Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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, 2002

Commission File Number: 001-13709

ANWORTH MORTGAGE ASSET CORPORATION
(Exact Name of Registrant as Specified in its Charter)

          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.

          As of June 30, 2002, the Registrant had 22,935,150 shares of Common Stock issued and outstanding.

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION

FORM 10-Q

INDEX

Table of Contents

Part I. FINANCIAL INFORMATION

Item 1.  Financial Statements

ANWORTH MORTGAGE ASSET CORPORATION

BALANCE SHEETS
(in thousands, except for per share amounts)
(unaudited)

See accompanying notes to financial statements

-1-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION

STATEMENTS OF OPERATIONS
(in thousands, except for per share amounts)
(unaudited)

See accompanying notes to financial statements.

-2-

Table of Contents

STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)

See accompanying notes to financial statements.

-3-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION

STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

See accompanying notes to financial statements.

-4-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

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

          The Company has elected to be taxed as a real estate investment trust (“REIT”) for federal income tax purposes.  Pursuant to the current federal tax regulations, one of the requirements of maintaining its status as a REIT is that the Company must distribute at least 90% of its annual taxable net income to its stockholders, subject to certain adjustments.

          From the time of its inception through June 13, 2002, the Company was externally managed by Anworth Mortgage Advisory Company (the “Manager”), pursuant to a management agreement between the parties (the “Management Agreement”).  As an externally managed company, the Company had no employees of its own and relied on the Manager to conduct its business and operations.

          On June 13, 2002, the Manager merged with and into the Company (the “Merger”).  The Merger was approved by a special committee consisting solely of the Company’s independent directors, the Company’s full board of directors and the vote of a majority of the Company’s stockholders.  Upon the closing of the Merger, the Management Agreement terminated.  The market value of the Company’s common stock issued, valued as of the consummation of the Merger, in excess of the fair value of the net tangible assets acquired, has been accounted for as a non-cash charge to operating income.

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

BASIS OF PRESENTATION

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

          In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. The operating results for the quarter ended June 30, 2002 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2002.

CASH AND CASH EQUIVALENTS

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

MORTGAGE BACKED SECURITIES

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

-5-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS-(Continued)

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

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

          MBS transactions are recorded on the date the securities are purchased or sold.  Purchases of new issue MBS are recorded when all significant uncertainties regarding the characteristics of the assets are removed, generally shortly before the settlement date. Realized gains and losses on sales of MBS are determined on the specific identification basis.

CREDIT RISK

          At June 30, 2002 the Company has limited its exposure to credit losses on its portfolio of mortgage backed securities by purchasing primarily securities from Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”). The payment of principal and interest on the FHLMC and FNMA MBS securities are guaranteed by those respective agencies. At June 30, 2002, over 99% of the Company’s mortgage backed securities have an implied “AAA” rating.

DERIVATIVE FINANCIAL INSTRUMENTS

          During the six months ended June 30, 2002, the Company purchased certain new issue MBS on a forward basis, i.e. for settlement beyond the next ordinary settlement date.  Under Statement of Financial Accounting Standard No. 133 (“SFAS 133”), Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted, such transactions are considered derivative instruments and are carried on the balance sheet at their fair value.  The Company designated the forward purchase agreements related to fixed-rate MBS as “cash flow hedges” for the settlements of the purchases.  The change in fair value of the hedge is included as Other Comprehensive Income to the extent the hedge is effective.  After the settlement date of the forward purchase the fair value of the hedge is transferred from Accumulated Other Comprehensive Income to earnings over the estimated life of the hedged item.  The ineffective amount of hedges is recognized in earnings each quarter.

          As the Company enters into hedging transactions, it formally documents the relationship between the hedging instruments and the hedged items.  The Company has also documented its risk-management policies, including objectives and strategies, as it relates to its hedging activities.  The Company assesses, both at inception of the hedging activity and on an on-going basis, whether or not the hedging activity is highly effective.  When it is determined that a hedge is not highly effective, the Company discontinues hedge accounting prospectively.

INCOME TAXES

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

-6-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS-(Continued)

EARNINGS PER SHARE

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

          The following table provides a reconciliation of the numerator and denominator of the earnings per share computation (amounts in thousands, except per share data):

USE OF ESTIMATES

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

-7-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS-(Continued)

NOTE 2. MORTGAGE BACKED SECURITIES

          The following table pertains to the Company’s mortgage backed securities classified as available-for-sale as of June 30, 2002, which are carried at their fair value (amounts in thousands):

          The following table summarizes the Company’s securities as of June 30, 2002 at their fair value (amounts in thousands):

          During the six-months ended June 30, 2002, the Company sold $108.5 million of its available-for-sale MBS for a net realized gain of $1,656,000. Included in interest income were gains $940,000 on forward purchase agreement which were designated as cash flow hedges at March 31, 2002 and mortgage dollar roll income. Unrealized gains of $391,000, which were included in accumulated other comprehensive income at March 31, 2002, that related to cash flow hedges were reclassified to interest income in the second fiscal quarter because the forecasted cash transaction did not occur (the Company elected not to settle the transaction and entered a mortgage dollar roll transaction instead). During the six-months ended June 30, 2001, the Company sold $1.1 million of MBS and realized net gains of $152,000.

At June 30, 2002, the Company had commitments to purchase $66.7 million of MBS.

NOTE 3. REVERSE REPURCHASE AGREEMENTS

          The Company has entered into reverse repurchase agreements to finance most of its MBS. The reverse repurchase agreements are short-term borrowings that are secured by the market value of the Company’s MBS and bear interest rates that have historically moved in close relationship to London Interbank Offer Rate (“LIBOR”). At June 30, 2002 the Company’s reverse repurchase agreements had a weighted average term to maturity of 177 days and a weighted average borrowing rate of 2.2%. MBS with a carrying value of approximately $1.5 billion have been pledged as collateral under the reverse repurchase agreements.

          At June 30, 2002, the repurchase agreements had the following remaining maturities (%):

NOTE 4. TRANSACTIONS WITH AFFILIATES

(a)  Management Fees and Merger with Our Management Company

          From the time of its inception through June 13, 2002, the Company was externally managed by the Manager, pursuant to the Management Agreement.  As an externally managed company, the Company had no employees of its own and relied on the Manager to conduct its business and operations.

          Under the terms of the Management Agreement, the Company paid the Manager an annual base management fee equal to 1% of the first $300 million of average net invested assets (as defined in the Management Agreement), plus 0.8% of the portion above $300 million.  In addition to the base management fee, the Manager received as incentive compensation for each fiscal quarter an amount equal to 20% of the amount of taxable net

-8-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS-(Continued)

income of the Company, before incentive compensation, for such fiscal quarter in excess of the amount that would produce an annualized return on equity (calculated by multiplying the return on equity for such fiscal quarter by four) equal to the Ten-Year U.S. Treasury Rate for such fiscal quarter plus 1%.  For the quarters ended June 30, 2002 and June 30, 2001, the Company paid the Manager $192,000 and $49,000, respectively, in base management fees.  The Company paid the Manager $1,0103,000 in incentive compensation for the quarter ended June 30, 2002 and $88,000 in incentive compensation for the quarter ended June 30, 2001.

          On June 13, 2002, the Manger merged with and into the Company pursuant to the Merger.  The Merger was approved by a special committee consisting solely of the Company’s independent directors, the Company’s full board of directors and the vote of a majority of the Company’s stockholders.  The stockholder of the Manager, a trust controlled by Lloyd McAdams, the Company’s President, Chairman and CEO, and Heather U. Baines, one of the Company’s Executive Vice Presidents, received 240,000 shares of the Company’s common stock as merger consideration, which was worth approximately $3.2 million based on the closing price of our common stock on June 13, 2002.  As a result of the Merger, the Company is now an internally managed company, and certain employees of the Manager have become employees of the Company.  As a condition to the Merger, the Company entered into direct employment contracts with Lloyd McAdams, Heather U. Baines and Joseph McAdams, adopted an incentive compensation plan for key executives, increased the size of its 1997 Stock Option and Awards Plan and provided for future automatic increases in the size of that plan.  Upon the closing of the Merger, the Management Agreement terminated.

          The market value of the Company’s common stock issued, valued as of the consummation of the Merger, in excess of the fair value of the net tangible assets acquired, has been accounted for as a non-cash charge to operating income. Since the Company did not acquire tangible net assets from the Manager in the merger, the non-cash charge equaled the value of the consideration paid in the Merger, which was approximately $3.2 million.  This non-cash charge does not reduce the Company’s taxable income of which at least 90% is paid as dividends to shareholders to maintain the Company’s status as a REIT.

          2002 Incentive Compensation Plan

          In connection with the Merger, the Company adopted its 2002 Incentive Compensation Plan which became effective on the effective date of the Merger. Under the 2002 Incentive Compensation Plan, eligible employees of the Company who are granted awards under the plan 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% (the “Threshold Return”).

          In any fiscal quarter in which the Company’s taxable net income is an amount less than the amount necessary to earn the Threshold Return, the Company will calculate negative incentive compensation for that fiscal quarter which will be carried forward and offset future incentive compensation due 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 the Company’s 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:

-9-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS-(Continued)

          The Incentive Compensation Plan requires that the Company pays all amounts earned thereunder each year (subject to offset for accrued negative incentive compensation), and the Company will be required to pay a percentage of such amounts to certain of its executives pursuant to the terms of their employment agreements.

          Employment Agreements

          Upon the closing of the Merger, the Company assumed the existing employment agreements of Lloyd McAdams, Joseph McAdams and Heather U. Baines. Such agreements were modified by the addenda entered into between the Company and each of the executives as described below. Pursuant to the terms of the employment agreements, Lloyd McAdams continues to serve as our President and Chief Executive Officer, Heather U. Baines continues to serves as one of our Executive Vice Presidents and Joseph McAdams will serve as one of our Executive Vice Presidents.  Heather U. Baines receives a $50,000 annual base salary, Lloyd McAdams receives a base salary equal to the greater of (i) $120,000 per annum, and (ii) a per annum amount equal to 0.125% of our book value, not to exceed $250,000. Joseph McAdams receives a base salary equal to the greater of (i) $100,000 per annum, and (ii) a per annum amount equal to 0.10% of our book value, not to exceed $250,000.

          These employment agreements, as modified by the addenda, also have the following provisions:

          For the period from June 13, 2002 through June 30, 2002, we accrued base compensation of $18,000 and incentive compensation of $324,000 related to the above agreements.

          The value of the 60,000 shares of restricted stock issued to the above executives is reflected on the Company’s balance sheet as a reduction to stockholders’ equity. This amount will be amortized to expense over the ten year restricted period until such shares vest.

          The Company and the Manager entered into a separation agreement with Pamela J. Watson, the Company’s former Chief Financial Officer, providing that her employment with the Manager terminated upon the Merger, and she resigned from her positions with the Company, upon the effective date of the Merger.  Under the terms of the

-10-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS-(Continued)

Merger Agreement, the Manager was obligated to pay the severance payable to Ms. Watson under such separation agreement prior to the merger.

(b)  Other Related Party Transactions

          1997 Stock Option and Awards Plan

          The Company has adopted the Anworth Mortgage Asset Corporation 1997 Stock Option and Awards Plan which authorizes the grant of options to purchase an aggregate of up to 1,500,000 of the outstanding shares of the Company’s common stock.  The Stock Option Plan authorizes the Board of Directors, or a committee of the Board of Directors, to grant Incentive Stock Options (“ISOs”) as defined under section 422 of the Internal Revenue Code of 1986, as amended, options not so qualified (“NQSOs”), dividend appreciation rights (“DERs”) and stock appreciation rights (“SARs”).  The exercise price for any option granted under the Stock Option Plan may not be less than 100% of the fair market value of the shares of common stock at the time the option is granted.  As of June 30, 2002, the Company had granted a total of 533,971 options, with strike prices ranging from $4.60 per share to $9.65 per share, and 148,500 DERs.  Options granted to officers became exercisable at a rate of 33.3% each year following their date of grant, six months after their date of grant or three years after their date of grant.  Options granted to directors either became exercisable six months after their date of grant or three years after their date of grant.  All options expire either five or ten years after their date of grant.  The DERs are payable only when their associated stock options are exercised, thereby reducing the effective strike price of such options. The Company recognizes compensation expense at the time the market price of the stock exceeds the effective strike price.

          During the quarter ended June 30, 2001, 114,000 of the outstanding DER’s were truncated and shortly after June 30, 2001 the remaining 34,500 DER’s were truncated.  After the dividend declared on April 20, 2001, no more dividends accrue to the DER’s.

          For the quarter ended June 30, 2002, the Company recorded no operating expense associated with the Stock Option Plan.  For the quarter ended June 30, 2001, the Company recorded an operating expense of $61,000 associated with the Stock Option Plan.

NOTE 5. FAIR VALUES OF FINANCIAL INSTRUMENTS

          ARM securities, forward purchase commitments and other marketable securities are reflected in the financial statements at estimated fair value.  Management bases its fair value estimates for ARM securities and other marketable securities primarily on third-party bid price indications provided by dealers who make markets in these financial instruments when such indications are available.  However, the fair value reported reflects estimates and may not necessarily be indicative of the amounts the Company could realize in a current market exchange.  Cash and cash equivalents, interest receivable, reverse repurchase agreements and payables for securities purchased are reflected in the financial statements at their costs, which approximates their fair value because of the short-term nature of these instruments.

NOTE 6. COMMON STOCK

          In December of 1998, the board of directors authorized the repurchase of 50,000 shares of the Company’s common stock. As of June 30, 1999, the entire 50,000 shares had been repurchased at an average cost of $4.58 per share.

           On February 19, 2002, the Company completed a public offering of 4,830,000 shares of its common stock for which it received net proceeds of approximately $40 million.

          On March 27, 2002, the Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission offering up to $200 million of the capital stock of the Company.  The registration statement was declared effective in June 2002.  As of June 30, 2002, $65 million remained available for issuance under the registration statement.

-11-

Table of Contents

ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS-(Continued)

          On June 21, 2002, the Company completed a follow-on offering of its common stock.  The Company issued 10,350,000 shares of common stock pursuant to a public offering at a public offering price of $13.00 per share and received net proceeds of $126,063,000, net of underwriting discount of $0.8125 per share.  Offering costs in connection with the public offering, including the underwriting discount and other expenses, which are expected to total $195,000, will be charged against the proceeds of the offering.

          During the three- and six-month periods ended June 30, 2002, the Company issued 181,000 and 233,000 shares, respectively, of common stock under its Dividend Reinvestment and Stock Purchase Plan and received net proceeds of $ 1.4 and $1.9 million, respectively.

           On April 18, 2002, the Company declared the first quarter 2002 dividend of $0.50 per common share, which was paid on May 15, 2002 to common stockholders of record as of May 1, 2002.

          On June 14, 2002, the Company declared a special dividend of $0.50 per which was paid on August 6, 2002 to common stockholders of record as of June 21, 2002.

          For federal income tax purposes, all dividends are expected to be ordinary income to the Company's stockholders, subject to year-end allocations of the common dividend between ordinary income, capital gain income and non-taxable income as return of capital, depending on the amount and character of the Company's full year taxable income.

-12-

Table of Contents

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 consolidated 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 SEC, including our Annual Report on Form 10-K for the year ended December 31, 2001 and our Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 27, 2002, as amended, that discuss our business in greater detail.

           This report contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of our plans and objectives for future operations, assumptions underlying such plans and objectives, and other forward-looking statements included in this report. Such statements may be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” or similar terms, variations of such terms or the negative of such terms. Such statements are based on management's current expectations and are subject to a number of factors and uncertainties, which could cause actual results to differ materially from those described in the forward-looking statements. Such statements address future events and conditions concerning changes in interest rates, capital expenditures, earnings, litigation, regulatory matters, markets for products and services, liquidity and capital resources and accounting matters. Actual results in each case could differ materially from those anticipated in such statements by reason of factors such as future economic conditions, changes in interest rates, changes in mortgage prepayment rates, legislative, regulatory and competitive developments in markets in which we operate, our ability to maintain our qualification as a real estate investment trust for federal income tax purposes, our ability to use borrowings to finance our assets, differences in the actual allocation of our assets from those assumed, the degree to which assets are hedged and the effectiveness of the hedge, and other circumstances affecting anticipated revenues and costs. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. Additional factors that could cause such results to differ materially from those described in the forward-looking statements are set forth in connection with the forward-looking statements.

General

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

           We are organized for tax purposes as a REIT.  Accordingly, we generally distribute substantially all of our earnings to stockholders without paying federal or state income tax at the corporate level on the distributed earnings.  As of June 30, 2002, our qualified REIT assets (real estate assets, as defined in the tax code, cash and cash items and government securities) were greater than 99% 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 2002 revenue qualifies for both the 75% source of income test and the 95% source of income test under the REIT rules.  We believe we met all REIT requirements regarding the ownership of our common stock and the distributions of our net income.  Therefore, we believe that we continue to qualify as a REIT under the provisions of the tax code.

Results Of Operations

      Three Months Ended June 30, 2002 Compared to June 30, 2001

           For the quarter ended June 30, 2002, our net income was $3,689,000 or $0.29 per diluted share based on an average of 12,823,000 diluted shares outstanding.  For the quarter ended June 30, 2001, our net income was $694,000, or $0.29 per diluted share based on an average of 2,361,000 shares outstanding

           Net interest income for the quarter ended June 30, 2002 totaled $7,103,000 or 58% of total interest income compared to $868,000 or 34% of total interest income for the quarter ended June 30, 2001.  Net interest income is comprised of the interest income earned on mortgage investments, net of premium amortization, less interest expense from borrowings and does not include realized capital gains or losses.   The increase in our net interest income was due primarily to short-term interest rates paid on our borrowings decreasing more than the interest rates earned on our mortgage-related assets.  Also, during the second quarter of 2002, we realized a gain on the sale of assets in the amount of $1,433,000 or 12% of total interest income compared to a gain on sale of $81,000 or 3% of total interest income realized during the second quarter of 2001.

           For the quarter ended June 30, 2002, our operating expenses increased to $4,847,000 or 40% of total interest income from $255,000 or 10% for the quarter ended June 30, 2001.  This increase was due primarily to an increase in the incentive compensation earned by our external manager as a result of our improved financial performance and the non-recurring costs incurred related to our acquisition of our external manager.

           For the quarter ended June 30, 2002, our operating expenses excluding the costs incurred related to our acquiring our external manager were $1,667,000 or 14% of total interest income.

-13-

Table of Contents

           Our return on average equity was 3.6%, or 15.3% on an annualized compounded basis, for the three months ended June 30, 2002 compared to 3.8%, or 16.3% annualized, for the three months ended June 30, 2001.  Excluding the non-recurring costs incurred related to our acquiring our external manager, our return on average equity was 6.7%, or 29.8% on an annualized compounded basis, for the three months ended June 30, 2002.

           For the quarter ended June 30, 2002, the constant prepayment rate (“CPR”) of all MBS was 30%.  The CPR of adjustable rate MBS was 33% and the CPR of fixed rate MBS was 10%.

           Prior to the June 13, 2002  termination of the management agreement, our management company earned an incentive fee when the rate of return on stockholders’ investment, as defined in the management agreement, exceeded the average ten-year U.S. Treasury rate during the quarter plus 1%.  During the second quarter of 2002 until the termination of the management agreement on June 13, 2002, our external manager earned $1,013,319 in incentive fees. The ten-year US Treasury rate for the corresponding period was 5.16% resulting in a Threshold Return of 6.16%.

     Six Months Ended June 30, 2002 Compared to June 30, 2001

           For the six-months ended June 30, 2002, our net income was $7,804,000, or $0.71 per diluted share based on an average of 11,041,000 shares outstanding.  For the six-months June 30, 2001, our net income was $1,239,000, or $0.52 per diluted share based on an average of 2,361,000 shares outstanding

           Net interest income for the six-months ended June 30, 2002 totaled $12,021,000 or 60% of total interest income compared to $1,504,000 and  30% of total interest income for the quarter ended June 30, 2001.  Net interest income is comprised of the interest income earned on mortgage investments, net of premium amortization, less interest expense from borrowings and does not include realized capital gains or losses.   The increase in our net interest income was due primarily to short-term interest rates paid on our borrowings decreasing more than the interest rates earned on our mortgage-related assets.  Also, during the six-months ended June 30, 2002, we realized a gain on the sale of assets in the amount of $1,656,000 or 8% of total interest income.

           For the six-months ended June 30, 2002, our operating expenses increased to $5,873,000 or 29% of total interest income from $417,000 or 8% of total interest income for the six months ended June 30, 2001.  This increase was due primarily to an increase in the incentive compensation earned by our external manager as a result of our improved financial performance and the non-recurring costs incurred related to our acquiring our external manager.

           Our return on average equity was 8.9%, or 18.6% on an annualized compounded basis, for the six months ended June 30, 2002 compared to 6.8%, or 14.1% annualized, for the six months ended June 30, 2001.  Excluding the non-recurring costs incurred related to our acquiring our external manager, our return on average equity was 12.5%, or 26.7% on an annualized compounded basis, for the six months ended June 30, 2002

Financial Condition

          At June 30, 2002, we held mortgage assets of $1,687 million at amortized cost, consisting primarily of $1,347 million of adjustable-rate mortgage-backed securities, $9 million of floating rate CMOs and $331 million of fixed-rate mortgage-backed securities.  This amount represents an approximate 298% increase over the $420 million held at December 31, 2001.  At June 30, 2002, we were well within our asset allocation guidelines, since 99% of total assets were mortgage-backed securities guaranteed by an agency of the United States government such as Fannie Mae or Freddie Mac.  Of the adjustable-rate mortgage-backed securities owned by us, 40% were adjustable-rate pass-through certificates whose coupon resets within one year.  The remaining 60% consisted of 3/1 hybrid adjustable-rate mortgage-backed securities and approximately 2% invested in 5/1 hybrid adjustable-rate mortgage-backed securities.  Hybrid adjustable-rate mortgage-backed securities have an initial interest rate that is fixed for a certain period, usually three to five years, and thereafter adjust annually for the remainder of the term of the loan.

-14-

Table of Contents

The following table presents a schedule of mortgage-backed securities owned at June 30, 2002 and December 31, 2001, classified by type of issuer (dollar amounts in thousands):

          The following table classifies our portfolio of mortgage-backed securities owned at June 30, 2002 and December 31, 2001, by type of interest rate index (dollar amounts in thousands):