Act will prohibit a REIT from owning (at the end of each quarter) more
than ten percent (10%) of the vote or value of the securities of a non-REIT
subchapter C corporation (the "10% Limitation"). However, the 10% limitation
will not apply to (i) any TRS securities, (ii) straight debt securities owned
by a REIT (and any of its TRS), (iii) mortgages from a REIT to its TRS, and
(iv) certain arrangements in place on July 12, 1999.

                              REPURCHASE STRATEGY

   From time to time, the Company may repurchase shares of Common Stock from
the open market in order to suit the Company's needs. Through December 31,
1999, the Board of Directors of the Company has authorized the Company to
repurchase, and the Company has repurchased, 50,000 shares of Common Stock on
the open market.

                                      26
<PAGE>

                                 RISK FACTORS

   An investment in the Company involves various risks, including the risk
that an investor can lose capital. There is no guarantee that the Company can
successfully implement its business strategy, reach its investment objectives
or achieve a positive return for stockholders.

   The various risks the Company faces can be separated into two categories,
Operational Risks and Legal and Other Risks. Following are descriptions of
several risks in each category.

OPERATIONAL RISKS

Use of Reverse Repurchase Agreements and Other Financing Agreements Could
Limit the Company's Ability to Acquire or Dispose of Mortgage Assets

   Substantially all of the Company's Mortgage Assets are pledged to secure
reverse repurchase agreements, bank borrowings or other credit arrangements.
Therefore, such Mortgage Assets may not be available to the stockholders in
the event of the liquidation of the Company, except to the extent that the
market value thereof exceeds the amounts due to the Company's creditors. The
market value of the Mortgage Assets will fluctuate as a result of numerous
market factors (including interest rates and prepayment rates) as well as the
supply of and demand for such Mortgage Assets. In the event of the bankruptcy
of a counter-party with whom the Company has a reverse repurchase agreement,
the Company might experience difficulty recovering its pledged Mortgage
Assets, which may adversely affect the Company's results of operations. See
"Operating Policies and Programs--Capital and Leverage Policy."

   In the event the Company is not able to renew or replace maturing
borrowings, it could be required to sell Mortgage Assets under adverse market
conditions and, as a result, could incur permanent capital losses. In
addition, in such event, the Company may be required to terminate hedge
positions, which could result in further losses. A sharp rise in interest
rates or increasing market concern about the value or liquidity of a type or
types of Mortgage Assets in which the Company's Mortgage Asset portfolio is
concentrated or a similar event or development will reduce the market value of
the Mortgage Assets, which would likely cause lenders to require additional
collateral. A number of such factors in combination may cause difficulties for
the Company, including a possible liquidation of a major portion of its
Mortgage Assets at disadvantageous prices with consequent losses, which would
have a material adverse effect on the Company and could render it insolvent.

   Additionally, although the Company intends generally to hold its Mortgage
Assets to maturity, because such assets will be pledged under reverse
repurchase agreements or other financing agreements, the ability of the
Company to sell Mortgage Assets and realize the cash therefrom is greatly
limited due to the obligation to repay amounts outstanding under such
agreements. If the Company desires to sell Mortgage Assets, its inability to
realize the cash therefrom could have a material adverse affect on its
financial condition and results of operations.

Interest Rate Fluctuations May Decrease Net Interest Income

   Adjustable-rate Mortgage Assets are typically subject to periodic and
lifetime interest rate caps that limit the amount an adjustable-rate Mortgage
Asset's interest rate can change during any given period. For example, a
typical periodic interest rate cap may limit the amount the interest rate on a
Mortgage Asset can increase annually to 1.5%, and a typical lifetime interest
rate cap may limit the amount the interest rate on Mortgage Asset may increase
during the life of the asset to 5% over the interest rate at origination of
the asset. Adjustable-rate Mortgage Securities are also typically subject to a
minimum interest rate payable. The Company's borrowings will not be subject to
similar restrictions. Hence, in a period of increasing interest rates,
interest rates on its borrowings could increase without limitation by caps,
while the interest rates on its Mortgage Assets could be so limited. This
problem will be magnified to the extent the Company acquires Mortgage Assets
that are not fully indexed (i.e., not yielding a rate equivalent to the
applicable index plus the specified margin over the index). Further, some
adjustable-rate Mortgage Assets may be subject to periodic payment caps that
result in some

                                      27
<PAGE>

portion of the interest being deferred and added to the principal outstanding.
This could result in receipt by the Company of less cash income on its
adjustable-rate Mortgage Assets than is required to pay interest on the
related borrowings. These factors could lower the Company's net interest
income or cause a net loss during periods of rising interest rates, which
would negatively impact the Company's liquidity and its ability to make
distributions to stockholders.

   The Company often purchases a substantial portion of its adjustable-rate
Mortgage Assets 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, in
most cases the interest rate indices and repricing terms of its Mortgage
Assets and its funding sources are not 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, especially during the 1979-1982 and 1994 interest
rate environments, when the spread between such indices was volatile. During
periods of changing interest rates, such interest rate mismatches could
negatively impact the Company's Net Income, dividend yield and the market
price of the Common Stock.

   A substantial portion of the Company's Mortgage Securities are adjustable-
rate Pass-Through Certificates or floating rate CMOs which also are subject to
periodic interest rate adjustments based on such objective indices as LIBOR,
the Treasury Index or the CD Rate. To the extent any of the Company's Mortgage
Securities are financed with borrowings bearing interest based on or varying
with an index different from that used for the related Mortgage Securities,
so-called "basis" interest rate risk results. In such event, if the index used
for the Mortgage Securities is a "lagging" index that reflects market interest
rate changes on a delayed basis, and the rate borne by the related borrowings
reflects market rate changes more rapidly, the Company's net interest income
will be adversely affected in periods of increasing market interest rates.

   The Company expects that the net effect of these factors, all other factors
being equal, could be to lower the Company's net interest income or cause a
net loss during periods of rapidly rising market interest rates, which could
negatively impact the level of dividend distributions and reduce the market
price of the Common Stock. This reduction in net income, or net loss, could
occur in an increasing interest rate environment as a result of interest rate
increases in borrowings which are more rapid than interest rate increases on
the Company's Mortgage Securities or as a result of periodic and lifetime
interest rate caps on the Company's Mortgage Securities. See Operating
Policies and Procedures--Asset Acquisition Policy.'

Failure To Successfully Manage Interest Rate Risks May Adversely Affect
Results of Operations

   The Company follows a policy intended to minimize the impact of interest
rate changes. Although the Company has not yet engaged in such practices, the
Company may minimize the impact of interest rate changes through the use of
interest rate caps, swaps, futures contracts, puts, calls and trade forward
contracts. However, developing an interest rate risk strategy is complex and
no strategy can completely insulate the Company from risks associated with
interest rate changes. See "Operating Policies and Programs." In addition,
hedging strategies typically involve transaction costs that increase
dramatically as the period covered by the hedging transaction increases and
that may also increase during periods of rising and fluctuating interest
rates. The REIT Provisions of the Code may substantially limit the Company's
ability to engage in these hedging transactions, and may prevent the Company
from effectively implementing hedging strategies that it determines, absent
such restrictions, would best insulate the Company from the risks associated
with changing interest rates.

   The adjustable-rate Mortgage Assets that the Company acquires are generally
subject to periodic and lifetime interest rate caps. The Company may purchase
Mortgage Derivative Securities for investment and to seek to mitigate the
negative impacts of those interest-rate caps in a rising interest rate
environment, but only on a limited basis due to the increased risk of loss
associated with such securities. Hedging techniques, when applied, will be
based, in part, on assumed levels of prepayments of the Company's Mortgage
Assets. If prepayments are slower than assumed, the life of the Mortgage
Assets will be longer and the effectiveness of the Company's hedging
techniques will be reduced. Hedging techniques involving the use of Mortgage
Derivative

                                      28
<PAGE>

Securities are highly complex and may produce volatile returns. The financial
futures contracts and options thereon in which the Company may invest are
subject to periodic margin calls that would result in additional costs to the
Company. Financial futures held at fiscal year end are also required to be
marked to market and valued for tax purposes, which could result in taxable
income to the Company with no corresponding cash available for distribution.
There can be no assurance that these hedging techniques will have a beneficial
impact on the Net Income of the Company and the dividend yield of the Common
Stock. If a hedging instrument utilized by the Company were found to be legally
unenforceable, the Company's portfolio would be exposed to interest rate
fluctuations which could materially and adversely affect the Company's business
and results of operations. Additionally, hedging strategies have significant
transaction costs and the Company will not be able to significantly reduce or
eliminate the risk associated with its investment portfolio without reducing or
perhaps even eliminating the return on its investments.

   Federal tax laws applicable to REITs may substantially limit the Company's
ability to engage in asset/liability management transactions. Such Federal tax
laws may prevent the Company from effectively implementing hedging strategies
that the Company determines, absent such restrictions, would best insulate the
Company from the risks associated with changing interest rates and prepayments.
See "Federal Income Tax Considerations--Requirements for Qualification as a
REIT" and "--Taxation of the Company." In this regard, the amount of income the
Company may earn from its interest rate caps and other hedging instruments may
be subject to substantial limitations under the REIT Provisions of the Code. In
particular, income generated by such instruments is non-qualifying income for
purposes of the 75% Gross Income Test and is income from the sale of a security
subject to the 30% Gross Income Test. Additionally, the Company will treat such
income as non-qualifying income for the 95% Gross Income Test unless it
receives advice from its tax advisors that such income constitutes qualifying
income for purposes of such test. Pursuant to recently enacted legislation, the
30% Gross Income Test has been repealed for taxable years beginning after
August 5, 1997, but such income would still not qualify for the 75% Gross
Income Test or, subject to the preceding sentence, the 95% Gross Income Test.
See "Federal Income Tax Considerations--Requirements for Qualification as a
REIT--Gross Income Tests." This determination may result in management electing
to have the Company bear a level of interest rate risk that might otherwise be
hedged. The "75% Gross Income Test" means the requirement for each taxable year
that at least 75% of the Company's gross income must be derived from certain
specified real estate sources including interest income and gain from the
disposition of Qualified REIT Real Estate Assets or "qualified temporary
investment income" (i.e., income derived from "new capital" within one year of
the receipt of such capital). The "95% Gross Income Test" means the requirement
for each taxable year that at least 95% of the Company's gross income for each
taxable year must be derived from sources of income qualifying for the 75%
Gross Income Test, dividends, interest, and gains from the sale of stock or
other securities (including certain interest rate swap and cap agreements
entered into to hedge variable rate debt incurred to acquire Qualified REIT
Real Estate Assets) not held for sale in the ordinary course of business.

   If the Company purchases interest rate caps or other interest rate
agreements to hedge against lifetime and periodic rate or payment caps, and the
provider of interest rate agreements become financially unsound or insolvent,
the Company may be forced to unwind its interest rate agreements with such
provider and may take a loss on such interest rate agreements. Although the
Company intends to purchase interest rate agreements only from financially
sound institutions and to monitor the financial strength of such institutions
on a periodic basis, no assurance can be given that the Company can avoid such
third party risks.

Risk of Decline of Market Value of Mortgage Securities; Margin Calls and
Defaults

   Certain of the Company's Mortgage Assets may be cross-collateralized to
secure multiple borrowing obligations of the Company to a single lender. A
decline in the market value of such assets could limit the Company's ability to
borrow or result in lenders initiating margin calls (i.e., requiring a pledge
of cash or additional Mortgage Assets to reestablish the ratio of the amount of
the borrowing to the value of the collateral). The Company could be required to
sell Mortgage Assets under adverse market conditions in order to maintain
liquidity. If these sales were made at prices lower than the carrying value of
its Mortgage Assets, the Company

                                       29
<PAGE>

would experience losses. A default by the Company under its collateralized
borrowings could also result in a liquidation of the collateral, including any
cross-collateralized assets, and a resulting loss of the difference between the
value of the collateral and the amount borrowed. Additionally, in the event of
a bankruptcy of the Company, certain reverse repurchase agreements may qualify
for special treatment under the Bankruptcy Code, the effect of which is among
other things, to allow the creditors under such agreement to avoid the
automatic stay provisions of the Bankruptcy Code and to liquidate the
collateral under such agreements without delay. Conversely, in the event of a
bankruptcy of a party with whom the Company had a reverse repurchase agreement,
the Company might experience difficulty repurchasing the collateral under such
agreement if it were to be repudiated and the Company's claim against the
bankrupt lender for damages resulting therefrom were to be treated simply as
one of an unsecured creditor. Should this occur, the Company's claims would be
subject to significant delay and, if and when received, may be substantially
less than the damages actually suffered by the Company. Although the Company
enters into reverse repurchase agreements with several different parties to
reduce such third party risks, no assurance can be given that the Company will
be able to avoid such risks. To the extent the Company is compelled to
liquidate Mortgage Assets classified as Qualified REIT Real Estate Assets to
repay borrowings, the Company may be unable to comply with the REIT asset and
income tests, possibly jeopardizing the Company's status as a REIT. See
"Operating Policies and Programs--Capital and Leverage Policy."

   Additionally, the Company is subject to the following Operational Risks:

  . The Company Faces Significant Competition For Mortgage Assets and
    Financing

  . The Company Uses Substantial Leverage and Faces Potential Net Interest
    and Operating Losses in Connection with Borrowings

  . Increased Levels of Prepayments from Mortgage Assets May Adversely Affect
    Net Interest Income

  . Value of Mortgage Assets May Be Adversely Affected by Defaults on
    Underlying Mortgage Obligations

  . Value of Mortgage Loans May Be Adversely Affected by Characteristics of
    Underlying Property and Borrower Credit and Other Considerations

  . Yields on Subordinated Interests, Interest Only Derivatives and Principal
    Only Derivatives May Be Affected Adversely By Interest Rate Changes

LEGAL AND OTHER RISKS

Control by the Company's Board of Directors of the Company's Operating Policies
and Investment Strategies

   The Company's established operating policies and strategies may be modified
or waived by the Board of Directors without the consent or approval of the
Company's stockholders. The ultimate effect of any such changes is uncertain.

Dependence on the Manager and its Personnel for Successful Operations

   The Company is wholly dependent for the selection, structuring and
monitoring of its Mortgage Assets and associated borrowings on the diligence
and skill of its officers and the officers and employees of the Manager,
particularly Lloyd McAdams, Pamela Watson, Heather U. Baines and Evangelos
Karagiannis. The Company does not anticipate having employment agreements with
its senior officers, or requiring the Manager to employ specific personnel or
dedicate employees solely to the Company and there are no restrictions on any
competing business activities of such individuals if they are no longer
employed by the Manager. The Manager's loss of any key person, particularly Mr.
McAdams, would have a material adverse effect on the Company's business,
financial condition, cash flows and results of operations.

                                       30
<PAGE>

Failure to Maintain REIT Status Would Result in the Company Being Subject to
Tax as a Regular Corporation and Substantially Reduce Cash Flow Available for
Distribution to Stockholders

   Limitation on Mortgage Assets to Comply with REIT Requirements. In order to
maintain its qualification as a REIT for Federal income tax purposes, the
Company must continue to satisfy certain tests with respect to the sources of
its income, the nature and diversification of its Mortgage Assets, the amount
of its distributions to stockholders and the ownership of its stock. See
"Federal Income Tax Considerations--Requirements for Qualification as a REIT."
Among other things, these restrictions may limit the Company's ability to
acquire certain types of assets that it otherwise would consider desirable,
limit the ability of the Company to securitize Mortgage Loans for sale to
third parties, and require the Company to make distributions to its
stockholders at times when it may deem it more advantageous to utilize the
funds available for distribution for other corporate purposes (such as the
purchase of additional assets or the repayment of debt) or at times that the
Company may not have funds readily available for distribution. Even if the
Company continues to qualify for taxation as a REIT, it may be subject to
certain federal taxes based on certain activities, which could result in
decreased dividend income available for distribution to stockholders. See
"Federal Income Tax Considerations--Taxation of the Company."

   Limitations Imposed by REIT Requirements on Hedging and Investments. The
REIT Provisions of the Code substantially limit the ability of the Company to
hedge its Mortgage Assets and the related Company borrowings. The Company must
limit its income in each year from Qualified Hedges (together with any other
income generated from other than Qualified REIT Real Estate Assets) to less
than 25% of the Company's gross income. In addition, the Company must limit
its 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
the Company's gross income each year. As a result, the Company may have to
limit its use of certain hedging techniques that might otherwise have been
advantageous. Any limitation on the Company's use of hedging techniques
results in greater interest rate risk. The Company intends to monitor closely
any income from such swap or cap agreements so as to comply with the 5% income
limitation. If the Company were to receive income in excess of the 25% or 5%
limitation, it could incur payment of a penalty tax equal to the amount of
income in excess of those limitations, or in the case of a willful violation,
loss of REIT status for federal tax purposes. See "Federal Income Tax
Considerations--Requirements for Qualification as a REIT--Gross Income Tests."

   The Company must also ensure that at the end of each calendar quarter at
least 75% of the value of its assets consists of cash, cash items, government
securities and Qualified REIT Real Estate Assets, and of the investments in
securities not included in the foregoing, the Company does not hold more than
10% of the outstanding voting securities of any one issuer and effective after
December 31, 2000, 10% of the value of any one issuer and no more than 5% by
value of the Company's assets consists of the securities of any one issuer.
(For an exception to the foregoing, see "Federal Income Tax Considerations--
New Tax Legislation.") Failure to comply with any of the foregoing tests
requires the Company to dispose of a portion of its assets within 30 days
after the end of the calendar quarter or face loss of REIT status and adverse
tax consequences. See "Federal Income Tax Considerations--Requirements for
Qualification as a REIT--Asset Tests."

   Distribution Requirements to Maintain REIT Status May Require the Company
to Borrow Funds to Make Distributions. The Company's operations may from time
to time generate Taxable Income in excess of its Net Income for financial
reporting purposes (such as from amortization of capitalized purchase
premiums). The Company may also experience circumstances in which its Taxable
Income is in excess of cash flows available for distribution to stockholders.
To the extent that the Company does not otherwise have funds available, either
situation could result in the Company's inability to distribute substantially
all of its Taxable Income as required to maintain its REIT status. In either
situation, the Company could be required to borrow funds in order to make the
required distributions that could increase borrowing costs and reduce the
yield to stockholders, to sell a portion of its Mortgage Assets at
disadvantageous prices in order to raise cash for distributions, or to make a
distribution in the form of a return of capital, which would have the effect
of reducing the equity of the Company. See "Federal Income Tax
Considerations--Requirements for Qualification as a REIT--Distribution
Requirement."

                                      31
<PAGE>

   Disqualification as a REIT May Result in Substantial Tax Liability. If the
Company should not qualify as a REIT in any tax year, it would be taxed as a
regular domestic corporation and, among other consequences, distributions to
the Company's stockholders would not be deductible by it in computing its
taxable income. Any resulting tax liability could be substantial and would
reduce the amount of cash available for distribution to the Company's
stockholders. In addition, the unremedied failure of the Company to be treated
as a REIT for any one year would disqualify the Company from being treated as
a REIT for four subsequent years. See "Federal Income Tax Considerations--
Termination or Revocation of REIT Status."

Effect of Future Offerings of Debt and Equity on Market Price of the Common
Stock

   The Company may in the future increase its capital resources by making
additional offerings of equity and debt securities, including classes of
preferred stock, Common Stock, commercial paper, medium-term notes, CMOs and
senior or subordinated notes. All debt securities, other borrowings and
classes of preferred stock will be senior to the Common Stock in a liquidation
of the Company. The effect of additional equity offerings may cause
significant dilution of the equity of stockholders of the Company or the
reduction of the price of shares of the Common Stock, or both. The Company is
unable to estimate the amount, timing or nature of additional offerings as
they will depend upon market conditions and other factors. Additionally, other
than leverage or the implementation of a dividend reinvestment plan, the
aforementioned offerings are the only means by which the Company can finance
its operations.

   Additionally, the Company is subject to the following Legal and Other
Risks:

  . Failure to Maintain an Exemption from the Investment Company Act Would
    Adversely Affect Results of Operations

  . Interest Rate Fluctuations May Adversely Affect the Market Price of the
    Common Stock

  . Active Formation and Operation of Competing Mortgage REITs May Adversely
    Affect the Market Price of the Common Stock

  . The Company Faces Restrictions on Ownership of the Common Stock

ITEM 2. PROPERTIES

   The Company's office space is provided by the Manager. The office of the
Manager is located at 1299 Ocean Avenue, Second Floor, Santa Monica,
California.

ITEM 3. LEGAL PROCEEDINGS

   At December 31, 1999 there were no pending legal proceedings to which the
Company was a party, or of which any of its property was subject.

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

   No matters were submitted to a vote of the Company's stockholders during
the fourth quarter of 1999.

                                      32
<PAGE>

                                    PART II

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

   The Company's stock began trading on March 17, 1998 and is traded on the
American Stock Exchange under the trading symbol ANH. As of March 17, 2000,
the Company had 2,316,067 shares of common stock outstanding which was held by
18 holders of record and approximately 1,200 beneficial owners.

   The following sets forth, for the periods indicated, the high, low and
closing sales prices on a per share of common stock basis, as reported on the
American Stock Exchange and the cash dividends per share of common stock.

<TABLE>
<CAPTION>
                                                               Stock Prices
                                                          ----------------------
                                                           High    Low    Close
                                                          ------- ------ -------
   <S>                                                    <C>     <C>    <C>
   For the quarter ended June 30, 1998...................   9 1/8  7 3/4   8 1/4
   For the quarter ended Sept. 30, 1998..................       8  4 1/4   4 5/8
   For the quarter ended Dec. 31, 1998................... 4 11/16  3 1/8  4 1/16
   For the quarter ended Mar. 31, 1999................... 4 15/16  3 3/4   4 1/2
   For the quarter ended June 30, 1999...................       5  4 1/8 4 15/16
   For the quarter ended Sept. 30, 1999..................   5 1/2 4 9/16   4 7/8
   For the quarter ended Dec. 31, 1999...................   5 1/4  4 1/2   4 1/2
</TABLE>

<TABLE>
<CAPTION>
                                             Cash Dividends
                                                Declared
                                               Per Share
                                             --------------
   <S>                                       <C>
   First quarter ended March 31, 1998......      $0.00 (partial period, 15 days)
   Second quarter ended June 30, 1998......      $0.15
   Third quarter ended September 30, 1998..      $0.10
   Fourth quarter ended December 31, 1998..      $0.12
   First quarter ended March 31, 1999......      $0.12
   Second quarter ended June 30, 1999......      $0.13
   Third quarter ended September 30, 1999..      $0.14
   Fourth quarter ended December 31, 1999..      $0.14
</TABLE>

   The Company intends to pay quarterly dividends and to make such
distributions to its stockholders in amounts such that all or substantially
all of its taxable income in each year (subject to certain adjustments) is
distributed so as to qualify for the tax benefits accorded to a REIT under the
Code. All distributions will be made by the Company at the discretion of the
Board of Directors and will depend on the earnings of the Company, the
financial condition of the Company, maintenance of REIT status and such other
factors as the Board of Directors may deem relevant from time to time.

                                      33
<PAGE>

ITEM 6. SELECTED FINANCIAL DATA

   The following selected financial data are derived from the audited
financial statements of the Company for the year ended December 31, 1999 and
for the period from commencement of operations on March 17, 1998 to December
31, 1998. The selected financial data should be read in conjunction with the
more detailed information contained in the Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this Annual Report on Form 10-K.

    For the year ended December 31, 1999 and the period from March 17, 1998
            (commencement of operations) through December 31, 1998
                 Dollars in thousands (except per share data)

<TABLE>
<CAPTION>
                                                               For the period
                                                               from March 17,
                                                                    1998
                                                              (commencement of
                                                   For the       operations)
                                                  year ended       through
                                                     1999     December 31, 1998
                                                  ----------  -----------------
<S>                                               <C>         <C>
STATEMENT OF OPERATIONS DATA
  Days in period.................................        365            290
  Interest and dividend income................... $    9,501     $    8,570
  Interest expense...............................      7,892          7,378
  Net interest income............................      1,609          1,192
  General and administrative expenses (G&A
   expenses).....................................        400            307
  Net income..................................... $    1,209     $      885
  Basic net income per average share............. $     0.53     $     0.38
  Diluted net income per average share........... $     0.53     $     0.38
  Dividends declared per average share........... $     0.53     $     0.37
  Weighted average common shares outstanding.....  2,289,790      2,315,651
BALANCE SHEET DATA AT DECEMBER 31,
  Mortgage backed securities, net................ $  161,488     $  184,245
  Total assets...................................    167,144        199,458
  Repurchase agreements..........................    147,690        170,033
  Total liabilities..............................    150,612        182,216
  Stockholders' equity...........................     16,532         17,242
  Number of common shares outstanding............  2,306,669      2,328,000
OTHER DATA
  Average earnings assets........................ $  169,618     $  181,445
  Average borrowings.............................    149,372        165,496
  Average equity(1)..............................     18,931         18,177
  Yield on interest earning assets for the year
   ended December 31, 1999 and the period ended
   December 31, 1998.............................       5.60%          5.94%
  Cost of funds on interest bearing liabilities
   for the year ended December 31, 1999 and the
   period ended December 31, 1998................       5.28%          5.61%
ANNUALIZED FINANCIAL RATIOS(1)(2)
  Net interest margin (net interest
   income/average assets)........................       0.96%          0.83%
  G&A expenses as a percentage of average
   assets........................................       0.24%          0.21%
  G&A expenses as a percentage of average
   equity........................................       2.11%          2.02%
  Return on average assets.......................       0.71%          0.61%
  Return on average equity.......................       6.38%          5.84%
</TABLE>
--------
(1) Average equity excludes fair value adjustment for ARM securities
(2) Each ratio for 1998 has been computed by annualizing the results for the
    290-day period ended December 31, 1998

                                      34
<PAGE>

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

   Certain statements contained in the following discussion are "forward-
looking statements" within the meaning of applicable federal securities laws.
Forward looking statements which are based on various assumptions (some of
which are beyond the Company's control) may be identified by reference to a
future period or periods, or by the use of forward-looking terminology, such
as "may", "will," "intend," "should," "expect," "anticipate," "estimate" or
"continue" or the negatives thereof or other comparable terminology. Forward-
looking statements included herein regarding the actual results, performance
and achievements of the Company are dependent on a number of factors. The
Company's actual results could differ materially from those anticipated in
such forward-looking statements as a result of certain factors, including but
not limited to, changes in interest rates, changes in yield curve, changes in
prepayment rates, the availability of mortgage-backed securities for purchase,
the availability of financing and, if available, the terms of any such
financing. The Company does not undertake, and specifically disclaims any
obligation, to publicly release the result of any revisions which may be made
to any forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.

GENERAL

   The Company is a REIT formed in October 1997 to invest in mortgage 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
and short-term investments.

   The Company's principal business objective is to generate net income for
distribution to stockholders from the spread between the interest income on
its Mortgage Assets and the costs of borrowing to finance its acquisition of
Mortgage Assets. The Company commenced operations on March 17, 1998 upon the
closing of its initial public offering which raised net proceeds of
$18,414,000. Since then the Company has deployed its capital and grown its
balance sheet through the acquisition of mortgage assets and the financing of
those assets in the credit markets. The financial statements included in this
Annual Report on Form 10-K should be read in light of this growth process and
are not necessarily representative of what they may be in the future.

   The Company will seek to generate growth in earnings and dividends per
share in a variety of ways, including through (i) issuing new Common Stock and
increasing the size of the balance sheet when opportunities in the market for
Mortgage Assets are likely to allow growth in earnings per share, (ii) seeking
to improve productivity by increasing the size of the balance sheet at a rate
faster than the rate of increase in operating expenses, (iii) continually
reviewing the mix of Mortgage Asset types on the balance sheet in an effort to
improve risk-adjusted returns, and (iv) attempting to improve the efficiency
of the Company's balance sheet structure through the issuance of
uncollateralized subordinated debt, preferred stock and other forms of
capital, to the extent management deems such issuances appropriate.

   The Company is organized for tax purposes as a REIT and therefore generally
passes through substantially all of its taxable earnings to stockholders
without paying federal or state income tax at the corporate level.

FINANCIAL CONDITION

   At December 31, 1999, the Company held total assets of $167 million,
consisting of $141 million of ARM securities, $21 million of fixed-rate
mortgage-backed securities, $1 million of REIT preferred stock and $4 million
of cash equivalents and other receivables. At December 31, 1999, 99% of the
qualified real estate assets held by the Company were Primary assets. Of the
ARM securities owned by the Company, 84% were adjustable-rate pass-through
certificates which reset at least once a year. The remaining 16% were new
origination 3/1 and 5/1 hybrid ARMS. Hybrid ARM 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.

                                      35
<PAGE>

   The following table presents a schedule of mortgage backed securities owned
at December 31, 1999 and December 31, 1998 classified by type of issuer.

MORTGAGE BACKED SECURITIES BY ISSUER

<TABLE>
<CAPTION>
                                     December 31, 1999      December 31, 1998
                                   ---------------------- ----------------------
                                   Carrying % of Mortgage Carrying % of Mortgage
                                    Value    Securities    Value    Securities
                                   -------- ------------- -------- -------------
                                           (Dollar amounts in thousands)
   <S>                             <C>      <C>           <C>      <C>
   Agency.........................
   FNMA........................... $131,758      81.8     $138,935      76.3
   FHLMC..........................   29,405      18.2       43,237      23.7
                                   --------     -----     --------     -----
                                   $161,163     100.0     $182,172     100.0
                                   ========     =====     ========     =====
</TABLE>

   The following table classifies the Company's portfolio of ARM securities by
type of interest rate index.

MORTGAGE ASSETS BY INDEX/FIXED

<TABLE>
<CAPTION>
                                   December 31, 1999      December 31, 1998
                                 ---------------------- ----------------------
                                 Carrying % of Mortgage Carrying % of Mortgage
            Index/Fixed           Value    Securities    Value    Securities
            -----------          -------- ------------- -------- -------------
                                         (Dollar amounts in thousands)
   <S>                           <C>      <C>           <C>      <C>
   Six-month LIBOR.............. $  9,330       5.8     $ 14,656       8.0
   Six-month Certificate of
    Deposit.....................    5,611       3.5        8,461       4.6
   One-year Constant Maturity
    Treasury....................  120,036      74.5      142,459      78.2
   Cost of Funds Index..........    5,615       3.5        6,545       3.6
   Fixed........................   20,570      12.7       10,051       5.6
                                 --------     -----     --------     -----
                                 $161,162     100.0     $182,172     100.0
                                 ========     =====     ========     =====
</TABLE>

   The Mortgage Assets portfolio had a weighted average coupon of 5.93% and
6.85% at December 31, 1999 and December 31, 1998, respectively. The weighted
average three-month constant prepayment rate ("CPR") of the Company's MBS
portfolio was 14.7% and 31.1% as of December 31, 1999 and December 31, 1998,
respectively. At December 31, 1999 and December 31, 1998, respectively, the
unamortized net premium paid for the mortgage-backed securities was $3.5
million and $4.6 million.

   The Company analyzes its mortgage-backed securities and the extent to which
prepayments impact the yield of the securities. When actual prepayments exceed
expectations, the Company amortizes the premiums paid on mortgage assets over
a shorter time period, resulting in a reduced yield to maturity on the
Company's 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. The Company monitors its
yield expectations versus its actual prepayment experience on a monthly basis
in order to adjust the amortization of the net premium.

   The fair value of the Company's portfolio of ARM securities classified as
available-for-sale was $2.4 million less than the amortized cost of the
securities, resulting in a negative adjustment of 1.43% of the amortized cost
of the portfolio as of December 31, 1999. This price decline reflects the
possibility of increased future prepayments, which would have the effect of
shortening the average life of the Company's ARM securities and decreasing
their yield and market value.


                                      36
<PAGE>

RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999

   For the year ended December 31, 1999, the Company's net income was
$1,209,000, or $0.53 per share (basic and diluted EPS), based on an average of
2,289,790 shares outstanding. Net interest income for the 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, the Company incurred general and administrative
expenses of $400,000, consisting operating expense of $225,000 and a base
management fee of $175,000.

   By comparison, the Company's net income was $885,000 during its initial
290-day period of operation in 1998. On an annualized basis, the Company's
1998 net income was $1,114,000. The primary reason for the increase in the
Company's profitability in 1999 over 1998 was the leveling off of interest
rates resulting in decreased refinancing activity which in turn lead to slower
prepayments of the Company's Mortgage Assets.

   The Company's annual return on average equity was 6.38% for the year ended
December 31, 1999; this compares favorably to the 1998 figure of 5.84%. The
table below shows the annualized components of return on average equity.

ANNUALIZED COMPONENTS OF RETURN ON AVERAGE EQUITY(/1/)

<TABLE>
<CAPTION>
                         Net Interest  G&A Expense/ Net Income/
                         Income/Equity    Equity      Equity
                         ------------- ------------ -----------
<S>                      <C>           <C>          <C>
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%
</TABLE>
--------
(1)   Average equity excludes unrealized gain (loss) on available-for-sale
      securities.

   The following table shows the Company's 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.

<TABLE>
<CAPTION>
                                                                    Annualized
                                                                     Yield on
                                      Average                        Average   Annualized
                                     Amortized           Yield on   Amortized   Yield on  Dividend
                           Average    Cost of  Average    Average    Cost of    Average     and
                            Cash     Mortgage  Earning     Cash      Mortgage   Earning   Interest
                         Equivalents  Assets    Assets  Equivalents   Assets     Assets    Income
                         ----------- --------- -------- ----------- ---------- ---------- --------
                                               (dollar amounts in thousands)
<S>                      <C>         <C>       <C>      <C>         <C>        <C>        <C>
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
</TABLE>

   The table below shows the Company's average borrowed funds and annualized
average cost of funds as compared to average one- and average three-month
LIBOR.

<TABLE>
<CAPTION>
                                                                     Average    Average     Average
                                                                    One-month   Cost of     Cost of
                                                                      LIBOR      Funds       Funds
                                                   Average Average  Relative    Relative   Relative
                         Average           Average  One-   Three-  to Average  to Average to Average
                         Borrowed Interest Cost of  Month   Month  Three-month One-month  Three-month
                          Funds   Expense   Funds   LIBOR   LIBOR     LIBOR      LIBOR       LIBOR
                         -------- -------- ------- ------- ------- ----------- ---------- ----------- ---
                                                (dollar amounts in thousands)
<S>                      <C>      <C>      <C>     <C>     <C>     <C>         <C>        <C>         <C>
For the year ended Dec.
 31, 1999............... $149,372  $7,892   5.28%   5.25%   5.42%     -0.17%     +0.03%      -0.14%
For the period ended
 Dec. 31, 1998.......... $165,496  $7,378   5.61%   5.55%   5.54%     +0.01%     +0.06%      +0.07%
</TABLE>


                                      37
<PAGE>

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

   The Company pays the Manager an annual base management fee, generally based
on average net invested assets, as defined in the Management Agreement,
payable monthly in arrears as follows: 1.0% of the first $300 million of
Average Net Invested Assets, plus 0.8% of the portion above $300 million.

   In order for the Manager to earn a performance fee, the rate of return on
the 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 year ended December 31, 1999, the Company's 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, the
Manager earned no performance fee. In 1998 the Manager earned $2,000 as a
result of the quarterly calculation of incentive management fee.

   Beginning in calendar year 1999, the quarterly Incentive Management
Compensation will be subject to annual reconciliation so that the Incentive
Management Compensation is based on the Manager's performance for a calendar
year rather than a quarter-by-quarter basis.

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

ANNUALIZED OPERATING EXPENSE RATIOS

<TABLE>
<CAPTION>
                              Management Fee &
                            Other Expenses/Total   Performance          Total G&A
                                   Assets        Fee/Total Assets Expenses/Total Assets
                            -------------------- ---------------- ---------------------
   <S>                      <C>                  <C>              <C>
   For the year ended
    December 31, 1999......         0.24%              0.00%              0.24%
   For the peiod ended
    December 31, 1998......         0.21%              0.00%              0.21%
</TABLE>

INTEREST RATE AGREEMENTS

   The Company has not entered into any interest rate agreements to date. As
part of its asset/liability management process, the Company may enter into
interest rate agreements such as interest rate caps, floors and swaps. These
agreements would be entered into to reduce interest rate risk and would be
designed to provide income and capital appreciation to the Company in the
event of certain changes in interest rates. The Company reviews the need for
interest rate agreements on a regular basis consistent with its capital
investment policy.

   The Company has not experienced credit losses on its portfolio of ARM
securities to date, but losses may be experienced in the future. At December
31, 1999, the Company had limited its exposure to credit losses on its
portfolio of ARM securities by purchasing only Agency Certificates, which,
although not rated, carry an implied "AAA" rating.

COMMON DIVIDEND

   As a REIT, the Company is required to declare dividends amounting to 85% of
each year's taxable income by the end of each calendar year and to have
declared dividends amounting to 95% of its taxable income for each year by the
time it files its applicable tax return and, therefore, generally passes
through substantially all of its earnings to stockholders without paying
federal income tax at the corporate level. Since the Company, as a REIT, pays
its dividends based on taxable earnings, the dividends may at times be more or
less than reported earnings.

   On December 17, 1999 the Company declared a dividend of $0.14 per share
payable on January 18, 2000 to holders of record as of January 3, 2000. In
total, the Company distributed $1,212,950 in dividends during the year ended
December 31, 1999 and $861,360 in dividends for the period ended December 31,
1998.

                                      38
<PAGE>

   The following table shows the quarterly dividends since inception.

<TABLE>
<CAPTION>
                                             Cash Dividends
                                                Declared
                                               Per Share
                                             --------------
   <S>                                       <C>
   First quarter ended March 31, 1998......      $0.00 (partial period, 15 days)
   Second quarter ended June 30, 1998......      $0.15
   Third quarter ended September 30, 1998..      $0.10
   Fourth quarter ended December 31, 1998..      $0.12
   First quarter ended March 31, 1999......      $0.12
   Second quarter ended June 30, 1999......      $0.13
   Third quarter ended September 30, 1999..      $0.14
   Fourth quarter ended December 31, 1999..      $0.14
</TABLE>

LIQUIDITY AND CAPITAL RESOURCES

   The Company's primary source of funds for the year ended December 31, 1999
consisted of reverse repurchase agreements, which totaled $148 million at
December 31, 1999. The Company's other significant source of funds for the
period ended December 31, 1999 consisted of payments of principal and interest
from its Mortgage Assets portfolio in the amount of $53.6 million. In the
future, the Company expects its primary sources of funds will consist of
borrowed funds under reverse repurchase agreement transactions with one to
twelve-month maturities and of monthly payments of principal and interest on
its ARM securities portfolio. The Company's liquid assets generally consist of
unpledged ARM assets, cash and cash equivalents.

   The borrowings incurred during the year ended December 31, 1999 had an
annual average interest cost during the period of 5.28%. As of December 31,
1999, all of the Company's reverse repurchase agreements were fixed-rate term
reverse repurchase agreements with original maturities that range from three
months to one year and an average maturity of 67 days. The Company has
borrowing arrangements with twelve different financial institutions and on
December 31, 1999, had borrowed funds under reverse repurchase agreements with
nine of these firms. Because the Company borrows money based on the fair value
of its ARM securities and because increases in short-term interest rates can
negatively impact the valuation of ARM securities, the Company's borrowing
ability could be limited and lenders may initiate margin calls in the event
short-term interest rates increase or the value of the Company's ARM
securities declines for other reasons. During the year ended December 31,
1999, the Company had adequate cash flow, liquid assets and unpledged
collateral with which to meet its margin requirements during the period.
Further, the Company believes it will continue to have sufficient liquidity to
meet its future cash requirements from its primary sources of funds for the
foreseeable future without needing to sell assets.

   The Company uses "available-for-sale" treatment for its 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, the Company's equity base at December 31, 1999 was $16.5 million,
or $7.17 per share. If the Company had used historical amortized cost
accounting, the Company's equity base at December 31, 1999 would have been
$18.9 million, or $8.19 per share.

   With the Company's "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact financial reporting 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 "Other comprehensive income, unrealized gain (loss) on available for
sale securities." By accounting for its assets in this manner, the Company
hopes to provide useful information to stockholders and creditors and to
preserve flexibility to sell assets in the future without having to change
accounting methods.

   As a result of this mark-to-market accounting treatment, the book value and
book value per share of the Company are likely to fluctuate far more than if
the Company 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 be misleading.

                                      39
<PAGE>

   Unrealized changes in the fair value of Mortgage-Backed Securities have one
direct effect on the Company's potential earnings and dividends: positive
mark-to-market changes will increase the Company's equity base and allow the
Company to increase its borrowing capacity while negative changes will tend to
limit borrowing capacity under the Company's Capital Investment Policy. A very
large negative change in the net market value of the Company's Mortgage-Backed
Securities might impair the Company's liquidity position, requiring the
Company to sell assets with the likely result of realized losses upon sale.
"Other comprehensive income, unrealized gain (loss) on available for sale
securities" was $(2.4) million, or (1.43)% of the amortized cost of mortgage
assets at December 31, 1999.

EFFECTS OF INTEREST RATE CHANGES

   The Company has invested in adjustable-rate mortgage securities and fixed
rate mortgage securities. Adjustable-rate mortgage assets are typically
subject to periodic and lifetime interest rate caps that limit the amount an
adjustable-rate mortgage security's interest rate can change during any given
period. Adjustable-rate mortgage securities are also typically subject to a
minimum interest rate payable. The Company borrowings will not be subject to
similar restrictions. Hence, in a period of increasing interest rates,
interest rates on its borrowings could increase without limitation by caps,
while the interest rates on its mortgage assets could be so limited. This
problem would be magnified to the extent the Company acquires mortgage assets
that are not fully indexed. Further, some adjustable-rate mortgage assets may
be subject to periodic payment caps that result in some portion of the
interest being deferred and added to the principal outstanding. This could
result in receipt by the Company of less cash income on its adjustable-rate
mortgage assets than is required to pay interest on the related borrowings.
These factors could lower the Company's net interest income or cause a net
loss during periods of rising interest rates, which would negatively impact
the Company's liquidity and its ability to make distributions to stockholders.

   Fixed rate mortgage securities pay a fixed rate of interest. Fixed rate
mortgage securities are not subject to the same types of limitations as
described above for adjustable rate mortgage securities but are subject to
prepayment risk and are more price sensitive to changes in the general level
of interest rates than are adjustable rate mortgage securities.

   The Company intends to fund the purchase of a substantial portion of its
adjustable-rate mortgage securities with borrowings that may 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, the Company anticipates that in most cases the interest rate
indices and repricing terms of its mortgage assets and its 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 the Company's net income,
dividend yield and the market price of the Common Stock.

   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 securities vary
from time to time and may cause changes in the amount of the Company's 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 securities. The purchase prices of mortgage securities are
generally based upon assumptions regarding the expected amounts and rates of
prepayments. Where slow prepayment assumptions are made, the Company may pay a
premium for mortgage securities. To the extent such assumptions materially and
adversely differ from the actual amounts of prepayments, the Company would
experience losses. The total prepayment of any mortgage asset that had been
purchased at a premium by the Company would result in the immediate write-off
of any remaining capitalized premium amount and consequent reduction of the
Company's net interest income by such amount. Finally in the event that the
Company is unable to acquire new mortgage assets to replace the prepaid
mortgage assets, its financial condition, cash flows and results of operations
could be materially adversely affected.

                                      40
<PAGE>

OTHER MATTERS

   As of December 31, 1999, the Company calculates its Qualified REIT Assets,
as defined in the Code, to be greater than 90% of its total assets, as
compared to the Code requirement that at least 75% of its total assets must be
Qualified REIT Assets. The Company also calculates that greater than 98% of
its 1999 revenue for the year ended December 31, 1999 qualifies for both the
75% source of income test and the 95% source of income test under the REIT
rules. The Company also met all REIT requirements regarding the ownership of
its common stock and the distributions of its net income. Therefore, as of
December 31, 1999, the Company believes that it will continue to qualify as a
REIT under the provisions of the Code.

   The Company at all times intends to conduct its business so as not to
become regulated as an investment company under the Investment Company Act. If
the Company were to become regulated as an investment company, then the
Company's use of leverage would be substantially reduced. The Investment
Company Act exempts entities that are Qualifying Interests. Under current
interpretation of the staff of the Securities and Exchange Commission, in
order to qualify for this exemption, the Company must maintain at least 55% of
its assets directly in Qualifying Interests. In addition, unless certain
mortgage securities represent all of the certificates issued with respect to
an underlying pool of mortgages, such mortgage securities may be treated as
securities separate from the underlying mortgage loans and, thus, may not be
considered Qualifying Interests for purposes of the 55% requirement. The
Company calculates that it is in compliance with this requirement.

INFLATION

   Virtually all of the Company's assets and liabilities are financial in
nature. As a result, interest rates and other factors drive the Company's
performance far more than does inflation. Changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates. The
Company's financial statements are prepared in accordance with generally
accepted accounting principles (GAAP) and the Company's dividends are
determined by the Company's net income as calculated for tax purposes; in each
case, the Company's activities and balance sheet are measured with reference
to historical cost or fair market value without considering inflation.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

   The financial statements of the Company and the related notes, together
with the Reports of Independent Accountants thereon, are set forth beginning
on page F-1 of this Annual Report on Form 10-K.

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

   On September 23, 1999, McGladrey & Pullen, LLP (McGladrey) resigned as
independent auditors of the Company. McGladrey resigned pursuant to their
agreement to sell their investment management practice to
PricewaterhouseCoopers LLP (PwC). Three partners and twenty-two professionals,
including the partner and staff previously serving the Company, have joined
PwC.

   The report of McGladrey on the financial statements of the Company for the
past fiscal year did not contain an adverse opinion or a disclaimer of
opinion, and was not qualified or modified as to uncertainty, audit scope or
accounting principles. The Company's past fiscal period ended December 31,
1998 was the Company's initial period of operation.

   During the Company's most recent fiscal year and subsequent interim period
preceding the termination of McGladrey, there were no disagreements with
McGladrey on any matter of accounting principle or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of McGladrey would have caused it to make
reference to the subject matter of disagreement in connection with its report.

                                      41
<PAGE>

   None of the reportable events listed in Item 304 (a) (1) (v) of Regulation
S-K occurred with respect to the Company during the Company's most recent
fiscal year and the subsequent interim period preceding the termination of
McGladrey.

   On September 20, 1999, the Company, with the approval of its Board of
Directors and its Audit Committee, engaged PwC as its independent auditors.

   During the Company's most recent fiscal year and the subsequent interim
period preceding the engagement of PwC, neither the Company nor anyone of its
behalf consulted PwC regarding the application of accounting principles to a
specified completed or contemplated transaction or the type of audit opinion
that might be rendered on the Company's financial statements, and no written or
oral advice concerning same was provided to the Company that was an important
factor considered by the Company in reaching a decision as to any accounting,
auditing or financial reporting issue.

                                       42
<PAGE>

                                   PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

   Information required by this item is incorporated by reference to the
information set forth under the caption "DIRECTORS AND EXECUTIVE OFFICERS" in
Anworth's definitive proxy statement proxy statement which Anworth intends to
file no later than 120 days after the end of fiscal year 1999, pursuant to
Regulation 14A.

ITEM 11. EXECUTIVE COMPENSATION

   Information required by this item is incorporated by reference to the
information set forth under the caption "EXECUTIVE COMPENSATION" in Anworth's
definitive proxy statement proxy statement which Anworth intends to file no
later than 120 days after the end of fiscal year 1999, pursuant to Regulation
14A.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   Information required by this item is incorporated by reference to the
information set forth under the caption "SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT" in Anworth's definitive proxy statement
proxy statement which Anworth intends to file no later than 120 days after the
end of fiscal year 1999, pursuant to Regulation 14A.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTION

   Information required by this item is incorporated by reference to the
information set forth under the caption "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS" in Anworth's definitive proxy statement proxy statement which
Anworth intends to file no later than 120 days after the end of fiscal year
1999, pursuant to Regulation 14A.

                                      43
<PAGE>

                                    PART IV

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

   (a) Documents filed as part of this report:

    1. Financial Statements.

    2. Schedules to Financial Statements. All financial statement schedules
  not included have been omitted because they are either inapplicable or the
  information required is provided in the Company's Financial Statements and
  Notes thereto, included in Part II, Item 8 of this Annual Report on Form
  10-K.

    3. Exhibits:

      3.1 Charter of the Registrant (incorporated by reference to Exhibit
    3.1 to the Company's Registration Statement on Form S-11(Registration
    No. 333-38641) filed with the Securities and Exchange Commission on
    October 24, 1997.).

      3.2 Bylaws of the Registrant (incorporated by reference to Exhibit
    3.2 to the Company's Registration Statement on Form S-11(Registration
    No. 333-38641) filed with the Securities and Exchange Commission on
    October 24, 1997.).

      4.1 Form of Stock Certificate of the Registrant (incorporated by
    reference to Exhibit 4.1 to the Company's Registration Statement on
    Form S-11(Registration No. 333-38641) filed with the Securities and
    Exchange Commission on December 12, 1997.).

      10.1 Management Agreement between the Registrant and Anworth Mortgage
    Advisory Corporation (incorporated by reference to Exhibit 10.1 to the
    Company's Registration Statement on Form S-11(Registration No. 333-
    38641) filed with the Securities and Exchange Commission on February
    25, 1998.).

      10.2 Form of 1997 Stock Option and Awards Plan (incorporated by
    reference to Exhibit 10.2 to the Company's Registration Statement on
    Form S-11(Registration No. 333-38641) filed with the Securities and
    Exchange Commission on December 12, 1997.).

      10.3 Form of Dividend Reinvestment and Stock Purchase Plan
    (incorporated by reference to the Company's Registration Statement on
    Form S-3 (Registration No. 333-87555) filed with the Securities and
    Exchange Commission on September 22, 1999.).

      27 Financial Data Schedule

   (c) Reports on Form 8-K.

   No reports on Form 8-K have been filed during the last quarter of the
period covered by this report.

                                      44
<PAGE>

                                   GLOSSARY

   There follows an abbreviated definition of certain capitalized terms used
in this Annual Report on Form 10-K.

   "Affiliate" means, when used with reference to a specified person, (i) any
person that directly or indirectly controls or is controlled by or is under
common control with the specified person, (ii) any person that is an officer
of, partner in or trustee of, or serves in a similar capacity with respect to,
the specified person or of which the specified person is an officer, partner
or trustee, or with respect to which the specified person serves in a similar
capacity, and (iii) any person that, directly or indirectly, is the beneficial
owner of 5% or more of any class of equity securities of the specified person
or of which the specified person is directly or indirectly the owner of 5% or
more of any class of equity securities.

   "Agency Certificates" means GNMA ARM Certificates, Fannie Mae ARM
Certificates and FHLMC ARM Certificates.

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

   "Average Net Invested Assets" means for any period the difference between
(i) the aggregate book value of the consolidated assets of the Company and its
subsidiaries, before reserves for depreciation or bad debts or other similar
noncash reserves and (ii) the book value of average debt associated with the
Company's ownership of Mortgage Assets, computed by taking the average of such
net values at the end of each month during such period.

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

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

   "Bylaws" means the bylaws of the Company, a copy of which is filed as an
exhibit to the Registration Statement of which this Prospectus forms a part.

   "Charitable Beneficiaries" means a charitable beneficiary of a Trust.

   "Charter" means the charter of the Company, a copy of which is filed as an
exhibit to the Registration Statement of which this Prospectus forms a part.

   "CD Rate" means the weekly average of secondary market interest rates on
six-month negotiable certificates of deposit, as published by the Federal
Reserve Board in its Statistical Release H. 15(519), Selected Interest Rates.

   "CMOs" means variable-rate debt obligations (bonds) that are collateralized
by mortgage loans or mortgage certificates other than Mortgage Derivative
Securities and Subordinated Interests. CMOs are structured so that principal
and interest payments received on the collateral are sufficient to make
principal and interest payments on the bonds. Such bonds may be issued by
United States government agencies or private issuers in one or more classes
with fixed or variable interest rates, maturities and degrees of subordination
which are characteristics designed for the investment objectives of different
bond purchasers. The Company will only acquire CMOs that constitute beneficial
interests in grantor trusts holding Mortgage Loans, or regular interests
issued by REMICs, or that otherwise constitute Qualified REIT Real Estate
Assets (provided that the Company has obtained a favorable opinion of counsel
or a ruling from the Service to that effect).

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

   "Collateral" means Mortgage Assets, debt service funds and reserve funds,
insurance policies, servicing agreements or master servicing agreements.

                                      45
<PAGE>

   "Commission" means the Securities and Exchange Commission.

   "Commitments" means commitments issued by the Company which will obligate
the Company to purchase Mortgage Assets from or sell them to the holders of
the commitment for a specified period of time, in a specified aggregate
principal amount and at a specified price.

   "Common Stock" means the Company's shares of Common Stock, $0.01 par value
per share.

   "Company" means Anworth Mortgage Asset Corporation, a Maryland corporation.

   "Conforming Mortgage Loans" means conventional Mortgage Loans that either
comply with requirements for inclusion in credit support programs sponsored by
FHLMC, Fannie Mae or GNMA or are FHA or VA Loans, all of which are secured by
first mortgages or deeds of trust on single-family (one to four units)
residences.

   "Counter-party" means a third-party financial institution with which the
Company enters into an interest rate cap agreement or similar agreement.

   "Dealer Property" means real property and real estate mortgages other than
stock in trade, inventory or property held primarily for sale to customers in
the ordinary course of the Company's trade or business.

   "Dollar-Roll Agreement" means an agreement to sell a security for delivery
on a specified future date and a simultaneous agreement to repurchase the same
or substantially similar security on a specified future date.

   "11th District Cost of Funds Index" means the index made available monthly
by the Federal Home Loan Bank Board of the cost of funds to members of the
Federal Home Loan Bank 11th District.

   "Excess Servicing Rights" means contractual rights to receive a portion of
monthly mortgage payments of interest remaining after those payments of
interest have already been applied, to the extent required, to Pass-Through
Certificates and the administration of mortgage servicing. The mortgage
interest payments are secured by an interest in real property.

   "Excess Shares" means the number of shares of capital stock held by any
person or group of persons in excess of 9.8% of the outstanding shares.

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

   "Federal Reserve Board" means the Board of Governors of the Federal Reserve
System.

   "Fannie Mae" means the Federal National Mortgage Association.

   "Fannie Mae Certificates" means guaranteed mortgage Pass-Through
Certificates issued by Fannie Mae either in certified or book-entry form.

   "FHA" means the United States Federal Housing Administration.

   "FHA Loans" means Mortgage Loans insured by the FHA.

   "FHLMC" means the Federal Home Loan Mortgage Corporation.

   "FHLMC Certificates" means mortgage participation certificates issued by
FHLMC, either in certificated or book-entry form.

   "FIRPTA" means the Foreign Investment in Real Property Tax Act of 1980.

   "First Loss Subordinated Bonds" means any bonds that bear the "first loss"
from losses incurred in respect of Mortgage Assets upon foreclosure sales and
other liquidations of underlying mortgaged properties that result in failure
to recover all amounts due on the loans secured thereby.

                                      46
<PAGE>

   "Foreclosure Property" means property acquired at or in lieu of foreclosure
of that mortgage secured by such property or a result of a default under a
lease of such property.

   "Foreign Holder" means an initial purchaser of Common Stock that, for
United States tax purposes, is not a United States person.

   "GNMA" means the Government National Mortgage Association.

   "GNMA Certificates" means fully modified pass-through mortgage backed
certificates guaranteed by GNMA and issued either in certificated or book-
entry form.

   "Housing Act" means the National Housing Act of 1934, as amended.

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

   "Interest Only Derivatives" mean Mortgage Derivative Securities
representing the right to receive interest only or a disproportionately large
amount of interest.

   "Inverse Floaters" means a class of CMOs with a coupon rate that moves
inversely to a designated index, such as LIBOR or the 11th District Cost of
Funds Index. Income floaters have coupon rates that typically change at a
multiple of the changes at the relevant index rate. Any rise in the index rate
(as a consequence of 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.

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

   "Investment Grade" means a security rating of BBB or better by Standard &
Poor's or Baa or better by Moody's Investors Service, Inc., or, as to unrated
Pass-Through Certificates and CMOs backed by single-family or multi-family
properties, a determination that the security is of comparable quality (by the
rating of at least one of the Rating Agencies) to a rated Investment Grade
security on the basis of credit enhancement features that meet Investment
Grade credit criteria approved by the Company's Board of Directors, including
approval by a majority of the Unaffiliated Directors.

   "IRAs" means Individual Retirement Accounts.

   "ISOs" means incentive stock options granted under the Stock Option and
Awards Plan which meet the requirements of Section 422 of the Code.

   "LIBOR" means London-Inter-Bank Offered Rate.

   "Limited Investment Assets" means Mortgage Assets that are less than
Primary, including (i) Mortgage Loans, (ii) Pass-Through Certificates and CMOs
which are not Primary but are backed by single-family residential mortgage
loans, (iii) Pass-Through Certificates and CMOs backed by loans on commercial,
multi-family or other real estate-related properties if they are at least
"Investment Grade" and (iv) Other Mortgage Securities. Limited Investment
Assets may not comprise more than 30% of the Company's total assets.

   "Management" means the Company's and the Manager's management team.

   "Management Agreement" means the agreement by and between the Company and
the Manager whereby the Manager agrees to perform certain services to the
Company in exchange for certain fees.

   "Manager" means Anworth Mortgage Advisory Corporation, a California
corporation.

   "Master Servicer" means an entity that will administer and supervise the
performance by servicers of the duties and responsibilities under Servicing
Agreements in respect of the Collateral for a series of Mortgage Securities.

                                      47
<PAGE>

   "Mortgage Assets" means (i) Mortgage Securities, (ii) Mortgage Loans and
(iii) Short-Term Investments. All Mortgage Securities and Mortgage Loans shall
be Qualified REIT Real Estate Assets.

   "Mortgage Derivative Securities" means Mortgage Securities which 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. The Company will only acquire Mortgage Derivative
Securities that constitute beneficial interests in grantor trusts holding
Mortgage Loans, or are regular interests issued by REMICs, or that otherwise
constitute Qualified REIT Real Estate Assets (provided the Company has
obtained a favorable opinion of counsel to that effect).

   "Mortgage Loans" means Conforming and Nonconforming Mortgage Loans, FHA
Loans and VA Loans. All Mortgage Loans to be acquired by the Company will be
ARMs and will be secured by first mortgages or deeds of trust on single-family
(one-to-four units) residential properties.

   "Mortgage Securities" means (i) Pass-Through Certificates, (ii) CMOs and
(iii) Other Mortgage Securities.

   "Mortgage Suppliers" means mortgage bankers, savings and loan associations,
investment banking firms, banks, home builders, insurance companies and other
concerns or lenders involved in mortgage finance and their Affiliates.

   "Mortgage Warehouse Participations" means participations in lines of credit
to mortgage originators that are secured by recently originated Mortgage Loans
which are in the process of being either securitized or sold to permanent
investors.

   "Net Cash Flows" means the difference between (i) the cash flows on
Mortgage Assets together with reinvestment income thereon and (ii) borrowing
and financing costs of the Company.

   "Net Income" means the taxable income of the Company before the Manager's
incentive compensation, net operating loss deductions arising from losses in
prior periods and deductions permitted by the Code in calculating taxable
income for a REIT plus the effects of adjustments, if any, necessary to record
hedging and interest transactions in accordance with generally accepted
accounting principles.

   "New Capital" means the proceeds from the sale of stock or certain debt
obligations.

   "Nonconforming Mortgage Loans" means conventional Mortgage Loans that do
not conform to one or more requirements of FHA, FHLMC, Fannie Mae, GNMA or VA
for participation in one or more of such agencies' mortgage loan credit
support programs, such as the principal amounts financed or the underwriting
guidelines used in making the loan.

   "One-Year U.S. Treasury Rate" means average of weekly average yield to
maturity for U.S. Treasury securities (adjusted to a constant maturity of one
year) as published weekly by the Federal Reserve Board during a yearly period.

   "Other Mortgage Securities" means securities representing interests in, or
secured by Mortgages on, real property other than Pass-Through Certificates
and CMOs and may include non-Primary certificates and other securities
collateralized by single-family loans, Mortgage Warehouse Participations,
Mortgage Derivative Securities, Subordinated Interests and other mortgage-
backed and mortgage-collateralized obligations.

   "Pass-Through Certificates" means securities (or interests therein) other
than Mortgage Derivative Securities and Subordinated Interests evidencing
undivided ownership interests in a pool of mortgage loans, the holders of
which receive a "pass-through" of the principal and interest paid in
connection with the underlying mortgage loans in accordance with the holders'
respective, undivided interests in the pool. Pass-Through Certificates include
Agency Certificates, as well as other certificates evidencing interests in
loans secured by single-family, multi-family, commercial and/or other real
estate related properties.

                                      48
<PAGE>

   "PIA" means Pacific Income Advisers, Inc., a Delaware corporation.

   "Primary" means securities which are either (i) rated within one of the two
highest rating categories by at least one nationally recognized statistical
rating organization (such as Moody's, Fitch or Standard & Poors), or (ii)
unrated Mortgage Loans or mortgage securities that are rated at least
Investment Grade by at least one nationally recognized statistical rating
organization.

   "Principal Only Derivatives" means Mortgage Derivative Securities
representing the right to receive principal only or a disproportionate amount
of principal.

   "Privately Issued Certificates" means mortgage participation certificates
issued by certain private institutions. These securities entitle the holder to
receive a pass-through of principal and interest payments in the underlying
pool of Mortgage Loans and are issued or guaranteed by the private
institution.

   "Prohibited Transaction" means a transaction involving a sale of Dealer
Property, other than Foreclosure Property.

   "Qualified Hedges" means bona fide interest rate swap or cap agreements
entered into by the Company to hedge short-term indebtedness only that the
Company incurred to acquire or carry Qualified REIT Real Estate Assets and any
futures and options, or other investments (other than Qualified REIT Real
Estate Assets) made by the Company to hedge its Mortgage Assets or borrowings
that have been determined by a favorable opinion of counsel to generate
qualified income for purposes of the 95% source of income test applicable to
REITs.

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

   "Qualified REIT Real Estate Assets" means Pass-Through Certificates,
Mortgage Loans, Agency Certificates, and other assets of the type described in
Section 856(c)(6)(B) of the Code.

   "Qualified REIT Subsidiary" means a corporation whose stock is entirely
owned by the REIT at all times during such corporation's existence.

   "Qualified Temporary Investment Income" means income attributable to stock
or debt instruments acquired with new capital of the Company received during
the one-year period beginning on the day such proceeds were received.

   "Rating Agencies" means either Standard & Poor's or Moody's.

   "REIT" means Real Estate Investment Trust.

   "REIT Provisions of the Code" means Sections 856 through 860 of the Code.

   "REMIC" means Real Estate Mortgage Investment Conduit. The Company will
limit the REMIC interests that it acquires to interests issued by REMICs, at
least 95% of whose assets consist of Qualified REIT Real Estate Assets.

   "Residuals" means the right to receive the remaining or residual cash flows
from a pool of Mortgage Loans or Mortgage Securities after distributing
required amounts to the holders of interests in or obligations backed by such
loans or securities and after payment of any required pool expenses.

   "Return on Equity" means an amount calculated for any quarter by dividing
the Company's Net Income for the quarter by its Average Net Worth for the
quarter.

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


                                      49
<PAGE>

   "Service" means the Internal Revenue Service.

   "Servicers" means those entities that perform the servicing functions with
respect to Mortgage Loans or Excess Servicing Rights owned by the Company.

   "Servicing Agreements" means the various agreements the Company may enter
into with Servicers.

   "Short-Term Investments" means short-term bank certificates of deposit,
short-term United States treasury securities, short-term United States
government agency securities, commercial paper, repurchase agreements, short-
term CMOs, short-term asset-backed securities and other similar types of
short-term investment instruments, all of which will have maturities or
average lives of less than one (1) year.

   "Stock Option and Awards Plan" means the stock option plan adopted by the
Company.

   "Suppliers of Mortgage Assets " means mortgage bankers, savings and loan
associations, investment banking firms, banks, home builders, insurance
companies and other concerns or lenders involved in mortgage finance or
originating and packaging Mortgage Loans, and their Affiliates.

   "Subordinated Interests" means a class of Mortgage Securities that is
subordinated to one or more other classes of Mortgage Securities, all of which
classes share the same collateral. The Company will only acquire Subordinated
Interests that are beneficial interests in grantor trusts holding Mortgage
Loans, or are regular interests issued by REMICs, or that otherwise constitute
Qualified REIT Real Estate Assets (provided the Company has obtained a
favorable opinion of counsel to that effect).

   "Tax-Exempt Entity" means a qualified pension, profit-sharing or other
employee retirement benefit plans, Keogh plans, bank commingled trust funds
for such plans, and IRAs, and other similar entities intended to be exempt
from federal income taxation.

   "Taxable Income" means for any year the taxable income of the Company for
such year (excluding any net income derived either from property held
primarily for sale to customers or from foreclosure property) subject to
certain adjustments provided in the REIT Provisions of the Code.

   "Ten Year U.S. Treasury Rate" means the arithmetic average of the weekly
average yield to maturity for actively traded current coupon U.S. Treasury
fixed interest rate securities (adjusted to a constant maturity of ten years)
published by the Federal Reserve Board during a quarter, or, if such rate is
not published by the Federal Reserve Board, any Federal Reserve Bank or agency
or department of the federal government selected by the Company. If the
Company determines in good faith that the Ten Year U.S. Treasury Rate cannot
be calculated as provided above, then the rate shall be the arithmetic average
of the per annum average yields to maturities, based upon closing asked prices
on each business day during a quarter, for each actively traded marketable
U.S. Treasury fixed interest rate security with a final maturity date not less
than eight nor more than twelve years from the date of the closing asked
prices as chosen and quoted for each business day in each such quarter in New
York City by at least three recognized dealers in U.S. government securities
selected by the Company.

   "Treasury Index" means the monthly/weekly average yield of the benchmark
U.S. Treasury securities, as published by the Board of Governors of the
Federal Reserve System.

   "Trust" means a trust that is the transferee of that number of shares of
Common Stock the beneficial or constructive ownership of which otherwise would
cause a person to acquire or hold, directly or indirectly, shares of Common
Stock in an amount that violates the Company's Charter, which trust shall be
for the exclusive benefit of one or more Charitable Beneficiaries.

   "Trustee" means a trustee of a Trust for the Charitable Beneficiary.

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

   "Unaffiliated Directors" means those directors that are not affiliated,
directly, or indirectly, with the Manager, whether by ownership of, ownership
interest in, employment by, any material business or professional

                                      50
<PAGE>

relationship with, or serving as an officer or director of the Manager or an
affiliated business entity of the Manager.

   "VA" means the United States Veterans Administration.

   "VA Loans" means Mortgage Loans partially guaranteed by the VA under the
Servicemen's Readjustment Act of 1944, as amended.

                                      51
<PAGE>

                                  SIGNATURES

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

Dated: March 30, 2000                        ANWORTH MORTGAGE ASSET CORPORATION

                                          By:      /s/ Lloyd McAdams
                                            ___________________________________
                                                      Lloyd McAdams,
                                                  Chief Executive Officer

   Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this Annual Report on Form 10-K has been signed by the
following persons in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
             Signature                         Capacity                   Date
             ---------                         --------                   ----

<S>                                  <C>                           <C>
        /s/ Lloyd McAdams            Chairman of the Board, Chief    March 30, 2000
____________________________________ Executive Officer and
           Lloyd McAdams             Director (Principal
                                     Executive Officer)

      /s/ Pamela J. Watson           Chief Financial Officer         March 30, 2000
____________________________________ (Principal Financial and
          Pamela J. Watson           Accounting Officer)

        /s/ Joe E. Davis             Director                        March 30, 2000
____________________________________
            Joe E. Davis

      /s/ Charles H. Black           Director                        March 30, 2000
____________________________________
          Charles H. Black
</TABLE>

                                      52
<PAGE>

                       ANWORTH MORTGAGE ASSET CORPORATION

          FINANCIAL STATEMENTS AND REPORTS OF INDEPENDENT ACCOUNTANTS

                           FOR INCLUSION IN FORM 10-K

                            ANNUAL REPORT FILED WITH

                       SECURITIES AND EXCHANGE COMMISSION

                               December 31, 1999
<PAGE>

                       ANWORTH MORTGAGE ASSET CORPORATION

                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S>                                                                         <C>
REPORTS OF INDEPENDENT ACCOUNTANTS......................................... F-2
FINANCIAL STATEMENTS:
  Balance Sheets--December 31, 1999 and 1998............................... F-4
  Statements of Operations for the year ended December 31, 1999 and for the
   period from March 17, 1998 (commencement of operations) through December
   31, 1998................................................................ F-5
  Statements of Stockholders' Equity for the year ended December 31, 1999
   and for the period from March 17, 1998 (commencement of operations)
   through December 31, 1998............................................... F-6
  Statements of Cash Flows for the year ended December 31, 1999 and for the
   period from March 17, 1998 (commencement of operations) through December
   31, 1998................................................................ F-7
  Notes to Financial Statements............................................ F-8
</TABLE>


                                      F-1
<PAGE>

                      REPORTS OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders
Anworth Mortgage Asset Corporation

   In our opinion, the accompanying balance sheet as of December 31, 1999 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, 1999, and the results of its
operations and its cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States. 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 of these statements in accordance with
auditing standards generally accepted in the United States, 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 audit provides a reasonable basis
for the opinion expressed above.

/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP

Los Angeles, California
January 10, 2000

                                      F-2
<PAGE>

To the Board of Directors and Shareholders
Anworth Mortgage Asset Corporation

   We have audited the accompanying balance sheet of Anworth Mortgage Asset
Corporation as of December 31, 1998, and the related statements of operations,
stockholders' equity and cash flows 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 referred to above present fairly,
in all material respects, the financial position of Anworth Mortgage Asset
Corporation as of December 31, 1998 and the results of its operations and its
cash flows for the period 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-3
<PAGE>

                       ANWORTH MORTGAGE ASSET CORPORATION

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                           December 31
                                                        ------------------
                                                          1999      1998
                                                        --------  --------
                                                           (amounts in
                                                           thousands)
<S>                                                     <C>       <C>       <C>
                        ASSETS
                        ------
  Mortgage backed securities (Notes 2, 3 and 6)........ $161,488  $184,245
  Other marketable securities (Notes 2 and 6)..........    1,193       488
  Cash and cash equivalents (Note 2)...................    3,303    13,299
  Accrued interest receivable..........................    1,111     1,411
  Prepaid expenses and other...........................       49        15
                                                        --------  --------
                                                        $167,144  $199,458
                                                        ========  ========

         LIABILITIES AND STOCKHOLDERS' EQUITY
         ------------------------------------
Liabilities
  Reverse repurchase agreements (Note 3)............... $147,690  $170,033
  Payable for purchase of mortgage-backed securities...      --     10,047
  Accrued interest payable.............................    2,445     1,799
  Dividends payable....................................      323       279
  Accrued expenses and other...........................      154        58
                                                        --------  --------
                                                         150,612   182,216
                                                        --------  --------

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; 2,356,669 and 2,328,000 issued
   and 2,306,669 and 2,328,000 outstanding
   respectively........................................       23        23
  Additional paid in capital...........................   19,070    18,971
  Accumulated other comprehensive income, unrealized
   gain (loss) on available for sale securities (Note
   2)..................................................   (2,351)   (1,775)
  Retained earnings....................................       19        23
  Treasury stock at cost (50,000 and 0 shares,
   respectively).......................................     (229)      --
                                                        --------  --------
                                                          16,532    17,242
                                                        --------  --------
                                                        $167,144  $199,458
                                                        ========  ========
</TABLE>

                       See notes to financial statements.

                                      F-4
<PAGE>

                       ANWORTH MORTGAGE ASSET CORPORATION

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                             Period from March
                                                                 17, 1998
                                                             (commencement of
                                              Year Ended      operations) to
                                           December 31, 1999 December 31, 1998
                                           ----------------- -----------------
                                            (amounts in thousands except per
                                                       share data)
<S>                                        <C>               <C>
Interest and dividend income, net of
 amortization of premium and discount.....      $9,501            $8,570
Interest expense..........................       7,892             7,378
                                                ------            ------
Net interest income.......................      $1,609            $1,192
Expenses: (Note 6)
  Management fee..........................         175               144
  Incentive fee...........................         --                  2
  Other expense...........................         225               161
                                                ------            ------
Net Income................................      $1,209            $  885
                                                ======            ======
Basic and diluted earnings per share......      $ 0.53            $ 0.38
                                                ======            ======
Dividends declared per share..............      $ 0.53            $ 0.37
                                                ======            ======
Weighted average number of shares
 outstanding..............................       2,290             2,316
                                                ======            ======
</TABLE>


                       See notes to financial statements.

                                      F-5
<PAGE>

                       ANWORTH MORTGAGE ASSET CORPORATION

                       STATEMENTS OF STOCKHOLDERS' EQUITY

  Period from March 17, 1998 (commencement of operations) to December 31, 1998
                        and year ended December 31, 1999

<TABLE>
<CAPTION>
                                 Common
                         Common  Stock  Additional Accum. Other
                         Stock    Par    Paid-in   Comprehensive Retained Treasury Comprehensive
                         Shares  Value   Capital   Income (Loss) Earnings  Stock   Income (Loss)  Total
                         ------  ------ ---------- ------------- -------- -------- ------------- -------
                                          (amounts in thousands except per share data)
<S>                      <C>     <C>    <C>        <C>           <C>      <C>      <C>           <C>
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   $   0                 $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)      0                                      (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
                         =====    ====   =======      =======     ======   =====                 =======
</TABLE>



                       See notes to financial statements.

                                      F-6
<PAGE>

                       ANWORTH MORTGAGE ASSET CORPORATION

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                               Period from March
                                                                   17, 1998
                                                   Year ended    (commencement
                                                  December 31, of operations) to
                                                      1999     December 31, 1998
                                                  ------------ -----------------
                                                  (dollar amounts in thousands)
<S>                                               <C>          <C>
Cash flows from operating activities:
  Net income....................................    $  1,209       $     885
  Adjustments to reconcile net income to net
   cash provided by operating activities:
    Amortization................................       1,468           1,489
    Decrease (increase) in accrued interest
     receivable.................................         300          (1,411)
    Decrease (increase) in prepaid expenses and
     other......................................         (34)            (15)
    Increase (decrease) in accrued interest
     payable....................................         646           1,799
    Increase (decrease) in accrued expenses and
     other......................................          96              58
                                                    --------       ---------
      Net cash provided by operating
       activities...............................       3,685           2,805

Cash flows from investing activities:
  Available-for-sale securities:
    Purchases...................................     (43,658)       (231,361)
    Principal payments..........................      53,619          53,409
                                                    --------       ---------
      Net cash provided by (used in) investing
       activities...............................       9,961        (177,952)

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

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

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

                       See notes to financial statements.

                                      F-7
<PAGE>

                      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, 1999 the Company had limited its exposure to credit losses
on its portfolio of ARM securities by purchasing primarily securities from
Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage
Association ("FNMA"). The payment of principal and interest on the FHLMC and
FNMA mortgage backed securities are guaranteed by those respective agencies.
At December 31, 1999, because of the government agencies' guarantee, all of
the Company's mortgage backed securities have an implied "AAA" rating.

INCOME TAXES

   The Company intends to elect to be taxed as a Real Estate Investment Trust
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-8
<PAGE>

                       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

   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.

RECENT ACCOUNTING PRONOUNCEMENTS

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

NOTE 2. SECURITIES

   The following table summarizes the Company's mortgage backed securities
(excluding paydowns receivable balances of $325,000 for 1999 and $2,073,000 for
1998) classified as available-for-sale as of December 31, 1999 and 1998, which
are carried at their fair value ($000's):

<TABLE>
<CAPTION>
                                                      December 31, 1999
                                               --------------------------------
                                                 Federal     Federal
                                                Home Loan   National    Total
                                                Mortgage    Mortgage     MBS
                                               Corporation Association  Assets
                                               ----------- ----------- --------
     <S>                                       <C>         <C>         <C>
     Amortized Cost...........................   $29,741    $133,612   $163,353
     Unrealized gains.........................        41         101        142
     Unrealized losses........................      (377)     (1,955)    (2,332)
                                                 -------    --------   --------
     Fair value...............................   $29,405    $131,758   $161,163
                                                 =======    ========   ========
</TABLE>

<TABLE>
<CAPTION>
                                                      December 31, 1998
                                               --------------------------------
                                                 Federal     Federal
                                                Home Loan   National    Total
                                                Mortgage    Mortgage     MBS
                                               Corporation Association  Assets
                                               ----------- ----------- --------
     <S>                                       <C>         <C>         <C>
     Amortized Cost...........................   $43,643    $140,327   $183,970
     Unrealized gains.........................        80          76        156
     Unrealized losses........................      (486)     (1,468)    (1,954)
                                                 -------    --------   --------
     Fair value...............................   $43,237    $138,935   $182,172
                                                 =======    ========   ========
</TABLE>

                                      F-9
<PAGE>

                      ANWORTH MORTGAGE ASSET CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

   In addition, at December 31, 1999 the Company held a position in preferred
stock of a mortgage REIT, valued at $1,193,000. The following table summarizes
the Company's securities as of December 31, 1999 and 1998 at their fair value
($000's):

<TABLE>
<CAPTION>
                                                        December 31, 1999
                                                   ----------------------------
                                                               REIT
                                                             Preferred
                                                     MBS       Stock    Total
                                                   --------  --------- --------
     <S>                                           <C>       <C>       <C>
     Amortized Cost............................... $163,353   $1,355   $164,708
     Unrealized gains.............................      142        0        142
     Unrealized losses............................   (2,332)    (162)    (2,494)
                                                   --------   ------   --------
     Estimated fair value......................... $161,163   $1,193   $162,356
                                                   ========   ======   ========
</TABLE>

<TABLE>
<CAPTION>
                                                        December 31, 1998
                                                   ----------------------------
                                                               REIT
                                                             Preferred
                                                     MBS       Stock    Total
                                                   --------  --------- --------
     <S>                                           <C>       <C>       <C>
     Amortized Cost............................... $183,970    $464    $184,434
     Unrealized gains.............................      156      24         180
     Unrealized losses............................   (1,954)      0      (1,954)
                                                   --------    ----    --------
     Estimated fair value......................... $182,172    $488    $182,660
                                                   ========    ====    ========
</TABLE>

NOTE 3. REVERSE REPURCHASE AGREEMENTS

   The Company has entered into reverse repurchase agreements to finance most
of its ARM securities. The reverse repurchase agreements are short-term
borrowings that bear interest rates that have historically moved in close
relationship to LIBOR (London Interbank Offer Rate). These agreements are
collateralized by mortgage backed securities with a fair value of
$161,163,000.

   At December 31, 1999, the repurchase agreements had a weighted average
interest rate of 5.77%, an average maturity of 67 days and the following
remaining maturities (amounts in thousands):

<TABLE>
       <S>                                                              <C>
       Within 59 days.................................................. $ 82,036
       60 to 89 days...................................................   22,092
       90 to 119 days..................................................   13,369
       Over 120 days...................................................   30,193
                                                                        --------
                                                                        $147,690
                                                                        ========
</TABLE>

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.


                                     F-10
<PAGE>

                      ANWORTH MORTGAGE ASSET CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

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 $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.

   During the year ended December 31, 1999, the Company declared dividends to
stockholders totaling $0.53 per share, of which $0.39 has been paid and $0.14
is payable on January 18, 2000. During the period ended December 31, 1998 the
Company declared dividends to stockholders of $0.37 per share, of which $0.25
was paid during 1998 and $0.12 was paid on January 14, 1999. 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 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. During 1999, the Company raised equity capital of $99,000 as a result
of this plan.

NOTE 6. TRANSACTIONS WITH AFFILIATES

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

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

   In addition to the Base Management 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").

   For the period ended December 31, 1999, the Company paid the Manager
$175,000 in base management fees and for the period from March 17, 1998
(commencement of operations) to December 31, 1998, the Company paid the
Manager $144,000 in base management fees and $2,000 in incentive management
fee.

                                     F-11
<PAGE>

                      ANWORTH MORTGAGE ASSET CORPORATION

                  NOTES TO FINANCIAL STATEMENTS--(Continued)


NOTE 7. STOCK OPTION PLAN

   The Company has adopted the Anworth Mortgage Asset Corporation 1997 Stock
Option and Awards Plan (the "Stock Option Plan") which authorizes the grant of
options to purchase an aggregate of up to 300,000 of the outstanding shares of
the company's common stock. The plan authorizes the Board of Directors, or a
committee of the Board of Directors, to grant incentive stock options ("ISOs")
as defined under section 422 of the Internal Revenue Code of 1986, as amended,
options not so qualified ("NQSOs"), dividend equivalent rights ("DERs") and
stock appreciation rights ("SARs"). The exercise price for any option granted
under the Stock Option Plan may not be less than 100% of the fair market value
of the shares of common stock at the time the option is granted. During the
period ended December 31, 1998, the Company had granted 148,000 options at an
exercise price of $9 per share and 136,000 DERs. For these options, those
granted to officers become exercisable over a three year period following
their date of grant, while those granted to directors become exercisable
six months after their date of grant. During the year ended December 31, 1999,
the Company granted an additional 50,000 options at an exercise price of $4.60
and 12,500 DER's. These options become exercisable three years after the date
of grant. All options granted expire ten years after the 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 average market price of the
stock exceeds the effective strike price of the options. Since inception, the
Company has recorded $5,000 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:

<TABLE>
<CAPTION>
                                                             1999       1998
                                                          ----------  --------
     <S>                                                  <C>         <C>
     Net income--as reported............................. $1,209,000  $885,000
     Net income--pro forma............................... $1,115,000  $811,000
     Basic and diluted earnings per share--as reported... $     0.53  $   0.38
     Basic and diluted earnings per share--pro forma..... $     0.49  $   0.35
     Assumptions:
       Dividend yield....................................         10%       10%
       Expected volatility...............................         35%       35%
       Risk-free interest rate...........................        6.6%      5.5%
       Expected lives....................................    7 years   7 years
</TABLE>

   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.

                                     F-12
<PAGE>

                       ANWORTH MORTGAGE ASSET CORPORATION

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


NOTE 8. SUMMARIZED QUARTERLY RESULTS (UNAUDITED)

<TABLE>
<CAPTION>
                                              For the year ended December 31,
                                                           1999
                                            -----------------------------------
                                               First    Second   Third  Fourth
                                              Quarter   Quarter Quarter Quarter
                                            ----------- ------- ------- -------
                                               (amounts in thousands except
                                                      per share data)
<S>                                         <C>         <C>     <C>     <C>
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
                                              ======    ======  ======  ======

   For the period from March 17, 1998 (commencement of operations) to December
31, 1998:

<CAPTION>
                                               First    Second   Third  Fourth
                                            Quarter (A) Quarter Quarter Quarter
                                            ----------- ------- ------- -------
<S>                                         <C>         <C>     <C>     <C>
Interest and dividend income...............   $   74    $2,799  $2,978  $2,719
Interest expense...........................       42     2,318   2,611   2,407
Net interest income........................       32       481     367     312
Expenses...................................       15       124     123      45
Net Income.................................   $   17    $  357  $  244  $  267
Basic and diluted earnings per share.......   $ 0.01    $ 0.15  $ 0.10  $ 0.12
Average number of shares outstanding.......    2,200     2,310   2,328   2,328
</TABLE>
--------
(A) The Company commenced operations on March 17, 1998

                                      F-13
<PAGE>

                                 EXHIBIT INDEX

   3.1 Charter of the Registrant (incorporated by reference to Exhibit 3.1 to
the Company's Registration Statement on Form S-11(Registration No. 333-38641)
filed with the Securities and Exchange Commission on October 24, 1997.).

   3.2 Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to
the Company's Registration Statement on Form S-11(Registration No. 333-38641)
filed with the Securities and Exchange Commission on October 24, 1997.).

   4.1 Form of Stock Certificate of the Registrant (incorporated by reference
to Exhibit 4.1 to the Company's Registration Statement on Form S-
11(Registration No. 333-38641) filed with the Securities and Exchange
Commission on December 12, 1997.).

   10.1 Management Agreement between the Registrant and Anworth Mortgage
Advisory Corporation (incorporated by reference to Exhibit 10.1 to the
Company's Registration Statement on Form S-11(Registration No. 333-38641)
filed with the Securities and Exchange Commission on February 25, 1998.).

   10.2 Form of 1997 Stock Option and Awards Plan (incorporated by reference
to Exhibit 10.2 to the Company's Registration Statement on Form S-
11(Registration No. 333-87555) filed with the Securities and Exchange
Commission on December 12, 1997.).

   10.3 Form of Dividend Reinvestment and Stock Purchase Plan (incorporated by
reference to the Company's Registration Statement on Form S-3 (Registration
333-38641) filed with the Securities and Exchange Commission on September 22,
1999.).

   27 Financial Data Schedule