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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

For the Fiscal Year Ended December 31, 2004

Or

For the transition period from              to             

Commission file number 1-32340

AAMES INVESTMENT CORPORATION

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (323) 210-5000

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

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

None

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

There was no public trading market for the Registrant’s common stock as of the last day of the Registrant’s most recently completed second fiscal quarter. The Registrant completed its initial public offering on November 5, 2004. At March 9, 2005 there were outstanding 61,421,751 shares of the common stock of Registrant.

Documents Incorporated by Reference

Portions of Registrant’s Proxy Statement relating to its 2005 Annual Meeting of Stockholders are incorporated by reference in Items 10, 11, 12 and 13 of Part III of this Annual Report.

PART I

Item 1.    Business

GENERAL

Aames Investment Corporation, a mortgage real estate investment trust, or REIT, was formed in February 2004 to build and manage a portfolio of high yielding subprime mortgage loans to offer its stockholders the opportunity for attractive dividend yields and earnings growth. In November 2004, we completed an initial public offering, and, concurrently with that offering, a reorganization with Aames Financial Corporation, formerly our parent company. As a result of the reorganization, Aames Financial became a wholly owned subsidiary of ours. Aames Financial is a fifty-year old mortgage banking company focused primarily on originating, selling and servicing mortgage loans through both wholesale and retail channels under the name “Aames Home Loan.” Our strategy is to use our equity capital, including a portion of the net proceeds from our initial public offering, and funds borrowed under revolving warehouse and repurchase facilities to finance our mortgage loan originations, and to use on-balance sheet securitizations to finance our REIT portfolio of mortgage loans. We retain in our REIT portfolio some of our mortgage loan originations, largely hybird/adjustable rate mortgage loans, which accounted for 77.5% of our loan production during the six months ended December 31, 2004. We sell the remainder, including a majority of the fixed-rate mortgage loans that we originate, on a whole loan servicing-released basis to third parties.

We have elected to be taxed as a REIT for U.S. federal income tax purposes, and Aames Financial is our taxable REIT subsidiary, or TRS. As a REIT, we generally are not subject to U.S. federal income tax on the REIT income that we distribute to our stockholders. We distribute a majority of the earnings from our REIT portfolio of mortgage loans to our stockholders, while growing our equity capital base by retaining a portion of Aames Financial’s earnings. The taxable income generated by Aames Financial is subject to regular corporate income tax. This includes fee income on all loans that Aames Financial, through its subsidiaries, originates and gains and net interest income on all loans that it sells.

As of December 31, 2004, Aames Financial had approximately $185.9 million of historical net operating loss carryforwards for U.S. federal income tax purposes that expire from 2017 through 2024. These losses are available to offset future income. The benefit for these losses has not been recognized, however, we believe that Aames Financial will be able to use these historical net operating loss carryforwards in the future, subject to annual limitations and, as a result, Aames Financial will have substantially lower effective tax rates than statutory rates.

Business Strategy

Our goal is to maximize stockholder value and increase earnings by:

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The strategies discussed above contain forward-looking statements. Such statements are based on current expectations and are subject to risks, uncertainties and assumptions, including those discussed under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors.” Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. Thus, no assurance can be given that we will be able to accomplish the above strategies.

Competitive Advantages

We believe that we have the following competitive advantages:

MORTGAGE PORTFOLIO MANAGEMENT

We invest in subprime one-to-four family, residential mortgage loans, operating as a long-term portfolio investor. We purchase loans originated by Aames Financial that we anticipate holding on our balance sheet, largely hybrid/adjustable rate loans. Aames Financial retains the servicing rights to those loans.

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To provide us with long-term financing for the portfolio of mortgage loans that we hold on our balance sheet, we securitize substantially all of those loans through on-balance sheet transactions structured as financings rather than sales for both tax and financial accounting purposes. Accordingly, these loans will remain on our consolidated balance sheet as an asset and the underlying bonds issued through the securitization will be reported as a liability on our consolidated balance sheet. Thus, we will record interest income generated by the mortgage loans and recognize interest expense on the related financings over the life of the mortgage loan pool, rather than generate a gain or loss at the time of the securitization.

We generate taxable earnings from the loans that we securitize or retain in our REIT portfolio primarily through:

We record interest income on the mortgage loans and interest expense on the securities issued in the securitization over the life of the securitization and do not recognize gain or loss upon the completion of the securitization for financial reporting purposes. This accounting treatment more closely matches the recognition of income with our actual receipt of cash payments, which we believe provides us with more stable results of operations compared to companies that structure their securitizations as sales.

During the six months ended December 31, 2004, we completed one securitization totaling $1.2 billion. This securitization was structured as an on-balance sheet securitization for accounting purposes under SFAS No. 140. Prior to our reorganization, Aames Financial’s securitizations were structured as sales for both tax and financial accounting purposes. We did not complete any securitizations during the six months ended December 31, 2003. Once we have built our REIT portfolio to its target range, we expect net interest income from our portfolio of mortgage loans to generate a substantial portion of our earnings. On February 24, 2005, we completed another on-balance sheet securitization totaling $1.2 billion.

We expect to purchase most of Aames Financial’s mortgage loan originations while we build our REIT portfolio. We have not established a limit on the amount of leverage we may incur, but generally we plan to leverage our stockholders’ equity 10 to 14 times. Once we have built our REIT portfolio to its target range, we anticipate purchasing a smaller portion of Aames Financial’s originations to maintain our target leverage ratio. Aames Financial will then sell the remainder of its loan originations, including a portion of its hybrid/adjustable rate mortgage loans, to third parties in the secondary market.

A significant risk to our operations that relates to our REIT portfolio management is the risk that interest rates on our assets will not adjust at the same time or amount as the rates on our liabilities adjust. This is because the interest on the underlying hybrid/adjustable rate mortgage loans is based on fixed rates payable on the underlying loans for the first two or three years from origination while the holders of the applicable securities are generally paid based on an adjustable one-month LIBOR-based yield. Moreover, even after the initial fixed period, our loans generally adjust every six months and are subject to periodic rate caps, whereas the bonds adjust monthly based primarily on LIBOR. Therefore, an increase in one-month LIBOR generally reduces the net interest income we receive from our securitized loan portfolio. We attempt to mitigate a portion of this net interest margin variability by purchasing derivative financial instruments referred to as interest rate cap agreements. In addition, the net interest income we receive from securitizations will be reduced if there are a significant amount of loan defaults or loan prepayments, especially on loans with interest rates that are high relative to the rest of the securitized mortgage loan pool.

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We do not use formalized hedge accounting for our derivative financial instruments as set forth in generally accepted accounting principles in the United States. Instead, we are required to record the change in the value of the derivatives as a component of earnings even though they may reduce our interest risk. In times where short-term rates drop significantly, the value of our interest rate caps will decrease; in times where short-term rates increase, the value of the interest rate caps will increase. The interest rate caps are designed to exchange the cost of our variable rate liabilities to fixed rates for the first two years of its estimated duration thereby better matching our interest-bearing fixed rate assets.

INVESTMENT AND OPERATIONAL POLICIES

Our investment strategy is subject to change if and when our board of directors determines that a change is in our stockholders’ best interest. Neither stockholder approval nor notification is required prior to changing our investment strategy.

Mortgage Loans

In general, our strategy is to build a portfolio of mortgage loans primarily originated by our TRS. Our mortgage loans are generally underwritten in accordance with the categories and criteria described in our underwriting guidelines. See “Underwriting Standards.”

Mortgage-backed Securities

Our current REIT portfolio consists of mortgage loans originated by Aames Financial that collateralize mortgage-backed securities and mortgage loans originated by Aames Financial that will collateralize future mortgage-backed securitizations. From time to time, we may acquire and hold mortgage-backed securities collateralized by mortgage loans originated by and purchased from third parties to satisfy certain asset and income tests applicable to REITs. The mortgage-backed securities are expected to be backed primarily by first mortgages on one- to four-family dwellings and are expected to be rated by S&P or Moody’s. We have not previously acquired or held any third-party mortgage-backed securities in our investment portfolio.

If we change our investment strategy, the new strategy may entail more risk than our current investment strategy. Alternative strategies that our board of directors may choose to put in place include:

Leverage Policy

We employ a leverage strategy by securitizing existing mortgages in transactions that we believe will be treated as borrowings for accounting and tax purposes. We generally intend to borrow approximately 10 to 14 times the amount of our consolidated equity capital, although our actual debt to equity ratio may vary from time to time depending on market conditions and other factors that our management and board of directors deem relevant. In general, our credit facilities limit our total debt-to-equity ratio to a level of 15.0 to 1.0. However, each of our credit facility lenders disregards nonrecourse financing, including the bonds underlying our on-balance sheet securitizations, in computing our adjusted leverage ratio which is limited to 5.5 to 1.0. The total and adjusted leverage ratios under our credit facilities were 5.5 to 1.0 and 2.8 to 1.0 at December 31, 2004, respectively.

Hedging Policy

To mitigate the adverse effects from interest increases on our mortgage loans held for sale or investment, we use several tools and risk management strategies to monitor and address interest rate risk. We believe that these

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tools allow us to monitor and evaluate our exposure to interest rates and to manage the risk profile of our mortgage loan portfolio in response to changes in market conditions. As part of our interest rate risk management process, we have used derivative financial instruments, such as interest rate cap agreements, interest rate swap agreements, Treasury futures and options on interest rates. We can also use other hedging instruments including mortgage derivative securities, when necessary. Hedging strategies also involve transaction and other costs. Because we use derivative financial instruments more than we did prior to the REIT reorganization, the aggregate costs to us of entering into contracts for these instruments is significantly higher than in the past.

We currently use derivative financial instruments such as interest rate cap agreements. It is not our policy to use derivatives to speculate on interest rates. These derivative instruments have an active secondary market and are intended to provide supplemental income and cash flow to offset potential reduced interest income and cash flow in certain interest rate environments. We report our derivative financial instruments on our consolidated balance sheets at their fair value with any changes in fair value reported as either a charge or credit to the consolidated statement of operations.

Financing Policy

We may raise funds through additional equity offerings, debt financings, retention of cash flow, or a combination of these methods subject to Internal Revenue Code provisions regarding distribution requirements and taxability of undistributed REIT taxable income. If our board of directors decides to raise additional equity capital, it has the authority to issue additional common or preferred stock, in any manner and on terms it deems appropriate, up to the amount authorized in our articles of incorporation without stockholder approval.

Currently, our borrowings consist primarily of funds borrowed under revolving warehouse and repurchase facilities and financings on loans held for investment. Borrowings going forward may be in the form of bank borrowings, secured or unsecured, and publicly or privately placed debt instruments, purchase money obligations to the sellers of assets, long-term, tax-exempt bonds or other publicly or privately placed debt instruments, financing from banks, institutional investors or other lenders, and securitizations, including collateralized debt obligations, any of which may be unsecured or secured by mortgages or other interests in the assets. This indebtedness may entail recourse to all or any part of our assets or may be limited to the particular assets to which the indebtedness relates.

We enter into collateralized borrowings only with institutions that we believe are financially sound and that are rated investment grade by at least one nationally recognized statistical rating organization.

MORTGAGE ORIGINATIONS

We originate primarily subprime, single-family residential mortgage loans. These originations are significant to our financial results because we produce the loans that we hold in our on-balance sheet portfolio of loans held for investment. During the six months ended December 31, 2004, we originated $3.6 billion of subprime mortgage loans. Of the $3.6 billion, approximately $1.7 billion were retained in our REIT portfolio. Of the $1.7 billion, $1.2 billion serve as collateral for our on-balance sheet securitization and $0.5 billion was designated as collateral for future on-balance sheet securitizations. The loans we originate that are not retained in our REIT portfolio of loans held for investment are sold to the secondary markets.

Our principal market is borrowers whose financing needs are not being met by traditional mortgage lenders for a variety of reasons, including the need for specialized loan products or credit histories that may limit such borrowers’ access to credit. These types of borrowers generally pay higher mortgage loan origination fees and interest rates than those charged by conventional lending sources. We believe these borrowers continue to represent an underserved niche of the residential mortgage loan market and present an opportunity to earn a superior return for the risk assumed. Our residential mortgage loans, which include fixed and hybrid/adjustable rate loans or ARMS, are generally used by borrowers to consolidate indebtedness, finance other consumer needs, or purchase homes. We believe that while our loan origination volume is affected by general levels of interest

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rates, because a majority of our loan originations are cash-out refinancings and purchase money loans our loan origination volume is generally less cyclical than conventional mortgage lending which has a higher percentage of rate/term refinance loans.

As of December 31, 2004 Aames Financial originated loans in 47 states through its retail and wholesale channels. Its wholesale channel operated five regional wholesale operations centers throughout the United States and originated loans through a nationwide network of approximately 4,400 independent mortgage brokers who submit mortgage loans to it. Its retail channel had a network of 96 retail branch offices directly serving borrowers throughout the United States.

The following table shows our total originations by retail and wholesale channels for the six months ended December 31, 2004 and the years ended June 30, 2004, 2003 and 2002 (in thousands):

A significant risk to our mortgage originations operations is liquidity risk—the risk that we will not have the financing facilities and cash available to fund and hold loans prior to their sale or securitization. We maintain committed borrowing facilities with large banking and investment institutions to reduce this risk.

Our Retail Channel

We generate applications for loans through our retail loan office network principally through a direct response marketing program, which relies primarily on the use of direct mailings to homeowners, telemarketing and Internet generated leads. We believe that our marketing efforts establish name recognition and serve to distinguish us from our competitors. We continually monitor the source of our applications to determine the most effective methods and manner of marketing. We generate customer leads for the retail network based upon models that we have derived and commercially developed customer lists. Our direct mail invites prospective borrowers to call us to apply for a loan. We also generate leads through several commercially available Internet sites as well as through our own retail Internet web site “Aames.net”. Whether generated through direct mail or the Internet, leads are generally followed up with telephone calls to potential customers. On the basis of an initial screening conducted at the time of the call, our loan officers at the local retail loan office make a determination of whether the customer and the property generally meet our lending criteria. The loan officer may complete the application over the telephone or schedule an appointment with the retail loan office most conveniently located to the customer or in the customer’s home, depending on the customer’s needs.

The retail loan officer assists the applicant in completing the loan application, arranges for an appraisal, orders a credit report from an independent, nationally recognized credit reporting agency and performs various other tasks in connection with the completion of the loan package. The loan package is underwritten for loan approval on a centralized basis. If we approve the loan package, the loan is funded. Our loan officers are trained to structure loans that meet the applicant’s needs while satisfying our lending guidelines.

We continually monitor our retail operations in the markets in which we operate and evaluate existing and potential retail offices on the basis of selected demographic statistics, marketing analyses and other criteria that we have developed in order to further enhance our mortgage loan production capabilities. As part of this evaluation process, we have closed 12 retail branches since December 31, 2004 in markets where it was not financially feasible to continue to service the market area in this manner. However, we continue to service these areas through our wholesale channel and the Internet.

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Our Wholesale Channel

During the six months ended December 31, 2004, we originated loans through our network of approximately 4,400 independent wholesale mortgage brokers throughout the United States, none of which accounted for more than 5.0% of total wholesale originations.

The broker’s role is to identify the applicant, assist in completing the loan application, gather necessary information and documents, submit the application requesting the interest rate and terms of the loan, and serve as our liaison with the borrower through the lending process. We review and underwrite the applications submitted by the broker in accordance with our underwriting guidelines and then approve or deny the application. If the loan is approved, we approve or counter the requested interest rate and other terms of the loan and, upon acceptance by the borrower and satisfaction of all conditions imposed by us, we fund the loan. Because brokers conduct their own marketing and employ their own personnel to complete loan applications and maintain contact with borrowers, originating loans through our wholesale network allows us to increase our loan volume without incurring the higher marketing and employee costs associated with retail originations.

Because mortgage brokers generally submit loan files to several prospective lenders simultaneously, competitive pricing, consistent underwriting, quick response times and personal service are critical to successfully producing loans through independent mortgage brokers. To meet these requirements, we strive to provide quick response time to the loan application (generally within 24 hours). In addition, the loans are processed and underwritten in regional offices, and loan consultants, loan processors and underwriters are available to answer questions, assist in the loan application process and facilitate ultimate funding of the loan.

We use telemarketing and the Internet to increase our wholesale loan production and further penetrate the subprime home equity wholesale market through our “Broker Direct” program. Through Broker Direct, we make outbound telemarketing calls to brokers that have been inactive for the past 90 days and brokers who are not currently doing business with us or are outside the geographic areas served by the loan officers. We also obtain leads through our wholesale Internet web site “AamesDirect.com.”

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The following table presents certain information about our mortgage loan production at or during the six months ended December 31, 2004 and 2003 and at or during the years ended June 30, 2004, 2003 and 2002:

Total Loan Production

Total loan production during the six months ended December 31, 2004 increased $430.7 million, or 13.6%, to $3.6 billion over the $3.2 billion of loan production during the six months ended December 31, 2003. Total loan production during the six months ended December 31, 2004 increased primarily due to continued demand for subprime products and improved geographic diversification in the wholesale and retail channels despite a generally increasing mortgage interest rate environment prevailing in the marketplace.

However, our mortgage loan origination volumes during the latter part of the six months ended December 31, 2004 were negatively impacted by competitive and interest rate pressures in the marketplace due to increases in short term interest rates. We expect the current interest rate environment to continue to negatively impact our mortgage loan origination volume in the current quarter.

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Total loan production during the year ended June 30, 2004 increased $2.5 billion, or 57.2%, to $7.0 billion over $4.4 billion of total loan production during the year ended June 30, 2003 which, in turn, was a $1.2 billion, or 37.5%, increase over the $3.2 billion during the year ended June 30, 2002. Our total loan production volumes increased during the year ended June 30, 2004 over production volumes during the year ended June 30, 2003 due to a combination of our adoption of new mortgage loan product guidelines, continued strong demand for subprime products in the generally favorable mortgage interest rate environment prevailing in the marketplace, growth in the number of sales staff in the retail channel, and improved geographic diversification in the wholesale channel. The increase in our total loan origination volumes during the year ended June 30, 2003 over production volumes during the year ended June 30, 2002 was due to a combination of the continuing favorable mortgage interest rate environment and, to a lesser extent, the issuance of new company-wide uniform underwriting guidelines designed to improve our competitive position and to provide greater underwriting consistency among our retail and wholesale origination channels.

Our total retail production was $1.2 billion during the six months ended December 31, 2004, an increase of $21.0 million, or 1.8%, over total retail production during the comparable six month period in 2003. Retail production increased slightly during the six months ended December 31, 2004 over the comparable period a year ago primarily due to a 2.7% increase in the number of loans originated offset partially by a 0.9% decline in average loan size. The increase in the number of loans was primarily due to our decision to expand staffing and loan origination capacity in certain retail branches, which we refer to as “Super Branches,” during the six months ended December 31, 2004, partially offset by increased competitive pressure in the December 2004 quarter due to the increased interest rate environment.

Our total retail loan production increased $605.0 million, or 33.7%, to $2.4 billion during the year ended June 30, 2004 over the $1.8 billion of total retail production during the year ended June 30, 2003 which, in turn, increased $185.6 million, or 11.5%, over the $1.6 billion of total retail production during the year ended June 30, 2002.

Our total wholesale production increased $409.6 million, or 20.6%, to $2.4 billion during the six months ended December 31, 2004 over $2.0 billion of total wholesale production during the six months ended December 31, 2003. The increase in our wholesale production dollar volume during the six months ended December 31, 2004 over the comparable six month period during 2003 was due primarily to an 18.5% increase in the number of loans originated coupled with a 1.8% increase in average loan size.

Our total wholesale production increased $1.9 billion, or 73.1%, during the year ended June 30, 2004 over the $2.7 billion of total wholesale production during the year ended June 30, 2003 which, in turn, increased $1.0 billion, or 62.4%, over the $1.6 billion of total wholesale production during the year ended June 30, 2002. In November 2003, we added a regional wholesale operations center in the Northeastern United States, which enabled us to increase our production in that region.

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The following table summarizes certain information about our mortgage loan production by purpose and property type during the six months ended December 31, 2004 and 2003 and the years ended June 30, 2004, 2003 and 2002 (in thousands):

NM = Not Meaningful

The following table shows our loan originations by geographic region during the six months ended December 31, 2004 and 2003 and during the years ended June 30, 2004, 2003 and 2002 (dollars in thousands):

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The following table summarizes certain information by interest rate about our mortgage loan production during the six months ended December 31, 2004 and 2003 and during the years ended June 30, 2004, 2003 and 2002 (in thousands):

UNDERWRITING STANDARDS

We underwrite each mortgage loan that we originate in both our wholesale and retail channels in accordance with our underwriting guidelines. We have developed underwriting processes and criteria that we believe generate quality loans and give us the ability to approve and fund loans quickly. Our underwriting guidelines are designed to help us evaluate a borrower’s history of payments on his prior mortgage credit history, capacity, willingness and ability to repay the loan, and the value and adequacy of the collateral. We review the borrower’s credit history from all three nationally recognized credit bureaus. In addition, we review credit scores derived from the borrower’s credit history by one or more nationally recognized credit scoring models.

Our underwriting policy is to analyze the overall situation of the borrower and to take into account compensating factors that may be used to offset certain areas of weakness. These compensating factors include proposed reductions in the borrower’s debt service expense, employment stability, number of years in residence and net disposable income. Based upon this analysis, we can determine loan terms and conditions to produce loans that we believe are appropriately priced, meet our quality standards, and are profitable. Our underwriting process and guidelines require a rigorous application review and documentation designed to determine the borrower’s ability to repay the loan and maximize the value of our mortgage loans. We also evaluate each loan that we originate to ensure that it provides a benefit to the borrower in accordance with regulatory requirements.

Underwriting Personnel

Our on-staff underwriting personnel underwrite all of our loans. We do not delegate underwriting authority to any broker or third party. We regularly train our underwriters on emerging trends in production, and believe that our originators and underwriters are highly qualified and experienced and are familiar with our underwriting guidelines. We believe that our regionalized underwriting process in wholesale provides us with the ability to fund loans fast, and that the experience of our loan originators and branch managers, our information systems and our rigorous quality control process ensure the continued quality of our loans.

Underwriting Guidelines

A critical function of our underwriting process is to identify the level of credit risk associated with each applicant for a mortgage loan. We have established six principal classifications, with respect to the credit profile of potential borrowers, and have assigned a rating to each loan based upon these classifications. We assign credit grades and pricing by analyzing mortgage payment history, consumer credit history, credit score and bankruptcy history. Debt-to-income ratios are evaluated to ascertain borrower’s ability to repay their obligation. If an individual loan application does not meet our formal written underwriting guidelines, our underwriters can make underwriting exceptions up to certain limits within our formal exception policies and approval authorities. We may, from time to time, apply underwriting criteria that are either more stringent or more flexible depending upon the economic conditions of a particular geographic market.

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Credit History

We obtain credit scores in connection with mortgage loan applications to help assess a borrower’s creditworthiness. Credit scores are obtained from credit reports provided by various reputable credit reporting organizations, each of which may employ differing computer models and methodologies. The credit score is designed to assess a borrower’s credit history at a single point in time, using objective information currently on file for the borrower at a particular credit reporting organization. Information utilized to create a credit score may include, among other things, payment history, delinquencies on accounts, level of outstanding indebtedness, length of credit history, types of credit, and bankruptcy experience. Credit scores generally range from approximately 400 to approximately 800, with higher scores indicating an individual with a more favorable credit history compared to an individual with a lower score. However, a credit score purports only to be a measurement of the relative degree of risk a borrower represents to a lender; that is, a borrower with a higher score is statistically expected to be less likely to default in payment than a borrower with a lower score. Moreover, credit scores were developed to indicate a level of default probability over the period of the next two years, which does not correspond to the life of a mortgage loan. Furthermore, credit scores were not developed specifically for use in connection with mortgage loans, but for consumer loans in general. Therefore, a credit score does not take into consideration the differences between mortgage loans and consumer loans generally or the specific characteristics of the related mortgage loan including, for example, the LTV or CLTV (defined below), the collateral for the mortgage loan, or the debt to income ratio. There can be no assurance that the credit scores of the mortgagors will be accurate predictors of the likelihood of repayment of the related mortgage loans.

Collateral Review

An assessment of the adequacy of the real property as collateral for the loan is primarily based upon an appraisal of the property and a calculation of the loan-to-value ratios, or LTV, of the loan applied for and of all mortgages existing on the property, including the loan applied for, (the combined loan-to-value ratio or CLTV) to the appraised value of the property at the time of origination. Appraisers determine a property’s value by reference to the sales prices of comparable properties recently sold, adjusted to reflect the condition of the property as determined through inspection.

We require title insurance coverage issued on an American Land Title Association (or similar) form of title insurance on all residential properties securing mortgage loans we originate. The loan originator and its assignees are generally named as the insured. Title insurance policies indicate the lien position of the mortgage loan and protect us against loss if the title or lien position is not as indicated. The applicant is also required to maintain hazard and, in certain instances, flood insurance, in an amount sufficient to cover the new loan and any senior mortgage, subject to the maximum amount available under the National Flood Insurance Program.

As a lender that generally specializes in loans made to credit impaired borrowers, we make home equity mortgage loans to borrowers with credit histories or other factors that might disqualify them from consideration for a loan from traditional financial institutions. Our underwriting guidelines for such credit impaired borrowers may, in certain instances, allow for higher combined loan-to-value ratios than would typically be the case if the borrower could qualify for a loan from a traditional financial institution, and at generally higher interest rates than the borrower could qualify for from a traditional financial institution.

The underwriting of a mortgage loan to be originated by us generally includes a review of the completed loan package, which includes the loan application, a current appraisal, a preliminary title report and a credit report. All loan applications and all closed loans offered to us for purchase must be approved by us in accordance with our underwriting criteria. We regularly review our underwriting guidelines and make changes when appropriate to respond to market conditions, the performance of loans representing a particular loan product or changes in laws or regulations.

Underwriting Requirements

Our current underwriting guidelines, called Super Aim, became effective in October 2003 and generally require a minimum credit score of 500, although a higher credit score is often required to qualify for the

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maximum LTV under the program. The following chart generally outlines the parameters of the credit grades of the Super Aim underwriting guidelines.

Income Documentation

Our underwriting guidelines include several levels of documentation used to verify the borrower’s income:

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LOAN PRODUCTION BY BORROWER RISK CLASSIFICATION

The following table sets forth our loan production under the Super Aim guidelines during the six months ended December 31, 2004 (dollars in thousands):

The Super Aim underwriting guidelines became effective October 1, 2003. Because our underwriting guidelines prior to October 1, 2003 were different from the Super Aim guidelines, information concerning loan production by credit grade for prior periods would not be meaningful.

The following table presents certain information about our loan production by credit score range during the six months ended December 31, 2004 and 2003 (dollars in thousands):

LOAN ORIGINATIONS DURING THE SIX MONTHS ENDED DECEMBER 31, 2004

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LOAN ORIGINATIONS DURING THE SIX MONTHS ENDED DECEMBER 31, 2003

The following tables present certain information about our total loan production by credit score range during the years ended June 30, 2004, 2003 and 2002 (dollars in thousands):

LOAN ORIGINATIONS DURING THE YEAR ENDED JUNE 30, 2004

LOAN ORIGINATIONS DURING THE YEAR ENDED JUNE 30, 2003

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LOAN ORIGINATIONS DURING THE YEAR ENDED JUNE 30, 2002

Quality Control

Our quality control program is intended to monitor and improve the overall quality of loan production generated by our retail channel and wholesale channel and identify and communicate to management existing or potential underwriting and loan packaging problems or areas of concern. The quality control file review examines compliance with our underwriting guidelines and federal and state regulations. This is accomplished by focusing on:

MORTGAGE LOAN SALES TO THIRD PARTIES AND SECURITIZATIONS

Before the REIT reorganization, Aames Financial sold loans to third parties in two types of transactions—whole loan sales and off-balance sheet securitizations. Aames Financial sold whole loans on a servicing released basis, meaning that it sold the loans together with the servicing rights.

Aames Financial continues to sell whole loans not retained for the REIT portfolio to capture any gain on sale of these loans and to grow our equity capital base on a consolidated basis. Aames Financial does not currently sell loans in off-balance sheet securitizations; however, after our on-balance sheet portfolio reaches its target level, Aames Financial may sell a portion of its loans in off-balance sheet securitizations depending on market conditions at that time. Aames Financial generally sells these loans within 45 days of funding and services these loans during the period between origination and transfer of servicing to the buyer, which is generally within 90 days after the sale of the loan. Aames Financial generates income primarily from:

Historically, Aames Financial’s off-balance sheet securitizations were structured as sales for both tax and financial accounting purposes. In these securitizations, Aames Financial would sell a pool of mortgage loans into

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a trust, which would then issue securities or bonds collateralized by the mortgage loans. Aames Financial might retain or sell the servicing rights to the securitized mortgages, as well as an interest in the pool of mortgages, called a residual interest, that entitled it to the remaining interests in the loans, if any, after all of the obligations on the issued securities or bonds had been paid in full. Today, Aames Financial sells us loans that we use to build our REIT portfolio of loans held for investment through the use of on-balance sheet securitizations.

Aames Financial uses the net proceeds of its loan sales, whether through off-balance sheet securitizations or whole loan sales, to pay down its warehouse and repurchase facilities to increase capacity under these facilities for future funding of mortgage loans. Proceeds we receive from financings on loans held for investment are also used to pay down our warehouse and repurchase facilities.

The following table sets forth information regarding our off-balance sheet securitizations and whole loan sales to third parties during the periods presented (in thousands):