SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000
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: 001-13731
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
(Exact name of registrant as specified in its charter)
Virginia 54-1837743
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
1001 Nineteenth Street North
Arlington, VA 22209
(Address of principal executive offices) (Zip code)
(703) 312-9500
(Registrant's telephone number including area code)
Securities registered pursuant to section 12(b) of the act:
Title of Securities Exchanges on Which Registered
- ------------------------------------- -----------------------------
Class A Common Stock, Par Value $0.01 New York Stock Exchange
Securities registered pursuant to section 12(g) of the act:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Aggregate market value of the voting stock held by non-affiliates of the
Registrant: $143,898,805 as of March 23, 2001.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date:
16,548,441 shares of Class A Common Stock as of March 23, 2001 and
32,909,029 shares of Class B Common Stock as of March 23, 2001.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's definitive Proxy Statement to be filed with
the Securities and Exchange Commission no later than 120 days after the
Registrant's fiscal year ended December 31, 2000 and to be delivered to
stockholders in connection with the 2001 Annual meeting of Stockholders in Part
III, Items 10 (as related to Directors), 11, 12 and 13.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
TABLE OF CONTENTS
Page
PART I
Item 1. Business......................................................... 4
Item 2. Properties....................................................... 31
Item 3. Legal Proceedings................................................ 31
Item 4. Submission of Matters to a Vote of Security Holders.............. 31
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholders
Matters.......................................................... 33
Item 6. Selected Consolidated Financial Data............................. 35
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 36
Item 8. Financial Statements and Supplementary Data...................... 47
PART III
Item 10. Directors and Executive Officers of the Registrant............... 47
Item 11. Executive Compensation........................................... 47
Item 12. Security Ownership of Certain Beneficial Owners and Management... 48
Item 13. Certain Relationships and Related Transactions................... 48
PART IV
Item 14. Exhibits, Consolidated Financial Statement Schedules, and Reports
on Form 8-K...................................................... 48
SIGNATURES................................................................. 51
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.................................... F-1
INDEX TO FINANCIAL STATEMENTS OF
FBR TECHNOLOGY VENTURE PARTNERS, L.P..................................... G-1
INDEX TO FINANCIAL STATEMENTS OF
FBR ASHTON, L.P.......................................................... H-1
INDEX TO FINANCIAL STATEMENTS OF
FBR ASSET INVESTMENT CORPORATION......................................... I-1
PART I
CAUTIONS ABOUT FORWARD-LOOKING INFORMATION
This Form 10-K and the information incorporated by reference in this Form
10-K include forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. Some of the forward-looking statements can be
identified by the use of forward-looking words such as "believes", "expects,"
"may," "will," "should," "seeks," "approximately," "intends," "plans,"
"estimates" or "anticipates" or the negative of those words or other comparable
terminology. Such statements include, but are not limited to, those relating to
the effects of growth, our principal investment activities, levels of assets
under management and our current equity capital levels. Forward-looking
statements involve risks and uncertainties. You should be aware that a number of
important factors could cause our actual results to differ materially from those
in the forward-looking statements. These factors include, but are not limited
to, competition among financial services firms for business and personnel, the
high degree of risk associated with venture capital investments, the effect of
demand for public offerings, mutual fund and 401(k) and pension plan inflows or
outflows in the securities markets, volatility of the securities markets,
available technologies, the effect of government regulation and of general
economic conditions on our own business and on the businesses in the industry
areas on which we focus, fluctuating quarterly operating results, the
availability of capital to us and risks related to online commerce. We will not
necessarily update the information presented or incorporated by reference in
this Form 10-K if any of these forward-looking statements turn out to be
inaccurate. Risks affecting our business are described throughout this Form 10-K
and especially in the section "Business--Factors Affecting Our Business,
Operating Results and Financial Condition" (page 21). This entire Form 10-K,
including the Consolidated Financial Statements and the notes and any other
documents incorporated by reference into this Form 10-K should be read for a
complete understanding of our business and the risks associated with that
business.
ITEM 1. BUSINESS
General
Friedman, Billings, Ramsey Group, Inc. ("FBR"), is a financial services
and investment firm focused on three businesses:
(1) Investment banking and securities. This business is conducted
primarily through Friedman, Billings, Ramsey & Co., Inc. ("FBRC")
our principal registered broker-dealer subsidiary.
(2) Specialized asset management products, including venture capital
funds. This business is conducted primarily through two registered
investment adviser subsidiaries, Friedman, Billings, Ramsey
Investment Management, Inc. ("FBRIM") and FBR Venture Capital
Managers, Inc. ("FBRVCM").
(3) Online investment banking, brokerage and securities distribution
services. This business is conducted through our online investment
bank and brokerage unit, fbr.com, a division of FBR Investment
Services, Inc. ("FBRIS"), a registered broker-dealer subsidiary.
Through these businesses, we provide a wide array of financial products
and services in the following broad industry sectors: financial services, real
estate, technology and energy, that we believe offer significant growth
opportunities for us to grow. We have continued to strengthen our business by
broadening and deepening our research and investment banking coverage within our
industry sectors and adding new products and services that benefit from our
knowledge of each sector, and building a wider customer base. We have also
continued to increase our principal investment activities, primarily through
investment in our own asset management products.
We believe that our goal of building shareholder value is best achieved by
strengthening our competitive position and our financial position. In order for
us to remain competitive, it is important for us to focus on our industry
sectors and within those sectors offer a broad range of products and services
both to corporate issuers who are seeking advice and finance, and to our
brokerage and asset management customers. We also believe it is important for us
to be involved with companies early in their lifecycles (or even to be involved
in creating businesses) in order to establish relationships that will provide us
with ongoing revenues as these companies' finance and advisory needs grow. We
seek to provide our corporate clients with the financing and advisory services
that they will need at all stages of their corporate lifecycle.
We are a Virginia corporation, and the successor company to that founded
in 1989 by our Co-Chief Executive Officers, Emanuel J. Friedman, Eric F.
Billings, and W. Russell Ramsey. As of December 31, 2000, we had 386 employees
engaged in the
4
following activities: 58 in research, 77 in corporate finance and investment
banking, 108 in sales, trading and syndicate, 33 in venture capital, private
equity and asset management, 16 in fbr.com and 94 in accounting, administration
and operations. Our employees are not subject to any collective bargaining
agreement and we believe that we have excellent relations with our employees.
As of December 31, 2000, our three founders owned approximately 51% of our
common stock. Our principal executive offices are located at Potomac Tower, 1001
Nineteenth Street North, Arlington, Virginia 22209. We also have offices in
Reston, Virginia; Irvine and Los Angeles, California; Boston, Massachusetts;
Charlotte, North Carolina; Chicago, Illinois; Seattle, Washington; Portland,
Oregon; Vienna, Austria; and London, England. In 2001, we have announced the
opening of offices in New York City, Dallas, Texas and Cleveland, Ohio.
Strategy
As of December 31, 2000, we had shareholders equity of $214.6 million and
virtually no long-term debt. We achieve operating leverage in three ways. First,
we leverage our expertise in each of our industry sectors by applying that
expertise to our products and services in our investment banking, securities and
asset management businesses. Second, we leverage our return on investment by
investing in our own asset management funds that provide us with incentive
income on all of the assets invested in the funds by our customers. As a result,
we receive a return that is disproportionate to our investment. Third, we have a
variable cost structure that has low fixed costs, and a large variable element
of compensation and other expense related to revenue levels.
We seek to combine businesses that provide relatively predictable revenues
and moderate growth from diverse business lines and customer bases, with higher
margin businesses that have greater potential for significant growth. In the
first category, we include our brokerage business, corporate finance advisory
business and that portion of our asset management business that generates fees
based on a percentage of assets under management. In the second category, we
include our capital raising business, that portion of our asset management
businesses that provides for incentive income based on gains above a certain
level, and our principal investing activity.
Revenues
Our goal is to maintain revenues from our base businesses at a level to
cover our fixed costs, including base compensation, and to provide bonus
compensation and significant profit margins from our other businesses.
Our revenues for the years ended December 31, 2000, 1999, and 1998 were
$180.9 million, $139.0 million and $122.9 million respectively. The increase in
revenue from 1999 to 2000 is primarily due to increased revenues from our
venture capital business that is focused on the Internet and related information
technology sectors and, to a lesser extent, our investment banking business
in the same sectors. See the table on page 40 for the percentage of total
revenues contributed by each of our principal products and services, including
investment gains related to our managed investment partnerships and trading
gains.
We began in 1989 as an institutional brokerage firm offering specialized
research, sales and trading. We have maintained and enhanced this business, and
in 2000 it contributed about 30% of our revenues.
In late 1992, we added investment banking to our institutional brokerage.
In late 1996, we added a dedicated merger and acquisition team. Since we began
our investment banking activities, we have been involved in 313 capital raising,
advisory and other transactions, with total transaction value in excess of $32.5
billion. In 2000, investment banking contributed about 30% of our revenues.
In late 1996, we expanded our asset management business, initiating
several new asset management products and hiring professionals to lead those
efforts. Among these were our venture capital, private equity and mutual fund
businesses. Our assets under management have increased from $119.3 million at
the beginning of 1996 to $819.6 million at the end of 2000. We earn base
management fees at a blended rate of more than 1% on our assets under
management, and on $653.8 million of these assets we have the potential to earn
incentive income. We also invest in our own asset management products, and earn
a return on our investment. In 2000, asset management (primarily venture
capital) contributed about 35% of our revenues (including unrealized gains
included in incentive income).
5
A significant portion of our 2000 asset management revenue was from
incentive fees of up to 20% of the gains (above certain levels) of the venture
capital partnerships that we manage. We record compensation expense against
those fees. These gains include unrealized "mark to market" gains resulting from
the valuation of public securities held in the partnerships' portfolios by
reference to the public trading price of the securities, discounted to reflect
selling restrictions such as liquidity, insider ownership, etc. Gains also
include unrealized gains from increases in the fair value of securities of non-
public companies. Accordingly, the partnerships' gains and our incentive income
may fluctuate with market prices, and may be reversed from one period to the
next. Please see footnotes 2 and 3 to our Financial Statements, for more
information about how we account for revenue from our venture capital business,
and "Factors Affecting our Business, Operating Results and Financial Condition"
for a discussion of the risks and volatility associated with our venture capital
revenue.
In March 2001 we received regulatory approval for our acquisition of Money
Management Associates, LP ("MMA") a mutual fund family of fixed income and money
market funds, and its affiliated bank, Rushmore Trust and Savings, FSB
("Rushmore"). Upon closing, will be converted to a national bank and named FBR
National Bank & Trust. This acquisition will increase our assets under
management by over $900 million to more than $1.7 billion, on which we will earn
base management fees at a rate in excess of 1%.
Industry Sector Focus
We began our business focused on the middle market financial services
sector, in particular thrifts and small banks. We extended sector coverage to
the related areas of real estate and non-depository institutions during 1994 to
1996. In 1996 we began to actively expand our sector coverage to industries with
significant growth potential and capital needs, that are less closely related to
the financial sector. In doing this, we have built our business in sectors that
we believe are somewhat counter-cyclical to each other, with some providing
active business opportunities to us when others are not. We are focused on four
broad industry sectors: financial institutions, real estate, technology and
energy. In the financial institutions sector, in March 2001, we opened an office
in Cleveland, Ohio to expand our coverage of middle market financial
institutions in the Mid-west. In the technology sector, we have broadened our
area of expertise to include the bio-technology and genomics industries. Like
our coverage of the Internet and related information technology industries,
these industries have a strong presence in the Washington, D.C. area where we
are headquartered. Also in March 2001, we opened an office in Dallas, Texas to
strengthen our presence in the energy sector. In March 2001 we also opened an
office in New York City.
Customer Base
The customer base of our brokerage business has historically been
primarily institutional, including large national institutions such as
well-known mutual fund complexes, as well as smaller, private investment pools.
We have built increased business from this existing base, and from new
institutional customers, by providing research, sales and trading in dedicated
teams by industry and by customer. We believe that this strategy allows us to
better serve the needs of our institutional customers, and is rewarded by
increased brokerage business from these institutions.
Starting in late 1997, we have also pursued a strategy of building our
client base of corporate and high net worth individuals through a specialized
private client group that offers brokerage and asset management services
specifically designed to meet the needs of corporate executives, major
shareholders, corporate investment offices, pension plans and foundations.
In early 1999, we completed our customer coverage by adding a retail group
for the first time. Our retail effort is entirely online, through our fbr.com
online investment bank, which we believe to be a much more efficient and
cost-effective platform to serve the needs of our retail customers than a retail
branch network of commission brokers.
Principal Investing
We invest in companies within our sectors of focus both as a partner with
our customers in the asset management vehicles that we manage, and as a direct
investor. We pursue this investing strategy to provide diversification of our
invested assets across industry sectors, and to invest strategically in sectors
and companies that can provide us with future business opportunities. As of the
end of 2000, our principal investments were primarily focused on three
sectors--Internet and related information technology, financial and real estate,
with a weighting towards Internet and related information technology investment
as a result of substantial appreciation in our managed technology venture
capital funds.
6
Strategic Relationships
PNC Bank Corp. ("PNC") owns slightly less than 5% of the outstanding
shares of FBR common stock as part of a strategic business relationship between
us and PNC with respect to selected capital markets and related activities. We
work with PNC on an arms-length basis to refer potential business to each other.
PNC is an investor in certain of our private equity, venture and proprietary
products.
PNC is one of the largest diversified financial services companies in the
United States. PNC offers a variety of financial products and services in its
primary geographic locations in Pennsylvania, New Jersey, Delaware, Ohio and
Kentucky and nationally through retail distribution networks and alternative
delivery channels.
We have built strategic relationships with other financial companies such
as Fidelity Investments initiated in August 1999 and Dawnay, Day, Lander, Ltd.,
a United Kingdom firm focused on capital finance and venture investing in the
Internet sector, initiated in January 2000.
We will continue to pursue strategic partnerships as part of our strategy
to strengthen our revenue sources by increasing our product offerings and
providing increased services to our customers. In addition, we may pursue joint
ventures or other business combinations or raise additional capital in order to
build our businesses. If we choose to raise additional capital, we may do so by
selling additional stock in or issuing debt of Friedman, Billings, Ramsey Group,
Inc. or by seeking investors or partners in one particular subsidiary or sector
of our businesses.
7
Capital Markets
Historically, we have derived the majority of our revenues from our
capital markets activities. We have maintained the strength of our investment
banking business in the financial services and real estate sector and expanded
our capabilities by adding research and investment banking personnel in areas
such as Internet and information technology and energy.
Our research activities and institutional sales and trading activities are
a part of our primary broker-dealer/investment banking subsidiary--FBRC. Our
underwriting and corporate finance activities consist of a broad range of
services, including public and private offerings of a wide variety of securities
and financial advisory services in mergers and acquisitions, mutual to stock
conversions, strategic partnering transactions and other advisory assignments.
Capital Raising Activities
Our capital raising activities include a wide range of securities,
structures and amounts. We are a leading underwriter of securities in our areas
of focus and are dedicated to the successful completion and aftermarket
performance of each underwriting transaction we execute. Our investment banking,
research, and sales and trading professionals work as a team to execute
successfully capital raising assignments.
Our strategy is to maintain long-term relationships with our corporate
clients by serving their capital needs beyond their initial access to capital
markets. We seek to increase our base of public company clients by serving as a
lead or co-manager or syndicate member in follow-on offerings for companies that
we believe have attractive investment characteristics, whether or not we
participated as a lead or co-manager in the IPOs for such companies.
Mergers and Acquisitions Advisory Services
Our mergers and acquisitions group uses the firm's research capability,
business valuation skills and secondary market experience to evaluate merger and
acquisition candidates and opportunities for our clients. We believe that our
research capacity and capital raising activities have created a network of
relationships that enables us to identify and engineer mutually beneficial
combinations between companies. As a financial adviser, we rely upon our
experience gained through in-depth and daily involvement in the capital markets.
Financial advisory services have included advice on mergers and on
acquisitions (including ongoing review of merger and acquisition opportunities),
market comparable performance analysis, advice on dividend policy, and
evaluation of stock repurchase programs. Since 1998, FBRC has provided merger
and acquisition and other advisory services in transactions valued at
$5.5 billion in the aggregate.
Research
A key part of our strategy is to support our businesses with specialized
and in-depth research. Our analysts cover a universe of over 370 companies in
our chosen industry sectors. We leverage the ideas generated by our research
teams across our entire organization, using them to attract underwriting and
institutional brokerage clients, to advise corporate finance clients, to inform
the direction of the various investment funds we advise or sponsor, and to
attract retail investors through fbr.com. We make almost all of our analyst's
research reports available online at fbr.com, making us one of the few
investment banks to allow the public direct access to its research product. In
addition, we increase our visibility to corporate clients and to investors by
holding annual investor conferences--each focused on a broad industry sector. In
2000, these conferences featured over 250 company presentations and drew more
than 1,300 attendees.
Our research analysts operate under two guiding principles: (i) to
identify undervalued investment opportunities in the capital markets and (ii) to
communicate effectively the fundamentals of these investment opportunities to
our investment banking and sales and trading professionals and to potential
investors. To achieve these objectives, we believe that industry specialization
is necessary, and, as a result, we organize our research staff along industry
lines. Each industry team works together to identify and evaluate industry
trends and developments. Within industry groups, analysts are further subdivided
into specific areas of focus so that they can maintain and apply specific
industry knowledge to each investment opportunity they address.
8
We have focused our research efforts in some of the fastest growing and
most rapidly changing sectors of the United States and world economies. These
sectors include Internet and information technology, electronic commerce,
telecommunications, bio-technology, genomics, financial technology, banks,
thrifts, real estate investment trusts, specialty finance companies and energy.
We believe that within these industry sectors there will be great demand for the
products and services we offer and this in turn will provide ample
diversification opportunities for our business.
After initiating coverage on a company, our analysts seek to maintain a
long-term relationship with that company and a long-term commitment to ensuring
that new developments are effectively communicated to our sales force and
institutional investors. We produce full-length research reports, notes or
earnings estimates on the companies we cover. In addition, our analysts
distribute written updates on these issuers both internally and to our clients
through the use of daily morning meeting notes, real-time electronic mail and
other forms of immediate communication. Our clients can also receive analyst
comments through our web site (www.fbr.com) and through electronic media,
including Multex and First Call.
Sales and Trading
FBRC and our United Kingdom subsidiary, Friedman, Billings, Ramsey
International Ltd., focus on institutional sales to and trading services for
equity and high-yield investors in the United States, Europe and elsewhere. We
execute securities transactions for institutional investors such as banks,
mutual funds, insurance companies, hedge funds, money managers and pension and
profit-sharing plans. Institutional investors normally purchase and sell
securities in large quantities, which requires special marketing and trading
expertise.
Our sales professionals provide services to a nationwide institutional
client base as well as to institutional clients in Europe and elsewhere. Sales
professionals work closely with our research analysts to provide the most up-
to-date information to our institutional clients. Our sales professionals are
organized into teams that focus on particular industry sectors in order to
facilitate the communication of in-depth information to our clients. Each team
maintains regular contact with our research staff and with the specialized
portfolio managers and buy-side analysts of each institutional client.
Our trading professionals facilitate trading in equity and high-yield
securities. We are involved in market-making in Nasdaq and other OTC securities,
trading listed securities and servicing the trading desks of major institutions
in the United States and Europe. Our trading professionals have direct access to
the major stock exchanges, including the New York Stock Exchange and the
American Stock Exchange through FBRC's clearing broker. At year-end 2000, FBRC
made a market in more than 400 securities.
Private Client Group
Since our inception in 1989, we have provided services to corporate
executives and small institutions, as well as to other sophisticated high net
worth clients. In late 1997, we formed the Private Client Group ("PCG") to focus
on the growth of this business for FBR's growing corporate client base. Given
our strong investment banking relationships with both public and private
companies, we believe that the executives of these companies form a natural
customer base for the PCG.
The PCG seeks to offer creative money management solutions and investment
ideas suited to high net worth individuals. Using a consultative approach, PCG
professionals research, interpret, evaluate and recommend sophisticated
investment strategies. PCG specializes in hedging and monetizing significant
equity positions. Additionally, PCG professionals are knowledgeable in various
aspects of the sale of restricted and control stocks, as well as the financing
of employee stock option exercises. Individuals who own restricted or control
stock receive PCG assistance with the complex regulations and paperwork required
to sell such securities. For individuals unable to sell positions, PCG offers a
number of strategies for preserving value in such assets, as well as the ability
to borrow funds at favorable rates to provide liquidity.
Online Financial Services
In April 1999, we opened a retail Internet securities distribution
channel, fbr.com, creating one of the world's first "online investment banks."
We account for fbr.com's operations in our online financial services segment
reporting. In addition to traditional online brokerage services such as low-cost
trades, quotes and news, fbr.com offers investors access to our own research and
the opportunity to participate in IPOs and secondary offerings in which we
participate as an underwriter. In addition, fbr.com offers online brokerage and
online access to a mutual fund supermarket with over 7,500 funds. fbr.com
currently has more than 16,000 registered users receiving offering alerts, about
30% of whom maintain accounts at fbr.com.
9
In January 2000, we launched Offering MarketplaceSM, the first service in
the industry that uses Internet browser based technology for automated customer
order capture, share allocation and order execution technologies to enable an
entire offering to be distributed online. In 2000, using Offering MarketplaceSM,
fbr.com participated in 38 public offerings.
Although fbr.com is not yet profitable on a stand-alone basis, we are
using its Internet presence across our capital markets business as part of our
strategy to leverage our strengths in research, underwriting and brokerage. We
believe that fbr.com's combination of proprietary products and services,
including its access to FBRC research, provides a cost effective way for us to
build our retail distribution network.
Asset Management
Since 1996, we have added specialized asset management capabilities, such
as private equity and technology and genomic venture capital, as part of an
effort to diversify our revenue stream and create additional revenue
opportunities by leveraging our unique research perspectives and our Washington,
D.C. location. In 2000, assets under management decreased by 7% from
$879 million at year-end 1999 to $820 million as of December 31, 2000, primarily
due to distributions to fund investors of $267 million from our successful FBR
Technology Venture Partners L.P. fund ("TVP I"). With the completion of our
acquisition of MMA in 2001, our assets under management will increase to
approximately $1.7 billion. Approximately 35% of our revenues for 2000 was
attributable to our asset management business.
The successful track record of our 1997 TVP I venture fund, which provides
early stage financing for non-public technology companies, allowed us to create
a second fund in 1999 ("TVP II") with $159.1 million of committed capital. In
2000, we launched two new technology funds, FBR Co-Motion Venture Capital L.L.C,
focused on non-public technology companies in the Pacific Northwest and ETP/FBR
Genomic Fund, L.P., focused on non-public genomics companies, primarily in the
Washington, D.C. area.
In March 2001, we received regulatory approval to acquire MMA and its
savings bank subsidiary, Rushmore. The acquisition will close at the end of
March 2001. We believe that this acquisition will allow us to provide a broader
array of asset management services and products to our clients. MMA had
approximately $965 million of assets under management as of December 31, 2000,
including fixed income mutual funds and cash management accounts that are
complementary to our more specialized asset management product offerings. MMA is
the investment adviser or administrator for 20 mutual funds. Rushmore, which
upon closing will become FBR National Bank, a federally chartered bank, brings
traditional banking services to our product offering (e.g., lending, deposits,
cash management, trust, transfer agency and custody services).
We use the expertise of our research professionals and portfolio managers
to develop and implement investment products for institutional and high net
worth individual investors. Following is a description of our primary asset
management products.
Venture Capital/Private Equity Funds Type of Investment Year Commenced
------------------------------------ ------------------ --------------
FBR Private Equity Fund, L.P. Private equity/mezzanine financing up to $3million 1996
("PEF")
FBR Technology Venture Partners, Pre-IPO stage financings of $1-4 million 1997
L.P. ("TVP I")
FBR Financial Services Partners, L.P. Financial services private equity 1998
("Financial Services")
FBR Technology Venture Partners II, Pre-IPO stage financings of $2-10 million 1999
L.P. ("TVP II")
FBR CoMotion Venture Capital L.L.C. Pre-IPO stage financings of $1-4 million 2000
("Co-Motion")
ETP/FBR Genomic, L.P. ("Genomic") Pre-IPO stage financings of $1-4 million 2000
Investment Partnerships Focused on
Public Equity
- -----------------------------------
FBR Weston, L.P. Long-term opportunistic 1989
10
FBR Ashton, L.P. Financial equities 1992
FBR Opportunity Fund,Ltd. Financial equities offshore 1995
FBR Arbitrage, LLC Merger/special situation arbitrage 1998
Mutual Funds
- -------------
FBR Family of Funds Mutual Funds 1997
REIT
- ----
FBR Asset Investment Corp. Real estate related investments 1997
Private Equity and Venture Capital Funds
At December 31, 2000, our private equity and venture capital funds had
$417.3 million in assets under management, a 13% decrease over December 31,
1999, due primarily to distributions made during 2000 to investors in TVP I. In
addition to base fees, these funds provide for incentive income (generally, 20%
of the net investment gains), if certain benchmarks are met.
11
The following table shows our assets under management, capital committed
and current capital employed for our private equity and venture capital funds at
December 31, 2000 (dollars in millions):
Assets Under Capital Current Capital
Fund Management Commitments Employed
---- ------------ ----------- --------------------
Cost Value
------ ------
TVP I .............. $109.0 $ 50.0 $ 27.2 $108.6
TVP II ............. 159.1 159.1 96.8 116.5
PEF ................ 19.5 19.9 13.0 18.5
Financial Services.. 82.4 82.4 50.1 49.0
Co-Motion .......... 38.0 38.0 20.3 20.7
Other .............. 9.3 4.7 4.7 9.7
------ ------ ------ ------
Total ......... $417.3 $354.1 $212.1 $323.0
====== ====== ====== ======
Asset Composition Cost Value
----------------- ------ ------
Public Securities... $ 29.8 $101.2
Private Investment.. 182.3 221.8
------ ------
Total ......... $212.1 $323.0
====== ======
At December 31, 2000, our investment partnerships focused on private
equity had approximately $111.2 million under management. In addition to base
fees, these partnerships provide for incentive income, if certain benchmarks
are met.
Mutual Funds
The FBR Family of Funds, an open-end management type investment company
registered under the Investment Company Act of 1940, began business in 1997 and
currently is comprised of four no-load funds: the FBR Financial Services Fund,
the FBR Small Cap Financial Services Fund and the FBR Small Cap Growth/Value
Fund . At December 31, 2000, total assets managed in The FBR Family of Funds
were $119.0 million.
FBR Asset Investment Corp.
FBR Asset Investment Corp. (FBR-Asset) is a publicly traded real estate
investment trust (FB-AMEX) that we manage and which is 35% owned by us. FBR-
Asset invests in real estate related assets, including mortgage loans and
mortgage-backed securities, as well as equity securities of companies engaged in
real estate-related activities. At December 31, 2000, FBR-Asset had total assets
of $226 million, shareholders' equity of $87 million and book value of $22 per
share. We receive dividend income on our investment in FBR-Asset, as well as
base management fees, and are entitled to receive performance based incentive
income if certain performance benchmarks are met.
Accounting, Administration and Operations
Our accounting, administration and operations personnel are responsible
for financial controls, internal and external financial reporting, office and
personnel services, management information and telecommunications systems, and
the processing of securities transactions. With the exception of payroll
processing, which is performed by an outside service bureau, and customer
account processing, which is performed by our clearing brokers, most data
processing functions are performed by our management information systems
department. We believe that future growth will require implementation of new and
enhanced communications and information systems and training of our personnel to
operate such systems, as well as the hiring of additional personnel.
Competition
We are engaged in the highly competitive financial services and investment
industries. We compete directly with large Wall Street securities firms,
securities subsidiaries of major commercial bank holding companies, U.S.
subsidiaries of large foreign institutions, major regional firms, venture
capital firms and smaller niche players, and those offering competitive services
via the
12
Internet. To an increasing degree, we also compete for various segments of the
financial services business with other institutions, such as commercial banks,
savings institutions, mutual fund companies, life insurance companies and
financial planning firms.
In addition to competing for customers and investments, companies in the
financial services and investment industries compete to attract and retain
experienced and productive investment professionals. See "Factors Affecting the
Our Business, Operations and Financial Condition--Competition for Retaining and
Recruiting Personnel."
Many competitors have greater personnel and financial resources than we
do. Larger competitors are able to advertise their products and services on a
national or regional basis and may have a greater number and variety of
distribution outlets for their products, including retail distribution. Discount
and Internet brokerage firms market their services through aggressive pricing
and promotional efforts. In addition, some competitors have much more extensive
investment banking activities than we do and therefore, may possess a relative
advantage with regard to access to deal flow and capital. Some of our venture
capital competitors have been established for a longer period of time and have
more established relationships, which may give them greater access to deal flow
and to capital.
Recent rapid advancements in computing and communications technology,
particularly the Internet, are substantially changing the means by which
financial services are delivered. These changes are providing consumers with
more direct access to a wide variety of financial and investment services,
including market information and on-line trading and account information.
Advancements in technology also create demand for more sophisticated levels of
client services. We are committed to using technological advancements to provide
a high level of client service to our target markets. Provision of these
services may entail considerable cost without an offsetting source of revenue.
For a further discussion of the competitive factors affecting our
business, see "Factors Affecting Our Business, Operating Results and Financial
Condition".
Risk Management
We have established various policies and procedures for the management of
our exposure across all of our businesses to operating, principal and credit
risk. There can be no assurance that our risk management procedures and internal
controls will prevent or reduce any such risks. Operating risk arises out of the
daily conduct of our business and relates to the possibility that one or more of
our employees could engage in an imprudent business activity that adversely
impacts us. Principal risk relates to the fact that we hold securities, directly
and through entities that we manage and in which we invest, that are subject to
changes in value, and such changes could result in our incurring material
losses. Credit risk occurs because we extend credit through our clearing brokers
to various of our customers in the form of margin and other types of loan
activities, such as subordinated and mezzanine loans.
Operating risk is monitored at the holding company level and by business
group managers, and by the directors of each of our operating subsidiaries.
These directors review the overall business activities of each of our
subsidiaries, and issue directions to address issues which, in the judgment of
the directors, could result in material losses.
Principal risk is monitored at the holding company and at the operating
subsidiary level is managed primarily by conducting real-time monitoring of the
amount and types of securities that we hold from time to time and by limiting
our exposure to any one investment or type of investment. The most common
categories of securities owned are those related to the daily trading activities
of our brokerage operations and those which arise out of our underwriting, asset
management, venture capital and mezzanine financing activities and other
securities held for investment and available for sale. We attempt to limit our
exposure to market risk on securities held as a result of our daily trading
activities by limiting our inventory of trading securities to the amount needed
to provide the appropriate level of liquidity in the securities for which we are
a market maker.
Credit risk for our broker-dealer operations is monitored both by our
operations personnel and by our clearing brokers. Margin calls are issued if the
value of collateral declines below established margin requirements, and margin
maintenance requirements are increased in the event that the concentration in a
client's account exceeds certain levels. Credit risk for subordinated and
mezzanine loans are monitored by the portfolio managers assigned to the loans.
Regulation
In the United States, a number of federal regulatory agencies are charged
with safeguarding the integrity of the securities and other financial markets
and with protecting the interests of customers participating in those markets.
The Securities and Exchange
13
Commission ("SEC") is the federal agency that is primarily responsible for the
regulation of broker-dealers and investment advisers doing business in the
United States, and the Federal Reserve Board promulgates regulations applicable
to securities credit (margin) transactions involving broker-dealers and certain
other institutions in the United States. Much of the regulation of
broker-dealers has been delegated to self-regulatory organizations ("SROs"),
principally the NASD (and its subsidiaries NASD Regulation, Inc. and the Nasdaq
Stock Market ("Nasdaq")), and the national securities exchanges. These
organizations (which are subject to oversight by the SEC) that govern the
industry, monitor daily activity and conduct periodic examinations of member
broker-dealers. While FBRC and our other broker-dealer subsidiaries are not
members of the New York Stock Exchange ("NYSE"), our business is impacted by the
exchange's rules and our Class A common stock is listed for trading on the NYSE.
Securities firms are also subject to regulation by state securities
commissions in the states in which they are required to be registered. FBRC is
registered as a broker-dealer with the SEC and in 49 states, Puerto Rico and the
District of Columbia, and is a member of, and subject to regulation by the NASD
and the Municipal Securities Rulemaking Board. FBRIS is registered as a broker-
dealer with the SEC and in all 50 states, Puerto Rico and the District of
Columbia; it is a member of the NASD.
As a result of federal and state registration and SRO memberships, FBRC
and FBRIS are subject to overlapping schemes of regulation which cover all
aspects of their securities businesses. Such regulations cover matters including
capital requirements, uses and safe-keeping of clients' funds, conduct of
directors, officers and employees, record-keeping and reporting requirements,
supervisory and organizational procedures intended to assure compliance with
securities laws and to prevent improper trading on material nonpublic
information, employee- related matters, including qualification and licensing of
supervisory and sales personnel, limitations on extensions of credit in
securities transactions, clearance and settlement procedures, requirements for
the registration, underwriting, sale and distribution of securities, and rules
of the SROs designed to promote high standards of commercial honor and just and
equitable principles of trade. A particular focus of the applicable regulations
concerns the relationship between broker-dealers and their customers. As a
result, many aspects of the broker-dealer customer relationship are subject to
regulation including, in some instances, "suitability" determinations as to
certain customer transactions, limitations on the amounts that may be charged to
customers, timing of proprietary trading in relation to customers' trades and
disclosures to customers.
FBRC and FBRIS are also subject to "Risk Assessment Rules" imposed by the
SEC which require, among other things, that certain broker-dealers maintain and
preserve certain information, describe risk management policies and procedures
and report on the financial condition of certain affiliates whose financial and
securities activities are reasonably likely to have a material impact on the
financial and operational condition of the broker-dealers. Certain "Material
Associated Persons" (as defined in the Risk Assessment Rules) of the broker-
dealers and the activities conducted by such Material Associated Persons may
also be subject to regulation by the SEC. In addition, the possibility exists
that, on the basis of the information it obtains under the Risk Assessment
Rules, the SEC could seek authority over our unregulated subsidiaries either
directly or through its existing authority over our regulated subsidiaries.
Three of our asset management subsidiaries are registered as investment
advisers with the SEC. As investment advisers registered with the SEC, they are
subject to the requirements of the Investment Advisers Act of 1940 and the SEC's
regulations thereunder. Such requirements relate to, among other things,
limitations on the ability of investment advisers to charge performance-based or
non-refundable fees to clients, record-keeping and reporting requirements,
disclosure requirements, limitations on principal transactions between an
adviser or its affiliates and advisory clients, as well as general anti-fraud
prohibitions. They may also be subject to certain state securities laws and
regulations. The state securities law requirements applicable to registered
investment advisers are in certain cases more comprehensive than those imposed
under the federal securities laws. In addition, FBR Fund Advisers, Inc. and the
mutual funds it manages are subject to the requirements of the Investment
Company Act of 1940 and the SEC's regulations thereunder.
In the event of non-compliance by us or one of our subsidiaries with an
applicable regulation, governmental regulators and one or more of the SROs may
institute administrative or judicial proceedings that may result in censure,
fine, civil penalties (including treble damages in the case of insider trading
violations), the issuance of cease-and-desist orders, the deregistration or
suspension of the non-compliant broker-dealer or investment adviser, the
suspension or disqualification of officers or employees or other adverse
consequences. The imposition of any such penalties or orders on us or our
personnel could have a material adverse effect on our operating results and
financial condition.
Our business is also subject to regulation by various foreign governments
and regulatory bodies. FBRC is registered with and subject to regulation by the
Ontario Securities Commission in Canada. Friedman, Billings, Ramsey
International, Ltd. ("FBRIL"), our United Kingdom brokerage subsidiary, is
subject to regulation by the Securities and Futures Authority in the United
Kingdom ("SFA") pursuant to the United Kingdom Financial Services Act of 1986.
Foreign regulation may govern all aspects of the investment business, including
regulatory capital, sales and trading practices, use and safekeeping of customer
funds and
14
securities, record-keeping, margin practices and procedures, registration
standards for individuals, periodic reporting and settlement procedures.
In connection with much of our asset management activities, we, and the
private investment vehicles that we manage, are relying on exemptions from
registration under the Investment Company Act of 1940, and under certain state
securities laws and the laws of various foreign countries. Failure to comply
with the initial and continuing requirements of any such exemptions could have a
material adverse effect on the manner in which we and these vehicles carry on
their activities.
Additional legislation and regulations, including those relating to the
activities of broker-dealers and investment advisers, changes in rules
promulgated by the SEC or other United States or foreign governmental regulatory
authorities and SROs or changes in the interpretation or enforcement of existing
laws and rules may adversely affect our manner of operation and our
profitability. Our businesses may be materially affected not only by regulations
applicable to us as a financial market intermediary, but also by regulations of
general application. For example, the volume of our underwriting, merger and
acquisition, securities trading and asset management activities in any year
could be affected by, among other things, existing and proposed tax legislation,
antitrust policy and other governmental regulations and policies (including the
interest rate policies of the Federal Reserve Board) and changes in
interpretation or enforcement of existing laws and rules that affect the
business and financial communities.
Net Capital Requirements
As broker-dealers registered with the SEC and as member firms of the NASD,
FBRC and FBRIS are subject to the net capital requirements of the SEC and the
NASD. FBRIL is subject to the capital regulations of the SFA. These capital
requirements specify minimum levels of capital, computed in accordance with
regulatory requirements, that each firm is required to maintain and also limit
the amount of leverage that each firm is able to obtain in its respective
business.
"Net capital" is essentially defined as net worth (assets minus
liabilities, as determined under generally accepted accounting principles), plus
qualifying subordinated borrowings, less the value of all of a broker-dealer's
assets that are not readily convertible into cash (such as furniture, prepaid
expenses and unsecured receivables), and further reduced by certain percentages
(commonly called "haircuts") of the market value of a broker-dealer's positions
in securities and other financial instruments. The amount of net capital in
excess of the regulatory minimum is referred to as "excess net capital."
The SEC's capital rules also (i) require that broker-dealers notify it, in
writing, two business days prior to making withdrawals or other distributions of
equity capital or lending money to certain related persons if those withdrawals
would exceed, in any 30-day period, 30% of the broker-dealer's excess net
capital, and that they provide such notice within two business days after any
such withdrawal or loan that would exceed, in any 30-day period, 20% of the
broker-dealer's excess net capital, (ii) prohibit a broker-dealer from
withdrawing or otherwise distributing equity capital or making related party
loans if, after such distribution or loan, the broker-dealer would have net
capital of less than $300,000 or if the aggregate indebtedness of the broker-
dealer's consolidated entities would exceed 1,000% of the broker-dealer's net
capital and in certain other circumstances, and (iii) provide that the SEC may,
by order, prohibit withdrawals of capital from a broker-dealer for a period of
up to 20 business days, if the withdrawals would exceed, in any 30-day period,
30% of the broker-dealer's excess net capital and if the SEC believes such
withdrawals would be detrimental to the financial integrity of the firm or would
unduly jeopardize the broker-dealer's ability to pay its customer claims or
other liabilities.
Compliance with regulatory net capital requirements could limit those
operations that require the intensive use of capital, such as underwriting and
trading activities, and also could restrict our ability to withdraw capital from
our affiliated broker-dealers, which in turn could limit our ability to pay
dividends, repay debt and redeem or repurchase shares of our outstanding capital
stock.
We believe that at all times FBRC and FBRIS have been in compliance in all
material respects with the applicable minimum net capital rules of the SEC and
the NASD and that FBRIL has been in compliance in all material respects with the
applicable minimum net capital rules of the SFA.
A failure of a broker-dealer to maintain its minimum required net capital
would require it to cease executing customer transactions until it came back
into compliance, and could cause it to lose its NASD membership, its
registration with the SEC or require its liquidation. Further, the decline in a
broker-dealer's net capital below certain "early warning levels," even though
above minimum net capital requirements, could cause material adverse
consequences to the broker-dealer and to us.
15
Regulation As a Result of Acquisition of MMA and Rushmore
Supervision and Regulation
As noted above, in March 2001 we received regulatory approval to acquire
MMA and Rushmore. MMA is a privately-held investment adviser and is also the
holding company for Rushmore, a federally chartered and federally insured
savings bank. The transaction will close at the end of March, at which time,
Rushmore will be converted into a national bank. We will then become a bank
holding company regulated under the Bank Holding Company Act of 1956, as amended
(the "BHC Act") and a financial holding company under the Gramm-Leach-Bliley
Act, or GLB Act that was enacted in 1999.
Upon closing of the transaction, we will be subject to supervision,
regulation and examination by federal banking regulatory agencies. The following
description summarizes the significant laws to which we and Rushmore will be
subject upon consummation of the acquisition.
The GLB Act significantly changed the regulatory structure and oversight
of the financial services industry. The GLB Act amended the BHC Act to permit a
qualifying bank holding company, called a financial holding company (an "FHC"),
to engage in a full range of financial activities, including banking, insurance,
and securities activities, as well as merchant banking and additional activities
that are "financial in nature" or "incidental" to such financial activities. In
order for a bank holding company to qualify as an FHC, all its subsidiary
depository institutions must be "well-capitalized" and "well- managed" and must
also maintain at least a "satisfactory" rating under the Community Reinvestment
Act. In March 2001, the Federal Reserve Board (the "Board") approved our
application to be a FHC and we are now permitted to engage in financial
activities as permitted by the BHC Act, as amended. Under the GLB Act, the Board
serves as the "umbrella" regulator for FHCs and has the power to supervise,
regulate and examine FHCs and their non-banking affiliates, subject to statutory
functional regulation provisions.
In general, the BHC Act and other federal laws subject all bank holding
companies, including FHC's, to restrictions on the types of activities in which
they may engage, and to a range of supervisory requirements and activities,
including regulatory enforcement actions for violations of laws and regulations.
As noted above, the GLB Act eliminated the barriers to affiliations among banks,
securities firms, insurance companies and other financial service providers, but
does not generally permit a FHC to engage in any non-financial activity. It
permits bank holding companies to become FHCs, to affiliate with securities
firms and insurance companies, and to engage in other activities that are
financial in nature.
Upon completion of the acquisition of Rushmore, we will convert Rushmore
into a national bank. National banks are subject to supervision and regulation
by the Office of the Comptroller of Currency ("OCC"). Because the Board will
regulate the FHC parent of Rushmore, the Board also has supervisory authority
that may affect Rushmore.
Regulatory Restrictions on Dividends; Source of Strength
It is the policy of the Board that bank holding companies should pay cash
dividends on common stock only out of income available over the past year and
only if prospective earnings retention is consistent with the organization's
expected future needs and financial condition. The policy provides that bank
holding companies should not maintain a level of cash dividends that undermines
the bank holding company's ability to serve as a source of strength to its
banking subsidiaries.
Under Board policy, a bank holding company is expected to act as a source
of financial strength to each of its banking subsidiaries and commit resources
to their support. Such support may be required at times when, absent this Board
policy, a holding company may not be inclined to provide it. As discussed below,
a bank holding company in certain circumstances could be required to guarantee
the capital plan of an undercapitalized banking subsidiary.
In the event of a bank holding company's bankruptcy under Chapter 11 of
the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is
required to cure immediately any deficit under any commitment by the debtor
holding company to any of the federal banking agencies to maintain the capital
of an insured depository institution, and any claim for breach of such
obligation will generally have priority over most other unsecured claims.
Safe and Sound Banking Practices
Bank holding companies are not permitted to engage in unsafe and unsound
banking practices. The Board's Regulation Y, for example, generally requires a
holding company to give the Board prior notice of any redemption or repurchase
of its own equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding
16
year,is equal to 10% or more of the holding company's consolidated net worth.
The Board may oppose the transaction if it believes that the transaction would
constitute an unsafe or unsound practice or would violate any law or regulation.
Depending upon the circumstances, the Board could take the position that paying
a dividend would constitute an unsafe or unsound banking practice.
The Board has broad authority to prohibit activities of bank holding
companies and their non-banking subsidiaries which represent unsafe and unsound
banking practices or which constitute violations of laws or regulations, and can
assess civil money penalties for certain activities conducted on a knowing and
reckless basis, if those activities caused a substantial loss to a depository
institution.
Anti-Tying Restrictions
Bank holding companies and their affiliates are prohibited from tying the
provision of certain services, such as extensions of credit, to other services
offered by a holding company or its affiliates.
Capital Adequacy Requirements
The Board has adopted a system using risk-based capital guidelines to
evaluate the capital adequacy of bank holding companies. Under the guidelines,
specific categories of assets are assigned different risk weights, based
generally on the perceived credit risk of the asset. These risk weights are
multiplied by corresponding asset balances to determine a "risk-weighted" asset
base. The guidelines require a minimum total risk-based capital ratio of 8.0%
(of which at least 4.0% is required to consist of Tier 1 capital elements).
Total capital is the sum of Tier 1 and Tier 2 capital.
In addition to the risk-based capital guidelines, the Board uses a
leverage ratio as an additional tool to evaluate the capital adequacy of bank
holding companies. The leverage ratio is a company's Tier 1 capital divided by
its average total consolidated assets. Certain highly-rated bank holding
companies may maintain a minimum leverage ratio of 3.0%, but other bank holding
companies may be required to maintain a leverage ratio of up to 200 basis points
above the regulatory minimum.
The OCC has also adopted regulations establishing minimum requirements for
the capital adequacy of national banks. The OCC's risk-based capital guidelines
parallel the Board's requirements for bank holding companies. As discussed
above, for us to qualify for FHC status, Rushmore must be continuously "well
capitalized" under OCC regulations: it must have at a minimum a total risk-based
capital ratio of 10%, a Tier I capital ratio of 6%, and a leverage capital ratio
of 5%.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Board guidelines also provide that banking organizations experiencing internal
growth or making acquisitions will be expected to maintain strong capital
positions substantially above the minimum supervisory levels, without
significant reliance on intangible assets. As discussed above, failure of
Rushmore to maintain capital significantly in excess of these minimum ratios
will jeopardize our status as a FHC and may lead to restrictions on activities
that would adversely affect our business.
Imposition of Liability for Undercapitalized Subsidiaries
Bank regulators are required to take "prompt corrective action" to resolve
problems associated with insured depository institutions whose capital declines
below certain levels. In the event an institution becomes "undercapitalized," it
must submit a capital restoration plan. The capital restoration plan will not be
accepted by the regulators unless each company having control of the
undercapitalized subsidiary guarantees the subsidiary's compliance with the
capital restoration plan up to a certain specified amount. Any such guarantee
from a depository institution's holding company is entitled to a priority of
payment in bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank
is limited to the lesser of 5% of the institution's assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically" undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to
17
obtain prior Board approval of proposed dividends, or might be required to
consent to a consolidation or to divest the troubled institution or other
affiliates.
Acquisitions by Bank Holding Companies of Banks
The BHC Act requires every bank holding company to obtain the prior
approval of the Board before it may acquire all or substantially all of the
assets of any bank, or ownership or control of any voting shares of any bank, if
after such acquisition it would own or control, directly or indirectly, more
than 5% of the voting shares of such bank. In approving bank acquisitions by
bank holding companies, the Board is required to consider the financial and
managerial resources and future prospects of the bank holding company and the
banks concerned, the convenience and needs of the communities to be served, and
various competitive factors.
Control Acquisitions
The Change in Bank Control Act prohibits a person or group of persons from
acquiring "control" of a bank holding company unless the Board has been notified
and has not objected to the transaction. Under a rebuttable presumption
established by the Board, the acquisition of 10% or more of a class of voting
stock of a bank holding company with a class of securities registered under
Section 12 of the Exchange Act would, under the circumstances set forth in the
presumption, constitute acquisition of control of a bank holding company.
In addition, any company is required to obtain the prior approval of the
Board under the BHC Act before acquiring 25% (5% in the case of an acquirer that
is a bank holding company) or more of any class of outstanding voting stock of a
bank holding company, having a majority of its Board of Directors, or otherwise
obtaining control or exercising a "controlling influence" over a bank holding
company.
Restrictions on Transactions with Affiliates and Insiders
Transactions between a bank holding company and its non-banking
subsidiaries are subject to Section 23A of the Federal Reserve Act. In general,
Section 23A imposes limits on the amount of such transactions, and also requires
certain levels of collateral for loans to affiliated parties. It also limits the
amount of advances to third parties, which are collateralized by the securities
or obligations of the holding company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal
Reserve Act which generally requires that certain transactions between a bank
and its affiliates be on terms substantially the same, or at least as favorable
to the bank, as those prevailing at the time for comparable transactions with or
involving nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and regulations apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the appropriate federal
regulator may determine that a lesser amount is appropriate. Insiders are
subject to enforcement actions for knowingly accepting loans in violation of
applicable restrictions.
Restrictions on Distribution of Subsidiary Bank Dividends and Assets
Capital adequacy requirements serve to limit the amount of dividends that
may be paid by a bank. Under federal law, a bank cannot pay a dividend if, after
paying the dividend, the bank will be "undercapitalized." The OCC may declare a
dividend payment to be unsafe and unsound even though the bank would continue to
meet its capital requirements after the dividend.
Because a bank holding company is a legal entity separate and distinct
from its subsidiaries, its right to participate in the distribution of assets of
any subsidiary upon the subsidiary's liquidation or reorganization will be
subject to the prior claims of the subsidiary's creditors. In the event of a
liquidation or other resolution of an insured depository institution, the claims
of depositors and other general or subordinated creditors are entitled to a
priority of payment over the claims of holders of any obligation of the
institution to its shareholders, including any depository institution holding
company or any shareholder or creditor thereof.
18
Examinations
The OCC periodically examines and evaluates insured national banks. Based
upon such an evaluation, the OCC may revalue the assets of the institution and
require that it establish specific reserves to compensate for the difference
between the examination-determined value and the book value of such assets.
Deposit Insurance Assessments
Rushmore will be required to pay assessments to the Federal Deposit
Insurance Corporation ("FDIC") for federal deposit insurance protection. The
FDIC has adopted a risk-based assessment system, under which FDIC-insured
depository institutions pay insurance premiums at rates based on their risk
classification
Enforcement Powers
The OCC and the other federal banking agencies have broad enforcement
powers, including the power to terminate deposit insurance, impose substantial
fines and other civil and criminal penalties and appoint a conservator or
receiver. Failure to comply with applicable laws, regulations and supervisory
agreements could subject us or Rushmore, as well as officers, directors and
other institution-affiliated parties of these organizations, to administrative
sanctions and potentially substantial civil money penalties. The appropriate
federal banking agency may appoint the FDIC as conservator or receiver for a
banking institution if any one or more of a number of circumstances exist,
including, without limitation, the fact that the banking institution is
undercapitalized and has no reasonable prospect of becoming adequately
capitalized; fails to become adequately capitalized when required to do so;
fails to submit a timely and acceptable capital restoration plan; or materially
fails to implement an accepted capital restoration plan. The OCC will also have
broad enforcement powers over Rushmore, including the power to impose orders,
remove officers and directors, impose fines and appoint supervisors and
conservators.
Community Reinvestment Act
The Community Reinvestment Act and the regulations issued thereunder are
intended to encourage insured depository institutions to help meet the credit
needs of their service area, including low and moderate income neighborhoods,
consistent with the safe and sound operations of the banks. These regulations
also provide for regulatory assessment of a bank's record in meeting the needs
of its service area when considering applications to establish branches, merger
applications and applications to acquire the assets and assume the liabilities
of another bank. Under the GLB Act, in order for an FHC to engage in new
financial activities, or to acquire, directly or indirectly, a company engaged
in new financial activities, its subsidiary insured depository institutions must
maintain at least a satisfactory rating under the CRA.
Consumer Laws and Regulations
In addition to the laws and regulations discussed herein, Rushmore is
subject to certain consumer laws and regulations that are designed to protect
consumers in transactions with banks. While the list set forth herein is not
exhaustive, these laws and regulations include the Truth in Lending Act, the
Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds
Availability Act, the Equal Credit Opportunity Act, and the Fair Housing Act,
among others. In addition, the GLB Act imposes extensive privacy requirements
applicable to all financial institutions. These laws and regulations impose
certain disclosure requirements and regulate the manner in which financial
institutions must deal with nonpublic personal information of consumers and
consumer customers in connection with offering and providing financial services.
Factors Affecting Our Business, Operating Results and Financial Condition
We are adversely affected by the general risks of the investment business
The financial and investment business is, by its nature, subject to
numerous and substantial risks, particularly in volatile or illiquid markets,
and in markets influenced by sustained periods of low or negative economic
growth. As a financial and investment firm, our operating results are adversely
affected by a number of factors, which include:
19
o the risk of losses resulting from the ownership or underwriting of
securities;
o the risks of trading securities for ourselves (i.e., principal
activities) and for our customers;
o reduced cash inflows from investors into our venture capital and
asset management businesses;
o the risk of losses from lending to small, privately-owned companies;
o counterparty failure to meet commitments;
o customer default and fraud;
o customer complaints;
o employee errors, misconduct and fraud (including unauthorized
transactions by traders);
o failures in connection with the processing of securities
transactions;
o litigation and arbitration;
o the risks of reduced revenues in periods of reduced demand for
public offerings or reduced activity in the secondary markets; and
o the risk of reduced fees we receive for selling securities on behalf
of our customers (i.e., underwriting spreads).
We may experience significant losses if the value of our principal, trading and
investment activities, or the value of our venture capital funds' investments,
deteriorates.
From time to time in connection with our underwriting, asset management
and venture capital activities, we own large amounts, or have commitments to
purchase large amounts, of the securities of companies. This ownership subjects
us to significant risks.
We conduct our securities trading, market-making and investment activities
primarily for our own account, which subjects our capital to significant risks.
These risks include market, credit, leverage, real estate, counterparty and
liquidity risks, which could result in losses for us. These activities often
involve the purchase, sale or short sale of securities as principal in markets
that may be characterized as relatively illiquid or that may be particularly
susceptible to rapid fluctuations in liquidity and price.
In addition, at December 31, 2000, our three technology venture funds
valued their investments in their portfolio companies at approximately $245.7
million. These companies are primarily Internet, information technology and
genomics companies, the valuations of which are extremely volatile. Since these
are largely private companies, their securities are illiquid and we would
generally not be able to sell them except as part of or after an initial public
offering or in connection with the sale of a portfolio company. General market
conditions affecting the Internet, information technology and genomics sectors
or conditions inherent in the companies themselves, could cause a drop in their
valuations and lead to losses for us before we have an opportunity to lock in
gains through the sale of their securities.
We experience reduced revenues during periods of declining prices or reduced
demand for public offerings and merger and acquisition transactions or reduced
activity in the secondary markets in sectors on which we focus.
Our revenues are likely to be lower during periods of declining prices or
inactivity in the markets for securities of companies in the sectors in which we
are focused. These markets have historically experienced significant volatility
not only in the number and size of equity offerings and merger and acquisition
transactions, but also in the aftermarket trading volume and prices of
securities.
In particular, Internet and information technology company stocks, which
are an area of focus in both our venture capital and investment banking
activities, are extremely volatile. During 2000, our revenues were favorably
affected by an increase in the value of the securities, based on current market
prices, in our venture capital investment portfolio. As a result, a decrease in
the
20
stock prices of Internet and information technology companies would lead to a
reduction in the value of securities owned by us and to a significant decrease
in our revenues, which could adversely affect the price of our stock. In
addition, since we anticipate that a substantial portion of our returns from
venture capital investments will be realized through initial public offerings of
our portfolio companies, a decrease in the number of underwritten transactions
in the technology sector, particularly of initial public offerings, could
significantly hinder our ability to realize such returns. Returns may also be
realized through sales of portfolio companies, which are dependent on the
availability of strategic or financial acquirers. Acquirers may be unavailable
or available only at unattractive prices during economic downturns or periods of
declining prices in the technology sector.
A significant amount of our revenues historically has resulted from
underwritten transactions by companies in our targeted industries, from
aftermarket trading for such companies, and from proprietary investments and
fees and incentive income received from assets under management. Underwriting
activities in our targeted industries can decline for a number of reasons
including increased competition for underwriting business or periods of market
uncertainty caused by concerns over inflation, rising interest rates or related
issues. For example, during the second half of 1998, the market for equity
offerings deteriorated and the market prices of many of the securities which we
had underwritten and made a market in, and securities in which we and our asset
management vehicles were invested in, were subject to considerable volatility
and declines in price. These factors led to a significant reduction in
underwriting revenues, to significant market making losses for us, and to a
significant reduction in the stream of fees received from our asset management
vehicles. Venture capital, underwriting, brokerage and asset management
activities can also be materially adversely affected for a company or industry
segment by disappointments in quarterly performance relative to analysts'
expectations or by changes in long-term prospects.
We experience reduced revenues due to economic, political and market conditions
Reductions in public offering, merger and acquisition, portfolio company
valuation and securities trading activities, due to any one or more changes in
economic, political or market conditions could cause our revenues from
investment banking, venture capital, trading, lending, sales and asset
management activities to decline materially. Many national and international
factors affect the amount and profitability of these activities, including:
o economic, political and market conditions;
o level and volatility of interest rates;
o legislative and regulatory changes;
o currency values;
o inflation;
o flows of funds into and out of mutual funds, pension funds and
venture
o capital funds; and
o availability of short-term and long-term funding and capital.
For example, in 2000, concerns about earnings of companies in the
technology sector of the United States economy led to increased volatility and,
in the second half of 2000, a decline in the Nasdaq. This decline has adversely
affected underwriting and securities trading activity in the technology sector
in the United States.
In addition, we have organized, and will continue to organize, regional
venture capital funds in Northern Virginia and other regions. Any of these
regions may be affected by severe economic downturns or lack of growth, which
could have an adverse effect on the availability and profitability of
investments in the region.
We experience reduced revenues due to declining market volume, price and
liquidity, which can also cause counterparties to fail to perform
Our revenues may decrease in the event of a decline in the market volume
of securities transactions, prices or liquidity. Declines in the volume of
securities transactions and in market liquidity generally result in lower
revenues from trading activities and commissions. Lower price levels of
securities may also result in a reduced volume of underwriting transactions, and
could
21
cause a reduction in our revenues from corporate finance fees, as well as losses
from declines in the market value of securities held by us in trading and other
investment, venture capital, lending and underwriting positions, reduced asset
management fees and incentive income and withdrawals of funds under management.
Sudden sharp declines in market values of securities can result in illiquid
markets and the failure of issuers and counterparties to perform their
obligations, as well as increases in claims and litigation, including
arbitration claims from customers. In such markets, we have incurred, and may
incur in the future, reduced revenues or losses in our principal trading,
market-making, investment banking, venture capital, lending and asset management
activities.
We may incur losses as a result of our venture capital activities.
Our venture capital funds' investments are generally in technology
companies in the early stages of their development. Our business and prospects
must be considered in light of the risks, expenses and difficulties frequently
encountered by companies in early stages of development, particularly companies
in new and rapidly evolving markets. Moreover, our venture funds invest
primarily in privately held companies as to which little public information is
available. Accordingly, we depend on our venture capital managers to obtain
adequate information to evaluate the potential returns from investing in these
companies. Fund managers may or may not be successful in this task. Also, these
companies frequently have less diverse product lines and smaller market presence
than larger competitors. They are thus generally more vulnerable to economic
downturns and may experience substantial variations in operating results.
Venture capital investment is an inherently risky business. Many venture capital
investments are unsuccessful and the future performance of our portfolio
companies is uncertain.
We may incur losses associated with our underwriting activities.
Participation in underwritings involves both economic and regulatory
risks. As an underwriter, we may incur losses if we are unable to resell the
securities we are committed to purchase or if we are forced to liquidate our
commitment at less than the agreed purchase price. In addition, the trend, for
competitive and other reasons, toward larger commitments on the part of lead
underwriters means that, from time to time, an underwriter (including a
co-manager) may retain significant ownership of individual securities. Increased
competition has eroded and is expected to continue to erode underwriting
spreads. Another result of increased competition is that revenues from
individual underwriting transactions have been increasingly allocated among a
greater number of co-managers, which has resulted in reduced revenues per
transaction. Our business will continue to be adversely affected if this trend
continues or worsens.
We may incur losses associated with our lending to small, privately-owned
businesses.
At December 31, 2000, our investments included $17.8 million in
subordinated and mezzanine loans outstanding to and securities issued by small,
privately-owned businesses. There is generally no publicly available information
about such companies and we must rely on the diligence of our employees and
agents to obtain information in connection with our investment decisions. Small
companies may be more vulnerable to economic downturns and often need
substantial additional capital to expand or compete. Such businesses may also
experience substantial variations in operating results and there will generally
be no established trading market for their securities. As a result of our
lending activities, we are exposed to:
o credit risks;
o interest rate risks;
o risks related to the illiquidity of our investments;
o leverage risks; and
o risks resulting from the competitive market for investment
opportunities.
Our focus on relatively few industries limits our revenues
We are dependent on revenues related to securities issued by companies in
specific industry sectors. The financial services, real estate technology
(primarily internet, information technology and genomics) and energy sectors,
account for the majority of
22
our investment banking, asset management and research activities and our venture
capital business is concentrated almost exclusively in the Internet and
information technology sectors. For example, in 2000 revenues from our
technology-related investment banking transactions and our technology-based
venture capital business accounted for 44% of our total revenues. Therefore, any
downturn in the market for the securities of companies in these industries, or
factors affecting such companies, would adversely affect our operating results
and financial condition. In 1998 and 1999, the specialty finance companies,
equity real estate investment trusts ("REITs") and mortgage REITs on which we
focused experienced a significant downturn which in turn adversely affected us.
Securities offerings can vary significantly from industry to industry due to
economic, legislative, regulatory and political factors. Underwriting activities
in a particular industry can decline for a number of reasons.
We also derive a significant portion of our revenues from institutional
brokerage transactions related to the securities of companies in these sectors.
In the past, our revenues from such institutional brokerage transactions have
declined when underwriting activities in these industry sectors declined, the
volume of trading on The Nasdaq Stock Market or the New York Stock Exchange
declined, or when industry sectors or individual companies reported results
below investors' expectations.
We experience significant fluctuations in our quarterly operating results due to
the nature of our business and therefore may fail to meet profitability
expectations.
Our revenues and operating results may fluctuate from quarter to quarter
and from year to year due to a combination of factors, including:
o the number of underwriting and merger and acquisition transactions
completed by our clients;
o the valuations of our principal investments, the investments of
funds we manage and our venture capital portfolio companies;
o the number of initial public offerings or sales of our venture
capital portfolio companies;
o access to public markets for companies in which we have invested as
a principal;
o the realization of profits or losses on principal investments or
warrants we hold;
o the level of institutional and retail brokerage transactions;
o the timing of recording of asset management fees and special
allocations of income; and
o variations in expenditures for personnel, litigation expenses, and
expenses of establishing new business units, including marketing and
technology expenses.
We record our revenues from an underwriting transaction only when the
underwriting is completed. We record revenues from merger and acquisition
transactions only when we have rendered the services and the client is
contractually obligated to pay; generally, most of the fee is earned only after
the transaction closes. Accordingly, the timing of our recognition of revenue
from a significant transaction can materially affect our quarterly operating
results. We have structured our operations based on expectations of a high level
of demand for underwriting and corporate finance transactions. As a result, we
have many fixed costs. Accordingly, we could experience losses if demand for
these transactions is lower than expected.
Due to the foregoing and other factors, we cannot assure you that we will
be able to sustain profitability on a quarterly or annual basis.
We face significant competition from larger financial services firms with
greater resources which could reduce our market share and harm our financial
performance.
We are engaged in the highly competitive financial services, venture
capital, underwriting and securities brokerage businesses. We compete directly
with large Wall Street securities firms, established venture capital funds,
securities subsidiaries of major commercial bank holding companies, major
regional firms, smaller "niche" players and those offering competitive services
via the Internet. To an increasing degree, we also compete for various segments
of the financial services business with other institutions, such as commercial
banks, savings institutions, mutual fund companies, life insurance companies and
financial planning firms. Our industry focus also subjects us to direct
competition from a number of specialty securities firms, smaller
23
investment banking boutiques and venture capital funds that specialize in
providing services to those industry sectors. If we are not able to compete
successfully in this environment, our business, operating results and financial
condition will be adversely affected.
There has been a significant amount of new capital invested in venture
capital funds in recent years. With the amount of capital available, some
companies that may have had difficulty in obtaining venture funding in the past
may be able to do so, notwithstanding that the chances for success in these
investments may be marginal. In addition, there is likely to be an increasing
amount of competition among venture capital funds for the best investment
prospects. Thus, our success will be largely dependent on our ability to
identify and invest in the most favorable opportunities in a highly competitive
venture capital market.
Competition from commercial banks has increased because of recent
acquisitions of securities firms by commercial banks, as well as internal
expansion by commercial banks into the securities business. In addition, we
expect competition from domestic and international banks to increase as a result
of recent legislation and regulatory initiatives in the United States to remove
or relieve certain restrictions on commercial banks. Our acquisition of a bank
will lead to direct competition from commercial banks, most of which will be
larger and have greater resources than our bank subsidiary. This competition
could adversely affect our operating results.
We also face intense competition in our asset management business from a
variety of sources, including venture capital funds, private equity funds,
mutual funds, hedge funds and other asset managers. We compete for investor
funds as well as for the opportunity to participate in transactions.
We offer many of our investment banking and brokerage services online. The
market for these services over the Internet is new, rapidly evolving and
intensely competitive. We expect competition in this area to continue and
intensify in the future. Our online brokerage services business faces direct
competition from other brokerage firms providing online investing services.
Many of our competitors have greater personnel and financial resources
than we do. Larger competitors are able to advertise their products and services
on a national or regional basis and may have a greater number and variety of
distribution outlets for their products, including retail distribution. Discount
brokerage firms market their services through aggressive pricing and promotional
efforts. In addition, some competitors have a much longer history of investment
activities than we do and, therefore, may possess a relative advantage with
regard to access to business and capital.
In addition, our venture capital portfolio companies will likely face
significant competition, both from other early-stage companies and from more
established companies. Early-stage competitors may have strategic capabilities
such as an innovative management team or an ability to react quickly to changing
market conditions, while more experienced companies may possess significantly
more experience and greater financial resources than our portfolio companies.
We face intense competition for personnel which could adversely affect our
business.
Our business is dependent on the highly skilled, and often highly
specialized, individuals we employ. The skills of our management personnel will
be of increasing importance to us in the future as we continue to integrate our
expanding venture capital business and our pending investment advisory and bank
acquisition into our ongoing investment activities. Retention of research,
investment banking, venture capital, sales and trading, asset management,
technology, lending and management and administrative professionals is
particularly important to our prospects. Our failure to recruit and retain
qualified employees would materially and adversely affect our future operating
results.
We are highly dependent on specially-trained individuals
The loss of professionals, particularly a senior professional with a broad
range of contacts in an industry, could materially and adversely affect our
operating results. Our strategy is to establish relationships with prospective
corporate clients in advance of any transaction, and to maintain these
relationships over their lifecycle by providing advisory services to corporate
clients in equity, debt and merger and acquisition transactions. These
relationships depend in part upon the individual employees who represent us in
our dealings with our clients. In addition, research professionals contribute
significantly to our ability to secure a role in managing public offerings and
in executing trades in the secondary market. From time to time, other companies
in the investment industry have experienced losses of professionals in all areas
of the investment business. The level of competition for key personnel has
increased recently, particularly due to the market entry efforts of
non-brokerage U.S. and foreign financial services companies, commercial banks,
other investment banks and venture capital firms targeting or increasing their
efforts in some of the same industries that we serve. In particular, in recent
periods, competition has grown dramatically for experienced
24
venture capital managers of the type on which our business is highly dependent.
We cannot assure you that losses of key personnel due to competition or
otherwise will not occur.
In addition, the success of our venture capital portfolio companies will
depend in large part upon the abilities of their key personnel. Competition for
qualified personnel is intense at any stage of a company's development and high
turnover of personnel is common in Internet and information technology
companies. The loss of one or a few key managers can hinder or delay a company's
implementation of its business plan. Our portfolio companies may not be able to
attract and retain qualified personnel. Any inability to do so may negatively
affect our investment returns.
Competition results in increased compensation costs
Competition for the recruiting and retention of employees has recently
increased elements of our compensation costs, and we expect that continuing
competition will cause our compensation costs to continue to increase. We cannot
assure you that we will be able to recruit and hire a sufficient number of new
employees with the desired qualifications in a timely manner. We regularly
review our compensation policies, including stock incentives. Nonetheless, our
incentives may be insufficient in light of the increasing competition for
experienced professionals in the investment industry, particularly if the value
of our stock declines or fails to appreciate sufficiently to be a competitive
source of a portion of professional compensation.
We are subject to extensive government regulation which could adversely affect
our results
The securities business is subject to extensive regulation under federal
and state laws in the United States, and also is subject to regulation in the
foreign countries in which we conduct our activities. Compliance with these laws
can be expensive, and any failure to comply could have a material adverse effect
on our operating results.
One of the most important regulations with which our broker-dealer
subsidiaries must continually comply is the SEC's net capital rule (Rule 15c3-1)
and a similar rule of the United Kingdom's Securities and Futures Authority.
These regulations require our broker-dealer subsidiaries to maintain minimum
levels of net capital, as defined under such regulations, and limit the amount
of leverage we can obtain in our business. Underwriting commitments require a
charge against net capital and, accordingly, our ability to make underwriting
commitments may be limited by our capital. Compliance with these regulatory net
capital requirements could limit other operations that require intensive use of
capital, such as trading activities, and also could restrict our ability to
withdraw capital from our affiliated broker-dealers, which in turn could limit
our ability to pay dividends, repay debt and redeem or repurchase shares of our
outstanding capital stock.
Compliance with many of the regulations applicable to us involves a number
of risks, particularly in areas where applicable regulations may be subject to
interpretation. In the event of non-compliance with an applicable regulation,
governmental regulators and self- regulatory organizations such as the National
Association of Securities Dealers may institute administrative or judicial
proceedings that may result in:
o censure, fines or civil penalties (including treble damages in the
case of insider trading violations);
o issuance of cease-and-desist orders;
o deregistration or suspension of the non-compliant broker-dealer or
investment adviser;
o suspension or disqualification of the broker-dealer's officers or
employees; or
o other adverse consequences.
The imposition of any such penalties or orders on us could have a material
adverse effect on our operating results and financial condition.
The regulatory environment in which we operate is also subject to change.
Our business may be adversely affected as a result of new or revised legislation
or regulations imposed by the SEC, other United States or foreign governmental
regulatory authorities or the NASD. We also may be adversely affected by changes
in the interpretation or enforcement of existing laws and rules by these
governmental authorities and the NASD.
25
Additional regulation, changes in existing laws and rules, or changes in
interpretations or enforcement of existing laws and rules often directly affect
the method of operation and profitability of securities firms such as ours. We
cannot predict what effect any such changes might have. Our businesses may be
materially affected not only by regulations applicable to us as a financial
market intermediary, but also by regulations of general application. For
example, the volume of our venture capital, underwriting, merger and
acquisition, asset management and principal investment businesses in a given
time period could be affected by, among other things, existing and proposed tax
legislation, antitrust policy and other governmental regulations and policies
(including the interest rate policies of the Federal Reserve Board) and changes
in interpretation or enforcement of existing laws and rules that affect the
business and financial communities. The level of business and financing activity
in each of the industries on which we focus can be affected not only by such
legislation or regulations of general applicability, but also by industry-
specific legislation or regulations.
Furthermore, due to the increasing popularity of the Internet, legislators
and regulators may pass laws and regulations dealing with issues such as user
privacy, advertising, customer suitability, taxation and the pricing, content
and quality of products and services. Increased attention to these issues could
adversely affect the growth of the Internet, which could in turn decrease the
demand for online services such as those we and our venture capital funds
provide or could otherwise have a material adverse effect on our business,
financial condition or operating results.
As a result of our acquisition of Rushmore and its conversion into a
national bank, in 2001 we became a bank holding company regulated under the Bank
Holding Company Act of 1956, as amended (the "BHC Act"). As a bank holding
company, we will be subject to extensive supervision, regulation and examination
by banking regulatory agencies. In general, the BHC Act prohibits or restricts a
bank holding company's engagement in a wide variety of businesses, some of which
are businesses in which we currently engage, including venture capital, merchant
banking and investment banking.
The Gramm-Leach-Bliley Act, or GLB Act, which became law in November 1999,
significantly changed the regulatory structure and oversight of the financial
services industry. The GLB Act permits a qualifying bank holding company, called
a financial holding company (an "FHC"), to engage in a full range of financial
activities, including banking, insurance, and securities activities, as well as
merchant banking and additional activities that are "financial in nature" or
"incidental" to such financial activities. In order for a bank holding company
to qualify as an FHC, its subsidiary depository institutions must be
"well-capitalized" and "well-managed" and have at least a "satisfactory"
Community Reinvestment Act rating. As noted above, the Federal Reserve Board has
approved our application to be a FHC.
We currently engage in a wide variety of businesses, including venture
capital, merchant banking and investment banking, that existing law would
prohibit us from engaging in as a bank holding company in the manner in which we
currently engage in such businesses, but which the GLB Act appears to permit an
FHC to engage in a similar fashion as we do today. Although we believe that we
will be able to maintain our qualification as an FHC under the GLB Act and
continue to engage in the businesses in which we currently engage, there can be
no assurance that we will be able to do so or that we will not be required to
incur substantial costs to maintain compliance with the GLB Act. In addition,
even if we are successful in maintaining FHC status, the GLB Act is a very
recently enacted law and there is a great deal of uncertainty surrounding its
scope and interpretation. There can be no assurance that these regulations and
subsequent interpretations will not prevent us from engaging in one or more
lines of businesses in which we currently engage or will not impose restrictions
that could limit the profitability of such businesses or otherwise restrict our
flexibility in engaging in them.
In addition, as a bank holding company (separate from our status as an
FHC), we will be subject to a wide variety of restrictions, liabilities and
other requirements applicable to bank holding companies, including required
capital levels, restrictions on transactions with our bank subsidiary,
restrictions on payment or receipt of dividends and community reinvestment
requirements. Federal banking regulators possess broad powers to take
supervisory action, including the imposition of potentially large fines, against
both us and Rushmore as they deem appropriate if we violate any of these
requirements or engage in unsafe or unsound practices. Such supervisory actions
could result in higher capital requirements and limitations on both our banking
and non-banking activities, any and all of which could have a material adverse
effect on our businesses and profitability. Finally, the GLB Act will impose
customer privacy requirements on any company engaged in financial activities
such as those engaged in by Rushmore and by us. Any failure to comply with such
privacy requirements could result in significant penalties or fines.
26
We are highly dependent upon the availability of capital and funding for our
operations
We are highly dependent upon the availability of adequate funding and
regulatory capital to operate our business and to meet applicable regulatory
requirements. Historically, we have satisfied these needs from equity
contributions, internally generated funds and loans from third parties. We
cannot assure you that any, or sufficient, funding or regulatory capital will
continue to be available to us in the future on terms that are acceptable to us.
Moreover, most of our venture capital portfolio companies will require
additional equity funding to satisfy their continuing working capital
requirements. Because of the circumstances of those companies or market
conditions, it is possible that one or more of our portfolio companies will not
be able to raise additional financing or may be able to do so only at a price or
on terms that are unfavorable to them. Although there have been a substantial
number of initial public offerings of Internet-related companies, if the market
for such offerings continues to weaken for an extended period of time, the
ability of our venture capital portfolio companies to grow and access the
capital markets would be impaired.
We have potential conflicts of interest with our employees, officers and
directors
From time to time, our executive officers, directors and employees invest,
or receive a profit interest, in investments in private or public companies or
investment funds in which we, or one of our affiliates, is or could potentially
be an investor or for which we carry out investment banking assignments, publish
research or act as a market maker. In addition, we have in the past organized
and will likely in the future organize businesses, such as our private
investment vehicles and venture capital funds, in which our employees may
acquire minority interests. There are risks that, as a result of such investment
or profit interest, a director, officer or employee may take actions that would
conflict with our best interests. There is also a risk that investment
opportunities directed to our employees through private investment vehicles or
venture capital funds could have been beneficial to our shareholders if they had
been made as our own investments. In addition, members of our senior management
are actively involved in managing investment funds and venture capital funds
operated by us which could create a conflict of interest to the extent these
officers are aware of inside information concerning potential investment targets
or to the extent these officials wish to invest in companies for which we are
underwriting securities. We have in place compliance procedures and practices
designed to ensure that inside information is not used for making investment
decisions on behalf of the funds and to monitor funds invested in our investment
banking clients. We cannot assure you that these procedures and practices will
be effective. In addition, this conflict and these procedures and practices may
limit the freedom of these officials to make potentially profitable investments
on behalf of those funds, which could have an adverse effect on our operations.
Our asset management activities may also preclude or delay the release of
research reports on companies in which we invest, which could negatively affect
our ability to compete for underwriting business in connection with such
companies. Also, we may have conflicts among our various subsidiaries for
investment opportunities and legal or regulatory restrictions may prevent one or
more of our subsidiaries from taking action to benefit other subsidiaries.
Litigation and potential securities laws liabilities may adversely affect our
business
Many aspects of our business involve substantial risks of liability,
litigation and arbitration, which could adversely affect us. As an underwriter,
a broker-dealer and an investment adviser we are exposed to substantial
liability under federal and state securities laws, other federal and state laws
and court decisions, including decisions with respect to underwriters' liability
and limitations on the ability of issuers to indemnify underwriters, as well as
with respect to the handling of customer accounts. For example, underwriters may
be held liable for material misstatements or omissions of fact in a prospectus
used in connection with the securities being offered and broker- dealers may be
held liable for statements made by their securities analysts or other personnel.
Broker-dealers and asset managers may also be held liable by customers and
clients for losses sustained on investments if it is found that they caused such
losses. In recent years there has been an increasing incidence of litigation
involving the securities industry, including class actions that seek substantial
damages and frequently name as defendants underwriters of a public offering and
investment banks that provide advisory services in merger and acquisition
transactions. We are also subject to the risk of other litigation, including
litigation that may be without merit. As we intend actively to defend any such
litigation, we could incur significant legal expenses. We carry very limited
insurance that may cover only a portion of any such expenses. An adverse
resolution of any future lawsuits against us could materially adversely affect
our operating results and financial condition. In addition to these financial
costs and risks, the defense of litigation or arbitration may materially divert
the efforts and attention of our management and staff from their other
responsibilities.
Our charter documents also allow indemnification of our officers,
directors and agents to the maximum extent permitted by Virginia law. We have
entered into indemnification agreements with these persons. We have been, and in
the future may be, the subject of indemnification assertions under these charter
documents or agreements by our officers, directors or agents who are or may
become defendants in litigation.
27
Our business is dependent on cash inflows to mutual funds
A slowdown or reversal of cash inflows to mutual funds and other pooled
investment vehicles could lead to lower underwriting and brokerage revenues for
us since mutual funds purchase a significant portion of the securities offered
in public offerings and traded in the secondary markets. Demand for new equity
offerings has been driven in part by institutional investors, particularly large
mutual funds, seeking to invest cash received from the public. The public may
sell mutual funds as a result of a decline in the market generally or as a
result of a decline in mutual fund net asset values. To the extent that a
decline in cash inflows into mutual funds or a decline in net asset values of
these funds reduces demand by fund managers for initial public or secondary
offerings, our business and results of operations could be materially adversely
affected. Moreover, a slowdown in investment activity by mutual funds may have
an adverse effect on the securities markets generally.
We may incur losses related to the real estate portfolio of our minority-owned
REIT
At December 31, 2000, we owned 35% of the outstanding common stock of FBR-
Asset. FBR-Asset's assets are primarily real estate and mortgage assets, which
include indirect holdings through investments in other companies. FBR-Asset's
investments in real estate-related assets are subject to a variety of general,
regional and local economic risks, as well as the following:
o increases in interest rates could negatively affect the value of
FBR-Asset's mortgage loans and mortgage-backed securities;
o the borrowing of funds by FBR-Asset and several of the REITs in
which it invests to finance mortgage loan investments could amplify
declines in market value resulting from interest rate increases;
o increases in prepayment rates during times of interest rate decline
could negatively affect the value of FBR-Asset's mortgage-backed
securities by requiring re-investment of the prepaid funds at the
lower interest rates;
o hedging against interest rate exposure may adversely affect
FBR-Asset's earnings because hedging can be expensive and may not be
effective;
o multifamily and commercial real estate, which comprise much of the
investments of the companies in which FBR-Asset has invested, may
lose value and fail to operate properly;
o investing in subordinate interests, which are owned by some of the
companies in which FBR- Asset invests, exposes FBR-Asset to
increased credit risk;
o competition in the purchase, sale and financing of mortgage assets
may limit the profitability of companies in which FBR- Asset
invests; and
o increased losses on uninsured mortgage loans can reduce the value of
FBR-Asset's equity investments.
Changes in the market values of FBR Asset's assets are directly charged or
credited to FBR-Asset's shareholders' equity. As a result, a general decline in
trading market values may also reduce the book value of FBR-Asset's assets. A
reduction in the book value of FBR-Asset's Assets would have a negative effect
on our financial results as a minority owner.
We may not be able to manage our growth effectively
Over the past several years, we have experienced significant growth in our
business activities and the number of our employees. We expect this growth to
continue as we further expand our venture capital business and integrate our
pending investment advisory and bank acquisition. This growth has required and
will continue to require increased investment in management personnel, financial
and management systems and controls and facilities, which could cause our
operating margins to decline from historical levels, especially in the absence
of revenue growth. In addition, as is common in the securities industry, we are
and will continue to be highly dependent on the effective and reliable operation
of our communications and information systems. We believe that our current and
anticipated future growth will require implementation of new and enhanced
communications and information systems and training of our personnel to operate
such systems. In addition, the scope of procedures for assuring compliance with
applicable laws and regulations and NASD rules has changed as the size and
complexity of our business has changed. Also, if we complete our pending
acquisition and thus become a bank holding company, we will become subject to an
entirely new and extremely stringent and complex set of regulatory requirements,
for which we will have to
28
develop compliance procedures. As we have grown and continue to grow, we have
implemented and continue to implement additional formal compliance procedures to
reflect such growth. Any difficulty or significant delay in the implementation
or operation of existing or new systems, compliance procedures or the training
of personnel could adversely affect our ability to manage growth.
We are highly dependent on systems and third parties, so systems failures could
significantly disrupt our business
Our business is highly dependent on communications and information
systems, including systems provided by our clearing brokers. Any failure or
interruption of our systems, the systems of our clearing broker or third party
trading systems could cause delays or other problems in our securities trading
activities, which could have a material adverse effect on our operating results.
In addition, our clearing brokers provide our principal disaster recovery
system. We cannot assure you that we or our clearing brokers will not suffer any
systems failure or interruption, including one caused by an earthquake, fire,
other natural disaster, power or telecommunications failure, act of God, act of
war or otherwise, or that our or our clearing brokers' back-up procedures and
capabilities in the event of any such failure or interruption will be adequate.
We may not be able to keep up with rapid technological change
Recent rapid advancements in computing and communications technology,
particularly on the Internet, are substantially changing the means by which
financial and other services are delivered. More specifically, the online
financial services industry, in which we operate, is experiencing rapid changes
in technology, changes in customer requirements, changes in service and product
offerings and evolving industry standards. In order for us to succeed in the
Internet and information technology sectors, we must be able to develop or
obtain new technologies, use these technologies effectively and enhance our
existing online services and products. Our success also depends on the ability
to develop new services and products that address the changing needs of
customers and prospective customers. If we are unable to respond to
technological advances and evolving industry standards and practices in a timely
and cost-effective manner, our operating results will be adversely affected.
There are significant technical and financial risks in the development of
new services and products or enhanced versions of existing services and
products. We cannot assure you that we will be able to:
o develop or obtain the necessary technologies;
o effectively use new technologies;
o adapt our services and products to evolving industry standards; or
o develop, introduce and market in a profitable manner service and
product enhancements or new services and products.
If we are unable to develop and introduce enhanced or new services or
products quickly enough to respond to market or customer requirements, or if our
or their services and products do not achieve market acceptance, our business,
financial condition and operating results will be materially adversely affected.
Our online business will require substantial expense and may not be successful
Conducting investment banking operations through the Internet involves a
new approach to the securities business. In order to attract customers in the
rapidly evolving online financial services market, many companies are incurring
significant expenses in providing client service and in the marketing and
advertising of their products and services. We are committed to providing a high
level of client service to our target market of institutional and high net worth
clients. In order to compete effectively in this market, we are likely to incur
similar substantial expenses, including intensive marketing and sales efforts to
educate prospective clients about the uses and benefits of our services and
products in order to generate demand. In addition, our ability to expand in this
market may require us to find strategic partners with content or distribution
capacity or equity partners. We may not be able to identify and reach agreements
with such partners. We cannot assure you that we will be successful in the
Internet market. Our online business does not produce revenues sufficient to
cover our expenses and we cannot assure you that it will ever do so.
29
We are subject to risks related to online commerce and the Internet which could
adversely affect our business
The markets for electronic investment banking and brokerage services,
particularly through the Internet, are at an early stage of development and are
rapidly evolving. It is difficult to predict demand and market acceptance for
online products, as well as the possible growth and size of these markets. We
cannot assure you that the markets for our online services will continue to
develop or become profitable. Many of these services and products will not be
successful unless the Internet is widely accepted as a marketplace for commerce
and communication. This acceptance could be hindered by a number of factors,
including government regulation and associated compliance costs, insufficient
infrastructure, insufficient or inefficient telecommunication services or
concerns about security, among others.
Inefficiencies related to traffic on the Internet and its service providers will
adversely affect our online business.
Traffic on the Internet and the number of users gaining access through the
Internet's various service providers have grown significantly and are expected
to continue to grow. The success of our online business will depend upon the
continued ability of the Internet's infrastructure to handle this increased
volume. This will require a reliable network backbone with the necessary speed,
data capacity and security, as well as the timely development of related
products such as high-speed modems, for providing reliable and efficient
Internet access and service. If the Internet or its service providers experience
outages or delays, the level of Internet usage and the processing of
transactions on our web site will be adversely affected.
Security concerns may adversely affect our online business and the businesses of
our portfolio companies
Our networks may be vulnerable to unauthorized access, computer viruses
and other security problems. Individuals who successfully circumvent our
security measures could misappropriate proprietary information or cause
interruptions or malfunctions in our and their online operations. In addition,
concerted attacks by hackers could make our and their online services
unavailable for significant periods of time. We may be required to expend
significant capital and other resources to protect against the threat of
security breaches or to alleviate problems caused by any breaches. Although we
intend to continue to implement industry-standard security measures, these
measures may be inadequate. If a compromise of security occurs, our business,
financial condition and operating results could be materially adversely
affected.
Our common stock price is highly volatile
The market price for our class A common stock has been highly volatile and
is likely to continue to be highly volatile. The trading price of our stock has
experienced significant price and volume fluctuations in recent months. These
fluctuations often have been unrelated or disproportionate to our operating
performance. The price of our class A common stock has generally traded below
our initial public offering price of $20.00 per share in December 1997 and has
ranged from $3 5/8 per share to $21 3/4 per share since that time through March
23, 2001. Any negative changes in the public's perception of the prospects for
companies in the investment, financial services or venture capital industries
could depress our stock price regardless of our results.
The following factors could contribute to the volatility of the price of
our class A common stock:
o actual or anticipated variations in our quarterly results and those
of our portfolio companies;
o new products or services offered by us, our portfolio companies and
their competitors;
o changes in our financial estimates and those of our portfolio
companies by securities analysts;
o conditions or trends in the investment, financial services or
venture capital industries in general;
o announcements by us, our portfolio companies or our competitors of
significant acquisitions, strategic partnerships, investments or
joint ventures;
o changes in the market valuations of our portfolio companies and
other technology companies;
o negative changes in the public's perception of the prospects of
investment, financial services or venture capital companies;
o general economic conditions such as a recession, or interest rate or
currency rate fluctuations;
30
o additions or departures of our key personnel and key personnel of
our portfolio companies; and
o additional sales of our securities.
Many of these factors are beyond our control.
Our corporate governance is controlled by insiders
As of December 31, 2000, our officers and directors directly controlled
approximately 51% of the voting power of our outstanding common stock.
Therefore, they are able to control the outcome of all corporate actions
requiring shareholder approval (other than actions requiring a vote of holders
of class A common stock voting as a separate class). Furthermore, our officers
and directors have control over our operations, including significant control
over compensation decisions under our benefit and compensation plans, including
plans under which they are direct beneficiaries.
ITEM 2. PROPERTIES
We lease over four floors of our headquarters building totaling
approximately 72,721 square feet. We also lease approximately 24,513 square feet
for our other offices. We believe that our present facilities, together with our
current options to extend lease terms and occupy additional space, are adequate
for our current and presently projected needs.
ITEM 3. LEGAL PROCEEDINGS
We are not currently a defendant or plaintiff in any material lawsuits or
arbitrations. We are a defendant in a small number of arbitrations and civil
lawsuits relating to our various investment banking and broker-dealer
businesses. There can be no assurances that these matters will not have a
material adverse effect on the results of our operations in a future period,
depending in part on the results for such period. However, based on our review
of these matters with counsel, we believe that any result of these actions
against us will not have a material adverse effect on either our consolidated
financial condition or on our results of operation. For a discussion of the
litigation risks associated with our business, see "Business--Factors Affecting
Our Business, Operating Results and Financial Condition --Litigation and
potential securities laws liabilities may adversely affect our business" (page
27).
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and their ages as of December 31, 2000 are as
follows:
Name Age Positions
---- --- ---------
Emanuel J. Friedman...... 54 Chairman and Co-Chief Executive Officer;
Director
Eric F. Billings......... 48 Vice Chairman and Co-Chief Executive Officer;
Director
W. Russell Ramsey*....... 41 President and Co-Chief Executive Officer;
Director
Robert S. Smith.......... 41 Executive Vice President and Chief Operating
Officer
Kurt R. Harrington....... 48 Senior Vice President and Chief Financial
Officer
* In February 2001, we announced that Mr. Ramsey would begin focusing
primarily on a new technology investment business, in which FBR will be a
substantial investor. While he takes on this new effort, Mr. Ramsey will
continue as President and Co-CEO of the company for a transition period
expected to last through the end of the year.
31
Emanuel J. Friedman
Mr. Friedman is Chairman and Co-Chief Executive Officer of FBR. He has
continuously served as Chairman and Chief Executive Officer since co-founding
FBR in 1989. He serves as a director of FBR-Asset. He manages FBR Ashton,
Limited Partnership and FBR Private Equity Fund, L.P. Mr. Friedman founded the
Friedman, Billings & Ramsey Charitable Foundation, Inc., a charitable
foundation, in 1993 and currently serves as a director.
32
Eric F. Billings
Mr. Billings became Vice Chairman and Co-Chief Executive Officer of FBR in
December 1999. Prior to that, he had served as Vice Chairman and Chief Operating
Officer since co-founding FBR in 1989. He serves as Chief Executive Officer and
as a director of FBR-Asset. He also manages FBR Weston, Limited Partnership.
W. Russell Ramsey
Mr. Ramsey became President and Co-Chief Executive Officer of FBR in
December 1999. Prior to that, he had served as President and Secretary since co-
founding FBR in 1989. Mr. Ramsey is also the managing principal of Capital
Crossover Partners LP in which FBR anticipates making a substantial investment,
but that is not controlled by FBR.
Robert S. Smith
Mr. Smith became Chief Operating Officer of FBR in December 1999. Mr.
Smith joined FBR as its General Counsel in January 1997 and became Executive
Vice President in December 1997. Prior to joining FBR, Mr. Smith was a partner
of McGuire, Woods, Battle & Boothe, LLP, where he had been in practice since
1986, and represented FBR Company from its inception in 1989.
Kurt R. Harrington
Kurt R. Harrington is the Chief Financial Officer of Friedman, Billings,
Ramsey Group, Inc. Mr. Harrington joined FBR as Vice President Finance and
Treasurer in March 1997. He was previously the Chief Financial Officer of
Jupiter National, Inc., a publicly traded, closed-end venture capital company.
As part of his portfolio management responsibilities at Jupiter, he also served
on the board of a number of companies including Viasoft, Inc., a publicly traded
software company. Mr. Harrington is also the Chief Financial Officer of
FBR-Asset. Mr. Harrington is a Certified Public Accountant.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The principal market for trading our Class A common stock is the New York
Stock Exchange. Set forth below are the high and low sale prices of our Class A
common stock for each quarter for 2000, 1999 and 1998.
High Low
---- ---
2000
Fourth Quarter... $ 9 3/8 $ 6
Third Quarter.... 9 1/2 6 5/8
Second Quarter... 11 5 1/2
First Quarter.... 19 15/16 6 3/16
1999
Fourth Quarter... 7 15/16 4 3/8
Third Quarter.... 14 6 3/8
Second Quarter... 21 1/4 6 1/4
First Quarter.... 8 3/16 5 1/2
1998
Fourth Quarter... 7 3/4 3 3/4
Third Quarter.... 16 5/16 5
Second Quarter... 21 13 3/4
First Quarter.... 17 13/16 14
According to the records of our transfer agent, we had approximately 125
shareholders of record as of December 31, 2000. Because many shares are held by
brokers and other institutions on behalf of shareholders, we are unable to
estimate the total number of beneficial shareholders represented by these record
holders.
33
Our policy is to reinvest earnings in order to fund future growth.
Therefore, we have not paid and do not plan to declare dividends on our Class A
common stock, at this time. We did not repurchase shares of our common stock in
2000 and issued 182,903 shares pursuant to our Employee Stock Purchase Plan.
34
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION (1)
(Dollars in thousands, except per share amounts)
Year Ended December 31,
------------------------------------------------------------------
2000 1999 1998 1997 1996
--------- --------- --------- --------- ---------
Consolidated Statements of Operations
Revenues:
Investment banking:
Underwriting .......................................... $ 21,086 $ 22,642 $ 70,791 $ 142,506 $ 55,159
Corporate finance ..................................... 31,404 22,541 41,356 60,649 10,362
Investment gains ...................................... 1,453 3,853 -- -- --
Institutional brokerage:
Principal transactions ................................ 32,319 22,058 (28,192) 16,646 25,466
Agency commissions .................................... 21,084 14,988 15,308 12,395 7,554
Asset management:
Base management fees .................................. 9,719 9,409 7,556 3,156 1,522
Incentive allocations ................................. 44,456 35,903 3,841 12,610 2,312
Net investment income (loss) .......................... 9,674 (3,196) (3,943) 3,228 3,974
Interest, dividends and other ........................... 9,695 10,768 16,151 4,945 3,554
--------- --------- --------- --------- ---------
Total revenues ...................................... 180,890 138,966 122,868 256,135 109,903
--------- --------- --------- --------- ---------
Expenses:
Compensation and benefits ............................... 109,768 98,424 82,599 156,957 61,504
Business development and professional services .......... 19,229 23,582 29,313 22,406 11,481
Clearing and brokerage fees ............................. 6,207 4,693 5,078 4,961 3,484
Occupancy and equipment ................................. 9,544 6,674 4,225 2,638 1,683
Communications .......................................... 5,085 4,323 3,592 2,325 1,109
Interest expense ........................................ 1,665 1,323 4,927 3,770 2,665
Other operating expenses ................................ 7,147 6,918 9,343 5,941 3,139
--------- --------- --------- --------- ---------
Total expenses ...................................... 158,645 145,937 139,0771 198,998 85,065
--------- --------- --------- --------- ---------
Net income (loss) before taxes ............................ 22,245 (6,971) (16,209) 57,137 24,838
Income tax provision ...................................... 4,163 -- -- 22,855(3) 9,960(3)
--------- --------- --------- --------- ---------
Net income (loss) ......................................... $ 18,082 $ (6,971) (16,209) $ 34,282 $ 14,878
========= ========= ======= ========= =========
Consolidated Balance Sheet Data
Assets:
Cash and cash equivalents ............................... $ 52,337 $ 43,743 $ 46,827 $ 207,691 $ 20,681
Marketable trading securities ........................... 18,447 6,137 13,150 78,784 55,013
Long-term investments ................................... 142,950 135,723 97,157 36,351 6,424
Other ................................................... 38,485 40,753 47,982 36,501 43,320
--------- --------- --------- --------- ---------
Total assets ........................................ $ 252,219 $ 226,356 $ 205,116 $ 359,327 $ 125,438
========= ========= ========= ========= =========
Liabilities:
Accounts payable and other liabilities .................. $ 36,733 $ 34,358 $ 15,322 $ 52,008 $ 14,565
Short-term debt ......................................... -- -- -- 40,000 22,000
Accrued dividends ....................................... -- -- -- 24,000 --
Trading account securities sold short ................... 930 3,029 2,892 16,673 39,814
--------- --------- --------- --------- ---------
Total liabilities ................................... 37,663 37,387 18,214 132,681 76,379
Shareholders' equity ...................................... 214,556 188,969 186,902 226,646 49,059
--------- --------- --------- --------- ---------
Total liabilities and shareholders' equity .......... $ 252,219 $ 226,356 $ 205,116 $ 359,327 $ 125,438
========= ========= ========= ========= =========
Statistical Data
Basic earnings (loss) per share ........................... $ 0.37 $ (0.14) $ (0.33) $ 1.48 $ 0.67
Diluted earnings (loss) per share ......................... $ 0.36 $ (0.14) $ (0.33) $ 1.48 $ 0.67
Pro forma basic and diluted earnings per share (2)......... N/A N/A N/A $ 0.85 $ 0.40
Book value per share (3)................................... $ 4.34 $ 3.86 $ 3.81 $ 4.53 $ 1.31
Total employees (3)........................................ 386 390 358 265 176
Revenue per employee ...................................... $ 466 $ 372 $ 394 $ 1,162 $ 766
Pre-tax return on average equity .......................... 11% (4)% (8)% 41% 87%
Compensation and benefits expense as a percentage of
revenues .................................................. 61% 71% 67% 61% 50%
Basic weighted average shares outstanding (in thousands) .. 49,162 48,872 49,724 40,276 37,079
Diluted weighted average shares outstanding (in thousands) 50,683 48,872 49,724 40,276 37,079
(1) See Notes 1 and 2 of Notes to Consolidated Financial Statements for an
explanation of the basis of presentation.
(2) Reflects pro forma Federal and state income taxes based on estimated
applicable tax rates as if we had not elected subchapter S corporation
status prior to December 21, 1997. Historical, as reported, income tax
benefit for 1997 was $2,402. Historical, as reported, net income for 1997
and 1996 was $59,539 and $24,838, respectively.
(3) As of end of the period reported.
35
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Friedman, Billings, Ramsey Group, Inc. is a holding company for Friedman,
Billings, Ramsey Capital Markets, Inc. ("Capital Markets Group") and FBR Capital
Management, Inc. ("Asset Management Group"). The Capital Markets Group is a
holding company whose primary subsidiaries are Friedman, Billings, Ramsey & Co.,
Inc. ("FBRC"), a U.S. investment banking firm and securities broker-dealer, and
FBR Investment Services, Inc. ("FBRIS") an electronic on-line investment bank
and securities brokerage company and mutual fund distributor. The Asset
Management Group is a holding company whose subsidiaries are engaged in
investment management and advisory services to private equity and venture
capital funds, managed accounts including a publicly-traded real estate
investment trust ("REIT"), proprietary investment partnerships, offshore funds
and mutual funds. The Asset Management Group also holds investments, as
principal, in several of the funds that it manages and other investments
acquired in connection with its business. Our company operates primarily in the
United States and Europe.
Business Environment
Our principal business activities (capital raising, securities sales and
trading, merger and acquisition and advisory services, venture capital,
proprietary investments and asset management services) are linked to the capital
markets. In addition, our business activities are primarily focused on small and
mid-cap stocks in the technology (primarily Internet and information
technology), bank, financial services, energy and real estate sectors. 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 to the conditions affecting the companies and
markets in our areas of focus. During 2000, financial markets in the United
States experienced increased volatility. During the second half of 2000, the
rate of growth in the United States declined and investor concerns about
corporate earnings increased and United States equity markets, as measured by a
number of financial indices, declined from their record levels. In the second
half of 2000, while a broad range of stocks declined, the prices of technology
stocks in particular, were generally adversely effected.
Our revenues, particularly from venture capital and private equity
activities, capital raising, and asset management activities, are subject to
substantial positive and negative fluctuations due to a variety of factors that
cannot be predicted with great certainty, including the overall condition of the
economy and the securities markets as a whole and of the sectors on which we
focus. A significant portion of the performance-based or incentive revenues that
we recognize from our venture capital, private equity and asset management
activities is based on the increase in value of securities held by the funds we
manage. These increases in value included unrealized gains that may be reduced
or reversed from one period to another. These securities are often illiquid and
therefore, the value of these securities is subject to increased market risk.
Fluctuations also occur due to the level of market activity, which, among other
things, affects the flow of investment dollars and the size, number and timing
of transactions. As a result, net income and revenues in any particular period
may not be representative of full-year results and may vary significantly from
year to year and from quarter to quarter.
The financial services industry continues to be affected by the
intensifying competitive environment, as demonstrated by consolidation through
mergers and acquisitions, as well as significant growth in competition in the
market for on-line trading services. The relaxation of banks' barriers to entry
into the securities industry and expansion by insurance companies into
traditional brokerage products, coupled with the repeal of laws separating
commercial and investment banking activities in the future, have increased the
competition for a similar customer base.
In order to compete in this increasingly competitive environment, we
continually evaluate our businesses across varying market conditions for
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.
Operating Groups
Asset Management Group
Our asset management activities consist of managing and investing in a
broad range of pooled investment vehicles, including venture capital funds and
other investment partnerships, FBR Asset Investment Corporation ("FBR-Asset"),
mutual funds and
36
separate accounts. Our total assets under management ("AUM") decreased 7% from
$879 million at December 31, 1999 to $820 million at December 31, 2000 primarily
due to distributions from FBR Technology Venture Partners, L.P. ("TVP"). As of
December 31, 2000, our long-term investments totaled $143.0 million.
We generate revenue from our asset management activities in three ways:
(1) We act as investment adviser and receive management fees for the
management of investment partnerships, including venture capital
funds, mutual funds, separate accounts and FBR-Asset, based upon the
amount of capital committed or under management. This revenue is
recorded in "base management fees" in our statements of operations.
(2) We receive incentive income based upon the operating results of the
venture capital funds and other partnerships. Incentive income
represents special allocations, generally 20%, of realized and
unrealized gains to our capital accounts as managing partner of the
partnerships. This special allocation is sometimes referred to as
"carried interest" and is recorded in "incentive allocations" in our
statements of operations.
(3) We record allocations, under the equity method of accounting, for
our proportionate share of the earnings or losses of the venture
funds and other partnerships and FBR-Asset. Income or loss
allocations are recorded in "net investment income (loss)" in
our statements of operations.
Asset management revenue increased 52% over the last year from
$42.1 million in 1999 to $63.8 million in 2000. This revenue has been derived
from an increasing variety of investment vehicles, in particular managed venture
capital funds. During all of 2000, technology venture capital emerged as a major
contributor to our asset management business. Revenue from venture capital
activity, including unrealized gains, accounted for $53.1 million of our total
revenues during 2000, and we received $49.0 million in gross distributions from
TVP. Venture capital assets under management decreased 18% from $373 million in
1999 to $306 million in 2000, due primarily to distributions of $267 million
from TVP.
Base management fees are earned on all of our AUM and are determined based
on a percentage of actual or committed assets, excluding our own investment and
certain other affiliated assets. The percentages used to determine our base fee
vary from vehicle to vehicle (from 0.25% for FBR-Asset's mortgage-backed
securities to 2.5% for one of our venture capital funds). We receive base
management fees from our managed funds quarterly or semi-annually. We recorded
$9.7 million in base management fees for the year ended December 31, 2000.
In addition to base management fees, we may earn incentive income on
venture capital, other investment partnerships and FBR-Asset. Generally, we
receive 20% of the net realized and unrealized investment gains (if any) on the
assets contributed by third parties to the investment partnerships. Assets on
which we have the potential to earn incentive income have decreased 11%, from
$736 million at December 31, 1999 to $654 million as of December 31, 2000. For
the year ended December 31, 2000, we recorded $44.5 million of incentive income,
of which $42.7 related to TVP. Under the terms of TVP's partnership agreement,
after allocations have been made to the limited partners in amounts totaling
their commitments, we are entitled to receive special allocations in an amount
equal to 20% of the realized and unrealized gains allocated to the limited
partners. In succeeding periods, we are entitled to an allocation of 20% of the
partnership's realized and unrealized gains and the remaining 80% is allocated
to the limited partners on a pro-rata basis. Our capital account in TVP, as of
December 31, 2000, reflects the allocation of this 20% carried interest.
The value of our investments in managed investment partnerships increased
11% to $77.7 million as of December 31, 2000 from $69.8 million as of December
31, 1999. In 2000, we recorded net investment income of $9.7 million and
incentive income of $44.5 million related to these partnerships. To the extent
that our managed partnerships hold securities of public companies that are
restricted as to resale due to contractual "lock-ups", regulatory requirements
including Rule 144 holding periods, or for other reasons, these securities are
generally valued by reference to the public market price, subject to discounts
to reflect the restrictions on liquidity. These discounts are sometimes referred
to as "haircuts". As the restriction period runs, the amount of the discount is
generally reduced. We review these valuations and discounts quarterly.
In May 1998, as part of our strategy to create new asset management
products and to diversify our asset management business, we organized a business
trust designed to extend financing to "middle-market" businesses in need of
subordinated debt or mezzanine financing. In connection therewith, in July 1998,
we made two loans and an equity investment totaling $24.5 million to three
unrelated businesses. During 1999 and 2000, we wrote-down the equity investment
to zero. The loans, valued at $17.8 million, bear interest at an average annual
rate of 13.6%. We subsequently decided not to seek outside investment for this
vehicle but continue to hold its investments as principal.
37
Capital Markets Group
Our investment banking and corporate finance activities consist of a broad
range of services, including public and private transactions of a wide variety
of securities and financial advisory services in merger, acquisition and
strategic partnering transactions. During 2000, we completed or advised on 42
managed or co-managed investment banking and corporate finance transactions
representing $5.4 billion, with $4.4 billion in public underwritings and private
placements and $1.0 billion in merger and acquisition ("M&A") and advisory
transactions. We also participated in 13 underwriting transactions as a
syndicate or selling group member.
During the year ended December 31, 2000, we managed or co-managed 10
initial public offerings ("IPOs") and 12 secondary offerings raising
approximately $4.0 billion and generating $21.1 million in revenues. The average
size of transactions managed was $184.0 million.
Corporate finance revenues include private placement fees and M&A and
advisory service fees. During the year ended December 31, 2000, we acted as
placement agent or co-placement agent in 5 non-public transactions, raising
$285.3 million and generating $8.9 million in revenues. We also advised on 15
M&A and other advisory assignments generating $22.5 million in revenues.
Over the last two years, procedures for conducting securities transactions
have changed dramatically due to the rise of online trading over the Internet.
The underwriting of securities increasingly involves the use of the Internet. In
order to capitalize on these trends and enhance our core business via the
Internet, during the second quarter of 1999, we introduced fbr.com, an online
investment bank and securities brokerage company. fbr.com is a division of
FBRIS. We can leverage our strengths in capital raising services by offering
these transactions online via fbr.com. Since announcing fbr.com on April 15,
1999, we had offered shares of 62 offerings online through December 31, 2000.
The following table shows a detail of our investment banking revenues for
the years indicated:
Investment Banking Revenues
2000 1999 1998 1997 1996
------- ------- -------- -------- -------
(Unaudited, in thousands)
Public Underwritings
Initial public offerings .. $ 8,343 $ 8,910 $ 50,502 $115,403 $25,997
Secondary public offerings 10,234 12,407 15,623 20,690 7,214
High yield debt & preferred 2,509 1,325 4,666 6,413 21,948
------- ------- -------- -------- -------
Underwriting ......... 21,086 22,642 70,791 142,506 55,159
------- ------- -------- -------- -------
Non Public Capital Raising and M&A
High yield debt & preferred -- 4,428 6,427 7,442 4,058
M&A and advisory services . 22,511 14,554 15,608 9,716 3,637
Private equity placements . 8,893 3,559 19,321 43,491 2,667
------- ------- -------- -------- -------
Corporate Finance .... 31,404 22,541 41,356 60,649 10,362
------- ------- -------- -------- -------
Total ................ $52,490 $45,183 $112,147 $203,155 $65,521
======= ======= ======== ======== =======
In addition to our capital raising activities, we also offer institutional
brokerage services to customers. Revenues related to these services are detailed
below for the years indicated:
38
Institutional Brokerage Revenues
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(Unaudited, in thousands)
Principal sales credits ..... $ 25,453 $ 24,305 $ 30,976 $ 29,276 $ 31,734
Trading gains and losses, net 6,866 (2,247) (59,168) (12,630) (6,268)
Agency commissions .......... 21,084 14,988 15,308 12,395 7,554
-------- -------- -------- -------- --------
Total ............. $ 53,403 $ 37,046 $(12,884) $ 29,041 $ 33,020
======== ======== ======== ======== ========
Results of Operations
Revenues
Our revenues consist primarily of asset management revenue, underwriting
revenue, corporate finance fees, principal sales credits, agency commissions and
net gains and losses. Our managed limited partnerships are subject to market
risk caused by illiquidity and volatility in the markets in which the
partnerships would seek to sell financial instruments. Revenue earned from these
activities, including unrealized gains that are included in the incentive income
portion of our asset management revenues and net gains and losses, may fluctuate
as a result. Revenue from underwriting and corporate finance transactions is
substantially dependent on the market for public and private offerings of equity
and debt securities in the sectors within which we focus our efforts. Principal
sales credits are dependent on NASDAQ trading volume and spreads in the
securities of such companies. Agency commissions are dependent on the level of
trading volume and penetration of our institutional client base by research,
sales and trading. Net trading and investment gains and losses are dependent on
the market performance of securities held, as well as our decisions as to the
level of market exposure we accept in these securities. Accordingly, our
revenues have fluctuated, and are likely to continue to fluctuate, based on
these factors.
We receive asset management revenue in our capacity as the investment
manager to advisory clients and as general partner of several investment
partnerships. Management fees and incentive income on investment partnerships
have been earned from entities that have invested primarily in the securities of
companies engaged in the technology, financial services and real estate sectors.
Incentive income is likely to fluctuate with the performance of securities in
these sectors. A growing base of AUM in incentive entities coupled with positive
returns can provide significant revenues with a high net margin for our company.
Underwriting revenue consists of underwriting discounts, selling
concessions, management fees and reimbursed expenses associated with
underwriting activities. We act in varying capacities in our underwriting
activities, which, based on the underlying economics of each transaction,
determine our ultimate revenues from these activities. When we are engaged as
lead-manager of an underwriting, we generally bear more risk and earn higher
revenues than if engaged as a co- manager, an underwriter ("syndicate member")
or a broker-dealer included in the selling group. As lead manager, we generally
receive 50% to 60% of the total underwriting spread and as a co-manager, we
generally receive 5% to 40% of the total underwriting spread.
Corporate finance revenues consist of M&A, private placement,
mutual-to-stock conversion and other corporate finance advisory fees and
reimbursed expenses associated with such activities. Corporate finance fees have
fluctuated, and are likely to continue to fluctuate, based on the number and
size of our completed transactions.
Principal sales credits consist of a portion of dealer spreads attributed
to the securities trading activities of FBRC as principal in NASDAQ-listed and
other over-the-counter ("OTC") securities, and are primarily derived from FBRC's
activities as a market-maker.
Trading gains and losses are combined and reported on a net basis. Gains
and losses result primarily from market price fluctuations that occur while
holding positions in our trading security inventory.
Agency commissions revenue includes revenue resulting from executing stock
exchange-listed securities and OTC transactions as agent.
Investment income and losses are combined and reported on a net basis.
Income and losses primarily represent our proportionate share of income or loss
related to investments in proprietary investment partnerships and FBR-Asset, in
addition to recognized losses for "other than temporary" impairment on
securities held as available-for-sale and realized gains and losses from the
sale of investment securities. As of December 31, 2000, we had $1.1 million of
unrealized losses related to available-for-sale securities including our
interest in FBR-Asset's unrealized losses, recorded in accumulated other
comprehensive loss. Upon the
39
sale of these securities or in the event the decline in value is deemed other
than temporary, the resulting difference between the cost and market value will
be recorded as an investment loss.
Expenses
Compensation and benefits expense includes base salaries as well as
incentive compensation paid to sales, trading, asset management (including
venture capital), underwriting and corporate finance professionals and to
executive management. Incentive compensation (other than under the Executive
Plan, described below) varies primarily based on revenue production. Salaries,
payroll taxes and employee benefits are relatively fixed in nature. During 2000,
certain of the Company's executive officers were eligible for bonuses under the
Key Employee Incentive Plan (the "Key Employee Plan"). During 2000, the Company
accrued $6.5 million of executive officer compensation, in accordance with the
Key Employee Plan, representing 22.4% of the Company's pre-tax income (before
executive officer compensation accruals). Compensation related to the Key
Employee Plan was paid subsequent to December 31, 2000.
The following table sets forth financial data as a percentage of revenues
for the years presented:
Year Ended December 31,
-----------------------
2000 1999 1998 1997 1996
----- ----- ----- ----- -----
Revenues:
Investment banking:
Underwriting ............................ 11.7% 16.3% 57.6% 55.6% 50.2%
Corporate finance ....................... 17.4% 16.2% 33.7% 23.7% 9.4%
Investment gains ........................ 0.8% 2.8% -- -- --
Institutional brokerage:
Principal transactions .................. 17.5% 15.9% (22.9)% 6.5% 23.2%
Agency commissions ...................... 12.0% 10.8% 12.5% 4.9% 6.9%
Asset management:
Base management fees .................... 5.4% 6.8% 6.1% 1.2% 1.4%
Incentive allocations ................... 24.6% 25.8% 3.1% 4.9% 2.1%
Net investment income ................... 5.3% (2.3)% (3.2)% 1.3% 3.6%
Interest, dividends and other ................ 5.3% 7.7% 13.1% 1.9% 3.2%
----- ----- ----- ----- -----
Total revenues ..................... 100.0% 100.0% 100.0% 100.0% 100.0%
----- ----- ----- ----- -----
Expenses:
Compensation and benefits .................... 60.7% 70.8% 67.2% 61.3% 56.0%
Business development and professional services 10.6% 17.0% 23.9% 8.8% 10.4%
Clearing and brokerage fees .................. 3.4% 3.4% 4.2% 1.9% 3.2%
Occupancy and equipment ...................... 5.3% 4.8% 3.4% 1.0% 1.5%
Communications ............................... 2.8% 3.1% 2.9% 0.9% 1.0%
Interest expense ............................. 0.9% 0.9% 4.0% 1.5% 2.4%
Other operating expenses ..................... 4.0% 5.0% 7.6% 2.3% 2.9%
----- ----- ----- ----- -----
Total expenses ..................... 87.7% 105.0% 113.2% 77.7% 77.4%
----- ----- ----- ----- -----
Income (loss) before income taxes .. 12.3% (5.0)% (13.2)% 22.3% 22.6%
===== ===== ===== ===== =====
We estimate that our fixed costs as a percentage of revenue decreased from
53% for the year ended December 31, 1999 to 43% for the year ended December 31,
2000. This decrease is attributed to a significant decrease in our net trading
losses and a decrease in business development and professional services.
Comparison of the Years Ended December 31, 2000 And 1999
Total revenues increased 30% from $139.0 million in 1999 to $180.9 million
in 2000 primarily due to an increase in asset management revenue, particularly
incentive income related to TVP, net trading gains attributed to the volatile
technology sector in the first half of 2000 and increased corporate finance
revenue.
Underwriting revenue decreased 7% from $22.6 million in 1999 to $21.1
million in 2000. The decrease is attributed to the decline in the size of our
proportionate fee and fewer completed deals attributed to the continuation of
lower prices and reduced activity in the markets for securities of companies in
the financial services and real estate sectors, two of our areas of focus.
During 2000, we managed 22 public offerings raising $4.0 billion and generating
$21.1 million in revenues. During 1999, we
40
managed 23 public offerings raising $2.0 billion and generating $22.6 million in
revenues. The average size of underwritten transactions for which we were a lead
or co-manager increased from $85.4 million in 1999 to $184.0 million in 2000.
Corporate finance revenue increased 40% from $22.5 million in 1999 to
$31.4 million in 2000. This increase was primarily due to a 55% increase in M&A
and other advisory assignments revenue from $14.5 million in 1999 to $22.5
million in 2000. In 2000, we completed 15 M&A transactions compared to 12 in
1999. In 2000, the average revenue earned per M&A and advisory assignment was
$1.5 million compared to $1.2 million in 1999. Additionally, in 2000, the
Company sold warrants that had been previously received as part of a private
capital raising transaction resulting in a gain of $1.5 million reflected in the
investment gains line under investment banking.
Institutional brokerage revenue from principal transactions increased 43%
from $22.1 million in 1999 to $32.3 million in 2000. This increase was primarily
due to an increase in the Company's penetration of large institutional accounts
and to the Company's ability, as a market maker for its own account, to generate
gains related to the market volatility in the technology sector.
Institutional brokerage agency commissions increased 45% from $15.0
million in 1999 to $21.1 million in 2000. This increase was primarily due to
increased customer trading, particulary in the technology sector, due to, among
other things, volatility in the markets. In addition, we believe we have
achieved greater penetration of institutional accounts through broader research
coverage and sales and trading services.
Asset management incentive allocations increased 24% from $35.9 million in
1999 to $44.5 million in 2000. Incentive allocations in 2000 are from several
partnership, primarily TVP, and represent realized and unrealized gains as well
as realization events related to our partnership interests and underlying
securities. Under the terms of TVP's partnership agreement, after allocations
have been made to the limited partners in amounts totaling their commitments, we
are entitled to receive special allocations in an amount equal to 20% of the
realized and unrealized gains allocated to the limited partners. To the extent
that TVP holds securities of public companies that are restricted as to resale
due to contractual "lock-ups", regulatory requirements include Rule 144 holding
periods, or for other reasons, these securities are generally valued by
reference to the public market price, subject to discounts to reflect the
restrictions on liquidity. As the restriction period decreases over time, the
amount of the discount is generally reduced. All such securities reflect the
December 31, 2000 closing price less a discount to reflect restrictions on
liquidity and marketability. We review these valuations and discounts quarterly
and make adjustments as appropriate.
Asset management net investment income (loss) changed from $(3.2) million
in 1999 to $9.7 million in 2000. Net investment income in 2000 included $12.7
million of net investment income from investments in our managed partnerships
and $7.1 million of net investment income generated from our investment in
FBR-Asset offset by $(7.9) million in write-downs of our private debt and
preferred equity investments and $(4.3) million of "other than temporary"
impairments related to available-for-sale equity investments. Net investment
income in 1999 included $5.1 million of net investment income from investments
in our managed partnerships offset by $(1.8) million in write-downs of our
private debt and preferred equity investments and $(6.5) million of "other than
temporary" impairments related to available-for-sale equity investments.
Unrealized losses related to our investments that are included in "accumulated
other comprehensive loss" in our balance sheet totaled $(1.1) million as of
December 31, 2000. If and when we liquidate these or determine that the decline
in value of these investments is "other than temporary", a portion or all of the
losses will be recognized as investment losses in the statement of operations
during the period in which the liquidation or determination is made. Our
investment portfolio is also exposed to future downturns in the markets and
private debt and equity investments are exposed to deterioration of credit
quality, defaults and downward valuations. We periodically review the valuations
of our private debt and equity investments. If and when we determine that the
net realizable value of these investments is less than our carrying value, we
will reflect the reductions as an investment loss.
Net interest, dividends and other revenue (net of interest expense)
decreased 15% from $9.4 million in 1999 to $8.0 million in 2000. This decrease
is primarily due to a decrease in our trading inventory from which dividend
income may be earned. During 1999, we recorded $1.7 million of dividend income
compared to $0.9 million in 2000 due to the decrease in inventory. Interest
income (net of interest expense) increased from $6.5 million in 1999 to $7.1
million in 2000 due to reduced interest expense on our trading accounts.
Total expenses increased 9% from $145.9 million in 1999 to $158.6 million
in 2000 due primarily to an increase in compensation and benefits expense
described below.
Compensation and benefits expense increased 12% from $98.4 million in 1999
to $109.8 million in 2000. This increase was due primarily to increased
compensation associated with our venture capital funds and, to a lesser extent,
an increase in investment banking compensation and executive officer
compensation. The fund management teams have an
41
agreement with the Company to receive a percentage of the incentive income paid
by the funds. For TVP, the fund management team earns 60% of the incentive
income and this amount is recorded as compensation expense at the time the
incentive income is recorded.
Business development and professional services decreased 19% from $23.6
million in 1999 to $19.2 million in 2000 primarily due to a decrease in
advertising and other promotional expenses incurred in 1999 related to fbr.com.
Clearing and brokerage fees increased 32% from $4.7 million in 1999 to
$6.2 million in 2000 due to an increase in the volume of sales and trading
activity. As a percentage of institutional brokerage revenue, clearing and
brokerage fees decreased from 13% in 1999 to 12% in 2000 due to the increase in
principal transactions.
Occupancy and equipment expense increased 42% from $6.7 million in 1999 to
$9.5 million in 2000 primarily due to the expansion of office space and an
increase in depreciation and amortization expense related to software, computer
and telecommunications equipment for fbr.com's operations. Depreciation and
amortization expense increased $ 2.1 million in 2000 compared to 1999.
Communications expense increased 19% from $4.3 million in 1999 to $5.1
million in 2000 due to increased Internet and data communications backbone
redundancy and increasing voice traffic.
Other operating expenses were fairly stable during 2000 increasing only 3%
from $6.9 million in 1999 to $7.1 million in 2000.
Comparison of the Years Ended December 31, 1999 And 1998
Total revenues increased 13% from $122.9 million in 1998 to $139.0 million
in 1999 primarily due to an increase in asset management revenue, particularly
incentive income related to TVP, and a decrease in net trading losses attributed
to a decrease in our trading inventory.
Underwriting revenue decreased 68% from $70.8 million in 1998 to $22.6
million in 1999. The decrease is attributed to (1) the decline in the size of
completed transactions and the size of our proportionate fee and (2) fewer
completed deals attributed to the continuation of lower prices and reduced
activity in the markets for securities of companies in the financial services
and real estate sectors, two of our areas of focus. During 1999, we managed 23
public offerings raising $2.0 billion and generating $22.6 million in revenues.
During 1998, we managed 30 transactions raising $4.1 billion and generating
$70.8 million in revenues. In 1998, we completed one of the largest public
offerings in our history from which we earned $22.9 million in revenues. The
average size of underwritten transactions for which we were a lead or co-manager
decreased from $138.0 million in 1998 to $85.4 million in 1999.
Corporate finance revenue decreased 45% from $41.4 million in 1998 to
$22.5 million in 1999. This decrease was primarily due to a 69% decrease in
private placement revenue from $25.7 million in 1998 to $8.0 million in 1999. In
1999, we completed 11 private placement transactions compared to 8 in 1998,
however, in 1998, we completed one of the largest private placement transactions
in our history from which we earned $17.8 million in revenue. In 1999, the
average revenue earned per private placement transaction was $0.7 million.
Additionally, in 1999, the Company exercised warrants that had been previously
received as part of a private capital raising transaction resulting in a gain of
$3.9 million reflected in the investment gains line under investment banking.
Institutional brokerage revenue from principal transactions increased
significantly from $(28.2) million in 1998 to $22.1 million in 1999. This
increase is primarily attributed to larger and more concentrated corporate
securities inventories in 1998, specifically in the REIT and mortage company
sectors and the market decline related to these sectors in the second half of
1998. The Company's largest losses in 1998 are principally from holding
positions in stocks in which the Company acted as an underwriter.
Institutional brokerage agency commissions decreased 2% from $15.3 million
in 1998 to $15.0 million in 1999 primarily due to the decline in securities
transaction volume attributed to less market activity in the real estate and
financial services sectors in 1999 compared to 1998.
Asset management incentive allocations increased 845% from $3.8 million in
1998 to $35.9 million in 1999. Incentive income in 1999 is almost entirely
related to TVP and primarily represents unrealized gains allocated as carried
interest to our capital account in TVP. In the fourth quarter of 1999, we
recorded $34.3 million of venture capital incentive income which reflects our
carried interest in the unrealized gains of TVP.
42
Asset management net investment loss decreased 18% from $(3.9) million in
1998 to $(3.2) million in 1999. Investment loss in 1998 was generated primarily
from investments in our managed partnerships. Net investment loss in 1999
includes gains of $9.2 million offset by losses of $(12.4) million as
follows: $5.1 million of net gains related to investments in our managed
partnerships, of which $4.0 million related to our investment in TVP; $4.1
million of gains related to our investment in FBR-Asset; $(10.4) million of
"other than temporary" unrealized depreciation related to available for sale
investments; $(1.8) million of unrealized losses related to a private, mezzanine
investment in a preferred stock and $(0.2) million of realized losses related to
the sale of available-for-sale investments. Unrealized losses related to our
investments that are included in "accumulated other comprehensive loss" in our
balance sheet totaled $(6.0) million as of December 31, 1999. If and when we
liquidate these or determine that the decline in value of these investments is
"other than temporary", a portion or all of the losses will be recognized as
investment losses in the statement of operations during the period in which the
liquidation or determination is made. Our investment portfolio is also exposed
to future downturns in the markets and private debt and equity securities are
exposed to deterioration of credit quality, defaults and downward valuations. We
periodically review the valuations of our private debt and equity investments.
If and when we determine that the net realizable value of these investments is
less than our carrying value, we will reflect the reduction as an investment
loss.
Net interest, dividends and other revenue (net of interest expense)
decreased 16% from $11.2 million in 1998 to $9.4 million in 1999. This decrease
is primarily due to a decrease in our trading inventory from which dividend
income may be earned. During 1998, we recorded $3.7 million of dividend income
compared to $1.7 million in 1999 due to the decrease in inventory.
Total expenses increased 5% from $139.1 million in 1998 to $145.9 million
in 1999 due primarily to an increase in compensation and benefits expense
described below.
Compensation and benefits expense increased 19% from $82.6 million in 1998
to $98.4 million in 1999. This increase was due primarily to higher compensation
associated with our venture capital funds and higher executive officer bonus
compensation. During 1999, our three Executive Officer Directors earned a total
of $6.0 million in bonuses. No bonuses were earned by Executive Officer
Directors in 1998. Also during 1999, we recorded $34.3 million of incentive
income related to our investment in TVP. The employees who manage the day to day
operations of TVP earn bonus compensation related to the level of incentive
income. Compensation expense related to incentive income from this venture
capital fund is recorded at a higher rate than compensation related to our other
revenues. In addition, $7.3 million of 1997 investment banking incentive
compensation accruals were reduced in 1998 due to the 1998 trading losses
attributable to capital raising transactions.
Business development and professional services decreased 20% from $29.3
million in 1998 to $23.6 million in 1999 primarily due to a decrease in legal
costs and travel and meals expenses associated with lower investment banking
activity. This decrease is offset by an increase in professional fees and other
promotional expenses in 1999 related to fbr.com's operations.
Clearing and brokerage fees decreased 8% from $5.1 million in 1998 to $4.7
million in 1999 due to the decline in the volume of sales and trading activity.
As a percentage of principal sales credits and agency commissions revenue,
clearing and brokerage fees increased from 11.0% in 1998 to 11.9% in 1999 due to
lower customer ticket volume and increased dealer-to-dealer ticket volume in
1999. Customer ticket volume decreased 7.5% in 1999 causing FBRC to pay higher
clearing rates to its clearing broker. By nature, dealer-to-dealer trades
generate clearing fees without necessarily generating institutional brokerage
revenue.
Occupancy and equipment expense increased 58% from $4.2 million in 1998 to
$6.7 million in 1999 primarily due to the expansion of office space and an
increase in depreciation expense related to software, computer and
telecommunications equipment and furniture for the expanded facilities and
fbr.com's operations. As a result of the expansion, rent expense increased $1.0
million in 1999 compared to 1998 and depreciation and amortization expense
increased $1.4 million in 1999 compared to 1998.
Communications expense increased 20% from $3.6 million in 1998 to $4.3
million in 1999 due to a one-time increase in costs associated with an upgrade
of our broker-dealer trading system.
Other operating expenses decreased 26% from $9.3 million in 1998 to $6.9
million in 1999 due to the reduction or elimination of certain non-revenue-
producing expenses and other overheard costs such as printing and copying and
other office expenses, offset by a $1.0 million charge in 1999 for litigation
accruals.
43
Liquidity and Capital Resources
Historically, we have satisfied our liquidity and regulatory capital needs
through three primary sources: (1) internally generated funds; (2) equity
capital contributions; and (3) credit provided by banks, clearing brokers, and
affiliates of our principal clearing broker. In prior years, we have required
the use, and may continue the use, of temporary subordinated loans in connection
with regulatory capital requirements to support our underwriting activities. We
have no material long-term debt.
Our principal assets consist of cash and cash equivalents, receivables,
securities held for trading purposes and long-term investments. As of December
31, 2000, liquid assets consisted primarily of cash and cash equivalents of
$52.3 million and a receivable for cash on deposit with FBRC's clearing broker
of $11.1 million. Cash equivalents consist primarily of money market funds
invested in debt obligations of the U.S. government. We also held $18.4 million
in marketable securities. We had borrowing capacity (borrowing against security
positions) from FBRC's clearing broker of approximately $17.7 million as of
December 31, 2000 and a total of $40.0 million in a committed subordinated
revolving loan from an affiliate of FBRC's clearing broker that is allowable for
net capital purposes. The agreement expires in December 2001.
Long-term investments consist primarily of investments in managed
partnerships, including venture capital funds in which we serve as managing
partner, available-for-sale securities, our investment in FBR-Asset and long-
term debt and preferred equity investments in privately held companies. Although
our investments in venture capital funds and other limited partnerships are for
the most part illiquid, the underlying investments of such entities are mostly
in publicly-traded, liquid equity and debt securities, some of which may be
restricted due to contractual "lock-up" requirements.
FBRC and FBRIS, as broker-dealers, are registered with the Securities and
Exchange Commission ("SEC") and are members of the National Association of
Securities Dealers, Inc. As such, they are subject to the minimum net capital
requirements promulgated by the SEC. FBRC's and FBRIS' regulatory net capital
has historically exceeded these minimum requirements. As of December 31, 2000,
FBRC was required to maintain minimum regulatory net capital of $0.9 million and
had total regulatory net capital of $30.2 million which was $29.3 million in
excess of its requirement. As of December 31, 2000, FBRIS was required to
maintain minimum regulatory net capital of $0.1 million and had total regulatory
net capital of $0.7 million which was $0.6 million in excess of its requirement.
Regulatory net capital requirements increase when FBRC and FBRIS are involved in
underwriting activities based upon a percentage of the amount being underwritten
by FBRC and FBRIS.
As of December 31, 2000, we had net operating losses ("NOL") for tax
purposes of $34.8 million that expire through 2019. We maintain a partial
valuation allowance related to the NOL and net deferred tax asset, in general
because, based on the weight of available evidence, it is more likely than not
that a portion of the net deferred tax assets may not be realized. As a result
of recording the valuation allowance, based on current evidence, we estimate
that future income tax provisions recorded in the Consolidated Statement of
Operations will be reduced by approximately $6.6 million in pre-tax income.
In October 1999, we announced a definitive agreement to acquire Money
Management Associates, LP ("MMA") and Rushmore Trust and Savings, FSB, Bethesda,
Maryland. MMA is a privately-held investment adviser with $965 million in assets
under management as of December 31, 2000. Together, MMA and Rushmore are the
investment adviser, servicing agent or administrator for 20 mutual funds.
Rushmore is a federally chartered and federally insured savings bank that offers
traditional banking services (lending, deposits, cash management, trust services
and serves as a transfer agent and custodian), along with mutual fund
accounting. Upon closing, we will have new capabilities in traditional banking
and cash management services, as well as fund administration, to offer our
customers. Under the terms of the agreement, we will acquire MMA/Rushmore for
$17.5 million in cash at closing and a $9.7 million non-interest-bearing
installment note payable over a ten-year period. The transaction has been
approved by the regulators and the shareholders of the Rushmore Funds and will
close effective April 1, 2001.
We believe that the company's current level of equity capital and
committed line of credit, including funds generated from operations, are
adequate to meet our liquidity and regulatory capital requirements and other
activities. We may, however, seek debt or equity financing, in public or private
transactions, or otherwise re-deploy assets, to provide capital for corporate
purposes and/or to fund strategic business opportunities, including possible
acquisitions, joint ventures, alliances or other business arrangements which
could require substantial capital outlays. Our policy is to evaluate strategic
business opportunities, including acquisitions and divestitures, as they arise.
We constantly review our capital needs and sources, the cost of capital
and return on equity, and we seek strategies to provide favorable returns on
capital. In evaluating our anticipated capital needs and current cash resources
during 1998, our Board of Directors authorized a share repurchase program of up
to 2.5 million shares of our company's Class A Common Stock. Since announcing
the share repurchase program, the company purchased 1,468,027 shares as of
December 31, 2000. 482,857 of the purchased shares were reissued to employees
pursuant to our Employee Stock Purchase Plan.
44
High Yield and Non-Investment Grade Debt and Preferred Securities
We underwrite, trade, invest in, and make markets in high-yield corporate
debt securities and preferred stock of below investment grade-rated companies.
For purposes of this discussion, non-investment grade securities are defined as
preferred securities or debt rated BB+ or lower, or equivalent ratings by
recognized credit rating agencies, as well as non-rated securities or debt.
Investments in non-investment grade securities generally involve greater risks
than investment grade securities due to the issuer's creditworthiness and the
comparative illiquidity of the market for such securities. Our portfolio of such
securities at December 31, 2000 and 1999 is included in trading securities and
long-term investments and had an aggregate fair value of approximately $25.5
million and $25.3 million, respectively. Our trading and investment portfolios
may, from time to time, contain concentrated holdings of selected issues. Our
largest, unhedged non-investment grade securities position was $10.0 million at
December 31, 2000 and 1999.
Warrants
In connection with various public and private capital raising
transactions, we have received and we hold the following warrants for stock of
the issuing corporation. The exercise price for each warrant is set at the
offering price of the underlying stock in the relevant capital raising
transaction. Due to the restrictions on the warrants and the underlying
securities, we carry the warrants at nominal values, and recognize profits, if
any, only when realized.
Expiration
Number of Exercise Closing Price on Date of
Warrants Price December 31, 2000 Warrants
-------- ----- ----------------- --------
Access Data ......................... 218,183 $ 1.6500 * 03/29/05
American Home Mortgage Holdings, Inc. 125,000 7.8000 $ 4.7500 09/30/04
BIT Central, Inc. ................... 63,000 1.0000 * 06/30/05
Capital Automotive REIT ............. 894,457 15.0000 13.8125 02/12/03
Dry, Inc. ........................... 11,832 10.0000 * 10/16/05
FBR Asset Investment Corporation .... 970,805 20.0000 20.0000 12/11/07
Headstrong .......................... 60,000 13.0000 * 05/26/10
Local Financial Corporation ......... 377,000 10.0000 13.1250 09/08/02
PlanetClick, Inc. ................... 56,164 3.1988 * 06/30/04
PocketScript ........................ 103,013 1.5000 * 01/27/07
RAIT Investment Trust ............... 99,292 15.0000 12.3200 01/08/03
Styling Technology Corporation ...... 71,050 12.0000 ** 11/21/01
Synchrologic ........................ 61,263 6.6500 * 08/25/05
The Bancorp.com, Inc. ............... 28,093 10.0000 * 11/01/04
Total Funding.com ................... 521,400 3.0000 * 02/11/05
Ultraprise Corporation .............. 136,427 2.5333 * 12/22/04
Vcampus Corporation (formerly UOLP) . 18,500 4.6250 0.8438 09/16/03
World Web, Ltd. ..................... 233,334 1.5000 * 12/13/04
Xypoint Corporation ................. 285,107 2.1000 * 07/10/03
* The underlying unregistered security does not have a ready market. We
received the warrants in a private placement transaction.
** This security was not trading on December 31, 2000.
Market and Business Risk
We monitor market and counter-party risk on a daily basis through a number
of control procedures designed to identify and evaluate the various risks to
which our investments and securities are exposed. We have established various
committees to assess and to manage risk associated with our investment banking
and other activities. The committees review, among other things, business and
transactional risks associated with potential clients and engagements. We seek
to control the risks associated with our investment banking activities by review
and approval of transactions by the relevant committee, prior to accepting an
engagement or pursuing a material investment transaction.
45
We believe that our primary risk exposure is to equity and debt price
changes and the resulting impact on our marketable trading and long-term
investments and unrealized incentive income. Direct market risk exposure to
changes in foreign exchange rates is not material. Equity and debt price risk is
managed primarily through the daily monitoring of capital committed to various
issuers and industry segments.
Marketable and Trading Securities
During the first half of 1998, we accumulated substantial trading
positions in securities for which we acted as underwriter. Many of these
securities, especially in the real estate and mortgage sectors, experienced
declines in market values during 1998, resulting in net trading losses of $59.2
million in 1998. We have reduced our exposure to such market risk through
partial or complete liquidation of our positions in many of these same
securities and the implementation of new position limits policies. We generally
attempt to limit exposure to market risk on securities held as a result of our
daily trading activities by limiting our intra-day and overnight inventory of
trading securities to that needed to provide the appropriate level of liquidity
in the securities for which we are a market maker.
At December 31, 2000, the fair value of our trading securities was $7.7
million in long positions and $0.9 million in short positions. In addition, at
December 31, 2000, the fair value of our marketable securities that we had
received in distributions from TVP was $10.7 million. The net potential
loss in fair value at December 31, 2000, using a 10% hypothetical decline in
reported value of long positions (offset by a 10% hypothetical increase in
reported value of short positions) was $1.8 million.
Long-Term Investments
Our long-term investments consist of investments in investment
partnerships, including venture funds, that we manage, an investment in a REIT
that we also manage, direct debt and equity investments in privately held
companies and direct investments in equity securities of public companies.
As of December 31, 2000, a majority, by value, of the underlying assets of
the investment partnerships and the REIT were equity securities of domestic,
publicly traded companies or, in the case of the REIT, mortgage-backed
securities. These underlying investments are marked to market, subject to
liquidity discounts in the case of securities that are subject to contractual
"lock-up" requirements or regulatory restrictions (including Rule 144) or
otherwise not readily marketable, and we record our proportionate share of
unrealized gains and losses. To the extent the underlying investments in the
investment partnerships, venture funds, REIT and direct investments are not
marketable securities, they are valued at estimated fair values. In 2000, we
recorded, in earnings, net realized and unrealized gains from our investments of
$9.7 million and incentive income from realized and unrealized gains in
investment partnerships, including venture capital, of $44.5 million. We also
maintain, as a separate component of shareholders' equity, $1.1 million of
accumulated other comprehensive loss, representing $0.9 million of unrealized
losses on our direct investments and $0.2 million of unrealized losses related
to our investment in the REIT.
The following chart shows the allocation of FBR's long-term investments as
stated on the December 31, 2000 balance sheet, by sector and by managed fund and
also shows the allocation of long-term investments in publicly traded and
private securities. Managed funds are categorized by the value of the majority
of their investments. In addition, from time to time, the Company implements
risk management strategies, the value of which may not be included in the
balance sheet line for long-term investments.
Financial Public Private Total
- --------- ------ ------- -------
FBR Ashton, LP $15,430 $ -- $15,430 13.1%
FBR Private Equity Fund, LP 1,315 2,353 3,668 3.1%
FBR Future Financial Fund, LP -- 1,659 1,659 1.4%
FBR Financial Services Partners, LP 187 1,393 1,580 1.3%
Direct investment 1,414 -- 1,414 1.2%
------ ------ ------- -----
18,346 5,405 23,751 20.1%
Real Estate
- -----------
FBR Asset Investment Corporation 28,626 1,428 30,054 25.5%
Direct investment 3,305 -- 3,305 2.8%
------ ------ ------- -----
31,931 1,428 33,359 28.3%
------ ------ ------- -----
Subtotal 50,277 6,833 57,110 48.4%
------ ------ ------- -----
46
Technology
- ----------
FBR Technology Venture Partners, LP (1) 7,812 3,163 10,975 9.3%
FBR Technology Venture Partners II, LP 344 6,074 6,418 5.4%
FBR CoMotion Venture Capital I, LP (2) -- 1,296 1,296 1.1%
DDL and related direct investments -- 4,658 4,658 4.0%
Other direct investment 652 -- 652 0.6%
------ ------ ------- -----
8,808 15,191 23,999 20.4%
------ ------ ------- -----
Debt
- ----
Direct investment (3) -- 17,837 17,837 15.1%
------ ------ ------- -----
Other
- -----
Braddock Partners, LP 4,920 -- 4,920 4.2%
FBR Arbitrage, LLC 10,320 -- 10,320 8.7%
FBR Weston, LP 1,403 -- 1,403 1.2%
Third-party partnerships -- 1,383 1,383 1.2%
Other 426 482 908 0.8%
------- ------- -------- -----
17,068 1,865 18,933 16.1%
------- ------- -------- -----
TOTALS $76,152 $41,728 $117,879 100.0%
======= ======= ======== =====
(1) Amount is net of accrued Fund Manager Compensation expense ("FMC")
of $12,938. Asset value before FMC as of December 31, 2000 was
$23,913. As part of the Company's risk management procedures,
when market conditions permit, the Company takes steps to realize or
lock-in gains on these securities including through option
strategies. As of December 31, 2000, the capital exposure of the
Company net of the effect of the implementation of option strategies
was $4,119. The fair value of options included in long-term
investments as of December 31, 2000 was $9,705.
(2) Amount is net of loans of $2,428 made by the Company to FBR
CoMotion Venture Capital I, LP.
(3) Represents Private debt of two issuers with a face amount of $10,337
and $7,500, respectively.
As of December 31, 2000, the recorded value of our long-term investment
securities was $143.0 million. The net potential loss in fair value, using a 10%
hypothetical decline in reported value, was $14.3 million.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 is set forth in Item 14 of this report.
47
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors required by this Item 10 is
incorporated by reference to our definitive Proxy Statement for our annual
meeting of shareholders to be held on June 7, 2001 under the headings "Proposal
No. 1--Election of Directors" and "Section 16 (a) Beneficial Ownership Reporting
Compliance." Information regarding executive officers found under the Heading
"Executive Officers of the Registrant" in Part I hereof is also incorporated by
reference into this Item 10.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference to
our definitive Proxy Statement for our annual meeting of shareholders to be held
on June 7, 2001 under the heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is incorporated by reference to
our definitive Proxy Statement for our annual meeting of shareholders to be held
on June 7, 2001 under the heading "Security Ownership of Certain Beneficial
Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is incorporated by reference to
our definitive Proxy Statement for our annual meeting of shareholders to be held
on June 7, 2001 under the heading "Certain Relationships and Related
Transactions."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements. The following consolidated financial
statements for the year ended December 31, 2000, filed as part of this Form 10-
K, are incorporated by reference into this Item 14:
A. Friedman, Billings, Ramsey Group, Inc. Report of Independent Public
Accounts (page F-2)
Consolidated Balance Sheets--Years ended 2000 and 1999 (page F-3)
Consolidated Statements of Operations--Years ended 2000, 1999 and
1998 (page F-4)
Consolidated Statements of Changes in Shareholders' Equity -Years
ended 2000, 1999 and 1998 (page F-5)
Consolidated Statements of Cash Flows--Years ended 2000, 1999 and
1998 (page F-6)
Notes to Consolidated Financial Statements (pages F-7)
48
B. FBR Technology Venture Partners L.P. Financial Statements (G-1)
C. FBR Ashton, L.P. Financial Statements (H-1)
D. FBR Asset Investment Corporation Financial Statements (I-1)
(b) On October 27, 2000, we filed a Form 8-K announcing our third quarter
2000 financial results and on November 2, 2000, we filed a Form 8-K
supplementing the information in the October 27, 2000 8-K with an Unaudited
Financial and Statistical Supplement.
2. All schedules are omitted because they are not required or because the
information is shown in the financial statements or notes thereto.
3. Exhibits identified in parenthesis below are on file with the SEC as
part of our Registration Statement on Form S-1, as amended, No. 333-39107, and
are incorporated herein by reference. Exhibits identified in brackets below are
on file with the SEC as part of our 1998 Annual Report on Form 10-K, and are
incorporated herein by reference. Exhibits identified in double parenthesis
below are on file with the SEC as part of our 1999 Annual Report on Form 10-K,
and are incorporated herein by reference.
49
EXHIBIT INDEX
Exhibit
Number Exhibit Title
- ------ --------------------------------------------------------------------
2.01 --Purchase and Sale Agreement Between Money Management Associates et
al. And FBR dated, October 20, 1999. ((Exhibit 2.01))
3.01 --Registrant's Articles of Incorporation. (Exhibit 3.01)
3.02 --Registrant's Bylaws. (Exhibit 3.03)
4.01 --Form of Specimen Certificate for Registrant's Class A Common Stock
(Exhibit 4.01)
10.01 --Revolving Subordinated Loan Agreement, between Friedman, Billings,
Ramsey & Co., dated August Custodial Trust Company and 4, 1998.
[10.01]
10.02 --The 1997 Employee Stock Purchase Plan. (Exhibit 10.05)
10.03 --FBR Stock and Annual Incentive Plan. ((Exhibit 10.03))
10.04 --The Non-Employee Director Stock Compensation Plan. (Exhibit 10.07)
10.05 --The Key Employee Incentive Plan. (Exhibit 10.08)
21.01 --List of Subsidiaries of the Registrant
23.01 --Consent of Independent Public Accountants
99.01 --Memorandum of Understanding between FBR and PNC Bank Corp., dated
as of October 28, 1997. (Exhibit 99.01)
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
/S/ EMANUEL J. FRIEDMAN
---------------------------------
By:
Emanuel J. Friedman,
Chairman of the Board of Directors,
Co-Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- ----------------------- ------------------------------- --------------
/s/ EMANUEL J. FRIEDMAN Chairman of the Board of March 29, 2001
Directors, Co-Chief
Emanuel J. Friedman Executive Officer
/s/ ERIC F. BILLINGS Vice Chairman of the Board of March 29, 2001
Directors and Co-Chief
Eric F. Billings Executive Officer
/s/ W. RUSSELL RAMSEY President, Co-Chief Executive March 29, 2001
Officer and Director
W. Russell Ramsey
/s/ KURT R. HARRINGTON Senior Vice President and Chief March 29, 2001
Financial Officer (Principal
Kurt R. Harrington Financial and Accounting
Officer)
/s/ DANIEL J. ALTOBELLO Director March 29, 2001
Daniel J. Altobello
/s/ WALLACE L. TIMMENY Director March 29, 2001
Wallace L. Timmeny
/s/ MARK R. WARNER Director March 29, 2001
Mark R. Warner
51
FINANCIAL STATEMENTS OF FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants .............................. F-2
Consolidated Balance Sheets--As of December 31, 2000 and 1999 ......... F-3
Consolidated Statements of Operations--Years ended December 31, 2000,
1999 and 1998 ......................................................... F-4
Consolidated Statements of Changes in Shareholders' Equity--Years ended
2000, 1999 and 1998 ................................................... F-5
Consolidated Statements of Cash Flows--Years ended December 31, 2000,
1999 and 1998 ......................................................... F-6
Notes to Consolidated Financial Statements ............................ F-7
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Friedman, Billings, Ramsey Group, Inc.:
We have audited the accompanying consolidated balance sheets of Friedman,
Billings, Ramsey Group, Inc. (a Virginia corporation) as of December 31, 2000
and 1999, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2000. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Friedman, Billings, Ramsey Group, Inc., as of December 31, 2000 and 1999, and
the results of its operations and its cash flows for each of the three years in
the period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Vienna, Virginia
January 30, 2001,except for
Note 16, as to which the date
is March 13, 2001
F-2
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
------------
2000 1999
---- ----
(Dollars in thousands,
except per share
amounts)
ASSETS
Cash and cash equivalents ............................................................. $ 52,337 $ 43,743
Receivables:
Investment banking ............................................................ 4,696 4,273
Asset management fees ......................................................... 1,806 3,112
Affiliates .................................................................... 1,849 1,339
Other ......................................................................... 2,744 1,698
Due from clearing broker .............................................................. 11,840 13,472
Marketable and trading securities, at market value .................................... 18,447 6,137
Long-term investments ................................................................. 142,950 135,723
Furniture, equipment, software and leasehold improvements, net of accumulated
depreciation and amortization of $10,636 and $5,798, respectively .................. 10,173 11,308
Deferred tax asset .................................................................... -- 2,402
Prepaid expenses and other assets ..................................................... 5,377 3,149
--------- ---------
Total assets ............................................................. $ 252,219 $ 226,356
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Trading account securities sold but not yet purchased, at market value ........ $ 930 $ 3,029
Accounts payable and accrued expenses ......................................... 11,348 8,869
Accrued compensation and benefits ............................................. 22,849 24,130
Deferred tax liability ........................................................ 1,760 --
Long-term secured loans ....................................................... 776 1,359
--------- ---------
Total liabilities ........................................................ 37,663 37,387
--------- ---------
Commitments and contingencies (Note 11) ............................................... -- --
Shareholders' Equity:
Preferred Stock, $0.01 par value, 15,000,000 shares authorized, none issued and
Outstanding ................................................................. -- --
Class A Common Stock, $0.01 par value, 150,000,000 shares authorized,
17,455,406 and 14,304,026 shares issued, respectively ....................... 175 143
Class B Common Stock $0.01 par value, 100,000,000 shares authorized,
32,910,029 and 35,799,729 shares issued and outstanding, respectively ....... 329 358
Additional paid-in capital .................................................... 210,164 208,678
Treasury stock, at cost, 985,170 and 1,143,027 shares, respectively ........... (7,188) (8,341)
Accumulated other comprehensive loss .......................................... (1,128) (5,991)
Retained earnings (deficit) ................................................... 12,204 (5,878)
--------- ---------
Total shareholders' equity ............................................... 214,556 188,969
--------- ---------
Total liabilities and shareholders' equity ............................... $ 252,219 $ 226,356
========= =========
The accompanying notes are an integral part of these consolidated statements.
F-3
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
------------------------
2000 1999 1998
----------- ------------ ------------
(Dollars in thousands
except per share amounts)
Revenues:
Investment banking:
Underwriting ................................. $ 21,086 $ 22,642 $ 70,791
Corporate finance ............................ 31,404 22,541 41,356
Investment gains ............................. 1,453 3,853 --
Institutional brokerage:
Principal transactions ....................... 32,319 22,058 (28,192)
Agency commissions ........................... 21,084 14,988 15,308
Asset management:
Base management fees ......................... 9,719 9,409 7,556
Incentive allocations ........................ 44,456 35,903 3,841
Net investment income (loss) ................. 9,674 (3,196) (3,943)
Interest, dividends and other ..................... 9,695 10,768 16,151
----------- ------------ ------------
Total revenues .......................... 180,890 138,966 122,868
Expenses:
Compensation and benefits .................... 109,768 98,424 82,599
Business development and professional services 19,229 23,582 29,313
Clearing and brokerage fees .................. 6,207 4,693 5,078
Occupancy and equipment ...................... 9,544 6,674 4,225
Communications ............................... 5,085 4,323 3,592
Interest expense ............................. 1,665 1,323 4,927
Other operating expenses ..................... 7,147 6,918 9,343
----------- ------------ ------------
Total expenses .......................... 158,645 145,937 139,077
Net income (loss) before taxes ............... 22,245 (6,971) (16,209)
Income tax provision - deferred .............. 4,163 -- --
----------- ------------ ------------
Net income (loss) ....................... $ 18,082 $ (6,971) $ (16,209)
=========== ============ ============
Basic earnings (loss) per share .............. $ 0.37 $ (0.14) $ (0.33)
=========== ============ ============
Diluted earnings (loss) per share ............ $ 0.36 $ (0.14) $ (0.33)
=========== ============ ============
Basic weighted average shares outstanding .... 49,161,799 48,872,191 49,723,514
=========== ============ ============
Diluted weighted average shares outstanding .. 50,682,582 48,872,191 49,723,514
=========== ============ ============
The accompanying notes are an integral part of these consolidated statements.
F-4
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
(Dollars in thousands)
Class A Class B Additional
Number Class A Number Class B Paid-In Treasury
of Shares Amount of Shares Amount Capital Stock
---------- ------- ---------- ------- --------- -------
Balances, December 31, 1997 ...... 13,451,421 134 36,577,579 366 208,843 --
Net loss ........................ -- -- -- -- -- --
Conversion of Class B shares to
Class A shares ................ 265,150 3 (265,150) (3) -- --
Repurchase of treasury stock .... -- -- -- -- -- (8,062)
Issuance of treasury stock ...... -- -- -- -- (318) 981
Other comprehensive loss:
Unrealized change in investment
securities .................. -- -- -- -- -- --
Comprehensive loss ............ -- -- -- -- -- --
---------- ---- ---------- ----- --------- -------
Balances, December 31, 1998 ...... 13,716,571 137 36,312,429 363 208,525 (7,081)
Net loss ........................ -- -- -- -- -- --
Conversion of Class B shares to
Class A shares ................ 512,700 5 (512,700) (5) -- --
Repurchase of treasury stock .... -- -- -- -- -- (2,712)
Issuance of treasury stock ...... -- -- -- -- (345) 1,452
Issuance of Class A common
stock ......................... 74,755 1 -- -- 498 --
Other comprehensive income:
Unrealized change in investment
securities .................... -- -- -- -- -- --
Comprehensive income ............ -- -- -- -- -- --
---------- ---- ---------- ----- --------- -------
Balances, December 31, 1999 ...... 14,304,026 $143 35,799,729 $ 358 $ 208,678 $(8,341)
========== ==== ========== ===== ========= =======
Net income ...................... -- -- -- -- -- --
Conversion of Class B shares to
Class A shares ................ 2,889,700 29 (2,889,700) (29) -- --
Issuance of treasury stock ...... -- -- -- -- (33) 1,153
Issuance of Class A common
stock ......................... 261,680 3 -- -- 1,519 --
Other comprehensive income:
Unrealized change in investment
securities .................... -- -- -- -- -- --
Comprehensive income ............ -- -- -- -- -- --
---------- ---- ---------- ----- --------- -------
Balances, December 31, 2000 ...... 17,455,406 $175 32,910,029 $ 329 $ 210,164 $(7,188)
========== ==== ========== ===== ========= =======
Accumulated Retained
Other Compre- Earnings Comprehensive
hensive Loss (Deficit) Total Income (Loss)
------------- -------- --------- -------------
Balances, December 31, 1997 ...... -- 17,302 226,645
Net loss ........................ -- (16,209) (16,209) $(16,209)
Conversion of Class B shares to
Class A shares ................ -- -- --
Repurchase of treasury stock .... -- -- (8,062)
Issuance of treasury stock ...... -- -- 663
Other comprehensive loss:
Unrealized change in investment
securities .................. (16,135) -- (16,135) (16,135)
--------
Comprehensive loss ............ -- -- -- $(32,344)
-------- -------- --------- ========
Balances, December 31, 1998 ...... (16,135) 1,093 186,902
Net loss ........................ -- (6,971) (6,971) $ (6,971)
Conversion of Class B shares to
Class A shares ................ -- -- --
Repurchase of treasury stock .... -- -- (2,712)
Issuance of treasury stock ...... -- -- 1,107
Issuance of Class A common
stock ......................... -- -- 499
Other comprehensive income:
Unrealized change in investment
securities .................... 10,144 -- 10,144 10,144
--------
Comprehensive income ............ -- -- -- $ 3,173
-------- -------- --------- ========
Balances, December 31, 1999 ...... $ (5,991) $ (5,878) $ 188,969
======== ======== =========
Net income ...................... -- 18,082 18,082 $ 18,082
Conversion of Class B shares to
Class A shares ................ -- -- --
Issuance of treasury stock ...... -- -- 1,120
Issuance of Class A common
stock ......................... -- -- 1,522
Other comprehensive income:
Unrealized change in investment
securities .................... 4,863 -- 4,863 4,863
--------
Comprehensive income ............ -- -- -- $ 22,945
-------- -------- --------- ========
Balances, December 31, 2000 ...... $ (1,128) $ 12,204 $ 214,556
======== ======== =========
The accompanying notes are an integral part of these consolidated statements.
F-5
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended December 31,
----------------------------------------
2000 1999 1998
--------- --------- ---------
Cash flows from operating activities:
Net income (loss) ................................................ $ 18,082 $ (6,971) $ (16,209)
Non-cash items included in earnings-
(Income) loss and incentive (income) on long-term investments .. (16,720) (33,269) 101
Depreciation and amortization .................................. 4,886 2,749 1,390
Income tax provision-deferred .................................. 4,163 -- --
Other .......................................................... -- (321) --
Changes in operating assets:
Receivables-
Investment banking ......................................... (423) (1,198) 4,157
Asset management fees ...................................... 1,416 1,679 (1,288)
Income taxes ............................................... -- 8,734 (8,795)
Affiliates ................................................. (510) 5,895 (6,392)
Other ...................................................... 231 291 1,019
Due from clearing broker ....................................... 1,632 (2,751) 4,367
Marketable trading securities .................................. (1,560) 7,013 26,699
Prepaid expenses and other assets .............................. (2,228) (52) (1,621)
Changes in operating liabilities:
Trading account securities sold but not yet purchased .......... (2,099) 137 (13,412)
Repayments on short-term subordinated loans .................... -- -- (40,000)
Accounts payable and accrued expenses .......................... 2,479 643 (22,963)
Accrued compensation and benefits .............................. (1,281) 18,945 (13,837)
--------- --------- ---------
Net cash provided by (used in) operating activities ........ 8,068 1,524 (86,784)
--------- --------- ---------
Cash flows from investing activities:
Purchases of fixed assets ........................................ (3,751) (7,401) (4,865)
Sales (purchases) of long-term investments, net .................. 2,218 4,451 (37,311)
--------- --------- ---------
Net cash used in investing activities ...................... (1,533) (2,950) (42,176)
--------- --------- ---------
Cash flows from financing activities:
Repayments of long-term secured loans ............................ (583) (552) (505)
Proceeds from issuance of common stock ........................... 1,489 499 --
Purchases of treasury stock ...................................... -- (2,712) (8,062)
Issuance of treasury stock ....................................... 1,153 1,107 663
Distributions .................................................... -- -- (24,000)
--------- --------- ---------
Net cash provided by (used in) financing activities ........ 2,059 (1,658) (31,904)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ............... 8,594 (3,084) (160,864)
Cash and cash equivalents, beginning of year ....................... 43,743 46,827 207,691
--------- --------- ---------
Cash and cash equivalents, end of year ............................. $ 52,337 $ 43,743 $ 46,827
========= ========= =========
The accompanying notes are an integral part of these consolidated statements.
F-6
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Dollars in thousands except for per share amounts)
NOTE 1. ORGANIZATION AND NATURE OF OPERATIONS:
Organization
Friedman, Billings, Ramsey Group, Inc., a Virginia corporation (the
"Company"), is a holding company of which the principal operating subsidiaries
are Friedman, Billings, Ramsey & Co., Inc. ("FBRC"), FBR Investment Services,
Inc. ("FBRIS"), Friedman, Billings, Ramsey Investment Management, Inc.
("FBRIM") and FBR Venture Capital Managers, Inc. ("VCM").
FBRC and FBRIS are registered broker-dealers and members of the National
Association of Securities Dealers, Inc. They act as introducing brokers and
forward all transactions to clearing brokers on a fully disclosed basis. FBRC
and FBRIS do not hold funds or securities for, nor owe funds or securities to,
customers. During the periods presented, FBRC's underwriting and corporate
finance activities were concentrated primarily on technology, energy, real
estate and financial services companies.
FBRIM and VCM are registered investment advisers that manage and act as
general partners of proprietary investment limited partnerships. FBRIM also
manages separate investment accounts and FBR Asset Investment Corporation
("FBR-Asset"), a publicly-traded real estate investment trust ("REIT").
Nature of Operations
The Company's principal business activities (capital raising, securities
sales and trading, merger and acquisition and advisory services, proprietary
investments, and venture capital and other asset management services) are linked
to the capital markets. In addition, the Company's business activities are
primarily focused on small and mid-cap stocks in the financial services, real
estate, technology and energy sectors. By their nature, the Company's business
activities are highly competitive and are not only subject to general market
conditions, volatile trading markets and fluctuations in the volume of market
activity but to the conditions affecting the companies and markets in the
Company's areas of focus.
The Company's revenues, particularly from capital raising, venture
capital, private equity and principal investment activities, are subject to
substantial fluctuations due to a variety of factors that cannot be predicted
with great certainty, including the overall condition of the economy and the
securities markets as a whole and of the sectors on which the Company focuses.
Fluctuations also occur due to the level of market activity, which, among other
things, affects the flow of investment dollars and the size, number and timing
of transactions. As a result, net income and revenues in any particular period
may vary significantly from period to period and year to year.
The financial services industry continues to be affected by the
intensifying competitive environment and by consolidation through mergers and
acquisitions, as well as significant growth in competition in the market for on-
line trading services. The relaxation of banks' barriers to entry into the
securities industry and expansion by insurance companies into traditional
brokerage products, coupled with the repeal of laws separating commercial and
investment banking activities, have increased the competition for a similar
customer base.
In order to compete in this increasingly competitive environment, the
Company continually evaluates its businesses across varying market conditions
for profitability and alignment with long-term strategic objectives, including
the diversification of revenue sources. The Company believes that it is
important to diversify and strengthen its revenue base by increasing the
segments of its business that offer a recurring and more predictable source of
revenue.
Concentration of Risk
A substantial portion of the Company's revenues in a year may be derived
from a small number of transactions or issues or may be concentrated in a
particular industry. Revenues derived from the Company's technology venture
capital and technology investment banking deals accounted for 44% of the
Company's revenues for the year ended December 31, 2000 compared to 41% for the
year ended December 31, 1999. Two unrelated investment banking transactions
accounted for 33% of the Company's revenues for the year ended December 31,
1998.
As of December 31, 2000 and 1999, respectively, the Company's investment
in FBR Technology Venture Partners, L.P. ("TVP") of $23,913 and $39,413
represented 17% and 29% of the Company's long-term investments. For the years
ended December 31, 2000 and 1999, the Company recorded revenue from TVP of
$47,211 and $40,284 representing 26% and 29% of the Company's revenue in 2000
and 1999, respectively. As of December 31, 2000 and 1999, respectively, the
Company's
F-7
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
investment in FBR-Asset of $30,054 and $24,194 represented 21% and 18% of the
Company's long-term investments. For the years ended December 31, 2000 and 1999,
the Company recorded revenue from FBR-Asset of $7,785 and $5,146 representing 4%
of the Company's revenue in 2000 and 1999, respectively. As of December 31, 2000
and 1999, respectively, the Company's investment in FBR Ashton, L.P. ("Ashton")
of $15,430 and $10,666 represented 11% and 8% of the Company's long-term
investments. For the years ended December 31, 2000 and 1999, respectively, the
Company recorded revenue from Ashton of $5,078 and $(800) representing 3% of the
Company's revenue in 2000. Collectively, these three investments represented 49%
of the Company's total long-term investments, 28% of the Company's total assets
as of December 31, 2000 and 33% of the Company's revenue for the year ended
December 31, 2000. These concentrations create exposure to market risk for the
Company in the technology, real estate and financial services sectors.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
All significant intercompany accounts and transactions have been
eliminated in consolidation. Certain prior-year amounts have been reclassified
to conform to the 2000 presentation.
Cash Equivalents
Cash equivalents include demand deposits with banks, money market accounts
and highly liquid investments with original maturities of three months or less
that are not held for sale in the ordinary course of business. As of December
31, 2000 and 1999, respectively, approximately 53% and 65% of the Company's cash
equivalents were invested in money market funds that invest primarily in U.S.
Treasuries and other government securities, backed by the U.S. government.
Supplemental Cash Flow Information Including Non-cash Transactions
Cash payments for interest approximated interest expense for the years
ended December 31, 2000, 1999 and 1998. The Company paid $8,795 of estimated
income tax payments in 1998 and none in 2000 and 1999. There were no significant
non-cash investing and financing activities during 2000 and 1999. In 1998, the
Company paid $24,000 of distributions to shareholders that were accrued as of
December 31, 1997. Also in 1998, the Company transferred $38,035 of investment
securities from marketable trading securities to long-term investments.
Securities and Principal Investments
Investments in proprietary investment partnerships and venture funds, in
which FBR is the general partner, and FBR-Asset are accounted for under the
equity method and the Company's proportionate share of income or loss ("income
allocation") is reflected in net investment income (loss) in the statements of
operations. Investments in investment partnerships and venture funds, in which
FBR is not the general partner and, therefore, does not have significant
influence, are accounted for under the cost method. Under the cost method, the
Company records income only when distributed by the partnership.
Securities owned by the Company's broker-dealer subsidiaries and
securities sold but not yet purchased are valued at market and resulting
realized and unrealized gains and losses are reflected in principal transactions
in the statements of operations. Long-term marketable securities held in
non-broker-dealer entities are classified as available-for-sale investments and
are valued at market with resulting unrealized gains and losses reflected in
other comprehensive gain or loss in the Company's balance sheet. Declines in the
value of available-for-sale investments that are "other than temporary" are
recorded in net investment loss.
Substantially all financial instruments used in the Company's trading and
investing activities are carried at fair value or amounts that approximate fair
value. Fair value is based generally on listed market prices or broker-dealer
price quotations. To the extent that prices are not readily available, or if
liquidating the Company's position is reasonably expected to affect market
prices, fair value is based on internal valuation models and estimates made by
management.
In connection with certain capital raising transactions, the Company has
received and holds warrants for stock of the issuing corporation generally
exercisable at the respective offering price, with respect to the relevant
transaction. Due to the restrictions on the warrants and the underlying
securities, the Company carries the warrants at nominal values, and recognizes
profits, if any,
F-8
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
only when realized. During 2000 and 1999, respectively, the Company sold a
portion of the warrants and recorded $1,453 and $3,853 in investment gains
related to the sales.
Furniture, Equipment, Software and Leasehold Improvements
Furniture, equipment and software are depreciated using the straight-line
method over their estimated useful lives of three to ten years. Leasehold
improvements are amortized using the straight-line method over the shorter of
the useful life or lease term. Amortization of purchased software is recorded
over the estimated useful life of three years. The Company has capitalized
certain software development costs associated with its launch of fbr.com.
These costs are being amortized over the estimated useful life of the software.
Income Taxes
Deferred tax assets and liabilities represent the differences between the
financial statement and income tax bases of assets and liabilities, using
enacted tax rates. The measurement of net deferred tax assets is adjusted by a
valuation allowance if, based on the weight of available evidence, it is more
likely than not that they will not be realized.
Other Comprehensive Income or Loss
Comprehensive income includes net income as currently reported by the
Company on the consolidated statements of operations adjusted for other
comprehensive income. Other comprehensive income for the Company represents
changes in unrealized gains and losses related to the Company's equity
securities and the Company's proportionate share of FBR-Asset's investments
accounted for as available-for-sale with changes in fair value recorded through
equity.
Revenues
Investment Banking
------------------
Underwriting revenues represent fees earned from public offerings of
securities in which the Company acts as underwriter or agent. These revenues are
comprised of selling concessions, underwriting fees, and management fees.
Corporate finance revenues represent fees earned from private placement
offerings, mergers and acquisitions, mutual conversions, financial restructuring
and other advisory services proved to clients. Underwriting revenues are
recorded as revenue at the time the underwriting is completed. Corporate finance
fees are recorded as revenue when the related service has been rendered and the
client is contractually obligated to pay. Fees received in advance of services
rendered are recognized as revenue over the service period.
Institutional Brokerage
-----------------------
Principal transactions consist of sales credits and trading gains or
losses, and agency commissions consist of commissions earned from executing
stock exchange-listed securities and OTC transactions as an agent. Revenues
generated from securities transactions and related commission income and
expenses are recorded on a trade date basis.
Asset Management
----------------
The Company records asset management revenue: (1) Certain of the Company's
subsidiaries act as investment advisers and receive management fees for the
management of proprietary investment partnerships, venture capital funds, mutual
funds and FBR-Asset, based upon the amount of capital committed or under
management. This revenue is recorded in base management fees in the Company's
statements of operations as earned. (2) The Company also receives incentive
income based upon the operating results of the partnerships and venture capital
funds. Incentive income represents a carried interest in the gains of the
partnerships and funds and is recorded in incentive allocations in the
statements of operations as earned. (3) The Company also records allocations,
under the equity method of accounting, for its proportionate share of the
earnings or losses of the partnerships, venture funds and FBR-Asset. Income or
loss allocations are recorded in net investment income (loss) in the Company's
statements of operations.
Compensation
A significant component of compensation expense relates to incentive
bonuses. Incentive bonuses are accrued based on the contribution of key business
units using certain pre-defined formulas. Since the bonus determinations are
also based on aftermarket security performance and other factors, which include
unrealized gains and losses, amounts currently accrued may not ultimately be
paid.
F-9
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
The Company's compensation accruals are reviewed and evaluated on a quarterly
basis.
Certain of the fund management teams have an agreement with the Company to
receive a percentage of the incentive income paid by the funds. For TVP, the
fund management team earns 60% of the incentive income and this amount is
recorded as compensation expense at the time the incentive income is recorded.
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with SFAS
No.123, "Accounting for Stock-Based Compensation." Pursuant to SFAS No. 123, the
Company continues to apply the provisions of Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees." Under APB No. 25,
compensation expense is recorded for the difference, if any, between the fair
market value of the common stock on the date of grant and the exercise price of
the option. For the years ended December 31, 2000, 1999 and 1998, the exercise
prices of all options granted equaled the market prices on the dates of grants,
therefore, the Company did not record any compensation expense in 2000, 1999 and
1998 related to option grants.
Earnings (Loss) Per Share
Basic earnings (loss) per share includes no dilution and is computed by
dividing net income or loss available to common shareholders by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share includes the impact of dilutive securities which for the
Company are stock options. For the year ended December 31, 2000, the difference
between basic and diluted earnings per share is due to certain dilutive stock
options. For the years ended December 31, 1999 and 1998, there were no
differences between basic and diluted earnings or loss per share as the impact
of options was anti-dilutive. For the year ended December 31, 2000, options to
purchase 3,565,762 shares of common stock were not included in the computation
of diluted earnings per share because the options' exercise price was greater
than the average market price of the common shares. See Note 13 for a detail of
total stock options outstanding.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
NOTE 3. MARKETABLE AND TRADING SECURITIES OWNED AND SECURITIES SOLD BUT NOT YET
PURCHASED:
Marketable and trading securities owned and trading account securities
sold but not yet purchased consisted of securities at market values for the
years indicated (in thousands):
December 31,
------------------------------------------------
2000 1999
----------------------- ----------------------
Sold But Not Sold But Not
Owned Yet Purchased Owned Yet Purchased
------- ------------- ------- -------------
Corporate stocks ..... $17,011 $ 865 $ 4,193 $ 3,015
Corporate bonds ...... 1,436 65 1,944 14
------- ------- ------- -------
$18,447 $ 930 $ 6,137 $ 3,029
======= ======= ======= =======
Trading account securities sold but not yet purchased represent
obligations of the Company to deliver the specified security at the contracted
price, and thereby, creates a liability to purchase the security in the market
at prevailing prices. Accordingly, these transactions result in
off-balance-sheet risk as the Company's ultimate obligation to satisfy the sale
of securities sold but not yet purchased may exceed the current value recorded
in the consolidated balance sheets.
F-10
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
NOTE 4. LONG-TERM INVESTMENTS:
Long-term investments consisted of the following for the years indicated
(in thousands):
December 31,
----------------------
2000 1999
-------- --------
Equity method investments
Venture capital and other proprietary investment partnerships $ 77,693 $ 69,755
FBR-Asset .................................................... 30,054 24,194
Private debt and preferred equity investments ................... 17,837 25,380
Other ........................................................... 15,078 16,161
Cost method partnership investments ............................. 2,288 233
-------- --------
$142,950 $135,723
======== ========
Venture Capital and Other Proprietary Investment Partnerships
VCM is the managing partner of FBR Technology Venture Partners, L.P.
("TVP") and FBR Technology Venture Partners II ("TVP II", consisting of 5
separate limited partnerships). FBRIM is the managing partner or member of FBR
Ashton, L.P., FBR Weston, L.P., FBR Future Financial Fund, L.P., FBR Private
Equity Fund, L.P., FBR Arbitrage, L.L.C., FBR CoMotion Venture Capital I, L.P.
and through a wholly-owned L.L.C., FBR Financial Services Partners, L.P. All of
these partnerships were formed for the purpose of investing in public and
private securities, therefore, their assets principally consist of investment
securities accounted for at fair value. The Company accounts for its investments
in these partnerships under the equity method. The following table shows the
Company's investments and percentage interest on which pro rata profit
allocations (as distinct from carried interest incentive income) are based (in
thousands):
December 31,
---------------------------------
2000 1999
------------- -------------
FBR Technology Venture Partners, L.P..... $23,913 3% $39,413 3%
FBR Ashton, L.P. ........................ 15,430 29% 10,666 19%
FBR Arbitrage, L.L.C .................... 10,320 15% 7,816 32%
FBR Technology Venture Partners II, L.P.. 6,418 5% 1,124 5%
Braddock Partners, L.P. ................. 4,920 11% 4,628 14%
FBR CoMotion Venture Capital I, L.P...... 3,724 8% -- --
FBR Private Equity Fund, L.P. ........... 3,669 19% 3,064 15%
FBR Future Financial Fund, L.P. ......... 1,659 9% 583 9%
FBR Financial Services Partners, L.P..... 1,580 6% 1,387 6%
FBR Weston, L.P ......................... 1,402 7% 1,069 7%
Other ................................... 4,658 -- 5 --
------- -------
$77,693 $69,755
======= =======
FBR Technology Venture Partners, L.P.
FBR Technology Venture Partners, L.P. ("TVP") is a limited partnership,
formed on August 12, 1997, to engage in the business of investing in securities.
FBR Venture Capital Managers, Inc., a wholly owned subsidiary of the Company, is
the corporate general partner of TVP. TVP's investments as of December 31, 2000
and 1999 included equity investments in securities of development-stage and
early-stage, privately and publicly held, technology companies. The disposition
of the privately held investments is generally restricted due to the lack of a
ready market. TVP's investments may represent significant proportions of the
issuer's equity and they may carry special contractual privileges not available
to other security holders. As a result, precise valuation for the private and
restricted investments is a matter of judgment and the determination of fair
value must be considered only an approximation. Public company investments are
valued based on the year-end closing price less a discount to reflect
restrictions on liquidity and marketability.
F-11
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
FBR Ashton, L.P.
FBR Ashton, L.P. ("Ashton") is a limited partnership, formed on November
8, 1991, to engage in the business of investing in securities primarily in the
financial services industry. Friedman, Billings, Ramsey Investment Management,
Inc., a wholly owned subsidiary of the Company, is the corporate general partner
of Ashton. Ashton's investments as of December 31, 2000 and 1999 included equity
investments in securities of publicly held companies.
FBR-Asset
FBR-Asset is a REIT, formed in 1997, whose primary purpose is to invest in
mortgage loans, mortgage-backed securities and public and private real estate
companies. As of December 31, 2000, 69% and 12% of FBR-Asset's assets were
invested in mortgage-backed securities and equity securities, respectively. FBR-
Asset classifies its investments as available-for-sale. Accordingly, unrealized
gains and losses related to securities are reflected as other comprehensive gain
or loss in FBR-Asset's equity. The Company accounts for its investment in FBR-
Asset under the equity method. As a result, the Company recorded $7,079 and
$4,134 in net investment income in the statements of operations for its
proportionate share (reflecting share repurchases) of FBR-Asset's 2000 and 1999
net income, respectively. In addition, during 2000 and 1999, respectively, the
Company reduced its carrying basis of FBR-Asset for declared dividends of $3,965
and $2,157. The Company also recorded, in other comprehensive loss, $2,746 and
($1,473) of net unrealized gain/(loss) on investments which represented its
proportionate share of FBR-Asset's net unrealized gain or loss related to
available-for-sale securities for the year ended December 31, 2000 and 1999
respectively. As of December 31, 2000 and 1999, respectively, net unrealized
loss related to FBR-Asset and included in the Company's accumulated other
comprehensive loss was $(259) and $(3,005). The Company's ownership percentage
of FBR-Asset was 35% as of December 31, 2000.
The Company's significant equity method investments are:
2000 TVP Ashton FBR-Asset Other Total
--------- ------- --------- -------- ---------
Total assets $ 109,463 $63,706 $ 225,804 $481,780 $ 880,753
Total liabilities 511 10,794 138,963 133,812 284,080
Total equity 108,952 52,912 86,841 347,968 596,673
FBR's share of total equity 23,913 15,430 30,054 38,350 107,747
Total revenue 139 1,752 23,841 9,000 34,732
Total expenses 1,306 1,528 12,610 12,542 27,986
Realized gains (losses) 257,954 318 (2,867) 16,908 272,313
Unrealized gains (losses) (105,967) 16,654 -- 31,760 (57,553)
Net income 150,820 17,196 8,364 45,126 221,506
FBR's share of net income - net investment income 3,242 4,765 7,079 6,159 21,245
FBR's share of net income - incentive allocations 30,186 -- -- 1,736 31,922
1999 TVP Ashton FBR-Asset Other Total
--------- ------- --------- -------- ---------
Total assets $ 223,685 $70,164 $ 330,180 $204,875 $ 828,904
Total liabilities 253 15,267 225,638 49,526 290,684
Total equity 223,432 54,897 104,542 155,349 538,220
FBR's share of total equity 39,413 10,666 24,194 19,676 93,949
Total revenue 59 3,300 23,474 3,922 30,755
Total expenses 1,718 3,277 10,682 6,314 21,991
Realized gains (losses) -- 2,960 (7,649) 6,925 2,236
Unrealized gains (losses) 186,239 (13,651) -- 10,218 182,806
Net income (loss) 184,580 (10,668) 5,143 14,751 193,806
FBR's share of net income - net investment
income (loss) 3,999 (1,527) 4,134 2,938 9,544
FBR's share of net income - incentive allocations 34,326 -- -- 1,577 35,903
1998 TVP Ashton FBR-Asset Other Total
--------- ------- --------- -------- ---------
Total assets $ 20,671 $130,773 $ 295,931 $133,169 $ 580,544
Total liabilities 1,119 39,817 145,026 24,373 210,335
Total equity 19,552 90,956 150,905 108,796 370,209
FBR's share of total equity 568 12,192 23,690 13,704 50,154
F-12
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
Total revenue 45 4,428 17,928 3,509 25,910
Total expenses 1,466 5,483 7,970 2,970 17,889
Realized gains (losses) -- (1,722) (8,370) 9,716 (376)
Unrealized gains (losses) 1,058 (46,028) -- 2,942 (42,028)
Net income (loss) (363) (48,805) 1,588 13,197 (34,383)
FBR's share of net income - net investment income (loss) 29 (5,113) 1,109 1,817 (2,158)
FBR's share of net income - incentive allocations -- 1,879 -- 1,962 3,841
Private Debt and Preferred Equity Investments
In May 1998, the Company organized a business trust designed to extend
financing to middle-market businesses in need of subordinated debt or mezzanine
financing. In connection therewith, the Company loaned $17,500 to two unrelated
businesses at an average annual interest rate of 13.6%. The loans mature as
follows: $7,500 in June 2003 and $10,000 in December 2005. The loans are
carried at cost. The Company also initially invested $7,000 in an unaffiliated
private company. During the years ended 2000 and 1999, respectively, the Company
recorded $5,880 and $1,820 of investment losses related to the preferred equity
investment.
Other
The Company's available-for-sale securities consist primarily of equity
investments in publicly traded companies that are held by an asset management
subsidiary of the Company. In accordance with SFAS No. 115, the securities are
valued at market with resulting unrealized gains and losses reflected as other
comprehensive gain or loss. During 2000 and 1999, respectively, the Company
recorded $2,519 and $10,385 of "other than temporary" loss in the statement of
operations as net investment income (loss). During 2000 and 1999, respectively,
the Company also sold $10,278 and $5,934 of other available-for-sale securities
at a realized loss of $1,814 and $221. As of December 31, 2000 and 1999,
respectively, the Company held available-for-sale securities with a fair value
of $5,373 and $16,161 with unrealized losses related to these securities of
$(869) and $(2,986). These unrealized losses are included in accumulated other
comprehensive loss.
During 2000, the Company employed option strategies that were indexed to
common equity shares held by certain of the Company's managed investment
partnerships. The options are subject to fair value accounting. Total realized
and unrealized gains of $12,534 were recognized during 2000 and included in
incentive allocations in the statements of operations. As of December 31, 2000,
the outstanding options had a fair value of $9,705.
NOTE 5. FURNITURE, EQUIPMENT, SOFTWARE AND LEASEHOLD IMPROVEMENTS:
Furniture, equipment, software and leasehold improvements, summarized by
major classification, were (in thousands):
December 31,
---------------------
2000 1999
-------- --------
Furniture and equipment ...................... $ 7,673 $ 6,471
Software ..................................... 8,366 6,049
Leasehold improvements ....................... 4,770 4,586
-------- --------
20,809 17,106
Less-Accumulated depreciation and amortization (10,636) (5,798)
-------- --------
$ 10,173 $ 11,308
======== ========
F-13
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
NOTE 6. INCOME TAXES:
Deferred tax assets and liabilities consisted of the following as of
December 31, 2000 and 1999 (in thousands):
December 31,
-----------------------
2000 1999
-------- --------
Unrealized investment gains on proprietary investment partnerships
and venture funds ........................................................ $(21,038) $(17,671)
Unrealized investment losses, recorded in accumulated other
comprehensive loss ....................................................... 494 2,467
Unrealized investment losses, recorded in earnings, related to "other than
temporary" declines in the value of available-for-sale securities ........ 5,657 4,246
Net operating loss carryforward .......................................... 15,241 15,712
Accrued compensation ..................................................... 98 8,523
Other .................................................................... 1,154 (61)
-------- --------
1,606 13,216
Less-valuation allowance recorded through accumulated other comprehensive
Loss ..................................................................... (494) (2,467)
Less-valuation allowance recorded through earnings ....................... (2,872) (8,347)
-------- --------
Net deferred tax (liability)/asset........................................ $ (1,760) $ 2,402
======== ========
The Company has a net operating loss (NOL) carryforward to offset future
taxable income. As of December 31, 2000 and 1999, respectively, the Company has
gross NOL carryforwards of $34,763 and $38,430 that expire through 2019. The
Company has provided a valuation allowance against its deferred tax assets based
on its ongoing assessment of realizability of the deferred tax assets. This
assessment includes analyzing future taxable income, a significant component of
which is dependent on the realizability of the investment partnerships' and
venture funds' unrealized gains that have been recorded for financial reporting
purposes, but not for income tax purposes.
The benefit for income taxes results in effective tax rates that differ
from the Federal statutory rates as follows:
December 31,
--------------------------
2000 1999 1998
---- ---- ----
Statutory Federal income tax rate ........ 35% (35)% (35)%
State income taxes, net of Federal benefit 5 (5) (5)
Nondeductible expenses ................... 9 11 6
Dividends received deduction ............. -- (6) --
Valuation allowance ...................... (30) 35 34
---- ---- ----
Effective income tax rate ................ 19% -- --
==== ==== ====
NOTE 7. PROFIT SHARING PLAN:
The Company maintains a qualified 401(k) profit sharing plan. Eligible
employees may defer a portion of their salary. At the discretion of the Board of
Directors, the Company may make matching contributions and discretionary
contributions from profits. There were no Company contributions made in 2000,
1999 or 1998.
NOTE 8. BORROWINGS:
Subordinated Revolving Loans
As of December 31, 2000 and 1999, FBRC had an unsecured revolving
subordinated loan agreement ("the line"), with total available credit of
$40,000, with an affiliate of its clearing broker. The purpose of the line is to
make additional funds available to meet regulatory net capital requirements for
participation in underwriting public offerings. The expiration date of the line
is December 2001. There were no outstanding balances under the line as of
December 31, 2000 and 1999. Borrowings under the revolving subordinated loan
agreement are available in computing net capital under the SEC's Uniform Net
Capital Rule (Rule 15c3-1).
F-14
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
Long-Term Loans
The Company has four long-term secured loans totaling $776 and $1,359 as
of December 31, 2000 and 1999, respectively, requiring fixed annual principal
and interest payments totaling $673. Each loan bears interest at an annual rate
based on a one-month commercial paper rate, plus a spread, which equaled 8.96%
and 7.76% at December 31, 2000 and 1999, respectively. The loans are
collateralized by certain furniture, equipment, and leasehold improvements of
the Company. The loans are scheduled to be entirely repaid in June 2001, October
2001, January 2002, and November 2002, respectively.
NOTE 9. NET CAPITAL COMPUTATION:
FBRC and FBRIS are subject to the SEC's Uniform Net Capital Rule (Rule
15c3-1) that requires the maintenance of minimum net capital and requires that
the ratio of aggregate indebtedness to net capital, both as defined, shall not
exceed 15 to 1. At December 31, 2000 and 1999, respectively, FBRC had net
capital of $30,545 and $33,984 which was $29,574 and $33,056 in excess of its
required net capital of $971 and $928. FBRC's aggregate indebtedness to net
capital ratio was 0.3 to 1 at December 31, 2000 and 1999, respectively. As of
December 31, 2000 and 1999, respectively, FBRIS had net capital of $679 and
$1,050, which was $579 and $921 in excess of its required net capital of $100
and $129. FBRIS' aggregate indebtedness to net capital ratio was 1.2 to 1 and
1.9 to 1 at December 31, 2000 and 1999, respectively.
NOTE 10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CREDIT RISK:
Financial Instruments
The Company's broker-dealer entities trade securities that are primarily
traded in United States markets. The Company's asset management entities trade
and invest in public and non-public securities. As of December 31, 2000 and
1999, the Company had not entered into any transactions involving financial
instruments, such as financial futures, forward contracts, options, swaps or
derivatives, that would expose the Company to significant related
off-balance-sheet risk. See Note 4 for a discussion of option strategies.
In addition, the Company has sold securities it does not currently own in
anticipation of a decline in the fair value of that security (securities sold,
not yet purchased). When the Company sells a security short, it must borrow the
security sold short and deliver it to the broker-dealer through which it made
the short sale. A gain, limited to the price at which the Company sold the
security short, or a loss, unlimited in size, will be realized upon the
termination of a short sale.
Market risk is primarily caused by movements in market prices of the
Company's trading and investment account securities and changes in value of the
underlying securities of the venture capital funds and proprietary investment
partnerships in which the Company invests. The Company's trading securities and
investments are also subject to interest rate volatility and possible
illiquidity in markets in which the Company trades or invests. The Company seeks
to control market risk through monitoring procedures. The Company's principal
transactions are primarily short and long debt and equity transactions.
Positions taken and commitments made by the Company, including those made
in connection with venture capital and investment banking activities, have
resulted in substantial amounts of exposure to individual issuers and
businesses, including non-investment grade issuers, securities with low trading
volumes and those not readily marketable. These issuers and securities expose
the Company to a higher degree of risk than associated with investment grade
instruments.
Credit Risk
The Company's broker-dealer subsidiaries function as introducing brokers
that place and execute customer orders. The orders are then settled by an
unrelated clearing organization that maintains custody of customers' securities
and provides financing to customers.
Through indemnification provisions in agreements with clearing
organizations, customer activities may expose the Company to off-balance-sheet
credit risk. Financial instruments may have to be purchased or sold at
prevailing market prices in the event a customer fails to settle a trade on its
original terms or in the event cash and securities in customer margin accounts
are not sufficient to fully cover customer obligations. The Company seeks to
control the risks associated with customer activities through customer screening
and selection procedures as well as through requirements on customers to
maintain margin collateral in compliance with various regulations and clearing
organization policies.
F-15
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
The Company's other equity and debt investments include non-investment
grade securities of privately held issuers with no ready markets. The
concentration and illiquidity of these investments expose the Company to a
higher degree of risk than associated with readily marketable securities.
NOTE 11. COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases premises under long-term lease agreements requiring
minimum annual rental payments with annual adjustments based upon increases in
the consumer price index, plus the pass-through of certain operating and other
costs above a base amount.
Future minimum aggregate annual rentals payable under these non-cancelable
leases for the years ending December 31, 2001 through 2005, are as follows (in
thousands):
Year Ending December 31,
------------------------
2001..................................... $ 3,294
2002..................................... 2,902
2003..................................... 2,791
2004..................................... 1,393
2005..................................... 75
-------
$10,455
=======
Equipment and office rent expense for 2000, 1999 and 1998 was $3,914,
$3,405 and $2,430, respectively.
Litigation
As of December 31, 2000, 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. The Company is a defendant in a small
number of civil lawsuits and arbitrations (together, "litigation") relating to
its various businesses. There can be no assurance that these matters will not
have a material adverse effect on the Company's financial condition or results
of operations in a future period. However, based on management's review with
counsel, resolution of these matters is not expected to have a material adverse
effect on the Company's financial condition or results of operations.
Many aspects of the Company's business involve substantial risks of
liability and litigation. Underwriters, broker-dealers and investment advisers
are exposed to liability under Federal and state securities laws, other Federal
and state laws and court decisions, including decisions with respect to
underwriters' liability and limitations on indemnification, as well as with
respect to the handling of customer accounts. For example, underwriters may be
held liable for material misstatements or omissions of fact in a prospectus used
in connection with the securities being offered and broker-dealers may be held
liable for statements made by their securities analysts or other personnel. In
certain circumstances, broker-dealers and asset managers may also be held liable
by customers and clients for losses sustained on investments. In recent years,
there has been an increasing incidence of litigation involving the securities
industry, including class actions that seek substantial damages. The Company is
also subject to the risk of litigation, including litigation that may be without
merit. As the Company intends actively to defend such litigation, significant
legal expenses could be incurred. An adverse resolution of any future litigation
against the Company could materially affect the Company's operating results and
financial condition.
NOTE 12. EXECUTIVE OFFICER COMPENSATION:
During 2000, certain of the Company's executive officers were eligible for
bonuses under the Key Employee Incentive Plan (the "Key Employee Plan").
During 2000, in accordance with an income-based performance formula, the Company
accrued $6.5 million of executive officer compensation, in accordance with the
Key Employee Plan, representing 22.4% of the Company's pre-tax income (before
executive officer compensation accruals). Compensation related to the Key
Employee Plan was paid subsequent to December 31, 2000.
During 1999, the Company's three Executive Officer Directors participated
in the Key Employee Plan. In accordance with the 1999 performance formula set
under this plan, Executive Officer Directors were eligible to participate in two
bonus pools. The first was a bonus pool of up to 20% of the Company's pre-tax
income (before executive officer compensation accruals), adjusted for certain
expense items excluded from pre-tax income. The 20% pool was subject to a cap
related to the ratio of compensation expense
F-16
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
(excluding certain items) to total revenues. For the year ended December 31,
1999, the Company generated adjusted income under the Key Employee Plan,
however, due to the application of the cap, no bonuses were paid under the 20%
pool. The second pool comprised up to $6.0 million in total bonuses based on a
formula tied to the performance of FBRC's trading operations. The entire $6.0
million pool was earned and recorded as compensation expense in 1999.
During 1998, the Company's Executive Officer Directors participated in the
Company's Stock and Annual Incentive Plan, however, no bonuses were earned due
to the net loss loss generated in 1998.
NOTE 13. SHAREHOLDERS' EQUITY:
The Company has authorized share capital of 100 million shares of Class B
Common Stock, par value $0.01 per share; 150 million shares of Class A Common
Stock, par value $0.01 per share; and 15 million shares of undesignated
preferred stock. Holders of the Class A and Class B Common Stock are entitled to
one vote and three votes per share, respectively, on all matters voted upon by
the shareholders. Shares of Class B Common Stock convert to shares of Class A
Common Stock at the option of the Company in certain circumstances including (i)
upon sale or other transfer, (ii) at the time the holder of such shares of Class
B Common Stock ceases to be affiliated with the Company and (iii) upon the sale
of such shares in a registered public offering. The Company's Board of Directors
has the authority, without further action by the shareholders, to issue
preferred stock in one or more series and to fix the terms and rights of the
preferred stock. Such actions by the Board of Directors could adversely affect
the voting power and other rights of the holders of common stock. Preferred
stock could thus be issued quickly with terms that could delay or prevent a
change in control of the Company or make removal of management more difficult.
At present, the Company has no plans to issue any of the preferred stock.
Stock and Annual Incentive Plan (the "Plan")
Under the Plan, the Company may grant options, stock appreciation rights,
performance awards and restricted and unrestricted stock to purchase up to 14.9
million shares of Class A Common Stock to eligible participants in the Plan.
Participants include employees and officers of the Company and its subsidiaries.
The Plan has a term of 10 years and options granted have an exercise period of
up to 10 years. Options may be incentive stock options, as defined by Section
422 of the Internal Revenue Code, or nonqualified stock options. Details of
stock options granted are as follows:
Number of
Shares Exercise Price
---------- ------------------
Balance as of December 31, 1997 ............... 4,383,400 $ 20.00
Granted in 1998 ............................... 2,160,280 $ 5.875 - $ 19.625
Forfeitures in 1998 upon departure of employees (293,200) $ 5.875 - $ 20.00
----------
Balance as of December 31, 1998 ............... 6,250,480 $ 5.875 - $ 20.00
Granted in 1999 ............................... 3,507,148 $5.1875 - $13.0625
Forfeitures in 1999 upon departure of employees (468,025) $ 5.875 - $ 20.00
----------
Balance as of December 31, 1999 ............... 9,289,603 $ 5.1875 - $ 20.00
Granted in 2000 ............................... 452,340 $6.125 - $16.875
Forfeitures in 2000 upon departure of employees (1,446,162) $ 5.8125 - $ 20.00
Exercised in 2000 ............................. (240,518) $ 5.875 - $ 8.625
----------
Balance as of December 31, 2000 ............... 8,055,263 $ 5.1875 - $ 20.00
==========
All options granted in 1997 and 70,780 of the options granted in 1998
become exercisable as follows: 10%, 40%, and 50% at the end of three, four, and
five years, respectively. The remainder of the grants in 1998, 2,089,500
options, and all grants in 1999 and 2000, become exercisable ratably over the
first three years. As of December 31, 2000, 2,360,187 of the total options
outstanding were exercisable. As of December 31, 2000 and 1999, respectively,
the weighted average exercise price was $11.78 and $11.84 and the remaining
contractual life of options outstanding was 8.0 years and 8.9 years,
respectively.
The Company applies APB Opinion No. 25 in accounting for option grants
under the Plan and, accordingly, does not recognize any compensation cost
associated with the grants in the financial statements. Had the Company
determined compensation cost based on the fair value at the grant date for its
options, under SFAS No. 123, the Company's pro forma net income (loss) for 2000
and 1999 would have been $10,621 and $(16,148), respectively. The Company's pro
forma basic net income (loss) per share for 2000 and 1999 would have been $0.22
and $(0.33), respectively.
F-17
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for options granted during 2000, 1999 and 1998, respectively:
no dividend yield, expected volatility of 75%, 65% and 50%, risk-free interest
rate of 6.2%, 6.1% and 4.5% and an expected life of five years for all grants.
The weighted average fair value of options granted during 2000, 1999 and 1998
was $5.69, $4.23 and $3.57, respectively, per share.
Director Stock Compensation Plan
Under the Director Stock Compensation Plan (the "Director Plan"), the
Company may grant options or stock (in lieu of annual director fees) up to
100,000 shares of Class A Common Stock to all non-employee directors as a group.
Options granted under the Director Plan will vest upon the first anniversary of
the grant and are exercisable up to 10 years from the date of grant. All options
and stock awarded under the Director Plan are nontransferable other than by will
or the laws of descent and distribution. During 2000, 1999 and 1998,
respectively, the Company granted 16,000, 6,000 and 6,000 options under the
Director Plan.
Employee Stock Purchase Plan
Employees began participating in the 1997 Employee Stock Purchase Plan
(the "Purchase Plan") on September 1, 1998. Under this Purchase Plan, one
million shares of Class A Common Stock are reserved for issuance. The Purchase
Plan permits eligible employees to purchase common stock through payroll
deductions at a price equal to 85% of the lower of the market value of the
common stock on the first day of the offering period or the last day of the
offering period. The Purchase Plan does not result in compensation expense.
During 2000, 182,903 shares were issued under the Purchase Plan for $1,122.
During 1999, 273,940 shares were issued under the Purchase Plan for $1,107.
Treasury Stock
In July 1998, the Company's Board of Directors approved a plan to
repurchase up to 2.5 million shares of the Company's Class A Common Stock from
time to time (the "Repurchase Plan"). In accordance with the Repurchase Plan, a
portion of the stock acquired may be used for the three stock-based compensation
plans described previously. As of December 31, 2000 and 1999, the Company's
treasury stock consists of stock purchased in the open market at cost. Treasury
stock issuances relate to issuances of common stock pursuant to the Employee
Stock Purchase Plan. Differences between the average cost of the treasury stock
and the sales price of the shares issued are charged to additional paid-in
capital. During 2000 and 1999, the Company's treasury stock transactions were as
follows (dollars in thousands):
Shares Cost
--------- -------
Balance as of December 31, 1997 ...... -- $ --
Open market purchases ................ 1,036,092 8,062
Employee Stock Purchase Plan issuances (126,055) (981)
--------- -------
Balance as of December 31, 1998 ...... 910,037 7,081
Open market purchases ................ 431,935 2,712
Employee Stock Purchase Plan issuances (198,945) (1,452)
--------- -------
Balance as of December 31, 1999 ...... 1,143,027 8,341
Employee Stock Purchase Plan issuances (157,857) (1,153)
--------- -------
Balance as of December 31, 2000 ...... 985,170 $ 7,188
--------- -------
F-18
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
NOTE 14. SEGMENT INFORMATION:
The Company considers its capital markets, asset management operations and
online financial services to be three separate reportable segments. Parent
company assets, liabilities, income and expenses, such as cash equivalents,
income taxes, interest income and executive officer compensation are not
allocated to the segments and, therefore, are included in the "Other" column in
1999 and 1998. During 2000, the Company has developed systems and methodologies
to allocate overhead costs to its business units and, accordingly, has presented
segment information consistent with internal management reporting. The
accounting policies of these segments are the same as those described in Note 2.
There are no significant revenue transactions between the segments. The
following tables illustrate the financial information for its segments for the
years indicated (in thousands):
Online
Capital Asset Financial Consolidated
Markets Management Services Other(1) Totals
--------- ---------- --------- -------- ------------
2000
Total revenues ................ $ 112,060 $ 68,011 $ 819 $ -- $ 180,890
Compensation and benefits...... 73,670 35,311 787 -- 109,768
Total expenses ................ 107,935 44,578 6,132 -- 158,645
Pre-tax income (loss) ......... 4,125 23,433 (5,313) -- 22,245
Total assets .................. 73,453 167,178 11,588 -- 252,219
Total net assets .............. 61,057 142,148 11,351 -- 214,556
1999
Total revenues ................ $ 93,060 $ 45,182 $ 411 $ 313 $ 138,966
Compensation and benefits...... 62,727 28,069 1,448 6,180 98,424
Total expenses ................ 101,284 31,707 7,714 5,232 145,937
Pre-tax income (loss) ......... (8,224) 13,475 (7,303) (4,919) (6,971)
Total assets .................. 74,842 130,631 10,595 10,288 226,356
Total net assets .............. 60,400 108,922 9,585 10,062 188,969
1998
Total revenues ................ $ 111,215 $ 8,389 $ -- $ 3,264 $ 122,868
Compensation and benefits...... 77,171 5,428 -- -- 82,599
Total expenses ................ 131,020 6,690 -- 1,367 139,077
Pre-tax income (loss) ......... (19,805) 1,699 -- 1,897 (16,209)
Total assets .................. 83,044 97,513 -- 24,559 205,116
Total net assets .............. 66,747 95,810 -- 24,345 186,902
(1) Includes inter-company eliminations.
F-19
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
NOTE 15. QUARTERLY DATA (UNAUDITED):
The following tables set forth selected information for each of the fiscal
quarters during the years ended December 31, 2000, 1999 and 1998 (dollars in
thousands, except per share data). The selected quarterly data is derived from
unaudited financial statements of the Company and has been prepared on the same
basis as the annual, audited financial statements to include, in the opinion of
management, all adjustments (consisting of only normal recurring adjustments)
necessary for fair presentation of the results for such periods.
Net Income
Total (Loss) Before Net Income Basic Earnings Diluted Earnings
Revenues Income Taxes (Loss) (Loss) Per Share (Loss) Per Share
-------- ------------- ---------- ---------------- ----------------
2000
First Quarter ..... $ 66,243 $ 8,556 $ 6,417 $ 0.13 $ 0.12
Second Quarter .... 43,536 6,065 5,280 0.11 0.11
Third Quarter ..... 44,702 6,193 4,954 0.10 0.10
Fourth Quarter .... 26,409 1,431 1,431 0.03 0.03
--------- -------- -------- ------- -------
Total Year ........ $ 180,890 $ 22,245 $ 18,082 $ 0.37 $ 0.36
========= ======== ======== ======= =======
1999
First Quarter ..... $ 22,069 $ 45 $ 45 $ 0.00 $ 0.00
Second Quarter .... 40,379 5,849 5,849 0.12 0.12
Third Quarter ..... 8,922 (23,061) (23,061) (0.47) (0.47)
Fourth Quarter .... 67,596 10,196 10,196 0.21 0.21
--------- -------- -------- ------- -------
Total Year ........ $ 138,966 $ (6,971) $ (6,971) $ (0.14) $ (0.14)
========= ======== ======== ======= =======
1998
First Quarter ..... $ 67,984 $ 25,736 $ 15,579 $ 0.31 $ 0.31
Second Quarter .... 57,334 12,593 7,433 0.15 0.15
Third Quarter ..... (21,509) (50,729) (35,412) (0.71) (0.71)
Fourth Quarter .... 19,059 (3,809) (3,809) (0.08) (0.08)
--------- -------- -------- ------- -------
Total Year ........ $ 122,868 $(16,209) $(16,209) $ (0.33) $ (0.33)
========= ======== ======== ======= =======
NOTE 16. SUBSEQUENT EVENT:
On March 13, 2001, the Board of Governors of the Federal Reserve System
approved the Company's acquisition of Money Management Associates, LP ("MMA")
and Rushmore Trust and Savings, FSB, Bethesda, Maryland. MMA is a privately-held
investment adviser with $965 million in assets under management as of December
31, 2000. Together, MMA and Rushmore are the investment adviser, servicing agent
or administrator for 20 mutual funds. Upon closing, Rushmore will be rechartered
as a national bank and will be called FBR National Bank & Trust ("FBR Bank").
The FBR Bank will offer traditional banking services (lending, deposits, cash
management, trust services and serve as a transfer agent and custodian), along
with mutual fund accounting. Under the terms of the agreement, the Company will
acquire MMA/Rushmore for $17.5 million in cash at closing and a $9.7 million
non-interest-bearing installment note payable over a ten-year period. The
transaction will close effective April 1, 2001.
F-20
Report of independent public accountants
To the Partners of
FBR Technology Venture Partners L.P.
(A limited partnership):
We have audited the accompanying statements of assets and liabilities of FBR
Technology Venture Partners L.P. as of December 31, 2000 and 1999, including the
schedule of investments as of December 31, 2000, and the related statements of
income, changes in net assets and cash flows for the years then ended. These
financial statements are the responsibility of the general partner. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of FBR Technology Venture Partners
L.P., as of December 31, 2000 and 1999, and the results of its operations and
its cash flows for the years then ended in conformity with accounting principles
generally accepted in the United States.
Vienna, Virginia
February 7, 2001
G-1
FBR Technology Venture Partners L.P.
(A limited partnership)
Table of contents
Statements of assets and liabilities
As of December 31, 2000 and 1999 ........................................ G-3
Schedule of investments
As of December 31, 2000 ................................................. G-4
Statements of income
For the years ended December 31, 2000 and 1999 .......................... G-5
Statements of changes in net assets
For the years ended December 31, 2000 and 1999 .......................... G-6
Statements of cash flows
For the years ended December 31, 2000 and 1999 .......................... G-7
Notes to financial statements
December 31, 2000 and 1999 .............................................. G-8
G-2
FBR Technology Venture Partners L.P.
(A limited partnership)
Statements of assets and liabilities
As of December 31, 2000 and 1999
2000 1999
------------ ------------
Assets:
Investments in securities, at fair value; cost basis
of $27,206,756 and $35,492,187 in 2000 and 1999,
respectively $108,551,260 $222,803,441
Cash and cash equivalents 901,083 763,435
Due from limited partners -- 101,030
Organization costs, net of $19,000 and $13,000 of
accumulated amortization in 2000 and 1999,
respectively 11,000 17,000
------------ ------------
Total assets $109,463,343 $223,684,906
============ ============
Liabilities:
Line-of-credit $ 462,500 $ --
Accounts payable and accrued liabilities 19,774 20,577
Due to affiliates 28,607 232,289
------------ ------------
Total liabilities 510,881 252,866
------------ ------------
Net assets $108,952,462 $223,432,040
============ ============
The accompanying notes are an integral part of these statements.
G-3
FBR Technology Venture Partners L.P.
(A limited partnership)
Schedule of investments
As of December 31, 2000
Beneficial
shares Value
- ---------- -------------
Common stock, United States Enterprises
Technology (70.8%)
3,245,000 Network Access Solutions, Inc. (1.9%) $ 2,028,125
664,091 LifeMinders.com, Inc. (2.1%) 2,324,319
546,907 webMethods, Inc. (44.6%) 48,640,540
992,063 Varsity Group, Inc. (0.2%) 186,012
661,960 Aether Systems (21.8%) 23,741,783
24,130 BindView (0.2%) 226,973
-------------
Total common stock (cost $13,914,561) 77,147,752
Convertible preferred stock, United States
Enterprises Technology (28.8%)
272,556 Pathnet, Inc. (5.5%) 5,988,055
6,251,594 Intranets.com (3.2%) 3,524,649
2,122,774 MarketSwitch Corporation (19.0%) 20,654,776
950,339 Iconixx Corporation (0.9%) 1,037,500
571,429 XYPOINT Corporation (0.2%) 198,528
-------------
Total convertible preferred stock
(cost $13,292,195) 31,403,508
-------------
Total investments (cost $27,206,756) $ 108,551,260
=============
The accompanying notes are an integral part of this schedule.
G-4
FBR Technology Venture Partners L.P.
(A limited partnership)
Statements of income
For the years ended December 31, 2000 and 1999
2000 1999
------------- -------------
Investment income:
Interest $ 138,802 $ 59,027
------------- -------------
Total income 138,802 59,027
------------- -------------
General and administrative expenses:
Management fees 1,250,000 1,527,397
Professional fees 17,010 41,531
Interest expense 31,524 139,600
Administrative fees and other 7,257 9,080
------------- -------------
Total expenses 1,305,791 1,717,608
------------- -------------
Net investment loss (1,166,989) (1,658,581)
Net realized gains on investments 257,953,411 --
Unrealized (depreciation) appreciation of investments (105,966,750) 186,238,865
------------- -------------
Net income $ 150,819,672 $ 184,580,284
============= =============
The accompanying notes are an integral part of these statements.
G-5
FBR Technology Venture Partners L.P.
(A limited partnership)
Statements of changes in net assets
For the years ended December 31, 2000 and 1999
Carried
interest
limited General Limited
partner partner partners Total
------------ ----------- ------------- -------------
Net assets,
December 31, 1998 $ 100 $ 154,493 $ 19,397,163 $ 19,551,756
Capital contributions -- 152,470 19,147,530 19,300,000
Net income -- 1,458,185 183,122,099 184,580,284
Special allocation 34,325,685 (274,030) (34,051,655) --
------------ ----------- ------------- -------------
Net assets,
December 31, 1999 34,325,785 1,491,118 187,615,137 223,432,040
Capital contributions -- 13,430 1,686,570 1,700,000
Net income -- 1,191,475 149,628,197 150,819,672
Special allocation 30,186,694 (240,981) (29,945,713) --
Distributions (42,948,492) (1,766,435) (222,284,323) (266,999,250)
------------ ----------- ------------- -------------
Net assets,
December 31, 2000 $ 21,563,987 $ 688,607 $ 86,699,868 $ 108,952,462
============ =========== ============= =============
The accompanying notes are an integral part of these statements.
G-6
FBR Technology Venture Partners L.P.
(A limited partnership)
Statements of cash flows
For the years ended December 31, 2000 and 1999
2000 1999
------------- -------------
Cash flows from operating activities:
Net income $ 150,819,672 $ 184,580,284
Adjustments to reconcile net income to net cash
provided by (used in) operating activities-
Amortization of organization costs 6,000 6,000
Purchases of investments (1,575,000) (16,793,360)
Proceeds from sale of investments 267,813,842 --
Change in unrealized depreciation (appreciation)
of investments 105,966,750 (186,238,865)
Net realized gains on investments (257,953,411) --
Changes in assets and liabilities:
Due from affiliates -- 34,338
Management fees payable -- (719,365)
Due from/to limited partners 101,030 (472,080)
Accounts payable and accrued expenses (803) (8,128)
Due to affiliates (203,682) 232,289
------------- -------------
Net cash provided by (used in) operating activities 264,974,398 (19,378,887)
Cash flows from financing activities:
Capital contributions 1,700,000 19,300,000
Capital distributions (266,999,250) --
Net borrowings under line-of-credit agreement 462,500 --
------------- -------------
Net cash (used in) provided by financing activities (264,836,750) 19,300,000
Net increase (decrease) in cash and cash equivalents 137,648 (78,887)
Cash and cash equivalents, beginning of period 763,435 842,322
------------- -------------
Cash and cash equivalents, end of period $ 901,083 $ 763,435
============= =============
Supplemental cash flow information:
Cash paid for interest $ 28,693 $ 115,920
============= =============
The accompanying notes are an integral part of these statements.
G-7
FBR Technology Venture Partners L.P.
(A limited partnership)
Notes to financial statements
December 31, 2000 and 1999
1. Organization:
FBR Technology Venture Partners L.P. (the Partnership) is a limited partnership
formed on August 12, 1997, to engage in the business of investing in securities.
The Partnership was organized under the laws of the state of Delaware.
Operations commenced on November 1, 1997. The Partnership will continue to
operate until the earlier of December 31, 2007, or the date the Partnership is
dissolved as provided for in the Partnership Agreement.
2. Management fees and other transactions with affiliates:
FBR Venture Capital Managers, Inc. (FBRVCM) is the corporate general partner and
carried interest limited partner of the Partnership. Friedman, Billings, Ramsey
Group, Inc. (FBRG) is the ultimate parent company of FBRVCM. In addition,
certain officers and directors of FBRG are limited partners of the Partnership.
At the beginning of each calendar quarter, FBRVCM is entitled to receive a
management fee for management of the businesses and affairs of the Partnership.
The fee is computed as 2.5 percent (on an annualized basis) of the total funds
committed to the Partnership. For each calendar quarter beginning after the end
of the Investment Period (July 31, 2003), the fee is computed as the lesser of
2.5 percent (on an annualized basis) of the total funds committed to the
Partnership, or an amount equal to 4.0 percent (on an annualized basis) of the
aggregate acquisition costs of the portfolio investments and any bridge loans
provided by limited partners and held as of the end of the preceding quarter.
3. Summary of significant accounting policies:
Use of estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of income and expenses during
the reporting periods and the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements. Actual results could differ from those estimates.
Security valuation
Investments in securities are recorded at fair value. The Partnership's
investments as of December 31, 2000 and 1999, consisted of equity investments in
securities of development-stage and early-stage, privately and publicly held,
technology companies. The disposition of these investments may be restricted due
to the lack of a ready market (in the case of privately held companies) or due
to contractual or regulatory restrictions on disposition (in the case of
publicly held companies). In addition, these securities may represent
significant proportions of the issuer's equity and carry special contractual
G-8
privileges not available to other security holders. As a result of these
factors, precise valuation for the restricted public securities and private
company securities is a matter of judgment, and the determination of fair value
must be considered only an approximation and may vary from the amounts that
could be realized if the investment was sold. The following is the methodology
employed by the General Partner in valuing its investments:
o Non-restricted public securities which are traded on a national securities
exchange (or reported on the NASDAQ national market) are valued at the
last reported sales price on the day of valuation.
o Restricted public securities - Securities which have underlying public
markets, but whose disposition is restricted, are valued at a discount
from the current market value. Discounts are taken for regulatory
restrictions and contractual lock-up agreements. If a security has either
regulatory restrictions or is contractually locked up, a market blockage
discount may be applied as well.
o Private securities - The investment will be carried at cost, subject to
the following: the investment may be marked up or down to reflect changes
in the fundamentals of the issuer, its industry sector, or the economy in
general, since the date of the original investment. Events considered in
this valuation are: (1) a subsequent third-party round of financing at a
per share price that is higher or lower than the Partnership's, (2) an
imminent public offering, (3) an imminent sale of the issuer or (4) if the
issuer's performance and potential have significantly deteriorated, as of
the valuation date.
Income recognition
For securities held, the difference between the purchase price and fair value of
investments in securities is included as unrealized appreciation or depreciation
of investments in the accompanying statements of income. Realized gains or
losses represent the difference between the fair value and cost basis upon the
sale of investments or distribution of securities to the Partners.
Income taxes
No provision for income taxes is made in the Partnership's financial statements
since all taxable income and loss is allocated to the partners.
Organization costs
Costs relating to the formation of the Partnership have been deferred and are
being amortized over five years using the straight-line method.
Cash and cash equivalents
For purposes of the statement of cash flows, the Partnership considers cash in
banks (including escrow accounts) and all highly liquid investments with a
maturity of three months or less to be cash equivalents.
Capital accounts, allocations, and expenses
In addition to the limited partners, the general partner may, at its discretion,
and without consent of any other partners, admit employees of FBRVCM and its
affiliates as "FBR Employee Limited Partners." The capital accounts of FBR
Employee Limited Partners are treated the same as other limited partners, except
in regard to items (b) and (c), below. At
G-9
the end of each fiscal quarter, the capital account of each partner is adjusted
for the allocation of partner distributions as defined in the Partnership
Agreement:
(a) For each fiscal quarter all gains and losses are allocated among the
partners in accordance with their respective percentage interests.
(b) Under the terms of the Partnership Agreement, after allocations to the
limited partners in amounts totaling their commitments, the carried
interest limited partner is entitled to receive allocations in an amount
equal to 20 percent carried interest of the allocations received by the
limited partners.
(c) In succeeding periods, the carried interest limited partner receives 20
percent of the allocations of the Partnership and the remaining 80 percent
is allocated to the limited partners on a pro-rata basis.
Distributions and withdrawals
The Partnership, at the sole discretion of the general partner, may make
distributions of cash or securities to all partners in proportion to their
respective capital accounts. The Partnership has no obligation to make any
distributions. The Partnership made distributions of $266,999,250 in 2000, which
consisted of $49,040,377 in cash and $217,958,873 in securities at their fair
value as of the date of distribution. No distributions were made in 1999.
The limited partners have no rights to demand the return of their capital
contributions unless they have contributed in excess of their pro-rata share of
capital.
4. Partner capital commitments:
The limited partners initially contributed 2 percent of their respective
committed amounts in cash at the date operations of the Partnership commenced.
The limited partners have agreed, upon 15 business days written notice from the
general partner, to contribute additional cash to the Partnership (a Capital
Call), up to that partner's capital commitment, provided that such Capital Calls
shall apply to all limited partners, pro-rata, in proportion to their respective
partnership interests. As of December 31, 2000 and 1999, the Partners made
cumulative contributions totaling $41,009,282 and $39,309,282, respectively, of
total Partnership commitments of $50,000,000.
5. Borrowings:
In June 2000, the Partnership and FBR Technology Venture Partners II (QP), L.P.,
an affiliate of the Partnership, renewed a $12,000,000 line-of-credit with an
expiration date of June 22, 2001, to better serve all of the Partnerships'
borrowing needs. The capital commitments of the Limited Partners serve as
collateral for the line-of-credit. The interest rate is based on the higher of
the Prime Rate plus 0.5 percent per annum or the Bank's Cost of Funds plus 1.5
percent per annum. As of December 31, 2000, the Prime Rate plus 0.5 percent per
annum was higher at 10.0 percent. The Partnership drew down $2.0 million and
$9.7 million in 2000 and 1999, respectively. As of December 31, 2000, the
Partnership had $462,500 in outstanding borrowings under this line-of-credit.
G-10
6. Financial instruments with off-balance-sheet risk and concentrations of
credit risk:
The Partnership has invested primarily in the United States, and has not entered
into any transactions involving financial instruments, such as financial
futures, forward contracts, swaps and derivatives, which would expose the
Partnership to related off-balance-sheet risk.
Market risk to the Partnership is caused by illiquidity and volatility in the
markets in which the Partnership would seek to sell its financial instruments.
The Partnership's concentration of investments in the technology industry and a
limited number of companies may result in the Partnership being exposed to a
risk of loss that is greater than it would be if the Partnership mitigated such
risks through a greater diversification or investment in securities for which
there is a ready public market.
Positions taken, commitments and unrealized appreciation on investments made by
the Partnership may involve substantial amounts relative to its net assets and
significant exposure to individual issuers and businesses.
7. Subsequent events:
On January 16, 2001, the Partnership distributed 537,876 shares of webMethods to
the Partners at their fair market value of $43.4 million. This distribution
resulted in a realized gain for the Partnership of $42.0 million.
On January 19, 2001, a merger between XYPOINT Corporation and Telecommunication
Systems, Inc. (NASDAQ: TSYS) was completed. All of the 571,429 shares that the
Partnership owned at December 31, 2000, were exchanged for 58,592 shares of
Class A Common Stock of Telecommunication Systems, Inc. Of the 58,592 shares
received by the Partnership, 10.9 percent, or 6,405 shares, will be escrowed for
a period of one year from the date of the merger, during which time, these
shares may not be sold by the Partnership.
G-11
Report of independent public accountants
To the Partners of
FBR Ashton, Limited Partnership:
We have audited the accompanying statements of assets and liabilities of FBR
Ashton, Limited Partnership, as of December 31, 2000 and 1999, including the
condensed schedule of investments as of December 31, 2000, and the related
statements of income, changes in net assets, and cash flows for the years then
ended. These financial statements are the responsibility of the General Partner.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of FBR Ashton, Limited
Partnership, as of December 31, 2000 and 1999, and the results of its operations
and its cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States.
Vienna, Virginia
March 10, 2001
H-1
FBR Ashton, Limited Partnership
Table of contents
Statements of assets and liabilities
As of December 31, 2000 and 1999 ...................................... H-3
Condensed schedule of investments
As of December 31, 2000 ............................................... H-4
Statements of income
For the years ended December 31, 2000 and 1999 ........................ H-5
Statements of changes in net assets
For the years ended December 31, 2000 and 1999 ........................ H-6
Statements of cash flows
For the years ended December 31, 2000 and 1999 ........................ H-7
Notes to financial statements
December 31, 2000 and 1999 ............................................ H-8
H-2
FBR Ashton, Limited Partnership
Statements of assets and liabilities
As of December 31, 2000 and 1999
2000 1999
----------- -----------
Assets:
Investments in securities, at market value,
identified cost of $59,819,376 and $72,241,028, respectively $56,483,062 $52,412,277
Due from broker 5,143,854 15,827,357
Cash in banks and savings and loan associations 2,035,221 1,856,904
Dividends receivable 23,885 54,877
Interest receivable 19,921 12,944
Other 230 --
----------- -----------
Total assets 63,706,173 70,164,359
----------- -----------
Liabilities:
Due to limited partners 5,309,449 14,816,771
Securities sold, not yet purchased, at market value;
proceeds of $5,480,204 and $272,891, respectively 5,283,686 238,000
Management fees payable 166,948 154,076
Accounts payable and accrued expenses 34,150 58,087
----------- -----------
Total liabilities 10,794,233 15,266,934
----------- -----------
Net assets $52,911,940 $54,897,425
=========== ===========
The accompanying notes are an integral part of these statements.
H-3
FBR Ashton, Limited Partnership
Condensed schedule of investments
As of December 31, 2000
Shares Value
- ------- ------------
Common stock, United States Enterprises (106.7%)
Financial services (82.6%)
338,250 ITLA Capital Corp. (12.2%) $ 6,469,031
136,000 Chase Manhattan Bank (11.7%) 6,179,500
148,750 Fleet Boston Financial Corp. (10.6%) 5,587,422
93,500 BankAmerica Corp. (8.1%) 4,289,312
76,500 Washington Mutual (7.7%) 4,059,281
155,500 BankNorth Group Inc. (5.9%) 3,101,278
83,985 Union Planters Corp. (5.7%) 3,002,464
Other financial services (20.7%) 11,026,040
------------
43,714,328
Technology (17.3%) 9,165,760
Healthcare (4.0%) 2,123,735
Real estate (1.4%) 743,750
Retail (.5%) 239,301
Other investments (.9%) 496,188
------------
Total common stock (cost, $59,819,376) $ 56,483,062
============
Securities sold, not yet purchased, United States
Enterprises (10.0%)
Financial services (10.0%) $ 5,283,686
------------
Total securities sold, not yet purchased
(total proceeds, $5,480,204) $ 5,283,686
============
The accompanying notes are an integral part of this schedule.
H-4
FBR Ashton, Limited Partnership
Statements of income
For the years ended December 31, 2000 and 1999
2000 1999
----------- ------------
Investment income:
Dividends $ 1,600,235 $ 3,125,467
Interest 150,033 173,865
Other 1,700 988
----------- ------------
Total income 1,751,968 3,300,320
Expenses:
Margin interest and dividends on
securities sold, not yet purchased 1,171,987 2,468,319
Management and professional fees 309,767 798,799
Administrative fees and other 45,751 10,218
----------- ------------
Total expenses 1,527,505 3,277,336
----------- ------------
Net investment gain 224,463 22,984
Realized and unrealized gains (losses) on
investments:
Net realized gains on investments 317,910 2,960,288
Change in unrealized appreciation (depreciation)
of investments 16,654,063 (13,650,819)
----------- ------------
Net gain (loss) on investments 16,971,973 (10,690,531)
----------- ------------
Net income (loss) $17,196,436 $(10,667,547)
=========== ============
The accompanying notes are an integral part of these statements.
H-5
FBR Ashton, Limited Partnership
Statements of changes in net assets
For the years ended December 31, 2000 and 1999
General Limited
partner partners Total
------------ ------------ ------------
Net assets, December 31, 1998 $ 12,192,390 $ 78,763,289 $ 90,955,679
Withdrawals -- (25,390,707) (25,390,707)
Net loss (1,526,684) (9,140,863) (10,667,547)
------------ ------------ ------------
Net assets, December 31, 1999 10,665,706 44,231,719 54,897,425
Withdrawals -- (19,181,921) (19,181,921)
Net income 4,764,523 12,431,913 17,196,436
------------ ------------ ------------
Net assets, December 31, 2000 $ 15,430,229 $ 37,481,711 $ 52,911,940
============ ============ ============
The accompanying notes are an integral part of these statements.
H-6
FBR Ashton, Limited Partnership
Statements of cash flows
For the years ended December 31, 2000 and 1999
2000 1999
------------- -------------
Cash flows from operating activities:
Net income (loss) $ 17,196,436 $ (10,667,547)
Changes in assets and liabilities-
Purchases of investments (447,851,778) (502,580,401)
Proceeds from sale of investments 459,833,743 566,763,008
Due from broker 10,683,503 (29,675,775)
Dividends receivable 30,992 286,263
Interest receivable (6,977) (12,944)
Other (230) --
Increase in securities sold short 5,964,909 (1,643,744)
Management fees payable 12,872 (82,482)
Interest payable -- (14,592)
Accounts payable and accrued expenses (23,937) 36,455
Change in unrealized (depreciation)
appreciation of investments (16,654,063) 13,650,819
Net realized gain on investments (317,910) (2,960,288)
------------- -------------
Net cash provided by operating activities 28,867,560 33,098,772
------------- -------------
Cash flows from financing activities:
Withdrawals (28,689,243) (34,526,656)
------------- -------------
Net cash used in financing activities (28,689,243) (34,526,656)
------------- -------------
Net increase (decrease) in cash and cash equivalents 178,317 (1,427,884)
Cash and cash equivalents, beginning of year 1,856,904 3,284,788
------------- -------------
Cash and cash equivalents, end of year $ 2,035,221 $ 1,856,904
============= =============
The accompanying notes are an integral part of these statements.
H-7
FBR Ashton, Limited Partnership
Notes to financial statements
December 31, 2000 and 1999
1. Organization:
FBR Ashton, Limited Partnership, formerly Ashton Enterprises, Limited
Partnership, (the Partnership), was formed for the purpose of investing in
securities as a General Partnership in December 1990. It was converted to a
limited partnership under the laws of the state of Maryland through the filing
of its Certificate of Limited Partnership on November 8, 1991. Operations
commenced in March 1992.
2. Related-party transactions:
Friedman, Billings, Ramsey Investment Management, Inc. (FBRIM), is the corporate
General Partner of the Partnership. Friedman, Billings, Ramsey & Co., Inc.
(FBRC), is the principal securities broker of the Partnership. Friedman,
Billings, Ramsey Group, Inc. (FBRG), is the ultimate parent company of both
FBRIM and FBRC. During 2000 and 1999, the Partnership paid commissions of
approximately $643,000 and $193,000, respectively, to FBRC. Emanual J. Friedman,
Chairman of FBRG, FBRIM and FBRC is the portfolio manager of the Partnership.
3. Summary of significant accounting policies:
Use of estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of income, expenses, 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.
Security valuation
Investments in securities, including securities sold, but not yet purchased
(Short Sales), that are listed on a national securities exchange (or reported on
the NASDAQ National Market) are stated at the last reported market sale price on
the day of valuation. Listed securities for which no sale was reported on that
date are stated at the mean between the closing "bid" and the "asked" price on
the day of valuation. At December 31, 2000 and 1999, all securities were valued
at the last reported market sale price on the day of valuation.
Securities for which quotations are not readily available are valued at fair
value as determined by the General Partner. The General Partner may use methods
of valuing securities other than described above if it believes that the
alternate method is preferable in determining the fair value of such securities.
As of December 31, 2000 and 1999, no such securities existed.
H-8
In addition, the Partnership has sold securities it does not currently own in
anticipation of a decline in the fair value of that security (securities sold,
not yet purchased). When the Partnership sells a security short, it must borrow
the security sold short and deliver it to the broker-dealer through which it
made the short sale. A gain, limited to the price at which the Company sold the
security short, or a loss, unlimited in size, will be realized upon the
termination of a short sale.
Income recognition
Realized gains and losses are recorded on the date securities are sold using the
specific identification method. Changes in unrealized appreciation of
investments are based on the difference between the purchase price and the
market value of investments in securities and the difference between the net
proceeds received and the market value of unsettled Short Sales. Dividend income
is recognized on the ex-dividend date, and interest income is recognized on an
accrual basis.
Income taxes
No provision for income taxes is made in the Partnership's financial statements
since all taxable income and loss is distributed to the Partners.
Cash equivalents and supplemental cash flow information
For purposes of the statements of cash flows, cash equivalents generally consist
of certificates of deposit, time deposits, and cash in escrow accounts for
subscriptions to certain securities offerings. For the years ended December 31,
2000 and 1999, cash payments for interest approximated interest expense.
Capital Accounts, allocations, and expenses
For purposes of the notes to the financial statements, the terms General
Partner, Capital Account, Pro Rata, Fiscal Period, Threshold Amount, Net Profit,
and Net Loss are assumed to be as defined in the Partnership Agreement. At the
end of each Fiscal Period, the Capital Account of each Partner is adjusted:
(a) Net Profits are allocated first to the Capital Account of the General
Partner in an amount that is equal to the excess of the amount of Net
Losses debited against the General Partner's Capital Account for all prior
Fiscal Periods over the amount of Net Profits allocated for all prior
Fiscal Periods. Any remaining Net Profits are allocated to the Capital
Accounts of all the Partners Pro Rata.
(b) Net Losses are first allocated to the Capital Accounts of all the partners
Pro Rata until the Capital Account of the Limited Partner with the
smallest Partnership Interest equals $1.00. The remainder of the Net
Losses is allocated to the Capital Account of the General Partner.
(c) Management fees and Special Allocations defined in (d) below are deducted
from the Limited Partners' Capital Accounts on which they were based after
the allocation of Net Profits and Net Losses as described in (a) and (b).
H-9
(d) Except as described in (e), at the end of each Fiscal Year, the
Partnership will debit against each Limited Partner's Capital Account
(other than a Capital Account beneficially owned by Emanual J. Friedman) a
portion of the Partnership's Net Profits equal to twenty percent (20
percent) of the aggregate Net Profits, if any, of the Partnership
allocated to such Limited Partner's Capital Account for that Fiscal Year,
provided that, following such debit, the amount of that Limited Partner's
Capital Account exceeds the Threshold Amount, and the aggregate amount of
such Net Profits (the Special Allocation) shall be credited to the General
Partner's Capital Account.
(e) Adjusting provisions apply to the Special Allocations with respect to
contributions made on a date other than January 1 (Non Conforming
Contributions). Because the Partnership is not required to make Special
Allocations to the General Partner on Non Conforming Contributions until
the end of the calendar quarter in which the 12 month anniversary of such
contributions occurs, the Special Allocations associated with Non
Conforming Contributions were not allocable to the General Partner at
December 31, 2000 and 1999. There were no Special Allocations for the
years ended December 31, 2000 and 1999.
Management fees
At the end of each calendar quarter, FBRIM receives a management fee for the
management of the business and affairs of the Partnership. The fee is 0.25
percent of the sum of the Adjusted Capital Accounts, as defined in the
Partnership Agreement, of all Limited Partners other than an Adjusted Capital
Account beneficially owned by Emanuel J. Friedman.
Distributions and withdrawals
The Partnership, at the sole discretion of the General Partner, may make
distributions within 90 days after the end of a fiscal year to all partners in
proportion to their respective Capital Accounts. The Partnership has no
obligation to make any distributions, and the Partnership made no distributions
in 2000 and 1999.
Upon at least 60 days prior written notice to the General Partner, each Limited
Partner has the right to withdraw amounts from his capital account at the end of
a fiscal year. The General Partner has the right to withdraw amounts from its
capital account at any time upon written notice to the Limited Partners stating
the amount to be withdrawn. However, the General Partner's Capital Account
cannot be less than the Minimum Investment, as defined in the Partnership
Agreement. Limited Partners made withdrawals of $19.2 million and $25.4 million
in 2000 and 1999, respectively, of which $5.3 million and $14.8 million were
accrued for as of December 31, 2000 and 1999, respectively.
Other
Certain amounts for the year ended December 31, 1999, have been reclassified for
presentation purposes.
4. Due from broker:
The clearing and depository operations for the Partnership's security
transactions are provided primarily by one clearing broker. At December 31, 2000
and 1999, substantially all of the securities owned and the amount due from
broker reflected in the accompanying statements of assets and liabilities are
positions with and amounts due from this clearing
H-10
broker. The amount due to broker is primarily for margin loans and is
collateralized by investment securities in that account. Interest is at a
variable rate (7.31 and 5.75 percent at December 31, 2000 and 1999,
respectively) that generally corresponds to the Federal Funds Rate plus 75 basis
points (three-quarters percent).
5. Financial instruments with off-balance-sheet risk and concentrations of
credit risk:
The Partnership invests only in U.S. markets and has not entered into any
transactions involving financial instruments, such as financial futures, forward
contracts, swaps, and derivatives, which would expose the Partnership to related
off-balance-sheet risk. See Note 3 regarding Short Sales.
Market risk to the Partnership is primarily caused by movements in interest
rates or market prices of the underlying financial instruments. Market risk is
also caused by volatility and illiquidity in securities and markets which the
Partnership trades its financial instruments. The Partnership seeks to reduce
market risk primarily through monitoring procedures and/or entering into
offsetting positions.
At December 31, 2000 and 1999, the Partnership's investments were primarily long
equity positions in U.S. bank and thrift institutions and non-depository
financial service companies. The Partnership's concentration of investments in
U.S. bank and thrift institutions, and non-depository financial service
companies, as well as its significant application of leverage, may result in the
Partnership being exposed to a risk of loss that is greater than it would be if
the Partnership mitigated such risks through a greater diversification of
investments and lower use of leverage.
Positions taken and commitments made by the Partnership may involve substantial
amounts and significant exposure to individual issuers and businesses, including
non-investment grade issuers that expose the Partnership to a higher degree of
risk than is associated with investment-grade instruments. Investments made by
the Partnership in the purchase of securities in initial public offerings of
mutual savings and loan associations that have converted to stock companies
carry restrictions on sale until the passage of a required holding period of 90
days. These restrictions may inhibit the ability of the Partnership to dispose
of such investments in order to mitigate potential losses. As of December 31,
2000 and 1999, the Partnership did not hold any positions in such securities.
H-11
FINANCIAL STATEMENTS OF FBR ASSET INVESTMENT CORPORATION
Index to Financial Statements
Page
-------
Report of Independent Public Accountants ......................................................... I-2
Statements of Financial Condition as of December 31, 2000, and December 31, 1999.................. I-3
Statements of Income for the Years Ended December 31, 2000, December 31, 1999, and
December 31, 1998.............................................................................. I-4
Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2000,
December 31, 1999 and December 31, 1998.......................................................... I-5
Statements of Cash Flows for the Years Ended December 31, 2000, December 31, 1999 and
December 31, 1998 and............................................................................ I-6
Notes to Financial Statements...................................................................... I-7
I-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of
FBR Asset Investment Corporation:
We have audited the accompanying statements of financial condition of FBR
Asset Investment Corporation (the "Company") as of December 31, 2000 and 1999,
and the related statements of income, changes in shareholders' equity and cash
flows for the years ended December 31, 2000, 1999, and 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of FBR Asset Investment
Corporation as of December 31, 2000, and 1999, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2000 in conformity with accounting principles generally accepted in the United
States.
/s/ Arthur Andersen LLP
Vienna, Virginia
January 31, 2001
I-2
FBR Asset Investment Corporation
Statements of Financial Condition as of December 31, 2000 and December 31, 1999
================================================================================
2000 1999
------------ ------------
ASSETS
Mortgage-backed securities, pledged as collateral, at fair value........ $144,867,416 $228,930,067
Mortgage-backed securities, at fair value............................... 9,980,789 7,084,777
Investments in equity securities, at fair value......................... 28,110,190 49,647,865
Cash and cash equivalents............................................... 36,810,566 13,417,467
Due from custodian...................................................... -- 806,093
Notes receivable........................................................ 4,000,000 27,000,000
Dividends receivable.................................................... 818,728 1,400,897
Prepaid expenses and other assets....................................... 221,628 253,516
Interest receivable..................................................... 994,750 1,639,778
------------ ------------
Total assets......................................................... $225,804,067 $330,180,460
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Repurchase agreements................................................... $133,896,000 $221,714,000
Interest payable........................................................ 844,841 487,222
Dividends payable....................................................... 3,731,911 2,891,368
Management fees payable................................................. 78,727 237,167
Accounts payable and accrued expenses................................... 237,218 129,677
Other................................................................... 174,786 178,305
------------ ------------
Total liabilities.................................................... 138,963,483 225,637,739
Shareholders' Equity:
Preferred stock, par value $.01 per share, 50,000,000 shares
authorized.............................................................. -- --
Common stock, par value $.01 per share, 200,000,000 shares
authorized, 10,415,827 shares issued as of December 31, 2000 and
1999, respectively...................................................... 104,158 104,158
Additional paid-in capital.............................................. 194,097,193 194,097,193
Accumulated other comprehensive loss.................................... (748,691) (12,982,359)
Retained deficit........................................................ (19,978,632) (15,463,462)
Treasury stock, at cost, 6,531,400 shares and 4,609,491 shares as of
December 31, 2000 and 1999, respectively................................ (86,633,444) (61,212,809)
------------ ------------
Total shareholders' equity........................................... 86,840,584 104,542,721
------------ ------------
Total liabilities and shareholders' equity........................... $225,804,067 $330,180,460
============ ============
==============================================================================
The accompanying notes are an integral part of these statements.
I-3
FBR Asset Investment Corporation
Statements of Income for the Years Ended December 31, 2000, 1999 and 1998
================================================================================
Year Ended December 31,
--------------------------------------------------------
2000 1999 1998
----------- ------------ -----------
Income:
Interest.............................................. $18,758,866 $ 15,823,914 $13,656,097
Dividends............................................. 5,082,191 7,649,935 4,271,405
----------- ------------ -----------
Total income...................................... 23,841,057 23,473,849 17,927,502
----------- ------------ -----------
Expenses:
Interest expense...................................... 10,935,130 7,920,648 5,359,633
Management fee expense................................ 1,078,713 1,329,063 1,520,725
Professional fees..................................... 388,407 755,561 436,885
Insurance............................................. 91,152 41,325 52,769
Amortization of stock options issued to manager....... -- 454,746 454,746
Other................................................. 116,815 180,957 144,702
----------- ------------ -----------
Total expenses.................................... 12,610,217 10,682,300 7,969,460
----------- ------------ -----------
Realized gain (loss) on sale of mortgage-backed
securities, net........................................ 67,358 (358,692) 176,048
Realized gain on sale of available-for-sale equity
securities, net......................................... 2,692,304 3,597,190 --
Recognized loss on available-for-sale equity
securities............................................. (5,626,022) (10,887,458) (6,615,000)
Realized loss on interest rate hedge................... -- -- (1,930,855)
----------- ------------ -----------
Net income............................................. $ 8,364,480 $ 5,142,589 $ 1,588,235
=========== ============ ===========
Basic and diluted earnings per share................... $ 1.84 $ 0.68 $ 0.16
=========== ============ ===========
Weighted-average common and equivalent shares.......... 4,543,532 7,523,715 10,044,483
=========== ============ ===========
================================================================================
The accompanying notes are an integral part of these statements.
I-4
FBR Asset Investment Corporation
Statements of Changes in Shareholders' Equity for the Years Ended December 31,
2000, 1999 and 1998
================================================================================
Additional Retained
Common Paid in Earnings Treasury
Stock Capital (Deficit) Stock
--------- ------------- ------------- -------------
Balance, December 31, 1997 $102,190 $189,528,668 $ 135,971 $ --
--------- ------------- ------------ ------------
Issuance of common stock 1,968 3,659,033 -- --
Repurchase of common stock -- -- -- (24,070,663)
Options issued to manager -- 909,492 -- --
Net income -- -- 1,588,235 --
Other comprehensive loss
Change in unrealized loss on available-for-sale securities -- -- -- --
Comprehensive loss
Dividends -- -- (11,149,785) --
--------- ------------- ------------ ------------
Balance, December 31, 1998 104,158 194,097,193 (9,425,579) (24,070,663)
--------- ------------- ------------ ------------
Repurchase of common stock -- -- -- (37,142,146)
Net income -- -- 5,142,589 --
Other comprehensive income
Change in unrealized loss on available-for-sale securities -- -- -- --
Comprehensive income -- -- -- --
Dividends -- -- (11,180,472) --
--------- ------------- ------------ ------------
Balance, December 31, 1999 104,158 194,097,193 (15,463,462) (61,212,809)
========= ============= ============ ============
Repurchase of common stock -- -- -- (25,420,635)
Net income -- -- 8,364,480 --
Other comprehensive income
Change in unrealized loss on available-for-sale securities -- -- -- --
Comprehensive income -- -- -- --
Dividends -- -- (12,879,650) --
--------- ------------- ------------ ------------
Balance, December 31, 2000 $104,158 $194,097,193 $(19,978,632) $(86,633,444)
========= ============= ============ ============
Accumulated
Other
Comprehensive Comprehensive
(Loss) Total Income (Loss)
----------- ---------- --------------
Balance, December 31, 1997 $ -- $189,766,829
------------ ------------
Issuance of common stock -- 3,661,001
Repurchase of common stock -- (24,070,663)
Options issued to manager -- 909,492
Net income -- 1,588,235 $ 1,588,235
Other comprehensive loss
Change in unrealized loss on available-for-sale securities (9,800,530) (9,800,530) (9,800,530)
-----------
Comprehensive loss $(8,212,295)
===========
Dividends -- (11,149,785)
------------ ------------
Balance, December 31, 1998 (9,800,530) 150,904,579
------------ ------------
Repurchase of common stock -- (37,142,146)
Net income -- 5,142,589 $ 5,142,589
Other comprehensive income
Change in unrealized loss on available-for-sale securities (3,181,829) (3,181,829) (3,181,829)
-----------
Comprehensive income -- -- $ 1,960,760
===========
Dividends -- (11,180,472)
------------ ------------
Balance, December 31, 1999 (12,982,359) 104,542,721
============ ============
Repurchase of common stock -- (25,420,635)
Net income -- 8,364,480 $ 8,364,480
Other comprehensive income
Change in unrealized loss on available-for-sale securities 12,233,668 12,233,668 12,233,668
-----------
Comprehensive income -- -- $20,598,148
===========
Dividends -- (12,879,650)
------------ ------------
Balance, December 31, 2000 $ (748,691) $ 86,840,584
============ ============
The accompanying notes are an integral part of these statements.
I-5
FBR Asset Investment Corporation
Statements of Cash Flows for the Years Ended December 31, 2000, 1999 and 1998
==============================================================================
For the Year Ended December 31
-----------------------------------------------------------
2000 1999 1998
------------- ------------- -------------
Cash flows from operating activities:
Net income................................................... $ 8,364,480 $ 5,142,589 $ 1,588,235
Adjustments to reconcile net income to net cash
Provided by operating activities--
Recognized loss on available-for-sale equity securities..... 5,626,022 10,887,458 6,615,000
Realized gain on sale of mortgage-backed and equity
securities.................................................. (2,759,662) (3,238,498) (176,048)
Amortization.............................................. 4,717 456,342 456,342
Premium amortization on mortgage-backed securities........ 296,626 682,695 777,179
Changes in operating assets and liabilities:
Due from custodian....................................... 806,093 (806,093) --
Due from affiliate....................................... -- -- 545,827
Dividends receivable..................................... 582,169 (530,420) (435,760)
Interest receivable...................................... 645,028 330,270 (1,962,048)
Prepaid expenses.............................................. 31,888 (248,799) --
Management fees payable....................................... (158,440) (1,038,347) 1,216,891
Accounts payable and accrued expenses......................... 107,539 (95,256) 212,933
Interest payable............................................. 357,619 177,126 310,096
Due to custodian............................................. -- (2,041,230) 2,041,230
Other......................................................... (3,519) 5,479 (17,174)
------------- ------------- -------------
Net cash provided by operating activities.............. 13,900,560 9,683,316 11,172,703
------------- ------------- -------------
Cash flows from investing activities:
Purchase of mortgage-backed securities....................... (40,917,985) (282,288,201) (221,156,241)
Investments in equity securities............................ (1,801,410) (11,454,320) (64,876,250)
Investments in notes receivable............................. (4,000,000) (59,113,179) (19,531,559)
Repayment of notes receivable............................... 27,000,000 51,196,100 3,531,559
Proceeds from sale of mortgage-backed securities............. 101,529,084 160,809,435 48,533,267
Proceeds from sale of equity securities...................... 29,239,857 27,894,010 --
Receipt of principal payments on mortgage-backed securities.. 23,720,735 30,376,288 21,204,987
------------- ------------- -------------
Net cash provided by (used in) investing activities..... 134,770,281 (82,579,867) (232,294,237)
------------- ------------- -------------
Cash flows from financing activities:
Repurchase of common stock.................................. (25,420,635) (37,142,146) (24,070,663)
Proceeds from issuance of common stock.................... -- -- 3,661,001
Proceeds from (repayments of) repurchase agreements (87,818,000) 93,164,000 128,550,000
Dividends paid............................................ (12,039,107) (10,852,162) (9,097,677)
------------- ------------- -------------
Net cash (used in) provided by financing activities..... (125,277,742) 45,169,692 99,042,661
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents.......... 23,393,099 (27,726,859) (122,078,873)
Cash and cash equivalents, beginning of the period............ 13,417,467 41,144,326 163,223,199
------------- ------------- -------------
Cash and cash equivalents, end of the period.................. $ 36,810,566 $ 13,417,467 $ 41,144,326
============= ============= =============
Supplemental disclosure:
Securities purchased but not settled
and non-cash investing activities......................... $ -- $ -- $ 9,888,384
Cash payments for interest.................................... $ 10,577,511 $ 7,743,522 $ 5,049,537
==============================================================================
The accompanying notes are an integral part of these statements.
I-6
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1 Organization and Nature of Operations
FBR Asset Investment Corporation ("FBR Asset" or the "Company") was
incorporated in Virginia on November 10, 1997. FBR Asset commenced operations on
December 15, 1997, upon the closing of a private placement of equity capital.
FBR Asset is organized as a real estate investment trust ("REIT") whose
primary purpose is to invest in mortgage loans and mortgage-backed securities
issued or guaranteed by instrumentalities of the U.S. Government or by private
issuers that are secured by real estate (together the "Mortgage Assets"). FBR
Asset also acquires indirect interests in those and other types of real estate-
related assets by investing in public and private real estate companies, subject
to the limitations imposed by the various REIT qualification requirements. Funds
not immediately allocated are generally temporarily invested in readily
marketable, interest-bearing securities. To seek yields commensurate with its
investment objectives, FBR Asset leverages its assets and mortgage loan
portfolio primarily with collateralized borrowings. FBR Asset uses derivative
financial instruments to hedge a portion of the interest rate risk associated
with its borrowings.
Note 2 Summary of Significant Accounting Policies
Investments in Mortgage-Backed Securities
FBR Asset invests primarily in mortgage pass-through certificates that
represent a 100 percent interest in the underlying conforming mortgage loans and
are guaranteed by the Government National Mortgage Association ("Ginnie Mae"),
the Federal Home Loan Mortgage Corporation ("Freddie Mac"), and the Federal
National Mortgage Association ("Fannie Mae").
Mortgage-backed security transactions are recorded on the date the securities
are purchased or sold. Any amounts payable or receivable for unsettled trades
are recorded as "due to or due from custodian" in FBR Asset's Statement of
Financial Condition.
FBR Asset accounts for its investments in mortgage-backed securities as
available-for-sale securities. FBR Asset does not hold its mortgage-backed
securities for trading purposes, but may not hold such investments to maturity,
and has classified these investments as available-for-sale. Securities
classified as available-for-sale are reported at fair value, with temporary
unrealized gains and losses excluded from earnings and reported as a separate
component of shareholders' equity. Realized gains and losses on mortgage-backed
securities transactions are determined on the specific identification basis.
Unrealized losses on mortgage-backed securities that are determined to be
other than temporary are recognized in income. Management regularly reviews its
investment portfolio for other than temporary market value decline. There were
no such adjustments for mortgage-backed investments during the periods
presented.
The fair value of FBR Asset's mortgage-backed securities are based on market
prices provided by certain dealers who make markets in these financial
instruments. The fair values reported reflect estimates and may not necessarily
be indicative of the amounts FBR Asset could realize in a current market
transaction.
I-7
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
Income from investments in mortgage-backed securities is recognized using the
effective interest method, using the expected yield over the life of the
investment. Income includes contractual interest accrued and the amortization or
accretion of any premium or discount recorded upon purchase. Changes in
anticipated yields result primarily from changes in actual and projected cash
flows and estimated prepayments. Changes in the yield that result from changes
in the anticipated cash flows and prepayments are recognized over the remaining
life of the investment with recognition of a cumulative catch-up at the date of
change from the date of original investment.
The following tables summarize FBR Asset's mortgage-backed securities as of
December 31, 2000 and 1999:
Total Mortgage
December 31, 2000 Freddie Mac Fannie Mae Ginnie Mae Assets
- ----------------- ----------- ---------- ---------- ------
Mortgage-backed securities,
available for sale-principal $85,927,247 $58,134,867 $ 9,660,054 $153,722,168
Unamortized premium 413,946 669,906 573,054 1,656,906
----------- ----------- ----------- ------------
Amortized cost 86,341,193 58,804,773 10,233,108 155,379,074
Gross unrealized gains 138,622 424,165 __ 562,787
Gross unrealized losses (380,578) (411,713) (301,365) (1,093,656)
----------- ----------- ----------- ------------
Estimated fair value $86,099,237 $58,817,225 $ 9,931,743 $154,848,205
=========== =========== =========== ============
During 2000, FBR Asset received proceeds of $101.5 million from the sale of
mortgage-backed securities. The Company recorded $1.4 million in realized losses
related to these sales. Concurrent with these sales, FBR Asset terminated a
related hedge position and recorded a $1.5 million gain. For the year ended
December 31, 2000 the weighted average coupon rate on mortgage-backed securities
was 7.00%.
Total Mortgage
December 31, 1999 Freddie Mac Fannie Mae Ginnie Mae Assets
- ----------------- ----------- ---------- ---------- ------
Mortgage-backed securities,
available for sale-principal $79,490,738 $107,859,276 $54,517,427 $241,867,441
Unamortized premium 359,594 (1,190,013) 829,206 (1,213)
----------- ----------- ---------- -----------
Amortized cost 79,850,332 106,669,263 55,346,633 241,866,228
Gross unrealized gains __ __ __ __
Gross unrealized losses (2,797,261) (2,196,860) (857,263) (5,851,384)
----------- ------------ ----------- ------------
Estimated fair value $77,053,071 $104,472,403 $54,489,370 $236,014,844
=========== ============ =========== ============
During 1999, FBR Asset received proceeds of $160.8 million from the sale of
mortgage-backed securities. The Company recorded $851,464 in realized gains
related to this sale. Concurrent with this sale, FBR Asset terminated a related
hedge position and recorded a $1.2 million loss. For the year ended December 31,
1999 the weighted average coupon rate on mortgage-backed securities was 6.79%.
Repurchase Agreements
FBR Asset has entered into short-term repurchase agreements to finance a
significant portion of its mortgage-backed investments. The repurchase
agreements are secured by FBR Asset's mortgage-backed securities and bear
interest at rates that have historically related closely to LIBOR for a
corresponding period.
I-8
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
At December 31, 2000, FBR Asset had $133.9 million outstanding under
repurchase agreements with a weighted average borrowing rate of 6.57% as of the
end of the period and a remaining weighted-average term to maturity of 16 days.
At December 31, 2000, mortgage-backed securities pledged had an estimated fair
value of $144.9 million. At December 31, 2000, the repurchase agreements had
remaining maturities of between 2 and 33 days. For the year ended December 31,
2000 the weighted average borrowing rate was 6.33% and the weighted average
repurchase agreement balance was $172.3 million.
At December 31, 1999, FBR Asset had $221.7 million outstanding under
repurchase agreements with a weighted average borrowing rate of 5.83% as of the
end of the period and a remaining weighted-average term to maturity of 45 days.
At December 31, 1999, mortgage-backed securities pledged had an estimated fair
value of $228.9 million. At December 31, 1999, the repurchase agreements had
remaining maturities of between 38 and 45 days. For the year ended December 31,
1999 the weighted average borrowing rate was 5.53% and the weighted average
repurchase agreement balance was $143.2 million.
Interest Rate Swaps
FBR Asset enters into interest rate swap agreements to offset the potential
adverse effects of rising interest rates under certain short-term repurchase
agreements. The interest rate swap agreements are structured such that FBR Asset
receives payments based on a variable interest rate and makes payments based on
a fixed interest rate. The variable interest rate on which payments are received
is calculated based on the three-month LIBOR. FBR Asset's repurchase agreements,
which generally have maturities of 30 to 90 days, carry interest rates that
correspond to LIBOR rates for those same periods. The swap agreements
effectively fix FBR Asset's borrowing cost and are not held for speculative or
trading purposes. As a result of these factors, FBR Asset has accounted for
these agreements as hedges.
The fair value of interest rate agreements that qualify as hedges are not
recorded. The differential between amounts paid and received under the interest
rate swap agreements is recorded as an adjustment to the interest expense
incurred under the repurchase agreements. In the event of early termination of
an interest rate agreement and repayment of the underlying debt, a gain or loss
is recorded and FBR Asset receives or makes a payment based on the fair value of
the interest rate agreement on the date of termination.
At December 31, 2000 and 1999, FBR Asset was party to an interest rate swap
agreement that matures on June 1, 2001, and has a notional amount of $50
million, and a fair value of $137,949 and $468,422 at December 31, 2000, and
December 31, 1999, respectively.
During 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133 "Accounting for Derivative Instruments and for Hedging Activities" ("FAS
133"). In June 1999, the FASB issued Statement No. 137, "Accounting for
Derivative Instruments and Hedging Activities-Deferral of the Effective Date of
FASB Statement No. 133". In June 2000, the FASB issued Statement 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities",
an amendment of FASB Statement No. 133. FAS 133, as amended, establishes
accounting and reporting standards for derivative investments and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as a hedge. The accounting for the changes in the fair
value of a derivative depends on the intended use of the derivative and the
resulting designation. FAS 133 is effective for the Company beginning January
1, 2001.
I-9
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
Under FAS 133, changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, depending
on the type of hedge transaction. For fair value hedge transactions, changes in
the fair value of the derivative instrument and changes in the fair value of the
hedged item due to the risk being hedged are recorded through the income
statement. For cash-flow hedge transactions, effective changes in the fair value
of the derivative instrument are reported in other comprehensive income while
ineffective changes are recorded through the income statement. The gains and
losses on cash flow hedge transactions that are reported in other comprehensive
income are reclassified to earnings in the periods in which earnings are
effected by the hedged cash flows.
As previously discussed, the Company uses interest rate swaps to hedge the
variablity in interest payments associated with the variable rate repurchase
agreements. Prior to SFAS 133, the Company did not record the value of these
swaps on the balance sheet. The Company has determined that the interest rate
swap is an effective hedge under FAS 133 and as a result the interest rate swap
will be carried at fair value as a cash flow hedge. The Company adopted FAS
133 on January 1, 2001. In accordance with the transition provisions of FAS
133, the Company recorded a cumulative-effect-type gain of $137,949 through
other comprehensive income to recognize at fair value the interest rate swap
designated as a cash flow hedge.
Investments in Equity Securities
Investments in securities that are listed on a national securities exchange
(or reported on the Nasdaq National Market) are stated at the last reported sale
price on the day of valuation. Listed securities for which no sale was reported
are stated at the mean between the closing "bid" and "asked" price on the
day of valuation. Other securities for which quotations are not readily
available are valued at fair value as determined by FBR Asset's investment
adviser, Friedman, Billings, Ramsey Investment Management, Inc. ("FBR
Management"). FBR Management may use methods of valuing securities other than
those described above if it believes the alternative method is preferable in
determining the fair value of such securities.
Consistent with the intention to have FBR Asset operate as a REIT, management
concluded that its investments in equity securities are being held for long-term
yield, capital appreciation, and cash flow. Accordingly, management has
classified such investments as available-for-sale.
Realized gains and losses are recorded on the date of the transaction using
the specific identification method. The difference between the purchase price
and market price (or fair value) of investments in securities is reported as an
unrealized gain or loss and a component of comprehensive income. Dividend
income is recognized on the record date.
Management regularly reviews any declines in the market value of its equity
investments for declines that are other than temporary. Such declines are
recorded in operations as a "recognized loss on available-for-sale
securities."
Notes Receivable
In November, 1999, FBR Asset made a $20 million loan to Prime Retail, Inc.
and Prime Retail, L.P. (together, "Prime Retail") secured by equity interests in
limited partnerships and limited liability companies that own commercial real
estate. The loan's original maturity date, as previously extended, was June 30,
2000, and the loan bore interest at 15% per annum through that date. The
maturity date was
I-10
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
extended to August 14, 2000, with an increased interest rate of 16% per annum
for accrual periods after June 30, 2000. The Prime Retail loan went into
default when it remained unpaid at the close of business on August 14, 2000.
Commencing August 15, 2000, the note began accruing interest at a default
rate initially set at 21% per annum, and increasing by 0.50% increments at the
end of each subsequent 30-day period. On December 22, 2000, Prime Retail repaid
the entire principal balance of the note and all interest accrued thereon, and
FBR Asset's expenses incurred in connection with the loan.
On July 17, 2000, FBR Asset extended a $4 million loan to Prime Capital
Funding I, LLC ("Prime Capital") pursuant to a Sixty-Day Loan and Security
Agreement. The loan bore interest at a rate of 18% per annum and was secured by
a pledge of two mortgage notes owned by Prime Capital (the "Collateral Mortgage
Notes") with an aggregate principal balance of approximately $11.28 million,
both of which notes were secured by deeds of trust on the same three commercial
real estate properties. This loan to Prime Capital was due in full on September
17, 2000. On September 29, 2000, Prime Capital conveyed the Collateral Mortgage
Notes to FBR Asset in exchange for FBR Asset's cancellation of Prime Capital's
indebtedness under the $4 million loan. In connection with this conveyance
Prime Capital also agreed to repurchase the Collateral Mortgage Notes from FBR
Asset on December 26, 2000, for a cash repurchase price of $4,155,778 plus any
costs associated with the transaction. The conveyance and agreement to
repurchase were made pursuant to a Bond Market Association form of master
repurchase agreement, with an addendum specifying additional specific terms
applicable to the transaction. On December 26, 2000, FBR Asset and Prime
Capital extended the date for the mandatory repurchase to January 4, 2001, for
an increased repurchase price of $4,171,951. As of December 31, 2000, FBR Asset
held this receivable. Prime Capital and FBR Asset further extended the
repurchase date to February 9, 2001, and increased the repurchase price to
$4,243,705. On February 9, 2001, Prime Capital repurchased the Collateral
Mortgage Notes from FBR Asset for this repurchase price, and reimbursed FBR
Asset for costs incurred in connection with the transaction, and FBR Asset no
longer holds this receivable.
Credit Risk
FBR Asset is exposed to the risk of credit losses on its portfolio of
mortgage-backed securities and notes receivable, such as the notes from Prime
Retail and Prime Capital referred to above. In addition, many of FBR Asset's
investments in equity securities are in companies that are also exposed to the
risk of credit losses in their businesses.
FBR Asset seeks to limit its exposure to credit losses on its portfolio of
mortgage-backed securities by purchasing securities issued and guaranteed by
Freddie Mac, Fannie Mae, or Ginnie Mae. The payment of principal and interest on
the Freddie Mac and Fannie Mae mortgage-backed securities are guaranteed by
those respective agencies and the payment of principal and interest on the
Ginnie Mae mortgage-backed securities is backed by the full-faith-and-credit of
the U.S. Government. At December 31, 2000 and 1999, all of FBR Asset's mortgage-
backed securities have an implied "AAA" rating. FBR Asset's notes receivable
and certain mortgage-backed securities and other loans of companies in which we
invest are not issued or guaranteed by Freddie Mac, Fannie Mae or Ginnie Mae.
Concentration Risk
Equity and debt investments, such as Capital Automotive REIT and the Prime
Capital note referred to above, may also involve substantial amounts relative to
FBR Asset's total net assets and create exposure to issuers that are generally
concentrated in the REIT industry. These investments may include non-investment
grade and securities of privately held issuers with no ready markets. The
concentration and illiquidity of these
I-11
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
investments expose FBR Asset to a significantly higher degree of risk than
is associated with more diversified investment grade or readily marketable
securities.
Cash and Cash Equivalents
All investments with original maturities of less than three months are cash
equivalents. As of December 31, 2000, cash and cash equivalents consisted of
$2.1 million of cash deposited in two commercial banks and $34.7 million in two
separate domestic money market funds. As of December 31, 1999, cash and cash
equivalents consisted of $3.8 million of cash deposited in two commercial banks
and $9.6 million in two separate domestic money market funds. The money market
funds invest primarily in obligations of the U.S. Government. The carrying
amount of cash equivalents approximates their fair value.
Comprehensive Income
Comprehensive income includes net income as currently reported by the Company
on the statement of income adjusted for other comprehensive income. Other
comprehensive income for the Company is changes in unrealized gains and losses
related to the Company's mortgage-backed securities ("MBS") and equity
securities accounted for as available for sale with changes in fair value
recorded through shareholders equity. The table below breaks out other
comprehensive income for the periods presented into the following two
categories: (1) the changes to unrealized gains and losses that relate to the
MBS and equity securities which were disposed of or impaired during the period
with the resulting gain or loss reflected in net income (reclassification
adjustments) and (2) the change in the unrealized gain or loss related to those
investments that were not disposed of or impaired during the period.
2000 1999 1998
---- ---- ----
Reclassification adjustment for (gains) losses from
dispositions included in net income $(2,220,998) $ (1,313) $ __
Reclassification adjustment for impairment loss
recognized on equity securities included in net
income 4,516,638 10,589,124 __
Unrealized holding (losses) gains arising
during the period 9,938,028 (13,769,640) (9,800,530)
----------- ----------- -----------
Net adjustment to unrealized (losses) gains on
investments $12,233,668 $(3,181,829) $(9,800,530)
=========== =========== ===========
Net Income Per Share
FBR Asset presents basic and diluted earnings per share. Basic earnings per
share excludes potential dilution and is computed by dividing income available
to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that would share in earnings. This includes stock options for the company
which were not dilutive for the periods presented.
I-12
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.
Income Taxes
FBR Asset has elected to be taxed as a REIT under the Internal Revenue Code.
To qualify for tax treatment as a REIT, FBR Asset must meet certain income and
asset tests and distribution requirements. FBR Asset generally will not be
subject to federal income tax at the corporate level to the extent that it
distributes at least 95 percent of its taxable income to its shareholders and
complies with certain other requirements. Failure to meet these requirements
could have a material adverse impact on FBR Asset's results or financial
condition. Furthermore, because FBR Asset's investments include stock in other
REITs, failure of those REITs to maintain their REIT status could jeopardize FBR
Asset's qualification as a REIT. No provision has been made for income taxes in
the accompanying financial statements, as FBR Asset believes it has met the
requirements.
Note 3 Shareholders' Equity
FBR Asset declared the following dividends
Year Per Share
---- ---------
2000 $ 2.95
1999 $ 1.61
1998 $ 1.16
FBR Asset has repurchased the following shares of it's common stock
Year Shares Cost Average price per share
---- ------ ---- -----------------------
2000 1,921,909 $25,420,635 $13.23
1999 2,737,191 $37,142,146 $13.57
1998 1,872,300 $24,070,663 $12.86
---------- ----------- ------
Totals 6,531,400 $86,633,444 $13.26
As of December 31, 2000, 996,900 options to purchase common stock were
outstanding. These options have terms of eight to ten years and have an exercise
price of $20 per share. During 2000, 25,000 of these options were forfeited.
Under FBR Asset's stock option plan, FBR Asset may grant, in the aggregate,
up to 155,000 tax qualified incentive stock options and non-qualified stock
options to its employees, directors or service providers. Options granted are
generally exercisable immediately and have a term of eight to ten years. As of
December 31, 2000 130,000 options were outstanding under the stock option plan.
I-13
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
FBR Asset accounts for its stock-based compensation in accordance with SFAS
No. 123, "Accounting For Stock Based Compensation." Pursuant to SFAS No. 123,
FBR Asset applies the provisions of Accounting Principles Board Opinion No. 25,
"Accounting For Stock Issued to Employees" (APB No. 25), for stock options
issued to employees. Under APB No. 25, compensation expense is recorded to the
extent the fair market value of FBR Asset's stock exceeds the strike price of
the option on the date of grant. In addition and in accordance with the
disclosure requirements of SFAS No. 123, FBR Asset does provide pro forma net
income disclosures for options granted to employees as if the fair value method,
as defined in SFAS No. 123, had been applied for the purpose of computing
compensation expense. The impact of the issued and outstanding employee options
under the fair value method was not material to FBR Asset's net income or basic
and diluted net income per share as reported in the statement of income for the
years ended December 31, 2000, 1999 and 1998.
Note 4 Management and Performance Fees
FBR Asset has a management agreement with Friedman, Billings, Ramsey
Investment Management, Inc. ("FBR Management"), expiring on December 17, 2001.
FBR Management performs portfolio management services on behalf of FBR Asset.
These services include, but are not limited to, consulting with FBR Asset on
purchase and sale opportunities, collection of information and submission of
reports pertaining to FBR Asset's assets, interest rates, and general economic
conditions, and periodic review and evaluation of the performance of FBR Asset's
portfolio of assets.
FBR Management is entitled to a quarterly "base" management fee equal to
the sum of (1) 0.25 percent per annum (adjusted to reflect a quarterly period)
of the average invested mortgage assets of FBR Asset during each calendar
quarter and, (2) 0.75 percent per annum (adjusted to reflect a quarterly period)
of the remainder of the average invested assets of FBR Asset during each
calendar quarter. In December 1997, FBR Management also received options to
purchase 1,021,900 shares of FBR Asset's common stock at $20 per share. The
estimated value of these options was $909,492, based on a discounted Black-
Scholes valuation, and was amortized over the initial term of the Management
Agreement. The value of these options has been fully amortized in the
accompanying statements of income. FBR Management assigned options to acquire
51,045 shares to BlackRock Financial Management, Inc. ("BlackRock") in
connection with the execution of the sub-management agreement discussed below.
In addition, FBR Management agreed to the rescission of options to purchase
155,000 common shares in connection with the establishment of FBR Asset's stock
incentive plan.
FBR Management is also entitled to receive incentive compensation based on
the performance of FBR Asset. On December 31, 1998, and each calendar quarter
thereafter, FBR Management is entitled to an incentive fee calculated by
reference to the preceding 12-month period. FBR Management is entitled to an
incentive fee calculated as: funds from operations (as defined), plus net
realized gains or losses from asset sales, less the threshold amount (all
computed on a weighted average share outstanding basis), multiplied by 25
percent. The threshold amount is calculated as the weighted average per share
price of all equity offerings of FBR Asset, multiplied by a rate equal to the
ten-year U.S. Treasury rate plus five percent per annum. No incentive
compensation was earned during the periods presented.
FBR Management previously engaged BlackRock to manage FBR Asset's mortgage
asset investment program (the "Mortgage Portfolio") as a sub-adviser.
BlackRock is a majority owned subsidiary of PNC Bank Corporation who is a 4.9
percent owner of FBR Management's parent company. As compensation for rendering
services, BlackRock was entitled to a sub-advisory fee based on the average
gross asset value managed by BlackRock. The agreement was terminated by FBR
Management on February 14, 2000, and FBR Management entered into a new agreement
with Fixed Income Discount
I-14
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
Advisory Company, Inc. ("FIDAC") on February 14, 2000 to assume management of
FBR Asset's Mortgage Portfolio under the same terms as BlackRock.
Note 5 Related Parties
As of December 31, 2000, a wholly-owned subsidiary of Friedman, Billings,
Ramsey Group, Inc. ("FBR Group") owned 1,344,086 shares or 34.60% of the
outstanding common stock of FBR Asset. As of December 31, 1999, that same
subsidiary owned 1,344,086 or 23.15% of the outstanding common stock of FBR
Asset. FBR Group is the parent company of FBR Management and FBR & Co.
Note 6 Equity Investments
At December 31, 2000, FBR Asset's equity investments had an aggregate cost
basis of $28.3 million, a fair value of $28.1 million, unrealized gains of $0.5
million and unrealized losses of $0.7 million.
At December 31, 1999, FBR Asset's equity investments had an aggregate cost
basis of $57.5 million, fair value of $49.6 million and unrealized losses of
$7.9 million.
Cost Basis of Market Value at Market Value
Equity Investments Investment Dec. 31, 2000 at Dec. 31, 1999
- ------------------ ---------- ------------- ----------------
Anthracite Capital, Inc........................................ $ -- $ -- $10,084,268
Capital Automotive REIT........................................ 23,298,100 23,068,463 21,841,402
Imperial Credit Commercial Mortgage Inv. Corp.................. -- -- 10,237,500
Prime Retail, Inc.............................................. -- -- 694,688
Prime Retail, Inc., pfd........................................ 1,038,800 543,939 1,151,696
Resource Asset Investment Trust................................ 3,704,181 4,245,164 3,725,717
Encompass Services Corporation................................. 286,931 252,624 1,912,594
----------- ----------- -----------
Total....................................................... $28,328,012 $28,110,190 $49,647,865
=========== =========== ===========
Capital Automotive REIT ("CARS")
On February 13, 1998, FBR Asset acquired 1,792,115 shares of common stock in
CARS for a price of $13.95 per share. CARS is a self-administered and self-
managed REIT formed to invest in the real property and improvements used by
operators of multi-site, multi-franchised motor vehicle dealerships and motor
vehicle-related businesses located in major metropolitan areas throughout the
United States. CARS primarily acquires real property and simultaneously leases
back this property for use by dealers. CARS' common stock is publicly traded.
Prime Retail, Inc. ("PRT preferred")
On April 22, 1999, FBR Asset purchased 78,400 shares of PRT's preferred stock
for a cost of $1,454,320 or $18.55 average cost per share. PRT is a REIT engaged
primarily in the ownership, development, construction, acquisition, leasing,
marketing and management of factory outlet centers. PRT's common stock is
publicly traded. PRT's preferred stock is publicly traded.
Resource Asset Investment Trust ("RAS")
On February 19, 1998, FBR Asset acquired 300,000 shares of common stock in
RAS for $15.33 per share. RAS's principal business activity is the acquisition
and/or financing of loans secured by mortgages
I-15
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
on real property (or interests in such loans) in situations that, generally,
do not conform to the underwriting standards of institution lenders or sources
that provide financing through securitization.
On June 24th and 25th, 1998, FBR Asset acquired an additional 44,575 shares
of RAS for an average price of $15.55 per share.
Encompass Services Corporation ("ESR") - formerly Building One Services
Corporation ("BOSS")
In December 1997, FBR Asset purchased 500,000 shares of BOSS (formerly
Consolidated Capital Corporation) common stock for $20.00 per share. BOSS was
founded in February 1997 to build consolidated enterprises through the
acquisition and integration of multiple businesses in one or more fragmented
industries. Pursuant to a BOSS tender offer, FBR Asset sold 297,341 of its
common shares during 1999 for a price of $22.50 per share, or $6.7 million. In
February 2000, Encompass Services Corporation (ESR) was formed through the
merger of GroupMac and Building One Services Corporation. As a result of the
merger FBR Asset received shares of ESR common stock in exchange for its BOSS
common stock.
Kennedy-Wilson, Inc. ("KWIC")
FBR Asset owns warrants to acquire 131,096 shares of Kennedy-Wilson common
stock at a price of $7.5526 per share. The warrants expire in June 2003. As of
December 31, 2000, the market price of Kennedy-Wilson common stock was $4.38 per
share.
I-16