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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 1-15049
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FBR Asset Investment Corporation
(Exact name of registrant as specified in its charter)
Virginia 54-1873198
(State or other Jurisdiction of (I.R.S. employer
Incorporation or Organization) identification no.)
Potomac Tower (703) 469-1000
1001 Nineteenth Street North (Registrant's telephone number
Arlington, Virginia 22209 including area code)
(Address of principal executive offices)
(zip code)
N/A
(former name)
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Indicate by check mark whether the Registrant (i) 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 report), and (ii) has been subject to such
filing requirements for the past 90 days. Yes: [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of 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] (No delinquent filers)
Aggregate market value of the voting stock held by non-affiliates of the
Registrant: $42,449,471 as of March 23, 2001.
As of March 23, 2001, the latest practicable date, there were 3,472,527 shares
of the Registrant's common stock outstanding.
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, are incorporated by
reference into Part III.
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FBR ASSET INVESTMENT CORPORATION
FORM 10-K
FOR THE YEARS ENDED DECEMBER 31, 20000 AND 1999
INDEX
Page
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
PART I.......................................................................... 1
Item 1. Business............................................................. 1
Item 2. Properties........................................................... 17
Item 3. Legal Proceedings.................................................... 17
Item 4. Submission Of Matters To Vote Of Security Holders.................... 17
Item 5. Market For Registrant's Common Equity And Related Stockholder Matters
Item 6. Selected Financial Data.............................................. 19
Item 7. Management's Discussion And Analysis Of Financial Condition And
Results Of Operations.............................................. 20
Overview
Item 8. Financial Statements and Supplementary Data.......................... 31
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure................................................. 31
PART II
Item 10. Directors and Executive Officers of the Registrant................... 31
Item 11. Executive Compensation............................................... 31
Item 12. Security Ownership of Certain Beneficial Owners and Management....... 31
Item 13. Certain Relationships and Related Transactions....................... 31
PART III
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..... 32
FINANCIAL STATEMENTS............................................................ F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS........................................ F-2
NOTES TO FINANCIAL STATEMENTS................................................... F-7
SIGNATURES
EXHIBITS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain information and statements set forth in this Report constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements can be
identified by the use of forward-looking terminology including, but not limited
to, "may," "will," "expect," "intend," "should," "anticipate," "estimate,"
"believe," "continue" or comparable terminology. The Company's actual results
may differ materially from those contained in the forward-looking statements.
Factors that could cause results to differ materially from those described in
the forward-looking statements include: the availability of opportunities to
acquire assets on favorable terms, the level and volatility of interest rates,
the cost and availability of short- and long-term credit, declines in the market
value of mortgage-backed securities, equity securities and other available-for-
sale assets owned by the Company, prepayment risks associated with the mortgage-
backed securities owned by the Company, declines in the value of commercial or
residential real estate owned by the companies in which the Company has
invested, declines in the profitability of companies in which the Company
invests resulting from competition in the sale, purchase and financing of
mortgage assets, limited liquidity of equity securities and other investment
securities owned by the Company and other risks described elsewhere in this
Report.
PART I
Item 1. Business
General
The Company was incorporated in the Commonwealth of Virginia on November 10,
1997, and has elected to be taxed as a real estate investment trust (REIT) since
its inception. The Company was initially capitalized through a private
placement of its common stock in late 1997. In September 1999, the Securities
and Exchange Commission (SEC) declared effective the Company's registration
statement on Form S-11 (File 333-67543) relating to the registration of
5,767,750 shares of the Company's common stock that had previously been issued
in the Company's private placement of its common stock in 1997.
Currently, the authorized capital stock of the Company consists of
200,000,000 shares of common stock, par value $0.01 per share, and 50,000,000
shares of preferred stock, par value $0.01 per share. As of December 31, 2000,
3,884,427 shares of the Company's common stock were outstanding and no shares of
preferred stock were outstanding.
The Company is involved in the business of investing directly in whole-pool
mortgage-backed securities, commercial loans and equity securities of real
estate-related businesses and indirectly, through its investment in the equity
securities of real estate-related businesses, in commercial and residential real
estate, commercial mortgage loans, and commercial mortgage-backed securities.
Subject to maintaining its REIT qualification, the Company also makes
investments from time to time in non-real estate related assets, including but
not limited to purchasing equity securities of, and making mezzanine and other
loans to, companies that are not involved primarily in the real estate business
or in a real estate-related business.
Operating Policies & Strategies
The Company relies on Friedman, Billings, Ramsey Investment Management, Inc.
(FBR Management), an affiliate of Friedman, Billings, Ramsey Group, Inc. (FBR),
to manage its investment portfolio, pursuant to a management agreement between
the parties. The management agreement and related information are described
below under "Business--Management Agreement."
Since its inception in 1989, FBR has sought to identify rapidly changing
industries and industries that are not fully understood or appropriately valued
by the market. Real estate is one of the sectors on which FBR currently focuses.
FBR has specialized in underwriting offerings of REIT securities, particularly
REITs that invest in mortgage loans and mortgage-backed securities. From 1993
through the end of 2000, FBR served as managing underwriter in the public
issuance of $5.3 billion of REIT and real estate equity securities, consisting
of $2.2 billion of mortgage and hybrid REITs and $3.1 billion of equity REITs
and real estate operating companies.
The Company believes that there is a global trend towards the securitization
of real estate and real estate-related assets and that this trend is represented
by the increased formation of non-traditional REITs. The Company also
1
believes that there is a global trend towards the consolidation of real estate
owners and operators and companies that provide services to real estate owners
and operators. The Company expects these trends to provide it with significant
opportunities for investing in real estate-related assets. The Company also
anticipates that, notwithstanding the late 1998 and continuing 2000 decline in
the mortgage REIT market, additional REITs or real estate-related companies will
be organized in the future and that, through investments in those companies and
in other non-traditional real estate-related and other assets, the Company can
diversify and expand its investments in the real estate market.
The Company's goal, subject to maintaining its REIT qualification, is to
acquire assets that it believes will generate the highest returns on capital
invested. To determine which assets are likely to provide those returns, the
Company considers:
. the amount and nature of anticipated cash flows from the asset;
. the risks of investing in the asset;
. the Company's ability to pledge the asset to secure collateralized
borrowings;
. the capital requirements for purchasing and financing the asset;
. the potential for appreciation and depreciation of the asset's value; and
. the cost of financing, hedging and managing the asset.
The Company is an opportunistic investor and does not have or expect to adopt
guidelines dictating specific investment or operating restrictions. The Company
has taken or may take the following actions without the consent of its
stockholders:
. borrowed money;
. made loans to other companies;
. invested in securities of other issuers;
. sold existing investments and made additional investments;
. repurchased or otherwise reacquired the Company's shares; and
. the Company also may issue preferred stock that has liquidation and dividend
preferences over the outstanding common stock or offer securities in exchange
for property, although to date the Company has chosen not to take those
actions.
Likewise, as to specific investments, the Company may invest directly or
indirectly in any type of mortgage, real estate or real estate-related assets,
as well as in other non-real estate related assets, subject to the policy that
the Company maintain its qualification as a REIT and its exemption from
registration as an investment company.
The Company expects that investment opportunities will change. REITs have had
a difficult time accessing the public capital markets in recent years, although
the market for REIT securities has improved in 2000 and 2001 as investors have
sought more stable, income-producing investment securities in the face of
significant volatility in the stock markets generally and particularly in the
technology sector. As the public capital markets become more receptive to REIT
securities, the Company may seek to raise additional capital in the capital
markets to fund its growth strategy. Until that time, the Company will seek
what it considers to be attractive opportunities to invest on a privately
negotiated basis. For example, the Company believes there will be opportunities
to enter into joint ventures with other REIT and non-REIT investors seeking to
complete planned acquisitions, to provide mezzanine loans with equity features,
and to provide private equity financing. If an adequate amount of what the
Company considers to be
2
appropriate investments becomes available, the Company intends to borrow funds
to make additional investments and, if market conditions are favorable, the
Company may seek to raise additional capital in the public capital markets to
fund its investments both in real estate related assets such as mortgages,
mortgage-backed securities, and equity securities of real estate-related
businesses and, subject to maintaining its REIT qualification, in non-real
estate related assets such as mezzanine loans to non-real estate related
businesses.
Investments
The Company invests directly and indirectly in whole-pool mortgage-backed
securities, commercial loans, equity securities of real estate-related
businesses, commercial and residential real estate, commercial mortgage loans,
and commercial mortgage-backed securities. As to the Company's indirect
investments, the Company holds interests in those assets through its equity
ownership of other companies. As an equity holder, the Company's return on its
investment is not directly linked to returns on any company's assets, but will
depend upon the authorization and payment of dividends and changes in the price
of the equity securities owned by the Company. Furthermore, as a common
stockholder, the Company's claims to the assets of the companies in which it
invests are subordinated to those of creditors and other senior stockholders.
In addition, from time to time, subject to maintaining the Company's REIT
qualification, the Company invests in other assets that are not related to the
real estate business, such as equity securities of, and mezzanine loans and
other loans to, companies that are not primarily involved in the real estate
business or a real estate-related business.
Based upon the information provided on Form 10-Q for the quarter ended
September 30, 2000, by the companies in which the Company held equity securities
on that date, the Company believes that at September 30, 2000, approximately
71.0% of the Company's assets were invested directly or indirectly in
residential mortgage-backed securities, approximately 11.1% were invested
indirectly in commercial real estate, approximately 11.8% were invested directly
or indirectly in commercial mortgage loans, approximately 2.2% were invested
indirectly in commercial mortgage-backed securities, and approximately 3.9% did
not fit into the identified categories.
Based upon the information provided on form 10-K for the year ended December
31, 1999, by the companies in which the Company held equity securities on that
date, the Company believes that at December 31, 1999, approximately 74.1% of the
Company's assets were invested directly or indirectly in residential mortgage-
backed securities, approximately 7.9% were invested indirectly in commercial
real estate, approximately 11.1% were invested directly or indirectly in
commercial mortgage loans, approximately 1.5% were invested indirectly in
commercial mortgage-backed securities, and approximately 5.4% did not fit into
the identified categories.
Whole-Pool Mortgage-Backed Securities
The Company currently invests, and intends to continue investing, at least
55% of its assets in whole-pool mortgage-backed securities. Those securities
represent the entire ownership interest in pools of mortgage loans made by
lenders such as savings and loan institutions, mortgage bankers, and commercial
banks. Various government, government-related and private organizations assemble
the pools of loans for sale to investors such as the Company.
At December 31, 2000, the Company owned mortgage-backed securities guaranteed
by Freddie Mac, Fannie Mae, or Ginnie Mae that had a market value of $154.8
million, and had borrowed $133.9 million to finance its investment in those
securities. Mortgage-backed securities differ from other forms of traditional
debt securities, which normally provide for periodic payments of interest in
fixed amounts with principal payments at maturity or on specified call dates.
Instead, mortgage-backed securities provide for a monthly payment that consists
of both interest and principal. In effect, these payments are a "pass-through"
of the monthly interest and principal payments made by borrowers on their
mortgage loans, net of any fees paid to the issuer or guarantor of the
securities.
The investment characteristics of pass-through mortgage-backed securities
differ from those of traditional fixed-income securities. The major differences
include the payment of interest and principal on the mortgage-backed securities,
as described above, and the possibility that principal may be prepaid on the
mortgage-backed securities at any time due to prepayments on the underlying
mortgage loans. These differences can result in significantly greater price and
yield volatility than is the case with traditional fixed-income securities.
3
Mortgage prepayments are affected by factors including the level of interest
rates, general economic conditions, the location and age of the mortgage, and
other social and demographic conditions. Generally prepayments on pass-through
mortgage-backed securities increase during periods of falling mortgage interest
rates and decrease during periods of rising mortgage interest rates.
Reinvestment of prepayments may occur at higher or lower interest rates than the
original investment, thus affecting the yield on the Company's investments.
At December 31, 2000, the Company owned 33 fixed rate, and 4 adjustable rate,
residential mortgage-backed securities that represented the entire ownership
interest in pools of single-family mortgage loans. In connection with those
investments, the Company entered into repurchase agreements, and an interest
rate swap. The mortgage-backed securities, the swap, and the repurchase
agreements are summarized on the following table.
4
Original Market
Issue Date Face Principal Value at
Descriptive of Amount Amount 12/31/00
Title(1) Securities (thousands) (thousands) (thousands)
-------- ---------- ----------- ----------- -----------
Freddie Mac
FGOLD 15 yr. 4/1/97 $ 52,678 $ 72,337 $ 52,678
Fannie Mae
FNMA 15 yr. 5/1/98 $ 16,470 $ 23,304 $ 16,465
Freddie Mac
FGOLD 30 yr. 5/1/98 $ 2,308 $ 4,645 $ 2,366
Freddie Mac
FGOLD 15 yr. 9/1/95 $ 2,463 $ 4,962 $ 2,489
Fannie Mae
30 yr. 4/1/98 $ 7,545 $ 15,861 $ 7,656
Fannie Mae
30 yr. 4/1/98 $ 7,105 $ 16,695 $ 7,343
Ginnie Mae
30 yr. 5/1/98 $ 9,660 $ 20,016 $ 9,932
Freddie Mac
FGOLD 15 yr. 4/1/97 $ 8,175 $ 10,003 $ 7,958
Fannie Mae
15 yr. 10/1/99 $ 9,883 $ 11,249 $ 9,988
Fannie Mae
ARM 4/1/00 $ 2,113 $ 2,234 $ 2,150
Fannie Mae
ARM 2/1/00 $ 4,442 $ 4,582 $ 4,500
Fannie Mae
ARM 3/1/00 $ 10,576 $ 11,397 $ 10,715
Freddie Mac
FGOLD ARM 3/1/00 $ 20,304 $ 22,503 $ 20,608
-------- -------- ---------
Mortgage Portfolio Total $153,722 $219,788 $ 154,848
======== ======== =========
Repurchase Agreement Liability $133,896
Interest Rate Swap Agreement 6/1/98 $ 50,000(3) $ 138
Expected
Weighted
Nominal Average Effective Relevant
Yield at Life Duration Prepayment
Descriptive at 12/31/00 12/31/00 Assumption
Title(1) 12/31/00(5) (years) (years) (CPR)(2)
-------- ----------- ------- ------- --------
Freddie Mac
FGOLD 15 yr. 6.45% 4.57 3.07 5.40
Fannie Mae
FNMA 15 yr. 6.40% 4.63 3.08 19.61
Freddie Mac
FGOLD 30 yr. 6.23% 2.10 1.37 8.33
Freddie Mac
FGOLD 15 yr. 6.49% 3.41 2.41 0.12
Fannie Mae
30 yr. 6.57% 3.45 2.08 6.15
Fannie Mae
30 yr. 6.70% 2.50 1.58 10.99
Ginnie Mae
30 yr. 6.89% 4.84 2.52 11.78
Freddie Mac
FGOLD 15 yr. 6.06% 4.95 3.92 13.24
Fannie Mae
15 yr. 6.85% 4.46 2.46 8.57
Fannie Mae
ARM 7.56% 3.75 1.73 0.26
Fannie Mae
ARM 7.58% 3.75 3.00 0.31
Fannie Mae
ARM 7.40% 3.75 2.67 10.95
Freddie Mac
FGOLD ARM 7.20% 3.75 0.72 10.94
---- ---- ---- -----
Mortgage Portfolio Total 6.67% 4.20 2.52 10.50
==== ==== ==== =====
Repurchase Agreement
Liabililty 6.57%
Interest Rate Swap
Agreement (4)
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(1) All of the mortgage-backed securities are backed by pools of fixed and
adjustable rate mortgages and are principal and interest paying
instruments.
(2) Prepayment assumptions express the relationship between the assumption for
a specific pass-through security and a constant prepayment rate ("CPR").
CPR are annualized equivalents of single monthly mortality. The CPR used by
the Company attempts to predict the percentage of principal that will
prepay over the next 12 months based on historical principal paydowns.
(3) Notional amount.
(4) Under the interest rate swap agreement, the Company receives quarterly
payments of interest based on three-month LIBOR and remits semi-annual
payments at a fixed rate of approximately 5.96% based on the $50 million
notional amount.
(5) The nominal yield is the internal rate of return of the security based on
the given market price. It is the single discount rate that equates a
security price (inclusive of accrued interest) with its projected cash
flows. For a mortgage product, it represents the yield for a given yield
curve environment based on prepayments for that environment.
As the table above shows, the average nominal yield (as defined in footnote 5
above) on the Company's mortgage-backed securities at December 31, 2000, was
approximately 6.67%. The yield is based on the anticipated life of the
securities. If the actual life of the security is reduced below its
anticipated life, the yield would be reduced. The actual life of the mortgage-
backed securities is reduced if the mortgage loans underlying the securities
are prepaid faster than anticipated at the time the securities were acquired.
The table that follows outlines the recent prepayment experience of the
mortgage-backed securities owned by the Company in terms of CPR. See footnote
2 to the preceding table for a more detailed discussion of CPR. For each
category of securities in which the Company owns only one pool of mortgage
loans, the prepayment history is for that specific pool. For each category of
securities in which the Company holds multiple pools of mortgage loans, we
have presented the prepayment history of a representative pool. Several
securities were recently issued and thus have little prepayment history.
5
Period from Period from
October 2000 to January 2000 to
Face Amount December 2000 December 2000
Mortgage-Backed Securities (in thousands) (CPR) (CPR)
- --------------------------- ------------------- ----------------- -------------------
Freddie Mac FGOLD 15-yr.............. $ 52,678 3.40 6.49
Fannie Mae FNMA 15-yr................ 16,470 11.80 8.54
Freddie Mac FGOLD 30-yr.............. 2,308 13.20 10.71
Freddie Mac FGOLD 15-yr.............. 2,463 28.80 13.17
Fannie Mae 30-yr..................... 7,545 10.50 14.43
Fannie Mae 30-yr..................... 7,105 12.20 15.66
Ginnie Mae 30-yr..................... 9,660 15.10 16.46
Freddie Mac FGOLD 15-yr.............. 8,175 12.10 6.42
Fannie Mae FNMA 15-yr................ 9,883 8.10 8.40
Fannie Mae ARM....................... 2,113 17.60 9.45
Fannie Mae ARM....................... 4,442 0.30 4.56
Fannie Mae ARM....................... 10,576 19.20 12.40
Freddie Mac FGOLD ARM................ 20,304 12.60 17.45
--------
Total........................... $153,722
========
Freddie Mac Certificates
Federal Home Loan Mortgage Corporation, better known as "Freddie Mac," is a
privately owned government-sponsored enterprise created pursuant to Title III of
the Emergency Home Finance Act of 1970. Freddie Mac's principle activities
currently consist of the purchase of mortgage loans or participation interests
in mortgage loans and the resale of the loans and participations in the form of
guaranteed mortgage-backed securities. Freddie Mac guarantees to holders of
Freddie Mac certificates, such as the Company, the timely payment of interest at
the applicable pass-through rate and ultimate collection of all principal on the
holder's pro rata share of the unpaid principal balance of the underlying
mortgage loans, but does not guarantee the timely payment of scheduled principal
on the underlying mortgage loans. The obligations of Freddie Mac under its
guarantees are solely those of Freddie Mac and are not backed by the full faith
and credit of the United States. If Freddie Mac were unable to satisfy its
obligations, distributions to the Company would consist solely of payments and
other recoveries on the underlying mortgage loans, and accordingly, monthly
distributions to the Company would be adversely affected by delinquent payments
and defaults on those mortgage loans.
Fannie Mae Certificates
Federal National Mortgage Association, better known as "Fannie Mae," is a
privately owned, federally chartered corporation organized and existing under
the Federal National Mortgage Association Charter Act. Fannie Mae provides funds
to the mortgage market primarily by purchasing home mortgage loans from local
lenders, thereby replenishing their funds for additional lending. Fannie Mae
guarantees to registered holders of Fannie Mae certificates, such as the
Company, that it will distribute amounts representing scheduled principal and
interest (at the rate provided by the Fannie Mae certificate) on the mortgage
loans in the pool underlying the Fannie Mae certificate, whether or not
received, and the full principal amount of any mortgage loan foreclosed or
otherwise finally liquidated, whether or not the principal amount is actually
received. The obligations of Fannie Mae under its guarantees are solely those of
Fannie Mae and are not backed by the full faith and credit of the United States.
If Fannie Mae were unable to satisfy its obligations, distributions to the
Company would consist solely of payments and other recoveries on the underlying
mortgage loans, and accordingly, monthly distributions to the Company would be
adversely affected by delinquent payments and defaults on the mortgage loans.
6
Ginnie Mae Certificates
Government National Mortgage Association, better known as "Ginnie Mae," is
a wholly owned corporate instrumentality of the United States within the
Department of Housing and Urban Development. Title III of the National Housing
Act of 1934 authorizes Ginnie Mae to guarantee the timely payment of principal
and interest on certificates that represent an interest in a pool of mortgages
insured by the Federal Housing Administration under the Housing Act or partially
guaranteed by the Veteran's Administration under the Servicemen's Readjustment
Act of 1944 and other loans eligible for inclusion in mortgage pools underlying
Ginnie Mae certificates. Section 306(g) of the Housing Act provides that "the
full faith and credit of the United States is pledged to the payment of all
amounts that may be required to be paid under any guaranty under this
subsection." An opinion, dated December 12, 1969, of an Assistant Attorney
General of the United States provides that guarantees under section 306(g) of
Ginnie Mae certificates of the type that may be purchased by the Company are
authorized to be made by Ginnie Mae and "would constitute general obligations
of the United States backed by its full faith and credit."
Single-Family and Multifamily Privately-Issued Certificates
Although the Company does not own single-family or multifamily privately-
issued certificates, some of the companies in which it invests may own these
certificates. The Company may in the future invest in other companies that
invest in these assets or may invest in them itself.
Single-family and multifamily privately-issued certificates are pass-through
certificates that are not issued or guaranteed by one of the agencies described
above and that are backed by a pool of single-family or multifamily mortgage
loans. Single-family and multifamily privately-issued certificates are issued by
originators of, investors in, and other owners of mortgage loans, including
savings and loan associations, savings banks, commercial banks, mortgage banks,
investment banks and special purpose "conduit" subsidiaries of those
institutions.
While agency certificates are backed by the express obligation or guarantee
of one of the agencies, as described above, single-family and multifamily
privately-issued certificates are generally covered by one or more forms of
private credit enhancements. Those credit enhancements provide an extra layer of
loss coverage in the event that losses are incurred upon foreclosure sales or
other liquidations of underlying mortgaged properties in amounts that exceed the
equity holder's equity interest in the property and result in realized losses.
Forms of credit enhancements include, but are not limited to, limited issuer
guarantees, reserve funds, private mortgage guaranty pool insurance, over-
collateralization, and subordination.
Borrowed Funds
The Company may reduce the amount of equity capital it has invested in
mortgages or other assets by funding a portion of those investments with long-
term borrowings, warehouse lines of credit, or other borrowing arrangements.
Borrowing funds creates interest expense that can exceed the revenue the Company
earns from its financed assets. To the extent that revenue derived from those
assets exceeds the interest expense, the Company's net income will be greater
than if the Company had not borrowed funds and had not invested in the mortgage-
backed securities. Conversely, if the revenue from those assets does not
sufficiently cover the expense, the Company's net income will be less than if
the Company had not borrowed funds.
The Company has borrowed and intends to continue borrowing funds by entering
into repurchase agreements. Under these agreements, the Company sells assets to
a third party with the commitment to repurchase the same assets at a fixed price
on an agreed date. The repurchase price reflects the purchase price plus an
agreed upon market rate of interest. The Company accounts for repurchase
agreements as loans, secured by the underlying assets, that the Company owes to
the third party.
The Company intends to use the proceeds from borrowings to invest in
mortgages or other assets and to repeat this process of borrowing and investing,
while continually monitoring its use of leverage. Based on book values, the
debt-to-equity ratio as of December 31, 2000, on the Company's mortgage-backed
securities portfolio was 6 to 1. Traditionally, lenders have permitted
repurchase agreement borrowings against agency mortgage-backed securities at
7
a debt-to-equity ratio of up to 19 to 1. The Company does not currently intend
to increase its leverage ratio, although its charter and bylaws do not impose
any specific limits on permissible leverage.
What follows are two examples of how the Company might use borrowings to
increase the yield on a hypothetical mortgage-backed security:
Example 1 Example 2
--------- ---------
1. Amount invested in mortgage-backed security.......................... $10,000,000 $10,000,000
2. Annual interest rate on mortgage-backed security..................... 7.25% 7.25%
3. Income from mortgage-backed security (1 x 2)*........................ $ 725,000 $ 725,000
4. Amount borrowed to finance investment in mortgage-backed security.... $ 8,000,000 $ 5,000,000
5. Interest rate on amount borrowed..................................... 5.50% 5.50%
6. Interest expense (4 x 5)*............................................ $ 440,000 $ 275,000
7. Equity capital invested (1 - 4)*..................................... $ 2,000,000 $ 5,000,000
8. Management fee (0.25% x $10,000,000)................................. $ 25,000 $ 25,000
9. Hedging expense (4 x 1%)*............................................ $ 80,000 $ 50,000
10. Total expenses (6 + 8 + 9)*.......................................... $ 545,000 $ 350,000
11. Net income on mortgage-backed security (3 - 10)*..................... $ 180,000 $ 375,000
12. Return on equity capital invested (11 divided by 7)*................. 9.00% 7.50%
- ---------
* The numbers in parentheses, unless otherwise specified, refer to the line
numbers on the far left.
In example 1 above, the Company uses borrowed funds to increase the initial
yield on its investment from 7.25% to 9.0%. In example 2 above, the Company
borrows less funds and increases its yield only from 7.25% to 7.50%. The Company
plans to complete these types of transactions by arranging loans in which it
pledges its assets as collateral to secure its repayment obligations. Some of
those loans may be margin loans in which a decline in the pledged assets' market
value could trigger an early repayment of the Company's obligations. If the
Company repays loans early, then the return on equity would be reduced. As
reflected above, if the Company were required to increase the amount of equity
capital it invested by $3 million in order to prepay $3 million of the loan,
then the return on equity would be reduced from 9.00% to 7.50%.
Hedging & Interest Rate Management
The Company acquires derivative financial instruments to hedge all or a
portion of the interest rate risk associated with its borrowings. The Company
does not intend to acquire derivative instruments for speculative purposes. The
Company's hedging activities may include entering into interest rate swaps and
caps and options to purchase swaps and caps. Under the tax laws applicable to
REITs, the Company generally will be able to enter into swap or cap agreements,
options, futures contracts, forward rate agreements, or similar financial
instruments to hedge indebtedness that the Company may incur, or plans to incur,
to acquire or carry real estate assets.
The Company engages in a variety of interest rate management techniques that
are intended to match the effective maturity of, and the interest received on,
its assets with the effective maturity of, and the interest owed on, its
liabilities. The Company generally will be able to use those techniques
directly, instead of through a corporate subsidiary that is fully subject to
corporate income taxation. The Company, however, cannot give any assurances that
it can successfully implement its investment and leverage strategies. The
Company's interest rate management techniques may include:
. puts and calls on securities or indices of securities;
. Eurodollar futures contracts and options on such contracts;
. interest rate swaps, which are the exchange of fixed-rate payments for
floating-rate payments; or
. other similar transactions.
The Company may also use these techniques to attempt to protect itself
against declines in the market value of its assets that result from general
trends in debt markets. The inability to match closely the maturities and
interest
8
rates, or the inability to protect adequately against declines in the
market values, could result in losses with respect to the Company's mortgage
assets.
At December 31, 2000, the Company was indebted for $133.9 million under
short-term repurchase agreements. These agreements expire and are renewed on a
regular basis. As of December 31, 2000, the repurchase agreements held by the
Company had stated maturity dates from January 2, 2001 to February 2, 2001. The
interest rate paid by the Company under the short-term borrowing arrangements
increases and decreases as short-term interest rates increase or decrease. The
interest rate on the mortgage-backed securities remains constant for fixed-rate
securities. If short-term rates increase significantly above 6.67%, which is the
average nominal yield (as defined in footnote 5 on page 5) of the Company's
mortgage portfolio as of December 31, 2000, the interest owed on the borrowings
would exceed the interest income payable to the Company on its mortgage-backed
securities.
To limit the adverse effect of rising short-term interest rates under its
short-term repurchase agreements, the Company entered into two interest rate
swap agreements pursuant to which the Company paid a fixed interest rate on $100
million notional amount of borrowings and received a variable interest rate on
$100 million notional amount of borrowings. The Company realized a $1.9 million
loss when it terminated one $50,000,000 agreement in October 1998 and repaid the
related repurchase agreement. The remaining $50,000,000 agreement matures on
June 1, 2001.
Interest rate management techniques do not eliminate risk. For example, if
both long-term and short-term interest rates were to increase significantly, it
could be expected that:
. the weighted average life of the mortgage-backed securities would be extended
because prepayments of the underlying mortgage loans would decrease; and
. the market value of the fixed rate mortgage-backed securities would decline
as long-term interest rates increased.
Yet, in this situation, the interest rate swap agreement would be ineffective
for periods after its June 1, 2001 termination date, and if the Company sold the
fixed-rate mortgage-backed securities to pay down its short-term borrowings, it
would realize a loss because of the decline in their market value.
Real Estate
The Company seeks to invest in real property to generate income and to
provide the Company with the potential for capital appreciation in the value of
property owned. Although the Company does not currently own any direct interests
in real property, it does own interests in real property through its equity
investments in Capital Automotive REIT ("Capital Automotive"), and to a lesser
extent through its equity investments in Prime Retail, Inc. ("Prime Retail"),
and Resource Asset Investment Trust ("Resource"). Through its relationship
with FBR, the Company was able to acquire the stock of Capital Automotive before
Capital Automotive offered its stock to the public. The Company purchased shares
of Prime Retail and Resource in open-market transactions. The Company also
loaned Prime Retail and its affiliates $24 million, $20 million of which was
repaid in December 2000.
Capital Automotive REIT invests 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 of the United
States. Capital Automotive is a self-administered and self-managed Maryland REIT
that primarily acquires real property and simultaneously leases back this
property to automobile dealers. These transactions generally have the following
characteristics:
. Capital Automotive's interest in the property acquired generally includes the
land, buildings and improvements, related easements and rights and fixtures,
but not any personal property, furniture or equipment.
. The leases generally range from 8 to 11 years and may be extended for one or
two terms of 10 years at the option of the lessee.
9
. The leases typically require the lessee to pay substantially all expenses
associated with the operation of the real property, such as real estate taxes
and other governmental charges, insurance, utilities, service, maintenance
and, therefore are on a "triple-net" basis.
. Upon expiration or termination of the lease, the lease generally provides
that additions, repairs, renovations and improvements become the property of
Capital Automotive.
. The leases also typically require the lessee to operate the property only for
the same purpose for which it was used on the date Capital Automotive
purchased it, unless Capital Automotive consents to a different use.
These types of "sale-leaseback" transactions generally enable Capital
Automotive to eliminate brokerage, re-leasing and similar costs and the risk of
high lessee turnover due to the general, historic long-term operation of
automobile dealerships.
Prime Retail invests in factory outlet centers. Prime is a self-administered
and self-managed REIT that develops, acquires, owns and operates factory outlet
centers in the United States. Resource invests in commercial office buildings
and land. Resource is a Maryland REIT whose principal business activity is to
provide specialized commercial mortgage loans to those who do not meet the
traditional underwriting standards of other lenders, but Resource also owns real
estate.
In the future, the Company may invest in other companies that own real
property. In addition, the Company may purchase real property directly or
through joint ventures that purchase real property.
Commercial Mortgage Loans & CMBS
The Company invests in commercial mortgage loans and commercial mortgage-
backed securities, commonly known as "CMBS." At December 31, 2000, the Company
owned interests in commercial loans and CMBS indirectly through its investment
in Resource Asset Investment Trust. FBR acted as lead underwriter or placement
agent for this company.
In the future, the Company may invest in other companies that originate or
acquire commercial mortgage loans or CMBS. In addition, the Company may purchase
commercial mortgage loans and CMBS directly.
Commercial mortgage loans are loans secured by senior or subordinate liens on
commercial or multifamily real estate. The characteristics of the commercial
mortgage loans held by companies in which the Company invests vary widely. Some
of those companies' commercial mortgage loan holdings are performing loans that
can be securitized.
Some of the companies in which the Company invests also own commercial
mortgage loans that are not intended to be securitized. For example, Resource
originates wraparound loans, in which a borrower grants Resource a junior lien
mortgage with a principal amount equal to the principal amount owed under any
existing loans plus an additional amount that Resource actually advances to the
borrower. The borrower makes all loan payments to Resource, which in turn pays
the prior lenders principal and interest on the prior loans. Because the loans
made by Resource are subordinated and include an obligation by Resource to make
payments on prior loans, these loans involve different and carry more
significant risk than traditional first mortgage loans originated by
institutional lenders and thus are generally not suitable for securitization.
The Company, or the companies in which it invests, may invest in commercial
mortgage loans with borrowers who are delinquent in payments on the loans. A
lender can purchase this kind of loan at a price less than the amount owed on
the loan, which enables the lender to work out a forbearance plan or other
restructuring. If an agreement cannot be made, the lender ultimately may
foreclose on the loan, acquiring ownership of the commercial property.
In addition to investing in commercial mortgage loans, some of the companies
in which the Company invests own CMBS.
CMBS typically are divided into two or more classes, sometimes called
"tranches." Generally the most senior class or classes would be rated
investment grade, which increases the marketability of the class. The junior, or
10
subordinated, classes typically would include a non-investment grade rated class
and an unrated, higher-yielding credit support class. The market for non-
investment grade CMBS is limited, and holders of CMBS have incurred, and might
in the future incur, significant losses if required to sell them as a result of
margin calls or otherwise.
Each class of CMBS generally is issued with a stated principal amount and a
specific fixed or variable interest rate. The principal of and interest on the
underlying mortgage loans may be allocated to the classes of CMBS in many ways,
and the credit quality of a particular class results primarily from the order
and timing of the receipt of payments on the underlying mortgage loans. For
example, subordinated classes of CMBS provide credit protection to the more
senior classes because the subordinated classes absorb all losses from loan
defaults and foreclosures before any losses are allocated to the more senior
classes. Typically, prepayments on mortgage loans are paid to the more senior
classes of CMBS for a period of time or until the senior classes are paid in
full. In some instances, subordinated classes of CMBS are not entitled to
receive any scheduled payments of principal until the more senior classes are
paid in full or until a specified time.
Some classes of CMBS are not entitled to any payments of principal, or are
entitled to only nominal principal payments. These classes are known as
interest-only securities or "IOs." IOs are sensitive to prepayments on the
underlying mortgage loans, and IO classes of CMBS are sensitive to losses
resulting from defaults on the underlying mortgage loans.
To the extent that the Company holds interests in commercial mortgage loans
and CMBS through its investments in other companies, the Company must rely on
the management of those other companies to make decisions with respect to the
commercial mortgage loans and CMBS. In general, the Company will have no ability
to control those decisions. Moreover, the management of those other companies
are not required to inform the Company of their decisions, although to the
extent the companies are reporting companies under the Securities Exchange Age
of 1934, they must file reports of material events with the SEC.
Loans
In November, 1999, the Company 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 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
the Company's expenses incurred in connection with the loan.
On July 17, 2000, the Company 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 the Company in exchange for the Company'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 the Company 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, the Company and Prime
Capital extended the date for the mandatory repurchase to January 4, 2001, for
an increased repurchase price of $4,171,951. Prime Capital and the Company
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 the Company for this repurchase price, and
reimbursed the Company for costs incurred in connection with the transaction.
11
Real Estate-Related Businesses
The tax rules limit the Company's ability to expand its investments beyond
its core direct and indirect investments in mortgage loans, mortgage-backed
securities and real estate. Subject to those limits, however, the Company
invests in businesses that provide services to real estate owners and operators.
For example, the Company owns common stock in Encompass Services Corporation
("Encompass"). Encompass intends to become a national single-source provider of
facilities services. Encompass currently derives most of its income from
providing janitorial maintenance management services and electrical and
mechanical installation and maintenance services. Encompass actively seeks to
expand its business by acquiring or merging with other facilities service
providers.
The Company believes that additional opportunities may arise in the future
for the Company to invest in businesses that provide services to real estate
owners and operators. In many cases, the Company believes that these investments
may provide higher returns than mortgage and real estate assets. Accordingly,
subject to applicable tax restrictions, the Company may invest in real estate-
related businesses in the future.
Other Non-Real Estate Related Investments
Subject to maintaining its qualification as a REIT, the Company invests from
time to time in assets that are not related to the real estate business. For
example, in 1998, the Company purchased 520,000 shares of the common stock of
East-West Bancorp, Inc., a bank holding company, for $5.2 million, or $10.00 per
share, from selling shareholders in a privately negotiated transaction. FBR
acted as placement agent in the transaction. The Company sold its position in
East-West Bancorp in 1999 for $5,998,000. In January 2000, the Company purchased
149,000 limited partner units in Atlas Pipeline Partners, L.P., a public limited
partnership formed to acquire and operate intrastate natural gas pipeline
gathering systems, for a price of $1.8 million, or $12.09 per unit, in a
privately negotiated transaction that was closed concurrently with the initial
public offering of the Atlas Pipeline units. FBR acted as underwriter in the
initial public offering. The Company sold its investment in Atlas Pipeline
during the fourth quarter of 2000 for a total price of $2.7 million, or an
average price per unit of $18.13. The Company intends to continue seeking
investments in non-real estate related businesses when presented with the
opportunity, subject to maintaining the Company's REIT qualification.
12
FBR ASSET INVESTMENT CORPORATION
Summary of Current Investments & Cash and Cash Equivalents
The following table summarizes the Company's investments as of December 31,
2000, and December 31, 1999.
As of December 31, 2000
----------------------------------------------
Amount Percentage
Shares Percent Of Market Increase
Owned Ownership/(3) Investment Value (Decrease)
--------- ------------- ------------ ------------ ------------
Mortgage-Backed Securities N/A N/A $155,379,074 $154,848,205 (0.34%)
------------ ------------
Equity Investments/(1)(2)/
Anthracite Capital, Inc.
(AHR) -- -- -- -- --
Capital Automotive REIT
(CARS) 1,670,115 6.70% 23,298,100 23,068,463 (0.99%)
Imperial Credit Commercial
Mortgage Inv. Corp.
(ICMI) -- -- -- -- 0.00%
Prime Retail, Inc. (PRT) -- -- -- -- 0.00%
Prime Retail, Inc., pfd
(PRT pfd) 78,400 3.41% 1,038,800 543,939 (47.64%)
Resource Asset Investment
Trust (RAS) 344,575 5.46% 3,704,181 4,245,164 14.60%
Encompass Services
Corporation (ESR)/(4)/ 49,900 0.08% 286,931 252,624 (11.96%)
------------ ------------ ------
Total Equity Investments 28,328,012 28,110,190 (0.77%)
------------ ------------ ------
Promissory Notes/(2)/
Prime Capital Holding,
LLC N/A N/A -- -- N/A
Prime Capital Funding I, LLC N/A N/A 4,000,000 4,000,000 N/A
Prime Retail, L.P. N/A N/A -- -- N/A
------------ ------------
Total Promissory Notes 4,000,000 4,000,000 N/A
------------ ------------
Cash and Cash Equivalents N/A N/A 36,810,566 36,810,566 N/A
------------ ------------
Total Investments & Cash
And Cash Equivalents $224,517,652 $223,768,961 (0.33%)
============ ============
As of December 31, 1999
---------------------------------------
Amount Percentage
of Market Increase
Investment Value (Decrease)
------------ ------------ ------------
Mortgage-Backed Securities $241,684,039 $236,014,844 (2.35%)
------------ ------------
Equity Investments/(1)(2)/
Anthracite Capital, Inc.
(AHR) 10,084,268 10,084,268 0.00%
Capital Automotive REIT
(CARS) 25,000,000 21,841,402 (12.63%)
Imperial Credit Commercial
Mortgage Inv. Corp.
(ICMI) 10,413,000 10,237,500 (1.69%)
Prime Retail, Inc. (PRT) 1,201,317 694,688 (42.17%)
Prime Retail, Inc., pfd
(PRT pfd) 1,454,320 1,151,696 (20.81%)
Resource Asset Investment
Trust (RAS) 5,292,516 3,725,717 (29.60%)
Encompass Services
Corporation (ESR)/(4)/ 4,053,180 1,912,594 (52.81%)
------------ ------------ ------
Total Equity Investments 57,498,601 49,647,865 (13.65%)
------------ ------------ ------
Promissory Notes/(2)/
Prime Capital Holding,
LLC 7,000,000 7,000,000 N/A
Prime Capital Funding I, LLC -- -- N/A
Prime Retail, L.P. 20,000,000 20,000,000 N/A
------------ ------------ ------
Total Promissory Notes 27,000,000 27,000,000 N/A
------------ ------------
Cash and Cash Equivalents 13,417,467 13,417,467 N/A
------------ ------------
Total Investments & Cash
And Cash Equivalents $339,600,107 $326,080,176 (3.98%)
============ ============ -------
(1) The symbols in parentheses next to the company names are the symbols of
those companies on Nasdaq or a national securities exchange. Each of these
companies is a reporting company under the Securities Exchange Act of 1934.
Information is available about these companies on the SEC's website,
www.sec.gov.
(2) FBR has underwritten or privately placed the securities of these companies
or their affiliates.
(3) As of September 30, 2000. For Prime Retail, Inc., this represents the
percentage ownership of 10.5% Series A Senior Cumulative Preferred Stock.
(4) Formerly Building One Services Corporation (BOSS)
13
The following table shows, for the calendar years 2000 and 1999, the
Company's investments and cash and cash equivalents, including, with respect to
its investments, the weighted average cost of each investment based on the
number of days from January 1, 2000 to December 31, 2000, January 1, 1999 to
December 31, 1999, and January 1, 1998 to December 31, 1998, on which the
Company held each investment, and the gross income from each investment for the
years ended December 31, 2000, 1999 and 1998.
For the Year Ended For the Year Ended For the Year Ended
December 31, 2000 December 31, 1999 December 31, 1998
----------------- ----------------- ------------------
Weighted Weighted Weighted
Average Cost Gross Income Average Cost Gross Income Average Cost Gross Income
------------ ------------ ------------ ------------ -------------------------
Mortgage-Backed Securities.................. $196,229,207 $13,106,945 $164,970,427 $10,744,041 $169,564,932 $ 7,101,326
------------ ----------- ------------ ----------- ------------ -----------
Equity Investments
Anthracite Capital, Inc..................... $ 8,449,779 $ 1,376,206 $ 18,334,496 $ 2,293,677 $ 10,356,129 $ 739,613
Capital Automotive REIT..................... 24,447,980 2,575,903 25,000,000 2,473,119 21,986,301 1,569,893
Chastain Capital Corporation................ -- 41,835 3,150,000 -- 6,581,342 287,000
Imperial Credit Commercial
Mortgage Inv. Corp......................... 2,589,025 207,000 12,616,713 1,035,000 13,050,230 1,062,000
Imperial Credit Industries, Inc............. -- -- 3,576,712 798,326 -- --
Prime Retail, Inc........................... 385,788 -- 1,201,317 145,730 374,166 36,433
Prime Retail, Inc., preferred............... 1,142,112 -- 1,016,032 154,350 -- --
Resource Asset Investment Trust............. 4,099,095 702,933 5,292,516 702,933 4,329,152 576,466
Encompass Services Corporation.............. 1,186,381 -- 6,187,518 -- 10,000,000 --
Atlas Pipeline Partners..................... 1,472,552 178,314 -- -- 2,621,370 --
Cargan City................................. 20,218 -- -- --
East-West Bancorp, Inc...................... -- -- 4,102,329 46,800
------------ ----------- ------------ ----------- ------------ -----------
Total Equity Investments & Dividends...... $ 43,792,930 $ 5,082,191 $ 80,477,633 $ 7,649,935 $ 69,298,690 $ 4,271,405
------------ ----------- ------------ ----------- ------------ -----------
Promissory Notes
Prime Capital Holding, LLC.................. $ 1,825,137 $ 902,418 $ 11,272,154 $ 1,808,451 $ 7,947,365 $ 1,248,707
Prime Group Realty, Inc..................... -- -- 3,049,315 494,742 -- --
Prime Retail, Inc........................... 19,508,197 3,773,658 5,095,890 1,055,555 -- --
Prime Capital Funding I, LLC ............... 2,108,204 511,778 -- --
Kennedy-Wilson Inc.......................... -- -- 3,510,608 511,411 5,506,849 749,264
Brookdale Living Communities................ -- -- 1,493,151 224,727 -- --
------------ ----------- ------------ ----------- ------------ ----------
Total Promissory Notes.................... $ 23,441,538 $ 5,187,854 $ 24,421,118 $ 4,094,886 $ 13,454,214 $ 1,997,971
------------ ----------- ------------ ----------- ------------ ----------
Cash & Cash Equivalents..................... $ 10,352,859 $ 464,067 $ 20,576,171 $ 984,987 $ 84,496,947 $ 4,556,800
------------ ----------- ------------ ----------- ------------ ----------
Total Investments and Cash & Cash
Equivalents............................. $273,816,534 $23,841,057 $290,445,349 $23,473,849 $336,814,783 $17,927,502
============ =========== ============ =========== ============ ==========
14
Competition
The Company's net income depends, in large part, on the Company's ability to
acquire mortgage assets at favorable spreads over the Company's borrowing costs.
In acquiring mortgage assets, the Company competes with other mortgage REITs,
specialty finance companies, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, institutional investors, investment
banking firms, other lenders, governmental bodies and other entities. In
addition, there are numerous mortgage REITs with asset acquisition objectives
similar to the Company, and others may be organized in the future. The effect
of the existence of additional REITs may be to increase competition for the
available supply of mortgage assets suitable for purchase by the Company. Many
of the Company's anticipated competitors are significantly larger than the
Company, have access to greater capital and other resources and may have other
advantages over the Company. In addition to existing companies, other companies
may be organized for purposes similar to that of the Company, including
companies organized as REITs focused on purchasing mortgage assets. A
proliferation of such companies may increase the competition for equity capital
and thereby adversely affect the market price of the Company's common stock.
Employees
The Company does not have any employees. The Company is managed by FBR
Management pursuant to the Management Agreement between the Company and FBR
Management. All of the Company's executive officers are employees of FBR Group
or one or more of its affiliates.
Management Agreement
The Company has a management agreement with FBR Management, expiring on
December 17, 2001. FBR Management is an affiliate of FBR. FBR Management
performs portfolio management services on behalf of the Company. These services
include, but are not limited to,
. consulting with the Company on purchase and sale opportunities,
. collection of information and submission of reports pertaining to the
Company's assets, Interest rates, and general economic conditions, and
. periodic review and evaluation of the performance of the Company's portfolio
of assets.
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 the Company during each calendar
quarter and (2) 0.75 percent per annum, adjusted to reflect a quarterly period,
of the remainder of the average invested assets of the Company during each
calendar quarter. In December 1997, FBR Management also received options to
purchase 1,021,900 shares of the Company's common stock at $20 per share. The
estimated value of these options at the time of grant was $909,492, based on a
discounted Black-Scholes valuation, and was amortized over the initial term of
the management agreement. The value of these options has been fully amortized by
the Company. FBR Management assigned options to acquire 51,045 shares to
BlackRock Financial Management, Inc. ("BlackRock") in connection with the
execution of a sub-management agreement between FBR Management and BlackRock
that was terminated in February 2000. In addition, FBR Management agreed to the
rescission of options to purchase 155,000 common shares in connection with the
establishment of the Company's stock incentive plan.
FBR Management is also entitled to receive incentive compensation based on
the performance of the Company. Since December 31, 1998, FBR Management has been
and continues to be entitled to a
15
quarterly incentive fee calculated by reference to the preceding 12-month
period. FBR Management is entitled to an incentive fee calculated as: funds
from operations (as defined), plus net realized gains or losses from asset
sales, less the threshold amount (all computed on a weighted average share
outstanding basis), multiplied by 25 percent. The threshold amount is calculated
as the weighted average per share price of all equity offerings of the Company,
multiplied by a rate equal to the ten-year U.S. Treasury rate plus five percent
per annum. No incentive compensation was earned during the periods presented.
FBR Management previously engaged BlackRock to manage the Company's mortgage
asset investment program 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, FBR. The agreement was terminated by FBR Management
on February 14, 2000, and FBR Management entered into a new agreement with Fixed
Income Discount Advisory Company, Inc. ("FIDAC") on February 14, 2000 to
assume management of the Company's mortgage portfolio. As compensation for
rendering services, FIDAC is entitled to a sub-advisory fee based on the average
gross asset value managed by FIDAC. FIDAC is a registered investment adviser
under the Investment Adviser's Act of 1940. FIDAC, in its discretion, subject
to the supervision of FBR Management and the Company's Board of Directors,
evaluates and monitors the Company's mortgage portfolio.
FIDAC is an affiliate of Annaly Mortgage Management, Inc., a mortgage REIT
which is listed for trading on the New York Stock Exchange under the symbol
"NLY." The Company owns approximately 3.3% of the outstanding common stock of
Annaly. See "Item 7 Management's Discussion and Analysis of Financial
Conditions and Results of Operations--Events since December 31, 2000."
FBR Management may in the future enter into subcontracts with other parties,
including affiliates of FBR, to provide other services to the Company.
Taxation
The Company has elected to be taxed as a REIT under the federal income tax
laws, commencing with its taxable year ended December 31, 1997, and the Company
intends to continue to operate in a manner consistent with the REIT provisions
of the federal income tax laws. The Company's qualification as a REIT depends
on its ability to meet the various requirements imposed by the federal income
tax laws, through actual operating results, asset holdings, distribution levels,
and diversity of stock ownership.
Provided the Company qualifies for taxation as a REIT, it generally will not
be subject to federal corporate income tax on its net income that is distributed
to shareholders. This treatment substantially eliminates the "double taxation"
(at the corporate and shareholder levels) that generally results from an
investment in a corporation. If the Company fails to qualify as a REIT in any
taxable year, its taxable income would be subject to federal income tax at
regular corporate rates (including any applicable alternative minimum tax).
Even if the Company qualifies as a REIT, it will be subject to federal income
and excise taxes on its undistributed income.
If in any taxable year the Company fails to qualify as a REIT and, as a
result, incurs additional tax liability, the Company may need to borrow funds or
liquidate certain investments in order to pay the applicable tax, and the
Company would not be compelled to make distributions under the federal income
tax laws. Unless entitled to relief under certain statutory provisions, the
Company would also be disqualified from treatment as a REIT for the four taxable
years following the year during which qualification is lost. Although the
Company currently intends to operate in a manner designated to qualify as a
REIT, it is possible that future economic, market, legal, tax or other
considerations may cause the Company to fail to qualify as a REIT or may cause
the Board of Directors to revoke the Company's REIT election.
The Company and its shareholders may be subject to foreign, state and local
taxation in various
16
foreign, state and local jurisdictions, including those in
which it or they transact business or reside. The state and local tax treatment
of the Company and its shareholders may not conform to the Company's federal
income tax treatment.
Item 2. Properties
The Company occupies a portion of the office space in the headquarters
building of Friedman, Billings, Ramsey Group, Inc. in Arlington, Virginia. The
Company believes that its present facilities are adequate for its current and
presently projected needs.
Item 3. Legal Proceedings
The Company is not currently a defendant or plaintiff in any material
lawsuits or arbitrations.
If plaintiffs in any future suits against the Company were to prosecute their
claims successfully, or if the Company were to settle these suits by making
significant payments to the plaintiffs, the Company's operating results and
financial condition could be materially and adversely affected. The Company
carries very limited insurance that may cover only a portion of any such
payments.
In addition to these financial costs and risks, the defense of litigation or
arbitration may divert the efforts and attention of the Company's management and
staff, and the Company may incur significant legal expenses in defending such
litigation or arbitration. This may be the case even with respect to claims and
litigation that management believes to be frivolous, and the Company intends to
defend vigorously any frivolous claims against it. The amount of time that
management and other employees may be required to devote in connection with the
defense of litigation could be substantial and might materially divert their
attention from other responsibilities within the Company.
In addition, the Company's charter documents allow indemnification of the
Company's officers, directors and agents to the maximum extent permitted under
Virginia law. The Company has been and in the future may be the subject of
indemnification assertions under these charter documents by officers, directors
or agents of the Company who are or may become defendants in litigation.
Item 4. Submission Of Matters To Vote Of Security Holders
None.
Item 5. Market For Registrant's Common Equity And Related Stockholder Matters
The principal market for trading the Company's common stock is the American
Stock Exchange. The effective date of the Company's initial public offering was
September 27, 1999. The high sale price of the Company's common stock for the
year ended December 31, 2000, was $20.00 and the low sale price of the Company's
common stock for the year ended December 31, 2000, was $9.75.
According to the records of the Company's transfer agent, the Company had
approximately 3.9 million shares outstanding as of December 31, 2000. Because
many shares are held by brokers and other institutions on behalf of
shareholders, the Company is unable to estimate the total number of beneficial
shareholders represented by these record holders.
The Company repurchased 1,921,909 shares of its common stock in 2000 at an
average price of $13.23 per share and has repurchased an additional 411,900
shares of its common stock from January 1, 2001 through March 24, 2001, at an
average price of $20.23 per share.
17
Dividends & Distribution Policy
To maintain its status as a REIT for federal income tax purposes, the Company
is required to distribute substantially all of its taxable income, which may
differ materially from its income calculated in accordance with generally
accepted accounting principles, to its shareholders each year. In order to
satisfy this requirement, the Company intends to declare regular quarterly
dividends and to distribute any taxable income remaining at the end of a year
with a first quarter dividend in the following year.
The Board of Directors may change the dividend policy at any time. The Board
of Directors will declare dividends based on:
. the taxable income of the Company;
. the financial condition of the Company;
. the distributions required to maintain REIT status and to avoid corporate
income tax and the 4% excise tax; and
. other factors that the Board of Directors considers relevant.
To date, the Company has declared the following dividends:
For the Period Total Per Share
-------------- ----- ---------
12/15/97--12/31/97....................... $ 562,045(1) $0.055
01/01/98--03/31/98....................... 2,083,165 0.200
04/01/98--06/30/98....................... 3,072,669 0.295
07/01/98--09/30/98....................... 3,379,798(2) 0.360
10/01/98--12/31/98(3).................... 2,563,058 0.300
01/01/99--03/31/99....................... 2,741,872 0.325
04/01/99--06/30/99....................... 2,702,498 0.380
07/01/99--09/30/99....................... 2,844,734 0.400
10/01/99--12/31/99(4).................... 2,903,718 0.500
01/01/99--12/31/99(5).................... 1,355,182 0.250
01/01/00--03/31/00....................... 2,803,475 0.550
04/01/00--06/30/00....................... 2,553,436 0.600
07/01/00--09/30/00....................... 2,423,296 0.600
10/01/00--12/31/00(6).................... 2,356,996 0.600
01/01/00--12/31/00(7).................... 1,374,914 0.350
----------- ------
$35,720,856 $5.765
=========== ------
(1) Includes $0.005 dividend declared in June 1998 and paid in July 1998 for
shareholders of record as of December 31, 1997.
(2) Dividend declared and paid in October 1998.
(3) Dividend paid in January 1999.
(4) Dividend declared December 15, 1999, and paid on January 15, 2000, to
shareholders of record as of December 31, 1999.
(5) Special dividend declared January 31, 2000, and paid on February 25, 2000,
to shareholders of record as of February 11, 2000.
(6) Dividend declared December 14, 2000, and paid on January 16, 2001, to
shareholders of record as of December 27, 2000.
(7) Special dividend declared December 14, 2000, and paid on January 16, 2001,
to shareholders of record as of December 27, 2000.
Through December 31, 2000, the Company had paid substantially all of its
dividends out of current or accumulated earnings and profits. In 1998 10% of the
dividends were a return of capital for federal income tax purposes. The level of
quarterly dividends is based on a number of factors and should not be
18
deemed indicative of taxable income for the quarter in which declared or future
quarters or of income calculated in accordance with generally accepted
accounting principles.
Distributions to shareholders will generally be subject to tax as ordinary
income, although in appropriate circumstances a portion of a distribution may be
designated by the Company as capital gain or may be determined to be a tax-free
return of capital. The Company generally does not intend to declare more than a
de minimus amount of dividends that are a return of capital for tax purposes,
except in those instances where companies in which the Company invests determine
that a portion of their dividends are a return of capital. The Company will
furnish annually to each shareholder a statement setting forth distributions
paid during the preceding year and their characterization as ordinary income,
capital gain or return of capital.
Item 6. Selected Financial Data
For the Year Ended December 31,
-----------------------------------------------
2000 1999 1998
-----------------------------------------------
Statement of Operations Data:
Interest income........................................ $18,758,866 $15,823,914 $13,656,097
Dividend income........................................ 5,082,191 7,649,935 4,271,405
Interest expense....................................... 10,935,130 7,920,648 5,359,633
Management Fee expense................................. 1,078,713 1,329,063 1,520,725
Other expense.......................................... 596,374 1,432,589 1,089,102
Net realized and recognized losses..................... (2,866,360) (7,648,960) (8,369,807)
Net income............................................. 8,364,480 5,142,589 1,588,235
Basic and diluted income per share..................... 1.84 0.68 0.16
Dividends declared per share(1)........................ 2.95 1.61 1.16
Weighted average basic and diluted shares.............. $ 4,543,532 7,523,715 $10,044,483
As of December 31,
------------------
2000 1999
---- ----
Selected Balance Sheet Data:
Mortgage-backed securities, at fair value................ $154,848,205 $236,014,844
Cash and cash equivalents................................ 36,810,566 13,417,467
Investments in equity securities, at fair value.......... 28,110,190 49,647,865
Notes receivable......................................... 4,000,000 27,000,000
Total assets............................................. 225,804,067 330,180,460
Repurchase agreements.................................... 133,896,000 221,714,000
Total liabilities........................................ 138,963,483 225,637,739
Accumulated other comprehensive loss(2).................. (748,691) (12,982,359)
Shareholders' equity..................................... 86,840,584 104,542,721
Book value per share..................................... 22.36 18.00
Common shares issued and outstanding(3).................. $ 3,884,427 $ 5,803,336
For the Year Ended December 31,
-------------------------------
2000 1999 1998
---- ---- ----
Other Selected Data
Weighted average daily borrowings........................ $172,287,472 $143,231,112 $144,793,891
Average equity........................................... 90,393,190 130,269,059 182,750,145
---------
(1) Dividends are calculated and declared based on estimates of the Company's
taxable income.
(2) Accumulated other comprehensive loss includes unrealized net loss on
mortgage-backed securities of $530,869 as of December 31, 2000, unrealized
net loss on mortgage-backed securities of $4,863,103 as of December 31,
1999, and unrealized net loss on investments in equity securities of
$217,822 as of December 31, 2000, and $8,119,256 as of December 31, 1999.
(3) Reflects 6,531,400 and 4,609,491 shares of treasury stock repurchased as of
December 31, 2000, and December 31, 1999, respectively.
19
Item 7. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations
Overview
The Company targets investments in real estate assets and real estate-related
companies. The Company has invested, and intends to continue investing in,
whole-pool mortgage-backed securities that are guaranteed by Fannie Mae, Freddie
Mac or Ginnie Mae, mortgage loans, mortgage-backed securities, real property,
and joint ventures formed to own real property. The Company invests in some of
these assets indirectly through its investments in and loans made to REITs and
other companies.
As of December 31, 2000, the Company had:
. mortgage-backed securities totaling $154.8 million, which were financed with
repurchase agreements totaling $133.9 million;
. investments in equity and debt securities of 4 companies with an total cost
basis of $28.3 million and a total market value of $28.1 million; and
. a loan to one company totaling $4 million.
A summary of the Company's current investments, cash and cash equivalents is
set forth at the end of this discussion.
Results of Operations
Net Income
The Company's sources of income since inception have been (i) quarterly
dividend earnings on its REIT holdings, (ii) interest earnings on its mortgage-
backed securities, notes receivable, and cash and cash equivalents and (iii)
gains on the sale of mortgage-backed securities and equity investments. The
Company's primary sources of interest income to date have been its investments
in fixed and variable rate mortgage-backed securities and outstanding loans.
Interest income is recorded based on contractual rates of interest and
amortization of any premium or discount associated with the original purchase.
The amount of future contractual interest income received may be adversely
affected in the event of prepayments or defaults on notes payable or mortgage
loans underlying the mortgage-backed securities. Generally, when interest rates
fall, prepayment rates may increase significantly. Accordingly, the Company's
interest income for any given period may not be indicative of that for future
interim or annual periods.
The following discussion sets forth the significant components of the Company's
net income for the years ended December 31, 2000 and 1999
The Company had net income for the year ended December 31, 2000 of $8.4
million, or $1.84 per share, compared to net income of $5.1 million or $0.68 per
share for the corresponding period in 1999. The increase is primarily due to the
reduction in recognized losses on available-for-sale equity securities.
For the year ended December 31, 2000, the weighted average annual yield on
the Company's mortgage-backed securities was 6.68%. As of December 31, 2000, the
Company had investments in 37 mortgage-backed securities. For the year ended
December 31, 1999, the weighted average annual yield on the Company's mortgage-
backed securities was 6.51%. As of December 31, 1999, the Company had
investments in 39 mortgage-backed securities.
20
The Company's interest income and dividend income increased to $23.8 million
for the year ended December 31, 2000 from $23.5 million for the year ended
December 31, 1999. This increase is primarily attributable to the Company's
increased investment in mortgage-backed securities throughout most of 2000 and a
corresponding increase in the average yield, thereby increasing the amount of
interest income generated by the company's mortgage-backed security portfolio.
For the year ended December 31, 2000, the weighted average annual yield on
the Company's equity securities and promissory notes was 15.27%, compared to
11.20% for the year ended December 31, 1999, based on interest and dividend
income accrued on, and the weighted average cost basis of, equity securities and
promissory notes. The average annual yield on all investments increased to 8.71%
from 8.08%.The increase reflects the increased investment in higher yielding
promissory notes and higher yielding mortgage backed securities.
The Company incurred interest expense of $10.9 million for the year ended
December 31, 2000. This represents 86.7% of the total expenses for the period.
The Company incurred interest expense of $7.9 million for the year ended
December 31,1999. This represents 74.2% of the total expenses for the period.
The $3.0 million increase in interest expense reflects the 20.3% increase in
weighted average borrowings under repurchase agreements to $172.3 million from
$143.2 million and a corresponding increase in the borrowing rate for the year
ended December 31, 2000 compared to the year ended December 31, 1999.
Management fees for the year ended December 31, 2000, were $1.1 million
compared to $1.3 million for the year ended December 31, 1999. The decrease is
due to the Company's increased investment in mortgage-backed securities
throughout most of 2000, and a corresponding reduction in the Company's other
assets. The Company increased its mortgage-backed securities portfolio during
the fourth quarter of 1999. The management fee the Company pays is lower for
mortgage-backed securities.
Professional fees consist primarily of legal and accounting fees.
Professional fees were $388,407 for the year ended December 31, 2000, and
$755,561 for the year ended December 31, 1999. The decreased fees are
attributable to the reduction of legal and audit fees related to the recent
registration statement of the Company's stock.
The following discussion sets forth the significant components of the Company's
net income for the years ended December 31, 1999 and 1998
The Company had net income for the year ended December 31, 1999 of $5.1
million, or $0.68 per share, compared to net income of $1.6 million or $0.16 per
share for the corresponding period in 1998. The increase is primarily due to
increased interest income on mortgage-backed securities and dividend income.
The Company did not begin investing in mortgage-backed securities until the
second quarter of 1998.
For the year ended December 31, 1999, the weighted average annual yield on
the Company's mortgage-backed securities was 6.51%. As of December 31, 1999, the
Company had investments in 39 mortgage-backed securities. For the year ended
December 31, 1998, the weighted average annual yield on the Company's mortgage-
backed securities was 6.19%. As of December 31, 1998, the Company had
investments in 33 mortgage-backed securities.
The Company's interest income and dividend income increased to $23.5 million
for the year ended December 31, 1999 from $17.9 million for the year ended
December 31, 1998. This 31.3% increase
21
reflects the increase in investment of cash in higher yielding promissory notes
and the increase in the number of dividend-paying equity securities.
For the year ended December 31, 1999, the weighted average annual yield on
the Company's equity securities and promissory notes was 11.20%, compared to
7.90% for the year ended December 31, 1998, based on interest and dividend
income accrued on, and the weighted average carrying value of, equity securities
and promissory notes. The average annual yield on all investments increased to
8.08% from 6.41%.
The Company incurred interest expense of $7.9 million for the year ended
December 31, 1999. This represents 74.2% of the total expenses for the period.
The Company incurred interest expense of $5.4 million for the year ended
December 31,1998. This represents 67.3% of the total expenses for the period.
The Company did not begin to leverage its mortgage portfolio until May 1998.
Management fees for the year ended December 31, 1999, were $1.3 million
compared to $1.5 million for the year ended December 31, 1998. The decrease is
due to the Company's increased investment in mortgage-backed securities during
the fourth quarter of 1999. The management fee the Company pays is lower for
mortgage-backed securities.
Professional fees consist primarily of legal and accounting fees.
Professional fees were $755,561 for the year ended December 31, 1999, and
$436,885 for the year ended December 31, 1998. The increased fees are
attributable to legal and audit fees related to the recent registration
statement of the Company's stock and to costs associated with the acquisition of
assets.
22
Interest and Dividend Income
The following tables set forth information regarding the total amount of
income from interest and dividend earning assets and the resultant average
yields for the years ended December 31, 2000, 1999 and 1998. Information is
based on daily average balances during the period.
Year Ended December 31, 2000
----------------------------
Interest/Dividend Weighted Weighted Average
Income Average Balance Annualized Yield
------------------------- ------------------ ------------------
Mortgage securities available for sale $13,106,945 $196,229,207 6.68%
Investment in equity securities and
promissory notes(1) 10,270,045 67,234,468 15.27%
Cash and cash equivalents 464,067 10,352,859 4.48%
----------- ------------ -----
Total(4) $23,841,057 $273,816,534 8.71%
=========== ============ =====
Year Ended December 31, 1999
----------------------------
Interest/Dividend Weighted Weighted Average
Income Average Balance Annualized Yield
------------------------- ------------------ ------------------
Mortgage securities available for sale $10,744,041 $164,970,427 6.51%
Investment in equity securities and
promissory notes(2) 11,744,821 104,898,751 11.20%
Cash and cash equivalents 984,987 20,576,171 4.79%
----------- ------------ -----
Total(4) $23,473,849 $290,445,349 8.08%
=========== ============ =====
Year Ended December 31, 1998
----------------------------
Interest/Dividend Weighted Weighted Average
Income Average Balance Annualized Yield
-------------- --------------- -----------------
Mortgage securities available for sale $ 7,101,326 $169,564,932 6.19%
Investment in equity securities and
promissory notes(3) 6,269,376 82,752,904 7.90%
Cash and cash equivalents 4,556,800 84,496,947 5.39%
----------- ------------ -----
Total(4) $17,927,502 $336,814,783 6.41%
=========== ============ =====
(2) Includes accrued interest and amortized commitment fees on convertible
loans to Prime Capital Holding LLC, Prime Capital Funding I, LLC, and Prime
Retail, Inc. These amounts are included as interest income in the Company's
statements of income included in its financial statements.
(3) Includes accrued interest and amortized commitment fees on convertible
loans to Prime Capital Holding LLC, Prime Retail, Inc., and Prime Group
Realty, L.P. , Kennedy-Wilson, Inc., and Brookdale Living Communities.
These amounts are included as interest income in the Company's statements
of income included in its financial statements.
(4) Includes accrued interest and amortized commitment fees on convertible
loans to Prime Capital Holding LLC, and Kennedy-Wilson, Inc.
(5) The Company accrues dividend income based on declared dividends for the
periods presented.
Interest Expense
The following table sets forth information regarding the total amount of
interest expense from repurchase agreements, including the net amount payable
under the interest rate swap agreement and the resultant average yields.
Information is based on daily average balances during the reported periods.
23
Year ended December 31, 2000
----------------------------
Weighted Weighted
Interest Average Average
Expense Balance(1) Expense
------- ---------- -------
Repurchase agreements $10,905,916 $172,287,472 6.33%
=========== ============ =====
(1) At December 31, 2000, the Company had $133,896,000 outstanding under
repurchase agreements, with a weighted-average remaining maturity of 16
days.
Year ended December 31, 1999
----------------------------
Weighted Weighted
Interest Average Average
Expense Balance(1) Expense
------- ---------- -------
Repurchase agreements $7,920,648 $143,231,112 5.53%
=========== ============= =====
(1) At December 31, 1999, the Company had $221,714,000 outstanding under
repurchase agreements, with a weighted-average remaining maturity of 45
days.
Year ended December 31, 1998
----------------------------
Weighted Weighted
Interest Average Average
Expense Balance(1) Expense
------- ---------- -------
Repurchase agreements $5,359,633 $144,793,891 5.82%
========== ============ ======
(1) At December 31, 1998, the Company had $128,550,000 outstanding under
repurchase agreements, with a weighted-average remaining maturity of 73
days. The Company began its repurchase agreement program on May 13, 1998.
Changes in Financial Condition
Mortgage-Backed Securities Available-for-Sale
The Company invests in mortgage-backed securities that are agency pass-
through securities representing a 100% interest in the underlying conforming
mortgage loans. Conforming loans comply with the underwriting requirements for
purchase by Fannie Mae, Freddie Mac, and Ginnie Mae. These securities bear
little risk of credit loss due to defaults because they are guaranteed by Ginnie
Mae, Fannie Mae or Freddie Mac.
The Company held mortgage-backed securities of $154.8 million as of December
31, 2000. The Company held mortgage-backed securities of $236.0 million on
December 31, 1999.
Premium and discount balances associated with the purchase of mortgage-backed
securities are amortized as a decrease or increase in interest income over the
life of the security. At December 31, 2000, the amount of unamortized premium,
net of discounts, recorded in the Company's statement of financial condition was
$1.7 million. At December 31, 1999, the amount of unamortized discount, net of
premiums, recorded in the Company's statement of financial condition was $1,213.
Given the Company's current portfolio composition, if mortgage principal
repayment rates increase over the life of the mortgage-backed securities
comprising the current portfolio, all other factors being equal, the Company's
net interest income would decrease, as the Company would be required to amortize
its net premium balance into income over a shorter time period. Similarly, if
mortgage principal repayment rates decrease over the life of the mortgage-backed
securities, all other factors being equal,
24
the Company's net interest income would increase, as the Company would be
required to amortize its net premium balance over a longer time period.
The Company received mortgage principal repayments equal to $23.7 million for
the year ended December 31, 2000. The Company received mortgage principal
repayments equal to $30.4 million for the year ended December 31, 1999.
At December 31, 2000, $0.2 million of net unrealized losses on equity
securities and $0.5 million of net unrealized losses on mortgage-backed
securities were included in the Company's statement of financial condition as
accumulated other comprehensive loss. At December 31, 1999, $8.1 million of net
unrealized losses on equity securities and $4.9 million of net unrealized losses
on mortgage-backed securities were included in the Company's statement of
financial condition as accumulated other comprehensive loss. See "Stockholders'
Equity" elsewhere in "Management's Discussion and Analysis".
Repurchase Agreements
To date, the Company's debt has consisted mainly of borrowings collateralized
by a pledge of most of the Company's mortgage-backed securities. The Company has
obtained, and believes it will be able to continue to obtain, short-term
financing in amounts and at interest rates consistent with the Company's
financing objectives.
The Company had $133.9 million outstanding under repurchase agreements with
several financial institutions on December 31, 2000. The Company had $221.7
million outstanding under repurchase agreements on December 31, 1999. At
December 31, 2000, the ratio of the Company's repurchase agreement to
shareholder's equity was 1.5 to 1.
At December 31, 2000, the term to maturity of the Company's borrowings had
been limited to 60 days with a weighted average remaining maturity of 16 days
and a weighted average cost of funds on outstanding borrowings of 6.57%.
At December 31, 1999, the term to maturity of the Company's borrowings had
been limited to 60 days with a weighted average remaining maturity of 45 days
and a weighted average cost of funds on outstanding borrowings of 5.83%.
Contractual Commitments
The Company is a party to an interest rate swap agreement to offset the
potential adverse effects of rising interest rates under some of its short-term
repurchase agreements. That agreement is with Salomon Brothers Holding Company
Inc. ("Salomon"). Salomon Smith Barney Holdings, Inc., the parent company of
Salomon Brothers Holding Company Inc., has a long-term debt rating of "A" by
S&P. Under the swap agreement with Salomon, the Company receives quarterly
payments of interest based on three-month LIBOR and remits semi-annual payments
based on a fixed interest rate of approximately 5.9% based upon the $50 million
notional amount of the swap.
The swap became effective on June 1, 1998, and matures on June 1, 2001. At
December 31, 2000, the interest rate payable to the Company by Salomon was
6.69%. At December 31, 1999, the interest rate payable to the Company by Salomon
was 6.12%. The timing of quarterly receipts under the swap approximates the
timing of the repricing dates for the repurchase agreements. The payments
received under the swap agreement have substantially offset the interest
payments under the repurchase agreements. In some circumstances, the Company may
be required to provide collateral to secure its obligations under the interest
rate swap agreement or may be entitled to receive collateral from the
25
counterparty to the swap agreement. At December 31, 2000, and December 31, 1999,
$500,000 of collateral was required under the interest rate swap agreement.
Capital Resources and Liquidity
Liquidity is a measurement of the Company's ability to meet potential cash
requirements including ongoing commitments to repay borrowings, fund
investments, loan acquisition and lending activities, and for other general
business purposes. The primary sources of funds for liquidity consist of
repurchase agreements and maturities, distributions or principal payments on
mortgage-backed and equity securities, and proceeds from sales of those
securities. To date, proceeds from the issuance of common stock and repurchase
agreements have provided the Company with sufficient funding for its investment
needs. Potential future sources of liquidity for the Company include existing
cash balances, borrowing capacity through margin accounts, and future issuances
of common, preferred stock or debt. The Company believes that its existing cash
balances, borrowing capacity through margin accounts and borrowing capacity
under collateralized repurchase agreements will be sufficient to meet its
investment objectives, fund operating expenses for at least the next twelve
months and repurchase shares of the Company common stock. The Company may,
however, seek debt or equity financings, in public or private transactions, to
provide capital for corporate purposes and/or strategic business opportunities.
There can be no assurance that the Company will be able to generate sufficient
funds from future operations, or raise sufficient debt or equity on acceptable
terms, to take advantage of investment opportunities that become available.
Should the Company's needs ever exceed these sources of liquidity, management
believes the Company's mortgage-backed securities could be sold, in most
circumstances, to provide cash.
For the year ended December 31, 2000, the Company's operating activities
resulted in net cash flows of $13.9 million. The primary source of operating
cash flow was interest on mortgage-backed securities, interest on notes
receivable and dividends from REIT investments. For the year ended December 31,
1999, the Company's operating activities provided net cash flows of $9.7
million. For the year ended December 31, 1998, the Company's operating
activities provided net cash flows of $11.2 million.
For the year ended December 31, 2000, the Company's investing activities
resulted in net cash provided of $134.8 million compared to net cash used for
the year ended December 31, 1999 of $82.6 million. The increase is primarily
attributable to a reduction in purchases of mortgage-backed securities during
2000. For the year ended December 31, 1998, the Company's investing activities
resulted in net cash used of $232.3 million.
For the year ended December 31 2000, net cash used for the Company's
financing activities was $125.3 million compared to net cash provided by
financing activities for the year ended December 31, 1999, of $45.2 million. The
decrease in cash provided from financing activities is primarily attributable to
a reduction in borrowings under repurchase agreements. For the year ended
December 31, 1998, net cash provided by the Company's financing activities was
$99.0 million
Shareholders' Equity
The Company accounts for its investments in mortgage-backed securities and
other equity instruments in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." Under SFAS 115, the Company 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 stockholders'
equity as accumulated other comprehensive income.
26
Also in accordance with SFAS 115, management must regularly evaluate whether
declines in the market value of its securities available-for-sale are other than
temporary. In performing this evaluation, the Company looks to the financial
condition and business performance of each investment relative to that expected
at the time of purchase. The Company also evaluates overall economic and
industry-specific conditions.
If the Company determines that declines are other than temporary, it records
a charge against income for the difference between an investment's cost basis
and its estimated fair value. As of December 31, 2000, the value of the equity
securities in the Company's portfolio had declined from $32.6 million as of the
date the investments were made to $28.1 million. Declines have been recorded as
accumulated other comprehensive income in the statement of financial condition.
In 2000, the Company recognized and charged to income losses of $5.6 million on
its investments in Encompass Services Corporation, Resource Asset Investment
Trust, and Prime Retail, Inc. In 1999, the Company realized and charged to
income losses of $10.9 million on its investments in Imperial Credit Commercial
Mortgage Investment Corp. and Anthracite Capital Corp. See Note 6 of "Notes to
Financial Statements--Equity Investments"
With respect to each of the Company's equity investments, management believes
that, as of December 31, 2000, their decline in fair value was temporary.
Further, the Company has the intent and ability to hold each of its investments
to allow for the anticipated recovery in stock prices. There can be no
assurance, however, that other charges will not be required in future periods.
As a result of "mark-to-market" accounting treatment, the book value and
book value per share of the Company are likely to fluctuate far more than those
of companies who do not make investments in marketable and non-marketable debt
and equity securities. As a result, comparisons with these companies may not be
meaningful.
The Company repurchased the following shares of it's common stock in 2000,
1999 and 1998.
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
Market Risk
Market risk generally represents the risk of loss that can result from a
change in the prices of equity securities in the equity market, a change in the
value of financial instruments as a result of changes in interest rates, a
change in the volatility of interest rates or, a change in the credit rating of
an issuer. The Company is exposed to the following market risks as a result of
its investments in mortgage-backed securities and equity investments. None of
these investments are held for trading purposes.
Interest Rate Risk
The Company is subject to interest rate risk as a result of its investments
in mortgage-backed securities and its financing with repurchase agreements, all
of which are interest rate sensitive financial
27
instruments. The Company is exposed to interest rate risk that fluctuates based
on changes in the level or volatility of interest rates and mortgage
prepayments and in the shape and slope of the yield curve. The Company attempts
to hedge a portion of its exposure to interest rate risk primarily through the
use of interest rate swaps.
The Company's primary risk is related to changes in both short and long term
interest rates, which affect the Company in several ways. As interest rates
increase, the market value of the mortgage-backed securities may be expected to
decline, prepayment rates may be expected to go down and durations may be
expected to extend. The Company finances its investment in mortgage-backed
securities through repurchase agreements. If short-term interest rates increase,
the Company's profit margin in mortgage-backed securities will decrease. Also,
the Company's ability to sell mortgage-backed securities to retire repurchase
agreement indebtedness may be restricted by its need to comply with certain tax
provisions applicable to REITs.
The fair value of interest rate swap agreements that qualify as hedges is not
recorded for accounting purposes. The differential between amounts paid and
received under the swap agreements is recorded as an adjustment to the interest
expense incurred under the repurchase agreements. In the event of early
termination of a swap agreement, a gain or loss is recorded and the Company
receives or makes a payment based on the fair value of the swap agreement.
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.
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.
28
The table that follows shows the expected change in market value for the
Company's current mortgage-backed securities and interest rate swaps under
several interest rate "shocks." Interest rates are defined by the U.S.
Treasury yield curve. The changes in rates are assumed to occur instantaneously.
It is further assumed that the changes in rates occur uniformly across the yield
curve and that the level of LIBOR changes by the same amount as the yield curve.
Actual changes in market conditions are likely to be different from these
assumptions.
Changes in value are measured as percentage changes form their respective
values presented in the column labeled "Value at 12/31/00." Actual results
could differ significantly from these estimates.
The change in value of the mortgage-backed securities also incorporates
assumptions regarding prepayments, which are based on a proprietary model. This
model forecasts prepayment speeds based, in part, on each security's issuing
agency (Fannie Mae, Ginnie Mae or Freddie Mac), coupon, age, prior exposure to
refinancing opportunities, the interest rate distribution of the underlying
loans, and an overall analysis of historical prepayment patterns under a variety
of past interest rate conditions.
Value at
12/30/00
with 100
Value at 12/30/00 basis point
with 100 basis decrease in
Value at point increase in Percent interest Percent
12/30/00(1) interest rates Change rates Change
---------------------------------------------------------------------------------------------------
Assets
Mortgage securities $154,848,205 $145,153,479 (6.26)% $155,838,219 0.64%
Other 70,955,862 70,955,862 - 70,955,862 -
Total Assets $225,804,067 $216,109,341 (4.29)% $226,794,081 0.44%
============ ============ ============
Liabilities
Interest rate swap $ (137,949)(2) (260,847)(2) $(13,664)(2)
Other 138,963,483 138,963,483 138,963,483
Total Liabilities $138,825,534 $138,702,636 (0.09)% $138,949,819 0.09%
------------ ------------ ------------
Shareholders' Equity
Common stock $ 104,158 $ 104,158 - $ 104,158 -
Paid-in-capital 194,097,193 194,097,193 - 194,097,193 -
Accumulated other
comprehensive income
(loss) (610,742) (10,182,570) (1,567.25)% 254,987 141.75%
Retained earnings -
(deficit) (19,771,491) (19,771,491) (19,771,491) -
Treasury stock (86,840,585) (86,840,585) - (86,840,585) -
Total Shareholders' Equity
$ 86,978,533(2) $ 77,406,705 (11.00)% $ 87,844,262 1.00%
Total Liabilities and
Shareholders' Equity $225,804,067 $216,109,341 (4.29)% $226,794,081 0.44%
============ ============ ============
(1) Includes Accrued Interest.
(2) In accordance with GAAP, the fair value of interest rate swaps accounted
for as hedges is not recorded. Accordingly, the carrying value of the
interest rate swap in the Company's financial statements is $0. See Note 2
to Notes to Financial Statements. The fair value of the interest rate swap
is based on quoted market prices as of December 31, 2000. As of December
31, 2000, interest payments received under the swap agreement were based on
an interest rate of 6.69% while interest payments made were based on an
interest rate of 5.96%.
As shown above, the portfolio generally will benefit more from a decline in
interest rates than it will be adversely affected by a similar-scale increase.
This effectively may limit investors' upside potential in a market rally.
The value of the Company's investments in other companies is also likely to
be affected by significant changes in interest rates. First, many of the
companies are exposed to risks similar to those identified above as being
applicable to the Company's direct investments. Second, the REITs in which the
Company has invested tend to trade on a yield basis. As interest rates increase,
the yield required by
29
investors in REITs, thrifts and other financial institutions increases with the
result that market values decline. Finally, changes in interest rates often
affect market prices of equity securities generally. Because each of the
companies in which the Company invests has its own interest rate risk
management process, it is not feasible for us to quantify the potential impact
that interest rate changes would have on the stock price or the future
dividend payments by any of the companies in which the Company has invested.
Equity Price Risk
The Company is exposed to equity price risk as a result of its investments in
equity securities of REITs and other real estate related companies. Equity price
risk changes as the volatility of equity prices change or the values of
corresponding equity indices change.
While it is impossible to project with any exactitude what factors may affect
the prices of equity sectors and how much that might be, the table below
illustrates the impact a ten percent increase and a ten percent decrease in the
price of the equities held by the Company would have on the value of the total
assets and the book value of the Company as of December 31, 2000.
Value at Value at
December 31, December 31,
2000 with 2000 with
Value at 10% increase Percent 10% decrease Percent
December 31, 2000 in price Change in price Change
----------------- -------- ------ -------- ------
Assets
Equity securities $ 28,110,190 $ 30,921,209 10.00% $ 25,299,171 (10.00%)
Other 197,693,877 197,693,877 - 197,693,877 -
------------ ------------ ------------
Total Assets $225,807,067 $228,615,086 1.24% $222,993,048 (1.24%)
============ ============ ============
Liabilities $138,963,483 $138,963,483 - $138,963,483 -
------------ ------------ ------------
Shareholders' Equity
Common stock $ 104,158 $ 104,158 - $ 104,158 -
Paid-in-capital 194,097,193 194,097,193 - 194,097,193 -
Accumulated comprehensive
income (loss) (748,691) 2,062,328 375.46% (3,559,710) (375.46%)
Retained earnings
(deficit) (19,978,632) (19,978,632) - (19,978,632) -
Treasury stock (86,633,444) (86,633,444) - (86,633,444) -
------------ ------------ ------------
Total Shareholders' Equity $ 86,840,584 $ 89,651,603 3.24% $ 84,029,565 (3.24%)
------------ ------------ ------------
Total Liabilities and
Shareholders' Equity $225,804,067 $228,615,086 1.24% $222,993,048 (1.24%)
============ ============ ============
Book value per share $ 22.36 $ 23.08 3.24% $ 21.63 (3.24%)
Except to the extent that the Company sells its equity investments, an
increase or decrease in the market value of those assets will not directly
affect the Company's earnings, although an increase or decrease in interest
rates would affect the market value of the assets owned by the companies in
which the Company invests. Consequently, if those companies' earnings are
affected by changes in the market value of their assets, that could in turn
impact their ability to pay dividends, which could in turn affect the Company's
earnings. If the Company had sold all of its equity investments on December 31,
2000, the Company would have incurred a loss of approximately $0.2 million which
would have been charged to earnings.
Events Since December 31, 2000
On January 24, 2001, the Company purchased 800,000 shares, or approximately
3.3%, of the
30
outstanding, common stock of Annaly Mortgage Management, Inc. at a
price of $8.93 per share in a non-underwritten public offering which was held
concurrently with a secondary underwritten public stock offering of Annaly's
common stock. Friedman, Billings, Ramsey & Co. Inc., an affiliate of FBR, was
the lead underwriter in the underwritten stock offering. An affiliate of Annaly
is the sub-manager of the Company's mortgage portfolio.
On March 30, 2001, the Company loaned $12 million to Prime Aurora, L.L.C.
("Prime Aurora"), a wholly-owned subsidiary of Prime Group Realty, L.P.
("PGRLP"). The loan bears interest at 12% per annum. The Company was paid a
commitment fee of $120,000 at closing. The loan matures on June 29, 2001,
subject to a one-time right of the borrower to extend the loan through September
30, 2001, upon payment of an extension fee of $120,000. Prime Aurora granted to
the Company a first lien mortgage on approximately 97 acres of unimproved land
owned by Prime Aurora and located in Aurora, Illinois. No assurances can be
provided that the value of the property encumbered by this mortgage will be
sufficient to secure the loan. PGRLP has unconditionally guaranteed all
obligations of Prime Aurora in connection with the loan.
Item 8. Financial Statements and Supplementary Data
The information required by Item 8 is set forth in Item 14 of this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART II
Item 10. Directors and Executive Officers of the Registrant
The information regarding directors required by this Item 10 is incorporated
by reference to the Company's definitive Proxy Statement for its annual meeting
of shareholders to be held on May 24, 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 the
Company's definitive Proxy Statement for its annual meeting of shareholders to
be held on May 24, 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 the
Company's definitive Proxy Statement for its annual meeting of shareholders to
be held on May 24, 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 the
Company's definitive Proxy Statement for its annual meeting of shareholders to
be held on or around May 24, 2001, under the heading "Certain Relationships and
Related Transactions."
31
PART III
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements. The following consolidated financial statements
of the Company included in the Company's Annual Report to Shareholders for the
year ended December 31, 2000, filed as Exhibit 13.01 to this Form 10-K, are
incorporated by reference into this Item 14:
Pages
-------
Report of Independent Public Accountants......................................................... F-2
Statements of Financial Condition as of December 31, 2000 and 1999............................... F-3
Statements of Income for the Years ended December 31, 2000, 1999 and 1998........................ F-4
Statements of Changes in Shareholders' Equity for the Years ended December 31, 2000, 1999 and
1998 ........................................................................................ F-5
Statements of Cash Flows for the Years ended December 31, 2000, 1999 and 1998.................... F-6
Notes to Financial Statements.................................................................... F-7
2. All schedules are omitted because they are not required or because the
information is shown in the financial statements or notes thereto.
3. Following is a list of exhibits to this Form 10-K, which are incorporated
by reference into this Item 14.
Exhibit
Number Exhibit Title
------ -------------
3.01 Registrant's Articles of Incorporation.*
3.02 Registrant's bylaws.*
4.01 Form of Specimen Certificate for Registrant's Common Stock.*
10.01 Management Agreement, dated December 17, 1997, by and between the Company and Friedman, Billings,
Ramsey Investment Management, Inc.*
10.02 Agreement to Extend and Amend Management Agreement, dated December 17, 1999, by and between the
Company and Friedman, Billings, Ramsey Investment Management, Inc.**
10.03 Agreement to Extend and Amend Management Agreement, dated December 17, 2000, by and between the
Company and Friedman, Billings, Ramsey Investment Management, Inc.
10.04 License Agreement, dated December 17, 1997, by and between the Company and Friedman, Billings,
Ramsey Group, Inc.*
10.05 Stock Option Agreement, dated December 17, 1997, by and between the Company and Friedman, Billings,
Ramsey Investment Management, Inc.*
10.06 Sub-Management Agreement, dated February 14, 2000, by and between Friedman, Billings, Ramsey
Investment Management, Inc. and Fixed Income Discount Advisory Company, Inc.**
10.07 Stock Incentive Plan.*
13.01 Annual Report to Shareholders for the Year ended December 31, 2000.
21.01 List of Subsidiaries of the Registrant.*
- ---------------
* Filed with the SEC as part of the Company's Registration Statement on
Form S-11, as amended, Registration No. 333-67343.
** Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1999, filed with the SEC on March 30, 2000.
32
FINANCIAL STATEMENTS
Index to Financial Statements
Page
-------
Report of Independent Public Accountants ......................................................... F-2
Statements of Financial Condition as of December 31, 2000, and December 31, 1999.................. F-3
Statements of Income for the Years Ended December 31, 2000, December 31, 1999, and
December 31, 1998.............................................................................. F-4
Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2000,
December 31, 1999 and December 31, 1998.......................................................... F-5
Statements of Cash Flows for the Years Ended December 31, 2000, December 31, 1999 and
December 31, 1998 and............................................................................ F-6
Notes to Financial Statements...................................................................... F-7
F-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
F-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.
F-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.
F-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.
F-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.
F-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.
F-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.
F-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.
F-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
F-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
F-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.
F-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 .
F-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
F-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
F-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.
F-16
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FBR ASSET INVESTMENT CORPORATION (Registrant)
Date: April 2, 2001
By: /s/ Eric F. Billings
-----------------------------------------
Eric F. Billings
Chairman, Chief Executive Officer,
and Director (Principal Executive Officer)
By: /s/ Kurt R. Harrington
-----------------------------------------
Kurt R. Harrington
Chief Financial Officer, Treasurer and
Principal Financial and Accounting
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/ Eric F. Billings Chairman, Chief Executive April 2, 2001
- ----------------------------------- Officer, and Director
Eric F. Billings (Principal Executive Officer)
/s/ Richard J. Hendrix Chief Operating Officer April 2, 2001
- -----------------------------------
Richard J. Hendrix
/s/ Emanuel J. Friedman Director April 2, 2001
- -----------------------------------
Emanuel J. Friedman
/s/ Peter A. Gallagher Director April 2, 2001
- -----------------------------------
Peter A. Gallagher
/s/ Russell C. Lindner Director April 2, 2001
- -----------------------------------
Russell C. Lindner
/s/ Stephen D. Harlan Director April 2, 2001
- -----------------------------------
Stephen D. Harlan
EXHIBIT INDEX
Exhibit
Number Exhibit Title
------ -------------
3.01 Registrant's Articles of Incorporation.*
3.02 Registrant's bylaws.*
4.01 Form of Specimen Certificate for Registrant's Common Stock.*
10.01 Management Agreement, dated December 17, 1997, by and between FBR Asset Investment Corporation
and Friedman, Billings, Ramsey Investment Management, Inc.*
10.02 Agreement to Extend and Amend Management Agreement, dated December 17, 1999, by and between FBR
Asset Investment Corporation and Friedman, Billings, Ramsey Investment Management, Inc.**
10.03 Agreement to Extend and Amend Management Agreement, dated December 17, 2000, by and between FBR
Asset Investment Corporation and Friedman, Billings, Ramsey Investment Management, Inc.
10.04 License Agreement, dated December 17, 1997, by and between FBR Asset Investment Corporation and
Friedman, Billings, Ramsey Group, Inc.*
10.05 Stock Option Agreement, dated December 17, 1997, by and between FBR Asset Investment
Corporation and Friedman, Billings, Ramsey Investment Management, Inc.*
10.06 Sub-Management Agreement, dated February 14, 2000, by and between Friedman, Billings, Ramsey
Investment Management, Inc. and Fixed Income Discount Advisory Company, Inc.**
10.07 Stock Incentive Plan.*
13.01 Annual Report to Shareholders for the Year ended December 31, 2000.
21.01 List of Subsidiaries of the Registrant*
- ----------
* Filed with the SEC as part of FBR Asset's registration statement on
Form S-11, as amended, Registration No. 333- 67543.
** Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1999, filed with the SEC on March 30, 2000.