- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
Form 10-K
<Table>
(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, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
</Table>
COMMISSION FILE NUMBER 1-15049
---------------------
FBR ASSET INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
<Table>
VIRGINIA 54-1873198
(State or other Jurisdiction of (I.R.S. employer
Incorporation or Organization) identification no.)
POTOMAC TOWER (703) 469-1000
NINETEENTH STREET NORTH (Registrant's telephone number
ARLINGTON, VIRGINIA 22209 including area code)
(Address of principal executive offices)
(zip code)
</Table>
N/A
(FORMER NAME)
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: $316,535,675 as of March 28, 2002.
As of March 28, 2002, the latest practicable date, there were 14,438,332
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, 2001, and to be delivered to
stockholders in connection with the 2002 Annual Meeting of Stockholders, are
incorporated by reference into Part III.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FBR ASSET INVESTMENT CORPORATION
FORM 10-K
FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
INDEX
<Table>
<Caption>
PAGE
----
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS............. 2
PART I................................................................ 2
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 20
Item 3. Legal Proceedings........................................... 20
Item 4. Submission of Matters to Vote of Security Holders........... 21
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 21
Item 6. Selected Financial Data..................................... 23
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 23
Item 8. Financial Statements and Supplementary Data................. 33
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 33
PART II............................................................... 34
Item 10. Directors and Executive Officers of the Registrant.......... 34
Item 11. Executive Compensation...................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 34
Item 13. Certain Relationships and Related Transactions.............. 34
PART III.............................................................. 34
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 34
FINANCIAL STATEMENTS.................................................. F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.............................. F-2
NOTES TO FINANCIAL STATEMENTS......................................... F-7
SIGNATURE
EXHIBIT INDEX
</Table>
1
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, including the risk factors filed as Exhibit 99.01 to this Report.
PART I
ITEM 1. BUSINESS
GENERAL
FBR Asset Investment Corporation (FBR Asset) is a Virginia corporation that
was formed in November 1997 and has elected to be taxed as a real estate
investment trust (REIT) under the federal tax laws since its inception. We are
managed by Friedman, Billings, Ramsey Investment Management, Inc. (FBR
Management) pursuant to a management agreement, the material terms of which are
described under the caption "Management Agreement" beginning on page 14 of this
report. FBR Management is a subsidiary of Friedman, Billings, Ramsey Group, Inc.
(FBR Group). We were formed to make opportunistic investments in debt and equity
securities of companies engaged in real estate-related and other businesses.
Many of these investment opportunities have been identified by FBR Management or
its affiliates. We invest in:
- mortgage-backed securities;
- mezzanine or senior loans; and
- equity securities.
We may from time to time make other opportunistic investments that may or
may not be real estate-related. We invest in non-real estate-related assets
subject to maintaining our REIT qualification.
MORTGAGE-BACKED SECURITIES
We invest directly in fixed- and adjustable-rate residential
mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae.
Our portfolio of mortgage-backed securities is sub-managed by FIDAC, an
affiliate of Annaly Mortgage Management, Inc. These real estate-related
investments, together with our other real estate-related assets, allow us to
maintain our qualification as a REIT under the federal tax code and to avoid
classification as an investment company under the Investment Company Act of
1940. We manage our residential mortgage-backed portfolio to provide a high
risk-adjusted return on capital. We typically invest in both adjustable-rate and
fixed-rate mortgage-backed securities in varying proportions to take advantage
of the differing prepayment characteristics of each of these securities in
different interest rate environments. We finance our investments in
mortgage-backed securities primarily by entering into repurchase agreements to
enhance the overall return on capital invested in this portfolio.
2
MEZZANINE AND SENIOR LOANS
We invest in short- and medium-term mezzanine and senior loans that may
have a higher risk credit profile and yield higher returns than the typical
senior loan made by a commercial bank or other traditional lending institution.
Our loans:
- may or may not be secured;
- may or may not be subordinated;
- have a variety of repayment structures and sources; and
- typically compensate for the higher risk profile of our borrowers through
higher interest rates rather than equity features.
We believe that more stringent credit standards of commercial banks and
other factors have resulted in an increased demand for alternative sources of
debt financing. We focus on industries with which we are familiar, including,
but not limited to, real estate, energy, financial services, consumer products
and industrial manufacturing. In evaluating any investment opportunities, we
intend to focus on, among other factors:
- the cash flow generated by the borrower;
- the tangible assets of the borrower;
- the overall financial leverage of the borrower; and
- the potential for the borrower to undergo a liquidity event that will
enable the repayment of the loan.
We believe our affiliation with Friedman, Billings, Ramsey & Co., Inc.
(FBR), the principal broker-dealer subsidiary of FBR Group, gives us an
advantage in identifying, analyzing and responding quickly to opportunities to
fund mezzanine or senior loans that meet our credit quality standards and
investment objectives. All of our current loans and equity investments are in
investment banking clients of FBR. We expect that most, but not necessarily all,
of the companies in which we invest in the future will have investment banking
relationships with FBR. We also intend to develop relationships with other
entities who may offer us investment opportunities with their clients.
EQUITY SECURITIES
Our investments in equity securities are primarily in current or former
underwriting or advisory clients of FBR. We generally have a longer-term time
horizon on these investments than on our mezzanine loans. In evaluating equity
investments, we follow a value-oriented investment approach. We focus
particularly on the anticipated future cash flows to be generated by the
underlying business, discounted by an appropriate rate to reflect both the risk
of achieving those cash flows and the alternative uses for the capital to be
invested. Other important considerations include:
- strength of management;
- liquidity of the investment;
- underlying value of the assets owned by the issuer; and
- prices of similar or comparable securities.
LEVERAGE
We generally have not used debt to finance the acquisition or origination
of any investment other than our mortgage-backed securities. As of December 31,
2001, we had an overall assets-to-equity ratio of approximately 6.50 to 1. As of
that date, the debt-to-equity ratio, based on book values, of our portfolio of
mortgage-backed securities was 8.30 to 1.
3
COMPOSITION OF ASSETS AND EQUITY CAPITAL
At December 31, 2001, we had total assets on our balance sheet of
approximately $1.3 billion and equity capital of approximately $203.9 million.
These are divided among our investments as follows:
<Table>
<Caption>
ASSETS EQUITY CAPITAL
------ --------------
Loans....................................................... 1% 4%
Equity Securities........................................... 5% 30%
Mortgage-backed securities.................................. 93% 65%
Cash and other assets....................................... 1% 1%
</Table>
We derived the foregoing allocation of our assets from our balance sheet as
of December 31, 2001. We derived the foregoing allocation of our equity capital
by dividing:
- the total principal amount of loans outstanding as of December 31, 2001;
- the fair market value of the equity securities we own as of December 31,
2001;
- the fair market value of our mortgage backed securities as of December
31, 2001, less the amount of indebtedness outstanding as of that date
under repurchase agreements used to finance the purchase of
mortgage-backed securities; and
- the difference between our total shareholders' equity as of December 31,
2001, and the sum of the amounts represented by the three bullets above,
by our total shareholders' equity as of December 31, 2001. We can give no
assurance that we will be able to achieve any specific level of returns. For a
detailed discussion of the factors that may adversely influence our desired
returns, see the "Risk Factors" filed as Exhibit 99.1 to this report.
AGREEMENT WITH FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
FBR Asset and its registered broker-dealer subsidiary, Pegasus Capital
Corporation ("Pegasus") entered into an agreement in August 2001 with FBR
regarding FBR Asset's extension of credit to or investment in entities that are
or may be FBR's investment banking clients. In circumstances where FBR
determines that a commitment by FBR Asset to make a loan to or investment in an
entity (each an "investment opportunity") would facilitate a possible investment
banking transaction, FBR presents the investment opportunity to FBR Asset. The
Investment Committee of FBR Asset, which is comprised of Richard J. Hendrix, FBR
Asset's President and Chief Operating Officer and Eric F. Billings, FBR Asset's
Chairman and Chief Executive Officer, reviews each investment opportunity and
recommends whether or not to commit to make a loan or an investment based on its
investment criteria. Mr. Billings is also an executive officer of FBR Group, FBR
Management and FBR, and Mr. Hendrix is also a Managing Director of FBR and FBR
Management. The approval of the Contracts Committee of FBR Asset's Board of
Directors (comprised of our three independent directors), which requires the
affirmative vote of at least two of FBR Asset's independent directors, is
required before any investment or loan is made in or to a client or proposed
client of FBR. If FBR Asset decides to make a loan or investment commitment to
an entity, the commitment is not contingent on FBR being engaged to provide
investment banking services by the entity. If, however, FBR is engaged to
provide investment banking services to the entity, Pegasus is provided the
opportunity to act as financial adviser to FBR in connection with structuring
the transaction and, in return for its services, it will receive 10% of the net
cash investment banking fees received by FBR as a result of the engagement. The
payments Pegasus receives from FBR will generally be taxed at normal corporate
rates and will generally not be distributed to FBR Asset's shareholders.
OPERATING POLICIES & STRATEGIES
We rely upon the professionals employed by FBR to identify and evaluate
opportunities for investment. 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.
4
Our goal, subject to maintaining our REIT qualification, is to make
investments that we believe will generate the highest returns on capital
invested. To determine which assets are likely to provide those returns, we
consider:
- the amount and nature of anticipated cash flows from the asset;
- the risks of investing in the asset;
- our 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.
We are an opportunistic investor and do not have guidelines dictating
specific investment or operating restrictions. We have taken or may take the
following actions without the consent of our shareholders:
- borrow money;
- make loans to other companies;
- invest in securities of other issuers;
- sell existing investments and make additional investments; and
- repurchase or otherwise reacquire our shares.
We 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 we have chosen not to take those actions. We have
distributed, and will continue to distribute, our annual report, including our
audited financial statements, to our shareholders as required under the
securities laws.
With regard to specific investments, we may invest directly or indirectly
in any type of loan, equity security or mortgage-backed security, subject to the
policy that we maintain our qualification as a REIT and our exemption from
registration as an investment company.
We expect that investment opportunities will change from time to time. We
will seek what we consider to be attractive opportunities to invest primarily on
a privately-negotiated basis. For example, we believe there will be
opportunities to co-invest with other REIT and non-REIT investors seeking to
complete planned acquisitions, to provide mezzanine and senior loans, and to
provide private equity financing. If an adequate amount of what we consider to
be appropriate investments becomes available, we may borrow funds to make
additional investments.
The Investment Committee
Management has formed an investment committee comprised of Richard J.
Hendrix, our President and Chief Operating Officer, and Eric F. Billings, our
Chief Executive Officer, to review each proposed investment or loan and to make
a determination about whether the investment or loan satisfies our investment
criteria. Mr. Billings is also an executive officer of FBR Group, FBR Management
and FBR, and Mr. Hendrix is also a Managing Director of FBR and FBR Management.
In addition, the approval of the Contracts Committee of our Board of Directors
(comprised of our three independent directors), which requires the affirmative
vote of at least two of our independent directors, is required before any
investment or loan is made in or to a client or proposed client of FBR.
Mortgage-Backed Securities
WHOLE-POOL MORTGAGE-BACKED SECURITIES
We currently invest, and intend to continue investing, at least 55% of our
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,
5
government-related and private organizations assemble the pools of loans for
sale to investors such as ourselves.
At December 31, 2001, we owned mortgage-backed securities guaranteed by
Freddie Mac and Fannie Mae that had a market value of $1.2 billion, and had
borrowed $1.1 billion through repurchase agreements to finance our 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, servicer 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.
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 our investments.
At December 31, 2001, we owned 12 fixed rate, and 45 adjustable rate,
residential mortgage-backed securities that represented ownership interest in
pools of single-family mortgage loans. At December 31, 2000, we owned 33 fixed
rate, and 4 adjustable rate, residential mortgage-backed securities that
represented the ownership interest in pools of single-family mortgage loans. In
connection with those investments, we entered into repurchase agreements, and an
interest rate swap.
The mortgage-backed securities we owned at December 31, 2001, are
summarized below:
<Table>
<Caption>
WEIGHTED EXPECTED RELEVANT
NOMINAL AVERAGE LIFE EFFECTIVE PREPAYMENT
DESCRIPTIVE TITLE(1) FACE AMOUNT MARKET VALUE YIELD(2) (YEARS) DURATION ASSUMPTIONS(3)
- -------------------- -------------- -------------- -------- ------------ --------- --------------
Floating Rate CMOs(4)....... $ 68,935,932 $ 70,064,564 2.68% 9.28 1.53 24.11CPR
ARMs/Hybrid ARMs............ 893,134,072 915,271,539 4.77% 3.72 2.23 41.96CPR
Fixed Rate Securities....... 249,480,844 253,029,408 6.51% 5.33 2.77 17.62CPR
-------------- -------------- ---- ---- ---- --------
Mortgage Portfolio Total.... $1,211,550,848 $1,238,365,511 5.01% 4.37 2.30 35.93CPR
============== ============== ==== ==== ==== ========
</Table>
The mortgage-backed securities we owned at December 31, 2000, are
summarized below:
<Table>
<Caption>
WEIGHTED EXPECTED RELEVANT
NOMINAL AVERAGE LIFE EFFECTIVE PREPAYMENT
DESCRIPTIVE TITLE(1) FACE AMOUNT MARKET VALUE YIELD(2) (YEARS) DURATION ASSUMPTIONS(3)
- -------------------- ------------ ------------ -------- ------------ --------- --------------
Floating Rate CMOs(4).......... $ -- $ -- -- -- -- --
ARMs/Hybrid ARMs............... 37,435,252 37,973,904 7.32% 3.75 1.60 9.08CPR
Fixed Rate Securities.......... 116,286,916 116,874,301 6.51% 4.35 2.81 9.10CPR
------------ ------------ ---- ---- ---- --------
Mortgage Portfolio Total....... $153,722,168 $154,848,205 6.70% 4.20 2.51 9.09CPR
============ ============ ==== ==== ==== ========
</Table>
- ---------------
(1) All of the mortgage-backed securities are backed by pools of fixed and
adjustable rate mortgages and are principal and/or interest paying
instruments.
(2) 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
6
flows. For a mortgage product, it represents the yield for a given yield
curve environment based on prepayments for that environment.
(3) Constant Prepayment Rate (CPR). Annualized equivalents of single monthly
mortality (SMM). CPR attempts to predict the percentage of principal that
will prepay over the next 12 months based on historical principal paydowns.
CPR is measured on 1 month, 3 month, 6 month, 12 month, or since issue
basis.
(4) CMOs are Collateralized Mortgage Obligations.
As the table shows, the average nominal yield (as defined in footnote 3
above) on our mortgage-backed securities at December 31, 2001, was approximately
5.01%. The yield is based on the anticipated life of the securities. 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.
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 principal 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 our 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, the distributions made to us would consist solely of payments and
other recoveries on the underlying mortgage loans, and accordingly, monthly
distributions to us 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 our
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, the distributions made to
us would consist solely of payments and other recoveries on the underlying
mortgage loans, and accordingly, monthly distributions to us would be adversely
affected by delinquent payments and defaults on the mortgage loans.
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
7
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 we may purchase 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 we do not own single-family or multifamily privately-issued
certificates, some of the companies in which we invest may own these
certificates. We may in the future invest in other companies that invest in
these assets or may invest in them directly.
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
We may reduce the amount of equity capital we have invested in mortgage
backed-securities 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 we earn from our financed assets. To the extent that revenue derived
from those assets exceeds the interest expense, our net income will be greater
than if we had not borrowed funds and had not invested in the assets.
Conversely, if the revenue from those assets does not sufficiently cover the
expense, our net income will be less than if we had not borrowed funds.
We have borrowed and intend to continue borrowing funds by entering into
repurchase agreements. Under these agreements, we sell 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. We account for repurchase agreements as loans, secured
by the underlying assets, that we owe to the third party.
We intend 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 our use of leverage. Based on book values, the
debt-to-equity ratio of our mortgage-backed securities portfolio as of December
31, 2001, was 8.30 to 1. Our lenders have generally permitted repurchase
agreement borrowings against agency mortgage-backed securities at a
debt-to-equity ratio of up to 19 to 1. Our Articles of Incorporation and Bylaws
do not impose any specific limits on permissible leverage and we may increase
our leverage ratio in the future.
8
What follows are two examples of how we might use borrowings to increase
the yield on a hypothetical mortgage-backed security:
<Table>
<Caption>
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 / 7)*............. 9.00% 7.50%
</Table>
- ---------------
* The numbers in parentheses, unless otherwise specified, refer to the line
numbers on the far left.
In example 1 above, we use borrowed funds to increase the initial yield on
our investment from 7.25% to 9.0%. In example 2 above, we borrow less funds and
increase our yield only from 7.25% to 7.50%. We plan to complete these types of
transactions by arranging loans in which we pledge our assets as collateral to
secure our 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 our obligations. If we repay loans early, then the return on equity
would be reduced. As reflected above, if we were required to increase the amount
of equity capital we 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
We may from time to time utilize derivative financial instruments to hedge
all or a portion of the interest rate risk associated with our borrowings. We do
not intend to utilize derivative instruments for speculative purposes. Our
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, we
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 we may incur, or plan to incur, to acquire or carry real
estate assets.
We engage in a variety of interest rate management techniques that are
intended to match the effective maturity of, and the interest received on, our
assets with the effective maturity of, and the interest owed on, our
liabilities. We generally will be able to use those techniques directly, instead
of through a corporate subsidiary that is fully subject to corporate income
taxation. However, we cannot give any assurances that we can successfully
implement our investment and leverage strategies. Our 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.
We may also use these techniques to attempt to protect ourselves against
declines in the market value of our assets that result from general trends in
debt markets. The inability to match closely the maturities and
9
interest rates, or the inability to protect adequately against declines in the
market value of our assets, could result in losses with respect to our mortgage
assets.
At December 31, 2001, we had entered into $1.1 billion of short-term
repurchase agreements. These agreements expire and are renewed on a regular
basis, and as of December 31, 2001, had stated maturity dates from January 1,
2002 to February 5, 2002. The interest rates on the short-term borrowing
arrangements increase and decrease 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
5.01%, which is the average nominal yield (as defined in footnote 3 on page 6)
of our mortgage portfolio as of December 31, 2001, the interest owed on the
borrowings would likely exceed the interest income payable to us on our
mortgage-backed securities.
We may from time to time enter into interest rate swap agreements to offset
the potential adverse effects of rising interest rates under certain short-term
repurchase agreements. The interest rate swap agreements have historically been
structured such that we receive payments based on a variable interest rate and
make payments based on a fixed interest rate. The variable interest rate on
which payments are received is calculated based on the three-month LIBOR. Our
repurchase agreements generally have maturities of 30 to 90 days and carry
interest rates that correspond to LIBOR rates for those same periods. The swap
agreements effectively fix our borrowing cost and are not held for speculative
or trading purposes.
At December 31, 2001, we were party to an interest rate swap agreement that
matures on July 27, 2004, and has a notional amount of $50 million and a fair
value of ($1.2 million). Under this agreement, we pay a fixed interest rate of
4.97% on the notional amount and receive a variable rate calculated based on the
three-month LIBOR, which was 2.28% at December 31, 2001. At December 31, 2000,
we were party to an interest rate swap agreement that matured on June 1, 2001,
and had a notional amount of $50 million and a fair value of $137,949 at
December 31, 2000. Under this agreement, we paid a fixed interest rate of 5.96%
on the notional amount and received a variable rate calculated based on the
three-month LIBOR, which was 6.69% at December 31, 2000.
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.
Commercial Mortgage Loans & CMBS
In the future, we may invest in companies that originate or acquire
commercial mortgage loans or commercial mortgage-backed securities commonly
known as "CMBS." In addition, we 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.
We may invest directly, or the companies in which we invest 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 we invest may 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
10
junior, or 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.
To the extent that we hold interests in commercial mortgage loans and CMBS
through our investments in other companies, we must rely on the management of
those other companies to make decisions with respect to the commercial mortgage
loans and CMBS. In general, we will have no ability to control those decisions.
Moreover, the management of those other companies are not required to inform us
of their decisions, although to the extent the companies are reporting companies
under the Securities Exchange Act of 1934, they must file reports of material
events with the SEC.
Mezzanine and Senior Loan Program
As of December 31, 2001, we had outstanding one short-term loan in the
aggregate principal amount of $8 million. We believe our affiliation with FBR
gives us an advantage over our competitors in identifying, analyzing and
responding quickly to opportunities to fund mezzanine or senior loans that meet
or exceed our credit quality standards and investment objectives. Many, but not
all, of the companies in which we invest or to which we make loans have or will
have an investment banking relationship with FBR.
Our investment and lending strategy is to focus on companies that have
stable operating histories and are profitable or near profitable at existing
operating levels. We review various criteria when determining whether to provide
a loan to a potential borrower, including but not limited to:
- the borrower's projected cash flows over the course of the loan and the
likelihood of achieving those projections;
- the borrower's ability to service and repay the loan based on the
historical results of the borrower;
- the overall financial leverage of the borrower;
- the tangible assets of the borrower;
- the liquidation value of the assets collateralizing the loan;
- alternative sources for repayment of the loan, including the potential
for the borrower to undergo a liquidity event that will enable the
repayment of the loan;
- the characteristics of the industry in which the borrower conducts its
business;
- competition faced by the borrower for the sale of its goods or services;
- the degree to which the borrower's results are tied to overall economic
activity; and
- the quality, experience and reputation of the borrower's management team.
The above criteria and other criteria that we consider when evaluating a
financing opportunity provide a general guide for lending and investment
decisions, although not all criteria are considered equally in the determination
of whether or not to make a loan.
We plan to invest in companies in the real estate sector as well as in
other sectors such as energy, financial services, consumer and industrial
manufacturing, and others that meet the above criteria.
Equity Investments
REAL ESTATE
We seek to invest in real property to generate income and to provide
ourselves with the potential for capital appreciation in the value of property
owned. Although we do not currently own any direct interests in real property,
we do own interests in real property through our equity investments in Capital
Automotive REIT and Resource Asset Investment Trust. As an equity holder, our
return on investment is not directly
11
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 we own. Through our relationship with FBR, we were able to acquire
the stock of Capital Automotive before Capital Automotive offered its stock to
the public. We purchased shares of Resource Asset in open-market transactions.
In the future, we may invest in other companies that own real property. In
addition, we may purchase real property directly or through joint ventures with
affiliated or non-affiliated third parties that purchase real property.
OTHER NON-REAL ESTATE RELATED INVESTMENTS
Subject to maintaining our qualification as a REIT, we also invest from
time to time in assets and companies that are not related to the real estate
business.
12
SUMMARY OF CURRENT INVESTMENTS & CASH AND CASH EQUIVALENTS
The following table summarizes FBR Asset's investments as of December 31,
2001, and December 31, 2000.
<Table>
<Caption>
DECEMBER 31, 2001
--------------------------------------------------------------------------------
SHARES PERCENT AMOUNT OF CARRYING PERCENTAGE INCREASE
OWNED OWNERSHIP(3) INVESTMENT VALUE (DECREASE)
--------- ------------ -------------- -------------- -------------------
MORTGAGE-BACKED SECURITIES................. N/A N/A $1,236,935,966 $1,238,365,511 0.12%
EQUITY INVESTMENTS(1)(2)
Capital Automotive REIT (CARS)........... 920,115 3.54% 12,835,604 18,301,087 42.58%
Annaly Mortgage Management, Inc. (NLY)... 800,000 1.36% 7,144,000 12,800,000 79.17%
Prime Retail, Inc., pfd (PRT pfd)........ -- -- -- -- --
MCG Capital Corporation (MCGC)........... 625,000 2.21% 9,934,375 11,125,000 11.98%
Resource Asset Investment Trust (RAS).... 344,575 2.77% 3,704,181 5,616,573 51.63%
Anworth Mortgage Asset Corporation
(ANH).................................... 500,000 4.50% 3,890,625 4,550,000 16.95%
Saxon Capital Acquisition Corp........... 1,000,000 3.57% 9,300,000 9,300,000(4) 0.00%
Encompass Services Corporation (ESR)..... -- -- -- -- --
--------- ---- -------------- -------------- -----
TOTAL EQUITY INVESTMENTS............... 46,808,785 61,692,660 31.80%
-------------- -------------- -----
PROMISSORY NOTES(2)
Prime Capital Funding I, LLC............. N/A N/A -- -- N/A
Prime Group Realty, L.P.................. N/A N/A 8,000,000 8,000,000 N/A
-------------- -------------- -----
TOTAL PROMISSORY NOTES................. 8,000,000 8,000,000 N/A
-------------- -------------- -----
CASH AND CASH EQUIVALENTS.................. N/A N/A 6,630,379 6,630,379 N/A
-------------- -------------- -----
TOTAL INVESTMENTS & CASH AND CASH
EQUIVALENTS............................ $1,298,375,130 $1,314,688,550 1.26%
============== ============== =====
<Caption>
DECEMBER 31, 2000
-------------------------------------------------
AMOUNT OF CARRYING PERCENTAGE
INVESTMENT VALUE INCREASE (DECREASE)
------------ ------------ -------------------
MORTGAGE-BACKED SECURITIES................. $155,379,074 $154,848,205 (0.34)%
EQUITY INVESTMENTS(1)(2)
Capital Automotive REIT (CARS)........... 23,298,100 23,068,463 (0.99)%
Annaly Mortgage Management, Inc. (NLY)... -- -- --
Prime Retail, Inc., pfd (PRT pfd)........ 1,038,800 543,939 (47.64)%
MCG Capital Corporation (MCGC)........... -- -- --
Resource Asset Investment Trust (RAS).... 3,704,181 4,245,164 14.60%
Anworth Mortgage Asset Corporation
(ANH).................................... -- -- --
Saxon Capital Acquisition Corp........... -- -- --
Encompass Services Corporation (ESR)..... 286,931 252,624 (11.96)%
------------ ------------ ------
TOTAL EQUITY INVESTMENTS............... 28,328,012 28,110,190 (0.77)%
------------ ------------ ------
PROMISSORY NOTES(2)
Prime Capital Funding I, LLC............. 4,000,000 4,000,000 N/A
Prime Group Realty, L.P.................. -- -- N/A
------------ ------------ ------
TOTAL PROMISSORY NOTES................. 4,000,000 4,000,000 N/A
------------ ------------ ------
CASH AND CASH EQUIVALENTS.................. 36,810,566 36,810,566 N/A
------------ ------------ ------
TOTAL INVESTMENTS & CASH AND CASH
EQUIVALENTS............................ $224,517,652 $223,768,961 (0.33)%
============ ============ ======
</Table>
- ---------------
(1) The symbols in parentheses next to the company names are the symbols of
those companies in Nasdaq or on a national securities exchange. Each of
these companies is a reporting company, except Saxon Capital Acquisition
Corp. (see Footnote "4") 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) Based on the most recent publicly available information.
(4) Saxon Capital Acquisition Corp. became a public corporation in January 2002.
13
The following table shows, for the calendar years 2001, 2000 and 1999, our
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, 2001 to December 31, 2001, January 1, 2000 to December 31,
2000, and January 1, 1999 to December 31, 1999, on which the Company held each
investment, and the gross income from each investment for the years ended
December 31, 2001, 2000 and 1999.
<Table>
<Caption>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 1999
--------------------------- --------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE COST GROSS INCOME AVERAGE COST GROSS INCOME AVERAGE COST GROSS INCOME
------------ ------------ ------------ ------------ ------------ ------------
MORTGAGE-BACKED SECURITIES.............. $513,269,378 $29,797,047 $196,229,207 $13,106,945 $164,970,427 $10,744,041
------------ ----------- ------------ ----------- ------------ -----------
EQUITY INVESTMENTS
Anthracite Capital, Inc................. -- -- 8,449,779 1,376,206 18,334,496 2,293,677
Capital Automotive REIT................. 20,283,274 1,669,598 24,447,980 2,575,903 25,000,000 2,473,119
Chastain Capital Corporation............ -- -- -- 41,835 3,150,000 --
Imperial Credit Commercial Mortgage Inv.
Corp.................................. -- -- 2,589,025 207,000 12,616,713 1,035,000
Imperial Credit Industries, Inc......... -- -- -- -- 3,576,712 798,326
Prime Retail, Inc....................... -- -- 385,788 -- 1,201,317 145,730
Prime Retail, Inc., preferred........... 596,755 -- 1,142,112 -- 1,016,032 154,350
Saxon Capital Acquisition Corporation... 4,688,219 -- -- -- -- --
MCG Capital Corporation................. 898,194 -- -- -- -- --
Anworth Mortgage Asset Corporation...... 42,637 -- -- -- -- --
Annaly Mortgage Management
Corporation........................... 6,674,258 1,400,000 -- -- -- --
Resource Asset Investment Trust......... 3,704,181 730,499 4,099,095 702,933 5,292,516 702,933
Encompass Services Corporation.......... 58,958 -- 1,186,381 -- 6,187,518 --
Atlas Pipeline Partners................. -- 20,888 1,472,552 178,314 -- --
Cargan City............................. -- -- 20,218 -- --
East-West Bancorp, Inc.................. -- -- -- -- 4,102,329 46,800
------------ ----------- ------------ ----------- ------------ -----------
TOTAL EQUITY INVESTMENTS &
DIVIDENDS......................... 36,946,476 3,820,985 43,792,930 5,082,191 80,477,633 7,649,935
------------ ----------- ------------ ----------- ------------ -----------
PROMISSORY NOTES
Prime Capital Holding, LLC.............. -- -- 1,825,137 902,418 11,272,154 1,808,451
Prime Group Realty, L.P................. 8,701,370 1,832,000 -- -- 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............ 416,805 207,586 2,108,204 511,778 -- --
Kennedy-Wilson Inc...................... -- -- -- -- 3,510,608 511,411
Brookdale Living Communities............ -- -- -- -- 1,493,151 224,727
------------ ----------- ------------ ----------- ------------ -----------
TOTAL PROMISSORY NOTES.............. 9,118,175 2,039,586 23,441,538 5,187,854 24,421,118 4,094,886
------------ ----------- ------------ ----------- ------------ -----------
CASH & CASH EQUIVALENTS................. 10,267,086 553,961 10,352,859 464,067 20,576,171 984,987
------------ ----------- ------------ ----------- ------------ -----------
TOTAL INVESTMENTS AND CASH & CASH
EQUIVALENTS....................... $569,601,115 $36,211,579 $273,816,534 $23,841,057 $290,445,349 $23,473,849
============ =========== ============ =========== ============ ===========
</Table>
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 AND EXECUTIVE OFFICERS OF THE COMPANY
Other than at its broker-dealer subsidiary, 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. Two of the Company's
directors, and each of the Company's executive officers, are officers of FBR
Group, FBR Management and FBR Group's principal broker-dealer subsidiary,
Friedman, Billings, Ramsey & Co., Inc.
MANAGEMENT AGREEMENT
We entered into a management agreement with FBR Management that expires on
December 17, 2002. The following section summarizes the material provisions of
the management agreement. This section does not completely describe the
management agreement, and you should not rely on it as if it did. You may obtain
a complete copy of the management agreement by following the document request
procedures set forth in "Other Matters -- Additional Information."
FBR Management's Responsibilities
FBR Management has only the authority that our Board of Directors delegates
to it and is, at all times, subject to our Board's supervision. Generally, FBR
Management performs the services necessary to keep our company running on a
day-to-day basis. These services include:
Investment Services
- representing us in connection with:
- the purchase and sale of assets,
- commitments to purchase and sell assets, and
- the maintenance and administration of our portfolio;
- engaging in hedging activities on our behalf, consistent with our status
as a REIT;
- upon request by and in accordance with the directions of the Board of
Directors, investing or reinvesting any of our money; and
- acting as liaison between our company and banking, mortgage banking,
investment banking and other parties with respect to the purchase,
financing and disposition of assets.
15
Advisory Services
- consulting with us on the formulation of investment criteria and
guidelines;
- furnishing reports and collecting information relating to our assets,
interest rates, and general economic conditions;
- furnishing reports regarding our activities and the services performed
for us by FBR Management;
- monitoring and providing the Board of Directors with price information
and other data obtained from nationally recognized dealers that maintain
markets in assets identified by the Board, and providing data and advice
to the Board of Directors in connection with the identification of such
dealers;
- counseling us in connection with policy decisions to be made by the Board
of Directors;
- counseling us regarding the maintenance of our status as a REIT and
monitoring compliance with the various REIT qualification tests; and
- counseling us regarding the maintenance of our exemption from the
Investment Company Act and monitoring compliance with the various
requirements for that status.
Administrative Services
- providing executive and administrative personnel, office space, and
office services required in rendering services to us;
- administering our day-to-day operations and performing and supervising
the performance of such other necessary administrative functions as may
be agreed upon by FBR Management and the Board of Directors, including:
- the collection of revenues,
- the payment of our debts and obligations,
- the maintenance of appropriate computer services to perform such
administrative functions, and
- other customary functions related to portfolio management;
- communicating on our behalf with holders of our securities as required to
satisfy the reporting and other requirements of any governmental bodies
or agencies or trading markets and to maintain effective relations with
those holders; and
- to the extent not otherwise subject to an agreement executed by us,
designating servicers for mortgage loans sold to us and arranging for the
monitoring and administering of those servicers.
The Management Fee
BASE MANAGEMENT FEE
FBR Management is entitled to receive a quarterly base management fee equal
to the sum of:
- 0.25% per annum of the average book value of our mortgage assets during
each calendar quarter; and
- 0.75% per annum of the average book value of the remainder of our
invested assets during each calendar quarter.
The Board of Directors may adjust the base management fee in the future if
necessary to align the fee more closely with the actual costs of services and,
by agreement with FBR Management, may reduce the base management fee to the
extent we incur costs internally.
For the years ended December 31, 1999, 2000 and 2001, the base management
fee was $1,329,063, $1,078,713 and $1,842,296, respectively.
16
INCENTIVE COMPENSATION
FBR Management is also entitled to receive incentive compensation based on
our performance. For each calendar quarter, FBR Management is entitled to
receive 25% of the "Incentive Calculation Amount" for the 12-month period ending
with the end of that calendar quarter.
The "Incentive Calculation Amount" for any 12-month period means an amount
equal to the product of
(A) 25% of the dollar amount by which
(1) (a) Our Funds from Operations (before the incentive fee) per share
of common stock, based on the weighted average number of shares
outstanding, plus (b) gains or minus losses from debt restructuring and
sales of property per share, based on the weighted average number of
shares outstanding, exceed
(2) an amount equal to (a) the weighted average of the price per share
in the initial private offering of our common stock in 1997 and in the
follow-on public offering of our common stock in August 2001 of $20.82
and the price per share in any future follow-on offerings by our company
multiplied by (b) the 10-Year U.S. Treasury Rate plus five percent per
annum, multiplied by
(B) the weighted average number of shares of common stock outstanding
during the applicable period.
"Funds from Operations" as defined by the National Association of Real
Estate Investment Trusts means net income computed in accordance with generally
accepted accounting principles, excluding gains or losses from debt
restructuring and sales of property, plus depreciation and amortization on real
estate assets, and after adjustments for unconsolidated partnerships and joint
ventures. Funds from Operations does not represent cash generated from operating
activities in accordance with generally accepted accounting principles and
should not be considered as an alternative to net income as an indication of our
performance or to cash flows as a measure of liquidity or ability to make
distributions.
As used in calculating FBR Management's compensation, the term "10-Year
U.S. Treasury Rate" means the arithmetic average of the weekly average yield to
maturity for actively traded current coupon U.S. Treasury fixed-rate securities,
adjusted to constant maturities of ten years, published by the Federal Reserve
Board during a quarter. The average weekly 10-Year U.S. Treasury Rate for the
twelve months ended December 31, 2001, was 5.02%.
We recorded $1,652,061 of incentive compensation expense during the year
ended December 31, 2001. There were no incentive compensation fees paid in
previous years.
Options Owned by FBR Management
In December 1997, FBR Management received options to purchase 1,021,900
shares of our common stock at $20 per share. The estimated value of these
options at the time of grant was $909,492 based on a discounted Black-Scholes
valuation, and was amortized over the initial term of the Management Agreement.
We have fully amortized the value of these options. FBR Management previously
transferred 51,095 of its options to its former sub-manager. FBR Management
agreed to the rescission of options to purchase 155,000 shares in connection
with the establishment of our stock incentive plan. In December 2001, FBR
Management exercised options with respect to 400,000 shares of our common stock
at the $20 per share exercise price.
Expenses
Because FBR Management's employees will perform due diligence tasks that
investors or investment advisors typically hire outside consultants to perform,
FBR Management will be reimbursed for its out of pocket costs in performing due
diligence on assets we purchased or considered for purchase. Moreover, FBR
Management tracks the time its employees spend in performing such due diligence
tasks and is entitled to reimbursement for the allocated portion of the salary
and benefits of such employees. However, (1) the amount of due diligence costs
for which FBR Management receives reimbursement with respect to any asset may
not exceed an arm's length due diligence fee for such asset, and (2) FBR
Management is not entitled to
17
reimbursement for any due diligence or employee time costs associated with
investments in securities being underwritten or placed by FBR.
Limits of Responsibility
Under the Management Agreement, FBR Management does not assume any
responsibility other than to render the services called for and is not
responsible for any action of the Board of Directors in following or declining
to follow its advice or recommendations. We have agreed to indemnify FBR
Management, FBR, and their directors and officers with respect to all expenses,
losses, damages, liabilities, demands, charges, and claims arising from acts not
constituting bad faith, willful misconduct, gross negligence, or reckless
disregard of duties, performed in good faith in accordance with and pursuant to
the Management Agreement.
The Management Agreement does not restrict the right of FBR Management or
any of its officers, directors, employees, or FBR to engage in any business or
render services of any kind to any other person, including the purchase of, or
the rendering of advice to others who purchase REIT or other securities or other
assets that meet our policies and criteria.
Term of Management Agreement
The Management Agreement has a term expiring on December 17, 2002. We may
terminate the Management Agreement without cause at any time upon 60 days'
written notice by a majority vote of our independent directors or by a vote of
the holders of a majority of the outstanding shares of common stock. If
terminated, FBR Management will be entitled to all fees accrued through the date
of termination and, as a termination fee, will be entitled to an amount equal to
the sum of the base management fee and incentive management fee earned during
the twelve months preceding the final day of the calendar quarter last ending
prior to the date of termination. In addition, we have the right to terminate
the Management Agreement without paying a termination fee if FBR Management
violates any material provision of the Management Agreement and fails to cure
the violation.
The Sub-Manager
On February 14, 2000, FBR Management entered into a sub-management
agreement with FIDAC to advise FBR Management with respect to management of our
mortgage-backed securities portfolio. FIDAC replaced Blackrock Financial
Management, Inc. as sub-advisor with respect to our mortgage-backed securities
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 Advisers Act of 1940.
FIDAC, in its discretion, subject to the supervision of FBR Management and our
Board of Directors, evaluates and monitors our mortgage-backed securities
portfolio. FBR Management may terminate its relationship with FIDAC at any time
in its sole discretion without penalty.
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." At September 20, 2001, we owned approximately 1.36% of the outstanding
common stock of Annaly.
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
18
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 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.
REITs are permitted to own up to 100% of the stock of one or more "taxable
REIT subsidiaries" ("TRSs") beginning on January 1, 2001. A TRS is a fully
taxable corporation that is permitted to engage in activities the income from
which would be nonqualifying income earned by the Company. The Company and its
subsidiary must jointly elect for the subsidiary to be treated as a TRS. A
corporation of which a qualifying TRS directly or indirectly owns more than 35%
of the voting power or value of the stock will automatically be treated as a
TRS. Overall, no more than 20% of the value of the Company's assets may consist
of securities of one or more TRSs. The TRS rules limit the deductibility of
interest paid or accrued by a TRS to the Company to assure that the TRS is
subject to an appropriate level of corporate taxation. Further, the rules impose
a 100% excise tax on transactions between the Company and its TRSs that are not
conducted on an arm's-length basis.
During 2001, the Company acquired a registered broker-dealer from FBR Group
called Pegasus Capital Corporation, made a TRS election for such entity, and
also formed two other TRSs. Pegasus participates in a fee-sharing arrangement
with FBR. The Company's TRSs are subject to corporate income tax on their
taxable income, and such taxable income generally will not be distributed to the
Company's shareholders.
RECENT DEVELOPMENTS
Dividend Payment
On March 14, 2002, we announced that our Board of Directors voted to
declare a first quarter dividend of $1.25 per share, payable on April 15, 2002,
to shareholders of record as of March 28, 2002.
Follow-on Common Stock Offering
On February 1, 2002, we completed the sale of 4,800,000 shares of our
common stock at a price per share of $26.50. The aggregate proceeds to us, net
of underwriting discounts and commissions, totaled approximately $120.8 million.
On February 28, 2002, we completed the sale of an additional 720,000 shares of
our common stock as a result of the underwriters' full exercise of their
over-allotment option. The aggregate proceeds to us, net of the underwriting
discounts and commission, totaled approximately an additional $18.1 million.
Exercise by FBR Management of Remaining Options
On February 15, 2002, FBR Management exercised its remaining options to
purchase 415,805 shares of our common stock at the exercise price of $20 per
share, or $8,316,100. FBR Management has advised us that it has no current
intention to sell any of the shares of our common stock that it has acquired
through option exercises or any of its other shares of our common stock that it
holds for investment purposes.
19
Election of Richard J. Hendrix as Our President
On March 14, 2002, our Board of Directors elected Richard J. Hendrix, our
Chief Operating Officer, to the additional position of President.
Additional Loan
On March 20, 2002, we extended to Oxford Finance Corporation a $10,000,000
loan to fund the extension of equipment leases to five companies primarily in
the pharmaceutical sector. The loan is secured by a first priority lien on the
leased equipment and other collateral. The term of the loan is 60 days. The loan
bears interest at a rate of 12% per annum. We received a $200,000 origination
fee when the loan was funded.
Change of Independent Accountants
On March 14, 2002, we determined not to renew the engagement of our
independent accountants, Arthur Andersen LLP ("Andersen"), and appointed KPMG
LLP ("KPMG") as our new independent accountants, effective immediately. This
determination followed our decision to seek proposals from independent
accountants to audit our financial statements for the fiscal year ending
December 31, 2002. The decision not to renew the engagement of Andersen and to
retain KPMG was approved by our Board of Directors upon the recommendation of
the Audit Committee of our Board. This change is subject to ratification by our
shareholders at our next annual meeting.
Termination of Sub-Advisory Agreement with Respect to Our Mortgage Assets
On March 22, 2002, Friedman, Billings, Ramsey Investment Management, Inc.
("FBRIM"), our external adviser, notified Fixed Income Discount Advisory
Company, Inc. ("FIDAC"), FBRIM's sub-adviser with respect to the management of
our mortgage-backed securities portfolio, that it had determined to terminate
the sub-advisory agreement with FIDAC. The decision to terminate the
sub-advisory agreement with FIDAC was based on FBRIM's determination, after
consultation with our Board of Directors, that it would be in the best interests
of our shareholders to terminate the sub-advisory agreement in light of the
increased size of our equity capital and mortgage-backed securities portfolio.
The sub-advisory agreement will end in accordance with its terms on April 30,
2002. Concurrently with the end of the sub-advisory agreement, we and FBRIM have
agreed to a reduction of the management fee that we will be required to pay from
0.25% to 0.20% per annum of the average book value of our mortgage assets during
each calendar quarter.
NYSE Original Listing Application
On March 25, 2002, we filed an application to list our common stock for
trading on the New York Stock Exchange. If we are able to list our common stock
on the New York Stock Exchange, we will immediately delist our common stock from
the American Stock Exchange.
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.
20
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, 2001, was $28.66 and the low sale price of the Company's
common stock for the year ended December 31, 2001, was $19.75.
According to the records of the Company's transfer agent, the Company had
8.5 million shares outstanding as of December 31, 2001. As of December 31, 2001,
the Company had seven shareholders of record. Because many shares are held by
brokers and other institutions on behalf of shareholders, the Company is unable
to determine the exact number of beneficial shareholders of the Company's common
stock; however, based on information provided to the Company by Investor
Communication Services, a division of Automatic Data Processing Inc., the
Company estimates that it had approximately 5,400 beneficial shareholders as of
the date of this Report.
DIVIDENDS & DISTRIBUTION POLICY
To maintain its status as a REIT for federal income tax purposes, the
Company is required to distribute at least 90% 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.
21
To date, the Company has declared the following dividends:
<Table>
<Caption>
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
01/01/01-03/31/01........................................... 2,083,516 0.600
04/01/01-06/30/01........................................... 2,257,143 0.650
07/01/01-09/30/01........................................... 6,386,022 0.800
10/01/01-12/31/01(8)........................................ 10,645,659 1.250
----------- ------
$57,093,196 $9.065
=========== ======
</Table>
- ---------------
(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.
(8) Dividend declared December 14, 2001, and paid on January 15, 2002, to
shareholder of record as of December 31, 2001.
Through December 31, 2001, 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
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.
22
ITEM 6. SELECTED FINANCIAL DATA
<Table>
<Caption>
2001 2000 1999
----------- ----------- -----------
STATEMENT OF OPERATIONS DATA:
Interest income....................................... $32,390,594 $18,758,866 $15,823,914
Dividend income....................................... 3,820,985 5,082,191 7,649,935
Fee income............................................ 2,875,780
Interest expense...................................... 14,612,625 10,935,130 7,920,648
Management fee expense................................ 3,494,357 1,078,713 1,329,063
Other expense......................................... 772,152 596,374 1,432,589
Net realized and recognized gains (losses)............ 3,330,252 (2,866,360) (7,648,960)
Net income............................................ 23,065,074 8,364,480 5,142,589
Basic income per share................................ 4.27 1.84 0.68
Weighted average basic shares......................... 5,402,150 4,543,532 7,523,715
Diluted income per share.............................. 4.17 1.84 0.68
Weighted average diluted shares....................... 5,525,270 4,543,532 7,523,715
Dividends declared per share(1)....................... 3.30 2.95 1.61
</Table>
<Table>
<Caption>
2001 2000
-------------- ------------
SELECTED BALANCE SHEET DATA:
Mortgage-backed securities, at fair value................... $1,238,365,511 $154,848,205
Cash and cash equivalents................................... 6,630,379 36,810,566
Investments in equity securities, at fair value............. 61,692,660 28,110,190
Notes receivable............................................ 8,000,000 4,000,000
Total assets................................................ 1,325,125,218 225,804,067
Repurchase agreements....................................... 1,105,145,000 133,896,000
Total liabilities........................................... 1,121,259,672 138,963,483
Accumulated other comprehensive income (loss)(2)............ 15,154,257 (748,691)
Shareholders' equity........................................ 203,865,546 86,840,584
Book value per share........................................ 23.98 22.36
Common shares issued and outstanding........................ 8,502,527 3,884,427
</Table>
<Table>
<Caption>
2001 2000 1999
------------ ------------ ------------
OTHER SELECTED DATA
Weighted average daily borrowings.................. $462,952,444 $172,287,472 $143,231,112
Average equity..................................... 133,848,577 90,393,190 130,269,059
</Table>
- ---------------
(1) Dividends are calculated and declared based on estimates of the Company's
taxable income.
(2) Accumulated other comprehensive income or loss includes unrealized net gain
on mortgage-backed securities of $270,378 as of December 31, 2001, and
unrealized net loss on mortgage-backed securities of $530,869 as of December
31, 2000, and unrealized net gain on investments in equity securities of
$14,883,879 as of December 31. 2001, unrealized net loss on investments in
equity securities of $217,822 as of December 31, 2000.
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 and, subject to maintaining REIT qualification,
companies unrelated to real estate. 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, mezzanine and senior loans, and equity
securities.
23
As of December 31, 2001, the Company's principal assets were:
- mortgage-backed securities totaling $1.2 billion, which were financed
with repurchase agreements totaling $1.1 billion;
- investments in equity securities of six companies with an original total
cost basis of $48.4 million and a total market value of $61.7 million;
and
- a loan to one company for $8.0 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 revenue are (i) quarterly dividend earnings on its
REIT holdings, (ii) interest earnings on its mortgage-backed securities, notes
receivable, and cash and cash equivalents, (iii) investment banking fee income
and (iv) 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, 2001 AND 2000
The Company generated net income for the year ended December 31, 2001 of
$23.1 million, or $4.27 per basic share, compared to net income of $8.4 million
or $1.84 per basic share for the corresponding period in 2000. Fully diluted net
income per share for the year ended December 31, 2001 was $4.17 per share,
compared to $1.84 per share for the year ended December 31, 2000. The increase
is primarily due to an increase in net interest income from mortgage-backed
securities and fee income.
The Company's total revenue increased to $39.1 million for the year ended
December 31, 2001, from $23.8 million for the year ended December 31, 2000. The
Company invested the proceeds from its follow-on offering completed on August 2,
2001, on a leveraged basis in mortgage-backed securities, thereby substantially
increasing the portfolio size and interest income generated from the portfolio.
For the year ended December 31, 2001, the weighted average annual yield on
the Company's mortgage-backed securities was 5.81%, compared to 6.68% for the
year ended December 31, 2000. Despite the lower yield, the larger asset base
increased interest revenue $13.6 million or 72% from $18.8 million to $32.4
million.
For the year ended December 31, 2001, the weighted average annual yield on
the Company's equity securities and promissory notes was 12.72%, compared to
15.27% for the year ended December 31, 2000. The average annual yield on all
investments decreased to 6.36% from 8.71%, reflecting the decreasing mix of
promissory notes and dividend paying equity securities during 2001 from the
levels of 2000. Dividend income decreased by $1.3 million or 25%.
During 2001, pursuant to an agreement completed during 2001 with Friedman,
Billings, Ramsey & Co., Inc., the Company earned $2.9 million in fees from three
investment banking transactions and one unfunded commitment that it facilitated.
The Company's interest expense increased $3.7 million or 34% from $10.9
million in 2000 to $14.6 million for the year ended December 31, 2001. This
represents 77.4% of the total expenses for the current period and 86.7% of the
total expenses for prior period. The increase in interest expense reflects the
24
168.7% increase in the weighted average borrowing under repurchase agreements to
$462.9 million from $172.3 million offset by a reduction in our average interest
rate from 6.33% to 3.16%.
Management fees increased $2.4 million (218%) for the year ended December
31, 2001, to $3.5 million from $1.1 million for the year ended December 31,
2000. The majority of the increase was due to the Company recording $1.7 million
in incentive management fees during the year. The incentive fee is based on the
company's performance over the preceding 12-month period.
Professional fees and other expenses consist primarily of legal, accounting
and directors fees. Professional fees and other expenses were $772,152 for the
year ended December 31, 2001, and $596,374 for the year ended December 31, 2000.
The increased fees are primarily attributable to increased directors fees
associated with the granting of in-the-money stock options during 2001.
The Company recorded a provision for income taxes on the net income of its
taxable REIT subsidiaries. During 2001, the Company acquired a registered
broker-dealer from FBR Group called Pegasus Capital Corporation and also
established two other taxable REIT subsidiaries. Pegasus participates in a
fee-sharing arrangement with FBR. The payments Pegasus and the other taxable
REIT subsidiaries receive will generally be taxed at normal corporate rates and
will generally not be distributed to our shareholders. At December 31, 2001, the
Company had recorded $473,403 in income taxes payable from income received by
Pegasus and a related taxable REIT subsidiary.
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 basic and diluted share, compared to net income of $5.1
million or $0.68 per basic and diluted share for the corresponding period in
1999. The increase is primarily due to the reduction in recognized losses on
available-for-sale equity securities.
The Company's total revenue 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 received on these mortgage-backed securities.
For the year ended December 31, 2000, the weighted average annual yield on
the Company's mortgage-backed securities was 6.68%, compared to 6.51% for the
year ended December 31, 1999.
The weighted average annual yield on FBR Asset's equity securities and
promissory notes was 15.27% during 2000, compared to 11.20% for the year ended
December 31, 1999. 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, which represents 74.2% of the total expenses for that period.
The $3.0 million increase in interest expense reflects the 20.3% increase in the
weighted average borrowing 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 starting
during the fourth quarter of 1999. The management fee is based on the Company's
assets, and is a lower percentage for mortgage-backed assets relative to other
investments.
Professional fees and other expenses consist primarily of legal and
accounting fees. Professional fees and other expenses were $596,374 for the year
ended December 31, 2000, and $1.4 million for the year ended
25
December 31, 1999. The decreased fees are attributable to the reduction of legal
and audit fees incurred in connection with the Company's registration of the
Company's stock in September, 1999.
CHANGES IN FINANCIAL CONDITION
MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE
The Company invests primarily 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 $1.2 billion as of December
31, 2001. The Company held mortgage-backed securities of $154.8 million on
December 31, 2000.
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, 2001, the amount of
unamortized premium, net of discounts, recorded in the Company's statement of
financial condition was $25.4 million. 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.
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
effective interest rate 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, the Company's
effective interest rate 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 $158.2 million
for the year ended December 31, 2001. The Company received mortgage principal
repayments equal to $23.7 million for the year ended December 31, 2000.
At December 31, 2001, $14.9 million of net unrealized gains on equity
securities and $0.3 million of net unrealized gains on mortgage-backed
securities, including unrealized losses on the interest rate swap, were included
in the Company's statement of financial condition as accumulated other
comprehensive loss. 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. 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 $1.1 billion outstanding under repurchase agreements with
several financial institutions on December 31, 2001. The Company had $133.9
million outstanding under repurchase agreements on December 31, 2000. At
December 31, 2001, the ratio of the Company's repurchase agreement to
shareholder's equity was 5.42 to 1.
At December 31, 2001, the remaining term to maturity of the Company's
borrowings had been limited to 36 days with a weighted average remaining
maturity of 15 days and a weighted average cost of funds on outstanding
borrowings of 1.87%.
26
At December 31, 2000, the remaining term to maturity of the Company's
borrowings had been limited to 33 days with a weighted average remaining
maturity of 16 days and a weighted average cost of funds on outstanding
borrowings of 6.57%.
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 Lehman Brothers Special Financing
Inc. ("Lehman"). Under the swap agreement with Lehman, 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 4.97% based upon the
$50 million notional amount of the swap.
The swap became effective on July 27, 2001, and matures on July 27, 2004.
At December 31, 2001, the interest rate payable to the Company by Lehman was
2.28%. 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 counterparty to the
swap agreement. At December 31, 2001, $783,774 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 interest and principal
payments on mortgage-backed securities, loans 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 stock, 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 and fund
operating expenses for at least the next twelve months. The Company may,
however, seek debt or equity financings, in public or private transactions, to
provide capital for corporate purposes and/or additional investment
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, 2001, the Company's operating activities
resulted in net cash flows of $19.2 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,
2000, the Company's operating activities provided net cash flows of $13.9
million. 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, 2001, the Company's investing activities
resulted in net cash used of $1.1 billion compared to net cash provided for the
year ended December 31, 2000 of $134.8 million. The increase is primarily
attributable to purchases of mortgage-backed securities during 2001. For the
year ended December 31, 1999, the Company's investing activities resulted in net
cash used of $82.6 million.
For the year ended December 31, 2001, net cash provided by the Company's
financing activities was $1.1 billion compared to net cash used in financing
activities for the year ended December 31, 2000, of $125.3 million. The change
is primarily attributable to an increase in borrowings under repurchase
agreements used to fund mortgage-backed securities purchases and the Company's
August 2001 follow-on common stock
27
offering. For the year ended December 31, 1999, net cash provided by the
Company's financing activities was $45.2 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.
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, 2001, the value of the
equity securities in the Company's portfolio had increased from $48.4 million as
of the date the investments were made to $61.7 million. Increases and declines
have been recorded as accumulated other comprehensive income in the statement of
financial condition. In 2001, the Company recognized and charged to income
losses of $0.5 million on its investment in Prime Retail preferred. 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.
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 shares of it's common stock in 2001, 2000 and 1999:
<Table>
<Caption>
AVERAGE PRICE
YEAR SHARES COST PER SHARE
- ---- --------- ----------- -------------
2001............................................. 411,900 $ 8,334,135 $20.23
2000............................................. 1,921,909 $25,420,635 $13.23
1999............................................. 2,737,191 $37,142,146 $13.57
</Table>
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are described in Note 2 of
the Consolidated Financial Statements. The Company believes its most critical
accounting policies (a critical accounting policy being one that is both very
important to the portrayal of the Company's financial condition and results of
operations and requires management's most difficult, subjective or complex
judgments) are the effective interest rate method the Company uses to recognize
interest income on the mortgage-backed securities and the impairment assessment
it applies to equity securities.
Interest income incudes contractual interest payments adjusted for the
amortization of premiums or discounts recorded upon purchase. Changes in
estimated yields for mortgage-backed securities result primarily from changes in
the timing and amount of actual cash flows that are impacted by interest rate
changes and prepayment speeds. Changes in the estimated yields are recognized
over the estimated remaining life of the investment, based on the experience to
date, as well as expected future returns. The mortgage-backed portfolio had
$25.4 million of net premium at December 31, 2001. Generally, if future
prepayment speeds occur faster
28
than estimated the effective yield on the mortgage-backed portfolio should
decrease, and conversely, if prepayment speeds occur slower than estimated, the
effective yield should increase.
The Company evaluates its investments in equity securities for "other than
temporary" impairment. If it is determined that an investment is impaired then
the amount that the fair value of the investment is below its cost basis is
recorded as an impairment charge and recorded through earnings as opposed to
through other comprehensive income as temporary changes in fair value would be.
The value of the Company's equity investments can fluctuate significantly as is
seen in the significant appreciation of fair value during 2001. Generally, when
an equity security's fair value has been below its cost basis for an extended
period of time the Company will record an impairment charge.
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 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 decline, prepayment
rates may slow and durations may extend. The Company finances its investments in
mortgage-backed securities through repurchase agreements. If short-term interest
rates increase, the Company's profit margin in mortgage-backed securities may
decrease.
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.
Under FAS 133, changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, depending
on the type of hedge transaction. For fair value hedge transactions, changes in
the fair value of the derivative instrument and changes in the fair value of the
hedged item due to the risk being hedged are recorded through the income
statement. For cash-flow hedge transactions, effective changes in the fair value
of the derivative instrument are reported in other comprehensive income while
ineffective changes are recorded through the income statement. The gains and
losses on cash flow hedge transactions that are reported in other comprehensive
income are reclassified to earnings in the periods in which earnings are
effected by the hedged cash flows.
As previously discussed, the Company uses interest rate swaps to hedge the
variability in interest payments associated with the variable rate repurchase
agreements. Prior to SFAS 133, the Company did not
29
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.
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 12/31/01." 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.
<Table>
<Caption>
VALUE AT VALUE AT
12/30/01 WITH 12/31/01 WITH
100 BASIS POINT 100 BASIS POINT
VALUE AT INCREASE IN PERCENT DECREASE IN PERCENT
12/30/01(1) INTEREST RATES CHANGE INTEREST RATES CHANGE
-------------- --------------- ------- --------------- -------
ASSETS
Mortgage securities.......... $1,238,365,511 $1,202,541,940 (2.89)% $1,258,759,791 1.65%
Other........................ 86,759,707 86,759,707 -- 86,759,707
-------------- -------------- --------------
TOTAL ASSETS............ $1,325,125,218 $1,289,301,647 (2.70)% $1,345,519,498 1.54%
============== ============== ==============
LIABILITIES
Interest rate swap........... $ (2,022,958)(2) $ (927,275) $ (3,340,582)
Other........................ 1,123,282,630 1,123,282,630 1,123,282,630
-------------- -------------- --------------
TOTAL LIABILITIES....... 1,121,259,672 1,122,355,355 0.10% 1,119,942,048 (0.12)%
-------------- -------------- --------------
SHAREHOLDERS' EQUITY
Common stock................. 85,025 85,025 85,025
Paid-in-capital.............. 206,916,930 206,916,930 206,916,930
Accumulated other
comprehensive income
(loss)..................... 15,154,257 (21,764,997) (243.62)% 36,866,161 143.27%
Retained earnings
(deficit).................. (18,290,666) (18,290,666) (18,290,666)
-------------- -------------- --------------
TOTAL SHAREHOLDERS' EQUITY... 203,865,546 166,946,292 (18.11)% 225,577,450 10.65%
-------------- -------------- --------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY....... $1,325,125,218 $1,289,301,647 $1,345,519,498
============== ============== ==============
</Table>
- ---------------
(1) Includes Accrued Interest.
(2) The fair value of the interest rate swap is based on counter party quotes as
of December 31, 2001. As of December 31, 2001, interest payments received
under the swap agreement were based on an interest rate of 2.28% while
interest payments made were based on an interest rate of 4.97%.
As shown above, the portfolio generally will benefit less from a decline in
interest rates than it will be negatively affected by a same scale increase in
interest rates. This may effectively limit an investor's upside potential
opportunity in a market rally.
30
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 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 exactly 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, 2001.
<Table>
<Caption>
VALUE AT VALUE AT
VALUE AT DECEMBER 31, DECEMBER 31,
DECEMBER 31, 2001 WITH 10% PERCENT 2001 WITH 10% PERCENT
2001 INCREASE IN PRICE CHANGE DECREASE IN PRICE CHANGE
-------------- ----------------- ------- ----------------- -------
ASSETS
Equity securities............... $ 61,692,660 $ 67,861,926 10.00% $ 55,523,394 (10.00)%
Other........................... 1,263,432,558 1,263,432,558 -- 1,263,432,558 --
-------------- -------------- --------------
TOTAL ASSETS............... $1,325,125,218 $1,331,294,484 0.47% $1,318,955,952 (0.47)%
============== ============== ==============
LIABILITIES....................... $1,121,259,672 $1,121,259,672 -- $1,121,259,672 --
SHAREHOLDERS' EQUITY
Common stock.................... $ 85,025 $ 85,025 -- $ 85,025 --
Paid-in-capital................. 206,916,930 206,916,930 -- 206,916,930 --
Accumulated comprehensive
income........................ 15,154,257 21,323,523 40.71% 8,984,991 (40.71)%
Retained earnings (deficit)..... (18,290,666) (18,290,666) -- (18,290,666) --
-------------- -------------- --------------
TOTAL SHAREHOLDERS' EQUITY.... 203,865,546 210,034,812 3.03% 197,696,280 (3.03)%
-------------- -------------- --------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY....... $1,325,125,218 $1,331,294,484 0.47% $1,318,955,952 (0.47)%
============== ============== ==============
BOOK VALUE PER SHARE.............. $ 23.98 $ 24.70 3.03% $ 23.25 (3.03)%
</Table>
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 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, 2001, the Company would have incurred
a gain of approximately $14.9 million which would have been credited to
earnings.
EVENTS SINCE DECEMBER 31, 2001
Dividend Payment
On March 14, 2002, the Company announced that its Board of Directors voted
to declare a first quarter dividend of $1.25 per share, payable on April 15,
2002, to shareholders of record as of March 28, 2002.
31
Follow-on Common Stock Offering
On February 1, 2002, the Company completed the sale of 4,800,000 shares of
its common stock at a price per share of $26.50. The aggregate proceeds to the
Company, net of underwriting discounts and commissions, totaled approximately
$120.8 million. On February 28, 2002, the Company completed the sale of an
additional 720,000 shares of its common stock as a result of the underwriters'
full exercise of their over-allotment option. The aggregate proceeds to the
Company, net of the underwriting discounts and commission, totaled approximately
an additional $18.1 million.
Exercise by FBR Management of Remaining Options
On February 15, 2002, FBR Management exercised its remaining options to
purchase 415,805 shares of the Company's common stock at the exercise price of
$20 per share, or $8,316,100. FBR Management has advised the Company that it has
no current intention to sell any of the shares of the Company's common stock
that it has acquired through option exercises or any of its other shares of the
Company's common stock that it holds for investment purposes.
Additional Loan
On March 20, 2002, the Company extended to Oxford Finance Corporation a
$10,000,000 loan to fund the extension of equipment leases to five companies
primarily in the pharmaceutical sector. The loan is secured by a first priority
lien on the leased equipment and other collateral. The term of the loan is 60
days. The loan bears interest at a rate of 12% per annum. The Company received a
$200,000 origination fee when the loan was funded.
Change of Independent Accountants
On March 14, 2002, the Company determined not to renew the engagement of
our independent accountants, Arthur Andersen LLP ("Andersen"), and appointed
KPMG LLP ("KPMG") as its new independent accountants, effective immediately.
This determination followed the Company's decision to seek proposals from
independent accountants to audit its financial statements for the fiscal year
ending December 31, 2002. The decision not to renew the engagement of Andersen
and to retain KPMG was approved by the Company's Board of Directors upon the
recommendation of the Audit Committee of the Company's Board.
Termination of Sub-Advisory Agreement with Respect to the Company's Mortgage
Assets
On March 22, 2002, Friedman, Billings, Ramsey Investment Management, Inc.
("FBRIM"), the Company's external adviser, notified Fixed Income Discount
Advisory Company, Inc. ("FIDAC"), FBRIM's sub-adviser with respect to the
management of the Company's mortgage-backed securities portfolio, that it had
determined to terminate the sub-advisory agreement with FIDAC. The decision to
terminate the sub-advisory agreement with FIDAC was based on FBRIM's
determination, after consultation with the Company's Board of Directors, that it
would be in the best interests of the Company and its shareholders to terminate
the sub-advisory agreement in light of the increased size of the Company's
equity capital and mortgage-backed securities portfolio. The sub-advisory
agreement will end in accordance with its terms on April 30, 2002. Concurrently
with the end of the sub-advisory agreement, FBR Asset and FBRIM have agreed to a
reduction of the management fee that the Company will be required to pay from
0.25% to 0.20% per annum of the average book value of the Company's mortgage
assets during each calendar quarter.
New York Stock Exchange Original Listing Application
On March 25, 2002, the Company filed an application to list its common
stock for trading on the New York Stock Exchange. If the Company is able to list
its common stock on the New York Stock Exchange, the Company will immediately
delist its common stock from the American Stock Exchange.
32
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.
33
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 23, 2002, under the headings
"Proposal No. 1 -- Election of Directors" and "Section 16 (a) Beneficial
Ownership Reporting Compliance." Information regarding executive officers found
under the heading "Business -- Employees and Executive Officers of the Company"
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 23, 2002, under the heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is incorporated by reference to
the Company's definitive Proxy Statement for its annual meeting of shareholders
to be held on May 23, 2002 under the heading "Security Ownership of Certain
Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is incorporated by reference to
the Company's definitive proxy statement for its annual meeting of shareholders
to be held on or around May 23, 2002, under the heading "Certain Relationships
and Related Transactions."
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, 2001, filed as Exhibit 13.01 to
this Form 10-K, are incorporated by reference into this Item 14:
<Table>
<Caption>
PAGES
-----
Report of Independent Public Accountants.................... F-2
Statements of Financial Condition as of December 31, 2001
and 2000.................................................. F-3
Statements of Income for the Years ended December 31, 2001,
2000 and 1999............................................. F-4
Statements of Changes in Shareholders' Equity for the Years
ended December 31, 2001, 2000 and 1999.................... F-5
Statements of Cash Flows for the Years ended December 31,
2001, 2000 and 1999....................................... F-6
Notes to Financial Statements............................... F-7
</Table>
2. All schedules are omitted because they are not required or because the
information is shown in the financial statements or notes thereto.
34
3. Following is a list of exhibits to this Form 10-K, which are
incorporated by reference into this Item 14.
<Table>
<Caption>
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.*
4.02 Form of Senior Indenture.*****
4.03 Form of Senior Debt Security.*****
4.04 Form of Subordinated Indenture.*****
4.05 Form of Subordinated Debt Security.*****
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 Agreement to Extend and Amend Management Agreement dated
December 17, 2001, by and between the Company and Friedman,
Billings, Ramsey Investment Management, Inc.*****
10.05 License Agreement, dated December 17, 1997, by and between
the Company and Friedman, Billings, Ramsey Group, Inc.*
10.06 Stock Option Agreement, dated December 17, 1997, by and
between the Company and Friedman, Billings, Ramsey
Investment Management, Inc.*
10.07 Sub-Management Agreement, dated February 14, 2000, by and
between Friedman, Billings, Ramsey Investment Management,
Inc. and Fixed Income Discount Advisory Company, Inc.**
10.08 Stock Incentive Plan.*
10.09 Letter Agreement, dated July 9, 2001, by and among FBR, FBR
Asset and Pegasus.****
13.01 Annual Report to Shareholders for the Year ended December
31, 2001.
21.01 List of Subsidiaries of the Registrant.*****
99.01 Risks of Investing in the Registrant.
99.02 Representation Pursuant to Temporary Note 3T to Article 3 of
Regulation S-X.
</Table>
- ---------------
* 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.
*** Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000, filed with the SEC on April 2, 2001.
**** Filed as an exhibit to FBR Asset's Registration Statement on Form S-11, as
amended, Registration No. 333-63344.
***** Filed as an exhibit to FBR Asset's Registration Statement on Form S-3, as
amended, Registration No. 333-75408.
35
FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
<Table>
<Caption>
PAGE
----
Report of Independent Public Accountants.................... F-2
Statements of Financial Condition as of December 31, 2001,
and December 31, 2000..................................... F-3
Statements of Income for the Years Ended December 31, 2001,
December 31, 2000, December 31, 1999...................... F-4
Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 2001, December 31, 2000, and December
31, 1999.................................................. F-5
Statements of Cash Flows for the Years Ended December 31,
2001, December 31, 2000, and December 31, 1999............ F-6
Notes to Financial Statements............................... F-7
</Table>
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, 2001 and 2000,
and the related statements of income, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of FBR Asset Investment
Corporation as of December 31, 2001 and 2000, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2001 in conformity with accounting principles generally accepted in the United
States.
/S/ ARTHUR ANDERSEN LLP
Vienna, Virginia
January 31, 2002
F-2
FBR ASSET INVESTMENT CORPORATION
STATEMENTS OF FINANCIAL CONDITION
AS OF DECEMBER 31, 2001 AND DECEMBER 31, 2000
<Table>
<Caption>
AS OF AS OF
DECEMBER 31, DECEMBER 31,
2001 2000
-------------- ------------
ASSETS
Mortgage-backed securities, pledged as collateral, at fair
value.................................................. $1,188,730,763 $144,867,416
Mortgage-backed securities, at fair value................. 49,634,748 9,980,789
Investments in equity securities, at fair value........... 61,692,660 28,110,190
Cash and cash equivalents................................. 6,630,379 36,810,566
Note receivable........................................... 8,000,000 4,000,000
Dividends, interest and fees receivable................... 10,241,837 1,813,478
Prepaid expenses and other assets......................... 194,831 221,628
-------------- ------------
TOTAL ASSETS...................................... $1,325,125,218 $225,804,067
============== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements..................................... $1,105,145,000 $133,896,000
Interest rate swap........................................ 1,159,167 --
Interest payable.......................................... 2,177,892 844,841
Dividends payable......................................... 10,645,659 3,731,911
Management fees payable................................... 1,117,458 78,727
Accounts payable and accrued expenses..................... 505,549 237,218
Income taxes payable...................................... 473,403 --
Other..................................................... 35,544 174,786
-------------- ------------
TOTAL LIABILITIES................................. 1,121,259,672 138,963,483
-------------- ------------
SHAREHOLDERS' EQUITY:
Preferred stock, par value $.01 per share, 50,000,000
shares authorized...................................... -- --
Common stock, par value $.01 per share, 200,000,000 shares
authorized, 8,502,527 and 3,884,427 shares issued and
outstanding as of December 31, 2001 and December 31,
2000, respectively..................................... 85,025 38,844
Additional paid-in capital................................ 206,916,930 107,529,063
Accumulated other comprehensive income (loss)............. 15,154,257 (748,691)
Retained deficit.......................................... (18,290,666) (19,978,632)
-------------- ------------
TOTAL SHAREHOLDERS' EQUITY........................ 203,865,546 86,840,584
-------------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $1,325,125,218 $225,804,067
============== ============
</Table>
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, 2001, 2000 AND 1999
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
REVENUE:
Interest............................................ $32,390,594 $18,758,866 $15,823,914
Dividends........................................... 3,820,985 5,082,191 7,649,935
Fee income.......................................... 2,875,780 -- --
----------- ----------- -----------
Total income..................................... 39,087,359 23,841,057 23,473,849
----------- ----------- -----------
EXPENSES:
Interest............................................ 14,612,625 10,935,130 7,920,648
Management fee...................................... 3,494,357 1,078,713 1,329,063
Professional fees and other......................... 772,152 596,374 1,432,589
----------- ----------- -----------
Total expenses................................... 18,879,134 12,610,217 10,682,300
----------- ----------- -----------
Realized gain (loss) on sale of mortgage-backed
securities, net..................................... 1,106,598 67,358 (358,692)
Realized gain on sale of equity securities, net....... 2,768,534 2,692,304 3,597,190
Recognized loss on available-for-sale equity
securities.......................................... (544,880) (5,626,022) (10,887,458)
----------- ----------- -----------
Net income before taxes............................... 23,538,477 8,364,480 5,142,589
----------- ----------- -----------
Income tax expense.................................... (473,403) -- --
----------- ----------- -----------
Net income............................................ $23,065,074 $ 8,364,480 $ 5,142,589
=========== =========== ===========
Basic earnings per share.............................. $ 4.27 $ 1.84 $ 0.68
=========== =========== ===========
Basic weighted-average common and equivalent shares... 5,402,150 4,543,532 7,523,715
=========== =========== ===========
Diluted earnings per share............................ $ 4.17 $ 1.84 $ 0.68
=========== =========== ===========
Diluted weighted-average common and equivalent
shares.............................................. 5,525,270 4,543,532 7,523,715
=========== =========== ===========
</Table>
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, 2001, 2000 AND 1999
<Table>
<Caption>
ACCUMULATED
OTHER
ADDITIONAL RETAINED COMPREHENSIVE
COMMON PAID IN EARNINGS INCOME COMPREHENSIVE
STOCK CAPITAL (DEFICIT) (LOSS) TOTAL INCOME
------- ------------ ------------ ------------- ------------ -------------
BALANCE, DECEMBER 31, 1998.......... $85,435 $170,045,253 $ (9,425,579) $(9,800,530) $150,904,579
Repurchase of common stock........ (27,372) (37,114,774) -- -- (37,142,146)
Net income........................ -- -- 5,142,589 -- 5,142,589 $ 5,142,589
Other comprehensive income
Change in unrealized loss on
available-for-sale
securities.................... -- -- -- (3,181,829) (3,181,829) (3,181,829)
Dividends......................... -- -- (11,180,472) -- (11,180,472) --
------- ------------ ------------ ----------- ------------ -----------
BALANCE, DECEMBER 31, 1999.......... 58,063 132,930,479 (15,463,462) (12,982,359) 104,542,721 $ 1,960,760
------- ------------ ------------ ----------- ------------ ===========
Repurchase of common stock........ (19,219) (25,401,416) -- -- (25,420,635)
Net income........................ -- -- 8,364,480 -- 8,364,480 $ 8,364,480
Other comprehensive income
Change in unrealized loss on
available-for-sale
securities.................... -- -- -- 12,233,668 12,233,668 12,233,668
Dividends......................... -- -- (12,879,650) -- (12,879,650) --
------- ------------ ------------ ----------- ------------ -----------
BALANCE, DECEMBER 31, 2000.......... 38,844 107,529,063 (19,978,632) (748,691) 86,840,584 $20,598,148
------- ------------ ------------ ----------- ------------ ===========
Issuance of common stock.......... 50,300 107,575,383 -- 107,625,683
Repurchase of common stock........ (4,119) (8,330,016) (8,334,135)
Options granted................... -- 142,500 -- 142,500
Net income........................ -- -- 23,065,074 -- 23,065,074 $23,065,074
Other comprehensive income
Change in unrealized gain (loss)
on available-for-sale
securities.................... -- -- -- 17,062,115 17,062,115 17,062,115
Change in unrealized loss on
cashflow hedge................ -- -- -- (1,159,167) (1,159,167) (1,159,167)
Dividends......................... -- -- (21,377,108) -- (21,377,108) --
------- ------------ ------------ ----------- ------------ -----------
BALANCE, DECEMBER 31, 2001.......... $85,025 $206,916,930 $(18,290,666) $15,154,257 $203,865,546 $38,968,022
======= ============ ============ =========== ============ ===========
</Table>
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, 2001, 2000 AND 1999
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31
-----------------------------------------------
2001 2000 1999
--------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................... $ 23,065,074 $ 8,364,480 $ 5,142,589
Adjustments to reconcile net income to net
cash provided by operating activities:
Realized and recognized (gain) loss on
mortgage-backed and equity securities,
net...................................... (3,330,252) 2,866,360 7,648,960
Amortization.......................... 4,717 456,342
Premium amortization on
mortgage-backed securities.......... 4,779,118 296,626 682,695
Compensation expense related to stock
option grants....................... 142,500 -- --
Changes in operating assets and
liabilities:
Dividends, interest and fees
receivable....................... (8,428,358) 1,227,197 (200,150)
Due from custodian.................. -- 806,093 (806,093)
Prepaid expenses.................... 26,797 31,888 (248,799)
Management fees payable............. 1,038,731 (158,440) (1,038,347)
Accounts payable and accrued
expenses......................... 268,329 107,539 (95,256)
Interest payable.................... 1,333,051 357,619 177,126
Due to custodian.................... -- -- (2,041,230)
Income taxes payable................ 473,403 -- --
Other............................... (139,241) (3,519) 5,479
--------------- ------------- -------------
Net cash provided by operating
activities..................... 19,229,152 13,900,560 9,683,316
--------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage-backed securities........ (1,340,540,932) (40,917,985) (282,288,201)
Investments in equity securities.............. (30,269,000) (1,801,410) (11,454,320)
Investments in notes receivable............... (12,000,000) (4,000,000) (59,113,179)
Repayment of notes receivable................. 8,000,000 27,000,000 51,196,100
Proceeds from sale of mortgage-backed
securities................................. 96,938,432 101,529,084 160,809,435
Proceeds from sale of equity securities....... 14,201,575 29,239,857 27,894,010
Receipt of principal payments on
mortgage-backed securities................. 158,183,398 23,720,735 30,376,288
--------------- ------------- -------------
Net cash (used in) provided by
investing activities........... (1,105,486,527) 134,770,281 (82,579,867)
--------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of common stock.................... (8,334,135) (25,420,635) (37,142,146)
Proceeds from issuance of common stock........ 107,625,683 -- --
Proceeds from (repayments of) repurchase
agreements, net............................ 971,249,000 (87,818,000) 93,164,000
Dividends paid................................ (14,463,360) (12,039,107) (10,852,162)
--------------- ------------- -------------
Net cash provided by (used in)
financing activities........... 1,056,077,188 (125,277,742) 45,169,692
--------------- ------------- -------------
Net (decrease) increase in cash and cash
equivalents................................... (30,180,187) 23,393,099 (27,726,859)
Cash and cash equivalents, beginning of the
period........................................ 36,810,566 13,417,467 41,144,326
--------------- ------------- -------------
Cash and cash equivalents, end of the period.... $ 6,630,379 $ 36,810,566 $ 13,417,467
=============== ============= =============
Supplemental disclosure:
Cash payments for interest...................... $ 13,279,574 $ 10,577,511 $ 7,743,522
=============== ============= =============
</Table>
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 purchase mortgage-backed securities and make investments
in debt and equity securities of companies engaged in real estate-related and
other businesses. FBR Asset invests in mortgage loans and mortgage-backed
securities, that represent a 100 percent interest in the underlying conforming
mortgage loans and are guaranteed by the Government National Mortgage
Association ("Ginnie Mae"), the Federal Home Loan Mortgage Corporation ("Freddie
Mac"), and the Federal National Mortgage Association ("Fannie Mae"), or by
private issuers that are secured by real estate (together the "Mortgage
Assets"). FBR Asset also acquires indirect interests in those and other types of
real estate-related assets by investing in public and private real estate
companies, subject to the limitations imposed by the various REIT qualification
requirements. Funds not immediately allocated are generally temporarily invested
in readily marketable, interest-bearing securities. To seek yields commensurate
with its investment objectives, FBR Asset leverages its mortgage-backed security
portfolio primarily with collateralized borrowings. FBR Asset uses derivative
financial instruments to hedge a portion of the interest rate risk associated
with its borrowings.
FBR Asset is managed by Friedman, Billings, Ramsey Investment Management,
Inc. ("FBR Management"), a subsidiary of Friedman, Billings, Ramsey Group, Inc.
("FBR Group").
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INVESTMENTS IN MORTGAGE-BACKED SECURITIES
Mortgage-backed security transactions are recorded on the date the
securities are purchased or sold. Any amounts payable or receivable for
unsettled trades are recorded as "due to or due from custodian" in FBR Asset's
Statement of Financial Condition.
FBR Asset accounts for its investments in mortgage-backed securities as
available-for-sale securities. FBR Asset does not hold its mortgage-backed
securities for trading purposes, but may not hold such investments to maturity.
Securities classified as available-for-sale are reported at fair value, with
temporary unrealized gains and losses excluded from earnings and reported as a
separate component of shareholders' equity. Realized gains and losses on
mortgage-backed securities transactions are determined on the specific
identification method.
Unrealized losses on mortgage-backed securities that are determined to be
other than temporary are recognized in income. Management regularly reviews its
investment portfolio for other than temporary market value decline. There were
no such adjustments for mortgage-backed investments during the periods
presented.
The fair value of FBR Asset's mortgage-backed securities are based on
market prices provided by certain independent dealers who make markets in these
financial instruments. The fair values reported reflect estimates and may not
necessarily be indicative of the amounts FBR Asset could realize in a current
market transaction.
Income from investments in mortgage-backed securities is recognized using
the effective interest method, using the expected yield over the life of the
investment. Income includes contractual interest accrued and the amortization or
accretion of any premium or discount recorded upon purchase. Changes in
anticipated yields result primarily from changes in actual and projected cash
flows and estimated prepayments. Changes in the yield that result from changes
in the anticipated cash flows and prepayments are recognized over the remaining
life of the investment with recognition of a cumulative catch-up at the date of
change from the date of original investment.
F-7
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
INVESTMENTS IN EQUITY SECURITIES
Investments in securities that are listed on a national securities exchange
(or reported on the Nasdaq National Market) are stated at the last reported sale
price on the day of valuation. Listed securities for which no sale was reported
are stated at the mean between the closing "bid" and "ask" price on the day of
valuation. Investments which are not listed on a national securities exchange
(or reported on the Nasdaq National Market) are carried at cost. FBR Management
may use methods of valuing securities other than those described above if it
believes the alternative method is preferable in determining the fair value of
such securities.
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 that have a readily determinable fair
value 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 ex-dividend date.
Management regularly reviews any declines in the market value of its equity
investments for declines that are other than temporary. Such declines are
recorded in operations as a "recognized loss on available-for-sale securities."
NOTE RECEIVABLE
Notes Receivable are carried at cost as the Company has the intent to hold
such note receivables for the foreseeable future. Interest income is recognized
using the effective interest method which recognizes any fees or costs related
to the Note over its life. If it becomes probable the Company will not collect
the scheduled payments on the Notes Receivable then the Note Receivable is
considered impaired and written down to fair value if applicable.
CASH AND CASH EQUIVALENTS
All investments with original maturities of less than three months are cash
equivalents. As of December 31, 2001, cash and cash equivalents consisted of
$1.4 million of cash deposited in two commercial banks and $5.2 million in three
separate domestic money market funds. As of December 31, 2000, cash and cash
equivalents consisted of $2.1 million of cash deposited in two commercial banks
and $34.7 million in two separate domestic money market funds. The carrying
amount of cash equivalents approximates their fair value.
COMPREHENSIVE INCOME
Comprehensive income includes net income as currently reported by the
Company on the statement of income adjusted for other comprehensive income.
Other comprehensive income for the Company is changes in unrealized gains and
losses related to the Company's mortgage-backed securities ("MBS") and equity
securities accounted for as available for sale with changes in fair value
recorded through shareholders equity and changes in unrealized gains and losses
related to the company's use of cash flow hedges. The table below breaks out
other comprehensive income for the periods presented into the following two
categories: (1) the changes to unrealized gains and losses that relate to the
MBS and equity securities which were disposed of or impaired during the period
with the resulting gain or loss reflected in net income (reclassification
adjustments) and (2) the change in the unrealized gain or loss related to those
investments and cash flow hedges that were not disposed of or impaired during
the period.
F-8
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
2001 2000 1999
----------- ----------- ------------
Reclassification adjustment for (gains) losses from
dispositions included in net income................ $(1,055,298) $(2,220,998) $ (1,313)
Reclassification adjustment for impairment loss
recognized on equity securities included in net
income............................................. 529,168 4,516,638 10,589,124
Unrealized holding (losses) gains arising during the
period............................................. 16,429,078 9,938,028 (13,769,640)
----------- ----------- ------------
Net adjustment to unrealized gains (losses) on
Investments........................................ $15,902,948 $12,233,668 $ (3,181,829)
=========== =========== ============
</Table>
CREDIT RISK
FBR Asset is exposed to the risk of credit losses on its portfolio of
mortgage-backed securities and notes receivable, such as the note from Prime
Group Realty referred to in Note 5. In addition, many of FBR Asset's investments
in equity securities are in companies that are also exposed to the risk of
credit losses in their businesses.
FBR Asset seeks to limit its exposure to credit losses on its portfolio of
mortgage-backed securities by purchasing securities issued and guaranteed by
Freddie Mac, Fannie Mae, or Ginnie Mae. The payment of principal and interest on
the Freddie Mac and Fannie Mae mortgage-backed securities are guaranteed by
those respective agencies and the payment of principal and interest on the
Ginnie Mae mortgage-backed securities is backed by the full-faith-and-credit of
the U.S. Government. At December 31, 2001 and 2000, all of FBR Asset's
mortgage-backed securities have an implied "AAA" rating. FBR Asset's notes
receivable are not issued or guaranteed by Freddie Mac, Fannie Mae or Ginnie
Mae.
LEVERAGE RISK
At December 31, 2001, our outstanding indebtedness for borrowed money under
repurchase agreements was 8.30 times the amount of our equity in the
mortgage-backed securities, based on book values. FBR Management has the
authority to increase or decrease our overall debt-to-equity ratio on our total
portfolio at any time. At December 31, 2001, our total debt-to-equity ratio was
5.42 to 1. If we borrow more funds, the possibility that we would be unable to
meet our debt obligations as they come due would increase. Financing assets
through repurchase agreements exposes us to the risk that margin calls will be
made and that we will not be able to meet those margin calls, which could result
in the Company selling the mortgage-backed securities at a loss to cover the
margin calls.
CONCENTRATION RISK
Equity and debt investments, such as Annaly Mortgage Management, Anworth
Mortgage Asset Corporation, Capital Automotive REIT and Prime Group Realty may
create exposure to issuers that are generally concentrated in the REIT industry
and may even pursue similar investment strategies as the Company. These entities
may hold non-investment grade securities and securities of privately held
issuers with no ready markets. The concentration and illiquidity of these
investments could expose the Company to a higher degree of risk than is
associated with more diversified investment grade or readily marketable
securities, and may also enhance the under-performance risk of the Company's
mortgage-backed securities strategy over time.
F-9
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NET INCOME PER SHARE
FBR Asset presents basic and diluted earnings per share. Basic earnings per
share excludes potential dilution and is computed by dividing income available
to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that would share in earnings. This includes stock options for the company
which were dilutive for the periods presented.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
INCOME TAXES
FBR Asset has elected to be taxed as a REIT under the Internal Revenue
Code. To qualify for tax treatment as a REIT, FBR Asset must meet certain income
and asset tests and distribution requirements. FBR Asset generally will not be
subject to federal income tax at the corporate level to the extent that it
distributes at least 90 percent of its taxable income to its shareholders and
complies with certain other requirements. Failure to meet these requirements
could have a material adverse impact on FBR Asset's results or financial
condition. Furthermore, because FBR Asset's investments include stock in other
REITs, failure of those REITs to maintain their REIT status could jeopardize FBR
Asset's qualification as a REIT. During 2001, FBR asset acquired a registered
broker-dealer from FBR Group called Pegasus Capital Corporation and also
established two other taxable REIT subsidiaries. Pegasus participates in a
fee-sharing arrangement with FBR (see Note 8 "Fee Income"). The payments Pegasus
and the other taxable REIT subsidiaries receive will generally be taxed at
normal corporate rates and will generally not be distributed to our
shareholders. At December 31, 2001, FBR Asset had recorded $473,403 in income
taxes payable from income received by Pegasus and a related taxable REIT
subsidiary.
NOTE 3 MORTGAGE-BACKED SECURITIES
The following tables summarize FBR Asset's mortgage-backed securities as of
December 31, 2001 and 2000:
<Table>
<Caption>
TOTAL MORTGAGE
DECEMBER 31, 2001 FREDDIE MAC FANNIE MAE ASSETS
----------------- ------------ ------------ --------------
Mortgage-backed securities, available-for-sale,
face........................................... $482,782,231 $728,768,617 $1,211,550,848
Unamortized net premium.......................... 10,631,657 14,753,461 25,385,118
------------ ------------ --------------
Amortized cost................................... 493,413,888 743,522,078 1,236,935,966
Gross unrealized gains........................... 1,412,595 2,680,256 4,092,851
Gross unrealized losses.......................... (1,174,291) (1,489,015) (2,663,306)
------------ ------------ --------------
Fair value....................................... $493,652,192 $744,713,319 $1,238,365,511
============ ============ ==============
</Table>
F-10
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
TOTAL MORTGAGE
DECEMBER 31, 2000 FREDDIE MAC FANNIE MAE GINNIE MAE ASSETS
----------------- ----------- ----------- ----------- --------------
Mortgage-backed securities,
available-for-sale, face.............. $85,927,247 $58,134,867 $ 9,660,054 $153,722,168
Unamortized net premium................. 413,946 669,906 573,054 1,656,906
----------- ----------- ----------- ------------
Amortized cost.......................... 86,341,193 58,804,773 10,233,108 155,379,074
Gross unrealized gains.................. 138,622 424,165 -- 562,787
Gross unrealized losses................. (380,578) (411,713) (301,365) (1,093,656)
----------- ----------- ----------- ------------
Fair value.............................. $86,099,237 $58,817,225 $ 9,931,743 $154,848,205
=========== =========== =========== ============
</Table>
During 2001, FBR Asset received proceeds of $98.2 million from the sale of
mortgage-backed securities. The Company recorded $1.1 million in net realized
gains related to these sales. For the year ended December 31, 2001 the weighted
average coupon rate on mortgage-backed securities was 6.38% and the weighted
average effective yield was 5.81%. The weighted average life of the
mortgage-backed securities based on assumptions used to determine fair value was
4.37 years at December 31, 2001.
During 2000, FBR Asset received proceeds of $101.5 million from the sale of
mortgage-backed securities. The Company recorded $1.4 million in realized losses
related to these sales. Concurrent with these sales, FBR Asset terminated a
related hedge position and recorded a $1.5 million gain. For the year ended
December 31, 2000 the weighted average coupon rate on mortgage-backed securities
was 7.00% and the weighted average effective yield was 6.68%. The weighted
average life of the mortgage-backed securities based on assumptions used to
determine fair value was 4.20 years at December 31, 2000.
NOTE 4 EQUITY INVESTMENTS
At December 31, 2001, FBR Asset's equity investments had an aggregate cost
basis of $46.8 million, a fair value of $61.7 million, and unrealized gains of
$14.9 million.
At December 31, 2000, FBR Asset's equity investments had an aggregate cost
basis of $28.3 million, fair value of $28.1 million, unrealized gains of $0.5
million and unrealized losses of $0.7 million.
<Table>
<Caption>
COST BASIS OF COST BASIS OF
INVESTMENT AT MARKET VALUE INVESTMENT AT MARKET VALUE
EQUITY INVESTMENTS DEC. 31, 2001 AT DEC. 31, 2001 DEC. 31, 2000 AT DEC. 31, 2000
------------------ ------------- ---------------- ------------- ----------------
Saxon Capital Acquisition Corp.(1).... $ 9,300,000 $ 9,300,000 $ -- $ --
Capital Automotive REIT............... 12,835,604 18,301,087 23,298,100 23,068,463
Annaly Mortgage Management, Inc. ..... 7,144,000 12,800,000 -- --
MCG Capital Corporation............... 9,934,375 11,125,000 -- --
Prime Retail, Inc., pfd............... -- -- 1,038,800 543,939
Resource Asset Investment Trust....... 3,704,181 5,616,573 3,704,181 4,245,164
Ecompass Service Corporation.......... -- -- 286,931 252,624
Anworth Mortgage Asset Corporation.... 3,890,625 4,550,000 -- --
----------- ----------- ----------- -----------
Total............................... $46,808,785 $61,692,660 $28,328,012 $28,110,190
=========== =========== =========== ===========
</Table>
- ---------------
(1) Saxon Capital became a public corporation in January 2002. As of December
31, 2001 the investment is carried at cost
During 2001, FBR Asset received proceeds of $14.2 million from the sale of
equity securities. The Company recorded $2.8 million in net realized gains
related to these sales. During 2000, FBR Asset received
F-11
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
proceeds of $29.2 million from the sale of equity securities. The Company
recorded $2.7 million in net realized gains related to these sales.
WARRANTS
FBR Asset owns warrants to acquire 131,096 shares of Kennedy-Wilson common
stock at a price of $7.5526 per share. The warrants expire in June 2003. As of
December 31, 2001, the market price of Kennedy-Wilson common stock was $4.24 per
share.
NOTE 5 NOTES RECEIVABLE
As of December 31, 2001, the Company had one secured note receivable
outstanding. On March 30, 2001, the Company loaned $12 million to Prime Aurora
L.L.C., a wholly-owned subsidiary of Prime Group Realty, L.P. The Prime Aurora
loan originally bore interest at a rate of 12% per annum and was due on January
15, 2002. At December 31, 2001, the outstanding principal amount of the Prime
Aurora loan was $8 million, and the note bore interest at a rate of 16% per
annum.
As of December 31, 2000, we had one secured note receivable outstanding
from Prime Capital Funding I, LLC in the principal amount of $4 million. The
note bore interest at a rate of 18% per annum. The note was restructured in late
2000 and paid off in full in February 2001.
NOTE 6 REPURCHASE AGREEMENTS
FBR Asset has entered into short-term repurchase agreements to finance a
significant portion of its mortgage-backed investments. The repurchase
agreements are secured by certain of FBR Asset's mortgage-backed securities
classified as pledged as collateral on the balance sheet and bear interest at
rates that have historically related closely to LIBOR for a corresponding
period.
At December 31, 2001, FBR Asset had $1.1 billion outstanding under
repurchase agreements with a weighted average borrowing rate of 1.87% as of the
end of the period and a remaining weighted-average term to maturity of 15 days.
At December 31, 2001, mortgage-backed securities pledged had an estimated fair
value of approximately $1.19 billion. At December 31, 2001, FBR Asset had a
current overall loan to value (repurchase agreements divided by pledged
mortgage-backed securities) of 93%. At December 31, 2001, the repurchase
agreements had remaining maturities of between 1 and 36 days. For the year ended
December 31, 2001 the weighted average borrowing rate was 3.16% and the weighted
average repurchase agreement balance was $463.0 million.
At December 31, 2000, FBR Asset had $133.9 million outstanding under
repurchase agreements with a weighted average borrowing rate of 6.57% as of the
end of the period and a remaining weighted-average term to maturity of 16 days.
At December 31, 2000, mortgage-backed securities pledged had an estimated fair
value of $144.9 million. At December 31, 2000, FBR Asset had a current overall
loan to value of 92%. At December 31, 2000, the repurchase agreements had
remaining maturities of between 2 and 33 days. For the year ended December 31,
2000 the weighted average borrowing rate was 6.33% and the weighted average
repurchase agreement balance was $172.3 million. Financing assets through
repurchase agreements exposes us to the risk that margin calls will be made
(when the loan to value increases above the lenders limit) and that we will not
be able to meet those margin calls. To meet margin calls the Company may sell
mortgage-backed securities and those sales of mortgage-backed securities could
result in realized losses.
NOTE 7 INTEREST RATE SWAPS
FBR Asset may from time to time enter into interest rate swap agreements to
offset the potential adverse effects of rising interest rates under certain
short-term repurchase agreements. The interest rate swap agreements have
historically been structured such that FBR Asset receives payments based on a
variable
F-12
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
interest rate and makes payments based on a fixed interest rate. The variable
interest rate on which payments are received is calculated based on the
three-month LIBOR. FBR Asset's repurchase agreements generally have maturities
of 30 to 90 days and carry interest rates that correspond to LIBOR rates for
those same periods. The swap agreements effectively fix FBR Asset's borrowing
cost and are not held for speculative or trading purposes.
At December 31, 2001, FBR Asset was party to an interest rate swap
agreement that matures on July 27, 2004, and has a notional amount of $50
million and a fair value of ($1.2 million). Under this agreement the Company
will pay a fixed interest rate of 4.97% on the notional amount and receive a
variable rate calculated based on the three-month LIBOR, which was 2.28% at
December 31, 2001. At December 31, 2000, FBR Asset was party to an interest rate
swap agreement that matured on June 1, 2001, and had a notional amount of $50
million and a fair value of $134,949. Under this agreement the Company paid a
fixed interest rate of 5.96% on the notional amount and received a variable rate
calculated based on the three-month LIBOR, which was 6.69% at December 31, 2000.
During 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133 "Accounting for Derivative Instruments and for Hedging Activities" ("FAS
133"). In June 1999, the FASB issued Statement No. 137, "Accounting for
Derivative Instruments and Hedging Activities -- Deferral of the Effective Date
of FASB Statement No. 133". In June 2000, the FASB issued Statement 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities",
an amendment of FASB Statement No. 133. FAS 133, as amended, establishes
accounting and reporting standards for derivative investments and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as a hedge. The accounting for the changes in the fair
value of a derivative depends on the intended use of the derivative and the
resulting designation. FAS 133 was effective for the Company beginning January
1, 2001.
Under FAS 133, changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, depending
on the type of hedge transaction. For fair value hedge transactions, changes in
the fair value of the derivative instrument and changes in the fair value of the
hedged item due to the risk being hedged are recorded through the income
statement. For cash-flow hedge transactions, effective changes in the fair value
of the derivative instrument are reported in other comprehensive income while
ineffective changes are recorded through the income statement. The gains and
losses on cash flow hedge transactions that are reported in other comprehensive
income are reclassified to earnings in the periods in which earnings are
effected by the hedged cash flows.
As previously discussed, the Company uses interest rate swaps to hedge the
variability in interest payments associated with the variable rate repurchase
agreements. Prior to SFAS 133, the Company did not record the value of these
swaps on the balance sheet. The Company has determined that the interest rate
swaps held during 2001 were effective hedges under FAS 133 and as a result the
interest rate swaps are carried at fair value as a cash flow hedge. The Company
adopted FAS 133 on January 1, 2001. In accordance with the transition provisions
of FAS 133, the Company recorded a cumulative-effect-type gain of $137,949
through other comprehensive income to recognize at fair value the interest rate
swap designated as a cash flow hedge.
NOTE 8 FEE INCOME
The Company and its registered broker-dealer subsidiary, Pegasus Capital
Corporation ("Pegasus") entered into an agreement in August 2001 with Friedman,
Billings, Ramsey & Co., Inc. ("FBR") regarding the Company's extension of credit
to or investment in entities that are or may be FBR's investment banking
clients. In circumstances where FBR determines that a commitment by the Company
to make a loan to or investment in an entity (each an "investment opportunity")
would facilitate a possible investment banking
F-13
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
transaction, FBR presents the investment opportunity to the Company. The
Investment Committee of the Company, which is comprised of Richard J. Hendrix,
the Company's President and Chief Operating Officer and Eric F. Billings, the
Company's Chairman and Chief Executive Officer, reviews the investment
opportunity and decides whether or not to recommend a commitment by the Company
to make a loan or an investment based on its investment criteria. Mr. Billings
is also an executive officer of FBR Group, FBR Management and FBR, and Mr.
Hendrix is also a Managing Director of FBR and FBR Management. The approval of
the Contracts Committee of the Company's Board of Directors (comprised of the
Company's three independent directors), which requires the affirmative vote of
at least two of the Company's independent directors, is required before any
investment or loan is made in or to a client or proposed client of FBR. If the
Company decides to make a loan or investment commitment to an entity, the
commitment is not contingent on FBR being engaged to provide investment baking
services by the entity. If, however, FBR is engaged to provide investment
banking services to the entity, Pegasus is provided the opportunity to act as
financial adviser to FBR in connection with structuring the transaction and, in
return for its services, it will receive 10% of the net cash investment banking
fees received by FBR as a result of the engagement. The payments Pegasus
receives from FBR will generally be taxed at normal corporate rates and will
generally not be distributed to the Company's shareholders. In 2001, pursuant to
this agreement, the Company earned $2.9 million in fees from FBR from three
investment banking transactions and one unfunded commitment. Fees are recognized
when the related investment banking transaction is completed.
NOTE 9 SHAREHOLDERS' EQUITY
On August 2, 2001, the Company completed a follow-on offering of 4,500,000
shares of common stock at a price of $23.00 per share. The lead underwriter for
the offering was Friedman, Billings, Ramsey & Co., Inc. and the co-manager was
Stifel, Nicolaus & Company. The proceeds after expenses to the company were
$97.1 million.
The Company has declared the following dividends.
<Table>
<Caption>
YEAR PER SHARE
- ---- ---------
2001........................................................ $3.30
2000........................................................ $2.95
1999........................................................ $1.61
</Table>
The Company has repurchased the following shares of common stock.
<Table>
<Caption>
AVERAGE PRICE
YEAR SHARES COST PER SHARE
- ---- --------- ----------- -------------
2001............................................. 411,900 $ 8,334,135 $20.23
2000............................................. 1,921,909 $25,420,635 $13.23
1999............................................. 2,737,191 $37,142,146 $13.57
</Table>
Under the Company's stock option plan, the Company may grant, in the
aggregate, up to 155,000 tax qualified incentive stock options and non-qualified
stock options to its employees, directors or service providers. Options granted
are generally exercisable immediately and have a term of eight to ten years. As
of December 31, 2001, 15,000 options were outstanding under the stock option
plan, and 10,000 options were available for future grant.
On December 20, 2001, FBR Management exercised options with respect to
400,000 shares of the Company's common stock at the $20 per share exercise
price, which left FBR Management with unexercised options to purchase 415,805
shares of the Company's common stock at December 31, 2001.
As of December 31, 2001, 481,900 options to purchase common stock were
outstanding. These options have terms of eight to ten years and have an exercise
price of $20 per share. As a result, 123,120 shares were
F-14
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
included to calculate diluted earnings per share for the year ended December 31,
2001. None of the stock options were dilutive for the years ended December 31,
2000 or 1999. Details of stock options granted, forfeited, and exercised are as
follows:
<Table>
<Caption>
NUMBER OF
SHARES EXERCISE PRICE
--------- ---------------
Balance as of December 31, 1998.......................... 1,021,900 $20.00
Granted in 1999.......................................... -- --
Forfeitures in 1999 upon departure of employees.......... -- --
--------- ---------------
Balance as of December 31, 1999.......................... 1,021,900 $20.00
Granted in 2000.......................................... -- --
Forfeitures in 2000 upon departure of employees.......... -- --
--------- ---------------
Balance as of December 31, 2000.......................... 1,021,900 $20.00
Granted in 2001.......................................... 15,000 $15.00
Forfeitures in 2001 upon departure of employees.......... (25,000) $20.00
Exercised in 2001........................................ (530,000) $15.00 - $20.00
--------- ---------------
Balance as of December 31, 2001.......................... 481,900 $20.00
--------- ---------------
</Table>
On December 24, 2001 the Company's Board of Directors approved awards of a
total of 14,000 shares of the Company's common stock under its stock incentive
plan to employees of FBR Management who provide services to the Company. These
awards are subject to approval by the Company's shareholders and an increase in
the number of shares available for issuance under the stock incentive plan.
Compensation expense will be recognized once the shares are approved, based on
the fair value on the date of shareholders approval. The compensation expense
will be recognized over the vesting schedule of 25% on the first anniversary of
the date of grant, 25% on the second anniversary and 50% on the third
anniversary.
The Company accounts for its stock-based compensation in accordance with
SFAS No. 123, "Accounting For Stock Based Compensation." Pursuant to SFAS No.
123, the Company applies the provisions of Accounting Principles Board Opinion
No. 25, "Accounting For Stock Issued to Employees" (APB No. 25), for stock
options issued to employees. Under APB No. 25, compensation expense is recorded
to the extent the fair market value of the Company's stock exceeds the strike
price of the option on the date of grant. In addition and in accordance with the
disclosure requirements of SFAS No. 123, the Company does provide pro forma net
income disclosures for options granted to employees as if the fair value method,
as defined in SFAS No. 123, had been applied for the purpose of computing
compensation expense. The impact of the issued and outstanding employee options
under the fair value method was not material to the Company's net income or
basic and diluted net income per share as reported in the statement of income
for the years ended December 31, 2001, 2000, and 1999.
NOTE 10 MANAGEMENT AND PERFORMANCE FEES
The Company has a management agreement with FBR Management, expiring on
December 17, 2002. FBR Management performs portfolio management services on
behalf of the Company. These services include, but are not limited to,
consulting with the Company on purchase and sale opportunities, collection of
information and submission of reports pertaining to the Company's assets,
interest rates, and general economic conditions, and periodic review and
evaluation of the performance of the Company's portfolio of assets.
FBR Management is entitled to a quarterly "base" management fee equal to
the sum of (1) 0.25 percent per annum (adjusted to reflect a quarterly period)
of the average book value of the mortgage assets of the Company during each
calendar quarter and, (2) 0.75 percent per annum (adjusted to reflect a
quarterly
F-15
FBR ASSET INVESTMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
period) of the remainder of the average book value of the mortgage assets of the
Company during each calendar quarter.
FBR Management is also entitled to receive incentive compensation based on
the performance of the Company. On December 31, 1998, and each calendar quarter
thereafter, FBR Management is entitled to an incentive fee calculated by
reference to the preceding 12-month period. FBR Management is entitled to an
incentive fee calculated as: funds from operations (as defined), plus net
realized gains or losses from asset sales, less the threshold amount (all
computed on a weighted average share outstanding basis), multiplied by 25
percent. The threshold amount is calculated as the weighted average per share
price of all equity offerings of the Company, multiplied by a rate equal to the
ten-year U.S. Treasury rate plus five percent per annum. The Company recorded
$1.7 million in incentive fees during 2001. No incentive fees were earned during
2000 or 1999.
FBR Management has engaged Fixed Income Advisory Company, Inc. ("FIDAC") to
manage the Company's mortgage asset investment program (the "Mortgage
Portfolio") as a sub-adviser. As compensation for rendering services, FIDAC is
entitled to a sub-advisory fee based on the average gross asset value managed by
FIDAC.
The following table summarizes the Company's management and incentive fee
expense:
<Table>
<Caption>
YEAR MANAGEMENT FEES INCENTIVE FEES TOTALS
---- --------------- -------------- ----------
1999......................................... $1,329,063 $ -- $1,329,063
2000......................................... $1,078,713 $ -- $1,078,713
2001......................................... $1,842,296 $ 1,652,061 $3,494,357
</Table>
In December 1997, FBR Management received options to purchase 1,021,900
shares of our common stock at $20 per share. The estimated value of these
options at the time of grant was $909,492 based on a discounted Black-Scholes
valuation, and was amortized over the initial term of the Management Agreement.
the Company has fully amortized the value of these options. FBR Management
previously transferred 51,095 of its options to its former sub-manager. FBR
Management agreed to the rescission of options to purchase 155,000 shares in
connection with the establishment of the Company's stock incentive plan.
NOTE 11 RELATED PARTIES
As of December 31, 2001, Friedman, Billings, Ramsey Group, Inc. and it's
affiliated entities ("FBR Group") owned 2,349,186 shares or 27.63% of the
outstanding common stock of the Company. As of December 31, 2000, these same
entities owned 1,344,086 or 34.60% of the outstanding common stock of the
Company. FBR Group is the parent company of FBR Management and FBR.
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)
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
Date: March 29, 2002
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.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ERIC F. BILLINGS Chairman, Chief Executive March 29, 2002
------------------------------------------------ Officer, and Director
Eric F. Billings (Principal Executive Officer)
/s/ EMANUEL J. FRIEDMAN Director March 29, 2002
------------------------------------------------
Emanuel J. Friedman
/s/ PETER A. GALLAGHER Director March 29, 2002
------------------------------------------------
Peter A. Gallagher
/s/ RUSSELL C. LINDNER Director March 29, 2002
------------------------------------------------
Russell C. Lindner
/s/ STEPHEN D. HARLAN Director March 29, 2002
------------------------------------------------
Stephen D. Harlan
</Table>
EXHIBIT INDEX
<Table>
<Caption>
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.*
4.02 Form of Senior Indenture.*****
4.03 Form of Senior Debt Security.*****
4.04 Form of Subordinated Indenture.*****
4.05 Form of Subordinated Debt Security.*****
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 Agreement to Extend and Amend Management Agreement dated
December 17, 2001, by and between the Company and Friedman,
Billings, Ramsey Investment Management, Inc.*****
10.05 License Agreement, dated December 17, 1997, by and between
the Company and Friedman, Billings, Ramsey Group, Inc.*
10.06 Stock Option Agreement, dated December 17, 1997, by and
between the Company and Friedman, Billings, Ramsey
Investment Management, Inc.*
10.07 Sub-Management Agreement, dated February 14, 2000, by and
between Friedman, Billings, Ramsey Investment Management,
Inc. and Fixed Income Discount Advisory Company, Inc.**
10.08 Stock Incentive Plan.*
10.09 Letter Agreement, dated July 9, 2001, by and among FBR, FBR
Asset and Pegasus.****
13.01 Annual Report to Shareholders for the Year ended December
31, 2001.
21.01 List of Subsidiaries of the Registrant.*****
99.01 Risks of Investing in the Registrant.
99.02 Representation Pursuant to Temporary Note 3T to Article 3 of
Regulation S-X.
</Table>
- ---------------
* 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.
*** Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000, filed with the SEC on April 2, 2001.
**** Filed as an exhibit to FBR Asset's Registration Statement on Form S-11, as
amended, Registration No. 333-63344.
***** Filed as an exhibit to FBR Asset's Registration Statement on Form S-3, as
amended, Registration No. 333-75408.