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SECURITIES AND EXCHANGE COMMISSION FORM 10-K (Mark One) For the fiscal year ended December 31, 2001 OR * TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES For the transition period from to Commission File Number: 001-13731 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. Virginia (703) 312-9500 Securities registered pursuant to section 12(b) of the
act:
Title of Securities Exchanges on Which Registered Class A Common Stock, Par Value $0.01 New York Stock Exchange 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 * Aggregate market value of the
voting stock held by non-affiliates of the Registrant: $214,284,795 as of
March 22, 2002. Indicate the number of shares outstanding of each of the registrant's classes
of common stock, as of the latest practicable date: 18,823,269 shares of Class A Common Stock as of March 22, 2002 and
26,921,029 shares of Class B Common Stock as of March 22, 2002. DOCUMENTS INCORPORATED BY REFERENCE: Portions of
the Registrant's definitive Proxy Statement to be filed with the Securities and
Exchange Commission no later than 120 days after the Registrant's fiscal year
ended December 31, 2001 and to be delivered to stockholders in connection with
the 2001 Annual meeting of Stockholders in Part III, Items 10 (as related to
Directors), 11, 12 and 13. 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 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 TABLE OF CONTENTS Page PART I 3 30 30 30 PART II 32 33 35 49 PART III 50 50 50 50 PART IV 50 52 F-1 G-1 H-1 PART I CAUTIONS ABOUT FORWARD-LOOKING INFORMATION This Form 10-K and
the information incorporated by reference in this Form 10-K include
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Some of the forward-looking statements can be identified by the use
of forward-looking words such as "believes," "expects," "may," "will," "should,"
"seeks," "approximately," "intends," "plans," "estimates" or "anticipates" or
the negative of those words or other comparable terminology. Such statements
include, but are not limited to, those relating to the effects of growth, our
principal investment activities, levels of assets under management and our
current equity capital levels. Forward-looking statements involve risks and
uncertainties. You should be aware that a number of important factors could
cause our actual results to differ materially from those in the forward-looking
statements. These factors include, but are not limited to, competition among
financial services firms for business and personnel, the high degree of risk
associated with venture capital investments, the effect of demand for public
offerings, mutual fund and 401(k) and pension plan inflows or outflows in the
securities markets, volatility of the securities markets, available
technologies, the effect of government regulation and of general economic
conditions on our own business and on the businesses in the industry areas on
which we focus, fluctuating quarterly operating results, the availability of
capital to us and risks related to online commerce. We will not necessarily
update the information presented or incorporated by reference in this Form 10-K
if any of these forward-looking statements turn out to be inaccurate. Risks
affecting our business are described throughout this Form 10-K and especially in
the section "Factors Affecting Our Business, Operating Results and Financial
Condition" (page 18). This entire Form 10-K, including the Consolidated
Financial Statements and the notes and any other documents incorporated by
reference into this Form 10-K should be read for a complete understanding of our
business and the risks associated with that business. ITEM 1. BUSINESS General
Friedman, Billings, Ramsey Group, Inc. ("FBR") is a financial holding company
for businesses that provide the following products and services: (1)
Investment banking and institutional brokerage. This business is conducted
primarily through Friedman, Billings, Ramsey & Co., Inc. ("FBRC") our
principal registered broker-dealer subsidiary, and in Europe through Friedman,
Billings, Ramsey International, Ltd., ("FBRIL") our U.K. subsidiary. Online
brokerage and securities distribution services are conducted through FBR
Investment Services, Inc. ("FBRIS"), a registered broker-dealer subsidiary. (2) Specialized asset
management. This business is conducted primarily through four registered
investment adviser subsidiaries: Friedman, Billings, Ramsey Investment
Management, Inc. ("FBRIM"); FBR Venture Capital Managers, Inc. ("FBRVCM"); FBR
Fund Advisers, Inc.; and Money Management Associates, Inc. FBR
National Bank & Trust ("FBR National Bank") provides transfer agency, custody,
shareholder services and mutual fund accounting for mutual funds. Through these
businesses, we provide a wide array of financial products and services in the
following broad industry sectors: financial services, real estate, technology,
energy, healthcare, and diversified industries, that we believe offer
significant business opportunities. We have continued to strengthen our business
by adding coverage of new industry sectors, broadening and deepening our
research and investment banking coverage within our industry sectors, adding new
products and services that benefit from our knowledge of each sector, and
building a wider customer base. Through FBRIM, we
are the investment manager of, and through FBRC we have a strategic relationship
with respect to investment banking business with, FBR Asset Investment
Corporation ("FBR-Asset"), a separate public company. FBR-Asset is a
Virginia corporation and has elected to be taxed as a real estate investment
trust ("REIT") under the federal tax laws. FBR-Asset makes investments in
mortgage-backed securities, equity securities of companies engaged in real
estate-related and other businesses, and mezzanine or senior loans. 3 We believe that
our goal of building shareholder value is best achieved by strengthening our
competitive position and thus our financial position. In order for us to remain
competitive, it is important for us to focus on our industry sectors and within
those sectors offer a broad range of products and services both to corporate
issuers who are seeking advice and financing, and to our brokerage and asset
management customers. We also believe it is important for us to be involved with
companies early in their lifecycles (or even to be involved in creating
businesses) in order to establish relationships that will provide us with
ongoing revenues as these companies' finance and advisory needs grow. We seek to
provide our corporate clients with the financing and advisory services that they
will need at all stages of their corporate lifecycle. We are a Virginia
corporation, and the successor company to that founded in 1989 by our Co-Chief
Executive Officers, Emanuel J. Friedman and Eric F. Billings, and by W. Russell
Ramsey, who remains a director of our company. As of December 31,
2001, we had 433 employees engaged in the following activities: 74 in research,
84 in investment banking, 114 in sales and trading, 28 in asset management, 3 in
online brokerage, 30 in mutual fund servicing, 24 in FBR National Bank (other
than mutual fund servicing), 53 in accounting, administration and operations, 15
in compliance, legal, risk management and internal audit, and 8 in the executive
group. Our employees are not subject to any collective bargaining agreement and
we believe that we have excellent relations with our employees. As of December 31,
2001, our Co-Chief Executive Officers owned approximately 38% (41% if the 4
million shares pledged as collateral by employees under the Employee Stock
Purchase and LoanPlan are excluded from the denominator; the Co-CEO's are not
participants in this program) of our common stock. Our principal executive
offices are located at Potomac Tower, 1001 Nineteenth Street North, Arlington,
Virginia 22209. We also have offices in Bethesda, Maryland; Atlanta, Georgia;
Boston, Massachusetts; Charlotte, North Carolina; Cleveland, Ohio; Dallas,
Texas; Denver, Colorado; Irvine, California; New York, New York; Portland,
Oregon; Seattle, Washington; Vienna, Austria; and London, England. Strategy We seek to combine
businesses that provide relatively predictable revenues and moderate
profitability from diverse business lines and customer bases with businesses
that, although less predictable, have greater potential for higher levels of
profitability. In the first category, we include our brokerage business, that
portion of our asset management business that generates fees based on a
percentage of assets under management and a base level of return on our
principal investment activity (generally targeted at 10-12%). In the second
category, we include our investment banking business, that portion of our asset
management businesses that provides for incentive income based on gains above a
certain level, and excess returns on our principal investing activity. We
seek to achieve operating leverage in three ways. First, we leverage our
expertise in each of our industry sectors by applying that expertise to our
products and services in our research, investment banking, securities brokerage
and asset management businesses. Second, we leverage our return on investment by
investing in our own asset management funds that provide us with incentive
income on the assets invested in the funds by our customers. As a result, we
have the opportunity to receive a return that is disproportionate to our
investment. Third, our goal is a cost structure in which fixed costs are
comparatively low, and a large element of compensation and other expenses are
variable as they relate to revenue levels. Revenues Our revenues for
the years ended December 31, 2001, 2000 and 1999 were $160.8 million, $180.9
million and $139.0 million, respectively. The decrease in revenue from 2000 to
2001 is primarily due to decreases in the value of our technology sector venture
capital portfolio offset by an increase in investment banking revenue.
Excluding technology sector net investment and incentive income (loss), revenues
for December 31, 2001, 2000 and 1999 were $178.9 million, $139.3 million and
$102.6 million. See the table on page 41 for the percentage of total
revenues contributed by each of our business lines. We began in 1989
as an institutional brokerage firm offering specialized research, sales and
trading. We have maintained and enhanced this business, and in 2001 it
contributed about one-third of our revenues. In late 1992, we added
investment banking to our capital markets business. In 2001, investment
banking contributed about one-half of our revenues. In 1989, we
launched our first hedge fund, which we continue to manage, and have remained
active in the alternative asset management business (hedge funds, private equity
and venture capital). In late 1996, we expanded our asset management
business, initiating several new asset management products and hiring
professionals to lead those efforts. Among these were our venture capital and
mutual fund businesses. Our gross assets under management have increased from
$153.7 million, representing productive capital assets under management (on
which our base management fees are calculated) of $119.3 million at the
beginning of 1996 to gross assets under management of $2.8 billion, representing
productive capital assets under management of $2.9 billion at the end of 2001.
Net assets under management have grown from $119.3 million at the beginning of
1996 to $1.5 billion at the end of 2001. The base management fees
(including mutual fund servicing fees) on our productive capital assets under
management were $5.3 million for the fourth quarter of 2001 or $21.2 million on
an annualized basis, representing 0.8% per annum of productive capital assets
under management, or 1.5% per annum of net assets under management at December
31, 2001. See "Management's Discussion and Analysis - Operations Group -
Asset Management Group" for a discussion of Gross, Net and Productive Capital
Assets Under Management. 4 In addition, on
$469.9 million of these net assets as of December 31, 2001, $405.0 million
excluding technology sector assets, we have the potential to earn incentive
income; in the fourth quarter of 2001 we earned $1.8 million, $7.2 million on an
annualized basis in incentive allocations and fees (excluding technology sector
incentive allocations). We also invest in our own asset management
products, and earn a return on our investment. In 2001, asset management
contributed about 10% of our revenues (including unrealized gains and losses
included in incentive income). Excluding technology sector net investment
and incentive income (loss), asset management contributed 20.5% of revenues. On April 1, 2001,
we completed the acquisition of Money Management Associates, LP ("MMA") and
Rushmore Trust and Savings, FSB ("Rushmore"). MMA was a privately-held
investment adviser with $933.4 million in assets under management as of March
31, 2001. Upon closing, Rushmore was rechartered as a national bank and
was named FBR National Bank & Trust ("FBR National Bank"). The FBR
National Bank offers mutual fund servicing (custody, transfer agency,
shareholder servicing and mutual fund accounting), traditional banking services
(lending, deposits, cash management and trust services). We acquired MMA/Rushmore
for $17.5 million in cash at closing and a $9.7 million non-interest-bearing
installment note payable over a ten-year period. The total purchase price
of $25.2 million, including capitalized transaction costs of $1.5 million and
the present value of the installment note at an imputed rate of 9%, was
allocated (in millions): Industry Sector Focus We began our
business focused on the middle market financial services sector, in particular
thrifts and small banks. We extended sector coverage to the related areas of
real estate and non-depository institutions during 1994 to 1996. In 1996 we
began to actively expand our sector coverage to industries with significant
growth potential and capital needs, that are less closely related to the
financial sector. In doing this, we have built our business in sectors that we
believe are somewhat counter-cyclical to each other, with some providing active
business opportunities to us when others are not. By the end of 2001, we were
focused on six broad industry sectors: financial institutions, real estate,
technology, energy, healthcare, and diversified industries. In 2001, we
opened an office in Cleveland, Ohio to expand our investment banking coverage of
middle market financial institutions and diversified industries companies in the
Mid-west, an office in New York City to accommodate newly hired technology and
financial institutions research analysts and an office in Dallas, Texas to
strengthen our presence in the energy sector. In the healthcare sector, we have
broadened our areas of expertise to include the bio-technology and genomics
industries. Like our coverage of the Internet and related information technology
industries, these industries have a strong presence in the Washington, D.C. area
where we are headquartered. Customer Base The customer base
of our brokerage business has historically been primarily institutional,
including large national institutions such as well-known mutual fund complexes,
as well as smaller, private investment pools. We have built increased business
from this existing base, and from new institutional customers, by providing
research, sales and trading in dedicated teams by industry and by customer. We
believe that this strategy allows us to better serve the needs of our
institutional customers; we expect increased brokerage business from these
institutions as a result. Starting in late
1997, we have also pursued a strategy of building our client base of corporate
and high net worth individuals through a specialized private client group that
offers brokerage and asset management services specifically designed to meet the
needs of corporate executives, major shareholders, corporate investment offices,
pension plans and foundations, as well as other high net worth individuals. In early 1999, we
extended our customer coverage by adding an online retail group for the first
time. This retail effort is entirely online, which we believe can be a more
efficient and cost-effective platform to serve the needs of retail customers
than a retail branch network of commission brokers. 5 Principal Investing We
invest in companies within our sectors of focus both as a co-investor with our
customers in the asset management vehicles that we manage, and occasionally as a
direct investor or as an investor in investment vehicles managed by third
parties with whom we believe it is productive to build a strategic relationship.
We pursue this investing strategy to provide diversification of our invested
assets across industry sectors, and to invest strategically in sectors and
companies that can provide us with future business opportunities. Our single
largest investment, representing 35% of our long-term investments as of December
31, 2001, is our equity interest in FBR-Asset. At December 31, 2001, 65%
of FBR-Asset's net equity was in mortgage backed securities guaranteed by
Freddie Mac, Fannie Mae and Ginnie Mae, 30% was invested in equity securities,
4% was in mezzanine loans and 1% was in cash or cash equivalents. See the
financial statements of FBR-Asset at page H-1. As of the end of 2001, our
principal investments were primarily focused on three sectors: financial
services, real estate, and technology. Strategic Relationships PNC
Bank Corp. ("PNC") owns slightly less than 5% of the outstanding shares of our
common stock as part of a strategic business relationship between us and PNC
with respect to selected capital markets and related activities. We work with
PNC on an arms-length basis to refer potential business to each other. PNC is an
investor in certain of our private equity, venture and proprietary asset
management products. PNC is one of the
largest diversified financial services companies in the United States. PNC
offers a variety of financial products and services in its primary geographic
locations in Pennsylvania, New Jersey, Delaware, Ohio and Kentucky and
nationally through retail distribution networks and alternative delivery
channels. We have built
strategic relationships with other financial companies such as Dawnay, Day,
Lander, Ltd., a United Kingdom firm focused on technology sector corporate
finance and early stage investing, Emerging Technology Partners, L.L.C., a
Rockville, Maryland firm focused on bio-technology sector investments and
Capital Crossover Partners, an Arlington, Virginia firm focused primarily on
technology sector investments. In 2001, our
principal broker-dealer subsidiary, FBRC, entered into an agreement with our
affiliate, FBR-Asset pursuant to which, in certain circumstances, FBR-Asset may
determine to make a commitment to extend credit or invest in an FBRC investment
banking client. In the event FBR-Asset makes such a commitment, FBR-Asset's
broker-dealer subsidiary participates in the investment banking transaction as a
financial advisor to FBRC and receives a fee for its participation. We
believe that the ability of FBRC to partner with FBR-Asset in certain investment
banking transactions enhances FBRC's ability to compete for investment banking
business. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Overview" for a detailed discussion of this
relationship. We intend to
continue to pursue strategic partnerships as part of our strategy to strengthen
our revenue sources by increasing our product offerings and providing increased
services to our customers. In addition, we may pursue joint ventures or other
business combinations or raise additional capital in order to build our
businesses. If we choose to raise additional capital, we may do so by selling
additional stock in or issuing debt of Friedman, Billings, Ramsey Group, Inc. or
by seeking investors or partners in our company or in one particular subsidiary
or sector of our businesses. Capital Markets
Historically, we have derived the majority of our revenues from our capital
markets. We have maintained the strength of our capital markets business in the
financial services and real estate sectors and expanded our capabilities by
adding research and investment banking personnel in those areas and by adding
new areas such as technology, energy, healthcare and diversified industries. Our capital
markets activities include research, institutional sales and trading, and
investment banking. In investment banking we provide a broad range of
services, including public and private offerings of a wide variety of securities
and financial advisory services in mergers and acquisitions, mutual to stock
conversions, strategic partnering transactions and other advisory assignments.
6 Capital Raising Activities Our capital
raising activities include a wide range of securities, structures and amounts.
We are a leading underwriter of equity securities in several of our areas of
focus and are dedicated to the successful completion and aftermarket performance
of each underwriting transaction we execute. Our investment banking, research,
and sales and trading professionals work as a team to successfully execute
capital raising assignments. Our strategy is to
maintain long-term relationships with our corporate clients by serving their
capital needs beyond their initial access to capital markets. We seek to
increase our base of public company clients by serving as a lead or co-manager,
or syndicate member, in follow-on offerings for companies that we believe have
attractive investment characteristics, whether or not we participated as a lead
or co-manager in the IPOs for such companies. Mergers and Acquisitions Advisory Services Our mergers and
acquisitions group uses our research capability, business valuation skills and
secondary market experience to evaluate merger and acquisition candidates and
opportunities for our clients. We believe that our research capacity and capital
raising activities have created a network of relationships that enables us to
identify and engineer mutually beneficial combinations between companies. As a
financial adviser, we rely upon our experience gained through in-depth and daily
involvement in the capital markets. Financial advisory
services have included advice on mergers and acquisitions (including ongoing
review of merger and acquisition opportunities), market comparable performance
analysis, advice on dividend policy, and evaluation of stock repurchase
programs. Research A key
part of our strategy is to support our businesses with specialized and in-depth
research. Our analysts cover a universe of over 350 companies in our focus
industry sectors. We leverage the ideas generated by our research teams across
our entire organization, using them to attract underwriting and institutional
brokerage clients, to advise corporate finance clients, to inform the direction
of the various investment funds we advise or sponsor, and to attract retail
investors. We make almost all of our analysts' research reports available
online. In addition, we increase our visibility to corporate clients and
to investors by holding annual investor conferences-each focused on broad
industry sectors. In 2001, these conferences featured over 200 company
presentations and drew more than 1,000 attendees. Our research
analysts operate under three guiding principles: (i) to provide objective,
independent analysis of securities, their issuers, and their place in the
capital markets; (ii) to identify undervalued investment opportunities in the
capital markets, and (iii) to communicate effectively the fundamentals of these
investment opportunities to potential investors. To achieve these objectives, we
believe that industry specialization is necessary, and, as a result, we organize
our research staff along industry lines. Each industry team works together to
identify and evaluate industry trends and developments. Within industry groups,
analysts are further subdivided into specific areas of focus so that they can
maintain and apply specific industry knowledge to each investment opportunity
they address. We have focused
our research efforts in some of the fastest growing and most rapidly changing
sectors of the United States and world economies. These sectors include
technology, bio-technology, genomics, financial technology, banks, thrifts, real
estate investment trusts, specialty finance companies and energy. We believe
that within these industry sectors there will be great demand for the products
and services we offer and that this in turn will provide ample diversification
opportunities for our business. After initiating
coverage on a company, our analysts seek to maintain a long-term relationship
with that company and a long-term commitment to ensuring that new developments
are effectively communicated to our sales force and institutional investors. We
produce full-length research reports, notes and earnings estimates on the
companies we cover. In addition, our analysts distribute written updates on
these issuers both internally and to our clients through the use of daily
morning meeting notes, real-time electronic mail and other forms of immediate
communication. Our clients can also receive analyst comments through electronic
media, and our sales force receives intra-day updates at meetings and through
regular announcements of developments. 7 Sales and Trading FBRC and
our United Kingdom subsidiary, FBRIL, focus on providing research, institutional
sales and trading services to equity and high-yield investors in the United
States, Europe and elsewhere. We execute securities transactions for
institutional investors such as banks, mutual funds, insurance companies, hedge
funds, money managers and pension and profit-sharing plans. Institutional
investors normally purchase and sell securities in large quantities, which
requires special marketing and trading expertise that we provide. Our sales
professionals provide services to a nationwide institutional client base as well
as to institutional clients in Europe and elsewhere. Sales professionals work
closely with our research analysts to provide the most up-to-date information to
our institutional clients. Our sales professionals are organized into teams to
facilitate the communication of in-depth information to our clients. Each team
maintains regular contact with our research staff and with the specialized
portfolio managers and buy-side analysts of each institutional client. Our trading
professionals facilitate trading in equity and high-yield securities. We make
markets in Nasdaq and other securities, trade listed securities and service the
trading desks of major institutions in the United States and Europe. Our trading
professionals have direct access to the major stock exchanges, including the New
York Stock Exchange and the American Stock Exchange, through FBRC's clearing
broker. At year-end 2001, FBRC made a market in more than 440 securities.
Private Client Group Since
our inception in 1989, we have provided services to corporate executives and
small institutions, as well as to other sophisticated high net worth clients. In
late 1997, we formed the Private Client Group ("PCG") to focus on the growth of
this business. The PCG seeks to
offer creative money management solutions and investment ideas suited to high
net worth individuals. Using a consultative approach, PCG professionals
research, interpret, evaluate and recommend sophisticated investment strategies.
PCG provides hedging and monetizing solutions for significant equity positions.
PCG professionals are knowledgeable in various aspects of the sale of restricted
and control stocks, as well as the financing of employee stock option exercises.
Individuals who own restricted or control stock receive PCG assistance with the
complex regulations and paperwork required to sell such securities. For
individuals unable to sell positions, PCG offers a number of strategies for
preserving value in such assets, as well as the ability to borrow funds at
favorable rates to provide liquidity. PCG also offers a
range of asset allocation and long range wealth management services.
Management of assets allocated to various strategies is provided by us, and by
external managers. PCG clients are also afforded access to our
proprietary asset management products. Online Distribution Services In
1999, we opened an online securities distribution channel. In addition to
traditional online brokerage services such as low-cost trades, quotes and news,
this service offers investors access to our own research and the opportunity to
participate in IPOs and follow-on offerings in which we participate as an
underwriter. In addition, we offer online access to a mutual fund supermarket
with over 7,500 funds. In 2000, we
launched Offering MarketplaceSM, which uses Internet browser-based
technology for automated customer order capture, share allocation and order
execution to enable an offering to be distributed online. In 2000, using
Offering MarketplaceSM, we participated in 38 public offerings, and
in 2001, 30 offerings. During 2001, we reduced
the headcount of our online unit and wrote-off software development costs.
Although our online unit is not profitable on a stand-alone basis, we believe
that the combination of online proprietary products and services, and the
availability of new issues of securities, may provide a way for us to build a
retail distribution network over time. Asset Management Since
1989, we have managed hedge funds and other alternative asset management
products. Since 1996, we have expanded these specialized asset management
capabilities, adding private equity, arbitrage, and technology and genomic
venture capital funds as part of an effort to diversify our revenue stream and
create additional revenue opportunities by leveraging our unique research
perspectives and our Washington, D.C. location. In 2001, gross assets under
management increased from $1.0 billion at year-end 2000 to $2.8 billion as of
December 31, 2001, and net assets under management increased from $721 million
at year-end 2000 to $1.5 billion at December 31, 2001, primarily due to the
acquisition of MMA in 2001 and the increased size of FBR Asset Investment
Corporation, which successfully raised approximately $100 million in a follow-on
offering in August, 2001. Subsequent to December 31, 2001, FBR-Asset
raised approximately $120 million in a follow-on offering in January 2002.
Approximately 20.5% of our revenues for 2001 were attributable to our asset
management business excluding technology sector net investment and incentive
loss. See "Management's Discussion and Analysis - Operations Group - Asset
Management Group" for a discussion of Gross, Net and Productive Capital Assets
Under Management. 8 We use the expertise of our research professionals and
portfolio managers to develop and implement investment products for
institutional and high net worth individual investors. Following is a
description of the primary products that we manage; we also provide placement,
advisory and administrative services to other funds. ASSET MANAGEMENT PRODUCTS Type of Fund Type of Investment Year 1996 1997 1998 1999 2000 1989 1992 1995 1998 1989 1996 1996 1996 2002 9 (Asset Management Products Continued) Type of Fund Type of Investment Year 1975 1983 1983 1983
The Rushmore Fund, Inc.: 1985 1997 Private Equity and Venture Capital Funds At
December 31, 2001, our private equity and venture capital funds had $117.4
million in gross assets under management and $340.3 million in productive
capital on which our base management fees of 2% to 2.5% are calculated. In
addition to base fees, these funds provide the potential for incentive income if
certain benchmarks are met. Hedge Funds At December
31, 2001 our hedge funds had $262.5 million in gross assets under management and
$154.6 million in productive capital on which our base management fees of 1% to
1.5% are calculated. In addition to base fees, these funds provide the
potential for incentive income if certain benchmarks are met. Mutual Funds The
FBR Family of Funds, an open-end management type investment company registered
under the Investment Company Act of 1940, began business in 1997 and currently
is comprised of four no-load equity mutual funds: the FBR Financial Services
Fund, the FBR Small Cap Financial Fund, the FBR Small Cap Value Fund and the FBR
Technology Fund (commenced operations on February 1, 2002). On April 1, 2001,
we completed the acquisition of MMA. As a result we became the manager of
the American Gas Index Fund, an equity index fund, the Fund for Government
Investors, a money market fund, and of several smaller funds. At December 31,
2001, The FBR Family of Funds and the acquired funds had total net assets under
management of just over $1 billion. We receive base asset management fees
and mutual fund servicing fees on these assets for a total of 0.75% to 1.25% in
fees, depending on the fund. In addition, through FBR National Bank, we
provide custody, transfer agency and mutual fund servicing to non-FBR funds. 10 FBR Asset Investment Corporation FBR-Asset
is a publicly traded real estate investment trust (AMEX:FB) that we manage and
in which we had a long-term investment of 20.8% owned by us as of December 31, 2001; 15.1% as of March 28, 2002.
At December 31, 2001, FBR-Asset had total gross assets of $1.3 billion and
shareholders' equity of $203.9 million. We receive base management fees of
0.25% of the average book value of mortgage assets and 0.75% of the average book
value of the remainder of the invested assets of FBR-Asset. In addition,
we have the potential to earn incentive fees if certain benchmarks are met. Accounting, Administration and Operations Our accounting,
administration and operations personnel are responsible for financial controls,
internal and external financial reporting, human resources and personnel
services, office operations, information technology and telecommunications
systems, the processing of securities transactions, and corporate
communications. With the exception of payroll processing, which is performed by
an outside service bureau, and customer account processing, which is performed
by our clearing brokers, most data processing functions are performed
internally. We believe that future growth will require implementation of new and
enhanced communications and information systems and training of our personnel to
operate such systems. Compliance, Legal, Risk Management and Internal Audit Our
compliance, legal and risk management personnel (together with other appropriate
personnel) are responsible for our compliance procedures with regard to the
legal and regulatory requirements of our holding company and our operating
businesses and for our procedures with regard to our exposure to market, credit,
operations, liquidity, compliance, legal, reputational and equity ownership
risk. In addition, our internal audit and compliance personnel
test and audit for compliance with our policies and procedures. Our legal
personnel also provide legal service throughout our company, including advice on
managing legal risk. The supervisory personnel in these areas have direct
access to senior management and to the Audit Committee of our Board of Directors
to ensure their independence in performing these functions. In addition to
our internal compliance, legal, risk management and internal audit personnel, we
outsource particular functions to outside consultants and attorneys for their
particular expertise. Competition We
are engaged in the highly competitive financial services and investment
industries. We compete directly with large Wall Street securities firms,
securities subsidiaries of major commercial bank holding companies, U.S.
subsidiaries of large foreign institutions, major regional firms, venture
capital firms, smaller niche players, and those offering competitive services
via the Internet. To an increasing degree, we also compete for various segments
of the financial services business with other institutions, such as commercial
banks, savings institutions, mutual fund companies, life insurance companies and
financial planning firms. In addition to
competing for customers and investments, we compete with other companies in the
financial services and investment industries to attract and retain experienced
and productive investment professionals. See "Factors Affecting Our Business,
Operating Results and Financial Condition-Competition for Retaining and
Recruiting Personnel." Many competitors
have greater personnel and financial resources than we do. Larger competitors
are able to advertise their products and services on a national or regional
basis and may have a greater number and variety of distribution outlets for
their products, including retail distribution. Discount and Internet brokerage
firms market their services through aggressive pricing and promotional efforts.
In addition, some competitors have much more extensive investment banking
activities than we do and therefore, may possess a relative advantage with
regard to access to deal flow and capital. Some of our venture capital
competitors have been established for a longer period of time and have more
established relationships, which may give them greater access to deal flow and
to capital. Recent rapid
advancements in computing and communications technology, particularly the
Internet, are substantially changing the means by which financial services and
information are delivered. These changes are providing consumers with more
direct access to a wide variety of financial and investment services, including
market information and on-line trading and account information. Advancements in
technology also create demand for more sophisticated levels of client services.
We are committed to using technological advancements to provide a high level of
client service to our target markets. Provision of these services may entail
considerable cost without an offsetting source of revenue. 11 For a further
discussion of the competitive factors affecting our business, see "Factors
Affecting Our Business, Operating Results and Financial Condition." Risk Management In
conducting our business, we are exposed to a range of risks including: Market risk is the risk to our earnings or capital
resulting from adverse changes in the values of assets resulting from movement
in market interest rates, equity prices or foreign exchange rates. Credit risk is the risk of loss due to an individual
customer's or institutional counterparty's unwillingness or inability to pay
its obligations. Operations risk is the risk of loss resulting from
systems failure, inadequate controls, human error, fraud or unforeseen
catastrophes. Liquidity risk is the potential that we would be
unable to meet our obligations as they come due because of an inability to
liquidate assets or obtain funding. Liquidity risk also includes the
risk of having to sell assets at a loss to generate liquid funds, which is a
function of the relative liquidity (market depth) of the asset(s) and general
market conditions. Compliance risk is the risk of loss, including fines
or penalties, from failing to comply with federal, state or local laws
pertaining to financial services activities. Legal risk is the risk that arises from the
potential that unenforceable contracts, lawsuits, adverse judgements, or
adverse governmental or regulatory proceedings that can disrupt or otherwise
negatively affect our operations or condition. Reputational risk is the potential that negative
publicity regarding our practices whether true or not will cause a decline in
the customer base, costly litigation, or revenue reductions. Equity Ownership Risk arises from making equity
investments that create an ownership interest in portfolio companies, and is a
combination of credit, market, operational, liquidity, compliance and
reputation risks. We have a
corporate wide risk management program approved by our Board of Directors.
This program sets forth various risk management policies, provides for a risk
management committee and assigns risk management responsibilities. The
program is designed to focus on the following: Identifying, assessing and reporting on corporate risk
exposures and trends. Establishing and revising as necessary policies, procedures
and risk limits. Monitoring and reporting on adherence with risk policies
and limits. Developing and applying new measurement methods to the risk
process as appropriate. Approving new product developments or business initiatives. We cannot provide
assurance that our risk management program or our internal controls will prevent
or reduce the risks to which we are exposed. Regulation In
the United States, a number of federal regulatory agencies are charged with
safeguarding the safety and soundness of certain companies involved in the
banking system, the integrity of the securities and other financial markets, and
with protecting the interests of customers participating in those markets.
In March 2001 we received regulatory approval to acquire MMA and Rushmore. The
transaction closed April 1, 2001. In connection with the transaction we
converted Rushmore, which had been a federally chartered savings bank, into FBR
National Bank & Trust, a federally chartered national bank ("FBR National
Bank"). We became a bank holding company regulated under the Bank Holding
Company Act of 1956, as amended (the "BHC Act") and a financial holding company
under the Gramm-Leach-Bliley Act, (the "GLB Act") that was enacted in 1999. 12 The GLB Act
significantly changed the regulatory structure and oversight of the financial
services industry. The GLB Act amended the BHC Act to permit a qualifying bank
holding company, called a financial holding company (an "FHC"), to engage in a
full range of financial activities, including banking, insurance, and securities
activities, as well as merchant banking and additional activities that are
"financial in nature" or "incidental" to such financial activities. In order for
a bank holding company to qualify as an FHC, all of its subsidiary depository
institutions must be "well-capitalized" and "well-managed" and must also
maintain at least a "satisfactory" rating under the Community Reinvestment Act.
In March 2001, the Federal Reserve Board (the "Board") approved our application
to be a FHC and we are now permitted to engage in financial activities as
permitted by the BHC Act, as amended. In general, the
BHC Act and other federal laws subject all bank holding companies, including
FHC's, to restrictions on the types of activities in which they may engage, and
to a range of supervisory requirements and activities, including regulatory
enforcement actions for violations of laws and regulations. As noted above, the
GLB Act eliminated the barriers to affiliations among banks, securities firms,
insurance companies and other financial service providers, but does not
generally permit a FHC to engage in any non-financial activity. It permits bank
holding companies to become FHCs, to affiliate with securities firms and
insurance companies, and to engage in other activities that are financial in
nature. Under the GLB Act,
the Board serves as the "umbrella" regulator for FHCs and has the power to
supervise, regulate and examine FHCs and their non-banking affiliates, subject
to statutory functional regulation provisions. The Securities and Exchange
Commission ("SEC") is the federal agency that is primarily responsible for the
regulation of broker-dealers and investment advisers doing business in the
United States, and the Board also promulgates regulations applicable to
securities credit (margin) transactions involving broker-dealers and certain
other institutions in the United States. Much of the regulation of
broker-dealers has been delegated to self-regulatory organizations ("SROs"),
principally the NASD (and its subsidiaries NASD Regulation, Inc. and the Nasdaq
Stock Market ("Nasdaq")), and the national securities exchanges. These
organizations (which are subject to oversight by the SEC) govern the industry,
monitor daily activity and conduct periodic examinations of member
broker-dealers. While FBRC and our other broker-dealer subsidiaries are not
members of the New York Stock Exchange ("NYSE"), our business is impacted by the
exchange's rules and our Class A common stock is listed for trading on the NYSE.
Securities firms
are also subject to regulation by state securities commissions in the states in
which they are required to be registered. FBRC is registered as a broker-dealer
with the SEC and in 49 states, Puerto Rico and the District of Columbia, and is
a member of, and subject to regulation by the NASD and the Municipal Securities
Rulemaking Board. FBRIS is registered as a broker-dealer with the SEC and in all
50 states, Puerto Rico and the District of Columbia; it is a member of the NASD.
The office of the Comptroller of the Currency ("OCC") is the federal agency that
is primarily responsible for the regulation of national banks, such as FBR
National Bank.
We and our operating subsidiaries are also subject to the recently-enacted
USA PATRIOT Act ("PATRIOT Act"), which requires financial institutions to
adopt and implement policies and procedures designed to prevent and detect money
laundering. Prior to the October 26, 2001 passage of the PATRIOT Act, FBR
and its subsidiaries adopted a comprehensive anti-money laundering compliance
program that we believe is in compliance with the PATRIOT Act. Regulation of our Holding Company Regulatory Restrictions on Dividends; Source of Strength
It is
the policy of the Board that bank holding companies should pay cash dividends on
common stock only out of income available over the past year and only if
prospective earnings retention is consistent with the organization's expected
future needs and financial condition. The policy provides that bank holding
companies should not maintain a level of cash dividends that undermines the bank
holding company's ability to serve as a source of strength to its banking
subsidiaries. Under Board
policy, a bank holding company is expected to act as a source of financial
strength to each of its banking subsidiaries and commit resources to their
support. Such support may be required at times when, absent this Board policy, a
holding company may not be inclined to provide it. As discussed below, a bank
holding company in certain circumstances could be required to guarantee the
capital plan of an undercapitalized banking subsidiary. In the event of a
bank holding company's bankruptcy under Chapter 11 of the U.S. Bankruptcy Code,
the trustee will be deemed to have assumed and is required to cure immediately
any deficit under any commitment by the debtor holding company to any of the
federal banking agencies to maintain the capital of an insured depository
institution, and any claim for breach of such obligation will generally have
priority over most other unsecured claims. 13 Safe and Sound Banking Practices Bank
holding companies are not permitted to engage in unsafe and unsound banking
practices. The Board's Regulation Y, for example, generally requires a holding
company to give the Board prior notice of any redemption or repurchase of its
own equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding year, is
equal to 10% or more of the holding company's consolidated net worth. The Board
may oppose the transaction if it believes that the transaction would constitute
an unsafe or unsound practice or would violate any law or regulation. The Board has
broad authority to prohibit activities of bank holding companies and their
non-banking subsidiaries which represent unsafe and unsound banking practices or
which constitute violations of laws or regulations, and can assess civil money
penalties for certain activities conducted on a knowing and reckless basis, if
those activities caused a substantial loss to a depository institution.
Depending upon the circumstances, the Board could take the position that paying
a dividend would constitute an unsafe or unsound banking practice. Capital Adequacy Requirements The Board has
adopted a system using risk-based capital guidelines to evaluate the capital
adequacy of bank holding companies. Under the guidelines, specific categories of
assets are assigned different risk weights, based generally on the perceived
credit risk of the asset. These risk weights are multiplied by corresponding
asset balances to determine a "risk-weighted" asset base. The guidelines require
a minimum total risk-based capital ratio of 8.0% (of which at least 4.0% is
required to consist of Tier 1 capital elements). Total capital is the sum of
Tier 1 and Tier 2 capital. In addition to the
risk-based capital guidelines, the Board uses a leverage ratio as an additional
tool to evaluate the capital adequacy of bank holding companies. The leverage
ratio is a company's Tier 1 capital divided by its average total consolidated
assets. Certain highly-rated bank holding companies may maintain a minimum
leverage ratio of 3.0%, but other bank holding companies may be required to
maintain a leverage ratio of up to 200 basis points above the regulatory
minimum. The federal
banking agencies' risk-based and leverage ratios are minimum supervisory ratios
generally applicable to banking organizations that meet certain specified
criteria, assuming that they have the highest regulatory rating. Banking
organizations not meeting these criteria are expected to operate with capital
positions well above the minimum ratios. The federal bank regulatory agencies
may set capital requirements for a particular banking organization that are
higher than the minimum ratios when circumstances warrant. Board guidelines also
provide that banking organizations experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions substantially
above the minimum supervisory levels, without significant reliance on intangible
assets. As discussed above, failure of FBR National Bank to maintain capital
significantly in excess of these minimum ratios will jeopardize our status as a
FHC and may lead to restrictions on activities that would adversely affect our
business. Imposition of Liability for Undercapitalized Subsidiaries
Bank regulators
are required to take "prompt corrective action" to resolve problems associated
with insured depository institutions such as FBR National Bank whose capital
declines below certain levels. In the event an institution becomes
"undercapitalized," it must submit a capital restoration plan. The capital
restoration plan will not be accepted by the regulators unless each company
having control of the undercapitalized subsidiary guarantees the subsidiary's
compliance with the capital restoration plan up to a certain specified amount.
Any such guarantee from a depository institution's holding company is entitled
to a priority of payment in bankruptcy. The aggregate
liability of the holding company of an undercapitalized bank is limited to the
lesser of 5% of the bank's assets at the time it became undercapitalized or the
amount necessary to cause the bank to be "adequately capitalized." The bank
regulators have greater power in situations where an institution becomes
"significantly" or "critically" undercapitalized or fails to submit a capital
restoration plan. For example, a bank holding company controlling such an
institution can be required to obtain prior Board approval of proposed
dividends, or might be required to consent to a consolidation or to divest the
troubled institution or other affiliates. Acquisitions by Bank Holding Companies of Banks The BHC Act
requires every bank holding company to obtain the prior approval of the Board
before it may acquire all or substantially all of the assets of any bank, or
ownership or control of any voting shares of any bank, if after such acquisition
it would own or control, directly or indirectly, more than 5% of the voting
shares of such bank. In approving bank acquisitions by bank holding companies,
the Board is required to consider the financial and managerial resources and
future prospects of the bank holding company and the banks concerned, the
convenience and needs of the communities to be served, and various competitive
factors. 14 Control Acquisitions The
Change in Bank Control Act prohibits a person or group of persons from acquiring
"control" of a bank holding company unless the Board has been notified and has
not objected to the transaction. Under a rebuttable presumption established by
the Board, the acquisition of 10% or more of a class of voting stock of a bank
holding company with a class of securities registered under Section 12 of the
Securities Exchange Act of 1934 would, under the circumstances set forth in the
presumption, constitute acquisition of control of a bank holding company. In addition, any
company is required to obtain the prior approval of the Board under the BHC Act
before acquiring 25% (5% in the case of an acquirer that is a bank holding
company) or more of any class of outstanding voting stock of a bank holding
company, having a majority of its Board of Directors, or otherwise obtaining
control or exercising a "controlling influence" over a bank holding company. Community Reinvestment Act Under the GLB Act,
in order for an FHC to engage in new financial activities, or to acquire,
directly or indirectly, a company engaged in new financial activities, its
subsidiary insured depository institutions must maintain at least a satisfactory
rating under the Community Reinvestment Act. Restrictions on Transactions with Affiliates and Insiders
Transactions between a bank holding company and its non-banking subsidiaries are
subject to Section 23A of the Federal Reserve Act. In general, Section 23A
imposes limits on the amount of such transactions, and also requires certain
levels of collateral for loans to affiliated parties. It also limits the amount
of advances to third parties, which are collateralized by the securities or
obligations of the holding company or its subsidiaries. Affiliate
transactions are also subject to Section 23B of the Federal Reserve Act which
generally requires that certain transactions between a bank and its affiliates
be on terms substantially the same, or at least as favorable to the bank, as
those prevailing at the time for comparable transactions with or involving
nonaffiliated persons. The restrictions
on loans to directors, executive officers, principal shareholders and their
related interests (collectively referred to herein as "insiders") contained in
the Federal Reserve Act and regulations apply to all insured institutions and
their subsidiaries and holding companies. These restrictions include limits on
loans to one borrower and conditions that must be met before such a loan can be
made. There is also an aggregate limitation on all loans to insiders and their
related interests. These loans cannot exceed the institution's total unimpaired
capital and surplus, and the appropriate federal regulator may determine that a
lesser amount is appropriate. Insiders are subject to enforcement actions for
knowingly accepting loans in violation of applicable restrictions. Anti-Tying Restrictions Bank
holding companies and their affiliates are prohibited from tying the provision
of certain services, such as extensions of credit, to other services offered by
a holding company or its affiliates. Regulation of Subsidiaries Broker-Dealer Subsidiaries As a
result of federal and state registration and SRO memberships, FBRC and FBRIS are
subject to overlapping schemes of regulation which cover all aspects of their
securities businesses. Such regulations cover matters including capital
requirements, uses and safe-keeping of clients' funds, conduct of directors,
officers and employees, record-keeping and reporting requirements, supervisory
and organizational procedures intended to assure compliance with securities laws
and to prevent improper trading on material nonpublic information,
employee-related matters, including qualification and licensing of supervisory
and sales personnel, limitations on extensions of credit in securities
transactions, clearance and settlement procedures, requirements for the
registration, underwriting, sale and distribution of securities, and rules of
the SROs designed to promote high standards of commercial honor and just and
equitable principles of trade. A particular focus of the applicable regulations
concerns the relationship between broker-dealers and their customers. As a
result, many aspects of the broker-dealer customer relationship are subject to
regulation including, in some instances, "suitability" determinations as to
certain customer transactions, limitations on the amounts that may be charged to
customers, timing of proprietary trading in relation to customers' trades and
disclosures to customers. 15 As broker-dealers
registered with the SEC and as member firms of the NASD, FBRC and FBRIS are
subject to the net capital requirements of the SEC and the NASD. These capital
requirements specify minimum levels of capital, computed in accordance with
regulatory requirements, that each firm is required to maintain and also limit
the amount of leverage that each firm is able to obtain in its respective
business. "Net capital" is
essentially defined as net worth (assets minus liabilities, as determined under
generally accepted accounting principles), plus qualifying subordinated
borrowings, less the value of all of a broker-dealer's assets that are not
readily convertible into cash (such as furniture, prepaid expenses and unsecured
receivables), and further reduced by certain percentages (commonly called
"haircuts") of the market value of a broker-dealer's positions in securities and
other financial instruments. The amount of net capital in excess of the
regulatory minimum is referred to as "excess net capital." The SEC's capital
rules also (i) require that broker-dealers notify it, in writing, two business
days prior to making withdrawals or other distributions of equity capital or
lending money to certain related persons if those withdrawals would exceed, in
any 30-day period, 30% of the broker-dealer's excess net capital, and that they
provide such notice within two business days after any such withdrawal or loan
that would exceed, in any 30-day period, 20% of the broker-dealer's excess net
capital, (ii) prohibit a broker-dealer from withdrawing or otherwise
distributing equity capital or making related party loans if, after such
distribution or loan, the broker-dealer would have net capital of less than
$300,000 or if the aggregate indebtedness of the broker-dealer's consolidated
entities would exceed 1,000% of the broker-dealer's net capital and in certain
other circumstances, and (iii) provide that the SEC may, by order, prohibit
withdrawals of capital from a broker-dealer for a period of up to 20 business
days, if the withdrawals would exceed, in any 30-day period, 30% of the
broker-dealer's excess net capital and if the SEC believes such withdrawals
would be detrimental to the financial integrity of the firm or would unduly
jeopardize the broker-dealer's ability to pay its customer claims or other
liabilities. Compliance with
regulatory net capital requirements could limit those operations that require
the intensive use of capital, such as underwriting and trading activities, and
also could restrict our ability to withdraw capital from our affiliated
broker-dealers, which in turn could limit our ability to pay dividends, repay
debt and redeem or repurchase shares of our outstanding capital stock. We believe that at
all times FBRC and FBRIS have been in compliance in all material respects with
the applicable minimum net capital rules of the SEC and the NASD. A failure of a
U.S. broker-dealer to maintain its minimum required net capital would require it
to cease executing customer transactions until it came back into compliance, and
could cause it to lose its NASD membership, its registration with the SEC or
require its liquidation. Further, the decline in a broker-dealer's net capital
below certain "early warning levels," even though above minimum net capital
requirements, could cause material adverse consequences to the broker-dealer and
to us. FBRC and FBRIS are
also subject to "Risk Assessment Rules" imposed by the SEC which require, among
other things, that certain broker-dealers maintain and preserve certain
information, describe risk management policies and procedures and report on the
financial condition of certain affiliates whose financial and securities
activities are reasonably likely to have a material impact on the financial and
operational condition of the broker-dealers. Certain "Material Associated
Persons" (as defined in the Risk Assessment Rules) of the broker-dealers and the
activities conducted by such Material Associated Persons may also be subject to
regulation by the SEC. In addition, the possibility exists that, on the basis of
the information it obtains under the Risk Assessment Rules, the SEC could seek
authority over our unregulated subsidiaries either directly or through its
existing authority over our regulated subsidiaries. Our broker-dealer
business is also subject to regulation by various foreign governments and
regulatory bodies. FBRC is registered with and subject to regulation by the
Ontario Securities Commission in Canada. Friedman, Billings, Ramsey
International, Ltd. ("FBRIL"), our United Kingdom brokerage subsidiary, is
subject to regulation by the Securities and Futures Authority in the United
Kingdom ("SFA") pursuant to the United Kingdom Financial Services Act of 1986.
Foreign regulation may govern all aspects of the investment business, including
regulatory capital, sales and trading practices, use and safekeeping of customer
funds and securities, record-keeping, margin practices and procedures,
registration standards for individuals, periodic reporting and settlement
procedures. 16 In the event
of non-compliance by us or one of our subsidiaries with an applicable
regulation, governmental regulators and one or more of the SROs may institute
administrative or judicial proceedings that may result in censure, fine, civil
penalties (including treble damages in the case of insider trading violations),
the issuance of cease-and-desist orders, the deregistration or suspension of the
non-compliant broker-dealer, the suspension or disqualification of officers or
employees or other adverse consequences. The imposition of any such penalties or
orders on us or our personnel could have a material adverse effect on our
operating results and financial condition. Asset Management Subsidiaries Four
of our asset management subsidiaries are registered as investment advisers with
the SEC. As investment advisers registered with the SEC, they are subject to the
requirements of the Investment Advisers Act of 1940 and the SEC's regulations
thereunder. Such requirements relate to, among other things, limitations on the
ability of investment advisers to charge performance-based or non-refundable
fees to clients, record-keeping and reporting requirements, disclosure
requirements, limitations on principal transactions between an adviser or its
affiliates and advisory clients, as well as general anti-fraud prohibitions.
They may also be subject to certain state securities laws and regulations. The
state securities law requirements applicable to registered investment advisers
are in certain cases more comprehensive than those imposed under the federal
securities laws. In addition, FBR Fund Advisers, Inc. and Money Management
Associates, Inc., and the mutual funds they manage, are subject to the
requirements of the Investment Company Act of 1940 and the SEC's regulations
thereunder. In connection with
much of our asset management activities, we, and the private investment vehicles
that we manage, are relying on exemptions from registration under the Investment
Company Act of 1940, and under certain state securities laws and the laws of
various foreign countries. Failure to comply with the initial and continuing
requirements of any such exemptions could have a material adverse effect on the
manner in which we and these vehicles carry on their activities, including
penalties similar to those listed above for broker-dealers. Banking Subsidiary FBR
National Bank is subject to regulation by the OCC. The OCC has adopted
regulations establishing minimum requirements for the capital adequacy of
national bank such as FBR National Bank. The OCC's risk-based capital guidelines
parallel the Board's requirements for bank holding companies. As discussed
above, for us to qualify for FHC status, FBR National Bank must be continuously
"well capitalized" under OCC regulations: it must have at a minimum a total
risk-based capital ratio of 10%, a Tier I capital ratio of 6%, and a leverage
capital ratio of 5%. Capital adequacy
requirements serve to limit the amount of dividends that may be paid by a bank.
Under federal law, a bank cannot pay a dividend if, after paying the dividend,
the bank will be "undercapitalized." The OCC may declare a dividend payment to
be unsafe and unsound even though the bank would continue to meet its capital
requirements after the dividend. Because a bank
holding company is a legal entity separate and distinct from its subsidiaries,
its right to participate in the distribution of assets of any subsidiary upon
the subsidiary's liquidation or reorganization will be subject to the prior
claims of the subsidiary's creditors. In the event of a liquidation or other
resolution of an insured depository institution, the claims of depositors and
other general or subordinated creditors are entitled to a priority of payment
over the claims of holders of any obligation of the institution to its
shareholders, including any depository institution holding company or any
shareholder or creditor thereof. The OCC
periodically examines and evaluates insured national banks. Based upon such an
evaluation, the OCC may revalue the assets of the institution and require that
it establish specific reserves to compensate for the difference between the
examination-determined value and the book value of such assets. FBR National Bank
is required to pay assessments to the Federal Deposit Insurance Corporation
("FDIC") for federal deposit insurance protection. The FDIC has adopted a
risk-based assessment system, under which FDIC-insured depository institutions
pay insurance premiums at rates based on their risk classification. The OCC and the
other federal banking agencies have broad enforcement powers, including the
power to terminate deposit insurance, impose substantial fines and other civil
and criminal penalties and appoint a conservator or receiver. Failure to comply
with applicable laws, regulations and supervisory agreements could subject us or
FBR National Bank, as well as officers, directors and other
institution-affiliated parties of these organizations, to administrative
sanctions and potentially substantial civil money penalties. The appropriate
federal banking agency may appoint the FDIC as conservator or receiver for a
banking institution if any one or more of a number of circumstances exist,
including, without limitation, the fact that the banking institution is
undercapitalized and has no reasonable prospect of becoming adequately
capitalized; fails to become adequately capitalized when required to do so;
fails to submit a timely and acceptable capital restoration plan; or materially
fails to implement an accepted capital restoration plan. The OCC also has broad
enforcement powers over FBR National Bank, including the power to impose orders,
remove officers and directors, impose fines and appoint supervisors and
conservators. 17 FBR National Bank
is subject to The Community Reinvestment Act and the regulations issued
thereunder, which are intended to encourage insured depository institutions to
help meet the credit needs of their service area, including low and moderate
income neighborhoods, consistent with the safe and sound operations of the
banks. These regulations also provide for regulatory assessment of a bank's
record in meeting the needs of its service area when considering applications to
establish branches, merger applications and applications to acquire the assets
and assume the liabilities of another bank. In addition to the
laws and regulations discussed herein, FBR National Bank is subject to certain
consumer laws and regulations that are designed to protect consumers in
transactions with banks. While the list set forth herein is not exhaustive,
these laws and regulations include the Truth in Lending Act, the Truth in
Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability
Act, the Equal Credit Opportunity Act, and the Fair Housing Act, among others.
In addition, the GLB Act imposes extensive privacy requirements applicable to
all financial institutions. These laws and regulations impose certain disclosure
requirements and regulate the manner in which financial institutions must deal
with nonpublic personal information of consumers and consumer customers in
connection with offering and providing financial services. Impact of Regulation Additional
legislation and regulations, including those relating to the activities of
financial holding companies, bank holding companies, banks, broker-dealers and
investment advisers, changes in rules promulgated by the Board, SEC, OCC, NASD
or other United States, states or foreign governmental regulatory authorities
and SROs or changes in the interpretation or enforcement of existing laws and
rules may adversely affect our manner of operation and our profitability. Our
businesses may be materially affected not only by regulations applicable to us
as a financial market intermediary, but also by regulations of general
application. For example, the volume of our underwriting, merger and
acquisition, securities trading and asset management activities in any year
could be affected by, among other things, existing and proposed tax legislation,
antitrust policy and other governmental regulations and policies (including the
interest rate policies of the Federal Reserve Board) and changes in
interpretation or enforcement of existing laws and rules that affect the
business and financial communities. Factors Affecting Our Business, Operating Results and
Financial Condition We may be adversely affected by the general risks
of the investment business The
financial and investment business is, by its nature, subject to numerous and
substantial risks, particularly in volatile or illiquid markets, and in markets
influenced by sustained periods of low or negative economic growth. As a
financial and investment firm, our operating results are adversely affected by a
number of factors, which include: the risk of losses resulting from the ownership or
underwriting of securities; the risks of trading securities for ourselves (i.e.,
principal activities) and for our customers; reduced cash inflows from investors into our and
asset management businesses; the risk of losses from lending, including to small,
privately-owned companies; counterparty failure to meet commitments; customer default and fraud;
customer complaints; employee errors, misconduct and fraud (including
unauthoized transactions by traders); failures in connection with the processing of
securities transactions; litigation and arbitration; the risks of reduced revenues in periods of reduced
demand for public offerings or reduced activity in the the risk of reduced fees we receive for selling
securities on behalf of our customers (i.e., underwriting spreads). 18 We may experience significant losses if the value of our
principal, trading and investment activities, or the value of our venture
capital funds' investments, deteriorates From
time to time in connection with our underwriting, asset management and other
activities, we own large amounts, or have commitments to purchase large amounts,
of the securities of companies. This ownership subjects us to significant risks.
We conduct our
securities trading, market-making and investment activities primarily for our
own account, which subjects our capital to significant risks. These risks
include market, credit, leverage, real estate, counterparty and liquidity risks,
which could result in losses for us. These activities often involve the
purchase, sale or short sale of securities as principal in markets that may be
characterized as relatively illiquid or that may be particularly susceptible to
rapid fluctuations in liquidity and price. At December 31,
2001, our equity exposure, through our three technology venture funds and other
investments in technology sector companies was approximately $21.7 million.
These companies are primarily Internet, information technology and genomics
companies, the valuations of which are extremely volatile. Since these are
largely private companies, their securities are illiquid and we would generally
not be able to sell them except as part of or after an initial public offering
or in connection with the sale of a portfolio company. General market conditions
affecting the Internet, information technology and genomics sectors, or
conditions inherent in the companies themselves, could cause a drop in their
valuations and lead to losses for us before we have an opportunity to lock in
gains through the sale of their securities. We may experience reduced revenues during periods of
declining prices or reduced demand for public offerings and merger and
acquisition transactions or reduced activity in the secondary markets in sectors
on which we focus. Our revenues are
likely to be lower during periods of declining prices or inactivity in the
markets for securities of companies in the sectors in which we are focused.
These markets have historically experienced significant volatility not only in
the number and size of equity offerings and merger and acquisition transactions,
but also in the aftermarket trading volume and prices of securities. In particular,
Internet and information technology company stocks, which are an area of focus
in both our venture capital and investment banking activities, are extremely
volatile. During 2001, our revenues were unfavorably affected by a decrease in
the value of the securities, in our venture capital investment portfolio. The
reduction in the value of securities owned by us led to a significant decrease
in our revenues. In addition, since we anticipate that a substantial
portion of our returns from venture capital investments will be realized through
initial public offerings of our portfolio companies, a decrease in the number of
underwritten transactions in the technology sector during 2001, particularly of
initial public offerings, significantly hindered our ability to realize
such returns. Returns may also be realized through sales of portfolio companies,
which are dependent on the availability of strategic or financial acquirers.
Acquirers may be unavailable or available only at unattractive prices during
economic downturns or periods of declining prices in the technology sector. A significant
amount of our revenues historically resulted from underwritten transactions by
companies in our targeted industries, from aftermarket trading for such
companies, and from proprietary investments and fees and incentive income
received from assets under management. Underwriting activities in our targeted
industries can decline for a number of reasons including increased competition
for underwriting business or periods of market uncertainty caused by concerns
over inflation, rising interest rates or related issues. For example, during the
second half of 1998, the market for equity offerings deteriorated and the market
prices of many of the securities which we had underwritten and made a market in,
and securities in which we and our asset management vehicles were invested in,
were subject to considerable volatility and declines in price. These factors led
to a significant reduction in underwriting revenues, to significant market
making losses for us, and to a significant reduction in the stream of fees
received from our asset management vehicles. Venture capital, underwriting,
brokerage and asset management activities can also be materially adversely
affected for a company or industry segment by disappointments in quarterly
performance relative to analysts' expectations or by changes in long-term
prospects. 19 We may experience reduced revenues due to economic,
political and market conditions
Reductions in public offering, merger and acquisition, portfolio company
valuation and securities trading activities, due to any one or more changes in
economic, political or market conditions could cause our revenues from
investment banking, trading, lending, sales and asset management activities to
decline materially. Many national and international factors affect the amount
and profitability of these activities, including: economic, political and market conditions; level and volatility of interest rates; legislative and regulatory changes; currency values; inflation; flows of funds into and out of mutual funds, pension
funds and venture capital funds; and availability of short-term and long-term funding and
capital. For example, in
2000, concerns about earnings of companies in the technology sector of the
United States economy led to increased volatility and a decline in the Nasdaq
that continued through much of 2001. This decline has adversely affected
underwriting and securities trading activity in the technology sector in the
United States. Furthermore, after the terrorist attacks of September
11, 2001 the broad equity markets in the United State were disrupted and market
conditions for equity transactions were adversely affected. In addition, we
have organized, and intend to continue to organize, regional venture capital
funds in Northern Virginia and other regions. Any of these regions may be
affected by severe economic downturns or lack of growth, which could have an
adverse effect on the availability and profitability of investments in the
region. We may experience reduced revenues due to declining market
volume, price and liquidity, which can also cause counterparties to fail to
perform Our
revenues may decrease in the event of a decline in the market volume of
securities transactions, prices or liquidity. Declines in the volume of
securities transactions and in market liquidity generally result in lower
revenues from trading activities and commissions. Lower price levels of
securities may also result in a reduced volume of underwriting transactions, and
could cause a reduction in our revenues from corporate finance fees, as well as
losses from declines in the market value of securities held by us in trading and
other investment, venture capital, lending and underwriting positions, reduced
asset management fees and incentive income and withdrawals of funds under
management. Sudden sharp declines in market values of securities can result in
illiquid markets and the failure of issuers and counterparties to perform their
obligations, as well as increases in claims and litigation, including
arbitration claims from customers. In such markets, we have incurred, and may
incur in the future, reduced revenues or losses in our principal trading,
market-making, investment banking, venture capital, lending and asset management
activities. We may incur losses as a result of our venture capital
activities Our
venture capital funds' investments are generally in technology companies in the
early stages of their development. Our business and prospects must be considered
in light of the risks, expenses and difficulties frequently encountered by
companies in early stages of development, particularly companies in new and
rapidly evolving markets. Moreover, our venture funds invest primarily in
privately held companies as to which little public information is available.
Accordingly, we depend on our venture capital managers to obtain adequate
information to evaluate the potential returns from investing in these companies.
Fund managers may or may not be successful in this task. Also, these companies
frequently have less diverse product lines and smaller market presence than
larger competitors. They are thus generally more vulnerable to economic
downturns and may experience substantial variations in operating results.
Venture capital investment is an inherently risky business. Many venture capital
investments are unsuccessful and the future performance of our portfolio
companies is uncertain. 20 We may incur losses associated with our underwriting
activities
Participation in underwritings involves both economic and regulatory risks. As
an underwriter, we may incur losses if we are unable to resell the securities we
are committed to purchase or if we are forced to liquidate our commitment at
less than the agreed purchase price. In addition, the trend, for competitive and
other reasons, toward larger commitments on the part of lead underwriters means
that, from time to time, an underwriter (including a co-manager) may retain
significant ownership of individual securities. Increased competition has eroded
and is expected to continue to erode underwriting spreads. Another result of
increased competition is that revenues from individual underwriting transactions
have been increasingly allocated among a greater number of co-managers, which
has resulted in reduced revenues per transaction. Our business will continue to
be adversely affected if this trend continues or worsens. We may incur losses associated with our lending to small,
privately-owned businesses At
December 31, 2001, our investments included a $7.5 million subordinated
mezzanine loan to a privately-owned business. There is generally no publicly
available information about such companies and we must rely on the diligence of
our employees and agents to obtain information in connection with our investment
decisions. Small companies may be more vulnerable to economic downturns and
often need substantial additional capital to expand or compete. Such businesses
may also experience substantial variations in operating results and there will
generally be no established trading market for their securities. As a result of
our lending activities, and those of FBR-Asset, we are exposed to: credit risk; interest rate risk; risks related to the illiquidity of our investments;
leverage risk; and risks resulting from the competitive market for
investment opportunities. Our focus on relatively few industries may limit our
revenues We
are dependent on revenues related to securities issued by companies in specific
industry sectors. The financial services, real estate, technology, energy,
healthcare and diversified industries sectors account for the majority of our
investment banking, asset management and research activities and our venture
capital business is concentrated in the Internet and information technology and
genomics sectors. For example, in 2000, revenues from our technology-related
investment banking transactions and our technology-based venture capital
business accounted for 44% of our total revenues. Therefore, any downturn in the
market for the securities of companies in these industries, or factors affecting
such companies, would adversely affect our operating results and financial
condition. In 1998 and 1999, the specialty finance companies, equity real estate
investment trusts ("REITs") and mortgage REITs on which we focused experienced a
significant downturn which in turn adversely affected us. Securities offerings
can vary significantly from industry to industry due to economic, legislative,
regulatory and political factors. Underwriting activities in a particular
industry can decline for a number of reasons. We also derive a
significant portion of our revenues from institutional brokerage transactions
related to the securities of companies in these sectors. Our revenues from such
institutional brokerage transactions may decline when underwriting activities in
these industry sectors declined, the volume of trading on The Nasdaq Stock
Market or the New York Stock Exchange declined, or when industry sectors or
individual companies reported results below investors' expectations. We may experience significant fluctuations in our
quarterly operating results due to the nature of our business and therefore may
fail to meet profitability expectations. 21 Our revenues and
operating results may fluctuate from quarter to quarter and from year to year
due to a combination of factors, including: the number of underwriting and merger and
acquisition transactions completed by our clients, and the level of the valuations of our principal investments, the
investments of funds we manage and our venture capital the number of initial public offerings or sales of
our venture capital portfolio companies; access to public markets for companies in which we
have invested as a principal; the realization of profits or losses on principal
investments or warrants we hold; the level of institutional and retail brokerage
transactions and the level of commissions we receive from the timing of recording of asset management fees and
special allocations of income; and variations in expenditures for personnel, consulting and
legal expenses, and expenses of establishing new We record our
revenues from an underwriting transaction only when the underwriting is
completed. We record revenues from merger and acquisition transactions only when
we have rendered the services and the client is contractually obligated to pay;
generally, most of the fee is earned only after the transaction closes.
Accordingly, the timing of our recognition of revenue from a significant
transaction can materially affect our quarterly operating results. We have
structured our operations based on expectations of a high level of demand for
underwriting and corporate finance transactions. As a result, we have fixed
costs associated with those businesses. Accordingly, we could experience losses
if demand for these transactions is lower than expected. Due to the
foregoing and other factors, we cannot assure you that we will be able to
sustain profitability on a quarterly or annual basis. We face significant competition from larger financial
services firms with greater resources which could reduce our market share and
harm our financial performance. We are engaged in
the highly competitive financial services, underwriting, securities brokerage,
asset management and banking businesses. We compete directly with large Wall
Street securities firms, established venture capital funds, securities
subsidiaries of major commercial bank holding companies, major regional firms,
smaller "niche" players and those offering competitive services via the
Internet. To an increasing degree, we also compete for various segments of the
financial services business with other institutions, such as commercial banks,
savings institutions, mutual fund companies, life insurance companies and
financial planning firms. Our industry focus also subjects us to direct
competition from a number of specialty securities firms, smaller investment
banking boutiques and venture capital funds that specialize in providing
services to those industry sectors. If we are not able to compete successfully
in this environment, our business, operating results and financial condition
will be adversely affected. There has been a
significant amount of new capital invested in venture capital funds in recent
years. With the amount of capital available, some companies that may have had
difficulty in obtaining venture funding in the past may be able to do so,
notwithstanding that the chances for success in these investments may be
marginal. In addition, there has been an increasing amount of competition among
venture capital funds for the best investment prospects. Thus, our success in
managing our venture funds is dependent on our ability to identify and invest in
the most favorable opportunities in a highly competitive venture capital market.
Competition from
commercial banks has increased because of recent acquisitions of securities
firms by commercial banks, as well as internal expansion by commercial banks
into the securities business. In addition, we expect competition from domestic
and international banks to increase as a result of recent legislation and
regulatory initiatives in the United States to remove or relieve certain
restrictions on commercial banks. This competition could adversely affect
our operating results. We also face
intense competition in our asset management business from a variety of sources,
including venture capital funds, private equity funds, mutual funds, hedge funds
and other asset managers. We compete for investor funds as well as for the
opportunity to participate in transactions. We offer brokerage
services online. The market for these services over the Internet is new, rapidly
evolving and intensely competitive. We expect competition in this area to
continue and intensify in the future. Our online brokerage services business
faces direct competition from other brokerage firms providing online investing
services. 22 Many of our
competitors have greater personnel and financial resources than we do. Larger
competitors are able to advertise their products and services on a national or
regional basis and may have a greater number and variety of distribution outlets
for their products, including retail distribution. Discount brokerage firms
market their services through aggressive pricing and promotional efforts. In
addition, some competitors have a much longer history of investment activities
than we do and, therefore, may possess a relative advantage with regard to
access to business and capital. In addition, our
venture capital portfolio companies will likely face significant competition,
both from other early-stage companies and from more established companies.
Early-stage competitors may have strategic capabilities such as an innovative
management team or an ability to react quickly to changing market conditions,
while more experienced companies may possess significantly more experience and
greater financial resources than our portfolio companies. We face intense competition for personnel which could
adversely affect our business Our
business is dependent on the highly skilled, and often highly specialized,
individuals we employ. The skills of our management personnel will be of
increasing importance to us in the future as we continue to integrate our
expanding venture capital business and our pending investment advisory and bank
acquisition into our ongoing investment activities. Retention of research,
investment banking, venture capital, sales and trading, asset management,
technology, lending and management and administrative professionals is
particularly important to our prospects. Our failure to recruit and retain
qualified employees would materially and adversely affect our future operating
results. We are highly dependent on specially-trained individuals
The
loss of professionals, particularly a senior professional with a broad range of
contacts in an industry, could materially and adversely affect our operating
results. Our strategy is to establish relationships with prospective corporate
clients in advance of any transaction, and to maintain these relationships over
their lifecycle by providing advisory services to corporate clients in equity,
debt and merger and acquisition transactions. These relationships depend in part
upon the individual employees who represent us in our dealings with our clients.
In addition, research professionals contribute significantly to our ability to
secure a role in managing public offerings and in executing trades in the
secondary market. From time to time, other companies in the investment industry
have experienced losses of professionals in all areas of the investment
business. The level of competition for key personnel has increased recently,
particularly due to the market entry efforts of non-brokerage U.S. and foreign
financial services companies, commercial banks, other investment banks and
venture capital firms targeting or increasing their efforts in some of the same
industries that we serve. In particular, we face competition for experienced
investment bankers, research analysts and venture capital managers of the
type on which our business is highly dependent. We cannot assure you that losses
of key personnel due to competition or otherwise will not occur. In addition, the
success of our venture capital portfolio companies will depend in large part
upon the abilities of their key personnel. Competition for qualified personnel
is intense at any stage of a company's development and high turnover of
personnel is common in Internet and information technology companies. The loss
of one or a few key managers can hinder or delay a company's implementation of
its business plan. Our portfolio companies may not be able to attract and retain
qualified personnel. Any inability to do so may negatively affect our investment
returns. Competition results in increased compensation costs
Competition for the recruiting and retention of employees has recently increased
elements of our compensation costs, and we expect that continuing competition
will cause our compensation costs to continue to increase. We cannot assure you
that we will be able to recruit and hire a sufficient number of new employees
with the desired qualifications in a timely manner. We regularly review our
compensation policies, including stock incentives. Nonetheless, our incentives
may be insufficient in light of the increasing competition for experienced
professionals in the investment industry, particularly if the value of our stock
declines or fails to appreciate sufficiently to be a competitive source of a
portion of professional compensation. We are subject to extensive government regulation which
could adversely affect our results The
securities business is subject to extensive regulation under federal and state
laws in the United States, and also is subject to regulation in the foreign
countries in which we conduct our activities. Compliance with these laws can be
expensive, and any failure to comply could have a material adverse effect on our
operating results. 23 One of the most
important regulations with which our broker-dealer subsidiaries must continually
comply is the SEC's net capital rule (Rule 15c3-1) and a similar rule of the
United Kingdom's Securities and Futures Authority. These regulations require our
broker-dealer subsidiaries to maintain minimum levels of net capital, as defined
under such regulations, and limit the amount of leverage we can obtain in our
business. Underwriting commitments require a charge against net capital and,
accordingly, our ability to make underwriting commitments may be limited by our
capital. Compliance with these regulatory net capital requirements could limit
other operations that require intensive use of capital, such as trading
activities, and also could restrict our ability to withdraw capital from our
affiliated broker-dealers, which in turn could limit our ability to pay
dividends, repay debt and redeem or repurchase shares of our outstanding capital
stock. Compliance with
many of the regulations applicable to us involves a number of risks,
particularly in areas where applicable regulations may be subject to
interpretation. In the event of non-compliance with an applicable regulation,
governmental regulators and self- regulatory organizations such as the National
Association of Securities Dealers may institute administrative or judicial
proceedings that may result in: censure,
fines or civil penalties (including treble damages in the case of insider
trading violations); issuance
of cease-and-desist orders;
deregistration or suspension of the non-compliant broker-dealer or investment
adviser; suspension
or disqualification of the broker-dealer's officers or employees; or other
adverse consequences. The imposition of
any such penalties or orders on us could have a material adverse effect on our
operating results and financial condition. The PATRIOT Act,
which became law on October 26, 2001 requires financial institutions to adopt
and implement policies and procedures designed to prevent and detect money
laundering. The United States Department of the Treasury, federal banking
regulators, the SEC and the NASD have the ability to impose civil and criminal
penalties, revoke or suspend our necessary licenses or registrations or impose
other penalties or sanctions if we fail to comply with the PATRIOT Act and its
implementing regulations. Such actions could have material adverse effects
on our ability to conduct our business and operations. As a result of our
acquisition of Rushmore and its conversion into a national bank, in 2001 we
became a bank holding company regulated under the Bank Holding Company Act of
1956, as amended (the "BHC Act"). As a bank holding company, we are subject to
extensive supervision, regulation and examination by banking regulatory
agencies. In general, the BHC Act prohibits or restricts a bank holding
company's engagement in a wide variety of businesses, some of which are
businesses in which we currently engage, including venture capital, merchant
banking and investment banking. The
Gramm-Leach-Bliley Act, or GLB Act, which became law in November 1999,
significantly changed the regulatory structure and oversight of the financial
services industry. The GLB Act permits a qualifying bank holding company, called
a financial holding company (an "FHC"), to engage in a full range of financial
activities, including banking, insurance, and securities activities, as well as
merchant banking and additional activities that are "financial in nature" or
"incidental" to such financial activities. In order for a bank holding company
to qualify as an FHC, its subsidiary depository institutions must be
"well-capitalized" and "well-managed" and have at least a "satisfactory"
Community Reinvestment Act rating. As noted above, the Federal Reserve Board has
approved our application to be a FHC. We currently
engage in a wide variety of businesses, including venture capital, merchant
banking and investment banking, that existing law would prohibit us from
engaging in as a bank holding company in the manner in which we currently engage
in such businesses, but which the GLB Act permits an FHC to engage in a
similar fashion as we do today. Although we believe that we will be able to
maintain our qualification as an FHC under the GLB Act and continue to engage in
the businesses in which we currently engage, there can be no assurance that we
will be able to do so or that we will not be required to incur substantial costs
to maintain compliance with the GLB Act. In addition, even if we are successful
in maintaining FHC status, the GLB Act is a very recently enacted law and there
is a great deal of uncertainty surrounding its scope and interpretation. There
can be no assurance that these regulations and subsequent interpretations will
not prevent us from engaging in one or more lines of businesses in which we
currently engage or will not impose restrictions that could limit the
profitability of such businesses or otherwise restrict our flexibility in
engaging in them. 24 In addition, as a
bank holding company (separate from our status as an FHC), we are subject to a
wide variety of restrictions, liabilities and other requirements applicable to
bank holding companies, including required capital levels, restrictions on
transactions with our bank subsidiary, restrictions on payment or receipt of
dividends and community reinvestment requirements. Federal banking regulators
possess broad powers to take supervisory action, including the imposition of
potentially large fines, against us as they deem appropriate if we violate any
of these requirements or engage in unsafe or unsound practices. Such supervisory
actions could result in higher capital requirements and limitations on both our
banking and non-banking activities, any and all of which could have a material
adverse effect on our businesses and profitability. Finally, the GLB Act imposes
customer privacy requirements on any company engaged in financial activities
such as those engaged in by us. Any failure to comply with such privacy
requirements could result in significant penalties or fines. The regulatory
environment in which we operate is also subject to change. Our business may be
adversely affected as a result of new or revised legislation or regulations
imposed by the SEC, other United States or foreign governmental regulatory
authorities or the NASD. We also may be adversely affected by changes in the
interpretation or enforcement of existing laws and rules by these governmental
authorities and the NASD. Additional
regulation, changes in existing laws and rules, or changes in interpretations or
enforcement of existing laws and rules often directly affect the method of
operation and profitability of securities firms such as ours. We cannot predict
what effect any such changes might have. Our businesses may be materially
affected not only by regulations applicable to us as a financial market
intermediary, but also by regulations of general application. For example, the
volume of our venture capital, underwriting, merger and acquisition, asset
management and principal investment businesses in a given time period could be
affected by, among other things, existing and proposed tax legislation,
antitrust policy and other governmental regulations and policies (including the
interest rate policies of the Federal Reserve Board) and changes in
interpretation or enforcement of existing laws and rules that affect the
business and financial communities. The level of business and financing activity
in each of the industries on which we focus can be affected not only by such
legislation or regulations of general applicability, but also by
industry-specific legislation or regulations. Furthermore, due
to the increasing popularity of the Internet, legislators and regulators may
pass laws and regulations dealing with issues such as user privacy, advertising,
customer suitability, taxation and the pricing, content and quality of products
and services. Increased attention to these issues could adversely affect the
growth of the Internet, which could in turn decrease the demand for online
services such as those we and our venture capital funds provide or could
otherwise have a material adverse effect on our business, financial condition or
operating results. We are highly dependent upon the availability of capital
and funding for our operations We
are highly dependent upon the availability of adequate funding and regulatory
capital to operate our business and to meet applicable regulatory requirements.
Historically, we have satisfied these needs from equity contributions,
internally generated funds and loans from third parties. We cannot assure you
that any, or sufficient, funding or regulatory capital will continue to be
available to us in the future on terms that are acceptable to us. Moreover, many of
our venture capital portfolio companies will require additional equity funding
to satisfy their continuing working capital requirements. Because of the
circumstances of those companies or market conditions, it is possible that one
or more of our portfolio companies will not be able to raise additional
financing or may be able to do so only at a price or on terms that are
unfavorable to them. Although there have been a substantial number of initial
public offerings of Internet-related companies, if the market for such offerings
continues to weaken for an extended period of time, the ability of our venture
capital portfolio companies to grow and access the capital markets would be
impaired. We have potential conflicts of interest with our
employees, officers and directors From
time to time, our executive officers, directors and employees invest, or receive
a profit interest, in investments in private or public companies or investment
funds in which we, or one of our affiliates, is or could potentially be an
investor or for which we carry out investment banking assignments, publish
research or act as a market maker. In addition, we have in the past organized
and will likely in the future organize businesses, such as our private
investment vehicles and venture capital funds, in which our employees may
acquire minority interests. There are risks that, as a result of such investment
or profit interest, a director, officer or employee may take actions that would
conflict with our best interests. There is also a risk that investment
opportunities directed to our employees through private investment vehicles or
venture capital funds could have been beneficial to our shareholders if they had
been made as our own investments. In addition, members of our senior management
are actively involved in managing investment funds and venture capital funds
operated by us which could create a conflict of interest to the extent these
officers are aware of inside information concerning potential investment targets
or to the extent these officials wish to invest in companies for which we are
underwriting securities. We believe we have in place compliance procedures and practices
designed to ensure that inside information is not used for making investment
decisions on behalf of the funds and to monitor funds invested in our investment
banking clients. We cannot assure you, however, that these procedures and practices will
be effective. In addition, this conflict and these procedures and practices may
limit the freedom of these officials to make potentially profitable investments
on behalf of those funds, which could have an adverse effect on our operations.
Our asset management activities may also preclude or delay the release of
research reports on companies in which we invest, which could negatively affect
our ability to compete for underwriting business in connection with such
companies. Also, we may have conflicts among our various subsidiaries for
investment opportunities and legal or regulatory restrictions may prevent one or
more of our subsidiaries from taking action to benefit other subsidiaries. 25 Litigation and potential securities laws liabilities may
adversely affect our business Many
aspects of our business involve substantial risks of liability, litigation and
arbitration, which could adversely affect us. As an underwriter, a broker-dealer
and an investment adviser we are exposed to substantial liability under federal
and state securities laws, other federal and state laws and court decisions,
including decisions with respect to underwriters' liability and limitations on
the ability of issuers to indemnify underwriters, as well as with respect to the
handling of customer accounts. For example, underwriters may be held liable for
material misstatements or omissions of fact in a prospectus used in connection
with the securities being offered and broker-dealers may be held liable for
statements made by their securities analysts or other personnel. Broker-dealers
and asset managers may also be held liable by customers and clients for losses
sustained on investments if it is found that they caused such losses. In recent
years there has been an increasing incidence of litigation involving the
securities industry, including class actions that seek substantial damages and
frequently name as defendants underwriters of a public offering and investment
banks that provide advisory services in merger and acquisition transactions. We
are also subject to the risk of other litigation, including litigation that may
be without merit. As we intend actively to defend any such litigation, we could
incur significant legal expenses. We carry very limited insurance that may cover
only a portion of any such expenses. An adverse resolution of any future
lawsuits against us could materially adversely affect our operating results and
financial condition. In addition to these financial costs and risks, the defense
of litigation or arbitration may materially divert the efforts and attention of
our management and staff from their other responsibilities. Our charter
documents also allow indemnification of our officers, directors and agents to
the maximum extent permitted by Virginia law. We have entered into
indemnification agreements with these persons. We have been, and in the future
may be, the subject of indemnification assertions under these charter documents
or agreements by our officers, directors or agents who are or may become
defendants in litigation. Our business is dependent on cash inflows to mutual funds
A
slowdown or reversal of cash inflows to mutual funds and other pooled investment
vehicles could lead to lower underwriting and brokerage revenues for us since
mutual funds purchase a significant portion of the securities offered in public
offerings and traded in the secondary markets. Demand for new equity offerings
has been driven in part by institutional investors, particularly large mutual
funds, seeking to invest cash received from the public. The public may sell
mutual funds as a result of a decline in the market generally or as a result of
a decline in mutual fund net asset values. To the extent that a decline in cash
inflows into mutual funds or a decline in net asset values of these funds
reduces demand by fund managers for initial public or secondary offerings, our
business and results of operations could be materially adversely affected.
Moreover, a slowdown in investment activity by mutual funds may have an adverse
effect on the securities markets generally. We may incur losses related to our investment in FBR-Asset,
our minority-owned REIT At
December 31, 2001, we owned 21% of the outstanding common stock of FBR-Asset.
FBR-Asset's assets are primarily real estate and mortgage assets, which include
indirect holdings through investments in other companies. FBR-Asset's
investments in real estate-related assets are subject to a variety of general,
regional and local economic risks, as well as the following: increases in interest rates could negatively affect the
value of FBR-Asset's mortgage loans and mortgage-backed securities; the borrowing of funds by FBR-Asset and several of the REITs
and other companies in which it invests to finance mortgage loan investments
could amplify declines in market value resulting from interest rate increases;
26 increases in prepayment rates during times of interest rate
decline could negatively affect the value of FBR-Asset's mortgage-backed
securities by requiring re-investment of the prepaid funds at the lower
interest rates; hedging against interest rate exposure may adversely affect
FBR-Asset's earnings because hedging can be expensive and may not be
effective; multifamily and commercial real estate, which comprise much
of the investments of the companies in which FBR-Asset has invested, may lose
value and fail to operate properly; investing in subordinate interests, which are owned by some
of the companies in which FBR- Asset invests, exposes FBR-Asset to increased
credit risk; competition in the purchase, sale and financing of mortgage
assets may limit the profitability of companies in which FBR- Asset invests;
increased losses on uninsured mortgage loans can reduce the
value of FBR-Asset's equity investments; and mezzanine lending Changes in the
market values of FBR-Asset's assets are directly charged or credited to FBR-Asset's
shareholders' equity. As a result, a general decline in trading market values
may also reduce the book value of FBR-Asset's assets. A reduction in the book
value of FBR-Asset's assets would have a negative effect on our financial
results as a minority owner. FBR-Asset's annual report on Form 10-K includes an
exhibit that sets forth risk factors affecting that company. A copy of
that exhibit is exhibit 99.02 to this Form 10-K. We may not be able to manage our growth effectively
Over
the past several years, we have experienced significant growth in our business
activities and the number of our employees. We expect this growth to continue as
we further expand our venture capital business and integrate our pending
investment advisory and bank acquisition. This growth has required and will
continue to require increased investment in management personnel, financial and
management systems and controls and facilities, which could cause our operating
margins to decline from historical levels, especially in the absence of revenue
growth. In addition, as is common in the securities industry, we are and will
continue to be highly dependent on the effective and reliable operation of our
communications and information systems. We believe that our current and
anticipated future growth will require implementation of new and enhanced
communications and information systems and training of our personnel to operate
such systems. In addition, the scope of procedures for assuring compliance with
applicable laws and regulations and NASD rules has changed as the size and
complexity of our business has changed. As we have grown and
continue to grow, we have implemented and continue to implement additional
formal compliance procedures to reflect such growth. Any difficulty or
significant delay in the implementation or operation of existing or new systems,
compliance procedures or the training of personnel could adversely affect our
ability to manage growth. We are highly dependent on systems and third parties, so
systems failures could significantly disrupt our business Our
business is highly dependent on communications and information systems,
including systems provided by our clearing brokers. Any failure or interruption
of our systems, the systems of our clearing broker or third party trading
systems could cause delays or other problems in our securities trading
activities, which could have a material adverse effect on our operating results.
In addition, our
clearing brokers provide our principal disaster recovery system. We cannot
assure you that we or our clearing brokers will not suffer any systems failure
or interruption, including one caused by an earthquake, fire, other natural
disaster, power or telecommunications failure, act of God, act of war or
otherwise, or that our or our clearing brokers' back-up procedures and
capabilities in the event of any such failure or interruption will be adequate.
27 We may not be able to keep up with rapid technological
change
Recent rapid advancements in computing and communications technology,
particularly on the Internet, are substantially changing the means by which
financial and other services are delivered. More specifically, the online
financial services industry, in which we operate, is experiencing rapid changes
in technology, changes in customer requirements, changes in service and product
offerings and evolving industry standards. In order for us to succeed in the
Internet and information technology sectors, we must be able to develop or
obtain new technologies, use these technologies effectively and enhance our
existing online services and products. Our success also depends on the ability
to develop new services and products that address the changing needs of
customers and prospective customers. If we are unable to respond to
technological advances and evolving industry standards and practices in a timely
and cost-effective manner, our operating results will be adversely affected. There are
significant technical and financial risks in the development of new services and
products or enhanced versions of existing services and products. We cannot
assure you that we will be able to: develop or obtain the necessary technologies; effectively use new technologies; adapt our services and products to evolving industry
standards; or develop, introduce and market in a profitable manner
service and product enhancements or new services and products. If we are unable
to develop and introduce enhanced or new services or products quickly enough to
respond to market or customer requirements, or if our or their services and
products do not achieve market acceptance, our business, financial condition and
operating results will be materially adversely affected. Our online business may require substantial expense and
may not be successful
Conducting investment banking operations through the Internet involves a new
approach to the securities business. In order to attract customers in the
rapidly evolving online financial services market, many companies have incurred
significant expenses in providing client service and in the marketing and
advertising of their products and services. We are committed to providing a high
level of client service to our target market of institutional and high net worth
clients. In order to compete effectively in this market, we may incur
substantial expenses, including intensive marketing and sales efforts to educate
prospective clients about the uses and benefits of our services and products in
order to generate demand. In addition, our ability to expand in this market may
require us to find strategic partners with content or distribution capacity or
equity partners. We may not be able to identify and reach agreements with such
partners. We cannot assure you that we will be successful in the Internet
market. Our online business does not produce revenues sufficient to cover our
expenses and we cannot assure you that it will ever do so. We are subject to risks related to online commerce and the
Internet which could adversely affect our business The
markets for electronic investment banking and brokerage services, particularly
through the Internet, are at an early stage of development and are rapidly
evolving. It is difficult to predict demand and market acceptance for online
products, as well as the possible growth and size of these markets. We cannot
assure you that the markets for our online services will continue to develop or
become profitable. Many of these services and products will not be successful
unless the Internet is widely accepted as a marketplace for commerce and
communication. This acceptance could be hindered by a number of factors,
including government regulation and associated compliance costs, insufficient
infrastructure, insufficient or inefficient telecommunication services or
concerns about security, among others. Inefficiencies related to traffic on the Internet and its
service providers may adversely affect our online business
Traffic on the Internet and the number of users gaining access through the
Internet's various service providers have grown significantly and are expected
to continue to grow. The success of our online business will depend upon the
continued ability of the Internet's infrastructure to handle this increased
volume. This will require a reliable network backbone with the necessary speed,
data capacity and security, as well as the timely development of related
products such as high-speed modems, for providing reliable and efficient
Internet access and service. If the Internet or its service providers experience
outages or delays, the level of Internet usage and the processing of
transactions on our web site will be adversely affected. 28 Security concerns may adversely affect our online business
and the businesses of our portfolio companies Our
networks may be vulnerable to unauthorized access, computer viruses and other
security problems. Individuals who successfully circumvent our security measures
could misappropriate proprietary information or cause interruptions or
malfunctions in our and their online operations. In addition, concerted attacks
by hackers could make our and their online services unavailable for significant
periods of time. We may be required to expend significant capital and other
resources to protect against the threat of security breaches or to alleviate
problems caused by any breaches. Although we intend to continue to implement
industry-standard security measures, these measures may be inadequate. If a
compromise of security occurs, our business, financial condition and operating
results could be materially adversely affected. Our common stock price is highly volatile The
market price for our class A common stock has been highly volatile and is likely
to continue to be highly volatile. The trading price of our stock has
experienced significant price and volume fluctuations in recent months. These
fluctuations often have been unrelated or disproportionate to our operating
performance. The price of our class A common stock has generally traded below
our initial public offering price of $20.00 per share in December 1997 and has
ranged from $3 5/8 per share to $21 3/4 per share since that time through March
22, 2002. Any negative changes in the public's perception of the prospects for
companies in the investment, financial services or venture capital industries
could depress our stock price regardless of our results. The following
factors could contribute to the volatility of the price of our class A common
stock: actual or anticipated variations in our quarterly results
and those of our portfolio companies; new products or services offered by us, our portfolio
companies and their competitors; changes in our financial estimates and those of our
portfolio companies by securities analysts; conditions or trends in the investment, financial services
or venture capital industries in general; announcements by us, our portfolio companies or our
competitors of significant acquisitions, strategic partnerships, investments
or joint ventures; changes in the market valuations of our portfolio companies
and other technology companies; negative changes in the public's perception of the
prospects of investment, financial services or venture capital companies; general economic conditions such as a recession, or
interest rate or currency rate fluctuations; additions or departures of our key personnel and key
personnel of our portfolio companies; and additional sales of our securities. Many of these
factors are beyond our control. Our corporate governance is controlled by insiders
As of
December 31, 2001, our officers and directors directly controlled approximately
40% of the voting power of our outstanding common stock. Therefore, they are
able to control the outcome of all corporate actions requiring shareholder
approval (other than actions requiring a vote of holders of class A common stock
voting as a separate class). Furthermore, our officers and directors have
control over our operations, including significant control over compensation
decisions under our benefit and compensation plans, including plans under which
they are direct beneficiaries. 29 ITEM 2. PROPERTIES We lease four floors of
our headquarters building totaling approximately 72,721 square feet. We also
lease approximately 28,538 square feet for our other offices. In October
2001, we announced plans to reduce office space as part of our cost reduction
program. We believe that our present facilities, together with our current
options to extend lease terms and occupy additional space, are adequate for our
current and presently projected needs. ITEM 3. LEGAL PROCEEDINGS We are not currently a
defendant or plaintiff in any material lawsuits or arbitrations. We are a
defendant in a small number of arbitrations and civil lawsuits relating to our
various investment banking and broker-dealer businesses. Because the
ultimate outcome of these matters cannot be ascertained at this time, there can
be no assurances that these matters will not have a material adverse effect on
the results of our operations in a future period, depending in part on the
results for such period. However, based on our review of these matters with
counsel, we believe that any result of these actions against us will not have a
material adverse effect on either our consolidated financial condition or on our
results of operation. For a discussion of the litigation risks associated with
our business, see "Factors Affecting Our Business, Operating Results and
Financial Condition-Litigation and potential securities laws liabilities may
adversely affect our business" (page 28). ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS None. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of
Friedman, Billings, Ramsey Group, Inc. and their ages as of December 31, 2001
are as follows: Age 55 49 42 49 51 Emanuel J. Friedman Mr. Friedman is Chairman
and Co-Chief Executive Officer of FBR. He has continuously served as Chairman
and Chief Executive Officer since co-founding FBR in 1989. He also serves as a
director of FBR-Asset. He is the portfolio manager of FBR Ashton, Limited
Partnership. Eric F. Billings Mr. Billings is Vice
Chairman and Co-Chief Executive Officer of FBR. He has continuously served
as Vice Chairman since co-founding FBR in 1989, and served as Chief Operating
Officer from 1989 until be became Co-Chief Executive Officer in 1999. He also
serves as Chief Executive Officer and as a director of FBR-Asset. He is
the portfolio manager of FBR Weston, Limited Partnership. Robert S. Smith Mr.
Smith became Chief Operating Officer of FBR in December 1999. Mr. Smith joined
FBR as its General Counsel in January 1997 and became Executive Vice President
in December 1997. Prior to joining FBR, Mr. Smith was a partner in the law firm
of McGuire, Woods, Battle & Boothe, LLP, where he had been in practice since
1986 30 Kurt R. Harrington Mr. Harrington became
Chief Financial Officer of FBR in January 2000. Mr. Harrington joined FBR as
Vice President Finance and Treasurer in March 1997. He was previously the Chief
Financial Officer of Jupiter National, Inc., a publicly traded, closed-end
venture capital company. As part of his portfolio management responsibilities at
Jupiter, he also served on the board of a number of companies including Viasoft,
Inc., a publicly traded software company. Mr. Harrington is also the Chief
Financial Officer of FBR-Asset. Mr. Harrington is a Certified Public Accountant. William J. Ginivan Mr. Ginivan
became Chief Legal Officer in January 2000. Mr. Ginivan joined FBR as Deputy
General Counsel in January 1998. Prior to joining FBR, Mr. Ginivan was Associate
General Counsel of the Student Loan Marketing Association (Sallie Mae), and
Managing Director and General Counsel of Sallie Mae's investment banking
subsidiary, Education Securities, Inc. 31 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED The principal
market for trading our Class A common stock is the New York Stock Exchange. Set
forth below are the high and low sale prices of our Class A common stock for
each quarter for 2001, 2000 and 1999. High Low $6.0000 $4.5000 7.2400 4.6000 7.0000 4.9200 7.9375 5.0000 93/8 6 91/2 65/8 11 51/2 1915/16 63/16 715/16 43/8 14 63/8 211/4 61/4 183/16 51/2 According to the
records of our transfer agent, we had approximately 118 shareholders of record
as of December 31, 2001. Because many shares are held by brokers and other
institutions on behalf of shareholders, we are unable to estimate the total
number of beneficial shareholders represented by these record holders. Our policy is to
reinvest earnings in order to fund future growth. Therefore, we have not paid
and do not plan to declare dividends on our Class A common stock, at this time. 32 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA SELECTED CONSOLIDATED FINANCIAL INFORMATION
Year Ended December 31, 2001
2000 $ 47,853 $ 21,086 $ 22,642 $ 70,791 $ 142,506 28,534 31,404 22,541 41,356 60,649 6,762 1,453 3,853 - - 83,149 53,943 49,036 112,147 203,155 26,330 32,319 22,058 (28,192) 16,646 27,084 21,084 14,988 15,308 12,395 53,414 53,403 37,046 (12,884) 29,041 19,744 9,719 9,409 7,556 3,156 3,628 1,673 1,577 3,841 12,610 9,532 10,843 (5,268) (3,972) 3,228 32,904 22,235 5,718 7,425 18,994 (18,100) 41,614 36,398 29 - 9,422 9,695 10,768 16,151 4,945 160,789 180,890 138,966 122,868 256,135 108,112 109,768 98,424 82,599 156,957 28,879 19,229 23,582 29,313 22,406 7,087 6,207 4,693 5,078 4,961 10,852 9,544 6,674 4,225 2,638 5,832 5,085 4,323 3,592 2,325 1,083 1,665 1,323 4,927 3,770 9,415 7,147 6,918 9,343 5,941 5,151 - - - - 176,411 158,645 145,937 139,077 198,998 (15,622) 22,245 (6,971) (16,209) 57,137 (1,760) 4,163 - - 22,855 (1) (13,862) 18,082 (6,971) (16,209) 34,282 1,148 - - - - $ (12,714) $ 18,082 $ (6,971) $ (16,209) $ 34,282 $ 46,246 $ 52,337 $ 43,743 $ 46,827 $ 207,691 15,706 18,447 6,137 13,150 78,784 119,982 142,950 135,723 97,157 36,351 110,024 38,485 40,753 47,982 36,501 $ 291,958 $ 252,219 $ 226,356 $ 205,116 $ 359,327 $ 73,075 $ 36,733 $ 34,358 $ 15,322 $ 52,008 20,195 - - - 40,000 - - - - 24,000 13,377 930 3,029 2,892 16,673 106,647 37,663 37,387 18,214 132,681 185,311 214,556 188,969 186,902 226,646 $ 291,958 $ 252,219 $ 226,356 $ 205,116 $ 359,327 33 SELECTED CONSOLIDATED FINANCIAL INFORMATION (Continued)
Year Ended December 31, 2001 2000 1999 1998 1997 $ (0.27) $ 0.37 $ (0.14) $ (0.33) $ 1.48 $ (0.27) $ 0.36 $ (0.14) $ (0.33) $ 1.48 N/A N/A N/A N/A $ 0.85 $ 4.06 (3) $ 4.34 $ 3.86 $ 3.81 $ 4.53 433 386 390 358 265 $ 393 $ 466 $ 372 $ 394 $ 1,162 (8)% 11% (4)% (8)% 41% 67% 61% 71% 67% 61% 47,466 (3) 49,162 48,872 49,724 40,276 47,466 (3) 50,683 48,872 49,724 40,276 (1) Reflects pro forma Federal and state income taxes based on
estimated applicable tax rates as if we had not elected subchapter S corporation
status prior to December 21, 1997. Historical, as reported, income tax benefit
for 1997 was $2,402. Historical, as reported, net income for 1997 was $59,539. (2) As of end of the period reported. (3) Excludes employee stock and purchase loan receivable
of $22.7 million as of December 31, 2001 and four million shares pledged as
collateral, or effectively $0.13 per share. (4) Includes 54 employees of FBR National Bank as of
December 31, 2001. 34 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
Overview Friedman, Billings,
Ramsey Group, Inc. is a financial holding comprising a Capital Markets Group and
an Asset Management Group. The Capital Markets Group includes an
institutional investment banking and securities broker-dealer, and an online
broker-dealer and securities distributor. The Asset Management Group is engaged
in investment management and advisory services to hedge funds, private equity
and venture capital funds, managed accounts, mutual funds and FBR Asset
Investment Corporation ("FBR-Asset") a publicly-traded real estate investment
trust. The Asset Management Group also provides administrative,
shareholder and accounting services for mutual funds through FBR National Bank.
Additionally, the Asset Management Group holds investments, as principal, in
several of the funds that it manages and other investments acquired in
connection with its business. Our company operates primarily in the United
States and Europe. FBR Asset Investment Corporation FBR-Asset is
a corporation that has been managed by us since its creation in 1997 through a
management agreement with our investment adviser subsidiary, FBRIM. At
December 31, 2001, our long-term investment was 20.8% of the company, and was 15.1% as of March 28,
2002. At December 31, 2001, FBR-Asset had gross assets of $1.3 billion and
shareholder's equity of $203.9 million. Our Vice Chairman and Co-Chief Executive
Officer, Mr. Billings, serves as the Chairman and Chief Executive Officer of FBR-Asset
and our Chairman and Co-Chief Executive Officer, Mr. Friedman, is also a
director of FBR-Asset. FBR-Asset also has three outside, independent
members of its Board of Directors who approved the management agreement with us,
which agreement includes the base and incentive fees that we are paid to us. Our
principal broker-dealer subsidiary, FBRC has entered into an agreement with FBR-Asset,
regarding FBR-Asset's extension of credit to or investment in entities that are
or may be FBRC investment banking clients. The agreement provides that in
circumstances where FBRC determines that a commitment to make an extension of
credit or an investment to an entity (each an "investment opportunity") by FBR-Asset
would facilitate a possible investment banking transaction, FBRC presents the
investment opportunity to FBR-Asset. The Investment Committee of FBR-Asset
reviews each investment opportunity and recommends whether or not to make a loan
or an investment based on its investment criteria. If recommended by the
Investment Committee, FBR-Asset's Board of Directors' Contracts Committee (the
three members of which are outside, independent directors of FBR-Asset) reviews
the investment opportunity and decides on the basis of the Investment
Committee's recommendation whether or not the investment opportunity is
appropriate and whether or not to commit to make an extension of credit or an
investment. If FBR-Asset makes a determination to commit to making an
extension of credit or an investment, the commitment is not contingent on FBRC
being engaged to provide investment banking services. If, however, FBRC is
engaged to provide investment banking services, FBR-Asset's wholly owned
broker-dealer subsidiary will act as a financial advisor to FBRC in connection
with structuring the transaction and in return for its services it will receive
10% of the net cash investment banking fees received by FBRC for the engagement.
We believe that this agreement with FBR-Asset allows FBRC to compete more
effectively with larger institutions for investment banking transactions. We
also believe the 10% fee to be paid to FBR-Asset's broker-dealer subsidiary is
reasonable given the value of the services to be provided and the assistance
provided by FBR Asset's commitment. In 2001, pursuant to this agreement,
FBR-Asset received $2.9 million in fees from FBRC from three investment banking
transactions, and one unfunded commitment it facilitated. Our investment banking
revenues for these transactions are recorded net of these fees. FBR-Asset
invests in mortgage-backed securities, equity securities, mezzanine or senior
loans, and, from time to time, opportunistic investments. As of December
31, 2001, 93% and 5% of FBR-Asset's total assets were invested in
mortgage-backed securities and equity securities, respectively, compared with
69% and 12% respectively as of December 31, 2000. FBR-Asset uses leverage to
enhance the return on its mortgaged-backed securities and as of December 31,
2001, the debt-to-equity ratio for that portfolio was 8.3 to 1. Through
our investment in FBR-Asset we are exposed to interest rate risk in connection
with FBR-Asset's ownership of mortgage-backed securities and other debt
instruments. That risk is magnified due to FBR-Asset's strategy of
borrowing funds to increase the size of its investment in mortgage-backed
securities. In addition, the use of such borrowings exposes FBR-Asset to
the risk of margin calls. Our management
agreement with FBR-Asset provides that we receive base management fees of 0.25%
based on the value of mortgage related assets and 0.75% based on the value of
all other invested assets. For the years ended December 31, 2001 and 2000,
we received base management fees of $1.8 million and $1.1 million respectively.
In addition, we are entitled to receive incentive fees based on performance
above a benchmark. For the year ended December 31, 2001, we received
incentive fees of $1.7 million. We did not receive incentive fees in any
other year.
35 We account
for our equity interest in FBR-Asset under the equity method and for the years
ended December 31, 2001 and 2000 recorded $4.3 million and $7.1 million of net
investment income for our proportionate share (reflecting share repurchases in
2000 and new share issuances in 2001) of FBR-Asset's net income for those years. Business Environment Our principal business
activities, investment banking (capital raising and merger and acquisition and
advisory services), institutional brokerage and asset management (including
proprietary investments), are linked to the capital markets. In addition,
our business activities, are focused in the financial services, real estate,
technology, energy, healthcare and diversified industries sectors.
Historically, we have focused on small and mid-cap stocks, although our research
coverage and associated brokerage activities increasingly involve larger-cap
stocks. By their nature, our business activities are highly competitive
and are not only subject to general market conditions, volatile trading markets
and fluctuations in the volume of market activity, but also to the conditions
affecting the companies and markets in our areas of focus. In 2001, although
the economic slowdown that began in the second half of 2000 continued, we
experienced an increase in underwriting and private placement activity in two of
our focused industry sectors: the financial institutions and real estate
sectors. After the economic slowdown, however, continued to adversely affect
some equity valuations, particularly in the technology sector. This slowdown was
accelerated in the aftermath of the events surrounding September 11.
Secondary equity market trading activity continued to remain under pressure in
2001 and the advent of decimal pricing has adversely affected secondary equity
market trading margins. Our revenues and
net income are subject to substantial positive and negative fluctuations due to
a variety of factors that cannot be predicted with great certainty. These
factors include the overall condition of the economy and the securities markets
as a whole and of the sectors on which we focus. For example, a
significant portion of the performance based or incentive revenues that we
recognize from our venture capital, private equity and other asset management
activities is based on the value of securities held by the funds we manage.
The value of these securities includes unrealized gains or losses that may
change from one period to another. The downturn in the technology sector
has adversely affected this portion of our business and caused reductions in
certain unrealized gains in technology sector funds securities held by us either
directly or through funds we manage. Although, when market conditions
permit, we may take steps to realize or lock-in gains on these securities, these
securities are often illiquid and therefore, such steps may not be possible, and
the value of these securities is subject to increased market risk. Fluctuations in
revenues and net income also occur due to the overall level of market activity
which, among other things, affects the flow of investment dollars and the size,
number and timing of investment banking transactions. In addition, a downturn in
the level of market activity can lead to a decrease in brokerage commissions.
Therefore, net income and revenues in any particular period may not be
representative of full-year results and may vary significantly from year to year
and from quarter to quarter. The financial
services industry continues to be affected by the intensifying competitive
environment, as demonstrated by consolidation through mergers and acquisitions,
as well as significant growth in competition in the market for brokerage and
investment banking services. The relaxation of banks' barriers to entry
into the securities industry and expansion by insurance companies into
traditional brokerage products, coupled with the repeal of laws separating
commercial and investment banking activities, has changed the number and size of
companies competing for a similar customer base, many of which have greater
capital resources and additional associated services with which to pursue these
activities. In order to
compete in this increasingly competitive environment, we continually evaluate
each of our businesses across varying market conditions for competitiveness,
profitability and alignment with our long-term strategic objectives, including
the diversification of revenue sources. As a result, we may choose, from time to
time, to reallocate resources based on the opportunities for profitability and
revenue growth for each of our businesses relative to our commitment of
resources. In October 2001, we announced a program to reduce fixed costs
by a targeted 20% of the third quarter run-rate over the next two quarters. 36 Operating Groups Capital Markets Group Our capital markets
activities consist of institutional research, investment banking and securities
brokerage. Our investment
banking (underwriting and corporate finance) activities consist of a broad range
of services, including public and private capital raising transactions that
include a wide variety of securities and financial advisory services in merger,
acquisition and strategic partnering transactions. During 2001, we completed or
advised on 37 managed or co-managed investment banking and corporate finance
transactions representing $2.7 billion of aggregate transaction value,
with $2.3 billion in public underwritings and private placements and $400
million in merger and acquisition ("M&A") and advisory transactions. We also
participated in 27 underwriting transactions as a syndicate or selling group
member. During the year
ended December 31, 2001, we managed or co-managed one initial public offering ("IPO")
and 24 secondary (or "follow-on") offerings raising approximately $1.9
billion and generating $47.4 million in revenues. The average size of
transactions managed was $76.5 million. In addition, during 2001 we sole-managed
a private placement (included in corporate finance revenue below) raising $277
million for a company whose securities began trading on the public markets in
January 2002. Corporate finance
revenues include private placement fees and M&A and advisory service fees.
During the year ended December 31, 2001, we acted as placement agent in four
non-public transactions, raising $331.3 million and generating $18.7 million in
revenues. We also advised on eight M&A and other advisory assignments generating
$9.8 million in revenues. The following
table shows details of our investment banking revenues for the years indicated:
Investment Banking Revenues 2001 2000 1999 1998 1997 (Unaudited, in thousands) $ 9,926 $ 8,343 $ 8,910 $ 50,502 $115,403 37,927 10,234 12,407 15,623 20,690 - 2,509 1,325 4,666 6,413 47,853 21,086 22,642 70,791 142,506 4,428 6,427 7,442 9,753 22,511 14,554 15,608 9,716 18,781 8,893 3,559 19,321 43,491 28,534 31,404 22,541 41,356 60,649 $76,387 $52,490 $45,183 $112,147 $203,155 37 In addition to our
investment banking activities, we also offer institutional brokerage services to
customers. Revenues related to these services are: Institutional Brokerage Revenues 2001 2000 1999 1998 1997 (Unaudited, in thousands) $24,310 $25,453 $24,305 $ 30,976 $29,276 2,020 6,866 (2,247) (59,168) (12,630) 26,330 32,319 22,058 (28,192) 16,646 27,084 21,084 14,988 15,308 12,395 $53,414 $53,403 $37,046 $(12,884) $29,041 $51,394 $41,671 Asset Management Group Our asset management
activities consist of managing and investing in a broad range of pooled
investment vehicles, including investment partnerships, FBR Asset
Investment Corporation ("FBR-Asset"), mutual funds, and separate accounts, as
well as some direct principal investments. Our total gross assets under
management ("AUM") increased 175% from $1.0 billion at December 31, 2000 to $2.8
billion at December 31, 2001 due primarily to the acquisition of MMA/Rushmore
and growth in FBR-Asset: Assets Under Management Productive Gross (2) Net (3) $ 1,371.4 $ 1,371.4 $ 250.2 153.4 260.6 153.4 1,001.7 1,005.8 1,001.7 93.3 48.3 47.6 248.3 71.0 64.9 $ 2,868.1 $ 2,757.1 $ 1,512.8 (1) Productive capital assets under management represents
the amount of actual or committed capital that determines the respective
investment vehicles' base management fees. The productive capital base
for each vehicle is determined by the terms of its specific agreement (which
is generally a partnership, operating or management agreement). For FBR-Asset the productive capital includes both equity and debt, and for
technology sector funds and certain private equity funds the productive
capital represents primarily committed capital. In prior reporting
periods AUM represented the greater of net assets under management or
committed capital, in order to approximate productive capital base.
Due to the significant increase in the gross assets of FBR-Asset, we have
expanded the information to include Assets Under Management by Gross, Net
and Productive Capital. (2) Gross assets under management represents the
amount of actual gross assets of FBR-Asset and our proprietary investment
partnerships and mutual funds. (3) Net assets under management represents gross
assets under management, net of any repo debt, margin loans, securities sold
but not yet purchased, lines of credit, and any other liabilities. As of
December 31, 2001, our long-term investments totaled $120.0 million, a decrease
of 16% from $143.0 million at December 31, 2000. We generate revenue
from our asset management activities in three ways: 1.) As investment adviser we receive management fees for
the management of investment vehicles' or accounts, including hedge, private
equity and venture capital funds, mutual funds, separate accounts and FBR-Asset,
based upon the amount of capital committed or under management.
Additionally, during 2001 we began earning mutual fund administrative
servicing fees from mutual funds for which we provide custody, transfer agent,
shareholder and mutual fund accounting services. These fees are earned
on both mutual funds we manage and mutual funds managed by others. This
revenue is recorded in "base management fees" in our statements of operations.
38 2.) Based on the performance of certain investment vehicles
we receive incentive income based upon their operating results.
Incentive income from investment partnerships represents special allocations,
generally 20%, of realized and unrealized gains to our capital accounts as
managing partner of the partnerships. This special allocation is sometimes
referred to as "carried interest" and is recorded in "incentive allocations
and fees" in our statements of operations. In addition, we may receive
quarterly cash incentive fees from FBR-Asset, based on 25% of net income over
a performance hurdle. The portion of technology sector funds incentive
allocations is reported in "technology sector net investment and incentive
income (loss)" in our statements of operations. 3.) As investor, we record realized and unrealized gains
and losses on our investments. Under the equity method of accounting, we
record allocations for our proportionate share of the earnings or losses of
the hedge, private equity and venture funds and other partnerships that we
manage and FBR-Asset. Income or loss allocations are recorded in "net
investment income (loss)" in our statements of operations. The
portion of technology sector funds income and losses is reported in
"technology sector net investment and incentive income (loss)" in our
statements of operations. Asset management
revenue decreased 77% over the last year from $63.8 million in 2000 to $14.8
million in 2001 primarily as a result of the downturn in the technology sector.
During 2001, we recorded $(18.1) million of net investment and incentive loss
from technology sector investments. During 2000, we recorded net
investment and incentive income from technology sector investments of $41.6
million. Venture capital gross assets under management decreased 70% from
$238.2 million in 2000 to $71.0 million in 2001, due primarily to security
valuation declines and distributions of $65 million from TVP. Base management
fees are earned on all of our productive capital AUM and are determined based on
a percentage of actual or committed capital, excluding, in some cases, our own
investment and certain other affiliated capital. The percentages used to
determine our base fee vary from vehicle to vehicle (from 0.25% for FBR-Asset's
mortgage-backed securities to 2.5% for two of our venture capital funds). We
earn base management fees from our managed vehicles monthly or quarterly, and
generally receive base management fees quarterly or semi-annually. We recorded
$19.7 million in base management fees (including mutual fund administrative
servicing fees) for the year ended December 31, 2001, of which $18.8 million was
earned on our managed assets and $0.9 million was earned on funds managed by
third parties. During 2001 the base management fees on our managed assets
as a percentage of ending productive capital AUM decreased from 1.0% to 0.7%,
and as a percentage of net assets AUM decreased from 1.3% to 1.2%, as the major
increases in the productive capital came from mutual funds and FBR-Asset, which
earn relatively lower percentage fees. Our annualized effective fee during
the fourth quarter of 2001 on the December 31, 2001 productive capital AUM was
0.8%, and on net asset AUM was 1.5%. In addition to
base management fees, we may earn incentive income on FBR-Asset and our managed
hedge, private equity and venture capital partnerships. FBR-Asset pays us a
quarterly incentive fee based on an annual rate of 25% of its excess net income
for the trailing twelve months over a performance hurdle. We generally are
allocated 20% of the net realized and unrealized investment gains (if any) over
a hurdle on the assets contributed by third parties to the investment
partnerships. Net AUM on which we have the potential to earn incentive income
have decreased 15%, from $555.4 million at December 31, 2000 to $469.9 million
as of December 31, 2001. However, excluding the technology sector funds,
these assets increased 28% from $317.0 million to $405.0 million.
For the year ended December 31, 2001, we recorded $3.6 million of non-technology
sector incentive allocations and fees, and in the technology sector $(7.7)
million related to TVP. Under the terms of TVP's partnership agreement, after
allocations have been made to the limited partners in amounts totaling their
commitments, we are entitled to receive special allocations in an amount equal
to 20% of the realized and unrealized gains allocated to the limited partners.
In succeeding periods, we are entitled to an allocation of 20% of the
partnership's realized and unrealized gains and losses and the remaining 80% is
allocated to the limited partners on a pro-rata basis. Changes in our TVP
capital account, as of December 31, 2001, include the effect of the allocation
of this 20% carried interest. The incentive
allocations and gains/(losses) in our managed investment partnerships are
determined, in part, by the value of securities held by those partnerships. To
the extent that our managed partnerships hold securities of public companies
that are restricted as to resale due to contractual "lock-ups", regulatory
requirements including Rule 144 holding periods, or for other reasons, these
securities are generally valued by reference to the public market price, subject
to discounts to reflect the restrictions on liquidity. These discounts are
sometimes referred to as "haircuts". As the restriction period runs, the amount
of the discount is generally reduced. We review these valuations and discounts
quarterly. We target a
blended rate of return on our long-term investments, including our own
investments in the vehicles we manage as well as direct investments, of 10-12%.
During 2001, we recorded net investment income (excluding technology sector
investment losses of $10.4 million) of $9.5 million, representing approximately
10% of our average non-technology sector long-term investments of $95.0 million.
In addition, we recorded interest on our long-term debt investments in
"interest, dividends and other" in our statements of operations. In May 1998, as
part of our strategy to create new asset management products and to diversify
our asset management business, we organized a business trust designed to extend
financing to "middle-market" businesses in need of subordinated debt or
mezzanine financing. In connection therewith, in July 1998, we made two loans
and an equity investment totaling $24.5 million to three unrelated businesses.
The equity investment was in a company in the technology sector. During
1999 and 2000, we wrote-down the technology sector equity investment to zero.
During 2001, one of the loans was repaid with interest and an equity "kicker"
resulting in a total annual return of approximately 20%. The remaining
loan, valued at $7.5 million, bears interest at an annual rate of 15.0%. We
subsequently decided not to seek outside investment for this vehicle but
continue to hold its investment as principal. 39 Results of Operations Revenues Our
revenues consist primarily of underwriting revenue, corporate finance fees,
agency commissions, principal transactions and asset management revenue. Revenue
from underwriting and corporate finance transactions is substantially dependent
on the market for public and private offerings of equity and debt securities in
the sectors within which we focus our efforts. Agency commissions are dependent
on the level of trading volume and penetration of our institutional client base
by research, sales and trading. Principal transactions are dependent on Nasdaq
trading volume and spreads in the securities of such companies. Net trading
gains and losses are dependent on the market performance of securities held, as
well as our decisions as to the level of market exposure we accept in these
securities. Asset management revenues are dependent on the level of the
productive capital on which our base management fees are calculated, the amount
and performance of capital on which we have the potential to generate incentive
income, and the amount of our own long-term investments with the performance of
those investments. Our asset management vehicles are subject to market risk
caused by illiquidity and volatility in the markets in which they would seek to
sell financial instruments. Revenue earned from these activities, including
unrealized gains that are included in the incentive income portion of our asset
management revenues and net gains and losses, may fluctuate as a result.
Accordingly, our revenues have fluctuated, and are likely to continue to
fluctuate, based on these factors. Underwriting
revenue consists of underwriting discounts, selling concessions, management fees
and reimbursed expenses associated with underwriting activities. We act in
varying capacities in our underwriting activities, which, based on the
underlying economics of each transaction, determine our ultimate revenues from
these activities. When we are engaged as lead-manager of an underwriting, we
generally bear more risk and earn higher revenues than if engaged as a
co-manager, an underwriter ("syndicate member") or a broker-dealer included in
the selling group. As lead manager, we generally receive 50% to 60% of the total
underwriting spread and as a co-manager, we generally receive 5% to 40% of the
total underwriting spread. Corporate finance
revenues consist of M&A, private placement, mutual-to-stock conversion and other
corporate finance advisory fees and reimbursed expenses associated with such
activities. Corporate finance fees have fluctuated, and are likely to continue
to fluctuate, based on the number and size of our completed transactions. Principal sales
credits consist of a portion of dealer spreads attributed to the securities
trading activities of FBRC as principal in Nasdaq-listed and other securities,
and are primarily derived from FBRC's activities as a market-maker. Agency commissions
revenue includes revenue resulting from executing stock exchange-listed
securities and other transactions as agent. Trading gains and
losses are combined and reported on a net basis. Gains and losses result
primarily from market price fluctuations that occur while holding positions in
our trading security inventory. We receive asset
management revenue in our capacity as the investment manager to advisory
clients, including FBR-Asset and our mutual funds, as general partner of several
hedge, private equity and venture capital investment partnerships and as
administrator to mutual funds. Management fees and incentive income on FBR-Asset
and investment partnerships have been earned from entities that have invested
primarily in the securities of companies engaged in the financial services, real
estate and technology sectors. Incentive income is likely to fluctuate with the
performance of securities in these sectors. Investment income
and losses are combined and reported on a net basis. Income and losses primarily
represent our proportionate share of income or loss related to investments in
proprietary investment partnerships and FBR-Asset, in addition to recognized
losses for "other than temporary" impairment on securities held as
available-for-sale and realized gains and losses from the sale of investment
securities. As of December 31, 2001, we had $3.2 million of unrealized gains
related to available-for-sale securities including our interest in FBR-Asset's
unrealized gains, recorded in accumulated other comprehensive income. Upon the
sale of these securities or in the event a decline in value is deemed other than
temporary, the resulting difference between the cost and market value will be
recorded as an investment gain or loss. 40 Expenses Compensation and benefits
expense includes base salaries as well as incentive compensation paid to sales,
trading, asset management, underwriting and corporate finance professionals and
to executive management. Incentive compensation varies primarily based on
revenue production and net income. Salaries, payroll taxes and employee benefits
are relatively fixed in nature. During 2001, certain of our executive officers
were eligible for bonuses under the Key Employee Incentive Plan (the "Key
Employee Plan"). During 2001, we accrued $0.9 million with respect to executive
officer compensation. Compensation related to the Key Employee Plan was
paid subsequent to December 31, 2001. Business
development and professional services expenses include travel and entertainment,
expenses related to investment banking transactions, costs of conferences,
advertising, legal and consulting fees, recruiting fees and sub-advisory fees.
Many of these expenses, such as investment banking expenses and sub-advisory
fees, are to a large extent variable with revenue. Clearing and
brokerage fees include trade processing expense that we pay to our clearing
brokers, execution fees that we pay to floor brokers and electronic
communication networks. These expenses are almost entirely variable with
revenue. Occupancy and
equipment includes rental costs for our facilities, depreciation and
amortization of equipment, software and leasehold improvements and expenses.
These expenses are largely fixed in nature. Communications
expenses include voice, data and Internet service fees, and data processing
costs. While variable in nature, these do not tend to vary with revenue. Interest expense
includes the cost of capital for equipment and acquisition notes, subordinated
credit lines, and bank deposits and other financing. Other operating
expenses include amortization of acquired management contracts, professional
liability and property insurance, printing and copying, business licenses and
taxes, offices supplies, charitable contributions and other miscellaneous office
expenses. The following
table sets forth financial data as a percentage of revenues for the years
presented: Year Ended December 31, 2001 2000 1999 1998 1997 29.8% 11.7% 16.3% 57.6% 55.6% 17.7% 17.4% 16.2% 33.7% 23.7% 4.2% 0.8% 2.8% - - 51.7% 29.9% 35.3% 91.3% 79.3% 16.4% 17.5% 15.9% (22.9)% 6.5% 16.8% 12.0% 10.8% 12.5% 4.9% 33.2% 29.5% 26.7% (10.4)% 11.4% 12.3% 5.4% 6.8% 6.1% 1.2% 2.3% 0.9% 1.1% 3.1% 4.9% 5.9% 6.0% (3.8)% (3.2)% 1.3% 31.9% 12.3% 4.1% 6.0% 7.4% (11.3)% 23.0% 26.2% - - 5.9% 5.3% 7.7% 13.1% 1.9% 100.0% 100.0% 100.0% 100.0% 100.0% 67.2% 60.7% 70.8% 67.2% 61.3% 18.0% 10.6% 17.0% 23.9% 8.8% 4.4% 3.4% 3.4% 4.2% 1.9% 6.7% 5.3% 4.8% 3.4% 1.0% 3.6% 2.8% 3.1% 2.9% 0.9% 0.7% 0.9% 0.9% 4.0% 1.5% 5.9% 4.0% 5.0% 7.6% 2.3% 3.2% - - - - 109.7% 87.7% 105.0% 113.2% 77.7% (9.7)% 12.3% (5.0)% (13.2)% 22.3% 41 We estimate that
our fixed costs, which for these purposes we consider to include all expenses
except for restructuring and software impairment charges, variable compensation,
investment banking deal expenses, sales and trading travel and entertainment,
asset management sub-advisory fees, clearing and brokerage fees, and interest
expense, as a percentage of revenues, increased from 40% of revenue to 58% of
revenue from 2000 to 2001 in part due to an 11% decrease in revenues and the
added costs associated with MMA/Rushmore, and the expansion of our capital
markets business. Comparison of the Years Ended December 31, 2001 and 2000 Our revenues
decreased 11% from $180.9 million in 2000 to $160.8 million in 2001 primarily
due to an adverse change in technology sector net investment and incentive
income (loss) of $59.7 million offset by an increase in investment banking
revenue of $29.2 million and an increase in base management fees of $10.0
million. Underwriting
revenue increased 127% from $21.1 million in 2000 to $47.9 million in 2001. The
increase is attributable to more lead-managed transactions resulting in higher
fees per transaction. During 2001, we managed 25 public offerings, of which we
lead-managed sixteen, raising $1.9 billion and generating $47.9 million in
revenues. These revenues included $4.4 million in underwriting fees in
connection with a follow on offering for FBR-Asset that we lead managed. During 2000, we managed 22 public offerings, of which we lead-managed
four, raising $4.0 billion and generating $21.1 million in revenues. The average
size of underwritten transactions for which we were a lead or co-manager
decreased from $181.9 million in 2000 to $76.0 million in 2001, but the average
fee per transaction increased. Corporate finance
revenue decreased 9% from $31.4 million in 2000 to $28.5 million in 2001 due
primarily to a decrease in the number of technology private placement and M&A
transactions completed offset by higher fees per private placement transaction.
M&A and advisory fee revenue decreased from $22.5 million in 2000 to $9.8
million in 2001. We completed fifteen M&A transactions in 2000 compared to eight
in 2001. In 2000, we completed five private placements generating $8.9 million
in revenues compared to four completed transactions in 2001 generating $18.7
million in revenues, net of $2.8 million in revenues paid to FBR-Asset pursuant
to the strategic agreement with FBRC. During 2001, FBR-Asset participated in
three private placements of common stock, where FBRC acted as the placement
agent. In connection with
certain capital raising transactions, we receive warrants for the stock of the
issuing companies, which are generally exercisable at the respective offering
price of the transaction. We previously carried the warrants at nominal values,
and recognized profits, if any, only when realized due to the restrictions on
the warrants and underlying securities, and the uncertainty surrounding the
valuation of the warrants. Based on the lapsing of restrictions and the
development of a trading history for these publicly traded securities, we
reassessed the valuation models and methodology for the warrants. As such, we
have valued warrants on publicly traded stocks, where the restriction periods
have lapsed, using an undiscounted Black-Scholes valuation model. During 2001,
we recorded an investment banking gain of $6.8 million; of this amount, $5.7
million related to warrants. By December 31, 2001, $5.5 million of the
warrant gain had been realized. For those warrants that do not have
publicly traded securities underlying them or that have restrictions on the
publicly traded securities underlying them, we carry these warrants at nominal
value. Institutional
brokerage revenue from principal transactions decreased 19% from $32.3 million
in 2000 to $26.3 million. We recorded trading gains of $2.2 million in
2001 compared to $6.9 million in 2000. Institutional
brokerage agency commissions increased 28% from $21.1 million in 2000 to $27.1
million in 2001 primarily due to increased customer trading attributed to, among
other things, greater penetration of institutional accounts through broader
research coverage and sales and trading services. Asset management
base management fees increased 103% from $9.7 million in 2000 to $19.7 million
in 2001 primarily due to additional fees earned as a result of our acquisition
of MMA/Rushmore and, to a lesser extent, FBR-Asset and other managed vehicles.
Asset management
incentive allocations and fees (excluding the technology sector) increased 117%
from $1.7 million in 2000 to $3.6 million in 2001, primarily due to FBR-Asset.
Asset management
net investment income (excluding the technology sector) decreased 12% from $10.8
million in 2000 to $9.5 million in 2001. Net investment income in 2001 includes:
$4.3 million of net investment income from our investment in FBR-Asset (net of
$1.1 million of investment loss, representing dilution associated with FBR-Asset's
secondary offering in August 2001), $4.9 million of net investment income from
investments in proprietary investment partnerships; $1.7 million of net
investment income from our private debt investments, offset by $(1.0) million of
"other than temporary" unrealized depreciation related to an available-for-sale
security and $(0.4) million of other miscellaneous net investment loss. Net
investment income in 2000 includes: $7.1 million of net investment income from
our investment in FBR-Asset, $8.7 million of net investment income from
investments in proprietary investment partnerships, offset by $(2.0) million in
write-downs of our private equity and private debt investments and $(2.8)
million of "other than temporary" unrealized depreciation related to our
available-for-sale securities. 42 Asset management
technology sector net investment and incentive income decreased from $41.6
million in 2000 to $(18.1) million in 2001. Technology sector net investment and
incentive loss in 2001 included $(14.8) million of net investment and incentive
from investments in venture capital proprietary investment partnerships, of
which $(13.6) million was associated with TVP I and TVP II, $(2.3) million of
net investment loss from direct technology sector investments and $(0.9) million
of "other than temporary" unrealized depreciation related to technology sector
available-for-sale securities. Technology sector net investment and
incentive income in 2000 included $46.7 million of net investment and incentive
income from investments in venture capital proprietary investment partnerships,
which was almost entirely attributable to TVP I and $1.5 million of net
investment income from direct technology sector investments offset by $(5.9)
million in write-downs of our technology sector private equity. Unrealized gains
related to our investments that are included in "accumulated other comprehensive
income" in our balance sheet totaled $3.2 million as of December 31, 2001. If
and when we liquidate these or determine that a decline in value of these
investments is "other than temporary", a portion or all of the gains or losses
will be recognized as investment income (loss) in the statement of operations
during the period in which the liquidation or determination is made. Our
investment portfolio is exposed to future downturns in the markets and private
debt and equity securities are exposed to deterioration of credit quality,
defaults and downward valuations. On a quarterly basis, we review the valuations
of our private debt and equity investments. If and when we determine that the
net realizable value of these investments is less than our carrying value, we
will reflect the reduction as an investment loss. Net interest,
dividends, and other revenue (net of interest expense) decreased 3% from $9.7
million in 2000 to $9.4 million in 2001 primarily due to lower cash balances and
lower interest rates, offset by increased other income. Total expenses
increased 11% from $158.6 million in 2000 to $176.4 million in 2001 due
primarily to an increase in business development and professional services and,
to a lesser extent, restructuring costs associated with personnel reductions and
facility consolidation and software impairment charges of capitalized software
related to fbr.com and other operating expenses offset by a decrease in variable
compensation expense. Compensation and
benefits expense decreased 2% from $109.8 million in 2000 to $108.1 million in
2001 due to a decrease of $10.6 million in variable compensation primarily
related to TVP and, to a lesser extent, a decrease of $5.5 million of executive
officer bonus compensation. These decreases were offset by an increase in fixed
compensation from $27.7 million in 2000 to $41.2 million in 2001 associated with
the hiring of investment banking, research, sales and trading professionals and
as a result of adding more than 50 employees with the acquisition of MMA/Rushmore.
Business
development and professional services increased 51% from $19.2 million in 2000
to $28.9 million in 2001 primarily due to an increase in consulting expenses
associated with recruiting investment banking, research, sales and trading
professionals and travel associated with the increase in underwriting activity
and, to a lesser extent, sub-advisory expenses for some asset management
vehicles. Clearing and
brokerage fees increased 15% from $6.2 million in 2000 to $7.1 million in 2001
primarily due to an increase in market-making activity and agency transactions.
As a percentage of institutional brokerage revenue, clearing and brokerage fees
increased from 12% in 2000 to 13% in 2001, due primarily to $6.6 million of
trading gains in 2000 and pressure on spread margins from the over-the-counter
business. Occupancy and
equipment expense increased 15% from $9.5 million in 2000 to $10.9 million in
2001 due to new offices and more equipment offset by the closing of
non-profitable offices at the end of the year. Depreciation and
amortization expense remained stable, decreasing $0.1 in 2001 compared to 2000. Communications
expense increased 14% from $5.1 million in 2000 to $5.8 million in 2001
primarily due to expenses in connection with the MMA/Rushmore business, acquired
in April 2001. Other operating
expenses increased 31% from $7.2 million in 2000 to $9.4 million in 2001
primarily due to expenses in connection with the MMA/Rushmore business, acquired
in April 2001, including $1.0 million of amortization related to the capitalized
costs of the acquired asset management contracts. These contracts, at the
date of closing, related to the management of $933.4 million of net assets under
management. 43 Restructuring and
software impairment charges of $5.2 million recorded in 2001 relate to the $2.7
million accelerated write-off of capitalized fbr.com software costs due to our
determining such capitalized costs were impaired during the third quarter, and
the $2.4 million of restructuring costs recorded in the fourth quarter related
to cost containment measures announced in October, 2001 associated with
personnel reductions and facility consolidation. Comparison of the Years Ended December 31, 2000 and 1999
Total revenues increased
30% from $139.0 million in 1999 to $180.9 million in 2000 primarily due to an
increase in asset management revenue, particularly incentive income related to
TVP, net trading gains attributed to the volatile technology sector in the first
half of 2000 and increased corporate finance revenue primarily in the technology
sector. Underwriting
revenue decreased 7% from $22.6 million in 1999 to $21.1 million in 2000. The
decrease is attributed to the decline in the size of our proportionate fee and
fewer completed deals attributed to the continuation of lower prices and reduced
activity in the markets for securities of companies in the financial services
and real estate sectors, two of our areas of focus. During 2000, we managed 22
public offerings raising $4.0 billion and generating $21.1 million in revenues.
During 1999, we managed 23 public offerings raising $2.0 billion and generating
$22.6 million in revenues. The average size of underwritten transactions for
which we were a lead or co-manager increased from $85.4 million in 1999 to
$184.0 million in 2000. Corporate finance
revenue increased 40% from $22.5 million in 1999 to $31.4 million in 2000. This
increase was primarily due to a 55% increase in M&A and other advisory
assignments revenue primarily in the technology sector from $14.5 million in
1999 to $22.5 million in 2000. In 2000, we completed 15 private placement
transactions compared to 11 in 1999. In 2000, the average revenue earned per M&A
and advisory assignments was $1.5 million compared to $1.2 million in 1999.
Additionally, in 2000, we exercised warrants that had been previously received
as part of a private capital raising transaction resulting in a gain of $1.5
million in 2000 compared to $3.9 million in 1999 reflected in the investment
gains line under investment banking. Institutional
brokerage revenue from principal transactions increased 43% from $22.1 million
in 1999 to $31.6 million in 2000. We recorded trading gains of $6.9 million in
2000 compared to $(2.2) million of trading losses in 1999. Institutional
brokerage agency commissions increased 45% from $15.0 million in 1999 to $21.8
million in 2000. This increase was primarily due to increased customer
trading, particularly in the technology sector, due to, among other things,
volatility in the markets. In addition, we believe we have achieved
greater penetration of institutional accounts through broader research coverage
and sales and trading services. Asset management
base management fees increased 3% from $9.4 million in 1999 to $9.7 million in
2000 primarily due to additional fees earned as a result of increased assets
under management. Asset management
incentive allocations and fees (excluding the technology sector) remain stable
increasing from $1.6 million in 1999 to $1.7 million in 2000. Asset management
net investment income (loss) (excluding the technology sector) increased from
$(5.3) million in 1999 to $10.8 million in 2000. Net investment income in 2000
includes: $7.1 million of net investment income from our investment in FBR-Asset,
$8.7 million of net investment income from investments in proprietary investment
partnerships, offset by $(2.0) million in write-downs of our private equity and
private debt investments and $(2.8) million of "other than temporary" unrealized
depreciation related to our available-for-sale securities. Net investment loss
in 1999 includes: $(6.4) million of "other than temporary"
unrealized depreciation related to our available-for-sale securities that was
previously deducted from shareholders' equity, offset by $1.1 million of net
investment income from investments in proprietary investment partnerships. Asset management
technology sector net investment and incentive income increased 14% from $36.4
million in 1999 to $41.6 million in 2000. Technology sector net investment
and incentive income in 2000 included $46.7 million of net investment and
incentive income from investments in venture capital proprietary investment
partnerships, which was almost entirely attributable to TVP and $1.5 million of
net investment income from direct technology sector investments offset by $(5.9)
million in write-downs of our technology sector private equity investments.
Technology sector net investment and incentive income in 1999 included $38.3
million of net investment and incentive income from TVP offset by net investment
loss of $(1.8) million in write-downs of our private equity investments.
Net interest,
dividends and other revenue (net of interest expense) decreased 15% from $9.4
million in 1999 to $8.0 million in 2000. This decrease is primarily due to a
decrease in our trading inventory from which dividend income may be earned.
During 1999, we recorded $1.7 million of dividend income compared to $0.9
million in 2000 due to the decrease in inventory. Interest income (net of
interest expense) increased from $6.5 million in 1999 to $7.1 million in 2000
due to reduced interest expense on our trading accounts. 44 Total expenses
increased 9% from $145.9 million in 1999 to $158.6 million in 2000 due primarily
to an increase in compensation and benefits expense described below. Compensation and
benefits expense increased 12% from $98.4 million in 1999 to $109.8 million in
2000. This increase was due primarily to increased compensation associated with
our technology sector venture capital funds and, to a lesser extent, an increase
in investment banking compensation and executive officer compensation. The
fund management team for the venture capital funds has an agreement with us to
receive a percentage of the incentive allocations. For TVP, the fund
management team earns 60% of the incentive allocations and this amount is
recorded as compensation expense at the time the incentive allocations are
recorded. Business
development and professional services decreased 19% from $23.6 million in 1999
to $19.2 million in 2000 primarily due to a decrease in advertising and other
promotional expenses incurred in 1999 related to fbr.com. Clearing and
brokerage fees increased 32% from $4.7 million in 1999 to $6.2 million in 2000
due to an increase in the volume of sales and trading activity. As a
percentage of institutional brokerage revenue, clearing and brokerage fees
decreased from 13% in 1999 to 12% in 2000 due to the increase in principal
transactions, in particular $6.9 million of trading gains in 1999. Occupancy and
equipment expense increased 42% from $6.7 million in 1999 to $9.5 million in
2000 primarily due to the expansion of office space and an increase in
depreciation and amortization expense related to software, computer and
telecommunications equipment for fbr.com's operations. Depreciation and
amortization expense increased $ 2.1 million in 2000 compared to 1999. Communications
expense increased 19% from $4.3 million in 1999 to $5.1 million in 2000 due to
increased Internet and data communications backbone redundancy and increasing
voice traffic. Other operating
expenses were fairly stable during 2000 increasing only 3% from $6.9 million in
1999 to $7.1 million in 2000. Liquidity and Capital Resources Historically, we have
satisfied our liquidity and regulatory capital needs through three primary
sources: (1) internally generated funds; (2) equity capital contributions; and
(3) credit provided by banks, clearing brokers, and affiliates of our principal
clearing broker. We have used, and may continue to use temporary subordinated
loans in connection with regulatory capital requirements to support our
underwriting activities. At December 31, 2001,there was $21.1 million
outstanding, of which $10.0 million was in the form of a subordinated loan, $8.0
million was on margin and $2.0 million in other secured loans. We have no material long-term debt other than acquisition debt
of $5.7 million. Our principal
assets consist of cash and cash equivalents, receivables, securities held for
trading purposes and long-term investments. As of December 31, 2001, liquid
assets consisted primarily of cash and cash equivalents of $46.2 million and a
receivable for cash on deposit with FBRC's clearing broker of $44.6 million, for
a total of $90.8 million. Cash equivalents consist primarily of money market
funds invested in debt obligations of the U.S. government. We also held $15.7
million in marketable securities. As of December 31,
2001, we had $10.0 million outstanding under a $40.0 million subordinated
revolving loan from an affiliate of FBRC's clearing broker that is allowable for
net capital purposes. We have until December 22, 2002 to repay the amount
outstanding under this agreement. The agreement had expired as of December
31, 2001, and we are currently negotiating a proposal to renew the
subordinated credit line. Additionally, during January, 2002, we signed a
term sheet for a $20 million working capital line of credit with a commercial
bank. Long-term
investments consist primarily of FBR-Asset, investments in managed partnerships,
including hedge, private equity and venture capital funds in which we serve as
managing partner, our investment in Capital Crossover Partners (a partnership we
do not manage), available-for-sale securities and our investment in a long-term
debt instrument of a privately held company. Although our investments in hedge
and venture capital funds and other limited partnerships are for the most part
illiquid, the underlying investments of such entities are, in the aggregate,
mostly publicly-traded, liquid equity and debt securities, some of which may be
restricted due to contractual "lock-up" requirements. 45 We are a financial
holding company under the Gramm-Leach-Bliley Act of 1999, or GLB Act, and are
therefore subject to supervision, regulation and examination by federal banking
regulatory agencies. The GLB Act significantly changed the regulatory structure
and oversight of the financial services industry. The GLB Act amended the Bank
Holding Company Act, or BHC Act, to permit a qualifying bank holding company,
called a financial holding company (an "FHC"), to engage in a full range of
financial activities, including banking, insurance, and securities activities,
as well as merchant banking and additional activities that are "financial in
nature" or "incidental" to such financial activities. In order for a bank
holding company to qualify as an FHC, all of its subsidiary depository
institutions must be "well-capitalized" and "well-managed" and must also
maintain at least a "satisfactory" rating under the Community Reinvestment Act.
In March 2001, the Federal Reserve Board (the "Board") approved our application
to be a FHC and we are now permitted to engage in financial activities as
permitted by the BHC Act, as amended. Under the GLB Act, the Board serves as the
"umbrella" superviser for FHCs and has the power to supervise, regulate and
examine FHCs and their non-banking affiliates, subject to statutory functional
regulation provisions. FBRC and FBRIS, as
broker-dealers, are registered with the Securities and Exchange Commission
("SEC") and are members of the National Association of Securities Dealers, Inc.
Additionally, FBRIL is registered with the Securities and Futures Authority ("SFA")
of the United Kingdom. As such, they are subject to the minimum net
capital requirements promulgated by the SEC and SFA. As of December 31, 2001,
FBRC was required to maintain minimum regulatory net capital of $2.5 million and
had total regulatory net capital of $35.4 million, which was $32.9 million in
excess of its requirement. As of December 31, 2001, all of our broker/dealers
were required to maintain minimum regulatory net capital of $3.6 million and had
total regulatory net capital of $36.5 million, which was $32.9 million in excess
of their requirement. Regulatory net capital requirements increase when the
broker/dealers are involved in underwriting activities based upon a percentage
of the amount being underwritten. On April 1, 2001,
we completed the acquisition of Money Management Associates, LP ("MMA") and
Rushmore Trust and Savings, FSB ("Rushmore"). MMA was a privately held
investment adviser with $933.4 million in assets under management as of March
31, 2001. Together, MMA and Rushmore were the investment adviser, servicing
agent or administrator for more than 20 mutual funds. Upon closing, Rushmore was
re-chartered as a national bank and was named FBR National Bank & Trust ("FBR
National Bank"). The FBR National Bank offers mutual fund servicing (custody,
transfer agency, shareholder servicing and mutual fund accounting) and
traditional banking services (lending, deposits, cash management and trust
services). Under the terms of the agreement, we acquired MMA/Rushmore for $17.5
million in cash at closing and a $9.7 million non-interest-bearing installment
note payable over a ten-year period. FBR National
Bank is subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory-and possibly additional discretionary-actions by
regulators that, if undertaken, could have a direct material effect on the
financial statements of FBR National Bank. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, FBR National Bank's
assets, liabilities, and certain off-balance sheet items are calculated under
regulatory accounting practices. FBR National Bank's capital levels and
classification are also subject to qualitative judgments by the regulators with
regard to components, risk weightings, and other factors. Quantitative
measures established by regulation to ensure capital adequacy require FBR
National Bank to maintain minimum capital levels and ratios of tangible and core
capital (defined in the regulations) to total adjusted assets (as defined), and
of total capital (as defined) to risk-weighted assets (as defined).
Management believes, as of December 31, 2001, FBR National Bank meets all
capital adequacy requirements to which it is subject. As of
December 31, 2001, the most recent notification from the Office of the
Comptroller of Currency (OCC) categorized FBR National Bank as
"well-capitalized" under the regulatory framework for prompt corrective action.
To be categorized as well capitalized, FBR National Bank must maintain minimum
tangible core and risk-based ratios. There are no conditions or events
since that notification that management believes have changed FBR National
Bank's "well-capitalized" status. During 2001,
we repurchased five million shares of Class B common stock from our former
president and Co-CEO for $5.50 per share. The shares were converted to
Class A common stock and sold to other Company employees at the same price.
Upon settlement of the repurchase and sales transactions we received 20% ($1.10
per share) of the purchase price in cash from the employees, and received
five-year, limited recourse promissory notes from the employees with interest
accruing at 6.5% accreting to principal for the remaining purchase price. Each
employee's note is collatoralized by all of the stock purchased by that employee
under the plan. 46 For
accounting purposes, the portion of the employee share purchase financed by us
(80%) is considered a stock option, and deducted from shareholders' equity.
These shares are deducted from shares outstanding, similar to treasury stock, in
computing book value and earnings per share. As a result, both the $22,706
financed (including accrued interest) by us and the 4,000,000 common shares
related to the financing are reflected as a receivable in shareholders' equity.
As the employees repay the loans, shareholders' equity and shares outstanding
will increase. In addition, the interest earned on the employee loans is
added to paid-in-capital and excluded from net income. We believe that
our current level of equity capital, including funds generated from operations,
are adequate to meet our liquidity and regulatory capital requirements and other
activities. We may, however, seek debt or equity financing, in public or private
transactions, or otherwise re-deploy assets, to provide capital for corporate
purposes and/or to fund strategic business opportunities, including possible
acquisitions, joint ventures, alliances or other business arrangements which
could require substantial capital outlays. Our policy is to evaluate strategic
business opportunities, including acquisitions and divestitures, as they arise.
As of December 31,
2001, we had $18.0 million of unfunded commitments to various investment
partnerships that may be called over the next ten years. We constantly
review our capital needs and sources, the cost of capital and return on equity,
and we seek strategies to provide favorable returns on capital. In evaluating
our anticipated capital needs and current cash resources during 1998, our Board
of Directors authorized a share repurchase program of up to 2,500,000 shares of
our company's Class A Common Stock. Since announcing the share repurchase
program, we repurchased 1,468,027 shares as of December 31, 2001, leaving
1,031,973 additional shares authorized for repurchase. Of the total shares
repurchased, 658,565 have been reissued to employees pursuant to our Employee
Stock Purchase Plan. As of December 31,
2001, we had net operating losses ("NOL") for tax purposes of $43.6 million that
expire through 2020. We maintain a valuation allowance related to the NOL and
net deferred tax asset, in general because, based on the weight of available
evidence, it is more likely than not that a portion of the net deferred tax
assets may not be realized. As a result of recording the valuation allowance,
based on current evidence, we estimate that future income tax provision recorded
in the Consolidated Statement of Operations will be calculated excluding
approximately $57.2 million in pre-tax income. High Yield and Non-Investment Grade Debt and Preferred
Securities We underwrite, trade,
invest in, and make markets in high-yield corporate debt securities and
preferred stock of below investment grade-rated companies. For purposes of this
discussion, non-investment grade securities are defined as preferred securities
or debt rated BB+ or lower, or equivalent ratings, by recognized credit rating
agencies, as well as non-rated securities or debt. Investments in non-investment
grade securities generally involve greater risks than investment grade
securities due to the issuer's creditworthiness and the comparative illiquidity
of the market for such securities. Our portfolio of such securities (excluding
those in which we may have an indirect interest through FBR-Asset, proprietary
investment partnerships or otherwise) at December 31, 2001 and 2000 is included
in trading securities and long-term investments and had an aggregate fair value
of approximately $9.2 million and $25.5 million, respectively. Our trading and
investment portfolios may, from time to time, contain concentrated holdings of
selected issues. Our largest, un-hedged, non-investment grade securities
position was $7.5 million and $10.0 million at December 31, 2001 and 2000. Critical Accounting Policies Our significant
accounting policies are described in Note 2 to of the Consolidated Financial
Statements. We believe our most critical accounting policies (a critical
accounting policy being one that is both very important to the portrayal of
financial condition and results of operations and requires management's most
difficult, subjective or complex judgments) include: 1) valuation methodologies
applied by the general partners to the securities of the partnerships they
manage, 2) recognition of incentive allocation revenue, 3) valuation allowance
determination related to deferred taxes and 4) the impairment assessments we
apply to our long-term investments in marketable equity securities. The investment
partnerships that we manage record their investments in securities at fair
value. Certain investments consist of equity investments in securities of
development-stage and early-stage privately and publicly held companies. The
disposition of these investments may be restricted due to the lack of a ready
market (in the case of privately held companies) or due to contractual or
regulatory restrictions on disposition (in the case of publicly held companies).
In addition, these securities may represent significant proportions of the
issuer's equity and carry special contractual privileges not available to other
security holders. As a result of these factors, precise valuation for the
restricted public securities and private company securities is a matter of
judgment, and the determination of fair value must be considered only an
approximation and may vary from the amounts that could be realized if the
investment were sold. We receive
incentive allocations based on the operating results of our managed partnerships.
Incentive allocations represent a share of the gains in the partnerships, and
are based on our partnership capital account, assuming the partnership were
liquidated on the balance sheet date. Incentive allocations are based on
unrealized gains and losses, and could vary significantly in the future based
upon the ultimate realization of the gains or losses. We may, therefore, reverse previously
recognized incentive allocations in future periods. Deferred tax
assets and liabilities represent the differences between the financial statement
and income tax bases of assets and liabilities, using enacted tax rates. The
measurement of net deferred tax assets is adjusted by a valuation allowance if,
based on our evaluation, it is more likely than not that they will not be
realized. We have provided a valuation allowance against our deferred tax assets
based on our ongoing assessment of their future realization. This allowance
could be reversed in future periods if we determine that such deferred tax
assets could be realized. We evaluate our
long-term investments in marketable equity securities for "other than temporary"
impairment. If it is determined that an investment is impaired then the amount
that the fair value is below its current basis is recorded as an impairment
charge and recorded through earnings as opposed to through other comprehensive
income, as other temporary changes in fair value would be. The value of our
long-term investments in marketable equity securities can fluctuate
significantly. Generally, when a long-term marketable equity security's value
has been below its current basis for an extended period of time we will record
an impairment charge. Market and Business Risk We monitor market and
business risk, including credit risk, operations, liquidity, compliance, legal,
reputational and equity ownership risk through a number of control procedures
designed to identify and evaluate the various risks to which our businesses and
investments are exposed. We have established various committees to assess and to
manage risk associated with our investment banking, merchant banking and other
activities. We review, among other things, business and transactional risks
associated with investment banking potential clients and engagements. We seek to
manage the risks associated with our investment banking and merchant banking
activities by review and approval of transactions by the relevant committee,
prior to accepting an engagement or pursuing a material investment transaction. We believe that
our primary risk exposure is to equity and debt price changes and the resulting
impact on our marketable trading and long-term investments and unrealized
incentive income as well as the risk to FBR-Asset's spread income posed by
interest changes. Direct market risk exposure to changes in foreign exchange
rates is not material. Equity and debt price risk is managed primarily through
the monitoring and reporting of capital exposure to various issuers. FBR-Asset
seeks to mitigate interest risk by managing the duration of their assets and
liabilities. 47 Marketable and Trading Securities We
generally attempt to limit exposure to market risk on securities held as a
result of our daily trading activities by limiting our intra-day and overnight
inventory of trading securities to that needed to provide the appropriate level
of liquidity in the securities for which we are a market maker. At December 31,
2001, the fair value of our trading securities was $15.7 million in long
positions and $13.4 million in short positions, for a net long position of $2.3
million. The net potential loss in fair value at December 31, 2001, using a 10%
hypothetical decline in reported value of long positions (offset by a 10%
hypothetical increase in reported value of short positions) was $0.2 million. Long-Term Investments Our long-term investments
consist of investments in FBR-Asset, hedge, venture capital and private equity
investment partnerships that we manage, direct debt and equity investments in
privately held companies and direct investments in equity securities of public
companies. As of
December 31, 2001, a majority, by value, of the underlying assets of the
investment partnerships and FBR-Asset were equity securities of domestic,
publicly traded companies or, in the case of FBR-Asset, mortgage-backed
securities. These underlying investments are marked to market, subject to
liquidity discounts in the case of securities that are subject to contractual
"lock-up" requirements or regulatory restrictions (including Rule 144) or
otherwise not readily marketable, and we record our proportionate share of
unrealized gains and losses. To the extent the underlying investments in the
investment partnerships, FBR-Asset and direct investments are not marketable
securities, they are valued at estimated fair values. In 2001, we recorded net
realized and unrealized gains from our investments (other than technology sector
funds) of $9.5 million, incentive income from realized and unrealized gains from
our investments (other than technology sector funds) of $3.6 million and a net
investment and incentive loss in our technology sector funds of $(18.1) million.
We also maintain, as a separate component of shareholders' equity, $3.2 million
of accumulated other comprehensive income, representing $0.6 million of
unrealized gains on our direct investments and $2.6 million of unrealized gains
related to our proportionate share of FBR-Asset's unrealized gains.
In 2001, we announced that our then President and Co-Chief Executive Officer, W.
Russsell Ramsey, would launch his own investment fund, Capital Crossover
Partners ("CCP"). On December 31, 2001, Mr. Ramsey resigned as our
President and Co-Chief Executive Officer; he remains a director of our company.
We are an investor in CCP and have a capital commitment to the fund of $15
million, of which $6 million was paid in to the fund during 2001. We made our
investment in CCP based on our assessment of the potential return on the
investment and because we believed it presented us with the potential for
certain strategic relationships that could be beneficial to our business.
In 2001, in connection with services provided to CCP, we earned fees and are
entitled to receive three points of carried interest in CCP.
The fees we have received and the carried interest we are entitled to receive
were determined based on negotiations with Mr. Ramsey. We do not control CCP or
have influence over the management or investment strategy of CCP. As of
December 31, 2001, we earned fees of $1.1 million for services provided to CCP.
We did not record any income in connection with our carried interest in CCP
during 2001. We classify our investment in CCP in our technology sector
investments based on CCP's representations to us in its offering memorandum and
on its report to us on its investment as of December 31, 2001. We account
for the investment under the equity method solely based on the size of our
investment in CCP relative to the total size of the fund, approximately 13 % at
December 31, 2001. The following
chart shows the allocation of our long-term investments as stated on the
December 31, 2001 and 2000 balance sheets, by sector and by managed fund and
also shows, as of December 31, 2001, the allocation of long-term investments in
publicly traded and private securities. Managed funds are categorized to an
industry sector by the value of the majority of their investments. In addition,
from time to time, we implement risk management strategies, the value of which
may not be included in the balance sheet line for long-term investments.
December 31, 2001
December 31, 2000
Public Private Total % Total % $ 19,000 $ - $ 19,000 15.8% $15,340 10.8% 91 1,787 1,878 1.6% 3,668 2.6% - 867 867 0.7% 1,659 1.2% 253 1,266 1,519 1.3% 1,580 1.1% 1,637 - 1,637 1.3% 1,414 1.0% 20,981 3,920 24,901 20.7% 23,751 16.7% 40,743 1,716 42,459 35.4% 30,054 21.0% 3,198 242 3,440 2.9% 3,305 2.3% 43,941 1,958 45,900 38.3% 33,359 23.3% 64,922 5,878 70,800 59.0% 57,110 40.0% 219 849 1,068 0.9% 23,913 16.7% 454 2,317 2,771 2.3% 6,418 4.5% - 3,148 3,148 2.6% 3,724 2.6% 77 5,568 5,645 4.7% 4,658 3.3% 73 - 73 0.1% 652 0.4% 144 2,809 2,953 2.4% 1,383 1.0% 86 - 86 0.1% 10,494 7.3% 1,053 14,691 15,744 13.1% 51,242 35.8% 6,000 - 6,000 5.0% - - 7,053 14,691 21,744 18.1% 51,242 35.8% - 7,500 7,500 6.3% 17,837 12.5% 5,613 - 5,613 4.7% 4,920 3.4% 11,415 - 11,415 9.6% 10,320 7.2% 2,138 189 2,327 1.9% 1,403 1.0% 387 196 583 0.5% 118 0.1% 19,553 385 19,938 16.6% 16,761 11.7% $91,528 $28,454 $119,982 100.0% $142,950 100.0% Amount includes loans of $1,369 and
$2,428 as of December 31, 2001 and 2000, respectively, made by us to FBR CoMotion
Venture Capital I, LP. The asset value net of loans was $1,779 and $1,296
as of December 31, 2001 and 2000, respectively. Represents private debt of one issuer
with a face amount of $7,500 and private debt of two issuers with a face amount
of $17,837 as of December 31, 2001 and 2000, respectively. As of December 31,
2001, the recorded value of our long-term investment securities was $120.0
million. The net potential loss in fair value, using a 10% hypothetical decline
in reported value, was $12.0 million. In addition, the hedge funds and
other partnerships that we manage through subsidiaries as general partner or
managing member had $114 million of liabilities as of December 31, 2001,
primarily margin debt, not reflected on our balance sheet. In addition,
FBR-Asset had repo debt of $1.1 billion as of December 31, 2001. FBR-Asset
is a separate corporation that we manage under an agreement between FBR-Asset
and our subsidiary FBRIM. We are not a general partner or managing member
of FBR-Asset. We neither directly, nor indirectly, guarantee any of these
liabilities or other obligations of the partnerships or FBR-Asset.
We believe that our maximum potential exposure to a catastrophic loss (defined
for these purposes as a 40% decline in the asset value of each partnership)
would not exceed the value of our investment in these entities. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required
by Item 8 is set forth in Item 14 of this report. 49 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF
THE REGISTRANT The information regarding
directors required by this Item 10 is incorporated by reference to our
definitive Proxy Statement for our annual meeting of shareholders to be held on
May 30, 2002 under the headings "Proposal No. 1-Election of Directors" and
"Section 16(a) Beneficial Ownership Reporting Compliance." Information regarding
executive officers found under the Heading "Executive Officers of the
Registrant" in Part I hereof is also incorporated by reference into this Item
10. ITEM 11. EXECUTIVE COMPENSATION The information required
by this Item 11 is incorporated by reference to our definitive Proxy Statement
for our annual meeting of shareholders to be held on May 30, 2002 under the
heading "Executive Compensation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT The information required
by this Item 12 is incorporated by reference to our definitive Proxy Statement
for our annual meeting of shareholders to be held on May 30, 2002 under the
heading "Security Ownership of Certain Beneficial Owners and Management." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS The information required
by this Item 13 is incorporated by reference to our definitive Proxy Statement
for our annual meeting of shareholders to be held on May 30, 2002 under the
heading "Certain Relationships and Related Transactions." PART IV ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES,
AND REPORTS (a) 1. Financial Statements. The following
consolidated financial statements for the year ended December 31, 2001, filed
as part of this Form 10-K, are incorporated by reference into this Item 14: (b) On October 25, 2001, we filed a Form
8-K containing our third quarter 2001 financial results, an Unaudited
Financial and Statistical Supplement and a Long-Term Investment Matrix. 2. All schedules are omitted
because they are not required or because the information is shown in the
financial statements or notes thereto. 50 3. Exhibits identified by "*"
below are on file with the SEC as part of our Registration Statement on Form
S-1, as amended, No. 333-39107, and are incorporated herein by reference.
Exhibits identified by "**" below are on file with the SEC as part of our 1998
Annual Report on Form 10-K, and are incorporated herein by reference. Exhibits
identified by "***" below are on file with the SEC as part of our 1999 Annual
Report on Form 10-K, and are incorporated herein by reference. EXHIBIT INDEX Exhibit Exhibit Title 51 Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized. Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated. Signature Title Date March 29, 2002 March 29, 2002 March 29, 2002 March 29, 2002 March 29, 2002 March 29, 2002 52 FINANCIAL STATEMENTS OF FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. Index to
Consolidated Financial Statements F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Friedman, Billings, Ramsey Group,
Inc.: We have audited the accompanying
consolidated balance sheets of Friedman, Billings, Ramsey Group, Inc. (a
Virginia corporation) as of December 31, 2001 and 2000, and the related
consolidated statements of operations, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 2001. These
financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits in
accordance with auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated
financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Friedman, Billings, Ramsey
Group, Inc. as of December 31, 2001 and 2000, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted
in the United States. /s/ Arthur
Andersen LLP Vienna, Virginia F-2 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. December 31, 2001
2000 (Dollars in thousands, ASSETS Cash
and cash equivalents $ 46,246 $ 52,337 Receivables: Investment
banking 3,464 4,696 Asset
management fees 3,604 1,806 Affiliates 2,209 1,849 Other. 4,352 2,744 Due
from clearing broker 44,621 11,840 Marketable
and trading securities, at market value 15,706 18,447 Bank
investment securities 8,142 -
Long-term
investments 119,982 142,950 Bank
loans, net 12,459 -
MMA
acquired management contracts 18,729 -
Building, furniture,
equipment, software and leasehold improvements, net of accumulated 9,203 10,173 Prepaid
expenses and other assets 3,241 5,377 Total
assets $ 291,958 $ 252,219 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Trading
account securities sold but not yet purchased, at market value $ 13,377 $ 930 Accounts
payable and accrued expenses 19,179 11,348 Accrued
compensation and benefits 27,775 22,849 Bank
deposits 19,457 -
Deferred
tax liability - 1,760 Short-term
loans payable 21,165 -
Long-term
secured loan 5,694 776 Total
liabilities 106,647 37,663 Commitments
and contingencies (Note 12) - -
Shareholders'
Equity: Preferred
Stock, $0.01 par value, 15,000,000 shares authorized, none issued and - -
Class
A Common Stock, $0.01 par value, 150,000,000 shares authorized, 235 175 Class
B Common Stock $0.01 par value, 100,000,000 shares authorized, 269 329 Additional
paid-in capital 210,703 210,164 Employee
stock loan receivable including accrued interest (4,000,000 shares) (22,706) -
Treasury
stock, at cost, 809,462 and 985,170 shares, respectively (5,906) (7,188) Accumulated
other comprehensive income (loss) 3,226 (1,128) Retained
(deficit) earnings (510) 12,204 Total
shareholders' equity 185,311 214,556 Total
liabilities and shareholders' equity $ 291,958 $ 252,219 The accompanying
notes are an integral part of these consolidated statements. F-3 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2001 2000 1999 (Dollars in thousands except per share amounts) Revenues: Investment
banking: Underwriting $ 47,853 $ 21,086 $ 22,642 Corporate
finance 28,534 31,404 22,541 Investment
gains 6,762 1,453 3,853 Institutional
brokerage: Principal
transactions 26,330 32,319 22,058 Agency
commissions 27,084 21,084 14,988 Asset
management: Base
management fees 19,744 9,719 9,409 Incentive
allocations and fees 3,628 1,673 1,577 Net
investment income (loss) 9,532 10,843 (5,268) Technology
sector net investment and incentive income (loss) (18,100) 41,614 36,398 Interest,
dividends and other 9,422 9,695 10,768 Total
revenues 160,789 180,890 138,966 Expenses: Compensation
and benefits 108,112 109,768 98,424 Business
development and professional services 28,879 19,229 23,582 Clearing
and brokerage fees 7,087 6,207 4,693 Occupancy
and equipment 10,852 9,544 6,674 Communications 5,832 5,085 4,323 Interest
expense 1,083 1,665 1,323 Other
operating expenses 9,415 7,147 6,918 Restructuring
and software impairment charges 5,151 - - Total
expenses 176,411 158,645 145,937 Net
income (loss) before taxes and extraordinary gain (15,622) 22,245 (6,971) Income
tax provision (benefit) (1,760) 4,163 - Net
income (loss) before extraordinary gain (13,862) 18,082 (6,971) Extraordinary
gain 1,148 - - Net
income (loss) $ (12,714) $ 18,082 $ (6,971) Basic
earnings (loss) per share before extraordinary gain. $ (0.29) $ 0.37 $ (0.14) Diluted
earnings (loss) per share before extraordinary gain $ (0.29) $ 0.36 $ (0.14) Basic
earnings (loss) per share $ (0.27) $ 0.37 $ (0.14) Diluted
earnings (loss) per share $ (0.27) $ 0.36 $ (0.14) Basic
weighted average shares outstanding 47,465,527 49,161,799 48,872,191 Diluted
weighted average shares outstanding 47,465,527 50,682,582 48,872,191 The accompanying
notes are an integral part of these consolidated statements. F-4 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. CONSOLIDATED STATEMENTS OF CHANGES
Class A Class A Class B Class B Additional Employee Treasury Accumulated Retained Total Comprehensive Balances, December 31, 1998 13,716,571 $ 137 36,312,429 $ 363 $ 208,525 $ - $ (7,081) $ (16,135) $ 1,093 $ 186,902 Net
loss - - - - - - - - (6,971) (6,971) $ (6,971) Conversion
of Class B shares to Class A shares 512,700 5 (512,700) (5) - - - - - - Repurchase
of treasury stock - - - - - - (2,712) - - (2,712) Issuance
of treasury stock - - - - (345) - 1,452 - - 1,107 Issuance
of Class A common stock 74,755 1 - - 498 - - - - 499 Other
comprehensive income: - Unrealized
change in investment securities - - - - - - - 10,144 - 10,144 10,144 Comprehensive
income - - - - - - - - - - $ 3,173 Balances, December 31, 1999 14,304,026 143 35,799,729 358 208,678 - (8,341) (5,991) (5,878) 188,969 Net
income - - - - - - - - 18,082 18,082 $ 18,082 Conversion
of Class B shares to Class A shares 2,889,700 29 (2,889,700) (29) - - - - - - Issuance
of treasury stock - - - - (33) - 1,153 - - 1,120 Issuance
of Class A common stock 261,680 3 - - 1,519 - - - - 1,522 Other
comprehensive income: - Unrealized
change in investment securities - - - - - - - 4,863 - 4,863 4,863 Comprehensive
income - - - - - - - - - - $ 22,945 Balances, December 31, 2000 17,455,406 175 32,910,029 329 210,164 - (7,188) (1,128) 12,204 214,556 Net
income - - - - - - - - (12,714) (12,714) $ (12,714) Conversion
of Class B shares to Class A shares 5,964,000 60 (5,964,000) (60) - - - - - - Issuance
of treasury stock - - - - (405) - 1,282 - - 877 Issuance
of Class A common stock 48,997 - - - 238 - - - - 238 Purchase
of stock (employee stock purchase and loan plan) - - - - (27,500) - - - - (27,500) Sale
of stock (employee stock purchase and loan plan) - - - - 27,500 (22,000) - - - 5,500 Other
comprehensive income: - - Unrealized
change in investment securities - - - - - - - 4,354 - 4,354 4,354 Comprehensive
loss - - - - - - - - - - $ (8,360) Balances, December 31, 2001 23,468,403 $ 235 26,946,029 $ 269 $ 210,703 $ (22,706) $ (5,906) $ 3,226 $ (510) $ 185,311 The
accompanying notes are an integral part of these consolidated statements. F-5 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001 2000 1999 Cash
flows from operating activities: Net
income (loss) $(12,714) $18,082 $ (6,971) Non-cash
items included in earnings- 35,599 (16,720) (33,269) Depreciation,
amortization and software impairment 8,711 4,886 2,749 Extraordinary
gain (1,148) - - Income
tax provision-deferred (1,760) 4,163 - Other. 439 - (321) Changes
in operating assets: Receivables- Investment
banking 1,232 (423) (1,198) Asset
management fees (1,798) 1,416 1,679 Income
taxes - - 8,734 Affiliates (360) (510) 5,895 Other
3,239 231 291 Due
from clearing broker (32,781) 1,632 (2,751) Marketable
and trading securities 2,741 (1,560) 7,013 Prepaid
expenses and other assets 1,034 (2,228) (52) Changes
in operating liabilities: Trading
account securities sold but not yet purchased 12,447 (2,099) 137 Accounts
payable and accrued expenses 6,867 2,479 643 Accrued
compensation and benefits 4,926 (1,281) 18,945 Net
cash provided by operating activities
26,674 8,068 1,524 Cash
flows from investing activities: MMA/Rushmore
acquisition (17,500) - - Cash
acquired from MMA/Rushmore acquisition 9,740 - - Bank
investment securities, net 5,107 - - Bank
loans, net (10,811) - - Purchases
of fixed assets, net (2,638) (3,751) (7,401) Proceeds
from long-term investments, net (10,856) 2,218 4,451 Net
cash used in investing activities (26,958) (1,533) (2,950) Cash
flows from financing activities: Purchase
of stock (employee stock purchase and loan plan) (27,500) - - Sale
of stock (employee stock purchase and loan plan) 5,500 - - Borrowing
on short-term loans 20,195 - - Net
decrease in bank deposits (4,341) - - Repayments
on short-term loans (776) (583) (552) Proceeds
from issuance of common stock 238 1,489 499 Purchases
of treasury stock - - (2,712) Issuance
of treasury stock 877 1,153 1,107 Net
cash provided by (used in) financing activities (5,807) 2,059 (1,658) Net
increase (decrease) in cash and cash equivalents (6,091) 8,594 (3,084) Cash
and cash equivalents, beginning of year 52,337 43,743 46,827 Cash
and cash equivalents, end of year. $46,246 $52,337 $43,743 The accompanying
notes are an integral part of these consolidated statements. F-6
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND NATURE OF OPERATIONS:
Organization Friedman, Billings, Ramsey Group,
Inc., a Virginia corporation (the "Company"), is a holding company of
which the principal operating subsidiaries are Friedman, Billings, Ramsey &
Co., Inc. ("FBRC"), FBR Investment Services, Inc.
("FBRIS"), Friedman, Billings, Ramsey International, Ltd.
("FBRIL"), Friedman, Billings, Ramsey Investment Management, Inc.
("FBRIM"), FBR Venture Capital Managers, Inc. ("VCM"), FBR
Fund Advisers, Inc. ("FBRFA"), Money Management Associates, LP
("MMA") and FBR National Bank & Trust ("FBR National
Bank"). FBRC and FBRIS are registered
broker-dealers and members of the National Association of Securities Dealers,
Inc. They act as introducing brokers and forward all transactions to clearing
brokers on a fully disclosed basis. FBRC and FBRIS do not hold funds or
securities for, nor owe funds or securities to, customers. During the periods
presented, FBRC's underwriting and corporate finance activities were
concentrated primarily on technology, energy, real estate and financial
services companies. FBRIM and VCM are registered
investment advisers that manage and act as general partners of proprietary
investment limited partnerships. FBRIM also manages separate investment
accounts and FBR Asset Investment Corporation ("FBR-Asset"), a
publicly traded real estate investment trust ("REIT"). FBRFA is a
registered investment adviser that manages The FBR Family of Funds. FBR
National Bank offers mutual fund servicing (custody, transfer agency,
shareholder servicing, and mutual fund accounting), and traditional banking
services (lending, deposits, cash management and trust services). Nature of Operations The Company's principal business
activities (capital raising, securities sales and trading, merger and
acquisition and advisory services, proprietary investments, and venture capital
and other asset management services) are linked to the capital markets. In
addition, the Company's business activities are primarily focused on small and
mid-cap stocks in the financial services, real estate, technology, energy,
healthcare and diversified industries sectors. By their nature, the Company's
business activities are highly competitive and are not only subject to general
market conditions, volatile trading markets and fluctuations in the volume of
market activity but to the conditions affecting the companies and markets in
the Company's areas of focus. The Company's revenues,
particularly from investment banking, incentive allocations and fees and
principal investment activities, are subject to substantial fluctuations due to
a variety of factors that cannot be predicted with great certainty, including
the overall condition of the economy and the securities markets as a whole and
of the sectors on which the Company focuses. Fluctuations also occur due to the
level of market activity, which, among other things, affects the flow of
investment dollars and the size, number and timing of transactions. As a
result, net income and revenues in any particular period may vary significantly
from period to period and year to year. The financial services industry
continues to be affected by the intensifying competitive environment and by
consolidation through mergers and acquisitions, as well as significant growth
in competition in the market for on-line trading services. The relaxation of
banks' barriers to entry into the securities industry and expansion by
insurance companies into traditional brokerage products, coupled with the
repeal of laws separating commercial and investment banking activities, have
increased the competition for a similar customer base. In order to compete in this
increasingly competitive environment, the Company continually evaluates its
businesses across varying market conditions for profitability and alignment
with long-term strategic objectives, including the diversification of revenue
sources. The Company believes that it is important to diversify and strengthen
its revenue base by increasing the segments of its business that offer a
recurring and more predictable source of revenue. Concentration of Risk A substantial portion of the
Company's revenues in a year may be derived from a small number of transactions
or issues or may be concentrated in a particular industry. For the year ended
December 31, 2001, investment banking accounted for 52% of the Company's
revenues. Revenues derived from the
Company's technology venture capital and technology investment banking deals
accounted for 44% of the Company's revenues for the year ended December 31,
2000 compared to 41% for the year ended December 31, 1999. F-7 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -
(Continued) As of December 31, 2001 and 2000,
respectively, the Company's investment in FBR Technology Venture Partners, L.P.
("TVP") of $1,068 and $23,913 represented 1% and 17% of the Company's
long-term investments. For the years ended December 31, 2001, 2000 and 1999,
the Company recorded revenue from TVP of $(7,373), $47,211 and $40,284
representing 5%, 26% and 29% of the Company's revenue in 2001, 2000 and 1999,
respectively. As of December 31, 2001 and 2000, respectively, the Company's
investment in FBR-Asset of $42,460 and $30,054 represented 35% and 21% of the
Company's long-term investments. For the years ended December 31, 2001, 2000
and 1999, the Company recorded revenue from FBR-Asset of $7,776, $7,785 and
$5,146 representing 5% of the Company's revenue in 2001 and 4% of the Company's
revenue in 2000 and 1999, respectively. In addition, in 2001, the Company
recorded an extraordinary gain of $1,148 associated with the exercise of
FBR-Asset warrants. Collectively, as of December 31, 2001 and 2000, these two
investments represented 36% and 49%, respectively, of the Company's total
long-term investments and 15% and 28%, respectively, of the Company's total
assets. These concentrations create earnings volatility exposure and market
risk exposure for the Company in the technology and real estate/mortgage
sectors, and there is interest
rate risk related to FBR-Asset as a leveraged mortgage REIT. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of
Consolidation All significant intercompany
accounts and transactions have been eliminated in consolidation. Certain
prior-year amounts have been reclassified to conform to the 2001 presentation. Cash Equivalents Cash equivalents include demand
deposits with banks, money market accounts and highly liquid investments with
original maturities of three months or less that are not held for sale in the
ordinary course of business. As of December 31, 2001 and 2000, respectively,
approximately 61% and 53% of the Company's cash equivalents were invested in
money market funds that invest primarily in U.S. Treasuries and other
government securities, backed by the U.S. government. Supplemental Cash Flow
Information Including Non-cash Transactions During 2001, as part of the
acquisition of MMA/Rushmore, the Company financed a portion of the purchase
price in the form of a non-interest bearing note. As of December 31, 2001, the
long-term portion of this note was $5,694 and the short-term portion of this
note was $970, of which $439 represented accrued non-cash interest expense.
Also in 2001, the Company provided employees with an opportunity to purchase
five million shares of FBR stock through the Employee Stock Purchase and Loan
Program ("ESPLP"). Through the ESPLP, employees could purchase shares
of FBR stock at $5.50 per share by paying $1.10 per share and
financing the remaining $4.40 per share with loans from the Company. These
loans to employees are interest bearing, limited-recourse loans. Cash payments for interest approximated
interest expense for the years ended December 31, 2000 and 1999. There were no
significant non-cash investing and financing activities during 2000 and 1999. Securities and
Principal Investments Investments in proprietary
investment partnerships including hedge, private equity and venture funds, in
which FBR is the general partner or has a significant limited partner interest,
and FBR-Asset are accounted for under the equity method and the Company's
proportionate share of income or loss ("income allocation") is
reflected in net investment income (loss) in the statements of operations.
Investments in investment partnerships, in which FBR is not the general partner
or does not have a significant limited partner interest and, therefore, does not
exercise significant
influence, are accounted for under the cost method. Under the cost method, the
Company records income only when distributed by the partnership. F-8 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Securities owned by the Company's
broker-dealer subsidiaries and securities sold but not yet purchased are valued
at market and resulting realized and unrealized gains and losses are reflected
in principal transactions in the statements of operations. Long-term marketable
securities held in non-broker-dealer entities are classified as
available-for-sale investments and are valued at market with resulting
unrealized gains and losses reflected in other comprehensive gain or loss in
the Company's balance sheet. Declines in the value of
available-for-sale investments that are "other than temporary" are
recorded in net investment loss in the statements of operations. Substantially all financial
instruments used in the Company's trading and investing activities are carried
at fair value or amounts that approximate fair value. Fair value is based
generally on listed market prices or broker-dealer price quotations. To the
extent that prices are not readily available, fair value is based on internal
valuation models and estimates made by management. In connection with certain
capital raising transactions, the Company has received and holds warrants for
the stock of the issuing companies, which are generally exercisable at the
respective offering price of the transaction. For restricted warrants,
including private company warrants, the Company carries the warrants at nominal
values, and recognizes profits, if any, only when realized due to the
restrictions on the warrants and underlying securities, and the uncertainty surrounding
the valuation of the warrants. The Company values warrants on publicly traded
stocks, where the restriction periods have lapsed, using an undiscounted
Black-Scholes valuation model. For the years ended December 31, 2001, 2000 and
1999, the Company recognized realized investment gains of $5.5 million, $1.5
million and $3.9 million, respectively. Building, Furniture, Equipment, Software and Leasehold
Improvements
Building, furniture, equipment and software are depreciated using the
straight-line method over their estimated useful lives of three to forty years. Leasehold improvements are amortized using the
straight-line method over the shorter of the useful life or lease term.
Amortization of purchased software is recorded over the estimated useful life
of three years. The Company had capitalized certain software development costs
associated with its launch of fbr.com. During 2001, the Company wrote-off $2.7
million which represented all of the unamortized fbr.com software costs as a result of determining such
capitalized costs were impaired. Income Taxes Deferred tax assets and
liabilities represent the differences between the financial statement and
income tax bases of assets and liabilities, using enacted tax rates. The
measurement of net deferred tax assets is adjusted by a valuation allowance if,
based on management's evaluation, it is more likely than not that they will not
be realized. Other Comprehensive
Income or Loss Comprehensive income includes net
income as currently reported by the Company on the consolidated statements of
operations adjusted for other comprehensive income. Other comprehensive income
for the Company represents changes in unrealized gains and losses related to
the Company's available-for-sale securities (including the bank investment
securities) and the Company's proportionate share of FBR-Asset's investments
accounted for as available-for-sale. These changes in fair value are recorded
through equity. F-9 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Investment Banking
Revenues Underwriting revenues represent
fees earned from public offerings of securities in which the Company acts as
underwriter. These revenues are comprised of selling concessions, underwriting
fees, and management fees. Corporate finance revenues represent fees earned
from private placement offerings, mergers and acquisitions, mutual conversions,
financial restructuring and other advisory services provided to clients.
Underwriting revenues are recorded as revenue at the time the underwriting is
completed. Corporate finance fees are recorded as revenue when the related
service has been rendered and the client is contractually obligated to pay.
Certain fees received in advance of services rendered are recognized as revenue
over the service period. Institutional
Brokerage Revenues Principal transactions consist of
sales credits and trading gains or losses, and agency commissions consist of
commissions earned from executing stock exchange-listed securities and other
transactions as an agent. Revenues generated from securities transactions and
related commission income and expenses are recorded on a trade date basis. Asset Management
Revenues The Company records three types
of asset management revenue: (1) Certain of the Company's subsidiaries act as
investment advisers and receive management fees for the management of
proprietary investment partnerships, mutual funds and FBR-Asset, based upon the
amount of capital committed or under management. This revenue is recorded in
base management fees in the Company's statements of operations as earned. (2)
The Company also receives incentive income based upon the operating results of
the partnerships, venture capital funds and FBR-Asset. Incentive income
represents a share of the gains in the partnerships and FBR-Asset, and is
recorded in incentive allocations and fees in the statements of
operations. The Company records
incentive income from the partnerships based on what would be due to the
Company if the partnership liquidated on the balance sheet date. (3) The
Company also records allocations, under the equity method of accounting, for
its proportionate share of the earnings or losses of the partnerships and
FBR-Asset. Income or loss allocations are recorded in net investment income
(loss) and technology sector investment and incentive income (loss) in the
Company's statements of operations. Compensation A significant component of
compensation expense relates to incentive bonuses. Incentive bonuses are
accrued based on the contribution of key business units using certain
pre-defined formulas. Since the bonus determinations in some cases are also
based on aftermarket security performance and other factors, which include
unrealized gains and losses, amounts currently accrued may not ultimately be
paid. The Company's compensation
accruals are reviewed and evaluated on a quarterly basis. Stock-Based
Compensation The Company
accounts for stock-based compensation in accordance with SFAS No.123,
"Accounting for Stock-Based Compensation." Pursuant to SFAS No. 123,
the Company continues to apply the provisions of Accounting Principles Board
Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees." Under APB No. 25, compensation expense is recorded for the
difference, if any, between the fair market value of the common stock on the
date of grant and the exercise price of the option. For the years ended
December 31, 2001, 2000 and 1999, the exercise prices of all options granted equaled
the market prices on the dates of grants, therefore, the Company did not record
any compensation expense in 2001, 2000 and 1999 related to option grants. F-10 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Earnings (Loss) Per
Share Basic earnings (loss) per share
includes no dilution and is computed by dividing net income or loss available
to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share includes the impact of
dilutive securities such as stock options. For the year ended December 31,
2001, there was no difference between basic and diluted loss per share as the
impact of options was anti-dilutive. For the year ended December 31, 2000, the
difference between basic and diluted earnings per share is due to certain
dilutive stock options. For the year ended December 31, 1999, there was no
difference between basic and diluted loss per share as the impact of options
was anti-dilutive. For the years ended December 31, 2001, 2000 and 1999,
options to purchase 7,981,345, 3,565,762 and 9,289,603 shares, respectively, of
common stock were not included in the computation of diluted earnings per share
because the options' exercise price was greater than the average market price
of the common shares. See Note 14 for a detail of total stock options
outstanding. Restructuring Charge During 2001,
the Company adopted a restructuring plan in response to the downturn in the
economy. In connection with the restructuring, 67 employees were terminated or
left and were not replaced. These employees primarily were from the technology
sector and administrative groups. As a result of
the restructuring plan, the Company recorded a restructuring charge of $2,410.
A summary of the costs comprising the total charge incurred are: Employee
severance and other termination costs $1,365 Non-cancelable
lease and other facility costs 947 Other 98 Total $2,410 The accrued restructuring charge
as of December 31, 2001, was $1,114. Use of Estimates The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States 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. Note 2 contains
the Company's significant accounting policies.
The Company believes its most critical policies (a critical accounting
policy being one that is both very important to the portrayal of the Company's
financial condition and results of operations and requires management's most
difficult, subjective or complex judgments) include 1) valuation of private and
restricted public company investments, 2) recognition of incentive fee revenue
and 3) valuation allowance determination related to deferred taxes. Actual
results could differ from those estimates. New Accounting
Policies In June 2001,
the FASB issued SFAS No. 141 "Business Combinations" ("FAS
141"). FAS 141, among other things, prohibits the use of the pooling
method in business combinations only allowing the purchase method. The
Company's acquisition of MMA/Rushmore was accounted for using the purchase
method. Another change under FAS 141 is
that prior to FAS 141 (FAS 141 being effective for all acquisitions after June
30, 2001), when an entity was acquired and the fair value of the acquired net
assets was greater than the purchase price that difference was allocated to
negative goodwill. Negative goodwill was then amortized over its expected
useful life. Under FAS 141, if the fair value of the acquired net assets is
greater than the purchase price, that difference is recorded as an
extraordinary gain. As further discussed in Note 4, in December 2001, the
Company exercised warrants of FBR-Asset, which resulted in a $1,148
extraordinary gain. FBR-Asset is accounted for using the equity method and, as
a result, this extraordinary gain represents the difference between the fair
value of the net assets acquired and the exercise price of the warrants. F-11 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) In June of
2001, the FASB issued SFAS No. 142 "Goodwill and Other Intangible
Assets" ("FAS 142"). FAS
142, among other things, prohibits the amortization of existing goodwill and
certain types of intangible assets and establishes a new method of testing
goodwill for impairment. FAS 142 is
effective January 1, 2002 for the Company.
The Company does not have goodwill recorded on its balance sheet. The MMA management contracts the Company
carries on its balance sheet are considered intangible assets under FAS 142
and, under FAS 142, these contracts should be amortized in proportion to their
expected economic benefit and tested for impairment by comparing expected
future gross cash flows to the asset's carrying amount and if the gross cash
flows are less than the carrying amount, the asset is impaired and is
written-down to fair value. The
accounting under FAS 142 for the MMA management contracts is the same
accounting currently being used by the Company and, as a result, the Company does not expect that there will
be any impact upon adoption of FAS 142. NOTE 3.
MARKETABLE AND TRADING SECURITIES OWNED AND SECURITIES SOLD Marketable and trading securities
owned and trading account securities sold but not yet purchased consisted of
securities at market values for the years indicated (in thousands): December 31, 2001 2000 Owned Sold But Owned Sold But Corporate stocks $ 15,355 $ 13,357 $17,011 $ 865 Corporate bonds 351 20 1,436 65 $ 15,706 $ 13,377 $18,447 $ 930 Trading account securities sold but not
yet purchased represent obligations of the Company to deliver the specified security at
the contracted price, and thereby, creates a liability to purchase the security
in the market at prevailing prices.
Accordingly, these transactions result in off-balance-sheet risk as the
Company's ultimate obligation to satisfy
the sale of securities sold but not yet purchased may exceed the current value
recorded in the
consolidated balance sheets. NOTE 4. LONG-TERM INVESTMENTS: Long-term investments consisted
of the following for the years indicated (in thousands): December 31, 2001 2000 Equity
method investments: Proprietary
investment partnerships excluding technology sector $ 42,619 $ 38,980 FBR-Asset
Investment Corporation 42,460 30,054 Marketable
securities 4,894 5,370 Private
debt investments 7,500 17,837 Cost
method investments excluding the technology sector - 115 Other 839 9,708 98,312 102,064 Equity
method investments - technology sector 14,584 34,845 Cost
method investments - technology sector 7,086 6,042 21,670 40,887 $119,982 $142,950 F-12 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Equity Method Investments Investment Partnerships VCM is the managing partner of
FBR Technology Venture Partners, L.P. ("TVP") and FBR Technology
Venture Partners II ("TVP II", consisting of five separate limited
partnerships). FBRIM is the managing partner or member of FBR Ashton, L.P., FBR
Weston, Limited Partnership, FBR Future Financial Fund, L.P., FBR Private
Equity Fund, L.P., FBR Arbitrage, L.L.C., FBR Biotech Fund, L.P., FBR CoMotion
Venture Capital I, L.P. and through a wholly-owned L.L.C., FBR Financial
Services Partners, L.P. All of these partnerships were formed for the purpose
of investing in public and private securities, therefore, their assets
principally consist of investment securities accounted for at fair value. The
Company accounts for its investments in these partnerships under the equity
method. Although we do not manage, we are a significant investor in Braddock
Partners, L.P., Capital Crossover Partners, ETP/FBR Genomic Fund, L.P. and
ETP/FBR Genomic Fund II (QP), L.P. and, due to our percentage ownership in
these partnerships, we also account for these investments under the equity
method. The following table shows the Company's investments and percentage
interest on which pro rata profit allocations (as distinct from carried
interest incentive income) are based (in thousands): December 31, 2001 2000 Non-Technology Sector FBR
Ashton, L.P. $19,000 35% $15,430 29% FBR
Arbitrage, L.L.C. 11,415 16% 10,320 15% Braddock
Partners, L.P. 5,613 11% 4,920 11% FBR
Weston, Limited Partnership 2,327 9% 1,403 7% FBR
Private Equity Fund, L.P. 1,878 20% 3,668 19% FBR
Financial Services Partners, L.P. 1,519 6% 1,580 6% FBR
Future Financial Fund, L.P. 867 59% 1,659 18% 42,619 38,980 Technology Sector Capital
Crossover Partners 6,000 13% - - FBR
CoMotion Venture Capital I, L.P. 3,148 8% 3,724 8% FBR
Technology Venture Partners II, L.P. 2,771 5% 6,418 5% ETP/FBR
Genomic Fund, L.P. 1,411 5% 790 5% FBR
Technology Venture Partners, L.P. 1,068 3% 23,913 3% ETP/FBR
Genomic Fund II (QP), L.P. 100 6% - - FBR
Biotech Fund, L.P. 86 8% - - 14,584 34,845 $57,203 $73,825 F-13 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The Company's significant equity
method investments are: 2001 TVP TVPII FBR-Asset Ashton Other Total Total assets $ 5,885 $41,248 $1,325,125 $60,094 $ 394,629 $1,826,981 Total liabilities 1,022 2,914 1,121,260 6,238 127,382 1,258,816 Total equity 4,863 38,334 203,865 53,856 267,247 568,165 FBR's share of total equity 1,068 2,771 42,460 19,000 34,364 99,663 Total revenue 13 360 39,087 1,975 11,116 52,551 Total expenses 1,390 3,460 18,879 1,372 15,597 40,698 Realized gains (losses) 49,536 (51,768) 3,330 3,550 27,955 32,603 Unrealized gains (losses) (89,033) (42,082) - 7,563 (28,152) (151,704) Net income (40,874) (96,950) 23,538 11,716 (4,678) (107,248) FBR's share of net
income-net investment income (loss) (917) (5,003) 4,278 3,570 907 2,835 FBR's share of net
income-incentive allocations and fees (7,706) - 1,656 - 1,707 (4,343) 2000 TVP TVPII FBR-Asset Ashton Other Total Total assets $ 109,463 $116,817 $ 225,804 $63,706 $ 379,823 $ 895,613 Total liabilities 511 3,347 138,963 10,794 131,335 284,950 Total equity 108,952 113,470 86,841 52,912 248,448 610,663 FBR's share of total equity 23,913 6,418 30,054 15,430 31,932 107,747 Total revenue 139 - 23,841 1,752 9,147 34,879 Total expenses 1,306 3,687 12,610 1,528 9,647 28,878 Realized gains (losses) 257,954 - (2,867) 318 16,908 272,313 Unrealized gains (losses) (105,967) 16,419 - 16,654 14,014 (58,880) Net income 150,820 12,732 8,364 17,196 30,422 219,534 FBR's share of net
income-net investment income 3,242 705 7,079 4,765 5,454 21,245 FBR's share of net
income-incentive allocations 30,186 - - - 1,736 31,922 1999 TVP TVPII FBR-Asset Ashton Other Total Total assets $ 223,685 $37,128 $ 330,180 $70,164 $ 176,440 $ 828,904 Total liabilities 253 12,323 225,638 15,267 40,303 290,684 Total equity 223,432 24,805 104,542 54,897 136,137 538,220 FBR's share of total equity 39,413 1,124 24,194 10,666 18,552 93,949 Total revenue 59 - 23,474 3,300 3,922 30,755 Total expenses 1,718 2,124 10,682 3,277 4,696 21,991 Realized gains (losses) - - (7,649) 2,960 6,925 2,236 Unrealized gains (losses) 186,239 3,290 - (13,651) 7,673 182,806 Net income (loss) 184,580 1,166 5,143 (10,668) 13,824 193,806 FBR's share of net income-net investment income (loss) 3,999 - 4,134 (1,527) 2,938 9,544 FBR's share of net
income-incentive allocations and fees 34,326 - - - 1,577 35,903 F-14 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) FBR Technology Venture
Partners, L.P. FBR Technology Venture Partners,
L.P. ("TVP") is a limited partnership, formed on August 12, 1997, to
engage in the business of investing in securities. FBR Venture Capital
Managers, Inc., a wholly owned subsidiary of the Company, is the corporate
general partner of TVP. TVP's investments as of December 31, 2001 and 2000
included equity investments in securities of development-stage and early-stage,
privately and publicly held, technology companies. The disposition of the
privately held investments is generally restricted due to the lack of a ready
market. TVP's investments may represent significant proportions of the issuer's
equity and they may carry special contractual privileges not available to other
security holders. As a result, precise valuation for the private and restricted
investments is a matter of judgment and the determination of fair value must be
considered only an approximation. As of December 31, 2001, public company
investments were valued based on the year-end closing price. FBR Technology Venture
Partners II FBR Technology Venture Partners
II ("TVP II") consists of five separate limited partnerships formed
during 1999, to engage in the business of investing in securities. FBR Venture
Capital Managers, Inc., a wholly owned subsidiary of the Company, is the
corporate general partner of TVP II. TVPII's investments as of December 31, 2001
and 2000 included equity investments in securities of development-stage and
early-stage, privately and publicly held, technology companies. The disposition
of the privately held investments is generally restricted due to the lack of a
ready market. TVPII's investments may represent significant proportions of the
issuer's equity and they may carry special contractual privileges not available
to other security holders. As a result, precise valuation for the private and
restricted investments is a matter of judgment and the determination of fair
value must be considered only an approximation. As of December 31, 2001, public
company investments were valued based on the year-end closing price less a
discount to reflect restrictions on liquidity and marketability. FBR-Asset FBR-Asset is a REIT, formed in
1997, whose primary purpose is to invest in mortgage-backed securities, equity
securities, public and private real estate companies and mezzanine and senior
loans. As of December 31, 2001, 93% and 5% of FBR-Asset's assets were invested
in mortgage-backed securities and equity securities, respectively. As of
December 31, 2000, 69% and 12% of FBR-Asset's assets were invested in
mortgage-backed securities and equity securities, respectively. FBR-Asset
classifies its investments as available-for-sale. Accordingly, unrealized gains
and losses related to securities are reflected as other comprehensive gain or
loss in FBR-Asset's equity. The Company accounts for its investment in
FBR-Asset under the equity method. As a result, the Company recorded $4,278,
$7,079 and $4,134 in net investment income in the statements of operations for
its proportionate share (reflecting share repurchases) of FBR-Asset's 2001,
2000 and 1999 net income, respectively. In addition, in December 2001, the
Company exercised 400,000 warrants of FBR-Asset, which resulted in an
extraordinary gain of $1,148. During 2001 and 2000, respectively, the Company
reduced its carrying basis of FBR-Asset for declared dividends of $5,007 and
$3,965. The Company also recorded, in other comprehensive income (loss),
$3,414, $2,746 and ($1,473) of net unrealized gain/(loss) on investments which
represented its proportionate share of FBR-Asset's net unrealized gain or loss
related to available-for-sale securities for the year ended December 31, 2001,
2000 and 1999 respectively. As of December 31, 2001 and 2000, respectively, net
unrealized gain or loss related to FBR-Asset and included in the Company's
accumulated other comprehensive income (loss) was $3,155 and $(259). The
Company's ownership percentage of FBR-Asset was 21% as of December 31, 2001. As
of December 31, 2001, FBR-Asset's market value per share was $27.95, which
results in the Company's investment in FBR-Asset having a fair value of $49,477. FBR Ashton, L.P. FBR Ashton, L.P.
("Ashton") is a limited partnership, formed on November 8, 1991, to
engage in the business of investing in securities primarily in the financial
services industry. Friedman, Billings, Ramsey Investment Management, Inc., a
wholly owned subsidiary of the Company, is the corporate general partner of
Ashton. Ashton's investments as of December 31, 2001 and 2000 were comprised of
equity investments in securities of publicly held companies. F-15 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The investment
partnerships, including venture capital funds, that the Company earns
management, incentive and investment income are non-registered investment
companies that record their investments in securities at fair value. Certain
investments consist of equity investments in securities of development-stage and
early-stage privately and publicly held companies. The disposition of these
investments may be restricted due to the lack of a ready market (in the case of
privately held companies) or due to contractual or regulatory restrictions on
disposition (in the case of publicly held companies). In addition, these
securities may represent significant proportions of the issuer's equity and
carry special contractual privileges not available to other security holders. As
a result of these factors, precise valuation for the restricted public
securities and private company securities is a matter of judgment, and the
determination of fair value must be considered only an approximation and may
vary from the amounts that could be realized if the investment were sold. The
following methodology is employed by the partnerships in valuing their
investments: Nonrestricted public securities
that are traded on a national securities exchange (or reported on the Nasdaq
national market) are valued at the last reported sales price on the day of
valuation. Restricted public securities -
Securities that have underlying public markets, but whose disposition is
restricted, are valued at a discount from the current market value. Discounts
are taken for regulatory restrictions and contractual lock-up agreements. If a
security has either regulatory restrictions or is contractually locked up, a
market blockage discount may be applied as well. Private securities - The
investment will be carried at cost, subject to the following: the investment
may be marked up or down to reflect changes in the fundamentals of the issuer,
its industry sector, or the economy in general, since the date of the original
investment. Events considered in this valuation are: (1) a subsequent
third-party round of financing at a per share price that is higher or lower
than the current valuation (2) an imminent public offering, (3) an imminent sale
of the issuer, or (4) if the issuer's performance and potential have
significantly deteriorated as of the valuation date. Marketable Securities The Company's available-for-sale
securities consist primarily of equity investments in publicly traded companies
that are held by an asset management subsidiary of the Company. In accordance
with SFAS No. 115, the securities are valued at market with resulting
unrealized gains and losses reflected as other comprehensive gain or loss.
During 2001, 2000 and 1999, respectively, the Company recorded $(1,945),
$(2,519) and $(10,385) of "other than temporary" loss in the
statement of operations as net investment income (loss). During 2001, there
were no sales of available-for-sale securities. During 2000 and 1999, respectively, the Company sold $10,278 and
$5,934 of available-for-sale securities at a realized loss of $(1,814) and
$(221). As of December 31, 2001 and 2000, respectively, the Company held
available-for-sale securities with a fair value of $4,894 and $5,373 with
unrealized gains (losses) related to these securities of $76 and $(869). These
unrealized gains (losses) are included in accumulated other comprehensive
income (loss). Private Debt In May 1998, the Company organized a business trust
designed to extend financing to middle-market businesses in need of
subordinated debt or mezzanine financing. In connection therewith, the Company
loaned $7,500 and $10,000, respectively, to two unrelated businesses. During
2001, the $10,000 loan was repaid, with interest, for total proceeds of $12,051
resulting in investment income of $1,715.
The remaining loan matures in June 2003 and is carried at cost. The Company also initially invested $7,000
in an unaffiliated technology sector private company in the form of a preferred
equity investment. During the years ended 2000 and 1999, respectively, the
Company recorded $5,880 and $1,820 of investment losses related to this
preferred equity investment. F-16 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Other During 2000, the
Company employed option strategies that were indexed to common equity shares
held by certain of the Company's managed investment partnerships. The
options are subject to fair value accounting. Total realized and
unrealized gains of $12,534 were recognized during 2000 and included in
incentive allocations in the statements of operations. As of December 31,
2000, the outstanding options had a fair value of $9,705. NOTE 5. MMA/RUSHMORE ACQUISITION: On April 1, 2001, the Company
completed the acquisition of Money Management Associates, LP ("MMA")
and Rushmore Trust and Savings, FSB ("Rushmore"). MMA was a privately
held investment adviser with $933.4 million in assets under management as of
March 31, 2001. Together, MMA and Rushmore were the investment adviser,
servicing agent or administrator for more than 20 mutual funds. Upon closing,
Rushmore was re-chartered as a national bank and was named FBR National Bank
& Trust ("FBR National Bank"). The FBR National Bank offers
mutual fund servicing (custody, transfer agency, shareholder servicing and
mutual fund accounting) and traditional banking services (lending, deposits,
cash management, trust services).. Under the terms of the agreement, the
Company acquired MMA/Rushmore for $17.5 million in cash at closing and a $9.7
million non-interest-bearing installment note payable over a ten-year period. The total purchase price of $25.2
million, including capitalized transaction costs of $1.5 million and the
present value of the installment note at an imputed rate of 9%, was allocated
(in millions): MMA
management contracts $19.7 Bank
equity 5.5 $25.2 The acquisition of MMA/Rushmore
was accounted for as a purchase and resulted in the recording of $19.7 million
of Management Contracts on the balance sheet. These Management Contracts were
previously unrecognized intangible assets of MMA. These Management Contracts
will be amortized straight-line over 15 years. Income related to these
management contracts is recognized as earned usually based on invested assets
at a stated management fee percentage. The accounting policies related
to FBR National Bank: Bank Investment Securities Bank investment securities represent FBR National Bank's investments in Mortgage-Backed Securities (MBS), which are
carried at fair value and classified as available-for-sale under SFAS 115.
Unrealized gains and losses on such MBS are reported as other comprehensive
income in shareholders' equity. Bank Loans Bank loans
are carried at cost less an allowance for loan losses as they are held for the
foreseeable future. The loss allowance as of December 31, 2001 is
$0.1 million. Interest on loans is accrued based on the outstanding principal
amount using the effective interest rate method. An allowance for uncollected
interest is provided on any loan that is contractually delinquent more than 90
days and on any other loan when the collectibility of the loan is in doubt and
such allowance is netted against accrued interest receivable. Any such interest ultimately collected is recorded
as interest income in the period of recovery.
Although FBR National Bank has experienced insignificant loan losses in the
past, management continues to provide for loan losses as necessary based on
changes in current economic conditions and other factors. Management
periodically reviews and evaluates the loan portfolio to determine the adequacy
of the allowance for loan losses. F-17 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) While management uses available
information to estimate losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions beyond management's
control. Loans receivable are accounted for in accordance with SFAS 114, which
requires that impaired loans be measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate. The Company considers a loan
impaired when FBR National Bank will be unable to collect all interest and principal
payments as scheduled in the loan agreement.
A valuation allowance is maintained to the extent that the measure of
the impaired loan is less than the recorded investment. Of
the $12,459 million of bank loans, $6,444 were made to employees of FBR Group.
A rollforward of bank loan activity is: April 1, 2001 $ 1,648 Originations 11,344 Prepayments, including
normal principal payments (533) December 31, 2001 $12,459 As of December 31, 2001, $10,331 of the
loans outstanding were first mortgage residential loans. Bank Deposits Bank deposits of $19,457 represent
deposits held by FBR National Bank for its customers. Interest expense for the
nine months ended December 31, 2001 since the acquisition of $421, is
recognized based on the deposit balance and the stated interest rate paid. NOTE 6. BUILDING, FURNITURE, EQUIPMENT, SOFTWARE AND
LEASEHOLD IMPROVEMENTS:
Building, furniture, equipment, software
and leasehold improvements, summarized by major classification, were (in
thousands): December 31, 2001 2000 Building, furniture and equipment $ 13,854 $ 7,673 Software 5,952 8,366 Leasehold improvements 4,985 4,770 Land 1,550 - 26,341 20,809 Less-Accumulated depreciation and
amortization (17,138) (10,636) $ 9,203 $10,173 NOTE 7. INCOME TAXES: Deferred tax assets and
liabilities consisted of the following as of December 31, 2001 and 2000 (in
thousands): F-18 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 2001 2000 Unrealized
investment (gains) losses on proprietary investment partnerships $ 339 $(9,170) Unrealized
investment (gains) losses, recorded in accumulated other comprehensive income
(loss) (1,293) 494 Unrealized
investment losses, recorded in earnings, related to "other than 9,020 8,242 Net
operating loss carryforward 17,423 22,007 Accrued
compensation 182 2,461 Other
(2,793) (2,936) 22,878 21,098 Less-valuation
allowance recorded through accumulated other comprehensive loss - (494) Less-valuation
allowance recorded through earnings (22,878) (22,364) Net
deferred tax asset/(liability) $ - $ (1,760) The Company has a net operating
loss (NOL) carryforward to offset future taxable income. As of December 31,
2001 and 2000, respectively, the Company has gross NOL carryforwards of $43,557
and $55,019 that expire through 2020. The Company has provided a valuation
allowance against its deferred tax assets based on its ongoing assessment of
realizability of the deferred tax assets. The benefit for income taxes
results in effective tax rates that differ from the Federal statutory rates as
follows: December 31, 2001 2000 1999 Statutory Federal income tax rate (34)% 35% (35)% State income taxes, net of Federal
benefit (4) 5 (5) Nondeductible expenses 9 9 11 Dividends received deduction - - (6) Valuation allowance 17 (30) 35 Effective income tax rate (12)% 19% - NOTE 8. PROFIT SHARING PLAN: The Company maintains a qualified
401(k) profit sharing plan. Eligible employees may defer a portion of their
salary. At the discretion of the Board of Directors, the Company may make
matching contributions and discretionary contributions from profits. There were
no Company contributions made in 2001, 2000 or 1999. NOTE 9. BORROWINGS: Short-Term Loans
Payable As of December 31, 2001, the
Company had $10 million outstanding under a $40 million unsecured revolving
subordinated credit line with an affiliate of its clearing broker with an
interest rate equal to 4.75 percent.
The Company has until December 22, 2002 to repay the amount outstanding
under this agreement. At December 31,
2001, this credit line had expired and, as a result, the remaining $30 million
of the facility is not available to borrow. During January 2002, the Company
agreed to terms with a financial institution for a secured revolving loan
facility in the amount of $20 million. As of December 31, 2001, the
Company had $8 million outstanding on margin borrowings with one of its asset
management subsidiaries with an interest rate of 2.25 percent. In addition,
bank investment securities with a carrying value of $3.4 million as of December 31, 2001, were pledged to secure a $2 million
revolving credit facility agreement with the Federal Home Loan Bank. This loan was subsequently repaid on January
2, 2002. F-19 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The Company has two short-term
secured loans totaling $195 and $776 as of December 31, 2001 and 2000,
respectively, requiring fixed monthly principal and interest payments of $35.
Each loan bears interest at an annual rate based on a one-month commercial
paper rate, plus a spread, which equaled 4.60% and 8.96% at December 31, 2001
and 2000, respectively. The loans are collateralized by certain furniture,
equipment, and leasehold improvements of the Company. The loans are scheduled
to be entirely repaid in January 2002 and November 2002, respectively. Long-Term Secured Loan As of December
31, 2001, the Company had outstanding long-term debt of $5,694 associated with
the Company's acquisition of MMA/Rushmore. This non-interest bearing note,
which is collateralized by the capital stock of FBR National Bank, matures on
January 2, 2011. NOTE 10. NET CAPITAL COMPUTATION: FBRC and FBRIS,
are registered with the Securities and Exchange Commission ("SEC") and are
members of the National Association of Securities Dealers, Inc.
Additionally, FBRIL, is registered with the Securities and Futures Authority ("SFA")
of the United Kingdom. As such, they are subject to to the minimum net
capital requirements promulgated by the SEC and SFA. As of December 31,
2001 and 2000, FBRC had net capital of $35.4 million and $30.6 million that was
$32.9 million and $29.6 million in excess of its required net capital of $2.5
million and $1.0 million. As of December 31, 2001, all of our
broker/dealers had net capital of $36.5 million that was $32.9
million in excess of its required net capital of $3.6 million. FHC's are required
to maintain capital levels in accordance with regulatory requirements. The
minimum ratio of total capital to risk weighted assets is 8.0 percent and the
minimum ratio of tier one capital to risk weighted assets is 4.0 percent. As of
December 31, 2001, we had total and tier one capital ratios of 83.0
percent and 78.1 percent, respectively. FBR National
Bank is subject to various regulatory capital requirements administered by the
federal banking agencies. Failures to
meet minimum capital requirements can initiate certain mandatory-and possibly
additional discretionary-actions by regulators that, if undertaken, could have
a direct material effect on the financial statements of FBR National Bank. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, FBR National Bank's assets,
liabilities, and certain off-balance sheet items are calculated under
regulatory accounting practices. FBR
National Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors. Quantitative
measures established by regulation to ensure capital adequacy require FBR
National Bank to maintain minimum amounts and ratios (set forth in the table
below) of tangible and core capital (defined in the regulations) to total
adjusted assets (as defined), and of total capital (as defined) to
risk-weighted assets (as defined).
Management believes, as of December 31, 2001, FBR National Bank meets
all capital adequacy requirements to which it is subject. As of December
31, 2001, the most recent notification from the Office of the Comptroller of
the Currency (OCC) categorized FBR National Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well capitalized, FBR National Bank must
maintain minimum tangible core and risk-based ratios as set forth in the
table. There are no conditions or
events since that notification that management believes have changed FBR
National Bank's category. FBR National
Bank's actual capital amounts and ratios for 2001 are presented in the table:
Actual
To be Considered Well Capitalized Amount Ratio Amount Ratio Tier I Leverage Capital (to average
adjusted total assets) $6,001 16.24% $1,848 5.00% Tier I Risk Based Capital (to risk
weighted assets) $6,001 38.01% $ 947 6.00% Total Risk Based Capital (to risk
weighted assets) $6,087 38.56% $1,579 10.00% F-20 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) NOTE 11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET
RISK AND CREDIT RISK: Financial Instruments The Company's broker-dealer
entities trade securities that are primarily traded in United States markets.
The Company's asset management entities trade and invest in public and
non-public securities. As of December 31, 2001 and 2000, the Company had not
entered into any transactions involving financial instruments, such as
financial futures, forward contracts, options, swaps or derivatives that would
expose the Company to significant related off-balance-sheet risk. In addition, the Company has sold
securities it does not currently own in anticipation of a decline in the fair
value of that security (securities sold, not yet purchased). When the Company
sells a security short and borrows the
security to make a delivery, a gain,
limited to the price at which the Company sold the security short, or a loss,
unlimited in size, will be realized upon the termination of the short sale. Market risk is primarily caused
by movements in market prices of the Company's trading and investment account
securities and changes in value of the underlying securities of the venture
capital funds and other proprietary investment partnerships in which the
Company invests. The Company's trading securities and investments are also
subject to interest rate volatility and possible illiquidity in markets in
which the Company trades or invests. The Company seeks to control market risk
through monitoring procedures. The Company's principal transactions are
primarily long and short equity and
debt transactions. Positions taken and commitments
made by the Company, including those made in connection with venture capital
and investment banking activities, have resulted in substantial amounts of
exposure to individual issuers and businesses, including non-investment grade
issuers, securities with low trading volumes and those not readily marketable.
These issuers and securities expose the Company to a higher degree of risk than
associated with investment grade instruments. The Company's investment in
FBR-Asset is subject to leverage and interest rate risk. FBR-Asset's
debt-to-equity ratio can increase or decrease at any time based on the amount
FBR-Asset may borrow. As a result, as FBR-Asset increases its debt, the
possibility that it may be unable to meet debt obligations as they come due
increases. Financing assets through repurchase agreements exposes FBR-Asset to
the risk that margin calls will be made that FBR-Asset may not be able to meet. Credit Risk The Company's broker-dealer
subsidiaries function as introducing brokers that place and execute customer
orders. The orders are then settled by an unrelated clearing organization that
maintains custody of customers' securities and provides financing to customers. Through indemnification
provisions in agreements with clearing organizations, customer activities may
expose the Company to off-balance-sheet credit risk. Financial instruments may
have to be purchased or sold at prevailing market prices in the event a
customer fails to settle a trade on its original terms or in the event cash and
securities in customer margin accounts are not sufficient to fully cover
customer obligations. The Company seeks to control the risks associated with
customer activities through customer screening and selection procedures as well
as through requirements on customers to maintain margin collateral in
compliance with various regulations and clearing organization policies. The Company's equity and debt
investments include non-investment grade securities of privately held issuers
with no ready markets. The concentration and illiquidity of these investments
expose the Company to a higher degree of risk than associated with readily
marketable securities. The Company's
bank loan portfolio is evaluated based on the risk characteristics that
considers such factors as past loan loss experience, financial condition of the
borrower, current economic conditions, net realizable value of the collateral
and other relevant factors. F-21 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) General Partnership
and Managing Member Interests As general
partner of investment partnerships (or managing member of limited liability
companies), certain of the Company's subsidiaries may be exposed to liabilities
that exceed the balance sheet value of the Company's investment in the relevant
vehicles. NOTE 12. COMMITMENTS AND CONTINGENCIES: Leases The Company leases premises under
long-term lease agreements requiring minimum annual rental payments with annual
adjustments based upon increases in the consumer price index, plus the
pass-through of certain operating and other costs above a base amount. Future minimum aggregate annual
rentals payable under these non-cancelable leases for the years ending December
31, 2002 through 2006, are as follows (in thousands): Year Ending December 31, 2002 $ 3,259 2003 2,890 2004 1,560 2005 243 2006 97 $ 8,049 Equipment and office rent expense
for 2001, 2000 and 1999 was $4,970, $3,914 and $3,405, respectively. Litigation As of December 31, 2001, the
Company was not a defendant or plaintiff in any lawsuits or arbitrations that
are expected to have a material adverse effect on the Company's financial condition
or statements of operations. The Company is a defendant in a small number of
civil lawsuits and arbitrations (together, "litigation") relating to
its various businesses. There can be no assurance that these matters
individually or in aggregate will not have a material adverse effect on the
Company's financial condition or results of operations in a future period.
However, based on management's review with counsel, resolution of these matters
is not expected to have a material adverse effect on the Company's financial
condition or results of operations. Many aspects of the Company's
business involve substantial risks of liability and litigation. Underwriters,
broker-dealers and investment advisers are exposed to liability under Federal
and state securities laws, other Federal and state laws and court decisions,
including decisions with respect to underwriters' liability and limitations on
indemnification, as well as with respect to the handling of customer accounts.
For example, underwriters may be held liable for material misstatements or
omissions of fact in a prospectus used in connection with the securities being
offered and broker-dealers may be held liable for statements made by their
securities analysts or other personnel. In certain circumstances,
broker-dealers and asset managers may also be held liable by customers and
clients for losses sustained on investments. In recent years, there has been an
increasing incidence of litigation involving the securities industry, including
class actions that seek substantial damages. The Company is also subject to the
risk of litigation, including litigation that may be without merit. As the
Company intends to actively defend such litigation, significant legal expenses
could be incurred. An adverse resolution of any future litigation against the
Company could materially affect the Company's operating results and financial
condition. Other As of December
31, 2001, the Company had $18.0 million of unfunded capital commitments to
various investment partnerships that may be called over the next ten years. F-22 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) NOTE 13. EXECUTIVE OFFICER COMPENSATION: During 2001, certain of the
Company's executive officers were eligible for bonuses under the Key Employee
Incentive Plan (the "Key Employee Plan"). During 2001, in accordance
with a performance formula that included revenue, net income, return on equity
and share price measures, the Company accrued $877 of executive officer
compensation, in accordance with the Key Employee Plan. Compensation related to
the Key Employee Plan was paid subsequent to December 31, 2001. During 2000, certain of the
Company's executive officers were eligible for bonuses under the Key Employee
Plan. During 2000, in accordance with an income-based performance formula, the
Company accrued $6.5 million of executive officer compensation, in accordance
with the Key Employee Plan, representing 22.4% of the Company's pre-tax income
(before executive officer compensation accruals). Compensation related to the
Key Employee Plan was paid subsequent to December 31, 2000. During 1999, the Company's three
Executive Officer Directors participated in the Key Employee Plan. In
accordance with the 1999 performance formula set under this plan, Executive
Officer Directors were eligible to participate in two bonus pools. The first
was a bonus pool of up to 20% of the Company's pre-tax income (before executive
officer compensation accruals), adjusted for certain expense items excluded
from pre-tax income. The 20% pool was subject to a cap related to the ratio of
compensation expense (excluding certain items) to total revenues. For the year
ended December 31, 1999, the Company generated adjusted income under the Key
Employee Plan, however, due to the application of the cap, no bonuses were paid
under the 20% pool. The second pool comprised up to $6.0 million in total
bonuses based on a formula tied to the performance of FBRC's trading
operations. The entire $6.0 million pool was earned and recorded as
compensation expense in 1999. NOTE 14. SHAREHOLDERS' EQUITY: The Company has authorized share
capital of 100 million shares of Class B Common Stock, par value $0.01 per
share; 150 million shares of Class A Common Stock, par value $0.01 per share;
and 15 million shares of undesignated preferred stock. Holders of the Class A
and Class B Common Stock are entitled to one vote and three votes per share,
respectively, on all matters voted upon by the shareholders. Shares of Class B
Common Stock convert to shares of Class A Common Stock at the option of the
Company in certain circumstances including (i) upon sale or other transfer,
(ii) at the time the holder of such shares of Class B Common Stock ceases to be
affiliated with the Company and (iii) upon the sale of such shares in a
registered public offering. The Company's Board of Directors has the authority,
without further action by the shareholders, to issue preferred stock in one or
more series and to fix the terms and rights of the preferred stock. Such
actions by the Board of Directors could adversely affect the voting power and
other rights of the holders of common stock. Preferred stock could thus be
issued quickly with terms that could delay or prevent a change in control of
the Company or make removal of management more difficult. At present, the
Company has no plans to issue any of the preferred stock. Stock and Annual
Incentive Plan (the "Plan") Under the Plan, the Company may
grant options, stock appreciation rights, performance awards and restricted and
unrestricted stock to purchase up to 14.9 million shares of Class A Common
Stock to eligible participants in the Plan. Participants include employees and
officers of the Company and its subsidiaries. The Plan has a term of 10 years
and options granted have an exercise period of up to 10 years. Options may be
incentive stock options, as defined by Section 422 of the Internal Revenue
Code, or nonqualified stock options. Details of stock options granted are as follows: F-23 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Number of Exercise Price Balance
as of December 31, 1997 4,383,400 $20.00 Granted
in 1998 2,160,280 $5.875 - $19.625 Forfeitures in 1998 upon departure of employees (293,200) $5.875 - $20.00 Balance
as of December 31, 1998 6,250,480 $5.875 - $20.00 Granted
in 1999 3,507,148 $5.1875 - $13.0625 Forfeitures in 1999 upon departure of employees (468,025) $5.875 - $20.00 Balance
as of December 31, 1999 9,289,603 $5.1875 - $20.00 Granted
in 2000 452,340 $6.125 - $16.875 Forfeitures in 2000 upon departure of employees (1,446,162) $5.8125 - $20.00 Exercised
in 2000 (240,518) $5.875 - $8.625 Balance
as of December 31, 2000 8,055,263 $5.1875 - $20.00 Granted
in 2001 4,567,721 $4.61 - $7.77 Forfeitures in 2001 upon departure of employees (1,512,641) $5.8125 - $20.00 Exercised
in 2001 (3,128,998) $5.8125 - $6.1875 Balance
as of December 31, 2001 7,981,345 $4.61 - $20.00 All options granted in 1997 and
70,780 of the options granted in 1998 become exercisable as follows: 10%, 40%,
and 50% at the end of three, four and five years, respectively. The remainder
of the grants in 1998, 2,089,500 options, and all grants in 1999, 2000 and
2001, become exercisable ratably over the first three years. As of December 31,
2001, 4,462,273 of the total options outstanding were exercisable. As of
December 31, 2001 and 2000, respectively, the weighted average exercise price
was $10.07 and $11.78 and the remaining contractual life of options outstanding
was 6.3 years and 8.0 years, respectively. The Company applies APB Opinion
No. 25 in accounting for option grants under the Plan and, accordingly, does
not recognize any compensation cost associated with the grants in the financial
statements as they are issued with a strike price at fair value. Had the
Company determined compensation cost based on the fair value at the grant date
for its options, under SFAS No. 123, the Company's pro forma net income (loss)
before extraordinary gain for 2001 and 2000 would have been $(30,206) and
$10,621, respectively. The Company's pro forma basic net income (loss) before
extraordinary gain per share for 2001 and 2000 would have been $(0.57) and
$0.22, respectively. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted average assumptions used for options granted
during 2001, 2000 and 1999, respectively: no dividend yield, expected
volatility of 73%, 81% and 75%, risk-free interest rate of 4.9%, 6.2% and 6.1%
and an expected life of five years for all grants. The weighted average fair
value of options granted during 2001, 2000 and 1999 was $3.90, $5.69 and $4.23,
respectively, per share. Director Stock
Compensation Plan Under the Director Stock
Compensation Plan (the "Director Plan"), the Company may grant
options or stock (in lieu of annual director fees) up to 200,000 shares of
Class A Common Stock to all non-employee directors as a group. Options granted
under the Director Plan will vest upon the first anniversary of the grant and
are exercisable up to 10 years from the date of grant. All options and stock
awarded under the Director Plan are nontransferable other than by will or the
laws of descent and distribution. During 2001, 2000 and 1999, respectively, the
Company granted 9,000, 16,000 and 6,000 options under the Director Plan. Employee Stock
Purchase Plan Employees began participating in
the 1997 Employee Stock Purchase Plan (the "Purchase Plan") on
September 1, 1998. Under this Purchase Plan, one million shares of Class A
Common Stock are reserved for issuance. The Purchase Plan permits eligible
employees to purchase common stock through payroll deductions at a price equal
to 85% of the lower of the market value of the common stock on the first day of
the offering period or the last day of the offering period. The Purchase Plan
does not result in compensation expense. During 2001, 175,708 shares were
issued under the Purchase Plan for $878. During 2000, 182,903 shares were
issued under the Purchase Plan for $1,122. F-24 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Employee Stock
Purchase and Loan Plan On June 26, 2001 and August 10, 2001, the Company
repurchased 4,228,000 and 772,000 shares, respectively, of Class B common stock
from an executive officer of the Company for $5.50 per share. The shares were converted to Class A common
stock and sold to other Company employees at the same price. Upon settlement of the repurchase and sales
transactions on July 5, 2001 and August 15, 2001, respectively, the Company
received 20% ($1.10 per share) of the purchase price in cash from the
employees, and received five-year, limited recourse promissory notes from the
employees with interest accruing at 6.5% accreting to principal for the
remaining purchase price. The notes are collateralized by all of the stock purchased
under the plan. For accounting purposes, the portion of the employee share
purchase financed by the Company (80%) is considered a stock option, and
deducted from shareholders' equity.
These shares are deducted from shares outstanding, similar to treasury
stock, in computing book value and earnings per share. As a result, both the
$22,706 financed (including accrued interest) by the Company and the 4,000,000
common shares related to the financing are reflected as a receivable in
shareholders' equity. As the employees
repay the loans, shareholders' equity and shares outstanding will
increase. In addition, the interest
earned on the employee loans was added to paid-in-capital and excluded from net
income. Treasury Stock In July 1998, the Company's Board
of Directors approved a plan to repurchase up to 2.5 million shares of the
Company's Class A Common Stock from time to time (the "Repurchase
Plan"). In accordance with the Repurchase Plan, a portion of the stock
acquired may be used for the three stock-based compensation plans described
previously. As of December 31, 2001 and 2000, the Company's treasury stock
consists of stock purchased in the open market at cost. Treasury stock
issuances relate to issuances of common stock pursuant to the Employee Stock
Purchase Plan. Differences between the average cost of the treasury stock and
the sales price of the shares issued are charged to additional paid-in capital.
During 2001 and 2000, the Company's treasury stock transactions were as follows
(dollars in thousands): Shares Cost Balance
as of December 31, 1997 - $ - Open market purchases 1,036,092 8,062 Employee Stock Purchase Plan issuances (126,055) (981) Balance
as of December 31, 1998 910,037 7,081 Open
market purchases 431,935 2,712 Employee Stock Purchase Plan issuances (198,945) (1,452) Balance
as of December 31, 1999 1,143,027 8,341 Employee Stock Purchase Plan issuances (157,857) (1,153) Balance
as of December 31, 2000 985,170 7,188 Employee Stock Purchase Plan issuances (175,708) (1,282) Balance
as of December 31, 2001 809,462 $ 5,906 NOTE 15. SEGMENT INFORMATION: The Company considers its capital
markets and asset management activities and online financial services to be
three separate reportable segments. Parent company assets, liabilities, income
and expenses, such as cash equivalents, income taxes, interest income and
executive officer compensation are not allocated to the segments and,
therefore, are included in the "Other" column in 1999. During 2000,
the Company developed systems and methodologies to allocate overhead costs to
its business units and, accordingly, has presented segment information
consistent with internal management reporting. The accounting policies of these
segments are the same as those described in Note 2. There are no significant
revenue transactions between the segments. The following tables illustrate the
financial information for its segments for the years indicated (in thousands): F-25 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Capital Asset Online Other (1) Consolidated 2001 Total
revenues $139,444 $ 20,938 $ 407 $ - $ 160,789 Compensation
and benefits 95,432 11,381 1,299 - 108,112 Total
expenses 141,325 28,057 7,029 - 176,411 Pre-tax
loss before extraordinary gain (1,881) (7,119) (6,622) - (15,622) Extraordinary
gain - 1,148 - - 1,148 Pre-tax
loss after extraordinary gain (1,881) (5,971) (6,622) - (14,474) Total
assets 102,682 187,832 1,444 - 291,958 Total
net assets 37,118 146,962 1,231 - 185,311 2000 Total
revenues $112,060 $ 68,011 $ 819 $ - $ 180,890 Compensation
and benefits 73,670 35,311 787 - 109,768 Total
expenses 107,935 44,578 6,132 - 158,645 Pre-tax
income (loss) 4,125 23,433 (5,313) - 22,245 Total
assets 73,453 167,178 11,588 - 252,219 Total
net assets 61,057 142,148 11,351 - 214,556 1999 Total
revenues $ 93,060 $ 45,182 $ 411 $ 313 $ 138,966 Compensation
and benefits 62,727 28,069 1,448 6,180 98,424 Total
expenses 101,284 31,707 7,714 5,232 145,937 Pre-tax
income (loss) (8,224) 13,475 (7,303) (4,919) (6,971) Total
assets 74,842 130,631 10,595 10,288 226,356 Total
net assets 60,400 108,922 9,585 10,062 188,969 (1)
Includes inter-company eliminations. F-26 FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) NOTE 16. QUARTERLY DATA (UNAUDITED): The following tables set forth
selected information for each of the fiscal quarters during the years ended
December 31, 2001, 2000 and 1999 (dollars in thousands, except per share data).
The selected quarterly data is derived from unaudited financial statements of
the Company and has been prepared on the same basis as the annual, audited
financial statements to include, in the opinion of management, all adjustments
(consisting of only normal recurring adjustments) necessary for fair
presentation of the results for such periods. Total Net Income Net Income Net Income Basic Earnings Diluted Earnings Basic Earnings Diluted Earnings 2001 First
Quarter $ 22,453 $ (6,139) $ (6,139) $ (6,139) $ (0.12) $ (0.12) $ (0.12) $ (0.12) Second
Quarter 55,152 5,110 5,110 5,110 0.10 0.10 0.10 0.10 Third
Quarter 21,783 (22,390) (22,390) (22,390) (0.49) (0.49) (0.49) (0.49) Fourth
Quarter 61,401 7,797 9,557 10,705 0.22 0.22 0.24 0.24 Total
Year $160,789 $(15,622) $ (13,862) $ (12,714) $ (0.29) $ (0.29) $ (0.27) $ (0.27) 2000 First
Quarter $ 66,243 $ 8,556 $ 6,417 $ 6,417 $ 0.13 $ 0.12 $ 0.13 $ 0.12 Second
Quarter 43,536 6,065 5,280 5,280 0.11 0.11 0.11 0.11 Third
Quarter 44,702 6,193 4,954 4,954 0.10 0.10 0.10 0.10 Fourth
Quarter. 26,409 1,431 1,431 1,431 0.03 0.03 0.03 0.03 Total
Year $180,890 $ 22,245 $ 18,082 $ 18,082 $ 0.37 $ 0.36 $ 0.37 $ 0.36 1999 First
Quarter $ 22,069 $ 45 $ 45 $ 45 $ 0.00 $ 0.00 $ 0.00 $ 0.00 Second
Quarter 40,379 5,849 5,849 5,849 0.12 0.12 0.12 0.12 Third
Quarter 8,922 (23,061) (23,061) (23,061) (0.47) (0.47) (0.47) (0.47) Fourth
Quarter 67,596 10,196 10,196 10,196 0.21 0.21 0.21 0.21 Total
Year $138,966 $ (6,971) $(6,971) $ (6,971) $(0.14) $(0.14) $(0.14) $(0.14)
F-27 FBR Technology Venture Partners L.P. G-1 Report of independent public accountants To the Partners of We have audited the accompanying
statements of assets and liabilities of FBR Technology Venture
Partners L.P. as of December 31, 2001 and 2000, including the
schedule of investments as of December 31, 2001, and the related
statements of operations, changes in net assets, and cash flows for the years
then ended. These financial statements are the responsibility of the General
Partner. Our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits in accordance with auditing
standards generally accepted in the United States. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred
to above present fairly, in all material respects, the financial position of
FBR Technology Venture Partners L.P., as of December 31, 2001 and 2000,
and the results of its operations and its cash flows for the years then ended
in conformity with accounting principles generally accepted in the United
States. /s/ ARTHUR ANDERSEN Vienna, Virginia
G-2
FBR TECHNOLOGY VENTURE PARTNERS L.P. 2001 2000 Assets: Investments in
securities, at fair value; cost basis $ 4,486,042 $ 108,551,260 Cash and cash
equivalents 1,394,489 901,083 Organization
costs, net of $25,000 and $19,000 of 5,000 11,000 Total assets 5,885,531 109,463,343 Liabilities: Line of credit 530,000 462,500 Accounts payable
and accrued liabilities 23,296 19,774 Due to General
Partner 467,326 - Due to affiliates - 28,607 Due to Limited
Partners 1,770 - Total liabilities 1,022,392 510,881 Net assets $ 4,863,139 $ 108,952,462 The accompanying notes are an integral part of these statements. G-3 FBR TECHNOLOGY VENTURE PARTNERS L.P. Shares Value
Common Stock,
United States Enterprises Technology (12.7%) 2,993,000 Network Access
Solutions, Inc. (12.0%) $ 583,635 6,405 Telecommunication
Systems (0.7%) 34,907 Total common
stock (cost, $2,886,499) 618,542 Convertible
Preferred Stock, United States 2,122,774 MarketSwitch
Corporation (72.0%) 3,500,000 6,251,594 Intranets.com
(7.5%) 367,500 Total convertible
preferred stock (cost, $9,287,959) 3,867,500 Total investments
(cost, $12,174,458) $ 4,486,042 The accompanying notes are an integral part of these statements. G-4 FBR TECHNOLOGY VENTURE PARTNERS L.P. 2001 2000 Investment
income: Interest $ 41,211 $ 138,802 Total income 41,211 138,802 General and
administrative expenses: Management fees 1,250,000 1,250,000 Professional fees 87,231 17,010 Interest expense 45,502 31,524 Administrative
fees and other 7,210 7,257 Total expenses 1,389,943 1,305,791 Net investment
loss (1,348,732) (1,166,989) Net realized
gains on investments 49,508,040 257,953,411 Unrealized
depreciation of investments (89,032,920) (105,966,750) Net (loss) income $ (40,873,612) $ 150,819,672
The accompanying notes are an integral part of these statements. G-5 FBR TECHNOLOGY VENTURE PARTNERS L.P. Carried General Limited Total Net assets, $ 34,325,785 $ 1,491,118 $ 187,615,137 $ 223,432,040 Capital contributions - 13,430 1,686,570 1,700,000 Net income - 1,191,475 149,628,197 150,819,672 Special allocation 30,186,694 (240,981) (29,945,713) - Distributions (42,948,492) (1,766,435) (222,284,323) (266,999,250) Net assets, 21,563,987 688,607 86,699,868 108,952,462 Capital contributions - 15,333 1,925,600 1,940,933 Net loss - (322,901) (40,550,711) (40,873,612) Special allocation (7,705,655) 61,514 7,644,141 - Distributions (12,895,847) (411,771) (51,849,026) (65,156,644) Net assets, $ 962,485 $ 30,782 $ 3,869,872 $ 4,863,139
The accompanying notes are an integral part of these statements. G-6 FBR TECHNOLOGY VENTURE PARTNERS L.P. 2001 2000 Cash flows from
operating activities: Net (loss) income $ (40,873,612) $ 150,819,672 Adjustments to
reconcile net (loss) income to net Amortization of
organization costs 6,000 6,000 Purchases of
investments - (1,575,000) Proceeds from
sale of investments 64,540,338 267,813,842 Change in
unrealized depreciation of investments 89,032,920 105,966,750 Net realized
gains on investments (49,508,040) (257,953,411) Changes in assets
and liabilities: Due to General
Partner 467,326 - Due from/to
Limited Partners 1,770 101,030 Accounts payable
and accrued expenses 3,522 (803) Due to affiliates (28,607) (203,682) Net cash provided
by operating activities 63,641,617 264,974,398 Cash flows from
financing activities: Capital
contributions 1,940,933 1,700,000 Capital
distributions (65,156,644) (266,999,250) Net borrowings
under line of credit agreement 67,500 462,500 Net cash used in
financing activities (63,148,211) (264,836,750) Net increase in
cash and cash equivalents 493,406 137,648 Cash and cash
equivalents, beginning
of period 901,083 763,435 Cash and cash
equivalents, end of period $ 1,394,489 $ 901,083 Supplemental
cash flow information: Cash paid for
interest expense $ 39,915 $ 28,693
The accompanying notes are an integral part of these statements. G-7 FBR TECHNOLOGY VENTURE PARTNERS L.P. 1. Organization: FBR Technology Venture Partners L.P. (the Partnership) is a
Limited Partnership formed on August 12, 1997, to engage in the business
of investing in securities. The Partnership was organized under the laws of the
state of Delaware. Operations commenced on November 1, 1997. The Partnership
will continue to operate until the earlier of December 31, 2007, or the
date the Partnership is dissolved as provided for in the Partnership Agreement. 2. Management
fees and other transactions with affiliates: FBR Venture Capital Managers, Inc. (FBRVCM) is the corporate
General Partner and Carried Interest Limited Partner of the Partnership.
Friedman, Billings, Ramsey Group, Inc. (FBRG) is the ultimate parent
company of FBRVCM. In addition, certain officers and directors of FBRG are
Limited Partners of the Partnership. At the beginning of each calendar quarter, FBRVCM is
entitled to receive a Management Fee for management of the businesses and
affairs of the Partnership. The fee is computed as 2.5 percent (on an
annualized basis) of the total funds committed to the Partnership. For each
calendar quarter beginning after the end of the Investment Period
(July 31, 2003), the fee is computed as the lesser of 2.5 percent (on
an annualized basis) of the total funds committed to the Partnership, or an
amount equal to 4.0 percent (on an annualized basis) of the aggregate
acquisition costs of the portfolio investments and any bridge loans provided by
Limited Partners and held as of the end of the preceding quarter. 3. Summary
of significant accounting policies: Use
of estimates The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts
of income and expenses during the reporting periods and the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements. Actual results could differ from those
estimates. Security
valuation Investments in securities are recorded at fair value. The
Partnership's investments as of December 31, 2001 and 2000, consisted of equity
investments in securities of development-stage and early-stage privately and
publicly held technology companies. The disposition of these investments may be
restricted due to the lack of a ready market (in the case of privately held
companies) or due to contractual or regulatory restrictions on disposition (in
the case of publicly held companies). In addition, these securities may
represent significant proportions of the issuer's equity and carry special
contractual privileges not available to other security holders. As a result of
these factors, precise valuation for the restricted public securities and
private company securities is a matter of judgment, and the determination of
fair value must be considered only an approximation and may vary from the
amounts that could be realized if the investment were sold. The following is the
methodology employed by the General Partner in valuing its investments: Nonrestricted
public securities that are traded on a national securities exchange (or
reported on the NASDAQ national market) are valued at the last reported sales
price on the day of valuation. Restricted
public securities - Securities that have underlying public markets, but whose
disposition is restricted, are valued at a discount from the current market
value. Discounts are taken for regulatory restrictions and contractual lock-up
agreements. If a security has either regulatory restrictions or is contractually
locked up, a market blockage discount may be applied as well. Private
securities - The investment will be carried at cost, subject to the following:
the investment may be marked up or down to reflect changes in the fundamentals
of the issuer, its industry sector, or the economy in general, since the date
of the original investment. Events considered in this valuation are: (1) a
subsequent third-party round of financing at a per share price that is higher
or lower than the Partnership's, (2) an imminent public offering, (3) an
imminent sale of the issuer, or (4) if the issuer's performance and potential
have significantly deteriorated as of the valuation date. G-8 FBR TECHNOLOGY VENTURE PARTNERS L.P. Income
recognition For securities held, the difference between the cost basis
and fair value of investments in securities is included as unrealized
depreciation of investments in the accompanying statements of operations.
Realized gains or losses represent the difference between the fair value and
cost basis upon the sale of investments or distribution of securities to the
Partners. Income
taxes No provision for income taxes is made in the Partnership's
financial statements since all taxable income and loss is allocated to the
Partners. Organization
costs Costs relating to the formation of the Partnership have been
deferred and are being amortized over five years using the straight-line
method. Cash
and cash equivalents For purposes of the statements of cash flows, the
Partnership considers cash in banks (including escrow accounts) and all highly
liquid investments with a maturity of three months or less to be cash
equivalents. Capital
accounts, allocations, and expenses In addition to the Limited Partners, the General Partner
may, at its discretion, and without consent of any other Partners, admit
employees of FBRVCM and its affiliates as "FBR Employee Limited
Partners." The Capital Accounts of FBR Employee Limited Partners are
treated the same as other Limited Partners, except in regard to items (b) and
(c) below. At the end of each fiscal quarter, the Capital Account of each
partner is adjusted for the allocation of Partner distributions as defined in
the Partnership Agreement: (a) For each fiscal quarter,
all gains and losses are allocated among the Partners in accordance with their
respective percentage interests. (b) After allocations to the
Limited Partners in amounts totaling their commitments have been received, the
Carried Interest Limited Partner is entitled to receive allocations in an
amount equal to 20 percent carried interest of the allocations received by
the Limited Partners. (c) In succeeding periods,
the Carried Interest Limited Partner receives 20 percent of the
allocations of the Partnership, and the remaining 80 percent is allocated
to the Limited Partners on a pro rata basis. Distributions
and withdrawals The Partnership, at the sole discretion of the General
Partner, may make distributions of cash or securities to all Partners in
proportion to their respective Capital Accounts. The Partnership has no
obligation to make any distributions. The Partnership made distributions of
$65,156,644 and $266,999,250 in 2001 and 2000, respectively, which consisted of
$3,554,813 and $49,040,377 in cash and $61,601,831 and $217,958,873, in
securities respectively, at their fair value as of the date of distribution. The Limited Partners have no rights to demand the return of
their Capital Contributions unless they have contributed in excess of their pro
rata share of capital. G-9 FBR TECHNOLOGY VENTURE PARTNERS L.P. 4. Partner
capital commitments: The Limited Partners initially contributed 2 percent of
their respective committed amounts in cash at the date operations of the
Partnership commenced. The Limited Partners have agreed, upon 15 business days'
written notice from the General Partner, to contribute additional cash to the
Partnership (a Capital Call) up to that Partner's Capital Commitment, provided
that such Capital Calls shall apply to all Limited Partners, pro rata, in
proportion to their respective Partnership interests. As of December 31,
2001 and 2000, the Partners have made cumulative contributions totaling
$42,950,215 and $41,009,282, respectively, of total Partnership commitments of
$50,000,000. 5. Borrowings: In October 2001, the Partnership renewed a $2,000,000 line
of credit with an expiration date of October 5, 2002, to better serve the
Partnership's borrowing needs. The Capital Commitments of the Limited Partners
serve as collateral for the line of credit. The interest rate is based on the
higher of the Prime Rate plus 0.5 percent per annum or the Bank's Cost of
Funds plus 1.5 percent per annum. As of December 31, 2001, the Prime
Rate plus 0.5 percent per annum was higher at 5.25 percent. As of
December 31, 2001, the Partnership had $530,000 in outstanding borrowings
under this line of credit. 6. Financial
instruments with off-balance-sheet risk and concentrations of credit risk: The Partnership has invested primarily in the United States
and has not entered into any transactions involving financial instruments, such
as financial futures, forward contracts, swaps, and derivatives, which would
expose the Partnership to related off-balance-sheet risk. Market risk to the Partnership is caused by illiquidity and
volatility in the markets in which the Partnership would seek to sell its
financial instruments. The Partnership's concentration of investments in the
technology industry and a limited number of companies may result in the
Partnership being exposed to a risk of loss that is greater than it would be if
the Partnership mitigated such risks through a greater diversification or investment
in securities for which there is a ready public market. Positions taken, commitments, and unrealized appreciation on
investments made by the Partnership may involve substantial amounts relative to
its net assets and significant exposure to individual issuers and businesses. 7. Financial
highlights: Limited Total return (88.8)% Ratio to average
net assets: Net
investment income (4.9)% Expenses 5.1% Total return is calculated as the change in a theoretical
Limited Partner's Capital Account, subject to the Management Fee and incentive
allocation, who was invested from January 1, 2001 to December 31,
2001. An individual Partner's return may vary from this return based on
different Management Fee and incentive arrangements (as applicable) and the
timing of capital transactions. The above ratios to average net assets are computed based
upon the weighted average net assets of the Limited Partners for the year 2001
and are calculated before the incentive allocation. G-10 FINANCIAL STATEMENTS H-1 REPORT OF
INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders of FBR Asset Investment Corporation: We have audited
the accompanying statements of financial condition of FBR Asset Investment
Corporation (the "Company") as of December 31, 2001 and 2000, and the related
statements of income, changes in shareholders' equity and cash flows for each of
the three years in the period ended December 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our
audits in accordance with auditing standards generally accepted in the United
States. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion. In our opinion,
the financial statements referred to above present fairly, in all material
respects, the financial position of FBR Asset Investment Corporation as of
December 31, 2001 and 2000, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2001 in conformity
with accounting principles generally accepted in the United States. /S/ ARTHUR ANDERSEN LLP Vienna, Virginia H-2 FBR ASSET INVESTMENT CORPORATION STATEMENTS OF
FINANCIAL CONDITION As of As of ASSETS Mortgage-backed securities, pledged as collateral, at fair value
$ 1,188,730,763
$ 144,867,416 LIABILITIES AND SHAREHOLDERS' EQUITY
85,025
38,844 The accompanying notes are an integral part of these
statements. H-3 FBR ASSET INVESTMENT CORPORATION STATEMENTS OF INCOME 2001
2000
1999
The accompanying notes are an integral part of these
statements. H-4 FBR ASSET INVESTMENT CORPORATION
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Common Additional Retained Total Comprehensive
-
-
-
(3,181,829)
(3,181,829)
(3,181,829)
-
-
-
12,233,668
12,233,668
12,233,668
-
-
-
17,062,115
17,062,115
17,062,115 The accompanying notes are an integral part of these
statements. H-5 FBR ASSET INVESTMENT CORPORATION STATEMENTS OF CASH FLOWS 2001
2000
1999
The accompanying notes are an integral part of these
statements. H-6 FBR ASSET INVESTMENT CORPORATION Note 1 Organization and Nature of Operations FBR Asset
Investment Corporation ("FBR Asset" or the "Company") was incorporated in
Virginia on November 10, 1997. FBR Asset commenced operations on December 15,
1997, upon the closing of a private placement of equity capital. FBR Asset is
organized as a real estate investment trust ("REIT") whose primary purpose is to
purchase mortgage-backed securities and make investments in debt and equity
securities of companies engaged in real estate-related and other businesses. FBR
Asset invests in mortgage loans and mortgage-backed securities, that represent a
100 percent interest in the underlying conforming mortgage loans and are
guaranteed by the Government National Mortgage Association ("Ginnie Mae"), the
Federal Home Loan Mortgage Corporation ("Freddie Mac"), and the Federal National
Mortgage Association ("Fannie Mae"), or by private issuers that are secured by
real estate (together the "Mortgage Assets"). FBR Asset also acquires indirect
interests in those and other types of real estate-related assets by investing in
public and private real estate companies, subject to the limitations imposed by
the various REIT qualification requirements. Funds not immediately allocated are
generally temporarily invested in readily marketable, interest-bearing
securities. To seek yields commensurate with its investment objectives, FBR
Asset leverages its mortgage-backed security portfolio primarily with
collateralized borrowings. FBR Asset uses derivative financial instruments to
hedge a portion of the interest rate risk associated with its borrowings. FBR Asset is
managed by Friedman, Billings, Ramsey Investment Management, Inc. ("FBR
Management"), a subsidiary of Friedman, Billings, Ramsey Group, Inc. ("FBR
Group"). Note 2 Summary of Significant Accounting Policies Investments in Mortgage-Backed Securities Mortgage-backed
security transactions are recorded on the date the securities are purchased or
sold. Any amounts payable or receivable for unsettled trades are recorded as
"due to or due from custodian" in FBR Asset's Statement of Financial Condition. FBR Asset accounts
for its investments in mortgage-backed securities as available-for-sale
securities. FBR Asset does not hold its mortgage-backed securities for trading
purposes, but may not hold such investments to maturity. Securities classified
as available-for-sale are reported at fair value, with temporary unrealized
gains and losses excluded from earnings and reported as a separate component of
shareholders' equity. Realized gains and losses on mortgage-backed securities
transactions are determined on the specific identification method. Unrealized losses
on mortgage-backed securities that are determined to be other than temporary are
recognized in income. Management regularly reviews its investment portfolio for
other than temporary market value decline. There were no such adjustments for
mortgage-backed investments during the periods presented. The fair value of
FBR Asset's mortgage-backed securities are based on market prices provided by
certain independent dealers who make markets in these financial instruments. The
fair values reported reflect estimates and may not necessarily be indicative of
the amounts FBR Asset could realize in a current market transaction. Income from
investments in mortgage-backed securities is recognized using the effective
interest method, using the expected yield over the life of the investment.
Income includes contractual interest accrued and the amortization or accretion
of any premium or discount recorded upon purchase. Changes in anticipated yields
result primarily from changes in actual and projected cash flows and estimated
prepayments. Changes in the yield that result from changes in the anticipated
cash flows and prepayments are recognized over the remaining life of the
investment with recognition of a cumulative catch-up at the date of change from
the date of original investment. Investments in Equity Securities Investments in
securities that are listed on a national securities exchange (or reported on the
Nasdaq National Market) are stated at the last reported sale price on the day of
valuation. Listed securities for which no sale was reported are stated at the
mean between the closing "bid" and "ask" price on the day of valuation.
Investments which are not listed on a national securities exchange (or reported
on the Nasdaq National Market) are carried at cost. FBR Management may use
methods of valuing securities other than those described above if it believes
the alternative method is preferable in determining the fair value of such
securities. H-7 FBR ASSET INVESTMENT CORPORATION NOTES TO FINANCIAL STATEMENTS - (Continued)
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
EXCHANGE ACT OF 1934
(Exact name of registrant as specified in its charter)
54-1837743
(State or other jurisdiction of
(I.R.S. Employer
Incorporation or organization)
Identification No.)
1001 Nineteenth Street North
Arlington, VA
22209
(Address of principal executive offices)
(Zip code)
(Registrant's telephone number including area code)
Item 1.
Business
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Submission of Matters to a Vote of
Security Holders
Item 5.
Market for Registrant's Common
Equity and Related Stockholder Matters
Item 6.
Selected Consolidated Financial
Data
Item 7.
Management's Discussion and
Analysis of Financial Condition and Results of Operations
Item 8.
Financial Statements and
Supplementary Data
Item 10.
Directors and Executive Officers of
the Registrant
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain
Beneficial Owners and Management
Item 13.
Certain Relationships and Related
Transactions
Item 14.
Exhibits, Consolidated Financial
Statement Schedules, and Reports on Form 8-K
SIGNATURES
INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS OF FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
INDEX TO
FINANCIAL
STATEMENTS OF FBR TECHNOLOGY VENTURE PARTNERS, L.P.
INDEX TO FINANCIAL
STATEMENTS OF FBR ASSET INVESTMENT CORPORATION
Mutual fund management and administrative contracts
$19.7
Bank equity
5.5
$25.2
Commenced
Private Equity/Venture
Capital
FBR Private Equity
Fund, L.P. ("PEF")
Private equity/mezzanine
financing up to $3 million
FBR Technology Venture
Partners, L.P. ("TVP")
Pre-IPO stage financings of
$1-4 million
FBR Financial Services
Partners, L.P.
("Financial Services")Financial services private
equity
FBR Technology Venture
Partners II, L.P. ("TVP II")
Pre-IPO stage financings of
$2-10 million
FBR CoMotion Venture
Capital, L.L.C.
("CoMotion")Pre-IPO stage financings of
$1-4 million
Hedge and other Funds
Focused on Public Equity
FBR Weston, Limited
Partnership
Long-term opportunistic
FBR Ashton, Limited
Partnership
Financial equities
FBR Opportunity Fund,
Ltd.
Financial equities offshore
FBR Arbitrage, L.L.C.
Merger/special situation
arbitrage
Equity Mutual Funds
American Gas Index Fund
Common stocks of natural gas
distribution, gas pipeline, diversified gas, and combination gas and
electric companies headquartered in the U.S.
FBR Financial Services
Fund
Financial services companies
FBR Small Cap Financial
Fund
Small-cap companies that
provide financial services to consumers and industry
FBR Small Cap Value
Fund
Small-cap companies with
assets less than $3 billion
FBR Technology Fund
Companies principally engaged
in research, design, development, manufacturing or distributing products
or services in the technology industry
Commenced
Fixed Income and Money Market Mutual Funds
Fund for Government Investors
Short-term U.S. Government
securities
Fund for Tax-Free Investors, Inc.:
Rushmore Maryland Tax-Free Portfolio
Long-term investment grade
tax-exempt securities issued by the State of Maryland, its political
subdivisions and other issuers exempt from federal income tax and Maryland
state income tax.
Rushmore Virginia Tax-Free Portfolio
Long-term investment grade
tax-exempt securities issued by the Commonwealth of Virginia, its
political subdivisions and other issuers exempt from federal income tax
and Virginia state income tax.
Rushmore Tax-Free Money Market Portfolio
Short-term tax-exempt
municipal securities
U.S. Government Bond Portfolio
U.S. Government securities
with maturities that range from short to long-term
Other
FBR-Asset Investment Corp.
Equity securities;
mortgage-backed securities and mezzanine loans
secondary markets; and
fees we receive from those transactions;
portfolio companies;
those transactions;
business units, including marketing and technology expenses.
Name
Positions
Emanuel J. Friedman
Chairman and Co-Chief Executive Officer;
Director
Eric F. Billings
Vice Chairman and Co-Chief Executive Officer;
Director
Robert S. Smith
Executive Vice President and Chief Operating
Officer
Kurt R. Harrington
Senior Vice President and Chief Financial
Officer
William J.Ginivan
Senior Vice President and General Counsel
STOCKHOLDERS MATTERS
2001
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
2000
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
1999
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
(Dollars in thousands, except per share amounts)
1999
1998
1997
Consolidated Statements of
Operations
Revenues:
Investment banking:
Underwriting
Corporate
finance
Investment
gains
Institutional brokerage:
Principal
transactions
Agency
commissions
Asset management:
Base management
fees
Incentive
allocations and fees
Net investment
income (loss)
Technology
sector net investment and
incentive income (loss)
Interest, dividends and
other
Total
revenues.
Expenses:
Compensation and
benefits.
Business development and
professional services
Clearing and brokerage
fees.
Occupancy and equipment
Communications
Interest expense
Other operating expenses
Restructuring and
software impairment charges
Total
expenses
Net income (loss) before taxes
and extraordinary gain
Income tax provision (benefit)
Net income (loss) before
extraordinary gain
Extraordinary gain
Net income (loss)
Consolidated Balance Sheet
Data
Assets:
Cash and cash equivalents
Marketable trading
securities
Long-term investments
Other
Total
assets
Liabilities:
Accounts payable and
other liabilities
Short-term debt
Accrued dividends
Trading account
securities sold short
Total
liabilities
Shareholders' equity
Total
liabilities and shareholders' equity
(Dollars in thousands, except per share amounts)
Statistical Data
Basic earnings (loss) per
share
Diluted earnings (loss) per
share
Pro forma basic and diluted
earnings per share (1)
Book value per share (2)
Total employees (2), (4)
Revenue per employee
Pre-tax return on average
equity
Compensation and benefits
expense as a percentage of revenues
Basic weighted average shares
outstanding (in thousands)
Diluted weighted average
shares outstanding (in thousands)
AND
RESULTS OF OPERATIONS
Revenues:
Public Underwritings
Initial public offerings
Secondary public offerings
High yield debt & preferred
Underwriting
Non Public Capital Raising and M&A
High yield debt & preferred
M&A and advisory services
Private equity placements
Corporate Finance
Total
Capital raising
$66,634
$29,979
$30,629
$96,539
$193,439
Principal sales credits
Trading gains and losses, net
Principal transactions
Agency commissions
Total
Principal and agency,
excluding trading gains and losses
$46,537
$39,293
$46,284
("AUM")
Capital (1)
Managed
accounts
Hedge
and offshore funds
Mutual
funds
Private
equity funds
Technology sector funds
Total
Revenues:
Investment banking:
Underwriting
Corporate finance
Investment gains.
Institutional brokerage:
Principal transactions
Agency commissions
Asset management:
Base management fees
Incentive allocations and
fees
Net investment income
(loss)
Technology sector net investment and incentive income (loss)
Interest, dividends and other
Total revenues
Expenses:
Compensation and benefits
Business development and
professional services
Clearing and brokerage fees
Occupancy and equipment
Communications
Interest expense
Other operating expenses
Restructuring and software impairment charges
Total expenses
Income (loss)
before income taxes
48
Financial
FBR Ashton, Limited Partnership
FBR Private Equity Fund, L.P.
FBR Future Financial Fund, L.P.
FBR Financial Services Partners, L.P.
Direct investment
Real Estate & Mortgages
FBR Asset Investment Corporation
Direct investment
Subtotal
Technology
FBR Technology Venture Partners,
L.P. (1)
FBR Technology Venture Partners II,
L.P.
FBR CoMotion Venture Capital I,
L.P. (2)
DDL and related direct investments
Direct investment
Third-party partnerships
Other
Capital Crossover Partners
Subtotal
Debt
Direct investment (3)
Other
Braddock Partners, L.P.
FBR Arbitrage, L.L.C.
FBR Weston, Limited Partnership
Other
TOTALS
(1)
Amount includes accrued Fund Manager
Compensation expense ("FMC") of $157 and $12,938 as of December 31,
2001 and 2000, respectively. Asset value net of FMC as of December 31, 2001
and 2000 was $911
and $10,975, respectively.
(2)
(3)
ON FORM 8-K
A.
Friedman, Billings, Ramsey Group, Inc. Report of Independent Public
Accountants (page F-2)
Consolidated Balance Sheets-Years ended 2001 and 2000 (page F-3)
Consolidated Statements of Operations-Years ended 2001, 2000 and 1999 (page F-4)
Consolidated Statements of Changes in Shareholders' Equity-Years ended 2001,
2000 and 1999 (page F-5)
Consolidated Statements of Cash Flows-Years ended 2001, 2000 and 1999 (page F-6)
Notes to Consolidated Financial Statements (page F-7)
B.
FBR
Technology Venture Partners, L.P. Financial Statements (G-1)
C.
FBR Asset Investment Corporation Financial Statements (H-1)
Number
3.01 *
-Registrant's Articles of Incorporation.
3.02 *
-Registrant's Bylaws.
4.01 *
-Form of Specimen Certificate for
Registrant's Class A Common Stock.
10.01 **
-Revolving Subordinated Loan Agreement,
between Friedman, Billings, Ramsey & Co.,
Custodial Trust Company and dated August 4, 1998.
10.02 *
-The 1997 Employee Stock Purchase Plan.
10.03***
-FBR Stock and Annual Incentive Plan.
10.04 *
-The Non-Employee Director Stock Compensation
Plan.
10.05 *
-The Key Employee Incentive Plan.
10.06
-Agreement between Friedman, Billings,
Ramsey Investment Management, Inc. and FBR Asset Investment Corporation.
10.07
-Agreement between Friedman, Billings, Ramsey
& Co., Inc. and FBR Asset Investment Corporation.
21.01
-List of Subsidiaries of the Registrant.
23.01
-Consent of Independent Public Accountants.
99.01*
-Memorandum of Understanding between FBR and
PNC Bank Corp., dated as of October 28, 1997.
99.02
-FBR Asset Investment Corporation Risk
Factors.
99.03
-Representation pursuant to Temporary Note 3T
to Article 3 of Regulation S-X.
Friedman, Billings, Ramsey Group, Inc.
By: /s/ Emanuel J. Friedman
Emanuel J. Friedman,
Chairman of the Board of Directors, Co-Chief
Executive Officer
/s/ Emanuel J. Friedman
Chairman of the Board of Directors,
Co-Chief
Executive Officer
Emanuel J. Friedman
/s/ Eric F. Billings
Vice Chairman of the Board of
Directors and Co-Chief
Executive Officer
Eric F. Billings
/s/ Kurt R. Harrington
Senior Vice President and Chief
Financial Officer (Principal
Financial and Accounting Officer)
Kurt R. Harrington
/s/ Daniel J. Altobello
Director
Daniel J. Altobello
/s/ W. Russell Ramsey
Director
W. Russell Ramsey
/s/ Wallace L. Timmeny
Director
Wallace L. Timmeny
Page
Report of Independent
Public Accountants
F-2
Consolidated Balance Sheets
As of December 31, 2001
and 2000F-3
Consolidated Statements of
Operations
For the years ended December 31, 2001, 2000 and 1999F-4
Consolidated Statements of Changes in Shareholders' Equity
For the years ended December 31, 2001, 2000 and 1999F-5
Consolidated Statements of
Cash Flows
For the years ended December 31, 2001, 2000 and 1999F-6
Notes
to Consolidated Financial Statements
F-7
January 31, 2002
except per share amounts)
depreciation
and amortization of $17,138 and $10,636, respectively
outstanding
23,468,403
and 17,455,406 shares issued, respectively
26,946,029
and 32,910,029 shares issued and outstanding, respectively
IN SHAREHOLDERS' EQUITY
(Dollars in thousands)
Number
of Shares
Amount
Number
of Shares
Amount
Paid-In
Capital
Stock Loan
Receivable
Stock
Other
Comprehensive
Income (Loss)
Earnings
(Deficit)
Income (Loss)
Interest on employee stock purchase
and loan plan
-
-
-
-
706
(706)
-
-
-
-
(Dollars in thousands)
Incentive
allocations and fees and net investment (income) loss from
long-term investments
BUT NOT YET
PURCHASED:
Not Yet
Purchased
Not Yet
Purchased
temporary"
declines in the value of available-for-sale securities
Under
Prompt Corrective Action Provisions
Shares
Markets
Management
Financial
Services
Totals
Revenues
(Loss) Before
Income Taxes
(Loss) Before
Extraordinary
Items
(Loss) After
Extraordinary
Items
(Loss) Per Share
Before
Extraordinary
Items
(Loss) Per Share
Before
Extraordinary
Items
(Loss) Per Share
After
Extraordinary
Items
(Loss) Per Share
After
Extraordinary
Items
(A Limited Partnership)
Index to Financial Statements
Report of Independent Public Accountants
G-2
Statements of assets and liabilities
As of December 31, 2001 and 2000
G-3
Schedule of
investments
As of
December 31, 2001
G-4
Statements
of operations
For the years ended December 31,
2001 and 2000
G-5
Statements
of changes in net assets
For the years ended December 31,
2001 and 2000
G-6
Statements
of cash flows
For the years ended December 31,
2001 and 2000
G-7
Notes to
financial statements
December 31, 2001 and 2000
G-8
FBR Technology Venture Partners L.P.:
January 31, 2002
(A Limited Partnership)
STATEMENTS OF ASSETS AND
LIABILITIES
As of December 31, 2001 and 2000
of $12,174,458 and $27,206,756 as of
2001 and
2000, respectively
accumulated amortization in 2001 and
2000,
respectively
(A Limited Partnership)
SCHEDULE OF INVESTMENTS
As of December 31, 2001
Enterprises Technology (79.5%)
(A Limited Partnership)
STATEMENTS OF OPERATIONS
For the years ended December 31,
2001 and 2000
(A Limited Partnership)
STATEMENTS OF CHANGES IN NET
ASSETS
For
the years ended December 31, 2001 and 2000
Interest
Limited
Partner
Partner
Partners
December 31, 1999
December 31, 2000
December 31, 2001
(A Limited Partnership)
STATEMENTS OF CASH FLOWS
For
the years ended December 31, 2001 and 2000
cash provided by operating activities-
(A Limited Partnership)
NOTES TO FINANCIAL STATEMENTS
December 31, 2001 and 2000
(A Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - (Continued)
December 31, 2001 and 2000
(A Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - (Continued)
December 31, 2001 and 2000
Partner
Page
Report of Independent
Public Accountants
H-2
Statements of Financial Condition as of December 31, 2001,
and December 31, 2000H-3
Statements of
Income for the Years Ended December 31, 2001,
December 31, 2000, December 31, 1999H-4
Statements of
Changes in Shareholders' Equity for the Years
Ended December 31, 2001, December 31, 2000, and December
31, 1999 H-5
Statements
of Cash Flows for the Years Ended December 31,
2001, December 31, 2000, and December 31, 1999H-6
Notes
to Financial Statements
H-7
January 31, 2002
As of December 31, 2001 and December 31, 2000
December 31,
2001
December 31,
2000
Mortgage-backed securities, at fair
value
49,634,748
9,980,789
Investments in equity securities, at
fair value
61,692,660
28,110,190
Cash and cash equivalents
6,630,379
36,810,566
Note receivable
8,000,000
4,000,000
Dividends, interest and fees receivable
10,241,837
1,813,478
Prepaid expenses and other assets
194,831
221,628
Total
assets
$ 1,325,125,218
$ 225,804,067
Liabilities:
Repurchase
agreements
$ 1,105,145,000
$ 133,896,000
Interest rate
swap
1,159,167
-
Interest
payable
2,177,892
844,841
Dividends
payable
10,645,659
3,731,911
Management
fees payable
1,117,458
78,727
Accounts
payable and accrued expenses
505,549
237,218
Income taxes
payable
473,403
-
Other
35,544
174,786
Total liabilities
1,121,259,672
138,963,483
Shareholders' Equity:
Preferred
stock, par value $.01 per share, 50,000,000 shares authorized
-
-
Common stock,
par value $.01 per share, 200,000,000 shares
authorized, 8,502,527 and
3,884,427 shares issued and
outstanding as of
December 31, 2001 and December 31,
2000, respectively
Additional paid-in capital
206,916,930
107,529,063
Accumulated other comprehensive income
(loss)
15,154,257
(748,691)
Retained deficit
(18,290,666)
(19,978,632)
Total shareholders' equity
203,865,546
86,840,584
Total liabilities and shareholders' equity
$ 1,325,125,218
$ 225,804,067
For the Years Ended December 31, 2001, 2000 and 1999
Year
Ended December 31,
Revenue:
Interest
$ 32,390,594
$ 18,758,866
$ 15,823,914
Dividends
3,820,985
5,082,191
7,649,935
Fee income
2,875,780
-
-
Total income
39,087,359
23,841,057
23,473,849
Expenses:
Interest
14,612,625
10,935,130
7,920,648
Management fee
3,494,357
1,078,713
1,329,063
Professional
fees and other
772,152
596,374
1,432,589
Total expenses
18,879,134
12,610,217
10,682,300
Realized gain (loss) on sale of
mortgage-backed securities, net
1,106,598
67,358
(358,692)
Realized gain on sale of equity
securities, net
2,768,534
2,692,304
3,597,190
Recognized loss on available-for-sale
equity securities
(544,880)
(5,626,022)
(10,887,458)
Net income before taxes
23,538,477
8,364,480
5,142,589
Income tax expense
(473,403)
-
-
Net income
$ 23,065,074
$ 8,364,480
$ 5,142,589
Basic earnings per share
$
4.27
$
1.84
$
0.68
Basic weighted-average common and
equivalent shares
5,402,150
4,543,532
7,523,715
Diluted earnings per share
$
4.17
$
1.84
$
0.68
Diluted weighted-average common and
equivalent shares
5,525,270
4,543,532
7,523,715
For the Years Ended December 31, 2001, 2000 and 1999
Stock
Paid In
Capital
Earnings
(Deficit)
Accumulated
Other
Comprehensive
Income
(Loss)
Income
Balance, December 31,
1998
$
85,435
$ 170,045,253
$ (9,425,579)
$ (9,800,530)
$ 150,904,579
Repurchase of common stock
(27,372)
(37,114,774)
-
-
(37,142,146)
Net income
-
-
5,142,589
-
5,142,589
$ 5,142,589
Other comprehensive income
Change in unrealized loss
on
available-for-sale
securities
Dividends
-
-
(11,180,472)
-
(11,180,472)
-
Balance, December 31,
1999
58,063
132,930,479
(15,463,462)
(12,982,359)
104,542,721
$
1,960,760
Repurchase of common stock
(19,219)
(25,401,416)
-
-
(25,420,635)
Net income
-
-
8,364,480
-
8,364,480
$ 8,364,480
Other comprehensive income
Change in unrealized loss
on
available-for-sale
securities
Dividends
-
-
(12,879,650)
-
(12,879,650)
-
Balance, December 31,
2000
38,844
107,529,063
(19,978,632)
(748,691)
86,840,584
$
20,598,148
Issuance of common stock
50,300
107,575,383
-
107,625,683
Repurchase of common stock
(4,119)
(8,330,016)
(8,334,135)
Options granted
-
142,500
-
142,500
Net income
-
-
23,065,074
-
23,065,074
$
23,065,074
Other comprehensive income
Change in unrealized gain
(loss)
on available-for-sale
securities
Change in unrealized loss on
cashflow hedge-
-
-
(1,159,167)
(1,159,167)
(1,159,167)
Dividends
-
-
(21,377,108)
-
(21,377,108)
-
Balance, December 31,
2001
$
85,025
$ 206,916,930
$ (18,290,666)
$
15,154,257
$ 203,865,546
$ 38,968,022
For the Years Ended December 31, 2001, 2000 and 1999
For
the Year Ended December 31
Cash flows from operating
activities:
Net income
$ 23,065,074
$ 8,364,480
$ 5,142,589
Adjustments to reconcile net income to net cash
provided by operating
activities
Realized and recognized (gain) loss on
mortgage-backed and equity securities, net(3,330,252)
2,866,360
7,648,960
Amortization
4,717
456,342
Premium amortization on
mortgage-backed securities4,779,118
296,626
682,695
Compensation expense related to stock option grants
142,500
-
-
Changes in operating assets and liabilities:
Dividends, interest and fees receivable
(8,428,358)
1,227,197
(200,150)
Due from custodian
-
806,093
(806,093)
Prepaid expenses
26,797
31,888
(248,799)
Management fees payable
1,038,731
(158,440)
(1,038,347)
Accounts payable and accrued expenses
268,329
107,539
(95,256)
Interest payable
1,333,051
357,619
177,126
Due to custodian
-
-
(2,041,230)
Income taxes payable
473,403
-
-
Other
(139,241)
(3,519)
5,479
Net cash provided by operating activities
19,229,152
13,900,560
9,683,316
Cash flows from investing
activities:
Purchase of
mortgage-backed securities
(1,340,540,932)
(40,917,985)
(282,288,201)
Investments in
equity securities
(30,269,000)
(1,801,410)
(11,454,320)
Investments in
notes receivable
(12,000,000)
(4,000,000)
(59,113,179)
Repayment of
notes receivable
8,000,000
27,000,000
51,196,100
Proceeds from
sale of mortgage-backed securities
96,938,432
101,529,084
160,809,435
Proceeds from
sale of equity securities
14,201,575
29,239,857
27,894,010
Receipt of
principal payments on
mortgage-backed
securities
158,183,398
23,720,735
30,376,288
Net cash (used in) provided by investing activities
(1,105,486,527)
134,770,281
(82,579,867)
Cash flows from financing
activities:
Repurchase of
common stock
(8,334,135)
(25,420,635)
(37,142,146)
Proceeds from
issuance of common stock
107,625,683
-
-
Proceeds from
(repayments of) repurchase agreements, net
971,249,000
(87,818,000)
93,164,000
Dividends paid
(14,463,360)
(12,039,107)
(10,852,162)
Net cash provided by (used in) financing activities
1,056,077,188
(125,277,742)
45,169,692
Net (decrease)
increase in cash and cash equivalents
(30,180,187)
23,393,099
(27,726,859)
Cash and cash
equivalents, beginning of the period
36,810,566
13,417,467
41,144,326
Cash and cash
equivalents, end of the period
$
6,630,379
$
36,810,566
$
13,417,467
Supplemental
disclosure:
Cash payments
for interest
$
13,279,574
$
10,577,511
$
7,743,522
Realized gains and losses are recorded on the date of the transaction using the specific identification method. The difference between the purchase price and market price (or fair value) of investments in securities is reported as an unrealized gain or loss and a component of comprehensive income. Dividend income is recognized on the ex-dividend date.
Management regularly reviews any declines in the market value of its equity investments for declines that are other than temporary. Such declines are recorded in operations as a "recognized loss on available-for-sale securities."
Note Receivable
Notes Receivable are carried at cost as the Company has the intent to hold such note receivables for the foreseeable future. Interest income is recognized using the effective interest method which recognizes any fees or costs related to the Note over its life. If it becomes probable the Company will not collect the scheduled payments on the Notes Receivable then the Note Receivable is considered impaired and written down to fair value if applicable.
Cash and Cash Equivalents
All investments with original maturities of less than three months are cash equivalents. As of December 31, 2001, cash and cash equivalents consisted of $1.4 million of cash deposited in two commercial banks and $5.2 million in three separate domestic money market funds. As of December 31, 2000, cash and cash equivalents consisted of $2.1 million of cash deposited in two commercial banks and $34.7 million in two separate domestic money market funds. The carrying amount of cash equivalents approximates their fair value.
Comprehensive Income
Comprehensive income includes net income as currently reported by the Company on the statement of income adjusted for other comprehensive income. Other comprehensive income for the Company is changes in unrealized gains and losses related to the Company's mortgage-backed securities ("MBS") and equity securities accounted for as available for sale with changes in fair value recorded through shareholders equity and changes in unrealized gains and losses related to the company's use of cash flow hedges. The table below breaks out other comprehensive income for the periods presented into the following two categories: (1) the changes to unrealized gains and losses that relate to the MBS and equity securities which were disposed of or impaired during the period with the resulting gain or loss reflected in net income (reclassification adjustments) and (2) the change in the unrealized gain or loss related to those investments and cash flow hedges that were not disposed of or impaired during the period.
2001 |
2000 |
1999 |
|
Reclassification adjustment for (gains)
losses from dispositions included in net income |
$ (1,055,298) | $ (2,220,998) | $ (1,313) |
Reclassification adjustment for
impairment loss recognized on equity securities included in net income |
529,168 | 4,516,638 | 10,589,124 |
Unrealized holding (losses) gains arising
during the period |
16,429,078 | 9,938,028 | (13,769,640) |
Net adjustment to unrealized gains
(losses) on Investments |
$ 15,902,948 | $ 12,233,668 | $ (3,181,829) |
|
|
|
Credit Risk
FBR Asset is exposed to the risk of credit losses on its portfolio of mortgage-backed securities and notes receivable, such as the note from Prime Group Realty referred to in Note 5. In addition, many of FBR Asset's investments in equity securities are in companies that are also exposed to the risk of credit losses in their businesses.
H-8
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
FBR Asset seeks to limit its exposure to credit losses on its portfolio of mortgage-backed securities by purchasing securities issued and guaranteed by Freddie Mac, Fannie Mae, or Ginnie Mae. The payment of principal and interest on the Freddie Mac and Fannie Mae mortgage-backed securities are guaranteed by those respective agencies and the payment of principal and interest on the Ginnie Mae mortgage-backed securities is backed by the full-faith-and-credit of the U.S. Government. At December 31, 2001 and 2000, all of FBR Asset's mortgage-backed securities have an implied "AAA" rating. FBR Asset's notes receivable are not issued or guaranteed by Freddie Mac, Fannie Mae or Ginnie Mae.
Leverage Risk
At December 31, 2001, our outstanding indebtedness for borrowed money under repurchase agreements was 8.30 times the amount of our equity in the mortgage-backed securities, based on book values. FBR Management has the authority to increase or decrease our overall debt-to-equity ratio on our total portfolio at any time. At December 31, 2001, our total debt-to-equity ratio was 5.42 to 1. If we borrow more funds, the possibility that we would be unable to meet our debt obligations as they come due would increase. Financing assets through repurchase agreements exposes us to the risk that margin calls will be made and that we will not be able to meet those margin calls, which could result in the Company selling the mortgage-backed securities at a loss to cover the margin calls.
Concentration Risk
Equity and debt investments, such as Annaly Mortgage Management, Anworth Mortgage Asset Corporation, Capital Automotive REIT and Prime Group Realty may create exposure to issuers that are generally concentrated in the REIT industry and may even pursue similar investment strategies as the Company. These entities may hold non-investment grade securities and securities of privately held issuers with no ready markets. The concentration and illiquidity of these investments could expose the Company to a higher degree of risk than is associated with more diversified investment grade or readily marketable securities, and may also enhance the under-performance risk of the Company's mortgage-backed securities strategy over time.
Net Income Per Share
FBR Asset presents basic and diluted earnings per share. Basic earnings per share excludes potential dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would share in earnings. This includes stock options for the company which were dilutive for the periods presented.
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 as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Income Taxes
FBR Asset has elected to be taxed as a REIT under the Internal Revenue Code. To qualify for tax treatment as a REIT, FBR Asset must meet certain income and asset tests and distribution requirements. FBR Asset generally will not be subject to federal income tax at the corporate level to the extent that it distributes at least 90 percent of its taxable income to its shareholders and complies with certain other requirements. Failure to meet these requirements could have a material adverse impact on FBR Asset's results or financial condition. Furthermore, because FBR Asset's investments include stock in other REITs, failure of those REITs to maintain their REIT status could jeopardize FBR Asset's qualification as a REIT. During 2001, FBR asset acquired a registered broker-dealer from FBR Group called Pegasus Capital Corporation and also established two other taxable REIT subsidiaries. Pegasus participates in a fee-sharing arrangement with FBR (see Note 8 "Fee Income"). The payments Pegasus and the other taxable REIT subsidiaries receive will generally be taxed at normal corporate rates and will generally not be distributed to our shareholders. At December 31, 2001, FBR Asset had recorded $473,403 in income taxes payable from income received by Pegasus and a related taxable REIT subsidiary.
H-9
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
Note 3 Mortgage-Backed Securities
The following tables summarize FBR Asset's mortgage-backed securities as of December 31, 2001 and 2000:
December 31, 2001 |
Freddie Mac |
Fannie Mae |
Total
Mortgage |
Mortgage-backed securities, available-for-sale, face | $ 482,782,231 | $ 728,768,617 | $ 1,211,550,848 |
Unamortized net premium | 10,631,657 | 14,753,461 | 25,385,118 |
Amortized cost | 493,413,888 | 743,522,078 | 1,236,935,966 |
Gross unrealized gains | 1,412,595 | 2,680,256 | 4,092,851 |
Gross unrealized losses | (1,174,291) | (1,489,015) | (2,663,306) |
Fair value | $ 493,652,192 | $ 744,713,319 | $ 1,238,365,511 |
|
|
|
December 31, 2000 |
Freddie Mac |
Fannie Mae |
Ginnie Mae |
Total
Mortgage |
Mortgage-backed securities, available-for-sale, face |
$ 85,927,247 | $ 58,134,867 | $ 9,660,054 | $ 153,722,168 |
Unamortized net premium | 413,946 | 669,906 | 573,054 | 1,656,906 |
Amortized cost | 86,341,193 | 58,804,773 | 10,233,108 | 155,379,074 |
Gross unrealized gains | 138,622 | 424,165 | - | 562,787 |
Gross unrealized losses | (380,578) | (411,713) | (301,365) | (1,093,656) |
Fair value | $ 86,099,237 | $ 58,817,225 | $ 9,931,743 | $ 154,848,205 |
|
|
|
|
During 2001, FBR Asset received proceeds of $98.2 million from the sale of mortgage-backed securities. The Company recorded $1.1 million in net realized gains related to these sales. For the year ended December 31, 2001 the weighted average coupon rate on mortgage-backed securities was 6.38% and the weighted average effective yield was 5.81%. The weighted average life of the mortgage-backed securities based on assumptions used to determine fair value was 4.37 years at December 31, 2001.
During 2000, FBR Asset received proceeds of $101.5 million from the sale of mortgage-backed securities. The Company recorded $1.4 million in realized losses related to these sales. Concurrent with these sales, FBR Asset terminated a related hedge position and recorded a $1.5 million gain. For the year ended December 31, 2000 the weighted average coupon rate on mortgage-backed securities was 7.00% and the weighted average effective yield was 6.68%. The weighted average life of the mortgage-backed securities based on assumptions used to determine fair value was 4.20 years at December 31, 2000.
Note 4 Equity Investments
At December 31, 2001, FBR Asset's equity investments had an aggregate cost basis of $46.8 million, a fair value of $61.7 million, and unrealized gains of $14.9 million.
At December 31, 2000, FBR Asset's equity investments had an aggregate cost basis of $28.3 million, fair value of $28.1 million, unrealized gains of $0.5 million and unrealized losses of $0.7 million.
Equity Investments |
Cost Basis of |
Market Value |
Cost Basis of |
Market Value |
Saxon Capital Acquisition Corp.(1) | $ 9,300,000 | $ 9,300,000 | $ - | $ - |
Capital Automotive REIT | 12,835,604 | 18,301,087 | 23,298,100 | 23,068,463 |
Annaly Mortgage Management, Inc | 7,144,000 | 12,800,000 | - | - |
MCG Capital Corporation | 9,934,375 | 11,125,000 | - | - |
Prime Retail, Inc., pfd | - | - | 1,038,800 | 543,939 |
Resource Asset Investment Trust | 3,704,181 | 5,616,573 | 3,704,181 | 4,245,164 |
Ecompass Service Corporation | - | - | 286,931 | 252,624 |
Anworth Mortgage Asset Corporation | 3,890,625 | 4,550,000 | - | - |
Total | $ 46,808,785 | $ 61,692,660 | $ 28,328,012 | $ 28,110,190 |
|
|
|
|
__________
(1) Saxon Capital became a public corporation in January 2002. As of December 31, 2001 the investment is carried at cost
During 2001, FBR Asset received proceeds of $14.2 million from the sale of equity securities. The Company recorded $2.8 million in net realized gains related to these sales. During 2000, FBR Asset received proceeds of $29.2 million from the sale of equity securities. The Company recorded $2.7 million in net realized gains related to these sales.
H-10
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
Warrants
FBR Asset owns warrants to acquire 131,096 shares of Kennedy-Wilson common stock at a price of $7.5526 per share. The warrants expire in June 2003. As of December 31, 2001, the market price of Kennedy-Wilson common stock was $4.24 per share.
Note 5 Notes Receivable
As of December 31, 2001, the Company had one secured note receivable outstanding. On March 30, 2001, the Company loaned $12 million to Prime Aurora L.L.C., a wholly-owned subsidiary of Prime Group Realty, L.P. The Prime Aurora loan originally bore interest at a rate of 12% per annum and was due on January 15, 2002. At December 31, 2001, the outstanding principal amount of the Prime Aurora loan was $8 million, and the note bore interest at a rate of 16% per annum.
As of December 31, 2000, we had one secured note receivable outstanding from Prime Capital Funding I, LLC in the principal amount of $4 million. The note bore interest at a rate of 18% per annum. The note was restructured in late 2000 and paid off in full in February 2001.
Note 6 Repurchase Agreements
FBR Asset has entered into short-term repurchase agreements to finance a significant portion of its mortgage-backed investments. The repurchase agreements are secured by certain of FBR Asset's mortgage-backed securities classified as pledged as collateral on the balance sheet and bear interest at rates that have historically related closely to LIBOR for a corresponding period.
At December 31, 2001, FBR Asset had $1.1 billion outstanding under repurchase agreements with a weighted average borrowing rate of 1.87% as of the end of the period and a remaining weighted-average term to maturity of 15 days. At December 31, 2001, mortgage-backed securities pledged had an estimated fair value of approximately $1.19 billion. At December 31, 2001, FBR Asset had a current overall loan to value (repurchase agreements divided by pledged mortgage-backed securities) of 93%. At December 31, 2001, the repurchase agreements had remaining maturities of between 1 and 36 days. For the year ended December 31, 2001 the weighted average borrowing rate was 3.16% and the weighted average repurchase agreement balance was $463.0 million.
At December 31, 2000, FBR Asset had $133.9 million outstanding under repurchase agreements with a weighted average borrowing rate of 6.57% as of the end of the period and a remaining weighted-average term to maturity of 16 days. At December 31, 2000, mortgage-backed securities pledged had an estimated fair value of $144.9 million. At December 31, 2000, FBR Asset had a current overall loan to value of 92%. At December 31, 2000, the repurchase agreements had remaining maturities of between 2 and 33 days. For the year ended December 31, 2000 the weighted average borrowing rate was 6.33% and the weighted average repurchase agreement balance was $172.3 million. Financing assets through repurchase agreements exposes us to the risk that margin calls will be made (when the loan to value increases above the lenders limit) and that we will not be able to meet those margin calls. To meet margin calls the Company may sell mortgage-backed securities and those sales of mortgage-backed securities could result in realized losses.
Note 7 Interest Rate Swaps
FBR Asset may from time to time enter into interest rate swap agreements to offset the potential adverse effects of rising interest rates under certain short-term repurchase agreements. The interest rate swap agreements have historically been structured such that FBR Asset receives payments based on a variable interest rate and makes payments based on a fixed interest rate. The variable interest rate on which payments are received is calculated based on the three-month LIBOR. FBR Asset's repurchase agreements generally have maturities of 30 to 90 days and carry interest rates that correspond to LIBOR rates for those same periods. The swap agreements effectively fix FBR Asset's borrowing cost and are not held for speculative or trading purposes.
At December 31, 2001, FBR Asset was party to an interest rate swap agreement that matures on July 27, 2004, and has a notional amount of $50 million and a fair value of ($1.2 million). Under this agreement the Company will pay a fixed interest rate of 4.97% on the notional amount and receive a variable rate calculated based on the three-month LIBOR, which was 2.28% at December 31, 2001. At December 31, 2000, FBR Asset was party to an interest rate swap agreement that matured on June 1, 2001, and had a notional amount of $50 million and a fair value of $134,949. Under this agreement the Company paid a fixed interest rate of 5.96% on the notional amount and received a variable rate calculated based on the three-month LIBOR, which was 6.69% at December 31, 2000.
H-11
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
During 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133 "Accounting for Derivative Instruments and for Hedging Activities" ("FAS 133"). In June 1999, the FASB issued Statement No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". In June 2000, the FASB issued Statement 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities", an amendment of FASB Statement No. 133. FAS 133, as amended, establishes accounting and reporting standards for derivative investments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge. The accounting for the changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. FAS 133 was effective for the Company beginning January 1, 2001.
Under FAS 133, changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, depending on the type of hedge transaction. For fair value hedge transactions, changes in the fair value of the derivative instrument and changes in the fair value of the hedged item due to the risk being hedged are recorded through the income statement. For cash-flow hedge transactions, effective changes in the fair value of the derivative instrument are reported in other comprehensive income while ineffective changes are recorded through the income statement. The gains and losses on cash flow hedge transactions that are reported in other comprehensive income are reclassified to earnings in the periods in which earnings are effected by the hedged cash flows.
As previously discussed, the Company uses interest rate swaps to hedge the variability in interest payments associated with the variable rate repurchase agreements. Prior to SFAS 133, the Company did not record the value of these swaps on the balance sheet. The Company has determined that the interest rate swaps held during 2001 were effective hedges under FAS 133 and as a result the interest rate swaps are carried at fair value as a cash flow hedge. The Company adopted FAS 133 on January 1, 2001. In accordance with the transition provisions of FAS 133, the Company recorded a cumulative-effect-type gain of $137,949 through other comprehensive income to recognize at fair value the interest rate swap designated as a cash flow hedge.
Note 8 Fee Income
The Company and its registered broker-dealer subsidiary, Pegasus Capital Corporation ("Pegasus") entered into an agreement in August 2001 with Friedman, Billings, Ramsey & Co., Inc. ("FBR") regarding the Company's extension of credit to or investment in entities that are or may be FBR's investment banking clients. In circumstances where FBR determines that a commitment by the Company to make a loan to or investment in an entity (each an "investment opportunity") would facilitate a possible investment banking transaction, FBR presents the investment opportunity to the Company. The Investment Committee of the Company, which is comprised of Richard J. Hendrix, the Company's President and Chief Operating Officer and Eric F. Billings, the Company's Chairman and Chief Executive Officer reviews the investment opportunity and decides whether or not to recommend a commitment by the Company to make a loan or an investment based on its investment criteria. Mr. Billings is also an executive officer of FBR Group, FBR Management and FBR, and Mr. Hendrix is also a managing director of FBR and FBR Management. The approval of the Contracts Committee of the Company's Board of Directors (comprised of the Company's three independent directors), which requires the affirmative vote of at least two of the Company's independent directors, is required before any investment or loan is made in or to a client or proposed client of FBR. If the Company decides to make a loan or investment commitment to an entity, the commitment is not contingent on FBR being engaged to provide investment baking services by the entity. If, however, FBR is engaged to provide investment banking services to the entity, Pegasus is provided the opportunity to act as financial adviser to FBR in connection with structuring the transaction and, in return for its services, it will receive 10% of the net cash investment banking fees received by FBR as a result of the engagement. The payments Pegasus receives from FBR will generally be taxed at normal corporate rates and will generally not be distributed to the Company's shareholders. In 2001, pursuant to this agreement, the Company earned $2.9 million in fees from FBR from three investment banking transactions and one unfunded commitment. Fees are recognized when the related investment banking transaction is completed.
Note 9 Shareholders' Equity
On August 2, 2001, the Company completed a follow-on offering of 4,500,000 shares of common stock at a price of $23.00 per share. The lead underwriter for the offering was Friedman, Billings, Ramsey & Co., Inc. and the co-manager was Stifel, Nicolaus & Company. The proceeds after expenses to the company were $97.1 million.
The Company has declared the following dividends.
Year |
Per Share |
2001 | $ 3.30 |
2000 | $ 2.95 |
1999 | $ 1.61 |
H-12
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
The Company has repurchased the following shares of common stock.
Year |
Shares |
Cost |
Average
price |
2001 | 411,900 | $ 8,334,135 | $ 20.23 |
2000 | 1,921,909 | $ 25,420,635 | $ 13.23 |
1999 | 2,737,191 | $ 37,142,146 | $ 13.57 |
Under the Company's stock option plan, the Company may grant, in the aggregate, up to 155,000 tax qualified incentive stock options and non-qualified stock options to its employees, directors or service providers. Options granted are generally exercisable immediately and have a term of eight to ten years. As of December 31, 2001, 15,000 options were outstanding under the stock option plan, and 10,000 options were available for future grant.
On December 20, 2001, FBR Management exercised options with respect to 400,000 shares of the Company's common stock at the $20 per share exercise price, which left FBR Management with unexercised options to purchase 415,805 shares of the Company's common stock at December 31, 2001.
As of December 31, 2001, 481,900 options to purchase common stock were outstanding. These options have terms of eight to ten years and have an exercise price of $20 per share. As a result, 123,120 shares were included to calculate diluted earnings per share for the year ended December 31, 2001. None of the stock options were dilutive for the years ended December 31, 2000 or 1999. Details of stock options granted, forfeited, and exercised are as follows:
Number of |
Exercise Price |
|
Balance as of December 31, 1998 | 1,021,900 | $20.00 |
Granted in 1999 | - |
- |
Forfeitures in 1999 upon departure of employees | - | - |
Balance as of December 31, 1999 | 1,021,900 | $20.00 |
Granted in 2000 | - |
- |
Forfeitures in 2000 upon departure of employees | - | - |
Balance as of December 31, 2000 | 1,021,900 | $20.00 |
Granted in 2001 | 15,000 | $15.00 |
Forfeitures in 2001 upon departure of employees | (25,000) | $20.00 |
Exercised in 2001 | (530,000) | $ 15.00 - $20.00 |
Balance as of December 31, 2001 | 481,900 | $20.00 |
On December 24, 2001 the Company's Board of Directors approved awards of a total of 14,000 shares of the Company's common stock under its stock incentive plan to employees of FBR Management who provide services to the Company. These awards are subject to approval by the Company's shareholders and an increase in the number of shares available for issuance under the stock incentive plan. Compensation expense will be recognized once the shares are approved, based on the fair value on the date of shareholders approval. The compensation expense will be recognized over the vesting schedule of 25% on the first anniversary of the date of grant, 25% on the second anniversary and 50% on the third anniversary.
The Company accounts for its stock-based compensation in accordance with SFAS No. 123, "Accounting For Stock Based Compensation." Pursuant to SFAS No. 123, the Company applies the provisions of Accounting Principles Board Opinion No. 25, "Accounting For Stock Issued to Employees" (APB No. 25), for stock options issued to employees. Under APB No. 25, compensation expense is recorded to the extent the fair market value of the Company's stock exceeds the strike price of the option on the date of grant. In addition and in accordance with the disclosure requirements of SFAS No. 123, the Company does provide pro forma net income disclosures for options granted to employees as if the fair value method, as defined in SFAS No. 123, had been applied for the purpose of computing compensation expense. The impact of the issued and outstanding employee options under the fair value method was not material to the Company's net income or basic and diluted net income per share as reported in the statement of income for the years ended December 31, 2001, 2000, and 1999.
Note 10 Management and Performance Fees
The Company has a management agreement with FBR Management, expiring on December 17, 2002. FBR Management performs portfolio management services on behalf of the Company. These services include, but are not limited to, consulting with the Company on purchase and sale opportunities, collection of information and submission of reports pertaining to the Company's assets, interest rates, and general economic conditions, and periodic review and evaluation of the performance of the Company's portfolio of assets.
H-13
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
FBR Management is entitled to a quarterly "base" management fee equal to the sum of (1) 0.25 percent per annum (adjusted to reflect a quarterly period) of the average book value of the mortgage assets of the Company during each calendar quarter and, (2) 0.75 percent per annum (adjusted to reflect a quarterly period) of the remainder of the average book value of the mortgage assets of the Company during each calendar quarter.
FBR Management is also entitled to receive incentive compensation based on the performance of the Company. On December 31, 1998, and each calendar quarter thereafter, FBR Management is entitled to an incentive fee calculated by reference to the preceding 12-month period. FBR Management is entitled to an incentive fee calculated as: funds from operations (as defined), plus net realized gains or losses from asset sales, less the threshold amount (all computed on a weighted average share outstanding basis), multiplied by 25 percent. The threshold amount is calculated as the weighted average per share price of all equity offerings of the Company, multiplied by a rate equal to the ten-year U.S. Treasury rate plus five percent per annum. The Company recorded $1.7 million in incentive fees during 2001. No incentive fees were earned during 2000 or 1999.
FBR Management has engaged Fixed Income Advisory Company, Inc. ("FIDAC") to manage the Company's mortgage asset investment program (the "Mortgage Portfolio") as a sub-adviser. As compensation for rendering services, FIDAC is entitled to a sub-advisory fee based on the average gross asset value managed by FIDAC.
The following table summarizes the Company's management and incentive fee expense:
Year |
Management Fees |
Incentive Fees |
Totals |
1999 | $ 1,329,063 | $ - | $ 1,329,063 |
2000 | $ 1,078,713 | $ - | $ 1,078,713 |
2001 | $ 1,842,296 | $ 1,652,061 | $ 3,494,357 |
In December 1997, FBR Management received options to purchase 1,021,900 shares of our common stock at $20 per share. The estimated value of these options at the time of grant was $909,492 based on a discounted Black-Scholes valuation, and was amortized over the initial term of the Management Agreement. the Company has fully amortized the value of these options. FBR Management previously transferred 51,095 of its options to its former sub-manager. FBR Management agreed to the rescission of options to purchase 155,000 shares in connection with the establishment of the Company's stock incentive plan.
Note 11 Related Parties
As of December 31, 2001, Friedman, Billings, Ramsey Group, Inc. and it's affiliated entities ("FBR Group") owned 2,349,186 shares or 27.63% of the outstanding common stock of the Company. As of December 31, 2000, these same entities owned 1,344,086 or 34.60% of the outstanding common stock of the Company. FBR Group is the parent company of FBR Management and FBR.
H-14
Exhibit 10.06
AGREEMENT TO EXTEND MANAGEMENT AGREEMENT
This Agreement to Extend Management Agreement (the "Extension Agreement") is made as of December 17, 2001, by and between FBR Asset Investment Corporation (the "Company") and Friedman, Billings, Ramsey Investment Management, Inc. (the "Manager").
WHEREAS, the Company and the Manager are parties to that certain Management Agreement, dated as of December 17, 1997, as extended and amended by that certain Agreement to Extend and Amend Management Agreement, dated as of December 17, 1999, as further extended and amended by that certain Agreement to Extend and Amend Management Agreement, dated as of December 17, 2000 (the "Management Agreement");
WHEREAS, the Management Agreement provides in Section 12 thereof that the parties may extend the term of the Management Agreement for up to 12 months by executing a written extension; and
WHEREAS, the parties have determined to extend the term of the Management Agreement by 12 months, from December 17, 2001 to December 17, 2002, in accordance with Section 12 of the Management Agreement.
NOW, THEREFORE, in consideration of the mutual agreements set forth herein, the parties agree as follows:
SECTION 1. Extension. The parties hereby agree to extend the term of the Management Agreement by 12 months, from December 17, 2001 to December 17, 2002.
SECTION 2. Other terms. Other than as expressly extended hereby, all other terms, conditions and provisions of the Management Agreement shall remain in effect during the 12 month extension provided for hereby, unless the Management Agreement is amended in writing by the parties or is sooner terminated in accordance with the provisions thereof.
IN WITNESS WHEREOF, the parties hereto have executed this Extension Agreement as of the date first written above.
FBR ASSET INVESTMENT CORPORATION | FRIEDMAN,
BILLINGS, RAMSEY |
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By: /s/ Richard Hendrix | By: /s/ Kurt R. Harrington |
Name: Richard Hendrix | Name: Kurt R. Harrington |
Title: Chief Operating Officer | Title: Chief Financial Officer |
MANAGEMENT AGREEMENT
This Management Agreement ("Agreement") is made and entered into as of December 17, 1997, by and between FBR Asset Investment Corporation, a Virginia corporation (the "Company"), and Friedman, Billings, Ramsey Investment Management, Inc., a Delaware corporation (the "Manager").
RECITALS
WHEREAS, the Company intends to conduct its business in the manner described in the Private Offering Memorandum, dated December 11, 1997 (the "Memorandum") and expects to qualify for the tax benefits accorded by Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"); and
WHEREAS, the Company desires to retain the Manager to acquire, sell and otherwise manage the investments of the Company and to perform administrative services for the Company in the manner and on the terms set forth herein;
NOW THEREFORE, in consideration of the mutual agreements herein set forth, the parties hereto agree as follows:
SECTION 1. Definitions. Capitalized terms used herein but not otherwise defined shall have the respective meanings assigned them in the Memorandum. In addition, the following terms shall have the meanings assigned them.
(a) "Agreement" means this Management Agreement, as amended from time to time.
(b) "Closing Date" means the date of closing of the Company's initial offering of common stock pursuant to the Memorandum.
(c) "Governing Instruments" means the articles of incorporation and bylaws of a corporation.
SECTION 2. Duties of the Manager.
(a) Administration and Operation of the Company. The Manager at all times will be subject to the supervision of the Company's Board of Directors and will have only such functions and authority as stated in this Agreement or as the Company may delegate to it. The Manager will be responsible for the day-to-day operations of the Company and will perform (or cause to be performed) such services and activities relating to the assets and operations of the Company as may be appropriate, including:
(i) serving as the Company's consultant with respect to formulation of investment criteria and policy guidelines;
(ii) representing the Company in connection with the purchase and commitment to purchase assets, the sale and commitment to sell assets, and the maintenance and administration of its portfolio of assets;
(iii) furnishing reports and statistical and economic research to the Company regarding the Company's activities and the services performed for the Company by the Manager;
(iv) monitoring and providing to the Board of Directors on an ongoing basis price information and other data, obtained from certain nationally recognized dealers that maintain markets in assets identified by the Board of Directors from time to time, and providing data and advice to the Board of Directors in connection with the identification of such dealers;
(v) providing certain executive and administrative personnel, office space and office services required in rendering services to the Company;
(vi) administering the day-to-day operations of the Company and performing and supervising the performance of such other administrative functions necessary in the management of the Company as may be agreed upon by the Manager and the Board of Directors, including the collection of revenues and the payment of the Company's debts and obligations and maintenance of appropriate computer services to perform such administrative functions;
(vii) communicating on behalf of the Company with the holders of any equity or debt securities of the Company as required to satisfy the reporting and other requirements of any trading markets or any governmental bodies or agencies and to maintain effective relations with such holders;
(viii) to the extent not otherwise subject to an agreement executed by the Company, designating a servicer for mortgage loans sold to the Company and arranging for the monitoring and administering of such servicers;
(ix) counseling the Company in connection with policy decisions to be made by the Board of Directors;
(x) counseling the Company regarding the maintenance of its status as a REIT and monitoring compliance with the various REIT qualification tests and other rules set out in the Code and regulations thereunder;
(xi) engaging in hedging activities on behalf of the Company, consistent with the Company's status as a REIT;
(xii) upon request by and in accordance with the directions of the Board of Directors, investing or reinvesting any money of the Company; and
(xiii) counseling the Company regarding the maintenance of its exemption from the Investment Company Act and monitoring compliance with the various requirements for such exemption.
(b) Portfolio Management. The Manager will perform portfolio management services on behalf of the Company with respect to the Company's investments. Such services will include, but not be limited to, consulting with the Company on purchase and sale opportunities; collection of information and submission of reports pertaining to the Company's assets, interest rates, and general economic conditions; periodic review and evaluation of the performance of the Company's portfolio of assets; acting as liaison between the Company and banking, mortgage banking, investment banking and other parties with respect to the purchase, financing and disposition of assets; and other customary functions related to portfolio management. The Manager may enter into subcontracts with other parties, including its Affiliates, to provide any such services to the Company.
(c) Reasonable Best Efforts. The Manager agrees to use its reasonable best efforts at all times in performing services for the Company hereunder.
SECTION 3. Additional Activities of Manager. Nothing herein shall prevent the Manager or any of its Affiliates from engaging in other businesses or from rendering services of any kind to any other person or entity, including investment in, or advisory service to others investing in, any type of real estate investment, including investments that meet the principal investment objectives of the Company.
The Manager will allocate investment opportunities among investors for whom the Manager and its Affiliates manage assets based upon primary investment objectives, applicable investment restrictions, and such other factors as the Manager deems appropriate and fair under the circumstances.
Directors, officers, employees and agents of the Manager or its Affiliates may serve as directors, officers, employees, agents, nominees or signatories for the Company, to the extent permitted by the Company's Governing Instruments, as from time to time amended, or by any resolutions duly adopted by the Board of Directors pursuant to the Company's Governing Instruments. When executing documents or otherwise acting in such capacities for the Company, such persons shall use their respective titles in the Company.
SECTION 4. Commitments. In order to meet the investment requirements of the Company, as determined by the Board of Directors from time to time, the Manager agrees, at the direction of the Board of Directors, to issue on behalf of the Company commitments on such terms as are established by the Board of Directors for the purchase of investments.
SECTION 5. Bank Accounts. At the direction of the Board of Directors, the Manager may establish and maintain one or more bank accounts in the name of the Company, and may collect and deposit into any such account or accounts, and disburse funds from any such account or accounts, under such terms and conditions as the Board of Directors may approve; and the Manager shall from time to time render appropriate accountings of such collections and payments to the Board of Directors and, upon request, to the auditors of the Company.
SECTION 6. Records; Confidentiality. The Manager shall maintain appropriate books of accounts and records relating to services performed hereunder, and such books of account and records shall be accessible for inspection by representatives of the Company at any time during normal business hours. The Manager shall keep confidential any and all information obtained in connection with the services rendered hereunder and shall not disclose any such information to nonaffiliated third parties except with the prior written consent of the Board of Directors.
SECTION 7. Obligations of Manager.
(a) The Manager shall require each seller or transferor of investments to the Company to make such representations and warranties regarding such investments as may, in the judgment of the Manager, be necessary and appropriate. In addition, the Manager shall take such other action as it deems necessary or appropriate with regard to the protection of the Company's investments.
(b) The Manager shall refrain from any action that, in its sole judgment made in good faith, would adversely affect the status of the Company as a REIT or that, in its sole judgment made in good faith, would violate any law, rule or regulation of any governmental body or agency having jurisdiction over the Company or that would otherwise not be permitted by the Company's Governing Instruments. If the Manager is ordered to take any such action by the Board of Directors, the Manager shall promptly notify the Board of Directors of the Manager's judgment that such action would adversely affect such status or violate any such law, rule or regulation, or the Governing Instruments. Notwithstanding the foregoing, the Manager, its directors, officers, stockholders and employees shall not be liable to the Company, the Independent Directors, or the Company's stockholders or partners for any act or omission by the Manager, its directors, officers, stockholders or employees except as provided in Section 10 of this Agreement.
SECTION 8. Compensation.
(a) Commencing with the first calendar quarter ending after the Closing Date, the Company shall pay to the Manager, for services rendered under this Agreement, a quarterly base management fee in an amount equal to the sum of (a) 1/4 of 1% per annum (adjusted to reflect a quarterly period) of the Average Invested Mortgage Assets of the Company during each calendar quarter (or a pro rata amount based on the number of days elapsed during any partial calendar quarter) and (b) 3/4 of 1% per annum of the remainder of the Average Invested Assets of the Company during each calendar quarter (or a pro rata amount based on the number of days elapsed during any partial calendar quarter). After the end of each calendar year (beginning with 1998), the Manager may, and at the request of the Company shall, provide an analysis of the costs of providing services under this Agreement during such calendar year. This information may be used by the Company to adjust the base management fee in order to align it more closely with the actual costs of such services, or with the consent of the Manager, to reduce the base management fee to the extent the Company incurs costs internally. No more than one such adjustment may be made in any calendar year.
(b) The Manager shall be entitled to receive incentive compensation based on the performance of the Company. At the end of 1998, the Manager will be entitled to receive the Incentive Calculation Amount for the period from the Closing Date through December 31, 1998. For each calendar quarter thereafter beginning with the quarter ended March 31, 1999, the Manager will be entitled to receive 25% of the Incentive Calculation Amount for the 12 month period ending with the end of that calendar quarter.
As used herein, the Incentive Calculation Amount for any period means an amount equal to the product of (A) 25% of the dollar amount by which (1)(a) Funds from Operations (before the incentive fee but after the base management fee) of the Company per share (based on the weighted average number of shares outstanding) plus (b) gains (or minus losses) from debt restructuring and sales of property per share (based on the weighted average number of shares outstanding), exceed (2) an amount equal to (a) the weighted average of the price per share at the Offering Price and the prices per share at any secondary offerings by the Company multiplied by (b) the Ten-Year U.S. Treasury Rate plus five percent per annum multiplied by (B) the weighted average number of Common Shares outstanding during such period.
"Funds from Operations" shall be computed in accordance with the definition thereof adopted by the National Association of Real Estate Investment Trusts ("NAREIT") and shall mean net income (computed in accordance with GAAP) excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization on real estate assets, and after adjustments for unconsolidated partnerships and joint ventures.
As used in calculating the Manager's compensation, the term "Ten Year U.S. Treasury Rate" means the arithmetic average of the weekly average yield to maturity for actively traded current coupon U.S. Treasury fixed interest rate securities (adjusted to constant maturities of ten years) published by the Federal Reserve Board during a quarter, or if such rate is not published by the Federal Reserve Board, any Federal Reserve Bank or agency or department of the federal government selected by the Company. If the Company determines in good faith that the Ten Year U.S. Treasury Rate cannot be calculated as provided above, then the rate shall be the arithmetic average of the per annum average yields to maturities, based upon closing asked prices on each business day during a quarter, for each actively traded marketable U.S. Treasury fixed interest rate security with a final maturity date not less than eight nor more than twelve years from the date of the closing asked prices as chosen and quoted for each business day in each such quarter in New York City by at least three recognized dealers in U.S. government securities selected by the Company.
(c) The Manager shall compute the compensation payable under Sections 8(a) and 8(b) of this Agreement within 45 days after the end of each calendar quarter. A copy of the computations made by the Manager to calculate its compensation shall thereafter promptly be delivered to the Company and, upon such delivery, payment of the compensation earned under Sections 8(a) and 8(b) of this Agreement shown therein shall be due and payable within 60 days after the end of such calendar quarter.
(d) The Manager may charge the Company for any out of pocket expenses that the Manager incurs in connection with any due diligence on assets considered for purchase by the Company. Moreover, the Manager shall document the time spent by the Manager's employees in performing such due diligence and shall be entitled to reimbursement for the allocable portion of such employees' salaries and benefits provided, however, that (i) the amount of due diligence costs for which the Manager receives reimbursement with respect to any asset shall not exceed an arm's length due diligence fee for such asset and (ii) the Manager shall not be entitled to reimbursement for any due diligence or employee time costs associated with investments in securities being underwritten or placed by an Affiliate of the Manager.
SECTION 9. Calculations of Expenses. Expenses incurred by the Manager on behalf of the Company shall be reimbursed quarterly to the Manager within 60 days after the end of each quarter. The Manager shall prepare a statement documenting the expenses of the Company and those incurred by the Manager on behalf of the Company during each quarter, and shall deliver such statement to the Company within 45 days after the end of each quarter.
SECTION 10. Limits of Manager Responsibility. The Manager assumes no responsibility under this Agreement other than to render the services called for hereunder in good faith and shall not be responsible for any action of the Company in following or declining to follow any advice or recommendations of the Manager, including as set forth in Section 7(b) of this Agreement. The Manager, its Affiliates, and their respective directors, officers, stockholders and employees will not be liable to the Company, any subsidiary, the Independent Directors or the Company's or any subsidiary's shareholders, creditors, or partners for any acts or omissions by the Manager, its Affiliates, and their respective directors, officers, stockholders or employees under or in connection with this Agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence or reckless disregard of their duties. The Manager may consult with and rely upon counsel in any case where it appears to the Manager to be necessary or desirable with respect to its authority and obligations under this Agreement. Additionally, the Manager may rely and act upon any certificates or other instruments believed in good faith by the Manager to be genuine and to have been signed by any person duly authorized. The Company shall reimburse, indemnify and hold harmless the Manager, its stockholders, directors, officers and employees of and from any and all expenses, losses, damages, liabilities, demands, charges and claims of any nature whatsoever, (including attorneys' fees) in respect of or arising from any acts or omissions of the Manager, its stockholders, directors, officers and employees made in good faith in the performance of the Manager's duties under this Agreement and not constituting bad faith, willful misconduct, gross negligence or reckless disregard of its duties.
SECTION 11. No Joint Venture. The Company and the Manager are not partners or joint venturers with each other and nothing herein shall be construed to make them such partners or joint venturers or impose any liability as such on either of them.
SECTION 12. Term; Termination. This Agreement shall commence on the Closing Date and shall continue in force until the second anniversary of the Closing Date, and thereafter, it may be extended only with the consent of the Manager and by the affirmative vote of a majority of the Board of Directors of the Company, including a majority vote of the Independent Directors.
Each extension shall be executed in writing by the parties and shall be dated as of the expiration of this Agreement or any extension thereof. Each such extension shall not exceed twelve months.
Notwithstanding any other provision to the contrary, this Agreement, or any extension hereof, may be terminated by the Company without cause, upon 60 days written notice, by a majority vote of the Independent Directors or by majority vote of the holders of the outstanding Common Shares; provided that the base management fee and incentive management fee earned during the twelve months preceding such termination, will be due.
If this Agreement is terminated pursuant to this Section 12, such termination shall be without any further liability or obligation of either party to the other, except as provided in Section 16 of this Agreement.
SECTION 13. Assignments.
(a) Except as set forth in subsection (b) of this Section 13, this Agreement shall terminate automatically in the event of its assignment, in whole or in part, by the Manager, unless such assignment is consented to in writing by the Company with the consent of a majority of the Independent Directors. Any such assignment shall bind the assignee hereunder in the same manner as the Manager is bound. In addition, the assignee shall execute and deliver to the Company a counterpart of this Agreement naming such assignee as Manager. This Agreement shall not be assigned by the Company without the prior written consent of the Manager, except in the case of assignment by the Company to another Company or other organization that is a successor (by merger, consolidation or purchase of assets) to the Company, in which case such successor organization shall be bound hereunder and by the terms of such assignment in the same manner as the Company is bound hereunder.
(b) Notwithstanding any provision of this Agreement, the Manager may subcontract and assign any or all of its responsibilities under Sections 2(a) and 2(b) of this Agreement to any of its Affiliates or to Blackrock Financial Management, Inc., and the Company hereby consents to any such assignment and subcontracting.
SECTION 14. Termination by Company for Cause. At the option of the Company, this Agreement shall be and become terminated upon 60 days' written notice of termination from a majority of the Independent Directors to the Manager, without payment of any termination fee, if any of the following events shall occur:
(a) if the Manager shall violate any material provision of this Agreement and, after notice of such violation, shall not cure such violation within 30 days; or
(b) there is entered an order for relief or similar decree or order with respect to the Manager by a court having competent jurisdiction in an involuntary case under the federal bankruptcy laws as now or hereafter constituted or under any applicable federal or state bankruptcy, insolvency or other similar laws; or the Manager (i) ceases, or admits in writing its inability to pay its debts as they become due and payable, or makes a general assignment for the benefit of, or enters into any composition or arrangement with, creditors; (ii) applies for, or consents (by admission of material allegations of a petition or otherwise) to the appointment of a receiver, trustee, assignee, custodian, liquidator or sequestrator (or other similar official) of the Manager or of any substantial part of its properties or assets, or authorizes such an application or consent, or proceedings seeking such appointment are commenced without such authorization, consent or application against the Manager and continue undismissed for 30 days; (iii) authorizes or files a voluntary petition in bankruptcy, or applies for or consents (by admission of material allegations of a petition or otherwise) to the application of any bankruptcy, reorganization, arrangement, readjustment of debt, insolvency, dissolution, liquidation or other similar law of any jurisdiction, or authorizes such application or consent, or proceedings to such end are instituted against the Manager without such authorization, application or consent and are approved as properly instituted and remain undismissed for 30 days or result in adjudication of bankruptcy or insolvency; or (iv) permits or suffers all or any substantial part of its properties or assets to be sequestered or attached by court order and the order remains undismissed for 30 days.
If any of the events specified in this Section 14 shall occur, the Manager shall give prompt written notice thereof to the Board of Directors upon the happening of such event.
SECTION 15. Action Upon Termination. From and after the effective date of termination of this Agreement pursuant to Sections 12, 13, or 14 of this Agreement, the Manager shall not be entitled to compensation for further services hereunder, but shall be paid all compensation accruing to the date of termination and, if terminated by the Company pursuant to Section 12, the applicable termination fee. Upon such termination, the Manager shall forthwith:
(a) after deducting any accrued compensation and reimbursement for its expenses to which it is then entitled, pay over to the Company all money collected and held for the account of the Company pursuant to this Agreement;
(b) deliver to the Company a full accounting, including a statement showing all payments collected by it and a statement of all money held by it, covering the period following the date of the last accounting furnished to the Board of Directors with respect to the Company; and
(c) deliver to the Company all property and documents of the Company then in the custody of the Manager.
SECTION 16. Release of Money or Other Property Upon Written Request. The Manager agrees that any money or other property of the Company held by the Manager under this Agreement shall be held by the Manager as custodian for the Company, and the Manager's records shall be appropriately marked clearly to reflect the ownership of such money or other property by the Company. Upon the receipt by the Manager of a written request signed by a duly authorized officer of the Company requesting the Manager to release to the Company any money or other property then held by the Manager for the account of the Company under this Agreement, the Manager shall release such money or other property to the Company within a reasonable period of time, but in no event later than 60 days following such request. The Manager shall not be liable to the Company, any subsidiary, the Independent Directors, or the Company's or a subsidiary's stockholders or partners for any acts performed or omissions to act by the Company in connection with the money or other property released to the Company in accordance with this Section. The Company shall indemnify the Manager, its directors, officers, stockholders and employees against any and all expenses, losses, damages, liabilities, demands, charges and claims of any nature whatsoever, which arise in connection with the Manager's release of such money or other property to the Company in accordance with the terms of this Section 16. Indemnification pursuant to this provision shall be in addition to any right of the Manager to indemnification under Section 10 of this Agreement.
SECTION 17. Representations and Warranties.
(a) The Company hereby represents and warrants to the Manager as follows:
(i) The Company is duly organized, validly existing and in good standing under the laws of the Commonwealth of Virginia, has the corporate power to own its assets and to transact the business in which it is now engaged and is duly qualified as a foreign corporation and in good standing under the laws of each jurisdiction where its ownership or lease of property or the conduct of its business requires such qualification, except for failures to be so qualified, authorized or licensed that could not in the aggregate have a material adverse effect on the business operations, assets or financial condition of the Company and its subsidiaries, taken as a whole. The Company does not do business under any fictitious business name.
(ii) The Company has the corporate power and authority to execute, deliver and perform this Agreement and all obligations required hereunder and has taken all necessary corporate action to authorize this Agreement on the terms and conditions hereof and the execution, delivery and performance of this Agreement and all obligations required hereunder. No consent of any other person including, without limitation, stockholders and creditors of the Company, and no license, permit, approval or authorization of, exemption by, notice or report to, or registration, filing or declaration with, any governmental authority is required by the Company in connection with this Agreement or the execution, delivery, performance, validity or enforceability of this Agreement and all obligations required hereunder. This Agreement has been, and each instrument or document required hereunder will be, executed and delivered by a duly authorized officer of the Company, and this Agreement constitutes, and each instrument or document required hereunder when executed and delivered hereunder will constitute, the legally valid and binding obligation of the Company enforceable against the Company in accordance with its terms.
(iii) The execution, delivery and performance of this Agreement and the documents or instruments required hereunder will not violate any provision of any existing law or regulation binding on the Company, or any order, judgment, award or decree of any court, arbitrator or governmental authority binding on the Company, or the Governing Instruments of, or any securities issued by the Company or of any mortgage, indenture, lease, contract or other agreement, instrument or undertaking to which the Company is a party or by which the Company or any of its assets may be bound, the violation of which would have a material adverse effect on the business operations, assets or financial condition of the Company and its subsidiaries, taken as a whole, and will not result in, or require, the creation or imposition of any lien on any of its property, assets or revenues pursuant to the provisions of any such mortgage, indenture, lease, contract or other agreement, instrument or undertaking.
(b) The Manager hereby represents and warrants to the Company as follows:
(i) the Manager is duly organized, validly existing and in good standing under the laws of the jurisdiction of its formation, has the corporate power to own its assets and to transact the business in which it is now engaged and is duly qualified to do business and is in good standing under the laws of each jurisdiction where its ownership or lease of property or the conduct of its business requires such qualification, except for failures to be so qualified, authorized or licensed that could not in the aggregate have a material adverse effect on the business operations, assets or financial condition of the Manager and its subsidiaries, taken as a whole. The Manager does not do business under any fictitious business name.
(ii) The Manager has the corporate power and authority to execute, deliver and perform this Agreement and all obligations required hereunder and has taken all necessary corporate action to authorize this Agreement on the terms and conditions hereof and the execution, delivery and performance of this Agreement and all obligations required hereunder. No consent of any other person including, without limitation, stockholders and creditors of the Manager, and no license, permit, approval or authorization of, exemption by, notice or report to, or registration, filing or declaration with, any governmental authority is required by the Manager in connection with this Agreement or the execution, delivery, performance, validity or enforceability of this Agreement and all obligations required hereunder. This Agreement has been, and each instrument or document required hereunder will be, executed and delivered by a duly authorized agent of the Manager, and this Agreement constitutes, and each instrument or document required hereunder when executed and delivered hereunder will constitute, the legally valid and binding obligation of the Manager enforceable against the Manager in accordance with its terms.
(iii) The execution, delivery and performance of this Agreement and the documents or instruments required hereunder, will not violate any provision of any existing law or regulation binding on the Manager, or any order, judgment, award or decree of any court, arbitrator or governmental authority binding on the Manager, or the partnership agreement of, or any securities issued by the Manager or of any mortgage, indenture, lease, contract or other agreement, instrument or undertaking to which the Manager is a party or by which the Manager or any of its assets may be bound, the violation of which would have a material adverse effect on the business operations, assets or financial condition of the Manager and its subsidiaries, taken as a whole, and will not result in, or require, the creation or imposition of any lien on any of its property, assets or revenues pursuant to the provisions of any such mortgage, indenture, lease, contract or other agreement, instrument or undertaking.
SECTION 18. Notices. Unless expressly provided otherwise herein, all notices, requests, demands and other communications required or permitted under this Agreement shall be in writing and shall be deemed to have been duly given, made and received when delivered against receipt or upon actual receipt of registered or certified mail, postage prepaid, return receipt requested, addressed as set forth below:
(a) |
If to the Company: |
FBR Asset Investment Corporation |
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1001 Nineteenth Street, North |
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Arlington, Virginia 22209 |
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Attention: Secretary |
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with a copy given in the manner prescribed above, to: |
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George C. Howell, III, Esquire |
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Hunton & Williams |
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951 East Byrd Street |
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Richmond, Virginia 23219-4074 |
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(b) | If to the Manager: |
Friedman, Billings, Ramsey Investment Management, Inc. |
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1001 Nineteenth Street, North |
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Arlington, Virginia 22209 |
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Attention: Secretary |
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with a copy given in the manner prescribed above, to: |
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George C. Howell, III, Esquire |
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Hunton & Williams |
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951 East Byrd Street |
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Richmond, Virginia 23219-4074 |
Either party may alter the address to which communications or copies are to be sent by giving notice of such change of address in conformity with the provisions of this Section 18 for the giving of notice.
SECTION 19. Binding Nature of Agreement; Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and assigns as provided herein.
SECTION 20. Entire Agreement. This Agreement contains the entire agreement and understanding among the parties hereto with respect to the subject matter hereof, and supersedes all prior and contemporaneous agreements, understandings, inducements and conditions, express or implied, oral or written, of any nature whatsoever with respect to the subject matter hereof. The express terms hereof control and supersede any course of performance and/or usage of the trade inconsistent with any of the terms hereof. This Agreement may not be modified or amended other than by an agreement in writing.
SECTION 21. Controlling Law. This Agreement and all questions relating to its validity, interpretation, performance and enforcement shall be governed by and construed, interpreted and enforced in accordance with the laws of the Commonwealth of Virginia, notwithstanding any Virginia or other conflict-of-law provisions to the contrary.
SECTION 22. Indulgences, Not Waivers. Neither the failure nor any delay on the part of a party to exercise any right, remedy, power or privilege under this Agreement shall operate as a waiver thereof, nor shall any single or partial exercise of any right, remedy, power or privilege preclude any other or further exercise of the same or of any other right, remedy, power or privilege, nor shall any waiver of any right, remedy, power or privilege with respect to any occurrence be construed as a waiver of such right, remedy, power or privilege with respect to any other occurrence. No waiver shall be effective unless it is in writing and is signed by the party asserted to have granted such waiver.
SECTION 23. Costs and Expenses. Each party hereto shall bear its own costs and expenses (including the fees and disbursements of counsel and accountants) incurred in connection with the negotiations and preparation of and the closing under this Agreement, and all matters incident thereto.
SECTION 24. Titles Not to Affect Interpretation. The titles of paragraphs and subparagraphs contained in this Agreement are for convenience only, and they neither form a part of this Agreement nor are they to be used in the construction or interpretation hereof.
SECTION 25. Execution in Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original as against any party whose signature appears thereon, and all of which shall together constitute one and the same instrument. This Agreement shall become binding when one or more counterparts hereof, individually or taken together, shall bear the signatures of all of the parties reflected hereon as the signatories.
SECTION 26. Provisions Separable. The provisions of this Agreement are independent of and separable from each other, and no provision shall be affected or rendered invalid or unenforceable by virtue of the fact that for any reason any other or others of them may be invalid or unenforceable in whole or in part.
SECTION 27. Computation of Interest. Interest will be computed on the basis of a 360-day year consisting of twelve months of thirty days each.
SIGNATURE PAGE FOLLOWS
IN WITNESS WHEREOF, the parties hereto have executed this Management Agreement as of the date first written above.
FBR ASSET INVESTMENT CORPORATION |
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By: /s/ W. Russell Ramsey |
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Name: W. Russell Ramsey |
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Title: President |
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FRIEDMAN, BILLINGS, RAMSEY |
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By: /s/ Emanuel J. Friedman | |
Name: Emanuel J. Friedman | |
Title: Chief Executive Officer |
Exhibit 10.07
July 9, 2001
FBR Asset Investment Corporation
Arlington Capital, Inc.
1001 Nineteenth Street North
Arlington, Virginia 22209
Re: Fee-sharing Arrangement
Dear Sirs:
The purpose of this Letter Agreement is to set forth the terms by which Arlington Capital, Inc. ("AC"), a subsidiary of FBR Asset Investment Corporation ("FBRAIC"), will share certain fees with Friedman, Billings, Ramsey & Co., Inc. ("FBR").
1. Sharing in FBR Fees.
From time to time, FBR presents investment opportunities to FBRAIC and AC. These investment opportunities may be equity investments in or loans to companies or other entities (an "Investment") that FBR has been retained to provide, or is soliciting for, investment banking business. FBR hereby agrees to (a) determine in good faith whether FBRAIC's or AC's commitment to an Investment could be a contributing factor to such entity's decision, if any, to engage FBR to provide such entity with investment banking services or would facilitate the provision of such investment banking services to the entity and (b) advise FBRAIC and AC of such determination. In the event that FBR makes a positive determination with regard to FBRAIC's or AC's commitment to an Investment, FBR and AC shall execute a letter agreement in the form of Exhibit A setting forth the terms of the fee-sharing arrangement between them with respect to certain fees paid in connection with FBR's provision of investment banking services. Such terms shall include payment by FBR to FBRAIC or AC of 10% of the net investment banking fees, if any, paid to FBR as a result of any engagement of FBR by the entity during a term specified in the fee-sharing agreement with respect to such entity.
The parties acknowledge that the types of engagements that could result in a fee payable to FBRAIC or AC pursuant to the terms hereof will include, but not be limited to, securities underwriting services, private placements of securities, merger and acquisition advisory services and other financial advisory services.
The parties further acknowledge that no investment in or loan to any entity by FBRAIC or AC will require such entity to engage FBR for any services whatsoever, and none of the terms of any investment in or loan to such entity will be affected by the entity's decision to engage or not to engage FBR to provide it with any services whatsoever. FBRAIC and AC further acknowledge that their decision to make an Investment in an entity does not guarantee that FBR will be engaged by that entity or that, if engaged, FBR will be paid any fees and, therefore, FBRAIC and AC cannot be assured that they will share in any fee with FBR. FBRAIC and AC, further acknowledge that, even if FBR is engaged by an entity, that entity may decide that it will not accept an investment from FBRAIC or AC.
The parties agree that the payments made pursuant to this Letter Agreement will be made on a quarterly basis within 45 days after the end of the quarter; such payments shall include all fees that FBRAIC and AC are entitled to receive for the quarter immediately prior to the relevant payment date.
2. Conditions to Payment of Underwriting Fees.The term of this Letter Agreement shall be two (2) years unless earlier terminated upon mutual agreement in writing by the parties. This Letter Agreement shall automatically renew for additional one (1) year periods unless the parties mutually agree in writing to terminate this Letter Agreement prior to the expiration of the then-current term. Notwithstanding the above, this Letter Agreement shall terminate immediately, if FBR Investment Management, Inc. is terminated as the investment advisor to FBRAIC. Upon termination of this Letter Agreement as a result of the termination of FBR Investment Management, Inc., any fees then due to FBRAIC and AC shall be paid to FBRAIC and AC on the next scheduled payment date.
4. Entire Agreement; Integration Clause.This Letter Agreement, including the exhibit hereto, sets forth the entire agreements and understandings of the parties hereto with respect to the subject matter of this Letter Agreement, and any prior agreements are hereby merged herein and terminated.
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5. No Oral Modification or Waivers.
The terms of this Letter Agreement may not be modified or waived orally, but only by an instrument in writing signed by the party against which enforcement of the modification or waiver (as the case may be) is sought.
6. Governing Law and Waiver if Jury Trial.The laws of the Commonwealth of Virginia (other than its conflicts of law principles) shall govern this Letter Agreement. In any dispute or claim arising under or in connection with this Agreement, the parties hereto waive all of their rights to a trial by jury.
7. Headings.The headings of the paragraphs and sub-paragraphs of this Letter Agreement are inserted for convenience only and do not constitute a part of this Letter Agreement.
8. Severability.To the extent any provision herein violates any applicable law, that provision shall be considered void and the balance of this Letter Agreement shall remain unchanged and in full force and effect.
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Please signify your acceptance of the terms of this Letter Agreement by executing below where indicated and returning such executed agreement to us.
Sincerely,
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
By: /s/ Emanuel J. Friedman
Name: Emanuel J. Friedman
Title: Chairman and Co-Chief Executive Officer
ACKNOWLEDGED, ACCEPTED AND AGREED
FBR ASSET INVESTMENT CORPORATION
By: /s/ Eric F. Billings
Name: Eric F. Billings
Title: Chairman and Chief Executive Officer
ARLINGTON CAPITAL, INC.
By: /s/ Eric F. Billings
Name: Eric F. Billings
Title: Chairman and Chief Executive Officer
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Exhibit A
[date]
Arlington Capital, Inc.
1001 Nineteenth Street North
Arlington, Virginia 22209
Attention:
Re: [name of investment opportunity]
Dear ___________:
The purpose of this Letter Agreement is to set forth the terms of the fee-sharing arrangement for any fees that are generated for Friedman, Billings, Ramsey & Co. Inc. (FBR) from [name of investment opportunity] or any successor thereto.
FBR hereby agrees to provide to Arlington Capital, Inc. ("AC") 10% of the [aggregate net fees] earned by FBR resulting from engagements of FBR by [name of investment opportunity] or any successor thereto from the date hereof through _________________ in exchange for assistance provided to FBR by AC in connection with the investment banking services that give rise to the fees and, in the case of underwriting fees for fixed price public offerings, services rendered by AC in the distribution.
This Letter Agreement is entered into pursuant to the terms of the Letter Agreement dated __________, 2001, by and among FBR, FBR Asset Investment Corporation ("FBRAIC") and AC and all of the terms of such agreement are incorporated herein by reference.
Sincerely,
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
By:
Name:
Title:
ACKNOWLEDGED, ACCEPTED AND AGREED
ARLINGTON CAPITAL, INC.
By:
Name:
Title:
Exhibit 21.01
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC. DIRECT AND INDIRECT
WHOLLY-OWNED SUBSIDIARIES
Friedman, Billings, Ramsey Capital Markets, Inc. - Delaware
FBR Capital Management, Inc. - Delaware
FBR Bancorp, Inc. - Delaware
Friedman, Billings, Ramsey & Co., Inc. - Delaware
Friedman, Billings, Ramsey International, Ltd. - England
FBR Investment Services, Inc. - Delaware
Friedman, Billings, Ramsey Investment Management, Inc. - Delaware
Orkney Holdings, Inc. - Delaware
FBR Fund Advisers, Inc. - Delaware
FBR Venture Capital Managers, Inc. - Delaware
Money Management Associates, Inc. - Delaware
Money Management Associates (L.P.), Inc. - Delaware
Money Management Advisers, Inc. - Delaware
FBR National Bank & Trust
EXHIBIT 23.01
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into the company's previously filed S-8 Registration Statement File Nos. 333-69697, 333-77027, 333-96295, 333-55936 and 333-63906.
/s/ ARTHUR ANDERSEN LLP
Vienna, Virginia
March 29, 2002.
EXHIBIT 99.02
RISK FACTORS
Investing in our company involves various risks, including the risk that you might lose your entire investment. The results of our operations depend upon many factors, including the availability of opportunities to acquire assets and make loans, the level and volatility of interest rates, the cost and availability of short- and long-term credit, financial market conditions, and general economic conditions. We will strive to attain our objectives through, among other things, FBR Management's research and portfolio management skills. There is no guarantee, however, that we will perform successfully, meet our objectives, or achieve positive returns.
The following risks are interrelated, and you should treat them as a whole.
CONFLICTS WITH FBR GROUP MAY RESULT IN DECISIONS THAT DO NOT REFLECT OUR BEST INTERESTS.
We are subject to various conflicts of interest arising from our relationship with FBR. Those conflicts include the following:
- We invest in the equity securities of or make loans to companies whose securities have been underwritten or placed by FBR and companies to which FBR has provided financial advisory services. FBR and its employees, including some of the officers of FBR Asset, are paid substantial fees for underwriting, placement agent and financial advisory services, and to the extent that the success of a new offering or transaction depends on our significant investment, FBR Management, because of its affiliation with FBR, will have a conflict of interest in recommending that investment to us. In those instances, our shareholders will rely on the investment recommendation of our investment committee, which must be approved by the Contracts Committee of our Board of Directors (comprised of the three independent members of our Board). The investment committee will in part rely on information provided by FBR Management.
- FBR Group and its affiliates, including FBR Management, manage other funds that are authorized to invest in assets similar to those in which we invest. In particular, FBR manages mutual and private equity funds, and may in the future manage other funds, that invest in private equity securities and in REITs and other real estate-related securities. In addition, FBR or its affiliates may choose to invest directly in these investment opportunities. There may be investment opportunities that are favorable to us and to the other funds managed by FBR or to FBR or its affiliates directly. In those cases, FBR will allocate investment opportunities among funds based upon primary investment objectives, applicable investment restrictions, and any other factors that FBR deems appropriate and fair under the circumstances.
- Under the terms of our agreement with FBR, we will be entitled to receive a portion of the fees earned by FBR as a result of engagements of FBR by companies in which we commit to invest or make a loan where our commitment is a contributing factor in the engagement of FBR or assists in facilitating the completion of a transaction. The existence of this agreement may discourage FBR from presenting investment opportunities to us in situations which may result in a fee-sharing arrangement with us.
- FIDAC, our mortgage portfolio manager, is an affiliate of Annaly Mortgage Management, Inc., an investment banking client of FBR Group. As a result of this investment banking relationship, Annaly has paid investment banking fees to FBR Group as follows: $7.0 million in 1997, $0 in 1998, $0 in 1999, $0 in 2000, and $7.6 million in 2001, and may pay FBR Group additional investment banking fees in the future. As a result, FBR Management has a conflict of interest with respect to decisions regarding the renewal or termination of the sub-management agreement between FBR Management and FIDAC.
- The incentive portion of the management fee, which is based on our income, may create an incentive for FBR Management to recommend investments that have greater potential for income or appreciation, but that are generally more speculative. If the management fee did not include a performance component, FBR Management might not otherwise recommend those investments because of their speculative nature.
- Two of the members of our board of directors, and each of our executive officers, also serve as executive officers or employees of FBR and its affiliates and devote substantial time to FBR. These persons devote the time and attention to our business that they, in their discretion, deem necessary, but conflicts may arise in allocating management time, services or functions between our company and FBR and its affiliates. The failure by these people to devote adequate time to us could result in our failure to take advantage of investment opportunities or failure to take other actions that might be in our best interests.
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- Because of our relationship with FBR, we may obtain confidential information about the companies in which we have invested. If we do possess confidential information about other companies, we may be restricted in our ability to dispose of, increase the amount of, or otherwise take action with respect to our investment in those companies.
WE ARE HEAVILY DEPENDENT UPON FBR MANAGEMENT IN A COMPETITIVE MARKET FOR INVESTMENT OPPORTUNITIES.
We can gain access to good investment opportunities only to the extent that they become known to FBR Group or FBR Management. Gaining access to good investment opportunities is a highly competitive business. FBR, FBR Management, and our company compete with other companies that have greater capital, more long-standing relationships, broader product offerings, and other advantages. Competitors include, but are not limited to, business development companies, small business investment companies, commercial lenders and mezzanine funds. Increased competition would make it more difficult for us to purchase or originate investments at attractive yields.
We are heavily dependent for the selection, structuring, and monitoring of our investments on the diligence and skill of FBR Management's officers and employees. We do not have employment agreements with our senior officers or require FBR Management to employ specific personnel or dedicate employees solely to us. FBR Management, in turn, is dependent on the efforts of its senior management personnel. Although we believe that FBR Management could find replacements for its key executives, the loss of their services could have an adverse effect on our operations and the operations of FBR Management.
THE TERMINATION OR NON-RENEWAL OF THE FBR MANAGEMENT AGREEMENT WOULD BE HARMFUL TO US.
We and FBR Management may terminate the management agreement without cause. The management agreement requires us to pay FBR Management a substantial termination fee in the event that we terminate the agreement without cause before expiration of its term. The termination fee would equal twelve months of base and incentive fees. For example, if we had terminated the management agreement in January 2001, the termination fee would have been $1.1 million, the amount of the base fee expensed in 2000. Because no incentive fee was earned in 2000, no additional termination fee would have been due.
Payment of a termination fee could have an adverse effect on our financial condition, cash flows, and results of operations and could reduce the amount of funds available for distribution to shareholders. In the event of termination, if we do not have sufficient cash to pay the termination fee, we may have to sell assets even though we would not otherwise choose to do so.
FBR Management may terminate the management agreement without cause and without penalty. In addition, in any year, it could elect not to renew the management agreement. It may be difficult or impossible to find a substitute management arrangement at a reasonable price or in a reasonable amount of time. In addition, it may be difficult or impossible to find a substitute manager who can identify investment opportunities to the same extent FBR Management and FBR Group currently do.
If the management agreement is terminated or expires, our fee-sharing agreement with FBR would terminate automatically. As a result, we would no longer be entitled to share in the net cash fees earned by FBR pursuant to the terms of the fee-sharing agreement.
OUR LIMITED OPERATING HISTORY DOES NOT INDICATE FUTURE RESULTS.
We were organized in November 1997, became a public reporting company in 1999 and have a limited operating history. In addition, our increased emphasis on mezzanine loans and on investments in other industries is a divergence from our previous emphasis on investments in equity securities and mortgage-backed securities. Because of this limited history, investors should be especially cautious before drawing conclusions about our future performance, including any conclusion about the future results of our expanded mezzanine loan program. Our past performance is not necessarily indicative of future results.
WE MAY INVEST IN ANY ASSET CLASS SUBJECT ONLY TO MAINTAINING OUR REIT QUALIFICATION AND OUR INVESTMENT COMPANY ACT EXEMPTION.
We make our investment decisions based in large part upon market conditions. Subject only to maintaining our REIT classification and our Investment Company Act exemption, we do not have any fixed guidelines for industry or asset diversification. As a result, we may decide to allocate a substantial portion of our assets or capital to a limited number of industries or asset classes. This potential concentration could make us more susceptible to significant losses and volatility than if we had further diversified our investments.
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DECLINES IN THE MARKET VALUES OF OUR ASSETS MAY ADVERSELY AFFECT CREDIT AVAILABILITY AND PERIODIC REPORTED RESULTS.
Currently, our assets are primarily real estate and mortgage assets, which include indirect holdings through investments in other companies. Those assets are classified for accounting purposes as "available-for-sale." Changes in the market values of those assets are directly charged or credited to our shareholders' equity. As a result, a general decline in trading market values may reduce the book value of our assets.
A decline in the market value of our assets may adversely affect us in instances where we have borrowed money based on the market value of those assets. At December 31, 2001, we had approximately $1.1 billion in outstanding repurchase agreements that were based on the market value of specific mortgage assets. The market value of those assets as of December 31, 2001, was approximately $1.2 billion. If the market value of those assets declines, the lender may require us to post additional temporary collateral to support the loan. If we were unable to post the additional collateral, we would have to sell the assets at a time when we would not otherwise choose to do so.
USE OF LEVERAGE COULD ADVERSELY AFFECT OUR OPERATIONS.
At December 31, 2001, our outstanding indebtedness for borrowed money under repurchase agreements was 8.30 times the amount of our equity in the mortgage-backed securities, based on book values. FBR Management has the authority to increase or decrease our overall debt-to-equity ratio on our total portfolio at any time and has not placed any limits on the amount we may borrow. At December 31, 2001, our total debt-to-equity ratio was 5.42 to 1. If we borrow more funds, the possibility that we would be unable to meet our debt obligations as they come due would increase. Financing assets through repurchase agreements exposes us to the risk that margin calls will be made and that we will not be able to meet those margin calls.
While we have not leveraged our equity securities or loan investments, we may choose to do so in the future. This leverage could expose us to the risk that margin calls will be made and that we will not be able to meet them. A leveraged company's income and net assets will tend to increase or decrease at a greater rate than if borrowed money were not used.
OUR ABILITY TO RECEIVE A SHARE OF THE INVESTMENT BANKING FEES EARNED BY FBR MAY CAUSE US TO MAKE INVESTMENTS IN OR LOANS TO COMPANIES THAT WOULD OTHERWISE NOT MEET OUR INVESTMENT OR CREDIT STANDARDS.
The decision to make an investment or loan will be made by our investment committee, which will have a duty to make its decision based on its analysis of the risks and rewards to us through the application of our normal investment criteria. The prospect of receiving a portion of the investment banking fees that FBR earns as a result of an engagement by a company where our commitment to invest in or make a loan to the company is a contributing factor to such engagement or assists in facilitating the completion of a transaction may, however, give us an incentive to invest in or make a loan to a company that we might not otherwise choose to make. If we commit to make an investment in or a loan to a company with the expectation of receiving a portion of any investment banking fees that FBR earns, there can be no assurance that the expected engagement will materialize, which could result in returns that are not commensurate with the level of r isk we took in making the investment. Consequently, the overall level of risk inherent in our investment and loan portfolio may increase as a result of our fee-sharing arrangement with FBR.
OUR ASSETS INCLUDE MEZZANINE OR SENIOR LOANS THAT MAY HAVE GREATER RISKS OF LOSS THAN A TYPICAL SECURED SENIOR LOANS.
In connection with our expanded mezzanine and senior loan program, we expect our assets to include a significant amount of loans that involve a higher degree of risk than long-term senior secured loans. First, our loans may not be secured by mortgages or liens on assets. Even if secured, our loans may have higher loan-to-value ratios than a typical senior secured loan. Furthermore, our right to payment and the security interest are usually subordinated to the payment rights and security interests of the senior lender. Therefore, we may be limited in our ability to enforce our rights to collect our loans and to recover any of the loan balance through a foreclosure of collateral.
Our loans typically have an interest only payment schedule, with the principal amount remaining outstanding and at risk until the maturity of the loan. A borrower's ability to repay its loan is often dependent upon a liquidity event that will enable the repayment of the loan. Accordingly, we may not recover some or all of our investments in our loans.
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In addition to the above, numerous other factors may affect a company's ability to repay its loan, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. A deterioration in a company's financial condition and prospects may be accompanied by deterioration in the collateral for the loan.
THE COMPANIES TO WHICH WE MAKE LOANS MAY BE HIGHLY LEVERAGED.
Leverage may have material adverse consequences to the companies to which we make loans and to us as an investor. These companies may be subject to restrictive financial and operating covenants. The leverage may impair these companies' ability to finance their future operations and capital needs. As a result, these companies' flexibility to respond to changing business and economic conditions and to business opportunities may be limited. A leveraged company's income and net assets will tend to increase or decrease at a greater rate than if borrowed money were not used.
DEPLOYMENT OF ANY NEW CAPITAL WE RAISE IN INVESTMENTS IDENTIFIED BY SOURCES OTHER THAN FBR MAY INCREASE THE LEVEL OF RISK IN OUR PORTFOLIO.
We may look to other entities for investment opportunities. If we do, we may not have as much information about these opportunities as we have with respect to companies identified by FBR. Consequently, the reduced amount of information available to us could cause the level of risk inherent in our investment portfolio to increase.
THE INDIRECT NATURE OF OUR INVESTMENTS EXPOSES US TO ADDITIONAL RISKS.
Approximately 5% of our total assets, as of December 31, 2001, were investments in equity securities. Approximately 1% of our total assets as of December 31, 2001 were short-term loans. Obtaining interests in assets indirectly by investing in other enterprises carries the following risks:
- Returns on investments are not directly linked to returns on investee companies' assets. We own equity securities of and have made loans to other companies. As an equity or debt holder, our return on investment is not directly linked to returns on any company's assets, but will depend upon either the payment of dividends and changes in the price of the equity securities or the payment of principal and interest on the outstanding debt, as applicable. Furthermore, as a common shareholder or junior debt holder, our claims to the assets of the companies in which we invest are junior to those of creditors and, with respect to our equity investments, senior shareholders.
- Obstacles to success may remain hidden if due diligence is inadequate. Before making an investment in another business entity, we will assess the strength and skills of the entity's management and other factors that we believe will determine the success of our investment. In making our assessment and otherwise conducting our customary due diligence, we will rely on the resources available to FBR Management and, in some cases, an investigation by third parties. This process is particularly important and subjective with respect to newly-organized entities because there may be little or no information publicly available about the companies. Against this background, we can give no assurance that the due diligence processes of FBR Management will uncover all relevant facts or that any investment will be successful.
- Dependence on management of other entities. We do not control the management, investment decisions, or operations of the enterprises in which we have invested. Management of those enterprises may decide to change the nature of their assets, or management may otherwise change in a manner that is not satisfactory to us. We have no ability to affect these management decisions, and as noted below, we may have only limited ability to dispose of our investments.
THE LIMITED LIQUIDITY OF SOME OF OUR INVESTMENTS EXPOSES US TO ADDITIONAL RISKS.
The equity securities of a new entity in which we invest are likely to be restricted as to resale and may otherwise be highly illiquid. We expect that there will be restrictions on our ability to resell the securities of any newly-public company that we acquire for one year after we acquire those securities. Thereafter, a public market sale may be subject to volume limitations or dependent upon securing a registration statement for a secondary offering of the securities. As of December 31, 2001, none of our equity investments was restricted in this manner.
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The securities of newly-public entities may trade less frequently and in smaller volume than securities of companies that are more widely held and have more established trading patterns. Thus, sales of these securities may cause their values to fluctuate more sharply. Furthermore, and because of our affiliation with FBR, our ability to invest in companies may be constrained by applicable securities laws and the rules of the National Association of Securities Dealers, Inc. This is because FBR is a registered broker-dealer and its investment and trading activities are regulated by the SEC and NASD. For example, the NASD's prohibition on "free-riding and withholding" may limit the number of shares we can acquire in a "hot issue" public offering that is underwritten by FBR.
The short- and medium-term loans we make are based, in part, upon our knowledge of the borrower and its industry. In addition, we do not yet nor may we ever have a significant enough portfolio of loans to easily sell them to a third party. As a result, these loans are and may continue to be highly illiquid.
THE VOLATILITY OF THE MARKET PRICES OF SOME OF OUR INVESTMENTS EXPOSES US TO ADDITIONAL RISK.
Prices of the equity securities of new entities in which we invest are likely to be volatile, particularly when we decide to sell those securities. We make investments in significant amounts, and resales of significant amounts of securities might adversely affect the market and the sales price for the securities.
THE DISPOSITION VALUE OF OUR INVESTMENTS IS DEPENDENT UPON GENERAL AND SPECIFIC MARKET CONDITIONS.
Even if we make an appropriate investment decision based on the intrinsic value of an enterprise, we have no assurance that the trading market value of the investment will not decline, perhaps materially, as a result of general market conditions. For example, an increase in interest rates, a general decline in the stock markets, or other market conditions adverse to companies of the type in which we have invested could result in a decline in the value of our investments.
OUR REAL ESTATE-RELATED INVESTMENTS MAY INCUR LOSSES.
We invest in real estate-related assets and in other entities, such as REITs, that themselves invest in real estate-related assets. Investments in real estate-related assets are subject to a variety of general, regional and local economic risks, as well as the following:
- Changes in interest rates could negatively affect the value of our mortgage loans and mortgage-backed securities. We have invested indirectly in mortgage loans by purchasing mortgage-backed securities. Some of the companies in which we have invested also own mortgage loans and mortgage-backed securities. At December 31, 2001, all of the mortgage-backed securities we held directly were backed by pools of fixed-rate and adjustable-rate residential mortgage loans. Under a normal yield curve, an investment in fixed-rate mortgage loans or mortgage-backed securities will decline in value if long-term interest rates increase. Although Fannie Mae, Freddie Mac or Ginnie Mae may guarantee payments on the mortgage-backed securities we own directly, those guarantees do not protect us from declines in market value caused by changes in interest rates.
- A significant risk associated with our current portfolio of mortgage-backed securities is the risk that both long-term and short-term interest rates will increase significantly. If long-term rates were to increase significantly, the market value of our mortgage-backed securities would decline and the weighted average life of the investments would increase. We could realize a loss if the securities were sold. At the same time, an increase in short-term interest rates would increase the amount of interest owed on our repurchase agreement borrowings.
- An increase in our borrowing costs relative to the interest we receive on our mortgage-backed securities may adversely affect our profitability. We earn money based upon the spread between the interest payments we receive on our mortgage-backed security investments and the interest payments we must make on our borrowings. We rely primarily on short-term borrowings of the funds to acquire mortgage-backed securities with long-term maturities. The interest we pay on our borrowings may increase relative to the interest we earn on our mortgage-backed securities. If the interest payments on our borrowings increase relative to the interest we earn on our mortgage-backed securities, our profitability may be adversely affected.
- Use of leverage can amplify declines in market value resulting from interest rate increases. We, and several of the REITs in which we have invested, borrow funds to finance mortgage related investments, which can worsen the effect of a decline in value resulting from an interest rate increase. For example, assume that our company or a REIT in which we have invested borrows $90 million to acquire $100 million of 8% mortgage-backed securities. If prevailing interest rates increase from 8% to 9%, the value of the mortgage loans may decline to a level below the amount required to be maintained under the terms of the borrowing. If the mortgage assets were then sold, our company or the REIT that owned the mortgage assets would have to find funds from another source to repay the borrowing.
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Market values of mortgage loans and mortgage-backed securities may decline without any general increase in interest rates for any number of reasons, such as increases in defaults, increases in voluntary prepayments and widening of credit spreads.
PREPAYMENT RATES COULD NEGATIVELY AFFECT THE VALUE OF OUR MORTGAGE-BACKED SECURITIES.
In the case of residential mortgage loans, there are seldom any restrictions on borrowers' abilities to prepay their loans. Homeowners tend to prepay mortgage loans faster when interest rates decline and when owners of the loans, such as our company or the REITs in which we have invested, do not want them to be prepaid. Consequently, owners of the loans have to reinvest the money received from the prepayments at the lower prevailing interest rates. Conversely, homeowners tend not to prepay mortgage loans when interest rates increase and when owners of the loans want them to be prepaid. Consequently, owners of the loans are unable to reinvest money that would have otherwise been received from prepayments at the higher prevailing interest rates.
Although Fannie Mae, Freddie Mac or Ginnie Mae may guarantee payments on the mortgage-backed securities we own directly, those guarantees do not protect investors against prepayment risks.
RAPID CHANGES IN THE VALUES OF OUR REAL ESTATE ASSETS MAY MAKE IT MORE DIFFICULT TO MAINTAIN OUR REIT STATUS.
If the market value or income potential of our mortgage-backed securities and mezzanine loans decline as a result of increased interest rates, prepayment rates or other factors, we may need to increase our real estate investments and income and/or liquidate our non-qualifying assets in order to maintain our REIT status or exemption from the Investment Company Act. If the decline in real estate asset values and/or income occurs quickly, this may be especially difficult to accomplish. This difficulty may be exacerbated by the illiquid nature of many of our non-real estate assets. We may have to make investment decisions that we otherwise would not want to make absent the REIT and Investment Company Act considerations.
HEDGING AGAINST INTEREST RATE EXPOSURE MAY ADVERSELY AFFECT OUR EARNINGS.
During 2001, we entered into a $50 million notional amount interest rate swap agreement to limit, or "hedge," the adverse effects of rising interest rates on our short-term repurchase agreements. In the future, we may enter into other interest rate swap agreements. Our hedging activity varies in scope based on the level and volatility of interest rates and principal prepayments, the type of mortgage-backed securities held, and other changing market conditions.
The companies in which we have invested also enter into interest rate hedging transactions to protect themselves from the effect of changes in interest rates. Interest rate hedging may fail to protect or adversely affect a company because, among other things:
- interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;
- available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;
- the duration of the hedge may not match the duration of the related liability;
- the amount of income that a REIT may earn from hedging transactions to offset interest rate losses is limited by federal tax provisions governing REITs;
- the party owing money in the hedging transaction may default on its obligation to pay; and
- the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction.
MULTIFAMILY AND COMMERCIAL REAL ESTATE MAY LOSE VALUE AND FAIL TO OPERATE PROFITABLY.
Some of the companies in which we may invest may own multifamily and commercial real estate. In the future, we may invest in other companies that invest in multifamily and commercial real estate or we may invest in those assets ourselves. Those investments and other similar investments are dependent on the ability of the real estate to generate income. Investing in real estate is subject to many risks. Among these are:
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- property managers may not have the ability to attract tenants willing to pay rents that sustain the property and to maintain and operate the properties on a profitable basis;
- the value of real estate may be significantly affected by general, regional and local economic conditions, and other factors beyond the investor's control;
- the value of real estate may be significantly affected by unknown or undetected environmental problems; and
- the value of real estate may be significantly affected by changes in zoning or land use regulations or other applicable laws.
INVESTING IN SUBORDINATED INTERESTS EXPOSES US TO INCREASED CREDIT RISK.
In the future, we may invest in companies that invest in subordinated interests or may ourselves invest in those interests. Subordinated interests are classes of commercial mortgage-backed securities and mortgage loans that are subject to the senior claim of mortgage-backed debt securities. Losses on the underlying mortgage loans may be significant to the owner of a subordinated interest because the investments are leveraged. For example, assume a REIT acquires a $10 million principal amount subordinated interest in a $100 million pool of mortgage loans that is subject to $90 million of senior mortgage-backed securities. If thereafter there are $7 million of losses on the $100 million of loans, the entire loss will be allocated to the owner of the subordinated interest. In essence, a 7% loss on the loans would translate into a 70% loss of principal and the related interest for the owner of the subordinated interest.
COMPETITION IN THE PURCHASE, SALE AND FINANCING OF MORTGAGE ASSETS MAY LIMIT THE PROFITABILITY OF COMPANIES IN WHICH WE INVEST.
Although we do not directly own commercial mortgage-backed securities or subordinated interests, in the future, we may invest in other companies that invest in commercial mortgage-backed securities or subordinated interests or may ourselves invest in those assets. Mortgage REITs derive their net income, in large part, from their ability to acquire mortgage assets that have yields above borrowing costs. In 1997 and 1998, increased competition for subordinated interests developed as new mortgage REITs entered the market. These mortgage REITs raised funds through public offerings and sought to invest those funds on a long-term basis. The amount of funds available for investment, however, exceeded the amount of available investments, which resulted in significant competition for assets. That competition resulted in higher prices for subordinated interests, lowering the yields and narrowing the spread of those yields over borrowing costs.
Competitors for the acquisition of mortgage assets include other mortgage REITs, such as Anthracite Capital, Inc., AMRESCO Capital Trust, and other REIT and non-REIT investors, such as Lennar Corporation and Capital Trust.
INCREASED LOSSES ON UNINSURED MORTGAGE LOANS CAN REDUCE THE VALUE OF OUR EQUITY INVESTMENTS.
Although our mortgage-backed securities are supported by instrumentality guarantees, companies in which we have invested may own uninsured mortgage loans. In the future, we may invest directly in uninsured mortgage loans.
Owners of uninsured mortgage loans are subject to the risk that borrowers will not pay principal or interest on their mortgage loans as they become due. Borrowers become unable to pay their mortgage loans for a wide variety of reasons, including general, regional, local and personal economics and declines in business activity or real estate values. Generally, if a borrower defaults, the owner of the mortgage loan will incur a loss to the extent the value of the property securing the mortgage loan is less than the amount of the mortgage loan. Defaults on mortgage loans often coincide with declines in real estate values, which can create greater losses than anticipated. Increased exposure to losses on uninsured mortgage loans can reduce the value of our equity investments.
PREPAYMENT SENSITIVITY OF INVESTMENTS IN INTEREST-ONLY SECURITIES.
We have no direct investments in interest-only securities. Interest-only securities are mortgage-backed securities that entitle the holder to receive only interest on the outstanding principal amount of the underlying mortgage loans, and no principal. The companies in which we invest do not own material amounts of interest-only securities as of December 31, 2001, but may do so in the future. We may also invest in other companies that invest in interest-only securities or we may invest in those securities directly. The value of these interest-only securities can be adversely affected if the underlying mortgage loans are prepaid faster than anticipated and the interest stream decreases. For example, an interest-only security with an initial notional amount of $100 million may entitle a holder to interest equal to 1% on the outstanding notional amount. The holder may anticipate that 10% of the loans will prepay at the end of each year; howev er, the actual experience is that 20% of the loans prepay at the end of each year. In that case, the anticipated and actual cash paid to the holder would be:
7
YEAR |
ANTICIPATED |
ACTUAL |
1 |
$ 1,000,000 |
$ 1,000,000 |
2 |
900,000 |
800,000 |
3 |
800,000 |
600,000 |
4 |
700,000 |
400,000 |
5 |
600,000 |
200,000 |
6 |
500,000 |
-- |
7 |
400,000 |
-- |
8 |
300,000 |
-- |
9 |
200,000 |
-- |
10 |
100,000 |
-- |
Total |
$ 5,500,000 |
$ 3,000,000 |
Some interest-only securities pay interest based on a floating rate that varies inversely with, and at a multiple of, a specified floating interest rate index, such as LIBOR. The yield on these securities is sensitive not only to prepayments, but also to changes in the related index. For example, a security might bear interest at a rate equal to forty percent minus the product of five and LIBOR, or 40% - (5 x LIBOR). An increase in LIBOR by only 1%, from 6% to 7%, would cause the interest rate on the investment to decline from 10% to 5%.
FEDERAL INCOME TAX REQUIREMENTS MAY RESTRICT OUR OPERATIONS.
We have operated and intend to continue operating in a manner that is intended to cause us to qualify as a REIT for federal income tax purposes. However, the REIT qualification requirements are extremely complex. Qualifying as a REIT requires us to meet tests regarding the nature of our assets and our income, the ownership of our outstanding stock, and the amount of our distributions on an ongoing basis. Some of our investments are in equity securities of other REITs, which generally are qualifying assets and produce qualifying income for purposes of the REIT qualification tests. The failure of the REITs in which we invest to maintain their REIT status, however, could jeopardize our own REIT status. Accordingly, we cannot be certain that we have been or will continue to be successful in operating so as to qualify as a REIT. At any time, new laws, interpretations, or court decisions may change the federal tax laws or the federal income tax consequences of qualification as a REIT. In addition, compliance with the REIT qualification tests could restrict our ability to take advantage of attractive investment opportunities in non-qualifying assets. Specifically, we may be required to limit our investment in non-REIT equity securities and mezzanine loans to the extent that such loans are not secured by real property.
FAILURE TO MAKE REQUIRED DISTRIBUTIONS WOULD SUBJECT US TO TAX.
In order to qualify as a REIT, we must distribute to our shareholders, each calendar year, at least 90% of our taxable income, other than any net capital gain. For years before 2001, we were required to distribute at least 95% of our taxable income annually. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than the sum of:
- 85% of our ordinary income for that year,
- 95% of our capital gain net income for that year, and
- 100% of our undistributed taxable income from prior years.
We generally intend to distribute all of our taxable income each year in order to satisfy the 90% distribution requirement and avoid corporate income tax and the 4% excise tax.
See "Federal Income Tax Consequences of Our Status as a REIT-Distribution Requirements."
8
Our taxable income may substantially exceed our net income as determined based on generally accepted accounting principles because, for example, capital losses will be deducted in determining our GAAP income, but may not be deductible in computing our taxable income. In addition, we may invest in assets that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets, referred to as phantom income. Although some types of phantom income are excluded in determining the 90% distribution requirement, we will incur corporate income tax and the 4% excise tax with respect to our phantom income items if we do not distribute those items on an annual basis. See "Federal Income Tax Consequences of Our Status as a REIT-Distribution Requirements." As a result of the foregoing, we may have less cash than is necessary to distribute all of our taxable income each year. Consequently, we may be required to incur debt or liquidate assets at rates or times that we regard as unfavorable in order to satisfy the distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year.
FAILURE TO QUALIFY AS A REIT WOULD SUBJECT US TO FEDERAL INCOME TAX.
If we fail to qualify as a REIT in any taxable year, we would be required to pay federal income tax on our taxable income. We might need to borrow money or sell assets in order to pay that tax. Our payment of income tax would decrease the amount of our income available for distribution to our shareholders. Furthermore, if we cease to be a REIT, we no longer would be required to distribute substantially all of our taxable income to our shareholders. Unless our failure to qualify as a REIT were excused under federal tax laws, we could not re-elect REIT status until the fifth calendar year following the year in which we failed to qualify.
THERE IS A RISK THAT YOU MAY NOT RECEIVE DIVIDENDS.
Our current intention is to continue to distribute at least 90% of our taxable income to our shareholders. There can be no assurance that we will achieve investment results or maintain a tax status that will allow any specified level of cash distributions.
OWNERSHIP LIMITATION MAY RESTRICT CHANGE OF CONTROL OR BUSINESS COMBINATION OPPORTUNITIES.
In order for us to qualify as a REIT, no more than 50% in value of our outstanding capital stock may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year. "Individuals" include natural persons, private foundations, some employee benefit plans and trusts, and some charitable trusts. In order to preserve our REIT status, our Articles generally prohibit:
- shareholders, other than FBR and some mutual funds and pension plans, from directly or indirectly owning more than 9.9% of the outstanding common stock or preferred stock of any series,
- FBR from directly or indirectly owning more than 20% of the outstanding common stock or preferred stock of any series, and
- some mutual funds and pension plans from directly or indirectly owning more than 15% of the outstanding common stock or preferred stock of any series.
Our Board has exempted FBR from the 20% ownership limit applicable to it. The exemption permits FBR to own, directly or indirectly, up to 62% of the outstanding common stock or preferred stock of any series. Our Board also has exempted some of our principal shareholders from the 9.9% ownership limit.
These ownership limitations could have the effect of discouraging a takeover or other transaction in which holders of some, or a majority, of our common stock might receive a premium for their shares over the then prevailing market price or which holders might believe to be otherwise in their best interests.
LOSS OF INVESTMENT COMPANY ACT EXEMPTION WOULD ADVERSELY AFFECT US.
We believe that we currently are not, and intend to continue operating so as not to become, regulated as an investment company under the Investment Company Act of 1940 because we are "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." Specifically, we have invested, and intend to continue investing, at least 55% of our assets in mortgage loans or mortgage-backed securities that represent the entire ownership in a pool of mortgage loans and at least an additional 25% of our assets in mortgages, mortgage-backed securities, securities of REITs, and other real estate-related assets.
If we fail to qualify for that exemption, we could be required to restructure our activities. For example, if the market value of our investments in equity securities were to increase by an amount that resulted in less than 55% of our assets being invested in whole pools of mortgage loans or mortgage-backed securities, we might have to sell equity securities in order to qualify for exemption under the Investment Company Act. The sale could occur under adverse market conditions.
9
AS A REGISTERED BROKER-DEALER, PEGASUS WILL BE SUBJECT TO EXTENSIVE GOVERNMENT AND OTHER REGULATION WHICH COULD ADVERSELY AFFECT OUR RESULTS.
The securities business is subject to extensive regulation under federal and state laws. Compliance with many of the regulations applicable to Pegasus involves a number of risks, particularly in areas where applicable regulations may be subject to interpretation. In the event of non-compliance with an applicable regulation, governmental authorities and self-regulatory organizations such as the NASD may institute administrative or judicial proceedings that could have a material adverse effect on the operations of Pegasus, and thus on our operating results.
The regulatory environment is also subject to change. Our business may be adversely affected as a result of new or revised legislation or regulations imposed by the NASD, SEC or other governmental regulatory authority. We also may be adversely affected by changes in the interpretation or enforcement of existing laws and rules by these governmental authorities and the NASD. These changes in interpretation or new laws, rules or regulations also could adversely affect our ability to share in investment banking fees earned by FBR, as described in this prospectus.
OUR BOARD OF DIRECTORS MAY CHANGE POLICIES WITHOUT SHAREHOLDER CONSENT.
Our major policies, including our investment policy and other policies with respect to acquisitions, financing, growth, operations, debt and distributions, are determined by our Board of Directors. The Board may amend or revise these and other policies, or approve transactions that deviate from these policies, from time to time without a vote of the common shareholders. The effect of those changes may be positive or negative. Our Articles also authorize the Board of Directors to issue up to 50,000,000 shares of preferred stock and to establish the preferences and rights of any shares of preferred stock issued. Although we have no current intention to issue any series of preferred stock, the issuance of preferred stock could increase the investment risk associated with common stock ownership, delay or prevent a change in control of our company, or otherwise change the nature of an investment in our common stock.
10
EXHIBIT 99.03
April 1, 2002
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Re: Annual Report on Form 10-K for the year ended December 31, 2001 for Friedman, Billings, Ramsey Group, Inc.
Ladies and Gentlemen:
Consistent with the Commission's release of March 18, 2002, please be advised that the Company has obtained a letter from Arthur Andersen LLP, the Company's independent public accountants, dated April 1, 2002, containing the following representations regarding the audits performed on the Company's balance sheets as of December 31, 2001 and 2000 and the related statements of income, changes in shareholders' equity and cash flows for the years ended December 31, 2001, 2000 and 1999:
Representation relating to the availability of personnel at foreign affiliates of Arthur Andersen was not relevant to these audits.
Sincerely, | |
/s/ Emanuel J. Friedman | |
Emanuel J. Friedman | |
Chairman of the Board of Directors, | |
Co-Chief Executive Officer |
/s/ Eric F. Billings |
|
Eric F. Billings |
|
Vice Chairman of the Board of Directors, |
|
Co-Chief Executive Officer |