10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 000-50230

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

(Exact name of Registrant as specified in its charter)

Virginia	54-1873198
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1001 Nineteenth Street North

Arlington, VA 22209

(Address of principal executive offices)

(Zip code)

(703) 312-9500

(Registrant’s telephone number including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:

Title	Outstanding
Class A Common Stock	159,056,784 shares as of October 28, 2005
Class B Common Stock	13,480,249 shares as of October 28, 2005

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2005

INDEX

		Page
Part I. FINANCIAL INFORMATION
Item 1.	Financial Statements — (unaudited)
	Consolidated Balance Sheets — September 30, 2005 and December 31, 2004	3
	Consolidated Statements of Operations — Three Months Ended September 30, 2005 and 2004	4
	Consolidated Statements of Operations — Nine Months Ended September 30, 2005 and 2004	5
	Consolidated Statements of Changes in Shareholders’ Equity — Nine Months Ended September 30, 2005 and Year Ended December 31, 2004	6
	Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2005 and 2004	7
	Notes to Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	44
Item 4.	Controls and Procedures	47
Part II. OTHER INFORMATION
Item 1.	Legal Proceedings	48
Item 6.	Exhibits	50
	Signatures	51

2

PART I — FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements and Notes — (unaudited)

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

(Unaudited)

	September 30, 2005			December 31, 2004
ASSETS
Cash and cash equivalents	$	181,534		$	224,371
Restricted cash		21,576			7,156
Receivables:
Interest		91,164			46,324
Due from servicer		86,345			—
Securities sold		63,064			—
Other		46,615			28,556
Investments:
Mortgage-backed securities, at fair value		9,268,662			11,726,689
Loans held for investment, net		6,999,409			—
Loans held for sale, net		1,541,283			—
Long-term investments		361,131			441,499
Reverse repurchase agreements		488,113			183,375
Trading securities, at fair value		1,429,547			7,744
Due from clearing broker		162,759			95,247
Goodwill		160,525			108,013
Intangible assets, net		27,880			14,404
Furniture, equipment, software and leasehold improvements, net of accumulated depreciation and amortization of $28,619 and $22,889, respectively		40,602			18,733
Prepaid expenses and other assets		100,948			26,177
Total assets	$	21,071,157		$	12,928,288
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Trading account securities sold but not yet purchased, at fair value	$	156,428		$	17,176
Commercial paper		8,214,835			7,294,949
Repurchase agreements		6,853,306			3,467,569
Securities purchased		—			144,430
Dividends payable		58,616			65,870
Interest payable		19,943			5,894
Accrued compensation and benefits		56,374			131,218
Accounts payable, accrued expenses and other liabilities		123,689			94,288
Temporary subordinated loan payable		100,000			—
Securitization financing for loans held for investment, net		3,809,901			—
Long-term debt		283,928			128,370
Total liabilities		19,677,020			11,349,764
Commitments and Contingencies (Note 11)
Shareholders’ equity:
Preferred Stock		—			—
Class A Common Stock, $0.01 par value, 450,000,000 shares authorized, 157,400,117 and 143,967,205 shares issued and outstanding, respectively		1,574			1,440
Class B Common Stock, $0.01 par value, 100,000,000 shares authorized, 15,130,249 and 24,929,599 shares issued and outstanding, respectively		151			249
Additional paid-in capital		1,544,661			1,483,640
Employee stock loan receivable (591,342 and 711,343 shares)		(4,242	)		(4,890	)
Deferred compensation		(20,295	)		(16,863	)
Accumulated other comprehensive loss, net		(209,168	)		(38,162	)
Retained earnings		81,456			153,110
Total shareholders’ equity		1,394,137			1,578,524
Total liabilities and shareholders’ equity	$	21,071,157		$	12,928,288

See notes to consolidated financial statements.

3

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

	Three Months Ended September 30,
	2005			2004
Revenues:
Investment banking:
Capital raising	$	86,035		$	130,019
Advisory		3,026			11,602
Institutional brokerage:
Principal transactions		4,348			4,241
Agency commissions		20,445			18,505
Mortgage trading interest		11,304			—
Mortgage trading net investment loss		(2,401	)		—
Asset management:
Base management fees		7,914			7,044
Incentive allocations and fees		832			1,737
Principal investment:
Interest		144,401			88,035
Net investment income		4,866			19,090
Dividends		8,772			5,820
Mortgage banking:
Interest		29,383			—
Gain on sale of loans, net		17,600			—
Other		3,376			1,827
Total revenues		339,901			287,920
Interest expense		156,373			44,265
Provision for loan losses		4,890			—
Revenues, net of interest expense and provision for loan losses		178,638			243,655
Non-Interest Expenses:
Compensation and benefits		88,348			95,824
Professional services		16,158			13,421
Business development		8,815			8,284
Clearing and brokerage fees		2,363			1,556
Occupancy and equipment		9,397			3,898
Communications		5,561			3,348
Other operating expenses		16,861			4,846
Total non-interest expenses		147,503			131,177
Net income before income taxes		31,135			112,478
Income tax provision		8,090			20,329
Net income	$	23,045		$	92,149
Basic earnings per share	$	0.14		$	0.55
Diluted earnings per share	$	0.14		$	0.55
Dividends declared per share	$	0.34		$	0.34
Weighted average shares outstanding:
Basic		169,745			167,593
Diluted		170,490			168,800

See notes to consolidated financial statements.

4

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

	Nine Months Ended September 30,
	2005			2004
Revenues:
Investment banking:
Capital raising	$	267,887		$	272,695
Advisory		10,344			22,027
Institutional brokerage:
Principal transactions		14,162			15,686
Agency commissions		61,772			68,702
Mortgage trading interest		11,304			—
Mortgage trading net investment loss		(2,401	)		—
Asset management:
Base management fees		24,195			19,963
Incentive allocations and fees		1,187			2,958
Principal investment:
Interest		360,021			264,141
Net investment income		18,746			74,531
Dividends		20,583			8,475
Mortgage banking:
Interest		56,993			—
Gain on sale of loans, net		35,640			—
Other		9,327			4,824
Total revenues		889,760			754,002
Interest expense		334,920			111,188
Provision for loan losses		6,028			—
Revenues, net of interest expense and provision for loan losses		548,812			642,814
Non-Interest Expenses:
Compensation and benefits		244,162			228,411
Professional services		49,994			38,635
Business development		36,215			33,707
Clearing and brokerage fees		6,435			6,937
Occupancy and equipment		23,893			10,128
Communications		14,893			9,732
Other operating expenses		45,695			16,168
Total non-interest expenses		421,287			343,718
Net income before income taxes		127,525			299,096
Income tax provision		26,825			36,129
Net income	$	100,700		$	262,967
Basic earnings per share	$	0.60		$	1.57
Diluted earnings per share	$	0.59		$	1.56
Dividends declared per share	$	1.02		$	1.14
Weighted average shares outstanding:
Basic		169,166			166,975
Diluted		170,122			168,500

See notes to consolidated financial statements.

5

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands)

(Unaudited)

	Class A Number of Shares	Class A Amount		Class B Number of Shares		Class B Amount			Additional Paid-In Capital		Employee Stock Loan Receivable			Deferred Compen- sation			Accumulated Other Compre- hensive Income (loss)			Retained Earnings			Total			Compre- hensive Income (Loss)
Balances, December 31, 2003	141,021,320	$	1,410	25,872,099		$	259		$	1,443,228	$	(8,277	)	$	(2,203	)	$	60,505		$	59,417		$	1,554,339
Net Income																					349,559			349,559		$	349,559
Conversion of Class B shares to Class A shares	942,500		10	(942,500	)		(10	)																—
Issuance of Class A common shares	2,003,385		20							40,003					(14,660	)								25,363
Repayment of employee stock purchase and loan plan receivable												3,796												3,796
Interest on employee stock purchase and loan plan										409		(409	)
Other comprehensive income:
Net change in unrealized gain (loss) on available-for-sale investment securities, (net of taxes of $1,978)																		(76,392	)					(76,392	)		(76,392	)
Net change in unrealized gain (loss) on cash flow hedges																		(22,275	)					(22,275	)		(22,275	)
Comprehensive income																										$	250,892
Dividends																					(255,866	)		(255,866	)
Balances, December 31, 2004	143,967,205	$	1,440	24,929,599		$	249		$	1,483,640	$	(4,890	)	$	(16,863	)	$	(38,162	)	$	153,110		$	1,578,524
Net Income																					100,700			100,700		$	100,700
Conversion of Class B shares to Class A shares	9,799,350		98	(9,799,350	)		(98	)
Issuance of Class A common shares	3,633,562		36							60,821					(3,432	)								57,425
Repayment on employee stock purchase and loan plan receivable										11		837												848
Interest on employee stock purchase and loan plan										189		(189	)
Other comprehensive income:
Net change in unrealized gain (loss) on available-for-sale investment securities, (net of taxes of $302)																		(180,613	)					(180,613	)		(180,613	)
Net change in unrealized gain (loss) on cash flow hedges																		9,607						9,607			9,607
Comprehensive loss																										$	(70,306	)
Dividends																					(172,354	)		(172,354	)
Balances, September 30, 2005	157,400,117	$	1,574	15,130,249		$	151		$	1,544,661	$	(4,242	)	$	(20,295	)	$	(209,168	)	$	81,456		$	1,394,137

See notes to consolidated financial statements.

6

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

	Nine Months Ended September 30,
	2005			2004
Cash flows from operating activities:
Net income	$	100,700		$	262,967
Non-cash items included in earnings:
Incentive allocations and fees and net investment income from long-term investments		(20,391	)		(76,526	)
Premium amortization on mortgage-backed securities		51,905			60,959
Premium amortization on loans held for investment		6,172			—
Derivative contracts marked-to-market		(2,026	)		4,316
Depreciation and amortization		9,678			4,241
Other		13,708			(490	)
Changes in operating assets:
Restricted cash		(14,420	)		—
Receivables:
Investment banking		(6,014	)		(7,490	)
Asset management fees		905			(260	)
Affiliates		4,724			763
Due from servicer		(85,512	)		—
Other		(58,549	)		409
Due from clearing broker		(67,512	)		(137,342	)
Marketable and trading securities		(1,421,803	)		(49,441	)
Originations and purchases of mortgage loans held for sale, net of fees		(4,177,109	)		—
Cost basis on sale and principal repayment of loans held for sale		2,704,559			—
Prepaid expenses and other assets		(49,083	)		(14,103	)
Changes in operating liabilities:
Trading account securities sold but not yet purchased		139,252			138,440
Repurchase agreements related to trading securities, net		1,477,987			—
Accounts payable, accrued expenses and other liabilities		16,382			9,869
Accrued compensation and benefits		(57,560	)		(7,393	)
Net cash (used in) provided by operating activities		(1,434,007	)		188,919
Cash flows from investment activities:
Purchases of mortgage-backed securities		(1,912,947	)		(5,075,794	)
Receipt of principal payments on mortgage-backed securities		3,024,039			3,227,861
Proceeds from sales of mortgage-backed securities		998,296			1,298,721
Purchases of reverse repurchase agreements, net		(137,363	)		(162,095	)
Purchases and origination of loans held for investment		(6,851,467	)		—
Receipt of principal repayment from loans held for investment		279,458			—
Purchases of long-term investments		(67,258	)		(71,825	)
Proceeds from sales of long-term investments		78,274			155,865
Purchase of First NLC Financial Services, LCC, net cash		(62,672	)		—
Purchases of fixed assets		(23,120	)		(7,274	)
Proceeds from disposals of fixed assets		—			22
Net cash used in investing activities		(4,674,760	)		(634,519	)
Cash flows from financing activities:
Proceeds from issuance of long-term debt		155,000			52,500
Repayments of long-term debt		(970	)		—
Proceeds from (repayments of) repurchase agreements, net		1,257,210			(310,709	)
Proceeds from issuances of commercial paper, net		919,886			953,353
Proceeds from temporary subordinated loan		200,000			—
Repayments of temporary subordinated loan		(100,000	)		—
Proceeds from securitization financing		3,910,563			—
Repayments of securitization financing		(100,699	)		—
Dividends paid		(179,391	)		(191,056	)
Proceeds from issuance of common stock		3,483			18,605
Proceeds from repayments of employee stock loan receivable		848			3,754
Net cash provided by financing activities		6,065,930			526,447
Net increase in cash and cash equivalents		(42,837	)		80,847
Cash and cash equivalents, beginning of period		224,371			92,688
Cash and cash equivalents, end of period	$	181,534		$	173,535
Supplemental Cash Flow Information:
Cash payments for interest	$	312,128		$	96,981
Cash payments for taxes	$	26,670		$	48,264

Note: A portion of the Company’s acquisition of First NLC Financial Services, LLC was a non-cash transaction see Note 2.

See notes to consolidated financial statements.

7

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands)

(Unaudited)

1. Basis of Presentation:

The consolidated financial statements of Friedman, Billings, Ramsey Group, Inc. and subsidiaries (“FBR Group,” “FBR,” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Therefore, they do not include all information required by accounting principles generally accepted in the United States of America for complete financial statements. The interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the results for the periods presented. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations for interim periods are not necessarily indicative of the results for the entire year. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2004 included on Form 10-K filed by the Company under the Securities Exchange Act of 1934.

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

Certain amounts in the consolidated financial statements and notes for prior periods have been reclassified to conform to the current period presentation.

2. First NLC Financial Services, LLC Acquisition:

On February 16, 2005, the Company completed the acquisition of First NLC Financial Services, LLC (First NLC), a non-conforming residential mortgage loan originator located in Florida for a purchase price of $98,563 paid in a combination of cash and stock. First NLC currently operates in 42 states and originates loans through both wholesale and retail channels. First NLC is part of the Company’s mortgage banking segment but operates as a wholly owned subsidiary. The Company expects that the acquisition of First NLC will assist in expanding and adding flexibility to the Company’s mortgage loan business by providing the ability to originate, price, portfolio and sell non-conforming mortgage loan assets based on market conditions.

The Company accounted for the acquisition of First NLC in accordance with Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations” using the purchase method of accounting. Under the purchase method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. In addition, SFAS 141 provides that the cost of an acquired entity must be allocated to the assets acquired, including identifiable intangible assets, and the liabilities assumed based on their estimated fair values at the date of acquisition. The excess of cost over the fair value of the net assets acquired must be recognized as goodwill.

8

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

The $98,563 purchase price included cash of $72,085, issuance of 1,297,746 shares of FBR Class A common stock at a price of $18.82 per share for a total of $24,420, and estimated direct acquisition costs of $2,058. A summary of the fair values of the net assets acquired is as follows:

Cash	$	11,471
Interest receivable		1,107
Loans held for sale, net		508,443
Intangible asset		16,500
Other assets		10,029
Warehouse finance facilities		(483,164	)
Other liabilities		(18,335	)
Goodwill		52,512
Total purchase price, including acquisition costs	$	98,563

Identified intangible assets represent the fair value of First NLC’s broker relationships. Pursuant to SFAS No. 142, “Goodwill and Other Intangible Assets,” this intangible asset will be amortized over an estimated useful life of ten years based on the economic depletion of this asset. The expected pre-tax amortization expense for the years ended December 31, 2005, 2006, 2007, 2008, and 2009, are estimated to be $2,911, $2,764, $2,304, $1,925, and $1,612, respectively. The total amount of goodwill represents the purchase price of First NLC in excess of the fair value of the net assets acquired. Under SFAS No. 142, goodwill is not amortized. Instead, this asset is required to be tested at least annually for impairment. Both the identified broker relationship intangible asset and the goodwill are deductible for tax purposes.

As a result of the acquisition of First NLC, the Company adopted the following accounting policies:

Mortgage Loans

Mortgage loans originated by First NLC are classified as held for sale and are carried at the lower of cost or market value. When there is a definitive agreement to transfer loans to MHC I, Inc. (MHC I), a wholly owned qualified REIT subsidiary of the Company, the loans are reclassified as held for investment and are transferred to MHC I at the lower of cost or market value on the transfer date. Loans classified as held for investment are reported at amortized cost. Market value is determined by current investor yield commitments and/or requirements on the aggregate basis, or in the absence of such, current investor commitments and/or requirements for loans of similar terms and credit quality.

The cost basis of mortgage loans includes premiums paid on loans purchased and direct loan origination costs (net of loan fees collected from borrowers) on loans originated by the Company. The cost basis of loans transferred from held for sale to held for investment includes market value adjustments, if any, to record such transfers as the lower of cost or market value.

The Company maintains an allowance for loan losses on loans held for investment. Specific allowance for loan losses are established for impaired loans based on a comparison of the recorded carrying value of the loan to either the present value of the loan’s expected cash flow, the loan’s estimated market price or the estimated fair value of the underlying collateral. The allowance is increased by charges to operations and decreased by charge-offs (net of recoveries). Management’s periodic evaluation of the adequacy of the allowance is based upon known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of underlying collateral, and current and expected future economic conditions.

9

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

Interest Income on Loans

Interest income on loans is recorded as earned to the extent that such amounts are expected to be collected. Interest on loans from borrowers not expected to service the debt and interest on loans that are contractually past due 90 or more days is charged-off, or an allowance is established based upon management’s periodic evaluation. The allowance is established by a charge to interest income equal to all interest previously accrued and unpaid, and income is subsequently recognized only to the extent that cash payments are received until the borrower’s ability to make periodic interest and principal payments is adequate, in which case the loan is returned to accrual status.

Gain on Sale of Loans, Net

Gain on sale of loans is the difference between the sale proceeds and the net carrying amount of the loans less a provision for repurchase and premium recapture obligations. Gain on sale of loans is recognized when the Company transfers ownership of the loan to the purchaser and the funds are collected. Loan sales are on a servicing-released basis. The Company reduces its gain on sale of loans to record liabilities (1) for loans sold which may be required to be repurchased due to breaches of representations and warranties or if a borrower fails to make one or more of the first loan payments due on the loan and (2) for premium recapture in instances where the sold loan is paid in full by the borrower during the first year subsequent to the sale date.

Transfers of financial assets (mortgage loans) are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the loan has been isolated from the Company, (2) the transferee has the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred loan, and (3) the Company does not maintain effective control over the transferred loan through either (a) an agreement that both entitles and obligates the Company to repurchase or redeem them before their maturity or (b) the ability to unilaterally cause the holder to return the specific loan.

The following presents unaudited pro forma consolidated results for the three and nine months ended September 30, 2005 and 2004, as though the acquisition had occurred as of January 1, 2004.

	Three Months Ended September 30,
	2005		2004
Gross revenues, as reported	$	339,901	$	287,920
Revenues, net of interest expense and provision for loan losses, as reported		178,638		243,655
Net earnings, as reported		23,045		92,149
Gross revenues, pro forma		339,901		304,823
Revenues, net of interest expense and provision for loan losses, pro forma		178,638		264,737
Net earnings, pro forma		23,045		100,199
Earnings per common share:
Basic, as reported	$	0.14	$	0.55
Diluted, as reported	$	0.14	$	0.55
Basic, pro forma	$	0.14	$	0.60
Diluted, pro forma	$	0.14	$	0.59

10

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

	Nine months Ended September 30,
	2005		2004
Gross revenues, as reported	$	889,760	$	754,002
Revenues, net of interest expense and provision for loan losses, as reported		548,812		642,814
Net earnings, as reported		100,700		262,967
Gross revenues, pro forma		902,518		817,586
Revenues, net of interest expense and provision for loan losses, pro forma		558,868		706,594
Net earnings, pro forma		99,441		286,447
Earnings per common share:
Basic, as reported	$	0.60	$	1.57
Diluted, as reported	$	0.59	$	1.56
Basic, pro forma	$	0.59	$	1.72
Diluted, pro forma	$	0.58	$	1.70

3. Stock Compensation:

The Company accounts for stock-based compensation in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended. Pursuant to SFAS 123, the Company continues to apply the provisions of Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees.” Under APB 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 certain option grants made during 2004, the exercise prices of options granted was below the market prices on the dates of grants. The following pro forma financial information reflects the application of SFAS 123’s fair value approach to recording stock compensation.

	Three Months Ended September 30,				Nine months Ended September 30,
	2005		2004		2005		2004
Net income, as reported	$	23,045	$	92,149	$	100,700	$	262,967
Add: Stock based employee compensation expense included in reported net income, net of tax effects		31		31		92		89
Deduct: Stock based employee compensation expense, net of tax effects		200		143		1,557		198
Pro forma net income	$	22,876	$	92,037	$	99,235	$	262,858
Basic earnings per share—as reported	$	0.14	$	0.55	$	0.60	$	1.57
Basic earnings per share—pro forma	$	0.13	$	0.55	$	0.59	$	1.57
Diluted earnings per share—as reported	$	0.14	$	0.55	$	0.59	$	1.56
Diluted earnings per share—pro forma	$	0.13	$	0.55	$	0.58	$	1.56

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

4. Investments:

Institutional Brokerage Trading Securities

Trading securities owned and trading account securities sold but not yet purchased consisted of securities at fair values as of September 30, 2005 and December 31, 2004:

	September 30, 2005				December 31, 2004
	Owned		Sold But Not Yet Purchased		Owned		Sold But Not Yet Purchased
Fixed income securities	$	1,395,729	$	155,899	$	2,658	$	3,102
Corporate equity securities		33,818		529		5,086		14,074
	$	1,429,547	$	156,428	$	7,744	$	17,176

In May 2005, the Company initiated certain fixed income trading activities primarily related to mortgage-backed, asset-backed and other structured securities, at its broker-dealer subsidiary Friedman, Billings, Ramsey and Co. (FBR & Co.). These activities include buying and selling mortgage-backed securities and other structured securities, in various financial transactions (which may include forward trades, dollar rolls and reverse repurchase transactions). The Company manages market risk associated with these securities positions primarily through forward purchases and sales of such securities. To accomplish this objective, the Company also may use U.S. Treasury securities, agency debt securities, Eurodollar futures and options to buy or sell agency debt and mortgage-related securities. To manage institutional credit risk, the Company analyzes and monitors the financial condition and trading positions of all counterparties and establishes trading limits consistent with these reviews.

Trading account securities sold but not yet purchased represent obligations of the Company to deliver the specified security at the contracted price, and thereby, create a liability to purchase the security in the market at prevailing prices. In general, the corporate equity obligations relate primarily to over-allotments associated with the Company’s underwriting activities. With respect to the securities sold but not yet purchased balance, the Company maintains an option to purchase additional shares from the issuer at the applicable offering price less the underwriter discount to cover these short positions for $-0- and $13,832, as of September 30, 2005 and December 31, 2004, respectively. Accordingly, these transactions when unrelated to over-allotments 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.

The weighted average coupon for fixed income trading securities owned and for fixed income securities sold but not yet purchased were 5.10% and 5.21%, respectively, as of September 30, 2005. The Company funds investments in such trading securities owned primarily with repurchase agreement borrowings (see Note 6). As of September 30, 2005, $1,313,587 of these securities were pledged as collateral for repurchase agreements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

Principal Investments

Mortgage-related and long-term investments consisted of the following as of the dates indicated:

	September 30, 2005		December 31, 2004
Mortgage-Related Investments:
Agency mortgage backed securities:
Fannie Mae	$	6,596,851	$	8,120,164
Freddie Mac		1,885,086		2,673,234
Ginnie Mae		370,710		525,236
		8,852,647		11,318,634
Private-label mortgage-backed securities (1)		416,015		408,055
Total mortgage-backed securities (2)		9,268,662		11,726,689
Mortgage Loans:
Loans held for investment, net		6,999,409		—
Loans held for sale, net		1,541,283		—
Total mortgage loans		8,540,692		—
Reverse repurchase agreements		488,113		183,375
Total mortgage-related investments		18,297,467		11,910,064
Long-term Investments
Merchant Banking:
Marketable equity securities		217,866		188,074
Non-public equity securities		76,550		158,478
Other		1,314		1,389
Preferred equity debt investment		5,000		5,000
Proprietary fund investments		47,129		70,434
Other investments		13,272		18,124
Total long-term investments		361,131		441,499
Total mortgage-related and long-term investments	$	18,658,598	$	12,351,563

⁽¹⁾ Private-label mortgage-backed securities held by the Company as of September 30, 2005 and December 31, 2004 were rated AAA by Standard & Poors.

⁽²⁾ The Company’s mortgage-backed securities portfolio is comprised of adjustable-rate MBS, substantially all of which are Hybrid ARM securities in which the coupon is fixed for three or five years before adjusting. The weighted-average coupon of the portfolio at September 30, 2005 and December 31, 2004 was 4.02% and 3.98%, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

Mortgage-Backed Securities and Long Term Investments

The Company’s investment securities consist primarily of mortgage-backed securities and equity investments in publicly traded companies. In accordance with SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” the securities are classified as either available-for-sale (carried at fair value with resulting unrealized gains and losses reflected as other comprehensive income and loss) or trading (carried at fair value with unrealized gains and losses recorded to net investment income). Gross unrealized gains and losses on these securities as of September 30, 2005 and December 31, 2004 were:

	September 30, 2005
	Amortized Cost/Cost Basis		Unrealized					Fair Value
			Gains		Losses
Mortgage-backed securities(1)– Available-for-sale	$	9,438,406	$	234	$	(169,978	)	$	9,268,662
Marketable equity securities – Available-for-sale		269,874		9,669		(61,677	)		217,866
	$	9,708,280	$	9,903	$	(231,655	)	$	9,486,528

⁽¹⁾ The amortized cost of MBS includes unamortized net premium of $142,965 at September 30, 2005.

	December 31, 2004
	Amortized Cost/Cost Basis		Unrealized					Fair Value
			Gains		Losses
Mortgage-backed securities – Available-for-sale	$	11,809,091	$	3,478	$	(85,880	)	$	11,726,689
Marketable equity securities – Available-for-sale		154,639		33,940		(505	)		188,074
	$	11,963,730	$	37,418	$	(86,385	)	$	11,914,763

The following table provides further information regarding the duration of unrealized losses on available-for-sale securities as of September 30, 2005:

	Continuous Unrealized Loss Position for
	Less Than 12 Months							12 Months or More
	Amortized Cost/Cost Basis		Unrealized Losses			Fair Value		Amortized Cost		Unrealized Losses			Fair Value
Mortgage-backed securities	$	6,169,992	$	(102,916	)	$	6,067,076	$	3,214,209	$	(67,062	)	$	3,147,147
Marketable equity securities		222,417		(61,677	)		160,740		—		—			—
Total	$	6,392,409	$	(164,593	)	$	6,227,816	$	3,214,209	$	(67,062	)	$	3,147,147

The unrealized losses on mortgage-backed securities are due to interest rate increases and are not related to credit quality. All of the mortgage-backed securities held by the Company with unrealized losses are either guaranteed as to principal and interest by Fannie Mae, Freddie Mac or Ginnie Mae or are rated AAA by Standard & Poors. The Company does not deem these investments to be other-than-temporarily impaired because the decline in market value is attributable to interest rate increases and because the Company has the intent and ability to hold these investments until a recovery of fair value occurs, which may be maturity. Additionally, there is a limited severity in the decline of value and substantially all of the Company’s mortgage-backed securities are adjustable rate Hybrid ARMs. These securities have interest reset dates, a substantial portion of which are within thirty-six months.

The Company has also evaluated its portfolio of marketable equity securities for impairment. For each of the securities in an unrealized loss position as of September 30, 2005, the Company reviewed the underlying causes for the impairments, as well as the severity and durations of the impairments. A significant portion of the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

unrealized losses relate to equity securities in the nonprime mortgage industry. Companies in this sector have been negatively affected during the three-months ended September 30, 2005, by various factors including, rising short-term interest rates and lower whole-loan premiums. Unrealized loss positions relating to such investments had not been significant prior to this period. The Company evaluated the near term prospects for each of the investments in unrealized loss positions in relation to the severity and duration of the impairment. Based on that evaluation the Company’s ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2005. We will continue to evaluate these investments at each reporting period end. If we determine at a future date that an impairment is other-than-temporary, the applicable unrealized loss will be reclassified from accumulated other comprehensive loss and recorded as a realized loss in the statement of operations at the time the determination is made.

During the three-months ended September 30, 2005, the Company received $218,237 from sales of mortgage-backed securities resulting in gross gains and losses of $-0- and $(812), respectively, and received $12,354 from sales of marketable equity securities resulting in gross gains and losses of $4,591 and $-0-, respectively. Included in mortgage-backed securities sold and the related gains and losses are $182,969 of mortgage-backed securities purchased and classified as trading during the three-months ended September 30, 2005. The Company recognized realized losses of $(722) on trading securities. During the three-months ended September 30, 2004, the Company received $1,419,986 from sales of mortgage-backed securities with gross gains and losses of $4,825 and $(2,983), respectively, and received $42,258 from sales of marketable equity securities with gross gains and losses of $13,194 and $-0-, respectively.

During the nine-months ended September 30, 2005, the Company received $1,061,360 from sales of mortgage-backed securities resulting in gross gains and losses of $704 and $(2,781), respectively, and received $52,970 from sales of marketable equity securities resulting in gross gains and losses of $19,523 and $(124), respectively. Included in MBS sold and the related gains and losses are $411,107 of MBS purchased and classified as trading during the nine-months ended September 30, 2005. The Company recognized realized losses of $(1,197) on trading securities. During the nine-months ended September 30, 2004, the Company received $1,673,765 from sales of mortgage-backed securities with gross gains and losses of $4,994 and $(3,820), respectively, and received $130,353 from sales of marketable equity securities with gross gains and losses of $66,785 and $-0-, respectively.

As of September 30, 2005, $9,032,263 of the mortgage-backed securities were pledged as collateral for repurchase agreements and commercial paper borrowings. In addition, $85,711 of principal and interest receivables related to the securities collateralizing commercial paper borrowings have also been pledged as collateral for those borrowings.

Mortgage Loans

Through First NLC and MHC I, the Company invests in non-conforming mortgage loans. Non-conforming mortgage loans include loans to borrowers who do not meet the conforming underwriting guidelines of Fannie Mae, Freddie Mac or Ginnie Mae because of higher loan-to-value ratios, the nature or absence of income documentation, limited credit histories, high levels of consumer debt, past credit difficulties or other factors. Non-conforming loans also include loans to more creditworthy borrowers where the size of the loan exceeds conforming underwriting guidelines.

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FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

Loans held for sale, net and loans held for investment, net were comprised of the following as of September 30, 2005:

	Held for Sale			Held for Investment
Principal balance	$	1,515,715		$	6,837,708
Deferred origination costs, net and unamortized premiums		26,169			167,729
Allowance for lower of cost or market value/ loan losses		(601	)		(6,028	)
Mortgage loans, net	$	1,541,283		$	6,999,409

The allowance for loan losses on loans held for investment is summarized as follows for the nine-months ended September 30, 2005:

Balance, beginning of period	$	—
Provision		6,028
Charge-offs, net		—
Allowance for loan losses	$	6,028

Mortgage loans 90 or more days past due totaled $59,485 as of September 30, 2005.

As of September 30, 2005, the Company had purchased mortgage insurance on $708,903 in principal balance of mortgage loans held for investment. The mortgage insurance policy insures the Company against certain losses on the covered loans, and assists the Company in reducing its credit risk by lowering the effective loan-to-value ratios on the applicable mortgage loans. The Company also manages credit risk by purchasing or originating loans at favorable loan to value ratios. Excluding the effects of Mortgage insurance, the weighted average loan to value ratio of loans held for sale as of September 30, 2005 was less that 82%.

Properties securing the mortgage loans in the Company’s portfolio are geographically dispersed throughout the United States. As of September 30, 2005, approximately 31%, 13%, 8% and 6% of the properties were located in California, Florida, Illinois and New York, respectively. The remaining properties securing the Company’s mortgage loan portfolio did not exceed 5% of the total portfolio in any other state.

The Company finances its mortgage loan portfolio through repurchase agreements and securitization financing transactions, which are described in Note 6. Substantially all of the mortgage loans held by the Company were pledged under such borrowings as of September 30, 2005.

Reverse Repurchase Agreements

Through Arlington Funding, LLC (Arlington Funding), a commercial paper conduit managed by the Company (see Note 6), the Company provides warehouse financing to mortgage originators. As of September 30, 2005, the outstanding balance of such financings was $320,752 and the weighted average coupon was 4.23%. The Company funds its advances through commercial paper borrowings.

In addition, in conjunction with its fixed income trading activity, the Company enters into reverse repurchase agreements with mortgage originators and other third parties that hold mortgage loans and mortgage securities. The outstanding balance of these transactions was $167,376 and the weighted average coupon was 3.62% as of September 30, 2005.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

5. Intangible Assets and Goodwill

The following table reflects the components of intangible assets as of the dates indicated:

	September 30, 2005			December 31, 2004
Management contracts:
Cost	$	19,929		$	19,929
Accumulated amortization		(6,469	)		(5,525	)
Net	$	13,460		$	14,404
Broker relationships:
Cost	$	16,500		$	—
Accumulated amortization		(2,080	)		—
Net	$	14,420		$	—
Intangible Assets, net	$	27,880		$	14,404

Estimated amortization expense for each of the next five years is as follows:

	Amount
Remaining 2005	$	1,146
2006		4,023
2007		3,563
2008		3,184
2009		2,871
2010		2,613

The carrying value of goodwill is $160,525 as of September 30, 2005, with $108,013 of this balance attributable to the Company’s merger with FBR Asset in 2003 and its principal investing segment. The remaining goodwill balance relates to the Company’s first quarter 2005 acquisition of First NLC that resulted in $52,512 of goodwill that is attributable to the mortgage banking segment (see Note 2 for further information).

6. Borrowings:

Commercial Paper and Repurchase Agreements

The Company issues commercial paper and enters into repurchase agreements to fund its investments in mortgage-backed securities, as well as its warehouse lending and fixed income trading activities. Commercial paper issuances are conducted through Georgetown Funding Company, LLC (Georgetown Funding) and Arlington Funding.

Georgetown Funding, formed in August 2003, is a special purpose Delaware limited liability company organized for the purpose of issuing extendable commercial paper notes collateralized by mortgage-backed securities and entering into reverse repurchase agreements with the Company and its affiliates. The Company serves as administrator for Georgetown Funding’s commercial paper program and all of Georgetown Funding’s transactions are conducted with FBR. Through the Company’s administration agreement and repurchase agreements, the Company is the primary beneficiary of Georgetown Funding and consolidates this entity for financial reporting purposes. The commercial paper notes issued by Georgetown Funding are rated A1+/P1 by Standard & Poor’s and Moody’s Investors Service, respectively. The Company’s Master Repurchase Agreement with Georgetown Funding enables the Company to finance up to $12,000,000 of mortgage-backed securities.

Arlington Funding, formed in October 2004, is a special purpose Delaware limited liability company organized for the purpose of issuing extendable commercial paper notes collateralized by non-conforming

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FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

mortgages and providing warehouse financing in the form of reverse repurchase agreements to the Company and its affiliates and to mortgage originators with which the Company has a relationship. The Company serves as administrator for Arlington Funding’s commercial paper program and provides collateral as well as guarantees for commercial paper issuances. As part of those guarantees, the Company has pledged $29,555 in cash to collateralize its obligation. Through these arrangements, the Company is the primary beneficiary of Arlington Funding and consolidates this entity for financial reporting purposes. The extendable commercial paper notes issued by Arlington Funding are rated A1+/P1 by Standard & Poor’s and Moody’s Investors Service, respectively. Our financing capacity through Arlington Funding is $5,000,000.

The Company also has short-term financing facilities that are structured as repurchase agreements with various financial institutions to fund its portfolio of mortgage loans. The interest rates under these agreements are based on LIBOR plus a spread that ranges between 0.60% to 1.50% based on the nature of the mortgage collateral.

The following tables provide information regarding the Company’s outstanding commercial paper, repurchase agreement borrowings, and mortgage financing facilities.

	September 30, 2005						December 31, 2004
	Commercial     Paper		Repurchase     Agreements		Short-Term Mortgage Financing Facilities (1)		Commercial     Paper		Repurchase     Agreements		Short-Term Mortgage Financing Facilities
Outstanding balance	$	8,214,835	$	2,791,905	$	4,061,401	$	7,294,949	$	3,467,569	$	—
Weighted-average rate		3.79%		3.79%		4.57%		2.38%		2.34%		—
Weighted-average term to maturity (1)		24.3 days		18.5 days		NA		28.3 days		39.8 days		NA

⁽¹⁾ Under these mortgage financing agreements, which expire or may be terminated by the Company or the counterparty within one year, the Company may finance mortgage loans for up to 180 days. The interest rates on these borrowings reset daily.

	September 30, 2005						September 30, 2004
	Commercial     Paper		Repurchase     Agreements		Short-Term Mortgage Financing Facilities		Commercial     Paper		Repurchase     Agreements		Short-Term Mortgage Financing Facilities
Weighted-average outstanding balance during the three months ended	$	8,300,373	$	2,014,444	$	3,661,232	$	4,775,182	$	6,310,166	$	—
Weighted-average rate during the three months ended		3.55%		3.50%		4.29%		1.56%		1.52%		—
Weighted-average outstanding balance during the nine months ended	$	7,836,804	$	2,997,247	$	1,923,132	$	4,659,973	$	5,762,767	$	—
Weighted-average rate during the nine months ended		3.08%		2.93%		4.15%		1.27%		1.29%		—

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

Securitization Financing

From time to time, the Company issues asset-backed securities through securitization trusts to finance a portion of the Company’s portfolio of loans held for investment. The asset-backed securities are secured solely by the mortgages transferred to the trust and are non-recourse to the Company. The principal and interest payments on the mortgages provide the funds to pay debt service on the securities. This securitization activity is accounted for as a financing since the securitization trusts do not meet the qualifying special purpose entity criteria under SFAS No. 140 and because the Company maintains continuing involvement in the securitized mortgages through its ownership of certain interests issued by the trust. As of September 30, 2005, the Company has issued $3,910,563 of asset-backed securities.

Interest rates on these securities reset monthly and are indexed to one-month LIBOR. The weighted average interest rate payable on the securities was 4.22% as of September 30, 2005. Although the stated maturities for each of these securities are 30 years, the Company expects the securities to be fully repaid prior due to borrower prepayments.

As of September 30, 2005, the outstanding balance of the securities was as follows:

Security balance	$	3,811,351
Discount on bonds, net		(1,450	)
Balance of securitization financing, net	$	3,809,901
Current balance of loans collateralizing the securities	$	4,019,887

In addition to the discount, which represents the difference between the sales price of the securities and the face amount, the Company has deferred the costs incurred to issue the securities. These costs totaled $8,648 as of September 30, 2005 and are included in prepaid expenses and other assets in the Consolidated Balance Sheets. The discount and deferred costs are amortized as a component of interest expense over the life of the debt.

See also Note 7 for information regarding the effects of derivative instruments on the Company’s borrowing costs.

Temporary Subordinated Loan

In September 2005, the Company through FBR & Co. obtained a $100,000 temporary subordinated loan from a subsidiary of its clearing broker. Proceeds of this borrowing are allowable for net capital purposes and were used by the Company in connection with regulatory capital requirements to support underwriting activity. Interest on this loan accrued at an annual rate of three-month LIBOR plus 4%. The loan was repaid in October 2005.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

Long Term Debt

As of September 30, 2005, the Company had issued a total of $277,500 of long term debentures through TRS Holdings. The long-term debentures accrue and require payments of interest quarterly at an annual rate of three- month LIBOR plus 2.25% to 3.25%. The weighted average interest rate on these long term debentures was 6.14% as of September 30, 2005. During the nine months ended September 30, 2005, the Company had issued the following long-term debentures:

Issuance Date	Amount		Interest Rate	Maturity Date	Redemption Date (1)
March 2005	$	25,000	3-month LIBOR plus 2.25%	March 30, 2035	March 30, 2010
April 2005	$	20,000	3-month LIBOR plus 2.25%	June 15, 2035	June 15, 2010
April 2005	$	20,000	3-month LIBOR plus 2.25%	July 7, 2035	July 7, 2010
May 2005	$	30,000	3-month LIBOR plus 2.50%	June 30, 2035	June 30, 2010
August 2005	$	35,000	3-month LIBOR plus 2.30%	August 15, 2035	August 15, 2010
August 2005	$	25,000	3-month LIBOR plus 2.50%	October 30, 2035	October 30, 2010

⁽¹⁾ Redemption Date represents the date after which the Company may redeem the securities in whole at any time or in part from time to time at a redemption amount equal to the principal amount thereof plus accrued interest.

7. Derivative Financial Instruments and Hedging Activities:

In the normal course of its operations, the Company is a party to financial instruments that are accounted for as derivative financial instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and for Hedging Activities,” as amended. These instruments include interest rate swaps and caps, credit default swaps, Eurodollar futures contracts, borrower interest rate lock agreements, commitments to purchase and sell mortgage loans and mortgaged-backed securities, and warrants to purchase common stock.

Derivative Instruments

The Company utilizes derivative financial instruments to hedge the interest rate risk associated with its short- and long-term borrowings. The Company also uses derivatives to economically hedge certain positions in mortgage-backed securities and mortgage loans. The counterparties to these instruments are U.S. financial institutions. Under the interest rate swap agreements, the Company receives a floating rate based on three-month LIBOR and pays a fixed rate. With interest rate caps, in exchange for a fee paid at inception of the agreement, the Company receives a floating rate based on one-month LIBOR whenever one-month LIBOR exceeds a specified rate (the “strike” rate). Under its credit derivative agreements, the Company is required to make payments based on a fixed interest rate and receives payments that float based on specified credit events. Eurodollar futures contracts are a proxy for the forward AA/AAA LIBOR-based credit curve and allow the Company the ability to lock in three-month LIBOR forward rates for its short term borrowings based on the maturity dates of the contracts. The following table summarizes the Company’s derivative positions as of September 30, 2005 and December 31, 2004:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

	September 30, 2005					December 31, 2004
	Notional Amount		Fair Value			Notional Amount		Fair Value
Cash flow hedges:
Interest rate swap agreements (1)	$	—	$	—		$	1,000,000	$	7,133
Interest rate cap agreements (2)		1,819,021		149			—		—
Eurodollar futures contracts (3)		9,424,000		6,040			500,000		897
Eurodollar future put option contracts (4)		22,350,000		20,004
No hedge designation (5)		1,000,000		(1,940	)		—		—

⁽¹⁾ Interest rate swap expired July 28, 2005

⁽²⁾ Comprised of two interest rate caps which mature on August 25, 2008 and October 28, 2005. The notional amounts of the caps amortize over the life of the agreements. The strike rates also vary over the life of the agreements between 6.30% and 10.50%.

⁽³⁾ The $9,424,000 total notional amount of Eurodollar futures contracts as of September 30, 2005 represents the accumulation of Eurodollar futures contracts that mature on a quarterly basis between December 2005 and September 2008 and hedge short term borrowings of between $1,300,000 and $150,000.

⁽⁴⁾ The $22,350,000 total notional amount of Eurodollar future put option contracts as of September 30, 2005, represents the accumulation of Eurodollar future put option contracts that mature on a quarterly basis between December 2005 and March 2007 and hedge short-term borrowings of between $5,240,000 and $750,000.

⁽⁵⁾ Comprised of two credit default swaps with maturities in July 2034 and November 2035, two interest rate caps maturing September 2010, and Eurodollar futures contracts with varying maturities in 2005 and 2006. The total notional amounts associated with the credit defaults swaps, interest rate caps, and Eurodollar futures contracts are $895,000, $-0-, and $105,000, respectively. The fair values totaled $(2,095), $152, and $3, respectively.

When hedging the variability in interest payments associated with the Company’s borrowing activities, the notional amount of each interest rate swap, cap agreement, Eurodollar futures contract, and Eurodollar future put option contract is matched against a like amount of current and/or anticipated borrowings under repurchase agreements, commercial paper or the Company’s variable securitization financings. These instruments are highly effective hedges and qualify as cash flow hedges under SFAS 133. Accordingly, changes in the fair value of these derivatives are reported in other comprehensive income to the extent the hedge was effective, while changes in value attributable to hedge ineffectiveness are reported in earnings. 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 the earnings are affected by the hedged cash flows.

The Company also uses various derivative instruments to economically hedge certain mortgage-backed security and mortgage loan positions. Eurodollar futures contracts are primarily used to hedge the fair value of certain mortgage-backed security positions, which are comprised of mortgage-backed securities classified as trading and commitments to purchase such mortgage-backed securities. Credit derivatives are used to hedge the risk of adverse changes to credit spreads on prospective securitization financing transactions. The Company does not designate these derivative instruments, as well as, certain interest rate caps as hedges under SFAS 133. The gains and losses on these derivatives are recorded to net investment income. For the three- and nine-months ended September 30, 2005, the Company recorded a net gain of $351 and $791 on these derivatives.

The net effect of the Company’s hedging of the variability in interest payments was to decrease interest expense by $1,133 and $8,474 for the three- and nine-months ended September 30, 2005. These hedging activities increased interest expense by $876 and $(6,187) during the same periods in 2004. The total net gain deferred in accumulated other comprehensive income relating to these derivatives was $11,777 at September 30, 2005. Of this amount, $6,199 is expected to flow through the Company’s statement of operations over the next twelve months.

21

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

Commitments

The Company enters into commitments to (i) originate mortgage loans (referred to as interest rate lock agreements), (ii) purchase and sell mortgage loans, and (iii) purchase and sell MBS. Interest rate locks related to the origination of loans held for sale and commitments to purchase and sell mortgage loans are accounted for as derivatives under SFAS 133. Outstanding interest rate locks totaled $448,136 as of September 30, 2005. There were no outstanding commitments to purchase mortgage loans, or purchase or sell mortgage-backed securities at September 30, 2005. There was a commitment to sell $410,000 of mortgage loans at September 30, 2005. The Company had no commitments to originate, purchase or sell loans prior to its acquisition of First NLC in the first quarter of 2005. Gains and losses on these derivatives were not material during the three months and nine months ended September 30, 2005.

Gains and losses on commitments that are net settled and optional commitments are recorded to income. During the three months and nine months ended September 30, 2004, net losses on these commitments totaled $(788) and $(638), respectively. There was no such commitment activity during the first nine months of 2005.

Stock Warrants

In connection with its capital raising activities, the Company may receive warrants to acquire equity securities. These instruments are accounted for as derivatives with changes in the fair value recorded to net investment income under SFAS 133. During the three and nine months ended September 30, 2005 the Company recorded a net gains of $727 and $467, respectively. During the same periods in 2004, the Company recorded net gains of $4,380 and $5,513 respectively, related to these instruments. As of September 30, 2005, the Company held stock warrants with a fair value of $2,484. Furthermore, during the three months and nine months ended September 30, 2005, the company exercised warrants and sold the resulting stock realizing a gain/(loss) of $(2) and $287, respectively.

8. Income Taxes:

In connection with the Company’s merger with FBR Asset effective March 31, 2003, the parent company, FBR Group elected REIT status under the Internal Revenue Code. As a REIT, FBR Group is not subject to Federal income tax on earnings distributed to its shareholders. Most states recognize REIT status as well. Since FBR Group intends to distribute 100% of its REIT taxable income to shareholders, the Company has recognized no income tax expense on its REIT income.

To maintain tax qualification as a REIT, FBR Group must meet certain income and asset tests and distribution requirements. The REIT must distribute to shareholders at least 90% of its (parent company) taxable income. A predominance of the REIT’s gross income must come from real estate sources and other portfolio-type income. A significant portion of the REIT’s assets must consist of real estate and similar portfolio investments, including mortgage-backed securities. Beginning in 2001, the tax law changed to allow REITs to hold a certain percentage of their assets in taxable REIT subsidiaries. The income generated from the Company’s taxable REIT subsidiaries is taxed at normal corporate rates and will generally not be distributed to the Company’s shareholders. Failure to maintain REIT qualification would subject FBR Group to Federal and state corporate income taxes at regular corporate rates.

During the three- and nine-months ended September 30, 2005, the Company recorded $8,090 and $26,825, respectively, of income tax expense for income attributable to taxable REIT subsidiaries. The Company’s effective tax rate at its taxable REIT subsidiaries for taxable income attributable these entities was 43% for the three and 46% for the nine months ended September 30, 2005. During the three- and nine-months ended September 30, 2004, the Company recorded $20,329 and $36,129, respectively, of income tax expense for

22

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

taxable income attributable to its taxable REIT subsidiaries. The Company’s effective tax rate applicable to this 2004 income was 39%. The increase in the effective tax rates in the three-months ended September 30, 2005 is due to an increase in the Company’s state taxes due to changes in state apportionment and the increase the effective tax rate for the nine months ended September 30, 2005 is due primarily to the to the non-deductible nature of the $7,500 charge recorded in the first quarter 2005 relating to the Company’s proposed settlements with the Securities and Exchange Commission (SEC) and the NASD’s Department of Market Regulation (see Note 11) and state taxes. The decrease in the dollar amounts of the tax provisions during the three- and nine-month periods ended September 30, 2005 is due to the decline in earnings attributable to the Company’s taxable REIT subsidiaries.

9. Net Capital Requirements:

The Company’s U.S. broker-dealer subsidiaries, FBR & Co. and FBR Investment Services, Inc. (FBRIS), are registered with the Securities and Exchange Commission (SEC) and are members of the National Association of Securities Dealers, Inc. Additionally, Friedman, Billings, Ramsey International Ltd. (FBRIL) is registered with the Financial Services Authority (FSA) of the United Kingdom. As such, they are subject to the minimum net capital requirements promulgated by the SEC and FSA. As of September 30, 2005, FBR & Co. had net capital of $90,664 that was $84,609 in excess of its required minimum net capital of $6,055. As of September 30, 2005, FBRIS and FBRIL had net capital in excess of required amounts.

10. Earnings Per Share:

The following tables present the computations of basic and diluted earnings per share for the three and nine months ended September 30, 2005 and 2004:

	Three Months Ended September 30, 2005				Three Months Ended September 30, 2004
	Basic		Diluted		Basic		Diluted
Weighted average shares outstanding:
Common stock		169,745		169,745		167,593		167,593
Stock options and restricted stock		—		745		—		1,207
Weighted average common and common equivalent shares outstanding		169,745		170,490		167,593		168,800
Net earnings applicable to common stock	$	23,045	$	23,045	$	92,149	$	92,149
Earnings per common share	$	0.14	$	0.14	$	0.55	$	0.55

	Nine months Ended September 30, 2005				Nine months Ended September 30, 2004
	Basic		Diluted		Basic		Diluted
Weighted average shares outstanding:
Common stock		169,166		169,166		166,975		166,975
Stock options and restricted stock		—		956		—		1,525
Weighted average common and common equivalent shares outstanding		169,166		170,122		166,975		168,500
Net earnings applicable to common stock	$	100,700	$	100,700	$	262,967	$	262,967
Earnings per common share	$	0.60	$	0.59	$	1.57	$	1.56

23

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

As of September 30, 2005 and 2004, respectively, 3,915,313 and 4,031,675 options to purchase shares of common stock were outstanding (both including shares associated with the Employee Stock Purchase and Loan Plan that are treated as options). As of September 30, 2005 and 2004, respectively, 2,428,133 and 3,174,175 of the total outstanding options were exercisable and 2,855,006 and 2,632,300 were anti-dilutive. In addition, the 2,047,930 restricted common shares granted to employees (see Note 12) are also included in the calculation of weighted average common equivalent diluted shares outstanding for the three- and nine-months ended September 30, 2005.

11. Commitments and Contingencies:

Contractual Obligations

The Company has contractual obligations to make future payments in connection with short and long-term debt, non-cancelable lease agreements and other contractual commitments as well as uncalled capital commitments to various investment partnerships that may be called over the next six years. The following table sets forth these contractual obligations by fiscal year:

	Remaining 2005		2006		2007		2008		2009		Thereafter		Total
Long-term debt (1)	$	—	$	970	$	970	$	970	$	970	$	280,048	$	283,928
Minimum rental and other contractual commitments		3,955		17,303		12,812		12,662		11,999		54,921		113,652
Capital commitments (2)		—		—		—		—		—		—		—
Total Contractual Obligations	$	3,955	$	18,273	$	13,782	$	13,632	$	12,969	$	334,969	$	397,580

⁽¹⁾ This table excludes interest payments to be made on the Company’s long-term debt securities issued through TRS Holdings. The Company will incur $4,599 in interest related to these long-term debt securities in the fourth quarter of 2005. Based on the 3-month LIBOR of 4.07% as of September 30, 2005, plus a weighted average margin of 2.58%, estimated annualized interest on the current outstanding principal of $277,500 of long-term debt securities would be approximately $18,500 for the year ending December 31, 2006. These long-term debt securities mature in thirty years beginning in March 2033 through October 2035. Note that interest on this long-term debt floats based on 3-month LIBOR, therefore, actual coupon interest will differ from this estimate.

⁽²⁾ The table above excludes $6,746 of uncalled capital commitments to various investment partnerships that may be called over the next ten years. This amount was excluded because the Company cannot determine when, if ever, the commitments will be called.

The Company also has short-term commercial paper and repurchase agreement liabilities of $8,214,835 and $6,853,306, respectively, as of September 30, 2005, as well as $3,809,901 of securitization financing that matures in 2035. See Note 6 for further information.

As of September 30, 2005, the Company had made interest rate lock agreements with mortgage borrowers and commitments to sell mortgage loans of $448,136 and $410,000, respectively.

24

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

Repurchase and Premium Recapture Obligations

The Company’s sales of mortgage loans are subject to standard mortgage industry representations and warranties that may require the Company to repurchase the mortgage loans due to breaches of these representations and warranties or if a borrower fails to make one or more of the first loan payments due on the loan. In addition, the Company is generally obligated to repay all or a portion of the original premium received on the sale of loans in the event that the loans are paid in full by the borrowers during the first year subsequent to the sale date. Generally, the gross contingent liability declines by one-twelfth each month over the twelve month period the contingency exists subsequent to the sale date. The Company maintains a liability reserve for its repurchase and premium recapture obligations. The reserve is increased through charges to the gain (or loss) recorded at the time of sale. The reserve is reduced by charge-offs when loans are repurchased or premiums are repaid. Activity for the reserve was as follows during the period since the Company’s acquisition of First NLC through September 30, 2005 (the Company did not maintain a reserve for repurchase and premium recapture obligations prior to the acquisition of First NLC):

	Total Reserve
Balance at acquisition of First NLC	$	8,238
Provision		6,724
Charge-offs		(5,484	)
Balance, at September 30, 2005	$	9,478

The Company’s exposure to repurchase and premium recapture obligations relates primarily to mortgage loans sold over the last three months which totaled $1,331,801. The total gross premium received by First NLC on mortgage loan sales over the last 12 months totaled $117,159. As noted above, the Company’s exposure to premium recapture generally declines by one-twelfth each month after the sale date.

Litigation

As of September 30, 2005, except as described below, the Company was not a defendant or plaintiff in any lawsuits or arbitrations, nor involved in any governmental or self-regulatory organization (SRO) matters 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. In addition, the Company is subject to various reviews, examinations, investigations and other inquiries by governmental agencies and SROs. 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 and actions by government agencies and SROs 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

25

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

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.

The Company’s business (through its recently acquired subsidiary First NLC and affiliated entities) includes the origination, acquisition, pooling, securitization and sale of non-conforming residential mortgage loans. Consequently, the Company is subject to additional federal and state laws in this area of operation, including laws relating to lending, consumer protection, privacy and unfair trade practices. Although the Company is not currently involved in any legal proceedings incidental to these operations, it may become so in the future in the normal course of business.

Putative Class Action Securities Lawsuits

The Company and certain current and former senior officers and directors have been named in a series of putative class action securities lawsuits filed in the second quarter of 2005, all of which are pending in the United States District Court for the Southern District of New York. The Company refers to these lawsuits as the Weiss et al. putative class action lawsuits. The complaints in these actions are brought under various sections of the Securities Exchange Act of 1934, as amended, and allege misstatements and omissions concerning (i) the SEC and NASD investigations described at page 48 relating to FBR & Co.’s involvement in the private investment in public equity on behalf of CompuDyne, Inc. in October 2001 and (ii) the Company’s expected earnings, including the potential adverse impact on the Company of changes in interest rates. The Company is contesting these lawsuits vigorously, but the Company cannot predict the likely outcome of these lawsuits or their likely impact on the Company at this time.

Shareholders’ Derivative Action

The Company and certain current and former senior officers and directors have been named in a shareholders’ derivative action that is presently pending in the United States District Court for the Southern District of New York. The Company, which is a nominal defendant in this action, refers to this derivative action as the Lemon Bay Partners derivative action. The complaint alleges conduct substantially similar to that alleged in the Weiss et al. putative class action lawsuits described above. The Company has not responded to the complaint and no discovery has commenced. The Company cannot predict the likely outcome of this action or its likely impact on the Company at this time. The Company’s Board of Directors has established a special committee comprised of two independent directors to evaluate shareholder demand letters which contain allegations similar to the Lemon Bay Partners derivative action and to recommend to the Board of Directors whether such a derivative action is in the best interests of the Company.

Regulatory Charges and Related Matters

On April 26, 2005, the Company announced that its broker-dealer subsidiary, FBR & Co. proposed settlement to the staffs of the SEC and the NASD’s Department of Market Regulation to resolve ongoing, previously disclosed investigations by the SEC and NASD staffs. The proposed settlement concerns insider trading, violations of antifraud provisions of the federal securities laws and applicable NASD rules and other charges concerning the Company’s trading in a company account and the offering of a private investment in public equity on behalf of a public company in October 2001.

In the settlement offers, without admitting or denying any wrongdoing, FBR & Co. proposed to pay $3,500 to the SEC and $4,000 to the NASD and consent to injunctions, censure and additional undertakings to improve its administrative and compliance procedures.

26

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

The proposed settlement is subject to review and approval by the SEC and the NASD, respectively, which may accept, reject or impose further conditions or other modifications to some or all of the terms of the proposed settlements. There are no assurances regarding the SEC’s and NASD’s consideration or determination of any offer of settlement, and no settlement is final unless and until approved by the SEC or NASD, as applicable. The Company has recorded a $7,500 charge, in March 2005, with respect to the proposed settlements with the SEC and NASD.

Incentive Fees

The Company recognizes incentive income from the partnerships based on what would be due to the Company if the partnership terminated on the balance sheet date. Incentive allocations may be based on unrealized gains and losses, and could vary significantly based on the ultimate realization of the gains or losses. We may therefore reverse previously recorded incentive allocations in future periods relating to the Company’s managed partnerships. As of September 30, 2005, $2,979 was subject to such potential future reversal.

12. Shareholders’ Equity:

Dividends

The Company declared the following distributions during the nine months ended September 30, 2005 and year ended December 31, 2004:

Declaration Date	Record Date	Payment Date	Dividends Per Share
2005
September 13, 2005	September 30, 2005	October 31, 2005	$	0.34
June 9, 2005	June 30, 2005	July 29, 2005	$	0.34
March 17, 2005	March 31, 2005	April 29, 2005	$	0.34
2004
December 9, 2004	December 31, 2004	January 28, 2005	$	0.39	(1)
September 9, 2004	September 30, 2004	October 29, 2004	$	0.34
June 10, 2004	June 30, 2004	July 30, 2004	$	0.46	(2)
March 10, 2004	March 31, 2004	April 30, 2004	$	0.34

⁽¹⁾ Includes a special dividend of $0.05 per share.

⁽²⁾ Includes a special dividend of $0.12 per share.

Restricted Stock

During the nine-months ended September 30, 2005, the Company granted 684,156 shares of restricted Class A common stock to employees for incentive compensation earned during 2004 and 2005, and 1,349,263 additional shares of restricted Class A common stock under the Company’s Stock and Annual Incentive Plans, including 239,323 shares issued in connection with the acquisition of First NLC. As of September 30, 2005, a total of 2,047,930 shares of restricted Class A common stock with an unamortized value of $20,295 is included in deferred compensation in shareholders’ equity.

Employee Stock Purchase and Loan Plan

In connection with the Employee Stock Purchase and Loan Plan, in July and August 2001, the Company issued stock and received five-year, limited recourse promissory notes from employees with interest accruing at 6.5 percent accreting to principal for the remaining purchase price. The notes are collateralized by the shares of

27

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

stock purchased under the plan. As of September 30, 2005 and December 31, 2004, the balance outstanding on these loans was $4,242 and $4,890, respectively. During the three- and nine-months ended September 30, 2005, $132 and $417, respectively, of compensation expense was recorded for dividends paid on the shares purchased with proceeds from the notes.

13. Segment Information:

The Company considers its capital markets, asset management, principal investing, and mortgage banking operations to be four separately reportable segments. The capital markets segment includes the Company’s investment banking and institutional brokerage operations. Asset management includes the Company’s fee based asset management operations. The Company’s principal investing segment includes mortgage related investment activities, and substantially all of the Company’s equity security investing activities. The Company’s mortgage banking segment includes the origination and sale of mortgage loans for residential properties. The Company has developed systems and methodologies to allocate overhead costs to its business units and, accordingly, presents segment information consistent with internal management reporting. Revenue generating transactions between the individual segments have been included in the net revenue and pre-tax income of each segment. These transactions include investment banking activities provided by the capital markets segment to other segments and the sale of mortgage loans between the mortgage banking and principal investing segments. The following table illustrates the financial information for the Company’s segments for the periods presented:

	Capital Markets		Asset Management		Principal Investing		Mortgage Banking		Intersegment Eliminations(1)			Consolidated Totals
Three Months Ended September 30, 2005
Net revenues	$	123,218	$	9,625	$	23,579	$	28,873	$	(6,657	)	$	178,638
Pre-tax income		21,790		77		12,873		3,052		(6,657	)		31,135
Three Months Ended September 30, 2004
Net revenues	$	165,181	$	10,482	$	67,992	$	—	$	—		$	243,655
Pre-tax income		53,315		1,704		57,459		—		—			112,478
Nine months Ended September 30, 2005
Net revenues	$	371,152	$	28,772	$	100,546	$	63,717	$	(15,375	)	$	548,812
Pre-tax income		62,017		192		76,109		4,582		(15,375	)		127,525
Nine months Ended September 30, 2004
Net revenues	$	381,729	$	27,701	$	233,384	$	—	$	—		$	642,814
Pre-tax income		93,081		2,644		203,371		—		—			299,096

⁽¹⁾ Intersegment Eliminations represent the elimination of intersegment transactions noted above.

14. Accounting Developments:

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R requires public companies to recognize expense in the income statement for the grant-date fair value of awards of equity instruments to employees. Expense is to be recognized over the period during which employees are required to provide service. SFAS 123R also clarifies and expands certain guidance in SFAS 123, including measuring fair value and attributing compensation cost to reporting periods. Under the modified prospective transition method the Company expects to apply, compensation cost is recognized after the date of adoption for the portion of outstanding awards granted prior to the adoption of SFAS 123 for which service has not yet been rendered. In April 2005, the SEC amended the effective date of SFAS 123R to be effective for annual periods that begin after September 15, 2005. We are currently evaluating the effect of adoption of SFAS 123R, but do not expect adoption to have a material effect on our results of operations and financial condition.

28

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (Continued)

15. Subsequent Event:

Securitization Financing

In November 2005, the Company issued $1,000,000 of additional asset-backed securities through a securitization trust to finance loans held for investment. The asset-backed securities are secured solely by the mortgages transferred to the trust and are non-recourse to the Company. The principal and interest payments of the mortgages provide the funds to pay debt service on the securities. The securitization will be accounted for as a financing since the securitization trust does not meet the qualifying special purpose entity criteria under SFAS No. 140 and because the Company maintains continuing involvement in the securitized mortgages through its ownership of certain interests issued by the trust.

Interest rates on these securities reset monthly and are indexed to one-month LIBOR. The stated maturity date of the securities is November 2035, although the Company expects the securities to be fully repaid prior to that date due to borrower prepayments.

29

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following analysis of the consolidated financial condition and results of operations of Friedman, Billings, Ramsey Group, Inc. (the “Company”) should be read in conjunction with the unaudited Consolidated Financial Statements as of September 30, 2005 and 2004, and the Notes thereto and the Company’s 2004 Annual Report on Form 10-K.

Business Environment

Our revenues consist primarily of capital raising revenue and advisory fees in investment banking; agency commissions, principal transactions, and mortgage trading income in institutional brokerage; base management fees and incentive allocations and fees in asset management; and net interest income, net investment income, including realized gains from merchant banking investments and mortgage loans, equity method earnings, and dividend income in principal investing and mortgage banking.

The majority of our principal investing is in mortgage related investments, particularly mortgage loans and mortgage-backed securities (MBS), but we also invest in merchant banking opportunities, including equity securities, mezzanine debt and senior loans, including non-real estate related assets, subject to maintaining our REIT status. As a result of our acquisition of First NLC in February 2005, we have initiated various mortgage-banking activities.

We constantly evaluate the rates of return that can be achieved in each investment category and for each individual investment in which we participate. Historically, our mortgage investments have provided us with higher risk adjusted rates of return than most other investment opportunities we have evaluated. Although increases in short-term rates over the past year have reduced the rate of return on our mortgage investments, we have continued to maintain a high allocation of our assets and capital in this sector. There is no assurance that our past experience will be indicative of future results and that mortgage investments will provide higher rates of return than other investment altrnatives. Consequently, we continue to evaluate investment opportunities against the returns available in each of our investment alternatives and endeavor to allocate our assets and capital with an emphasis toward the highest risk-adjusted returns available. This strategy will cause us to have different allocations of capital in different environments.

Our investment banking (capital raising, merger and acquisition, restructuring, and advisory services), institutional brokerage and asset management revenues are linked to the capital markets business activities. In addition, our business activities are focused in the financial services, real estate, energy, technology, 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. As a result, revenues can be subject to significant volatility from period to period.

Our investment banking and asset management 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 the industry 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. 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. Similarly, investment banking activities and our market share are subject to significant market risk.

30

In order to profit 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. We believe that it is important to diversify and strengthen our revenue base by increasing the segments of our business that offer a recurring and more predictable source of revenue.

Trends

The principal external factor affecting our mortgage investments is interest rates.

Short-term interest rates have been increasing and may continue to increase. Over the last twelve months, the Federal Reserve has increased the Federal Funds rate eight times, from 1.75% at September 30, 2004 to 3.75% at September 30, 2005, and it is unknown for how much longer and in what amount, if any, the Federal Reserve will continue to increase such rates. This increase in short-term interest rates has also caused LIBOR, the interest rate that is the basis for most of our funding costs, to increase by a similar amount. Because the financing arrangements we have for our mortgage assets, including securitization financing for loans held for investment, are floating-rate and adjust periodically, the interest expense on this funding increases directly as LIBOR increases. It is possible to mitigate some of the increase in short-term rates by hedging with derivative instruments such as interest-rate cap, swaps, or futures. As of September 30, 2005, we have entered into various derivative instruments to partially hedge the interest rate risk on our borrowings (see Note 7 to the financial statements for detail).

At the same time that short-term interest rates have risen, long-term interest rates have been relatively stable, with ten-year Treasury yields only increasing 0.20% from September 30, 2004 to September 30, 2005. This environment has led to the continuation of refinancing opportunities for mortgage borrowers and, thus, higher than historical prepayment speeds. Higher prepayment speeds cause us to amortize any premium (the amount paid in excess of par for the asset) we have in our mortgage portfolio at a faster rate thus reducing our reported net interest yield. These higher prepayment speeds may persist causing our yield in the mortgage portfolio to be lower than anticipated.

The increase in interest rates and, in particular, the increase in the two-year LIBOR swap rate from September 30, 2004 to September 30, 2005 of 1.63% has not been accompanied by a comparable increase in coupons for non-conforming mortgage loans. Coupons on newly originated non-conforming loans have, in general, increased by less than half of the increase in the two-year swap rate over this period. The resulting compression in spread between these assets and related liabilities has resulted in lower profitability for non-conforming mortgage assets that are either held in portfolio or that are sold for cash. It is not known when or if coupons will fully adjust to reflect the higher cost of funds for these mortgage assets.

Results of Operations

Three months ended September 30, 2005 compared to three months ended September 30, 2004

Net income decreased from $92.1 million during the third quarter of 2004 to $23.0 million during the third quarter of 2005. This decrease is primarily due to decreased investment banking revenues of $52.6 million and a decrease in net interest income in our principal investing activities as a result of increased borrowing costs and increased non-interest expenses of $16.3 million. These decreases and increases were offset, to some degree, by gains on sale of mortgage loans and net interest income resulting from the initiation of mortgage banking activities. Regarding non-interest expenses, the Company continues to make investments in its operations and technology infrastructure in order to address the increase in employees and support growth initiatives. During the first quarter 2005, the Company completed the acquisition of First NLC a non-conforming mortgage originator (see further detail regarding First NLC in the discussion of the Company’s results of operations for the nine months ended September 30, 2005). Third quarter 2005 results reflect increased professional services, occupancy and equipment, communication, and other expenses due to the increase in employees and related facilities as a result of the acquisition. Third quarter 2005 net income also includes $8.1 million of income tax expenses as compared to $20.3 million of income taxes recorded in the third quarter of 2004.

The Company’s net revenues decreased 26.7% from $243.7 million in 2004 to $178.6 million in 2005 due to the following changes in revenues and interest expense:

Capital raising revenue decreased 33.8% from $130.0 million in 2004 to $86.0 million in 2005. The decrease is attributable to fewer lead or co-managed transactions completed in 2005 as compared to 2004. During

31

Results of Operations—(Continued)

the third quarter of 2005, the Company managed 11 public equity offerings raising $4.8 billion. During the third quarter of 2004, the Company managed 19 public equity/debt offerings raising $3.2 billion. The average size of underwritten equity/debt transactions for which we were a lead or co-manager increased from $168.4 million in 2004 to $436.4 million in 2005. The company also managed 9 asset-backed security offerings during the third quarter of 2005 totaling $7.6 billion in transaction volume. In addition, the Company completed four private equity placements in during the third quarter 2005 generating $56.8 million in revenues compared to two private equity placements in 2004 generating $64 million.

Advisory revenue decreased 74.1% from $11.6 million in 2004 to $3.0 million in 2005 due primarily to a decrease in the number of advisory engagements.

Institutional brokerage revenue from principal transactions increased 2.4% from $4.2 million in 2004 to $4.3 million in 2005 as a result of increases in both trading gains and trading volume. Institutional brokerage agency commissions increased 10.3% from $18.5 million in 2004 to $20.4 million in 2005 as a result of increases in trading volume. In addition, the Company’s mortgage trading operations contributed $11.3 million in interest income to institutional brokerage activity. The mortgage trading interest income was offset by a net investment loss of $2.4 million related to these securities and $8.2 million of interest expense related to repurchase agreements used to finance these trading activities.

Asset management base management fees increased 12.9% from $7.0 million in 2004 to $7.9 million in 2005. The increase is primarily attributable to the increase in average productive assets under management in 2005 as compared to 2004, as well as an increase in mutual fund administrative fees. Asset management incentive allocations and fees decreased 52.9% from $1.7 million in 2004 to $0.8 million in 2005 primarily as a result of fund performance during the period and the reversal of incentive allocations from certain investment partnerships.

Revenues from our principal investment and mortgage banking activities, net of related interest expense and provision for loan losses, totaled $57.7 million for the third quarter of 2005 compared to $71.7 million for the third quarter of 2004. A primary source of these revenues is net interest income from mortgage investments, the components of which are summarized in the following table (dollars in thousands).

	Three Months Ended September 30, 2005							Three Months Ended September 30, 2004
	Average Balance		Income / (Expense)			Yield / Cost		Average Balance		Income / (Expense)			Yield / Cost
Mortgage-backed securities	$	9,783,015	$	77,102		3.15	%	$	11,501,189	$	86,116		3.00	%
Mortgage loans		5,449,225		94,044		6.90	%		—		—		—
Reverse repurchase agreements		193,780		2,018		4.08	%		—		—		—
	$	15,426,020		173,164		4.49	%	$	11,501,189		86,116		3.00	%
Other (1)				620							1,919
				173,784							88,035
Repurchase agreements	$	1,567,729		(13,896	)	(3.47	)%	$	6,059,695		(23,063	)	(1.49	)%
Commercial paper		8,300,373		(75,299	)	(3.55	)%		4,775,181		(19,024	)	(1.56	)%
Mortgage financing credit facilities		3,661,232		(40,174	)	(4.29	)%		—		—		—
Securitization financing		1,322,002		(14,224	)	(4.21	)%		—		—		—
Derivative contracts (2)				1,133							876
	$	14,851,336		(142,460	)	(3.75	)%	$	10,834,876		(41,211	)	(1.49	)%
Net interest income/spread			$	31,324		0.74	%			$	46,824		1.51	%

⁽¹⁾ Includes interest income on cash and other miscellaneous interest-earning assets.

⁽²⁾ Includes the effect of derivative instruments accounted for as cash flow hedges.

32

Results of Operations—(Continued)

As shown in the table above, net interest income decreased by $15.5 million from third quarter 2004 to third quarter 2005 due to an increase in interest expense. This increase was due to eight increases in the federal funds rate over the last year. The increase in interest expense was partially offset by increases in the average balance of interest earning assets, particularly non-prime mortgage loans which have higher yields than those earned on our MBS portfolio. Premium amortization expense, a component of interest income, totaled $24.9 million in the third quarter of 2005 compared to $24.2 million in the third quarter of 2004.

Other sources of principal investing and mortgage banking revenues are dividends, gains on sale of loans and net investment income. The Company recorded $8.8 million in dividend income from its merchant banking equity investment portfolio for third quarter 2005, compared to $5.8 million during the third quarter 2004. The increase in dividend income was primarily due to an increase in investments making such distributions. Net investment income totaled $4.9 million during the three months ended September 30, 2005, compared to $19.1 million for the same period in 2004, as summarized in the following table (dollars in thousands).

	Three Months Ended September 30,
	2005			2004
Realized gains on sale of available for sale investments, net	$	4,502		$	15,036
Income/(loss) from equity method investments		(404	)		1,425
Gains/(losses) on investment securities—marked-to-market, net		683			4,860
Other, net		85			(2,231	)
	$	4,866		$	19,090

Income (loss) from equity method investments reflects the Company’s equity in earnings from investments in proprietary investment partnerships and other managed investments. Gains and losses on investment securities—marked-to-market relate to securities received in connection with capital raising activities. Other net investment income includes gains and losses from mortgage-backed securities classified as trading and derivatives not designated as hedges under SFAS No. 133. See Notes 4 and 7 to the financial statements for further information on these other gains and losses, as well as gains and losses on available-for-sale investments.

During the third quarter of 2005, the Company sold $1.3 billion of loans held for sale at a weighted average premium of 2.57%. Net of related direct costs and provision for repurchase and premium recapture obligations, the Company’s gain on sale of loans for the quarter was $17.6 million or 1.32% of principal sold.

Other interest expense, primarily relating to long term debt issued through FBR TRS Holdings, increased from $1.2 million in 2004 to $4.2 million in 2005 due to increased long term borrowing of $175.0 million since September of 2004.

In the third quarter of 2005, the Company recorded a $4.9 million provision for loan losses. The Company’s mortgage loan portfolio is comprised of 2005 originations and was acquired primarily during the second and third quarters of 2005. The provision recorded in the third quarter reflects management’s estimate of losses incurred during this period.

Total non-interest expenses increased 12.4% from $131.2 million in 2004 to $147.5 million in 2005. This increase is due to increased headcount at the Company, investments in facilities and technology and also costs associated First NLC’s non-conforming mortgage loan investment operations offset by the decrease in variable compensation as a result of decreased investment banking revenues.

Compensation and benefits expense decreased 7.8% from $95.8 million in 2004 to $88.3 million in 2005. This decrease was primarily due to decreased variable compensation associated with investment banking and executive compensation. These decreases were offset by increased headcount as a result of the acquisition of First NLC.

33

Results of Operations—(Continued)

Professional services increased 20.9% from $13.4 million in 2004 to $16.2 million in 2005 primarily due to increases in consultant costs associated with technology infrastructure improvements as well as costs associated with the integration of First NLC operations.

Business development expenses increased 6.0% from $8.3 million in 2004 to $8.8 million in 2005. This increase is primarily due to an increase in travel costs and business promotions related to the mortgage origination services of the Company as a result of the acquisition of First NLC.

Clearing and brokerage fees increased 50.0% from $1.6 million in 2004 to $2.4 million in 2005. The increase is due to increased equity trading volumes as well as mortgage trading activity initiated in 2005.

Occupancy and equipment expense increased 141.0% from $3.9 million in 2004 to $9.4 million in 2005 primarily due to the investments made in the expanding of office space at the Arlington, New York, and Boston offices and upgrade of technology to accommodate the increase in headcount during 2004, as well as the increase in the Company’s headcount related to the acquisition of First NLC. Total employees as of September 30, 2005 were 2,455, including 1,654 First NLC employees, compared to 665 employees as of September 30, 2004.

Communications expense increased 69.7% from $3.3 million in 2004 to $5.6 million in 2005 primarily due to increased costs related to market data and customer trading services and the acquisition of First NLC.

Other operating expenses increased 252.1% from $4.8 million in 2004 to $16.9 million in 2005. This change reflects the addition of approximately $4.6 million in servicing fees and insurance related to the mortgage loan portfolio, costs related to First NLC’s operations of $4.8 million which includes $0.8 million of amortization for the identified broker relationship intangible asset, and increase in business registration fees of $0.5 million.

The total income tax provision decreased from $20.3 million in 2004 to $8.1 million in 2005 due to decreased taxable income related to the investment banking operations in 2005 as compared to 2004. The Company’s effective tax rate at its taxable REIT subsidiaries was 43.0% for the three months ended September 30, 2005 compared to 39.0% in 2004. The increase in the effective tax rate is due to an increase in the Company’s state income taxes due to the changes in state apportionment.

Nine months ended September 30, 2005 compared to nine months ended September 30, 2004

Net income decreased from $263.0 million in 2004 to $100.7 million in 2005. This decrease is primarily due to decreased net interest income in our principal investing activities as a result of increased borrowing costs and decreased realized gains in 2005 as compared to 2004, as well as increased non-interest expenses. These decreases and increases were offset, to some degree, by gains on the sale of mortgage loans and net interest income resulting from the initiation of mortgage banking activities. Regarding non-interest expenses, the Company recognized $7.5 million in expenses in the first quarter of 2005 related to proposed settlements with the Securities and Exchange Commission (SEC) and the NASD’s Department of Market Regulation relating to charges concerning the Company’s trading in a company account and the offering of a private investment in public equity on behalf of a public company in 2001. In addition, the Company continues to make investments in its operations and technology infrastructure in order to address the increase in employees and support growth initiatives. During the first quarter 2005, the Company completed the acquisition of First NLC a non-conforming mortgage originator (see below). The nine months ended September 2005 results reflect higher compensation, including certain non-recurring compensation payments related to the acquisition of First NLC, occupancy and equipment, and other expenses due to the increase in employees and related facilities as a result of the acquisition. Our 2005 net income also includes $26.8 million of income tax expenses as compared to $36.1 million of income tax expenses recorded in the first nine months of 2004.

On February 16, 2005, the Company completed the acquisition of First NLC, a non-conforming residential mortgage loan originator located in Florida for $98.6 million in a combination of cash and stock. First NLC currently operates in 42 states and originates loans through both wholesale and retail channels. First NLC is part

34

Results of Operations—(Continued)

of the Company’s principal investing group but operates as a wholly owned subsidiary. The Company expects that the acquisition of First NLC will assist in expanding and adding flexibility to the Company’s mortgage loan business by providing the ability to originate, price, portfolio and sell non-conforming mortgage loan assets based on market conditions.

The Company accounted for the acquisition of First NLC in accordance with Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations” using the purchase method of accounting. Under the purchase method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. In addition, SFAS 141 provides that the cost of an acquired entity must be allocated to the assets acquired, including identifiable intangible assets, and the liabilities assumed based on their estimated fair values at the date of acquisition. The excess of cost over the fair value of the net assets acquired must be recognized as goodwill.

The $98.6 million purchase price included cash of $72.1 million, issuance of 1,297,746 shares of FBR Class A common stock at a price of $18.82 per share for a total of $24.4 million, and estimated direct acquisition costs of $2.1 million.

The Company’s net revenues decreased 14.6% from $642.8 million in 2004 to $548.8 million in 2005 due to the following changes in revenues and interest expense:

Capital raising revenue decreased 1.8% from $272.7 million in 2004 to $267.9 million in 2005. The decrease is attributable to fewer lead or co-managed transactions completed in 2005 as compared to 2004. During the first nine months of 2005, the Company managed 42 public equity/debt offerings raising $12.1 billion. During the first nine months of 2004, the Company managed 60 public equity/debt offerings raising $9.0 billion. The average size of underwritten equity/debt transactions for which we were a lead or co-manager increased from $150.4 million in 2004 to $288.3 million in 2005. The company also managed 20 asset-backed security offerings during the first nine months of 2005 totaling $15.5 billion in transaction volume. In addition, the Company completed 10 private placements in 2005 generating $163.6 million in revenues compared to 7 in 2004 generating $112.7 million.

Advisory revenue decreased 53.2% from $22.0 million in 2004 to $10.3 million in 2005 due primarily to a decrease in advisory engagements.

Institutional brokerage revenue from principal transactions decreased 9.6% from $15.7 million in 2004 to $14.2 million in 2005 as a result of decreases in both trading gains and trading volume. Institutional brokerage agency commissions decreased 10.1% from $68.7 million in 2004 to $61.8 million in 2005 as a result of decreases in trading volume. In addition, the Company’s mortgage trading operations contributed $11.3 million in interest income to institutional brokerage activity. The mortgage trading interest income was offset by a net investment loss of $2.4 million related to these securities and $8.2 million of interest expense related to repurchase agreements used to finance these trading activities.

Asset management base management fees increased 21.0% from $20.0 million in 2004 to $24.2 million in 2005. The increase is primarily attributable to the increase in average productive assets under management in 2005 as compared to 2004, as well as an increase in mutual fund administrative fees. Asset management incentive allocations and fees decreased 60% from $3 million in 2004 to $1.2 million in 2005 primarily as a result of fund performance during the period and the reversal of incentive allocations from certain investment partnerships.

Revenues from our principal investment and mortgage banking activities, net of related interest expense, totaled $176.9 million for the first nine months of 2005 compared to $241.4 million for the first nine months of 2004. A primary source of these revenues is net interest income from mortgage investments, the components of which are summarized in the following table (dollars in thousands).

35

Results of Operations—(Continued)

	Nine months Ended September 30, 2005						Nine months Ended September 30, 2004
	Average Balance		Income / (Expense)			Yield /   Cost	Average Balance		Income / (Expense)			Yield /   Cost
Mortgage-backed securities	$	10,749,189	$	266,593		3.31%	$	10,986,397	$	259,417		3.15%
Mortgage loans		2,714,293		141,946		6.97%		—		—
Reverse repurchase agreements		284,159		7,495		3.48%		—		—
	$	13,747,641		416,034		4.03%	$	10,986,397		259,417		3.15%
Other (1)				980						4,724
				417,014						264,141
Repurchase agreements	$	2,832,484		(62,031	)	(2.89)%	$	5,643,850		(54,445	)	(1.27)%
Commercial paper		7,836,804		(182,852	)	(3.08)%		4,659,972		(45,070	)	(1.27)%
Mortgage financing credit facilities		1,923,132		(60,590	)	(4.15)%		—		—
Securitization		573,722		(18,101	)	(4.16)%		—		—
Derivative contracts (2)				8,474						(6,187	)
	$	13,166,142		(315,100	)	(3.15)%	$	10,303,822		(105,702	)	(1.35)%
Net interest income/spread			$	101,914		0.88%			$	158,439		1.80%

⁽¹⁾ Includes interest income on cash and other miscellaneous interest-earning assets. Other interest income in the first nine months of 2004 includes $2.1 million of income related to bridge financing arrangements.

⁽²⁾ Includes the effect of derivative instruments accounted for as cash flow hedges.

As shown in the table above, net interest income decreased by $56.5 million from the nine months ended September 30, 2004 to the nine months ended September 30, 2005 due to an increase in interest expense. This increase was due to eight increases in the federal funds rate over the last year. The increase in interest expense was partially offset by increases in the average balance of interest earning assets particularly non-prime mortgage loans which have higher yields than those earned on our MBS portfolio. Premium amortization expense totaled $58.0 million in the first nine months of 2005 compared to $60.9 million in the first nine months of 2004.

Other sources of principal investing and mortgage banking revenues are dividends, gain on sale of loans and net investment income. The Company recorded $20.6 million in dividend income from its merchant banking equity investment portfolio for the first nine months of 2005, compared to $8.5 million during the first nine months of 2004. The increase in dividend income was primarily due to an increase in investments making such distributions. Net investment income totaled $18.7 million during the nine months ended September 30, 2005, compared to a gain of $74.5 million for the same period in 2004. The following table summarizes the components of net investment income (dollars in thousands).

	Nine months Ended September 30,
	2005			2004
Realized gains on sale of available for sale investments, net	$	18,520		$	67,961
(Loss)/income from equity method investments		(840	)		2,099
Gains on investment securities—marked-to-market, net		929			7,138
Other, net		137			(2,667	)
	$	18,746		$	74,531

36

Results of Operations—(Continued)

Income (loss) from equity method investments reflects the Company’s equity in earnings from investments in proprietary investment partnerships and other managed investments. Gains and losses on investment securities—marked-to-market relate to securities received in connection with capital raising activities. Other net investment income includes gains and losses from mortgage-backed securities classified as trading and derivatives not designated as hedges under SFAS No. 133. See Notes 4 and 7 to the financial statements for further information on these other gains and losses, as well as gains and losses on available-for-sale investments.

During the first nine months of 2005, the Company sold $2.7 billion of loans held for sale at a weighted average premium of 2.68%. Net of related direct costs and provision for repurchase and premium recapture obligations the Company’s gain on sale of loans for the period was $35.6 million or 1.33% of principal sold.

Other interest expense, primarily relating to long term debt issued through FBR TRS Holdings, increased from $2.5 million in 2004 to $9.3 million in 2005 due to increased long term borrowing of $175.0 million since September of 2004.

For the nine-months ended September 30, 2005, the Company recorded a $6.0 million provision for loan losses. The Company’s mortgage loan portfolio is comprised of 2005 origination and was acquired primarily during the second and third quarters of 2005. The provision recorded reflects management’s estimate of losses incurred during this period.

Total non-interest expenses increased 22.6% from $343.7 million in 2004 to $421.3 million in 2005 due primarily to increases in employees and the acquisition of First NLC. In addition, the Company recognized an expense of $7.5 million based on the estimated settlements with the SEC and the NASD’s Department of Market Regulation.

Compensation and benefits expense increased 6.9% from $228.4 million in 2004 to $244.2 million in 2005. This increase was primarily due to increased headcount as a result of the acquisition of First NLC offset by decreased variable compensation in 2005 as compared to 2004 as result of decreased investment banking revenues and a reduction in executive officer variable compensation. Certain executive officers elected to relinquish $7.3 million of their variable cash compensation associated with the Company’s earnings during the first two quarters of 2005. In conjunction with this relinquishment of variable cash compensation, in July 2005 the Board of Directors approved restricted stock grants totaling approximately $4.5 million to these executive officers. These grants were made in August 2005 and are subject to forfeiture restrictions that lapse ratably over the three year period after the date of grant. As a percentage of net revenues, compensation and benefits expense increased from 35.5% in 2004 to 44.5% in 2005 due to the effects of the acquisition of First NLC.

Professional services increased 29.5% from $38.6 million in 2004 to $50.0 million in 2005 primarily due to increases in accounting and consultants fees related to Sarbanes-Oxley compliance performed in the first quarter, consultant fees related to the integration of First NLC operations, legal costs associated with the proposed settlements with the SEC and NASD as discussed above, and sub-advisory fees related to the increase in assets under management.

Business development expenses increased 7.4% from $33.7 million in 2004 to $36.2 million in 2005. This increase is primarily due to an increase in travel costs and business promotions related to the mortgage origination services of the Company as a result of the acquisition of First NLC

Clearing and brokerage fees decreased 7.2% from $6.9 million in 2004 to $6.4 million in 2005 due to decreased institutional brokerage volume and related revenue.

Occupancy and equipment expense increased 136.6% from $10.1 million in 2004 to $23.9 million in 2005 primarily due to the investments made in the expanding of office space at the Arlington, New York, and Boston

37

Results of Operations—(Continued)

offices, as well as the increase in the Company’s headcount related specifically to the acquisition of First NLC at September 30, 2005 as compared to September 30, 2004. Total employees as of September 30, 2005 were 2,455, including 1,654 First NLC employees, compared to 665 employees as of September 30, 2004.

Communications expense increased 53.6% from $9.7 million in 2004 to $14.9 million in 2005 primarily due to increased costs related to market data and customer trading services and the acquisition of First NLC.

Other operating expenses increased 182.1% from $16.2 million in 2004 to $45.7 million in 2005. This change reflects $7.5 million relating to the proposed settlements with the SEC and the NASD’s Department of Market Regulation as discussed above, loan servicing fees and insurance relating mortgage loan portfolio of $5.8 million, costs related to First NLC’s operations of $10.4 million which includes amortization of the identified broker relationship intangible of $2.1 million, and increase in business registration fees of $1.4 million, and increased 12b-1 fees of $0.6 million.

The total income tax provision decreased from $36.1 million in 2004 to $26.8 million in 2005 due to decreased taxable income in 2005 as compared to 2004. The Company’s effective tax rate at its taxable REIT subsidiaries was 46% for the nine months ended September 30, 2005 due primarily to the non-deductible nature of the $7.5 million charge recorded during the period relating to the Company’s proposed settlements with the SEC and the NASD’s Department of Market Regulation and state income taxes due to changes in state apportionment. The Company’s 2004 effective tax rate was 39%.

Liquidity and Capital Resources

Liquidity is a measurement of our ability to meet potential cash requirements including ongoing commitments to repay borrowings, fund investments, loan acquisition and lending activities, and for other general business purposes. In addition, regulatory requirements applicable to our broker-dealer and banking subsidiaries provide for minimum capital levels in these entities. The primary sources of funds for liquidity consist of repurchase agreements and commercial paper borrowings, securitization borrowings, principal and interest payments on mortgage loans and mortgage-backed securities, dividends on equity securities, proceeds from sales of mortgage loans and other investments, internally generated funds, equity capital contributions, and credit provided by banks, clearing brokers, and affiliates of our principal clearing broker. Potential future sources of liquidity for us include existing cash balances, internally generated funds, sales of investments, borrowing capacity through margin accounts and under lines of credit, and future issuances of common stock, preferred stock, or debt.

Sources of Funding

We believe that our existing cash balances, cash flows from operations, borrowing capacity, other sources of liquidity and execution of our financing strategies should be sufficient to meet our cash requirements. We have obtained, and believe we will be able to continue to obtain, short-term financing in amounts and at interest rates consistent with our financing objectives. We may, however, seek debt or equity financings, in public or private transactions, to provide capital for corporate purposes and/or 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. There can be no assurance that we will be able to generate sufficient funds from future operations, or raise sufficient debt or equity on acceptable terms, to take advantage of strategic business or investment opportunities that become available. Should our needs ever exceed these sources of liquidity, we believe that most of our investments could be sold, in most circumstances, to provide cash.

As of September 30, 2005, the Company’s indebtedness totaled $19.6 billion, which resulted in a leverage ratio of 14.1 to 1. In addition to trading account securities sold short and other payables and accrued expenses, our indebtedness consisted of repurchase agreements with several financial institutions, commercial paper issued through Georgetown Funding and Arlington Funding, securitization financings and long-term debentures issued through our taxable REIT subsidiary, FBR TRS Holdings. Such long-term debt issuances have totaled $277.5

38

Liquidity and Capital Resources—(Continued)

million. These long term debt securities accrue and require payments of interest quarterly at annual rates of three-month LIBOR plus 2.25%-3.25%, mature in thirty years, and are redeemable, in whole or in part, without penalty after five years. As of September 30, 2005, we had $283.9 million of long-term corporate debt.

As of September 30, 2005, we have issued $3.9 billion of mortgage-backed bonds through securitization trusts to finance a portion of the Company’s portfolio of loans held for investment. Interest rates on these bonds reset monthly and are indexed to one-month LIBOR. The weighted average interest rate payable on the securities was 4.22% as of September 30, 2005.

In September 2005, the Company through FBR & Co. obtained a $100 million temporary subordinated loan from a subsidiary of its clearing broker. Proceeds of this borrowing are allowable for net capital purposes and were used by the Company in connection with regulatory capital requirements to support underwriting activity. Interest on this loan accrued at an annual rate of three-month LIBOR plus 4%. The loan was repaid in October 2005.

In July 2005, we renewed a $200 million, 364-day senior unsecured credit agreement with various financial institutions. This facility includes a one-year term-out option. The facility is available for general corporate purposes, working capital and other potential short-term liquidity needs.

Georgetown Funding is a special purpose Delaware limited liability company organized for the purpose of issuing extendable commercial paper notes collateralized by mortgage-backed securities and entering into reverse repurchase agreements with us and our affiliates. We serve as administrator for Georgetown Funding’s commercial paper program, and all of Georgetown Funding’s transactions are conducted with FBR. Through our administration agreement and repurchase agreements, we are the primary beneficiary of Georgetown Funding and consolidate this entity for financial reporting purposes. The extendable commercial paper notes issued by Georgetown Funding are rated A1+/P1 by Standard & Poor’s and Moody’s Investors Service, respectively. Our Master Repurchase Agreement with Georgetown Funding enables us to finance up to $12 billion of mortgage-backed securities.

Arlington Funding is a special purpose Delaware limited liability company organized for the purpose of issuing extendable commercial paper notes collateralized by non-conforming mortgage loans and providing warehouse financing in the form of reverse repurchase agreements to us and our affiliates, and with mortgage originators with which we have a relationship. We serve as administrator for Arlington Funding’s commercial paper program and provide collateral as well as guarantees for commercial paper issuances. Through these arrangements, we are the primary beneficiary of Arlington Funding and consolidate this entity for financial reporting purposes. The extendable commercial paper notes issued by Arlington Funding are rated A1+/P1 by Standard & Poor’s and Moody’s Investors Service, respectively. Our financing capacity through Arlington Funding is $5 billion.

The Company also has short-term financing facilities that are structured as repurchase agreements with various financial institutions to fund its portfolio of mortgage loans. The interest rates under these agreements are based on LIBOR plus a spread that ranges between 0.60% to 1.50% based on the nature of the mortgage collateral.

Our mortgage financing repurchase agreements include provisions contained in the standard master repurchase agreement as published by the Bond Market Association and may be amended and supplemented in accordance with industry standards for repurchase facilities. Our mortgage financing repurchase agreements include financial covenants, with which the failure to comply would represent an event of default under the applicable repurchase agreement. Similarly, each repurchase agreement includes events of default for failures to

39

Liquidity and Capital Resources—(Continued)

qualify as a REIT, events of insolvency and events of default on other indebtedness. As provided in the standard master repurchase agreement as typically amended, upon the occurrence of an event of default or termination event the applicable counterparty has the option to terminate all repurchase transactions under such counterparty’s repurchase agreement and to demand immediate payment of any amount due from us to the counterparty.

Under our repurchase agreements, we may be required to pledge additional assets to our repurchase agreement counterparties in the event the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral (i.e., margin call), which may take the form of additional securities or cash. Margin calls on repurchase agreements collateralized by our MBS investments primarily result from events such as declines in the value of the underlying mortgage collateral caused by factors such as rising interest rates or prepayments. Margin calls on repurchase agreements collateralized by our mortgage loans primarily result from events such as declines in the value of the underlying mortgage collateral caused by interest rates, prepayments, and/or the deterioration in the credit quality of the underlying loans.

To-date, we have not had any margin calls on our repurchase agreements that we were not able to satisfy with either cash or additional pledged collateral. However, should we encounter a surge in interest rates, prepayments, or delinquency levels, margin calls on our repurchase agreements could result in a manner that could cause an adverse change in our liquidity position.

The following table provides information regarding the Company’s outstanding commercial paper, repurchase agreement borrowings, and mortgage financing facilities (dollars in thousands).

	September 30, 2005						December 31, 2004
	Commercial     Paper		Repurchase     Agreements		Short-Term Mortgage Financing Facilities(1)		Commercial     Paper		Repurchase     Agreements		Short-Term Mortgage Financing Facilities
Outstanding balance	$	8,214,835	$	2,791,905	$	4,061,401	$	7,294,949	$	3,467,569	$	—
Weighted-average rate		3.79%		3.79%		4.57%		2.38%		2.34%		—
Weighted-average term to maturity (1)		24.3 days		18.5 days		NA		28.3 days		39.8 days		NA

⁽¹⁾ Under these mortgage financing agreements, which expire or may be terminated by the Company or the counterparty within one year, the Company may finance mortgage loans for up to 180 days. The interest rates on these borrowings reset daily.

Assets

Our principal assets consist of MBS, non-conforming mortgage loans, cash and cash equivalents, receivables, long-term investments and securities held for trading purposes. As of September 30, 2005, liquid assets consisted primarily of cash and cash equivalents of $181.5 million. Cash equivalents consist primarily of money market funds invested in debt obligations of the U.S. government. In addition, we held $9.3 billion in MBS, $8.5 billion in non-conforming mortgage loans, $361.1 million in long-term investments, $1.4 billion in marketable trading securities, and a receivable due from our clearing broker of $162.8 million at September 30, 2005.

As of September 30, 2005, our mortgage-backed securities portfolio was comprised primarily of agency mortgage-backed ARM and Hybrid ARM securities. Excluding principal receivable, which totaled $79.7 million, the total par value of the portfolio was $9.22 billion and the market value was $9.19 billion. As of September 30, 2005, the weighted average coupon of the portfolio was 4.02%. Our non-conforming mortgage loan portfolio is also comprised substantially of Hybrid ARMs. As of September 30, 2005, the principal balance of the mortgage loan portfolio was $8.4 billion and the weighted average coupon was 7.46%. The actual yield of the MBS and the

40

Liquidity and Capital Resources—(Continued)

mortgage portfolio is affected by the price paid to acquire or the deferred net costs incurred to originate the investment. Our cost basis in MBS and mortgage loans is normally greater than the par value (i.e., a premium) resulting in the yield being less than the stated coupon. At September 30, 2005, the MBS portfolio had a net premium of $143 million (1.55% of the unpaid principal balance or par value) and the mortgage portfolio had a net premium of $194 million (2.32%), including deferred net origination costs and purchase loan price adjustments associated with the acquisition of First NLC. The weighted average yield on the mortgage portfolio was 6.92% as of September 30, 2005. Based on the amount of the premium and our estimates of future prepayments, the weighted average yield of the mortgage-backed securities portfolio was 3.10% as of September 30, 2005. Management’s estimate of prepayments, which was equivalent to a lifetime CPR of approximately 26%, is based on historical performance and estimates of future performance, including historical CPRs, interest rates and characteristics of the mortgage-backed securities portfolio, including Hybrid ARM type, age, and the weighted average coupon of the loans underlying the securities assessed in relation to current market data.

Long-term investments primarily consist of investments in marketable equity and non-public equity securities, 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), and our investment in preferred equity of a privately held company. Although our investments in hedge, private equity and venture capital funds are mostly 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.

The following table provides additional detail regarding the Company’s merchant banking investments as of September 30, 2005 (dollars in thousands).

	Shares	Cost Basis		Fair Value / Carrying Value
Merchant Banking Investments
Aames Investment Corporation	4,707,900	$	37,216	$	29,566
Asset Capital Corporation, Inc. (1)	943,766		7,500		7,500
Cmet Finance Holdings, Inc. (1)	65,000		6,150		6,150
ECC Capital Corp. (1)	3,940,110		25,000		12,845
Fieldstone Investment Corporation	3,588,329		49,734		41,840
Government Properties Trust	210,000		2,100		2,058
JER Investors Trust (1)	377,350		5,264		6,815
KKR Financial Corp. (2)	1,250,000		23,250		27,800
Lexington Strategic Asset Corp. (1)	537,634		5,000		5,000
Medical Properties Trust, Inc. (2)	1,795,571		16,180		17,596
New Century Financial Corporation	636,885		35,050		23,100
New York Mortgage Trust, Inc.	200,000		1,760		1,494
People’s Choice Financial Corporation (1)	3,500,000		32,900		32,900
Quanta Capital Holdings Ltd.	2,870,620		26,697		17,224
Saxon Capital, Inc.	1,679,300		31,264		19,899
Specialty Underwriters Alliance, Inc. (1)	1,242,410		10,977		10,163
Taberna Realty Finance Trust (1)	985,663		10,000		10,000
Tower Group, Inc.	325,000		2,763		4,914
Vintage Wine Trust, Inc. (1)	1,075,269		10,000		10,000
Whittier Energy Corporation (convertible preferred) (1)	89,606		5,000		5,000
Preferred equity investment (1)	—		5,000		5,000
Other	—		3,960		3,865
Total Merchant Banking Investments		$	352,765	$	300,729

⁽¹⁾ As of September 30, 2005 these shares cannot be traded in a public market (e.g. NYSE or Nasdaq) but may be sold in private transactions.

⁽²⁾ As of September 30, 2005, the Company is restricted from selling its shares.

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Liquidity and Capital Resources—(Continued)

Net unrealized gains and losses related to our MBS and merchant banking investments that are included in “accumulated other comprehensive loss” in our balance sheet totaled $(169) million and $(52) million, respectively, as of September 30, 2005. If we choose to liquidate these securities or we determine that a decline in value of these investments below our cost basis is “other than temporary,” a portion or all of the gains or losses will be recognized as realized gain (loss) in the statement of operations during the period in which the liquidation or determination is made. Our investment portfolio is exposed to potential future downturns in the markets and private debt and equity securities are exposed to deterioration of credit quality, defaults, and downward valuations.

Regulatory Capital

FBR & Co. and FBR Investment Services, Inc. (FBRIS), as U.S. broker-dealers, are registered with the SEC and are members of NASD. Additionally, Friedman, Billings, Ramsey International, Ltd. (FBRIL), our U.K. broker-dealer, is registered with the Financial Services Authority (FSA) of the United Kingdom. As such, they are subject to the minimum net capital requirements promulgated by the SEC and FSA, respectively. As of September 30, 2005, FBR & Co. had regulatory net capital as defined of $90.7 million, which exceeded its required net capital of $6.1 million by $84.6 million, FBRIS and FBRIL had regulatory net capital as defined in excess of the amounts required.

FBR National Trust (FBR Bank) is subject to various regulatory capital requirements administered by the federal banking agencies. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, FBR Bank’s assets, liabilities, and certain off-balance sheet items are calculated under regulatory accounting practices. FBR 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 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 September 30, 2005, FBR Bank meets all capital adequacy requirements to which it is subject.

Dividends

The Company declared the following distributions during the nine months ended September 30, 2005 and year ended December 31, 2004:

Declaration Date	Record Date	Payment Date	Dividends Per Share
2005
September 13, 2005	September 30, 2005	October 31, 2005	$	0.34
June 9, 2005	June 30, 2005	July 29, 2005	$	0.34
March 17, 2005	March 31, 2005	April 29, 2005	$	0.34
2004
December 9, 2004	December 31, 2004	January 28, 2005	$	0.39	(1)
September 9, 2004	September 30, 2004	October 29, 2004	$	0.34
June 10, 2004	June 30, 2004	July 30, 2004	$	0.46	(2)
March 10, 2004	March 31, 2004	April 30, 2004	$	0.34

⁽¹⁾ Includes a special dividend of $0.05 per share.

⁽²⁾ Includes a special dividend of $0.12 per share.

In October 2005, the Company announced its intention to reduce its quarterly dividend payment from $0.34 per share to $0.20 per share beginning in the fourth quarter 2005. This planned change in dividend policy is intended to enable the Company to maintain a stable dividend and maintain the integrity of our business model.

42

Liquidity and Capital Resources—(Continued)

Contractual Obligations

We have contractual obligations to make future payments in connection with long-term debt and non-cancelable lease agreements and other contractual commitments as well as uncalled capital commitments to various investment partnerships that may be called over the next ten years. The following table sets forth these contractual obligations by fiscal year (dollars in thousands):

	Remaining 2005		2006		2007		2008		2009		Thereafter		Total
Long-term debt (1)	$	—	$	970	$	970	$	970	$	970	$	280,048	$	283,928
Minimum rental and other contractual commitments		3,955		17,303		12,812		12,662		11,999		54,921		113,652
Capital commitments (2)		—		—		—		—		—		—		—
Total Contractual Obligations	$	3,955	$	18,273	$	13,782	$	13,632	$	12,969	$	334,969	$	397,580

⁽¹⁾ This table excludes interest payments to be made on the Company’s long-term debt securities issued through TRS Holdings. The Company will incur $4.6 million in interest related to these long-term debt securities in the fourth quarter of 2005. Based on the 3-month LIBOR of 4.07% as of September 30, 2005, plus a weighted average margin of 2.58%, estimated annualized interest on the current outstanding principal of $277.5 million of long-term debt securities would be approximately $18.5 million for the year ending December 31, 2006. These long-term debt securities mature in thirty years beginning in March 2033 through October 2035. Note that interest on this long-term debt floats based on 3-month LIBOR, therefore, actual coupon interest will differ from this estimate.

⁽²⁾ The table above excludes $6.7 million of uncalled capital commitments to various investment partnerships that may be called over the next ten years. This amount was excluded because the Company cannot determine when, if ever, the commitments will be called.

The Company also has short term commercial paper and repurchase agreement liabilities of $8.2 billion and $6.9 billion, respectively as of September 30, 2005, as well as $3.8 billion of securitization financing that matures in 2035. See Note 6 for further information.

As of September 30, 2005, the Company had made interest rate lock agreements with mortgage borrowers and commitments to sell mortgage loans of $448 million and $410 million, respectively.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk generally represents the risk of loss through a change in realizable value that can result from a change in the prices of equity securities, a change in the value of financial instruments as a result of changes in interest rates, a change in the volatility of interest rates or, a change in the credit rating of an issuer. The Company is exposed to the following market risks as a result of its investments in mortgage-backed securities, mortgage loans and equity investments. Except for trading securities held by FBR & Co. and certain mortgage-backed securities designated as trading, none of these investments is held for trading purposes.

Interest Rate Risk

Leveraged MBS and Mortgage Loans

The Company is subject to interest-rate risk as a result of its principal investment and mortgage banking activities. Through these activities, the Company invests in mortgage-backed securities and mortgage loans and finances those investments with repurchase agreement, commercial paper and securitization borrowings, all of which are interest rate sensitive financial instruments. The Company is exposed to interest rate risk that fluctuates based on changes in the level or volatility of interest rates and mortgage prepayments and in the shape and slope of the yield curve. The Company attempts to hedge a portion of its exposure to rising interest rates primarily through the use of paying fixed and receiving floating interest rate swaps, interest rate caps, and Eurodollar futures and put option contracts. The counterparty to the Company’s derivative agreements at September 30, 2005 are U.S. financial institutions.

The Company’s primary risk is related to changes in both short and long term interest rates, which affect the Company in several ways. As interest rates increase, the market value of the mortgage-backed securities and mortgage loans may be expected to decline, prepayment rates may be expected to go down, and duration may be expected to extend. An increase in interest rates is beneficial to the market value of the Company’s derivative instruments designated as hedges. For example, for interest rate swap positions, the cash flows from receiving the floating rate portion increase and the fixed rate paid remains the same under this scenario. If interest rates decline, the reverse is true for mortgage-backed securities and mortgage loans, paying fixed and receiving floating interest rate swaps, interest rate caps, and Eurodollar futures and put option contracts.

The Company records its derivatives at fair value. The differential between amounts paid and received for derivative instruments designated as hedges is recorded as an adjustment to interest expense. In addition, the Company records the ineffectiveness of its hedges, if any, in interest expense. In the event of early termination of these derivatives, the Company receives or makes a payment based on the fair value of the instrument, and the related deferred gain or loss recorded in other comprehensive income is amortized into income or expense over the original hedge period.

The table that follows shows the expected change in market value for the Company’s current mortgage-backed securities, mortgage loans, and derivatives related to the Company’s principal investment and mortgage banking activities under several hypothetical interest-rate scenarios. Interest rates are defined by the U.S. Treasury yield curve. The changes in rates are assumed to occur instantaneously. It is further assumed that the changes in rates occur uniformly across the yield curve and that the level of LIBOR changes by the same amount as the yield curve. Actual changes in market conditions are likely to be different from these assumptions.

Changes in value are measured as percentage changes from their respective values presented in the column labeled “Value at September 30, 2005.” Actual results could differ significantly from these estimates. The estimated change in value of the mortgages loans and mortgage-backed securities reflects an effective duration of 1.60 years and 1.01 years, respectively. The effective durations are based on observed market value changes, as well as management’s own estimate of the effect of interest rate changes on the fair value of the investments including assumptions regarding prepayments based, in part, on age of and interest rate on the mortgages and the mortgages underlying the mortgage-backed securities, prior exposure to refinancing opportunities, and an overall analysis of historical prepayment patterns under a variety of past interest rate conditions (dollars in thousands, except per share amounts).

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Interest Rate Risk—(Continued)

	Value at September 30, 2005		Value at September 30, 2005 with 100 basis point increase in interest rates		Percent Change		Value at September 30, 2005 with 100 basis point decrease in interest rates		Percent Change
Assets
Mortgage-backed securities	$	9,268,662	$	9,159,755	(1.18	)%	$	9,346,982	0.84	%
Mortgage loans		8,540,692		8,372,014	(1.97	)%		8,645,316	1.23	%
Derivative assets		54,583		101,290	85.57	%		7,522	(86.22	)%
Reverse repurchase agreements		488,113		488,113				488,113
Other		2,719,107		2,719,107				2,719,107
Total Assets	$	21,071,157	$	20,840,279	(1.10	)%	$	21,207,040	0.64	%
Liabilities
Repurchase agreements and commercial paper	$	15,068,141	$	15,068,141			$	15,068,141
Securitization financing		3,809,901		3,809,901				3,809,901
Derivative liabilities		30,331		53,356	75.91	%		4,272	(85.92	)%
Other		768,647		768,647				768,647
Total Liabilities		19,677,020		19,700,045	0.12	%		19,650,961	(0.13	)%
Shareholders’ Equity		1,394,137		1,140,234	(18.21	)%		1,556,079	11.62	%
Total Liabilities and Shareholders’ Equity	$	21,071,157	$	20,840,279	(1.10	)%	$	21,207,040	0.64	%
Book Value per Share	$	8.21	$	6.71	(18.21	)%	$	9.16	11.62	%

As shown above, the Company’s portfolio of mortgage loans and mortgage-backed securities generally will benefit less from a decline in interest rates than it will be adversely affected by a same scale increase in interest rates. This may effectively limit an investor’s upside potential in a market rally. The changes in the fair value of mortgage loans as presented in the table above will not necessarily affect the Company’s earnings or shareholders’ equity since mortgage loans held for investment are reported at amortized cost and mortgage loans held for sale are reported at fair value only when fair value is less than amortized cost. See also discussion of Trends that affect our business in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Other

The value of our direct investments in other companies is also likely to be affected by significant changes in interest rates. For example, many of the companies are exposed to risks similar to those identified above as being applicable to our own investments in mortgage-backed securities and mortgage loans. Additionally, changes in interest rates often affect market prices of equity securities. Because each of the companies in which we invest has its own interest rate risk management process, it is not feasible for us to quantify the potential impact that interest rate changes would have on the stock price or the future dividend payments by any of the companies in which we have invested.

Equity Price Risk

The Company is exposed to equity price risk as a result of its investments in marketable equity securities, investment partnerships, and trading securities. Equity price risk changes as the volatility of equity prices changes or the values of corresponding equity indices change.

While it is impossible to exactly project what factors may affect the prices of equity sectors and how much the effect might be, the table below illustrates the impact a ten percent increase and a ten percent decrease in the

45

Equity Price Risk—(Continued)

price of the equities held by the Company would have on the value of the total assets and the book value of the Company as of September 30, 2005 (dollars in thousands, except per share amounts).

	Value at September 30, 2005			Value of Equity at September 30, 2005 with 10% Increase in Price			Percent     Change	Value at September 30, 2005 with 10% Decrease in Price			Percent     Change
Assets
Marketable equity securities	$	300,729		$	330,802		10%	$	270,656		(10)%
Equity method investments		47,129			51,842		10%		42,416		(10)%
Investment securities-marked to market		5,541			6,095		10%		4,987		(10)%
Other long-term investments		7,732			7,732				7,732
Trading securities—equities		35,265			38,792		10%		31,739		(10)%
Other		20,674,761			20,674,761				20,674,761
Total Assets	$	21,071,157		$	21,110,024		0.18%	$	21,032,291		(0.18)%
Liabilities	$	19,677,020		$	19,677,020			$	19,677,020
Shareholders’ Equity
Common stock		1,725			1,725				1,725
Paid-in-capital		1,544,661			1,544,661				1,544,661
Employee stock loan receivable		(4,242	)		(4,242	)			(4,242	)
Deferred compensation		(20,295	)		(20,295	)			(20,295	)
Accumulated comprehensive income		(209,168	)		(179,095	)	14.38%		(239,241	)	(14.38)%
Retained earnings		81,456			90,250		10.80%		72,663		(10.79)%
Total Shareholders’ Equity		1,394,137			1,433,004		2.79%		1,355,271		(2.79)%
Total Liabilities and Shareholders’ Equity	$	21,071,157		$	21,110,024		0.18%	$	21,032,291		(0.18)%
Book Value per Share	$	8.21		$	8.43		2.74%	$	7.98		(2.83)%

Except to the extent that the Company sells its marketable equity securities or other long term investments, or a decrease in their market value is deemed to be other than temporary, an increase or decrease in the market value of those assets will not directly affect the Company’s earnings, however an increase or decrease in the value of equity method investments, investment securities-marked to market, as well as trading securities will directly effect the Company’s earnings.

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Item 4. Controls and Procedures

Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s principal executive officer Eric F. Billings, and principal financial officer, Kurt R. Harrington, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined under Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, Eric F. Billings and Kurt R. Harrington concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.

Except as discussed below, there has been no change in the Company’s internal control over financial reporting during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

On February 16, 2005, the Company completed the acquisition of First NLC Financial Services, LLC (First NLC). As a result of this acquisition the Company adopted certain new accounting policies relative to mortgage loans, including policies relating to mortgage loans held for investment and mortgage loans held for sale (see Note 2 to the interim financial statements). Currently, the Company is in the process of assessing internal controls relative to First NLC and its operations.

Forward-Looking Statements

This Form 10-Q includes 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, the effect of demand for public offerings, activity in the secondary securities markets, interest rates, interest spreads, and mortgage prepayment speeds, the risks associated with merchant banking investments, available technologies, competition for business and personnel, and general economic, political, and market conditions. We will not necessarily update the information presented or incorporated by reference in this Form 10-Q if any of these forward-looking statements turn out to be inaccurate. For a more detailed discussion of the risks affecting our business see our Form 10-K for 2004 and especially the section “Risk Factors.”

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

Regulatory Investigations

As previously reported on Form 8-K and in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, on April 26, 2005, the Company announced that its broker-dealer subsidiary, FBR & Co., has proposed a settlement to the staff of the Division of Enforcement (SEC staff) of the Securities and Exchange Commission (Commission) and the staff of the Department of Market Regulation of NASD (NASD staff) to resolve ongoing, previously disclosed investigations by the SEC and NASD staffs. The proposed settlement concerns insider trading and other charges related to the Company’s trading in a company account and the offering of a private investment in public equity on behalf of CompuDyne, Inc. in October 2001.

In the SEC proceeding, FBR & Co., without admitting or denying any wrongdoing, proposed to pay disgorgement, civil penalties and interest totaling approximately $3.5 million and to consent to the entry of a permanent injunction with respect to violations of the antifraud provisions of the federal securities laws, and agreed to consent to an administrative proceeding in which FBR & Co. would be subjected to a censure and agree to certain additional undertakings including engagement of an independent consultant to review its procedures and oversee the implementation of improvements. FBR & Co. has requested that the SEC staff recommend to the Commission that such an offer of settlement be approved, pending final negotiation of the settlement language. The offer of settlement is subject to approval by the Commission, and the Commission may accept, reject or impose further conditions or other modifications to some or all of the terms of the proposed settlement. Furthermore, there are no assurances regarding the Commission’s consideration or determination of any offer of settlement, and no settlement is final unless and until approved by the Commission.

In the parallel NASD proceeding, without admitting or denying any wrongdoing, FBR & Co. has proposed a settlement of alleged violations of the antifraud provisions of the federal securities laws and applicable NASD Rules. FBR & Co. would also agree to the same undertakings provided for in the proposed settlement with the SEC, and to pay a fine of $4 million to the NASD. The proposed settlement must be reviewed and accepted by the NASD.

The proposed SEC and NASD settlements are subject to FBR & Co. obtaining relief from certain statutory disqualifications, and the SEC staff can make no assurance that any or all of the requested relief will be granted by the Commission. The Company recorded a $7.5 million charge in its 2005 first quarter with respect to the proposed settlements with the SEC and NASD.

Putative Class Action Securities Lawsuits

The Company and certain current and former senior officers and directors have been named in a series of putative class action securities lawsuits filed in the third quarter of 2005, all of which are pending in the United States District Court for the Southern District of New York. The Company refers to these lawsuits as the Weiss et al. putative class action lawsuits. The complaints in these actions are brought under various sections of the Securities Exchange Act of 1934, as amended, and allege misstatements and omissions concerning (i) the SEC and NASD investigations described above relating to FBR & Co.’s involvement in the private investment in public equity on behalf of CompuDyne, Inc. in October 2001 and (ii) the Company’s expected earnings, including the potential adverse impact on the Company of changes in interest rates. The Company is contesting these lawsuits vigorously, but the Company cannot predict the likely outcome of these lawsuits or their likely impact on the Company at this time.

Shareholders’ Derivative Action

The Company and certain current and former senior officers and directors have been named in a shareholders’ derivative action that is presently pending in the United States District Court for the Southern

48

District of New York. The Company, which is a nominal defendant in this action, refers to this derivative action as the Lemon Bay Partners derivative action. The complaint alleges conduct substantially similar to that alleged in the Weiss et al. putative class action lawsuits described above. The Company has not responded to the complaint and no discovery has commenced. The Company cannot predict the likely outcome of this action or its likely impact on the Company at this time. The Company’s Board of Directors has established a special committee comprised of two independent directors to evaluate shareholder demand letters which contain allegations similar to the Lemon Bay Partners derivative action and to recommend to the Board of Directors whether such a derivative action is in the best interests of the Company.

Other Legal Proceedings

As previously reported in the Company’s Annual Report on 10-K for the year ended December 31, 2004, one of the Company’s investment adviser subsidiaries, Money Management Associates, Inc. (MMA) and one of its now closed mutual funds are involved in an investigation by the SEC with regard to certain losses sustained by the fund in 2003. The Company continues to cooperate fully with the investigation, and to date the investigation is continuing. Since no proceedings have been initiated in this investigation, it is inherently difficult to predict its outcome or potential affect on MMA or the Company. It is possible that the SEC may initiate proceedings as a result of its investigations, and any such proceedings could result in adverse judgments, injunctions, fines, penalties or other relief against MMA or one or more of its officers or employees.

Except as described above, as of September 30, 2005, 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 results of operations. The Company is a defendant in a small number of civil lawsuits and arbitrations relating to its various businesses, and is subject to various reviews, examinations, investigations and other inquiries by governmental agencies and SROs, none of which are expected to have a material adverse effect on the Company’s financial condition or results of operations.

49

Item 6. Exhibits

The exhibits identified with ⁽¹⁾ 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.

The exhibit identified with ⁽²⁾ below is on file with the SEC as part of our 1999 annual report on Form 10-K and is incorporated by reference.

The exhibit identified with ⁽³⁾ below is on file with the SEC as part of our 1999 annual report on Form 10-K and is incorporated by reference. This exhibit was modified by an announcement filed with the SEC in a current report on Form 8-K, dated March 31, 2005 and is incorporated by reference.

3.01	(1)	Registrant’s Articles of Incorporation.
3.02	(1)	Registrant’s Bylaws.
4.01	(1)	Form of Specimen Certificate for Registrant’s Class A Common Stock.
10.02	(1)	The 1997 Employee Stock Purchase Plan.
10.03	(2)	FBR Stock and Annual Incentive Plan.
10.04	(1)	The Non-Employee Director Stock Compensation Plan.
10.05	(1)(3)	The Key Employee Incentive Plan.
12		Computation of Ratio of Earnings to Fixed Charges
31(a)		Certification of Eric F. Billings, Chief Executive Officer of Friedman, Billings, Ramsey Group, Inc. pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b)		Certification of Kurt R. Harrington, Chief Financial Officer of Friedman, Billings, Ramsey Group, Inc. pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32(a)		Certification of Eric F. Billings, Chief Executive Officer of Friedman, Billings, Ramsey Group, Inc. pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32(b)		Certification of Kurt R. Harrington, Chief Financial Officer of Friedman, Billings, Ramsey Group, Inc. pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

50

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Friedman, Billings, Ramsey Group, Inc.
By:	/s/    KURT R. HARRINGTON
	Kurt R. Harrington
	Senior Vice President and Chief Financial Officer
	(Principal Financial Officer)

Date: November 9, 2005

By:	/s/    ROBERT J. KIERNAN
	Robert J. Kiernan
	Vice President, Controller and Chief Accounting Officer
	(Principal Accounting Officer)

Date: November 9, 2005

51

EX-12

Exhibit 12

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES

(dollars in thousands)

	Nine months Ended September 30, 2005		Years Ended December 31,
			2004		2003		2002		2001			2000
Pre-tax income (loss) from continuing operations adjusted to exclude income or loss from equity investees	$	128,071	$	399,536	$	225,165	$	42,229	$	(18,457	)	$	1,000
Distributed income of equity investees		23,936		2,141		553		14,089		10,747			12,036
Fixed charges:
Interest expense and amortization of debt discount and premium on all indebtedness		334,920		164,156		68,995		2,073		1,083			1,665
Rentals: Equipment and office rent expense—33.33%		4,344		2,798		1,719		1,692		1,657			1,305
Total fixed charges	$	399,264	$	166,954	$	70,714	$	3,765	$	2,740		$	2,970
Pre-tax income (loss) from continuing operations before adjustments for income or loss from equity investees plus fixed charges and distributed income of equity investees	$	491,271	$	568,631	$	296,432	$	60,083	$	(4,970	)	$	16,006
Ratio of earnings to fixed charges		1.4		3.4		4.2		16.0		(A	)		5.4

^(A) Due to the company’s losses in 2001, the ratio coverage for that year was less than 1:1. The company would have had to generate additional earnings of $7,710 to achieve coverage of 1:1 in 2001.

EX-31.(A)

Exhibit 31(a)

CERTIFICATION

I, Eric F. Billings, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 of Friedman, Billings, Ramsey Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 9, 2005	/s/    ERIC F. BILLINGS
	Eric F. Billings
	Chairman and Chief Executive Officer

EX-31.(B)

Exhibit 31(b)

CERTIFICATION

I, Kurt R. Harrington, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 of Friedman, Billings, Ramsey Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 9, 2005	/s/    KURT R. HARRINGTON
	Kurt R. Harrington
	Chief Financial Officer

EX-32.(A)

Exhibit 32(a)

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report on Form 10-Q of Friedman, Billings, Ramsey Group, Inc. (the “Company”) for the period ending September 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Eric F. Billings, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/    ERIC F. BILLINGS

Eric F. Billings

Chief Executive Officer

November 9, 2005

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Friedman, Billings, Ramsey Group, Inc. and will be retained by Friedman, Billings, Ramsey Group, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.(B)

Exhibit 32(b)

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report on Form 10-Q of Friedman, Billings, Ramsey Group, Inc. (the “Company”) for the period ending September 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Kurt R. Harrington, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/    KURT R. HARRINGTON

Kurt R. Harrington

Chief Financial Officer

November 9, 2005

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Friedman, Billings, Ramsey Group, Inc. and will be retained by Friedman, Billings, Ramsey Group, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.