<PAGE>

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

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

                                   FORM 10-Q

(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001.

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

                         Commission File No. 001-13709

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

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

                     MARYLAND                               52-2059785
          (State or other jurisdiction of                (I.R.S. Employer
          incorporation or organization)               Identification No.)

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

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

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

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

   As of September 30, 2001, 2,397,359 shares of Common Stock, $0.01 par value
per share, were outstanding.

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

<PAGE>

                                     INDEX

<TABLE>
<CAPTION>

                                                                                                   Page
                                                                                                   ----
<C>     <S>                                                                                        <C>

Part I. Financial Information

Item 1. Financial Statements

        Balance Sheets at September 30, 2001 and December 31, 2000................................   3

        Statements of Operations for the three months and nine months ended September 30, 2001 and
        September 30, 2000........................................................................   4

        Statement of Stockholders' Equity for the three months ended March 31, June 30 and
        September 30, 2001........................................................................   5

        Statements of Cash Flows for the three months and nine months ended September 30, 2001
        and September 30, 2000....................................................................   6

        Notes to the Financial Statements.........................................................   7

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.....  11

Item 3. Quantitative and Qualitative Disclosures About Market Risk................................  18

Part II. Other Information

Item 1. Legal Proceedings.........................................................................  21

Item 2. Changes in Securities.....................................................................  21

Item 3. Defaults upon Senior Securities...........................................................  21

Item 4. Submission of Matters to a Vote of Security Holders.......................................  21

Item 5. Other Information.........................................................................  21

Item 6. Exhibits and Reports on Form 8-K..........................................................  21

Signatures........................................................................................  22
</TABLE>

                                      2

<PAGE>

                         PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

                      ANWORTH MORTGAGE ASSET CORPORATION

                                BALANCE SHEETS
                            (Amounts in thousands)

<TABLE>
<CAPTION>
                                                                                September 30, December 31,
                                                                                    2001          2000
                                                                                ------------- ------------
                                                                                 (unaudited)
<S>                                                                             <C>           <C>
                                    ASSETS
Mortgage backed securities.....................................................   $210,159      $134,889
Other marketable securities....................................................      1,745         1,948
Cash and cash equivalents......................................................        141         3,894
Accrued interest and dividends receivable......................................      1,306         1,090
Prepaid expenses and other.....................................................         24            13
Receivable for security sold...................................................     10,306            --
                                                                                  --------      --------
                                                                                  $223,681      $141,834
                                                                                  ========      ========
                     LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
   Reverse repurchase agreements...............................................   $179,567      $121,891
   Payable for securities purchased............................................     20,730            --
   Accrued interest payable....................................................        915         1,706
   Dividends payable...........................................................         --            --
   Accrued expenses and other..................................................        518            36
                                                                                  --------      --------
                                                                                   201,730       123,633
                                                                                  --------      --------
Stockholders' Equity
   Preferred stock, par value $.01 per share; authorized 20,000,000 shares; no
     shares issued and outstanding.............................................         --            --
   Common stock; par value $.01 per share; authorized 100,000,000 shares;
     2,447,359 and 2,400,016 issued and 2,397,359 and 2,350,016 outstanding
     respectively..............................................................         24            24
   Additional paid in capital..................................................     19,531        19,243
   Accumulated other comprehensive income, unrealized gain (loss) on available
     for sale securities.......................................................      1,315        (1,186)
   Retained earnings...........................................................      1,310           349
   Treasury stock at cost (50,000 shares)......................................       (229)         (229)
                                                                                  --------      --------
                                                                                    21,951        18,201
                                                                                  --------      --------
                                                                                  $223,681      $141,834
                                                                                  ========      ========
</TABLE>


                      See notes to financial statements.

                                      3

<PAGE>

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

<TABLE>
<CAPTION>
                                                            Three months ended Nine months ended
                                                              September 30,      September 30,
                                                            -----------------  ----------------
                                                              2001     2000     2001     2000
                                                            -------   -------  -------  -------
<S>                                                         <C>       <C>      <C>      <C>
Interest and dividend income net of amortization of premium $ 2,564   $ 2,549  $ 7,639  $ 7,822
Interest expense...........................................  (1,403)   (2,241)  (4,974)  (6,554)
                                                            -------   -------  -------  -------
Net interest income........................................ $ 1,161   $   308  $ 2,665  $ 1,268
   Gain on sale of assets..................................     166        --      318       --
Less:
   Management fee..........................................     (52)      (41)    (148)    (123)
   Incentive fee...........................................    (174)       --     (318)      (1)
   Other expense...........................................     (77)      (58)    (254)    (173)
                                                            -------   -------  -------  -------
Net income................................................. $ 1,024   $   209  $ 2,263  $   971
                                                            =======   =======  =======  =======
Basic earnings per share................................... $  0.43   $  0.09  $  0.96  $  0.42
                                                            =======   =======  =======  =======
Diluted earnings per share................................. $  0.42   $  0.09  $  0.95  $  0.42
                                                            =======   =======  =======  =======
Dividends per share (Note A)............................... $  0.54   $  0.10  $  0.98  $  0.40
                                                            =======   =======  =======  =======
Average number of shares outstanding (diluted).............   2,423     2,338    2,381    2,326
                                                            =======   =======  =======  =======
</TABLE>

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



                      See notes to financial statements.

                                      4

<PAGE>

                STATEMENTS OF STOCKHOLDERS' EQUITY (unaudited)

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

<TABLE>
<CAPTION>
                                                                Accum.
                                           Common               Other
                                    Common Stock  Additional   Compre-             Treasury   Compre-
                                    Stock   Par    Paid-in     hensive    Retained  Stock     hensive
                                    Shares Value   Capital   Income(Loss) Earnings at Cost  Income(Loss)  Total
                                    ------ ------ ---------- ------------ -------- -------- ------------ -------
<S>                                 <C>    <C>    <C>        <C>          <C>      <C>      <C>          <C>
Balance, December 31, 2000......... 2,350   $24    $19,243     $(1,186)    $  349   $(229)               $18,201
Issuance of common stock...........    10     0         45                                                    45
Available-for-sale securities, Fair
  value adjustment.................                                437                            437        437
Net income.........................                                           545                 545        545
                                                                                               ------
Other comprehensive income
  (loss)...........................                                                            $  982
                                                                                               ======
Dividends declared--$0.11 per
  share............................                                          (259)                          (259)
                                    -----   ---    -------     -------     ------   -----                -------
Balance, March 31, 2001............ 2,360   $24    $19,288     $  (749)    $  635   $(229)               $18,969
                                    =====   ===    =======     =======     ======   =====                =======
Issuance of common stock...........    16     0         91                                                    91
Available-for-sale securities,
  Fair value adjustment............                                 98                             98         98
Net income.........................                                           694                 694        694
                                                                                               ------
Other comprehensive income
  (loss)...........................                                                            $  792
                                                                                               ======
Dividends declared--$0.20 per
  share............................                                          (472)                          (472)
                                    -----   ---    -------     -------     ------   -----                -------
Balance, June 30, 2001............. 2,376   $24    $19,379     $  (651)    $  857   $(229)               $19,380
                                    =====   ===    =======     =======     ======   =====                =======
Issuance of common stock...........    21     0        152                                                   152
Available-for-sale securities,
  Fair value adjustment............                              1,965                          1,965      1,965
Net income.........................                                         1,024               1,024      1,024
                                                                                               ------
Other comprehensive income
  (loss)...........................                                                             2,989
                                                                                               ======
Dividends declared--$0.24 per
  share............................                                          (570)                          (570)
                                    -----   ---    -------     -------     ------   -----                -------
Balance, September 30, 2001........ 2,397   $24    $19,531     $ 1,315     $1,310   $(229)               $21,951
                                    =====   ===    =======     =======     ======   =====                =======
</TABLE>

                      See notes to financial statements.

                                      5

<PAGE>

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

<TABLE>
<CAPTION>
                                                                      Three months ended   Nine months ended
                                                                         September 30,       September 30,
                                                                      ------------------  ------------------
                                                                        2001      2000      2001      2000
                                                                      --------  --------  --------  --------
<S>                                                                   <C>       <C>       <C>       <C>
Operating Activities:
Net income........................................................... $  1,024  $    209  $  2,262  $    971
     Adjustments to reconcile net income to
     net cash provided by operating activities:
       Amortization..................................................      308       158       514       514
       Gain on sales of assets.......................................     (166)       --      (318)       --
       Decrease (increase) in accrued interest and dividends
         receivable..................................................      (62)      (25)       49         6
       Increase (decrease) in accrued interest payable...............       32      (282)     (791)   (1,395)
       Increase (decrease) in accrued expenses and other.............      311        49       525       (40)
                                                                      --------  --------  --------  --------
          Net cash provided by operating activities..................    1,447       109     2,241        56
Investing Activities:
   Available-for-sale securities:....................................
   Purchases.........................................................  (61,538)       (6)  (99,542)     (676)
   Proceeds from sale................................................       --        --     1,095        --
   Principal payments................................................   14,380     8,482    35,790    21,043
                                                                      --------  --------  --------  --------
          Net cash provided by (used in) investing activities........  (47,158)    8,476   (62,657)   20,367
Financing Activities:
   Net borrowings from reverse repurchase agreements.................   45,130   (10,176)   57,676   (21,166)
   Proceeds from common stock issued, net............................      152        59       288       142
   Dividends paid....................................................     (570)     (349)   (1,301)   (1,020)
                                                                      --------  --------  --------  --------
          Net cash provided by (used in) financing activities........   44,712   (10,466)   56,663   (22,044)
                                                                      --------  --------  --------  --------
Net increase (decrease) in cash and cash equivalents.................     (999)   (1,881)   (3,753)   (1,621)
Cash and cash equivalents at beginning of period.....................    1,140     3,562     3,894     3,302
                                                                      --------  --------  --------  --------
Cash and cash equivalents at end of period........................... $    141  $  1,681  $    141  $  1,681
                                                                      ========  ========  ========  ========
Supplemental Disclosure of Cash Flow Information.....................
   Cash paid for interest............................................ $  1,371  $  2,524  $  5,765  $  7,950
Supplemental Disclosure of Noncash Investing and Financing...........
   Mortgage securities purchased, not yet settled.................... $ 10,306  $     --  $ 10,306  $     --
   Mortgage securities sold, not yet settled......................... $ 20,730  $     --  $ 20,730  $     --
</TABLE>


                      See notes to financial statements.

                                      6

<PAGE>

                         NOTES TO FINANCIAL STATEMENTS

                              September 30, 2001

NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

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

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

BASIS OF PRESENTATION

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

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

CASH AND CASH EQUIVALENTS

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

MORTGAGE BACKED SECURITIES

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

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

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

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

CREDIT RISK

   At September 30, 2001 the Company has limited its exposure to credit losses
on its portfolio of mortgage backed securities by purchasing primarily
securities from Federal Home Loan Mortgage Corporation ("FHLMC") and Federal
National Mortgage Association ("FNMA"). The payment of principal and interest
on the FHLMC and FNMA ARM securities are guaranteed by those respective
agencies. At September 30, 2001, over 99% of the Company's mortgage backed
securities have an implied "AAA" rating.

                                      7

<PAGE>

                               ANWORTH MORTGAGE

                  NOTES TO FINANCIAL STATEMENTS--(Continued)


INCOME TAXES

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

EARNINGS PER SHARE

   Basic earnings per share ("EPS") is computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
EPS assumes the conversion, exercise or issuance of all potential common stock
equivalents unless the effect is to reduce a loss or increase the income per
share.

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

<TABLE>
<CAPTION>
                                                                 Earnings
                                              Income     Shares  Per Share
                                              ------     ------  ---------
                                              (amounts in thousands except
                                                    per share data)
        <S>                                   <C>        <C>     <C>
        Three Months Ended September 30, 2001
        Basic EPS............................ 1,024      2,384     $0.43
                                                                   =====
        Effect of dilutive securities:
        Stock options........................    --         39
                                              -----      -----
        Diluted EPS.......................... 1,024      2,423     $0.42
                                              =====      =====     =====
        Three Months Ended September 30, 2000
        Basic EPS............................   209      2,338     $0.09
                                                                   =====
        Effect of dilutive securities:
        Stock options........................    --         --
                                              -----      -----
        Diluted EPS..........................   209      2,338     $0.09
                                              =====      =====     =====
        Nine Months Ended September 30, 2001
        Basic EPS............................ 2,263      2,369     $0.96
                                                                   =====
        Effect of dilutive securities:
        Stock options........................    --         12
                                              -----      -----
        Diluted EPS.......................... 2,263      2,381     $0.95
                                              =====      =====     =====
        Nine Months Ended September 30, 2000
        Basic EPS............................   971      2,326     $0.42
                                              =====      =====     =====
        Effect of dilutive securities:
        Stock options........................    --         --
                                              -----      -----
        Diluted EPS..........................   971      2,326     $0.42
                                              =====      =====     =====
</TABLE>
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.


                                      8

<PAGE>

                               ANWORTH MORTGAGE

                 NOTES TO FINANCIAL STATEMENTS -- (Continued)

NOTE 2. MORTGAGE BACKED SECURITIES

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

<TABLE>
<CAPTION>
                                     Federal     Federal
                                    Home Loan   National     Other     Total
                                    Mortgage    Mortgage    Mortgage    MBS
             ($000's)              Corporation Association Securities  Assets
             --------              ----------- ----------- ---------- --------
<S>                                <C>         <C>         <C>        <C>
Amortized Cost....................   $52,037    $156,177      $--     $208,214
Paydown Receivable................       885          --       --          885
Unrealized gains..................       462       1,083       --        1,545
Unrealized losses.................      (103)       (382)      --         (485)
                                     -------    --------      ---     --------
Fair value........................   $53,281    $156,878      $--     $210,159
                                     -------    --------      ---     --------
</TABLE>

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

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

<TABLE>
<CAPTION>
                                                   Fixed
                                                   Rate   REIT
                  ($000's)                ARMS      MBS   Stock   Total
                  --------              --------  ------- ------ --------
     <S>                                <C>       <C>     <C>    <C>
     Amortized Cost.................... $174,066  $34,148 $1,491 $209,704
     Paydown Receivable................      885       --     --      885
     Unrealized gains..................      719      827    255    1,800
     Unrealized losses.................     (485)      --     --     (485)
                                        --------  ------- ------ --------
     Fair value........................ $175,185  $34,975 $1,746 $211,905
                                        --------  ------- ------ --------
</TABLE>

NOTE 3. REVERSE REPURCHASE AGREEMENTS

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

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

<TABLE>
      <S>                                                         <C>
      Within 59 days............................................. $112,860
      60 to 89 days..............................................       --
      90 to 119 days.............................................   18,103
      Over 120 days..............................................   48,604
                                                                  --------
                                                                  $179,567
                                                                  ========
</TABLE>

NOTE 4. TRANSACTIONS WITH AFFILIATES

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

                                      9

<PAGE>

                               ANWORTH MORTGAGE

                  NOTES TO FINANCIAL STATEMENTS--(Continued)


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

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

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

   The Company has adopted the Anworth Mortgage Asset Corporation 1997 Stock
Option and Awards Plan (the "Stock Option Plan") which authorizes the grant of
options to purchase an aggregate of up to 600,000 of the outstanding shares of
the Company's common stock. The Stock Option Plan authorizes the Board of
Directors, or a committee of the Board of Directors, to grant incentive stock
options ("ISOs") as defined under section 422 of the Internal Revenue Code of
1986, as amended, options not so qualified ("NQSOs"), dividend equivalent
rights ("DERs") and stock appreciation rights ("SARs"). The exercise price for
any option granted under the Stock Option Plan may not be less than 100% of the
fair market value of the shares of common stock at the time the option is
granted. As of June 30, 2001, the Company had granted a total of 198,000
options, with strike prices of either $9 per share or $4.60 per share, and
148,500 DER's. Options granted to officers either become exercisable at a rate
of 33.3% each year following their date of grant or become exercisable three
years after their date of grant. Options granted to directors either became
exercisable six months after their date of grant or become exercisable three
years after their date of grant. All options must expire with a maximum of ten
years after their date of grant. The DER's are payable only when their
associated stock options are exercised, thereby reducing the effective strike
price of such options. The Company recognizes compensation expense at the time
the market price of the stock exceeds the effective strike price.

   During the quarter ended June 30, 2001, 114,000 of the outstanding DER's
were truncated and shortly after June 30, 2001 the remaining 34,500 DER's were
truncated. After the dividend declared on April 20, 2001, no more dividends
will accrue to the DER's. For the quarter ended June 30, 2001, the Company
recorded $61,000 in operating expense associated with the Stock Option Plan.

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

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

NOTE 5. COMMON STOCK

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


                                      10

<PAGE>

Item 2. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations

   Certain information contained in this Quarterly Report on Form 10-Q
constitutes "Forward-Looking Statements" within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Exchange Act,
which can be identified by the use of forward-looking terminology such as
"may," "will," "expect," "anticipate," "estimate," or "continue" or the
negatives thereof or other variations thereon or comparable terminology.
Investors are cautioned that all forward-looking statements involve risks and
uncertainties including, but not limited to, risks related to the future level
and relationship of various interest rates, prepayment rates and the timing of
new programs. The statements in the "Risk Factors" of our Registration
Statement on Form S-2 dated October 17, 2001 constitute cautionary statements
identifying important factors, including certain risks and uncertainties, with
respect to such forward-looking statements that could cause our actual results,
performance or achievements to differ

General

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

   Over the past several months, the dramatic decline in the general level of
interest rates has had a materially positive impact on our financial results.
As a result of the interest rate reductions by the Federal Reserve Board, the
one-month treasury bill has declined from 5.37% as of December 31, 2000 to
2.28% as of September 30, 2001. This decline has reduced the rates at which we
borrow funds to finance our portfolio holdings. Our cost of financing has
declined from 6.76% for the quarter ended December 31, 2000 to 3.86% for the
quarter ended September 30, 2001. This contrasts significantly with the much
less substantial decline of our asset yield from 7.05% for the quarter ended
December 31, 2000 to 6.40% for the quarter ended September 30, 2001.

   We are organized for tax purposes as a REIT. Accordingly, we generally
distribute substantially all of our earnings to stockholders without paying
federal or state income tax at the corporate level on the distributed earnings.
As of September 30, 2001, our qualified REIT assets (real estate assets, as
defined in the tax code, cash and cash items and government securities) were
greater than 90% of our total assets, as compared to the tax code requirement
that at least 75% of our total assets must be qualified REIT assets. Greater
than 99% of our 2001 revenue to date qualifies for both the 75% source of
income test and the 95% source of income test under the REIT rules. We believe
we met all REIT requirements regarding the ownership of our common stock and
the distributions of our net income. Therefore, we believe that we continue to
qualify as a REIT under the provisions of the tax code.

Results of Operations

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

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

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

                                      11

<PAGE>

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

<TABLE>
<CAPTION>
                                      Net
                                    Interest     G&A          Net
                                    Income/  Expense(2)/ Income(2)(3)/
                                     Equity    Equity       Equity
         For the Quarter Ended (1): -------- ----------- -------------
         <S>                        <C>      <C>         <C>
          September 30, 2001.......  5.75%      0.64%        5.11%
          June 30, 2001............  4.39%      0.85%        3.55%
          March 31, 2001...........  3.24%      0.54%        2.70%
          December 31, 2000........  1.93%      0.43%        1.50%
          September 30, 2000.......  1.61%      0.52%        1.09%
          June 30, 2000............  2.43%      0.50%        1.93%
          March 31, 2000...........  2.59%      0.53%        2.06%
</TABLE>
--------
(1) Average equity excludes unrealized gain (loss) on available for sale
    mortgage-backed securities.
(2) Excludes incentive fees paid to our management company.
(3) Excludes gain on sale of $71,000 for the quarter ended March 31, 2001,
    $81,000 for the quarter ended June 30, 2001 and $166,000 for the quarter
    ended September 30, 2001.

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

<TABLE>
<CAPTION>
                                                                  Annualized
                                                                   Yield on
                                    Average                        Average   Annualized
                                     Daily            Annualized    Daily     Yield on
                                   Amortized Average   Yield on   Amortized   Average   Dividend
                         Average    Cost of   Daily     Average    Cost of     Daily      and
                       Daily Cash  Mortgage  Earning  Daily Cash   Mortgage   Earning   Interest
                       Equivalents  Assets   Assets   Equivalents   Assets     Assets    Income
                       ----------- --------- -------- ----------- ---------- ---------- --------
For the quarter ended:                          (dollars in thousands)
<S>                    <C>         <C>       <C>      <C>         <C>        <C>        <C>
  September 30, 2001..   $4,045    $156,305  $160,350    3.31%       6.48%      6.40%    $2,564
  June 30, 2001.......   $4,706    $148,362  $153,069    4.14%       6.66%      6.58%    $2,518
  March 31, 2001......   $3,542    $143,408  $146,951    5.39%       7.00%      6.96%    $2,556
  December 31, 2000...   $1,912    $139,590  $141,502    5.86%       7.06%      7.05%    $2,493
  September 30, 2000..   $2,075    $146,265  $148,340    6.60%       6.88%      6.87%    $2,549
  June 30, 2000.......   $2,186    $154,130  $156,317    6.30%       6.78%      6.77%    $2,646
  March 31, 2000......   $2,316    $160,684  $163,000    4.86%       6.47%      6.45%    $2,627
</TABLE>

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

<TABLE>
<CAPTION>
                                                                            Average     Average     Average
                                                                           One-month    Cost of     Cost of
                                                                             LIBOR       Funds       Funds
                       Average           Annualized                       Relative to Relative to Relative to
                        Daily             Average    Average    Average     Average     Average     Average
                       Borrowed Interest Daily Cost One-Month Three-Month Three-month  One-month  Three-month
                        Funds   Expense   of Funds    LIBOR      LIBOR       LIBOR       LIBOR       LIBOR
                       -------- -------- ---------- --------- ----------- ----------- ----------- -----------
For the quarter ended:                                 (dollars in thousands)
<S>                    <C>      <C>      <C>        <C>       <C>         <C>         <C>         <C>
  September 30, 2001.. $145,316  $1,403     3.86%     3.55%      3.46%        0.09%       0.31%       0.40%
  June 30, 2001....... $138,275  $1,650     4.84%     4.27%      4.17%        0.10%       0.57%       0.67%
  March 31, 2001...... $130,279  $1,921     5.98%     5.47%      5.29%        0.18%       0.51%       0.69%
  December 31, 2000... $127,150  $2,120     6.76%     6.64%      6.67%       (0.03)%      0.12%       0.09%
  September 30, 2000.. $131,880  $2,240     6.89%     6.62%      6.70%       (0.08)%      0.17%       0.19%
  June 30, 2000....... $138,799  $2,181     6.37%     6.47%      6.65%       (0.18)%     (0.10)%     (0.28)%
  March 31, 2000...... $144,696  $2,132     5.98%     5.93%      6.12%       (0.19)%     (0.05)%     (0.14)%
</TABLE>


                                      12

<PAGE>

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

<TABLE>
<CAPTION>
                                    Annualized
                                 Yield on Average Annualized
                                 Daily Amortized   Average    Average
                                     Cost of      Daily Cost Operating
                                 Mortgage Assets   of Funds   Margin
          For the quarter ended: ---------------- ---------- ---------
          <S>                    <C>              <C>        <C>
            September 30, 2001..       6.48%         3.86%      2.62%
            June 30, 2001.......       6.66%         4.84%      1.82%
            March 31, 2001......       7.00%         5.98%      1.02%
            December 31, 2000...       7.06%         6.76%      0.30%
            September 30, 2000..       6.88%         6.89%     (0.01)%
            June 30, 2000.......       6.78%         6.37%      0.41%
            March 31, 2000......       6.47%         5.98%      0.49%
</TABLE>

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

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

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

<TABLE>
<CAPTION>
                                  Management
                                 Fee & Other  Incentive   Total G&A
                                  Expenses/   Fee/Total Expenses/Total
                                 Total Assets  Assets       Assets
          For the quarter ended: ------------ --------- --------------
          <S>                    <C>          <C>       <C>
            September 30, 2001..     0.23%      0.31%        0.54%
            June 30, 2001.......     0.41%      0.21%        0.62%
            March 31, 2001......     0.26%      0.14%        0.40%
            December 31, 2000...     0.23%        --%        0.23%
            September 30, 2000..     0.27%        --%        0.27%
            June 30, 2000.......     0.25%        --%        0.25%
            March 31, 2000......     0.25%        --%        0.25%
</TABLE>

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

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

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

                                      13

<PAGE>

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

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

<TABLE>
<CAPTION>
                                                 Annualized   Annualized
                                    Annualized       G&A          Net
                                   Net Interest  Expense(2)/ Income(2)(3)/
                                   Income/Equity   Equity       Equity
                                   ------------- ----------- -------------
     <S>                           <C>           <C>         <C>
     For the nine months ended:(1)
       September 30, 2001.........     17.90%       2.70%        15.20%
       September 30, 2000.........      8.84%       2.07%         6.77%
</TABLE>
--------
(1)  Average equity excludes unrealized gain (loss) on available for sale
     securities.
(2)  Excludes incentive fees paid to our management company.
(3)  Excludes gain on sale of $318,000 for the nine months ended September 30,
     2001.

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

<TABLE>
<CAPTION>
                                        Average                         Annualized
                                         Daily            Annualized     Yield on
                                       Amortized Average   Yield on    Average Daily    Annualized   Dividend
                             Average    Cost of   Daily     Average      Amortized       Yield on      and
                           Daily Cash  Mortgage  Earning  Daily Cash      Cost of     Average Daily  Interest
                           Equivalents  Assets   Assets   Equivalents Mortgage Assets Earning Assets  Income
                           ----------- --------- -------- ----------- --------------- -------------- --------
                                                         (dollars in thousands)
<S>                        <C>         <C>       <C>      <C>         <C>             <C>            <C>
For the nine months ended:
  September 30, 2001......   $4,098    $149,325  $153,423    4.23%         6.70%           6.64%      $7,639
  September 30, 2000......   $2,192    $153,693  $155,885    5.89%         6.70%           6.69%      $7,822
</TABLE>

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

<TABLE>
<CAPTION>
                                                                                Average     Average     Average
                                                                               One-month    Cost of     Cost of
                                                                                 LIBOR       Funds       Funds
                           Average           Annualized                       Relative to Relative to Relative to
                            Daily             Average    Average    Average     Average     Average     Average
                           Borrowed Interest Daily Cost One-Month Three-Month Three-month  One-month  Three-month
                            Funds   Expense   of Funds    LIBOR      LIBOR       LIBOR       LIBOR       LIBOR
                           -------- -------- ---------- --------- ----------- ----------- ----------- -----------
                                                           (dollars in thousands)
<S>                        <C>      <C>      <C>        <C>       <C>         <C>         <C>         <C>
For the nine months ended:
  September 30, 2001...... $137,956  $4,974     4.81%     4.45%      4.33%        0.12%       0.36%       0.48%
  September 30, 2000...... $138,458  $6,554     6.31%     6.33%      6.48%       (0.15)%     (0.02)%     (0.17)%
</TABLE>

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

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

<TABLE>
<CAPTION>
                                    Annualized
                                 Yield on Average
                                 Daily Amortized   Annualized    Average
                                     Cost of      Average Daily Operating
                                 Mortgage Assets  Cost of Funds  Margin
                                 ---------------- ------------- ---------
      <S>                        <C>              <C>           <C>
      For the nine months ended:
        September 30, 2001......       6.70%          4.81%       1.89%
        September 30, 2000......       6.70%          6.31%       0.39%
</TABLE>

                                      14

<PAGE>

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

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

<TABLE>
<CAPTION>
                                                                   Total G&A
                            Management Fee & Other Incentive Fee/  Expenses/
                            Expenses/ Total Assets  Total Assets  Total Assets
                            ---------------------- -------------- ------------
 <S>                        <C>                    <C>            <C>
 For the nine months ended:
   September 30, 2001......          0.24%              0.19%         0.43%
   September 30, 2000......          0.27%              0.00%         0.27%
</TABLE>

Financial Condition

   At September 30, 2001, we held total assets of $224 million, consisting of
$175 million of adjustable-rate mortgage-backed securities, $35 million of
fixed-rate mortgage-backed securities and $1.7 million of preferred stock
issued by REITs. This balance sheet size represents an approximate 58% increase
over our balance sheet size at December 31, 2000. At September 30, 2001, we
were well within our asset allocation guidelines, with 94% of total assets
consisting of mortgage-backed securities guaranteed by an agency of the United
States government such as Fannie Mae or Freddie Mac. Of the adjustable-rate
mortgage-backed securities owned by us, 59% were adjustable-rate pass-through
certificates that reset at least once a year. The remaining 41% were 3/1 and
5/1 hybrid adjustable-rate mortgage-backed securities. Hybrid adjustable-rate
mortgage-backed securities have an initial interest rate that is fixed for a
certain period, usually three to five years, and then adjust annually for the
remainder of the term of the loan.

   The following table presents a schedule of mortgage-backed securities owned
at September 30, 2001 and December 31, 2000, classified by type of issuer:

<TABLE>
<CAPTION>
                                             At September 30, 2001 At December 31, 2000
                                             --------------------- --------------------
                                               Fair     Portfolio    Fair    Portfolio
                                               Value    Percentage   Value   Percentage
                                             --------   ---------- --------  ----------
                                                       (dollars in thousands)
<S>                                          <C>        <C>        <C>       <C>
Agency
FNMA........................................ $156,869      74.6%   $110,415     81.9%
FHLMC.......................................   53,289      25.4%     23,957     17.8%
Private Placement...........................       --        --%        517      0.4%
                                             --------     -----    --------    -----
   Total Portfolio.......................... $210,159     100.0%   $134,889    100.0%
</TABLE>

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

<TABLE>
<CAPTION>
                                        At September 30, 2001 At December 31, 2000
                                        --------------------  -------------------
                                          Fair     Portfolio    Fair    Portfolio
                                          Value    Percentage   Value   Percentage
                                        --------   ---------- --------  ----------
                                                  (dollars in thousands)
<S>                                     <C>        <C>        <C>       <C>
Index
One-month LIBOR........................ $    501       0.2%   $  1,249      0.9%
Six-month LIBOR........................    4,893       2.3%      7,332      5.4%
One year LIBOR.........................    6,036       2.9%         --       --%
Six-month Certificate of Deposit.......    2,148       1.0%      3,692      2.7%
One-year Constant Maturity Treasury....  157,500      75.0%     97,491     72.3%
Cost of Funds Index....................    4,107       2.0%      4,713      3.5%
Fixed rate.............................   34,974      16.6%     20,412     15.2%
                                        --------     -----    --------    -----
   Total Portfolio..................... $210,159     100.0%   $134,889    100.0%
</TABLE>

   Our mortgage-backed securities portfolio had a weighted average yield of
6.86% at September 30, 2001. The weighted average one-month constant prepayment
rates of our mortgage-backed securities portfolio were

                                      15

<PAGE>

34%, 26% and 31%, respectively, for the months of July, August and September
2001. At September 30, 2001 the unamortized net premium paid for our
mortgage-backed securities was $4.3 million.

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

   As of September 30, 2001, the fair value of our portfolio of
mortgage-related assets classified as available for sale was $1.32 million, or
0.62% greater than the amortized cost of our portfolio.

Hedging

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

Liquidity and Capital Resources

   Our primary source of funds consists of repurchase agreements, which totaled
$180 million at September 30, 2001. Our other significant source of funds for
the quarter ended September 30, 2001 consisted of payments of principal and
interest from our mortgage securities portfolio in the amount of $17.1 million.
Additionally, as of September 30, 2001, we had raised approximately $600,000 in
capital under our dividend reinvestment plan.

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

   Our borrowings had a weighted average interest cost during the quarter ended
September 30, 2001 of 3.86% compared with 6.89% for the quarter ended September
30, 2000. As of September 30, 2001, all of our repurchase agreements were
fixed-rate term repurchase agreements with original maturities ranging from
three months to one year. On September 30, 2001, we had borrowing arrangements
with eleven different financial institutions and had borrowed funds under
repurchase agreements with eight of these firms. Because we borrow money based
on the fair value of our mortgage-backed securities and because increases in
short-term interest rates can negatively impact the valuation of
mortgage-backed securities, our borrowing ability could be limited and lenders
may initiate margin calls in the event short-term interest rates increase or
the value of our mortgage-backed securities declines for other reasons. During
the quarter ended September 30, 2001, we had adequate cash flow, liquid assets
and unpledged collateral with which to meet our margin requirements during the
period. Further, we believe we will continue to have sufficient liquidity to
meet our future cash requirements from our primary sources of funds for the
foreseeable future without needing to sell assets.

   We may raise additional equity dependent upon market conditions and other
factors. In that regard, we intend to raise approximately $116.5 million of net
proceeds through the issuance of common stock as described in our registration
statement on Form S-2 filed October 17, 2001.

                                      16

<PAGE>

Stockholders' Equity

   We use available for sale treatment for our mortgage-backed securities.
These assets are carried on the balance sheet at fair value rather than
historical amortized cost. Based upon such available for sale treatment, our
equity base at September 30, 2001 was $21.95 million, or $9.16 per share.

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

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

   Unrealized changes in the fair value of mortgage-backed securities have one
significant and direct effect on our potential earnings and dividends: positive
mark-to-market changes will increase our equity base and allow us to increase
our borrowing capacity while negative changes will tend to limit borrowing
capacity under our capital investment policy. A very large negative change in
the net market value of our mortgage-backed securities might reduce our
liquidity, requiring us to sell assets with the likely result of realized
losses upon sale. "Accumulated other comprehensive income, unrealized gain
(loss) on available for sale securities" was 1.32 million, or 0.62% of the
amortized cost of mortgage-backed securities at September 30, 2001.

                                      17

<PAGE>

Item 3. Quantitative And Qualitative Disclosures About Market Risk

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

   Interest Rate Risk

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

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

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

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

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

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

                                      18

<PAGE>

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

<TABLE>
<CAPTION>
                                                           Assets               Debt Obligations
                                                  ------------------------  ------------------------
                                                           Percent of Total          Percent of Total
                                                   Amount    Investments     Amount    Investments
                                                  -------- ---------------- -------- ----------------
        Investment Type/Rate Reset Dates                        (dollars in thousands)
<S>                                               <C>      <C>              <C>      <C>
Fixed-Rate Investments........................... $ 34,974       16.6%      $     --         --%

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

   Market Value Risk

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

   Liquidity Risk

   Our primary liquidity risk arises from financing long-maturity
mortgage-backed securities with short-term debt. The interest rates on our
borrowings generally adjust more frequently than the interest rates on our
adjustable-rate mortgage-backed securities. For example, at September 30, 2001,
our adjustable-rate mortgage-backed securities had a weighted average term to
next rate adjustment of approximately 18 months, while our borrowings had a
weighted average term to next rate adjustment of 68 days. Accordingly, in a
period of rising interest rates, our borrowing costs will usually increase
faster than our interest earnings from mortgage-backed securities. As a result,
we could experience a decrease in net income or a net loss during these
periods. Our assets that are pledged to secure short-term borrowings are
high-quality, liquid assets. As a result, we have not had difficulty rolling
over our short-term debt as it matures. There can be no assurance that we will
always be able to roll over our short-term debt. We had no long-term debt at
September 30, 2001.

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

   Prepayment Risk

   Prepayments are the full or partial repayment of principal prior to the
original term to maturity of a mortgage loan and typically occur due to
refinancing of mortgage loans. Prepayment rates on mortgage-related securities
vary from time to time and may cause changes in the amount of our net interest
income. Prepayments of adjustable-rate mortgage loans usually can be expected
to increase when mortgage interest rates fall below the then-current interest
rates on such loans and decrease when mortgage interest rates exceed the
then-current interest rate on such loans, although such effects are not
predictable. Prepayment experience also may be affected by the conditions in
the housing and financial markets, general economic conditions and the relative
interest rates on fixed-rate and adjustable-rate mortgage loans underlying
mortgage-backed securities. The purchase prices of mortgage-backed securities
are generally based upon assumptions regarding the expected amounts and rates
of prepayments. Where slow prepayment assumptions are made, we may pay a
premium for mortgage-backed

                                      19

<PAGE>

securities. To the extent such assumptions differ from the actual amounts of
prepayments, we could experience reduced earnings or losses. The total
prepayment of any mortgage-backed securities purchased at a premium by us would
result in the immediate write-off of any remaining capitalized premium amount
and a reduction of our net interest income by such amount. Finally, in the
event that we are unable to acquire new mortgage-backed securities to replace
the prepaid mortgage-backed securities, our financial condition, cash flows and
results of operations could be harmed.

   We often purchase mortgage-backed securities that have a higher interest
rate than the market interest rate at the time. In exchange for this higher
interest rate, we must pay a premium over par value to acquire these
securities. In accordance with accounting rules, we amortize this premium over
the term of the mortgage-backed security. As we receive repayments of mortgage
principal, we amortize the premium balances as a reduction to our income. If
the mortgage loans underlying a mortgage-backed security are prepaid at a
faster rate than we anticipate, we would have to amortize the premium at a
faster rate. This would reduce our income. At September 30, 2001, unamortized
mortgage premium balances of mortgage-backed securities for financial
accounting purposes were $4.3 million, or 1.9% of total assets.

   Tabular Presentation

   The information presented in the table below projects the impact of changes
in interest rates on our 2001 projected net income and net assets as more fully
discussed below based on investments in place on September 30, 2001, and
includes all of our interest-rate sensitive assets and liabilities. We acquire
interest-rate sensitive assets and fund them with interest-rate sensitive
liabilities. We generally plan to retain such assets and the associated
interest rate risk to maturity.

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

   When interest rates are shocked, these prepayment assumptions are further
adjusted based on our best estimate of the effects of changes on interest rates
or prepayment speeds. For example, under current market conditions, a 100 basis
point decline in interest rates is estimated to result in a 33% increase in the
prepayment rate of our adjustable-rate mortgage-backed securities. The base
interest rate scenario assumes interest rates at September 30, 2001. Actual
results could differ significantly from those estimated in the table.

<TABLE>
<CAPTION>
  Change in   Percentage Change Percentage Change
Interest Rate   in Net Income     in Net Assets
------------- ----------------- -----------------
<S>           <C>               <C>
    -2.0%             6.9%             1.1%
    -1.0%           (1.0)%             0.7%
     0.0%             0.0%             0.0%
     1.0%             3.3%           (1.5)%
     2.0%          (13.3)%           (3.5)%
</TABLE>

                                      20

<PAGE>

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

   At September 30, 2001, there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.

Item 2. Changes in Securities

   Not applicable

Item 3. Defaults Upon Senior Securities

   Not applicable

Item 4. Submission of Matters to a Vote of Security Holders

   Not applicable

Item 5. Other Information

   On October 17, 2001, the Company filed a registration statement on Form S-2
to sell 13,000,000 shares of the Company's common stock in a follow-on public
offering (14,950,000 shares of common stock if the underwriters fully exercise
their over-allotment option).

   Our management company, Anworth Mortgage Advisory Corporation, has granted
us an option, exercisable on or before April 30, 2003, to acquire our
management company by merger for consideration consisting of 240,000 shares or
our common stock. If this option is exercised, we would become an internally
managed company and the employees of the management company would become our
employees. The closing of the merger would be subject to a number of
conditions, including the approval of our stockholders and receipt by our board
of directors of a fairness opinion regarding the fairness of the consideration
payable by us in the merger. We have agreed, as a condition to exercising the
option, to enter into direct employment contracts with Lloyd McAdams and the
other key employees of the management company, adopt an incentive compensation
plan for our key executives and increase and maintain the size of our 1997
Stock Option and Awards Plan. If the merger is consummated, the management
agreement would be terminated.

   Our board of directors intends to consider the exercise of our option from
time to time following completion of the offering. Our board of directors will
exercise the option only if it determines that becoming internally managed
would be in the best interests of our stockholders.

Item 6. Exhibits and Reports on Form 8-K

   (a) Exhibits

   None

   (b) Reports on Form 8-K

   None


                                      21

<PAGE>

                                  SIGNATURES

   Pursuant to the requirements 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.

                                          ANWORTH MORTGAGE ASSET CORPORATION

                                                     /s/ LLOYD MCADAMS
Dated: October 30, 2001
                                          By: _________________________________
                                                       Lloyd McAdams
                                                         President
                                             (authorized officer of registrant)

                                                    /s/ PAMELA J. WATSON
Dated: October 30, 2001
                                          By: _________________________________
                                                      Pamela J. Watson
                                             Chief Financial Officer and
                                                         Treasurer
                                               (principal accounting officer)

                                      22