As used in this Quarterly Report on Form 10-Q, "company," "we," "us," "our," and "Anworth" refer to Anworth Mortgage Asset Corporation.

You should read the following discussion and analysis in conjunction with the unaudited consolidated financial statements and related notes thereto contained in item 1 of this Quarterly Report on Form 10-Q. 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 stock. We urge you to carefully review and consider the various disclosures made by us in this Quarterly Report on Form 10-Q and in our other reports filed with the SEC, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the 1933 Act and Section 21E of the Securities Exchange Act of 1934, as amended, and, as such, may involve known and unknown risks, uncertainties and assumptions. 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 assumptions, known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control.

Statements regarding the following subjects, among others, may be forward-looking: changes in interest rates and the market value of our MBS; changes in the prepayment rates on the mortgage loans securing our MBS; our ability to borrow to finance our assets; implementation of or changes in government regulations or programs affecting our business; our ability to maintain our qualification as a REIT for federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended; and risks associated with investing in real estate assets, including changes in business conditions and the general economy. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those projected in any forward-looking statements we make. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

General

Our Company

We were formed in October 1997 and commenced operations on March 17, 1998. We are in the business of investing primarily in U.S. agency mortgage-backed securities, or MBS, which are obligations guaranteed by the U.S. government, such as Ginnie Mae, or federally sponsored enterprises, such as Fannie Mae or Freddie Mac. Our principal business objective is to generate net income for distribution to stockholders based upon the spread between the interest income on our mortgage-related assets and the cost of borrowing to finance our acquisition of these assets.

We are organized for tax purposes as a real estate investment trust, or 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. At September 30, 2009, our qualified REIT assets (real estate assets, as defined under the Internal Revenue Code of 1986, or the Code, cash and cash items and government

securities) were greater than 90% of our total assets, as compared to the Code requirement that at least 75% of our total assets must be qualified REIT assets. Greater than 99% of our 2008 revenue qualifies for both the 75% source of income test and the 95% source of income test under the REIT rules. At September 30. 2009, we believe we met all REIT requirements regarding the ownership of our common stock and the distributions of our net income. Therefore, we believe that we continue to qualify as a REIT under the provisions of the Code.

Our Portfolio

Our operations consist of the following portfolios: Agency mortgage-backed securities, or Agency MBS, and Non-Agency mortgage-backed securities, or Non-Agency MBS. Approximately 99.9% of our total portfolio is Agency MBS.

At September 30, 2009, we had total assets of $5.98 billion. Our Agency MBS portfolio, consisting of $5.94 billion, was distributed as follows: 22% adjustable-rate Agency MBS, 63% hybrid adjustable-rate Agency MBS, 15% fixed-rate Agency MBS and less than 1% agency floating-rate collateralized mortgage obligations, or CMOs. Our Non-Agency MBS portfolio consisted of approximately $5.1 million of floating-rate CMOs. Stockholders' equity available to common stockholders at September 30, 2009 was approximately $853 million, or $7.58 per share. The $853 million equals total stockholders' equity of $902 million less the Series A Cumulative Preferred Stock, or Series A Preferred Stock, liquidating value of $46.9 million and less the difference between the Series B Cumulative Convertible Preferred Stock, or Series B Preferred Stock, liquidating value of $31.2 million and the proceeds from its sale of $29.1 million. For the three months ended September 30, 2009, we reported net income to common stockholders of $30.2 million. Net income to common stockholders consists of net income of $31.7 million minus payment of preferred dividends of approximately $1.5 million.

Recent Regulatory Developments

In March 2009, the U.S. Treasury, the Federal Deposit Insurance Corporation, or FDIC, and the Federal Reserve announced the creation of the Public Private Investment Program, or PPIP. The PPIP has two components: the Legacy Loans Program (which has been temporarily postponed) and the Legacy Securities Program. The Legacy Securities Program contemplates the establishment of joint public and private investment funds, or PPIFs to purchase legacy non-Agency residential MBS, as well as commercial mortgage backed securities, that were originally AAA-rated. Legacy Securities PPIFs will have access to equity capital from the U.S. Treasury, as well as debt financing provided by the U.S. Government. In July 2009, the Treasury announced that it will invest up to $30 billion in equity and debt issued by Legacy Securities PPIFs and announced that it has selected nine asset managers to manage these PPIFs. These nine asset managers are expected to organize PPIFs to purchase, in partnership with private capital, Senior MBS as well as other eligible assets. The PPIFs established by these managers will increase the competition for Senior MBS assets, which could cause prices of these assets to rise. Higher prices mean lower effective yields on available assets and potentially higher values for our existing Senior MBS portfolio. In October, two funds closed on $1.13 billion of private sector capital commitments, matched 100% by the U.S. Treasury, for a total equity capital commitment of $2.26 billion. The U.S. Treasury will also provide debt financing up to 100% of the total capital commitments, representing $4.52 billion of total equity and debt capital commitments.

Further, the Federal Reserve, the Federal Housing Administration and the FDIC have stepped up implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. These programs may involve the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or may extend the payment terms of the loans. These loan modification programs, as well as future legislative or regulatory actions that result in the modification of outstanding mortgage loans, may affect the value of, and the returns on, our MBS portfolio.

The U.S. Government, Federal Reserve, U.S. Treasury, FDIC and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. We are unable to predict

whether or when such actions may occur or what impact, if any, such actions could have on our business, results of operations and financial condition.

Results of Operations

Three Months Ended September 30, 2009 Compared to September 30, 2008

For the three months ended September 30, 2009, our net income available to common stockholders was $30.2 million. This includes net income of $31.7 million and the payment of preferred stock dividends of approximately $1.5 million. For the three months ended September 30, 2008, our net loss was $1.3 million and our net loss to common stockholders was $2.8 million.

Net interest income for the three months ended September 30, 2009 was $35.3 million, or 51% of gross income, compared to $29.2 million, or 38% of gross income, for the three months ended September 30, 2008. Net interest income is comprised of the interest income earned on mortgage investments less interest expense from borrowings. Interest income net of premium amortization expense for the three months ended September 30, 2009 was $63.2 million, compared to $73.6 million for the three months ended September 30, 2008, a decrease of 14%, due primarily to a decrease in the weighted average coupon of our Agency MBS from 5.58% at September 30, 2008 to 5.33% at September 30, 2009, and a decline in the average balance outstanding of our portfolio, from approximately from $5.55 billion at September 30, 2008 to approximately $5.24 billion at September 30, 2009. Interest expense for the three months ended September 30, 2009 was $27.9 million, compared to $44.4 million for the three months ended September 30, 2008, a decrease of 37%. This decrease was due primarily to the decrease in short-term interest rates.

The results of our operations are affected by a number of factors, many of which are beyond our control, and primarily depend on, among other things, the level of our net interest income, the market value of our MBS, the supply of, and demand for, MBS in the marketplace, and the terms and availability of financing. Our net interest income varies primarily as a result from changes in interest rates, the slope of the yield curve (the differential between long-term and short-term interest rates), borrowing costs (our interest expense) and prepayment speeds on our MBS portfolios, the behavior of which involves various risks and uncertainties. Interest rates and prepayment speeds, as measured by the constant prepayment rate, or CPR, vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. With respect to our business operations, increases in interest rates, in general, may, over time, cause:
(i) the interest expense associated with our borrowings, which are primarily comprised of repurchase agreements, to increase; (ii) the value of our MBS portfolios and, correspondingly, our stockholders' equity to decline;
(iii) coupons on our MBS to reset, although on a delayed basis, to higher interest rates; (iv) prepayments on our MBS portfolios to slow, thereby slowing the amortization of our MBS purchase premiums; and (v) the value of our interest rate swap agreements and, correspondingly, our stockholders' equity to increase. Conversely, decreases in interest rates, in general, may, over time, cause:
(i) prepayments on our MBS portfolios to increase, thereby accelerating the amortization of our MBS purchase premiums; (ii) the interest expense associated with our borrowings to decrease; (iii) the value of our MBS portfolios and, correspondingly, our stockholders' equity to increase; (iv) the vale of our interest rate swap agreements and, correspondingly, our stockholders' equity to decrease; and (v) coupons on our MBS to reset, although on a delayed basis, to lower interest rates. In addition, our borrowing costs and credit lines are further affected by the type of collateral pledged and general conditions in the credit markets.

During the three months ended September 30, 2009, premium amortization expense based on the effective interest yield method increased $2.7 million, or 93%, from $2.9 million during the three months ended September 30, 2008 to $5.6 million.

The table below shows the approximate constant prepayment rate of our MBS for each of the following quarters:

                                                   2009                                         2008
                                    First         Second          Third          First         Second          Third
Portfolio                          Quarter        Quarter        Quarter        Quarter        Quarter        Quarter
Agency MBS and Non-Agency MBS           15 %           17 %           21 %           18 %           18 %           14 %

For the three months ended September 30, 2009, there was no gain or loss on derivative instruments due to hedge ineffectiveness, compared to a net loss on derivative instruments of approximately $941 thousand for the three months ended September 30, 2008.

For the three months ended September 30, 2008, there was an impairment charge on Non-Agency MBS of $34.1 million and a gain on the disposition of discontinued operations of approximately $7.7 million.

Total expenses were $3.6 million for the three months ended September 30, 2009, compared to $3.2 million for the three months ended September 30, 2008. The increase of $0.4 million in total expenses was due to an increase in compensation and benefits of $0.6 million (due primarily to an increase of $0.4 million in the accrual for year-end 2009 additional compensation over the additional compensation accrued in the third quarter of 2008), partially offset by a decrease in other expenses of $126 thousand and a write-off in 2008 of $108 thousand in offering costs.

Nine Months Ended September 30, 2009 Compared to September 30, 2008

For the nine months ended September 30, 2009, our net income available to common stockholders was $92.0 million. This includes net income of $96.5 million and the payment of preferred stock dividends of approximately $4.5 million. For the nine months ended September 30, 2008, our net income was $41.0 million and our net income available to common stockholders was $36.6 million.

Net interest income for the nine months ended September 30, 2009 was $107.9 million, or 51% of gross income, compared to $77.3 million, or 34% of gross income, for the nine months ended September 30, 2008. Interest income net of premium amortization expense for the nine months ended September 30, 2009 was $197.5 million, compared to $216.4 million for the nine months ended September 30, 2008, a decrease of 9%, due primarily to a decrease in the weighted average coupon of our Agency MBS from 5.58% at September 30, 2008 to 5.33% at September 30, 2009 and an increase in premium amortization expense. Interest expense for the nine months ended September 30, 2009 was $89.6 million, compared to $139.1 million for the nine months ended September 30, 2008, a decrease of 36%. This decrease was due primarily to the decrease in short-term interest rates.

During the nine months ended September 30, 2009, premium amortization expense based on the effective interest yield method increased $4.1 million, or 41%, from $10.1 million during the nine months ended September 30, 2008 to $14.2 million.

For the nine months ended September 30, 2009, there was a gain of approximately $107 thousand on derivative instruments due to hedge ineffectiveness, compared to a net loss on derivative instruments of approximately $0.9 million for the nine months ended September 30, 2008.

Total expenses were $11.5 million for the nine months ended September 30, 2009, compared to $9.0 million for the nine months ended September 30, 2008. The increase of $2.5 million in total expenses was due to an increase in compensation and benefits of $2.8 million (due primarily to an increase in the accrual for year-end 2009 additional compensation over the additional compensation accrued through September 2008), partially offset by a decrease in other expenses of $104 thousand and a write-off in 2008 of $108 thousand in offering costs.

Financial Condition

Agency MBS Portfolio

At September 30, 2009, we held Agency MBS, whose amortized cost was approximately $5.76 billion, consisting primarily of $4.91 billion of adjustable-rate MBS, $845 million of fixed-rate MBS and $6 million of floating-rate CMOs. This amount represents an approximate 10% increase from the $5.26 billion held at December 31, 2008. Of the adjustable-rate Agency MBS owned by us, 27% were adjustable-rate pass-through certificates whose coupons reset within one year. The remaining 73% consisted of hybrid adjustable-rate MBS whose coupons will reset between one year and five years. Hybrid adjustable-rate MBS 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.

The following table presents a schedule of our Agency MBS at fair value owned at September 30, 2009 and December 31, 2008, classified by type of issuer (dollar amounts in thousands):

                               September 30, 2009            December 31, 2008
                               Fair       Portfolio          Fair       Portfolio
      Agency                   Value      Percentage         Value      Percentage
      Fannie Mae (FNM)      $ 4,535,243         76.3 %    $ 3,971,748         74.8 %
      Freddie Mac (FHLMC)     1,384,544         23.3        1,309,149         24.7
      Ginnie Mae (GNMA)          23,719          0.4           26,543          0.5

      Total Agency MBS:     $ 5,943,506        100.0 %    $ 5,307,440        100.0 %

The following table classifies our portfolio of Agency MBS owned at September 30, 2009 and December 31, 2008 by type of interest rate index (dollar amounts in thousands):

                                             September 30, 2009                December 31, 2008
                                            Fair         Portfolio            Fair         Portfolio
Index                                       Value        Percentage           Value        Percentage
One-month LIBOR                          $     5,933            0.1 %      $     7,669            0.2 %
Six-month LIBOR                              149,921            2.5             43,192            0.8
One-year LIBOR                             4,440,337           74.7          3,690,221           69.5
Six-month certificate of deposit               1,523             -               1,653            0.1
Six-month constant maturity treasury             572             -                 671             -
One-year constant maturity treasury          425,559            7.2            478,422            9.0
Cost of Funds Index                           34,557            0.6             38,972            0.7
Fixed-rate                                   885,104           14.9          1,046,640           19.7

Total Agency MBS:                        $ 5,943,506          100.0 %      $ 5,307,440          100.0 %

The fair values indicated do not include interest earned but not yet paid. With respect to our hybrid adjustable-rate MBS, 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. The fair value of our Agency MBS is reported to us independently from dealers who are large financial institutions and are market makers for these types of instruments.

At September 30, 2009, our total Agency MBS portfolio had a weighted average coupon of 5.33%. The average coupon of the adjustable-rate securities was 4.40%, the hybrid securities average coupon was 5.57%, the fixed-rate securities average coupon was 5.79% and the CMO floaters average coupon was 1.05%. At December 31, 2008, our total Agency MBS portfolio had a weighted average coupon of 5.54%. The average coupon of the adjustable-rate securities was 5.19%, the hybrid securities average coupon was 5.56%, the fixed-rate securities average coupon was 5.79% and the CMO floaters average coupon was 2.01%.

At September 30, 2009, the average amortized cost of our Agency MBS was 101.86%, the average amortized cost of our adjustable-rate securities was 102.07% and the average amortized cost of our fixed-rate securities was 100.68%. Relative to our Agency MBS portfolio at September 30, 2009, the average interest rate on outstanding repurchase agreements was 0.33% and the average days to maturity was 39 days. After adjusting for interest rate swap transactions, the average interest rate on outstanding repurchase agreements was 2.22% and the weighted average term to next rate adjustment was 295 days.

At December 31, 2008, the average amortized cost of our Agency MBS was 101.22%, the average amortized cost of our adjustable-rate securities was 101.35% and the average amortized cost of our fixed-rate securities was 100.68%. Relative to our Agency MBS portfolio at December 31, 2008, the average interest rate on outstanding repurchase agreements was 2.07% and the average days to maturity was 34 days. After adjusting for interest rate swap transactions, the average interest rate on outstanding repurchase agreements was 3.25% and the weighted average term to next rate adjustment was 422 days.

At September 30, 2009 and December 31, 2008, the unamortized net premium paid for our Agency MBS was $101 million and $63 million, respectively.

At September 30, 2009, the current yield on our Agency MBS portfolio was 5.23%, based on a weighted average coupon of 5.33% divided by the average amortized cost of 101.86%. At December 31, 2008, the current yield on our Agency MBS portfolio was 5.47%, based on a weighted average coupon of 5.54% divided by the average amortized cost of 101.22%.

One of the factors that impacts the reported yield on our MBS portfolio is the actual prepayment rate on the underlying mortgages. We analyze our MBS and the extent to which prepayments impact the yield. When the rate of prepayments exceeds expectations, we amortize the premiums paid on mortgage assets over a shorter time period, resulting in a reduced yield to maturity on our mortgage assets. Conversely, if actual prepayments are less than the assumed CPR, the premium would be amortized over a longer time period, resulting in a higher yield to maturity.

Non-Agency MBS Portfolio

At September 30, 2009, our Non-Agency MBS portfolio consisted of a fair value of $5.1 million of floating-rate CMOs with an average coupon of 0.49%, which were acquired at par value. At December 31, 2008, our Non-Agency MBS portfolio consisted of $7.3 million of floating-rate CMOs with an average coupon of 0.72% which were acquired at par value. Non-Agency MBS are securities not issued by the government or government-sponsored enterprises and are secured primarily by first-lien residential mortgage loans.

At September 30, 2009, the fair value of our Non-Agency MBS portfolio declined to approximately $5.1 million from a fair value of approximately $7.3 million at December 31, 2008 due to principal reductions of approximately $2.1 million, and unrealized losses (net of unrealized gains) of approximately $0.1 million.

At September 30, 2009, two securities representing the principal balance of our Non-Agency MBS portfolio were rated CCC by Standard & Poor's and Ca by Moody's Investor Service.

We received valuations at December 31, 2008 for the Non-Agency MBS from an independent third party pricing service whose methodologies are based on broker-provided pricing as well as indirect observation of market activity. Generally, we would consider this to be a Level 2 input. However, given the severely reduced trading activity surrounding the Non-Agency MBS, which limited the observability of significant inputs utilized in valuing these securities, we reduced the fair value measurement to a Level 3 input at December 31, 2008 and it remains a Level 3 input at September 30, 2009. For more detail on the fair value of our Non-Agency MBS, see Note 5 to the accompanying unaudited consolidated financial statements.

The table below provides additional details regarding our Non-Agency MBS portfolio at September 30, 2009 and December 31, 2008:

                                                      September 30,          December 31,
                                                          2009                   2008
Non-Agency MBS at fair value                         $  5.14 million        $  7.34 million
Principal balance of Non-Agency MBS                  $ 42.75 million        $ 44.87 million
Original principal balance on Non-Agency MBS         $    60 million        $    60 million
Original FICO (credit score)                                     730                    730

Information on Loan Collateral of Non-Agency MBS
Securitizations
Loan principal as percentage of original loan
principal                                                       71.0 %                 76.3 %

Weighted average original loan-to-value (LTV)                     69 %                   69 %
Weighted average original LTV adjusted for
negative loan amortization                                        73 %                   73 %

California loans(1)                                               69 %                   68 %
Pay-option ARM loans(1)                                          100 %                  100 %
2006 loan originations(1)                                         99 %                   99 %

3-month CPR                                                     13.5 %                  7.4 %

Loans in foreclosure(1)                                         15.6 %                  6.0 %
Real estate owned (REO)(1)(2)                                    3.2 %                  2.4 %
Total seriously delinquent(1)(3)                                25.1 %                 12.3 %
Realized losses (as percentage of original
collateral balance)                                              2.7 %                  0.5 %

Information on Subordination Levels of
Non-Agency MBS Securitizations(4)
Average securitization principal subordinate to
Anworth-owned tranches                                           7.2 %                  9.5 %
Average securitization principal of
Anworth-owned tranches                                          15.9 %                 15.5 %
Average securitization principal senior to
Anworth-owned tranches                                          76.9 %                 75.0 %

(1) As a percentage of collateral loan principal.

(2) Represents the amount of collateral loan principal where the properties are now REO.

. . .