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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, 2005



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 5, 2005, the Registrant had 1,875,500
shares of Series A Cumulative Preferred Stock issued and outstanding and 48,231,312 shares of Common Stock issued and outstanding.



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##### Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION



FORM 10-Q



INDEX



|           |  |                                                                                                                         |  |     
|---------- |  | ----------------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                                         |  | Page
|Part I.    |  | FINANCIAL INFORMATION                                                                                                   |  | 2   
|           |  |                                                                                                                        
|Item 1.    |  | Consolidated Financial Statements                                                                                       |  | 2   
|           |  |                                                                                                                        
|           |  | Consolidated Balance Sheets as of June 30, 2005 (unaudited) and December 31, 2004                                       |  | 2   
|           |  |                                                                                                                        
|           |  | Consolidated Statements of Income for the three and six months ended June 30, 2005 and 2004 (unaudited)                 |  | 3   
|           |  |                                                                                                                        
|           |  | Consolidated Statements of Stockholders Equity for the three months ended March 31, 2005 and June 30, 2005 (unaudited) |  | 4   
|           |  |                                                                                                                        
|           |  | Consolidated Statements of Cash Flows for the three and six months ended June 30, 2005 and 2004 (unaudited)             |  | 5   
|           |  |                                                                                                                        
|           |  | Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2005 and 2004 (unaudited)   |  | 6   
|           |  |                                                                                                                        
|           |  | Notes to Unaudited Consolidated Financial Statements                                                                    |  | 7   
|           |  |                                                                                                                        
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                   |  | 26  
|           |  |                                                                                                                        
|Item 3.    |  | Qualitative and Quantitative Disclosures About Market Risk                                                              |  | 52  
|           |  |                                                                                                                        
|Item 4.    |  | Controls and Procedures                                                                                                 |  | 56  
|           |  |                                                                                                                        
|Part II.   |  | OTHER INFORMATION                                                                                                       |  | 56  
|           |  |                                                                                                                        
|Item 1.    |  | Legal Proceedings                                                                                                       |  | 56  
|           |  |                                                                                                                        
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                             |  | 56  
|           |  |                                                                                                                        
|Item 3.    |  | Defaults Upon Senior Securities                                                                                         |  | 56  
|           |  |                                                                                                                        
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                                     |  | 56  
|           |  |                                                                                                                        
|Item 5.    |  | Other Information                                                                                                       |  | 56  
|           |  |                                                                                                                        
|Item 6.    |  | Exhibits                                                                                                                |  | 58  
|           | 
|Signatures |  | 60                                                                                                                     



i



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##### Table of Contents

Part I. FINANCIAL INFORMATION



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



ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)



|                                                                                                                                                                                               |  |              |           |   |                  |   |           |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | --------- | - | ---------------- | - | --------- | -
|                                                                                                                                                                                               |  | June 30,2005 |           |   | December 31,2004 |  
|                                                                                                                                                                                               |  | (unaudited)  |           |   |                  |  
|ASSETS                                                                                                                                                                                         |  |              |           |   |                  |   |           |  
|Agency mortgage-backed securities:                                                                                                                                                             |  |              |           |   |                  |   |           |  
|Agency mortgage-backed securities pledged to counterparties at fair value                                                                                                                      |  | $            | 4,470,551 |   |                  | $ | 4,362,779 |  
|Agency mortgage-backed securities at fair value                                                                                                                                                |  |              | 288,793   |   |                  |   | 225,762   |  
|                                                                                                                                                                                               |  |              |           |   |                  |   |           |  
|                                                                                                                                                                                               |  |              | 4,759,344 |   |                  |   | 4,588,541 |  
|Other mortgage-backed securities pledged to counterparties at fair value                                                                                                                       |  |              | 71,227    |   |                  |   | 63,470    |  
|Residential real estate loans                                                                                                                                                                  |  |              | 3,125,781 |   |                  |   | 2,628,334 |  
|Allowance for loan losses                                                                                                                                                                      |  |              | (1,161    | ) |                  |   | (591      | )
|Cash and cash equivalents                                                                                                                                                                      |  |              | 1,050     |   |                  |   | 3,042     |  
|Restricted cash                                                                                                                                                                                |  |              | 1,250     |   |                  |   | 1,250     |  
|Interest and dividends receivable                                                                                                                                                              |  |              | 33,724    |   |                  |   | 28,141    |  
|Derivative instruments at fair value                                                                                                                                                           |  |              | 7,689     |   |                  |   | 6,399     |  
|Prepaid expenses and other                                                                                                                                                                     |  |              | 3,641     |   |                  |   | 484       |  
|                                                                                                                                                                                               |  |              |           |   |                  |   |           |  
|                                                                                                                                                                                               |  | $            | 8,002,545 |   |                  | $ | 7,319,070 |  
|                                                                                                                                                                                               |  |              |           |   |                  |   |           |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                           |  |              |           |   |                  |   |           |  
|Liabilities:                                                                                                                                                                                   |  |              |           |   |                  |   |           |  
|Accrued interest payable                                                                                                                                                                       |  | $            | 34,704    |   |                  | $ | 23,244    |  
|Repurchase agreements (Anworth Mortgage)                                                                                                                                                       |  |              | 4,284,170 |   |                  |   | 4,172,930 |  
|Repurchase agreements (Belvedere Trust)                                                                                                                                                        |  |              | 527,254   |   |                  |   | 544,506   |  
|Whole loan financing facilities                                                                                                                                                                |  |              | 32,289    |   |                  |   | 556,233   |  
|Mortgage-backed securities issued                                                                                                                                                              |  |              | 2,533,712 |   |                  |   | 1,494,851 |  
|Junior subordinated notes                                                                                                                                                                      |  |              | 37,380    |   |                  |   |          |  
|Derivative instruments at fair value                                                                                                                                                           |  |              | 1,091     |   |                  |   | 2,278     |  
|Dividends payable                                                                                                                                                                              |  |              | 1,011     |   |                  |   | 12,924    |  
|Accrued expenses and other                                                                                                                                                                     |  |              | 5,562     |   |                  |   | 4,837     |  
|                                                                                                                                                                                               |  |              |           |   |                  |   |           |  
|                                                                                                                                                                                               |  | $            | 7,457,173 |   |                  | $ | 6,811,803 |  
|                                                                                                                                                                                               |  |              |           |   |                  |   |           |  
|Minority interest                                                                                                                                                                              |  |              | 249       |   |                  |   | 231       |  
|Stockholders equity:                                                                                                                                                                          |  |              |           |   |                  |   |           |  
|Series A cumulative preferred stock, par value $0.01 per share, liquidation preference $25.00 per share; authorized 20,000 shares; 1,876 and
1,101 shares issued and outstanding, respectively |  |              | 19        |   |                  |   | 11        |  
|Common stock, par value $0.01 per share; authorized 100,000 shares; 48,026 and 46,497 issued and outstanding, respectively                                                                     |  |              | 480       |   |                  |   | 465       |  
|Additional paid-in capital                                                                                                                                                                     |  |              | 594,118   |   |                  |   | 560,745   |  
|Accumulated other comprehensive loss consisting of unrealized losses                                                                                                                           |  |              | (46,613   | ) |                  |   | (42,598   | )
|Accumulated deficit                                                                                                                                                                            |  |              | (2,325    | ) |                  |   | (10,991   | )
|Unearned restricted stock                                                                                                                                                                      |  |              | (556      | ) |                  |   | (596      | )
|                                                                                                                                                                                               |  |              |           |   |                  |   |           |  
|                                                                                                                                                                                               |  |              | 545,123   |   |                  |   | 507,036   |  
|                                                                                                                                                                                               |  |              |           |   |                  |   |           |  
|                                                                                                                                                                                               |  | $            | 8,002,545 |   |                  | $ | 7,319,070 |  
|                                                                                                                                                                                               |  |              |           |   |                  |   |           |  



See accompanying notes
to consolidated financial statements.



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##### Table of Contents



ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(unaudited)



|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|---------------------------------------------------------------- |  | -------------------------- | ------- | - | ------------------------ | - | ------- | ---- |  | - | -------- | - |  | - | ------- | -
|                                                                 |  | Three months endedJune 30, |         |   | Six months endedJune 30, |  
|                                                                 |  | 2005                       |         |   | 2004                     |   |         | 2005 |  |   | 2004     |  
|Interest income net of amortization of premium and discount      |  | $                          | 70,847  |   |                          | $ | 32,904  |      |  | $ | 137,287  |   |  | $ | 68,150  |  
|Interest expense                                                 |  |                            | (59,663 | ) |                          |   | (19,346 | )    |  |   | (108,425 | ) |  |   | (34,286 | )
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Net interest income                                              |  |                            | 11,184  |   |                          |   | 13,558  |      |  |   | 28,862   |   |  |   | 33,864  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Gain on sale of securities                                       |  |                            |        |   |                          |   | 102     |      |  |   |         |   |  |   | 259     |  
|Net gain on derivative instruments                               |  |                            |        |   |                          |   | 532     |      |  |   |         |   |  |   | 329     |  
|Expenses:                                                        |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Compensation and benefits                                        |  |                            | (894    | ) |                          |   | (470    | )    |  |   | (1,772   | ) |  |   | (866    | )
|Incentive compensation                                           |  |                            | (87     | ) |                          |   | (457    | )    |  |   | (851     | ) |  |   | (1,582  | )
|Provision for loan losses                                        |  |                            | (273    | ) |                          |   | (32     | )    |  |   | (570     | ) |  |   | (32     | )
|Other expenses                                                   |  |                            | (970    | ) |                          |   | (912    | )    |  |   | (2,091   | ) |  |   | (1,727  | )
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Total expenses                                                   |  |                            | (2,224  | ) |                          |   | (1,871  | )    |  |   | (5,284   | ) |  |   | (4,207  | )
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Income from operations before income taxes and minority interest |  |                            | 8,960   |   |                          |   | 12,321  |      |  |   | 23,578   |   |  |   | 30,245  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Income taxes                                                     |  |                            |        |   |                          |   | (28     | )    |  |   |         |   |  |   | (79     | )
|Minority interest in net income of a subsidiary                  |  |                            | (105    | ) |                          |   | (103    | )    |  |   | (241     | ) |  |   | (103    | )
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Net income                                                       |  | $                          | 8,855   |   |                          | $ | 12,190  |      |  | $ | 23,337   |   |  | $ | 30,063  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Dividend on Series A cumulative preferred stock                  |  | $                          | (1,011  | ) |                          | $ |        |      |  | $ | (1,879   | ) |  | $ |        |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Net income available to common stockholders                      |  | $                          | 7,844   |   |                          | $ | 12,190  |      |  | $ | 21,458   |   |  | $ | 30,063  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Basic earnings per share available to common stockholders        |  | $                          | 0.16    |   |                          | $ | 0.27    |      |  | $ | 0.45     |   |  | $ | 0.68    |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Weighted average number of shares outstanding                    |  |                            | 47,637  |   |                          |   | 45,016  |      |  |   | 47,240   |   |  |   | 44,346  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Diluted earnings per share available to common stockholders      |  | $                          | 0.16    |   |                          | $ | 0.27    |      |  | $ | 0.45     |   |  | $ | 0.68    |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  
|Weighted average number of diluted shares outstanding            |  |                            | 47,668  |   |                          |   | 45,101  |      |  |   | 47,274   |   |  |   | 44,463  |  
|                                                                 |  |                            |         |   |                          |   |         |      |  |   |          |   |  |   |         |  



See accompanying notes
to consolidated financial statements.



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##### Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

(in thousands, except per share amounts)

(unaudited)



|                                                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   |         |  
|-------------------------------------------------- |  | -------------------- |  | ----------------- |  | ---------------------- | -- | ------------------- | - | ------------------------ |  | ---------------------------------------------- | ------- |  | ----------------------------------------- | ------- | - | --------------------------------------- | - | ------ | ----------------------- |  | - | ----------------------- | - |  | -------------------------- | ------- | - | ----- | - | ---- | - |  | - | ------- | - |  | - | ------- | -
|                                                   |  | PreferredStockShares |  | CommonStockShares |  | PreferredStockParValue |    | CommonStockParValue |   | AdditionalPaid-InCapital |  | Accum. OtherComp.Income (Loss)AgencySecurities |         |  | Accum.Other Comp. Income(Loss)Derivatives |         |   | Accum. OtherComp.Income (Loss)Other MBS |   |        | Accum.Earnings(Deficit) |  |   | UnearnedRestrictedStock |   |  | ComprehensiveIncome (Loss) |         |   | Total |  
|Balance, December 31, 2004                         |  | 1,101                |  | 46,497            |  | $                      | 11 |                     | $ | 465                      |  | $                                              | 560,745 |  | $                                         | (45,491 | ) |                                         | $ | 4,122  |                         |  | $ | (1,229                  | ) |  | $                          | (10,991 | ) |       | $ | (596 | ) |  |   |        |   |  | $ | 507,036 |  
|Issuance of Series A preferred stock               |  | 660                  |  |                   |  |                        | 7  |                     |   |                          |  |                                                | 16,127  |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   | 16,134  |  
|Issuance of common stock                           |  |                      |  | 663               |  |                        |    |                     |   | 7                        |  |                                                | 6,402   |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   | 6,409   |  
|Other comprehensive income (loss)                  |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           | (22,589 | ) |                                         |   | 6,717  |                         |  |   | (87                     | ) |  |                            |         |   |       |   |      |   |  |   | (15,959 | ) |  |   | (15,959 | )
|Net income                                         |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            | 14,482  |   |       |   |      |   |  |   | 14,482  |   |  |   | 14,482  |  
|                                                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   |         |  
|Total comprehensive loss                           |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  | $ | (1,477  | ) |  |   |         |  
|                                                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   |         |  
|Amortization of restricted stock                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   | 20   |   |  |   |         |   |  |   | 20      |  
|Dividends declared  $0.539063 per preferred share |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            | (868    | ) |       |   |      |   |  |   |         |   |  |   | (868    | )
|                                                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   |         |  
|Balance, March 31, 2005                            |  | 1,761                |  | 47,160            |  | $                      | 18 |                     | $ | 472                      |  | $                                              | 583,274 |  | $                                         | (68,080 | ) |                                         | $ | 10,839 |                         |  | $ | (1,316                  | ) |  | $                          | 2,623   |   |       | $ | (576 | ) |  |   |         |   |  | $ | 527,254 |  
|                                                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   |         |  
|Issuance of Series A preferred stock               |  | 115                  |  |                   |  |                        | 1  |                     |   |                          |  |                                                | 2,827   |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   | 2,828   |  
|Issuance of common stock                           |  |                      |  | 866               |  |                        |    |                     |   | 8                        |  |                                                | 8,017   |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   | 8,025   |  
|Other comprehensive income (loss)                  |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           | 15,589  |   |                                         |   | (4,240 | )                       |  |   | 595                     |   |  |                            |         |   |       |   |      |   |  |   | 11,944  |   |  |   | 11,944  |  
|Net income                                         |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            | 8,855   |   |       |   |      |   |  |   | 8,855   |   |  |   | 8,855   |  
|                                                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   |         |  
|Total comprehensive income                         |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  | $ | 20,799  |   |  |   |         |  
|                                                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   |         |  
|Amortization of restricted stock                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   | 20   |   |  |   |         |   |  |   | 20      |  
|Dividends declared$0.539063 per preferred share   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            | (1,011  | ) |       |   |      |   |  |   |         |   |  |   | (1,011  | )
|Dividends declared$0.27 per common share          |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            | (12,792 | ) |       |   |      |   |  |   |         |   |  |   | (12,792 | )
|                                                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   |         |  
|Balance, June 30, 2005                             |  | 1,876                |  | 48,026            |  | $                      | 19 |                     | $ | 480                      |  | $                                              | 594,118 |  | $                                         | (52,491 | ) |                                         | $ | 6,599  |                         |  | $ | (721                    | ) |  | $                          | (2,325  | ) |       | $ | (556 | ) |  |   |         |   |  | $ | 545,123 |  
|                                                   |  |                      |  |                   |  |                        |    |                     |   |                          |  |                                                |         |  |                                           |         |   |                                         |   |        |                         |  |   |                         |   |  |                            |         |   |       |   |      |   |  |   |         |   |  |   |         |  



See accompanying notes
to consolidated financial statements



4



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##### Table of Contents



ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                  |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|--------------------------------------------------------------------------------- |  | ---------------------------------- | ---------- | - | -------------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                                                  |  | For the three months endedJune 30, |            |   | For the six months endedJune 30, |  
|                                                                                  |  | 2005                               |            |   | 2004                             |   |            | 2005 |  |   | 2004       |  
|Operating Activities:                                                             |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Net income                                                                        |  | $                                  | 8,855      |   |                                  | $ | 12,190     |      |  | $ | 23,337     |   |  | $ | 30,063     |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Amortization of premiums and discounts (Anworth Mortgage)                         |  |                                    | 10,610     |   |                                  |   | 15,739     |      |  |   | 19,760     |   |  |   | 24,939     |  
|Amortization of premiums and discounts (Belvedere Trust)                          |  |                                    | 4,349      |   |                                  |   | 788        |      |  |   | 7,533      |   |  |   | 1,011      |  
|Gain on sales of agency securities                                                |  |                                    |           |   |                                  |   | (102       | )    |  |   |           |   |  |   | (102       | )
|Gain on sales of securities in securitization                                     |  |                                    |           |   |                                  |   |           |      |  |   |           |   |  |   | (157       | )
|Gain on hedging instruments                                                       |  |                                    |           |   |                                  |   | (532       | )    |  |   |           |   |  |   | (329       | )
|Provision for loan losses                                                         |  |                                    | 273        |   |                                  |   | 32         |      |  |   | 570        |   |  |   | 32         |  
|Provision for income taxes                                                        |  |                                    |           |   |                                  |   | 28         |      |  |   |           |   |  |   | 28         |  
|Adjustment for minority interest in net income                                    |  |                                    | 105        |   |                                  |   | 103        |      |  |   | 241        |   |  |   | 103        |  
|Amortization of restricted stock                                                  |  |                                    | 20         |   |                                  |   | 20         |      |  |   | 40         |   |  |   | 40         |  
|Changes in assets and liabilities:                                                |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Increase in interest receivable                                                   |  |                                    | (2,741     | ) |                                  |   | (221       | )    |  |   | (5,583     | ) |  |   | (2,628     | )
|Increase (decrease) in prepaid expenses and other                                 |  |                                    | 3,470      |   |                                  |   | (285       | )    |  |   | (938       | ) |  |   | (1,889     | )
|Increase in accrued interest payable                                              |  |                                    | 6,466      |   |                                  |   | 4,045      |      |  |   | 11,459     |   |  |   | 6,809      |  
|(Decrease) increase in accrued expenses and other                                 |  |                                    | (31,043    | ) |                                  |   | 9,057      |      |  |   | 725        |   |  |   | 9,296      |  
|                                                                                  |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Net cash provided by operating activities                                         |  |                                    | 364        |   |                                  |   | 40,862     |      |  |   | 57,144     |   |  |   | 67,216     |  
|Investing Activities:                                                             |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Available-for-sale agency securities:                                             |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Purchases                                                                         |  |                                    | (404,317   | ) |                                  |   | (152,405   | )    |  |   | (994,165   | ) |  |   | (786,292   | )
|Proceeds from sales                                                               |  |                                    |           |   |                                  |   | 119,356    |      |  |   |           |   |  |   | 119,356    |  
|Principal payments                                                                |  |                                    | 431,925    |   |                                  |   | 571,476    |      |  |   | 796,603    |   |  |   | 903,646    |  
|Residential real estate loans:                                                    |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Purchases                                                                         |  |                                    | (485,340   | ) |                                  |   | (810,704   | )    |  |   | (850,905   | ) |  |   | (1,273,561 | )
|Proceeds from securitizations                                                     |  |                                    |           |   |                                  |   |           |      |  |   |           |   |  |   | 196,428    |  
|Principal payments                                                                |  |                                    | 2,328      |   |                                  |   | 7,023      |      |  |   | 3,544      |   |  |   | 7,613      |  
|ARM loans collateralizing mortgage-backed securities issued:                      |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Principal payments                                                                |  |                                    | 235,307    |   |                                  |   | 24,202     |      |  |   | 349,267    |   |  |   | 24,202     |  
|Available-for-sale securities:                                                    |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Purchases                                                                         |  |                                    | (13,826    | ) |                                  |   |           |      |  |   | (13,826    | ) |  |   |           |  
|Principal payments                                                                |  |                                    | 2,014      |   |                                  |   |           |      |  |   | 5,930      |   |  |   |           |  
|                                                                                  |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Net cash used in investing activities                                             |  |                                    | (231,909   | ) |                                  |   | (241,052   | )    |  |   | (703,552   | ) |  |   | (808,608   | )
|Financing Activities:                                                             |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Borrowings from repurchase agreements                                             |  |                                    | 4,603,007  |   |                                  |   | 2,339,449  |      |  |   | 9,718,225  |   |  |   | 4,618,666  |  
|Repayments on repurchase agreements                                               |  |                                    | (4,684,336 | ) |                                  |   | (2,676,074 | )    |  |   | (9,624,237 | ) |  |   | (4,607,540 | )
|Borrowings on whole loan financing facilities                                     |  |                                    | 463,794    |   |                                  |   | 778,997    |      |  |   | 814,903    |   |  |   | 1,213,422  |  
|Repayments on whole loan financing facilities                                     |  |                                    | (443,188   | ) |                                  |   | (632,466   | )    |  |   | (1,338,847 | ) |  |   | (878,380   | )
|Borrowings on mortgage-backed securities issued                                   |  |                                    | 469,484    |   |                                  |   | 412,679    |      |  |   | 1,317,623  |   |  |   | 412,679    |  
|Repayments on mortgage-backed securities issued                                   |  |                                    | (198,094   | ) |                                  |   | (11,604    | )    |  |   | (285,000   | ) |  |   | (11,604    | )
|Proceeds from junior subordinated notes issued, net                               |  |                                    |           |   |                                  |   |           |      |  |   | 35,160     |   |  |   |           |  
|Proceeds from preferred stock issued, net                                         |  |                                    | 2,828      |   |                                  |   |           |      |  |   | 18,962     |   |  |   |           |  
|Proceeds from common stock issued, net                                            |  |                                    | 8,025      |   |                                  |   | 15,162     |      |  |   | 14,434     |   |  |   | 36,302     |  
|Minority investments                                                              |  |                                    |           |   |                                  |   |           |      |  |   |           |   |  |   | 50         |  
|Preferred stock dividends paid                                                    |  |                                    | (868       | ) |                                  |   |           |      |  |   | (1,238     | ) |  |   |           |  
|Common stock dividends paid                                                       |  |                                    | (12,792    | ) |                                  |   | (16,961    | )    |  |   | (25,346    | ) |  |   | (31,054    | )
|Minority profit distributions                                                     |  |                                    | (223       | ) |                                  |   |           |      |  |   | (223       | ) |  |   |           |  
|                                                                                  |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Net cash provided by financing activities                                         |  |                                    | 207,637    |   |                                  |   | 209,182    |      |  |   | 644,416    |   |  |   | 752,541    |  
|                                                                                  |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Net (decrease) increase in cash and cash equivalents                              |  |                                    | (23,908    | ) |                                  |   | 8,992      |      |  |   | (1,992     | ) |  |   | 11,149     |  
|Cash and cash equivalents at beginning of period                                  |  |                                    | 24,958     |   |                                  |   | 2,353      |      |  |   | 3,042      |   |  |   | 196        |  
|                                                                                  |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Cash and cash equivalents at end of period                                        |  | $                                  | 1,050      |   |                                  | $ | 11,345     |      |  | $ | 1,050      |   |  | $ | 11,345     |  
|                                                                                  |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Supplemental Disclosure of Cash Flow Information:                                 |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Cash paid for interest                                                            |  | $                                  | 53,196     |   |                                  | $ | 15,301     |      |  | $ | 96,965     |   |  | $ | 27,477     |  
|Supplemental Disclosure of Investing and Financing Activities:                    |  |                                    |            |   |                                  |   |            |      |  |   |            |   |  |   |            |  
|Certificates retained from securitization                                         |  | $                                  |           |   |                                  | $ |           |      |  | $ |           |   |  | $ | 64,451     |  
|Mortgage-backed securities purchased, not yet settled                             |  |                                    |           |   |                                  |   | 8,033      |      |  | $ |           |   |  |   | 8,033      |  



See accompanying notes
to consolidated financial statements.



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##### Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(unaudited)



|                                                                        |  |                                    |        |   |                                  |   |         |      |  |   |        |   |  |   |         |  
|----------------------------------------------------------------------- |  | ---------------------------------- | ------ | - | -------------------------------- | - | ------- | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                        |  | For the three monthsended June 30, |        |   | For the six monthsended June 30, |  
|                                                                        |  | 2005                               |        |   | 2004                             |   |         | 2005 |  |   | 2004   |  
|Net income                                                              |  | $                                  | 8,855  |   |                                  | $ | 12,190  |      |  | $ | 23,337 |   |  | $ | 30,063  |  
|Available for-sale agency securities, fair value adjustment             |  |                                    | 15,589 |   |                                  |   | (40,630 | )    |  |   | (7,000 | ) |  |   | (26,667 | )
|Other mortgage-backed securities, fair value adjustment                 |  |                                    | 595    |   |                                  |   | (788    | )    |  |   | 508    |   |  |   | (806    | )
|Unrealized gains (losses) on cash flow hedges                           |  |                                    | (4,587 | ) |                                  |   | 5,064   |      |  |   | 1,230  |   |  |   | 5,899   |  
|Reclassification adjustment for interest expense included in net income |  |                                    | 347    |   |                                  |   | 1,012   |      |  |   | 1,247  |   |  |   | 1,127   |  
|                                                                        |  |                                    |        |   |                                  |   |         |      |  |   |        |   |  |   |         |  
|                                                                        |  |                                    | 11,944 |   |                                  |   | (35,342 | )    |  |   | (4,015 | ) |  |   | (20,447 | )
|Comprehensive income (loss)                                             |  | $                                  | 20,799 |   |                                  | $ | (23,152 | )    |  | $ | 19,322 |   |  | $ | 9,616   |  
|                                                                        |  |                                    |        |   |                                  |   |         |      |  |   |        |   |  |   |         |  



See accompanying notes
to consolidated financial statements.



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ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES



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, and 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. We seek attractive long-term investment returns primarily by investing our equity
capital and borrowed funds in mortgage-related assets. Our returns are principally earned on the spread between the yield on our interest-earning assets and the interest cost of the funds we borrow.



In November 2003, we formed a subsidiary called Belvedere Trust Mortgage
Corporation, or Belvedere Trust, to acquire, own and securitize mortgage loans, with a focus on the high credit-quality jumbo adjustable-rate and hybrid first-lien single-family residential mortgage markets. Belvedere Trust acquires mortgage loans,
securitizes a substantial amount of those mortgage loans and then retains a portion of those mortgage-backed securities while pledging the balance to third parties in the secondary market. Belvedere Trust is externally managed by BT Management
Company, L.L.C., or BT Management, a company owned 50% by us and 50% by the officers of BT Management, 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. As of June 30, 2005, Belvedere Trusts assets comprised approximately 40% of our overall assets. Through June 30, 2005, we had made an investment of $100 million in Belvedere Trust to capitalize its mortgage operations.



On May 17, 2005, Belvedere Trust filed a registration
statement with the Securities and Exchange Commission for the purpose of registering $100 million of its common stock in connection with a contemplated initial public offering. We do not intend to sell any of our shares of Belvedere Trusts
common stock in the initial public offering.



BASIS OF PRESENTATION AND
CONSOLIDATION



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 of America. 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 materially differ from those estimates. Our consolidated financial statements include the accounts of all subsidiaries and consolidated VIEs. Significant intercompany accounts and transactions have
been eliminated. 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,
2005 and 2004 are not necessarily indicative of the results that may be expected for the calendar year. The interim financial information should be read in conjunction with the consolidated financial statements included in our Annual Report on Form
10-K for the year ended December 31, 2004.



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



Cash and Cash
Equivalents



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



Restricted Cash



Restricted cash may include principal and interest payments on real estate loans or securities held as collateral for mortgage-backed securities issued,
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)



Relative to our investment grade agency
MBS portfolio, we have invested primarily in fixed-rate and adjustable-rate mortgage-backed pass-through certificates and hybrid adjustable-rate mortgage-backed securities. Hybrid adjustable-rate mortgage-backed securities have an initial interest
rate that is fixed for a certain period, usually three to five years, and then adjust annually for the remainder of the term of the loan. We structure our investment portfolio to be diversified with a



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variety of prepayment characteristics, investing in mortgage-related assets with prepayment penalties, investing in certain mortgage security structures that
have prepayment protections and purchasing mortgage-related assets at a premium and at a discount.



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 with a carrying value of approximately $71.2 million. This amount includes approximately $39.2 million in securities that were retained from our first
securitization during the first quarter of 2004. The remaining balance of approximately $32 million were securities that were purchased from major issuers.



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 these securities include the first
loss security, we bear credit risk associated with mortgages with a face value of $723 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. As of
June 30, 2005, we have not sold the first loss securities from our securitizations to third parties.



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 agency and non-agency 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 of those individual securities that have been in a continuous
unrealized loss position, at June 30, 2005, aggregated by investment category and length of time:



|                                          |  |                     |           |                  |                   |   |            |       |                  |  |         |            |  |                  |           |  |         |  
|----------------------------------------- |  | ------------------- | --------- | ---------------- | ----------------- | - | ---------- | ----- | ---------------- |  | ------- | ---------- |  | ---------------- | --------- |  | ------- | -
|                                          |  | 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 |  | $                   | 1,667,923 |                  | (14,088           | ) |            | $     | 2,428,122        |  | (40,001 | )          |  | $                | 4,096,045 |  | (54,089 | )
|Other mortgage-backed securities          |  | $                   | 15,920    |                  | (481              | ) |            | $     | 36,158           |  | (413    | )          |  | $                | 52,078    |  | (894    | )



We do not consider
those securities that 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-sponsored agency guaranteed securities with limited credit risk and the Company has
the ability and intent to hold these investments until a forecasted recovery of fair value up to the cost of the investment which, in certain cases, may mean until maturity.



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 (see Note 6) until a sufficient quantity has been accumulated for



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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. Premiums or discounts are amortized into current operations.



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 high credit-quality mortgage loans. Applicable banking laws 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 an allowance for loan losses 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 sheets.



Allowance for Loan Losses



We establish and maintain an allowance for estimated loan losses inherent 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 including, but not limited to, the characteristics of the loan portfolio, review of loan
level data, borrowers credit scores, delinquency and collateral value. The reserves are reviewed on a regular basis and adjusted as deemed necessary. The allowance for loan losses on our real estate loans is established by taking loan loss
provisions through our consolidated statements of income. The Company does not maintain a loan repurchase reserve, as any risk of loss due to loan repurchases (i.e., due to breach of representations) would normally be covered by recourse to the
companies from whom we acquired the loans.



Repurchase Agreements



We finance the acquisition of our mortgage-related assets
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 or enter into new repurchase agreements at the then prevailing financing rate. When
repurchase agreements are renewed, the future repurchase price is reset. 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.



Variable Interest Entities



Belvedere Trust structures securitization transactions primarily through
non-qualified special purpose entities (such as REMIC trusts). The principal business activity involves issuing various series of mortgage-backed securities (in the form of pass-through certificates or bonds collateralized by residential real estate
loans). The collateral specific to each series of mortgage-backed securities 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 Financial Accounting Standards
Board Interpretation No. 46 (FIN 46), these interests in non-qualified special purpose entities are deemed to be variable interest entities (VIEs) and we are considered the primary beneficiary. We disclose our interests in consolidated
VIEs under FIN 46 in the Investments in Residential Real Estate Loans footnote.



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Derivative Financial Instruments



Interest Rate Risk Management



We use primarily short-term (less than or equal to 12 months) 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 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.



To mitigate the impact
of rising interest rates on the consummation of forward loan purchase commitments in connection with planned securitization funding, Belvedere Trust uses Eurodollar futures. 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. We do not designate the Eurodollar futures for hedge accounting.



Accounting for Derivatives and Hedging Activities



In accordance with FASB No. 133, Accounting for
Derivative Instruments and Hedging Activities, or FASB 133, as amended by FASB No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, or FASB 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 FASB 133.



On the date we
enter into an interest rate swap contract, we designate the swap 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 sheets 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 assess (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 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 determine 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.



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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.



In connection with its loan acquisitions, Belvedere Trust enters into forward loan purchase commitments. To mitigate the impact of rising interest rates on the consummation of forward loan purchase commitments in
connection with planned securitization funding, Belvedere Trust uses Eurodollar futures. Both of these are treated as derivatives, carried at fair value and any changes in fair value are recognized in current-period earnings.



Credit Risk



At June 30, 2005, we had limited our exposure to credit losses on our portfolio of fixed-rate and adjustable-rate
mortgage-backed 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, 2005, because of the guarantee of these government-sponsored agencies, all of our agency mortgage-backed securities have an implied AAA rating.



Other-than-temporary losses on available-for-sale 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 estimates
that are susceptible to a significant change. At June 30, 2005, 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 it 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 an allowance for estimated loan losses on our
residential real estate loans. The allowance for loan losses is based upon estimates of inherent 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 loan losses is recognized through our consolidated statements of income.



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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, and BT Finances wholly-owned subsidiaries, BT Residential Funding Corporation and BellaVista Funding Corporation, are taxable REIT subsidiaries (TRS) of the Company. In general, a TRS of the Company may hold assets
that the Company cannot hold directly and may engage in any real estate or non-real estate related business. A TRS is subject to corporate federal and state income tax and will be taxed as a regular C corporation. Securities of a TRS will constitute
non-real estate assets for purposes of determining whether at least 75% of a REITs assets consist of real estate. Under current law, no more than 20% of a REITs total assets can consist of securities of one or more taxable REIT
subsidiaries. As of June 30, 2005, the amount of the Companys assets attributable to its taxable REIT subsidiaries was less than 5%. A more detailed description of federal income tax considerations regarding the Companys qualifications
and taxation as a REIT appears in the Companys 2004 Annual Report on Form 10-K on page 11.



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. 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.



On December 16, 2004, the FASB issued
the final statement on Accounting for Share-Based Payments (FASB 123(R)) to be effective for certain public entities as of the first interim reporting period that begins after June 15, 2005. On April 14, 2005, the Securities and Exchange
Commission amended the implementation date to the interim reporting period for the first quarter of 2006. This statement replaces FASB 123, Accounting for Stock-Based Compensation and supersedes APB Opinion 25, Accounting for Stock
Issued to Employees. Instead of disclosing the effect of stock options in a footnote to the financial statements, this statement will require that compensation cost relating to share-based payment transactions be recognized in the financial
statements and that cost will be measured on the fair value of the equity or liability instruments issued. The provisions of FASB 123(R) are not expected to have a material effect on the Companys financial statements. Prior to the effective
date of FASB 123(R), the Company has elected to continue to provide the disclosures set forth in SFAS 123, as amended by FASB 148.



As required by SFAS 123, as amended by SFAS 148, we provide pro forma net income and pro forma net income 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 FASB No. 123, our net income would have been reduced to the pro
forma amounts indicated below:



|                                                                                                                               |  |                            |       |                          |   |        |  |      |        |  |   |       
|------------------------------------------------------------------------------------------------------------------------------ |  | -------------------------- | ----- | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                                                                                                               |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|(in thousands, except per share amounts)                                                                                       |  | 2005                       |       | 2004                     |   | 2005   |  | 2004
|Net income available to common stockholders, as reported                                                                       |  | $                          | 7,844 |                          | $ | 12,190 |  | $    | 21,458 |  | $ | 30,063
|Add: Stock-based compensation expense included in net income                                                                   |  |                            | 20    |                          |   | 20     |  |      | 40     |  |   | 40    
|Less: Total stock-based compensation expense determined under the fair value-based method for all awards, net of related taxes |  |                            | 59    |                          |   | 159    |  |      | 118    |  |   | 278   
|                                                                                                                               |  |                            |       |                          |   |        |  |      |        |  |   |       
|Pro forma net income                                                                                                           |  | $                          | 7,805 |                          | $ | 12,051 |  | $    | 21,380 |  | $ | 29,825
|Basic income per share, as reported                                                                                            |  | $                          | 0.16  |                          | $ | 0.27   |  | $    | 0.45   |  | $ | 0.68  
|Pro forma basic income per share                                                                                               |  | $                          | 0.16  |                          | $ | 0.27   |  | $    | 0.45   |  | $ | 0.67  
|Diluted income per share, as reported                                                                                          |  | $                          | 0.16  |                          | $ | 0.27   |  | $    | 0.45   |  | $ | 0.68  
|Pro forma diluted income per share                                                                                             |  | $                          | 0.16  |                          | $ | 0.27   |  | $    | 0.45   |  | $ | 0.67  



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The fair value of the aforementioned stock-based awards was estimated using the Black-Scholes model with
the following weighted-average assumptions for the three months ended June 30:



|                        |  |           |   |  |           |  
|----------------------- |  | --------- | - |  | --------- | -
|                        |  | 2005      |   |  | 2004      |  
|Assumptions:            |  |           |   |  |           |  
|Dividend yield          |  | 10.00     | % |  | 10.00     | %
|Expected volatility     |  | 32.00     | % |  | 32.00     | %
|Risk-free interest rate |  | 2.97      | % |  | 2.97      | %
|Expected lives          |  | 6.4 years |   |  | 7.4 years |  



Earnings Per Share



Basic earnings per share, or EPS, is computed by dividing net income
available to common stockholders 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 amounts):



|                                             |  |                                      |        |               |        |                  |   |     
|-------------------------------------------- |  | ------------------------------------ | ------ | ------------- | ------ | ---------------- | - | ----
|                                             |  | IncomeAvailable toCommonStockholders |        | AverageShares |        | EarningsPerShare
|For the three months ended June 30, 2005     |  |                                      |        |               |        |                  |   |     
|Basic EPS                                    |  | $                                    | 7,844  |               | 47,637 |                  | $ | 0.16
|Effect of dilutive securities: Stock options |  |                                      |       |               | 31     |                  |   |    
|                                             |  |                                      |        |               |        |                  |   |     
|Diluted EPS                                  |  | $                                    | 7,844  |               | 47,668 |                  | $ | 0.16
|                                             |  |                                      |        |               |        |                  |   |     
|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
|                                             |  |                                      |        |               |        |                  |   |     
|                                             |  |                                      |       
|                                             |  | IncomeAvailable toCommonStockholders |        | AverageShares |        | EarningsPerShare
|For the six months ended June 30, 2005       |  |                                      |        |               |        |                  |   |     
|Basic EPS                                    |  | $                                    | 21,458 |               | 47,240 |                  | $ | 0.45
|Effect of dilutive securities: Stock options |  |                                      |       |               | 34     |                  |   |    
|                                             |  |                                      |        |               |        |                  |   |     
|Diluted EPS                                  |  | $                                    | 21,458 |               | 47,274 |                  | $ | 0.45
|                                             |  |                                      |        |               |        |                  |   |     
|For the six months ended June 30, 2004       |  |                                      |        |               |        |                  |   |     
|Basic EPS                                    |  | $                                    | 30,063 |               | 44,346 |                  | $ | 0.68
|Effect of dilutive securities: Stock options |  |                                      |       |               | 117    |                  |   |    
|                                             |  |                                      |        |               |        |                  |   |     
|Diluted EPS                                  |  | $                                    | 30,063 |               | 44,463 |                  | $ | 0.68
|                                             |  |                                      |        |               |        |                  |   |     



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 FASB 133.



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USE OF ESTIMATES



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



RECENT ACCOUNTING PRONOUNCEMENTS



On December
16, 2004, the FASB issued the final statement on Accounting for Share-Based Payments (FASB 123(R)) to be effective for all public entities as of the first interim reporting period that begins after June 15, 2005. On April 14, 2005, the
Securities and Exchange Commission amended the implementation date to the interim reporting period for the first quarter of 2006. This statement covers a wide range of share-based compensation arrangements including share options, restricted share
plans, performance-based awards, share appreciation rights and employee share purchase plans. This statement replaces FASB 123, Accounting for Stock Based Compensation and supersedes APB Opinion 25, Accounting for Stock Issued to
Employees. Instead of disclosing the effect of stock options in a footnote to the financial statements, this statement will require that compensation cost relating to share-based payment transactions be recognized in the financial statements
and that cost will be measured on the fair value of the equity or liability instruments issued. The provisions of FASB 123 (R) are not expected to have a material effect on the Companys financial statements.



On March 3, 2005, the FASB issued staff position (FIN 46(R)-5),
Implicit Variable Interests under FASB Interpretation No. 46, Consolidation of Variable Interest Entities. The determination as to whether an implicit variable interest exists should be based on whether, in substance, the reporting
enterprise, through its relationship with the variable interest entities (VIEs) 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. The
effective date of this position is the first reporting period beginning after March 3, 2005. This Company does not believe this will have a material impact on its financial statements, as it has disclosed its interests in consolidated VIEs under FIN
46 in the Investments in Residential Real Estate Loans footnote.



In May 2005, the FASB issued Accounting Changes and Error Corrections-A replacement of APB Opinion No. 20 and FASB Statement No. 3 (FASB 154) to be effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. This statement also applies to all voluntary changes in accounting principle and changes required by an accounting pronouncement in the unusual instance that the pronouncement does not
include specific transition provisions. Opinion No. 20 previously required that most changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting
principle. FASB 154 requires retrospective application (related to the direct effect of the change) to prior periods financial statements of changes in accounting principle. The Company is not currently aware of any accounting changes or error
corrections and, as such, does not believe FASB 154 will have a material effect on its financial statements.



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



The following table summarizes our mortgage-backed securities classified as available-for-sale as of June 30, 2005 and December 31, 2004, which are
carried at their fair value (amounts in thousands):



June 30, 2005



|                    |  |            |         |   |             |   |           |            |  |   |                       |   |  |   |           |  
|------------------- |  | ---------- | ------- | - | ----------- | - | --------- | ---------- |  | - | --------------------- | - |  | - | --------- | -
|                    |  | Ginnie Mae |         |   | Freddie Mac |   |           | Fannie Mae |  |   | TotalAgency MBSAssets |  
|Amortized cost      |  | $          | 108,860 |   |             | $ | 1,283,508 |            |  | $ | 3,385,135             |   |  | $ | 4,777,503 |  
|Paydowns receivable |  |            |        |   |             |   | 34,332    |            |  |   |                      |   |  |   | 34,332    |  
|Unrealized gains    |  |            |        |   |             |   | 372       |            |  |   | 1,226                 |   |  |   | 1,598     |  
|Unrealized losses   |  |            | (1,381  | ) |             |   | (12,020   | )          |  |   | (40,688               | ) |  |   | (54,089   | )
|                    |  |            |         |   |             |   |           |            |  |   |                       |   |  |   |           |  
|Fair value          |  | $          | 107,479 |   |             | $ | 1,306,192 |            |  | $ | 3,345,673             |   |  | $ | 4,759,344 |  
|                    |  |            |         |   |             |   |           |            |  |   |                       |   |  |   |           |  



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|                  |  |           |        |  
|----------------- |  | --------- | ------ | -
|                  |  | Other MBS |       
|Amortized cost    |  | $         | 71,949 |  
|Unrealized losses |  |           | (894   | )
|Unrealized gains  |  |           | 172    |  
|                  |  |           |        |  
|Fair value        |  | $         | 71,227 |  
|                  |  |           |        |  



December 31, 2004



|                    |  |            |         |   |             |   |           |            |  |   |                       |   |  |   |           |  
|------------------- |  | ---------- | ------- | - | ----------- | - | --------- | ---------- |  | - | --------------------- | - |  | - | --------- | -
|                    |  | Ginnie Mae |         |   | Freddie Mac |   |           | Fannie Mae |  |   | TotalAgency MBSAssets |  
|Amortized cost      |  | $          | 131,686 |   |             | $ | 1,141,429 |            |  | $ | 3,334,582             |   |  | $ | 4,607,697 |  
|Paydowns receivable |  |            |        |   |             |   | 26,335    |            |  |   |                      |   |  |   | 26,335    |  
|Unrealized gains    |  |            |        |   |             |   | 228       |            |  |   | 1,639                 |   |  |   | 1,867     |  
|Unrealized losses   |  |            | (2,461  | ) |             |   | (10,082   | )          |  |   | (34,815               | ) |  |   | (47,358   | )
|                    |  |            |         |   |             |   |           |            |  |   |                       |   |  |   |           |  
|Fair value          |  | $          | 129,225 |   |             | $ | 1,157,910 |            |  | $ | 3,301,406             |   |  | $ | 4,588,541 |  
|                    |  |            |         |   |             |   |           |            |  |   |                       |   |  |   |           |  



|                  |  |           |        |  
|----------------- |  | --------- | ------ | -
|                  |  | Other MBS |       
|Amortized cost    |  | $         | 64,699 |  
|Unrealized losses |  |           | (1,302 | )
|Unrealized gains  |  |           | 73     |  
|                  |  |           |        |  
|Fair value        |  | $         | 63,470 |  
|                  |  |           |        |  



The following table
summarizes our agency securities at their fair value as of June 30, 2005 and December 31, 2004 (amounts in thousands):



June 30, 2005



|                    |  |      |           |   |         |   |           |       |  |   |                   |   |       |   |        |  |   |           |  
|------------------- |  | ---- | --------- | - | ------- | - | --------- | ----- |  | - | ----------------- | - | ----- | - | ------ |  | - | --------- | -
|                    |  | ARMs |           |   | Hybrids |   |           | Fixed |  |   | Floating-Rate CMO |   | Total |  
|Amortized cost      |  | $    | 1,616,293 |   |         | $ | 2,963,230 |       |  | $ | 182,404           |   |       | $ | 15,576 |  | $ | 4,777,503 |  
|Paydowns receivable |  |      | 12,245    |   |         |   | 22,087    |       |  |   |                  |   |       |   |       |  |   | 34,332    |  
|Unrealized gains    |  |      | 643       |   |         |   | 685       |       |  |   | 196               |   |       |   | 74     |  |   | 1,598     |  
|Unrealized losses   |  |      | (18,656   | ) |         |   | (31,916   | )     |  |   | (3,517            | ) |       |   |       |  |   | (54,089   | )
|                    |  |      |           |   |         |   |           |       |  |   |                   |   |       |   |        |  |   |           |  
|Fair value          |  | $    | 1,610,525 |   |         | $ | 2,954,086 |       |  | $ | 179,083           |   |       | $ | 15,650 |  | $ | 4,759,344 |  
|                    |  |      |           |   |         |   |           |       |  |   |                   |   |       |   |        |  |   |           |  



December 31, 2004



|                    |  |      |           |   |         |   |           |       |  |   |                   |   |       |   |        |  |   |           |  
|------------------- |  | ---- | --------- | - | ------- | - | --------- | ----- |  | - | ----------------- | - | ----- | - | ------ |  | - | --------- | -
|                    |  | ARMs |           |   | Hybrids |   |           | Fixed |  |   | Floating-Rate CMO |   | Total |  
|Amortized cost      |  | $    | 1,427,620 |   |         | $ | 2,955,923 |       |  | $ | 205,717           |   |       | $ | 18,437 |  | $ | 4,607,697 |  
|Paydowns receivable |  |      | 8,929     |   |         |   | 17,406    |       |  |   |                  |   |       |   |       |  |   | 26,335    |  
|Unrealized gains    |  |      | 896       |   |         |   | 504       |       |  |   | 425               |   |       |   | 42     |  |   | 1,867     |  
|Unrealized losses   |  |      | (14,278   | ) |         |   | (28,453   | )     |  |   | (4,627            | ) |       |   |       |  |   | (47,358   | )
|                    |  |      |           |   |         |   |           |       |  |   |                   |   |       |   |        |  |   |           |  
|Fair value          |  | $    | 1,423,167 |   |         | $ | 2,945,380 |       |  | $ | 201,515           |   |       | $ | 18,479 |  | $ | 4,588,541 |  
|                    |  |      |           |   |         |   |           |       |  |   |                   |   |       |   |        |  |   |           |  



|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 year ended December 31, 2004, Belvedere Trust transferred approximately $2.4 billion of residential mortgage loans in six separate transactions to securitization trusts pursuant to pooling and third party servicing agreements. Five of the
six securitization transactions in 2004, totaling approximately $2.1 billion, utilized non-qualified SPEs requiring consolidation, which effectively resulted in these transactions being accounted for as financings. During the second quarter ended
June 30, 2005, Belvedere Trust transferred approximately $0.4 billion of residential mortgage loans to a securitization trust pursuant to a pooling and third party service agreement.



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##### Table of Contents

During the first quarter ended March 31, 2005, Belvedere Trust transferred approximately $0.9 billion of residential mortgage loans to a securitization trust
pursuant to a pooling and third party service agreement. These transactions utilized non-qualified SPEs requiring consolidation, which effectively resulted in these transactions being accounted for as financings. The residential real estate loans
remain as assets on our consolidated balance sheets subsequent to securitization, and the financing resulting from these securitizations is shown on our consolidated balance sheets as Mortgage-backed securities issued. The servicing of
the mortgage loans is performed by third parties under servicing arrangements that resulted in no servicing asset or liability. Since its formation, Belvedere Trust has securitized approximately $3.8 billion of mortgage loans.



On April 11, 2005, the SEC declared effective a shelf registration statement
on Form S-3 filed by Belvedere Trusts wholly-owned direct and indirect subsidiaries, BellaVista Finance Corporation and BellaVista Funding Corporation, as co-registrants. This registration statement registered for sale to the public up to $4.5
billion in asset-backed securities.



For the one securitization
transaction accounted for as a sale, we transferred approximately $253 million of residential mortgage loans to a securitization trust pursuant to a pooling and third party servicing agreement dated as of February 1, 2004. The net proceeds of the
sale were used primarily to pay off a whole loan financing line of credit. The retained securities are carried at amortized cost, adjusted for fair market valuation based on quoted market prices. As these securities include first loss security, we
bear the credit risk associated with these mortgages. The principal balance outstanding, at June 30, 2005, of all the securities from this transaction was $147 million; the amount of assets derecognized was $108 million and the amount recognized as
our retained securities was $39 million. As of June 30, 2005, the delinquent amount of all the principal balances from this transaction was $1.9 million and there have been no credit losses to date.



The information in the following table projects the impact of sudden changes
in interest rates on the fair value of these retained securities at June 30, 2005 and December 31, 2004:



|                         |  |                                                     |   |  |                  |  
|------------------------ |  | --------------------------------------------------- | - |  | ---------------- | -
|                         |  | Projected PercentageChange in RetainedSecurities at |  
|Change in Interest Rates |  | June 30,2005                                        |   |  | December 31,2004 |  
|-2.0%                    |  | 1.7                                                 | % |  | 1.3              | %
|-1.0%                    |  | 1.2                                                 | % |  | 0.7              | %
|0%                       |  |                                                    |   |  |                 |  
|1.0%                     |  | -2.5                                                | % |  | -2.0             | %
|2.0%                     |  | -5.4                                                | % |  | -5.4             | %



At June 30, 2005, we
had acquired approximately $34 million in residential mortgage loans (including related premiums) which are scheduled to be securitized at a later date.



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



Our residential real estate loan portfolio of $3.12 billion at June 30, 2005 includes $34 million of loans pending securitization and $3.09 billion in
loans which have been financed through securitization.



The
following table represents the changes at June 30, 2005 and December 31, 2004 in our residential real estate loans (in thousands):



|                                                            |  |              |           |   |                  |   |           |  
|----------------------------------------------------------- |  | ------------ | --------- | - | ---------------- | - | --------- | -
|                                                            |  | June 30,2005 |           |   | December 31,2004 |  
|Balance, beginning of year                                  |  | $            | 2,628,334 |   |                  | $ |          |  
|New loan acquisitions                                       |  |              | 850,905   |   |                  |   | 3,030,405 |  
|Sales (other than to consolidated securitization trusts)(1) |  |              |          |   |                  |   | (258,164  | )
|Principal repayments                                        |  |              | (352,811  | ) |                  |   | (141,350  | )
|Premium amortization                                        |  |              | (5,253    | ) |                  |   | (3,079    | )
|Capitalized securitization costs and other adjustments      |  |              | 4,606     |   |                  |   | 522       |  
|                                                            |  |              |           |   |                  |   |           |  
|Balance, end of period                                      |  | $            | 3,125,781 |   |                  | $ | 2,628,334 |  
|                                                            |  |              |           |   |                  |   |           |  

---

|(1) | Includes related premium
|--- | ------------------------



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The following table represents the changes at June 30, 2005 and December 31, 2004 in our residential
allowance for loan losses (in thousands):



|                           |  |              |       |                  |   |    
|-------------------------- |  | ------------ | ----- | ---------------- | - | ---
|                           |  | June 30,2005 |       | December 31,2004
|Balance, beginning of year |  | $            | 591   |                  | $ |   
|Additions                  |  |              | 570   |                  |   | 591
|                           |  |              |       |                  |   |    
|Balance, end of period     |  | $            | 1,161 |                  | $ | 591
|                           |  |              |       |                  |   |    



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



Agency Repurchase Agreements



We have entered into repurchase agreements to finance most of our MBS. The repurchase agreements are short-term borrowings that are secured by the market
value of our MBS and bear fixed interest rates that have historically had their basis on LIBOR. Relative to our agency MBS portfolio, at June 30, 2005, our repurchase agreements had a weighted average term to maturity of 142 days and a weighted
average borrowing rate of 3.03%. After adjusting for swap transactions, the weighted average term to the next rate adjustment was 242 days with a weighted average borrowing rate of 3.04%. At June 30, 2005, agency MBS with a fair value of
approximately $4.47 billion have been pledged as collateral under the repurchase agreements.



Relative to our agency MBS portfolio, at December 31, 2004, our repurchase agreements had a weighted average term to maturity of 184 days and a weighted average borrowing rate of 2.25%. After adjusting for swap
transactions, the weighted average term to the next rate adjustment was 304 days with a weighted average borrowing rate of 2.34%. At December 31, 2004, agency MBS with a fair value of approximately $4.36 billion have been pledged as collateral under
the repurchase agreements.



At June 30, 2005 and December 31,
2004, the repurchase agreements had the following remaining maturities:



|                             |  |              |   |  |                  |  
|---------------------------- |  | ------------ | - |  | ---------------- | -
|                             |  | June 30,2005 |   |  | December 31,2004 |  
|Less than 3 months           |  | 38.2         | % |  | 36.9             | %
|3 months to less than 1 year |  | 56.4         | % |  | 51.9             | %
|1 year to less than 2 years  |  | 5.4          | % |  | 11.2             | %
|2 years to less than 3 years |  |             |   |  |                 |  
|Greater than 3 years         |  |             |   |  |                 |  
|                             |  |              |   |  |                  |  
|                             |  | 100.0        | % |  | 100.0            | %



Belvedere Trust
Repurchase Agreements



Belvedere Trust has entered into
repurchase agreements to finance most of its other MBS. In addition, Belvedere Trust has entered into repurchase agreements to finance most of the retained portion of the residential real estate loans which they have securitized. The repurchase
agreements are short-term borrowings that are secured by the market value of the pledged assets and bear interest rates that have historically had their basis on LIBOR. At June 30, 2005, Belvedere Trusts repurchase agreements had a weighted
average term to maturity of 314 days and a weighted average borrowing rate of 3.30%. At December 31, 2004, Belvedere Trusts repurchase agreements had a weighted average term to maturity of 313 days and a weighted average borrowing rate of
2.65%.



At June 30, 2005 and December 31, 2004, the repurchase
agreements had the following remaining maturities:



|                             |  |              |   |  |                  |  
|---------------------------- |  | ------------ | - |  | ---------------- | -
|                             |  | June 30,2005 |   |  | December 31,2004 |  
|Less than 3 months           |  | 39.3         | % |  | 47.5             | %
|3 months to less than 1 year |  | 26.8         | % |  | 3.1              | %
|1 year to less than 2 years  |  | 21.3         | % |  | 44.5             | %
|2 years to less than 3 years |  | 12.6         | % |  | 4.9              | %
|Greater than 3 years         |  |             |   |  |                 |  
|                             |  |              |   |  |                  |  
|                             |  | 100.0        | % |  | 100.0            | %



17



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##### Table of Contents

|NOTE 6. | MORTGAGE-BACKED SECURITIES ISSUED AND WHOLE LOAN FINANCING FACILITIES
|------- | ---------------------------------------------------------------------



We finance our residential real estate loans using mortgage-backed securities issued (obligations due on pass-through certificates or bonds) through
securitizations. The interest rates on the mortgage-backed securities issued are variable and are based either upon the interest rates on the underlying loan collateral or upon LIBOR. The maturities on the mortgage-backed securities issued are also
based upon the maturities of the underlying mortgages. Principal is paid on the mortgage-backed securities issued following receipt of principal payments on the loans. The scheduled maturities of the mortgage-backed securities issued extend to
January 2045. At June 30, 2005, whole loans with a face value of approximately $3.1 billion have been pledged as collateral for the mortgage-backed securities issued. At December 31, 2004, whole loans with a face value of approximately $2 billion
were pledged as collateral for the mortgage-backed securities issued.



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, 2005, loans with a face value of approximately $33 million have been pledged as collateral under these facilities. At December 31, 2004, loans with a face value of approximately $567
million were pledged as collateral under these facilities.



The
following tables represent, at June 30, 2005 and December 31, 2004, the principal payments of the mortgage-backed securities issued and the whole loan financing facilities for each of the succeeding five years:



June 30, 2005



|                                  |  |                |         |      |   |         |  |      |         |      |   |         |  |   |        
|--------------------------------- |  | -------------- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                  |  | 2005           |         | 2006 |   | 2007    |  | 2008 |         | 2009
|                                  |  | (in thousands)
|Whole loan financing facilities   |  | $              | 32,289  |      | $ |        |  | $    |        |      | $ |        |  | $ |       
|Mortgage-backed securities issued |  |                | 339,355 |      |   | 548,406 |  |      | 411,304 |      |   | 308,478 |  |   | 231,359



December 31, 2004



|                                  |  |                |         |      |   |         |  |      |         |      |   |         |  |   |        
|--------------------------------- |  | -------------- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                  |  | 2005           |         | 2006 |   | 2007    |  | 2008 |         | 2009
|                                  |  | (in thousands)
|Whole loan financing facilities   |  | $              | 556,233 |      | $ |        |  | $    |        |      | $ |        |  | $ |       
|Mortgage-backed securities issued |  |                | 373,523 |      |   | 280,142 |  |      | 210,107 |      |   | 157,580 |  |   | 118,185



The whole loan
financing facilities are short-term credit facilities. The total balance owed on the whole loan financing facilities, as of June 30, 2005, is due in 2005. Principal is paid on the mortgage-backed securities issued following receipt of principal
payments on the loans. For the table above, the principal payments have been estimated based on contractual payments on the underlying loans as adjusted for prepayment assumptions. The actual principal paid in each year will be dependent upon the
principal received on the underlying loans. The collateral specific to each mortgage-backed securities series is the sole source of repayment of the debt.



|NOTE 7. | JUNIOR SUBORDINATED NOTES
|------- | -------------------------



On March 15, 2005, we issued $37,380,000 of junior subordinated notes to a newly-formed statutory trust, Anworth Capital Trust I, organized by us under
Delaware law. The trust issued $36,250,000 in trust preferred securities to unrelated third party investors. Both the notes and the trust preferred securities require quarterly payments and bear interest at the prevailing three-month LIBOR rate plus
3.10%, reset quarterly. The first interest payment was made on June 30, 2005. Both the notes and the securities will mature in 2035 and may be redeemable, in whole or in part, without penalty, at our option after March 30, 2010. We used the net
proceeds of this private placement to invest in agency MBS. We have reviewed the structure of the transaction under FIN 46 and concluded that it does not meet the requirements for consolidation.



|NOTE 8. | FAIR VALUES OF FINANCIAL INSTRUMENTS
|------- | ------------------------------------



Agency MBS and other MBS are reflected in the financial statements at estimated fair value. Management bases its fair value estimates for agency MBS and
other MBS 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.



18



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##### Table of Contents

Cash and cash equivalents, interest receivable, 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 at June 30, 2005 and December 31, 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.



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



|                                                     |  |                |           |                     |   |                |  |                     |           |  |   |          
|---------------------------------------------------- |  | -------------- | --------- | ------------------- | - | -------------- |  | ------------------- | --------- |  | - | ---------
|                                                     |  | June 30, 2005  |           | December 31, 2004  
|                                                     |  | (in thousands) |           | (in thousands)     
|                                                     |  | CarryingAmount |           | EstimatedFair Value |   | CarryingAmount |  | EstimatedFair Value
|Residential real estate loans pending securitization |  | $              | 33,788    |                     | $ | 33,663         |  | $                   | 577,932   |  | $ | 578,189  
|Residential real estate loans securitized            |  |                | 3,091,993 |                     |   | 3,064,267      |  |                     | 2,050,402 |  |   | 2,039,828
|Mortgage-backed securities issued                    |  |                | 2,533,712 |                     |   | 2,502,506      |  |                     | 1,494,851 |  |   | 1,493,213



These fair value
estimates at June 30, 2005 and December 31, 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.



| |  |  | Residential real estate loans are carried on the consolidated balance sheets at historical cost, net of amortization, as we hold these assets for investment. The fair value of the
residential real estate loans is calculated using assumptions based on historical experience, industry information and estimated rates of future prepayments and credit losses. The estimates of fair value are inherently subjective in nature, involve
matters of uncertainty and judgment and do not necessarily indicate the amounts that could be received in a current market exchange;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The estimated fair value of mortgage-backed securities issued (obligations due on pass-through certificates) is based on dealers quotes.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



|NOTE 9. | PUBLIC OFFERINGS AND CAPITAL STOCK
|------- | ----------------------------------



In February 2004, we filed with the Securities and Exchange Commission an Amended and Restated Dividend Reinvestment and Stock Purchase Plan pursuant to a
registration statement on Form S-3, primarily to increase the number of shares authorized under our predecessor plan. The plan allows stockholders and non-stockholders to purchase shares of our common stock and to reinvest dividends in additional
shares of our common stock. During the three months ended June 30, 2005, we issued 866 thousand shares of common stock under the plan, resulting in proceeds to us of approximately $8 million.



In May 2004, we filed a shelf registration statement on Form S-3 with the
Securities and Exchange Commission for offering up to $300 million of our capital stock. The registration statement incorporated the securities available under our prior shelf registration statement and was declared effective on May 25, 2004. As of
June 30, 2005, $250 million of our securities remained available for issuance under the registration statement.



During November 2004, we completed a public offering of 1.15 million shares of 8.625% Series A Cumulative Preferred Stock and received net proceeds of
$26.4 million. The shares were sold pursuant to our shelf registration on Form S-3.



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##### Table of Contents

On January 19, 2005, we entered into an Amended and Restated Sales Agreement with Cantor Fitzgerald &
Co., or Cantor, to sell up to 2.0 million shares of our Series A Preferred Stock and up to 5.7 million shares of our Common Stock from time to time through a controlled equity offering program under which Cantor acts as sales agent. The agreement
amended and restated the Sales Agreement that we entered into on April 21, 2004 with Cantor. Sales of the shares of our Series A Preferred Stock and Common Stock are made on the New York Stock Exchange by means of ordinary brokers transactions
at market prices and through privately negotiated transactions. During the three months ended June 30, 2005, we sold 115 thousand shares of Series A Preferred Stock under the controlled equity offering program which provided net proceeds to us of
approximately $2.8 million. The sales agent received an aggregate of approximately $80,000, which represents an average commission of approximately 2.74% on the gross sales price per share.



At June 30, 2005, our authorized capital included 20 million shares of $0.01
par value preferred stock, of which 5.15 million shares had been designated 8.625% Series A Cumulative Preferred Stock (liquidation preference $25.00 per share). The remaining 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.



On May 17, 2005, Belvedere Trust filed a registration statement with the Securities and Exchange Commission for the purpose of registering $100 million of its common stock in connection with a contemplated initial
public offering. We do not intend to sell any of our shares of Belvedere Trusts common stock in the initial public offering.



|NOTE 10. | 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.



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 three months and six months ended June 30, 2005, eligible employees under the 2002
Incentive Compensation Plan earned $87 thousand and $851 thousand, respectively, in incentive compensation. For the three months and six months ended June 30, 2004, eligible employees under the 2002 Incentive Compensation Plan earned $457 thousand
and $1,582 thousand, respectively, 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 thousand per annum. Pursuant to the terms of an addendum to his original employment agreement, Joseph McAdams receives
a base salary equal to $400 thousand per annum. Heather U. Baines receives a $50 thousand 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
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| | 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 thousand 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.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



At June 30, 2005, the value of the 42,000 unvested shares of restricted stock
issued to the above executives is reflected on our consolidated balance sheets 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.



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 $46.72 per square foot. The sublease runs through June 30, 2012 unless earlier terminated pursuant to the master lease. During the three months and six months ended June 30, 2005, we paid $64,235 and $128,469, respectively, in rent to PIA
under the sublease which is included in Other expenses on the consolidated statements of income. During the three months and six months ended June 30, 2004, we paid $62,363 and $124,726, respectively, in rent to PIA under the sublease
which is included in other expenses on the consolidated statements of income.



The future minimum lease commitment (in whole dollars) is as follows:



|                  |  |      |         |      |   |         |  |            |         |                 |   |           |  |   |          
|----------------- |  | ---- | ------- | ---- | - | ------- |  | ---------- | ------- | --------------- | - | --------- |  | - | ---------
|Year              |  | 2005 |         | 2006 |   | 2007    |  | Thereafter |         | TotalCommitment
|Commitment Amount |  | $    | 132,322 |      | $ | 268,611 |  | $          | 276,669 |                 | $ | 1,350,238 |  | $ | 2,027,840



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 stockholders 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 consolidated statements of income are fees of $65,411 and $129,277, respectively, paid to PIA in connection with this agreement during the three
months and six months



21



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##### Table of Contents

ended June 30, 2005. During the three months and six months ended June 30, 2004, fees of $64,467 and $124,678, respectively, were paid to PIA in connection
with this agreement.



Belvedere Trust Mortgage Corporation



On November 3, 2003, we formed our wholly-owned
subsidiary, Belvedere Trust. Belvedere Trust was formed to acquire, own and securitize mortgage loans, with a focus on the high credit-quality jumbo adjustable-rate and hybrid first-lien single-family residential mortgage markets. Belvedere Trust
acquires mortgage loans, securitizes a substantial amount of these mortgage loans and then retains a portion of those mortgage-backed securities, while pledging the balance to third parties in the secondary market. The mortgage-backed securities it
retains are purchased by one of our qualified REIT subsidiaries to maximize tax efficiency on the interest income on those securities. Belvedere Trust was formed as a qualified REIT subsidiary, but it structures securitizations through taxable REIT
subsidiaries (which generally are taxed as C corporations subject to full corporate taxation), which in turn establish special purpose entities that issue securities through real estate mortgage investment conduit, or REMIC, trusts. Since its
formation, Belvedere Trust has become an increasingly important part of our overall operations and, at June 30, 2005, Belvedere Trusts assets comprised 40% of our overall assets. As of June 30, 2005, we had made an investment of $100 million
in Belvedere Trust to capitalize its mortgage operations.



On
November 3, 2003, we also formed 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 three months and six months ended June 30, 2005, Belvedere Trust paid BT Management incentive compensation of $301 thousand and $792 thousand, respectively. For the three months and six months ended June 30, 2004, Belvedere
Trust paid BT Management incentive compensation of $229 thousand and $229 thousand, respectively.



Certain of our executive officers serve as officers and directors of Belvedere Trust and officers and managers of BT Management (and certain of our
employees are also employees of BT Management). Our employees who are also employed by BT Management may receive compensation from BT Management in the form of salary, employee benefits and incentive compensation. The compensation of all BT
Management employees is the responsibility of the BT Management board of directors. However, compensation paid by BT Management to our executive officers who also serve as officers, managers or employees of BT Management is subject to approval of
the compensation committee of Anworths board of directors.



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.



On May 16, 2005, Belvedere Trust and BT Management entered into an Assignment
and Assumption of Sublease and Consent of Sublessor and Keefe Bruyette & Woods, Inc. Pursuant to this agreement, BT Management assumed Belvedere Trusts obligation under a sublease for approximately 2,305 square feet of office space that BT
Management utilizes to manage the operations of Belvedere Trust. On May 16, 2005, we entered into a Guaranty of Sublease with Keefe Bruyette & Woods, Inc. pursuant to which we guaranty the obligations of BT Management under the sublease. The
sublease runs through July 31, 2008 unless earlier terminated pursuant to the master lease. From May 16, 2005 through June 30, 2005, BT Management paid $11,100 in rent under the sublease.



The future minimum lease commitment (in whole dollars) is as follows:



|                  |  |      |        |      |   |        |  |      |        |                 |   |        |  |   |        
|----------------- |  | ---- | ------ | ---- | - | ------ |  | ---- | ------ | --------------- | - | ------ |  | - | -------
|Year              |  | 2005 |        | 2006 |   | 2007   |  | 2008 |        | TotalCommitment
|Commitment Amount |  | $    | 32,270 |      | $ | 64,540 |  | $    | 64,540 |                 | $ | 37,648 |  | $ | 198,998



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On May 17, 2005, Belvedere Trust filed a registration statement with the Securities and Exchange
Commission for the purpose of registering $100 million of its common stock in connection with a contemplated initial public offering. We do not intend to sell any of our shares of Belvedere Trusts common stock in the initial public
offering.



Deferred Compensation Plan



On January 15, 2003, we adopted the Anworth Mortgage Asset Corporation
Deferred Compensation Plan, or the Deferred Compensation Plan. We amended the plan effective January 1, 2005 to comply with Section 409A of the Code enacted as part of the American Jobs Creation Act of 2004. The Deferred Compensation Plan permits
our eligible officers to defer the payment of all or a portion of their cash compensation that otherwise would be in excess of the $1,000,000 annual limitation on deductible compensation imposed by Section 162(m) of the Code (based on the
officers compensation and benefit elections made prior to January 1 of the calendar year in which the compensation will be deferred). 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 Chairman, President and Chief Executive Officer, and Joseph McAdams, our Chief Investment Officer and Executive Vice President, 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 subsequent year.



Amounts deferred
under the Deferred Compensation Plan are not 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. The balance in the participants account is paid to the participant six months after termination of employment or upon the death of the participant or a change in control of
our company. Each participant is a general unsecured creditor of our company with respect to all amounts deferred under the plan.



|NOTE 11. | STOCK OPTION PLAN
|-------- | -----------------



At our May 27, 2004 annual stockholders meeting, our stockholders adopted the Anworth Mortgage Asset Corporation 2004 Equity Compensation Plan, or
the Stock Option Plan, which amended and restated our 1997 Stock Option and Awards Plan. The Stock Option Plan authorized the grant of stock options and other stock-based awards, as of June 30, 2005, for 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, restricted stock, dividend equivalent rights (DERs), phantom shares, stock-based awards that qualify as performance-based awards under Section 162(m) of the Internal Revenue Code, and other stock-based awards. The exercise price for any
option granted under the Stock Option Plan may not be less than 100% of the fair market value of the shares of common stock at the time the option is granted. As of June 30, 2005, 1,639,804 shares remained available for future issuance under the
Stock Option Plan through any combination of stock options or other awards. 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 12. | HEDGING INSTRUMENTS
|-------- | -------------------



At June 30, 2005, we were a counter-party to swap agreements, which are derivative instruments as defined by FASB 133 and FASB 138, with an aggregate
notional amount of $400 million and an average maturity of 3.1 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.



At June 30, 2005, there was an increase in unrealized gains of $2.5 million from $4.1 million at December 31, 2004 to $6.6 million on our swap
agreements included in Other comprehensive income (this increase consisted of unrealized gains on cash flow hedges of $1.2 million and a reclassification adjustment for interest expense included in net income of



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$1.3 million) and shown as Derivative instruments at fair value on the consolidated balance sheets as an asset of $7.7 million and a liability of
$1.1 million.



For the three months ended June 30, 2005, there
was no gain or loss recognized in earnings due to hedge ineffectiveness. There were no components of the derivative instruments gain or loss excluded from the assessment of hedge effectiveness. The maximum length of our swap agreements is 4
years. We do not anticipate any discontinuance of the swap agreements and thus do not expect to recognize any gain or loss into earnings because of this.



To mitigate the impact of rising interest rates on the consummation of forward loan purchase commitments in connection with planned securitization
funding, Belvedere Trust may enter into Eurodollar futures transactions. 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. We
do not designate the Eurodollar futures for hedge accounting.



For the three months and six months ended June 30, 2005, there were no recognized gains or recognized losses incurred on Eurodollar futures transactions. During the three months ended June 30, 2004, Belvedere Trust recognized a net
unrealized gain of $423 thousand and a realized gain of $103 thousand on Eurodollar futures and forward loan purchase commitments. During the six months ended June 30, 2004, Belvedere Trust recognized an unrealized gain of $219 thousand and a
realized gain of $103 thousand on Eurodollar futures and forward loan purchase commitments.



As of June 30, 2005, we did not have any positions outstanding on Eurodollar futures transactions. It is possible that Belvedere Trust may enter into Eurodollar futures transactions within the next twelve months. As
the transactions are short-term, there may be either gain or loss recognized into earnings, but we can not anticipate the amount that would be recognized within the next twelve months at this time.



As of June 30, 2005, Belvedere Trust had entered into approximately $14.4
million in forward loan purchase commitments for which the market value had not significantly fluctuated from the inception of the commitment to June 30, 2005. These forward loan purchase commitments did not experience significant fluctuations in
value during the periods for which the commitments were open.



|NOTE 13. | COMMITMENTS AND CONTINGENCIES
|-------- | -----------------------------



| | (a) | Lease Commitment and Administrative Services CommitmentThe Company subleases office space and uses administrative services from PIA as more fully described in Note 10.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | We sublease 2,305 square feet of office space for our Belvedere operations from an independent third party. The sublease commenced March 1, 2005 and ends on July 31, 2008. The
future minimum lease commitment (in whole dollars) is as follows:
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                  |  |      |        |      |   |        |  |      |        |                 |   |        |  |   |        
|----------------- |  | ---- | ------ | ---- | - | ------ |  | ---- | ------ | --------------- | - | ------ |  | - | -------
|Year              |  | 2005 |        | 2006 |   | 2007   |  | 2008 |        | TotalCommitment
|Commitment Amount |  | $    | 32,270 |      | $ | 64,540 |  | $    | 64,540 |                 | $ | 37,648 |  | $ | 198,998



| | (c) | Loan Purchase CommitmentAs of June 30, 2005, Belvedere Trust has entered into commitments to purchase mortgage loans in the amount of $14.4 million.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------



|NOTE 14. | OTHER EXPENSE
|-------- | -------------



|                                        |  |                            |     |                          |   |      |  |      |       |  |   |      
|--------------------------------------- |  | -------------------------- | --- | ------------------------ | - | ---- |  | ---- | ----- |  | - | -----
|                                        |  | Three Months EndedJune 30, |     | Six Months EndedJune 30,
|                                        |  | 2005                       |     | 2004                     |   | 2005 |  | 2004
|                                        |  | (in thousands)             |     | (in thousands)          
|Legal and accounting fees               |  | $                          | 301 |                          | $ | 250  |  | $    | 555   |  | $ | 398  
|Fees related to loan acquisitions       |  |                            | 100 |                          |   | 55   |  |      | 282   |  |   | 155  
|Printing and stockholder communications |  |                            | 25  |                          |   | 98   |  |      | 64    |  |   | 99   
|D&O insurance                           |  |                            | 102 |                          |   | 90   |  |      | 185   |  |   | 179  
|Software and implementation             |  |                            | 70  |                          |   | 50   |  |      | 157   |  |   | 105  
|Administrative service fees             |  |                            | 73  |                          |   | 65   |  |      | 126   |  |   | 126  
|Rent                                    |  |                            | 81  |                          |   | 66   |  |      | 156   |  |   | 135  
|Stock exchange and filing fees          |  |                            | 34  |                          |   | 39   |  |      | 94    |  |   | 76   
|Custodian fees                          |  |                            | 32  |                          |   | 22   |  |      | 64    |  |   | 44   
|Sarbanes-Oxley consulting fees          |  |                            | 7   |                          |   | 50   |  |      | 86    |  |   | 65   
|Other                                   |  |                            | 145 |                          |   | 127  |  |      | 322   |  |   | 345  
|                                        |  |                            |     |                          |   |      |  |      |       |  |   |      
|Total of Other Expense                  |  | $                          | 970 |                          | $ | 912  |  | $    | 2,091 |  | $ | 1,727
|                                        |  |                            |     |                          |   |      |  |      |       |  |   |      



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|NOTE 15. | SUBSEQUENT EVENTS
|-------- | -----------------



On May 17, 2005, Belvedere Trust filed a registration statement with the Securities and Exchange Commission for the purpose of registering $100 million of
its common stock in connection with a contemplated initial public offering. Belvedere Trust filed amendments to the registration statement with the Securities and Exchange Commission on June 17, 2005 and July 13, 2005. We do not intend to sell any
of our shares of Belvedere Trusts common stock in the initial public offering.



On July 19, 2005, we declared a common stock dividend of $0.18 per share which is payable on August 11, 2005 to our common stockholders of record as of the close of business on July 29, 2005.



On July 19, 2005, we declared a Series A preferred stock dividend of
$0.539063 per share for the third quarter of 2005 which is payable on October 17, 2005 to our preferred stockholders of record as of the close of business on September 30, 2005.



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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, 2004 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.



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



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 mortgage loans and the costs of borrowing to finance our acquisition of mortgage-backed securities and mortgage loans.



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, 2005, our qualified REIT assets (real estate assets, as defined in the tax code, cash and cash items and government
securities) were greater than 90% of our total assets, as compared to the tax code requirement that at least 75% of our total assets must be qualified REIT assets. Greater than 99% of our 2004 revenue qualifies for both the 75% source of income test
and the 95% source of income test under the REIT rules. We believe we met all REIT requirements regarding the ownership of our common stock and the distributions of our net income. Therefore, we believe that we continue to qualify as a REIT under
the provisions of the tax code.



On November 3, 2003, we formed
our wholly-owned subsidiary, Belvedere Trust, to acquire, own and securitize mortgage loans, with a focus on the high credit-quality jumbo adjustable-rate and hybrid first-lien mortgage markets. Belvedere Trust acquires mortgage loans, securitizes a
substantial amount of those mortgage loans and then retains a portion of those mortgage-backed securities, while selling the balance to third parties in the secondary market. The mortgage-backed securities that are retained (classified on our
consolidated balance sheets as Residential real estate loans) are purchased by a qualified REIT subsidiary to maximize tax efficiency on the interest income on those securities. Belvedere Trust was formed as a qualified REIT subsidiary,
but it structures securitizations through taxable REIT subsidiaries (which generally are taxed as C corporations subject to full corporate taxation), which in turn establish special purpose entities, or SPE, that issue securities through real estate
mortgage investment conduit, or REMIC, trusts. Since its formation, Belvedere Trust has become an increasingly important part of our overall operations and, as of June 30, 2005, Belvedere Trusts assets comprised 40% of our overall assets.
Through June 30, 2005, we had made an investment of $100 million in Belvedere Trust to capitalize its mortgage operations.



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We acquire residential mortgage loans from third party originators, including banks and other mortgage
lenders, through our Belvedere Trust subsidiary. During the year ended December 31, 2004, Belvedere Trust transferred approximately $2.4 billion of residential mortgage loans in six separate transactions to securitization trusts pursuant to pooling
and third party servicing agreements. Five of the six securitization transactions in 2004 totaling approximately $2.1 billion utilized non-qualified SPEs requiring consolidation, which effectively resulted in the transactions being accounted for as
financings. One securitization transaction (as more fully described in Note 3) in the first quarter of 2004 of approximately $253 million was accounted for as a sale. During the second quarter ended June 30, 2005, Belvedere Trust transferred
approximately $0.4 billion of residential mortgage loans to a securitization trust pursuant to a pooling and third party service agreement. During the first quarter ended March 31, 2005, Belvedere Trust transferred approximately $0.9 billion of
residential mortgage loans to a securitization trust pursuant to a pooling and third party service agreement. These transactions utilized non-qualified SPEs requiring consolidation, which effectively resulted in these transactions being accounted
for as financings. The residential real estate loans remain as assets on our consolidated balance sheets subsequent to securitization, and the financing resulting from these securitizations is shown on our consolidated balance sheets as
Mortgage-backed securities issued. The servicing of the mortgage loans is performed by third parties under servicing arrangements that resulted in no servicing asset or liability. Since its formation, Belvedere Trust has securitized
approximately $3.8 billion of mortgage loans.



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 Anworth and 50% by the executive officers of Belvedere Trust. 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.



On May 17, 2005, Belvedere Trust filed a registration statement with the
Securities and Exchange Commission for the purpose of registering $100 million of its common stock in connection with a contemplated initial public offering. We do not intend to sell any of our shares of Belvedere Trusts common stock in the
initial public offering.



At June 30, 2005, we had total assets
of $8.0 billion. Our portfolio consisted of $4.76 billion of agency mortgage-backed securities allocated as follows: 34% agency adjustable-rate mortgage-backed securities, 62% agency hybrid adjustable-rate mortgage-backed securities, 3% agency
fixed-rate mortgage-backed securities and less than 1% agency floating-rate CMOs. Our non-agency mortgage-backed securities held at June 30, 2005 were approximately $71 million. Mortgage loans held for securitization at June 30, 2005 were $34
million and securitized mortgage loans were $3.09 billion. As of June 30, 2005, Belvedere Trusts assets comprised 40% of our overall assets, or approximately $3.2 billion in mortgage-related assets. Our total equity at June 30, 2005 was $545
million. Common stockholders equity was approximately $498 million, or $10.37 per share. For the three months ended June 30, 2005, we reported net income of $8.9 million. Our net income available to common stockholders was $7.8 million, or
$0.16 per diluted share.



Results of Operations



Three Months Ended June 30, 2005 Compared to June 30, 2004



For the three months ended June 30, 2005, our net income
was $8.9 million. Our net income available to common stockholders was $7.8 million, or $0.16 per diluted share, based on an average of 47,668,000 shares outstanding. For the three months ended June 30, 2004, our net income was $12.2 million, or
$0.27 per diluted share available to common stockholders, based on an average of 45,101,000 shares outstanding.



Net interest income for the three months ended June 30, 2005 totaled $11.2 million, or 16% of total interest income, compared to $13.6 million, or 41% of
total interest income, for the three months ended June 30, 2004. Net interest income is comprised of the interest income earned on mortgage investments net of premium and discount amortization less interest expense from borrowings. Interest income
net of premium amortization expense for the three months ended June 30, 2005 was $70.8 million, compared to $32.9 million for the three months ended June 30, 2004, an increase of 115%. Interest expense for the three months ended June 30, 2005 was
$59.6 million, compared to $19.3 million for the three months ended June 30, 2004, an increase of 208%. The larger percentage increase in interest expense was due primarily to the increase in interest rates during the year.



Premium amortization expense for Anworths agency securities decreased
$5.1 million, or 32%, from $15.7 million to $10.6 million, and premium amortization expense on Belvedere Trusts assets was $4.3 million during the three months ended June 30, 2005, compared to $0.8 million for the three months ended June 30,
2004, due to the increase in Belvedere Trusts assets.



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The table below shows the approximate constant prepayment rate of our agency mortgage-backed securities:



|     |  |               |   |  |                |  
|---- |  | ------------- | - |  | -------------- | -
|     |  | First Quarter |   |  | Second Quarter |  
|2005 |  | 27            | % |  | 31             | %
|2004 |  | 27            | % |  | 42             | %



During the three
months ended June 30, 2005, we did not sell any securities, compared to a gain on sale of securities of $102 thousand, or 0.3% of total interest income, during the three months ended June 30, 2004. During the three months ended June 30, 2005, we did
not have any recognized gain or loss on derivative instruments compared to a realized net gain on derivative instruments of $532 thousand, or 1.6% of total interest income, during the three months ended June 30, 2004.



Total expenses were $2.2 million for the three months ended June 30, 2005,
compared to $1.9 million, for the three months ended June 30, 2004. The increase of $300 thousand in total expenses was due primarily to an increase in compensation and benefit expenses of $424 thousand (due primarily to staffing at Belvedere Trust
and an increase in salaries at the Company), an increase in the provision for loan losses of $241 thousand (relating to the residential real estate loans at Belvedere Trust), an increase in other expense of $58 thousand and partially offset by a
decrease in incentive compensation expense of $370 thousand. Other expenses for the three months ended June 30, 2005 were $970 thousand, compared to $912 thousand for the three months ended June 30, 2004. This increase was due primarily to an
increase in legal and accounting fees of $51 thousand (due primarily to increased accounting and audit fees relating to Sarbanes-Oxley and the addition of Belvedere Trust), an increase in fees relating to residential real estate loan acquisitions
and securitizations (Belvedere Trust) of $45 thousand and a net increase in all other expenses of $35 thousand partially offset by a decrease in printing and stockholder communications of $73 thousand.



Six Months Ended June 30, 2005 Compared to June 30, 2004



For the six months ended June 30, 2005, our net income was $23.3 million.
Our net income available to common stockholders was $21.5 million, or $0.45 per diluted share, based on an average of 47,274,000 shares outstanding. For the six months ended June 30, 2004, our net income was $30.1 million, or $0.68 per diluted share
available to common stockholders, based on an average of 44,463,000 shares outstanding.



Net interest income for the six months ended June 30, 2005 totaled $28.9 million, or 21% of total interest income, compared to $33.9 million, or 50% of total interest income, for the six months ended June 30, 2004.
Net interest income is comprised of the interest income earned on mortgage investments net of premium and discount amortization less interest expense from borrowings. Interest income net of premium amortization expense for the six months ended June
30, 2005 was $137.3 million, compared to $68.2 million for the six months ended June 30, 2004, an increase of 102%. Interest expense for the six months ended June 30, 2005 was $108.4 million, compared to $34.3 million for the six months ended June
30, 2004, an increase of 216%. As a result of investing the proceeds of our common and preferred stock offerings, our assets and borrowings and the related interest income and interest expense have increased during the year. Although the amortized
cost of Anworths agency mortgage-backed securities increased by 4%, from $4.58 billion to $4.76 billion, the large increase in our mortgage-related assets and borrowings was due to the growth of Belvedere Trust, our wholly-owned subsidiary.
Belvedere Trust, which was formed in November 2003, now represents approximately 40% of our total assets. The larger percentage increase in interest expense was due primarily to the increase in interest rates during the year.



Premium amortization expense for Anworths agency securities decreased
$5.1 million, or 21%, from $24.9 million to $19.8 million, and premium amortization expense on Belvedere Trusts assets was $7.5 million during the six months ended June 30, 2005, compared to $1.0 million for the six months ended June 30, 2004,
due to the increase in Belvedere Trusts assets.



During
the six months ended June 30, 2005, we did not sell any securities, compared to a gain on sale of securities of $259 thousand, or 0.4% of total interest income, during the six months ended June 30, 2004. During the six months ended June 30, 2005, we
did not have any recognized gain or loss on derivative instruments compared to a realized net gain on derivative instruments of $329 thousand, or 0.5% of total interest income, during the six months ended June 30, 2004.



Total expenses were $5.3 million for the six months ended June 30, 2005,
compared to $4.2 million, for the six months ended June 30, 2004. The increase of $1.1 million in total expenses was due primarily to an increase in compensation and benefit expenses of $906 thousand (due primarily to staffing at Belvedere Trust and
an increase in salaries at the Company), an increase in the provision for loan losses of $538 thousand (relating to the residential real estate loans at Belvedere Trust), an increase in other expense of $364 thousand and partially offset by a
decrease in incentive compensation expense of $731 thousand. Other expenses for the six months ended June 30, 2005 were $2.1 million, compared to $1.7 million for the six months ended June 30, 2004. This increase was due primarily to an increase in
legal and accounting fees of $157 thousand (due primarily to increased accounting and audit fees relating to Sarbanes-Oxley and the addition of Belvedere Trust), an increase in fees relating to residential real estate loan acquisitions and
securitizations (Belvedere Trust)



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of $127 thousand, an increase in Sarbanes-Oxley consulting fees of $21 thousand and a net increase in other expenses of $59 thousand.



Financial Condition



At June 30, 2005, we held agency mortgage assets whose amortized cost was approximately $4.78 billion, consisting primarily
of $4.58 billion of adjustable-rate mortgage-backed securities, $16 million of floating rate CMOs and $182 million of fixed-rate mortgage-backed securities. This amount represents an approximate 4% increase from the $4.61 billion held at December
31, 2004. Of the adjustable-rate agency mortgage-backed securities owned by us, 35% were adjustable-rate pass-through certificates whose coupons reset within one year. The remaining 65% 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.



Agency Securities



The following table presents a schedule of agency
mortgage-backed securities at fair value owned at June 30, 2005 and December 31, 2004, classified by type of issuer (dollar amounts in thousands):



|                                        |  |               |           |                      |                   |   |            |   |                      |  |       |  
|--------------------------------------- |  | ------------- | --------- | -------------------- | ----------------- | - | ---------- | - | -------------------- |  | ----- | -
|                                        |  | June 30, 2005 |           |                      | December 31, 2004 |  
|Agency                                  |  | Fair Value    |           | Portfolio Percentage |                   |   | Fair Value |   | Portfolio Percentage | 
|Fannie Mae (FNM)                        |  | $             | 3,345,673 |                      | 70.3              | % |            | $ | 3,301,406            |  | 72.0  | %
|Freddie Mac (FHLMC)                     |  |               | 1,306,192 |                      | 27.4              | % |            |   | 1,157,910            |  | 25.2  | %
|Ginnie Mae (GNMA)                       |  |               | 107,479   |                      | 2.3               | % |            |   | 129,225              |  | 2.8   | %
|                                        |  |               |           |                      |                   |   |            |   |                      |  |       |  
|Total agency mortgage-backed securities |  | $             | 4,759,344 |                      | 100.0             | % |            | $ | 4,588,541            |  | 100.0 | %
|                                        |  |               |           |                      |                   |   |            |   |                      |  |       |  



The following table
classifies our portfolio of agency mortgage-backed securities owned at June 30, 2005 and December 31, 2004, by type of interest rate index (dollar amounts in thousands):



|                                        |  |               |           |                     |                   |   |            |   |                     |  |       |  
|--------------------------------------- |  | ------------- | --------- | ------------------- | ----------------- | - | ---------- | - | ------------------- |  | ----- | -
|                                        |  | June 30, 2005 |           |                     | December 31, 2004 |  
|Index                                   |  | Fair Value    |           | PortfolioPercentage |                   |   | Fair Value |   | PortfolioPercentage | 
|One-month LIBOR                         |  | $             | 15,754    |                     | 0.3               | % |            | $ | 18,584              |  | 0.4   | %
|Six-month LIBOR                         |  |               | 13,109    |                     | 0.3               | % |            |   | 20,008              |  | 0.5   | %
|One-year LIBOR                          |  |               | 2,612,442 |                     | 54.9              | % |            |   | 2,251,782           |  | 49.1  | %
|Six-month Certificate of Deposit        |  |               | 5,515     |                     | 0.1               | % |            |   | 6,402               |  | 0.1   | %
|Six-month Constant Maturity Treasury    |  |               | 1,381     |                     | 0                 | % |            |   | 1,648               |  | 0     | %
|One-year Constant Maturity Treasury     |  |               | 1,857,864 |                     | 39.0              | % |            |   | 2,006,235           |  | 43.7  | %
|Cost of Funds Index                     |  |               | 74,196    |                     | 1.6               | % |            |   | 82,367              |  | 1.8   | %
|Fixed-Rate                              |  |               | 179,083   |                     | 3.8               | % |            |   | 201,515             |  | 4.4   | %
|                                        |  |               |           |                     |                   |   |            |   |                     |  |       |  
|Total agency mortgage-backed securities |  | $             | 4,759,344 |                     | 100.0             | % |            | $ | 4,588,541           |  | 100.0 | %
|                                        |  |               |           |                     |                   |   |            |   |                     |  |       |  



The fair values
indicated do not include interest earned but not yet paid. With respect to our hybrid adjustable-rate mortgage-backed securities, 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 agency portfolio had a weighted average coupon of 4.42% at June 30, 2005. The average coupon of the adjustable-rate securities was 4.21%, the hybrid average coupon was 4.50%, the CMO floaters average coupon
was 4.03% and the average coupon of the fixed-rate securities was 5.12%. At December 31, 2004, our total agency portfolio had a weighted average coupon of 4.28%. The average coupon of the adjustable-rate securities was 4.13%, the hybrid average
coupon was 4.30%, the CMO floaters average coupon was 3.22% and the average coupon of the fixed-rate securities was 5.12%.



At June 30, 2005, the unamortized net premium paid for our agency mortgage-backed securities was $100 million. At December 31, 2004, the unamortized net
premium paid for our mortgage-backed securities was $111 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



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assumed constant prepayment rate, the premium would be amortized over a longer time period, resulting in a higher yield to maturity.



At June 30, 2005, the average amortized cost of our agency mortgage-related
assets was 102.1%, the average amortized cost of the adjustable-rate securities was 102.1% and the average amortized cost of the fixed-rate securities was 102.9%. Relative to our agency MBS portfolio, at June 30, 2005, the average interest rate on
outstanding repurchase agreements was 3.03% and the average days to maturity was 142 days. After adjusting for interest rate swap transactions, the average interest rate on outstanding repurchase agreements was 3.04% and the weighted average term to
next rate adjustment was 242 days.



At December 31, 2004, the
average amortized cost of our agency mortgage-related assets was 102.5%, the average amortized cost of the adjustable-rate securities was 102.5% and the average amortized cost of the fixed-rate securities was 102.9%. Relative to our agency MBS
portfolio, at December 31, 2004, the average interest rate on outstanding repurchase agreements was 2.25% and the average days to maturity was 184 days. After adjusting for interest rate swap transactions, the average interest rate on outstanding
repurchase agreements was 2.34% and the weighted average term to next rate adjustment was 304 days.



Residential Real Estate Loans (Belvedere Trust)



Residential real estate loans held for securitization and held in securitization trusts are reflected in the financial statements at their amortized cost.
At June 30, 2005 and December 31, 2004, residential real estate loans consisted of the following (in thousands):



June 30, 2005



|                                 |  |                                                      |        |                                            |   |                                     |  |   |          
|-------------------------------- |  | ---------------------------------------------------- | ------ | ------------------------------------------ | - | ----------------------------------- |  | - | ---------
|Residential Real Estate Loans    |  | Residential Real Estate Loans Pending Securitization |        | Residential Real Estate Loans, Securitized |   | Total Residential Real Estate Loans
|Principal balance                |  | $                                                    | 32,763 |                                            | $ | 3,026,869                           |  | $ | 3,059,632
|Unamortized premium and expenses |  |                                                      | 1,025  |                                            |   | 65,124                              |  |   | 66,149   
|                                 |  |                                                      |        |                                            |   |                                     |  |   |          
|Carrying value                   |  | $                                                    | 33,788 |                                            | $ | 3,091,993                           |  | $ | 3,125,781
|                                 |  |                                                      |        |                                            |   |                                     |  |   |          



December 31, 2004



|                                 |  |                                                      |         |                                            |   |                                     |  |   |          
|-------------------------------- |  | ---------------------------------------------------- | ------- | ------------------------------------------ | - | ----------------------------------- |  | - | ---------
|Residential Real Estate Loans    |  | Residential Real Estate Loans Pending Securitization |         | Residential Real Estate Loans, Securitized |   | Total Residential Real Estate Loans
|Principal balance                |  | $                                                    | 566,748 |                                            | $ | 2,015,175                           |  | $ | 2,581,923
|Unamortized premium and expenses |  |                                                      | 11,184  |                                            |   | 35,227                              |  |   | 46,411   
|                                 |  |                                                      |         |                                            |   |                                     |  |   |          
|Carrying value                   |  | $                                                    | 577,932 |                                            | $ | 2,050,402                           |  | $ | 2,628,334
|                                 |  |                                                      |         |                                            |   |                                     |  |   |          



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As of June 30, 2005, residential real estate loans consisted of the following (in thousands):



|                                                         |  |                           |  |                 |  |               |  |                   |           |                              |   |                               |  |   |      
|-------------------------------------------------------- |  | ------------------------- |  | --------------- |  | ------------- |  | ----------------- | --------- | ---------------------------- | - | ----------------------------- |  | - | -----
|Loan Description                                         |  | Interest Rate Type        |  | Interest Rate   |  | Maturity Date |  | Principal Balance |           | Delinquent Balance (30 Days) |   | Delinquent Balance (60+ Days)
|First Lien Adjustable-Rate Residential Real Estate Loans |  | MovingTreasuryAverage ARM |  | 1.000%6.875%   |  | 20322045     |  | $                 | 1,135,107 |                              | $ | 4,868                         |  | $ | 616  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 1-Month ARM               |  | 4.125%6.750%   |  | 2034-2035     |  |                   | 234,657   |                              |   | 1,639                         |  |   | 558  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 6-Month ARM               |  | 3.500%  7.000% |  | 20332035     |  |                   | 465,738   |                              |   | 7,914                         |  |   | 1,403
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 1-Year ARM                |  | 3.625%  6.000% |  | 20332034     |  |                   | 6,414     |                              |   |                              |  |   |     
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 3-Year Hybrid             |  | 2.875%  7.000% |  | 20332035     |  |                   | 316,693   |                              |   | 652                           |  |   | 161  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 5-Year Hybrid             |  | 3.375%  6.750% |  | 20332035     |  |                   | 685,988   |                              |   | 5,688                         |  |   | 982  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 7-Year Hybrid             |  | 3.750%  6.625% |  | 20332034     |  |                   | 191,907   |                              |   | 817                           |  |   | 392  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 10-Year Hybrid            |  | 4.500%  6.750% |  | 20342035     |  |                   | 23,128    |                              |   |                              |  |   |     
|                                                         |  |                           |  |                 |  |               |  |                   |           |                              |   |                               |  |   |      
|                                                         |  |                           |  |                 |  |               |  | $                 | 3,059,632 |                              | $ | 21,578                        |  | $ | 4,112
|                                                         |  |                           |  |                 |  |               |  |                   |           |                              |   |                               |  |   |      



At December 31, 2004,
residential real estate loans consisted of the following (in thousands):



|                                                         |  |                           |  |                 |  |               |  |                   |           |                              |   |                               |  |   |      
|-------------------------------------------------------- |  | ------------------------- |  | --------------- |  | ------------- |  | ----------------- | --------- | ---------------------------- | - | ----------------------------- |  | - | -----
|Loan Description                                         |  | Interest Rate Type        |  | Interest Rate   |  | Maturity Date |  | Principal Balance |           | Delinquent Balance (30 Days) |   | Delinquent Balance (60+ Days)
|First Lien Adjustable-Rate Residential Real Estate Loans |  | MovingTreasuryAverage ARM |  | 1.000%6.000%   |  | 2034  2035   |  | $                 | 492,003   |                              | $ |                              |  | $ |     
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 1-Month ARM               |  | 1.000%5.750%   |  | 2034          |  |                   | 153,546   |                              |   |                              |  |   |     
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 6-Month ARM               |  | 2.250%  6.750% |  | 2033  2035   |  |                   | 549,270   |                              |   | 1,939                         |  |   |     
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 1-Year ARM                |  | 3.625%  7.125% |  | 2033 2034    |  |                   | 8,600     |                              |   |                              |  |   |     
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 3-Year Hybrid             |  | 2.875%  7.000% |  | 2033  2035   |  |                   | 359,181   |                              |   | 3,838                         |  |   | 110  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 5-Year Hybrid             |  | 3.375%  7.125% |  | 2033  2035   |  |                   | 777,493   |                              |   | 5,406                         |  |   | 350  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 7-Year Hybrid             |  | 3.750%  6.625% |  | 2033  2035   |  |                   | 217,700   |                              |   | 1,219                         |  |   | 754  
|First Lien Adjustable-Rate Residential Real Estate Loans |  | 10-Year Hybrid            |  | 4.500%  6.750% |  | 2034  2035   |  |                   | 24,130    |                              |   |                              |  |   |     
|                                                         |  |                           |  |                 |  |               |  |                   |           |                              |   |                               |  |   |      
|                                                         |  |                           |  |                 |  |               |  | $                 | 2,581,923 |                              | $ | 12,402                        |  | $ | 1,214
|                                                         |  |                           |  |                 |  |               |  |                   |           |                              |   |                               |  |   |      



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As of June 30, 2005 and December 31, 2004, the residential real estate loans consisted of the following
(in thousands):



|                                   |  |                 |  |                   |           |                 |       |                  |   |          
|---------------------------------- |  | --------------- |  | ----------------- | --------- | --------------- | ----- | ---------------- | - | ---------
|                                   |  | June 30, 2005   |  | December 31, 2004
|Range of Carrying Amounts of Loans |  | Number of Loans |  | Principal Balance |           | Number of Loans |       | PrincipalBalance
|$0$99                             |  | 504             |  | $                 | 20,939    |                 | 261   |                  | $ | 16,976   
|$100$149                          |  | 893             |  |                   | 112,568   |                 | 779   |                  |   | 97,545   
|$150$199                          |  | 901             |  |                   | 157,207   |                 | 760   |                  |   | 131,914  
|$200$249                          |  | 832             |  |                   | 186,260   |                 | 719   |                  |   | 160,615  
|$250$299                          |  | 742             |  |                   | 203,078   |                 | 585   |                  |   | 159,731  
|$300$349                          |  | 761             |  |                   | 248,687   |                 | 634   |                  |   | 206,815  
|$350$399                          |  | 969             |  |                   | 364,313   |                 | 804   |                  |   | 301,503  
|$400$449                          |  | 755             |  |                   | 319,707   |                 | 611   |                  |   | 258,586  
|$450$499                          |  | 600             |  |                   | 284,860   |                 | 474   |                  |   | 224,893  
|$500$749                          |  | 1,218           |  |                   | 718,971   |                 | 1,030 |                  |   | 607,384  
|$750$999                          |  | 294             |  |                   | 258,840   |                 | 275   |                  |   | 243,157  
|$1,000 & greater                   |  | 148             |  |                   | 184,202   |                 | 140   |                  |   | 172,804  
|                                   |  |                 |  |                   |           |                 |       |                  |   |          
|                                   |  | 8,617           |  | $                 | 3,059,632 |                 | 7,072 |                  | $ | 2,581,923
|                                   |  |                 |  |                   |           |                 |       |                  |   |          



The weighted average
coupon on whole loans which we have securitized was 5.06% at June 30, 2005. At December 31, 2004, the weighted average coupon on whole loans which we have securitized was 4.30%.



As of June 30, 2005 and December 31, 2004, the residential real estate loans consisted of the following:



|                                    |  |               |   |  |                   |  
|----------------------------------- |  | ------------- | - |  | ----------------- | -
|Geographic Concentration            |  | June 30, 2005 |   |  | December 31, 2004 |  
|Southern California                 |  | 32            | % |  | 32                | %
|Northern California                 |  | 22            | % |  | 21                | %
|Florida                             |  | 6             | % |  | 6                 | %
|Virginia                            |  | 4             | % |  | 4                 | %
|Colorado                            |  | 3             | % |  | 3                 | %
|Illinois                            |  | 3             | % |  | 3                 | %
|Michigan                            |  | 3             | % |  | 3                 | %
|Other states (none greater than 2%) |  | 27            | % |  | 28                | %
|                                    |  |               |   |  |                   |  
|Total:                              |  | 100           | % |  | 100               | %



Our residential real
estate loan portfolio of $3.12 billion as of June 30, 2005 includes $34 million of loans pending securitization and $3.09 billion in loans which have been securitized. The securitized residential real estate loans serve as collateral for $2.53
billion of mortgage-backed securities issued and $527 million of repurchase agreement financings. Belvedere Trust structures securitization transactions primarily through special purpose entities (such as real estate mortgage investment conduit, or
REMIC, trusts). The principal business activity involves issuing various series of mortgage-backed securities (in the form of pass-through certificates or bonds collateralized by residential real estate loans). The collateral specific to each
mortgage-backed securities 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. Although the $3.09 billion of residential real estate loans which have been
securitized are consolidated on our balance sheets, the special purpose entities that hold such loans, including BellaVista Funding Corporation, are legally separate from us and Belvedere Trust. Consequently, the assets of these special purpose
entities (including the securitized mortgage loans) are not available to our creditors or to creditors of Belvedere Trust, and such mortgage loans are not assets of Anworth or of Belvedere Trust. Only our interest in the securities issued by the
special purpose entities are legal assets of Anworth and Belvedere Trust.



At June 30, 2005, Belvedere Trust owned approximately $34 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 high credit-quality jumbo adjustable-rate and hybrid first-lien single-family residential mortgages with initial fixed-rate periods of three to ten years.



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Hedging



We periodically enter into derivative transactions, in the form of interest rate swaps, which are intended to hedge our exposure to rising rates on funds
borrowed to finance our investments in securities. We designate the interest rate swap 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, 2005, we were a
counter-party to swap agreements, which are derivative instruments as defined by FASB 133 and FASB 138, with an aggregate notional amount of $400 million and an average maturity of 3.1 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, 2005, there were unrealized gains of approximately $6.6 million on our swap agreements.



To mitigate the impact of rising interest rates on the consummation of forward loan purchase commitments in connection with planned securitization
funding, Belvedere Trust may enter into Eurodollar futures transactions. There is typically 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. We do not designate the Eurodollar futures for hedge accounting. Once the financing rates on
the securitization are fixed, we remove the hedge positions. We recognize the change in value of the projected cash flows on loans that we have purchased and loans that we have committed to purchase as well as the change in value of the Eurodollar
futures transactions. The difference between these changes in value is included in income during the current period. For the three months ended June 30, 2005, there were no recognized gains or recognized losses incurred on Eurodollar futures
transactions. As of June 30, 2005, Belvedere Trust did not have any outstanding Eurodollar futures positions.



Liquidity and Capital Resources



Our primary source of funds consists of repurchase agreements, relative to our agency MBS portfolio, which totaled $4.3 billion at June 30, 2005 and Belvedere Trusts repurchase agreements, which totaled $527 million at June 30, 2005.
Belvedere Trust also had $32 million in whole loan financing at June 30, 2005. Our other significant source of funds for the three months ended June 30, 2005 consisted of payments of principal from our mortgage securities portfolio in the amount of
$432 million and $240 million from our residential real estate loans.



Relative to our agency MBS portfolio, at June 30, 2005, all of our repurchase agreements were fixed-rate term repurchase agreements with original maturities ranging from one to twenty-four months. Belvedere Trust enters into its own
repurchase agreements. As of June 30, 2005, other than three repurchase agreements that reprice monthly subject to a cap, all of Belvedere Trusts repurchase agreements were fixed-rate term repurchase agreements with original maturities ranging
from twenty-two days to thirty-six months. On June 30, 2005, we had borrowing arrangements with 20 different financial institutions and had borrowed funds under repurchase agreements with 12 of these firms. As the repurchase agreements mature, we
enter into new repurchase agreements to take their place. 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 three months ended June 30, 2005.



We acquire residential mortgage loans from third party originators, including banks and other mortgage lenders, through our Belvedere Trust subsidiary.
Belvedere Trust structures securitization transactions primarily through special purpose entities (such as real estate mortgage investment conduit, or REMIC, trusts). The principal business activity involves issuing various series of mortgage-backed
securities (in the form of pass-through certificates or bonds collateralized by residential real estate loans). The collateral specific to each mortgage-backed securities 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. During the second quarter



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ended June 30, 2005, Belvedere Trust transferred approximately $0.4 billion of residential mortgage loans to a securitization trust pursuant to a pooling and
third party service agreement. During the first quarter ended March 31, 2005, Belvedere Trust transferred approximately $0.9 billion of residential mortgage loans to a securitization trust pursuant to a pooling and third party service agreement.
These transactions utilized non-qualified SPEs requiring consolidation, which effectively resulted in these transactions being accounted for as financings. During the year ended December 31, 2004, Belvedere Trust transferred approximately $2.4
billion of residential mortgage loans in six separate transactions to securitization trusts pursuant to pooling and third party servicing agreements. Five of the six securitization transactions in 2004 totaling approximately $2.1 billion utilized
non-qualified SPEs requiring consolidation, which effectively resulted in the transactions being accounted for as financings. The residential real estate loans remain as assets on our consolidated balance sheets subsequent to securitization, and the
financing resulting from these securitizations is shown on our consolidated balance sheets as Mortgage-backed securities issued. The servicing of the mortgage loans is performed by third parties under servicing arrangements that resulted
in no servicing asset or liability. One securitization transaction (as more fully described in Note 3) in the first quarter of 2004 of approximately $253 million was accounted for as a sale. Since its formation, Belvedere Trust has securitized
approximately $3.8 billion of mortgage loans.



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.



During the three months ended June 30, 2005, we had raised approximately $8 million in capital under our Dividend Reinvestment and Stock Purchase Plan.



At June 30, 2005, our authorized capital included 20 million
shares of $0.01 par value preferred stock. During the three months ended June 30, 2005, we issued 115 thousand shares of Series A preferred stock, par value $0.01 per share, liquidation preference $25.00 per share, resulting in net proceeds to us of
approximately $2.8 million.



At June 30, 2005, Belvedere Trust
has entered into commitments to purchase mortgage loans in the amount of $14.4 million and whole loan financing facilities which provide for up to $1.15 billion in financing secured by single-family mortgage loans. At June 30, 2005, Belvedere Trust
has borrowed $32 million under the facilities, secured by mortgage loans held for securitization with a face value of $33 million.



Off-Balance Sheet and Contractual Arrangements



The following table represents the Companys contractual obligations as of June 30, 2005 (in thousands):



|                                            |  |                        |           |                  |   |           |  |           |           |                   |   |         |  |   |        
|------------------------------------------- |  | ---------------------- | --------- | ---------------- | - | --------- |  | --------- | --------- | ----------------- | - | ------- |  | - | -------
|                                            |  | Payments Due By Period
|                                            |  | Total                  |           | Less Than 1 Year |   | 1-3 Years |  | 3-5 Years |           | More Than 5 Years
|Repurchase agreements (Anworth Mortgage(1)) |  | $                      | 4,284,170 |                  | $ | 4,053,170 |  | $         | 231,000   |                   | $ |        |  | $ |       
|Repurchase agreements (Belvedere Trust(1))  |  |                        | 527,254   |                  |   | 348,354   |  |           | 178,900   |                   |   |        |  |   |       
|Whole loan financing facilities             |  |                        | 32,289    |                  |   | 32,289    |  |           |          |                   |   |        |  |   |       
|Mortgage-backed securities issued(2)        |  |                        | 2,532,977 |                  |   | 633,244   |  |           | 831,133   |                   |   | 467,512 |  |   | 601,088
|Junior subordinated notes(3)                |  |                        | 37,380    |                  |   |          |  |           |          |                   |   |        |  |   | 37,380 
|Purchase commitments                        |  |                        | 14,413    |                  |   | 14,413    |  |           |          |                   |   |        |  |   |       
|Lease commitment (Belvedere Trust)          |  |                        | 199       |                  |   | 65        |  |           | 129       |                   |   | 5       |  |   |       
|                                            |  |                        |           |                  |   |           |  |           |           |                   |   |         |  |   |        
|Total(4)                                    |  | $                      | 7,428,682 |                  | $ | 5,081,535 |  | $         | 1,241,162 |                   | $ | 467,517 |  | $ | 638,468
|                                            |  |                        |           |                  |   |           |  |           |           |                   |   |         |  |   |        

---

|(1) | These represent amounts due by maturity.
|--- | ----------------------------------------



|(2) | Principal is paid on the mortgage-backed securities issued following receipt of principal payments on the loans. For the table above, the principal payments have been estimated
based on the underlying contractual payments as adjusted for prepayment assumptions. The actual principal paid in each year will be dependent upon the principal received on the underlying loans.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | These represent amounts due by contractual maturity. However, we do have the option to redeem these after March 30, 2010.
|--- | -------------------------------------------------------------------------------------------------------------------------



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|(4) | This does not include annual compensation agreements, leases with affiliates and incentive compensation agreements which are more fully described in Note 10.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------



The following table represents the
Companys contractual obligations as of December 31, 2004 (in thousands):



|                                            |  |                        |           |                  |   |           |  |           |           |                   |   |         |  |   |        
|------------------------------------------- |  | ---------------------- | --------- | ---------------- | - | --------- |  | --------- | --------- | ----------------- | - | ------- |  | - | -------
|                                            |  | Payments Due By Period
|                                            |  | Total                  |           | Less Than 1 Year |   | 1-3 Years |  | 3-5 Years |           | More Than 5 Years
|Repurchase agreements (Anworth Mortgage(1)) |  | $                      | 4,172,930 |                  | $ | 3,705,930 |  | $         | 467,000   |                   | $ |        |  | $ |       
|Repurchase agreements (Belvedere Trust(1))  |  |                        | 544,506   |                  |   | 275,631   |  |           | 268,875   |                   |   |        |  |   |       
|Whole loan financing facilities             |  |                        | 556,233   |                  |   | 556,233   |  |           |          |                   |   |        |  |   |       
|Mortgage-backed securities issued(2)        |  |                        | 1,494,851 |                  |   | 373,523   |  |           | 490,249   |                   |   | 275,765 |  |   | 355,314
|Purchase commitments                        |  |                        | 350,513   |                  |   | 350,513   |  |           |          |                   |   |        |  |   |       
|                                            |  |                        |           |                  |   |           |  |           |           |                   |   |         |  |   |        
|Total(3)                                    |  | $                      | 7,119,033 |                  | $ | 5,261,830 |  | $         | 1,226,124 |                   | $ | 275,765 |  | $ | 355,314
|                                            |  |                        |           |                  |   |           |  |           |           |                   |   |         |  |   |        

---

|(1) | These represent amounts due by maturity.
|--- | ----------------------------------------



|(2) | Principal is paid on the mortgage-backed securities issued following receipt of principal payments on the loans. For the table above, the principal payments have been estimated
based on the underlying contractual payments as adjusted for prepayment assumptions. The actual principal paid in each year will be dependent upon the principal received on the underlying loans.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | This does not include annual compensation agreements, leases and incentive compensation agreements which are more fully described in Note 10.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------



Stockholders Equity



We use available-for-sale treatment for our agency mortgage-backed
securities which are carried on our consolidated balance sheets at fair value rather than historical cost. Real estate loans are carried at historical cost. Based upon these treatments, our total equity base at June 30, 2005 was $545 million. Common
stockholders equity was approximately $498 million, or $10.37 book value per share.



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 consolidated balance sheets 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. Accumulative Other Comprehensive Income, Unrealized Loss on Available-for-Sale Agency Securities was $52.5 million or 1.1% of the amortized cost of agency mortgage-backed securities at June 30, 2005. This, along with
Accumulative other comprehensive gain, derivatives of $6.6 million, and Accumulative other comprehensive loss, other MBS, of $0.7 million, constitute the total Accumulative other comprehensive loss of $46.6
million.



Critical Accounting Policies



Management has the obligation to determine 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.



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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-related assets. 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-related assets 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 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.



Allowance for Loan Losses



We establish and maintain an allowance for estimated loan losses inherent 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 including, but not limited to, the characteristics of the loan portfolio, review of loan level data, borrowers credit scores, delinquency and collateral
value. The reserves are reviewed on a regular basis and adjusted as deemed necessary. The allowance for loan losses on our real estate loans is established by taking loan loss provisions through our consolidated statements of income.



Valuation of Investment Securities



We carry our investment securities on the consolidated balance sheets 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.



Variable Interest Entities



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 mortgage-backed securities (in the form of pass-through certificates or
bonds collateralized by residential real estate loans). The collateral specific to each series of mortgage-backed securities 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 whole loan financing
agreements where we are acquiring assets prior to securitization. We disclose our interests in consolidated VIEs under FIN 46 in the Investments in Residential Real Estate Loans footnote.



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 (see Note 6) 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



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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. Premiums or discounts are amortized into current operations.



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 high
credit-quality mortgage loans. Applicable banking laws 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 an allowance for loan losses 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 sheets.



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 and may be liable for corporate income tax expenses.



Subsequent Events



On May 17, 2005, Belvedere Trust filed a registration statement with the Securities and Exchange Commission for the purpose
of registering $100 million of its common stock in connection with a contemplated initial public offering. Belvedere Trust filed amendments to the registration statement with the Securities and Exchange Commission on June 17, 2005 and July 13, 2005.
We do not intend to sell any of our shares of Belvedere Trusts common stock in the initial public offering.



On July 19, 2005, we declared a common stock dividend of $0.18 per share which is payable on August 11, 2005 to our common stockholders of record as of
the close of business on July 29, 2005.



On July 19, 2005, we
declared a Series A preferred stock dividend of $0.539063 per share for the third quarter of 2005 which is payable on October 17, 2005 to our preferred stockholders of record as of the close of business on September 30, 2005.



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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 harmed. If this were to occur, the
trading price of our securities could decline significantly and you may lose all or part of your investment.



General Risks Related to Our Business



Our leveraging strategy increases the risks of our operations.



Relative to our investment grade agency mortgage-backed securities, 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-related assets. 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-related assets, generally under repurchase agreements. A decline in the market value of the mortgage-related assets 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-related assets 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 repurchase agreement or whole loan financing facility 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.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



Lloyd McAdams, Joseph E. McAdams, Thad M. Brown, 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 $4.3 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 mortgage loan subsidiary,
and Lloyd McAdams



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is also an owner and Chairman of Syndicated Capital, Inc., a registered broker-dealer. Our officers service to PIA, BT Management Company, L.L.C. and
Syndicated Capital, Inc. 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 harm our overall management and
operating results.



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



Currently, all of our borrowings are collateralized borrowings in the form of repurchase and whole loan financing agreements. If the interest rates on these agreements increase, that would harm 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-related assets.
| | - |  | -------------------------------------------------------



An increase in interest rates may harm our book value and cause a decrease in the demand for mortgage loans, which could harm the cash available for distribution to
you.



Increases in interest rates may harm the market
value of our mortgage-related assets. Our hybrid adjustable-rate mortgage-related assets (during the fixed-rate component of the mortgages underlying such assets) and our fixed-rate securities are generally more harmed 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.



Furthermore, rising interest rates generally reduce the demand for consumer credit, including mortgage loans. Interest rates have been at record low
levels in recent years. The Mortgage Bankers Association of America has predicted that residential mortgage loan originations will decrease in 2005 and for a period thereafter, primarily due to an anticipated decrease in refinancings caused by
rising interest rates. In a period of rising interest rates, we expect to acquire and securitize fewer loans which would harm parts of our business, revenues and results of operations, which could adversely affect the amount of cash available for
distribution to you.



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 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.



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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 harming 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 hedging strategies may not be successful in mitigating our risks associated with
interest rates.



We engage in hedging activity. As
such, we use various derivative financial instruments to provide a level of protection against interest rate risks, but no hedging strategy can protect us completely. When interest rates change, we expect to record a gain or loss on derivatives,
which would be offset by an inverse change in the value of loans or residual interests. Additionally, from time to time, we may enter into hedging transactions in connection with our holdings of mortgage-backed securities and government securities
with respect to one or more of our assets or liabilities. Our hedging activities may include entering into interest rate swaps, caps and floors, options to purchase these items, and futures and forward contracts. Currently, we intend to primarily
use interest rate swap agreements to manage the interest rate risk of our portfolio of agency mortgage-backed securities and Eurodollar futures contracts to manage the interest rate risk associated with holding loans in our whole loan financing
facility before securitization; however, our actual hedging decisions will be determined in light of the facts and circumstances existing at the time and may differ from our currently anticipated hedging strategy. We cannot assure you that our use
of derivatives will offset the risks related to changes in interest rates. It is likely that there will be periods in the future during which we will incur losses after accounting for our derivative financial instruments. The derivative financial
instruments we select may not have the effect of reducing our interest rate risk. In addition, the nature and timing of hedging transactions may influence the effectiveness of these strategies. Poorly designed strategies or improperly executed
transactions could actually increase our risk and losses. In addition, hedging strategies involve transaction and other costs. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest
rate volatility or that our hedging transactions will not result in losses.



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.



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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.



We depend on our key personnel and the loss of any of our key personnel could harm 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, Chairman, President and Chief Executive Officer, Joseph E. McAdams, Chief Investment Officer,
Executive Vice President and Director, Thad M. Brown, Chief Financial Officer, Charles J. Siegel, Senior Vice President-Finance, Evangelos Karagiannis, Vice President 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 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-related assets for our investment, there is a risk that management will cause us to assume more risk than is prudent.



Risk Related Primarily to Anworths 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 harm 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, at June 30, 2005, our agency adjustable-rate mortgage-backed securities had a weighted average term to next rate adjustment of approximately 23 months, while our borrowings had a weighted average term to next rate adjustment of 142 days.
After adjusting for interest rate swap transactions, the weighted average term to next rate adjustment was 242 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.



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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 harm 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. At June 30, 2005, substantially all of our mortgage-backed securities had been 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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



We may 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. At June 30, 2005, 3.8% of our mortgage-backed securities were fixed-rate 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. At
June 30, 2005, approximately 96% of our agency mortgage-backed securities were adjustable-rate securities.



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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 harm our net income and overall profitability.



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.



Risk Related Primarily to Belvedere Trusts Business



Belvedere Trusts use of short-term debt exposes us to liquidity, market value and securitization execution risks that could result in harm to our financial condition.



In order to continue our securitization operations, Belvedere Trust requires
access to short-term debt to finance loan inventory accumulation prior to sale to securitization entities. In times of market dislocation, this type of short-term debt might become unavailable from time to time. During such periods Belvedere Trust
would have to reduce the volume of its holdings and the number of securitizations that it undertakes. Belvedere Trust uses the inventory of assets it acquires to collateralize the debt. The debt is recourse to Belvedere Trust, and if the market
value of the collateral declines Belvedere Trust may need to use its liquidity to increase the amount of collateral pledged to secure the debt or to reduce the debt amount.



Belvedere Trusts payment of commitment fees and other expenses to secure borrowing lines may not protect us from
liquidity issues or losses. Variations in lenders ability to access funds, lender confidence in Belvedere Trust, lender collateral requirements, available borrowing rates, the acceptability and market values of Belvedere Trust collateral, and
other factors could force Belvedere Trust to utilize its liquidity reserves or to sell assets, and, thus, could harm its liquidity, financial soundness, and earnings.



If Belvedere Trust is unable to complete securitizations or experiences delayed mortgage loan sales or securitization closings, it
could face a liquidity shortage which would harm our operating results.



Belvedere Trust relies significantly upon securitizations to generate cash proceeds to repay borrowings and replenish its borrowing capacity. If there is a delay in a securitization closing or any reduction in its
ability to complete securitizations, Belvedere Trust may be required to utilize other sources of financing, which, if available at all, may not be on similar terms. In addition, delays in closing mortgage sales or securitizations of our mortgage
loans increase our risk by exposing us to credit and interest rate risks for this extended period of time. Several factors could harm Belvedere Trusts ability to complete securitizations of its mortgage loans, including, among others, the
following:



| |  |  | conditions in the securities and secondary markets;
| | - |  | ---------------------------------------------------



| |  |  | credit quality of the mortgage loans acquired;
| | - |  | ----------------------------------------------



| |  |  | volume of its mortgage loan acquisitions;
| | - |  | -----------------------------------------



| |  |  | its ability to obtain credit enhancements;
| | - |  | ------------------------------------------



| |  |  | downgrades by rating agencies of its previous securitizations; and
| | - |  | ------------------------------------------------------------------



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| |  |  | lack of investor demand for purchasing components of the securities.
| | - |  | --------------------------------------------------------------------



Belvedere Trusts business may be significantly harmed by a slowdown in the economy of California, resulting in potentially higher delinquencies and increased
loan losses.



At June 30, 2005, approximately 54% of
the residential mortgage loans that Belvedere Trust owns 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 mortgage loans underlying Belvedere
Trusts mortgage-backed securities. This could harm Belvedere Trusts credit loss experience and may harm other aspects of Belvedere Trusts business, including Belvedere Trusts ability to securitize mortgage loans.



Belvedere Trust has had only limited experience in the business of acquiring and
securitizing whole mortgage loans and it may not be successful.



Belvedere Trust was formed in November 2003 as our subsidiary to engage in the business of acquiring and securitizing mortgage loans and it has a limited operating history. The acquisition of whole loans and the
securitization process are inherently complex and involve risks related to the types of mortgage loans Belvedere Trust seek to acquire, interest rate changes, funding sources, delinquency rates, prepayment rates, borrower bankruptcies and other
factors that Belvedere Trust may not be able to manage. Incorrect management of these risks may take years to become apparent. If it fails to manage these and other risks, this could harm our business and the results of our operations.



Belvedere Trusts investment strategy of acquiring, accumulating and
securitizing loans involves credit risk that could result in loan losses and could harm our operating results.



While Belvedere Trust securitizes the loans it acquires in order to improve its access to financing, it bears the risk of loss on any loans that it
acquires and which it subsequently securitizes. Belvedere Trust has risk of loss for all loans it holds on its balance sheet. Belvedere Trust acquires loans that are typically not credit enhanced and that do not have the backing of Fannie Mae or
Freddie Mac. Accordingly, Belvedere Trust 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 and any premium paid for the loan. In the event of a default on any such loans that Belvedere Trust holds, Belvedere Trust would bear the loss of principal between
the realized value of the mortgaged property and the principal amount of the loan, as well as foreclosure costs and the loss of interest. We have not established any limits upon the geographic concentration or the credit quality of suppliers of the
mortgage loans that Belvedere Trust acquires.



Belvedere Trusts
efforts to manage credit risk may not be successful in limiting delinquencies and defaults in underlying loans or losses on its investments.



As of June 30, 2005, approximately 0.88% of the loans in Belvedere Trusts portfolio, including Belvedere Trusts first securitization, were 30
days or more delinquent by outstanding principal balance. Belvedere Trust has incurred no losses to date, but we anticipate that Belvedere Trust will incur losses in the future. Based on current analysis, Belvedere Trust projects loan losses to
approximate 0.19% of the loan balances. This analysis is based on factors related to borrower credit, such as FICO score, as well as the value of the underlying properties relative to the loan balances.



Loan losses may be greater than we anticipated. Despite our efforts to manage
credit risk, there are many aspects of credit that we cannot control, and there can be no assurance that Belvedere Trusts quality control and loss mitigation operations will be successful in limiting future delinquencies, defaults and losses.
Belvedere Trusts underwriting reviews or third-party reviews may not be effective. The securitizations in which Belvedere Trust has invested may not receive funds that Belvedere Trust believes are due from mortgage insurance companies. Loan
servicing companies may not cooperate with Belvedere Trusts loss mitigation efforts, or such efforts may otherwise be ineffective. Various service providers to securitizations, such as trustees, bond insurance providers, and custodians, may
not perform in a manner that promotes Belvedere Trusts interests. The value of the homes collateralizing residential loans may decline. Belvedere Trust acquires loans that allow for negative amortization; if the borrowers make payments that
are less than the amount required to pay the interest due on these loans, the principal balance of the loans will increase. As of June 30, 2005, 35.4% of Belvedere Trusts loans allowed for negative amortization. If loans become real
estate owned, servicing companies will have to manage these properties and may not be able to sell them. Changes in consumer behavior, bankruptcy laws, and other laws may



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increase loan losses. In most cases, the value of the underlying property will be the sole source of funds for any recoveries. Expanded loss mitigation
efforts in the event that defaults increase could increase Belvedere Trusts operating costs.



Belvedere Trust requires a significant amount of capital, and if it is not available, our business and financial performance could be significantly harmed.



Belvedere Trust requires substantial capital to fund its loan acquisitions,
to pay its loan acquisition expenses and to hold its loans prior to securitization. Pending sale or securitization of a pool of mortgage loans, Belvedere Trust acquires mortgage-related assets that it expects to finance through borrowings from whole
loan financing facilities and repurchase facilities. It is possible that its lenders could experience changes in their ability to advance funds to us, independent of Belvedere Trusts performance or the performance of its loans. Belvedere Trust
anticipates that its repurchase facilities will be dependent on the ability of counterparties 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 counterparties is itself unable to access the repurchase market, Belvedere Trusts access to this source of liquidity could be harmed. Capital 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 harm Belvedere Trusts operating
results, liquidity, financial condition and earnings.



To date,
we have invested $100 million in Belvedere Trust to capitalize its mortgage operations. If Belvedere Trust fully invests all of the proceeds of our investment in it prior to the point at which it can access external sources of capital, if it ever
can, then Belvedere Trust will need to either restructure the securities supporting its portfolio 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, Belvedere Trust may need to sell assets at an inopportune time, thus reducing its earnings. Adverse cash flow could threaten
Belvedere Trusts ability to maintain solvency or to satisfy the income and asset tests necessary to elect and maintain REIT status.



Second-lien mortgage loans expose Belvedere Trust to greater credit risks.



To the extent Belvedere Trust invests in second-lien mortgage loans, its security interests in the property securing the
second-lien mortgage loans is subordinated to the interests of the first mortgage holder and the second mortgages have a higher loan-to-value ratio than does the first mortgage. If the value of the property is equal to or less than the amount needed
to repay the borrowers obligation to the first mortgage holder upon foreclosure, the second-lien mortgage loan will not be repaid.



Residential mortgage loan delinquencies, defaults, and credit losses could reduce Belvedere Trusts ability to complete securitizations, which could expose
Belvedere Trust to risk from holding loans longer than expected.



Credit losses from any of the mortgage loans in the securitized loan pools reduce the principal value of and economic returns from residential mortgage-backed securities. Credit losses could reduce Belvedere
Trusts ability to sponsor new securitizations of residential loans. Therefore, Belvedere Trust may have to hold loans longer on its balance sheet which may change its risk profile with regard to credit and interest rate risk. As of June 30,
2005, by outstanding principal balances, approximately 0.71% of residential mortgage loans in Belvedere Trusts portfolio, including Belvedere Trusts first securitization, were 30 days delinquent, approximately 0.12% were 60 days
delinquent and approximately 0.06% were 90 days delinquent.



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



Belvedere Trust does not currently use securitizations with over-collateralization requirements but may do so in the future. If Belvedere Trust utilizes
over-collateralization as a credit enhancement to its securitizations, Belvedere Trust expects that such over-collateralization will restrict its cash flow if loan delinquencies exceed certain levels. The terms of Belvedere Trusts
securitizations will 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 harm our results of operations.



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Representations and warranties made by Belvedere Trust in loan sales and securitizations may subject Belvedere
Trust to liability that could result in loan losses and could harm our operating results.



In connection with securitizations, Belvedere Trust makes representations and warranties regarding the mortgage-related assets transferred into
securitization trusts. The trustee in the securitizations has recourse to Belvedere Trust with respect to the breach of the standard representations and warranties regarding the loans made at the time such mortgage-related assets are transferred.
While Belvedere Trust generally has recourse to its loan originators for any such breaches, there can be no assurance of the originators abilities to honor their respective obligations. Belvedere Trust attempts to generally limit the potential
remedies of the trustee to the potential remedies Belvedere Trust receives from the originators from whom Belvedere Trust acquired the mortgage loans. However, in some cases, the remedies available to the trustee may be broader than those available
to Belvedere Trust against the originators of the mortgage-related assets and should the trustee enforce its remedies against Belvedere Trust, it may not always be able to enforce whatever remedies it has against its loan originators. Furthermore,
if Belvedere Trust discovers, prior to the securitization of a loan, that there is any fraud or misrepresentation with respect to the mortgage and the originator fails to repurchase the mortgage, then Belvedere Trust may not be able to sell the
mortgage or may have to sell the mortgage at a discount.



The
mortgage-related assets Belvedere Trust own expose it concentrated risks and thus are likely to lead to variable returns.



Belvedere Trusts permanent asset portfolio produces a significant amount of its revenue. It consists principally of mortgage loans that have been
securitized by Belvedere Trust and, to a lesser extent, securities acquired from securitizations sponsored by others. The mortgage-related assets Belvedere Trust owns employ a high degree of internal structural leverage that concentrates risk into
the assets that Belvedere Trust acquires. No amount of risk management or mitigation can change the variable nature of cash flows, market values, and financial results generated by concentrated risks in Belvedere Trusts mortgage-related
investments, which, in turn, can result in variable returns to Belvedere Trust. Due to the concentration of risks, the assets Belvedere Trust hold may be exposed to greater credit, interest-rate and prepayment risk.



The success of Belvedere Trusts business will depend upon its ability to
determine that mortgage loans are serviced effectively.



The success of Belvedere Trusts mortgage loan business will depend to a great degree upon its ability to determine that its mortgage loans are serviced effectively. In general, it is Belvedere Trusts intention 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. In those instances where 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 transfer the servicing of the loans to a third party with whom
Belvedere Trust has established a sub-servicing relationship. We cannot assure you 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 has contracted with an experienced servicer of the type of loans it acquires to sub-service its loans. The fees paid to such subservicer will reduce to a certain extent the revenue Belvedere Trust is able to retain from
its mortgage loans, and Belvedere Trusts net interest income will be reduced and at risk, depending on the effectiveness of the servicing company.



Belvedere Trust acquires and owns interest-only loans which expose it to increased risk of default.



A portion of the loans Belvedere Trust acquires have interest-only features
during the initial term of the loan. At June 30, 2005, 47% of the loans Belvedere Trust owned had interest-only features as measured by outstanding principal balance. These loans permit borrowers not to begin repayment of the principal balance of
the loans until after the interest only period expires. After the expiration of the interest-only period, the borrowers payments increase to amortize the entire principal balance owed over the remaining life of the loan. Variable-rate
interest-only products, especially when coupled with an amortization feature that begins at a time in the future, can significantly increase the payment obligation. Consequently, there is a risk that these mortgagors may be unable to make the
increased payments and could default under these loans. In the event the performance of Belvedere Trusts interest-only loans is below expectations, our operating results, financial condition and business prospects could be harmed.



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Belvedere Trust has acquired most of its mortgage-related assets from a limited number of originators and the
failure to properly manage these relationships, or if these originators experience origination problems, Belvedere Trusts ability to acquire loans from them could be harmed, which would negatively affect its operations.



Belvedere Trust has acquired most of its mortgage-related assets from a
limited number of originators. As of June 30, 2005, approximately 50.9% of the loans held by Belvedere Trust had been acquired from Countrywide Home Loans, Inc. and 15.6% of the loans held by Belvedere Trust had been acquired from Washington Mutual
Bank, N.A. and its affiliates, as measured by outstanding principal balance as of that date. If Belvedere Trust is unable to properly manage these relationships, or if these originators experience significant problems with their origination
capabilities, Belvedere Trusts ability to acquire loans from them may be harmed and its results from operations may be negatively affected.



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, 50% is also owned by the executive officers of Belvedere Trust. 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 require us to pay a penalty or 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 could 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



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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 qualifying and non-qualifying hedges, together with any other income not generated from qualified sources, to less
than 25% of our gross income. In addition, we must limit our aggregate income from non-qualifying hedging, fees and certain other non-qualifying 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 or implement those hedges through a taxable REIT subsidiary. This could result in greater risks associated with changes in interest rates
than we would otherwise want to incur. If we were to violate the 25% or 5% limitations, we may have to pay a penalty tax equal to the amount of income in excess of those limitations, multiplied by a fraction intended to reflect our profitability. If
we fail to satisfy the 25% and 5% limitations, unless our failure was due to reasonable cause and not due to willful neglect, we could lose our REIT status for federal income tax purposes.



Complying with REIT requirements may force us to liquidate otherwise attractive
investments or to make investments inconsistent with our business plan.



In order to qualify as a REIT, we must also determine 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. The need to comply with these gross income and asset tests may cause us to acquire other assets that are
qualifying real estate assets for purposes of the REIT requirements that are not part of our overall business strategy and might not otherwise be the best investment alternative for us.



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, a qualified REIT subsidiary 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



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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. In the event of a more than de minimis failure of the 20% asset test occurring in taxable years after 2004, we will
not lose our REIT status as long as (i) the failure was due to reasonable cause and not to willful neglect, (ii) we dispose of the assets causing the failure or otherwise comply with the 20% asset test within six months after the last day of the
applicable quarter in which we identify such failure, and (iii) we pay a tax equal to the greater of $50,000 or 35% of the net income from the non-qualifying assets during the period in which we failed the 20% asset test. If there is more than a de
minimis failure of the 20% asset test occurring in taxable years after 2004 and we do not satisfy the requirements described in the preceding sentence, we would lose our REIT status.



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 as a REIT in the future, possibly as early as its taxable year ending December 31, 2005. 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 if
Belvedere Trust failed to qualify as a REIT after it makes a REIT election, this 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.



We conduct a portion of our business through taxable REIT subsidiaries, which could have adverse tax consequences.



We conduct a portion of our business, including securitizations, through
taxable REIT subsidiaries, such as Belvedere Trust Finance Corporation. Despite our qualification as a REIT, our taxable REIT subsidiaries must pay federal income tax on their taxable income. In addition, we must comply with various tests to
continue to qualify as a REIT for federal income tax purposes, and our income from, and investments in, our taxable REIT subsidiaries generally do not constitute permissible income and investments for these tests. While we attempt to determine that
our dealings with our taxable REIT subsidiaries will not adversely affect our REIT qualification, no assurance can be given that we will successfully achieve that result. Furthermore, we may be subject to a 100% penalty tax, or our taxable REIT
subsidiaries may be denied deductions, to the extent our dealings with our taxable REIT subsidiaries are not deemed to be arms-length in nature.



The tax imposed on REITs engaging in prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing
loans, that would be treated as sales for federal income tax purposes.



A REITs net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including any
mortgage loans, held in inventory primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to sell a loan or securitize loans in a manner that was treated as a sale of such inventory for federal
income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans other than through a taxable REIT subsidiary, and may limit the structures we utilize for our securitization
transaction even though such sales or structures might otherwise be beneficial for us. In addition, this prohibition may limit our ability to restructure our investment portfolio of mortgage loans from time to time even if we believe that it would
be in our best interest to do so.



Failure to maintain an exemption from
the Investment Company Act would harm 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



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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.



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 Internal Revenue Code. If we realize excess inclusion income and allocate it to stockholders, however, then this income would be fully taxable as unrelated business
taxable income under Section 512 of the Internal Revenue Code. If the stockholder is foreign, it would generally be subject to United States federal income tax withholding on this income without reduction pursuant to any otherwise applicable income
tax treaty. United States stockholders would not be able to offset such income with their operating losses.



We generally structure our borrowing arrangements in a manner designed to avoid generating significant amounts of excess inclusion income. However, excess
inclusion income could result if we held a residual interest in a real estate mortgage investment conduit, or REMIC. Excess inclusion income also may be generated if we were to issue debt obligations with two or more maturities and the terms of the
payments or these obligations bore a relationship to the payments that we received on our mortgage loans or mortgage-backed securities securing those debt obligations. For example, we may engage in non-REMIC collateralized mortgage obligations, or
CMO, securitizations. We also 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 Internal Revenue Service may
determine that these transactions give rise to excess inclusion income that should be allocated among our stockholders. We may invest in equity securities of other REITs and it is possible that we might receive excess inclusion income from those
investments. Some types of entities, including, without limitation, voluntarily employee benefit associations and entities that have borrowed funds to acquire their shares of our stock, may be required to treat a portion of or all of the dividends
they receive from us as unrelated business taxable income.



Misplaced
reliance on legal opinions or statements by issuers of mortgage-backed securities and government securities could result in a failure to comply with REIT gross income or asset tests.



When purchasing mortgage-backed securities and government securities, we may
rely on opinions of counsel for the issuer or sponsor of such securities, or statements made in related offering documents, for purposes of determining whether and to what extent those securities constitute REIT real estate assets for purposes of
the REIT asset tests and produce income that qualifies under the REIT income tests. The inaccuracy of any such opinions or statements may harm our REIT qualification and result in significant corporate level tax.



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-related assets at favorable prices. We may not be able to acquire enough mortgage-related assets 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 for our common stockholders and there are no assurances of our ability to pay dividends to them in the future.



We intend to pay quarterly dividends and to make distributions to our common
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



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minimum dividend payment level for our common stockholders and our ability to pay dividends may be harmed by the risk factors described in this quarterly
report on Form 10-Q. All distributions to our common stockholders 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.



Our future offerings of debt or preferred equity securities may harm the value of our Series A Preferred Stock.



Our charter provides that we may issue up to 20 million shares of preferred stock in one or more series. In addition to our outstanding Series A
Preferred Stock, we currently have an agreement with Cantor pursuant to which we may issue up to 2.0 million shares of our Series A Preferred Stock. The issuance of additional preferred stock on parity with or senior to our Series A Preferred Stock
could have the effect of diluting the amounts we may have available for distribution to holders of our Series A Preferred Stock. In addition, our Series A Preferred Stock will be subordinated to all our existing and future debt. None of the
provisions relating to our Series A Preferred Stock contains any provisions affording the holders of our Series A Preferred Stock protection in the event of a highly leveraged or other transaction, including a merger or the sale, lease or conveyance
of all or substantially all our assets or business, that might harm the holders of our Series A Preferred Stock.



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 an unrelated third party institutional investor an exemption from the 9.8% ownership limitation as set forth in our
charter documents. This exemption permits this entity to hold up to 170,400 preferred shares or 9.8% of our outstanding shares of preferred stock, whichever is greater.



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 or
more than 9.8% of our preferred 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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



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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 or Series A Preferred Stock upon liquidation, or equity securities, which would dilute our existing stockholders and may be senior to our common stock or Series A Preferred Stock for the purposes of dividend distributions,
may harm the market price of our common stock or Series A Preferred 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 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 common stockholders bear the risk of our future offerings reducing the market price of our common
stock.



Our charter provides that we may issue up to 20 million
shares of preferred stock in one or more series. The issuance of additional preferred stock on parity with or senior to the Series A Preferred Stock could have the effect of diluting the amounts we may have available for distribution to holders of
the Series A Preferred Stock. The Series A Preferred Stock will be subordinated to all our existing and future debt. Thus, our Series A Preferred Stockholders bear the risk of our future offerings reducing the market price of our Series A Preferred
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 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-related assets. 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.



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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.



At June 30, 2005, our agency mortgage-backed
securities and related borrowings will prospectively reprice based on the following time frames (dollar amounts in thousands):



|                                           |  |        |           |                                |            |   |        |   |                               |  |       |  
|------------------------------------------ |  | ------ | --------- | ------------------------------ | ---------- | - | ------ | - | ----------------------------- |  | ----- | -
|                                           |  | Assets |           |                                | Borrowings |  
|                                           |  | Amount |           | Percentage of TotalInvestments |            |   | Amount |   | Percentage of TotalBorrowings | 
|Investment Type/Rate Reset Dates:          |  |        |           |                                |            |   |        |   |                               |  |       |  
|Fixed-rate investments                     |  | $      | 179,083   |                                | 3.8        | % |        | $ |                              |  |      |  
|Adjustable-Rate Investments/ Obligations:  |  |        |           |                                |            |   |        |   |                               |  |       |  
|Less than 3 months                         |  |        | 312,669   |                                | 6.5        | % |        |   | 1,637,050                     |  | 38.2  | %
|Greater than 3 months and less than 1 year |  |        | 1,313,506 |                                | 27.6       | % |        |   | 2,416,120                     |  | 56.4  | %
|Greater than 1 year and less than 2 years  |  |        | 421,729   |                                | 8.9        | % |        |   | 231,000                       |  | 5.4   | %
|Greater than 2 years and less than 3 years |  |        | 1,760,947 |                                | 37.0       | % |        |   |                              |  |      |  
|Greater than 3 years and less than 5 years |  |        | 771,410   |                                | 16.2       | % |        |   |                              |  |      |  
|                                           |  |        |           |                                |            |   |        |   |                               |  |       |  
|Total                                      |  | $      | 4,759,344 |                                | 100.0      | % |        | $ | 4,284,170                     |  | 100.0 | %
|                                           |  |        |           |                                |            |   |        |   |                               |  |       |  



At December 31, 2004,
our agency mortgage-backed securities and related borrowings will prospectively reprice based on the following time frames (dollar amounts in thousands):



|                                           |  |        |           |                                |            |   |        |   |                               |  |       |  
|------------------------------------------ |  | ------ | --------- | ------------------------------ | ---------- | - | ------ | - | ----------------------------- |  | ----- | -
|                                           |  | Assets |           |                                | Borrowings |  
|                                           |  | Amount |           | Percentage of TotalInvestments |            |   | Amount |   | Percentage of TotalBorrowings | 
|Investment Type/Rate Reset Dates:          |  |        |           |                                |            |   |        |   |                               |  |       |  
|Fixed-rate investments                     |  | $      | 201,515   |                                | 4.4        | % |        | $ |                              |  |      |  
|Adjustable-Rate Investments/ Obligations:  |  |        |           |                                |            |   |        |   |                               |  |       |  
|Less than 3 months                         |  |        | 335,616   |                                | 7.3        | % |        |   | 1,540,060                     |  | 36.9  | %
|Greater than 3 months and less than 1 year |  |        | 1,106,030 |                                | 24.1       | % |        |   | 2,165,870                     |  | 51.9  | %
|Greater than 1 year and less than 2 years  |  |        | 902,916   |                                | 19.7       | % |        |   | 467,000                       |  | 11.2  | %
|Greater than 2 years and less than 3 years |  |        | 1,504,897 |                                | 32.8       | % |        |   |                              |  |      |  
|Greater than 3 years and less than 5 years |  |        | 537,567   |                                | 11.7       | % |        |   |                              |  |      |  
|                                           |  |        |           |                                |            |   |        |   |                               |  |       |  
|Total                                      |  | $      | 4,588,541 |                                | 100.0      | % |        | $ | 4,172,930                     |  | 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 periodic adjustment to fair value reflected as part of Accumulated Other Comprehensive Income that is included in
the equity section of our consolidated balance sheets. 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, 2005, our agency
adjustable-rate mortgage-backed securities had a weighted average term to next rate adjustment of approximately 23 months, while our borrowings had a weighted average term to next rate adjustment of 142 days. After adjusting for interest rate swap
transactions, the weighted average term to next rate



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adjustment was 242 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, 2005, we had unrestricted cash of $1.1 million 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 assets 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 entirely 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-related assets. The purchase prices of mortgage-related assets 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-related assets. 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-related assets
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-related
assets to replace the prepaid mortgage-related assets, our financial condition, cash flows and results of operations could be harmed.



We often purchase mortgage-related assets 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-related asset. 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-related asset 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



Anworth Agency Mortgage-Backed Securities



The information presented in the table below projects the impact of sudden
changes in interest rates on Anworths annual projected net income and Portfolio Value (excluding Belvedere Trusts operations) as more fully discussed below, based on investments in place at June 30, 2005, and includes all of
Anworths interest rate-sensitive assets, liabilities and hedges such as interest rate swap agreements. Changes in Portfolio Value equals the change in value of our assets that Anworth carries 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. Anworth acquires interest rate-sensitive assets and funds them with interest rate-sensitive liabilities. Anworth generally plans to
retain such assets and the associated interest rate risk to maturity.



|                         |  |                                                   |  |                                              
|------------------------ |  | ------------------------------------------------- |  | ---------------------------------------------
|Change in Interest Rates |  | Projected PercentageChange in Net Interest Income |  | Projected PercentageChange in Portfolio Value
|2.0%                    |  | -311%                                             |  | 0.4%                                         
|1.0%                    |  | -247%                                             |  | 0.3%                                         
|0%                       |  |                                                  |  |                                             
|1.0%                     |  | -157%                                             |  | -1.2%                                        
|2.0%                     |  | -290%                                             |  | -3.1%                                        



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 67% increase in the prepayment rate of our mortgage-backed securities portfolio. The base interest rate scenario assumes interest rates at June 30, 2005. Actual results could differ significantly from



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those estimated in the table. The above table includes the effect of interest rate swap agreements. At June 30, 2005, the aggregate notional amount of the
interest rate swap agreements was $400 million and the average maturity was 3.1 years.



The information presented in the table below projects the impact of sudden changes in interest rates on Anworths annual projected net income and Portfolio Value (excluding Belvedere Trusts operations) and
excludes the effect of the interest rate swap agreements.



|                         |  |                                                    |  |                                               
|------------------------ |  | -------------------------------------------------- |  | ----------------------------------------------
|Change in Interest Rates |  | Projected Percentage Change in Net Interest Income |  | Projected Percentage Change in Portfolio Value
|2.0%                    |  | -265%                                              |  | 0.8%                                          
|1.0%                    |  | -229%                                              |  | 0.5%                                          
|0%                       |  |                                                   |  |                                              
|1.0%                     |  | -198%                                              |  | -1.5%                                         
|2.0%                     |  | -372%                                              |  | -3.5%                                         



Belvedere Trust



The information presented in the table below projects the
impact of sudden changes in interest rates on Belvedere Trusts annual projected net income and Portfolio Value as more fully discussed below based on investments in place at June 30, 2005. Changes in Portfolio Value equals the change in value
of our assets that Belvedere Trust carries at fair value (shown on the consolidated balance sheets as Other mortgage-backed securities) rather than at historical amortized cost and any change in the value of any derivative instruments or
hedges, such as interest rate swap agreements and Eurodollar futures contracts, divided by Belvedere Trusts equity. Belvedere Trusts residential real estate loans are carried at historical amortized cost and therefore are not included in
Portfolio Value in the table below. Belvedere Trust acquires interest rate-sensitive assets and funds them with interest rate-sensitive liabilities. Belvedere Trust generally plans to retain such assets and the associated interest rate risk to
maturity.



|                         |  |                                                    |  |                                               
|------------------------ |  | -------------------------------------------------- |  | ----------------------------------------------
|Change in Interest Rates |  | Projected Percentage Change in Net Interest Income |  | Projected Percentage Change in Portfolio Value
|2.0%                    |  | 61.8%                                              |  | 1.9%                                          
|1.0%                    |  | 32.5%                                              |  | 1.2%                                          
|0%                       |  |                                                   |  |                                              
|1.0%                     |  | -42.7%                                             |  | -1.9%                                         
|2.0%                     |  | -82.9%                                             |  | -4.1%                                         



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 an increase from 31.2% to 37.2% in the prepayment rate of Belvedere Trusts mortgage-related assets (which include those assets that have been securitized). The base interest rate scenario assumes interest rates at June
30, 2005. Actual results could differ significantly from those estimated in the table.



General



Many assumptions are
made to present the information in the above tables, 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 tables and all related disclosures
constitute forward-looking statements. The analyses presented utilize assumptions and estimates based on managements judgment and experience. Furthermore, future sales, acquisitions and restructuring could materially change the interest rate
risk profile for Anworth and Belvedere Trust. The tables quantify 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-related assets 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-related
assets relative to prevailing interest rates.



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|Item 4. | CONTROLS AND PROCEDURES
|------- | -----------------------



We maintain disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), designed to determine
that information required to be disclosed by us in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported on a timely basis.



Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our
disclosure controls and procedures are effective.



Part II. OTHER INFORMATION



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



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



|Item 2. | Unregistered Sales of Equity 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, 2005 at our offices in Santa Monica, California. At the annual meeting, our stockholders voted on
the following two (2) items:



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



|                  |  |            |  |         
|----------------- |  | ---------- |  | --------
|Name              |  | For        |  | Withheld
|Lloyd McAdams     |  | 44,957,821 |  | 552,200 
|Lee A. Ault, III  |  | 44,813,784 |  | 696,237 
|Charles H. Black  |  | 44,792,304 |  | 717,716 
|Joe E. Davis      |  | 44,803,688 |  | 706,332 
|Robert C. Davis   |  | 45,093,369 |  | 416,652 
|Joseph E. McAdams |  | 45,065,660 |  | 444,360 



|(ii) | The ratification of the appointment of BDO Seidman, LLP as our independent accountants and auditors for the fiscal year ending December 31, 2005 was approved as follows:
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|           |  |         |  |        
|---------- |  | ------- |  | -------
|For        |  | Against |  | Abstain
|45,259,911 |  | 140,368 |  | 109,740



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



On May 17, 2005, Belvedere Trust filed a registration statement with the Securities and Exchange Commission for the purpose of registering $100 million of
its common stock in connection with a contemplated initial public offering. Belvedere Trust filed amendments to the registration statement with the Securities and Exchange Commission on June 17, 2005 and July 13, 2005. We do not intend to sell any
of our shares of Belvedere Trusts common stock in the initial public offering.



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On May 17, 2005, we announced plans to acquire up to 2,000,000 shares of our common stock, or
approximately 4% of our total shares of common stock outstanding. The shares are expected to be acquired at prevailing prices through open market transactions. The purchases are to be made subject to restrictions relating to volume, price and
timing. The actual number and timing of share repurchases will be subject to market conditions and applicable Securities and Exchange Commission rules.



On May 27, 2005, we declared a preferred stock dividend of $0.539063 per share which was payable on July 15, 2005 to our preferred stockholders of record
as of the close of business on June 30, 2005.



On May 27, 2005,
BellaVista Funding Corporation completed a securitization of mortgage-backed securities backed by adjustable-rate and hybrid mortgage loans. The total amount of the securities underwritten was approximately $444 million. These mortgage loans were
purchased by BellaVista Funding Corporation from Belvedere Trust. Belvedere Trust has previously completed seven other securitizations of mortgage loans and, since its formation, has securitized $3.8 billion of mortgage loans.



As of June 30, 2005, Belvedere Trust had entered into forward loan purchase
commitments of $14 million for the purchase of residential mortgage loans.



On July 19, 2005, we declared a common stock dividend of $0.18 per share which is payable on August 11, 2005 to our common stockholders of record as of the close of business on July 29, 2005.



On July 19, 2005, we declared a Series A preferred stock dividend of
$0.539063 per share for the third quarter of 2005 which is payable on October 17, 2005 to our preferred stockholders of record as of the close of business on September 30, 2005.



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##### Table of Contents

|Item 6. | Exhibits
|------- | --------



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



|              |  |                                                                                                                                                                                                                                                                                                                                                                          
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                                                                                              
|3.1           |  | Amended Articles of Incorporation of Anworth (incorporated by reference from our Registration Statement on Form S-11, Registration No. 333-38641, which became effective under the Securities
Act of 1933 on March 12, 1998)                                                                                                                                             
|              | 
|3.2           |  | Articles of Amendment to Amended Articles of Incorporation (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 May 14, 2003)                                                                                                  
|              | 
|3.3           |  | Articles Supplementary for Series A Cumulative Preferred Stock (incorporated by reference from our Current Report on Form 8-K filed with the Securities and Exchange Commission on November 3,
2004)                                                                                                                                                                     
|              | 
|3.4           |  | Articles Supplementary for Series A Cumulative Preferred Stock (incorporated by reference from our Current Report on Form 8-K filed with the Securities and Exchange Commission on January 21,
2005)                                                                                                                                                                     
|              | 
|3.5           |  | Bylaws (incorporated by reference from our Registration Statement on Form S-11, Registration No. 333-38641, which became effective under the Securities Act of 1933 on March 12,
1998)                                                                                                                                                                                   
|              | 
|4.1           |  | Specimen Common Stock Certificate (incorporated by reference from our Registration Statement on Form S-11, Registration No. 333-38641, which became effective under the Securities Act of 1933
on March 12, 1998)                                                                                                                                                        
|              | 
|4.2           |  | Specimen Series A Cumulative Preferred Stock Certificate (incorporated by reference from our Current Report on Form 8-K filed with the Securities and Exchange Commission on November 3,
2004)                                                                                                                                                                           
|              | 
|10.1          |  | 2004 Equity Compensation Plan (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)                                                                                                                             
|              | 
|10.2          |  | 2003 Dividend Reinvestment and Stock Purchase Plan (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)                                                                                                                     
|              | 
|10.3          |  | 2002 Incentive Compensation Plan (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)                                                                                                                                
|              | 
|10.4          |  | Agreement and Plan of Merger dated April 18, 2002 by and among Anworth, Anworth Mortgage Advisory Corporation (the Manager) and the shareholder of the Manager (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)
|              | 
|10.5          |  | Employment Agreement dated January 1, 2002, between the Manager and Lloyd McAdams (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)                                                                                                        
|              | 
|10.6          |  | Employment Agreement dated January 1, 2002, between the Manager and Heather U. Baines (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)                                                                                                    
|              | 
|10.7          |  | Employment Agreement dated January 1, 2002, between the Manager and Joseph E. McAdams (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)                                                                                                    
|              | 
|10.8          |  | Addendum to Employment Agreement dated April 18, 2002, among Anworth, the Manager and Lloyd McAdams (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)                                                                                      
|              | 
|10.9          |  | Addendum to Employment Agreement dated April 18, 2002, among Anworth, the Manager and Heather U. Baines (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)                                                                                  



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|              |  |                                                                                                                                                                                                                                                                                                  
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                      
|              | 
|10.10         |  | Addendum to Employment Agreement dated April 18, 2002, among Anworth, the Manager and Joseph E. McAdams (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)          
|              | 
|10.11         |  | Second Addendum to Employment Agreement dated as of May 28, 2004 between Anworth and Lloyd McAdams (incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended June
30, 2004, as filed with the Securities and Exchange Commission on August 9, 2004)                
|              | 
|10.12         |  | Second Addendum to Employment Agreement dated as of June 13, 2002 by and among Anworth and Joseph E. McAdams (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)     
|              | 
|10.13         |  | Third Addendum to Employment Agreement dated as of May 28, 2004, between Anworth and Joseph E. McAdams (incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended
June 30, 2004, as filed with the Securities and Exchange Commission on August 9, 2004)            
|              | 
|10.14         |  | Sublease dated June 13, 2002, between Anworth and Pacific Income Advisers, Inc. (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)                                  
|              | 
|10.15         |  | Amendment to Sublease dated July 8, 2003 between Anworth and Pacific Income Advisers, Inc. (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)                        
|              | 
|10.16         |  | Administrative Agreement dated October 14, 2002, between Anworth and Pacific Income Advisers, Inc. (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)        
|              | 
|10.17         |  | Deferred Compensation Plan (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)                                                                                          
|              | 
|10.18         |  | BT Management Company, L.L.C. (BT Management) Operating Agreement dated November 3, 2003 (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)                
|              | 
|10.19         |  | Management Agreement dated November 3, 2003 between BT Management and Belvedere Trust Mortgage Corporation (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)
|              | 
|10.20         |  | Employment Agreement dated November 3, 2003 between BT Management and Claus Lund (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)                          
|              | 
|10.21         |  | Employment Agreement dated November 3, 2003 between BT Management and Russell J. Thompson (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)                 
|              | 
|10.22         |  | Amended and Restated Sales Agreement dated January 19, 2005 between Anworth and Cantor Fitzgerald & Co. (incorporated by reference from our Current Report on Form 8-K filed with the
Securities and Exchange Commission on January 21, 2005)                                                    
|              | 
|10.23         |  | Assignment and Assumption of Sublease and Consent of Sublessor dated May 16, 2005 among Belvedere Trust Mortgage Corporation, BT Management Holding Corporation and Keefe, Bruyette &
Woods, Inc.                                                                                                
|              | 
|10.24         |  | Guaranty of Sublease dated May 16, 2005 between Anworth Mortgage Asset Corporation and Keefe, Bruyette & Woods, Inc.                                                                                                                                                                             
|              | 
|12            |  | Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends                                                                                                                                                                                                         
|              | 
|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                                                                                                                                   



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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                                                                                 
|                      |  | 
|Dated: August 9, 2005 |  |  |  | /s/ Joseph Lloyd McAdams                                                                                           
|                      |  |  |  | Joseph Lloyd McAdams Chairman of the Board, President and Chief Executive Officer(authorized officer of registrant)
|                      |  | 
|Dated: August 9, 2005 |  |  |  | /s/ Thad M. Brown                                                                                                  
|                      |  |  |  | Thad M. Brown Chief Financial Officer (principal accounting officer)                                               



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