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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



| | x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
| | - | ------------------------------------------------------------------

EXCHANGE ACT OF 1934



FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004



Commission File Number: 001-13709



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ANWORTH MORTGAGE ASSET

CORPORATION

(Exact Name of Registrant as Specified in Its Charter)



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



|                                                  |  |           
|------------------------------------------------- |  | ----------
|1299 Ocean Avenue, #250, Santa Monica, California |  | 90401     
|(Address of principal executive offices)          |  | (Zip Code)



Registrants
telephone number, including area code: (310) 255-4493



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



Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).     Yes  x    No ̈



As of August 6, 2004, the Registrant had 45,728,258
shares of Common Stock outstanding.



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ANWORTH MORTGAGE ASSET CORPORATION



FORM 10-Q



INDEX



|         |  |            |  |                                                                                                |  |     
|-------- |  | ---------- |  | ---------------------------------------------------------------------------------------------- |  | ----
|         |  |            |  |                                                                                                |  | Page
|Part I.  |  |            |  | FINANCIAL INFORMATION                                                                          |  | 1   
|         |  |            | 
|         |  | Item 1.    |  | Consolidated Financial Statements                                                              |  | 1   
|         |  |            | 
|         |  |            |  | Balance Sheets as of June 30, 2004 and December 31, 2003                                       |  | 1   
|         |  |            | 
|         |  |            |  | Statements of Operations for the three and six months ended June 30, 2004 and 2003             |  | 2   
|         |  |            | 
|         |  |            |  | Statements of Stockholders Equity for the three months ended March 31, 2004 and June 30, 2004 |  | 3   
|         |  |            | 
|         |  |            |  | Statements of Cash Flows for the three and six months ended June 30, 2004 and 2003             |  | 4   
|         |  |            | 
|         |  |            |  | Statements of Comprehensive Income for the three and six months ended June 30, 2004 and 2003   |  | 5   
|         |  |            | 
|         |  |            |  | Notes To Unaudited Financial Statements                                                        |  | 6   
|         |  |            | 
|         |  | Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations          |  | 18  
|         |  |            | 
|         |  | Item 3.    |  | Qualitative and Quantitative Disclosures About Market Risk                                     |  | 34  
|         |  |            | 
|         |  | Item 4.    |  | Controls and Procedures                                                                        |  | 34  
|         |  |            | 
|Part II. |  |            |  | OTHER INFORMATION                                                                              |  | 37  
|         |  |            | 
|         |  | Item 1.    |  | Legal Proceedings                                                                              |  | 37  
|         |  |            | 
|         |  | Item 2.    |  | Changes in Securities and Use of Proceeds                                                      |  | 37  
|         |  |            | 
|         |  | Item 3.    |  | Defaults Upon Senior Securities                                                                |  | 37  
|         |  |            | 
|         |  | Item 4.    |  | Submission of Matters to a Vote of Security Holders                                            |  | 37  
|         |  |            | 
|         |  | Item 5.    |  | Other Information                                                                              |  | 38  
|         |  |            | 
|         |  | Item 6.    |  | Exhibits and Reports on Form 8-K                                                               |  | 39  
|         |  |           
|         |  | Signatures |  | 41                                                                                            



i



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Part I. FINANCIAL INFORMATION



|Item 1. | Consolidated Financial Statements
|------- | ---------------------------------



ANWORTH MORTGAGE ASSET CORPORATION



BALANCE SHEETS

(in thousands)

(unaudited)



|                                                                                                            |  |              |           |   |                  |   |           |  
|----------------------------------------------------------------------------------------------------------- |  | ------------ | --------- | - | ---------------- | - | --------- | -
|                                                                                                            |  | June 30,2004 |           |   | December 31,2003 |  
|ASSETS                                                                                                      |  |              |           |   |                  |   |           |  
|Agency mortgage-backed securities:                                                                          |  |              |           |   |                  |   |           |  
|Agency mortgage-backed securities pledged to counterparties at fair value                                   |  | $            | 3,695,846 |   |                  | $ | 3,954,019 |  
|Agency mortgage-backed securities at fair value                                                             |  |              | 269,782   |   |                  |   | 291,834   |  
|                                                                                                            |  |              |           |   |                  |   |           |  
|                                                                                                            |  | $            | 3,965,628 |   |                  | $ | 4,245,853 |  
|Other mortgage-backed securities pledged to counterparties at fair value                                    |  |              | 55,410    |   |                  |   |          |  
|Residential real estate loans                                                                               |  |              | 988,911   |   |                  |   |          |  
|Allowance for loan losses                                                                                   |  |              | (32       | ) |                  |   |          |  
|Cash and cash equivalents                                                                                   |  |              | 11,345    |   |                  |   | 196       |  
|Restricted cash                                                                                             |  |              | 1,361     |   |                  |   |          |  
|Interest and dividends receivable                                                                           |  |              | 19,635    |   |                  |   | 17,007    |  
|Derivative instruments at fair value                                                                        |  |              | 7,087     |   |                  |   |          |  
|Prepaid expenses and other                                                                                  |  |              | 394       |   |                  |   | 218       |  
|                                                                                                            |  |              |           |   |                  |   |           |  
|                                                                                                            |  | $            | 5,049,739 |   |                  | $ | 4,263,274 |  
|                                                                                                            |  |              |           |   |                  |   |           |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                        |  |              |           |   |                  |   |           |  
|Liabilities:                                                                                                |  |              |           |   |                  |   |           |  
|Accrued interest payable                                                                                    |  | $            | 21,493    |   |                  | $ | 14,684    |  
|Repurchase agreements (Anworth Mortgage)                                                                    |  |              | 3,535,523 |   |                  |   | 3,775,691 |  
|Repurchase agreements (Belvedere Trust)                                                                     |  |              | 251,294   |   |                  |   |          |  
|Payable for purchase of mortgage-backed securities                                                          |  |              | 8,033     |   |                  |   |          |  
|Whole loan financing facilities                                                                             |  |              | 335,802   |   |                  |   |          |  
|Long-term debt                                                                                              |  |              | 401,075   |   |                  |   |          |  
|Dividends payable                                                                                           |  |              |          |   |                  |   | 14,093    |  
|Accrued expenses and other                                                                                  |  |              | 9,972     |   |                  |   | 1,409     |  
|                                                                                                            |  |              |           |   |                  |   |           |  
|                                                                                                            |  | $            | 4,563,192 |   |                  | $ | 3,805,877 |  
|                                                                                                            |  |              |           |   |                  |   |           |  
|Minority interest                                                                                           |  |              | 153       |   |                  |   |          |  
|Stockholders Equity:                                                                                       |  |              |           |   |                  |   |           |  
|Preferred stock, par value $.01 per share; authorized 20,000 shares; no shares issued and outstanding       |  |              |          |   |                  |   |          |  
|Common stock, par value $.01 per share; authorized 100,000 shares; 45,622 and 42,707 issued and outstanding |  |              | 456       |   |                  |   | 427       |  
|Additional paid-in capital                                                                                  |  |              | 525,182   |   |                  |   | 488,909   |  
|Accumulated other comprehensive (loss) income consisting of unrealized (losses) gains                       |  |              | (42,380   | ) |                  |   | (21,933   | )
|Retained earnings (deficit)                                                                                 |  |              | 3,771     |   |                  |   | (9,331    | )
|Unearned restricted stock                                                                                   |  |              | (635      | ) |                  |   | (675      | )
|                                                                                                            |  |              |           |   |                  |   |           |  
|                                                                                                            |  |              | 486,394   |   |                  |   | 457,397   |  
|                                                                                                            |  |              |           |   |                  |   |           |  
|                                                                                                            |  | $            | 5,049,739 |   |                  | $ | 4,263,274 |  
|                                                                                                            |  |              |           |   |                  |   |           |  



See accompanying notes
to financial statements.



1



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ANWORTH MORTGAGE ASSET CORPORATION



STATEMENTS OF OPERATIONS

(in thousands, except for per share amounts)

(unaudited)



|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------------- |  | -------------------------- | ------- | - | ------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                 |  | Three months endedJune 30, |         |   | Six months endedJune 30, |  
|                                                                 |  | 2004                       |         |   | 2003                     |   |         | 2004 |  |   | 2003    |  
|Interest income net of amortization of premium and discount      |  | $                          | 32,904  |   |                          | $ | 24,370  |      |  | $ | 68,150  |   |  | $ | 47,697  |  
|Interest expense                                                 |  |                            | (19,346 | ) |                          |   | (10,802 | )    |  |   | (34,286 | ) |  |   | (21,013 | )
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Net interest income                                              |  |                            | 13,558  |   |                          |   | 13,568  |      |  |   | 33,864  |   |  |   | 26,684  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Gain on sale of securities                                       |  |                            | 102     |   |                          |   | 2,140   |      |  |   | 259     |   |  |   | 2,791   |  
|Net gain on derivative instruments                               |  |                            | 532     |   |                          |   |        |      |  |   | 329     |   |  |   |        |  
|Expenses:                                                        |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Compensation and benefits                                        |  |                            | (470    | ) |                          |   | (361    | )    |  |   | (866    | ) |  |   | (747    | )
|Incentive compensation                                           |  |                            | (457    | ) |                          |   | (1,188  | )    |  |   | (1,582  | ) |  |   | (2,406  | )
|Provision for credit losses                                      |  |                            | (32     | ) |                          |   |        |      |  |   | (32     | ) |  |   |        |  
|Legal and accounting services                                    |  |                            | (250    | ) |                          |   | (102    | )    |  |   | (398    | ) |  |   | (177    | )
|Other expenses                                                   |  |                            | (662    | ) |                          |   | (485    | )    |  |   | (1,329  | ) |  |   | (751    | )
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Total expenses                                                   |  |                            | (1,871  | ) |                          |   | (2,136  | )    |  |   | (4,207  | ) |  |   | (4,081  | )
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Income from operations before income taxes and minority interest |  |                            | 12,321  |   |                          |   | 13,572  |      |  |   | 30,245  |   |  |   | 25,394  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Income taxes                                                     |  |                            | (28     | ) |                          |   |        |      |  |   | (79     | ) |  |   |        |  
|Minority interest in net income of a subsidiary                  |  |                            | (103    | ) |                          |   |        |      |  |   | (103    | ) |  |   |        |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Net income                                                       |  | $                          | 12,190  |   |                          | $ | 13,572  |      |  | $ | 30,063  |   |  | $ | 25,394  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Basic earnings per share                                         |  | $                          | 0.27    |   |                          | $ | 0.45    |      |  | $ | 0.68    |   |  | $ | 0.91    |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Average number of shares outstanding                             |  |                            | 45,016  |   |                          |   | 29,925  |      |  |   | 44,346  |   |  |   | 27,861  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Diluted earnings per share                                       |  | $                          | 0.27    |   |                          | $ | 0.45    |      |  | $ | 0.68    |   |  | $ | 0.91    |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Average number of diluted shares outstanding                     |  |                            | 45,101  |   |                          |   | 30,147  |      |  |   | 44,463  |   |  |   | 28,052  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Dividends declared per share (see Note 12)                       |  | $                          | 0.38    |   |                          | $ | 0.45    |      |  | $ | 0.38    |   |  | $ | 0.45    |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  



See accompanying notes
to financial statements.



2



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ANWORTH MORTGAGE ASSET CORPORATION



STATEMENT OF STOCKHOLDERS EQUITY

(in thousands)

(unaudited)



|                                                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   |         |  
|---------------------------------------------------- |  | ----------------- |  | -------------------- | --- | ------------------------ | - | --------------------------------------------------------- |  | ---------------------------------------------------------------------------------- | ----- |  | ------------------------------------------------------- | ------- | - | ------------------------- | - | ---- | ----------------------- |  | - | ------------------- | - |  | ----- | ---- | - |  | - | ------- | - |  | - | ------- | -
|                                                     |  | CommonStockShares |  | CommonStock ParValue |     | AdditionalPaid-InCapital |   | Accumulative Other ComprehensiveIncome (Loss) Derivatives |  | Accumulative Other Comprehensive Income (Loss) Available-For-Sale AgencySecurities |       |  | Accumulative Other ComprehensiveIncome (Loss) Other MBS |         |   | RetainedEarnings(deficit) |   |      | UnearnedRestrictedStock |  |   | ComprehensiveIncome |   |  | Total |     
|Balance, December 31, 2003                           |  | 42,707            |  | $                    | 427 |                          | $ | 488,909                                                   |  | $                                                                                  |      |  | $                                                       | (21,933 | ) |                           | $ |     |                         |  | $ | (9,331              | ) |  | $     | (675 | ) |  | $ |        |   |  | $ | 457,397 |  
|Issuance of common stock                             |  | 1,584             |  |                      | 16  |                          |   | 21,124                                                    |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   | 21,140  |  
|Available-for-sale securities, fair value adjustment |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    | 950   |  |                                                         | 13,963  |   |                           |   | (18  | )                       |  |   |                     |   |  |       |      |   |  |   | 14,895  |   |  |   | 14,895  |  
|Net income                                           |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   | 17,873              |   |  |       |      |   |  |   | 17,873  |   |  |   | 17,873  |  
|                                                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   |         |  
|Total comprehensive income                           |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  | $ | 32,768  |   |  |   |         |  
|                                                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   |         |  
|Amortization of restricted stock                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       | 20   |   |  |   |         |   |  |   | 20      |  
|                                                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   |         |  
|Balance, March 31, 2004                              |  | 44,291            |  | $                    | 443 |                          | $ | 510,033                                                   |  | $                                                                                  | 950   |  | $                                                       | (7,970  | ) |                           | $ | (18  | )                       |  | $ | 8,542               |   |  | $     | (655 | ) |  |   |         |   |  | $ | 511,325 |  
|                                                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   |         |  
|Issuance of common stock                             |  | 1,331             |  |                      | 13  |                          |   | 15,149                                                    |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   | 15,162  |  
|Other comprehensive income, fair value adjustment    |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    | 6,076 |  |                                                         | (40,630 | ) |                           |   | (788 | )                       |  |   |                     |   |  |       |      |   |  |   | (35,342 | ) |  |   | (35,342 | )
|Net income                                           |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   | 12,190              |   |  |       |      |   |  |   | 12,190  |   |  |   | 12,190  |  
|                                                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   |         |  
|Total comprehensive income                           |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   | (23,152 | ) |  |   |         |  
|                                                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   |         |  
|Amortization of restricted stock                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       | 20   |   |  |   |         |   |  |   | 20      |  
|Dividends declared - $0.38/share                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   | (16,961             | ) |  |       |      |   |  |   |         |   |  |   | (16,961 | )
|                                                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   |         |  
|Balance, June 30, 2004                               |  | 45,622            |  | $                    | 456 |                          | $ | 525,182                                                   |  | $                                                                                  | 7,026 |  | $                                                       | (48,600 | ) |                           | $ | (806 | )                       |  | $ | 3,771               |   |  | $     | (635 | ) |  |   |         |   |  | $ | 486,394 |  
|                                                     |  |                   |  |                      |     |                          |   |                                                           |  |                                                                                    |       |  |                                                         |         |   |                           |   |      |                         |  |   |                     |   |  |       |      |   |  |   |         |   |  |   |         |  



See accompanying notes
to financial statements.



3



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ANWORTH MORTGAGE ASSET CORPORATION



STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                  |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|--------------------------------------------------------------------------------- |  | ---------------------------------- | -------- | - | --------------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                                                  |  | For the three months endedJune 30, |          |   | For the six months ended June 30, |  
|                                                                                  |  | 2004                               |          |   | 2003                              |   |            | 2004 |  |   | 2003       |  
|Operating Activities:                                                             |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Net income                                                                        |  | $                                  | 12,190   |   |                                   | $ | 13,572     |      |  | $ | 30,063     |   |  | $ | 25,394     |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Amortization of premiums and discounts                                            |  |                                    | 16,527   |   |                                   |   | 9,223      |      |  |   | 25,950     |   |  |   | 16,020     |  
|Gain on sales of agency securities                                                |  |                                    | (102     | ) |                                   |   | (2,140     | )    |  |   | (102       | ) |  |   | (2,791     | )
|Gain on sales of securities in securitization                                     |  |                                    |         |   |                                   |   |           |      |  |   | (157       | ) |  |   |           |  
|Gain on hedging instruments                                                       |  |                                    | (532     | ) |                                   |   |           |      |  |   | (329       | ) |  |   |           |  
|Provision for credit losses                                                       |  |                                    | 32       |   |                                   |   |           |      |  |   | 32         |   |  |   |           |  
|Provision for income taxes                                                        |  |                                    | 28       |   |                                   |   |           |      |  |   | 28         |   |  |   |           |  
|Adjustment for minority interest in net income                                    |  |                                    | 103      |   |                                   |   |           |      |  |   | 103        |   |  |   |           |  
|Amortization of restricted stock                                                  |  |                                    | 20       |   |                                   |   | 19         |      |  |   | 40         |   |  |   | 39         |  
|Changes in assets and liabilities:                                                |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|(Increase) in interest receivable                                                 |  |                                    | (221     | ) |                                   |   | (1,406     | )    |  |   | (2,628     | ) |  |   | (2,205     | )
|Decrease (increase) in prepaid expenses and other                                 |  |                                    | (285     | ) |                                   |   | 819        |      |  |   | (1,889     | ) |  |   | 528        |  
|Increase in accrued interest payable                                              |  |                                    | 4,045    |   |                                   |   | 2,840      |      |  |   | 6,809      |   |  |   | 904        |  
|Increase (decrease) in accrued expenses and other                                 |  |                                    | 9,057    |   |                                   |   | (442       | )    |  |   | 9,296      |   |  |   | (321       | )
|                                                                                  |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Net cash provided by operating activities                                         |  |                                    | 40,862   |   |                                   |   | 22,485     |      |  |   | 67,216     |   |  |   | 37,568     |  
|Investing Activities:                                                             |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Available-for-sale agency securities:                                             |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Purchases                                                                         |  |                                    | (152,405 | ) |                                   |   | (1,083,708 | )    |  |   | (786,292   | ) |  |   | (1,727,585 | )
|Proceeds from sales                                                               |  |                                    | 119,356  |   |                                   |   | 109,687    |      |  |   | 119,356    |   |  |   | 143,607    |  
|Principal payments                                                                |  |                                    | 571,476  |   |                                   |   | 358,169    |      |  |   | 903,646    |   |  |   | 618,860    |  
|Residential real estate loans:                                                    |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Purchases                                                                         |  |                                    | (810,704 | ) |                                   |   |           |      |  |   | (1,273,561 | ) |  |   |           |  
|Proceeds from securitization                                                      |  |                                    |         |   |                                   |   |           |      |  |   | 196,428    |   |  |   |           |  
|Principal payments                                                                |  |                                    | 7,023    |   |                                   |   |           |      |  |   | 7,613      |   |  |   |           |  
|ARM loans collateralizing long-term debt:                                         |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Principal payments                                                                |  |                                    | 24,202   |   |                                   |   |           |      |  |   | 24,202     |   |  |   |           |  
|                                                                                  |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Net cash used in investing activities                                             |  |                                    | (241,052 | ) |                                   |   | (615,852   | )    |  |   | (808,608   | ) |  |   | (965,118   | )
|Financing Activities:                                                             |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Net (repayments) borrowings from repurchase agreements                            |  |                                    | (336,625 | ) |                                   |   | 522,594    |      |  |   | 11,126     |   |  |   | 854,138    |  
|Net whole loan financing facilities borrowings                                    |  |                                    | 146,531  |   |                                   |   |           |      |  |   | 335,042    |   |  |   |           |  
|Borrowings long-term debt                                                         |  |                                    | 401,075  |   |                                   |   |           |      |  |   | 401,075    |   |  |   |           |  
|Repayments long-term debt                                                         |  |                                    | (11,604  | ) |                                   |   |           |      |  |   | (11,604    | ) |  |   |           |  
|Proceeds from common stock issued, net                                            |  |                                    | 15,162   |   |                                   |   | 83,169     |      |  |   | 36,302     |   |  |   | 97,804     |  
|Minority investments                                                              |  |                                    |         |   |                                   |   |           |      |  |   | 50         |   |  |   |           |  
|Dividends paid                                                                    |  |                                    | (16,961  | ) |                                   |   | (12,358    | )    |  |   | (31,054    | ) |  |   | (25,031    | )
|                                                                                  |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Net cash provided by financing activities                                         |  |                                    | 209,182  |   |                                   |   | 593,405    |      |  |   | 752,541    |   |  |   | 926,911    |  
|                                                                                  |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Net increase (decrease) in cash and cash equivalents                              |  |                                    | 8,992    |   |                                   |   | 38         |      |  |   | 11,149     |   |  |   | (639       | )
|Cash and cash equivalents at beginning of period                                  |  |                                    | 2,353    |   |                                   |   | 229        |      |  |   | 196        |   |  |   | 906        |  
|                                                                                  |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Cash and cash equivalents at end of period                                        |  | $                                  | 11,345   |   |                                   | $ | 267        |      |  | $ | 11,345     |   |  | $ | 267        |  
|                                                                                  |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Supplemental Disclosure of Cash Flow Information:                                 |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Cash paid for interest                                                            |  | $                                  | 15,301   |   |                                   | $ | 7,963      |      |  | $ | 27,477     |   |  | $ | 20,109     |  
|Supplemental Disclosure of Investing and Financing Activities:                    |  |                                    |          |   |                                   |   |            |      |  |   |            |   |  |   |            |  
|Mortgage securities purchased, not yet settled                                    |  | $                                  | 8,033    |   |                                   | $ | 70,681     |      |  | $ | 8,033      |   |  | $ | 70,681     |  
|Certificates retained from securitization                                         |  |                                    |         |   |                                   |   |           |      |  | $ | 64,451     |   |  |   |           |  



See accompanying notes
to financial statements.



4



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ANWORTH MORTGAGE ASSET CORPORATION



STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(unaudited)



|                                                            |  |                                    |         |   |                                  |   |        |      |  |   |         |   |  |   |        |  
|----------------------------------------------------------- |  | ---------------------------------- | ------- | - | -------------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                            |  | For the three monthsended June 30, |         |   | For the six monthsended June 30, |  
|                                                            |  | 2004                               |         |   | 2003                             |   |        | 2004 |  |   | 2003    |  
|Net income                                                  |  | $                                  | 12,190  |   |                                  | $ | 13,572 |      |  | $ | 30,063  |   |  | $ | 25,394 |  
|Available for-sale agency securities, fair value adjustment |  |                                    | (40,630 | ) |                                  |   | (9,327 | )    |  |   | (26,667 | ) |  |   | (8,491 | )
|Other mortgage-backed securities, fair value adjustment     |  |                                    | (788    | ) |                                  |   |       |      |  |   | (806    | ) |  |   |       |  
|Derivative instruments, fair value adjustment               |  |                                    | 6,076   |   |                                  |   |       |      |  |   | 7,026   |   |  |   |       |  
|                                                            |  |                                    |         |   |                                  |   |        |      |  |   |         |   |  |   |        |  
|                                                            |  |                                    | (35,342 | ) |                                  |   | (9,327 | )    |  |   | (20,447 | ) |  |   | (8,491 | )
|Comprehensive income                                        |  | $                                  | (23,152 | ) |                                  | $ | 4,245  |      |  | $ | 9,616   |   |  | $ | 16,903 |  
|                                                            |  |                                    |         |   |                                  |   |        |      |  |   |         |   |  |   |        |  



See accompanying notes
to financial statements.



5



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ANWORTH MORTGAGE ASSET CORPORATION



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



|NOTE 1. | ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
|------- | ------------------------------------------------



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



On November 3, 2003, we formed a wholly-owned subsidiary called Belvedere Trust Mortgage Corporation, or Belvedere Trust. Belvedere Trust was formed as a
qualified REIT subsidiary to acquire and own mortgage loans, with a focus on the high credit-quality jumbo adjustable rate, hybrid and second-lien mortgage markets. Belvedere Trust was also formed with the intent of securitizing the mortgage loans
it acquires and selling mortgage-backed securities in the capital markets. Since its formation, Belvedere Trust has become an increasingly important part of our overall operations and, as of June 30, 1004, Belvedere Trusts assets comprised
20.8% of our overall assets. Through June 30, 2004, we had made an investment of approximately $61 million in Belvedere Trust to capitalize its mortgage operations and our board of directors had authorized additional capital contributions of up to
$39 million to Belvedere Trust, for a total commitment of $100 million. Belvedere Trust is externally managed by BT Management Company, L.L.C., or BT Management, a Delaware limited liability company that is owned 50% by us, 27.5% by Claus Lund, the
Chief Executive Officer of Belvedere Trust, 17.5% by Russell J. Thompson, the Chief Financial Officer of Belvedere Trust, and 5% by Lloyd McAdams, our Chairman and Chief Executive Officer. BT Management manages Belvedere Trust through a management
agreement with Belvedere Trust pursuant to which BT Management manages the day-to-day operations of Belvedere Trust in exchange for an annual base management fee and a quarterly incentive fee.



In January 2003, the Financial Accounting Standards Board, or FASB, issued
FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46). In December 2003, FASB issued FIN No. 46R which replaced FIN 46 and clarified ARB 51. This interpretation provides
guidance on how to identify a variable interest entity, or VIE, and when a company should include in its financial statements the assets, liabilities and activities of a VIE. Under FIN 46, a company must consolidate a VIE when it is considered to be
its primary beneficiary. The primary beneficiary is the entity that will absorb a majority (50% or more) of the risk of expected losses and/or receive most of the expected residual benefit from taking on that risk.



Belvedere Trust structures securitization transactions primarily through
non-qualified special purpose entities (such as real estate mortgage investment conduit, or REMIC, trusts). The principal business activity involves issuing various series of long-term debt (in the form of pass-through certificates or bonds
collateralized by residential real estate loans). The collateral specific to each long-term debt series is the sole source of repayment of the debt and, therefore, our exposure to loss is limited to our net investment in the collateral. Under FIN
46, these interests in non-qualified special purpose entities are deemed to be VIEs and we are considered the primary beneficiary. In addition, we consolidate our interest in loans financed through warehouse agreement where we are acquiring assets
prior to securitization. We disclose our interests in VIEs under FIN 46 in the Investments in Residential Real Estate Loans footnote.



Basis of Presentation



The accompanying consolidated financial statements are prepared on the accrual basis of accounting in accordance with generally accepted accounting
principles, or GAAP, utilized in the United States for interim financial information. The preparation of financial statements in conformity with GAAP 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. Our
consolidated financial statements include the accounts of all subsidiaries. Significant intercompany accounts and transactions have been eliminated. The interim financial information should be read in conjunction with the financial statements
included in our Annual Report on Form 10-K for the year ended December 31, 2003.



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 three and six months
ended June 30, 2004 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2004.



6



---

A summary of our 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 value.



Restricted Cash



Restricted cash may include principal and interest payments on real estate loans or securities held as collateral for long-term debt, cash pledged as
collateral on certain interest rate agreements and cash held from borrowers until certain loan agreement requirements have been met. Any corresponding liability for cash held from borrowers is included in accrued expenses and other liabilities on
our Consolidated Balance Sheets.



Mortgage-Backed Securities (MBS)



Our MBS assets are comprised of fixed-rate and
adjustable-rate mortgage, or ARM, securities, other mortgage-backed securities and ARM loans held for securitization.



We have invested primarily in fixed-rate and ARM pass-through certificates and hybrid ARM securities. 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. We structure our investment portfolio to be diversified with a variety of prepayment characteristics, investing in
mortgage-related assets with prepayment prohibitions and penalties, investing in certain mortgage security structures that have prepayment protections, and purchasing mortgage related assets at a premium and at a discount.



We classify our 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. We currently
classify all of our 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. Losses on securities classified as available-for-sale which are determined by management to be other than temporary in nature are reclassified from accumulated other comprehensive income to current operations.



Interest income on our mortgage-backed securities is accrued based on the
actual coupon rate and the outstanding principal amount of the underlying mortgages. Premiums and discounts are amortized or accreted into interest income over the lives of the securities using the effective interest yield method adjusted for the
effects of estimated prepayments based on the Statement of Financial Accounting Standards, or SFAS, No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, an
amendment of FASB Statements No. 13, 60, and 65 and a rescission of FASB Statement No. 17. Our policy for estimating prepayments speeds for calculating the effective yield is to evaluate historical performance, street consensus prepayment speeds and
current market conditions. If our estimate of prepayments is incorrect, we may be required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income.



Securities are recorded on the date the securities are purchased or sold (the
trade date). Realized gains or losses from securities transactions are determined based on the specific identified cost of the securities.



The following table shows our investments gross unrealized losses and fair value, aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position, at June 30, 2004:



|                                          |  |                     |           |                  |                   |   |            |       |                  |  |         |            |  |                  |           |  |         |  
|----------------------------------------- |  | ------------------- | --------- | ---------------- | ----------------- | - | ---------- | ----- | ---------------- |  | ------- | ---------- |  | ---------------- | --------- |  | ------- | -
|                                          |  | Less than 12 months |           |                  | 12 months or more |   |            | Total |                 
|                                          |  | (in thousands)      |          
|Description of Securities                 |  | Fair Value          |           | UnrealizedLosses |                   |   | Fair Value |       | UnrealizedLosses |  |         | Fair Value |  | UnrealizedLosses |          
|Federal agency mortgage-backed securities |  | $                   | 2,023,548 |                  | (22,975           | ) |            | $     | 1,540,694        |  | (27,787 | )          |  | $                | 3,564,242 |  | (50,762 | )



We do not consider
those securities which have been in a continuous loss position for 12 months or more to be other than temporarily impaired due to the fact that these are government agency guaranteed securities with limited credit risk.



Residential Real Estate Loans



We acquire residential mortgage loans and hold them as long-term investments
through our Belvedere Trust subsidiary. We finance the mortgage loans with short-term debt until a sufficient quantity has been accumulated for securitization into mortgage-backed securities in order to obtain long-term financing and to enhance
liquidity. While all mortgage loans are acquired with the intention of securitizing them, we may not be successful in our efforts to securitize the loans into mortgage-backed securities. Our residential real estate loans are classified as
held-for-investment and are carried at their unpaid principal balance adjusted for unamortized premiums or discounts.



7



---

To meet our investment criteria, mortgage loans acquired by us will generally conform to the underwriting
guidelines established by the Federal Home Loan Mortgage Corporation, or Freddie Mac, Fannie Mae and the Government National Mortgage Association, or Ginnie Mae, or to secondary market standards for A quality mortgage loans. Applicable
banking laws, however, generally require that an appraisal be obtained in connection with the original issuance of mortgage loans by the lending institution, and we do not intend to obtain additional appraisals at the time of acquiring mortgage
loans. Mortgage loans may be originated by or purchased from various suppliers of mortgage-related assets throughout the United States, including savings and loans associations, banks, mortgage bankers and other mortgage lenders. We may acquire
mortgage loans directly from originators and from entities holding mortgage loans originated by others.



Our Belvedere Trust subsidiary maintains a loan loss reserve for residential real estate loans held in consolidated securitization trusts and for loans
held prior to securitization. The balance is included in Allowance for Loan Losses on the consolidated balance sheet.



Allowance for Loan Losses



We establish and maintain credit reserves for estimated loan losses in our residential real estate loan portfolio. The loan loss reserves are based upon
our assessment of various factors affecting the credit quality of our assets. The reserves are reviewed on a regular basis and adjusted as deemed necessary. The reserve for credit losses on our real estate loans is established by taking credit
provisions through our Consolidated Statements of Operations.



Repurchase Agreements



We finance the
acquisition of our MBS through the use of repurchase agreements. Under these repurchase agreements, we sell securities to a lender and agree to repurchase the same securities in the future for a price that is higher than the original sales price.
The difference between the sale price that we receive and the repurchase price that we pay represents interest paid to the lender. Although structured as a sale and repurchase obligation, a repurchase agreement operates as a financing under which we
pledge our securities as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. We retain beneficial ownership of the pledged collateral. At the maturity of a repurchase
agreement, we are required to repay the loan and concurrently receive back our pledged collateral from the lender or, with the consent of the lender, we may renew such agreement at the then prevailing financing rate. These repurchase agreements may
require us to pledge additional assets to the lender in the event the estimated fair value of the existing pledged collateral declines.



Derivative Financial Instruments



Interest Rate Risk Management



We use primarily short-term repurchase agreements to finance the purchase of our MBS. These obligations expose us to variability in interest payments due
to changes in interest rates. We continuously monitor changes in interest rate exposures and evaluate hedging opportunities.



Our objective is to limit the impact of interest rate changes on earnings and cash flows. We achieve this by entering into interest rate swap agreements
to convert a percentage of our Repurchase Agreements to fixed rate obligations over a period up to five years. Under interest rate swap contracts, we agree to pay an amount equal to a specified fixed-rate of interest times a notional principal
amount, and to receive in return an amount equal to a specified variablerate of interest times a notional amount, generally based on the London Interbank Offer Rate, or LIBOR. The notional amounts are not exchanged. We account for these swap
agreements as cash flow hedges. We do not issue or hold derivative contracts for speculative purposes.



We are exposed to credit losses in the event of non-performance by counterparties to these interest rate swap agreements, but we do not expect any of the
counterparties to fail to meet their obligations. In order to limit credit risk associated with swap agreements, our current policy is to only purchase swap agreements from financial institution counterparties rated A or better by at
least one of the rating agencies, limit our exposure to a single counterparty under our defined guidelines and either pay or receive collateral to or from each counterparty on a periodic basis to cover the net fair market value position of the swap
agreements held with that counterparty.



Belvedere Trust uses
Eurodollar futures in order to mitigate the impact of rising interest rates on planned securitization funding. There is usually a time difference between the date we enter into an agreement to purchase whole loans and the date on which we fix the
interest rates paid for securitization financing. We are exposed to interest rate fluctuations during this period.



8



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Accounting for Derivatives and Hedging Activities



In accordance with FAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, or FAS 133, as amended by FAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, or FAS 138, a derivative that is designated as a hedge is recognized as an asset/liability
and measured at estimated fair value. In order for our interest rate swap agreements to qualify for hedge accounting, upon entering into the swap agreement, we must anticipate that the hedge will be highly effective, as defined by FAS
133. Upon commencement of the swap agreement active period, the premium paid to enter into the swap agreement is amortized and reflected in Interest Expense. The periodic amortization of the premium expense is based on an estimated allocation of the
premium, determined at inception of the hedge, for the monthly components on an estimated fair value basis. Payments received in connection with the swap agreement will be reported as a reduction to interest expense.



On the date we enter into a derivative contract, it designates the derivative
as a hedge of the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a cash flow hedge). Changes in the fair value of a derivative that is highly effective and that is designated
and qualifies as a cash flow hedge, to the extent that the hedge is effective, are recorded in other comprehensive income, and reclassified to earnings when the derivative is affected by the variability of cash flows of the hedged transaction (e.g.,
when periodic settlement interest payments are due on Repurchase Agreements). The swap agreements are carried on our consolidated balance sheet at their fair value. Hedge ineffectiveness, if any, is recorded in current-period earnings.



We formally document all relationships between hedging instruments and
hedged items, as well as our risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as cash flow hedges to (1) specific assets and liabilities on the
balance sheet or (2) specific firm commitments or forecasted transactions. We also formally assesses (both at the hedges inception and on an ongoing basis) whether the derivatives that are used in hedging transactions have been highly
effective in offsetting changes in the cash flows of hedged items and whether those derivatives may be expected to remain highly effective in the future periods. If it is determined that a derivative is not (or has ceased to be) highly effective as
a hedge, we discontinue hedge accounting prospectively, as discussed below.



We discontinue hedge accounting prospectively when (1) we determines that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item (including hedged items such as firm commitments
or forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; (3) it is no longer probable that the forecasted transaction will occur; (4) a hedged firm commitment no longer meets the definition of a firm commitment;
or (5) management determines that designating the derivative as a hedging instrument is no longer appropriate.



When we discontinue hedge accounting because it is no longer probable that the forecasted transaction will occur in the originally expected period, the
gain or loss on the derivative remains in accumulated other comprehensive income and is reclassified into earnings when the forecasted transaction affects earnings. However, if it is probable that a forecasted transaction will not occur by the end
of the originally specified time period or within an additional two-month period of time thereafter, the gains and losses that were accumulated in other comprehensive income will be recognized immediately in earnings. In all situations in which
hedge accounting is discontinued and the derivative remains outstanding, we will carry the derivative at its fair value on the balance sheet, recognizing changes in the fair value in current-period earnings.



For purposes of the cash flow statement, cash flows from derivative
instruments are classified with the cash flows from the hedged item.



Credit
Risk



At June 30, 2004, we had limited our exposure to
credit losses on our portfolio of fixed-rate and ARM securities by purchasing primarily securities from Freddie Mac and Fannie Mae. The payment of principal and interest on the Freddie Mac and Fannie Mae mortgage-backed securities are guaranteed by
those respective agencies. At June 30, 2004, because of the government agencies guarantee, all of our agency mortgage-backed securities have an implied AAA rating.



Other-than-temporary losses on investment securities, as measured by the amount of decline in estimated fair value
attributable to factors that are considered to be other-than-temporary, are charged against income, resulting in an adjustment of the cost basis of such securities. The following are among, but not all of, the factors considered in determining
whether and to what extent an other-than-temporary impairment exists: (i) the expected cash flow from the investment; (ii) whether there has been an other-than-temporary deterioration of the credit quality of the underlying mortgages; (iii) the
credit protection available to the related mortgage pool for MBS; (iv) any other market information available, including analysts assessments and statements, public statements and filings made by the debtor, or counterparty; (v) managements
internal analysis of the security, considering all known relevant information at the time of assessment; and (vi) the magnitude and duration of historical decline in market prices. Because managements assessments are based on factual
information as well as subjective information available at the time of assessment, the determination as to whether an other-than-temporary decline exists and, if so, the amount considered impaired is also subjective and, therefore, constitutes
material



9



---

estimates that are susceptible to a significant change. At June 30, 2004, we had no assets on which an impairment charge had been taken.



Belvedere Trusts investment strategy of acquiring, accumulating and
securitizing loans involves credit risk. While Belvedere Trust intends to securitize the loans that it acquires into high quality assets in order to achieve better financing rates and to improve its access to financing, it bears the risk of loss on
any loans that its acquires and which it subsequently securitizes. Belvedere Trust acquires loans that are not credit enhanced and that do not have the backing of Fannie Mae or Freddie Mac. Accordingly, it will be subject to risks of borrower
default, bankruptcy and special hazard losses (such as those occurring from earthquakes) with respect to those loans to the extent that there is any deficiency between the value of the mortgage collateral and insurance and the principal amount of
the loan. In the event of a default on any such loans that it holds, Belvedere Trust would bear the loss equal to the difference between the realizable value of the mortgaged property, after expenses, and the outstanding indebtedness, as well as the
loss of interest.



We establish and maintain a reserve for
estimated credit losses on our residential real estate loans. The credit reserve is based upon estimates of future losses on the portfolio of residential loans. Various factors, including borrowers credit scores and loan-to-value ratios are
used to estimate losses. A provision for credit losses is recognized through our Statements of Operations.



Income Taxes



We have
elected to be taxed as a REIT and to comply with the provisions of the Internal Revenue Code of 1986, as amended, or the Code, with respect thereto. Accordingly, we will not be subject to Federal income tax to the extent that our distributions to
stockholders satisfy the REIT requirements and certain asset, income and stock ownership tests are met.



Belvedere Trust Finance Corporation, or BT Finance, an indirect wholly-owned subsidiary of the Company, is a taxable subsidiary and may be liable for
corporate income tax expenses. We accrue an income tax expense on an on-going basis for BT Finance to the extent it remains profitable.



Stock-Based Compensation



SFAS 123, Accounting for Stock-Based Compensation, amended by SFAS 148, Accounting for Stock-Based CompensationTransition and
Disclosure, encourages companies to measure compensation cost of stock-based awards based on their estimated fair value at the date of grant and recognize that amount over the related service period. We believe the existing stock option
valuation models do not necessarily provide a transparent measure of the fair value of stock-based awards. Therefore, as permitted by SFAS 148, we apply the existing accounting rules under APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. In general, as the exercise price of all options granted under these plans is equal to the market price of the underlying common stock on the grant date, no stock-based employee compensation cost is
recognized in net income (loss). In addition, under these plans, options to purchase shares of common stock may be granted at less than fair market value, which results in compensation expense equal to the difference between the market value on the
date of grant and the purchase price. This expense is recognized over the vesting period of the shares in net income (loss).



As required by SFAS 148, we provide pro forma net income (loss) and pro forma net income (loss) per common share disclosures for stock-based awards as if
the fair-value-based method defined in SFAS 123 had been applied. Had we determined compensation cost based on the fair value at the grant date for our stock options under FAS No. 123, our net income would have been reduced to the pro forma amounts
indicated below for the three months ended June 30:



|                                                                                                                                 |  |      |        |      |   |       
|-------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------ | ---- | - | ------
|(in thousands except per share amounts)                                                                                          |  | 2004 |        | 2003
|Net income, as reported                                                                                                          |  | $    | 12,190 |      | $ | 13,572
|Deduct: Total stock-based compensation expense determined under the fair value-based method for all awards, net of related
taxes |  |      | 139    |      |   |      
|                                                                                                                                 |  |      |        |      |   |       
|Pro forma net income                                                                                                             |  | $    | 12,051 |      | $ | 13,572
|Basic income per share, as reported                                                                                              |  | $    | 0.27   |      | $ | 0.45  
|Pro forma basic income per share                                                                                                 |  | $    | 0.27   |      | $ | 0.45  
|Diluted income per share, as reported                                                                                            |  | $    | 0.27   |      | $ | 0.45  
|Pro forma diluted income per share                                                                                               |  | $    | 0.27   |      | $ | 0.45  



10



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The fair value of the following stock-based awards was estimated using the Black-Scholes model with the
following weighted-average assumptions for fiscal years ended December 31:



|                        |  |              |  |           |  |           |  |          
|----------------------- |  | ------------ |  | --------- |  | --------- |  | ---------
|                        |  | June 30,2004 |  | 2003      |  | 2002      |  | 2001     
|Assumptions:            |  |              |  |           |  |           |  |          
|Dividend yield          |  | 10.00%       |  | 11.00%    |  | 17.00%    |  | 10.00%   
|Expected volatility     |  | 32.00%       |  | 32.00%    |  | 27.00%    |  | 41.00%   
|Risk-free interest rate |  | 2.97%        |  | 3.52%     |  | 4.30%     |  | 4.98%    
|Expected lives          |  | 7.4 years    |  | 8.4 years |  | 8.8 years |  | 7.0 years



Earnings Per Share



Basic earnings per share, or 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 computation of EPS is as follows (amounts in thousands,
except per share data):



|                                             |  |        |        |               |        |                  |   |     
|-------------------------------------------- |  | ------ | ------ | ------------- | ------ | ---------------- | - | ----
|                                             |  | Income |        | AverageShares |        | EarningsPerShare
|For the three months ended June 30, 2004     |  |        |        |               |        |                  |   |     
|Basic EPS                                    |  | $      | 12,190 |               | 45,016 |                  | $ | 0.27
|Effect of dilutive securities: Stock options |  |        |        |               | 85     |                  |   |     
|                                             |  |        |        |               |        |                  |   |     
|Diluted EPS                                  |  | $      | 12,190 |               | 45,101 |                  | $ | 0.27
|                                             |  |        |        |               |        |                  |   |     
|For the three months ended June 30, 2003     |  |        |        |               |        |                  |   |     
|Basic EPS                                    |  | $      | 13,572 |               | 29,925 |                  | $ | 0.45
|Effect of dilutive securities: Stock options |  |        |        |               | 222    |                  |   |     
|                                             |  |        |        |               |        |                  |   |     
|Diluted EPS                                  |  | $      | 13,572 |               | 30,147 |                  | $ | 0.45
|                                             |  |        |        |               |        |                  |   |     



Accumulated Other Comprehensive
Income (Loss)



The Financial Accounting Standard
Boards Statement 130, Reporting Comprehensive Income, divides comprehensive income into net income and other comprehensive income (loss), which includes unrealized gains and losses on marketable securities defined as
available-for-sale and unrealized gains and losses on derivative financial instruments that qualify for hedge accounting under FAS 133.



Reclassifications



$1,361,000 of restricted cash related to the period ended March 31, 2004 has been reclassified to conform to the June 30, 2004 presentations.



Use of Estimates



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



|NOTE 2. | SECURITIES
|------- | ----------



The following table summarizes our mortgage-backed securities classified as available-for-sale as of June 30, 2004, which are carried at their fair value
(amounts in thousands):



|                    |  |            |         |   |             |   |         |            |  |   |                       |   |  |   |           |  
|------------------- |  | ---------- | ------- | - | ----------- | - | ------- | ---------- |  | - | --------------------- | - |  | - | --------- | -
|                    |  | Ginnie Mae |         |   | Freddie Mac |   |         | Fannie Mae |  |   | TotalAgency MBSAssets |  
|Amortized cost      |  | $          | 164,983 |   |             | $ | 897,396 |            |  | $ | 2,917,691             |   |  | $ | 3,980,070 |  
|Paydowns receivable |  |            |        |   |             |   | 34,158  |            |  |   |                      |   |  |   | 34,158    |  
|Unrealized gains    |  |            |        |   |             |   | 649     |            |  |   | 1,513                 |   |  |   | 2,162     |  
|Unrealized losses   |  |            | (3,376  | ) |             |   | (8,911  | )          |  |   | (38,475               | ) |  |   | (50,762   | )
|                    |  |            |         |   |             |   |         |            |  |   |                       |   |  |   |           |  
|Fair value          |  | $          | 161,607 |   |             | $ | 923,292 |            |  | $ | 2,880,729             |   |  | $ | 3,965,628 |  
|                    |  |            |         |   |             |   |         |            |  |   |                       |   |  |   |           |  



11



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|                  |  |          |        |  
|----------------- |  | -------- | ------ | -
|                  |  | OtherMBS |       
|Amortized cost    |  | $        | 56,216 |  
|Unrealized losses |  |          | (806   | )
|                  |  |          |        |  
|Fair value        |  | $        | 55,410 |  
|                  |  |          |        |  



The following table
summarizes our agency securities at their fair value as of June 30, 2004 and December 31, 2003 (amounts in thousands):



June 30, 2004



|                    |  |      |           |   |         |   |           |       |  |   |                  |   |  |       |        |   |  |   |           |  
|------------------- |  | ---- | --------- | - | ------- | - | --------- | ----- |  | - | ---------------- | - |  | ----- | ------ | - |  | - | --------- | -
|                    |  | ARMs |           |   | Hybrids |   |           | Fixed |  |   | Floating-RateCMO |   |  | Total |       
|Amortized cost      |  | $    | 1,316,637 |   |         | $ | 2,406,720 |       |  | $ | 234,587          |   |  | $     | 22,126 |   |  | $ | 3,980,070 |  
|Paydowns receivable |  |      | 10,598    |   |         |   | 23,560    |       |  |   |                 |   |  |       |       |   |  |   | 34,158    |  
|Unrealized gains    |  |      | 1,349     |   |         |   | 256       |       |  |   | 488              |   |  |       | 69     |   |  |   | 2,162     |  
|Unrealized losses   |  |      | (10,564   | ) |         |   | (31,550   | )     |  |   | (8,506           | ) |  |       | (142   | ) |  |   | (50,762   | )
|                    |  |      |           |   |         |   |           |       |  |   |                  |   |  |       |        |   |  |   |           |  
|Fair value          |  | $    | 1,318,020 |   |         | $ | 2,398,986 |       |  | $ | 226,569          |   |  | $     | 22,053 |   |  | $ | 3,965,628 |  
|                    |  |      |           |   |         |   |           |       |  |   |                  |   |  |       |        |   |  |   |           |  



December 31, 2003



|                    |  |      |             |   |         |   |           |       |  |   |                  |   |  |       |        |   |  |   |           |  
|------------------- |  | ---- | ----------- | - | ------- | - | --------- | ----- |  | - | ---------------- | - |  | ----- | ------ | - |  | - | --------- | -
|                    |  | ARMs |             |   | Hybrids |   |           | Fixed |  |   | Floating-RateCMO |   |  | Total |       
|Amortized cost      |  | $    | 1,133,58711 |   |         | $ | 2,682,363 |       |  | $ | 404,677          |   |  | $     | 30,265 |   |  | $ | 4,250,892 |  
|Paydowns receivable |  |      | 5,539       |   |         |   | 11,355    |       |  |   |                 |   |  |       |       |   |  |   | 16,894    |  
|Unrealized gains    |  |      | 1,490       |   |         |   | 2,024     |       |  |   | 2,240            |   |  |       | 12     |   |  |   | 5,766     |  
|Unrealized losses   |  |      | (4,903      | ) |         |   | (17,416   | )     |  |   | (5,181           | ) |  |       | (199   | ) |  |   | (27,699   | )
|                    |  |      |             |   |         |   |           |       |  |   |                  |   |  |       |        |   |  |   |           |  
|Fair value          |  | $    | 1,135,713   |   |         | $ | 2,678,326 |       |  | $ | 401,736          |   |  | $     | 30,078 |   |  | $ | 4,245,853 |  
|                    |  |      |             |   |         |   |           |       |  |   |                  |   |  |       |        |   |  |   |           |  



During the three
months ended June 30, 2003, we sold approximately $119.3 million of our available-for-sale MBS for a net realized gain of approximately $102,000.



Other mortgage-backed securities at fair value include securities which are backed by first-lien hybrid adjustable-rate residential mortgages. These
mortgage-backed securities include investment grade and non-investment grade securities.



The non-investment grade securities include first loss, second loss and third loss securities. Credit losses are generally allocated to securities in order, beginning with the first loss security up to a maximum of
the principal amount of the first loss security. Losses are then allocated in order to the second loss, third loss and more senior securities. Since we hold non-investment grade securities including the first loss security, we bear the credit risk
associated with mortgages with a face value of approximately $218 million.



We also bear the credit risk related to our residential real estate loans as discussed under Note 1 in the section titled, Credit Risk. We have not sold the subordinate securities from our
securitizations to third parties.



|NOTE 3. | SECURITIZATION ACTIVITIES
|------- | -------------------------



We acquire residential mortgage loans from third party originators, including banks and other mortgage lenders, through our Belvedere Trust subsidiary.
During the three months ended June 30, 2004, we transferred approximately $345 million of residential mortgage loans (of which $147 million were purchased during the second quarter of 2004) to a securitization trust pursuant to a pooling and third
party servicing agreement with Countrywide Securities Corporation dated as of April 1, 2004, and we acquired approximately $314 million of residential mortgage loans which were transferred to a securitization trust pursuant to a pooling and third
party servicing agreement with Countrywide Securities Corporation dated as of May 1, 2004. The servicing of the mortgage loans is performed by third parties under servicing arrangements that resulted in no servicing asset or liability.



The two transactions in the three months ending June, 30, 2004 were
accounted for as financings. The residential real estate loans remain as assets on our balance sheet subsequent to securitization, and the financing resulting from these securitizations is shown on our balance sheet as long-term debt.



During the three months ended March 31, 2004, we transferred approximately
$253 million of residential mortgage loans to a securitization trust pursuant to a pooling and third party servicing agreement with Countrywide Securities Corporation dated as of



12



---

February 1, 2004. The transaction was accounted for as a sale. We retained securities from this transaction with a book value at June 30, 2004, of $55
million.



As of June 30, 2004, we had acquired approximately
$350 million in residential mortgage loans which were scheduled to be securitized at a later date.



|NOTE 4. | RESIDENTIAL REAL ESTATE LOANS
|------- | -----------------------------



Our residential real estate loan portfolio of $989 million as of June 30, 2004, includes $350 million of loans pending securitization and $639 million in
loans which have been financed through securitization.



|NOTE 5. | REPURCHASE AGREEMENTS
|------- | ---------------------



We have entered into reverse repurchase agreements to finance most of our MBS. The reverse repurchase agreements are short-term borrowings that are
secured by the market value of our MBS and bear interest rates that have historically had their basis on the London Interbank Offer Rate, or LIBOR. At June 30, 2004, our reverse repurchase agreements had a weighted average term to maturity of 230
days and a weighted average borrowing rate of 1.58%. After adjusting for swap transactions, the weighted average term to maturity was 379 days with a weighted average borrowing rate of 1.78%. At June 30, 2004, agency MBS with a fair value of
approximately $3,696 million have been pledged as collateral under the reverse repurchase agreements.



At June 30, 2004, the repurchase agreements had the following remaining maturities:



|                             |  |       |  
|---------------------------- |  | ----- | -
|Less than 3 months           |  | 37.6  | %
|3 months to less than 1 year |  | 37.2  | %
|1 year to less than 2 years  |  | 23.1  | %
|2 years to less than 3 years |  | 2.1   | %
|Greater than 3 years         |  |      |  
|                             |  |       |  
|                             |  | 100.0 | %



|NOTE 6. | LONG-TERM OBLIGATIONS AND WAREHOUSE LOANS
|------- | -----------------------------------------



We finance our residential real estate loans using long-term debt (obligations due on pass-through certificates or bonds) through securitizations. The
interest rates on the long-term debt are variable and are based upon the interest rates on the underlying loan collateral. The maturities on the long-term debt are also based upon the maturities of the underlying mortgages. Principal is paid on the
debt following receipt of principal payments on the loans. The scheduled maturities of the debt extend to June 2034. At June 30, 2004, whole loans with a face value of approximately $401 million have been pledged as collateral for the long-term
debt.



We have entered into whole loan financing facilities to
finance our residential loan acquisitions prior to securitization. The whole loan financing facilities are short-term borrowings that are secured by the loans and bear interest rates that have historically had their basis on LIBOR. At June 30, 2004,
loans with a face value of approximately $350 million have been pledged as collateral under these facilities.



|NOTE 7. | FAIR VALUES OF FINANCIAL INSTRUMENTS
|------- | ------------------------------------



Fixed-rate MBS, ARM securities and other residual interest 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 we 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 nature of these instruments.



The following table of the estimated fair value of financial instruments as of June 30, 2004 is made by using available market information, historical
data, and appropriate valuation methodologies. However, considerable judgment is required to interpret market and historical data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of
the amounts we could realize in a current market exchange.



13



---

The use of different market assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts.



|                                                     |  |                              |         |                      |   |        
|---------------------------------------------------- |  | ---------------------------- | ------- | -------------------- | - | -------
|                                                     |  | June 30, 2004 (in thousands)
|                                                     |  | CarryingAmount               |         | Estimated Fair Value
|Residential real estate loans pending securitization |  | $                            | 349,705 |                      | $ | 346,759
|Residential real estate loans securitized            |  |                              | 639,206 |                      |   | 625,726
|Long-term debt                                       |  |                              | 401,075 |                      |   | 395,803



These fair value
estimates as of June 30, 2004 are based on pertinent information available to management as of the respective dates. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have
not been revalued for purposes of these consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.



The following describes the methods and assumptions used in estimating fair
values:



Residential real estate loans are based on the present
value of expected future cash flows using assumptions based on historical experience, industry information and estimated rates of future prepayment and credit loss.



Long-term debt obligations due on pass-through certificates are based on dealers quotes.



|NOTE 8. | PUBLIC OFFERINGS AND CAPITAL STOCK
|------- | ----------------------------------



On May 11, 2004, we filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission, or SEC, offering up to $300 million of
our capital stock. The registration statement was declared effective on May 25, 2004. As of June 30, 2004, all of this amount remained available for issuance under the registration statement.



In February 2004, we filed with the SEC an amended and restated Dividend
Reinvestment and Stock Purchase Plan, primarily to increase the number of shares authorized under our predecessor plan. The plan allows shareholders and non-shareholders to purchase shares of our common stock and to reinvest dividends in additional
shares of our common stock. During the six-month period ended June 30, 2004, we issued 2,847,983 shares of common stock under the plan, resulting in proceeds to us of approximately $35.6 million.



Our 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 our board of directors.



|NOTE 9. | TRANSACTIONS WITH AFFILIATES
|------- | ----------------------------



Anworth 2002 Incentive Compensation Plan



Under our 2002 Incentive Compensation Plan, eligible employees have the opportunity to earn incentive compensation for each fiscal quarter. The total
aggregate amount of compensation that may be earned by all employees equals a percentage of taxable net income, before incentive compensation, in excess of the amount that would produce an annualized return on average net worth equal to the Ten-Year
US Treasury Rate plus 1%, or the Threshold Return.



The 2002
Incentive Compensation Plan contains a high water mark provision requiring that in any fiscal quarter in which our taxable net income is an amount less than the amount necessary to earn the Threshold Return, we will calculate negative
incentive compensation for that fiscal quarter which will be carried forward and will offset future incentive compensation earned under the plan, but only with respect to those participants who were participants during the fiscal quarter(s) in which
negative incentive compensation was generated.



14



---

The percentage of taxable net income in excess of the Threshold Return earned under the plan by all
employees is calculated based on our quarterly average net worth as defined in the Incentive Compensation Plan. The percentage rate used in this calculation is based on a blended average of the following tiered percentage rates:



| |  | 25% for the first $50 million of average net worth;
| | - | ---------------------------------------------------



| |  | 15% for the average net worth between $50 million and $100 million;
| | - | -------------------------------------------------------------------



| |  | 10% for the average net worth between $100 million and $200 million;
| | - | --------------------------------------------------------------------



| |  | 5% for the average net worth in excess of $200 million.
| | - | -------------------------------------------------------



The 2002 Incentive Compensation Plan requires that we pay all amounts earned thereunder each quarter (subject to offset for accrued negative incentive
compensation), and we will be required to pay a percentage of such amounts to certain of our executives pursuant to the terms of their employment agreements. For the quarter ended June 30, 2004, eligible employees under the 2002 Incentive
Compensation Plan earned $456,985 in incentive compensation.



Employment Agreements



Pursuant to the terms
of employment agreements with us, Lloyd McAdams serves as our President, Chairman and Chief Executive Officer, Joseph E. McAdams serves as our Chief Investment Officer and Executive Vice President, and Heather U. Baines serves as our Executive Vice
President. Pursuant to the terms of an addendum to his original employment agreement, Lloyd McAdams receives a base salary of $600,000 per annum. Pursuant to the terms of an addendum to his original employment agreement, Joseph McAdams receives a
base salary equal to $400,000 per annum. Heather U. Baines receives a $50,000 annual base salary. The terms of the employment agreements are for three years following June 13, 2002 and automatically renew for one-year terms unless written notice is
provided by either party six months prior to the end of the current term.



These employment agreements also have the following provisions:



| |  | the three executives are entitled to participate in our 2002 Incentive Compensation Plan and each of these individuals are provided a minimum percentage of the amounts earned under
such plan. Lloyd McAdams is entitled to 45% of all amounts paid under the plan; Joseph E. McAdams is entitled to 25% of all amounts paid under the plan; and Heather U. Baines is entitled to 5% of all amounts paid under the plan. The three executives
may be paid up to 50% of their respective incentive compensation earned under such plan in the form of our common stock;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the incentive compensation plan may not be amended without the consent of the three executives;
| | - | -----------------------------------------------------------------------------------------------



| |  | in the event of a registered public offering of our shares, the three executives are entitled to piggyback registration rights in connection with such offering;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | in the event any of the three executives is terminated without cause, or if they terminate for good reason, or in the case of Lloyd McAdams or Joseph
McAdams, their employment agreements are not renewed, then the executives would be entitled to (1) all base salary due under the contracts, (2) all discretionary bonus due under the contracts, (3) a lump sum payment of an amount equal to three years
of the executives then-current base salary, (4) payment of COBRA medical coverage for eighteen months, (5) immediate vesting of all pension benefits, (6) all incentive compensation to which the executives would have been entitled to under the
contract prorated through the termination date, and (7) all expense reimbursements and benefits due and owing the executives through the termination. In addition, under these circumstances, Lloyd McAdams and Joseph McAdams would each be entitled to
a lump sum payment equal to 150% of the greater of (i) the highest amount paid or payable to all employees under the 2002 Incentive Compensation Plan during any one of the three fiscal years prior to their termination, and (ii) the highest amount
paid, or that would be payable, under the plan during any of the three fiscal years following their termination. Ms. Baines would also be entitled to a lump sum payment equal to all incentive compensation that Ms. Baines would have been entitled to
under the plan during the three year period following her termination;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the three executives received restricted stock grants of 20,000 shares each, which grants vest in equal, annual installments over ten years beginning June 13, 2002; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the three executives are each subject to a one-year non-competition provision following termination of their employment.
| | - | ------------------------------------------------------------------------------------------------------------------------



As of June 30, 2004, the value of the 54,000 unvested shares of restricted
stock issued to the above executives is reflected on our balance sheet as a reduction to stockholders equity. This amount is being amortized to expense over the ten-year restricted period until such shares vest and is accounted for as unearned
restricted stock.



15



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Agreements with Pacific Income Advisers, Inc.



On June 13, 2002, we entered into a sublease with Pacific Income Advisers,
Inc., or PIA, a company owned by a trust controlled by certain of our officers.



Under the sublease, we lease 5,500 square feet of office space from PIA and pay at a rate equal to PIAs obligation, currently $45.36 per square foot. The sublease runs through June 30, 2012 unless earlier
terminated pursuant to the master lease. During the three months ended June 30, 2004, we paid $62,363 in rent to PIA under the sublease which is included in Other Expenses on the Statements of Operations.



The future minimum lease commitment is as follows:



|                  |  |      |         |      |   |         |  |      |         |            |   |                 |  |   |           |  |   |          
|----------------- |  | ---- | ------- | ---- | - | ------- |  | ---- | ------- | ---------- | - | --------------- |  | - | --------- |  | - | ---------
|Year              |  | 2004 |         | 2005 |   | 2006    |  | 2007 |         | Thereafter |   | TotalCommitment
|Commitment Amount |  | $    | 132,234 |      | $ | 264,660 |  | $    | 272,580 |            | $ | 280,775         |  | $ | 1,209,890 |  | $ | 2,160,139



On October 14, 2002,
we entered into an administrative agreement with PIA. Under the administrative agreement, PIA provides administrative services and equipment to us in the nature of accounting, human resources, operational support and information technology, and we
pay an annual fee of 7 basis points on the first $225 million of stockholder equity and 3.5 basis points thereafter (paid quarterly in advance) for those services. The administrative agreement is for an initial term of one year and will renew for
successive one year terms thereafter unless either party gives notice of termination at least 90 days before the expiration of the then-current annual term. We may also terminate the administrative agreement upon 30 days notice for any reason and
immediately if there is a material breach by PIA. Included in Other Expenses on the Statement of Operations are fees of $64,467 paid to PIA in connection with this agreement during the three months ended June 30, 2004. During the three
months ended June 30, 2003, we paid fees of $60,555 to PIA in connection with this agreement.



Belvedere Trust Mortgage Corporation



On November 3, 2003, we formed a wholly-owned subsidiary called Belvedere Trust Mortgage Corporation, or Belvedere Trust. Belvedere Trust was formed as a qualified REIT subsidiary to acquire and own mortgage loans,
with a focus on the high credit-quality jumbo adjustable rate, hybrid and second-lien mortgage markets. Belvedere Trust was also formed with the intent of securitizing the mortgage loans it acquires and selling mortgage-backed securities in the
capital markets. Since its formation, Belvedere Trust has become an increasingly important part of our overall operations and, as of June 30, 1004, Belvedere Trusts assets comprised 20.8% of our overall assets. Through June 30, 2004, we had
made an investment of approximately $61 million in Belvedere Trust to capitalize its mortgage operations and our board of directors had authorized additional capital contributions of up to $39 million to Belvedere Trust, for a total commitment of
$100 million.



On November 3, 2003, we also formed BT
Management Company, L.L.C., or BT Management, a Delaware limited liability company that is owned 50% by us, 27.5% by Claus Lund, the Chief Executive Officer of Belvedere Trust, 17.5% by Russell J. Thompson, the Chief Financial Officer of Belvedere
Trust, and 5% by Lloyd McAdams, our Chairman and Chief Executive Officer. BT Management has entered into a management agreement with Belvedere Trust pursuant to which BT Management will manage the day-to-day operations of Belvedere Trust in exchange
for an annual base management fee and a quarterly incentive fee. The annual base management fee is equal to 1.15% of the first $300 million of average net invested assets (as defined in the management agreement), plus 0.85% of the portion above $300
million. The incentive fee for each fiscal quarter is equal to 20% of the amount of net income of Belvedere Trust, before incentive compensation, for such 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 management agreement requires that Belvedere Trust pay all amounts earned thereunder each quarter (subject to offset for accrued negative incentive
compensation). For the quarter ended June 30, 2004, Belvedere Trust paid BT Management incentive compensation of $229,000.



Certain of our executive officers serve as officers and directors of Belvedere Trust and officers and managers of BT Management. BT Management has also
entered into employment agreements with Messrs. Lund and Thompson whereby Mr. Lund serves as the President of BT Management and Mr. Thompson serves as Executive Vice President and Treasurer of BT Management. The employment agreements are for a term
of three years and automatically renew for one-year terms unless written notice is provided by either party ninety days prior to the end of the current term.



16



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Deferred Compensation Plan



On January 15, 2003, we adopted the Anworth Mortgage Asset Corporation Deferred Compensation Plan, or the Deferred
Compensation Plan, which permits our eligible officers to defer the payment of all or a portion of their cash compensation in excess of the $1,000,000 annual limitation on deductible compensation imposed by Section 162(m) of the Code. Under this
limitation, compensation paid to our chief executive officer and our four other highest paid officers is not deductible by us for income tax purposes to the extent the amount paid to any such officer exceeds $1,000,000 in any calendar year, unless
such compensation qualifies as performance-based compensation under Section 162(m). Our board of directors designates the eligible officers who may participate in the Deferred Compensation Plan from among the group consisting of our chief executive
officer and our other four highest paid officers. To date, the board has designated Lloyd McAdams, our President, Chairman and Chief Executive Officer, and Joseph McAdams, our Executive Vice President and Chief Investment Officer, as the only
officers who may participate in the Deferred Compensation Plan. Each eligible officer becomes a participant in the Deferred Compensation Plan by making a written election to defer the payment of cash compensation. With certain limited exceptions,
the election must be filed with us before January 1 of the calendar year in which the compensation will be deferred. The election is effective for the entire calendar year and may not be terminated or modified for that calendar year. If a
participant wishes to defer compensation in a subsequent calendar year, a new deferral election must be made before January 1 of that year.



Amounts deferred under the Deferred Compensation Plan are not being paid to the participant as earned, but are credited to a bookkeeping account
maintained by us in the name of the participant. The balance in the participants account is credited with earnings at a rate of return equal to the annual dividend yield on our common stock. Each participant is a general unsecured creditor of
our company with respect to all amounts deferred under the plan.



|NOTE 10. | STOCK OPTION PLAN
|-------- | -----------------



At our May 27, 2004 annual stockholder meeting, we adopted the Anworth Mortgage Asset Corporation 2004 Equity Compensation Plan, or the Stock Option Plan,
which amends and restates our 1997 Stock Option and Awards Plan. The Stock Option Plan which authorized the grant of options to purchase, as of June 30, 2004, an aggregate of up to 3,500,000 of the outstanding shares of our common stock. The plan
authorizes our board of directors, or a committee of our board, to grant incentive stock options, as defined under section 422 of the Internal Revenue Code of 1986, as amended, options not so qualified, dividend equivalent rights, and stock
appreciation rights. 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. The Stock Option Plan does not provide for
automatic annual increases in the aggregate share reserve or the number of shares remaining available for grant.



|NOTE 11. | HEDGING INSTRUMENTS
|-------- | -------------------



At June 30, 2004, we were a counter-party to swap agreements, which are derivative instruments as defined by FAS 133 and FAS 138, with an aggregate
notional amount of $400 million and an average maturity of 4.2 years. We utilize swap agreements to manage interest rate risk and do not anticipate entering into derivative transactions for speculative or trading purposes. In accordance with the
swap agreements, we will pay a fixed rate of interest during the term of the swap agreements and receive a payment that varies with the three-month LIBOR rate. During the three months ended June 30, 2004, the unrealized gains on our swap agreements
increased by $6,076,000.



As of June 30, 2004, there were
unrealized gains of $7,026,000 on our swap agreements included in Other Comprehensive Income and on the consolidated balance sheet as fair value of hedge instruments. In addition, we had a cash collateral balance of $9,052,000 included in Cash and
Cash Equivalents with a corresponding liability for the same amount included in Accrued Expenses and Other as of June 30, 2004.



At June 30, 2004, the open position on the Eurodollar futures for Belvedere Trust was $1,372,000 and the open forward loan purchase commitment was
$298,000. Belvedere Trust recognized a net unrealized gain of $423,000 and a realized gain of $103,000 on the Eurodollar futures and forward loan purchase commitments during the three months ended June 30, 2004.



During the quarter ended June 30, 2004, we also entered in Eurodollar
transactions in order to mitigate the impact of rising interest rates on planned securitization funding. There is usually a time difference between the date we enter into an agreement to purchase whole loans and the date on which we fix the interest
rates paid for securitization financing. We are exposed to interest rate fluctuations during this period. In order to mitigate this risk, we hedge our position using Eurodollar futures. Once the financing rates on the securitization are fixed, we
remove the hedge positions.



|NOTE 12. | SUBSEQUENT EVENTS
|-------- | -----------------



On July 2, 2004, we declared a dividend of $0.33 per share which is payable on August 11, 2004 to our holders of record as of the close of business on
July 27, 2004. The ex-dividend date was July 23, 2004.



On July
30, 2004, we completed our fourth securitization of jumbo hybrid adjustable-rate mortgages through our subsidiary, BT Finance. The total amount of the securities underwritten by Countrywide Securities Corporation was approximately $387,000,000.



17



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ANWORTH MORTGAGE ASSET CORPORATION



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------



Cautionary Statement



You should read the following discussion and analysis in conjunction with the financial statements and related notes thereto contained elsewhere in this
report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various
disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission, or SEC, including our Annual Report on Form 10-K for the year ended December 31, 2003 and our Registration Statement on Form S-3 filed
with the SEC on May 11, 2004, that discuss our business in greater detail.



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



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.



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 June 30, 2004, our qualified REIT assets (real estate assets,
as defined in the Code, cash and cash items and government securities) were greater than 99% of our total assets, as compared to the Code requirement that at least 75% of our total assets must be qualified REIT assets. As of June 30, 2004, greater
than 99% of our 2003 revenue qualified 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 Code.



On November 3, 2003, we formed a wholly-owned subsidiary called Belvedere Trust Mortgage Corporation, or Belvedere Trust. Belvedere Trust was formed as a
qualified REIT subsidiary to acquire and own mortgage loans, with a focus on the high credit-quality jumbo adjustable rate, hybrid and second-lien mortgage markets. Belvedere Trust was also formed with the intent of securitizing the mortgage loans
it acquires and selling mortgage-backed securities in the capital markets. Since its formation, Belvedere Trust has become an increasingly important part of our overall operations and, as of June 30, 1004, Belvedere Trusts assets comprised
20.8% of our overall assets. Through June 30, 2004, we had made an investment of approximately $61 million in Belvedere Trust to capitalize its mortgage operations and our board of directors had authorized additional capital contributions of up to
$39 million to Belvedere Trust, for a total commitment of $100 million. Belvedere Trust is externally managed by BT Management Company, L.L.C., or BT Management, a Delaware limited liability company that is owned 50% by us, 27.5% by Claus Lund, the
Chief Executive Officer of Belvedere Trust, 17.5% by Russell J. Thompson, the Chief Financial Officer of Belvedere Trust, and 5% by Lloyd McAdams, our Chairman and Chief Executive Officer. BT Management manages Belvedere Trust through a management
agreement with Belvedere Trust pursuant to which BT Management manages the day-to-day operations of Belvedere Trust in exchange for an annual base management fee and a quarterly incentive fee.



Belvedere Trusts business involves the acquisition, securitization and
management of residential real estate loans. Belvedere Trust acquires mortgage loans for investment. Mortgage loans may be purchased from various suppliers of mortgage-related assets throughout the United States, including savings and loan
associations, banks, mortgage bankers and other mortgage lenders. It may acquire mortgage loans directly from originators and from entities holding mortgage loans originated by others. Belvedere Trust is in the process of building up a diversified
network of loan sellers. Belvedere Trusts loan sourcing will determine the quality, consistency and volume of loans.



18



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Belvedere Trust targets the types and attributes of the mortgage loans it seeks to acquire and holds
these mortgage loans until a sufficient quantity has been accumulated for securitization into high-quality mortgage-backed securities.



Results of Operations



Three Months Ended June 30, 2004 Compared to June 30, 2003



For the three months ended June 30, 2004, our net income was $12,190,000, or $0.27 per diluted share, based on an average of
45,101,000 shares outstanding. For the three months ended June 30, 2003, our net income was $13,572,000, or $0.45 per diluted share, based on an average of 30,147,000 shares outstanding.



Net interest income for the three months ended June 30, 2004 totaled $13,558,000, or 41% of total interest income, compared
to $13,568,000, or 56% of total interest income, for the three months ended June 30, 2003. Net interest income is comprised of the interest income earned on mortgage investments, net of premium amortization, less interest expense from borrowings and
does not include realized capital gains or losses. As a result of investing the proceeds of our common stock offerings, our assets and borrowings have increased significantly during the past year.



The decrease in net interest income and the percentage of total interest
income during the three months ended June 30, 2004 compared to the three months ended June 30, 2003 resulted from an increase in the speed of prepayments and an increase in our cost of borrowings. For the quarter ended June 30, 2004, our mortgage
assets were paid down at an approximate average annualized constant prepayment rate, or CPR, of 42% compared to 40% for the quarter ended June 30, 2003. As a result, we amortized our premiums over a shorter time period. Reverse repurchase borrowings
during the quarter ended June 30, 2004 and June 30, 2003 had a weighted average cost of 1.74% and 1.59% respectively.



For the three months ended June 30, 2004, our operating expenses decreased to $1,871,000, or 5.7% of total interest income, from $2,135,000, or 8.8% of
total interest income, for the three months ended June 30, 2003. This decrease was due primarily to a decrease in incentive fees, although the provision for credit losses, compensation and other expenses have increased.



Six Months Ended June 30, 2004 Compared to June 30, 2003



For the six months ended June 30, 2004, our net income was $30,063,000,
or $0.68 per diluted share, based on an average of 44,463,000 shares outstanding. For the six months ended June 30, 2003, our net income was $25,394,000, or $0.91 per diluted share, based on an average of 28,052,000 shares outstanding.



Net interest income for the six months ended June 30, 2004 totaled
$33,864,000 or 50% of total interest income, compared to $26,684,000, or 56% of total interest income, for the six months ended June 30, 2003. Net interest income is comprised of the interest income earned on mortgage investments, net of premium
amortization, less interest expense from borrowings and does not include realized capital gains or losses. As a result of investing the proceeds of our common stock offerings, our assets and borrowings have increased significantly during the past
year. This has resulted in a large increase in our income and interest expense compared to last year.



For the six months ended June 30, 2004, our operating expenses increased, in absolute terms, to $4,207,000, or 6.2% of total interest income, from
$4,081,000, or 8.6% of total interest income, for the six months ended June 30, 2003. This increase was due primarily to an increase in the provision for compensation, credit losses and other expenses.



Financial Condition



At June 30, 2004, we held agency mortgage assets whose amortized cost was approximately $3.98 billion, consisting primarily
of $3.7 billion of adjustable-rate mortgage-backed securities, $22 million of floating rate CMOs and $235 million of fixed-rate mortgage-backed securities. This amount represents an approximate 6% decrease from the $4.25 billion held at December 31,
2003. Of the adjustable-rate agency mortgage-backed securities owned by us, 36% were adjustable-rate pass-through certificates whose coupons reset within one year. The remaining 64% consisted of hybrid adjustable-rate mortgage-backed securities
whose coupons will reset between one year and five years. Hybrid adjustable-rate mortgage-backed securities have an initial interest rate that is fixed for a certain period, usually three to five years, and thereafter adjust annually for the
remainder of the term of the loan.



19



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The following table presents a schedule of agency mortgage-backed securities at fair value owned at June
30, 2004 and December 31, 2003, classified by type of issuer (dollar amounts in thousands):



|                                        |  |                  |           |                     |                      |   |            |   |                     |  |       |  
|--------------------------------------- |  | ---------------- | --------- | ------------------- | -------------------- | - | ---------- | - | ------------------- |  | ----- | -
|                                        |  | At June 30, 2004 |           |                     | At December 31, 2003 |  
|Agency                                  |  | Fair Value       |           | PortfolioPercentage |                      |   | Fair Value |   | PortfolioPercentage | 
|Fannie Mae (FNM)                        |  | $                | 2,880,729 |                     | 72.6                 | % |            | $ | 2,984,941           |  | 70.3  | %
|Freddie Mac (FHLMC)                     |  |                  | 923,292   |                     | 23.3                 | % |            |   | 1,059,517           |  | 25.0  | %
|Ginnie Mae (GNMA)                       |  |                  | 161,607   |                     | 4.1                  | % |            |   | 201,395             |  | 4.7   | %
|                                        |  |                  |           |                     |                      |   |            |   |                     |  |       |  
|Total agency mortgage-backed securities |  | $                | 3,965,628 |                     | 100.0                | % |            | $ | 4,245,853           |  | 100.0 | %
|                                        |  |                  |           |                     |                      |   |            |   |                     |  |       |  



The following table
classifies our portfolio of agency mortgage-backed securities owned at June 30, 2004 and December 31, 2003, by type of interest rate index (dollar amounts in thousands):



|                                        |  |                  |           |                     |                      |   |            |   |                     |  |       |  
|--------------------------------------- |  | ---------------- | --------- | ------------------- | -------------------- | - | ---------- | - | ------------------- |  | ----- | -
|                                        |  | At June 30, 2004 |           |                     | At December 31, 2003 |  
|Index                                   |  | Fair Value       |           | PortfolioPercentage |                      |   | Fair Value |   | PortfolioPercentage | 
|One-month LIBOR                         |  | $                | 22,158    |                     | 0.6                  | % |            | $ | 30,184              |  | 0.7   | %
|Six-month LIBOR                         |  |                  | 29,207    |                     | 0.7                  | % |            |   | 17,131              |  | 0.4   | %
|One-year LIBOR                          |  |                  | 1,508,151 |                     | 38.0                 | % |            |   | 1,439,064           |  | 33.9  | %
|Six-month Certificate of Deposit        |  |                  | 7,424     |                     | 0.2                  | % |            |   | 8,831               |  | 0.2   | %
|Six-month Constant Maturity Treasury    |  |                  | 1,752     |                     | 0.1                  | % |            |   | 1,874               |  | 0     | %
|One-year Constant Maturity Treasury     |  |                  | 2,078,754 |                     | 52.4                 | % |            |   | 2,241,179           |  | 52.8  | %
|Cost of Funds Index                     |  |                  | 91,613    |                     | 2.3                  | % |            |   | 105,854             |  | 2.5   | %
|Fixed-Rate                              |  |                  | 226,569   |                     | 5.7                  | % |            |   | 401,736             |  | 9.5   | %
|                                        |  |                  |           |                     |                      |   |            |   |                     |  |       |  
|Total agency mortgage-backed securities |  | $                | 3,965,628 |                     | 100.0                | % |            | $ | 4,245,853           |  | 100.0 | %
|                                        |  |                  |           |                     |                      |   |            |   |                     |  |       |  



The fair values
indicated do not include interest earned but not yet paid. With respect to our hybrid ARMs, the fair value of these securities appears on the line associated with the index based on which the security will eventually reset, once the initial fixed
interest rate period has expired.



Our total portfolio had a
weighted average coupon of 4.20% as of June 30, 2004. The average coupon of the adjustable-rate securities was 4.07%, the hybrid average coupon was 4.23%, the CMO floaters average coupon was 2.05% and the average coupon of the fixed-rate securities
was 5.12%. The weighted average coupon on whole loans which we have securitized was 4.12% at quarter end.



At June 30, 2004, the unamortized net premium paid for our mortgage-backed securities was $109 million.



We analyze our mortgage-backed securities and the extent to which prepayments
impact the yield of the securities. When the rate of prepayments exceeds 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.



As of June 30, 2004, the average amortized cost of our agency mortgage-related assets was 102.83%, the average amortized
cost of the adjustable-rate securities was 102.83% and the average amortized cost of the fixed-rate securities was 102.83%. As of June 30, 2004, the average interest rate on outstanding repurchase agreements was 1.58% and the average days to
maturity was 230 days. After adjusting for interest rate swap transactions, the average interest rate on outstanding repurchase agreements was 1.78% and the average days to maturity was 379 days.



Residential real estate loans held for securitization and held in
securitization trusts are reflected in the financial statements at their cost.



|                                 |  |                                                   |         |                                          |   |                                   |  |   |        
|-------------------------------- |  | ------------------------------------------------- | ------- | ---------------------------------------- | - | --------------------------------- |  | - | -------
|Residential Real Estate Loans    |  | ResidentialReal EstateLoans PendingSecuritization |         | Residential RealEstate Loans,Securitized |   | Total ResidentialReal EstateLoans
|Principal balance                |  | $                                                 | 349,127 |                                          | $ | 634,032                           |  | $ | 983,159
|Unamortized premium and expenses |  |                                                   | 578     |                                          |   | 5,174                             |  |   | 5,752  
|                                 |  |                                                   |         |                                          |   |                                   |  |   |        
|Carrying value                   |  | $                                                 | 349,705 |                                          | $ | 639,206                           |  | $ | 988,911
|                                 |  |                                                   |         |                                          |   |                                   |  |   |        
|Fair value                       |  | $                                                 | 346,759 |                                          | $ | 625,726                           |  | $ | 972,484
|                                 |  |                                                   |         |                                          |   |                                   |  |   |        



20



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As of June 30, 2004, residential real estate loans consisted of the following:



|                                                         |  |                   |  |                 |  |              |  |                              |         |                            |   |                              |  |   |  
|-------------------------------------------------------- |  | ----------------- |  | --------------- |  | ------------ |  | ---------------------------- | ------- | -------------------------- | - | ---------------------------- |  | - | -
|                                                         |  |                   |  |                 |  |              |  | June 30, 2004 (in thousands) |         |                           
|Loan Description                                         |  | Interest RateType |  | Interest Rate   |  | MaturityDate |  | PrincipalBalance             |         | DelinquentBalance(30 Days) |   | DelinquentBalance (60 Days+)
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 3-Year Hybrid     |  | 2.875%  7.000% |  | 2033-2034    |  | $                            | 298,073 |                            | $ | 1,360                        |  | $ | 
|                                                         |  |                   |  |                 |  |              |  |                              |         |                            |   |                              |  |   |  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 5-Year Hybrid     |  | 3.375%  6.250% |  | 2033-2034    |  |                              | 490,947 |                            |   | 2,266                        |  |   | 
|                                                         |  |                   |  |                 |  |              |  |                              |         |                            |   |                              |  |   |  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 7-Year Hybrid     |  | 3.750%  6.625% |  | 2033-2034    |  |                              | 185,112 |                            |   |                             |  |   | 
|                                                         |  |                   |  |                 |  |              |  |                              |         |                            |   |                              |  |   |  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 10-Year Hybrid    |  | 4.500%  6.750% |  | 2034-2034    |  |                              | 9,027   |                            |   |                             |  |   | 
|                                                         |  |                   |  |                 |  |              |  |                              |         |                            |   |                              |  |   |  
|                                                         |  |                   |  |                 |  |              |  | $                            | 983,159 |                            | $ | 3,626                        |  | $ | 
|                                                         |  |                   |  |                 |  |              |  |                              |         |                            |   |                              |  |   |  



|                                    |  |               |  
|----------------------------------- |  | ------------- | -
|Geographic Concentration            |  | June 30, 2004 |  
|Southern California                 |  | 35            | %
|Northern California                 |  | 26            | %
|Illinois                            |  | 6             | %
|Florida                             |  | 3             | %
|Washington                          |  | 3             | %
|Colorado                            |  | 2             | %
|Virginia                            |  | 2             | %
|New York                            |  | 2             | %
|Nevada                              |  | 2             | %
|Michigan                            |  | 2             | %
|Massachusetts                       |  | 2             | %
|Other States (none greater than 2%) |  | 15            | %
|                                    |  |               |  
|Total:                              |  | 100           | %



Fair values were
estimated using pricing models employed in pricing the loans for acquisition and updated for interest rates as of June 30, 2004.



Our residential real estate loan portfolio of $989 million as of June 30, 2004 includes $350 million of loans pending securitization and $639 million in
loans which have been securitized. The securitized residential real estate loans serve as collateral for $401 million of long-term debt and $202 million of repurchase agreements financing. Belvedere Trust structures securitization transactions
primarily through non-qualified special purpose entities (such as real estate mortgage investment conduit, or REMIC, trusts). The principal business activity involves issuing various series of long-term debt (in the form of pass-through certificates
or bonds collateralized by residential real estate loans). The collateral specific to each long-term debt series is the sole source of repayment of the debt and, therefore, our exposure to loss is limited to our net investment in the collateral.



At June 30, 2004, Belvedere Trust owned approximately $350
million in loans held for securitization. This figure includes the face amount of the mortgages, as well as accrued interest and premium or discount. The loans consist of adjustable-rate single-family residential mortgages with initial fixed-rate
periods of three to ten years.



21



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Hedging



We periodically enter into derivative transactions, in the form of forward purchase commitments and interest rate swaps, which are intended to hedge our
exposure to rising rates on funds borrowed to finance our investments in securities. We designate these transactions as cash flow hedges. We also enter into derivative transactions, in the form of forward purchase commitments, which are not
designated as hedges. To the extent that we enter into hedging transactions to reduce our interest rate risk on indebtedness incurred to acquire or carry real estate assets, any income or gain from the disposition of hedging transactions should be
qualifying income for purposes of the 95% gross income test, but not the 75% gross income test.



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. At June 30, 2004, we were a counter-party to swap agreements, which are derivative instruments as defined by FAS 133 and FAS 138, with an aggregate notional amount of $400 million and a maturity of 4.2 years. We
utilize swap agreements to manage interest rate risk and do not anticipate entering into derivative transactions for speculative or trading purposes. In accordance with the swap agreements, we pay a fixed rate of interest during the term of the swap
agreements and receive a payment that varies with the three-month LIBOR rate. At June 30, 2004, there were unrealized gains of $7,026,000 and realized gains of $7,000 on our swap agreements.



During the quarter ended June 30, 2004, we also entered into Eurodollar
transactions in order to mitigate the impact of rising interest rates on planned securitization funding. There is usually a time difference between the date we enter into an agreement to purchase whole loans and the date on which we fix the interest
rates paid for securitization financing. We are exposed to interest rate fluctuations during this period. In order to mitigate this risk, we hedge our position using Eurodollar futures. Once the financing rates on the securitization are fixed, we
remove the hedge positions. In accordance with FAS 133, we account for the change in value of the mortgage loan cash flows, the commitments to purchase loans and the change in value of the hedge instruments. The difference between these changes in
value is included in income during the current period. For the six months ended June 30, 2004, there were recognized gains of $329,000 on Eurodollar futures contracts, of which $525,000 were recognized gains during the quarter ended June 30, 2004.



Liquidity and Capital Resources



Our primary source of funds consists of repurchase agreements, which totaled
$3.79 billion at June 30, 2004. Our other significant source of funds for the three months ended June 30, 2004 consisted of payments of principal from our mortgage securities portfolio in the amount of $571 million and $31 million from our
residential real estate loans.



As of June 30, 2004, all of our
repurchase agreements were fixed-rate term repurchase agreements with original maturities ranging from one to twenty-seven months. On June 30, 2004, we had borrowing arrangements with 20 different financial institutions and had borrowed funds under
repurchase agreements with 13 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 reduced 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. We had adequate cash flow, liquid assets and
unpledged collateral with which to meet our margin requirements during the quarter ended June 30, 2004.



In the future, we expect that our primary sources of funds will continue to consist of borrowed funds under repurchase agreement transactions with one to
twenty-four 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.



On April 21, 2004, we entered into a sales agreement with Cantor Fitzgerald
& Co. to sell up to 6.0 million shares of common stock from time to time through a controlled equity offering program under which Cantor will act as sales agent. Sales of the shares will be made on the New York Stock Exchange by means of
ordinary brokers transactions at market prices and through privately negotiated transactions.



During the six months ended June 30, 2004, we had raised approximately $36 million in capital under our Dividend Reinvestment and Stock Purchase Plan.



As of June 30, 2004, we have entered into commitments to
purchase mortgage loans in the amount of $245 million. Of this amount, approximately $77 million in mortgages were acquired in July and subsequently securitized on July 30, 2004.



22



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We have entered into whole loan lending facilities which provide for up to $500 million in financing
secured by single family mortgage loans. At June 30, 2004, we had borrowed $336 million under the facilities, secured by $350 million in mortgage loans held for securitization.



Off-Balance Sheet and Contractual Arrangements



Management has addressed the issues of off-balance sheet contractual obligations and has determined that all such
obligations are reflected on the financial statements. In addition, management has also determined that all reverse repurchase agreements and employment obligations under contract and lease commitments are also fully disclosed on the financial
statements (refer to Note 9).



Stockholders Equity



We use available-for-sale treatment for our agency mortgage-backed
securities which are carried on our balance sheet at fair value rather than historical cost. Real estate loans are carried at historical cost. Based upon these treatments, our equity base at June 30, 2004 was $486 million, or $10.66 per share, which
includes the $0.33 per share dividend declared on July 2, 2004.



Under 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 on all of our assets. As a result, comparisons with some companies that use historical cost accounting for 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 reduce 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 loss on available-for-sale agency securities was $48.6 million or 1.2% of the amortized cost of agency mortgage-backed securities at June 30, 2004.



Critical Accounting Policies



Management has the obligation to ensure that its policies and methodologies
are in accordance with generally accepted accounting principles. Management has reviewed and evaluated its critical accounting policies and believes them to be appropriate.



The preparation of financial statements in accordance with generally accepted accounting principles requires management to
make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included
in the financial statements, giving due consideration to materiality. We do not believe that there is a great likelihood that materially different amounts would be reported related to accounting policies described below. Nevertheless, application of
these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.



Our accounting policies are described in Note 1 to our financial statements. Management believes the more significant of
these to be as follows:



Revenue Recognition



The most significant source of our revenue is derived from our
investments in mortgage-backed securities. We reflect income using the effective yield method, which, through amortization of premiums and accretion of discounts at an effective yield, recognizes periodic income over the estimated life of the
investment on a constant yield basis, as adjusted for estimated prepayment activity. Management believes our revenue recognition policies are appropriate to reflect the substance of the underlying transactions.



Interest income on our mortgage-backed securities is accrued based on the
actual coupon rate and the outstanding principal amount of the underlying mortgages. Premiums and discounts are amortized or accreted into interest income over the expected lives of the securities using the effective interest yield method adjusted
for the effects of estimated prepayments based on the Statement of Financial Accounting Standards, or SFAS, No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases, an amendment of FASB Statements No. 13, 60, and 65 and a rescission of FASB Statement No. 17. Our policy for estimating prepayments speeds for calculating the effective yield is to evaluate historical



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performance, street consensus prepayment speeds and current market conditions. If our estimate of prepayments is incorrect, we may be required to make an
adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income.



Valuation of Investment Securities



We carry our investment securities on the balance sheet at fair value. The fair values of our mortgage-backed securities are generally based on market
prices provided by certain dealers who make markets in such securities. The fair values of other marketable securities are obtained from the last reported sale of such securities on its principal exchange or, if no representative sale is reported,
the mean between the closing bid and ask prices. If, in the opinion of management, one or more securities prices reported to us are not reliable or unavailable, management estimates the fair value based on characteristics of the security it receives
from the issuer and available market information. The fair values reported reflect estimates and may not necessarily be indicative of the amounts we could realize in a current market exchange. Losses on securities classified as available-for-sale,
which are determined by management to be other than temporary in nature, are reclassified from accumulated other comprehensive income to current operations.



Income Taxes



Other than Belvedere Trust Finance Corporation, BT Finance, as noted below, our financial results do not reflect provisions for current or deferred income
taxes. Management believes that we have and intend to continue to operate in a manner that will continue to allow us to be taxed as a REIT and as a result does not expect to pay substantial corporate level taxes. Many of these requirements, however,
are highly technical and complex. If we were to fail to meet these requirements, we would be subject to federal income tax.



BT Finance, our indirect wholly-owned subsidiary, is a taxable REIT subsidiary may be liable for corporate income tax expenses.



Subsequent Events



On July 2, 2004, we declared a dividend of $0.33 per share which is payable on August 11, 2004 to our holders of record as
of the close of business on July 27, 2004. The ex-dividend date is July 23, 2004.



On July 30, 2004, Belvedere Trust completed its fourth securitization of jumbo hybrid adjustable-rate mortgages through its subsidiary, BT Finance. The total amount of the securities underwritten by Countrywide
Securities Corporation was approximately $387,000,000.



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RISK FACTORS



An investment in our stock involves a number of risks. Before making a decision to purchase our securities, you should
carefully consider all of the risks described in this quarterly report. If any of the risks discussed in this quarterly report actually occur, our business, financial condition and results of operations could be materially adversely affected. If
this were to occur, the trading price of our securities could decline significantly and you may lose all or part of your investment.



Risk Related to Our Business



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



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



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



The interest rates on our borrowings generally adjust more frequently than the interest rates on our adjustable-rate mortgage-backed securities. For
example, on June 30, 2004, our adjustable-rate mortgage-backed securities had a weighted average term to next rate adjustment of approximately 19 months, while our borrowings had a weighted average term to next rate adjustment of 230 days. After
adjusting for interest rate swap transactions, the weighted average term to next rate adjustment was 379 days. Accordingly, in a period of rising interest rates, we could experience a decrease in net income or a net loss because the interest rates
on our borrowings adjust faster than the interest rates on our adjustable-rate mortgage-backed securities.



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



We generally fund our acquisition of fixed-rate mortgage-backed securities with short-term borrowings. During periods of
rising interest rates, our costs associated with borrowings used to fund acquisition of fixed-rate assets are subject to increases while the income we earn from these assets remains substantially fixed. This reduces or could eliminate the net
interest spread between the fixed-rate mortgage-backed securities that we purchase and our borrowings used to purchase them, which could lower our net interest income or cause us to suffer a loss. On June 30, 2004, 6% of our mortgage-backed
securities were fixed-rate securities.



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



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



| |  | We usually 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 pay a
premium over the par value to acquire the security. In accordance with accounting rules, we amortize this premium over the term of the mortgage-backed security. If the mortgage-backed security is prepaid in whole or in part prior to its maturity
date, however, we expense the premium that was prepaid at the time of the prepayment. On June 30, 2004, substantially all of our mortgage-backed securities were acquired at a premium.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We anticipate that a substantial portion of our adjustable-rate mortgage-backed securities may bear interest rates that are lower than their fully indexed rates, which are
equivalent to the applicable index rate plus a margin. If an adjustable-rate mortgage-backed security is prepaid prior to or soon after the time of adjustment to a fully-indexed rate, we will have held that mortgage-backed security while it was less
profitable and lost the opportunity to receive interest at the fully indexed rate over the remainder of its expected life.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



Our officers devote a portion of their time to another company in capacities that could
create conflicts of interest that may adversely affect our investment opportunities; this lack of a full-time commitment could also adversely affect our operating results.



Lloyd McAdams, Joseph E. McAdams, Bistra Pashamova and other of our officers and employees are officers and employees of
Pacific Income Advisers, Inc., or PIA, where they devote a portion of their time. These officers and employees are under no contractual obligations mandating minimum amounts of time to be devoted to our company. In addition, a trust controlled by
Lloyd McAdams and Heather U. Baines is the principal stockholder of PIA.



These officers and employees are involved in investing both our assets and approximately $3.7 billion in mortgage-backed securities and other fixed income assets for institutional clients and individual investors
through PIA. These multiple responsibilities and ownerships may create conflicts of interest if these officers and employees of our company are presented with opportunities that may benefit both us and the clients of PIA. These officers allocate
investments among our portfolio and the clients of PIA by determining the entity or account for which the investment is most suitable. In making this determination, these officers consider the investment strategy and guidelines of each entity or
account with respect to acquisition of assets, leverage, liquidity and other factors that our officers determine appropriate. These officers, however, have no obligation to make any specific investment opportunities available to us and the above
mentioned conflicts of interest may result in decisions or allocations of securities that are not in our best interests.



Several of our officers and employees are also directors, officers and managers of BT Management Company, L.L.C., the company that manages the day-to-day
operations of Belvedere Trust, our newly formed mortgage loan subsidiary, and Lloyd McAdams is also an owner and officer of Syndicated Capital, a registered broker-dealer. Our officers service to PIA, BT Management Company, L.L.C. and
Syndicated Capital allow them to spend only part of their time and effort managing our company as they are required to devote a portion of their time and effort to the management of other companies and this may adversely affect our overall
management and operating results.



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



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



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



| |  | the movement of interest rates;
| | - | -------------------------------



| |  | the availability of financing in the market; and
| | - | ------------------------------------------------



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



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



Our adjustable-rate mortgage-backed securities are
subject to periodic and lifetime interest rate caps. Periodic interest rate caps limit the amount an interest rate can increase during any given period. Lifetime interest rate caps limit the amount an interest rate can increase through maturity of a
mortgage-backed security. Our borrowings are not subject to similar restrictions. Accordingly, in a period of rapidly increasing interest rates, the interest rates paid on our borrowings could increase without limitation while interest rate caps
would limit the interest rates on our adjustable-rate mortgage-backed securities. This problem is magnified for our adjustable-rate mortgage-backed securities that are not fully indexed. Further, some adjustable-rate mortgage-backed securities may
be subject to periodic payment caps that result in a portion of the interest being deferred and added to the principal outstanding. As a result, we could receive less cash income on adjustable-rate mortgage-backed securities than we need to pay
interest on our related borrowings. These factors could lower our net interest income or cause us to suffer a loss during periods of rising interest rates. On June 30, 2004, approximately 94% of our mortgage-backed securities were adjustable-rate
securities.



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Our leveraging strategy increases the risks of our operations.



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



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



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



| |  | A default of a mortgage-related asset that constitutes collateral for a loan could also result in an involuntary liquidation of the mortgage-related asset. This would result in a
loss to us of the difference between the value of the mortgage-related asset upon liquidation and the amount borrowed against the mortgage-related asset.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



Our
policies permit us to enter into interest rate swaps, caps and floors and other derivative transactions to help us reduce our interest rate and prepayment risks described above. We have made limited use of these types of instruments as discussed
under Hedging above. This strategy saves us the additional costs of such hedging transactions, but it leaves us exposed to the types of risks that such hedging transactions would be designed to reduce. If we decide to enter into
additional derivative transactions in the future, these transactions may mitigate our interest rate and prepayment risks but cannot eliminate these risks. Additionally, the use of derivative transactions could have a negative impact on our earnings.



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



Increases in interest rates may negatively affect the
market value of our mortgage-related assets. Our fixed-rate securities are generally more negatively affected by these increases. In accordance with accounting rules, we reduce our book value by the amount of any decrease in the market value of our
mortgage-related assets. Losses on securities classified as available-for sale which are determined by management to be other than temporary in nature are reclassified from accumulated other comprehensive income to current operations.



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



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



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



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



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basis. Moreover, we depend on a limited number of lenders to provide the primary credit facilities for our purchases of mortgage-related assets.



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



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



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



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



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



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



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



Our business may be significantly harmed by a slowdown in the economy of California.



As of June 30, 2004, approximately 60% of the residential real estate loans that we own or credit enhance are secured by
property in California. An overall decline in the economy or the residential real estate market, or the occurrence of a natural disaster that is not covered by standard homeowners insurance policies, such as an earthquake, could decrease the
value of mortgaged properties in California. This, in turn, would increase the risk of delinquency, default or foreclosure on real estate loans in our residential loan portfolios. This could adversely affect our credit loss experience and other
aspects of our business, including our ability to securitize real estate loans.



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



We depend on the diligence, experience and skill of our officers and other employees for the selection, structuring and monitoring of our mortgage-related
assets and associated borrowings. Our key officers include Lloyd McAdams, President, Chairman and Chief Executive Officer, Joseph E. McAdams, Chief Investment Officer, Executive Vice President and Director, Thad Brown, Chief Financial Officer, and
Bistra Pashamova, Vice President. Belvedere Trusts key officers are Claus Lund and Russell Thompson. Our dependence on our key personnel is heightened by the fact that we have a relatively small number of employees, and the loss of any key
person could harm our entire business, financial condition, cash flow and results of operations. In particular, the loss of the services of Lloyd McAdams or Joseph E. McAdams could seriously harm our business.



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



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



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Our incentive compensation plan may create an incentive to increase the risk of our mortgage portfolio in an
attempt to increase compensation.



In addition to their
base salaries, management and key employees are eligible to earn incentive compensation for each fiscal year pursuant to our incentive compensation plan. Under the plan, the aggregate amount of compensation that may be earned by all employees equals
a percentage of taxable net income, before incentive compensation, in excess of the amount that would produce an annualized return on average net worth equal to the ten-year US Treasury Rate plus 1%. In any fiscal quarter in which our taxable net
income is an amount less than the amount necessary to earn this threshold return, we calculate negative incentive compensation for that fiscal quarter which will be carried forward and will offset future incentive compensation earned under the plan,
but only with respect to those participants who were participants during the fiscal quarter(s) in which negative incentive compensation was generated. Although negative incentive compensation is used to offset future incentive compensation, as our
management evaluates different mortgage-backed securities for our investment, there is a risk that management will cause us to assume more risk than is prudent.



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



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



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



Our mortgage-backed securities have primarily been agency certificates
that, although not rated, carry an implied AAA rating. agency certificates are mortgage-backed securities where either Freddie Mac or Fannie Mae guarantees payments of principal or interest on the certificates. Freddie Mac and Fannie Mae
are government-sponsored enterprises and securities guaranteed by these entities are not guaranteed by the United States government. Our capital investment policy, however, provides us with the ability to acquire a material amount of lower credit
quality mortgage-backed securities. If we acquire mortgage-backed securities of lower credit quality, our profitability may decline and we may incur losses if there are defaults on the mortgages backing those securities or if the rating agencies
downgrade the credit quality of those securities or the securities of Fannie Mae and Freddie Mac. Belvedere Trust invests in non-agency securities, some of which are rated AAA, some of which carry lower ratings and some of which are not
rated.



We have not previously engaged in the business of acquiring and
securitizing whole mortgage loans and we may not be successful.



Belvedere Trust was formed as our subsidiary in 2003 to engage in the business of acquiring and securitizing whole mortgage loans. Although we hired a management team that we believe has appropriate experience managing the acquisition and
securitization of whole loans, we have never engaged in this particular business and we may not be successful. The acquisition of whole loans and the securitization process are inherently complex and involve risks related to the types of mortgages
we seek to acquire, interest rate changes, funding sources, delinquency rates, borrower bankruptcies and other factors that we may not be able to manage. Incorrect management of these risks may take years to become apparent. Our failure to manage
these and other risks could have a material adverse effect on our business and results of operations.



Belvedere Trusts investment strategy of acquiring, accumulating and securitizing loans involves credit risk.



While Belvedere Trust intends to securitize the loans that it acquires into high quality assets in order to achieve better financing rates and to
improve its access to financing, it bears the risk of loss on any loans that its acquires or originates and which it subsequently securitizes. Belvedere Trust acquires loans that are not credit enhanced and that do not have the backing of Fannie Mae
or Freddie Mac. Accordingly, it is subject to risks of borrower default, bankruptcy and special hazard losses (such as those occurring from earthquakes) with respect to those loans to the extent that there is any deficiency between the value of the
mortgage collateral and insurance and the principal amount of the loan. In the event of a default on any such loans that it holds, Belvedere Trust would bear the loss of principal between the value of the mortgaged property and the outstanding
indebtedness, as well as the loss of interest. We have not established any limits upon the geographic concentration or the credit quality of suppliers of the mortgage-related assets that we acquire.



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Belvedere Trust requires a significant amount of cash, and if it is not available, the business and financial
performance of Belvedere Trust will be significantly harmed.



Belvedere Trust requires substantial cash to fund its loan acquisitions, to pay its loan acquisition expenses and to hold its loans prior to securitization. Belvedere Trust also needs cash to meet its working capital and other needs.
Pending sale or securitization of a pool of mortgage loans, Belvedere Trust acquires mortgage loans that it expects to finance through borrowings from warehouse lines of credit and repurchase facilities. It is possible that Belvedere Trusts
warehouse lenders could experience changes in their ability to advance funds to Belvedere Trust, independent of the performance of Belvedere Trust or its loans. We anticipate that Belvedere Trusts repurchase facilities will be dependent on the
ability of counter-parties to re-sell Belvedere Trusts obligations to third parties. If there is a disruption of the repurchase market generally, or if one of Belvedere Trusts counter-parties is itself unable to access the repurchase
market, Belvedere Trusts access to this source of liquidity could be adversely affected. Cash could also be required to meet margin calls under the terms of Belvedere Trusts borrowings in the event that there is a decline in the market
value of the loans that collateralize its debt, the terms of short-term debt become less attractive, or for other reasons. Any of these events would have a material adverse effect on Belvedere Trust.



We have invested $61 million in Belvedere Trust to capitalize its mortgage
operations, and our board of directors has authorized additional capital contributions to Belvedere Trust of $39 million. If Belvedere Trust fully invests all of the proceeds of our investments in it prior to the point at which Belvedere Trust can
access external sources of capital, , if it ever can, then Belvedere Trust will need to either restructure the securities supporting its portfolio, require additional capital from us or, if it is unable to sell additional securities on reasonable
terms or at all, it will need to either reduce its acquisition business or sell a higher portion of its loans. In the event that Belvedere Trusts liquidity needs exceed its access to liquidity, it may need to sell assets at an inopportune
time, thus reducing its earnings. Adverse cash flow could threaten Belvedere Trusts ability to maintain its solvency or to satisfy the income and asset tests necessary to elect and maintain REIT status.



The use of securitizations with over-collateralization requirements may have a negative
impact on Belvedere Trusts cash flow.



If
Belvedere Trust utilizes over-collateralization as a credit enhancement to its securitizations, it expects that such over-collateralization will restrict its cash flow if loan delinquencies exceed certain levels. The terms of its securitizations
generally provide that, if certain delinquencies and/or losses exceed the specified levels based on rating agencies (or the financial guaranty insurers, if applicable) analysis of the characteristics of the loans pledged to collateralize
the securities, the required level of over-collateralization may be increased or may be prevented from decreasing as would otherwise be permitted if losses and/or delinquencies did not exceed those levels. Other tests (based on delinquency levels or
other criteria) may restrict Belvedere Trusts ability to receive net interest income from a securitization transaction. We cannot assure you that the performance tests will be satisfied. Failure to satisfy performance tests may materially and
adversely affect the availability of net excess income to Belvedere Trust.



The success of Belvedere Trusts business will depend upon its ability to ensure that loans to be held in its securitizations are serviced effectively.



The success of Belvedere Trusts mortgage loan business will depend to a great degree upon its ability to ensure that
its loans held for securitization are serviced effectively. In general, it is the intention of Belvedere Trust to acquire loans servicing retained, where the loans will be serviced by the originating or selling institution. Belvedere
Trust has no experience servicing a portfolio of loans. If Belvedere Trust is required to purchase the servicing of a loan portfolio in order to acquire a portfolio with desirable attributes, Belvedere Trust will be required to sell the servicing
rights, implement a servicing function or contract with a third party to service the loans in order for Belvedere Trust to implement its strategy. We cannot assure that Belvedere Trust will be able to service the loans or effectively supervise a
sub-servicing relationship according to industry standards. Failure to service the loans properly will harm Belvedere Trusts business and operating results. Prior to either building the servicing capabilities that Belvedere Trust may require
or acquiring an existing servicing operation that has such capabilities, if ever, Belvedere Trust anticipates contracting with an experienced servicer of non-conforming loans to sub-service its loans. The fees paid to a subservicer will
reduce to a certain extent the revenue Belvedere Trust is able to retain from its loans, and its net interest income will be reduced and at risk, depending on the effectiveness of the servicing company.



If actual prepayments or defaults with respect to mortgages serviced occurs more
quickly than originally assumed, the value of Belvedere Trusts mortgage servicing rights would be subject to downward adjustment.



If Belvedere Trust acquires the servicing rights to mortgage loans and subsequently retains the servicing right separately from the loans, the allocated
cost of the servicing rights will be reflected on its financial statements. To determine the fair value of these servicing rights, Belvedere Trust will use assumptions to estimate future net servicing income including projected discount rates,
mortgage loan prepayments and credit losses. If actual prepayments or defaults with respect to loans serviced occur more quickly than Belvedere Trust originally assumed, Belvedere Trust would have to reduce the carrying value of its mortgage
servicing rights. There us no guarantee that Belvedere Trusts assumptions will prove correct.



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Belvedere Trust is externally managed and this may diminish or eliminate our return on our investment in this line
of business.



Belvedere Trust is externally managed
pursuant to a management agreement between Belvedere Trust and BT Management Company, L.L.C., or BT Management. Although we own 50% of BT Management, it is also owned 27.5% by Claus Lund, the Chief Executive Officer of Belvedere Trust, 17.5% by
Russell J. Thompson, the Chief Financial Officer of Belvedere Trust and 5% by Lloyd McAdams, our Chairman and Chief Executive Officer. Our ability to generate profits from our ownership of Belvedere Trust, if any, could be greatly diminished due to
the fact that we will be required to pay a base management fee to BT Management and we may also be required to pay an incentive fee. An externally managed structure may not optimize our interest in Belvedere Trust and, if we are unable to properly
manage fixed costs at Belvedere Trust could, when combined with the base management fee, result in losses at Belvedere Trust.



Our Chairman has an ownership interest in BT Management that creates potential conflicts of interest.



Mr. McAdams, our Chairman and Chief Executive Officer, has a direct ownership
interest in BT Management that creates potential conflicts of interest. Mr. McAdams is Chairman of the Board and Chief Executive Officer and a member of the Board of Managers of BT Management and owns an equity interest in BT Management. Under the
management agreement between Belvedere Trust and BT Management, BT Management is entitled to earn certain incentive compensation based on the level of Belvedere Trusts annualized net income. In evaluating mortgage assets for investment and
with respect to other management strategies, an undue emphasis on the maximization of income at the expense of other criteria could result in increased risk to the value of our portfolio.



Risks Related to REIT Compliance and Other Matters



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



We believe that since our initial public offering in
1998 we have operated so as to qualify as a REIT under the Internal Revenue Code of 1986, as amended, or the Code, and we intend to continue to meet the requirements for taxation as a REIT. Nevertheless, we may not remain qualified as a REIT in the
future. Qualification as a REIT involves the application of highly technical and complex Code provisions for which only a limited number of judicial or administrative interpretations exist. Even a technical or inadvertent mistake could jeopardize
our REIT status. Furthermore, Congress or the IRS might change tax laws or regulations and the courts might issue new rulings, in each case potentially having retroactive effects that could make it more difficult or impossible for us to qualify as a
REIT. If we fail to qualify as a REIT in any tax year, then:



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



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



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



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



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



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



The REIT provisions of the Code may substantially limit our ability to hedge mortgage-backed securities and related borrowings by requiring us to limit
our income in each year from qualified hedges, together with any other income not generated from qualified REIT real estate assets, to less than 25% of our gross income. In addition, we must limit our aggregate income from hedging and services from
all sources, other than from qualified REIT real estate assets or qualified hedges, to less than 5% of our annual gross income. As a result, we may in the future have to limit our use of advantageous hedging techniques. This could result in greater
risks associated with changes in interest rates than we would otherwise want to incur. If we were to violate the 25% or 5% limitations, we may have to pay a penalty tax equal to the amount of income in excess of those limitations, multiplied by a
fraction intended to reflect our profitability. If we fail to satisfy the 25% and 5% limitations, unless our failure was due to reasonable cause and not due to willful neglect, we could lose our REIT status for federal income tax purposes.



31



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



In order to qualify as a REIT, we must also ensure that at the end of each
calendar quarter at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets. The remainder of our investment in securities generally cannot include more than 10% of the
outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets can consist of the securities of any one issuer.
The 5% and 10% limitations described above will apply to our investment in Belvedere Trust unless Belvedere Trust is a qualified REIT subsidiary of ours (i.e., we own 100% of Belvedere Trusts outstanding stock), Belvedere Trust is a qualified
REIT or Belvedere Trust is a taxable REIT subsidiary of ours. If we fail to comply with these requirements, we must dispose of a portion of our assets within 30 days after the end of the calendar quarter in order to avoid losing our REIT status and
suffering adverse tax consequences.



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



As a REIT, we must distribute 90% of our annual taxable income (subject to certain adjustments) to our stockholders. From time to time, we may generate taxable income greater than our net income for financial reporting purposes from, among
other things, amortization of capitalized purchase premiums, or our taxable income may be greater than our cash flow available for distribution to stockholders. For example, our taxable income would exceed our net income for financial reporting
purposes to the extent that compensation paid to our chief executive officer and our other four highest paid officers exceeds $1,000,000 for any such officer for any calendar year under Section 162(m) of the tax code. Since payments under our 2002
Incentive Compensation Plan do not qualify as performance-based compensation under Section 162(m), a portion of the payments made under the plan to certain of our officers would not be deductible for federal income tax purposes under such
circumstances. If we do not have other funds available in these situations, we may be unable to distribute substantially all of our taxable income as required by the REIT provisions of the tax code. Thus, we could be required to borrow funds, sell a
portion of our mortgage-backed securities at disadvantageous prices or find another alternative source of funds. These alternatives could increase our costs or reduce our equity.



If Belvedere Trust fails to qualify as a REIT, a qualified REIT subsidiary or a taxable REIT subsidiary, we may lose our REIT status.



As long as we own 100% of Belvedere Trusts
outstanding stock, Belvedere Trust will be treated as a qualified REIT subsidiary for federal income tax purposes. As such, for federal income tax purposes, we will not be treated as owning stock in Belvedere Trust and, Belvedere Trusts
assets, liabilities and income will generally be treated as our assets, liabilities and income for purposes of the REIT qualification tests described above under Certain Federal Income Tax Considerations. If, however, we do not own 100%
of Belvedere Trusts outstanding stock, and Belvedere Trust does not qualify as a REIT or a taxable REIT subsidiary, we will lose our REIT status if, at the end of any calendar quarter, the value of our Belvedere Trust securities exceeds 5% of
the value of our total assets or we own more than 10% of the value or voting power of Belvedere Trusts outstanding securities. If we fail to satisfy the 5% test or the 10% test at the end of any calendar quarter, a 30-day cure
period may apply following the close of the quarter. If we make an election to treat Belvedere Trust as a taxable REIT subsidiary, the total value of any securities we own in Belvedere Trust and all of our other taxable REIT subsidiaries, if any,
may not exceed 20% of the value of our total assets at the end of any calendar quarter. Since Belvedere Trust may elect to be taxed as a REIT in the future, however, we do not intend to make a taxable REIT subsidiary election for Belvedere Trust



If Belvedere Trust fails to qualify as a REIT, Belvedere Trust will be
subject to corporate income taxes on its taxable income which will reduce the amount available for distribution to us.



Though Belvedere Trust was formed as a qualified REIT subsidiary, it may elect to be taxed to be as a REIT in the future, possibly as early as its taxable
year ending December 31, 2004. Although Belvedere Trust expects to operate in a manner to permit it to qualify as a REIT if and when it makes a REIT election and to continue to maintain such qualification, the actual results of Belvedere
Trusts operations for any particular taxable year may not satisfy these requirements. If Belvedere Trust fails to qualify for taxation as a REIT in any taxable year after it makes a REIT election, and the relief provisions of the Code do not
apply, Belvedere Trust will be required to pay tax on Belvedere Trusts taxable income in that taxable year and all subsequent taxable years at regular corporate rates. Distributions to us in any year in which Belvedere Trust fails to qualify
as a REIT will not be deductible by Belvedere Trust. As a result, we anticipate that Belvedere Trusts failure to qualify as a REIT after it makes a REIT election would reduce the cash available for distribution to us. Unless entitled to relief
under specific statutory provisions, if Belvedere Trust fails to maintain its REIT status after it makes a REIT election, Belvedere Trust will also be disqualified from taxation as a REIT for the four taxable years following the year in which it
loses its qualification.



32



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



We believe that we conduct our business in a manner
that allows us to avoid being regulated as an investment company under the Investment Company Act of 1940, as amended. If we fail to continue to qualify for an exemption from registration as an investment company, our ability to use leverage would
be substantially reduced and we would be unable to conduct our business as planned. The Investment Company Act exempts entities that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate. Under the SECs current interpretation, qualification for this exemption generally requires us to maintain at least 55% of our assets directly in qualifying real estate interests. Mortgage-backed securities that
do not represent all the certificates issued with respect to an underlying pool of mortgages may be treated as securities separate from the underlying mortgage loans and thus may not qualify for purposes of the 55% requirement. Therefore, our
ownership of these mortgage-backed securities is limited by the Investment Company Act. In meeting the 55% requirement under the Investment Company Act, we treat as qualifying interests mortgage-backed securities issued with respect to an underlying
pool for which we hold all issued certificates. If the SEC or its staff adopts a contrary interpretation, we could be required to sell a substantial amount of our mortgage-backed securities under potentially adverse market conditions. Further, in
order to maintain our exemption from registration as an investment company, we may be precluded from acquiring mortgage-backed securities whose yield is somewhat higher than the yield on mortgage-backed securities that could be purchased in a manner
consistent with the exemption.



Additional Risk Factors



We may not be able to use the money we raise to acquire investments
at favorable prices.



We intend to seek to raise
additional capital from time to time if we determine that it is in our best interests and the best interests of our stockholders, including through public offerings of our stock. The net proceeds of any offering could represent a significant
increase in our equity. Depending on the amount of leverage that we use, the full investment of the net proceeds of any offering might result in a substantial increase in our total assets. There can be no assurance that we will be able to invest all
of such additional funds in mortgage-backed securities at favorable prices. We may not be able to acquire enough mortgage-backed securities to become fully invested after an offering, or we may have to pay more for mortgage-backed securities than we
have historically. In either case, the return that we earn on stockholders equity may be reduced.



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



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



If we raise additional capital, our earnings per share and dividends per
share may decline since we may not be able to invest all of the new capital during the quarter in which additional shares are sold and possibly the entire following calendar quarter.



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



In general, dividend income that a tax-exempt entity receives from us should
not constitute unrelated business taxable income as defined in Section 512 of the Code. If we realize excess inclusion income and allocate it to stockholders, this income cannot be offset by net operating losses. If the stockholder was a tax-exempt
entity, then this income would be fully taxable as unrelated business taxable income under Section 512 of the Code. If the stockholder was foreign, then it would be subject to federal income tax withholding on this income without reduction pursuant
to any otherwise applicable income-tax treaty. Excess inclusion income could result if we held a residual interest in a real estate mortgage investment conduit, or REMIC. Excess inclusion income also would be generated if we were to issue debt
obligations with two or more maturities and the terms of the payments on these obligations bore a relationship to the payments that we received on our mortgage-backed securities securing those debt obligations. We generally structure our borrowing
arrangements in a manner designed to avoid generating significant amounts of excess inclusion income. We do, however, enter into various repurchase agreements that have differing maturity dates and afford the lender the right to sell any pledged
mortgage securities if we default on our obligations. The IRS may determine that these borrowings give rise to excess inclusion income that should be allocated among stockholders. Furthermore, some types of tax-exempt entities, including, without
limitation, voluntary employee benefit associations and entities that have borrowed funds to acquire their shares of our common stock, may be required to treat a portion of or all of the dividends they may receive from us as unrelated business
taxable income. We also invest in equity securities of other REITs. If we were to receive excess inclusion income from another REIT, we may be required to distribute the excess inclusion income to our stockholders, which may result in the
recognition of unrelated business taxable income.



33



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



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



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



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



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



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



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



| |  | Maryland control share acquisition statute. Maryland law limits the voting rights of control shares of a corporation in the event of a control share
acquisition.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



Issuances of large amounts of our stock
could cause the price of our stock to decline.



We may
issue additional shares of common stock or shares of preferred stock that are convertible into common stock. If we issue a significant number of shares of common stock or convertible preferred stock in a short period of time, there could be a
dilution of the existing common stock and a decrease in the market price of the common stock.



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



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



|Item 3. | Qualitative and Quantitative 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



34



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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 an 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 debt securities with borrowings that have interest rates based on
indices and repricing terms similar to, but of somewhat shorter maturities than, the interest rate indices and repricing terms of our 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
interest 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 the same direction, but there can be
no assurance that this will continue to occur.



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



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



As of June 30, 2004, our agency mortgage-backed securities and borrowings will prospectively reprice based on the following
time frames (dollar amounts in thousands):



|                                           |  |                        |           |                               |            |   |        |   |                              |  |       |  
|------------------------------------------ |  | ---------------------- | --------- | ----------------------------- | ---------- | - | ------ | - | ---------------------------- |  | ----- | -
|                                           |  | Assets                 |           |                               | Borrowings |  
|                                           |  | Amount                 |           | Percentage ofTotalInvestments |            |   | Amount |   | Percentage ofTotalBorrowings | 
|                                           |  | (amounts in thousands) |          
|Investment Type/Rate Reset Dates:          |  |                        |           |                               |            |   |        |   |                              |  |       |  
|Fixed-Rate Investments                     |  | $                      | 226,569   |                               | 5.7        | % |        | $ |                             |  |      |  
|Adjustable-Rate Investments/ Obligations:  |  |                        |           |                               |            |   |        |   |                              |  |       |  
|Less than 3 months                         |  |                        | 222,679   |                               | 5.6        | % |        |   | 1,424                        |  | 37.6  | %
|Greater than 3 months and less than 1 year |  |                        | 1,117,399 |                               | 28.2       | % |        |   | 1,407,302                    |  | 37.2  | %
|Greater than 1 year and less than 2 years  |  |                        | 1,031,824 |                               | 26.0       | % |        |   | 875,835                      |  | 23.1  | %
|Greater than 2 years and less than 3 years |  |                        | 754,489   |                               | 19.0       | % |        |   | 79,250                       |  | 2.1   | %
|Greater than 3 years and less than 5 years |  |                        | 612,668   |                               | 15.5       | % |        |   |                             |  |      |  
|                                           |  |                        |           |                               |            |   |        |   |                              |  |       |  
|Total                                      |  | $                      | 3,965,628 |                               | 100.0      | % |        | $ | 3,786,817                    |  | 100.0 | %
|                                           |  |                        |           |                               |            |   |        |   |                              |  |       |  



Market Value Risk



Substantially all of our mortgage-backed securities and
equity securities are classified as available-for-sale assets. As such, they are reflected at fair value (i.e., market value) with the adjustment to fair value reflected as part of Accumulated Other Comprehensive



35



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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 June 30, 2004, our adjustable-rate
mortgage-backed securities had a weighted average term to next rate adjustment of approximately 19 months, while our borrowings had a weighted average term to next rate adjustment of 230 days. After adjusting for interest rate swap transactions, the
average maturity was 379 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 borrowings as they mature. There can be no assurance
that we will always be able to roll over our short-term debt.



At June 30, 2004, we had unrestricted cash of $10,027,000 available to meet margin calls on short-term borrowings that could be caused by asset value declines or changes in lender collateralization requirements.



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 rates may also be affected by the conditions in the housing and financial markets, general economic conditions and the relative interest rates on fixed-rate and adjustable-rate mortgage
loans underlying mortgage-backed securities. The purchase prices of mortgage-backed securities are generally based upon assumptions regarding the expected amounts and rates of prepayments. Where slow prepayment assumptions are made, we may pay a
premium for mortgage-backed securities. To the extent such assumptions differ from the actual amounts of prepayments, we could experience reduced earnings or losses. The total prepayment of any mortgage-backed securities purchased at a premium by us
would result in the immediate write-off of any remaining capitalized premium amount and a reduction of our net interest income by such amount. Finally, in the event that we are unable to acquire new mortgage-backed securities to replace the prepaid
mortgage-backed securities, our financial condition, cash flows and results of operations could be harmed.



We often purchase mortgage-backed securities that have a higher interest rate than the market interest rate at the time. In exchange for this higher
interest rate, we must pay a premium over par value to acquire these securities. In accordance with accounting rules, we amortize this premium over the term of the mortgage-backed security. As we receive repayments of mortgage principal, we amortize
the premium balances as a reduction to our income. If the mortgage loans underlying a mortgage-backed security were prepaid at a faster rate than we anticipate, we would amortize the premium at a faster rate. This would reduce our income.



Tabular Presentation



The information presented in the table below projects the impact of sudden
changes in interest rates on our annual projected net income and net assets as more fully discussed below based on investments in place on June 30, 2004, and includes all of our interest rate-sensitive assets, liabilities and hedges such as interest
rate Swap Agreements. Changes in net assets equals the change in value of our assets that we carry at fair value rather than at historical amortized cost and any change in the value of any derivative instruments or hedges, such as interest rate Swap
Agreements. 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.



|                         |  |                                                   |  |                                         
|------------------------ |  | ------------------------------------------------- |  | ----------------------------------------
|Change in Interest Rates |  | Projected Percentage Changein Net Interest Income |  | Projected Percentage Changein Net Assets
|-2.0%                    |  | -68%                                              |  | 0.4%                                    
|-1.0%                    |  | -25%                                              |  | 0.8%                                    
|0%                       |  |                                                  |  |                                        
|1.0%                     |  | -11%                                              |  | -2.0%                                   
|2.0%                     |  | -22%                                              |  | -4.6%                                   



Many assumptions are
made to present the information in the above table, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes; therefore, the above table and all related disclosures
constitute



36



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forward-looking statements. The analysis presented utilizes assumptions and estimates based on managements judgment and experience. Furthermore, future
sales, acquisitions and restructuring could materially change our interest rate risk profile. The table quantifies the potential changes in net income and net asset value should interest rates immediately change (are shocked). The
results of interest rate shocks of plus and minus 100 and 200 basis points are presented. The cash flows associated with the portfolio of mortgage-backed securities for each rate shock are calculated based on a variety of assumptions, including
prepayment speeds, time until coupon reset, yield on future acquisitions, slope of the yield curve and size of the portfolio. Assumptions made on the interest-rate sensitive liabilities, which are repurchase agreements, include anticipated interest
rates (no negative rates are utilized), collateral requirements as a percent of the repurchase agreement and amount of borrowing. Assumptions made in calculating the impact on net asset value of interest rate shocks include interest rates,
prepayment rates and the yield spread of mortgage-backed securities relative to prevailing interest rates.



When interest rates are shocked, prepayment assumptions are adjusted based on managements best estimate of the effects of changes in interest rates
on prepayment speeds. For example, under current market conditions, a 100 basis point decline in interest rates is estimated to result in a 98% increase in the prepayment rate of our mortgage-backed securities portfolio. The base interest rate
scenario assumes interest rates at June 30, 2004. Actual results could differ significantly from those estimated in the table.



|Item 4. | Controls and Procedures
|------- | -----------------------



(a) We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14(c) and Rule 15b-14(c) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by
this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us required to be
included in our periodic SEC filings.



(b) There has been no
change in our internal controls over financial reporting during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We did acquire and
implement a portfolio accounting system from Princeton Financial Systems.



Part II. OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------



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



|Item 2. | Changes in Securities and Use of Proceeds
|------- | -----------------------------------------



(a) None



(b) None



(c) None



(d) None



|Item 
3. | Defaults Upon Senior Securities
|-------- | -------------------------------



None



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



We held our annual meeting of stockholders on May 27, 2004 at our offices in Santa Monica, California. At the annual meeting, our stockholders voted on
the following three (3) items:



|(i) | Six nominees for election to our board of directors were elected based upon the following votes:
|--- | ------------------------------------------------------------------------------------------------



|                  |  |            |  |         
|----------------- |  | ---------- |  | --------
|Name              |  | For        |  | Withheld
|Lloyd McAdams     |  | 34,866,749 |  | 289,709 
|Lee A. Ault III   |  | 34,942,426 |  | 214,033 
|Joe E. Davis      |  | 34,943,726 |  | 212,733 
|Charles H. Black  |  | 34,943,504 |  | 212,955 
|Joseph E. McAdams |  | 34,942,192 |  | 214,266 
|Charles F. Smith  |  | 34,943,607 |  | 212,852 



37



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|(ii) | The amendment and restatement of our 1997 Stock Option and Awards Plan by replacing it with the 2004 Equity Compensation Plan was approved as follows:
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------



|           |  |           |  |        
|---------- |  | --------- |  | -------
|For        |  | Against   |  | Abstain
|15,452,305 |  | 1,072,974 |  | 230,339



|(iii) | The ratification of the appointment of BDO Seidman, LLP as our independent accountants and auditors for the fiscal year ending December 31, 2004 was approved as follows:
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|           |  |         |  |        
|---------- |  | ------- |  | -------
|For        |  | Against |  | Abstain
|34,917,349 |  | 113,381 |  | 125,725



|Item 5. | Other Information
|------- | -----------------



On July 2, 2004, we declared a dividend of $0.33 per share which is payable on August 11, 2004 to holders of record as of the close of business on July
27, 2004.



38



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



(a)Exhibits. The following exhibits are either filed herewith or incorporated herein by reference:



|              |  |                                                                                                                                                                                                  
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                      
|              | 
|3.1  (1)      |  | Amended Articles of Incorporation                                                                                                                                                                
|              | 
|3.2  (2)      |  | Articles of Amendment                                                                                                                                                                            
|              | 
|3.3  (1)      |  | Bylaws                                                                                                                                                                                           
|              | 
|4.1  (1)      |  | Specimen Common Stock certificate                                                                                                                                                                
|              | 
|4.2  (3)      |  | Specimen Preferred Stock certificate                                                                                                                                                             
|              | 
|10.1  (2)     |  | 2004 Equity Compensation Plan                                                                                                                                                                    
|              | 
|10.2  (4)     |  | Dividend Reinvestment and Stock Purchase Plan                                                                                                                                                    
|              | 
|10.3  (5)     |  | 2002 Incentive Compensation Plan                                                                                                                                                                 
|              | 
|10.4  (5)     |  | Agreement and Plan of Merger dated April 18, 2002, among Anworth Mortgage Asset Corporation (Anworth), Anworth Mortgage
Advisory Corporation (the Manager) and the shareholder of the Manager
|              | 
|10.5  (6)     |  | Employment Agreement dated January 1, 2002, between the Manager and Lloyd McAdams                                                                                                                
|              | 
|10.6  (6)     |  | Employment Agreement dated January 1, 2002, between the Manager and Heather U. Baines                                                                                                            
|              | 
|10.7  (6)     |  | Employment Agreement dated January 1, 2002, between the Manager and Joseph E. McAdams                                                                                                            
|              | 
|10.8  (6)     |  | Addendum to Employment Agreement dated April 18, 2002, among Anworth, the Manager and Lloyd McAdams                                                                                              
|              | 
|10.9  (6)     |  | Addendum to Employment Agreement dated April 18, 2002, among Anworth, the Manager and Heather U. Baines                                                                                          
|              | 
|10.10(6)      |  | Addendum to Employment Agreement dated April 18, 2002, among Anworth, the Manager and Joseph E. McAdams                                                                                          
|              | 
|10.11         |  | Second Addendum to Employment Agreement dated as of May 28, 2004, between Anworth and Lloyd McAdams                                                                                              
|              | 
|10.12(6)      |  | Second Addendum to Employment Agreement dated as of June 13, 2002, between Anworth and Joseph E. McAdams                                                                                         
|              | 
|10.13         |  | Third Addendum to Employment Agreement dated as of May 28, 2004, between Anworth and Joseph E. McAdams                                                                                           
|              | 
|10.14(6)      |  | Sublease dated June 13, 2002, between Anworth and Pacific Income Advisers, Inc.                                                                                                                  
|              | 
|10.15(7)      |  | Amendment to Sublease dated July 8, 2003, between Anworth and Pacific Income Advisers, Inc.                                                                                                      
|              | 
|10.16(8)      |  | Administrative Agreement dated October 14, 2002, between Anworth and Pacific Income Advisers, Inc.                                                                                               
|              | 
|10.17(9)      |  | Deferred Compensation Plan                                                                                                                                                                       
|              | 
|10.18(10)     |  | BT Management Company, L.L.C. (BT Management) Operating Agreement dated November 3, 2003                                                                                                       



39



---

|          |  |                                                                                                                                                               
|--------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.19(10) |  | Management Agreement dated November 3, 2003 between BT Management and Belvedere Trust Mortgage Corporation                                                    
|          | 
|10.20(10) |  | Employment Agreement dated November 3, 2003 between BT Management and Claus Lund                                                                              
|          | 
|10.21(10) |  | Employment Agreement dated November 3, 2003 between BT Management and Russell J. Thompson                                                                     
|          | 
|10.22(11) |  | Sales Agreement dated April 21, 2004, between Anworth and Cantor Fitzgerald & Co.                                                                             
|          | 
|31.1      |  | Certification of the Chief Executive Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934                                            
|          | 
|31.2      |  | Certification of the Chief Financial Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934                                            
|          | 
|32.1      |  | Certifications of the Chief Executive Officer provided pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|          | 
|32.2      |  | Certifications of the Chief Financial Officer provided pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

---

|(1) | Incorporated by reference from our Registration Statement on Form S-11, Registration No. 333-38641, which became effective under the Securities Act of 1933, as amended (the
Act), on March 12, 1998.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Incorporated by reference from our Definitive Proxy Statement filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as filed with the Securities and Exchange
Commission on April 26, 2004.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Incorporated by reference from our Registration Statement on form S-3, Registration No. 333-85036, which became effective under the Act on June 13, 2002.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Incorporated by reference from Post-Effective Amendment No. 1 to our Registration Statement on Form S-3, Registration No. 333-110744, which became effective under the Act on
February 20, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Incorporated by reference from our Definitive Proxy Statement filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as filed with the Securities Exchange
Commission on May 17, 2002.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, as filed with the Securities and Exchange Commission on August 14, 2002.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(7) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, as filed with the Securities and Exchange Commission on August 8, 2003.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(8) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, as filed with the Securities and Exchange Commission on November 14, 2002.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(9) | Incorporated by reference from our Annual Report on Form 10-K for the year ended December 31, 2002, as filed with the Securities and Exchange Commission on March 26, 2003.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(10) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, as filed with the Securities and Exchange Commission on November 13, 2003.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(11) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, as filed with the Securities and Exchange Commission on May 10, 2004.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



(b)Reports on Form 8-K. We filed the
following current reports on Form 8-K during the quarter ended June 30, 2004:



| |  | On April 13, 2004, we furnished, but did not file, a Current Report on Form 8-K to announce the issuance of our press release announcing our financial results for the quarter ended
March 31, 2004.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



40



---

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/     JOSEPH LLOYD
MCADAMSJoseph Lloyd McAdamsChairman of the Board, President and Chief Executive Officer(authorized officer of registrant)




Dated:    August 9, 2004



/s/     THAD M. BROWNThad M. BrownChief Financial Officer(principal accounting officer)




Dated:    August 9, 2004



41



---

INDEX TO EXHIBITS



|              |  |                                                                                                                                                                                                  
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                      
|              | 
|3.1  (1)      |  | Amended Articles of Incorporation                                                                                                                                                                
|              | 
|3.2  (2)      |  | Articles of Amendment                                                                                                                                                                            
|              | 
|3.3  (1)      |  | Bylaws                                                                                                                                                                                           
|              | 
|4.1  (1)      |  | Specimen Common Stock certificate                                                                                                                                                                
|              | 
|4.2  (3)      |  | Specimen Preferred Stock certificate                                                                                                                                                             
|              | 
|10.1  (2)     |  | 2004 Equity Compensation Plan                                                                                                                                                                    
|              | 
|10.2  (4)     |  | Dividend Reinvestment and Stock Purchase Plan                                                                                                                                                    
|              | 
|10.3  (5)     |  | 2002 Incentive Compensation Plan                                                                                                                                                                 
|              | 
|10.4  (5)     |  | Agreement and Plan of Merger dated April 18, 2002, among Anworth Mortgage Asset Corporation (Anworth), Anworth Mortgage
Advisory Corporation (the Manager) and the shareholder of the Manager
|              | 
|10.5  (6)     |  | Employment Agreement dated January 1, 2002, between the Manager and Lloyd McAdams                                                                                                                
|              | 
|10.6  (6)     |  | Employment Agreement dated January 1, 2002, between the Manager and Heather U. Baines                                                                                                            
|              | 
|10.7  (6)     |  | Employment Agreement dated January 1, 2002, between the Manager and Joseph E. McAdams                                                                                                            
|              | 
|10.8  (6)     |  | Addendum to Employment Agreement dated April 18, 2002, among Anworth, the Manager and Lloyd McAdams                                                                                              
|              | 
|10.9  (6)     |  | Addendum to Employment Agreement dated April 18, 2002, among Anworth, the Manager and Heather U. Baines                                                                                          
|              | 
|10.10(6)      |  | Addendum to Employment Agreement dated April 18, 2002, among Anworth, the Manager and Joseph E. McAdams                                                                                          
|              | 
|10.11         |  | Second Addendum to Employment Agreement dated as of May 28, 2004, between Anworth and Lloyd McAdams                                                                                              
|              | 
|10.12(6)      |  | Second Addendum to Employment Agreement dated as of June 13, 2002, between Anworth and Joseph E. McAdams                                                                                         
|              | 
|10.13         |  | Third Addendum to Employment Agreement dated as of May 28, 2004, between Anworth and Joseph E. McAdams                                                                                           
|              | 
|10.14(6)      |  | Sublease dated June 13, 2002, between Anworth and Pacific Income Advisers, Inc.                                                                                                                  
|              | 
|10.15(7)      |  | Amendment to Sublease dated July 8, 2003, between Anworth and Pacific Income Advisers, Inc.                                                                                                      
|              | 
|10.16(8)      |  | Administrative Agreement dated October 14, 2002, between Anworth and Pacific Income Advisers, Inc.                                                                                               
|              | 
|10.17(9)      |  | Deferred Compensation Plan                                                                                                                                                                       
|              | 
|10.18(10)     |  | BT Management Company, L.L.C. (BT Management) Operating Agreement dated November 3, 2003                                                                                                       
|              | 
|10.19(10)     |  | Management Agreement dated November 3, 2003 between BT Management and Belvedere Trust Mortgage Corporation                                                                                       





---

|          |  |                                                                                                                                                               
|--------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|          | 
|10.20(10) |  | Employment Agreement dated November 3, 2003 between BT Management and Claus Lund                                                                              
|          | 
|10.21(10) |  | Employment Agreement dated November 3, 2003 between BT Management and Russell J. Thompson                                                                     
|          | 
|10.22(11) |  | Sales Agreement dated April 21, 2004, between Anworth and Cantor Fitzgerald & Co.                                                                             
|          | 
|31.1      |  | Certification of the Chief Executive Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934                                            
|          | 
|31.2      |  | Certification of the Chief Financial Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934                                            
|          | 
|32.1      |  | Certifications of the Chief Executive Officer provided pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|          | 
|32.2      |  | Certifications of the Chief Financial Officer provided pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

---

|(1) | Incorporated by reference from our Registration Statement on Form S-11, Registration No. 333-38641, which became effective under the Securities Act of 1933, as amended (the
Act), on March 12, 1998.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Incorporated by reference from our Definitive Proxy Statement filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as filed with the Securities and Exchange
Commission on April 26, 2004.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Incorporated by reference from our Registration Statement on form S-3, Registration No. 333-85036, which became effective under the Act on June 13, 2002.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Incorporated by reference from Post-Effective Amendment No. 1 to our Registration Statement on Form S-3, Registration No. 333-110744, which became effective under the Act on
February 20, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Incorporated by reference from our Definitive Proxy Statement filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as filed with the Securities Exchange
Commission on May 17, 2002.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, as filed with the Securities and Exchange Commission on August 14, 2002.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(7) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, as filed with the Securities and Exchange Commission on August 8, 2003.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(8) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, as filed with the Securities and Exchange Commission on November 14, 2002.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(9) | Incorporated by reference from our Annual Report on Form 10-K for the year ended December 31, 2002, as filed with the Securities and Exchange Commission on March 26, 2003.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(10) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, as filed with the Securities and Exchange Commission on November 13, 2003.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(11) | Incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, as filed with the Securities and Exchange Commission on May 10, 2004.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------