EXHIBIT 99.1
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
ANALYST/INVESTOR CONFERENCE CALL WITH:
EMANUEL J. FRIEDMAN, CO-CHAIRMAN AND CO-CEO
ERIC F. BILLINGS, CO-CHAIRMAN AND CO-CEO
RICHARD J. HENDRIX,
PRESIDENT AND CHIEF OPERATING OFFICER
J. ROCK TONKEL,
PRESIDENT AND HEAD OF INVESTMENT BANKING
KURT R. HARRINGTON, CHIEF FINANCIAL OFFICER
THURSDAY, FEBRUARY 10, 2005
9:00 A.M. (U.S. EST)
P R O C E E D I N G S
MR. HARRINGTON: Good morning. This is Kurt Harrington, Chief Financial Officer
of Friedman Billings Ramsey Group, Inc.
Before we begin this morning's earnings call, I would like to remind everyone
that statements concerning future performance, developments, events, market
forecasts, revenues, expenses, earnings, run rates and any other guidance on
present or future periods constitute forward-looking statements. These
forward-looking statements are subject to a number of factors, risks, and
uncertainties that might cause actual results to differ materially from stated
expectations or current circumstances. These factors include, but are not
limited to, the effect of demand for public offerings, activity in the secondary
securities markets, interest rates, our cost of borrowing, interest spreads,
mortgage prepayment speeds, the risks associated with merchant banking
investments, the realization of gains and losses on principal investments,
available technologies, competition for business and personnel and general
economic, political and market conditions. Additional information concerning
these factors that could cause results to differ materially is contained in FBR
Group's annual report on Form 10-K and in quarterly reports on Forms 10-Q.
I would now like to turn over the call to FBR Group's Co-Chairmen and Co-Chief
Executive Officers, Emanuel Friedman and Eric Billings. Also joining us this
morning are Rick Hendrix, President and Chief Operating Officer, and Rock
Tonkel, President and Head of Investment Banking.
MR. FRIEDMAN: Thank you and good morning.
Hopefully you have all had an opportunity to review our earnings press release
issued last night. Our 2004 results include record net revenues, record net
income, record earnings per share and many other reported achievements.
Similarly, the fourth quarter was our best fourth quarter ever in all of the
above categories. The strength of the 2004 results was broad based across our
business model.
Our investment banking business had its best year ever, growing revenues 64
percent to $428 million on 127 assignments with a total transaction value
greater than $27 million.
FBR's institutional brokerage revenues totaled $110 million for the year, an
increase of 48.6 percent over 2003.
Assets under management in the mutual funds and alternative investment vehicles
increased by 52 percent during the year and revenues and profitability from
these businesses rose accordingly.
Our mortgage-backed investment strategy has performed well, and despite a
generally flattening yield curve, we have been able to preserve capital while
providing an 18.4 percent return on equity during 2004.
Our merchant banking activities have continued to earn results greater than that
of the mortgage-backed portfolio, and we foresee many new opportunities to
deploy new capital in this business.
Compensation as a percentage of net revenue dropped to 36.4 percent in 2004 from
40.5 percent in 2003, despite adding over 200 employees and running the lowest
comparable leverage in the industry.
Net revenue and net income per employee for 2004 equaled approximately $1.5
million and 600,000, respectively, versus $1.1 million and $400,000 in 2003.
Before we go to the breakdown of our reported results, I would like to emphasize
that not only was 2004 a great year in terms of our financial results, but it
was also a year in which we invested heavily to position FBR for future growth.
These investments included:
A significant increase in senior professionals across the platform and a greater
than 40 percent increase in personnel overall to a total of approximately 700 at
year end.
The build-out of our asset-backed securities investment banking unit.
Increased branding efforts led by our sponsorship of the FBR Open PGA Tour golf
tournament.
Significant upgrades of technology and facilities.
In addition to these investments we initiated an effort to better serve the
financial sponsor community. This resulted in a number of transactions in 2004
and increased relationships, leading us to believe there will be further growth
in this area in 2005.
We have continued these business building efforts in 2005 with the anticipated
acquisition this month of First NLC, a nonconforming mortgage lender, and the
formation of an institutional fixed-income group in our broker dealer. We expect
the benefits of these actions to be realized for many years to come.
In addition, we have begun to grow our mortgage-related businesses using our
significant relationships and knowledge in the sector. We are building our
asset-backed securities capabilities and have added a mortgage-backed trading
group comprised primarily of the professionals from the former Freddie Mac
trading group. We now have the ability to originate a mortgage, purchase a
mortgage, securitize a mortgage, own a mortgage- backed security and analyze and
trade mortgage- backed securities with customers.
We believe that the combination of the new synergistic business lines, with
further expansion in our existing franchise, will position us well for future
growth.
Now, I would like to hand the call over to Eric Billings who will discuss our
results in more detail as well as our outlook for the future.
MR. BILLINGS: Thank you, Manny. I would like to go through each of the different
businesses and underscore a few points that we feel are important and which may
not be easily discernible in our numbers.
As Manny previously stated, 2004 was the best investment banking year in our
history, and the fourth quarter was our best banking fourth quarter ever. Both
periods featured continuing trends which we really think are worth noting.
FBR was the number one ranked book- running manager of all U.S. small
capitalization common equity capital raises for the year and for the quarter.
In addition, FBR was the number seven ranked book-running manager for all U.S.
IPOs.
Of the 16 common equity transactions managed during the fourth quarter, three
were from our Energy group, three in Financial Institutions, four in Real
Estate-related, three in Insurance, two Technology transactions and one
Diversified Industries transaction.
We are steadily building our roster of frequent capital issuers whom we can call
clients who are the base for the pipeline in the future periods. Specifically we
expect more than half of our lead-managed issuer clients from 2004 to initiate
another capital transaction within the next 18 months.
As evidence of our success in building long term productive client
relationships, 49 percent of all our banking transactions, accounting for $126
million in revenues, were repeat business in 2004.
Additionally, the fourth quarter included four preferred stock capital raises
and five completed M&A assignments, which demonstrate the continued broadening
of our investment banking platform.
Our extraordinary track record of after-market performance continued throughout
2004, and, as we have frequently said, this performance provides FBR with the
confidence and credibility to complete transactions in almost any market.
As we have stated in the past, one of our goals over the next few years is to
achieve a market share in secondary commissions similar to the one that we have
achieved in our primary equity capital markets business. This will be harder to
accomplish because we are not interested in competing for volume based on
commission levels, but we do feel that we have proven that we can grow our
commission dollars significantly as we broaden our research coverage and
continue to strive to add value for our accounts. During 2004, and the fourth
quarter, our accomplishments and continued efforts toward this goal included:
Total brokerage revenues were 48 percent greater year over year and nine percent
greater for the fourth quarter, rising to $110 million and $26 million
respectively.
Agency commissions rose 79 percent to $90 million on the year and 27 percent to
$21 million for the fourth quarter.
We continue efforts to expand and improve our research coverage and client
service, increasing coverage by 167 companies raising the total companies
covered to over 550.
Our latest and highly successful investment banking conference in New York City
last December drew more than 2100 registrants and featured 190 presenting
companies.
After-tax profits from the equity capital markets businesses - including
investment banking and sales and trading - totaled $91.2 million for the year,
producing an 80 percent return on equity after tax.
Our asset management business achieved significant inflows of capital that we
believe are the result of our long-term track records in both mutual funds and
alternative investment vehicles.
Net inflows into our hedge funds totaled $223 million for the year, which was
our best year ever.
Net inflows into the mutual funds for the year totaled $600 million.
FBR's Small Cap Fund was ranked number one by Lipper among small cap growth
funds for one-year performance for the period ending February 5, 2005.
FBR's Small Cap Financial Fund was ranked by Money magazine as the number seven
major stock fund for the five years ended December 15, 2004.
We are confident that our investment performance will continue to lead to
growing asset inflows in this business.
Turning to our principal activities, I will address our mortgage-backed
securities strategy first. The ROE in our mortgage-backed securities strategy
was 18.4 percent. This was a particularly strong result given the flattening
yield curve environment and our capital preservation strategy, which features
relatively low leverage and duration. Importantly, this return was well within
our range of expectations for this business. The ROE for the fourth quarter was
14.4 percent.
During the fourth quarter the Federal Reserve increased short-term rates by 50
basis points impacting our funding cost and the cost of hedging during the
quarter by about 45 basis points. Additionally, medium-term interest rates have
not risen, leading to a flattening of the yield curve. Consequently, the
increase in funding cost has not been fully offset by higher yields as CPRs are
just now beginning to show signs of slowing and coupons on new production have
not risen as much as they will if and when medium-term interest rates begin to
rise as well.
We continue to manage the mortgage-backed security portfolio with a neutral
interest rate bias and re-emphasize that our strategy will perform well in many
different environments over time. We have, though, continued to re-allocate some
capital to the merchant banking business because of the number of attractive
opportunities we see in that business. We will also talk later about our
intention to further shift the portfolio into non-conforming mortgages.
Our other long term principal investing Activities - including our merchant
banking and other long-term investment portfolio - returned outstanding results
again in the fourth quarter. Realized gains from this area were approximately
$19 million. It is important to note that returns from this business will be
volatile quarter to quarter. However, we would point out that our expectation is
for somewhat more consistent returns, based on expected dividends from these
investments. We believe our merchant banking business will continue its track
record of exceeding returns in the MBS portfolio into the future.
We expect to close our acquisition of First NLC as soon as next week at which
time we estimate it will have approximately $450 million of loans on its balance
sheet. We believe that by the end of the first quarter, through originations and
selected purchases, we could have up to $1.5 billion of non-conforming loans on
FBR's balance sheet. As we have stated, it is our current intention to
re-allocate approximately 70 percent of the capital that we have invested in MBS
into non-conforming mortgages during 2005. This would mean approximately $700
million of capital and an approximate portfolio of $10.5 billion.
We believe that we can achieve an ROE in excess of 25 percent in the current
environment in this portfolio strategy, which includes substantially matched
funding to mitigate interest rate risk. In addition, we feel that there is
considerable upside potential from a 25 percent ROE which would be realized in
the form of lower than assumed losses or more attractive pricing in the future.
As Manny mentioned earlier, we have made a real effort to more efficiently
capitalize on our relationships and knowledge in the mortgage sector. This
applies to both our principal investments and our capital markets activities.
While periodic market conditions may affect certain sectors of this industry, we
continue to believe that the restructuring of the mortgage orientation industry
from a one-time-gain- on-sale model to a specialty finance lending model offers
some of the most compelling values in our markets and we hope to capitalize
further on this industry transition. We believe that by broadening our reach in
these areas we will be able to continue to find areas of relative value for our
clients and our principal investments.
Finally, we now have the ability to originate and sell or securitize mortgages
if we do not choose to invest in them and to earn fees by advising and trading
with clients in this market through the expansion of our fixed-income
capabilities. It is important to our overall mortgage business that we have
efficient access to all markets in which we may choose to finance these assets.
Our ability to both invest in our growth for the future and report record
earnings in the current periods makes us optimistic about our growth potential
in 2005 as we build on the outstanding foundation we created in 2004 and
previously. As we move ahead, we will continue to focus on using our investment
principles and discipline to grow our business and provide outstanding total
returns to shareholders.
Thank you, and before we take questions, I would like to add a few thoughts
about the non-conforming mortgage industry as a whole.
We know there has been some question in the last week or so about potential
spread compression and other activities in this industry. We would like to make
just a handful of observations.
First, we have clearly seen this happen in the past. When the Fed tends to raise
rates very sharply in short periods of time, as in 1994, 1995, 1999, 2000 and
certainly now, it is very normal to see spreads lag into that timeframe simply
because, while coupons do rise, they don't rise quite as fast as the Fed is
raising rates. If we look back nine months, coupons were about 40 basis points
higher. While this represents a potential contraction of spread, it should be
noted that during this timeframe losses continued to come in well below
expectations, continuing a 15-year trend of lowering or falling loss activity.
We believe, for the industry, these companies' models have provided up to as
high as 150 basis points of losses. The models ranged between 100 and 150 points
with losses coming in at less than 70 and, in some cases, less than 60. There
clearly is a pickup in spread activity that is resulting from this, and it is
probably affecting prices somewhat. As the market becomes more mature and
understands that losses are more likely to run continuously lower than current
levels in the model, this will be passed on to the borrowers. And it will not
necessarily be reflected in higher spreads, but rather in lower rates in the
same spread, and we are probably now in the midst of that phenomenon to some
degree.
In addition to that, we clearly have greater volumes in origination levels in
these companies so operating costs are lower. So, it is perfectly reasonable to
expect that, in the totality, that too will be passed along.
Finally, we have heard comments from certain clients, originators, and other
companies that large originators are causing pricing compression. We think this
is not a rational thought. In point of fact, this is an industry that has many
participants, and no one, two, or three companies lead pricing.
Having said that, pricing changes in 1994 and 1995 and certainly in 2000 were
made by the high- cost producer. Specifically, there are 80 or so originators of
this product who are doing less than $4 billion a year of origination volume,
and their cost to originate tends to be higher than 300 basis points. When the
gain on sale tends to get to that level or even lower, these companies, which
have insufficient capital or marginally enough capital to provide even warehouse
financing, find it necessary to raise prices because they cannot withstand
losses. It makes no sense for these companies to originate coupons and sell them
at a loss.
We believe that these are the companies that lead pricing and have done so
historically. We believe we are right in the midst of a normal timeframe here,
and these companies will, as they have in the past, continue to lead pricing,
and the large originators will naturally follow. Over proper periods of time -
over the next quarter, two quarters, three-quarters - we will see a spread which
normalizes back to levels we saw about six or nine months ago in the more normal
180 to 220 basis point range.
So we believe it is important to note that this is nothing abnormal. These
portfolios are dynamic, just as are those of a thrift, a bank or credit card
portfolio, meaning that at the margin you are always rolling some loans out,
bringing new loans in, but it is an average life of three years in these
portfolios.
Therefore, the blended average spread in the portfolio will be only marginally
affected even when spreads are lower at the margin in a given short period of
time. Thus, overall, we do believe that the returns on equity in these
businesses will continue to well exceed 25 percent, excluding gains and sales on
the TRS activity, and represent one of the great investment opportunities that
we believe, as a company and as investors, we have ever seen.
Those are the end of our comments, and we would now like to open up for
questions on our quarter.
TODD HALKY WITH SANDLER O'NEILL: Just one question on the investment banking
stuff. You ran through the equity deals pretty quickly. You said, three energy,
three financial, four real estate, three insurance, one diversified. I missed
one of them.
MR. BILLINGS: Three insurance, two technology deals, one diversified, and three
energy.
MR. HALKY: So, my question is on the deal flow on a revenue basis. What was in
financial institutions and real estate on a percentage basis?
MR. BILLINGS: Todd, the rough breakdown for the year is approximately 60 to 63
percent of transaction volume was in financial services and real estate. Roughly
35 to 40 percent was everything else. On a revenue volume basis, the numbers
were about 75/25, where 75 percent of the revenues were from financial
institutions and real estate and 25 percent were everything else. So, clearly,
there are two trends there. Needless to say, the continuing bulk of the revenues
is in financial and real estate, something very normal from our perspective. We
anticipate that will virtually always be the case.
These transactions do ebb and flow. For instance, we are on the road today with
an energy transaction that is north of $400 million. The transaction volume is
very important to focus on, however, because it does show where we are headed.
It is growing very steadily, as we pointed out before, and we think that
revenues will normalize at something closer to transaction volumes, although it
will never quite get there over the course of the next year.
MR. HALKY: On the banking pipeline, I know it was $10 billion at the end of last
quarter, of which $5 billion was one transaction. Can we say what the current
pipeline is and then take out that one transaction? What is the mix is of real
estate and financial services versus other industries?
MR. TONKEL: We said last quarter that the pipeline was in excess of $10 billion,
and it continues to be in excess of $10 billion. Whereas before we said there
was one transaction in the neighborhood of $5 billion, there is today a
transaction in there of that magnitude, maybe a little smaller, but of that
magnitude. The mix overall continues to be about 50 percent non-real estate,
non-FIG versus 50 percent FIG and real estate.
Insurance, which is a portion of what we are counting as FIG, is actually
growing, so the non-insurance part of the FIG business is a lower proportion as
we grow the insurance business. As you may recall, we had, I believe the number
one market share in insurance IPOs for the year. Therefore, based on that and a
number of other factors, the insurance business has grown very nicely.
The energy business is also growing. The transaction that Eric alluded to
earlier was a transaction that was going to be an IPO of significant size done
by a major firm. We were able to take that transaction away and conduct it as a
144-A, well north of $400 billion. So that is a significant transaction for us
and a significant extension of the franchise.
As you know, we focused a great deal on growing the financial sponsor business
in 2004. This particular energy company is owned by one of the largest private
equity firms in the country, and it is the first piece of significant business
we have done with this partner. And it adds to the list of those we have done
business with - KKR, Blackstone, and Summit.
So it is a very important transaction for the energy business, as well as for
the expansion of the financial sponsor business.
MR. HALKY: On the MBS portfolio, on the spread -- where did you exit the
quarter? It was at 123 for the entire quarter, but assuming it continued to
compress towards the latter part of quarter, are we in the 100 basis point range
given the continued flattening of the yield curve?
MR. HENDRIX: We have had another tightening this year, and we had one later in
the quarter last year. Our funding costs are continuing to trend up, and our
yields are trending up as well. You saw some of that in the fourth quarter -
yields were up from 3 percent to 3.18 percent. It didn't quite offset the rise
in the cost of funds. We don't get into where it is during any one month or any
one week because it moves around a lot; but we are starting to see yields trend
up, and we think that is going to substantially offset increases in funding
costs. Is it reasonable to think it may trend down a little further from the
fourth quarter, but to pick a number for December or to pick a number for the
last two weeks of December is tough given how the yields are calculated on the
portfolio.
MR. BILLINGS: And the re-allocation of the non-conforming assets will have, even
in small numbers, a significant affect on the total portfolio. Obviously, as the
ramp-up in the non-conforming portfolio grows significantly over the next
handful of quarters - because that spread is so much wider - even a 10 or 15
percent change has a significant effect on the total portfolio. These things
will be a dynamic part of that portfolio over the next three or four quarters as
we get the capital redirected into the non-conforming assets from the agency
side.
MR. HALKY: A final question on the institutional brokerage segment. While the
agency business did increase from the third quarter, it was basically down from
the first half of the year average and was lower than what we were anticipating
given the strong market conditions experienced in the fourth quarter and the
overall equity in the market. What would you attribute that to? Is it just year
end? A lot of your institutional clients had already exceeded their expectations
of what they were going to pay you for the year. Or is it a function of
something else?
MR. BILLINGS: It is a handful of different factors. I do want to be clear. We
were pleased with the numbers so I don't know what your expectations were, but
we were very pleased with the numbers, and we think the trends bode well for
continued growth in those areas. In our judgment, this is very clear.
As you know, the fourth quarter can be a very funky quarter in that regard for
certain reasons. Some of the larger institutions - Fidelity, and people like
that - have paid; and then they do other things for other reasons. You also had
a higher level of regulatory activity and scrutiny that may, I think, have
altered marginal behavior. But, in any case, I think those are marginal issues.
What is relevant to us is that we have expanded the research account. We have
expanded the coverage significantly. We have expanded our institutional
brokerage group to 70 institutional brokers. So as our penetration and name
recognition continues to grow, and the banking business continues to grow, we
are very, very confident that, despite the fact that commission rates continue
to go down, we will continue to grow our sales and trading lines throughout the
course of the year, as we have over the last five years. But it bounces around a
little bit. It is a pretty stable number, but it does bounce around for these
reasons.
JOE STIEVEN FROM STIFEL NICOLAUS: First of all, good quarter. A couple of my
questions were answered, but talk a little bit about how fast you will get fully
ramped-up and leveraged in the non-conforming business. That is number one. And
number two, is the $300 million, give or take, that you will then have left in
the MBS portfolio, is that what we should model- out as the base level, or can
that ebb and flow from there?
MR. BILLINGS: Thanks. Let me comment on that generally, Joe. As you know, we
have indicated in our model that we are anticipating that we can get about $700
million of our equity capital re-allocated through the course of the year. And
that comes from our ability and our pretty good knowledge of what refinancing
activity will be. Also, what we know what we can actually sell of those assets
at no loss, and allow us to re-deploy that capital - plus other working
assumptions in terms of what we will be able to do during the course of the
year. Of course these are never precisely predictable and things can change, but
that is our estimate at this time.
So, Joe, what is interesting to note, however, is that while right now, for
instance, the market is showing lower TRS sale price - a sale price where you
can have a cash gain on sale on these assets It works to our advantage because
we can actually acquire these assets at a cost which is essentially now close to
reflecting origination costs. So sometimes people get concerned about things,
but this is what has worked to our advantage, and it will allow us to deploy
capital more quickly in this area than we might have otherwise. So we are very
comfortable with that model. Don't forget we anticipate, certainly, very
substantial retained equity in our capital markets businesses which also will be
deployed over into the spread-based non-conforming side in all probability. So
we are very confident that, if things work out as we expect, these will be
achieved.
Longer-term, Joe, it is a function of the markets, it is a function of spreads.
If we were in a world today where we could snap our fingers and re-deploy 100
percent of that equity to non-conforming assets, we would do that. Whether that
ends up being the case precisely, time will tell. Certainly, in your model, you
can say right now that 70 percent for this year is in line with our model, which
we are comfortable with.Longer-term, we will see where the market takes it.
MR. FRIEDMAN: This is Manny. Running it mechanically, if we redeploy $700
million, we earn 14 percent, and we said we think we can get 25 percent on that
$700 million when we redeploy it over time into the non-conforming area. Then
that is a pick up of approximately $75 million on the $700 million.
HOWARD FEINGOLD WITH RAYMOND JAMES AND ASSOCIATES: Good morning, gentlemen. I
just have a few questions. A lot of my questions have been answered on the MBS
portfolio. It appears that, as the spreads in the fourth quarter contracted, you
more than made up the difference by increasing the leverage. Am I on the right
track there?
MR. HENDRIX: This is Rick. We stayed right in the middle of our leverage range.
Our average for the quarter was 10.4. When you are talking about average,
sometimes you will see nine, sometimes 11, and it is hard to see what is going
on during the quarter with regard to prepayments, but we have said we will not
take our leverage up to try to maintain returns in spreads. We have not changed
our philosophy from that perspective. We averaged 10.4, which is in the strike
zone.
MR. BILLINGS: But the difference was capital markets business continued to be
very strong, probably stronger than people were expecting, and we had more than
50 percent of our earnings come from our capital markets businesses as opposed
to our spread-based business. So this represents the continued growth and
evolution of the company, and it is really the reason why we had a very, very
fine quarter.
MR. FEINGOLD: As you do the conversion to non-conforming, how do you see that
impacting your leverage?
MR. HENDRIX: With these nonconforming mortgages - because the way we finance
them will be without exposure to interest increases - we believe that it makes
sense to take the leverage up. Our models are going to run leverage anywhere
from 14 to 15 times on these assets, and in fact, the market will easily
facilitate higher leverage than that. We have always looked at our business as
one where we are going to run at the lower end of the market-acceptable leverage
ranges, and we will do the same thing here. But certainly you can finance these
assets to a higher point than 14 or 15, and there may be environments where we
would want to do that. Today, as we look at the business, that is what we think
the leverage will be from the risk perspective, and, in the way we look at the
business, this is a lower risk point to capital than even the 10.5 or 11 times
on the agency side because we are not exposed to changes in rates.
MR. BILLINGS: Because this is securitization-financed, it is effectively a
matched book and you don't have rate risk, and that is very important, as Rick
said. Secondly, there's the spread. As you look at these businesses, the average
thrift today is About 16 times leveraged, the average bank is 16 times, and
credit card companies are about the same. So this is a very, very good high
capital level, relative to spread-based businesses, and, in fact, inside
securitization, OC levels or equity requirement levels do change and ebb and
flow, but they tend to be between 3 and 2.5 percent -- sometimes as high as 3
percent, or in other words allowing leverage as high as 30 to 40 times; so this
is a very balanced and very healthy risk-adjusted leverage ratio, and it is
where we would intend to run.
MR. FRIEDMAN: Not only are we substantially match-funded during the time period,
but the funding can never be pulled so that it is absolute funding. So those two
advantages mean that we are comfortable running the leverage at 14 to one.
MR. FEINGOLD: So we can anticipate over the course of the year increasing
leverage as the composition of the portfolio changes?
MR. BILLINGS: Yes.
MR. FEINGOLD: My understanding is non-conforming loans are not necessarily in
the sub- prime category.
MR. BILLINGS: You should think of them as being sub-prime and non-conforming.
It's a sort of different way of saying it, but we are intending to have probably
an average FICO score in the 630 to 640 range, which gives you a sense of where
that is and where we are very comfortable. Remember, from a credit perspective,
there are a number of different ways to think about this. Losses run about 65
basis points annualized today and have for a number of years. There has been a
15-year down trend as society has learned to credit score and otherwise make
judgments on credit risk. FICO scores have risen from 580 to 620 to 640. So all
of these things are helping these loss ratios to come down. Our model, for
instance - which allows us to earn, we think, well north of 25 percent -
provides for a loss anticipation and/or cost to private mortgage insurance which
can be as high as 125 basis points, which gives us huge protection from current
loss rates and gives us great comfort on those activities, depending on how we
do it. So we think, for the totality, this is very balanced.
MR. FEINGOLD: Just two last questions. If I did my math correctly, in the fourth
quarter from the MBS portfolio you over-earned the regular quarterly dividend?
MR. HARRINGTON: Not just from the MBS. You also add in the merchant banking
activities. The REIT earnings are comprised of both the MBS and merchant
banking, and certainly we earned the dividend there.
MR. FEINGOLD: Last question. Your business model last year had looked like
special dividends had come to about 25 percent on an semi-annual basis. What
does your model currently look like?
MR. BILLINGS: Actually, Howard, we haven't finished our work on that, but I
think to the degree you have run the deployment of the non-prime assets and
depending simply on how fast that happens, you can get a sense of what that can
be. As Manny alluded, it would be about a $75 to $80 million increase in
earnings from the redeployment on an annualized basis when completed. So you can
make a judgment. That would all be basically special dividends. Again, it is a
function of how fast we get there. We anticipate being able to have two special
dividends and obviously are very, very comfortable at this time. It would at
least equal and in all probability exceed last year's levels, but we will come
back to you with more specific guidance once we have finished our work on this.
MR. FEINGOLD: Thank you. You guys have once again delivered quite a good quarter
in less than optimal conditions. Keep on doing it. Thank you.
K. C. AMBRECHT WITH MILLENIUM: Thanks very much for taking the question. I
didn't really get the answer to Todd's original question, where did the NIM go
out at the end of December, just 123 for the quarter?
MR. HENDRIX: We don't talk about it on a monthly basis ever. We had increases in
the fourth quarter, and we had another increase in January. So it is reasonable
as you look forward to think that there may be lower spreads in the first
quarter than the fourth quarter, but to pick a month or a week or a day and put
a number on it is not the way we look at the business, nor would it give anybody
an accurate picture of what is going on.
MR. BILLINGS: Remember CPRs are starting to back up a little bit. There are a
number of mitigating factors. We do have assets to re-price. It is hard to say
precisely, but most importantly, remember that, if you run the numbers and the
difference in the spread, with even as little as 10 percent of our portfolio in
nonconforming assets, it has a fairly significant effect on the marginal spread
in our total portfolio. And, as you understand, we intend to get to 70 percent
through the course of the year. So when you are looking to try to get that
number, it is very important that you adjust for the fact that the
non-conforming portion of the portfolio has a very, very significant effect
upward effect on that spread.
MR. AMBRECHT: And then, Eric, you referenced that you expect the NIM or excess
spread to migrate back in one or two quarters to the 180 level. You were talking
about Friedman but also about the industry. I was wondering if you could dig
into that a little deeper -- why that is and what if the yield curve remains
flat for a year?
MR. BILLINGS: I think the question really goes, again, to the point that I made
in the earlier discussion. From our perspective - and we have seen these
circumstances before - when you get to a point where cash gain on sales from the
sale of these assets at the margin are equal or less than the cost to originate,
then clearly high cost producers which still produce, in our judgment, north of
40 percent of the volume in the industry, cannot produce at that level. They
don't have capital, they don't have balance sheets or have limited capital, only
enough to provide for warehouse finance. So it is important that they don't go
through long periods of time where they originate at a loss. In fact, they
cannot, and, therefore, they are enormously incentivized. It is, in fact,
completely necessary that they raise coupons even at the risk of losing volume
because they have to make sure at the margin at which they do originate they
make a profit of some kind. Therefore, the history of this would tell us that
when they do that, the large firms follow because large firms want to follow.
They need to have stickiness as they do.
Again, remember, coupons are up over the last nine months. They are not up as
much as funding. Funding is about 100 basis and coupons are up about 40. They do
have some stickiness, and as you bounce off of this level you will see a more
normalized level resume as we have in the past.
MR. AMBRECHT: One last question, I know your business is very seasonal, but if
you could address how we should think about your mortgage pipeline in a
flattening yield curve. Does it kind of get delayed a bit.
MR. FRIEDMAN: Because of underwriting?
MR. AMBRECHT: Yes.
MR. BILLINGS: We have been in a flattened yield curve since March or April, and
we just produced a record year. A non-trivial portion of that came from these
kinds of companies. As I think you probably know, and, as I think we have stated
many, many times, we try to look at these businesses and look at the total
returns. In the non-prime business right now, these companies, even at the
margin, are still generating ROEs that are at the very least in the mid 20s
right now at the margin, but they are dynamic portfolios, just like banks, just
like credit cards. That means, over an average three-year life, you are rolling
some assets out, some in, and you end up with an average spread on the total
portfolio, creating a return on equity. These are extraordinarily good
businesses. The valuation of these businesses relative to their intrinsic value
is ridiculous, in our judgment. They represent extraordinarily good investment
opportunities, and we see no evidence that that will slow. None of these things
are predictable. Sometimes they do slow. It is not so much a seasonal business.
The banking business is not precisely predictable. We may have lumpy quarters
but we have seen no evidence whatsoever, and we don't anticipate any but time
will tell.
MR. FRIEDMAN: The actual interest in the REIT model seems to growing. It is
spreading into the prime area across the board, the sub-prime area and all real
estate-type originators. So even though the curve has flattened somewhat or
dramatically, the actual interest has increased because it is simply a better
model. In other areas, it is increasing even faster, especially in the triple
net leasing area and even in the property area.
BRIAN WALL OF NORTH POINTE CAPITAL: Can you talk about your brokerage business
volumes. I don't know if you look at your volumes kind of ex your
banking-related deals. How you are doing in that business, and secondly, since
you bank a lot of the sub-prime guys, how do they consider you with your
entrance into the business. Do you think that will impact your relationships
with those guys now that you are a competitor?
MR. FRIEDMAN: This is Manny. In terms of the second question, whether it affects
all of the different people we banked. Before we did the acquisition, we talked
to everybody. We discussed it just to get a feeling for what their reaction
would be. The reaction has been very positive. Also, keep in mind that in our
model we will become a buyer of $5 to $6, $7 billion dollars of loans in the
open market. That is a tremendous plus so that deepens our relationship with
many of our clients. So in terms of our ability to underwrite in the industry,
it appears not to have any effect.
MR. BILLINGS: Repeat the first question. I didn't follow the first question.
MR. WALL: On the institutional brokerage. Are you able to break out whether you
get a lot of business because you are doing a lot of banking? Can you step right
out of the non-banking related business you are getting and how are those
volumes doing? Are they going up with the rest of the business?
MR. BILLINGS: Clearly, when we do banking activity, the second day of trading is
higher than the first day. That is part of secondary trading, there is no
question about that. And that is why there tends to be a strong correlation of
volume activity. But, cleary, the vast majority is not related to banking
transactions. I don't have the specific break down. I can get it. I just don't
have the off the top of my head, but there is clearly a correlation, and it is a
very important correlation. But it should be viewed not only just at the time of
a transaction, but obviously to a degree that we take a company public we will
be typically the dominant trader of their stock afterwards. So we are building
the foundation, this sort of geometric progression that helps to build the
franchise every day, every week, every month. Doesn't mean it doesn't bounce
around but it is always broadening. There is a very broadening effect on what
happen in secondary trading as well as banking every time you have a client and
establish a business relationship with them.
I don't know if that answers your question specifically enough, but you can call
and I will give you that number.
JUSTIN HUGHES WITH PHILADELPHIA FINANCIAL: One of the things we haven't talked
about is the strong performance of the asset management unit. You really
exceeded estimates on the base fee but mostly on the incentive fee. What kind of
performance returns did it take to have that type of performance fee, just to
get a sense of how sustainable it is?
MR. FRIEDMAN: Mutual funds were very, very strong with two funds having great
performance. The alternatives had strong inflows, and we did have some incentive
fees. We don't actually break down the performance of the alternatives because
of the regulatory rules.
MR. BILLINGS: Asset management, it is a very exciting business for us. It is the
smallest of our profit centers - we earned about $3 million. Having said that,
it has tremendous potential, and with these asset inflows, as they come in, all
of the net revenues fall to the bottom line. So we are very optimistic about the
future profitability of it but at this time the total contribution is not
significant.
MR. HUGHES: But we can't get the average performance of your alternative
investments in the fourth quarter?
MR. BILLINGS: As much as we would like to give them to you, we are instructed
not to.
MR. HUGHES: On your investment portfolio, you had sizable gains this quarter.
How much do we have left in unrealized gains? I know it will be disclosed in the
Q, but I was wondering if we could find now.
MR. FRIEDMAN: The unrealized gains number at the end of the year was $34
million, and then if you mark the 144s, which we carry at cost until they trade,
it was $55 million.
MR. BILLINGS: Again, at this point, there are dividends from many of the
investments. About $300 million of our investments are dividend-paying
companies, most of which have very high dividends associated with them once the
companies are fully invested and ramped. So the dividends will build very
significantly during the course of the year and that provides a very sound base
for profitability on the merchant banking side, regardless of whether we take
gains or not. But, clearly, we will take gains, and we haven't changed our
guidance that we intend to realize gains somewhere in the vicinity of 20 percent
of the portfolio a year.
MR. HUGHES: So as to the $6 million you are showing in dividends, even though
you have sold off a lot of investments, you have re-deployed even more capital,
so we should see that number increase?
MR. HENDRIX: We deployed north of $80 million in the fourth quarter into new
investments, virtually all of which are dividend payers, and we had dividend
payers that we invested in earlier in the year that are just now ramping into
their full dividend. The $6.2 million actually had one relatively large dividend
in it, but we think that is shy of the run rate quarterly that we will see
throughout all of 2005.
MR. FRIEDMAN: That is a new phenomenon for us.
MR. HUGHES: Some special dividends at the end of the year?
MR. HENDRIX: There was one, but as I said that $6.2 million is actually lower
than what the run rate will be quarterly in `05.
MR. BILLINGS: It should build through each quarter of the year.
LAUREN SMITH WITH KBW: Good morning. Most everything has been answered but I am
curious, you have been building in the asset-backed and mortgage-backed areas. I
guess you said recently that on the mortgage-backed side you got some traders
from Freddie Mac, and you acquired a team from Wachovia in the asset-backed
area. I am curious how big that effort is now, and how big you perhaps might
expect that business to get?
MR. HENDRIX: From a head count, we have added around 10 people in the
mortgage-backed area. Some of the team came from Freddie Mac, and they will be
adding people from outside Freddie as well. The ABS effort continued to grow
through the year, and we have about 15 people in that business. We are merging
the sales and trading efforts of those two businesses. We expect relatively
significant numbers out of that business in 2005. We haven't really provided
guidance on that business specifically yet, but I will tell you that we think
the total revenues in that business ought to exceed $50 million in 2005. We are
hopeful it is significantly above that, but we feel good about that number given
where we are in the ABS business and when we started trading in the MBS
business.
MR. BILLINGS: This is a business that does require an allocation of capital,
and, as we do in all our businesses, we have to believe we can achieve a higher
return than we can on the spread-based side of our business in order to
allocate, and we absolutely do. So that gives you a sense of how good a business
this will be. We do believe it will increase the profitability of the company in
a good way -- actually in a stable and somewhat predictable way. And that is not
yet in our numbers or our models, so we will be adding them as we go forward.
MR. FRIEDMAN: This gives us the ability to be a manufacturer of mortgages along
all parts of the capital structure of the mortgage across the board.
MS. SMITH: I know in the past you have given us this $200 million breakeven for
the brokerage business. Is it fair to say, then, as this has grown with the
addition of newer businesses that are not rolled up in there?
<
MR. BILLINGS: It was to the degree that it existed in the past. Our break even
number for this year will be higher than the $200 million for last year. It will
be some where in the vicinity of probably $250 million this year, and we will be
more specific with you a little bit later as we finish these numbers. But most
of the build-out of the franchise has taken place in '04, and one of the things
that is very exciting for us is we have increased the structure, the
infrastructure, and the cost structure, and, despite that, we had an 80 percent
return on equity in the capital markets business in totality. And, yet, we
believe, given all the new additions, we can grow the revenues across the board
in that part of our business as we increase fixed-income and mortgage trading
activity quite significantly. So, while our breakeven will go up, it will go up
not nearly as much as it has in the past couple of years, and we think our
revenues will go up considerably more than that. Obviously, time will tell. It
depends on markets and things like that.
RHYS WILLIAMS WITH COLUMBIA PARTNERS: Really great quarter, very impressive
across a bunch of business lines. It is amazing that your stock really is sort
of de-coupled from the other brokerage and capital markets firms because you are
now a mortgage REIT. As you can tell from the questions, everybody is very
nervous about that side of it. Can you give us some comfort that the first
quarter, given the spread compression but also given that you are shifting some
money into non-conforming loans, that the first quarter won't be worse than the
fourth quarter so you can get some baseline profitability there?
MR. BILLINGS: Are you talking about in the spread-based side of the business?
MR. WILLIAMS: Yes, because everything else is a grand slam home run for you guys
right now.
MR. BILLINGS: I love the analogy of the grand slam, but it is continued business
growth and stability and predictability that we are really happy with. But we
have indicated that on a spread basis, we don't, and we can't give that out. We
don't know what it is. It will be a function of many factors that nobody knows.
We are very, very excited about the business model and the totality. We have
parts of our business which are very stable and predictable and parts which are
not. So in totality we can't give that guidance. But we are very optimistic
about 2005, and that the profitability, the returns on equity, all of the above,
will certainly equal or exceed our expectations, but, again, time will tell.
MR. FRIEDMAN: The spread-based business will be determined by the exact timing
of when the sub-prime pieces go on, and we have said about a billion and a half
could go on by the end of the first quarter, though the exact timing is not
certain. But every time we do that, there will be a substantial pick-up.
MR. BILLINGS: Remember, even in the MBS, if we were to get a continued
contraction on that spread, you are talking about for a quarter or something. It
is generally not going to be meaningful in the totality of the profitability of
the company in a given quarter. There are a lot of moving parts at the margin,
and so generally it is not going to be that significant in any case even if it
happens, which may or may not. But it should be somewhat significantly mitigated
by the non-conforming assets that we put on the balance sheet, and again,
depending on how much we put on there, if there were contraction, it might
completely mitigate it. On the other hand, it may not. But I think it is
important that, if you think about it and you put a model together, you can see
the total direction that this is heading, and it will happen in a fairly rapid
way and I think you should be able to model out what that net effect is.
Remember, in any given quarter there can be marginal issues, but they shouldn't
be taken as any more than that, and they are certainly not precisely
predictable. But the trend and the direction are clear, and so we think that
probably you can have great confidence in executing a model.
MR. WILLIAMS: You mentioned there would be a couple more special dividends this
year. Are there any thoughts of raising the regular dividend?
MR. HENDRIX: Yes, and in fact, this really gets to the timing of the transition
of the mortgage portfolio, but our hope and expectation is that we will be able
to increase the core dividend.
MR FRIEDMAN: On the non-prime side, to the extent we have it match-funded, to
the extent we know we have the income on the balance sheet for three years, we
are much more comfortable about slowing turning that into a regular dividend.
MR. WILLIAMS: One last question. The asset management side, I know, it is small
relative to everything else, but is there anything else you can do to leverage
that number one small cap fund ranking? Are there clone funds you can come up
with?
MR. HENDRIX: I think it is important to understand the definition of closed.
That fund is closed to new investors, and even since the closing it has grown by
50 percent. So we believe we will continue to grow that fund, and there may be
other similar funds that we will be able to create to add to the growth in the
mutual fund area. But it is not a fund that has no more growth for FBR or the
fund's shareholders. It's simply closed to new investors.
MR. BILLINGS: We are working on all of those thoughts in terms of adding new
funds. It is an ongoing part of what we are trying to do, and I think you will
see that as the years unfold.
TELEPHONE OPERATOR: At this time there are no further questions.
MR. BILLINGS: Thank you all very much. We appreciate it a great deal.
(Whereupon, at 10:08 a.m. the conference call was concluded.)