FBR Asset Investment Corporation
Common Stock
5,767,750 Shares
FBR Asset Investment Corporation is a real estate investment trust that invests
in mortgages, mortgage-backed securities and other real estate-related assets,
both directly and indirectly through investments in other companies. The selling
shareholders identified in this prospectus are offering and selling up to
5,767,750 shares of FBR Asset's common stock. FBR Asset will not receive any
proceeds from the sale of those shares.
The selling shareholders may offer their shares of common stock in public or
private transactions in the over-the-counter markets, on or off any stock
exchange on which the shares may be listed at the time of sale, at prevailing
market prices, or at privately negotiated prices. The selling shareholders may
engage brokers or dealers who may receive commissions or discounts from the
selling shareholders. FBR Asset's common stock has been approved for listing on
the American Stock Exchange under the symbol "FB."
You should consider the risk factors discussed on pages 4-16 before investing in
FBR Asset, which include:
o Significant Conflicts of Interest;
o Sensitivity to Fluctuations in Interest Rates, Mortgage Prepayments,
and Borrower Defaults;
o Leverage;
o Riskiness of Interest Rate Hedging;
o Sensitivity to Declines in Market Value of Investments;
o Management's Limited Experience Operating a REIT; and
o Limited Operating History.
===============================================================================
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
===============================================================================
This prospectus is dated September 27, 1999.
<PAGE>
===============================================================================
This prospectus incorporates by reference exhibits to the registration statement
that we have filed with the SEC. You may request copies of those exhibits, free
of charge, by calling or writing Mr. John M. Blassingame, Jr. at FBR Asset
Investment Corporation, Potomac Tower, 1001 Nineteenth Street North, Arlington,
Virginia 22209, (703) 469-1000.
===============================================================================
Table of Contents
SUMMARY........................................1
FBR Asset....................................1
FBR & FBR Management.........................2
Summary Financial Information................3
RISKS OF INVESTING IN FBR ASSET................4
Conflicts with FBR may result in decisions
that do not reflect FBR Asset's
best interests...............................4
FBR Asset's limited operating history does
not indicate future results..................5
FBR Management's limited experience in
managing a REIT may affect FBR Asset's
performance..................................6
Declines in the market values of FBR
Asset's assets may adversely affect credit
availability and periodic reported results...6
FBR Asset is heavily dependent upon
FBR Management...............................6
Use of leverage could adversely affect
FBR Asset's operations.......................7
FBR Asset's real estate-related investments
may incur losses.............................7
Changes in interest rates could negatively
affect the value of FBR Asset's mortgage
loans and mortgage-backed securities......7
Use of leverage can amplify declines in
market value resulting from interest
rate increases............................8
Prepayment rates could negatively affect
the value of FBR Asset's mortgage-backed
securities................................8
Hedging against interest rate exposure may
adversely affect FBR Asset's earnings.....9
Multifamily and commercial real estate may
lose value and fail to operate
profitably................................9
Investing in subordinated interests
exposes FBR Asset to increased
credit risk..............................10
Competition in the purchase, sale and
<PAGE>
financing of mortgage assets may limit the
profitability of companies in which FBR
Asset invests............................10
Increased losses on uninsured mortgage
loans can reduce the value of FBR Asset's
equity investments.......................10
Prepayment sensitivity of investments in
interest-only securities.................11
Indirect nature of investments exposes FBR
Asset to additional risks...................12
Returns on equity investments are not
directly linked to returns on investee
companies' assets........................12
Obstacles to success may remain hidden if
due diligence is inadequate..............12
Dependence on management of other
entities.................................12
Limited liquidity of equity security
investments..............................12
Volatility of prices.....................13
Disposition value of investments is
dependent upon general and specific
market conditions........................13
Management Agreement requires FBR Asset to
pay fee upon termination of FBR Management..13
Tax requirements may restrict FBR Asset's
operations..................................14
Loss of Investment Company Act exemption
would adversely affect FBR Asset............15
Ownership limitation may restrict change of
control or business combination
opportunities...............................15
Board of Directors may change policies
without shareholder consent.................16
No prior market for common shares...........16
ORGANIZATION & RELATIONSHIPS..................17
FBR & FBR MANAGEMENT..........................18
Related Party Transactions..................18
FBR Management's Executive Officers.........21
The Management Agreement....................22
FBR Management's Responsibilities........22
The Management Fee.......................24
Options Owned by FBR Management..........25
Expenses.................................25
Limits of Responsibility.................25
Term of Management Agreement.............26
FBR ASSET'S BUSINESS..........................27
Operating Policies & Strategies.............27
Current Investments.........................28
Whole-Pool Mortgage-Backed Securities....29
i
<PAGE>
Real Estate..............................36
Commercial Mortgage Loans & CMBS.........37
Loans....................................39
Real Estate-Related Businesses...........39
Summary of Current Investments & Cash and
Cash Equivalents............................40
Dividends & Distribution Policy.............41
SELECTED FINANCIAL DATA.......................43
MANAGEMENT'S DISCUSSION & ANALYSIS............44
Overview....................................44
Results of Operations.......................44
Net Income...............................44
Interest and Dividend Income.............46
Interest Expense.........................47
Dividends Declared and Distributions in
Excess of GAAP Net Income................48
Changes in Financial Condition..............48
Securities Available for Sale............48
Repurchase Agreements....................49
Contractual Commitments..................50
Capital Resources and Liquidity..........50
Shareholders'Equity......................51
Year 2000 Compliance........................53
Market Conditions...........................54
Equity Market Conditions.................54
REIT and Real Estate Market Conditions...55
Interest Rate Environment................58
Market Risk..............................60
Developments Since June 30, 1999............63
FBR ASSET'S DIRECTORS & OFFICERS..............65
The Board of Directors......................65
Composition of the Board.................65
Executive Committee......................66
Audit Committee..........................66
Contracts Committee......................66
Nominating Committee.....................67
The Directors...............................67
The Independent Directors................67
Directors Affiliated with FBR Management.67
Executive Officers Who Are Not Directors....68
Time Required of Directors & Executive
Officers....................................69
Executive Compensation & Other Benefits.....69
Directors' Fees..........................69
Salaries.................................69
Indemnification..........................70
Stock Options............................70
Related Party Transactions...............71
FBR ASSET'S CAPITAL STOCK.....................72
General.....................................72
Common Stock................................72
Preferred Stock.............................72
Restrictions on Ownership and Transfer......73
Transfer Agent & Registrar..................75
Reports to Shareholders.....................75
FBR Asset's Charter and Bylaws..............76
Notice of Shareholder Proposals..........76
Charter Amendments.......................76
Amendments to Bylaws.....................76
COMMON STOCK AVAILABLE FOR FUTURE SALE........77
PRINCIPAL SHAREHOLDERS........................78
FEDERAL INCOME TAX CONSEQUENCES OF FBR ASSET'S
STATUS AS A REIT..............................79
Taxation of FBR Asset.......................79
Requirements for Qualification..............81
Income Tests.............................82
Asset Tests..............................86
Distribution Requirements................88
Recordkeeping Requirements..................90
Failure to Qualify..........................90
Taxation of Taxable U.S. Shareholders.......90
Taxation of U.S. Shareholders on the
Disposition of the Common Stock.............92
Capital Gains and Losses....................92
Information Reporting Requirements and
Backup Withholding..........................93
Taxation of Tax-Exempt Shareholders.........93
Taxation of Non-U.S. Shareholders...........94
Other Tax Consequences......................96
ERISA CONSIDERATIONS..........................97
SELLING SHAREHOLDERS..........................99
USE OF PROCEEDS..............................102
PLAN OF DISTRIBUTION.........................103
OTHER MATTERS................................105
Legal......................................105
Independent Accountants....................105
Additional Information.....................105
INDEX TO FINANCIAL STATEMENTS...................F-1
ii
<PAGE>
===============================================================================
Neither FBR Asset nor the selling shareholders have authorized anyone to
give you any information other than that which is included in this
document.
Neither FBR Asset nor the selling shareholders have authorized anyone to
make any representations to you other than those that are included in this
document.
If anyone gives you additional information, or makes additional
representations, you must not rely on them at all.
===============================================================================
===============================================================================
This prospectus is not an offer to sell or the solicitation of an offer to
buy any securities other than those to which it relates, nor is it an offer
or solicitation of any person in any jurisdiction to whom it would be
unlawful to make an offer or solicitation.
The delivery of this prospectus at any time does not imply that the
information herein is correct as of any time after September 27, 1999.
===============================================================================
iii
<PAGE>
Summary
This summary highlights only a few of the facts that you will need to make an
informed decision about investing in FBR Asset. We encourage you to read this
entire prospectus, and the other documents to which it refers, very carefully.
References to "we," "us," and "our" indicate the management of FBR Asset.
FBR Asset
FBR Asset is a Virginia corporation that was formed in November 1997. FBR Asset
invests in:
o whole-pool mortgage-backed securities guaranteed by Fannie Mae,
Freddie Mac, or Ginnie Mae;
o residential and commercial real property;
o residential and commercial mortgage loans;
o residential and commercial mortgage-backed securities;
o direct loans to real estate-related companies; and
o other real estate-related assets.
FBR Asset invests in some of these assets directly by buying the assets and
invests in others indirectly by buying equity interests in, or making loans to,
REITs and other companies engaged in real estate-related businesses. In the
future, FBR Asset may enter into joint ventures or partnerships that will also
invest in these assets.
FBR Asset expects to generate income primarily from the net earnings derived
from its investments. FBR Asset also seeks to generate growth in earnings and
dividends per share by:
o increasing the income generated from new assets at a rate faster than
the rate of increases in operating expenses;
o increasing the size of its balance sheet when opportunities in the
market for its targeted investments are likely to allow growth in
earnings per share;
o continually reviewing the mix of its investments in an effort to
improve and enhance returns; and
o using leverage to create greater equity returns for shareholders.
We can give no assurance that FBR Asset will be able to achieve these results.
For a detailed discussion of the factors that may limit our ability to achieve
these results, see "Risks of Investing in FBR Asset," which begins on page 4.
FBR Asset has elected to be taxed as a REIT under the federal tax laws and
intends to continue operating as a REIT. Accordingly, FBR Asset will not incur
federal income tax on its earnings to the extent that it distributes those
earnings to its shareholders, and as long as the asset, income, stock ownership
and minimum distribution tests of the federal tax laws are met. FBR Asset will,
however, be subject to tax at normal corporate rates on net income or capital
gains not distributed to shareholders.
1
<PAGE>
FBR Asset intends to continue operating its business so as not to become
regulated as an investment company under the Investment Company Act of 1940.
For more information about FBR Asset's business, see "FBR Asset's Business" on
page 27.
FBR & FBR Management
Friedman, Billings, Ramsey Investment Management, Inc. manages FBR Asset's
day-to-day operations, subject to the direction and oversight of FBR Asset's
Board of Directors. FBR Management is a wholly-owned subsidiary of Friedman,
Billings, Ramsey Group, Inc., an investment banking firm that focuses on
research, underwriting, brokerage, and asset management activities in various
sectors, including real estate, financial services, specialty finance,
technology, insurance, and consumer products. FBR Group, together with its other
subsidiaries ("FBR"), has presented FBR Asset with opportunities to invest in
other companies, including REITs, that invest in or manage real estate and
companies that provide services to real estate owners and operators.
FBR Management has engaged BlackRock Financial Management, Inc., a subsidiary of
PNC Bank Corp., to sub-manage FBR Asset's mortgage portfolio. Through BlackRock,
FBR Asset has access to market expertise and risk management systems that allow
FBR Asset actively to monitor and manage its mortgage portfolio's exposure to
interest and prepayment risks. FBR Management has retained BlackRock to assist
it in assessing credit risk, risk of capital loss, the availability and cost of
financing, and yield spread movements on FBR Asset's mortgage assets.
For more information about FBR, FBR Management, and BlackRock, see "FBR & FBR
Management" on page 18.
2
<PAGE>
Summary Financial Information
The summary financial data set forth below should be read in conjunction with
"Management's Discussion & Analysis" and the Financial Statements and Notes
thereto included elsewhere in this prospectus. The selected balance sheet data
as of December 31, 1997 and 1998, and June 30, 1998, and the statement of
operations data for the period from December 15, 1997 (Inception) to December
31, 1997, the year ended December 31, 1998, and the six months ended June 30,
1998, has been derived from FBR Asset's audited financial statements, which are
included elsewhere in this prospectus. The selected balance sheet data as of
June 30, 1999 and statement of operations data for the six-month period ended
June 30, 1999, has been derived from FBR Asset's unaudited financial statements
and has been prepared on the same basis as the audited financial statements. The
unaudited financial statements include, in the opinion of management, all
adjustments, consisting of normal recurring adjustments, necessary for the fair
presentation of the financial information set forth herein. The results for the
year ended December 31, 1998, and for the six month periods ended June 30, 1998
and 1999, are not necessarily indicative of the results to be expected for any
future annual or interim period.
<PAGE>
<TABLE>
<CAPTION>
December 15, 1997 For the
(Inception) For the Year Six Months Ended June 30,
through Ended ----------------------------------
December 31, 1997 December 31, 1998 1998 1999
----------------- ----------------- ------------ ------------
(unaudited)
<S> <C> <C> <C> <C>
Statement of Operations Data
Interest income ............ $ 18,040 $ 13,656,097 $ 4,817,569 $ 7,745,578
Dividend income ............ 434,717 4,271,405 833,749 2,838,852
Net realized losses ........ - (8,369,807) - -
Net income ................. 646,921 1,588,235 4,465,641 6,530,192
Basic and diluted income per
share ...................... $ 0.06 $ 0.16 $ 0.43 $ 0.81
Dividends declared per
share(1) ................... $ 0.06 $ 1.16 $ 0.50 $ 0.71
</TABLE>
<TABLE>
<CAPTION>
As of
As of December 31 June 30,
---------------------------------- ------------
1997 1998 1999
------------ ------------ ------------
Selected Balance Sheet Data: (unaudited)
<S> <C> <C> <C>
Mortgage-backed securities,
at fair value................. $ - $161,418,739 $140,943,202
Cash and cash equivalents..... 163,223,199 41,144,326 20,336,693
Investments in equity
securities, at fair value..... 23,318,750 70,983,050 73,515,801
Total assets.................. 190,538,402 295,930,620 253,950,693
Repurchase agreements......... - 128,550,000 113,794,000
Total liabilities............. 771,573 145,026,041 126,969,514
Accumulated other
comprehensive income (loss)(2) - (9,800,530) (15,896,077)
Shareholders' equity.......... 189,766,829 150,904,579 126,981,179
Shares issued and
outstanding(3)................ 10,218,999 8,543,527 7,111,836
Book value per share.......... $ 18.57 $ 17.66 $ 17.85
</TABLE>
(1) Dividends declared are based upon FBR Asset's taxable income. Net realized
losses are not included in FBR Asset's ordinary taxable income.
(2) Accumulated other comprehensive loss includes unrealized net gain on
mortgage-backed securities of $713,499 as of December 31, 1998, unrealized
net loss on mortgage-backed securities of $2,407,299 as of June 30, 1999,
and unrealized net loss on investments in equity securities of $10,514,029
as of December 31, 1998, and $13,488,778 as of June 30, 1999.
(3) Reflects 1,872,300 and 3,303,991 shares of treasury stock repurchased as of
December 31, 1998 and June 30, 1999, respectively.
3
<PAGE>
Risks of Investing in FBR Asset
Investing in FBR Asset involves various risks, including the risk that you might
lose your entire investment. The results of FBR Asset's operations depend upon
many factors, including the availability of opportunities to acquire assets, the
level and volatility of interest rates, the cost and availability of short- and
long-term credit, financial market conditions, and general economic conditions.
FBR Asset will strive to attain its objectives through, among other things, FBR
Management's research and portfolio management skills. There is no guarantee,
however, that FBR Asset will perform successfully, meet its objectives, or
achieve positive returns.
Some of the information in this prospectus contains forward-looking statements.
Those statements can be identified by the use of words like "may," "will,"
"expect," "anticipate," "estimate," or other similar words. Those statements
discuss our future expectations and contain our projections of operation results
or financial condition. When considering forward-looking statements, you should
keep in mind the risk factors discussed below and the other cautionary
statements contained in this prospectus. Those factors could cause our actual
results to differ materially from our expectations and projections.
The following risks are interrelated, and you should treat them as a whole.
Conflicts with FBR may result in decisions that do not reflect FBR Asset's
best interests.
FBR Asset is subject to various conflicts of interest arising from its
relationship with FBR. Those conflicts include the following:
o FBR Asset acquires indirect interests in real estate, commercial
mortgage loans and commercial mortgage-backed securities by investing
in companies whose securities have been underwritten or placed by FBR.
FBR and its employees are paid substantial fees for underwriting and
placement agent services, and to the extent that the success of a new
offering depends upon a significant investment by FBR Asset, FBR
Management will have a conflict of interest in recommending that
investment to FBR Asset. In those instances, FBR Asset's shareholders
will rely on the investment decision of FBR Asset's independent
directors, who will in part rely on information provided by FBR
Management. At September 16, 1999, the total market value of FBR
Asset's investments in securities underwritten or placed by FBR had
declined by approximately $21.7 million, or 23.3%, since FBR Asset
acquired the securities. Of that $21.7 million loss, approximately $6.6
million was realized and charged to FBR Asset's earnings in 1998 and
1999; the remaining $15.1 million has been charged to shareholders'
equity, but not to FBR Asset's earnings. If, however, FBR Asset had
sold all of its equity investments on September 16, 1999, the company
would have realized a $15.1 million loss and that loss would have been
charged directly to earnings.
o FBR manages other funds that are authorized to invest in assets similar
to those in which FBR Asset invests. In particular, FBR manages mutual
and private equity funds, and may in the future manage other funds,
that invest in private equity
4
<PAGE>
securities and in REITs and other real estate-related securities. There
may be investment opportunities that are favorable to each of FBR Asset
and the other funds managed by FBR. In that case, FBR will allocate
investment opportunities among funds based upon primary investment
objectives, applicable investment restrictions, and any other factors
that FBR deems appropriate and fair under the circumstances.
o BlackRock, the mortgage portfolio manager, currently manages funds and
accounts, and may in the future manage other funds or accounts, that
have investment objectives similar to those of FBR Asset. There may be
investment opportunities that are favorable to each of FBR Asset and
the other funds or accounts managed by BlackRock. Although there are no
contractual requirements for BlackRock to allocate specific investment
opportunities to FBR Asset, BlackRock will allocate investment
opportunities to its accounts in a manner that is reasonably fair to
each account over time. In allocating opportunities, BlackRock may
consider any factors that it deems appropriate under the circumstances.
o The incentive portion of the management fee, which is based on FBR
Asset's income, may create an incentive for FBR Management to recommend
investments that have greater potential for income or appreciation, but
that are generally more speculative. If the management fee did not
include a performance component, FBR Management might not otherwise
recommend those investments because of their speculative nature.
o A majority of the Board, and each of FBR Asset's executive officers,
also serve as executive officers or employees of FBR and devote
substantial time to FBR. These persons devote such time and attention
to FBR Asset's business as they, in their discretion, deem necessary,
but conflicts may arise in allocating management time, services or
functions between FBR Asset and FBR. The failure by these people to
devote adequate time to FBR Asset could result in FBR Asset failing to
take advantage of investment opportunities or failing to take other
actions that might be in the company's best interests.
o FBR may provide a broad range of financial services to enterprises in
which FBR Asset has invested or with which it otherwise does business.
For these services, FBR will be paid fees or will otherwise receive
compensation and thus might have an incentive to recommend an
investment to FBR Asset when it might not otherwise choose to do so.
o Because of its relationship with FBR, FBR Asset may obtain confidential
information about the companies in which it has invested. If FBR Asset
does possess confidential information about other companies, it may be
restricted in its ability to dispose of, increase the amount of, or
otherwise take action with respect to its investment in those
companies.
FBR Asset's limited operating history does not indicate future results.
FBR Asset was organized in November 1997 and has a limited operating history.
Because of this limited history, investors should be especially cautious before
drawing conclusions about the company's future. FBR Asset's past performance,
particularly given its short operating history, is not necessarily indicative of
future results.
5
<PAGE>
FBR Management's limited experience in managing a REIT may affect FBR Asset's
performance.
Before November 1997, none of FBR Asset's or FBR Management's officers had ever
managed a REIT. FBR Management has no experience in managing a REIT other than
its experience with FBR Asset. There can be no assurance that the limited past
experience of FBR Management will enable it successfully to manage FBR Asset's
business.
Declines in the market values of FBR Asset's assets may adversely affect
credit availability and periodic reported results.
FBR Asset's assets are primarily real estate and mortgage assets, which include
indirect holdings through investments in other companies. Those assets are
classified for accounting purposes as "available-for-sale." Changes in the
market values of those assets are directly charged or credited to FBR Asset's
shareholders' equity. As a result, a general decline in trading market values
may reduce the book value of FBR Asset's assets even though there may have been
no change in the inherent value of those assets.
A decline in the market value of FBR Asset's assets may adversely affect FBR
Asset in instances where FBR Asset has borrowed money based on the market value
of those assets. At June 30, 1999, FBR Asset had $113.8 million in outstanding
repurchase agreements that were based on the market value of specific mortgage
assets. The market value of those assets was $117.1 million when FBR Asset
entered into the repurchase agreements and as of June 30, 1999, was $117.4
million. If the market value of those assets declines, the lender may require
FBR Asset to post additional temporary collateral to support the loan. If FBR
Asset is unable to post the additional collateral, it may have to sell the
assets at a time when it would not otherwise choose to do so. Between January 1,
1999, and June 30, 1999, lenders required FBR Asset to post additional temporary
collateral in an approximate aggregate amount of $2.5 million.
FBR Asset is heavily dependent upon FBR Management.
FBR Asset can gain access to good investment opportunities only to the extent
that they become known to FBR Management. Gaining access to opportunities is a
highly competitive business. FBR, FBR Management, and FBR Asset compete with
other companies that have greater capital, more long-standing relationships,
broader product offerings, and other advantages. Competitors include, but are
not limited to, Merrill Lynch, Morgan Stanley Dean Witter, GE Capital, Ocwen
Asset Investment Corp., Imperial Credit Commercial Mortgage Investment
Corporation, and General Motors Acceptance Corporation.
FBR Asset is heavily dependent for the selection, structuring, and monitoring of
its investments on the diligence and skill of FBR Management's officers and
employees, primarily those named under "FBR Asset's Directors & Officers." FBR
Asset does not have employment agreements with its senior officers or require
FBR Management to employ specific personnel or dedicate employees solely to FBR
Asset. FBR Management, in turn, is dependent on the efforts of senior management
personnel. Although FBR Asset believes that FBR Management could find
replacements for its key
6
<PAGE>
executives, the loss of their services could have an adverse effect on the
operations of FBR Management and FBR Asset.
Use of leverage could adversely affect FBR Asset's operations.
At June 30, 1999, FBR Asset's outstanding indebtedness for borrowed money was
0.90 times the amount of its equity based on book values. The Board has the
authority to increase or decrease the company's debt-to-equity ratio at any time
and has not placed any limits on the amount FBR Asset may borrow. During 1998,
FBR Asset's debt-to-equity ratio ranged from 0.10 to 1.2 to 1. During the first
half of 1999, FBR Asset's debt-to-equity ratio ranged from 0.81 to 0.92 to 1. If
FBR Asset borrows more funds, the possibility that it would be unable to meet
its debt obligations as they come due would increase.
Of FBR Asset's $140.9 million mortgage-backed securities at June 30, 1999,
$113.8 million were financed with repurchase agreements. As of June 30, 1999,
FBR Asset's portfolio of mortgage-backed securities was leveraged at
approximately a 4 to 1 ratio, based on book values. Financing assets through
repurchase agreements exposes FBR Asset to the risk that margin calls will be
made and that FBR Asset will not be able to meet those margin calls. Between
December 31, 1998, and June 30, 1999, FBR Asset had margin calls requiring it to
post additional temporary collateral in the amount of $2.5 million. Although FBR
Asset was able to meet those margin calls, there can be no assurance that it
will be able to meet future margin calls.
As of June 30, 1999, FBR Asset had authorization from its Board to repurchase up
to 696,009 shares of FBR Asset's common stock. A repurchase of shares would
reduce stockholders' equity and could increase leverage and the company's
debt-to-equity ratio. See "Management's Discussion & Analysis--Developments
Since June 30, 1999."
FBR Asset's real estate-related investments may incur losses.
FBR Asset invests in real estate-related assets and in other entities, such as
REITs, that themselves invest in real estate-related assets. Investments in real
estate-related assets are subject to a variety of general, regional and local
economic risks, as well as the following:
Changes in interest rates could negatively affect the value of FBR Asset's
mortgage loans and mortgage-backed securities.
FBR Asset has invested indirectly in mortgage loans by purchasing
mortgage-backed securities. Some of the companies in which FBR Asset has
invested also own mortgage loans and mortgage-backed securities. At December 31,
1998, and June 30, 1999, all of the mortgage-backed securities held directly by
FBR Asset were backed by pools of fixed-rate, residential mortgage loans. An
investment in fixed-rate mortgage loans or mortgage-backed securities will
decline in value if long-term interest rates increase. Although Fannie Mae,
Freddie Mac or Ginnie Mae may guarantee payments on the mortgage-backed
securities owned directly by FBR Asset, those guarantees do not protect FBR
Asset from declines in market value caused by changes in interest rates.
7
<PAGE>
A significant risk associated with FBR Asset's current portfolio of
mortgage-backed securities is the risk that both long-term and short-term
interest rates will increase significantly. If long-term rates were to increase
significantly, the market value of FBR Asset's mortgage-backed securities would
decline and the weighted average life of the investments would increase. FBR
Asset could realize a loss if the securities were sold. At the same time, an
increase in short-term interest rates would increase the amount of interest owed
on FBR Asset's repurchase agreement borrowings. The swap agreement to which FBR
Asset is a party would ameliorate a portion of the risk associated with an
increase in short-term interest rates, but only to the extent of the $50 million
swap agreement and only until June 2001.
Use of leverage can amplify declines in market value resulting from interest
rate increases.
FBR Asset and several of the REITs in which FBR Asset has invested borrow funds
to finance mortgage loan investments, which can worsen the effect of a decline
in value resulting from an interest rate increase. For example, assume FBR Asset
or a REIT in which FBR Asset has invested borrows $90 million to acquire $100
million of 8% mortgage certificates. If prevailing interest rates increase from
8% to 9%, the value of the mortgage loans may decline to a level below the
amount required to be maintained under the terms of the borrowing. If the
mortgage assets were then sold, FBR Asset or the REIT that owned the mortgage
assets would have to find funds from another source to repay the borrowing.
Market values of mortgage loans and mortgage-backed securities may decline
without any general increase in interest rates for any number of reasons, as was
the case with commercial mortgage loans in the wake of the bankruptcy filing in
September 1998 by CRIIMI Mae, Inc., a mortgage REIT.
Prepayment rates could negatively affect the value of FBR Asset's
mortgage-backed securities.
In the case of residential mortgage loans, there are seldom any restrictions on
borrowers' abilities to prepay their loan. As a consequence, homeowners tend to
prepay mortgage loans faster when interest rates decline and when owners of the
loans, such as FBR Asset or the REITs in which FBR Asset has invested, do not
want them to be prepaid. Consequently, owners of the loans have to reinvest the
money received from the prepayments at the lower prevailing interest rates.
Correspondingly, homeowners tend not to prepay mortgage loans when interest
rates increase and when owners of the loans want them to be prepaid.
Consequently, owners of the loans are unable to reinvest money that would have
otherwise been received from prepayments at the higher prevailing interest
rates. During 1998, FBR Asset acquired $226.6 million face amount of residential
mortgage-backed securities. Principal payments on the mortgage-backed securities
averaged $2.7 million per month for the periods that FBR Asset owned the
securities. Of that amount, approximately 90-95% were principal prepayments.
Although Fannie Mae, Freddie Mac or Ginnie Mae may guarantee payments on the
mortgage-backed securities owned directly by FBR Asset, those guarantees do not
protect investors against prepayment risks.
8
<PAGE>
Hedging against interest rate exposure may adversely affect FBR Asset's
earnings.
During 1998, FBR Asset entered into two $50 million notional amount
interest rate swap agreements to limit, or "hedge," the adverse effects of
rising interest rates on its short-term repurchase agreements. In the future,
FBR Asset may enter into other interest rate swap agreements. FBR Asset's
hedging activity varies in scope based on the level and volatility of interest
rates and principal prepayments, the type of mortgage-backed securities held,
and other changing market conditions.
The companies in which FBR Asset has invested also enter into interest rate
hedging transactions to protect themselves from the effect of changes in
interest rates. Interest rate hedging may fail to protect or adversely affect a
company because, among other things:
o interest rate hedging can be expensive, particularly during periods of
rising and volatile interest rates;
o available interest rate hedging may not correspond directly with the
interest rate risk for which protection is sought;
o the duration of the hedge may not match the duration of the related
liability;
o the amount of income that a REIT may earn from hedging transactions to
offset interest rate losses is limited by federal tax provisions
governing REITs;
o the party owing money in the hedging transaction may default on its
obligation to pay; and
o the credit quality of the party owing money on the hedge may be
downgraded to such an extent that it impairs FBR Asset's ability to
sell or assign its side of the hedging transaction.
In October 1998, FBR Asset sold mortgage assets, repaid certain outstanding
repurchase agreements, and terminated a related hedge transaction, resulting in
a $1.9 million recorded loss for the fourth quarter of 1998. Similarly, Chastain
Capital Corporation, a REIT of which FBR Asset owned 9.53% at June 30, 1999,
declared in its 1998 third quarter report a loss of $13.5 million resulting from
its termination of an interest rate hedge.
Multifamily and commercial real estate may lose value and fail to operate
profitably.
Several of the companies in which FBR Asset has invested own multifamily and
commercial real estate. In the future, FBR Asset may invest in other companies
that invest in multifamily and commercial real estate or may itself invest in
those assets. Those investments and other similar investments are dependent on
the ability of the real estate to generate income. Investing in real estate is
subject to many risks. Among these are:
o property managers may not have the ability to attract tenants willing
to pay rents that sustain the property and to maintain and operate the
properties on a profitable basis;
9
<PAGE>
o the value of real estate may be significantly affected by general,
regional and local economic conditions, and other factors beyond the
investor's control;
o the value of real estate may be significantly affected by unknown or
undetected environmental problems; and
o the value of real estate may be significantly affected by changes in
zoning or land use regulations or other applicable laws.
Investing in subordinated interests exposes FBR Asset to increased credit
risk.
Although FBR Asset does not directly own "subordinated interests," some of
the companies in which FBR Asset invests do. In the future, FBR Asset may invest
in other companies that invest in subordinated interests or may itself invest in
those interests. Subordinated interests are classes of commercial
mortgage-backed securities and mortgage loans that are subject to the senior
claim of mortgage-backed debt securities. Losses on the underlying mortgage
loans may be significant to the owner of a subordinated interest because the
investments are leveraged. For example, assume a REIT acquires a $10 million
principal amount subordinated interest in a $100 million pool of mortgage loans
that is subject to $90 million of senior mortgage-backed securities. If
thereafter there are $7 million of losses on the $100 million of loans, the
entire loss will be allocated to the owner of the subordinated interest. In
essence, a 7% loss on the loans would translate into a 70% loss of principal for
the owner of the subordinated interest.
Competition in the purchase, sale and financing of mortgage assets may limit
the profitability of companies in which FBR Asset invests.
Although FBR Asset does not directly own commercial mortgage-backed securities
or subordinated interests, some of the mortgage REITs in which FBR Asset invests
do. Mortgage REITs derive their net income, in large part, from their ability to
acquire mortgage assets that have yields above borrowing costs. In 1997 and
1998, increased competition for subordinated interests developed as new mortgage
REITs entered the market. These mortgage REITs raised funds through public
offerings and sought to invest those funds on a long-term basis. The amount of
funds available for investment, however, exceeded the amount of available
investments, which resulted in significant competition for assets. That
competition resulted in higher prices for subordinated interests, lowering the
yields and narrowing the spread of those yields over borrowing costs.
Competitors for the acquisition of mortgage assets include newer mortgage REITs,
such as Imperial Credit Commercial Mortgage Investment Corporation, Anthracite
Capital, Inc., AMRESCO Capital Trust, and other REIT and non-REIT investors,
such as Lennar Corporation and Capital Trust.
Increased losses on uninsured mortgage loans can reduce the value of FBR
Asset's equity investments.
Although the majority of FBR Asset's investments in mortgage loans are insured,
several of the companies in which FBR Asset has invested own uninsured mortgage
loans. In the future, FBR Asset may invest directly in uninsured mortgage loans.
10
<PAGE>
Owners of uninsured mortgage loans are subject to the risk that borrowers will
not pay principal or interest on their mortgage loans as it becomes due.
Borrowers become unable to pay their mortgage loans for a wide variety of
reasons, including general, regional, local and personal economics and declines
in business activity or real estate values. Generally, if a borrower defaults,
the owner of the mortgage loan will incur a loss to the extent the value of the
property securing the mortgage loan is less than the amount of the mortgage
loan. Defaults on mortgage loans often coincide with declines in real estate
values, which can create greater losses than anticipated. Increased exposure to
losses on uninsured mortgage loans can reduce the value of FBR Asset's equity
investments. For example, because of increased delinquencies on its uninsured
mortgage loans, Imperial Credit Commercial Mortgage Investment Corporation, a
REIT of which FBR Asset owned 3.09% at June 30, 1999, revised its estimates of
potential losses in 1998. For this reason, and because it wrote down its
interest-only securities to their fair market value based primarily upon
prepayments on the underlying mortgage loans, Imperial Credit reflected a
non-cash charge of $6.4 million in its financial statements for the third
quarter of 1998.
Prepayment sensitivity of investments in interest-only securities
FBR Asset has no direct investments in interest-only securities. The companies
in which FBR Asset invests owned no significant amount of interest-only
securities as of June 30, 1999, but may do so in the future. FBR Asset may also
invest in other companies that invest in interest-only securities or may invest
in those securities itself. Interest-only securities are mortgage-backed
securities that entitle the holder to receive only interest on the outstanding
principal amount of the underlying mortgage loans, and no principal. The value
of these interest-only securities can be adversely affected if the underlying
mortgage loans are prepaid faster than anticipated and the interest stream
therefore decreases. For example, an interest-only security with an initial
notional amount of $100 million may entitle a holder to interest equal to 1% on
the outstanding notional amount. The holder may anticipate that 10% of the loans
will prepay at the end of each year; however the actual experience is that 20%
of the loans prepay at the end of each year. In that case, the anticipated and
actual cash paid to the holder would be:
Year Anticipated Actual
------ ------------ ---------
1 $1,000,000 $1,000,000
2 900,000 800,000
3 800,000 600,000
4 700,000 400,000
5 600,000 200,000
6 500,000 --
7 400,000 --
8 300,000 --
9 200,000 --
10 100,000 --
---------- ----------
Total $5,500,000 $3,000,000
========== ==========
Some interest-only securities pay interest based on a floating rate that varies
inversely with, and at a multiple of, a specified floating interest rate index,
such as LIBOR. The yield on these securities is sensitive not only to
prepayments, but also to changes in the
11
<PAGE>
related index. For example, a security might bear interest at a rate equal to
forty percent minus the product of five and LIBOR, or 40% - (5 X LIBOR). An
increase in LIBOR by only 1%, from 6% to 7%, would cause the interest rate on
the investment to decline from 10% to 5%.
Indirect nature of investments exposes FBR Asset to additional risks.
Approximately 26% of FBR Asset's total investments, including cash and cash
equivalents, as of June 30, 1999, were investments in equity securities issued
by REITs and other business entities that own real estate, commercial mortgage
loans and commercial mortgage-backed securities. In addition to the risks
described above, obtaining interests in real estate and mortgage-related assets
indirectly by investing in other enterprises carries the following risks:
Returns on equity investments are not directly linked to returns on investee
companies' assets.
FBR Asset owns equity securities of other companies. As an equity holder, FBR
Asset's return on its investment is not directly linked to returns on any
company's assets, but will depend upon the payment of dividends and changes in
the price of the equity securities. Furthermore, as a common shareholder, FBR
Asset's claims to the assets of the companies in which it invests are junior to
those of creditors and senior shareholders.
Obstacles to success may remain hidden if due diligence is inadequate.
Before making an investment in another REIT or business entity, FBR Asset will
assess the strength and skills of the entity's management and other factors that
FBR Asset believes will determine the success of its investment. In making its
assessment and otherwise conducting its customary due diligence, FBR Asset will
rely on the resources available to FBR Management and, in some cases, an
investigation by third parties. This process is particularly important and
subjective with respect to newly-organized entities because there may be little
or no information publicly available about the companies. Against this
background, FBR Asset can give no assurance that the due diligence processes of
FBR Management will uncover all relevant facts or that any investment will be
successful.
Dependence on management of other entities
FBR Asset does not control the management, investment decisions, or operations
of the enterprises in which it has invested. Management of those enterprises may
decide to change the nature of their assets, or management may otherwise change
in a manner that is not satisfactory to FBR Asset. FBR Asset has no ability to
affect these management decisions, and as noted below, FBR Asset may have only
limited ability to dispose of its investments.
Limited liquidity of equity security investments
The equity securities of a new entity in which FBR Asset invests are likely to
be restricted as to resale and may otherwise be highly illiquid. FBR Asset
expects that there will be restrictions on its ability to resell the securities
of any newly public company that it acquires for one year after it acquires
those securities. Thereafter, a public market sale may be subject to volume
limitations or dependent upon securing a registration statement
12
<PAGE>
for a secondary offering of the securities. As of June 30, 1999, none of the
equity securities held by FBR Asset were restricted in this manner.
The securities of newly public entities may trade less frequently and in smaller
volume than securities of companies that are more widely held and have more
established trading patterns. Thus, sales of these securities may cause their
values to fluctuate more sharply. Furthermore, and because of its affiliation
with FBR, FBR Asset's ability to invest in companies may be constrained by
applicable securities laws and the rules of the National Association of
Securities Dealers, Inc. This is so because Friedman, Billings, Ramsey & Co.,
Inc., another subsidiary of FBR Group, is a registered broker-dealer and its
investment and trading activities are regulated by the SEC and NASD. For
example, the NASD's prohibition on "free-riding and withholding" may limit the
number of shares FBR Asset can acquire in a "hot issue" public offering that is
underwritten by FBR & Co.
Volatility of prices
Prices of the equity securities of new entities in which FBR Asset invests are
likely to be volatile, particularly when FBR Asset decides to sell those
securities. FBR Asset makes investments in significant amounts, and resales of
significant amounts of securities might adversely affect the market and the
sales price for the securities.
Disposition value of investments is dependent upon general and specific
market conditions.
Even if FBR Asset makes an appropriate investment decision based on the
intrinsic value of an enterprise, FBR Asset has no assurance that the trading
market value of the investment will not decline, perhaps materially, as a result
of general market conditions. For example, an increase in interest rates, a
general decline in the stock markets, or other market conditions adverse to
companies of the type in which FBR Asset has invested could result in a decline
in the value of FBR Asset's equity investments.
At September 16, 1999, the total market value of FBR Asset's investments in
securities underwritten or placed by FBR had declined by approximately $21.7
million, or 23.3%, since FBR Asset acquired the securities. Of that $21.7
million loss, approximately $6.6 million was realized and charged to FBR Asset's
earnings in 1998; the remaining $15.1 million has been charged to shareholders'
equity but not to FBR Asset's earnings. See "Summary of Current Investments &
Cash and Cash Equivalents" on page 40. FBR Asset believes that much of the
decline in value of these investments is attributable to market turmoil during
the third and fourth quarters of 1998 and the first quarter of 1999. See
"Management's Discussion & Analysis--Market Conditions" on page 54.
Management Agreement requires FBR Asset to pay fee upon termination of FBR
Management.
Either FBR Asset or FBR Management may terminate the Management Agreement
without cause after December 17, 1999. The Management Agreement requires FBR
Asset to pay FBR Management a substantial termination fee in the event that FBR
Asset terminates the agreement, except in the case of a termination for cause.
The termination fee would equal twelve months of base and incentive fees, as
further explained under "FBR & FBR Management--The Management Agreement." For
example, if FBR Asset
13
<PAGE>
had terminated the Management Agreement in January 1999, the termination fee
would have been $1.52 million, the amount of the base fee expensed in 1998.
Because no incentive fee was earned in 1998, no additional termination fee would
have been due.
Payment of a termination fee could have an adverse effect on FBR Asset's
financial condition, cash flows, and results of operations and could reduce the
amount of funds available for distribution to shareholders. In the event of
termination, if FBR Asset does not have sufficient cash to pay the termination
fee, it may have to sell assets even though it would not otherwise choose to do
so.
Tax requirements may restrict FBR Asset's operations.
FBR Asset has operated and intends to continue operating in a manner so as to
qualify as a REIT for federal income tax purposes. Qualifying as a REIT requires
FBR Asset to meet certain tests regarding the nature of its assets and its
income on an ongoing basis. Some of FBR Asset's investments are in equity
securities of REITs, which are qualifying assets and produce qualifying income
for purposes of the REIT qualification tests. The failure of the REITs in which
FBR Asset invests to maintain their REIT status, however, could jeopardize FBR
Asset's own REIT status.
In order to qualify as a REIT, FBR Asset must distribute to its shareholders,
each calendar year, at least 95% of its taxable income, other than any net
capital gain. To the extent that FBR Asset meets the 95% distribution
requirement, but distributes less than 100% of its taxable income, it will be
required to pay income tax on its undistributed income. In addition, FBR Asset
will incur a 4% nondeductible excise tax if the actual amount it pays out to its
shareholders in a calendar year is less than a minimum amount specified under
the federal tax laws. See "Federal Income Tax Consequences of FBR Asset's Status
as a REIT--Requirements for Qualification--Distribution Requirements." FBR Asset
has distributed and intends to continue distributing all of its taxable income
to its shareholders on an annual basis so that it will satisfy the 95% test and
avoid both corporate income tax and the 4% excise tax. The U.S. Congress
recently passed legislation that would reduce the 95% distribution requirement
to 90%. There can be no assurance that such legislation will be enacted into
law.
FBR Asset's taxable income may differ substantially from its net income as
determined based on generally accepted accounting principles because, for
example, FBR Asset may deduct capital losses in determining its GAAP income but
not its taxable income. For example, FBR Asset's net income was $0.16 per share
in 1998, but it was required to distribute $1.155 per share in order to satisfy
the 95% distribution requirement.
FBR Asset may invest in assets that generate taxable income in excess of
economic income or in advance of the corresponding cash flow from the assets
("phantom income") or that cause FBR Asset's shareholders to suffer adverse tax
consequences. Although some types of phantom income are excluded in determining
the 95% distribution requirement, FBR Asset will incur corporate income tax and
the 4% excise tax with respect to phantom income items if it does not distribute
those items on an annual basis. As a result of the foregoing, FBR Asset may have
less cash than is necessary to distribute all of its taxable income each year.
Consequently, FBR Asset may have to incur debt or liquidate assets at rates or
times that it regards as unfavorable
14
<PAGE>
in order to distribute all of its taxable income and thereby avoid corporate
income and excise tax. See "Federal Income Tax Consequences of FBR Asset's
Status as a REIT."
If FBR Asset fails to qualify as a REIT in any year, FBR Asset would be required
to pay federal income tax on its taxable income. FBR Asset might need to borrow
money or sell assets in order to pay that tax. FBR Asset's payment of income tax
would decrease the amount of its income available for distribution to
shareholders. Furthermore, FBR Asset no longer would be required to distribute
substantially all of its taxable income to its shareholders. Unless its failure
to qualify as a REIT is excused under federal tax laws, FBR Asset could not
re-elect REIT status until the fifth calendar year following the year in which
it fails to qualify.
Loss of Investment Company Act exemption would adversely affect FBR Asset.
FBR Asset believes that it is not, and intends to continue operating so as not
to become, regulated as an investment company under the Investment Company Act
of 1940 because it is "primarily engaged in the business of purchasing or
otherwise acquiring mortgages and other liens on and interests in real estate."
Specifically, FBR Asset has invested, and intends to continue investing, at
least 55% of its assets in mortgage loans or mortgage-backed securities that
represent the entire ownership in a pool of mortgage loans and at least an
additional 25% of its assets in mortgages, mortgage-backed securities,
securities of REITs, and other real estate-related assets.
If FBR Asset fails to qualify for that exemption, it could be required to
restructure its activities. For example, if the market value of FBR Asset's
investments in equity securities were to increase by an amount that resulted in
less than 55% of the company's assets being invested in mortgage loans or
mortgage-backed securities, FBR Asset might have to sell equity securities in
order to qualify for its exemption under the Investment Company Act. The sale
could occur under adverse market conditions.
Ownership limitation may restrict change of control or business combination
opportunities.
In order for FBR Asset to qualify as a REIT, no more than 50% in value of its
outstanding capital stock may be owned, directly or indirectly, by five or fewer
individuals during the last half of any calendar year. "Individuals" include
natural persons, private foundations, some employee benefit plans and trusts,
and some charitable trusts. In order to preserve FBR Asset's REIT status, FBR
Asset's Charter generally prohibits:
o shareholders, other than FBR and some mutual funds and pension plans,
from directly or indirectly owning more than 9.9% of the outstanding
common stock or preferred stock of any series,
o FBR from directly or indirectly owning more than 20% of the outstanding
common stock or preferred stock of any series, and
o some mutual funds and pension plans from directly or indirectly owning
more than 15% of the outstanding common stock or preferred stock of any
series.
15
<PAGE>
FBR Asset's Board has exempted FBR from the 20% ownership limit applicable to
it. The exemption permits FBR to own up to 30% of the outstanding common stock
or preferred stock of any series.
These ownership limitations could have the effect of discouraging a takeover or
other transaction in which holders of some, or a majority, of FBR Asset's common
stock might receive a premium for their shares over the then prevailing market
price or which holders might believe to be otherwise in their best interests.
See "FBR Asset's Capital Stock--Restrictions on Ownership and Transfer" and
"Federal Income Tax Consequences of FBR Asset's Status as a REIT--Requirements
for Qualification."
Board of Directors may change policies without shareholder consent.
FBR Asset's major policies, including its investment policy and other policies
with respect to acquisitions, financing, growth, operations, debt and
distributions, are determined by its Board of Directors. The Board may amend or
revise these and other policies, or approve transactions that deviate from these
policies, from time to time without a vote of the common shareholders. The
effect of those changes may be positive or negative. FBR Asset's Charter also
authorizes the Board of Directors to issue up to 50,000,000 shares of preferred
stock and to establish the preferences and rights of any shares of preferred
stock issued. Although FBR Asset has no current intention to issue any series of
preferred stock, the issuance of preferred stock could increase the investment
risk associated with common stock ownership, delay or prevent a change in
control of FBR Asset, or otherwise change the nature of an investment in FBR
Asset's common stock.
No prior market for common shares.
Prior to this offering, there has been no public market for FBR Asset's common
stock. Although the company's common stock has been approved for listing on the
American Stock Exchange, we can give no assurance that an active trading market
will develop.
16
<PAGE>
Organization & Relationships
[graphic omitted]
17
<PAGE>
FBR & FBR Management
FBR is a full-service investment banking firm that makes a market in more than
400 securities and provides research coverage on more than 400 publicly traded
companies.
As of June 30, 1999, FBR, including FBR Management, which is a registered
investment adviser under the Investment Advisers Act of 1940, managed more than
$812 million of net assets. Of those net assets, $213 million were managed in
separately managed accounts, including FBR Asset's account. FBR's investment
management services include more traditional management services for individual
accounts and investment funds. These funds include four open-end mutual funds,
an offshore fund whose capital is maintained outside the United States,
proprietary investment partnerships, and private equity and venture capital
funds. Two of FBR's mutual funds seek capital appreciation through investments
in financial services companies. The third fund invests in the equity securities
of small cap companies that FBR believes to be undervalued, and the fourth
invests in REITs and other real estate-related securities.
FBR Group, the parent company of FBR Management, completed an initial public
offering in December 1997, and its stock is listed on the New York Stock
Exchange. FBR Group's management and employees own a majority of its outstanding
stock. On December 29, 1997, PNC Bank Corp. purchased 4.9% of FBR Group's
outstanding shares of common stock. PNC is the majority owner of BlackRock, the
sub-manager of FBR Asset's mortgage portfolio, and also owns less than 5% of
Anthracite, one of the companies in which FBR Asset has invested. Pursuant to a
non-binding memorandum of understanding entered into between FBR and PNC in
October 1997, FBR and PNC have established a strategic business relationship
with respect to selected capital markets and related activities. The
understanding provides a framework pursuant to which FBR and PNC work together
on an arms-length basis to refer potential business to each other. FBR and PNC
have also agreed to work together to provide enhanced derivatives, asset
securitization, bridge lending, and other bank financing products to FBR's
clients.
Related Party Transactions
Because of its extensive involvement in real estate securities, FBR may have
material direct and indirect interests in, or relationships with, companies in
which FBR Asset also has an interest. FBR's interests may conflict with FBR
Asset's interests. For example, FBR Asset may purchase equity securities of a
company whose securities have been or will be underwritten by FBR or of a
company on which FBR provides ongoing research or in whose securities FBR makes
a market. Any such purchase of securities by FBR Asset creates a conflict
because it may indirectly benefit FBR and its directors, officers, and owners.
FBR Asset has made the following investments in companies with which FBR has a
relationship:
18
<PAGE>
FBR was the lead underwriter in October 1997 of an initial public offering by
Imperial Credit Commercial Mortgage Investment Corporation of 30 million shares
of common stock at a public offering price of $15 per share. The underwriting
discount was 7%. Beginning in December 1997, FBR Asset purchased in open-market
transactions 900,000 shares of Imperial Credit common stock at an average price
per share of $14.50. As of September 16, 1999, shares of Imperial Credit were
selling for $10.63 per share. On June 30, 1999, FBR Asset purchased 400,000
shares of Series B 14.5% cumulative preferred stock of Imperial Credit
Industries, Inc., an affiliate of Imperial Credit, in a privately negotiated
transaction for $25 per share. On July 22, 1999, Imperial Credit Industries,
Inc. and Imperial Credit Commercial Mortgage Corporation entered into a merger
agreement under which Imperial Credit Industries would acquire all of the
outstanding capital stock of Imperial Credit Commercial Mortgage for a cash
purchase price of $11.50 per share, subject to increase under certain
circumstances.
Since 1994, FBR has provided underwriting and other investment banking services
to Prime Group Inc. and its affiliates. Between January 1, 1997, and June 30,
1999, FBR acted as lead underwriter or co-manager, or provided advisory services
to affiliates of Prime Group Inc., in connection with $710.5 million of capital
raising and $973.1 million of merger transactions. On December 23, 1997, FBR
Asset entered into an interim financing and security agreement with Prime
Capital Holding, LLC, an affiliate of Prime Group Inc., for up to $20 million.
As of December 31, 1998, approximately $12.5 million, which includes
approximately $1 million of accrued interest, had been drawn against this loan.
The note accrues interest at a rate between 12% and 17% per annum depending upon
the funding period, and interest is payable monthly on the twenty-fifth day of
each month. The agreement originally called for the repayment of principal on
May 31, 1998. Prime Capital Holding, LLC has used the proceeds of the loan to
fund commercial first mortgages and mezzanine loans. In order to give Prime
Capital sufficient time to negotiate a sale of those loans in one or more sale
or securitization transactions, FBR Asset extended the maturity date on the
$12.5 million balance until June 30, 1999, and Prime Capital paid 1% of the
aggregate advance balance in consideration for that extension. In accordance
with the extension agreement, and subject to the claims of some of Prime
Capital's senior lenders, Prime is required to repay FBR Asset from the proceeds
of any sale of the loans. As of June 30, 1999, the outstanding principal balance
of the loan had been reduced to $10.2 million. FBR Asset further extended the
maturity date on the remaining $10.2 million balance until September 30, 1999.
On August 4, 1999, Prime Capital paid $315,500 in principal payments to reduce
the outstanding balance to $9.9 million.
FBR was the co-managing underwriter in November 1997 of an initial public
offering by Prime Group Realty Trust, another affiliate of Prime Group Inc., of
12,380,000 common shares at a public offering price of $20.00 per share. FBR was
the co-managing underwriter in May 1998 of an offering by Prime Group Realty of
4,000,000 preferred shares at an offering price of $25.00 per share. On February
5, 1999, FBR Asset loaned Prime Group Realty $7 million. The loan was secured by
real property and was due and payable on August 5, 1999. The loan bore interest
at a rate of 15% per annum and was repaid on July 14, 1999.
FBR Asset acquired 123,500 common shares of Prime Retail, Inc., an affiliate of
Prime Group Inc., in open-market transactions at an average price per share of
$9.73. As of
19
<PAGE>
September 16, 1999, shares of Prime Retail were selling for $7.00 per share. On
April 21, 1999, FBR Asset acquired 78,400 shares of Prime Retail's Series A
10.5% preferred stock in open-market transactions at $18.55 per share. As of
September 16, 1999, those shares were selling for $17.50 per share. On September
10, 1999 FBR Asset also committed to loan Prime Retail up to $20 million.
In connection with the organization of Building One Services Corporation, FBR
Asset agreed to acquire 500,000 shares of Building One for $10,000,000, or $20
per share. FBR Asset also agreed not to sell the shares purchased until after
November 25, 1998. At the time of the acquisition, FBR Asset was a wholly-owned
subsidiary of FBR. FBR was the lead underwriter of a $480 million initial public
offering by Building One that closed in December 1997. The public offering price
was $20 per share and the underwriting discount was 7%. W. Russell Ramsey, one
of FBR Management's executive officers, served as a director of Building One
until June 30, 1999. On May 11, 1999, Building One Services Corporation
announced the results of a tender offer that expired on April 29, 1999. Pursuant
to Building One's tender offer, FBR Asset sold 297,341 of its Building One
common shares for a price of $22.50 per share, or $6.7 million. FBR Asset
retained 202,659 shares of Building One's common stock. As of September 16,
1999, shares of Building One were selling for $14.00 per share.
FBR was the lead underwriter in January 1998 of an initial public offering by
Resource Asset Investment Trust of 2,833,334 shares at a public offering price
of $15 per share. The underwriting discount was 7%. Beginning in February 1998,
FBR Asset has purchased in open-market transactions 344,575 shares of Resource
common stock at an average price per share of $15.36. As of September 16, 1999,
shares of Resource were selling for $11.63 per share.
FBR was the lead underwriter in February 1998 of an initial public offering by
Capital Automotive REIT of 20 million shares at a public offering price of $15
per share. The underwriting discount was 7%. In a privately negotiated
transaction that closed at the same time, FBR Asset purchased from Capital
Automotive 1,792,115 shares for $25 million, or $13.95 per share. At the time of
purchase, FBR Asset agreed not to sell the shares purchased until after February
12, 1999. William R. Swanson, one of FBR Asset's directors and executive
officers, is a director of Capital Automotive. As of September 16, 1999, shares
of Capital Automotive were selling for $12.38 per share.
FBR was the lead underwriter in March 1998 of an initial public offering by
Anthracite Capital, Inc. of 20 million shares at a public offering price of $15
per share. The underwriting discount was 7%. In a privately negotiated
transaction that closed at the same time, FBR Asset purchased from Anthracite
716,846 shares for $10 million, or $13.95 per share. At the time of purchase,
FBR Asset agreed not to sell the shares purchased until after March 24, 1999. In
September and October 1998, FBR Asset purchased an additional 865,000 shares of
Anthracite in open-market transactions for $8.3 million, or an average price per
share of $9.64. As of September 16, 1999, shares of Anthracite were selling for
$6.88 per share.
FBR was the lead underwriter in April 1998 of an initial public offering by
Chastain Capital Corporation of 7,380,000 common shares at a public offering
price of $15 per share. The underwriting discount was 7%. In a privately
negotiated transaction that closed at the same time, FBR Asset purchased from
Chastain 700,000 shares for
20
<PAGE>
$9,765,000, or $13.95 per share. At the time of purchase, FBR Asset agreed not
to sell the shares purchased until after April 15, 1999. In the fourth quarter
of 1998, FBR Asset recorded a charge to operations in the amount of $6,615,000
to reflect management's determination that the decline in the value of
Chastain's stock was other than temporary. On May 14, 1999, Chastain announced
that its Board of Directors had voted to sell all of Chastain's assets, either
through a plan or liquidation or through a sale of the company. As of September
16, 1999, shares of Chastain were selling for $6.88 per share.
In June 1998, FBR entered into an agreement with Kennedy-Wilson Inc. to
underwrite an offering of common shares of Kennedy-Wilson to obtain capital for
the expansion of its business. At the same time, FBR Asset loaned Kennedy-Wilson
$10 million that was due and payable in December 1998. In December 1998,
Kennedy-Wilson paid $2.5 million in principal on the loan, and the term of the
$7.5 million balance was extended to June 3, 1999. The loan bore interest at 17%
per annum and entitled FBR Asset to five-year warrants to acquire 131,096 shares
of Kennedy-Wilson stock at a price of $7.5526 per share. The entire outstanding
balance of this loan was repaid from the proceeds of an equity offering by
Kennedy-Wilson on May 17, 1999. As of September 16, 1999, shares of
Kennedy-Wilson were selling for $8.81 per share.
On June 30, 1998, FBR Asset purchased 520,000 common shares of East-West
Bancorp, Inc. from selling shareholders for a purchase price of $5.2 million, or
$10 per share, in a $237.8 million private transaction. FBR acted as placement
agent in the transaction and for its services received a private placement fee
equal to 7%. As of September 16, 1999, shares of East-West Bancorp were selling
for $9.81 per share.
FBR was the lead underwriter in May 1997 of an initial public offering by
Brookdale Living Communities, Inc. of 4,500,000 common shares at a public
offering price of $11.50 per share. FBR was the lead underwriter in December
1997 of a secondary offering by Brookdale of 2,000,000 common shares at a share
price of $16.69 and was the lead underwriter in November 1998 of a secondary
offering by Brookdale of 2,000,000 common shares at a share price of $16.50. On
January 25, 1999, FBR Asset loaned Brookdale $5 million in subordinated debt
that was due and payable on April 26, 1999. The loan bore interest at 13% per
annum. FBR Asset agreed to extend the maturity date on the loan to May 21, 1999,
at an interest rate of 15% per annum. On May 14, 1999, Brookdale repaid the
entire outstanding balance of the loan.
FBR Management's Executive Officers
The following table sets forth some information about the executive officers of
FBR Management. FBR Management's executive officers are also directors or
executive officers of FBR Asset. No executive officer is related by blood,
marriage, or adoption to any other director or executive officer of FBR Asset or
FBR.
21
<PAGE>
Name Age Position(s) Held
- ---- --- ----------------
Emanuel J. Friedman 52 Chairman & Chief Executive Officer
Eric F. Billings 46 Vice Chairman & Chief Operating Officer
W. Russell Ramsey 39 President & Secretary
For biographical information on Messrs. Friedman and Billings, see "FBR Asset's
Directors & Officers--The Board of Directors."
W. Russell Ramsey is President of FBR Group. He has continuously served as
President of FBR Group since co-founding FBR in 1989. As of June 30, 1999, Mr.
Ramsey owned 12.0% of the outstanding common stock of FBR Group. Mr. Ramsey is
involved in FBR's investment banking, research, brokerage, and asset management
activities. Before co-founding FBR, Mr. Ramsey served as Vice President in the
institutional sales group at Johnston, Lemon & Co., Incorporated, a Washington,
DC brokerage firm.
The Management Agreement
FBR Asset and FBR Management entered into a Management Agreement on December 17,
1997. The following section summarizes 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 the "Additional
Information" section of this document.
FBR Management's Responsibilities
FBR Management has only the authority that FBR Asset's Board of Directors
delegates to it. FBR Management is at all times subject to the Board's
supervision. Generally, FBR Management performs the services necessary to keep
FBR Asset running on a day-to-day basis. These services include:
Investment Services
- -------------------
o representing FBR Asset in connection with
o the purchase and sale of assets,
o commitments to purchase and sell assets, and
o the maintenance and administration of FBR Asset's portfolio;
o engaging in hedging activities on FBR Asset's behalf, consistent with
FBR Asset's status as a REIT;
o upon request by and in accordance with the directions of the Board of
Directors, investing or reinvesting any of FBR Asset's money;
o acting as liaison between FBR Asset and banking, mortgage banking,
investment banking and other parties with respect to the purchase,
financing and disposition of assets;
22
<PAGE>
Advisory Services
- -----------------
o consulting with FBR Asset on the formulation of investment criteria and
guidelines;
o furnishing reports and collecting information relating to FBR Asset's
assets, interest rates, and general economic conditions;
o furnishing reports regarding FBR Asset's activities and the services
performed for FBR Asset by FBR Management;
o 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;
o counseling FBR Asset in connection with policy decisions to be made by
the Board of Directors;
o counseling FBR Asset regarding the maintenance of its status as a REIT
and monitoring compliance with the various REIT qualification tests;
o counseling FBR Asset regarding the maintenance of its exemption from
the Investment Company Act and monitoring compliance with the various
requirements for that status;
Administrative Services
- -----------------------
o providing executive and administrative personnel, office space, and
office services required in rendering services to FBR Asset;
o administering FBR Asset's 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
o the collection of revenues,
o the payment of FBR Asset's debts and obligations,
o the maintenance of appropriate computer services to perform such
administrative functions, and
o other customary functions related to portfolio management;
o communicating on behalf of FBR Asset with holders of FBR Asset's
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
o to the extent not otherwise subject to an agreement executed by FBR
Asset, designating servicers for mortgage loans sold to FBR Asset and
arranging for the monitoring and administering of those services.
FBR Management has engaged BlackRock to advise it on the management of FBR
Asset's mortgage portfolio and may enter into subcontracts with other parties,
including FBR, to provide other services to FBR Asset.
23
<PAGE>
The Management Fee
Base Management Fee
- -------------------
FBR Management is entitled to receive a quarterly base management fee equal to
the sum of:
o 0.25% per annum of the average book value of FBR Asset's mortgage
assets during each calendar quarter, and
o 0.75% per annum of the average book value of the remainder of FBR
Asset's 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 FBR Asset incurs costs internally.
For the period December 17, 1997 through December 31, 1998, the base management
fee was $1,579,348. For the six months ended June 30, 1999, the base management
fee was $678,706.
Incentive Compensation
- ----------------------
FBR Management is also entitled to receive incentive compensation based on FBR
Asset's 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) FBR Asset's Funds from Operations (before the incentive fee)
per share of common stock, based on the weighted average number of
shares outstanding, (b) plus 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
at the initial offering price ($20) and the price per share at any
secondary offerings by FBR Asset multiplied by (b) the 10-Year U.S.
Treasury Rate plus five percent per annum multiplied by
(B) the weighted average number of common shares 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
24
<PAGE>
indication of FBR Asset's 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 10-Year U.S. Treasury Rate for the three
months ended June 30, 1999, was 5.53%.
No incentive compensation had been earned by FBR Management as of June 30, 1999.
Options Owned by FBR Management
FBR Management received options to acquire 1,021,900 shares of FBR Asset's stock
at an option price of $20 per share. In connection with the execution of the
sub-management agreement, FBR Management assigned options to acquire 51,095
shares to BlackRock. In connection with the establishment of FBR Asset's stock
incentive plan, FBR Management agreed to rescind options to acquire 155,000
shares, leaving FBR Management with options to acquire 815,805 shares. FBR
Management also intends to assign certain of these options to FBR's officers and
employees. The options held by FBR Management and BlackRock are exercisable in
whole or in part at any time before December 17, 2007.
Expenses
Because FBR Management's employees will perform due diligence tasks that
purchasers of real estate typically hire outside consultants to perform, FBR
Management will be reimbursed for FBR Management's out of pocket costs in
performing due diligence on assets purchased or considered for purchase by FBR
Asset. 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 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. FBR Asset has 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
25
<PAGE>
others who purchase REIT or other securities or other real estate-related assets
that meet FBR Asset's policies and criteria.
Term of Management Agreement
The Management Agreement has an initial term expiring on December 17, 1999. FBR
Asset may terminate the Management Agreement without cause at any time after
December 17, 1999, upon 60 days written notice by a majority vote of FBR Asset's
independent directors or by a vote of the holders of a majority of the
outstanding common shares. 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, FBR
Asset has 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.
26
<PAGE>
FBR Asset's Business
Operating Policies & Strategies
FBR Asset relies upon the professionals employed by FBR to 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. Real estate is one of the
sectors on which FBR currently focuses. FBR has specialized in underwriting
offerings of REIT securities, particularly REITs that invest in mortgage loans
and mortgage-backed securities. From 1993 to 1998, FBR served as managing
underwriter in the public issuance of $5.3 billion of REIT and real estate
equity securities, consisting of $2.2 billion of mortgage and hybrid REITs and
$3.1 billion of equity REITs and real estate operating companies.
FBR Asset believes that there is a global trend towards the securitization of
real estate and real estate-related assets and that this trend is represented by
the increased formation of non-traditional REITs. FBR Asset also believes that
there is a global trend towards the consolidation of real estate owners and
operators and companies that provide services to real estate owners and
operators. FBR Asset expects these trends to provide it with significant
opportunities for investing in real estate-related assets. FBR Asset also
anticipates that, notwithstanding the late 1998 decline in the mortgage REIT
market, additional REITs or real estate-related companies will be organized in
the future and that through investments in those companies, FBR Asset can
diversify and expand its investments in the real estate market.
FBR Asset's goal, subject to maintaining its REIT qualification, is to acquire
assets that it believes will generate the highest returns on capital invested.
To determine which assets are likely to provide those returns, FBR Asset
considers:
o the amount and nature of anticipated cash flows from the asset;
o the risks of investing in the asset;
o FBR Asset's ability to pledge the asset to secure collateralized
borrowings;
o the capital requirements for purchasing and financing the asset;
o the potential for appreciation and depreciation of the asset's value;
and
o the cost of financing, hedging and managing the asset.
FBR Asset is an opportunistic investor and does not have or expect to adopt
guidelines dictating specific investment or operating restrictions. Among other
things, FBR Asset may, without the consent of its stockholders:
o borrow any amount of money as FBR Asset has already done;
o issue preferred stock that has liquidation and dividend preferences
over the outstanding common stock;
o make loans to other companies as FBR Asset has already done;
o invest in securities of other issuers as FBR Asset has already done;
27
<PAGE>
o sell existing investments and make additional investments as FBR Asset
has already done;
o offer securities in exchange for property; and
o repurchase or otherwise reacquire FBR Asset's shares as FBR Asset has
already done.
Likewise, as to specific investments, FBR Asset may invest directly or
indirectly in any type of mortgage, real estate or real estate-related assets,
as well as in other assets, subject to the policy that FBR Asset maintain its
qualification as a REIT and its exemption from registration as an investment
company.
FBR Asset expects that investment opportunities will change. Based on the recent
past, FBR Asset anticipates that REITs will continue to have difficulty
accessing the public capital markets. In this environment, FBR Asset will seek
what it considers to be attractive opportunities to invest on a privately
negotiated basis. For example, FBR Asset believes there will be opportunities to
enter into joint ventures with other REIT and non-REIT investors seeking to
complete planned acquisitions, to provide mezzanine loans with equity features,
and to provide private equity financing. If an adequate amount of what FBR Asset
considers to be appropriate investments becomes available, FBR Asset intends to
borrow funds to make additional investments.
Current Investments
FBR Asset invests directly in whole-pool mortgage-backed securities, commercial
loans, and equity securities of real estate-related businesses and invests
indirectly in commercial and residential real estate, commercial mortgage loans,
and commercial mortgage-backed securities. As to FBR Asset's indirect
investments, FBR Asset holds interests in those assets through its equity
ownership of other companies. As an equity holder, FBR Asset's return on its
investment is not directly linked to returns on any company's assets, but will
depend upon the authorization and payment of dividends and changes in the price
of the company's equity securities. Furthermore, as a common stockholder, FBR
Asset's claims to the assets of the companies in which it invests are
subordinated to those of creditors and other senior stockholders.
Based upon the information provided on Form 10-Q for the quarter ended June 30,
1999, by the companies in which FBR Asset held equity securities on that date,
FBR Asset believes that at June 30, 1999, approximately 62% of FBR Asset's
assets were invested in residential mortgage-backed securities, approximately
13% were invested in commercial real estate, approximately 8% were invested in
commercial mortgage loans, approximately 4% were invested in commercial
mortgage-backed securities, approximately 7% were loans made to other companies,
and approximately 6% did not fit into the identified categories.
Based upon the information provided on form 10-K for the year ended December 31,
1998, by the companies in which FBR Asset held equity securities on that date,
FBR Asset believes that at December 31, 1998, approximately 66% of FBR Asset's
assets were invested in residential mortgage-backed securities, approximately
11% were invested in commercial real estate, approximately 5% were invested in
commercial mortgage loans, approximately 2% were invested in commercial
mortgage-backed
28
<PAGE>
securities, approximately 8% were loans made to other companies, and
approximately 8% did not fit into the identified categories.
Whole-Pool Mortgage-Backed Securities
FBR Asset currently invests, and intends to continue investing, at least 55% of
its assets in whole-pool mortgage-backed securities. Those securities represent
the entire ownership interest in pools of mortgage loans made by lenders such as
savings and loan institutions, mortgage bankers, and commercial banks. Various
government, government-related and private organizations assemble the pools of
loans for sale to investors, such as FBR Asset.
At June 30, 1999, FBR Asset owned mortgage-backed securities guaranteed by
Freddie Mac, Fannie Mae, or Ginnie Mae that had a market value of $140.9
million, and had borrowed $113.8 million to finance its investment in those
securities. Anthracite Capital, Inc., one of the companies in which FBR Asset
has invested, also owned similar securities at December 31, 1998, and June 30,
1999.
Mortgage-backed securities differ from other forms of traditional debt
securities, which normally provide for periodic payments of interest in fixed
amounts with principal payments at maturity or on specified call dates. Instead,
mortgage-backed securities provide for a monthly payment that consists of both
interest and principal. In effect, these payments are a "pass-through" of the
monthly interest and principal payments made by borrowers on their mortgage
loans, net of any fees paid to the issuer or guarantor of the securities.
The investment characteristics of pass-through mortgage-backed securities differ
from those of traditional fixed-income securities. The major differences include
the payment of interest and principal on the mortgage-backed securities, as
described above, and the possibility that principal may be prepaid on the
mortgage-backed securities at any time due to prepayments on the underlying
mortgage loans. These differences can result in significantly greater price and
yield volatility than is the case with traditional fixed-income securities.
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 FBR Asset's investments.
At June 30, 1999, FBR Asset owned 33 fixed rate, residential mortgage-backed
securities that represented the entire ownership interest in pools of
single-family mortgage loans. In connection with those investments, FBR Asset
entered into one interest rate swap and two repurchase agreements. The
mortgage-backed securities, the swap, and the repurchase agreements are
summarized on the following table:
29
<PAGE>
<TABLE>
<CAPTION>
Effective Effective
Original Market Nominal Weighted Duration Relevant
Issue Face Principal Value at Yield Average Life at Prepayment
Descriptive Date of Amount Amount 6/30/99 at at 6/30/99 6/30/99 Assumption
Title(1) Securities (thousands) (thousands) (thousands) 6/30/99(5) (years) (years) (%PAM)(2)
-------- ---------- ----------- ----------- ----------- ---------- ------- ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Freddie Mac
FGOLD 15-yr. 5/1/98 $ 68,567 $ 79,334 $ 67,903 6.80% 5.40 3.40 144
Fannie Mae
FNMA 15-yr. 5/1/98 $ 20,867 $ 23,381 $ 20,626 6.75% 5.50 3.43 144
Freddie Mac
FGOLD 30-yr. 7/1/93 $ 3,379 $ 11,850 $ 3,457 6.86% 2.40 1.90 200
Freddie Mac
FGOLD 15-yr. 9/1/95 $ 3,397 $ 7,496 $ 3,425 6.72% 3.70 2.36 159
Fannie Mae
30-yr. 4/1/98 $ 10,983 $ 16,291 $ 11,144 6.96% 3.70 2.82 170
Fannie Mae
30-yr. 4/1/98 $ 10,770 $ 16,868 $ 11,410 6.58% 3.00 2.18 268
Ginnie Mae
30-yr. 11/1/89 $ 13,244 $ 45,874 $ 13,724 7.14% 5.90 2.88 177
Freddie Mac
FGOLD 15-yr. 9/1/98 $ 9,783 $ 10,083 $ 9,254 6.79% 5.60 4.18 129
------------ ------------ ---------- ----- ---- ---- ---
Mortgage
Portfolio
Total $ 140,990 $ 211,177 $ 140,943 6.82% 5.10 3.20 174
============ ============ ========== ===== ==== ==== ===
Repurchase
Agreement Liability
6/21/99 $ 113,794 5.06%
Interest Rate Swap
Agreement 6/1/98 $ 50,000(3) (4) 1.62
</TABLE>
(1) All of the mortgage-backed securities are backed by pools of
fixed-rate mortgages and are principal and interest paying
instruments.
(2) Prepayment assumptions express the relationship between the assumption
for a specific pass-through security and a prepayment assumption model
("PAM"). For example, a prepayment assumption of 100% PAM for a
30-year mortgage assumes a prepayment rate increase of 0.2% per month
for the first 30 months, and then levels off at 6% for the remainder
of the term. "50% PAM" means that the prepayment rate is half of "100%
PAM" for that month. "300% PAM" means that the prepayment rate is
three times "100% PAM" for that month. We can give no assurance that
actual prepayments will not be materially different from the
prepayment rates assumed in the PAM. For more information on the risk
of prepayments with respect to mortgage investments, see "Prepayment
rates could negatively affect the value of FBR Asset's mortgage-backed
securities" on page 8.
(3) Notional amount.
(4) Under the interest rate swap agreement, FBR Asset receives quarterly
payments of interest based on three-month LIBOR and remits semi-annual
payments at a fixed rate of approximately 5.9% based in each case on
the $50 million notional amount.
(5) The nominal yield is the internal rate of return of the security based
on the given market price. It is the single discount rate that equates
a security price (inclusive of accrued interest) with its projected
cash flows. For a mortgage product, it represents the yield for a
given yield curve environment based on prepayments for that
environment.
30
<PAGE>
As the table above shows, the average nominal yield (as defined in footnote 5
above) on FBR Asset's mortgage-backed securities at June 30, 1999, was
approximately 6.82%. The yield is based on the anticipated life of the
securities. If the actual life of the security is reduced below its anticipated
life, the yield would be reduced. The actual life of the mortgage-backed
securities is reduced if the mortgage loans underlying the securities are
prepaid faster than anticipated at the time the securities were acquired.
The table that follows outlines the recent prepayment experience of the
mortgage-backed securities owned by FBR Asset in terms of PAM. See footnote 2 to
the table on page 30 for a more detailed discussion of PAM. For each category of
securities in which FBR Asset owns only one pool of mortgage loans, the
prepayment history is for that specific pool. For each category of securities in
which FBR Asset holds multiple pools of mortgage loans, we have presented the
prepayment history of a representative pool. Several securities were recently
issued and thus have little prepayment history.
<TABLE>
<CAPTION>
Period from Period from
January 1999 to June 1998 to
Face Amount June 1999 June 1999
Mortgage-Backed Securities (in thousands) (%PAM) (%PAM)
-------------------------- -------------- ------ ------
<S> <C> <C> <C>
Freddie Mac FGOLD 15yr. 6.5% $ 68,567 516 511
Fannie Mae 15yr. 6.5% 20,867 447 466
Freddie Mac FGOLD 15yr. 7.0% 3,397 586 492
Freddie Mac FGOLD 30yr. 8.0% 3,379 282 299
Fannie Mae 30yr. 7.5% 10,983 412 414
Fannie Mae 30yr. 9.0% 10,770 413 433
Ginnie Mae 30yr. 7.95% 13,244 387 421
Freddie Mac FGOLD 15yr. 5.5% 9,783 272 N/A
------------
Total $ 140,990
============
</TABLE>
Freddie Mac Certificates
- ------------------------
The Federal Home Loan Mortgage Corporation, better known as "Freddie Mac," is a
privately owned government-sponsored enterprise created pursuant to Title III of
the Emergency Home Finance Act of 1970. Freddie Mac's principle activities
currently consist of the purchase of mortgage loans or participation interests
in mortgage loans and the resale of the loans and participations in the form of
guaranteed mortgage-backed securities. Freddie Mac guarantees to holders of
Freddie Mac certificates, such as FBR Asset, the timely payment of interest at
the applicable pass-through rate and ultimate collection of all principal on the
holder's pro rata share of the unpaid principal balance of the underlying
mortgage loans, but does not guarantee the timely payment of scheduled principal
on the underlying mortgage loans. The obligations of Freddie Mac under its
guarantees are solely those of Freddie Mac and are not backed by the full faith
and credit of the United States. If Freddie Mac were unable to satisfy its
obligations, distributions to FBR Asset would consist solely of payments and
other recoveries on the underlying mortgage loans, and accordingly, monthly
distributions to FBR Asset would be adversely affected by delinquent payments
and defaults on those mortgage loans.
Fannie Mae Certificates
- -----------------------
The 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,
31
<PAGE>
thereby replenishing their funds for additional lending. Fannie Mae guarantees
to registered holders of Fannie Mae certificates, such as FBR Asset, that it
will distribute amounts representing scheduled principal and interest (at the
rate provided by the Fannie Mae certificate) on the mortgage loans in the pool
underlying the Fannie Mae certificate, whether or not received, and the full
principal amount of any mortgage loan foreclosed or otherwise finally
liquidated, whether or not the principal amount is actually received. The
obligations of Fannie Mae under its guarantees are solely those of Fannie Mae
and are not backed by the full faith and credit of the United States. If Fannie
Mae were unable to satisfy its obligations, distributions to FBR Asset would
consist solely of payments and other recoveries on the underlying mortgage
loans, and accordingly, monthly distributions to FBR Asset would be adversely
affected by delinquent payments and defaults on the mortgage loans.
Ginnie Mae Certificates
- -----------------------
The Government National Mortgage Association, better known as "Ginnie Mae," is a
wholly owned corporate instrumentality of the United States within the
Department of Housing and Urban Development. Title III of the National Housing
Act of 1934 authorizes Ginnie Mae to guarantee the timely payment of principal
and interest on certificates that represent an interest in a pool of mortgages
insured by the Federal Housing Administration under the Housing Act or partially
guaranteed by the Veteran's Administration under the Servicemen's Readjustment
Act of 1944 and other loans eligible for inclusion in mortgage pools underlying
Ginnie Mae certificates. Section 306(g) of the Housing Act provides that "the
full faith and credit of the United States is pledged to the payment of all
amounts that may be required to be paid under any guaranty under this
subsection." An opinion, dated December 12, 1969, of an Assistant Attorney
General of the United States provides that guarantees under section 306(g) of
Ginnie Mae certificates of the type that may be purchased by FBR Asset 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 FBR Asset does not own single-family or multifamily privately-issued
certificates, some of the companies in which it invests may own these
certificates. FBR Asset may in the future invest in other companies that invest
in these assets or may invest in them itself.
Single-family and multifamily privately-issued certificates are pass-through
certificates that are not issued or guaranteed by one of the agencies described
above and that are backed by a pool of single-family or multifamily mortgage
loans. Single-family and multifamily privately-issued certificates are issued by
originators of, investors in, and other owners of mortgage loans, including
savings and loan associations, savings banks, commercial banks, mortgage banks,
investment banks and special purpose "conduit" subsidiaries of those
institutions.
While agency certificates are backed by the express obligation or guarantee of
one of the agencies, as described above, single-family and multifamily
privately-issued certificates are generally covered by one or more forms of
private credit enhancements. Those credit enhancements provide an extra layer of
loss coverage in the event that losses are incurred upon foreclosure sales or
other liquidations of underlying mortgaged properties in
32
<PAGE>
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
- --------------
FBR Asset may reduce the amount of equity capital it has invested in mortgages
or other assets by funding a portion of those investments with long-term
borrowings, warehouse lines of credit, or other borrowing arrangements.
Borrowing funds creates interest expense that can exceed the revenue FBR Asset
earns from its financed assets. To the extent that revenue derived from those
assets exceeds the interest expense, FBR Asset's net income will be greater than
if FBR Asset had not borrowed funds. Conversely, if the revenue from those
assets does not sufficiently cover the expense, FBR Asset's net income will be
less than if FBR Asset had not borrowed funds.
FBR Asset has borrowed and intends to continue borrowing funds by entering into
repurchase agreements. Under these agreements, FBR Asset sells assets to a third
party with the commitment to repurchase the same assets at a fixed price on an
agreed date. The repurchase price reflects the purchase price plus an agreed
upon market rate of interest. FBR Asset accounts for repurchase agreements as
loans, secured by the underlying assets, that FBR Asset owes to the third party.
FBR Asset intends to use the proceeds from borrowings to invest in mortgages or
other assets and to repeat this process of borrowing and investing, while
continually monitoring its use of leverage. Based on book values, the
debt-to-equity ratio as of June 30, 1999, on FBR Asset's mortgage-backed
securities portfolio was 4 to 1. Traditionally, lenders have permitted
repurchase agreement borrowings against agency mortgage-backed securities at a
debt-to-equity ratio of up to 19 to 1. FBR Asset does not currently intend to
increase its leverage ratio, although its Charter and Bylaws do not impose any
specific limits on permissible leverage.
What follows are two examples of how FBR Asset might use borrowings to increase
the yield on a hypothetical mortgage-backed security:
33
<PAGE>
--------------------------------------------------------------------------
Example 1 Example 2
--------- ---------
1. Amount invested in
mortgage-backed security.......... $10,000,000 $10,000,000
2. Annual interest rate on
mortgage-backed security.......... 7.25% 7.25%
3. Income from mortgage-backed
security (1 x 2)*................. $ 725,000 $ 725,000
4. Amount borrowed to finance
investment in mortgage-backed
security.......................... $ 8,000,000 $ 5,000,000
5. Interest rate on amount borrowed.. 5.50% 5.50%
6. Interest expense (4 x 5)*......... $ 440,000 $ 275,000
7. Equity capital invested (1 - 4)*.. $ 2,000,000 $ 5,000,000
8. Management fee (0.25% x
$10,000,000)...................... $ 25,000 $ 25,000
9. Hedging expense (4 x 1%)*......... $ 80,000 $ 50,000
10. Total expenses (6 + 8 + 9)*....... $ 545,000 $ 350,000
11. Net income on mortgage-backed
security (3-10)*.................. $ 180,000 $ 375,000
12. Return on equity capital
invested (11 divided by 7)*....... 9.00% 7.50%
--------------------------------------------------------------------------
* The numbers in parentheses, unless otherwise specified, refer to the
line numbers on the far left.
In example 1 above, FBR Asset uses borrowed funds to increase the initial yield
on its investment from 7.25% to 9.0%. In example 2 above, FBR Asset borrows less
funds and increases its yield only from 7.25% to 7.50%. FBR Asset plans to
complete these types of transactions by arranging loans in which it pledges its
assets as collateral to secure its repayment obligations. Some of those loans
may be margin loans in which a decline in the pledged assets' market value could
trigger an early repayment of FBR Asset's obligations. If FBR Asset repays loans
early, then the return on equity would be reduced. As reflected above, if FBR
Asset were required to increase the amount of equity capital it invested by $3
million in order to prepay $3 million of the loan, then the return on equity
would be reduced from 9.00% to 7.50%.
Hedging & Interest Rate Management
- ----------------------------------
FBR Asset acquires derivative financial instruments to hedge all or a portion of
the interest rate risk associated with its borrowings. FBR Asset does not intend
to acquire derivative instruments for speculative purposes. FBR Asset's hedging
activities may include entering into interest rate swaps and caps and options to
purchase swaps and caps. Under the tax laws applicable to REITs, FBR Asset
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 FBR Asset may incur, or plans to incur, to acquire or carry
real estate assets. The applicable tax provisions, however,
34
<PAGE>
may limit FBR Asset's ability to enter into other types of hedging transactions.
If so, FBR Asset may conduct some or all of its hedging activities through a
to-be-formed subsidiary that is fully subject to income tax.
FBR Asset engages in a variety of interest rate management techniques that are
intended to match the effective maturity of, and the interest received on, its
assets with the effective maturity of, and the interest owed on, its
liabilities. FBR Asset generally will be able to use those techniques directly,
instead of through a corporate subsidiary that is fully subject to corporate
income taxation. FBR Asset, however, cannot give any assurances that it can
successfully implement its investment and leverage strategies. FBR Asset's
interest rate management techniques may include:
o puts and calls on securities or indices of securities;
o Eurodollar futures contracts and options on such contracts;
o interest rate swaps, which are the exchange of fixed-rate payments for
floating-rate payments; or
o other similar transactions.
FBR Asset may also use these techniques to attempt to protect itself against
declines in the market value of its assets that result from general trends in
debt markets. The inability to match closely the maturities and interest rates,
or the inability to protect adequately against declines in the market values,
could result in losses with respect to FBR Asset's mortgage assets.
At June 30, 1999, FBR Asset owned $140.9 million of long-term fixed-rate
mortgage-backed securities and was indebted for $113.8 million under short-term
repurchase agreements. These agreements expire and are renewed on a regular
basis. As of June 30, 1999, all of the repurchase agreements held by FBR Asset
had a stated maturity date of July 19, 1999. On July 19, 1999, $110.6 million of
the expired repurchase agreements were renewed; the renewed agreements had a
stated maturity date of August 19, 1999. On August 19, 1999, $107.8 million of
the expired agreements were renewed; the renewed agreements have a stated
maturity date of September 20, 1999. The interest rate received by FBR Asset
under the short-term borrowing arrangements increases and decreases as
short-term interest rates increase or decrease. The interest rate on the
mortgage-backed securities remains constant. If short-term rates increase
significantly above 6.82%, which is the average nominal yield (as defined in
footnote 5 on page 30) on FBR Asset's mortgage portfolio as of June 30, 1999,
the interest owed on the borrowings would exceed the interest income payable to
FBR Asset on its mortgage-backed securities.
To limit the adverse effect of rising short-term interest rates under its
short-term repurchase agreements, FBR Asset entered into two interest rate swap
agreements pursuant to which FBR Asset paid a fixed interest rate on $100
million notional amount of borrowings and received a variable interest rate on
$100 million notional amount of borrowings. FBR Asset realized a $1.9 million
loss when it terminated one $50,000,000 agreement in October 1998. The remaining
$50,000,000 agreement matures on June 1, 2001.
35
<PAGE>
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:
o the weighted average life of the mortgage-backed securities would be
extended because prepayments of the underlying mortgage loans would
decrease; and
o the market value of the fixed rate mortgage-backed securities would
decline as long-term interest rates increased.
Yet, in this situation, the interest rate swap agreement would be ineffective
for periods after its June 1, 2001 termination date, and if FBR Asset sold the
fixed-rate mortgage-backed securities to pay down its short-term borrowings, it
would realize a loss because of the decline in their market value.
Real Estate
FBR Asset seeks to invest in real property to generate income and to provide the
company with the potential for capital appreciation in the value of property
owned. Although FBR Asset does not currently own any direct interests in real
property, it does own interests in real property through its equity investments
in Capital Automotive REIT, and to a lesser extent through its equity
investments in Prime Retail, Resource, and Imperial Credit. Through its
relationship with FBR, FBR Asset was able to acquire the stock of Capital
Automotive before Capital Automotive offered its stock to the public. FBR Asset
purchased shares of Prime Retail, Resource and Imperial Credit in open-market
transactions. FBR Asset has also committed to loan Prime Retail $20 million.
Capital Automotive REIT invests in the real property and improvements used by
operators of multi-site, multi-franchised motor vehicle dealerships and motor
vehicle-related businesses located in major metropolitan areas of the United
States. Capital Automotive is a self-administered and self-managed Maryland REIT
that primarily acquires real property and simultaneously leases back this
property to automobile dealers. These transactions generally have the following
characteristics:
o Capital Automotive's interest in the property acquired generally
includes the land, buildings and improvements, related easements and
rights and fixtures, but not any personal property, furniture or
equipment.
o The leases generally range from 8 to 11 years and may be extended for
one or two terms of 10 years at the option of the lessee.
o The leases typically require the lessee to pay substantially all
expenses associated with the operation of the real property, such as
real estate taxes and other governmental charges, insurance, utilities,
service, maintenance and, therefore are on a "triple-net" basis.
o Upon expiration or termination of the lease, the lease generally
provides that additions, repairs, renovations and improvements become
the property of Capital Automotive.
o The leases also typically require the lessee to operate the property
only for the same purpose for which it was used on the date Capital
Automotive purchased it, unless Capital Automotive consents to a
different use.
36
<PAGE>
These types of "sale-leaseback" transactions generally enable Capital Automotive
to eliminate brokerage, re-leasing and similar costs and the risk of high lessee
turnover due to the general, historic long-term operation of automobile
dealerships.
Prime Retail invests in factory outlet centers. Prime is a self-administered and
self-managed REIT that develops, acquires, owns and operates factory outlet
centers in the United States. Resource invests in commercial office buildings
and land. Resource is a Maryland REIT whose principal business activity is to
provide specialized commercial mortgage loans to those who do not meet the
traditional underwriting standards of other lenders, but Resource also owns real
estate.
In the future, FBR Asset may invest in other companies that own real property.
In addition, FBR Asset may purchase real property directly or through joint
ventures that purchase real property.
Commercial Mortgage Loans & CMBS
FBR Asset invests in commercial mortgage loans and commercial mortgage-backed
securities, commonly known as "CMBS." At June 30, 1999, FBR Asset owned
interests in commercial loans and CMBS indirectly through its investments in
Anthracite Capital, Inc., Chastain Capital Corporation, Imperial Credit
Commercial Mortgage Investment Corporation, Prime Capital, Resource Asset
Investment Trust and East-West Bancorp. FBR acted as lead underwriter or
placement agent for each of these companies. Through its relationship with FBR,
FBR Asset was able to acquire stock in Anthracite and Chastain before or while
the companies offered their stock to the public or, in the case of East-West
Bancorp, when FBR placed the stock with private investors.
In the future, FBR Asset may invest in other companies that originate or acquire
commercial mortgage loans or CMBS. In addition, FBR Asset may purchase
commercial mortgage loans and CMBS directly.
Commercial mortgage loans are loans secured by senior or subordinate liens on
commercial or multifamily real estate. The characteristics of the commercial
mortgage loans held by companies in which FBR Asset invests vary widely. Some of
those companies' commercial mortgage loan holdings are performing loans that can
be securitized. Imperial Credit, for example, invests primarily in performing
multifamily and commercial term loans. East-West Bancorp originates commercial
mortgage loans to borrowers who have ties to the Asia Pacific region. Prime
Capital originates first and mezzanine commercial loans. Chastain was organized
to originate commercial mortgage loans in the major metropolitan markets in the
United States.
Some of the companies in which FBR Asset invests also own commercial mortgage
loans that are not intended to be securitized. For example, Resource originates
wraparound loans, in which a borrower grants Resource a junior lien mortgage
with a principal amount equal to the principal amount owed under any existing
loans plus an additional amount that Resource actually advances to the borrower.
The borrower makes all loan payments to Resource, which in turn pays the prior
lenders principal and interest on the prior loans. Because the loans made by
Resource are subordinated and include an obligation by Resource to make payments
on prior loans, these loans involve different and carry more significant risk
than traditional first mortgage loans originated by institutional lenders and
thus are generally not suitable for securitization. Anthracite and
37
<PAGE>
Chastain own other commercial loans that generally are not securitized because
they involve a higher degree of credit risk, they have a shorter term, or
because they cannot be grouped together easily. These loans include mezzanine
loans, which are loans subject to a prior lien on the property, bridge loans,
which are short-term loans that are intended to provide interim financing before
a property is sold or the loan refinanced, and loans made to facilitate
construction of new commercial properties.
FBR Asset, or the companies in which it invests, may invest in commercial
mortgage loans with borrowers who are delinquent in payments on the loans. A
lender can purchase this kind of loan at a price less than the amount owed on
the loan, which enables the lender to work out a forbearance plan or other
restructuring. If an agreement cannot be made, the lender ultimately may
foreclose on the loan, acquiring ownership of the commercial property.
In addition to investing in commercial mortgage loans, some of the companies in
which FBR Asset invests own CMBS. At June 30, 1999, FBR Asset owned interests in
CMBS through its equity ownership of Anthracite, Imperial Credit and Chastain.
Imperial Credit issues CMBS secured by its commercial term loans and retains an
equity interest in those loans with characteristics similar to a subordinated
CMBS. When organized, Chastain planned to create CMBS and retain similar equity
interests.
CMBS typically are divided into two or more classes, sometimes called
"tranches." Generally the most senior class or classes would be rated investment
grade, which increases the marketability of the class. The junior, or
subordinated, classes typically would include a non-investment grade rated class
and an unrated, higher-yielding credit support class. The market for
non-investment grade CMBS is limited, and holders of CMBS have incurred, and
might in the future incur, significant losses if required to sell them as a
result of margin calls or otherwise.
Each class of CMBS generally is issued with a stated principal amount and a
specific fixed or variable interest rate. The principal of and interest on the
underlying mortgage loans may be allocated to the classes of CMBS in many ways,
and the credit quality of a particular class results primarily from the order
and timing of the receipt of payments on the underlying mortgage loans. For
example, subordinated classes of CMBS provide credit protection to the more
senior classes because the subordinated classes absorb all losses from loan
defaults and foreclosures before any losses are allocated to the more senior
classes. Typically, prepayments on mortgage loans are paid to the more senior
classes of CMBS for a period of time or until the senior classes are paid in
full. In some instances, subordinated classes of CMBS are not entitled to
receive any scheduled payments of principal until the more senior classes are
paid in full or until a specified time.
Some classes of CMBS are not entitled to any payments of principal, or are
entitled to only nominal principal payments. These classes are known as
interest-only securities or "IOs." IOs are sensitive to prepayments on the
underlying mortgage loans, and IO classes of CMBS are sensitive to losses
resulting from defaults on the underlying mortgage loans. In November 1998,
Imperial Credit reported a non-cash charge of $6.4 million, or $0.20 per share,
primarily because of a write down of its IOs to estimated fair market value.
According to Imperial Credit's management, the write down was
38
<PAGE>
necessary because the company revised its estimates of anticipated prepayments
and losses on the underlying loans.
To the extent that FBR Asset holds interests in commercial mortgage loans and
CMBS through its investments in other companies, FBR Asset must rely on the
management of those other companies to make decisions with respect to the
commercial mortgage loans and CMBS. In general, FBR Asset will have no ability
to control those decisions. Moreover, the management of those other companies
are not required to inform FBR Asset of their decisions, although to the extent
the companies are reporting companies under the Securities Exchange Age of 1934,
they must file reports of material events with the SEC.
Loans
FBR Asset directly makes and invests in real estate-based loans. In 1998, FBR
Asset made a loan of $11.5 million to Prime Capital, $9.9 million of which is
currently outstanding, and made a loan of $7.5 million to Kennedy-Wilson, which
has since been repaid. Since December 31, 1998, FBR Asset invested $5.0 million
in loans to Brookdale Living Communities and $7.0 million in loans to Prime
Group Realty Trust, both of which have been repaid, and has committed to loan
Prime Retail $20 million. Each of these loans provides debt financing for
capital needs not covered by traditional secured and senior loans and available
equity. FBR Asset seeks to receive origination fees and to charge interest rates
that are appropriate for this type of lending under prevailing market
conditions. FBR Asset anticipates that there will be a continued demand for this
type of loan and that it will make additional, similar real estate-based loans
in the future.
Real Estate-Related Businesses
The tax rules limit FBR Asset's ability to expand its investments beyond its
core direct and indirect investments in mortgage loans, mortgage-backed
securities and real estate. Subject to those limits, however, FBR Asset invests
in businesses that provide services to real estate owners and operators.
For example, FBR Asset owns common stock in Building One Services Corporation.
Building One intends to become a national single-source provider of facilities
services. Building One currently derives most of its income from providing
janitorial maintenance management services and electrical and mechanical
installation and maintenance services. Building One actively seeks to expand its
business by acquiring or merging with other facilities service providers.
FBR Management believes that additional opportunities may arise in the future
for FBR Asset to invest in businesses that provide services to real estate
owners and operators. In many cases, FBR Management believes that these
investments may provide higher returns than mortgage and real estate assets.
Accordingly, subject to applicable tax restrictions, FBR Asset may invest in
real estate-related businesses in the future.
39
<PAGE>
Summary of Current Investments & Cash and Cash Equivalents
The following table summarizes FBR Asset's investments as of December 31, 1998,
and June 30, 1999.
<TABLE>
<CAPTION>
As of December 31, 1998 As of June 30, 1999
------------------------------------ ----------------------------------------
Amount Percentage Amount Percentage
Shares Percent of Market Increase of Market Increase
Owned(7) Ownership(7) Investment Value (Decrease) Investment Value (Decrease)(6)
-------- ------------ ---------- ----- ---------- ---------- ----- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-Backed Securities N/A N/A $160,705,240 $161,418,739 0.44% $143,350,501 $140,943,202 (1.68)%
------------ ------------ ------------ ------------
Equity Investments(1)(2)
Anthracite Capital, Inc.
(AHR) 1,581,846 7.53% $ 18,334,496 $ 12,358,170 (32.60%) $ 18,334,496 $ 10,380,864 (43.38%)
Capital Automotive REIT
(CARS) 1,792,115 7.23% 25,000,000 26,657,711 (6.63%) 25,000,000 23,745,524 (5.02%)
Chastain Capital
Corporation
(CHAS)(3) 700,000 9.53% 9,765,000 3,150,000 (67.74%) 3,150,000 4,637,500 47.22%
Imperial Credit
Commercial Mortgage
Inv. Corp. (ICMI) 900,000 3.09% 13,050,230 8,437,500 (35.35%) 13,050,230 9,731,250 (25.43%)
Imperial Credit
Industries, Inc.
(ICII pfd). 400,00(9) - - - - 10,000,000 10,000,000 0.00%
Prime Retail, Inc.
(PRT) 123,500 0.29% 1,201,317 1,211,844 0.88% 1,201,317 1,072,906 (10.69%)
Prime Retail, Inc.,
pfd (PRT pfd) 78,400 0.18% - - - 1,454,320 1,553,104 6.79%
Resource Asset
Investment Trust
(RAS) 344,575 5.59% 5,292,516 3,790,325 (28.38%) 5,292,516 4,350,259 (17.80%)
Building One Services
Corporation (BOSS) 202,659 0.46% 10,000,000 10,437,500 4.38% 4,053,180 2,811,894 (30.63%)
East-West Bancorp,
Inc. (EWBC) 520,000 2.19% 5,200,000 4,940,000 (5.00%) 5,200,000 5,232,500 0.63%
------------ ------------ ------- ------------ ------------ -------
Total Equity
Investments $ 87,843,559 $ 70,983,050 (19.20%) $ 86,736,059(8) $ 73,515,801(8) (15.24%)(8)
------------ ------------ ------- ------------ ------------ -------
Promissory Notes(2)
Prime Capital Holding,
LLC(4) N/A N/A $ 12,504,334 $ 12,504,334 N/A $ 10,264,058 $ 10,264,058 N/A
Prime Group Realty
Trust N/A N/A - - N/A 7,000,000 7,000,000 N/A
Kennedy-Wilson,
Inc.(5) N/A N/A 7,525,479 7,525,479 N/A - - N/A
Brookdale Living
Communities (BLCI) N/A N/A - - N/A - N/A
------------ ------------ ------------ ------------
Total Promissory
Notes $ 20,029,813 $ 20,029,813 N/A $ 17,264,058 $ 17,264,058 N/A
------------ ------------ ------------ ------------
Cash and Cash
Equivalents N/A N/A $ 41,144,326 $ 41,144,326 N/A $ 20,336,693 $ 20,336,693 N/A
------------ ------------ ------------ ------------
Total Investments
& Cash and Cash
Equivalents $309,722,938 $293,575,928 (5.21%) $267,687,311 $252,059,754 (5.84%)
============ ============ ======= ============ ============ =======
</TABLE>
(1) The symbols in parentheses next to the company names are the symbols of
those companies on Nasdaq or a national securities exchange. Each of these
companies is a reporting company under the Securities Exchange Act of 1934.
Information is available about these companies on the SEC's website,
www.sec.gov.
(2) FBR has underwritten or privately placed the securities of these companies
or their affiliates. See "FBR & FBR Management--Related Party Transactions"
on page 18.
(3) FBR Asset realized a permanent loss on its investment in Chastain as of
December 31, 1998, equal to $6,615,000.
(4) Includes principal of $11,557,442 as of December 31, 1998 and $10,235,059 as
of June 30, 1999, and accrued interest receivable of $946,892 as of December
31, 1998, and $28,999 as of June 30, 1999.
(5) Includes principal of $7,500,000 and accrued interest receivable of $25,479
as of December 31, 1998.
(6) The amount by which the market value at June 30, 1999, differs from the
amount of FBR Asset's original investment, except for the realized loss
recorded in 1998 on FBR Asset's investment in Chastain, which is discussed
in footnote 3.
(7) As of June 30, 1999.
(8) As of September 16, 1999, the amount of FBR Asset's equity investments was
$86,736,059. On that date, those investments had a market value of
$71,609,525, which represents a 17.44% decrease in their value from the
amount of FBR Asset's original investment, except for the realized loss
recorded in 1998 on FBR Asset's investment in Chastain, which is discussed
in footnote 3.
(9) This represents 33.33% of the issued and outstanding Series B Cumulative
Preferred Stock of Imperial Credit Industries, Inc.
40
<PAGE>
The following table shows, for the calendar year 1998 and for the first half
of 1999, FBR Asset's investments and cash and cash equivalents, including, with
respect to its investments, the weighted average cost of each investment based
on the number of days from January 1, 1998, to December 31, 1998, and January 1,
1999 to June 30, 1999, on which FBR Asset held each investment, and the gross
income from each investment for the year ended December 31, 1998, and for the
six months ended June 30, 1999.
<TABLE>
<CAPTION>
For the Year Ended For the Six Months Ended
December 31, 1998 June 30, 1999
--------------------------- -------------------------
Weighted Gross Weighted Gross
Average Cost Income Average Cost Income
------------ ------ ------------ ------
<S> <C> <C> <C> <C>
Mortgage-Backed Securities $ 169,564,932 $ 7,101,326 $ 151,662,859 $4,701,607
--------------- ------------- --------------- ----------
Equity Investments
Anthracite Capital, Inc. $ 10,356,129 $ 739,613 $ 18,334,496 $1,376,206
Capital Automotive REIT 21,986,301 1,569,893 25,000,000 591,398
Chastain Capital Corporation 6,581,342 287,000 3,150,000 -
Imperial Credit Commercial
Mortgage Inv. Corp. 13,050,230 1,062,000 13,050,230 540,000
Imperial Credit Industries, Inc. - - (1) -
Prime Retail, Inc. 374,166 36,433 1,201,317 72,865
Prime Retail, Inc., preferred - - 570,479 51,450
Resource Asset Investment Trust 4,329,152 576,466 5,292,516 175,733
Building One Services
Corporation 10,000,000 - 8,357,232 -
East-West Bancorp, Inc. 2,621,370 - 5,200,000 31,200
--------------- ------------- --------------- -----------
Total Equity Investments &
Dividends $ 69,298,690 $ 4,271,405 $ 80,156,270 $2,838,852
--------------- ------------- --------------- ----------
Promissory Notes
Prime Capital Holding, LLC $ 7,947,365 $ 1,248,707 $ 11,564,915 $1,244,264
Prime Group Realty, Inc. - - 5,685,513 448,039
Kennedy-Wilson Inc. 5,506,849 749,264 7,079,404 511,411
Brookdale Living Communities - - 3,011,050 224,727
--------------- ------------- --------------- -----------
Total Promissory Notes $ 13,454,214 $ 1,997,971 $ 27,340,882 $2,428,441
--------------- ------------- --------------- ----------
Cash & Cash Equivalents $ 84,496,947 $ 4,556,800 $ 26,767,566 $ 615,530
--------------- ------------- --------------- ----------
Total Investments and
Cash & Cash Equivalents $ 336,814,783 $ 17,927,502 $ 285,927,577 $10,584,430
=============== ============= =============== ===========
</TABLE>
- ----------------------------------
(1) Subsequent to June 30, 1999, FBR Asset paid $10 million for the investment
in Imperial Credit Industries, Inc. with available cash.
41
<PAGE>
Dividends & Distribution Policy
To maintain its status as a REIT for federal income tax purposes, FBR Asset is
required to distribute substantially all of its taxable income, which may differ
materially from its income calculated in accordance with generally accepted
accounting principles, to its shareholders each year. In order to satisfy this
requirement, FBR Asset 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:
o the taxable income of FBR Asset;
o the financial condition of FBR Asset;
o the distributions required to maintain REIT status and to avoid
corporate income tax and the 4% excise tax; and
o other factors that the Board of Directors considers relevant.
To date, FBR Asset has declared the following dividends:
For the Period Total Per Share
-------------- ----- ---------
12/15/97 - 12/31/97 $ 562,045(1) $ 0.055
01/01/98 - 03/31/98 2,083,165 0.200
04/01/98 - 06/30/98 3,072,669 0.295
07/01/98 - 09/30/98 3,379,798(2) 0.360
10/01/98 - 12/31/98(3) 2,563,058 0.300
01/01/99 - 03/31/99 2,741,872 0.325
04/01/99 - 06/30/99 2,702,498 0.380
07/01/99 - 09/30/99(4) 2,844,734 0.400
------------- ---------
$ 19,949,839 $ 2.315
============= =========
(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 September 15, 1999 and payable on October 15, 1999 for
shareholders of record as of September 30, 1999.
Through December 31, 1998, FBR Asset had paid substantially all of its dividends
to date out of current or accumulated earnings and profits; only 10% of those
dividends was a return of capital for 1998 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 FBR Asset as capital gain or may be determined to be a tax-free
return of capital. FBR Asset generally does not intend to declare more than a de
minimis amount of dividends that are a return of capital for tax purposes,
except in those instances where companies in which FBR Asset invests determine
that a portion of their dividends are a return of capital. FBR Asset 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. For a discussion of the federal income tax
treatment of distributions by FBR Asset, see "Federal Income Tax Consequences of
FBR Asset's Status as a REIT--Taxation of Taxable U.S. Shareholders."
42
<PAGE>
Selected Financial Data
The selected financial data set forth below should be read in conjunction with
"Management's Discussion & Analysis" and the Financial Statements and Notes
thereto included elsewhere in this prospectus. The selected balance sheet data
as of December 31, 1997 and 1998 and June 30, 1998, and statement of operations
data for the period from December 15, 1997 (Inception) to December 31, 1997, the
year ended December 31, 1998, and the six-month period ended June 30, 1998, has
been derived from FBR Asset's audited financial statements, which are included
elsewhere in this prospectus. The selected balance sheet data as of June 30,
1999 and statement of operations data for the six-month period ended June 30,
1999, has been derived from FBR Asset's unaudited financial statements and has
been prepared on the same basis as the audited financial statements. The
unaudited financial statements include, in the opinion of management, all
adjustments, consisting of normal recurring adjustments, necessary for the fair
presentation of the financial information set forth herein. The results for the
year ended December 31, 1998, or the six month periods ended June 30, 1998 and
1999, are not necessarily indicative of the results to be expected for any
future annual or interim period.
<TABLE>
<CAPTION>
December 15, 1997 For the For the Six Months Ended June 30,
(Inception) through Year Ended ---------------------------------
December 31, 1997 December 31, 1998 1998 1999
----------------- ----------------- --------------- ---------------
<S> <C> <C> <C> <C>
Statement of Operations Data: (unaudited)
Interest income..................... $ 18,040 $13,656,097 $ 4,817,569 $ 7,745,578
Dividend income..................... 434,717 4,271,405 833,749 2,838,852
Other income........................ 268,520 - - -
Interest expense.................... - 5,359,633 552,783 3,382,129
Management Fee expense.............. 58,623 1,520,725 469,139 678,706
Other expense....................... 15,733 1,089,102 163,755 736,756
Net realized gains (losses) ........ - (8,369,807) - 743,353
Net income ......................... 646,921 1,588,235 4,465,641 6,530,192
Basic and diluted income per share.. $ 0.06 $ 0.16 $ 0.43 $ 0.81
Dividends declared per share(1)..... $ 0.06 $ 0.06 $ 0.50 $ 0.71
Weighted average basic and diluted
shares........................... 10,218,999 10,044,483 10,399,515 8,109,353
</TABLE>
<TABLE>
<CAPTION>
As of December 31 As of June 30,
----------------------------------- ---------------
1997 1998 1999
--------------- --------------- ---------------
<S> <C> <C> <C>
Selected Balance Sheet Data: (unaudited)
Mortgage-backed securities, at
fair value..................... $ - $ 161,418,739 $ 140,943,202
Cash and cash equivalents........ 163,223,199 41,144,326 20,336,693
Investments in equity securities, 23,318,750 70,983,050 73,515,801
at fair value..................
Total assets..................... 190,538,402 295,930,620 253,950,693
Repurchase agreements............ - 128,550,000 113,794,000
Total liabilities................ 771,573 145,026,041 126,969,514
Accumulated other comprehensive - (9,800,530) (15,896,077)
(loss)(2)......................
Shareholders' equity............. 189,766,829 150,904,579 126,981,179
Book value per share............. $ 18.57 $ 17.66 $ 17.85
Common shares issued and 10,218,999 8,543,527 7,111,836
outstanding(3).................
<CAPTION>
December 15, 1997 For the For the Six
(Inception) through Year Ended Months Ended
December 31, 1997 December 31, 1998 June 30, 1999
--------------- ----------------- ---------------
(unaudited)
<S> <C> <C> <C>
Other Selected Data
Weighted average daily borrowings $ - $144,793,891(4) $ 126,557,757
Average equity .................. 189,766,829 182,750,145 139,523,251
</TABLE>
(1) Dividends are calculated and declared based on estimates of FBR Asset's
taxable income.
(2) Accumulated other comprehensive loss includes unrealized net gain on
mortgage-backed securities of $713,499 as of December 31, 1998, unrealized
net loss on mortgage-backed securities of $2,407,299 as of June 30, 1999,
and unrealized net loss on investments in equity securities of $10,514,029
as of December 31, 1998, and $13,488,778 as of June 30, 1999.
(3) Reflects 1,872,300 and 3,303,991 shares of treasury stock repurchased as of
December 31, 1998 and June 30, 1999, respectively.
(4) For May 13, 1998 through year end. Repurchase agreements were entered into
on May 13, 1998.
43
<PAGE>
Management's Discussion & Analysis
Overview
FBR Asset targets investments in real estate and real estate-related companies.
FBR Asset has invested, and intends to continue investing in, whole-pool
mortgage-backed securities that are guaranteed by Fannie Mae, Freddie Mac or
Ginnie Mae, mortgage loans, mortgage-backed securities, real property, and joint
ventures formed to own real property. FBR Asset invests in some of these assets
indirectly through its investments in and loans made to REITs and other
companies.
As of June 30, 1999, FBR Asset had:
o mortgage-backed securities totaling $140.9 million, which were
financed with repurchase agreements totaling $113.8 million;
o investments in equity securities of nine companies with an original
total cost basis of $86.7 million and a total market value of $73.5
million as of June 30, 1999; and
o loans to two companies totaling $17.2 million.
Results of Operations
FBR Asset began operations on December 15, 1997. Operations from December 15,
1997 through December 31, 1997, were not material. The following discussion sets
forth the significant components of FBR Asset's net income for the six month
periods ended June 30, 1999 and 1998, and for the year ended December 31, 1998.
Net Income
FBR Asset's sole sources of income since inception have been quarterly dividend
earnings on its REIT holdings and interest earnings on its mortgage-backed
securities, notes receivable, and cash and cash equivalents. FBR Asset's primary
sources of interest income to date have been its investments in fixed-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 the mortgage loans underlying the mortgage-backed securities.
Generally, as interest rates fall, prepayment rates may increase significantly.
Accordingly, FBR Asset's interest income for any given period may not be
indicative of that for future interim or annual periods.
Net income for the six months ended June 30, 1999, was $6.5 million, or $0.81
per share basic and diluted. This is an increase of 44% over net income of $4.5
million for the six months ended June 30, 1998, or $0.43 per share basic and
diluted. The increase is primarily due to increased interest income and dividend
income. Interest income, including interest earned on mortgage-backed
securities, notes receivable, outstanding loans, and cash and cash equivalents
for the six months ended June 30, 1999, was $7.7 million compared to $4.8
million for the six months ended June 30, 1998. This represents an increase of
60%, which is attributable to increased income from mortgage-
44
<PAGE>
backed securities and notes receivable. FBR Asset did not begin investing in
mortgage-backed securities until the second quarter of 1998.
For the six months ended June 30, 1999, the weighted average annual yield on FBR
Asset's mortgage-backed securities was 6.25%. As of June 30, 1999, FBR Asset had
33 investments in mortgage-backed securities.
For the six months ended June 30, 1999, based on interest and dividend income
accrued on, and the weighted average cost of, equity securities and promissory
notes, the weighted average annual yield on FBR Asset's equity securities and
promissory notes was 9.88%, compared to 4.34% for the six months ended June 30,
1998. The increase reflects the increase in investment of cash in promissory
notes and the increase in the number of dividend-paying equity securities.
Net income for the year ended December 31, 1998, was $1.6 million, or $0.16 per
share (basic and diluted). Interest income, including interest earned on
mortgage-backed securities, notes receivable, and cash and cash equivalents, for
the year ended December 31, 1998, was approximately $13.7 million.
For the year ended December 31, 1998, the weighted average yield on FBR Asset's
mortgage-backed securities was 6.19%. For that same period the weighted average
yield on equity securities and cash and cash equivalents was approximately 7.90%
and 5.39%, respectively.
In order to maintain its preferential tax status under the federal income tax
laws, a REIT must distribute at least 95% of its taxable income to shareholders.
REITs generally make distributions on a quarterly basis. FBR Asset has received
and expects to continue receiving quarterly distributions from its equity
investments in other REITs, except for Chastain, which suspended its quarterly
dividend for the fourth quarter of 1998 and the first and second quarters of
1999. However, depending on the nature of the underlying business of each REIT
investment, quarterly distributions and annual taxable income may vary. As a
result, dividend distributions for any one quarterly or annual period may not be
indicative of receipts for future quarterly or annual periods. Dividend income
for the six months ended June 30, 1999, was $2.8 million, compared to $833,749
for the six months ended June 30, 1998. The increase is due to increased
investments by FBR Asset in REIT securities that pay dividends. Dividend income
for the year ended December 31, 1998, was $4.3 million.
FBR Asset did not begin to leverage its mortgage portfolio until May 1998. FBR
Asset anticipates that its cost of borrowed funds will continue to comprise the
largest portion of its total expenses in future periods.
FBR Asset incurred interest expense of $3.4 million for the six months ended
June 30, 1999. This represents 70.5% of the total expenses for the period. At
June 30, 1999, FBR Asset had $113.8 million outstanding under repurchase
agreements, with a weighted average cost of borrowing equal to 5.06%. At June
30, 1998 FBR Asset had $181.3 million outstanding under repurchase agreements,
with a weighted average cost of borrowing equal to 5.46%.
Interest expense of $5.4 million attributable to FBR Asset's repurchase and
interest rate swap agreements accounted for 67.3% of FBR Asset's total expenses
for the year ended
45
<PAGE>
December 31, 1998. As of December 31, 1998, $128.6 million was outstanding under
repurchase agreements, with a weighted average cost of borrowing equal to 5.08%.
For the year ended December 31, 1998, FBR Asset recognized non-recurring
expenses of $8.5 million, resulting from two actions. First, FBR Asset
determined that there had been an other than temporary impairment to the value
of its investment in Chastain and charged earnings $6.6 million to reduce the
carrying value of the investment to the market value of the Chastain stock as of
December 31, 1998. Second, FBR Asset sold mortgage-backed securities in October
1998, and in connection with the sale, repaid certain short-term repurchase
agreements and terminated an interest rate swap agreement. The swap agreement
termination charge of $1.9 million was also charged to earnings.
FBR Management has subcontracted with a mortgage portfolio manager, BlackRock,
to manage FBR Asset's mortgage portfolio. BlackRock receives a fee based on the
average gross asset value of FBR Asset's mortgage portfolio. See Note 5 of Notes
to Financial Statements. FBR Management receives a quarterly fee based on FBR
Asset's average invested assets. FBR Management is also entitled to receive an
annual incentive fee if Funds from Operations, as defined on page 24 of this
prospectus, exceed certain thresholds. From inception through March 31, 1999,
FBR Asset's Funds from Operations did not exceed the threshold amounts.
Management fees for the six months ended June 30, 1999, were $678,706 compared
to $469,139 for the six months ended June 30, 1998. The increase is due to
increased assets under management.
Management fees for the year ended December 31, 1998, were approximately $1.52
million.
In connection with the organization of FBR Asset, FBR Asset granted FBR
Management ten-year options to acquire 1,021,900 shares of FBR Asset common
stock at a purchase price of $20 per share. The value of the options at the date
of grant was $909,492, and is being amortized over the two years ending December
31, 1999. For the year ended December 31, 1998, $454,746 was charged to income.
For the six months ended June 30, 1999, $227,373 was charged to income. The
remaining $227,373 will be charged to income in 1999.
Professional fees consist primarily of legal and accounting fees. Professional
fees were $414,780 for the six months ended June 30, 1999, and $132,035 for the
six months ended June 30, 1998. The increased fees are attributable to legal and
audit fees related to this filing.
Professional fees were approximately $440,185 for the year ended December 31,
1998 and consisted primarily of legal and accounting fees. The legal fees are
attributable to the costs associated with the acquisition of assets and FBR
Asset's private placement of its equity securities. Accounting fees are
primarily attributable to the audits related to this filing.
Interest and Dividend Income
The following tables set forth information regarding the total amount of income
from interest and dividend earning assets and the resultant average yields for
the year ended
46
<PAGE>
December 31, 1998 and the six months ended June 30, 1998 and 1999. Information
is based on daily average balances during the period.
Year Ended December 31, 1998
Weighted
Weighted Average
Interest/Dividend Average Annual
Income Balance Yield
----------------- ------------ -------
Mortgage securities available for
sale(1) $ 7,101,326 $169,564,932 6.19%
Investment in equity securities
and promissory notes(2)(3) 6,269,376 82,752,904 7.90%
Cash and cash equivalents 4,556,800 84,496,947 5.39%
------------ ------------ ----
Total(3) $ 17,927,502 $336,814,783 6.41%
============ ============ ====
(1) Weighted average mortgage assets were held for 247 days.
(2) Includes accrued interest and amortized commitment fees on convertible
loans to Prime Capital and Kennedy-Wilson. Such amounts are included as
interest income in FBR Asset's statements of income included in its
financial statements.
(3) FBR Asset accrues dividend income based on declared dividends for the
periods presented.
Six Months Ended June 30, 1999
Weighted
Weighted Average
Interest/Dividend Average Annual
Income Balance Yield
----------------- ------------ -------
Mortgage securities available
for sale $4,701,607 $151,662,859 6.25%
Investment in equity securities
and promissory notes(1)(2) 5,267,293 107,497,152 9.88%
Cash and cash equivalents 615,530 26,767,566 4.64%
----------- ------------- ----
Total(2) $10,584,430 $285,927,577 7.46%
=========== ============= ====
(1) Includes accrued interest and amortized commitment fees on convertible
loans to Prime Capital, Brookdale and Kennedy-Wilson. Such amounts are
included as interest income in FBR Asset's statements of income included in
its financial statements.
(2) FBR Asset accrues dividend income based on declared dividends for the
periods presented.
Six Months Ended June 30, 1998
Weighted
Weighted Average
Interest/Dividend Average Annual
Income Balance Yield
----------------- ------------ -----
Mortgage securities available
for sale $1,160,309 $ 86,968,581 7.73%
Investment in equity securities
and promissory notes(1) 1,314,696 61,050,933 4.34%
Cash and cash equivalents 3,176,313 121,318,967 5.28%
---------- ------------ ----
Total(1) $5,651,318 $269,338,481 5.86%
========== ============ ====
(1) FBR Asset accrues dividend income based on declared dividends for the
periods presented.
Interest Expense
The following table sets forth information regarding the total amount of
interest expense from repurchase agreements, including the net amount payable
under the interest rate swap agreement and the resultant average yields.
Information is based on daily average balances during the reported periods.
47
<PAGE>
Year ended December 31, 1998
Weighted Weighted
Interest Average Average
Expense Balance(1) Expense
----------- ---------- -------
Repurchase agreements(2) $ 5,359,633 $144,793,891 5.82%
=========== ============ ====
(1) At December 31, 1998, FBR Asset had $128,550,000 outstanding under
repurchase agreements, with a weighted-average remaining maturity of 73
days.
(2) Repurchase Agreements were entered into on May 13, 1998.
Six Months Ended June 30, 1999
Weighted Weighted
Interest Average Average
Expense Balance(1) Expense
---------- ------------ -------
Repurchase agreements $3,382,129 $126,557,757 5.39%
========== ============ ====
(1) At June 30, 1999, FBR Asset had $113,794,000 outstanding under repurchase
agreements, with a weighted-average remaining maturity of 19 days.
Six Months Ended June 30, 1998
Weighted Weighted
Interest Average Average
Expense Balance(1) Expense
------- ---------- --------
Repurchase agreements $ 552,783 $76,929,069 5.46%
========= =========== ====
(1) At June 30, 1998, FBR Asset had $181,287,958 outstanding under repurchase
agreements, with a weighted-average remaining maturity of 19 days.
Dividends Declared and Distributions in Excess of GAAP Net Income
For the six months ended June 30, 1999, FBR Asset declared dividends of $5.4
million, or $0.71 per share. For the period from January 1, 1998 through
December 31, 1998, FBR Asset declared dividends in the amount of $11.1 million,
or $1.155 per share, as reflected in Note 3 of Notes to Financial Statements.
These dividends covered FBR Asset's undistributed taxable income for the period
from January 1, 1998, through December 31, 1998, which exceeded its net income
calculated based on generally accepted accounting principles. For federal income
tax purposes, 90% per share of dividends paid in 1998 is ordinary income to FBR
Asset's stockholders, and 10% per share is a return of capital for 1998.
Changes in Financial Condition
Securities Available for Sale
FBR Asset invests in mortgage-backed securities that are agency pass-through
securities representing a 100% interest in the underlying conforming mortgage
loans. Conforming loans comply with the underwriting requirements for purchase
by Fannie Mae, Freddie Mac, and Ginnie Mae. These securities bear little risk of
credit loss due to defaults because they are guaranteed by Ginnie Mae, Fannie
Mae or Freddie Mac.
48
<PAGE>
FBR Asset held mortgage-backed securities of $140.9 million as of June 30, 1999.
FBR Asset held mortgage-backed securities of $218.7 million on June 30, 1998. At
December 31, 1998, FBR Asset held mortgage-backed securities equal to $161.4
million.
Premium balances associated with the purchase of mortgage-backed securities are
amortized as a decrease in interest income over the life of the security. FBR
Asset includes on its balance sheet unamortized premiums representing the
difference between the remaining principal value and the then current historical
amortized cost of mortgage-backed securities acquired. At June 30, 1999, the
amount of unamortized premium recorded in FBR Asset's statement of financial
condition was $2.4 million. At December 31, 1998, the amount of unamortized
premium recorded in FBR Asset's statement of financial condition was $2.7
million.
Given FBR Asset'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, FBR Asset's net interest
income would decrease during the life of the mortgage-backed securities, as FBR
Asset 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,
FBR Asset's net interest income would increase during the life of the
mortgage-backed securities, as FBR Asset would be required to amortize its net
premium balance over a longer time period.
FBR Asset received mortgage principal repayments equal to $16.9 million for the
six months ended June 30, 1999. Mortgage principal repayments received were
$21.2 million for the year ended December 31, 1998.
At June 30, 1999, $13.5 million of net unrealized losses on equity securities
and $2.4 million of net unrealized losses on mortgage-backed securities were
included in FBR Asset's statement of financial condition as accumulated other
comprehensive loss. At December 31, 1998, $10.5 million of net unrealized losses
on equity securities and $0.7 million of net unrealized gains on mortgage-backed
securities were included in FBR Asset's statement of financial condition as
accumulated other comprehensive loss. See "Stockholders' Equity" elsewhere in
"Management's Discussion and Analysis" and Note 3 of Notes to Financial
Statements for further discussion.
Repurchase Agreements
To date, FBR Asset's debt has consisted entirely of borrowings collateralized by
a pledge of most of FBR Asset's mortgage-backed securities. FBR Asset has
obtained, and believes it will be able to continue to obtain, short-term
financing in amounts and at interest rates consistent with FBR Asset's financing
objectives. FBR Asset limits its borrowings, and thus its potential asset
growth, in order to maintain unused borrowing capacity, and thereby increase the
liquidity and strength of its balance sheet.
FBR Asset had $113.8 million outstanding under repurchase agreements with
several financial institutions on June 30, 1999. FBR Asset had $181.3 million
outstanding under repurchase agreements on June 30, 1998. At June 30, 1999, the
ratio of the company's indebtedness for borrowed money to shareholder's equity
was 0.90 to 1.
49
<PAGE>
At June 30, 1999, the term to maturity of FBR Asset's borrowings had been
limited to 30 days with a weighted average remaining maturity of 19 days and a
weighted average cost of funds on outstanding borrowings of 5.06%.
On December 31, 1998, FBR Asset had $128.6 million outstanding under various
repurchase agreements with several financial institutions. At December 31, 1998,
the ratio of the company's indebtedness for borrowed money to shareholders'
equity was 0.85 to 1.
For the year ended December 31, 1998, the term to maturity of FBR Asset's
borrowings had been limited to 92 days with a weighted average remaining
maturity as of December 31, 1998, of 73 days and a weighted average cost of
funds on outstanding borrowings of 5.08%.
Contractual Commitments
During 1998, FBR Asset entered into two interest rate swap agreements to offset
the potential adverse effects of rising interest rates under some of its
short-term repurchase agreements, of which only one remains a commitment. That
agreement is with Salomon Brothers Holding Company Inc. Salomon Smith Barney
Holdings, Inc., the parent company of Salomon Brothers Holding Inc., has a
long-term debt rating of "A" by S&P. Under the swap agreement with Salomon, FBR
Asset receives quarterly payments of interest based on three-month LIBOR and
remits semi-annual payments based on a fixed interest rate of approximately 5.9%
based upon the $50 million notional amount of the swap.
The swap became effective on June 1, 1998, and matures on June 1, 2001. At June
30, 1999, the interest rate payable to FBR Asset by Salomon was 5.07%. At
December 31, 1998, the interest rate payable to FBR Asset by Salomon was 5.07%.
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, FBR Asset 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 June 30, 1999 and December 31, 1998, $0.5 million of
collateral was required under the interest rate swap agreement.
In October 1998, FBR Asset terminated an interest rate swap agreement with
Lehman Brothers. As a result of the termination, FBR Asset realized a loss of
$1.9 million that was recognized as a charge to income.
Capital Resources and Liquidity
Liquidity is a measurement of FBR Asset's ability to meet potential cash
requirements including ongoing commitments to repay borrowings, fund
investments, loan acquisition and lending activities, and for other general
business purposes. The primary sources of funds for liquidity consist of
repurchase agreements and maturities, distributions or principal payments on
mortgage-backed and equity securities, and proceeds from sales of those
securities. To date, proceeds from the issuance of common stock and repurchase
agreements have provided FBR Asset with sufficient funding for its investment
needs. Potential future sources of liquidity for FBR Asset include existing cash
balances, borrowing capacity through margin accounts, and future issuances of
common, preferred
50
<PAGE>
stock or debt. FBR Asset 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. FBR Asset may,
however, seek debt or equity financings, in public or private transactions, to
provide capital for corporate purposes and/or strategic business opportunities.
There can be no assurance that FBR Asset 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 FBR Asset's needs ever exceed these sources of liquidity, management
believes FBR Asset's mortgage-backed securities could be sold, in most
circumstances, to provide cash.
For the six months ended June 30, 1999, FBR Asset's operating activities
provided net cash flows of $4 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 six months ended June 30, 1998, FBR
Asset's operating activities provided net cash flows of $4.3 million.
For the six months ended June 30, 1999, FBR Asset's investing activities
provided net cash flows of $14.2 million compared to net cash used for the six
months ended June 30, 1998, of $289.2 million. The decrease in net cash used is
primarily attributable to a decrease in new investments in mortgage-backed
securities.
For the six months ended June 30, 1999, net cash used in FBR Asset's financing
activities was $39.0 million compared to net cash provided by financing
activities for the six months ended June 30, 1998, of $182.4 million. The
decrease in cash provided from financing activities is primarily attributable to
FBR Asset's purchase of mortgage-backed securities in the second quarter of
1998.
For the year ended December 31, 1998, FBR Asset's operating activities provided
net cash flows of $11.2 million. The primary source of operating cash flow was
interest on mortgage-backed securities and cash equivalents and dividends from
REIT investments. For the same period, FBR Asset's investing activities, which
were primarily purchases of mortgage-backed securities and equity investments,
resulted in net cash out-flows totaling $232.3 million. FBR Asset's financing
activities resulted in net cash in-flows of $99.0 million during the year ended
December 31, 1998. Cash flows from financing activities consisted primarily of
net proceeds from short-term repurchase agreements and proceeds from the
issuance of 196,828 shares of common stock in January 1998, offset partially by
funds used to repurchase FBR Asset's common stock and funds distributed to
shareholders.
Shareholders' Equity
FBR Asset 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, FBR Asset 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.
51
<PAGE>
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, FBR Asset looks to the financial
condition and business performance of each investment relative to that expected
at the time of purchase. FBR Asset also evaluates overall economic and
industry-specific conditions.
If FBR Asset 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. For the year ended December 31, 1998, FBR Asset
recorded a charge to reflect the decline in value of its investment in Chastain,
which FBR Asset determined was other than temporary. That determination
resulted, in substantial part, from Chastain's announcement that it was
suspending its dividend for the fourth quarter of 1998.
As of December 31, 1998, the value of the equity securities in FBR Asset's
portfolio had declined from $87.8 million from the date the investments were
made to $71 million. As of June 30, 1999, the value of the equity securities in
FBR Asset's portfolio had declined from $86.7 million as of the date the
investments were made to $73.5 million. Declines have been recorded as
accumulated other comprehensive income in the statement of financial condition,
except that for the year ended December 31, 1998, FBR Asset realized and charged
to income a loss of $6.6 million on its investment in Chastain. See Note 6 of
Notes to Financial Statements.
With respect to each of FBR Asset's other equity investments, management
believes that, as of June 30, 1999 and December 31, 1998, their decline in fair
value was temporary. That belief is based on several facts, including the
following:
o None of the other REITs has suspended their dividends.
o Each of the equity securities has increased in fair value since the
worst of the liquidity crisis in September 1998.
o Each of the REIT securities owned has experienced pricing movements
similar to the Morgan Stanley REIT Index for the past six months. This
similar movement indicates that the entire industry has declined and
not just one specific company.
o The sharpest movements within the REIT sector track similar declines
and subsequent increases in the Dow Jones Index (serving as a leading
indicator by several weeks) and the Russell 2000 Index.
Based on these factors, FBR Asset believes that the declines are not persistent
declines in market value, but rather reflect general market and REIT sector
pricing movements, and are therefore temporary changes. Further, FBR Asset has
the intent and ability to hold each of its investments to allow for the
anticipated recovery in stock prices. There can be no assurance, however, that
other charges will not be required in future periods.
As a result of "mark-to-market" accounting treatment, the book value and book
value per share of FBR Asset 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.
In June 1998, FBR Asset's Board of Directors authorized a program to repurchase
up to 2,000,000 shares of FBR Asset's common stock. On March 30, 1999, FBR
Asset's
52
<PAGE>
Board authorized the repurchase of up to 2,000,000 additional shares of
FBR Asset's common stock. Between June 1998 and June 1999, FBR Asset repurchased
3,303,991 shares of its common stock at an average price of $13.01 per share.
Year 2000 Compliance
FBR Asset's software and information systems are Year 2000 compliant. However,
FBR Asset places significant reliance on the technologies of BlackRock.
Management has inquired of BlackRock and has been provided information regarding
the status of BlackRock's Year 2000 readiness. BlackRock has identified its
critical technology areas and systems with Year 2000 exposure. Those systems and
the areas identified by BlackRock that may affect FBR Asset include BlackRock's
internally developed trading and analytical systems, the accounting and
reporting systems for fixed income securities including mortgage-backed
investments, and relationships with daily market pricing and data providers,
asset custodians and clearing brokers. BlackRock has indicated that it has
completed all testing, remediation, and validation of its internal systems.
Furthermore, BlackRock has received written assurances from all of its critical
vendors that their products or systems are Year 2000 compliant. In addition, in
excess of 90% of BlackRock's other vendors have represented in writing that
their products or systems are Year 2000 compliant. To date, BlackRock has not
received any responses from vendors indicating that they will not be Year 2000
compliant by the end of 1999. There is no assurance, however, that either
BlackRock's internal systems or the external systems it uses will work properly
on or after January 1, 2000.
BlackRock has completed developing its contingency plans related to this issue.
BlackRock expects that those plans will be fully implemented by the end of 1999.
BlackRock has estimated that the aggregate cost of its Year 2000 compliance
efforts will not exceed $500,000, although the cost may be higher.
To a lesser extent, FBR Asset also relies on the technologies of FBR Management.
That reliance primarily relates to information technology systems, more
specifically, the general ledger applications and to a lesser degree the
brokerage and trading information and market data systems. These systems are
commercially provided and widely-used. FBR and FBR Management have contacted all
material third parties and have received written responses from 100% of the key
external vendors whose software and hardware supports the systems material to
FBR Asset's operations, acknowledging that the software and hardware used by FBR
and FBR Management is Year 2000 compliant. FBR and FBR Management has also
received written responses from the suppliers of building services for the
office space occupied by FBR and FBR Management, acknowledging that their
underlying computer systems are Year 2000 compliant. Because of the relatively
low volume of FBR Asset's monthly trading and accounting transactions, FBR Asset
believes that if FBR Management were unable to provide these services because of
Year 2000 problems, FBR Asset could obtain comparable, Year 2000 compliant
services elsewhere. Management has, however, inquired of FBR Management and FBR
and has been provided the following information regarding the status of FBR's
Year 2000 readiness.
Both FBR Management and FBR are currently in the process of finalizing their own
internal testing, remediation and validation of all vendor supported critical
systems,
53
<PAGE>
including those related to FBR Asset. FBR Management and FBR are also currently
finalizing their contingency planning for Year 2000 and have represented that
those plans will be completed and tested in the third quarter of 1999. FBR
Management and FBR have represented to FBR Asset that the total cost to complete
their Year 2000 compliance efforts is estimated to be less than $350,000.
FBR Asset is currently evaluating its contingency plan alternatives,
particularly with respect to its reliance on the information systems provided by
BlackRock and FBR Management. FBR Asset expects to complete such plans not later
than the third quarter of 1999.
There can be no assurance that the systems on which FBR Asset currently relies
will be operationally effective by the end of 1999. If those systems are not
Year 2000 compliant, their failure could have a material adverse effect on FBR
Asset's operations. Furthermore, the failure of banking and securities systems
in general--although an unlikely occurrence and one totally beyond our
control--could have a material adverse effect on FBR Asset's operations. In the
worst case, FBR Asset could be required to establish its ownership of assets and
its entitlement to interest and dividend payments on those assets. FBR Asset
maintains trade tickets and other written documentation that it believes would
be adequate to establish its ownership of those assets.
Market Conditions
The ability of FBR Asset to make investments is dependent upon a number of
factors, including the overall health of the equity and debt capital markets,
the condition of the U.S. and foreign real estate markets, the ability of other
REITs and real estate owners and operators to access equity and debt through the
capital markets, the availability of credit to finance the acquisition of
assets, and the interest rates that FBR Asset pays to finance its purchases.
Equity Market Conditions
The first half of 1999 continued to be a volatile period for the U.S. equity
markets. The Standard & Poor's 500 Index, or "S&P 500," is a
capitalization-weighted index of 500 stocks designed to measure changes in the
aggregate market value of 500 stocks that represent all major industries. The
S&P 500 began the period at 1,228.1 and ended the period at 1,372.7, an increase
of 11.8%. In contrast, the S&P 500 started January 1, 1998 at 975.0 and ended
June 30, 1998 at 1,133.8, an increase of 16.3%. The S&P 500 increased 21.1% from
June 30, 1998 to June 30, 1999.
FBR Asset has investments in REIT securities and small-cap stock securities.
While the S&P 500 was up from the first half of 1998 to the first half of 1999,
indices that track composite prices for small-cap and REIT stocks reflect a
different performance. A key index that tracks small-cap stocks is the Russell
2000 Index. The Russell 2000 is comprised of the smallest 2000 companies in the
Russell 3000 Index, which represents 98% of the investable securities in the
U.S. equity market. The Russell 2000 was at 421.3 on January 1, 1999 and 457.68
on June 30, 1999, an increase equal to 8.6%. The Russell 2000 was at 436.5 on
January 1, 1998 and 457.4 on June 30, 1998, an increase equal to 4.8%. From June
30, 1998 to June 30, 1999 the Russell 2000 was unchanged.
54
<PAGE>
The Morgan Stanley REIT Index is a total return index that tracks the most
actively traded real estate investment trusts and is designed to be a measure of
real estate equity performance. On January 1, 1999, the Morgan Stanley REIT
Index was 306.1 and on June 30, 1999, it closed at 316.3, an increase equal to
3.3%. For the first half of 1998, the Morgan Stanley REIT Index started at 363.2
and ended at 345.4, a decrease equal to 4.9%. The Morgan Stanley REIT Index
declined 8.4% from June 30, 1998 to June 30, 1999.
Some of the factors FBR Asset believes are influencing the equity markets
include strong demand for stocks of internet and technology stocks and large-cap
industrial stocks.
1998 was a volatile year in the U.S. equity and debt markets. The S&P 500 began
the year at 975.0 and ended the year at 1,229.2, an increase of 26.1%. However,
from July 15, 1998, to October 21, 1998, the S&P 500 dropped approximately 100
points, a decrease equal to 10%. The Russell 2000 began 1998 at 436.5 and ended
the year at 422.0, a decrease of 3.32%. Similar to the mid-1998 drop in the S&P
500, the Russell 2000 dropped from a 1998 high on April 21, 1998, of 491.4 to a
low on October 10, 1998, of 310.3, a decline of 36.9%. The Morgan Stanley REIT
Index began 1998 at 363.2 and ended the year at 302.4, a decrease of 16.7%.
Some of the factors that FBR Asset believes influenced the fluctuations of the
equity markets in 1998 include statements from the Chairman of the Federal
Reserve Board, Alan Greenspan, that the prices of stocks reflected an
"irrational exuberance" relative to historical price earnings ratios, a
declaration from the Russian government that it did not intend to continue
current payments on its outstanding debt obligations, general turmoil in Asia,
particularly Asian financial institutions, and currency devaluation in Brazil.
The debt markets were also affected by the factors influencing the equity
markets. In response to concerns about a potential recession in the U.S. and
events such as the Russian bond default, the Federal Reserve cut the federal
funds rate, the rate it charges on overnight borrowings by banks, on three
separate occasions in 1998. General uneasiness about the health of international
economies prompted investors to sell their investments in the debt of other
countries and invest the sales proceeds in U.S. Treasuries. As a result, prices
for U.S. Treasuries increased and yields decreased.
REIT and Real Estate Market Conditions
Since inception, FBR Asset has made aggregate investments of $99.3 million in
equity securities of ten companies, including six REITs and three companies that
operate real estate-related businesses. The value of FBR Asset's equity
investments is subject to factors that affect the stock prices of companies in
which it has invested. FBR Asset and the companies in which it has invested are
affected by changes in interest rates, the condition of the REIT equity and debt
markets, the availability of credit to REITs through commercial mortgage-backed
securities issuance and lending from financial institutions, and the underlying
leasing, occupancy and development trends affecting the fundamental operations
of real property.
REIT Equity Market
- ------------------
REITs, such as FBR Asset, are required to distribute to their shareholders at
least 95% of their taxable income each year. As a result, REITs have limited
ability to retain earnings for growth and must access the capital markets on a
continual basis to finance growth
55
<PAGE>
plans. During the period from 1995 to mid-1998, the prices of REIT stocks
steadily increased, driven by investor expectations that REITs would use the
proceeds from equity financings to acquire additional properties that would
generate accretive earnings. However, FBR Asset believes that as more REITs
raised more money and prices for property acquisitions increased, there were
fewer opportunities available for REITs to acquire properties that were
accretive to earnings. As a result, in mid-1998, investors began to adjust their
growth expectations for REITs, which caused REIT stock prices to decline. In
addition, just as the global financial crises caused investors to sell
investments in foreign debt issuances and invest in U.S. Treasuries, FBR Asset
believes that investors began selling REIT securities to invest in larger, more
well-capitalized stocks such as those included in the S&P 500. See "Equity
Market Conditions" for a more detailed discussion of the factors that FBR Asset
believes to have influenced the equity markets.
FBR Asset's ability to fund its growth and find attractive investments is, in
part, dependent upon the market conditions for REITs. During the first half of
1999, there was one REIT initial public offering that raised $13.7 million and 8
secondary offerings that raised $512.3 million. This compares to 15 REIT initial
public offerings, which raised $2.1 billion during the first six months of 1998
and 133 secondary offerings, which raised $6.8 billion. In 1998, there were
sixteen REIT initial public offerings, which raised a total of $2.1 billion. Of
the sixteen REIT initial public offerings, seven were mortgage REITs, which
raised $860 million. Of the seven mortgage REIT initial public offerings, FBR
Asset invested $19.8 million in contemporaneous private placements by two. Of
the nine equity REIT initial public offerings, FBR Asset invested $25 million in
a contemporaneous private placement by one.
The market for initial public offerings and secondary common stock offerings of
REIT securities was robust during the first and second quarters of 1998.
However, because of factors affecting the debt and equity markets, the market
for REIT offerings essentially closed during the third and fourth quarters. The
table below summarizes public common equity raised by REITs for each quarter
from January 1, 1998, through June 30, 1999.
56
<PAGE>
<TABLE>
<CAPTION>
IPO Secondary
--------------------------------------- ----------------------------------------
($ In Millions) ($ In Millions)
Market Market
Mortgage Equity Value Mortgage Equity Value
1998 REITs REITs Total 6/30/99 REITs REITs Total 6/30/99
---- ----- ------ ----- ------- ----- ----- ----- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
First Quarter $ 522.3 $657.4 $1,179.7 -33.10% $ 71.6 $4,250.8 $4,322.4 -12.83%
Second Quarter 325.7 557.3 883.0 -27.02% 44.1 2,395.4 2,439.5 -11.00%
Third Quarter 12.0 0.0 12.0 -54.69% 0.0 100.9 100.9 -2.63%
Fourth Quarter 0.0 0.0 0.0 0.00 0.0 211.2 211.2 -2.84%
------- -------- ------- ------- ------- -------- -------- ------
Total 1998 $ 860.0 $1,214.7 $2,074.7 -30.64% $ 115.7 $6,958.3 $7,074.0 -11.76%
======= ======== ======== ======= ======= ======== ======== ======
1999
First Quarter $ 0.0 $ 13.7 $ 13.7 -6.25% $ 0.0 $ 149.1 $ 149.1 -2.98%
Second Quarter 0.0 0.0 0.0 0.00 0.0 363.2 363.2 -2.97%
------- ------ -------- ------- ------- -------- -------- ------
Year-to-Date
1999 $ 0.0 $ 13.7 $ 13.7 -6.25% $ 0.0 $ 512.3 $ 512.3 -2.97%
======= ====== ======== ======= ======= ======== ======== ======
</TABLE>
Source: CommScan Equidesk, Inc. & Bloomberg
FBR Asset's investments in REITs have experienced declines similar to the
declines in market value reflected above. See "Summary of Current Investments &
Cash and Cash Equivalents." Historically, FBR Asset has invested in REITs and
companies that propose to elect REIT status. There has been no significant
strengthening in the market for REIT stocks since December 31, 1998.
Real Estate Market
- ------------------
Despite the fluctuations of the REIT equity markets, FBR Asset believes the
underlying fundamentals in real estate have continued to improve. Overall
vacancy rates in many major U.S. real estate markets have decreased from highs
reached in the late 1980s and early 1990s to levels that historically would have
resulted in substantial increases in speculative development. However, FBR Asset
believes that REIT investors and reports by analysts who follow REITs have
effectively restrained new speculative development activity by reducing the
availability of financing for development and by analyzing and questioning the
need for new developments.
FBR Asset believes that sectors of the commercial real estate market such as
central business district office buildings, industrial warehouse facilities that
serve as national distribution centers, luxury and full service hotels,
apartments in areas where development is constrained by lack of land or
development restrictions, and assisted living facilities with strong operators
are still attractive to institutional investors.
FBR Asset has invested in the equity securities of Prime Retail, which invests
in factory outlet malls, and East-West Bancorp, which invests in multifamily
housing. In addition, FBR Asset has made loans to Kennedy-Wilson, Prime Capital,
Prime Group and Brookdale, as described below.
Real Estate-Based Lending Market
- --------------------------------
One of the most important factors associated with an investment in real estate
is the availability of debt to finance a significant portion of the investment.
In recent years, traditional lending sources such as banks and insurance
companies have been
57
<PAGE>
supplemented by capital market financing through lending conduits. These
conduits make loans and finance the loans by the sale of securities backed by
and payable from the payments on the loans. The growth of these commercial
mortgage-backed securities, or CMBS, has been significant.
The mortgage loans that can be most efficiently securitized are traditional
first mortgage loans underwritten to traditional institutional lending
standards. The CMBS that can be most easily placed at attractively low interest
rates are those that have been rated in one of the investment grade categories
by a recognized rating agency.
FBR Asset has concentrated its investment in real estate based lending
investments in real estate based loans that are not easily securitized and, to a
lesser extent, in CMBS that are not investment grade rated. FBR Asset has made
indirect investments in commercial mortgage REITs whose business plans
contemplated them retaining subordinated mortgage loans that they originate or
acquire and securitize. The market value of those mortgage REITs has declined
significantly since the time FBR Asset made those investments, attributable in
fact to the filing in October of 1998 by CRIIMI MAE, the largest commercial
mortgage REIT, for protection under Chapter 11 of the bankruptcy code. The
filing by CRIIMI MAE and general market conditions resulted in a tightening of
credit available to mortgage REITs. This in turn made it more difficult for
mortgage REITs and other conduit lenders to originate loans and finance growth.
FBR Asset has made direct investments in real estate based loans. Investments in
1998 were loans to Prime Capital and Kennedy-Wilson aggregating $19 million.
Since December 31, 1998, FBR Asset has invested $12 million in loans to
Brookdale Living Communities and Prime Group Realty Trust and has committed to
loan $20 million to Prime Retail. Each of these loans provides debt financing
for capital needs not covered by traditional secured and senior loans and
available equity. FBR Asset anticipates that there will be a continued demand
for this type of loan and that it will make additional similar real estate based
loans in the future.
Interest Rate Environment
FBR Asset's earnings depend, in part, on the relationship between long-term
interest rates and short-term interest rates. FBR Asset's direct investments in
mortgage-backed securities bear interest at fixed rates determined by reference
to the yields of medium- or long-term U.S. Treasury securities or at adjustable
rates determined by reference to the yields on various short-term instruments.
From January 1, 1999 to June 30, 1999, interest rates on 10-year U.S. Treasury
securities increased for an average yield equal to 5.26%. At the same time,
one-month LIBOR decreased to an average yield for the period equal to 4.96%. As
a result, the yield curve flattened such that short-term, non-Treasury borrowing
rates approximately equaled long-term Treasury rates. For the same period in
1998, the average yield on 10-year U.S. Treasury securities was 5.59% and the
average yield on one-month LIBOR was 5.65%. The average yield on the 10-year
U.S. Treasury decreased by 5.90% from the first half of 1998 to the first half
of 1999. For the same period, the average yield on one-month LIBOR decreased by
12.21%.
From January 1, 1998, to December 31, 1998, interest rates on U.S. Treasury
securities declined, in part, as a reaction to global financial uncertainties.
U.S. and international
58
<PAGE>
investors reduced their exposure to foreign government and corporate bonds and
increased their investments in U.S. Treasury securities. This resulted in higher
prices for Treasury securities and lower yields. As a result, the yield curve
inverted such that short-term, non-Treasury borrowing rates exceeded long-term
Treasury rates.
FBR Asset has invested in fixed-rate long-term mortgage-backed securities and
financed a significant portion of that investment with short-term borrowings at
short-term borrowing rates. As a general matter, FBR Asset's mortgage-backed
securities portfolio performs better when the spread between short-term interest
rates and long-term interest rates increases and less well as it decreases. The
following table summarizes the relationship in 1998 and the first half of 1999
between one-month LIBOR and the 10-year U.S. Treasury yield. FBR Asset's
borrowings typically bear interest rates that have historically moved in close
relationship to LIBOR. FBR Asset's incentive management fee is based on the
ten-year U.S. Treasury.
<TABLE>
<CAPTION>
Yield
----------------------------------------------------------------------------------
High Low Average
------------------------- ------------------------ ------------------------
10-Year Net 10-Year Net 10-Year Net
Treasury LIBOR Spread Treasury LIBOR Spread Treasury LIBOR Spread
-------- ----- ------ -------- ----- ------ -------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
First Quarter 5.77% 5.72% 0.05 5.36% 5.59% -0.23 5.58% 5.65% -0.07
Second Quarter 5.81% 5.69% 0.12 5.35% 5.64% -0.29 5.60% 5.66% -0.06
Third Quarter 5.52% 5.66% -0.14 4.42% 5.34% -0.92 5.20% 5.62% -0.42
Fourth Quarter 4.94% 5.63% -0.69 4.16% 5.03% -0.87 4.66% 5.36% -0.70
---- ---- ----- ---- ---- ----- ---- ---- ----
1998 Average 5.51% 5.68% -0.17 4.88% 5.40% -0.52 5.27% 5.57% -0.30
==== ==== ===== ==== ==== ==== ==== ==== ====
1998
Increase/(Decrease) -0.83 -0.09 -1.2 -0.56 -0.92 -0.29
1998 Percentage
Increase/(Decreases) -14.39% -1.57% -22.39% -10.02% -16.49% -5.13%
First Quarter
1999 5.42% 5.06% 0.36 4.61% 4.93% -0.32 4.98% 4.95% -0.03
Second Quarter
1999 6.03% 5.24% 0.79 5.03% 4.90% 0.13 5.53% 4.96% 0.57
---- ---- ----- ---- ---- ----- ---- ---- ----
Year-to-Date
Average 5.73% 5.15% 0.58% 4.82% 4.92% -0.10 5.26% 4.96% 0.30%
==== ==== ===== ==== ==== ===== ==== ==== ====
</TABLE>
Source: Bloomberg
As the table indicates, as of December 31, 1998, the average yield on the
ten-year U.S. Treasury security had decreased 16.49% during 1998, from 5.58% to
4.66%, and LIBOR decreased 5.13% from 5.65% to 5.36% during the same period.
For the period ended June 30, 1999, the weighted average annual yield on
mortgage-backed securities owned by FBR Asset was 6.25%; the annual management
fee associated with that investment was 0.25%; and the weighted average interest
rate on FBR Asset's repurchase agreement borrowings was 5.39%. The net interest
rate spread was 0.61%.
For the year ended December 31, 1998, the weighted average annual yield on
mortgage-backed securities owned by FBR Asset was 6.19%; the annual management
fee associated with that investment was 0.25%; and the weighted average interest
rate on FBR Asset's repurchase agreement borrowings was 5.82%. The net interest
rate spread was 0.12%.
The decline in the yields of U.S. Treasury securities have caused an increase in
the spreads in the CMBS market. Increasing spreads, in turn, have caused
declines in CMBS
59
<PAGE>
values. As a result, many lenders who financed CMBS assets with repurchase
agreements have required borrowers to meet margin calls resulting from the
declining value of the CMBS assets. Unlike CMBS, the mortgage-backed securities
held directly by FBR Asset are insured by Ginnie Mae, Fannie Mae or Freddie Mac
and are not leveraged to the fullest extent possible. There can be no assurance
that FBR Asset can obtain additional leverage, that margin calls will not be
made, or that replacement financing will be available if lenders rescind their
repurchase agreements.
For the mortgage REITs in which FBR Asset has invested, the inversion of the
yield curve, coupled with the higher yields commanded by investors in CMBS, made
it less profitable or unprofitable to acquire and finance commercial mortgage
loan portfolios priced at a spread fixed to corresponding U.S. Treasury rates.
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.
FBR Asset 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
- ------------------
FBR Asset 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. FBR Asset 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. FBR Asset attempts to hedge a portion of its exposure to interest
rate risk primarily through the use of interest rate swaps.
FBR Asset's primary risk is related to changes in both short and long term
interest rates, which affect the company in several ways. As interest rates
increase, the market value of the mortgage-backed securities may be expected to
decline, prepayment rates may be expected to go down and durations may be
expected to extend. An increase in interest rates is beneficial to the market
value of FBR Asset's swap position as the cash flows from the floating rate
portion increase under this scenario. The reverse is true for mortgage-backed
securities and the swap if interest rates decline.
The fair value of interest rate swap agreements that qualify as hedges is not
recorded for accounting purposes. The differential between amounts paid and
received under the swap agreements is recorded as an adjustment to the interest
expense incurred under the repurchase agreements. In the event of early
termination of a swap agreement, a gain or loss is recorded and the company
receives or makes a payment based on the fair value of the swap agreement.
The table that follows shows the expected change in market value for FBR Asset'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 that the level of LIBOR changes by
60
<PAGE>
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 6/30/99." 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 6/30/99
6/30/99 with 100
with 100 basis point
basis point decrease in
Value at increase in Percent interest Percent
6/30/99(1) interest rates Change rates Change
------------ -------------- ---------- -------------- ----------
<S> <C> <C> <C> <C> <C>
Assets
Mortgage securities $140,943,202 $136,079,195 (3.45%) $ 144,850,207 2.77%
Other 113,007,491 113,007,491 - 113,007,491 -
------------ ------------ --------------
Total Assets $253,950,693 $249,086,686 (1.92%) $ 257,857,698 1.54%
============ ============ ==============
Liabilities
Interest rate swap $ (16,905)(2) (796,535)(2) $ 791,387(2)
Other 126,969,514 126,969,514 126,969,514
------------ ------------ --------------
Total Liabilities $126,952,609 $126,172,979 (0.61%) $ 127,760,901 0.64%
------------ ------------ --------------
Shareholders' Equity
Common stock $ 104,158 $ 104,158 - $ 104,158 -
Paid-in-capital 194,097,193 194,097,193 - 194,097,193 -
Accumulated other
comprehensive
income (loss) (15,879,172) (19,963,549) (25.72%) (12,780,459) 19.51%
Retained earnings
(deficit) (8,339,757) (8,339,757) - (8,339,757) -
Treasury stock (42,984,338) (42,984,338) - (42,984,338) -
------------ ------------- --------------
Total
Shareholders'
Equity $126,998,084(2) $ 122,913,707 (3.22%) $ 130,096,797 2.44%
------------ ------------- --------------
Total Liabilities
and Shareholders'
Equity $253,950,693 $ 249,086,686 (1.92%) $ 257,857,698 1.39%
============ ============= ==============
</TABLE>
(1) Includes Accrued Interest.
(2) In accordance with GAAP, the fair value of interest rate swaps accounted
for as hedges is not recorded. Accordingly, the carrying value of the
interest rate swap in the company's financial statements is $0. See Note 2
to Notes to Financial Statements. The fair value of the interest rate swap
is based on quoted market prices as of June 30, 1999. As of June 30, 1999,
interest payments received under the swap agreement were based on an
interest rate of 5.07% while interest payments made were based on an
interest rate of 5.9%.
As shown above, the portfolio generally will benefit less from a decline in
interest rates than it will be adversely affected by a similar-scale increase.
This effectively may limit investors' upside potential in a market rally.
The value of FBR Asset'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
FBR Asset's direct investments. Second, the REITs in which FBR Asset has
invested tend to trade on a yield basis. As interest rates increase, the yield
required by investors in REITs, thrifts and other
61
<PAGE>
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 FBR Asset 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 FBR Asset
has invested.
Equity Price Risk
- -----------------
FBR Asset 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 changes or the values of
corresponding equity indices change.
While it is impossible to project with any exactitude what factors may affect
the prices of equity sectors and how much that might be, the table below
illustrates the impact a ten percent increase and a ten percent decrease in the
price of the equities held by FBR Asset would have on the value of the total
assets and the book value of FBR Asset as of June 30, 1999.
<TABLE>
<CAPTION>
Value at Value at
June 30, June 30,
Value at 1999 with 1999 with
June 30, 10% increase Percent 10% decrease Percent
1999 in price Change in price Change
------------ -------------- --------- -------------- ----------
<S> <C> <C> <C> <C> <C>
Assets
Equity securities $ 73,515,801 $ 80,867,381 10.00% $ 66,164,221 (10.00%)
Other 180,434,892 180,434,892 - 180,434,892 -
------------ ------------ ------------
Total Assets $253,950,693 $261,302,273 2.89% $246,599,113 (2.89%)
============ ============ ============
Liabilities $126,969,514 $126,969,514 - $126,969,514
------------ ------------ ------------
Shareholders' Equity
Common stock $ 104,158 $ 104,158 - $ 104,158 -
Paid-in-capital 194,097,193 194,097,193 - 194,097,193 -
Accumulated
comprehensive
income (loss) (15,896,077) (8,544,497) 46.25% (23,247,657) (46.25%)
Retained earnings
(deficit) (8,339,757) (8,339,757) - (8,339,757) -
Treasury stock (42,984,338) (42,984,338) - (42,984,338) -
------------ ----------- ------------
Total
Shareholders'
Equity $126,981,179 $134,332,759 5.79% $119,629,599 (5.79%)
------------ ------------ ------------
Total Liabilities
and Shareholders'
Equity $253,950,693 $261,302,273 2.89% $246,599,113 (2.89%)
============ ============ ============
Book value per share $ 17.85 $ 18.89 5.79% $ 16.82 (5.79%)
</TABLE>
Except to the extent that FBR Asset sells its equity investments, an increase or
decrease in the market value of those assets will not directly affect FBR
Asset's earnings, although an increase or decrease in interest rates would
affect the market value of the assets owned by the companies in which FBR Asset
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 FBR Asset's earnings. If FBR Asset had
sold all of its equity investments on June 30, 1999, the company would have
incurred a loss of approximately $15.1 million which would have been charged to
earnings.
62
<PAGE>
Developments Since June 30, 1999
On June 30, 1999, FBR Asset further extended the maturity date on its loan to
Prime Capital Holding, LLC until September 30, 1999. On August 4, 1999, Prime
Capital Holding, LLC paid $315,500 in principal payments to reduce the
outstanding balance of the loan to $9.9 million.
FBR Asset is currently in negotiations with Prime Capital Holding, LLC to extend
the maturity date on the $9.9 million balance of this loan (the "PCH Mezzanine
Loan") until October 31, 1999. Further, FBR Asset is in negotiations with Prime
Group, Inc. and Prime Capital Holding, LLC to lend an additional $7,000,000 to
Prime Capital Holding, LLC secured by the same collateral that secures the PCH
Mezzanine Loan (the "PCH Subordinated Loan"). FBR Asset is seeking to negotiate
improved collateral and repayment terms with respect to the existing loan and is
seeking corporate guarantees and additional collateral with respect to the
entire financing. It is anticipated that the PCH Subordinated Loan will have a
four-to-six month term to maturity and will bear interest at a rate of 12.00%
per annum for the first 60 days it is outstanding, and at 17.00% per annum
thereafter.
On July 22, 1999 Imperial Credit Commercial Mortgage and Imperial Credit
Industries announced a merger agreement under which Imperial Credit Industries
would acquire all of the outstanding shares of Imperial Credit Mortgage for a
cash purchase price of $11.50 per share, subject to increase under certain
circumstances. Completion of the merger is conditioned on, among other things,
approval by the shareholders of Imperial Credit Mortgage. The merger agreement
also contemplates that Imperial Credit Mortgage will, for a period of
approximately 60 days, solicit and explore alternative transactions which would
provide its shareholders with a more favorable alternative to the Imperial
Credit Industries merger. In the event of closing of the transaction or upon
earlier determination by management that the per share consideration likely to
be received by FBR Asset as a result of the merger will be less than FBR Asset's
original cost of $14.50, the difference between the expected transaction price
and that original cost will be reflected as a realized loss in FBR Asset's
statement of income. If the merger is consummated for a cash purchase price of
$11.50 per share, then FBR Asset will recognize a loss of $2.7 million.
On September 10, 1999, FBR Asset executed an Interim Financing and Security
Agreement under which it committed to lend up to $20,000,000 to Prime Retail,
Inc. and Prime Retail, L.P. This loan has a nine-month term to maturity and
bears interest at 11.00% per annum. FBR Asset will fund the loan out of
available cash or using available borrowings secured by its mortgage or
securities holdings.
On September 16, 1999, FBR Asset announced a cash dividend of $0.40 per share
payable October 15, 1999 to shareholders of record as of September 30, 1999.
Cumulatively, the total dividends declared by FBR Asset year-to-date represents
approximately 95% of year-to-date taxable income through September 30, 1999. In
connection with its status as a REIT, FBR Asset expects to distribute 100% of
its annual taxable income each year. Accordingly, to the extent that FBR Asset
distributes less than 100% of taxable income in the first three quarters of any
year, FBR Asset expects that the fourth quarter dividend would reflect both
taxable income for that quarter and the balance of the taxable income for the
first three quarters.
63
<PAGE>
Also on September 16, 1999, the board of directors appointed Mr. Kurt R.
Harrington as Chief Financial Officer, Treasurer and Secretary of FBR Asset. Mr.
Harrington previously served as Treasurer of FBR Asset. Mr. Harrington replaced
Ms. Elaine M. Clancy, who had served as Chief Financial Officer since January
1998.
64
<PAGE>
FBR Asset's Directors & Officers
FBR Asset's principal executive offices are located in Arlington, Virginia, at
Potomac Tower, 1001 Nineteenth Street North. The phone number is (703) 469-1000.
The Board of Directors
Composition of the Board
FBR Asset's Board consists of five members. All directors are elected at each
annual meeting of FBR Asset's shareholders for a term of one year. Directors
hold office until their successors are elected and qualified. Two of FBR Asset's
five directors are independent directors. The remaining three directors are
Affiliates of FBR Management.
An "independent director" is a person who has not, in the past two years:
o owned an interest in FBR Management or any of its Affiliates;
o been employed by FBR Management or any of its Affiliates;
o been an officer or director of FBR Management or any of its Affiliates;
or
o performed services for FBR Management or any of its Affiliates.
No person will be disqualified from serving as an independent director solely
because that person maintains a discretionary brokerage account with FBR
Management or its Affiliates.
An "Affiliate" of FBR Management is any person, including a corporation or other
entity, that:
o FBR Management directly or indirectly controls;
o directly or indirectly controls FBR Management;
o is under common control with FBR Management;
o is an officer of, partner in, or director of FBR Management, or serves
in a similar capacity with respect to FBR Management; or
o directly or indirectly, beneficially owns, controls or holds, with the
power to vote, more than 10% of any class of FBR Management's equity
securities.
Affiliates of FBR Management also include those persons, including corporations
and other entities:
o for which FBR Management serves as an officer, partner, or director, or
serves in some similar capacity; or
o of which FBR Management beneficially owns, controls or holds, with the
power to vote, directly or indirectly, more than 10% of a class of that
person's equity securities.
FBR Asset's Charter requires that, except in the case of a vacancy, at least 30%
of the members of the Board of Directors must be independent directors. With a
view toward protecting the interests of FBR Asset's shareholders in transactions
involving conflicts with FBR Management, a majority of the independent directors
must approve:
65
<PAGE>
o any transaction in which FBR Asset seeks to acquire securities that are
being underwritten or placed by FBR; and
o any transaction involving FBR Asset in which FBR has a material
financial interest, as determined by all of the directors in their role
as fiduciaries, including but not limited to, any decisions concerning
the termination or renewal of the Management Agreement.
In making their decisions, the independent directors will consider information
provided by FBR Management and such other information as they deem appropriate
to determine whether such transactions will be in FBR Asset's best interests.
The independent directors will not otherwise participate in FBR Asset's daily
operations and will have no ability to cause the company to take action or
refrain from taking action against the wishes of the inside directors. The
independent directors will, however, review transactions engaged in by FBR Asset
on a quarterly basis and will review FBR Asset's investment policies annually.
Investors should be aware that, in conducting these reviews, the independent
directors will rely primarily on information provided to them by FBR Management.
Executive Committee
The executive committee consists of Messrs. Friedman, Billings, and Swanson. Mr.
Billings serves as the chairman of the executive committee. When the Board is
not in session, the executive committee exercises all of the Board's authority,
provided, however, that unless otherwise authorized by FBR Asset's Bylaws, the
executive committee does not have the authority to elect directors, declare
dividends or distributions on stock, recommend to shareholders any action that
requires shareholder approval, amend or repeal FBR Asset's Bylaws, approve any
merger or share exchange that does not require shareholder approval, authorize
the issuance of stock, or approve transactions that require the approval of the
independent directors.
Audit Committee
The audit committee consists solely of FBR Asset's independent directors,
Messrs. Harlan and Lindner. The audit committee meets with management to
consider the adequacy of the internal controls and the objectivity of financial
reporting. The audit committee also meets with the independent auditors and with
appropriate financial personnel of FBR Asset regarding these matters. The audit
committee recommends to the Board the appointment of independent auditors,
subject to ratification by the shareholders at the annual meeting. The
independent auditors periodically meet alone with the audit committee and have
unrestricted access to the audit committee.
Contracts Committee
The contracts committee consists solely of FBR Asset's independent directors,
Messrs. Harlan and Lindner. The contracts committee assists the Board in
reviewing any contract that FBR Asset may propose to enter into with FBR
Management or its Affiliates, including without limitation, the Management
Agreement, and monitors on an ongoing basis the performance of FBR Management or
any of its Affiliates pursuant to any such contract.
66
<PAGE>
Nominating Committee
The nominating committee consists solely of FBR Asset's independent directors,
Messrs. Harlan and Lindner. The nominating committee assists the Board in
establishing processes for director nominations, including the criteria for
selecting nominees, and identifies and recommends nominees for election to the
Board.
The Directors
FBR Asset's directors are as follows:
The Independent Directors
Name Age Position(s) Held with FBR Asset
- ---- --- -------------------------------
Stephen D. Harlan 65 Director
Russell C. Lindner 45 Director
Directors Affiliated with FBR Management
Name Age Position(s) Held with FBR Asset
- ---- --- -------------------------------
Emanuel J. Friedman 53 Chairman of the Board
Eric F. Billings 47 Vice Chairman, President &
Chief Executive Officer
William R. Swanson 50 Executive Vice President &
Chief Operating Officer
Stephen D. Harlan is Chairman of H.G. Smithy Company, a specialized real estate
firm that provides mortgage banking, finance, investment, advisory, and property
management services to commercial real estate investors. Before joining H.G.
Smithy in 1993, Mr. Harlan was Vice Chairman of KPMG Peat Marwick, where he also
served on KPMG's International Council, Board of Directors, and Management
Committee. In June 1995, President Clinton appointed Mr. Harlan to the District
of Columbia Financial Responsibility and Management Assistance Authority, where
he served as Vice Chairman until June 1998. Mr. Harlan chairs the Finance
Committee and is a member of the Board of Directors of MedStar Health, Inc. He
(i) serves on the Board of Directors of the Mary and Daniel Loughran Foundation,
Inc., (ii) is a member of the Senior Council of the Greater Washington Board of
Trade, (iii) is a Trustee and member of the Executive Committee of the Carnegie
Endowment for International Peace, and (iv) is the Chairman of the Board of the
Counsel for Court Excellence.
Russell C. Lindner is Chairman of the Forge Company, the parent company of
Colonial Parking, Inc. He has continuously served as Chairman of the Forge
Company since January 1, 1994. Mr. Lindner is a former or current board member
of Riggs Bank (Board of Consultants), The National Conference of Christians and
Jews (DC), Jubilee Housing, GW Law Alumni Association, The Salvation Army (DC),
The Federal City Council, and the National Rehabilitation Hospital. Mr. Lindner
recently also served a three-year term as Chairman of the Board of The Landon
School. Mr. Lindner received a Bachelor of Arts from John Hopkins University, a
Juris Doctor from The George Washington University, and a Masters of Science
from the Massachusetts Institute of Technology.
67
<PAGE>
Emanuel J. Friedman is Chairman and Chief Executive Officer of FBR Group. He has
continuously served as Chairman and Chief Executive Officer of FBR Group since
co-founding FBR in 1989. As of March 31, 1999, Mr. Friedman owned 21.6% of the
outstanding common stock of FBR Group. Mr. Friedman is involved in FBR's
investment banking, research, brokerage, and asset management activities. He
also manages private investment funds sponsored by FBR Management. Mr. Friedman
founded the Friedman, Billings, Ramsey Foundation, a charitable foundation, in
1993 and currently serves as one of its directors. Mr. Friedman entered the
securities industry in 1973, when he joined Legg Mason Wood Walker & Co., Inc.,
and from 1985 until 1989, he was Senior Vice President in the institutional
sales group at Johnston, Lemon & Co., Incorporated, a Washington, DC brokerage
firm.
Eric F. Billings is Vice Chairman and Chief Operating Officer of FBR Group. He
has continuously served as Vice Chairman and Chief Operating Officer of FBR
Group since co-founding FBR in 1989. As of March 31, 1999, Mr. Billings owned
17.9% of the outstanding common stock of FBR Group. Mr. Billings is involved in
FBR's investment banking, research, brokerage, and asset management activities.
He also manages private investment funds sponsored by FBR Management and is a
director and executive officer of the FBR Family of Funds. Mr. Billings entered
the securities industry in 1982, when he joined Legg Mason Wood Walker & Co.,
Inc., and from 1984 until 1989, he was Senior Vice President in the
institutional sales group at Johnston, Lemon & Co., Incorporated, a Washington,
DC brokerage firm.
William R. Swanson is a Managing Director of FBR & Co.'s real estate investment
banking group. Mr. Swanson joined FBR Group in February 1994. Before that, Mr.
Swanson served as president of H.G. Smithy Company, Inc., a specialized real
estate firm that provides mortgage banking, finance, investment, advisory, and
property management services to commercial real estate investors. Before working
at H.G. Smithy, Mr. Swanson served as a managing director at LaSalle Partners,
Ltd. While with LaSalle Partners, Mr. Swanson managed and directed the firm's
acquisition and development activities for the southeastern region of the United
States. Mr. Swanson received a Bachelor of Science in accounting from the
University of Illinois at Urbana-Champaign and is a Certified Public Accountant.
Mr. Swanson is also a director of Capital Automotive REIT, one of the companies
in which FBR Asset has invested.
Executive Officers Who Are Not Directors
All of FBR Asset's executive officers are Affiliates of FBR Management. All
officers serve at the discretion of FBR Asset's Board of Directors.
Name Age Position(s) Held with FBR Asset
- ---- --- -------------------------------
Robert S. Smith 40 Senior Vice President & General Counsel
Kurt R. Harrington 46 Chief Financial Officer, Treasurer & Secretary
John M. Blassingame, Jr. 35 Controller
Robert S. Smith is Executive Vice President and General Counsel of FBR Group and
FBR Management. Before joining FBR in January 1997, Mr. Smith was a partner in
the
68
<PAGE>
law firm of McGuire, Woods, Battle & Boothe, LLP, where he had been in practice
since 1986, and represented FBR from its inception in 1989. Mr. Smith formerly
practiced as a lawyer in the United Kingdom from 1982-1985. Mr. Smith received
his Masters in Law from the University of Virginia and his diploma in legal
practice and a Bachelor of Laws from the University of Edinburgh.
Kurt R. Harrington joined FBR Group in March 1997, as Vice President,
Finance/Treasurer and currently serves as Chief Financial Officer, Treasurer and
Secretary of FBR Asset. From September 1996 to March 1997, Mr. Harrington was a
consultant to the venture capital industry. For the five years before then, Mr.
Harrington was Chief Financial Officer of Jupiter National, Inc., a
publicly-traded venture capital company, and in that capacity, served as a
director of a number of companies, including Viasoft, Inc., a publicly-held
software company from January 1994 to October 1995. Mr. Harrington is a
Certified Public Accountant.
John M. Blassingame, Jr., joined FBR Group in February 1998, as a Senior
Accountant. From 1993 to 1998, Mr. Blassingame was a Senior Accountant at
Capital Real Estate Investment where he supervised a REIT portfolio consisting
of approximately 5,000 apartment units, with approximately $50 million in yearly
gross revenues. From 1988 to 1993, Mr. Blassingame was a Senior Public Fund
Accountant at Oxford Realty Services Corp., where he supervised the SEC filings
for Oxford Residential Properties. Mr. Blassingame received a Bachelor of
Business Administration in Accounting from The University of the District of
Columbia.
Time Required of Directors & Executive Officers
FBR Asset requires its directors and executive officers to devote only so much
of their time to FBR Asset's affairs as is necessary or required for the
effective conduct and operation of FBR Asset's business. Because FBR Management
assumes principal responsibility for managing FBR Asset's affairs, FBR Asset
does not expect its officers, in their capacities as officers, to devote
substantial portions of their time to FBR Asset. However, in their capacities as
officers or employees of FBR Management or its Affiliates, they will devote such
portion of their time to FBR Asset's affairs as is required to perform FBR
Management's duties under the Management Agreement.
Executive Compensation & Other Benefits
Directors' Fees
Each independent director receives an annual director's fee of $20,000. After
the Board's first four meetings, each independent director will receive $1,000
for each additional Board meeting that he personally attends. Directors who are
Affiliates of FBR Management will not receive separate compensation from FBR
Asset. FBR Asset will, however, reimburse all directors, including affiliated
directors, for the costs and expenses of attending all Board meetings.
Salaries
FBR Asset has not paid, and does not expect to pay, any cash compensation to
those executive officers who are also executive officers or employees of FBR
Management or
69
<PAGE>
any of its Affiliates. That policy may change, however, if at any time, FBR
Management ceases to conduct FBR Asset's day-to-day operations.
Indemnification
FBR Asset's Articles require FBR Asset to indemnify its current and former
directors, officers, employees and agents to the fullest extent permitted by
Virginia law. If a director, officer, employee or agent becomes a party to a
proceeding because of his or her position in FBR Asset, Virginia law permits the
company to indemnify that person against judgments, penalties, settlements and
reasonable expenses incurred in connection with that proceeding. However, FBR
Asset may not indemnify the person if:
o the person was judged liable to FBR Asset; or
o the person received an improper personal benefit in money, property or
services.
The SEC has expressed the opinion that public policy would prevent FBR Asset
from indemnifying its directors, officers, or any persons controlling FBR Asset
from liability under the Securities Act of 1933.
FBR Asset's Articles also limit, to the fullest extent permitted by Virginia
law, any director's or officer's personal liability for money damages. Under
current Virginia law, this means that a director or officer would owe money
damages only if the person engaged in willful misconduct or a knowing violation
of the criminal law of any federal or state securities law.
Stock Options
FBR Asset has adopted a stock option plan that provides for the grant of both
tax-qualified incentive stock options and non-qualified stock options. FBR
Asset's Board, or a committee appointed by the Board, administers the stock
incentive plan, which is designed to promote the success and enhance the value
of FBR Asset by linking the interests of those who provide services to FBR Asset
with the interests of FBR Asset's shareholders, and by providing those persons
with an incentive for outstanding performance. The stock incentive plan is
further intended to provide flexibility to FBR Asset in its ability to motivate,
attract and retain persons upon whose judgment, interest, and special efforts
FBR Asset's successful operation is largely dependent.
Officers, employees, and directors of FBR Asset and FBR, as well as other
persons who provide services to FBR Asset, are eligible to participate in the
stock incentive plan. The Board or a committee of the Board determines which
officers, employees, and service providers will participate in the plan and sets
the terms of these persons' awards.
The stock incentive plan provides that the total number of shares of common
stock available for issuance under the plan may not exceed 155,000 shares. The
options granted under the stock incentive plan will be exercisable in whole or
in part at any time before December 17, 2007, at an option price of $20 per
share. A participant exercising an option may pay the exercise price in full in
cash, or, if approved by the Board, with previously acquired shares of common
stock or a combination thereof.
FBR Asset's Board may at any time terminate, amend, or modify the stock
incentive plan; provided that no termination, amendment, or modification may
impair the rights of award holders, and no amendment may be made without
shareholders' approval to the extent such approval is required by law or stock
exchange rules.
70
<PAGE>
On May 28, 1999, FBR Asset's Board granted options to acquire an aggregate of
155,000 shares of the company's common stock to persons it deemed to be key
personnel. Information about the grants is set forth in the following table:
<TABLE>
<CAPTION>
Individual Grants
- --------------------------------------------------------------------------
Number
of Shares % of Total Per Potential Realizable Value
Underlying Options Granted Share at Assumed Annual Rates of
Options to Individuals Exercise Expiration Stock Price Appreciation
Name Granted(2) in Fiscal Year Price Date for Option Term(1)
- ------------------- ---------- --------------- -------- ---------- --------------------------
5% 10%
-- ---
<S> <C> <C> <C> <C> <C> <C>
Stephen D. Harlan 15,000 9.68% $20 12/17/2007 $ 17,169 $ 182,082
Russell C. Lindner 15,000 9.68% $20 12/17/2007 $ 17,169 $ 182,082
William R. Swanson 100,000 64.51% $20 12/17/2007 $ 114,460 $1,213,883
Elaine M. Clancy 25,000 16.13% $20 12/17/2007 $ 28,615 $ 303,471
</TABLE>
- --------------
(1) The amounts shown as potential realizable value on options are based on
assumed amortized rates of appreciation in the price of FBR Asset's common
stock of 5% and 10% over the term of the options, as required by the rules
of the SEC. Actual gains, if any, on the stock option exercises are
dependent on future performance of the common stock. There can be no
assurance that the potential realizable values reflected in this table
will be realized.
(2) All options are fully vested.
Related Party Transactions
FBR Asset has made investments in companies with which FBR has a relationship.
See "FBR & FBR Management--Related Party Transactions."
71
<PAGE>
FBR Asset's Capital Stock
The following summary discusses the material terms of FBR Asset's capital stock.
This summary does not purport to be a complete description of FBR Asset's
capital stock, and you should not rely on it as if it were. We have filed
complete copies of FBR Asset's Charter and Bylaws with the SEC as exhibits to
our registration statement and are incorporating the full text of those
documents by reference. You may obtain complete copies of the Charter and Bylaws
by following the document request procedures set forth in the "Additional
Information" section. We encourage you to read each of those documents in its
entirety.
General
FBR Asset's Charter provides that FBR Asset may issue up to 250,000,000 shares
of capital stock, consisting of 200,000,000 shares of common stock, $.01 par
value per share, and 50,000,000 shares of preferred stock, $.01 par value per
share. No preferred stock is issued or outstanding.
Common Stock
All of FBR Asset's outstanding common shares are duly authorized, fully paid,
and nonassessable. Subject to the preferential rights of any other shares or
series of shares of capital stock, FBR Asset's common shareholders are entitled:
(a) to receive dividends if and when authorized and declared by the Board
out of assets legally available therefor and
(b) to share ratably in the assets legally available for distribution to
shareholders in the event of liquidation, dissolution, winding-up,
after payment of, or adequate provision for, all known debts and
liabilities of the company.
The holders of FBR Asset's common stock are entitled to one vote for each share
on all matters submitted to a vote of common shareholders. FBR Asset does not
permit cumulative voting, and accordingly, the holders of a majority of the
company's outstanding shares have the power to elect all directors to be elected
in any given year.
Preferred Stock
FBR Asset may issue preferred stock, in one or more series, as authorized by the
Board. Because the Board has the power to establish the preferences and rights
of any class or series of preferred stock, it may afford the holders of that
stock preferences, powers and rights, voting or otherwise, senior to the rights
of common shareholders. The Board can also authorize the issuance of preferred
stock with terms and conditions that would have the effect of discouraging
takeovers or other transactions that holders of some, or even a majority, of
common shares might believe to be in their best interests or in which holders of
some, or a majority, of common shares might receive a premium for their shares
over the then prevailing market price. FBR Asset has no current plans to issue
any preferred stock.
72
<PAGE>
Restrictions on Ownership and Transfer
For FBR Asset to qualify as a REIT under the federal tax laws, it must meet two
requirements concerning the ownership of its outstanding shares of capital
stock. Specifically, no more than 50% in value of FBR Asset's outstanding
capital stock may be owned, directly or indirectly, by five or fewer individuals
during the last half of a calendar year. For this purpose, individuals include
natural persons, private foundations, some employee benefit plans and trusts,
and some charitable trusts. In addition, FBR Asset must have at least 100
beneficial owners of its shares of stock during at least 335 days of a taxable
year of 12 months or during a proportionate part of a shorter taxable year. See
"Federal Income Tax Consequences of FBR Asset's Status as a REIT--Requirements
for Qualification."
To ensure that FBR Asset meets the stock ownership requirements, subject to the
exemptions described below, FBR Asset's Charter restricts the ownership and
transfer of FBR Asset's outstanding stock. Specifically, the Charter prohibits
any person from owning, or being deemed to own by virtue of the attribution
provisions of the federal tax laws, more than 9.9% of the number of outstanding
shares of common stock or preferred stock of any series. However, under FBR
Asset's Charter, FBR may own up to 20% of the outstanding common stock and the
preferred stock of any series, and certain mutual funds and pension trusts may
own up to 15% of the outstanding common stock and the preferred stock of any
series. FBR Asset's Board of Directors has exempted FBR from the 20% limit
applicable to FBR. The exemption allows FBR to own up to 30% of FBR Asset's
common stock.
In order to prevent FBR Asset from incurring an entity-level tax if and when it
accrues phantom taxable income from REMIC residual interests, FBR Asset's
Charter, subject to the exemptions described below, also contains provisions
designed to prevent a "disqualified organization," as defined in "Federal Income
Tax Consequences of FBR Asset's Status as a REIT--Taxation of FBR Asset," from
owning FBR Asset's shares.
Subject to the exemptions described below, shares of common stock or preferred
stock the purported transfer of which would:
o result in any person owning, directly or indirectly, common stock or
preferred stock in excess of the limits described above;
o result in FBR Asset's capital stock being beneficially owned by fewer
than 100 persons, determined without reference to any rules of
attribution;
o result in FBR Asset being "closely held" within the meaning of the
federal tax laws;
o cause FBR Asset to own, actually or constructively, 10% or more of the
ownership interests in a tenant of its real property, within the
meaning of the federal tax laws; or
o cause any common stock or preferred stock to be owned by a
"disqualified organization," as defined in "Federal Income Tax
Consequences of FBR Asset's Status as a REIT--Taxation of FBR Asset;"
will be transferred automatically to a trust effective on the day before the
purported transfer of the common stock or preferred stock.
73
<PAGE>
The record holder of the shares of common stock or preferred stock that are
transferred to a trust will be required to submit the stock to FBR Asset for
registration in the name of the trust. FBR Asset will designate a trustee of the
trust that is not affiliated with FBR Asset. The beneficiary of the trust will
be one or more charitable organizations that are named by FBR Asset.
Shares in the trust will remain issued and outstanding shares and will be
entitled to the same rights and privileges as all other shares of the same class
or series. The trustee will receive all dividends and distributions on the
shares and will hold those dividends or distributions in trust for the benefit
of the beneficiary. The trustee will vote all shares in the trust. The trustee
will designate a permitted transferee of the shares, provided that the permitted
transferee purchases the shares for valuable consideration and acquires the
shares without the acquisition resulting in a transfer to another trust.
The owner of shares in the trust will be required to repay to the trustee the
amount of any dividends or distributions received by the owner (1) that are
attributable to shares in the trust and (2) the record date of which was on or
after the date that the shares were transferred to the trust. The owner
generally will receive from the trustee the lesser of (a) the price per share
the owner paid for the shares in the trust, or in the case of a gift or devise,
the market price per share on the date of the transfer, or (b) the price per
share received by the trustee from the sale of the shares in the trust. Any
amounts received by the trustee in excess of the amounts to be paid to the owner
will be distributed to the beneficiary of the trust.
Shares in the trust will be deemed to have been offered for sale to FBR Asset,
or its designee, at a price per share equal to the lesser of (a) the price per
share in the transaction that created the trust, or in the case of a gift or
devise, the market price per share on the date of the transfer, or (b) the
market price per share on the date that FBR Asset, or its designee, accepts the
offer. FBR Asset will have the right to accept the offer for a period of ninety
days after the later of (1) the date of the purported transfer that resulted in
the trust or (2) the date FBR Asset determines in good faith that a prohibited
transfer has occurred.
For these purposes, the "market price" on any date means the average of the
"closing price" of FBR Asset's stock for the five previous consecutive trading
days ending on such date. The "closing price" on any date means:
o the last sale price for the stock, as reported on the New York Stock
Exchange, NASDAQ, or other principal national securities exchange on
which the stock is listed; or
o if no sale takes place on the day, the average of the closing bid and
asked prices for the stock, as reported on the New York Stock Exchange,
NASDAQ, or other principal national securities exchange on which the
stock is listed; or
o if the stock is not listed on any exchange, the average of the closing
bid and asked prices as furnished by a professional market maker making
a market in FBR Asset's stock selected by FBR Asset's Board of
Directors; or
o in the event that no trading price is available for the stock, the fair
market value of the stock, as determined in good faith by FBR Asset's
Board of Directors.
74
<PAGE>
Any person who acquires or attempts to acquire common stock or preferred stock
in violation of the restrictions set forth in FBR Asset's Charter, or any person
who owned common stock or preferred stock that was transferred to a trust, will
be required (1) to give immediately written notice to FBR Asset of that event
and (2) to provide to FBR Asset any other information as it may request in order
to determine the effect, if any, of the transfer on FBR Asset's status as a
REIT.
The ownership limits generally will not apply to the acquisition of common stock
or preferred stock by an underwriter that participates in a public offering of
that stock. In addition, FBR Asset's Board of Directors, upon receipt of a
ruling from the IRS or an opinion of counsel that FBR Asset will not jeopardize
its REIT status by granting the exemption and upon such other conditions as the
Board of Directors may direct, may exempt a person from the ownership
limitations or the restrictions on transfer set forth in the Charter. As
discussed above, FBR Asset's Board of Directors has exempted FBR from the 20%
ownership limit applicable to FBR.
The foregoing restrictions will not be removed until:
o the restrictions are no longer required in order to qualify as a REIT,
and the Board of Directors determines that it is no longer in the best
interests of FBR Asset to retain the restrictions; or
o the Board of Directors determines that it is no longer in the best
interests of FBR Asset to attempt to qualify, or to continue to
qualify, as a REIT, and there is an affirmative vote of 80% of the
members of the Board of Directors, or in the absence of an 80% vote,
there is an affirmative vote of at least two-thirds of the holders of
FBR Asset's outstanding shares of common stock.
All certificates representing FBR Asset's common or preferred stock will bear a
legend referring to the restrictions described above.
All persons who own, directly or indirectly, more than 5%, or any lower
percentage as set forth in the federal tax laws, of FBR Asset's outstanding
common stock and preferred stock must, within 30 days after January 1 of each
year, provide to FBR Asset a written statement or affidavit stating the name and
address of the direct or indirect owner, the number of shares owned directly or
indirectly, and a description of how the shares are held. In addition, each
direct or indirect shareholder must provide to FBR Asset any additional
information that FBR Asset requests in order to determine the effect, if any, of
such ownership on FBR Asset's status as a REIT and to ensure compliance with the
restrictions on ownership and transfer set forth in FBR Asset's Charter.
Transfer Agent & Registrar
American Stock Transfer & Trust Company serves as the transfer agent and
registrar for FBR Asset's common stock.
Reports to Shareholders
FBR Asset furnishes its shareholders with annual reports containing audited
financial statements certified by independent public accountants and such other
periodic reports as it determines to furnish or as is required by law.
75
<PAGE>
FBR Asset's Charter and Bylaws
Notice of Shareholder Proposals
FBR Asset's Bylaws govern shareholder proposals. To advance a proposal, a
shareholder must give written notice of the proposal to the company's Secretary.
The Secretary must receive the notice at least 90 days before the annual
meeting. The notice must:
o describe briefly the proposal with supporting reasoning,
o contain the shareholder's name and address,
o state the number of each class of shares the shareholder beneficially
owns, and
o disclose any material interest the shareholder has in the proposed
business.
Charter Amendments
FBR Asset's Charter provides that a majority of outstanding shares of common
stock must approve an amendment to the Charter. However, as discussed in
previous sections, the voting requirements are greater for amending those
provisions addressing the number and composition of the Board of Directors and
the restrictions pertaining to stock ownership and transfer.
Amendments to Bylaws
Except as set forth below, FBR Asset's Bylaws may be amended by majority vote of
FBR Asset's Board or its shareholders. The provisions addressing:
o the number, tenure and qualifications of directors,
o changes in the numbers of directors,
o the removal of directors,
o the quorum requirement for director votes, and
o the majority approval for certain transactions involving FBR Management
require the vote of 80% of the Board of Directors, or two-thirds of the
outstanding shares.
76
<PAGE>
Common Stock Available For Future Sale
At September 16, 1999, FBR Asset had outstanding 7,111,836 shares of common
stock, excluding 1,021,900 shares reserved for issuance upon exercise of
outstanding options. Of the shares outstanding at September 16, 1999, 5,767,750
shares of common stock may be sold in this offering, and if so, will be freely
tradable without restriction or further registration under the federal
securities laws, unless the shares are purchased by "affiliates" of the company
as that term is defined in Rule 144 under the Securities Act of 1933. The
remaining 1,344,086 shares have not been registered with the SEC; accordingly,
they cannot be sold except as permitted by Rule 144. In general, under Rule 144,
a person who beneficially owned shares for at least one year may sell within any
three-month period a number of shares that does not exceed 1% of the shares of
FBR Asset's common stock outstanding shares or the average weekly trading volume
in common stock during the four weeks preceding the date on which notice of the
sale is filed with the SEC. A person who is not an affiliate of FBR Asset at any
time during the three months before a sale and who has beneficially owned shares
for at least two years would be entitled to sell such shares under Rule 144,
without regard to the volume limitation described above.
FBR Asset may issue additional shares at any time without shareholder consent.
No prediction can be made as to the effect, if any, that future sales of shares,
or the availability of shares for future sale, will have on the market price
prevailing from time to time. Sales of substantial amounts of common stock, or
the perception that such sales could occur, may adversely affect prevailing
market prices of the common stock.
77
<PAGE>
Principal Shareholders
The following table sets forth some information as of September 16, 1999,
relating to the beneficial ownership of FBR Asset's common stock by (a) all
persons known by FBR Asset to beneficially own more than 5% of the company's
outstanding shares, (b) each director and named executive officer of FBR Asset,
and (c) all directors and executive officers of FBR Asset as a group:
<TABLE>
<CAPTION>
Principal Shareholders
Name and Address of Number of Shares
Beneficial Owner Beneficially Owned Percent(3)
- ---------------- ------------------ ----------
<S> <C> <C>
Friedman Billings, Ramsey Group, Inc.(1)
1001 Nineteenth Street North
Arlington, VA 22209 2,159,891(2) 26.55%
Boston Partners Asset Management
One Financial Center
43rd Floor
Boston, MA 02111 772,200 9.49%
Franklin Mutual Advisers, LLC
51 John F. Kennedy Parkway
Short Hills, NJ 07078 750,000 9.22%
Oppenheimer Funds
Two World Trade Center
New York, NY 10048 543,500 6.68%
Angelo Gordon
245 Park Avenue, 26th Floor
New York, NY 10167 525,000 6.45%
Loews Corp.
667 Madison Avenue
New York, NY 10021 500,000 6.15%
<CAPTION>
Management Shareholders
<S> <C> <C>
Stephen D. Harlan 15,000(2) (4)
Russell C. Lindner 15,000(2) (4)
Emanuel J. Friedman 0(6) 0%
Eric F. Billings 104,700(5)(6) 1.29%
William R. Swanson 160,000(2) 1.97%
George E. Abraham 1,250 (4)
Robert S. Smith 1,000 (4)
Kurt R. Harrington 750 (4)
John M. Blassingame 0 0%
--------- -----
All directors and officers of FBR Asset 297,700 3.66%
========= =====
</TABLE>
- --------------
(1) Held through wholly-owned subsidiaries.
(2) Includes shares as to which options are held.
(3) Assumes exercise of options to purchase 1,021,900 shares.
(4) Less than 1%.
(5) Includes 92,800 shares held by FBR Weston, LP, as to which Mr. Billings may
be deemed to have shared voting and dispositive power. Mr. Billings
disclaims beneficial ownership of all shares held by Weston in excess of
his pecuniary interest.
(6) Does not include shares identified above for Friedman, Billings, Ramsey
Group, Inc., of which Messrs. Friedman, Billings, and Ramsey are principal
shareholders.
78
<PAGE>
Federal Income Tax Consequences of FBR
Asset's Status as a REIT
This section summarizes the federal income tax issues that you, as a
shareholder, may consider relevant. Hunton & Williams, our counsel, has reviewed
this section and has given us an opinion that this section correctly describes
the relevant law and fairly summarizes the federal income tax issues that may be
material to FBR Asset and its shareholders. Because this section is a summary,
it does not address all of the tax issues that may be important to you. In
addition, this section does not address all of the tax issues that may be
important to shareholders that are subject to special treatment under the
federal income tax laws, such as insurance companies, tax-exempt organizations,
(except as discussed below in "--Taxation of Tax-Exempt Shareholders") financial
institutions or broker-dealers, and non-U.S. individuals and foreign
corporations (except as discussed below in "--Taxation of Non-U.S.
Shareholders").
The statements in this section and the opinion of Hunton & Williams are based on
the current federal income tax laws governing qualification as a REIT. We cannot
assure you that new laws, interpretations thereof, or court decisions, any of
which may take effect retroactively, will not cause any statement in this
section to become inaccurate.
We urge you to consult your own tax advisor regarding the specific tax
consequences to you of investing in the common stock and of FBR Asset's election
to be taxed as a REIT. Specifically, you should consult your own tax advisor
regarding the federal, state, local, foreign, and other tax consequences of your
investment, and regarding potential changes in applicable tax laws.
Taxation of FBR Asset
FBR Asset elected to be taxed as a REIT under the federal income tax laws
commencing with its short taxable year ended December 31, 1997. FBR Asset has
operated in a manner intended to qualify as a REIT since its formation in
November 1997, and FBR Asset intends to continue to so operate. This section
discusses the laws governing the federal income tax treatment of a REIT and its
shareholders, which laws are highly technical and complex.
Hunton & Williams has given us an opinion that FBR Asset qualified to be taxed
as a REIT under the federal income tax laws beginning with its taxable year
ended December 31, 1997, and FBR Asset's organization and current and proposed
method of operation will enable it to continue to qualify as a REIT. You should
be aware that the opinion is based on current law and is not binding upon the
IRS or any court. In addition, Hunton & Williams' opinion is based on some
assumptions and on our factual representations, all of which are described in
the opinion.
FBR Asset's qualification as a REIT depends on its ability to meet on a
continuing basis certain qualification tests set forth in the federal tax laws.
Those qualification tests involve:
o the percentage of income that FBR Asset earns from specified sources;
79
<PAGE>
o the percentage of its assets that falls within certain categories;
o the diversity of its share ownership; and
o the percentage of its earnings that it distributes.
We describe the REIT qualification tests in more detail below. Hunton & Williams
will not review FBR Asset's compliance with those tests on a continuing basis.
Accordingly, neither we nor Hunton & Williams can assure you that FBR Asset will
satisfy those tests in the future. For a discussion of the tax treatment of FBR
Asset and its shareholders if FBR Asset fails to qualify as a REIT, see
"--Failure to Qualify."
If FBR Asset qualifies as a REIT, it generally will not be subject to federal
income tax on the taxable income that it distributes to its shareholders. The
benefit of that tax treatment is that it avoids the "double taxation," or
taxation at both the corporate and shareholder levels, that generally results
from owning stock in a corporation. However, FBR Asset will be subject to
federal tax in the following circumstances:
o First, FBR Asset will pay federal income tax on taxable income,
including net capital gain, that it does not distribute to its
shareholders during, or within a specified time period after, the
calendar year in which the income is earned.
o Second, FBR Asset may be subject to the "alternative minimum tax" on
any items of tax preference that it does not distribute or allocate to
its shareholders.
o Third, FBR Asset will pay income tax at the highest corporate rate on
(1) net income from the sale or other disposition of property acquired
through foreclosure that it holds primarily for sale to customers in
the ordinary course of business and (2) other non-qualifying income
from property acquired through foreclosure.
o Fourth, FBR Asset will pay a 100% tax on net income from sales or other
dispositions of property, other than foreclosure property, that it
holds primarily for sale to customers in the ordinary course of
business.
o Fifth, if FBR Asset fails to satisfy the 75% gross income test or the
95% gross income test, as described below under "--Requirements for
Qualification--Income Tests," and nonetheless continues to qualify as a
REIT because it meets certain other requirements, it will pay a 100%
tax on (1) the gross income attributable to the greater of the amounts
by which it fails the 75% and 95% gross income tests, multiplied by (2)
a fraction intended to reflect its profitability.
o Sixth, if FBR Asset fails to distribute during a calendar year at least
the sum of (1) 85% of its REIT ordinary income for that year, (2) 95%
of its REIT capital gain net income for that year, and (3) any
undistributed taxable income from prior periods, it will pay a 4%
excise tax on the excess of the required distribution over the amount
it actually distributed.
o Seventh, FBR Asset may elect to retain and pay income tax on its net
long-term capital gain.
o Eighth, if FBR Asset acquires any asset from a C corporation, or a
corporation generally subject to full corporate-level tax, in a merger
or other transaction in which it acquires a basis in the asset that is
determined by reference to the C corporation's basis in the asset, it
will pay tax at the highest regular corporate rate
80
<PAGE>
applicable if it recognizes gain on the sale or disposition of such
asset during the 10-year period after it acquires the asset. The amount
of gain on which it will pay tax is the lesser of (1) the amount of
gain that it recognizes at the time of the sale or disposition and (2)
the amount of gain that it would have recognized if it had sold the
asset at the time it acquired the asset. The rule described in this
paragraph will apply assuming that FBR Asset makes an election under
IRS Notice 88-19 upon its acquisition of an asset from a C corporation.
o Ninth, FBR Asset will pay tax at the highest corporate rate on the
portion of any excess inclusion, or phantom taxable income, that it
derives from REMIC residual interests equal to the percentage of its
stock held by "disqualified organizations." A "disqualified
organization" includes the United States, any state or political
subdivision thereof, any foreign government, any international
organization, any agency or instrumentality of any of the foregoing,
any other tax-exempt organization, other than a farmer's cooperative
described in section 521 of the Code, that is exempt both from income
taxation and from taxation under the unrelated business taxable income
provisions of the Code, or any rural electrical or telephone
cooperative. For this reason, FBR Asset's Charter prohibits
disqualified organizations from owning stock of FBR Asset.
o Tenth, FBR Asset may be subject to tax at the highest corporate rate on
the portion of its allocable share of any Excess Inclusion that a REIT
in which it owns an equity interest derives from REMIC residual
interests, equal to the percentage of its stock that is held by
disqualified organizations. For this reason, FBR Asset's Charter
prohibits disqualified organizations from owning the stock of FBR
Asset.
Requirements for Qualification
A REIT is a corporation, trust, or association that meets the following
requirements:
1. it is managed by one or more trustees or directors;
2. its beneficial ownership is evidenced by transferable shares, or by
transferable certificates of beneficial interest;
3. it would be taxable as a domestic corporation, but for the REIT
provisions of the federal income tax laws;
4. it is neither a financial institution nor an insurance company subject
to certain provisions of the federal income tax laws;
5. at least 100 persons are beneficial owners of its shares or ownership
certificates;
6. not more than 50% in value of its outstanding shares or ownership
certificates is owned, directly or indirectly, by five or fewer
individuals, including specified entities, during the last half of any
taxable year;
7. it elects to be a REIT, or has made a REIT election for a previous
taxable year, and satisfies all relevant filing and other
administrative requirements established by the IRS that must be met to
elect and maintain REIT status;
8. it uses a calendar year for federal income tax purposes and complies
with the record keeping requirements of the federal income tax laws;
and
81
<PAGE>
9. it meets other qualification tests, described below, regarding the
nature of its income and assets.
FBR Asset must meet requirements 1 through 4 during its entire taxable year and
must meet requirement 5 during at least 335 days of a taxable year of 12 months,
or during a proportionate part of a taxable year of less than 12 months.
Requirements 5 and 6 apply to FBR Asset beginning with its 1998 taxable year. If
FBR Asset complies with all the requirements for ascertaining the ownership of
its outstanding shares in a taxable year and has no reason to know that it
violated requirement 6 above, it will be deemed to have satisfied that
requirement for that taxable year. For purposes of determining share ownership
under requirement 6, an "individual" generally includes a supplemental
unemployment compensation benefits plan, a private foundation, or a portion of a
trust permanently set aside or used exclusively for charitable purposes. An
"individual," however, generally does not include a trust that is a qualified
employee pension or profit sharing trust under the federal income tax laws, and
beneficiaries of such a trust will be treated as holding shares of FBR Asset in
proportion to their actuarial interests in the trust for purposes of requirement
6.
FBR Asset has issued sufficient common stock with sufficient diversity of
ownership to satisfy requirements 5 and 6 set forth above. In addition, FBR
Asset's Charter restricts the ownership and transfer of the common stock so that
FBR Asset should continue to satisfy requirements 5 and 6. The provisions of the
Charter restricting the ownership and transfer of the common stock are described
in "FBR Asset's Capital Stock--Restrictions on Ownership and Transfer."
FBR Asset currently does not have corporate subsidiaries, but may have corporate
subsidiaries in the future. A corporation that is a "qualified REIT subsidiary"
is not treated as a corporation separate from its parent REIT. All assets,
liabilities, and items of income, deduction, and credit of a qualified REIT
subsidiary are treated as assets, liabilities, and items of income, deduction,
and credit of the REIT. A qualified REIT subsidiary is a corporation, all of the
capital stock of which is owned by the REIT.
In the case of a REIT that is a partner in a partnership, the REIT is treated as
owning its proportionate share of the assets of the partnership and as earning
its allocable share of the gross income of the partnership for purposes of the
applicable REIT qualification tests. FBR Asset is not currently a partner in any
partnership, but it may become a partner in the future.
Income Tests
FBR Asset must satisfy two gross income tests annually to maintain its
qualification as a REIT. First, at least 75% of its gross income for each
taxable year must consist of defined types of income that it derives, directly
or indirectly, from investments relating to real property or mortgages on real
property or temporary investment income. Qualifying income for purposes of that
75% gross income test includes:
o "rents from real property;"
o interest on debt secured by mortgages on real property or on interests
in real property; and
o dividends or other distributions on and gain from the sale of shares in
other REITs.
82
<PAGE>
Second, at least 95% of its gross income for each taxable year must consist of
income that is qualifying income for purposes of the 75% gross income test
described above, dividends, other types of interest, gain from the sale or
disposition of stock or securities, or any combination of the foregoing. Gross
income from FBR Asset's sale of property that it holds primarily for sale to
customers in the ordinary course of business is excluded from both income tests.
The following paragraphs discuss the specific application of the income tests to
FBR Asset.
Interest on debt secured by mortgages on real property or on interests in real
property generally is qualifying income for purposes of the 75% gross income
test. However, if the highest principal amount of a loan outstanding during a
taxable year exceeds the fair market value of the real property securing the
loan as of the date FBR Asset acquired the loan, a portion of the interest
income from such loan will not be qualifying income for purposes of the 75%
gross income test, but will be qualifying income for purposes of the 95% gross
income test. The portion of the interest income that will not be qualifying
income for purposes of the 75% gross income test will be equal to the portion of
the principal amount of the loan that is not secured by real property.
Interest and Rents
- ------------------
The term "interest," as defined for purposes of both gross income tests,
generally excludes any amount that is based in whole or in part on the income or
profits of any person, but includes the following:
o an amount that is based on a fixed percentage or percentages of
receipts or sales; and
o an amount that is based on the income or profits of a debtor, as long
as the debtor derives substantially all of its income from the related
property from leasing such property, and only to the extent that the
amounts received by the debtor would be qualifying income if received
directly by a REIT.
If a loan contains a provision that entitles a REIT to a percentage of the
borrower's gain upon the sale of the secured property or a percentage of the
appreciation in the property's value as of a specific date, income attributable
to that loan provision will be treated as gain from the sale of the secured
property, which generally is qualifying income for purposes of both gross income
tests.
We believe that the interest and original issue discount income that FBR Asset
receives from mortgage-backed securities and other mortgage-related assets
generally is qualifying income for purposes of both gross income tests. However,
the loan amount of a mortgage loan owned by FBR Asset may exceed the value of
the real property securing the loan. In that case, a portion of the income from
the loan will be qualifying income for purposes of the 95% gross income test,
but not the 75% gross income test. It also is possible that, in some instances,
the interest income from a mortgage loan may be based in part on the borrower's
profits or net income. That scenario generally will cause the income from the
loan to be non-qualifying income for purposes of both gross income tests.
We believe that FBR Asset's income from stock in other REITs is qualifying
income for purposes of both gross income tests. However, if a REIT in which FBR
Asset owns stock fails to qualify as a REIT in any year, FBR Asset's income from
such REIT will be
83
<PAGE>
qualifying income for purposes of the 95% gross income test, but not the 75%
gross income test. We believe that FBR Asset's income from stock in real
estate-related companies that are C corporations is qualifying income for
purposes of the 95% gross income test, but not the 75% gross income test. In
addition to stock, FBR Asset may own debt securities issued by other REITs or C
corporations. Interest income from such debt securities will be qualifying
income for purposes of the 95% gross income test. Such interest income will not
be qualifying income for purposes of the 75% gross income test unless such debt
securities are secured by mortgages on real property or on interests in real
property.
FBR Asset currently does not own any real property, but it may acquire real
property or an interest therein in the future. To the extent that FBR Asset
acquires real property or an interest therein, any rent that FBR Asset receives
from the tenants of such real property will qualify as "rents from real
property," which is qualifying income for purposes of both gross income tests,
only if the following conditions are met:
o First, the rent must not be based, in whole or in part, on the income
or profits of any person, but may be based on a fixed percentage or
percentages of receipts or sales.
o Second, neither FBR Asset nor a direct or indirect owner of 10% or more
of its stock may own, actually or constructively, 10% or more of a
tenant from whom it receives rent.
o Third, all of the rent received under a lease of real property will not
qualify as rents from real property unless the rent attributable to the
personal property leased in connection with such lease is no more than
15% of the total rent received under the lease.
o Finally, FBR Asset generally must not operate or manage its real
property or furnish or render services to its tenants, other than
through an independent contractor who is adequately compensated and
from whom FBR Asset does not derive revenue. However, FBR Asset may
provide services directly to its tenants, if the services are usually
or customarily rendered in connection with the rental of space for
occupancy only and are not considered to be provided for the tenants'
convenience. In addition, FBR Asset may provide a minimal amount of
services that are not customarily rendered to the tenants of a
property, other than through an independent contractor, as long as its
income from the services does not exceed 1% of its income from the
related property. The U.S. Congress has passed legislation that would
allow FBR Asset to own up to 100% of a "taxable REIT subsidiary," which
could provide customary and noncustomary services to FBR Asset's
tenants. See "--Asset Tests."
We have represented that we will manage FBR Asset's mortgage assets so that
substantially all of the income from those assets will be qualifying income for
purposes of both gross income tests. Furthermore, we have represented that we
will manage any real property that FBR Asset acquires so that the rent it
receives from such property qualifies as rents from real property. In summary,
we believe that FBR Asset will be able to satisfy both gross income tests on a
continuing basis. However, FBR Asset may receive income not described above that
is not qualifying income for purposes of the gross income tests. We will monitor
the amount of non-qualifying income that its assets
84
<PAGE>
produce and we will manage its portfolio to comply at all times with the gross
income tests.
Hedging Transactions
- --------------------
From time to time, FBR Asset may enter into hedging transactions with respect to
one or more of its assets or liabilities. Its hedging activities may include
entering into interest rate swaps, caps, and floors, or options to purchase
those items, and futures and forward contracts. To the extent that FBR Asset
enters into an interest rate swap or cap contract, option, futures contract,
forward rate agreement, or any similar financial instrument to hedge its
indebtedness incurred to acquire or carry assets that are qualifying real
estate-related assets under the federal income tax laws, any periodic income or
gain from the disposition of such contract should be qualifying income for
purposes of the 95% gross income test, but not the 75% gross income test. To the
extent that FBR Asset hedges with other types of financial instruments, or in
other situations, it is not entirely clear how the income from those
transactions will be treated for purposes of the gross income tests. We intend
to structure any hedging transactions in a manner that does not jeopardize FBR
Asset's status as a REIT.
Failure to Satisfy Income Tests
- -------------------------------
If FBR Asset fails to satisfy one or both of the gross income tests for any
taxable year, it nevertheless may qualify as a REIT for such year if it
qualifies for relief under federal income tax laws. Those relief provisions
generally will be available if:
o FBR Asset's failure to meet such tests is due to reasonable cause and
not due to willful neglect;
o we attach a schedule of the sources of its income to its tax return,
and
o any incorrect information on the schedule was not due to fraud with
intent to evade tax.
We cannot predict, however, whether in all circumstances FBR Asset would qualify
for the relief provisions. In addition, as discussed above in "--Taxation of FBR
Asset," even if the relief provisions apply, FBR Asset would incur a 100% tax on
the gross income attributable to the greater of the amounts by which it fails
the 75% and 95% gross income tests, multiplied by a fraction intended to reflect
its profitability.
Foreclosure Property Rules
- --------------------------
REITs generally will incur tax at the maximum corporate rate on any net income
from any real property, or an interest in real property, acquired through
foreclosure and any personal property incident to such real property that meets
the following requirements:
o a REIT acquires the property when the REIT bids in such property at
foreclosure, or otherwise reduces such property to ownership or
possession by agreement or process of law, after a default or imminent
default on a lease of such property or on a debt owed to the REIT that
such property secured;
o the REIT acquired the related loan when default was not imminent or
anticipated; and
o the REIT elects to treat the property as foreclosure property.
85
<PAGE>
However, that tax does not apply to income that would be qualifying income for
purposes of the 75% gross income test.
We do not anticipate that FBR Asset will receive any income from property
acquired through foreclosure that is not qualifying income for purposes of the
75% gross income test, but if it does receive any such income, we will make an
election to treat the related property as foreclosure property.
If property is not eligible for the election to be treated as foreclosure
property because the REIT acquired the related loan when default was imminent or
anticipated, income the REIT receives with respect to that property may not be
qualifying income for purposes of the 75% or 95% gross income test. We
anticipate that any income FBR Asset receives with respect to property that is
not eligible for a foreclosure property election will be qualifying income for
purposes of both gross income tests.
Prohibited Transaction Rules
- ----------------------------
A REIT will incur a 100% tax on the net income derived from any sale or other
disposition of property, other than foreclosure property, that the REIT holds
primarily for sale to customers in the ordinary course of a trade or business.
We believe that none of FBR Asset's assets is held for sale to customers and
that a sale of any such asset would not be in the ordinary course of its
business. Whether a REIT holds an asset "primarily for sale to customers in the
ordinary course of a trade or business" depends, however, on the facts and
circumstances in effect from time to time, including those related to a
particular asset. Nevertheless, we will attempt to comply with the terms of
safe-harbor provisions in the federal income tax laws prescribing when an asset
sale will not be characterized as a sale to customers in the ordinary course of
business. We cannot provide assurance, however, that we can comply with such
safe-harbor provisions or that FBR Asset will avoid owning property that may be
characterized as property that it holds primarily for sale to customers in the
ordinary course of a trade or business.
Asset Tests
To maintain its qualification as a REIT, FBR Asset also must satisfy two asset
tests at the close of each quarter of each taxable year. First, at least 75% of
the value of its total assets must consist of:
o cash or cash items, including certain receivables;
o government securities;
o investments in stock or debt instruments during the one-year period
following FBR Asset's receipt of new capital that it raises through
equity offerings or offerings of debt with at least a five-year term;
o stock in other REITs;
o interests in real property, including leaseholds and options to acquire
real property and leaseholds;
o interests in mortgages on real property; or
o regular or residual interests in a real estate mortgage investment
conduit, or "REMIC." However, if less than 95% of the assets of a REMIC
consists of assets that are qualifying real estate-related assets under
the federal income tax laws,
86
<PAGE>
determined as if FBR Asset held such assets, FBR Asset will be treated
as holding directly its proportionate share of the assets of such
REMIC.
To the extent that the fair market value of the real property securing a loan
equals or exceeds the outstanding principal balance of the loan, the loan will
be a qualifying asset for purposes of the 75% asset test described above.
However, if the outstanding principal balance of a loan exceeds the fair market
value of the real property securing the loan, the portion of such loan in excess
of the value of the associated real property likely will not be a qualifying
asset for purposes of the 75% asset test described above.
The second asset test has two components:
o First, of FBR Asset's investments not included in the 75% asset class,
the value of its interest in any one issuer's securities may not exceed
5% of the value of its total assets (the "5% asset test").
o Second, FBR Asset may not own more than 10% of any one issuer's
outstanding voting securities.
For purposes of both components of the second asset test, "securities" does not
include FBR Asset's stock in other REITs or in any qualified REIT subsidiary or
its interest in any partnership.
We also believe that FBR Asset's mortgage loans and mortgage-backed securities
are qualifying assets for purposes of the 75% asset test. However, if the
outstanding principal balance of a mortgage loan exceeds the fair market value
of the real property securing the loan as of the date that the loan is acquired,
a portion of such loan will not be a qualifying real estate-related asset under
the federal income tax laws. The non-qualifying portion of that mortgage loan
will be equal to the portion of the loan amount that exceeds the value of the
associated real property.
We believe that FBR Asset's stock in other REITs is a qualifying asset for
purposes of the 75% asset test. However, if a REIT in which it owns stock fails
to qualify as a REIT in any year, the stock in such REIT will not be a
qualifying asset for purposes of the 75% asset test. Instead, FBR Asset would be
subject to both components of the second asset test described above with respect
to its investment in such disqualified REIT. We believe that FBR Asset satisfies
both components of the second asset test with respect to its stock in real
estate-related companies that are C corporations. To the extent that FBR Asset
owns debt securities issued by other REITs or C corporations which debt
securities are not secured by mortgages on real property, such securities will
not be qualifying assets for purposes of the 75% asset test. Instead, FBR Asset
would be subject to both components of the second asset test with respect to
such debt securities. We will monitor the status of FBR Asset's assets for
purposes of the various asset tests and we will manage its portfolio to comply
at all times with such tests.
The U.S. Congress recently passed legislation (the "Tax Bill") that would allow
FBR Asset to own up to 100% of the stock of a "taxable REIT subsidiary" ("TRS"),
which could provide services to FBR Asset's tenants and to others and conduct
other activities without disqualifying the rent that FBR Asset receives from its
tenants. An election would be required for a subsidiary to be treated as a TRS.
The Tax Bill would limit the deductibility of interest paid or accrued by a TRS
to FBR Asset to assure that the TRS is subject to an appropriate level of
corporate taxation. Further, the Tax Bill would impose
87
<PAGE>
a 100% excise tax on amounts paid by a TRS to FBR Asset that are determined to
be excessive or more than arm's length. The Tax Bill also would prevent FBR
Asset from owning more than 10% of the voting power or value of the stock of a
taxable subsidiary for which a TRS election is not made. Current law only
prevents FBR Asset from owning more than 10% of the voting stock of a taxable
subsidiary. Overall, no more than 25% of FBR Asset's assets may consist of
securities of TRSs and other taxable subsidiaries under the Tax Bill.
If enacted, the TRS provisions of the Tax Bill would apply for taxable years
beginning after December 31, 2000. However, a taxable subsidiary in existence on
July 12, 1999 would be grandfathered unless and until (i) such corporation
engages in a new line of business or acquires a substantial new asset, other
than in certain tax-free transactions or pursuant to a binding contract in
effect on July 12, 1999, or (ii) FBR Asset acquires, directly or indirectly,
additional stock in the taxable subsidiary, other than in certain tax-free
transactions or pursuant to a binding contract in effect on July 12, 1999.
Existing taxable subsidiaries could be converted into TRSs on a tax-free basis
prior to January 1, 2004. FBR Asset would not need the grandfather treatment for
its existing equity investments in real estate-related C corporations, because
FBR Asset currently does not own more than 10% of the voting power or value of
the stock of any such corporation. There can be no assurance that the Tax Bill
will be enacted into law.
If FBR Asset should fail to satisfy the asset tests at the end of a calendar
quarter, it would not lose its REIT status if (1) it satisfied the asset tests
at the close of the preceding calendar quarter and (2) the discrepancy between
the value of its assets and the asset test requirements arose from changes in
the market values of its assets and was not wholly or partly caused by the
acquisition of one or more non-qualifying assets. If FBR Asset did not satisfy
the condition described in clause (2) of the preceding sentence, it still could
avoid disqualification as a REIT by eliminating any discrepancy within 30 days
after the close of the calendar quarter in which the discrepancy arose.
Distribution Requirements
Each taxable year, FBR Asset must distribute dividends, other than capital gain
dividends and deemed distributions of retained capital gain, to its shareholders
in an aggregate amount at least equal to:
o the sum of (1) 95% of its REIT taxable income, computed without regard
to the dividends paid deduction and its net capital gain or loss, and
(2) 95% of its after-tax net income, if any, from foreclosure property;
minus
o the sum of certain items of non-cash income.
FBR Asset must pay such distributions in the taxable year to which they relate,
or in the following taxable year if it declares the distribution before it
timely files its federal income tax return for such year and pays the
distribution on or before the first regular dividend payment date after such
declaration. Under the Tax Bill, the 95% distribution requirement discussed
above would be reduced to 90%. If enacted, that provision of the Tax Bill would
apply for taxable years beginning after December 31, 2000. There can be no
assurance that the Tax Bill will be enacted into law.
FBR Asset will pay federal income tax on taxable income, which includes net
capital gain, that it does not distribute to shareholders. Furthermore, if it
fails to distribute
88
<PAGE>
during a calendar year, or by the end of January following such calendar year,
in the case of distributions with declaration and record dates falling in the
last three months of the calendar year, at least the sum of:
o 85% of its REIT ordinary income for such year;
o 95% of its REIT capital gain income for such year; and
o any undistributed taxable income from prior periods;
it will incur a 4% nondeductible excise tax on the excess of such required
distribution over the amounts it actually distributed. FBR Asset may elect to
retain and pay income tax on the net long-term capital gain it receives in a
taxable year. See "--Taxation of Taxable U.S. Shareholders." If it so elects, it
will be treated as having distributed any such retained amount for purposes of
the 4% excise tax described above. FBR Asset has made, and intends to continue
to make, timely distributions sufficient to satisfy the annual distribution
requirements.
It is possible that, from time to time, FBR Asset may experience timing
differences between (1) the actual receipt of income and actual payment of
deductible expenses and (2) the inclusion of that income and deduction of such
expenses in arriving at its REIT taxable income. Possible examples include:
o Because FBR Asset may deduct capital losses only to the extent of its
capital gains, it may have taxable income that exceeds its economic
income.
o FBR Asset will recognize taxable income in advance of the related cash
flow if any of its subordinated mortgage-backed securities or mortgage
loans are deemed to have original issue discount. FBR Asset generally
must accrue original issue discount based on a constant yield method
that takes into account projected prepayments but that defers credit
losses until they are actually incurred.
o FBR Asset may be required to recognize the amount of any payment
projected to be made pursuant to a provision in a mortgage loan that
entitles FBR Asset to share in the gain from the sale of or the
appreciation in the property over the term of the related loan using
the constant yield method, even though FBR Asset may not receive the
related cash until the maturity of the loan.
o FBR Asset may recognize taxable market discount income when it receives
the proceeds from the disposition of, or principal payments on, loans
that have a stated redemption price at maturity that is greater than
FBR Asset's tax basis in those loans, although such proceeds often will
be used to make non-deductible principal payments on related
borrowings.
o FBR Asset may recognize taxable income without receiving a
corresponding cash distribution if it forecloses on or makes a
significant modification to a loan, to the extent that the fair market
value of the underlying property or the principal amount of the
modified loan, as applicable, exceeds FBR Asset's basis in the original
loan.
o Although several types of non-cash income are excluded in determining
the annual distribution requirement, FBR Asset will incur corporate
income tax and the 4% excise tax with respect to those non-cash income
items if it does not distribute those items on a current basis.
89
<PAGE>
o FBR Asset may recognize phantom taxable income from any residual
interests in REMICs or retained ownership interests in mortgage loans
subject to collateralized mortgage obligation debt that it owns.
As a result of the foregoing, FBR Asset may have less cash than is necessary to
distribute all of its taxable income and thereby avoid corporate income tax and
the excise tax imposed on undistributed income. In such a situation, it may need
to borrow funds or issue preferred stock or additional common stock.
Under some circumstances, FBR Asset may be able to correct a failure to meet the
distribution requirement for a year by paying deficiency dividends to its
shareholders in a later year. FBR Asset may include such deficiency dividends in
its deduction for dividends paid for the earlier year. Although FBR Asset may be
able to avoid income tax on amounts distributed as deficiency dividends, it will
be required to pay interest to the Internal Revenue Service based upon the
amount of any deduction it takes for deficiency dividends.
Recordkeeping Requirements
FBR Asset must maintain certain records in order to qualify as a REIT. In
addition, to avoid a monetary penalty, it must request on an annual basis
information from its shareholders designed to disclose the actual ownership of
its outstanding stock. FBR Asset has complied, and FBR Asset intends to continue
to comply, with such requirements.
Failure to Qualify
If FBR Asset failed to qualify as a REIT in any taxable year, and no relief
provision applied, it would be subject to federal income tax and any applicable
alternative minimum tax on its taxable income at regular corporate rates. In
calculating its taxable income in a year in which it failed to qualify as a
REIT, FBR Asset would not be able to deduct amounts paid out to shareholders. In
fact, FBR Asset would not be required to distribute any amounts to shareholders
in such year. In such event, to the extent of its current and accumulated
earnings and profits, all distributions to shareholders would be taxable as
ordinary income. Subject to certain limitations of the federal income tax laws,
corporate shareholders might be eligible for the dividends received deduction.
Unless FBR Asset qualified for relief under specific statutory provisions, it
also would be disqualified from taxation as a REIT for the four taxable years
following the year during which it ceased to qualify as a REIT. We cannot
predict whether in all circumstances FBR Asset would qualify for such statutory
relief.
Taxation of Taxable U.S. Shareholders
As long as FBR Asset qualifies as a REIT, a taxable "U.S. shareholder" must take
into account distributions that are made out of FBR Asset's current or
accumulated earnings and profits and that FBR Asset does not designate as
capital gain dividends or retained long-term capital gain as ordinary income. A
U.S. shareholder will not qualify for the dividends received deduction generally
available to corporations. As used herein, the term "U.S. shareholder" means a
holder of common stock that for U.S. federal income tax purposes is:
90
<PAGE>
o a citizen or resident of the United States;
o a corporation, partnership, or other entity created or organized in or
under the laws of the United States or of an political subdivision
thereof;
o an estate whose income from sources without the United States is
includible in gross income for U.S. federal income tax purposes
regardless of its connection with the conduct of a trade or business
within the United States; or
o any trust with respect to which (1) a U.S. court is able to exercise
primary supervision over the administration of such trust and (2) one
or more U.S. persons have the authority to control all substantial
decisions of the trust.
A U.S. shareholder generally will recognize distributions that FBR Asset
designates as capital gain dividends as long-term capital gain without regard to
the period for which the U.S. shareholder has held its common stock. FBR Asset
generally will designate its capital gain dividends as either 20% or 25% rate
distributions. Under the Tax Bill, the 25% rate described in the preceding
sentence would be reduced to 23%. If enacted, that provision of the Tax Bill
would apply for taxable years beginning after December 31, 1998. There can be no
assurance that the Tax Bill will be enacted into law. A corporate U.S.
shareholder, however, may be required to treat up to 20% of certain capital gain
dividends as ordinary income.
FBR Asset may elect to retain and pay income tax on the net long-term capital
gain that it receives in a taxable year. In that case, a U.S. shareholder would
be taxed on its proportionate share of FBR Asset's undistributed long-term
capital gain. The U.S. shareholder would receive a credit or refund for its
proportionate share of the tax FBR Asset paid. The U.S. shareholder would
increase the basis in its stock by the amount of its proportionate share of FBR
Asset's undistributed long-term capital gain, minus its share of the tax FBR
Asset paid.
If a distribution exceeds FBR Asset's current and accumulated earnings and
profits but does not exceed the adjusted basis of a U.S. shareholder's common
stock, the U.S. shareholder will not incur tax on the distribution. Instead,
such distribution will reduce the adjusted basis of the common stock. A U.S.
shareholder will recognize a distribution that exceeds both FBR Asset's current
and accumulated earnings and profits and the U.S. shareholder's adjusted basis
in its common stock as long-term capital gain if the common stock has been held
for more than one year, or short-term capital gain if the common stock has been
held for one year or less, assuming the common stock is a capital asset in the
hands of the U.S. shareholder. In addition, if FBR Asset declares a distribution
in October, November, or December of any year that is payable to a U.S.
shareholder of record on a specified date in any such month, such distribution
shall be treated as both paid by FBR Asset and received by the U.S. shareholder
on December 31 of such year, provided that FBR Asset actually pays the
distribution during January of the following calendar year. We will notify U.S.
shareholders after the close of FBR Asset's taxable year as to the portions of
the distributions attributable to that year that constitute ordinary income or
capital gain dividends.
FBR Asset's investments may cause it to recognize taxable income in excess of
its economic income and to experience an offsetting excess of economic income
over its taxable income in later years. As a result, U.S. shareholders may from
time to time be
91
<PAGE>
required to pay federal income tax on distributions that economically represent
a return of capital, rather than a dividend. Such distributions would be offset
in later years by distributions representing economic income that would be
treated as returns of capital for federal income tax purposes. Accordingly, if
FBR Asset receives phantom income, its U.S. shareholders may incur federal
income tax with respect to such income before they realize such income in an
economic sense. Taking into account the time value of money, such an
acceleration of federal income tax liabilities would cause shareholders to
receive an after-tax rate of return on an investment in the common stock that
would be less than the after-tax rate of return on an investment with an
identical before-tax rate of return that did not generate phantom income. We
will consider the potential effects of phantom income on FBR Asset's taxable
U.S. shareholders in managing FBR Asset's investments.
Although FBR Asset does not currently own REMIC residual interests or retained
ownership interests in mortgage loans subject to collateralized mortgage
obligation debt, FBR Asset could acquire assets of that type in the future. If
FBR Asset does so, its U.S. Shareholders may suffer the following adverse tax
consequences:
o Those types of assets may produce significant amounts of phantom
income; and
o Those types of assets may cause a portion of the dividends received by
U.S. shareholders to be treated as excess inclusion, a type of income
that generally cannot be offset by tax losses and is not subject to any
exemptions from federal income tax.
Taxation of U.S. Shareholders on the Disposition of the Common Stock
In general, a U.S. shareholder who is not a dealer in securities must treat any
gain or loss realized upon a taxable disposition of the common stock as
long-term capital gain or loss if the U.S. shareholder has held the common stock
for more than one year and otherwise as short-term capital gain or loss.
However, a U.S. shareholder generally must treat any loss upon a sale or
exchange of common stock held by such shareholder for six months or less as a
long-term capital loss to the extent of capital gain dividends and other
distributions from FBR Asset that such U.S. shareholder treats as long-term
capital gain. All or a portion of any loss a U.S. shareholder realizes upon a
taxable disposition of the common stock may be disallowed if the U.S.
shareholder purchases other shares of common stock within 30 days before or
after the disposition.
Capital Gains and Losses
A taxpayer generally must hold a capital asset for more than one year for gain
or loss derived from its sale or exchange to be treated as long-term capital
gain or loss. The highest marginal individual income tax rate is 39.6%. The
maximum tax rate on long-term capital gain applicable to non-corporate taxpayers
is 20% for sales and exchanges of assets held for more than one year. The
maximum tax rate on long-term capital gain from the sale or exchange of
depreciable real property that is treated as "section 1250 property" under the
federal income tax laws is 25% to the extent that such gain would have been
treated as ordinary income if the property were personal property that is
treated as "section 1245 property" under the federal income tax laws. With
respect to distributions that FBR Asset designates as capital gain dividends and
any retained capital
92
<PAGE>
gain that it is deemed to distribute, FBR Asset generally may designate whether
such a distribution is taxable to its non-corporate shareholders at a 20% or 25%
rate. Thus, the tax rate differential between capital gain and ordinary income
for non-corporate taxpayers may be significant. In addition, the
characterization of income as capital gain or ordinary income may affect the
deductibility of capital losses. A non-corporate taxpayer may deduct capital
losses not offset by capital gains against its ordinary income only up to a
maximum annual amount of $3,000. A non-corporate taxpayer may carry forward
unused capital losses indefinitely. A corporate taxpayer must pay tax on its net
capital gain at ordinary corporate rates. A corporate taxpayer can deduct
capital losses only to the extent of capital gains, with unused losses being
carried back three years and forward five years. Under the Tax Bill, the maximum
tax rate on long-term capital gain from the sale or exchange of section 1250
property would be reduced from 25% to 23%. If enacted, that provision of the Tax
Bill would apply for taxable years beginning after December 31, 1998. There can
be no assurance that the Tax Bill will be enacted into law.
Information Reporting Requirements and Backup Withholding
FBR Asset will report to its shareholders and to the Internal Revenue Service
the amount of distributions it pays during each calendar year, and the amount of
tax it withholds, if any. Under the backup withholding rules, a shareholder may
be subject to backup withholding at the rate of 31% with respect to
distributions unless such holder either:
o is a corporation or comes within another exempt category and, when
required, demonstrates this fact; or
o provides a taxpayer identification number, certifies as to no loss of
exemption from backup withholding, and otherwise complies with the
applicable requirements of the backup withholding rules.
A shareholder who does not provide FBR Asset with its correct taxpayer
identification number also may be subject to penalties imposed by the Internal
Revenue Service. Any amount paid as backup withholding will be creditable
against the shareholder's income tax liability. In addition, FBR Asset may be
required to withhold a portion of capital gain distributions to any shareholders
who fail to certify their non-foreign status to FBR Asset. The Treasury
Department has issued final regulations regarding the backup withholding rules
as applied to non-U.S. shareholders. Those regulations alter the current system
of backup withholding compliance and are effective for distributions made after
December 31, 2000. See "--Taxation of Non-U.S. Shareholders."
Taxation of Tax-Exempt Shareholders
Tax-exempt entities, including qualified employee pension and profit sharing
trusts and individual retirement accounts and annuities, generally are exempt
from federal income taxation. However, they are subject to taxation on their
unrelated business taxable income. While many investments in real estate
generate unrelated business taxable income, the Internal Revenue Service has
issued a published ruling that dividend distributions from a REIT to an exempt
employee pension trust do not constitute unrelated business taxable income,
provided that the exempt employee pension trust does not otherwise use the
shares of the REIT in an unrelated trade or business of the pension
93
<PAGE>
trust. Based on that ruling, amounts that FBR Asset distributes to tax-exempt
shareholders generally should not constitute unrelated business taxable income.
However, if a tax-exempt shareholder were to finance its acquisition of the
common stock with debt, a portion of the income that it receives from FBR Asset
would constitute unrelated business taxable income pursuant to the
"debt-financed property" rules. Furthermore, social clubs, voluntary employee
benefit associations, supplemental unemployment benefit trusts, and qualified
group legal services plans that are exempt from taxation under special
provisions of the federal income tax laws are subject to different unrelated
business taxable income rules, which generally will require them to characterize
distributions that they receive from FBR Asset as unrelated business taxable
income. Finally, in certain circumstances, a qualified employee pension or
profit sharing trust that owns more than 10% of FBR Asset's stock is required to
treat a percentage of the dividends that it receives from FBR Asset as unrelated
business taxable income. The percentage of its dividends that the tax-exempt
trust must treat as unrelated business taxable income is equal to the gross
income FBR Asset derives from an unrelated trade or business, determined as if
it were a pension trust, divided by its total gross income for the year in which
it pays the dividends. The unrelated business taxable income rule applies to a
pension trust holding more than 10% of FBR Asset's stock only if:
o the percentage of its dividends that the tax-exempt trust must treat as
unrelated business taxable income is at least 5%;
o FBR Asset qualifies as a REIT by reason of the modification of the rule
requiring that no more than 50% of FBR Asset's shares be owned by five
or fewer individuals that allows the beneficiaries of the pension trust
to be treated as holding FBR Asset's stock in proportion to their
actuarial interests in the pension trust; and
o either (1) one pension trust owns more than 25% of the value of FBR
Asset's stock or (2) a group of pension trusts individually holding
more than 10% of the value of FBR Asset's stock collectively owns more
than 50% of the value of FBR Asset's stock.
Although FBR Asset does not currently own REMIC residual interests or retained
ownership interests in mortgage loans subject to collateralized mortgage
obligation debt, FBR Asset could acquire assets of that type in the future. If
FBR Asset does so, tax-exempt shareholders may be required to treat a portion of
their dividends as unrelated business taxable income. Tax-exempt shareholders
also may suffer those adverse tax consequences if FBR Asset acquires stock in
other REITs that own REMIC residual interests or mortgage loans subject to
collateralized mortgage debt.
Taxation of Non-U.S. Shareholders
The rules governing U.S. federal income taxation of nonresident alien
individuals, foreign corporations, foreign partnerships, and other foreign
shareholders are complex. This section is only a summary of such rules. We urge
those non-U.S. shareholders to consult their own tax advisors to determine the
impact of federal, state, and local income tax laws on ownership of the common
stock, including any reporting requirements.
A non-U.S. shareholder that receives a distribution that is not attributable to
gain from FBR Asset's sale or exchange of U.S. real property interests (as
defined below) and that
94
<PAGE>
FBR Asset does not designate as a capital gain dividend or retained capital gain
will recognize ordinary income to the extent that FBR Asset pays such
distribution out of its current or accumulated earnings and profits. A
withholding tax equal to 30% of the gross amount of the distribution ordinarily
will apply to such distribution unless an applicable tax treaty reduces or
eliminates the tax. However, if a distribution is treated as effectively
connected with the non-U.S. shareholder's conduct of a U.S. trade or business,
the non-U.S. shareholder generally will be subject to federal income tax on the
distribution at graduated rates, in the same manner as U.S. shareholders are
taxed with respect to such distributions. A non-U.S. corporation also may be
subject to the 30% branch profits tax . FBR Asset plans to withhold U.S. income
tax at the rate of 30% on the gross amount of any such distribution paid to a
non-U.S. shareholder unless either:
o a lower treaty rate applies and the non-U.S. shareholder files the
required form evidencing eligibility for that reduced rate with FBR
Asset; or
o the non-U.S. shareholder files an IRS Form 4224 with FBR Asset claiming
that the distribution is effectively connected income.
The U.S. Treasury Department has issued final regulations that modify the manner
in which FBR Asset will comply with the withholding requirements. Those
regulations are effective for distributions made after December 31, 2000.
Although FBR Asset does not currently own REMIC residual interests or retained
ownership interests in mortgage loans subject to collateralized mortgage
obligation debt, FBR Asset may acquire assets of that type in the future. If FBR
Asset does so, or invests in the stock of a REIT that owns assets of that type,
a portion of the dividends that are paid by FBR Asset to non-U.S shareholders
may be subject to 30% withholding tax, regardless of any reduced rate that
otherwise would apply under a tax treaty.
A non-U.S. shareholder will not incur tax on a distribution that exceeds FBR
Asset's current and accumulated earnings and profits but does not exceed the
adjusted basis of its common stock. Instead, such a distribution will reduce the
adjusted basis of such common stock. A non-U.S. shareholder will be subject to
tax on a distribution that exceeds both FBR Asset's current and accumulated
earnings and profits and the adjusted basis of its common stock, if the non-U.S.
shareholder otherwise would be subject to tax on gain from the sale or
disposition of its common stock, as described below. Because FBR Asset generally
cannot determine at the time it makes a distribution whether or not the
distribution will exceed its current and accumulated earnings and profits, it
normally will withhold tax on the entire amount of any distribution at the same
rate as it would withhold on a dividend. However, a non-U.S. shareholder may
obtain a refund of amounts that FBR Asset withholds if it later determines that
a distribution in fact exceeded its current and accumulated earnings and
profits.
FBR Asset must withhold 10% of any distribution that exceeds its current and
accumulated earnings and profits. Consequently, although it intends to withhold
at a rate of 30% on the entire amount of any distribution, to the extent that it
does not do so, it will withhold at a rate of 10% on any portion of a
distribution not subject to withholding at a rate of 30%.
For any year in which FBR Asset qualifies as a REIT, a non-U.S. shareholder will
incur tax on distributions that are attributable to gain from its sale or
exchange of "U.S. real
95
<PAGE>
property interests" under special provisions of the federal income tax laws. The
term "U.S. real property interests" includes certain interests in real property
and stock in corporations at least 50% of whose assets consists of interests in
real property, but excludes mortgage loans and mortgage-backed securities. Under
those rules, a non-U.S. shareholder is taxed on distributions attributable to
gain from sales of U.S. real property interests as if such gain were effectively
connected with a U.S. business of the non-U.S. shareholder. A non-U.S.
shareholder thus would be taxed on such a distribution at the normal capital
gain rates applicable to U.S. shareholders and also might be subject to the
alternative minimum tax. A nonresident alien individual also might be subject to
special alternative minimum tax. A non-U.S. corporate shareholder not entitled
to treaty relief or exemption also may be subject to the 30% branch profits tax
on such a distribution. FBR Asset must withhold 35% of any distribution that it
could designate as a capital gain dividend. A non-U.S. shareholder may receive a
credit against its tax liability for the amount FBR Asset withholds.
A non-U.S. shareholder generally will not incur tax under the provisions
applicable to distributions that are attributable to gain from the sale of U.S.
real property interests on gain from the sale of its common stock as long as at
all times non-U.S. persons hold, directly or indirectly, less than 50% in value
of FBR Asset's stock. We cannot assure you that that test will be met. However,
a non-U.S. shareholder that owned, actually or constructively, 5% or less of the
common stock at all times during a specified testing period will not incur tax
under the provisions applicable to distributions that are attributable to gain
from the sale of U.S. real property interests if FBR Asset's common stock is
"regularly traded" on an established securities market. If the gain on the sale
of the common stock were taxed under those provisions, a non-U.S. shareholder
would be taxed in the same manner as U.S. shareholders with respect to such
gain, subject to applicable alternative minimum tax, a special alternative
minimum tax in the case of nonresident alien individuals, and the possible
application of the 30% branch profits tax in the case of non-U.S. corporations.
Furthermore, a non-U.S. shareholder will incur tax on gain not subject to the
provisions applicable to distributions that are attributable to gain from the
sale of U.S. real property interests if either:
o the gain is effectively connected with the non-U.S. shareholder's U.S.
trade or business, in which case the non-U.S. shareholder will be
subject to the same treatment as U.S. shareholders with respect to such
gain; or
o the non-U.S. shareholder is a nonresident alien individual who was
present in the United States for 183 days or more during the taxable
year, in which case the non-U.S. shareholder will incur a 30% tax on
his capital gains.
Other Tax Consequences
FBR Asset and/or you may be subject to state and local tax in various states and
localities, including those states and localities in which FBR Asset or you
transact business, own property, or reside. The state and local tax treatment in
such jurisdictions may differ from the federal income tax treatment described
above. Consequently, you should consult your own tax advisor regarding the
effect of state and local tax laws upon an investment in the common stock.
96
<PAGE>
ERISA Considerations
This section discusses only issues relevant under the "plan asset regulations"
(as defined below) and, as a result, does not address all of the issues that may
be important to you under the Employee Retirement Income Security Act of 1974
("ERISA") and the prohibited transaction provisions of the federal income tax
laws. The discussion contained in this section is based on current federal law
and interpretations thereof. We cannot assure you that new laws or
interpretations thereof, which may take effect retroactively, will not cause any
statement in this section to become inaccurate.
This section is a summary of materially relevant law and is not a substitute for
careful planning with a professional.
A fiduciary deciding whether to buy common stock on behalf of an employee
benefit plan, a tax-qualified retirement plan, or an individual retirement
account should consult its own legal advisor regarding the specific
considerations arising under ERISA, the prohibited transaction provisions of the
federal income tax laws, and state law with respect to an investment in the
common stock by such plan or individual retirement account. A fiduciary also
should consider the entire discussion under the heading "Federal Income Tax
Consequences of FBR Asset's Status as a REIT," because the discussion in that
section is relevant to a plan or individual retirement account's decision to
purchase common stock.
Department of Labor Regulations defining plan assets (the "plan asset
regulations") generally provide that when an ERISA investor acquires an equity
interest in an entity, the ERISA investor's assets include both the equity
interest and an undivided interest in each of the underlying assets of the
issuer of such equity interest, unless one or more exceptions specified in the
plan asset regulations are satisfied. An "ERISA investor" includes:
o a pension, profit sharing, or other employee benefit plan subject to
Title I of ERISA;
o a qualified retirement plan not subject to Title I of ERISA because it
is a governmental or church plan or because it does not cover common
law employees; and
o an individual retirement account or an individual retirement annuity.
One exception under the plan asset regulations provides that an ERISA investor's
assets will not include any of the underlying assets of an entity if at all
times ERISA investors own less than 25% of the value of each class of equity
interests in the entity (the "insignificant participation exception"). Another
exception provides that an ERISA Investor's assets will not include the
underlying assets of an entity if the class of equity interests in which the
ERISA investor invests meets the following requirements and, as a result, is
"publicly-offered":
o it is held by 100 or more investors who are independent of the issuer
and each other;
o it is freely transferable; and
97
<PAGE>
o it is part of a class of securities registered under Section 12(b) or
12(g) of the Securities Exchange Act of 1934.
The plan asset regulations list restrictions on transfer that ordinarily will
not prevent securities from being "freely transferable." Such restrictions
include any restriction on or prohibition against a transfer that would result
in the termination or reclassification of an entity for federal or state tax
purposes.
FBR Asset's Charter provides that before the date that either (1) the common
stock is "publicly offered" or (2) FBR Asset qualifies for another exception to
the plan asset regulations (other than the insignificant participation
exception), FBR Asset must satisfy the insignificant participation exception.
FBR Asset's common stock is held by 100 or more shareholders who are independent
of FBR Asset and each other. In addition, we believe that the restrictions on
transfer of the common stock imposed under FBR Asset's Charter do not prevent
the common stock from being "freely transferable." Furthermore, FBR Asset will
register its common stock under Section 12(b) of the Securities Exchange Act of
1934 at the same time that this registration statement becomes effective under
the Securities Act of 1933. Accordingly, the common stock should be "publicly
offered" securities, and FBR Asset's assets should not be deemed to be "plan
assets" of any ERISA investor that owns common stock. As a result, the
requirement described above that FBR Asset satisfy the insignificant
participation exception no longer applies as of the time that this registration
statement becomes effective under the Securities Act of 1933. However, if at any
time FBR Asset fails to qualify for an exception from the plan asset
regulations, the assets of an ERISA investor that invests in the common stock
will include an undivided interest in FBR Asset's assets. In such event, FBR
Asset's assets, transactions involving its assets, and the persons with
authority or control over and that provide services with respect to its assets
would be subject to the fiduciary responsibility provisions of Title I of ERISA
and the prohibited transaction provisions of the federal income tax laws.
98
<PAGE>
Selling Shareholders
The shareholders listed below and the beneficial owners of the common stock and
their transferees, pledgees, donees, or other successors are the selling
shareholders under this prospectus. The following table sets forth as of a
recent practicable date, the respective number of common shares owned by each
selling shareholder that may be offered pursuant to this prospectus.
<TABLE>
<CAPTION>
Selling Shareholder Number of Shares
- ------------------- ----------------
<S> <C>
AG Long Term SuperFund, LP......................................... 200,000
AGMM LP............................................................ 15,000
AG SuperFund, LP................................................... 150,000
Angelo Gordon Co., LP.............................................. 35,000
Norman and Gail Antin.............................................. 250
Don Stephen Aron................................................... 1,250
Aqua Fund, LP...................................................... 5,000
Don and Kathy Bavely............................................... 5,000
Bay Brook Partners................................................. 10,000
Thomas E. Beach.................................................... 45,000
Raymond L. Benson, IRA............................................. 2,500
Roger L. Benson.................................................... 2,500
Roger Lewis Benson, IRA............................................ 2,500
Jacobo Benzaquen................................................... 5,000
Paul Berger........................................................ 5,000
Dr. Michael & Rose Bernstein....................................... 3,000
Berl Biderman...................................................... 2,500
Boston Partners Asset Management, LP............................... 575,500
Branchard Tucker Revocable Trust................................... 2,500
Spencer Browne..................................................... 2,500
Charles and Nancy Byrd............................................. 10,000
Cahnman Family Trust General Partnership........................... 5,000
Ray Cahnman........................................................ 5,000
Joseph P. Cohen.................................................... 2,500
Colony Partners, A CA General Partnership.......................... 5,000
Computech, Inc..................................................... 1,250
Continental Casualty Company....................................... 483,100
Alfred Degaetano................................................... 1,000
Diversified Long Term Growth Fund, L.P............................. 5,000
Drake Associates, LP............................................... 15,000
Mark Ein........................................................... 1,000
Elsa Benson, Inc................................................... 3,500
Cecilia Fireworker as custodian for David E. Fireworker............ 1,750
Cecilia Fireworker as custodian for Elliott Fireworker Ugma........ 1,750
Max M. Fisher Revocable Trust UAD 8/13/88.......................... 50,000
The Frances R. Ford Family Ltd. Partnership........................ 5,000
Frank and Nancy Frangione.......................................... 2,000
Frank Russell Investment Company................................... 61,200
Michael L. Gordon.................................................. 16,200
Sally Gordon....................................................... 6,300
Gross Foundation, Inc.............................................. 35,000
Robert Haft........................................................ 50,000
Rodney L. Hale..................................................... 5,000
David H. Hancock, IRA.............................................. 25,000
</TABLE>
99
<PAGE>
<TABLE>
<CAPTION>
Selling Shareholder Number of Shares
- ------------------- ----------------
<S> <C>
Ira Hershmann Revocable Trust UAD DTD 1/4/85....................... 1,000
Robert G. Hisaoka.................................................. 2,500
John C. Jackson.................................................... 5,000
E. Ann Marie Johnson Trust......................................... 1,250
Edward J. Katz IRA................................................. 5,000
Harry Katz......................................................... 2,500
Julian E. and Elizabeth Kulas...................................... 5,000
Lakeshore Capital, Inc............................................. 15,500
Richard A. Larkin, Jr., IRA, SEP................................... 1,250
LH Rich Companies.................................................. 5,000
Patrick Little..................................................... 500
Lyonshare Venture Capital.......................................... 10,000
Martinique Hotel, Inc.............................................. 50,000
Mark and Tracy Mason, Joint Tenants................................ 5,000
Dennis Mykytyn, IRA, SEP........................................... 12,500
Eve Mykytyn, IRA, SEP.............................................. 12,500
Joseph A. Niznik................................................... 5,000
Northern Trust Co. as Master Trustee of the
Teachers Retirement System of the State of Illinois............. 20,000
Nutmeg Partners, LP................................................ 80,000
Oppenheimer Capital Income Fund.................................... 500,000
Mark Ordan......................................................... 5,000
Mark Palmer........................................................ 2,000
Ralph Pastore Pension Plan......................................... 5,000
Craig L. Patterson, Sr............................................. 1,000
Richard Allen Patterson............................................ 2,500
PFF Bancorp, Inc................................................... 200,000
Geoffrey P. Pohanka................................................ 12,500
John J. Pohanka Declaration of Trust U/A DTD 3/3/95................ 25,000
Robert Potoker..................................................... 1,250
Prospect Street High Income Portfolio Inc.......................... 25,000
Provident Financial Holdings, Inc.................................. 25,000
Rath Foundation, Inc............................................... 100,000
Jill Sorensen Robert and Joseph E. Robert, Jr...................... 2,500
Joseph E. Robert, Jr............................................... 22,500
David Roberts...................................................... 2,500
Robert Rosenthal................................................... 25,000
Salomon Smith Barney Asset Management.............................. 176,800
Susan Pohanka Schantz Declaration of Trust......................... 12,500
Karyn Sherwood..................................................... 1,000
Gordon V. and Helen C. Smith Foundation............................ 2,500
Samuel Spritzer.................................................... 1,000
Richard B. Stewart Family Limited Partnership...................... 5,000
Chil Scheinwexler.................................................. 2,500
Steve Schlam....................................................... 10,000
John K. Schulte.................................................... 1,000
Peter N. Stathis................................................... 2,500
Chaya Unger........................................................ 5,000
Paul Von Kuster.................................................... 10,000
Lorraine V. Urethane, Employees Pension Plan....................... 10,000
Lorraine V. Urethane, Pension Plan Allocated Acct.................. 5,000
Mark Warner........................................................ 125,000
Julia A. Wingard Trust............................................. 750
</TABLE>
100
<PAGE>
<TABLE>
<CAPTION>
Selling Shareholder Number of Shares
- ------------------- ----------------
<S> <C>
Donato B. Zucco.................................................... 500
Others............................................................. 2,333,900
---------
Total......................................................... 5,767,750
=========
</TABLE>
To FBR Asset's knowledge, none of the selling shareholders has, or within the
past three years has had, any position, office or other material relationship
with FBR Asset or any of its predecessors or affiliates. Because the selling
shareholders may, pursuant to this prospectus, offer all or some portion of
their shares of common stock, no estimate can be given as to the number of
shares that will be held by the selling shareholder upon the termination of any
sales. In addition, the selling shareholders identified above may have sold,
transferred or otherwise disposed of all or a portion of their shares, since the
date of which they provided the information regarding their shares, in
transactions exempt from the registration requirements of the Securities Act.
See "Plan of Distribution."
Only selling shareholders identified above who beneficially own the shares set
forth opposite their name in the foregoing table on the effective date of the
Registration Statement of which this prospectus forms a part may sell the shares
pursuant to the Registration Statement. Prior to any use of this prospectus in
connection with an offering of shares by any holder not identified above, this
prospectus will be updated to set forth the name and number of shares
beneficially owned by the selling shareholder intending to sell the shares, and
the number of shares to be offered. The prospectus will also disclose whether
any selling shareholder selling in connection with this prospectus has held any
position or office with, been employed by or otherwise has had a material
relationship with, FBR Asset or any of its affiliates during the three years
prior to the date of the prospectus.
101
<PAGE>
Use of Proceeds
The shares of common stock offered hereby are being registered for the account
of the selling shareholders identified in this prospectus. All net proceeds from
the sale of the common stock will go to the shareholders who offer and sell
their shares. Accordingly, we will not receive any part of the proceeds from the
sale of these shares.
102
<PAGE>
Plan of Distribution
The selling shareholders may offer their shares of common stock directly or
through pledgees, donees, transferees or other successors in interest in one or
more of the following transactions:
o in the over-the-counter market;
o on any stock exchange on which shares of the common stock may be listed
at the time of sale;
o in negotiated transactions; or
o in a combination of any of the above transactions.
The selling shareholders may offer their shares of common stock at any of the
following prices:
o fixed prices that may be changed;
o market prices prevailing at the time of sale;
o prices related to prevailing market prices; or
o at negotiated prices.
The selling shareholders may sell their shares of common stock by one or more of
the following methods, without limitation:
o a block trade in which the broker-dealer so engaged will attempt to
sell the shares as agent, but may position and resell a portion of the
block as principal to facilitate the transaction;
o a broker or dealer may purchase as principal and resell for its own
account pursuant to this prospectus;
o ordinary brokerage transactions and transactions in which the broker
solicits purchasers; or
o face-to-face transactions between the selling shareholders and
purchasers without a broker-dealer.
In effecting sales, brokers or dealers engaged by selling shareholders may
arrange for other brokers or dealers to participate. The selling shareholders
may give such brokers or dealers commissions or discounts in amounts to be
negotiated immediately prior to the sale. The selling shareholders, such brokers
or dealers and any other participating brokers or dealers may be deemed to be
"underwriters" within the meaning of Section 2(11) of the Securities Act of 1933
in connection with such sales, and any commissions received by them and any
profit realized by them on the resale of shares of common stock as principals
may be deemed underwriting compensation under the Securities Act. Any
broker-dealer selling shares of common stock offered by this prospectus
off-the-shelf cannot receive compensation (calculated as the difference between
the purchase and resale price of the shares) in excess of 8% on principal
transactions, or in excess of normal, ordinary brokerage commissions, which in
any event may not exceed 5% of the sales price for any agency transaction.
Friedman, Billings, Ramsey & Co., Inc., a
103
<PAGE>
registered broker-dealer and an affiliate of FBR Management, may act as an agent
on behalf of selling shareholders in connection with this offering.
If and when a selling shareholder notifies us that he or she has entered into a
material arrangement with a broker-dealer for the sale of shares of common stock
through a block trade, special offering or secondary distribution, or a purchase
by a broker or dealer, we will file a supplemental prospectus, if required,
pursuant to Rule 424(c) under the Securities Act, disclosing (1) the name of the
selling shareholder and of the participating broker-dealer(s); (2) the number of
shares of common stock involved; (3) the price at which such shares of common
stock were sold; (4) the commissions paid or discounts or concessions allowed to
such broker-dealer(s), where applicable; (5) that such broker-dealer(s) did not
conduct any investigation to verify the information set out or incorporated by
reference in this prospectus; and (6) other facts material to the transaction.
Each selling shareholder reserves the sole right to accept and, together with
any agent of the selling shareholder, to reject in whole or in part any proposed
purchase of the shares of common stock. The selling shareholder will pay any
sales commissions or other seller's compensation applicable to such
transactions.
Any securities covered by this prospectus that qualify for sale pursuant to Rule
144 might be sold under Rule 144 rather than pursuant to this prospectus.
We have not registered or qualified offers and sales of shares of the common
stock under the laws of any country, other than the United States. To comply
with certain states' securities laws, if applicable, the selling shareholders
will offer and sell their shares of common stock in such jurisdictions only
through registered or licensed brokers or dealers. In addition, in certain
states the selling shareholders may not offer or sell shares of common stock
unless we have registered or qualified such shares for sale in such states or we
have complied with an available exemption from registration or qualification.
Under applicable rules and regulations under the Securities Exchange Act of
1934, any person engaged in a distribution of shares of the common stock may not
simultaneously engage in market-making activities with respect to those shares
of common stock for a period of five business days prior to the completion of
the distribution. In addition, the selling shareholders and any other person
participating in a distribution will be subject to applicable provisions of the
Exchange Act and the rules and regulations under the Exchange Act, including
Regulation M. Those provisions may limit the timing of purchases and sales of
any of the shares of common stock by the selling shareholders or any other
person. This may affect the marketability of the common stock and the brokers'
and dealers' ability to engage in market-marking activities with respect to the
common stock.
We will pay substantially all of the expenses incident to the registration of
the shares of common stock, estimated to be approximately $600,000.
104
<PAGE>
Other Matters
Legal
We have based the description of federal income tax consequences in "Federal
Income Tax Consequences of FBR Asset's Status as a REIT" upon the opinion of
Hunton & Williams, Richmond, Virginia.
Independent Accountants
The audited financial statements included in this prospectus have been audited
by Arthur Andersen LLP, independent public accountants, to the extent and for
the periods stated in their reports and are included herein in reliance upon the
authority of Arthur Andersen as experts in giving those reports.
Additional Information
From FBR Asset
You can obtain complete copies of the documents to which we refer in this
prospectus, free of charge, by writing or calling:
John M. Blassingame, Jr., Controller
FBR Asset Investment Corporation
1001 Nineteenth Street North
Arlington, Virginia 22209
(703) 469-1000 phone
(703) 312-9602 fax
From the SEC
This prospectus is part of a Registration Statement that we have filed with the
SEC. You can read and copy that Registration Statement, and the exhibits
attached to it, at the SEC's public reference rooms in Washington, DC, New York,
New York and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for more
information about the public reference rooms.
After the offering, we will file annual, quarterly and special reports, proxy
statements and other information with the SEC. You will be able to read and copy
those documents at the SEC's public reference rooms too.
You can also obtain copies of all documents that we file with the SEC on the
SEC's website (http://www.sec.gov).
105
<PAGE>
Index to Financial Statements
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants.............................................F-2
Financial Statements:
Statements of Financial Condition as of December 31, 1997 and 1998
and as of June 30, 1999 (unaudited)..........................................F-3
Statements of Income for the Period from December 15, 1997 (Inception),
through December 31, 1997, the Year Ended December 31, 1998,
and the Six Months Ended June 30, 1998 and 1999 (unaudited)..................F-4
Statements of Changes in Shareholders' Equity for the Period from December
15, 1997 (Inception), through December 31, 1997, the Year Ended December
31, 1998, and the Six Months Ended June 30, 1999 (unaudited).................F-5
Statements of Cash Flows for the Period from December 15, 1997 (Inception),
through December 31, 1997, the Year Ended December 31, 1998,
and the Six Months Ended June 30, 1998 and 1999 (unaudited)..................F-6
Notes to Financial Statements........................................................F-8
</TABLE>
F-1
<PAGE>
Report of Independent Public Accountants
To FBR Asset Investment Corporation:
We have audited the accompanying statements of financial condition of FBR Asset
Investment Corporation (the "Company", a Virginia corporation) as of December
31, 1997 and 1998, and the related statements of income, changes in
shareholders' equity and cash flows for the period from December 15, 1997
(inception) through December 31, 1997, the year ended December 31, 1998 and the
six months ended June 30, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, 1997 and 1998, and the results of its operations
and its cash flows for the period from December 15, 1997 (inception), through
December 31, 1997, the year ended December 31, 1998 and the six months ended
June 30, 1998, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Vienna, VA
February 12, 1999
F-2
<PAGE>
FBR Asset Investment Corporation
Statements of Financial Condition as of December 31, 1997 and 1998, and
June 30, 1999 (unaudited)*
================================================================================
<TABLE>
<CAPTION>
As of December 31 As of June 30
------------------------------------ -------------
1997 1998 1999
------------- ------------- -------------
(unaudited)
<S> <C> <C> <C>
Assets
Mortgage-backed securities, at fair value - $ 161,418,739 $ 140,943,202
Cash and cash equivalents $ 163,223,199 41,144,326 20,336,693
Investments in equity securities, at
fair value 23,318,750 70,983,050 73,515,801
Notes receivable 3,000,000 19,082,921 17,235,059
Due from affiliate 545,827 - -
Dividends receivable 434,717 870,477 728,735
Prepaid expenses - 454,746 227,373
Organization costs, net of accumulated
amortization of $3,733, $5,329 and
$6,127, respectively 7,909 6,313 5,515
Interest receivable 8,000 1,970,048 958,315
------------- ------------- -------------
Total assets $ 190,538,402 $ 295,930,620 $ 253,950,693
============= ============= =============
Liabilities and Shareholders' Equity
Liabilities:
Repurchase agreements $ - $ 128,550,000 $ 113,794,000
Interest payable - 310,096 181,085
Dividends payable 510,950 2,563,058 2,702,498
Management fees payable 58,623 1,275,514 146,054
Accounts payable and accrued expenses 12,000 224,933 139,448
Due to custodian-mortgage securities - 11,929,614 -
Due to issuer - - 10,000,000
Deferred revenue 190,000 172,826 6,429
------------- ------------- -------------
Total liabilities $ 771,573 $ 145,026,041 $ 126,969,514
------------- ------------- -------------
Shareholders' equity:
Preferred stock, par value $.01 per
share, 50,000,000 shares authorized - - -
Common stock, par value $.01 per share,
200,000,000 shares authorized,
10,218,999, 10,415,827 and 10,415,827
shares issued as of December 31, 1997
and 1998, and June 30, 1999,
respectively $ 102,190 $ 104,158 $ 104,158
Additional paid-in capital 189,528,668 194,097,193 194,097,193
Accumulated other comprehensive loss - (9,800,530) (15,896,077)
Retained earnings (deficit) 135,971 (9,425,579) (8,339,757)
Treasury stock, at cost, 1,872,300
shares and 3,303,991 shares as of
December 31, 1998 and June 30, 1999,
respectively - (24,070,663) (42,984,338)
------------- ------------- -------------
Total shareholders' equity $ 189,766,829 $ 150,904,579 $ 126,981,179
------------- ------------- -------------
Total liabilities and shareholders'
equity $ 190,538,402 $ 295,930,620 $ 253,950,693
============= ============= =============
</TABLE>
================================================================================
*The accompanying notes are an integral part of these statements.
F-3
<PAGE>
FBR Asset Investment Corporation
Statements of Income for the Period from December 15, 1997 (Inception) through
December 31, 1997, the Year Ended December 31, 1998, and the Six Months Ended
June 30, 1998 and 1999 (unaudited)*
================================================================================
<TABLE>
<CAPTION>
December 15,
1997
(Inception)
through Year Ended Six Months Ended June 30,
December 31, December 31, --------------------------------
1997 1998 1998 1999
------------ --------------- ------------ ------------
(unaudited)
<S> <C> <C> <C> <C>
Income:
Interest $ 18,040 $ 13,656,097 $ 4,817,569 $ 7,745,578
Dividends 434,717 4,271,405 833,749 2,838,852
Other income 268,520 - - -
------------ ------------ ------------ ------------
Total Income 721,277 17,927,502 5,651,318 10,584,430
------------ ------------ ------------ ------------
Expenses:
Interest expense - 5,359,633 552,783 3,382,129
Management fee expense 58,623 1,520,725 469,139 678,706
Professional fees 12,000 440,185 132,035 414,780
Insurance - 52,769 26,384 17,416
Amortization of stock options issued to manager - 454,746 - 227,373
Amortization of organization costs 3,733 1,596 798 798
Other - 139,806 4,538 76,389
------------ ------------ ------------ ------------
Total expenses 74,356 7,969,460 1,185,677 4,797,591
------------ ------------ ------------ ------------
Realized gain on sale of mortgage securities - 176,048 - -
Realized gain on sale of equity investments - - - 743,353
Realized loss on equity investment - (6,615,000) - -
Realized loss on interest rate hedge - (1,930,855) - -
------------ ------------ ------------ ------------
Net income $ 646,921 $ 1,588,235 $ 4,465,641 $ 6,530,192
============ ============ ============ ============
Basic and diluted earnings per share $ 0.06 $ 0.16 $ 0.43 $ 0.81
============ ============ ============ ============
Weighted-average common and equivalent shares 10,218,999 10,044,483 10,399,515 8,109,353
============ ============ ============ ============
</TABLE>
================================================================================
*The accompanying notes are an integral part of these statements.
F-4
<PAGE>
FBR Asset Investment Corporation
Statements of Changes in Shareholders' Equity for the Period from December 15,
1997 (Inception) through December 31, 1997, the Year Ended December 31, 1998,
and the Six Months Ended June 30, 1999 (unaudited)*
================================================================================
<TABLE>
<CAPTION>
Accumulated
Additional Retained Other
Common Paid in Earnings Treasury Comprehensive Comprehensive
Stock Capital (Deficit) Stock Income (Loss) Total Income (Loss)
------------ ------------ ------------- ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 15, 1997 $ - $ - $ - $ - $ - $ - $ -
Issuance of common stock 102,190 189,528,668 - - - 189,630,858 -
Net income - - 646,921 - - 646,921 646,921
------------
Comprehensive income - - - - - - $ 646,921
============
Dividends - - (510,950) - - (510,950)
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1997 102,190 189,528,668 135,971 - - 189,766,829
------------ ------------ ------------ ------------ ------------ ------------
Issuance of common stock 1,968 3,659,033 - - - 3,661,001
Stock options issued to
manager - 909,492 - - - 909,492
Repurchase of common
stock - - - (24,070,663) - (24,070,663)
Net income - - 1,588,235 - - 1,588,235 $ 1,588,235
Other comprehensive
income (loss)--
Change in unrealized
loss on available-
for-sale securities - - - - (9,800,530) (9,800,530) (9,800,530)
------------
Comprehensive loss - - - - - - $ (8,212,295)
============
Dividends - - (11,149,785) - - (11,149,785)
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1998 $ 104,158 $194,097,193 $ (9,425,579) $(24,070,663) $ (9,800,530) $150,904,579
------------ ------------ ------------ ------------ ------------ ------------
Repurchase of common stock - - - (18,913,675) - (18,913,675)
Net Income - - 6,530,192 - - 6,530,192 $ 6,530,192
Other comprehensive
income (loss)--
Change in unrealized
loss on available-
for-sale securities - - - - (6,095,547) (6,095,547) (6,095,547)
------------
Comprehensive loss - - - - - - $ 434,645
============
Dividends - - (5,444,370) - - (5,444,370)
------------ ------------ ------------ ------------ -------------- ------------
Balance, June 30, 1999 $ 104,158 $194,097,193 $ (8,339,757) $(42,984,338) $(15,896,077) $126,981,179
============ ============ ============ ============ ============ ============
</TABLE>
================================================================================
*The accompanying notes are an integral part of these statements.
F-5
<PAGE>
FBR Asset Investment Corporation
Statements of Cash Flows for the Period from December 15, 1997 (Inception)
through December 31, 1997, the Year Ended December 31, 1998, and the Six Months
Ended June 30, 1998 and 1999 (unaudited)*
================================================================================
<TABLE>
<CAPTION>
December 15, 1997
(Inception) For the Six Months Ended June 30
through Year Ended ----------------------------------
December 31, 1997 December 31, 1998 1998 1999
----------------- ----------------- ------------- -------------
(unaudited)
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income $ 646,921 $ 1,588,235 $ 4,465,641 $ 6,530,192
Adjustments to reconcile net
income to net cash (used in)
provided by operating activities--
Realized loss on equity - 6,615,000 - -
securities
Realized gain on sale of
mortgage-backed and equity
securities - (176,048) - (743,353)
Unrealized gain on equity
investments (268,520) - - -
Amortization of organization
costs and stock options
issued to manager 3,733 456,342 798 228,171
Premium amortization on
mortgage-backed securities - 777,179 137,518 385,264
Changes in operating assets and
liabilities:
Due from affiliate (545,827) 545,827 545,609 -
Dividends receivable (434,717) (435,760) 178,169 141,742
Interest receivable (8,000) (1,962,048) (1,895,099) 1,011,733
Prepaid expenses - - (26,385) -
Organization costs (11,642) - - -
Management fees payable 58,623 1,216,891 207,912 (1,129,460)
Accounts payable and accrued
expenses 12,000 212,933 69,349 (85,485)
Interest payable - 310,096 552,783 (129,011)
Due to custodian - 2,041,230 167,402 (2,041,230)
Deferred revenue 190,000 (17,174) (145,340) (166,397)
------------- ------------- ------------- -------------
Net cash (used in) provided by
operating activities $ (357,429) $ 11,172,703 $ 4,258,357 $ 4,002,166
============= ============= ============= =============
Cash flows from investing activities:
Purchase of mortgage-backed securities - (221,156,241) (221,156,241) (9,888,384)
Investments in equity securities $ (23,050,230) $ (64,876,250) $ (55,295,839) $ (1,454,320)
Investments in notes receivable,
net of repayments (3,000,000) (16,000,000) (15,000,000) 1,847,862
Proceeds from sale of mortgage-backed
securities - 48,533,267 - -
Proceeds from sale of equity securities - - - 6,690,173
Receipt of principal payments on
mortgage-backed securities - 21,204,987 2,226,225 16,969,474
------------- ------------- ------------- -------------
Net cash (used in) provided by
investing activities $ (26,050,230) $(232,294,237) $(289,225,855) $ 14,164,805
------------- ------------- ------------- -------------
Cash flows from financing activities:
Repurchase of common stock $ - $ (24,070,663) $ $ (18,913,675)
Proceeds from issuance of common stock 189,630,858 3,661,001 3,661,001 -
Proceeds from (repayments of)
repurchase agreements, net - 128,550,000 181,287,958 (14,756,000)
Dividends paid - (9,097,677) (2,594,115) (5,304,929)
------------- ------------- ------------- -------------
Net cash provided by (used in)
financing activities $ 189,630,858 $ 99,042,661 $ 182,354,844 $ (38,974,604)
------------- ------------- ------------- -------------
</TABLE>
================================================================================
*The accompanying notes are an integral part of these statements.
F-6
<PAGE>
FBR Asset Investment Corporation
Statements of Cash Flows for the Period from December 15, 1997 (Inception)
through December 31, 1997, the Year Ended December 31, 1998, and the Six Months
Ended June 30, 1998 and 1999 (unaudited)* (Continued)
================================================================================
<TABLE>
<CAPTION>
December 15, 1997
(Inception) For the Six Months Ended June 30
through Year Ended ----------------------------------
December 31, 1997 December 31, 1998 1998 1999
----------------- ----------------- ------------- -------------
(unaudited)
<S> <C> <C> <C> <C>
Net increase (decrease) in cash and cash
equivalents $ 163,223,199 $(122,078,873) $(102,612,654) $ (20,807,633)
Cash and cash equivalents, beginning of
the period - 163,223,199 163,223,199 41,144,326
------------- ------------- ------------- -------------
Cash and cash equivalents, end of the
period $ 163,223,199 $ 41,144,326 $ 60,610,545 $ 20,336,693
------------- ------------- ------------- -------------
Supplemental disclosure of non-cash
investing activities:
------------- ------------- ------------- -------------
Securities purchased but not settled - $ 9,888,384 - $ 10,000,000
</TABLE>
================================================================================
*The accompanying notes are an integral part of these statements.
F-7
<PAGE>
Notes to Financial Statements
(Information as of and for the six month period ended June 30, 1999 is
unaudited.)
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 (the "Private
Placement") (see Note 3).
FBR Asset is organized as a real estate investment trust ("REIT") whose primary
purpose is to invest in mortgage loans and mortgage-backed securities issued or
guaranteed by instrumentalities of the U.S. Government or by private issuers
that are secured by real estate (together the "Mortgage Assets"). FBR Asset also
acquires indirect interests in those and other types of real estate-related
assets by investing in public and private real estate companies, subject to the
limitations imposed by the various REIT qualification requirements. Funds not
immediately allocated will generally be temporarily invested in readily
marketable, interest-bearing securities. To create yields commensurate with its
investment objectives, FBR Asset leverages its assets and mortgage loan
portfolio primarily with collateralized borrowings. FBR Asset uses derivative
financial instruments to hedge a portion of the interest rate risk associated
with its borrowings.
Note 2 Summary of Significant Accounting Policies
Investments in Mortgage-Backed Securities
FBR Asset invests primarily in mortgage pass-through certificates that represent
a 100 percent interest in the underlying conforming mortgage loans and are
guaranteed by the Government National Mortgage Association ("Ginnie Mae"), the
Federal Home Loan Mortgage Corporation ("Freddie Mac"), and the Federal National
Mortgage Association ("Fannie Mae").
Mortgage-backed security transactions are recorded on the date the securities
are purchased or sold. Any amounts payable for unsettled trades are recorded as
"due to custodian--mortgage securities" in FBR Asset's Statement of Financial
Condition.
FBR Asset accounts for its investments in mortgage-backed securities in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," which
requires FBR Asset to classify its investments as either trading,
available-for-sale or held to maturity. FBR Asset does not hold its
mortgage-backed securities for trading purposes, but may not hold such
investments to maturity, and has classified these investments as
available-for-sale. Securities classified as available for sale are reported at
fair value, with temporary unrealized gains and losses excluded from earnings
and reported as a separate component of shareholders' equity. Realized gains and
losses on mortgage-backed securities transactions are determined on the specific
identification basis.
Unrealized losses on mortgage-backed securities that are determined to be other
than temporary are recognized in income. Management regularly reviews its
investment
F-8
<PAGE>
portfolio for other than temporary impairment. There were no such adjustments
for mortgage-backed investments.
The fair value of FBR Asset's mortgage-backed securities are based on market
prices provided by certain dealers who make markets in these financial
instruments. The fair values reported reflect estimates and may not necessarily
be indicative of the amounts FBR Asset could realize in a current market
exchange.
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 the 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.
During 1998, FBR Asset received proceeds of $48.5 million from the sale of
mortgage-backed securities. The Company recorded $176,048 in realized gains
related to this sale.
The following table summarizes FBR Asset's mortgage-backed securities as of
December 31, 1998:
<TABLE>
<CAPTION>
Total Mortgage
Freddie Mac Fannie Mae Ginnie Mae Assets
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Mortgage-backed
securities, available
for sale-principal $ 93,278,879 $ 48,386,870 $ 16,294,168 $ 157,959,917
Unamortized premium 512,080 1,415,625 780,216 2,745,323
------------- ------------- ------------- -------------
Amortized cost 93,790,959 49,802,495 17,074,384 160,705,240
Gross unrealized gains 682,949 196,615 135,862 978,024
Gross unrealized losses (89,511) (156,584) (18,430) (264,525)
------------- ------------- ------------- -------------
Estimated fair value $ 94,384,397 $ 49,842,526 $ 17,191,816 $ 161,418,739
============= ============= ============= =============
</TABLE>
The following table summarizes FBR Asset's mortgage-backed securities as of June
30, 1999:
<TABLE>
<CAPTION>
Total Mortgage
Freddie Mac Fannie Mae Ginnie Mae Assets
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Mortgage-backed
securities, available
for sale-principal $ 85,126,237 $ 42,619,956 $ 13,244,252 $ 140,990,445
Unamortized premium 438,721 1,214,706 706,629 2,360,056
------------- ------------- ------------- -------------
Amortized cost 85,564,958 43,834,662 13,950,881 143,350,501
Gross unrealized gains - - - -
Gross unrealized losses (1,525,642) (655,132) (226,525) (2,407,299)
------------- ------------- ------------- -------------
Estimated fair value $ 84,039,316 $ 43,179,530 $ 13,724,356 $ 140,943,202
============= ============= ============= =============
</TABLE>
F-9
<PAGE>
Repurchase Agreements
FBR Asset has entered into short-term repurchase agreements to finance a
significant portion of its mortgage-backed investments. The repurchase
agreements are secured by FBR Asset's mortgage-backed securities and bear
interest at rates that have historically related closely to LIBOR for a
corresponding period. As of December 31, 1998, FBR Asset had $128.6 million
outstanding under repurchase agreements with a borrowing rate of 5.08% as of the
end of the period and a weighted-average remaining maturity of 73 days. At
December 31, 1998, mortgage-backed securities pledged had an estimated fair
value of $136.2 million. At December 31, 1998, the repurchase agreements had
remaining maturities of between 69 and 74 days.
At June 30, 1999, FBR Asset had $113.8 million outstanding under repurchase
agreements with a weighted average borrowing rate of 5.06% as of the end of the
period and a remaining term to maturity of 19 days. At June 30, 1999,
mortgage-backed securities pledged had an estimated fair value of $117.4
million.
Interest Rate Swaps
During 1998, FBR Asset entered into two interest rate swap agreements to offset
the potential adverse effects of rising interest rates under certain short-term
repurchase agreements. The interest rate swap agreements are structured such
that FBR Asset receives payments based on a variable interest rate and makes
payments based on a fixed interest rate. The variable interest rate on which
payments are received is calculated based on the three-month LIBOR. The
Company's repurchase agreements, which generally have maturities of 60 to 90
days, carry interest rates that correspond to LIBOR rates for those same
periods. The swap agreements effectively fix the Company's borrowing cost and
are not held for speculative or trading purposes. As a result of these factors,
the Company has accounted for these agreements as hedges.
The fair value of interest rate agreements that qualify as hedges are not
recorded. The differential between amounts paid and received under the interest
rate swap agreements is recorded as an adjustment to the interest expense
incurred under the repurchase agreements. In the event of early termination of
an interest rate agreement, a gain or loss is recorded and the Company receives
or makes a payment based on the fair value of the interest rate agreement on the
date of termination.
In October 1998, in connection with the sale of mortgage assets and repayment of
certain repurchase agreements, the Company terminated one of its swap
agreements. The Company realized a loss of $1.9 million upon termination. The
remaining interest rate agreement has a notional amount of $50 million, a fair
value of $(910,535) and $16,745 at December 31, 1998, and June 30, 1999,
respectively, and matures on June 1, 2001.
Investments in Equity Securities
Investments in securities that are listed on a national securities exchange (or
reported on the Nasdaq National Market) are stated at the last reported sale
price on the day of valuation. Listed securities for which no sale was reported
are stated at the mean between the closing "bid" and "asked" price on the day of
valuation. Other securities for which quotations are not readily available are
valued at fair value as determined by FBR Asset's investment adviser, Friedman,
Billings, Ramsey Investment Management, Inc. ("FBR Management"). FBR Management
may use methods of valuing securities other
F-10
<PAGE>
than those described above if it believes the alternative method is preferable
in determining the fair value of such securities.
At December 31, 1997, FBR Asset classified its only three equity portfolio
investments as trading securities in accordance with SFAS No. 115. In January
1998, consistent with the intention to have the Company operate as a REIT,
management reevaluated its investment objectives for these investments and
concluded that these investments were being held for long-term yield, capital
appreciation, and cash flow. Accordingly, management reclassified such
investments as available for sale. The transfer of these securities between
categories was accounted for at fair value, and there was no change to FBR
Asset's net assets as a result of this change in classification.
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.
Management regularly reviews any declines in the market value of its equity
investments for declines and impairments that are other than temporary. Such
declines are recorded in operations when determined. In 1998, management
recorded a charge to operations for $6.6 million associated with an other than
temporary decline in the value of its investment in Chastain Capital
Corporation.
Notes Receivable
On December 23, 1997, FBR Asset entered into an Interim Financing and Security
Agreement with Prime Capital Holding, LLC ("Prime Capital"). The agreement
allows for up to a $20 million bridge loan to Prime Capital. The note accrues
interest at an annualized rate of 12-17% depending upon the funding period. All
amounts due under the bridge loan were due on June 30, 1999. As of December 31,
1998, $11.5 million had been drawn against the bridge loan. From inception
through December 31, 1998, and for the six months ended June 30, 1999, $1.0
million and $1.2 million in interest income has been recorded on this note. FBR
Asset further extended the maturity date on the remaining $10.2 million balance
until September 30, 1999. On August 4, Prime Capital paid $315,500 in principal
payments to reduce the outstanding balance to $9.9 million. Prime Capital is a
Delaware limited liability company formed in August 1997 and is an early stage
mortgage origination company.
On February 5, 1999, FBR Asset loaned Prime Group Realty, an affiliate of Prime
Group Inc., $7 million. The loan bore interest at a rate of 15% per annum and
was secured by real property. The note was repaid on July 14, 1999.
On June 3, 1998, FBR Asset entered into a promissory note agreement with
Kennedy-Wilson, Inc. for $10 million. The note accrued interest at a rate of 12
percent per annum, which was payable monthly. The agreement called for the
repayment of the advanced principal amount upon the earlier of, the closing of a
public offering of common stock by Kennedy-Wilson, or December 3, 1998. On
November 30, 1998, Kennedy-Wilson paid the note down to $7,500,000, and FBR
Asset and Kennedy-Wilson entered into an amended promissory note agreement
increasing the interest rate to 17% and extending the repayment date to June 3,
1999. Kennedy-Wilson is a U.S. real estate marketing and investment firm
specializing in innovative marketing programs for various types of
F-11
<PAGE>
properties and financial instruments. From inception through December 31, 1998,
and for the six months ended June 30, 1999, interest income of $0.7 million and
$0.5 million, respectively, has been recorded on this note. The note was repaid
on May 17, 1999.
On January 25, 1999, the Company loaned Brookdale Living Community, Inc. $5
million in subordinated debt. The debt bore interest at 13 percent per annum and
was due on April 26, 1999. FBR Asset agreed to extend the maturity date on this
loan and was repaid on May 14, 1999.
Credit Risk
FBR Asset has limited its exposure to credit losses on its mortgage-backed
portfolio of mortgage-backed securities by purchasing securities only from
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, 1998, and June 30, 1999, all of FBR Asset's
mortgage-backed securities have an implied "AAA" rating.
Cash and Cash Equivalents
All investments with original maturities of less than three months are cash
equivalents. As of December 31, 1998, cash and cash equivalents consisted of
$14.4 million of cash deposited in two commercial banks and $26.7 million in two
separate domestic money market funds. As of June 30, 1999, cash and cash
equivalents consisted of $4.1 million of cash deposited in two commercial banks
and $16.2 million in two separate domestic money market funds. The money market
funds invest primarily in obligations of the U.S. Government. The carrying
amount of cash equivalents approximates their fair value.
New Accounting Pronouncements
During the period, FBR Asset adopted SFAS No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130"). SFAS No. 130 requires the reporting of comprehensive
income in addition to net income from operations. Comprehensive income is a
financial reporting methodology that includes certain financial information that
historically has not been recognized in the calculation of net income. FBR
Asset's only component of other comprehensive income is the net unrealized loss
on investments classified as available for sale in accordance with SFAS No. 115.
In June 1998, the Financial Accounting Standards Board issued Statement on
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). This statement is effective for all
fiscal years beginning after June 15, 2000, and generally requires that an
entity recognize derivative financial instruments as assets or liabilities and
measure them at fair value. Management is currently evaluating the impact of
adopting the requirements of SFAS 133.
Net Income Per Share
FBR Asset has adopted SFAS No. 128, "Earnings Per Share." SFAS No. 128 requires
the presentation of basic and diluted earnings per share. SFAS No. 128 specifies
that basic earnings per share excludes potential dilution and is computed by
dividing income
F-12
<PAGE>
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. The potentially dilutive securities did not
impact the computation of earnings per share for any period 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 95 percent of its taxable income to its shareholders and
complies with certain other requirements. Failure to meet these requirements
could have material adverse impact on FBR Asset's results or financial
condition. Furthermore, because FBR Asset's investments include stock in other
REITs, failure of those REITs to maintain their REIT status could jeopardize FBR
Asset's qualification as a REIT. No provision has been made for income taxes in
the accompanying financial statements, as FBR Asset believes it has met the
prescribed distribution and other requirements.
Reclassifications
Certain amounts in the financial statements as of December 31, 1997, have been
reclassified to conform with 1998 presentation.
Note 3 Stockholders' Equity
On December 15, 1997, FBR Asset completed a private placement of equity capital.
FBR Asset received net proceeds of $189.7 million from the issuance of
10,218,999 shares of common stock.
On January 15, 1998, FBR purchased 196,828 shares of FBR Asset for $3.7 million
pursuant to a stock option awarded in connection with the private placement
offering.
F-13
<PAGE>
FBR Asset has paid the following dividends:
Declaration Date Payable Date Dividend
- ---------------- ------------ --------
December 31, 1997 January 22, 1998 $.055(1)
April 6, 1998 April 22, 1998 $.200
June 24, 1998 July 14, 1998 $.295
October 13, 1998 October 20, 1998 $.360
December 31, 1998 January 15, 1999 $.300
March 31, 1999 April 14, 1999 $.325
June 14, 1999 July 15, 1999 $.380
(1) Includes $0.005 divided declared in June 1998 and paid in July 1998 to
shareholders of record as of December 31, 1997.
In September 1998, the Board of Directors authorized the repurchase of up to
2,000,000 shares of FBR Asset's common stock. Through December 31, 1998, FBR
Asset had repurchased 1,872,300 shares for a cost of $24 million, or $12.86
average cost per share. On March 30, 1999, the Board of Directors authorized the
repurchase of up to an additional 2,000,000 shares of FBR Asset's common stock.
Between December 31, 1998 and June 30, 1999, the Company repurchased an
additional 1,431,691 shares of its common stock at an average price of $13.21
per share.
FBR Asset had outstanding, as of December 31, 1998, and June 30, 1999, 1,021,900
options to purchase common stock. These options have terms of eight to ten years
and have an exercise price of $20 per share.
Note 4 Management and Performance Fees
FBR Asset has entered into a management agreement with Friedman, Billings,
Ramsey Investment Management, Inc. ("FBR Management"), for an initial term
expiring on December 15, 1999. FBR Management will perform portfolio management
services on behalf of FBR Asset. Such services shall include, but are not
limited to, consulting with FBR Asset on purchase and sale opportunities,
collection of information and submission of reports pertaining to FBR Asset's
assets, interest rates, and general economic conditions, and periodic review and
evaluation of the performance of FBR Asset's portfolio of assets.
FBR Management is entitled to a quarterly "base" management fee equal to the sum
of (1) 0.25 percent per annum (adjusted to reflect a quarterly period) of the
average invested mortgage assets of FBR Asset during each calendar quarter and,
(2) 0.75 percent per annum (adjusted to reflect a quarterly period) of the
remainder of the average invested assets of FBR Asset during each calendar
quarter. FBR Management also received 1,021,900 options to purchase FBR Asset's
common stock at $20 per share. The estimated value of these options is $909,492,
based on a discounted Black-Scholes valuation, and is being amortized over the
initial term of the Management Agreement. FBR Management assigned options to
acquire 51,045 shares to Blackrock in connection with the execution of the
sub-management agreement. The unamortized value of these options has been
recorded as prepaid expenses in the accompanying statements of financial
condition. In addition, FBR Management agreed to the rescision of 155,000
options to purchase common shares in connection with the establishment of FBR
Asset's stock incentive plan.
F-14
<PAGE>
FBR Management is also entitled to receive incentive compensation based on the
performance of FBR Asset. On December 31, 1998, and each subsequent year
thereafter, FBR Management is entitled to an incentive fee calculated as: funds
from operations (as defined), plus net realized gains or losses from asset
sales, less the threshold amount (all computed on a weighted average share
outstanding basis), multiplied by 25 percent. The threshold amount is calculated
as the weighted average per share price of all equity offerings of FBR Asset,
multiplied by a rate equal to the ten-year U.S. Treasury rate plus five percent
per annum.
FBR Management has engaged BlackRock Financial Management, Inc. ("BlackRock") to
manage FBR Asset's mortgage asset investment program (the "Mortgage Portfolio")
as a sub-adviser. BlackRock is a majority owned subsidiary of PNC Bank
Corporation who is a 4.9 percent owner of FBR Management's parent company. As
compensation for rendering services, BlackRock will be entitled to share the
management fees of FBR Management, calculated based on the average gross asset
value managed by BlackRock, with a minimum annual fee of $100,000, payable
quarterly. The agreement may be terminated by either party with thirty days
advance notice.
Note 5 Related Parties
As of December 31, 1998, a wholly-owned subsidiary of Friedman, Billings, Ramsey
Group, Inc. ("FBR Group") owned 1,344,086 shares or 15.73% of the outstanding
common stock of FBR Asset. As of June 30, 1999, that same subsidiary owned
1,344,086 or 18.90% of the outstanding common stock of FBR Asset. FBR Group is
the parent company of FBR Management and FBR & Co.
Note 6 Equity Investments
As of December 31, 1997, the Company's equity investments had an aggregate cost
basis of $23 million, a fair value of $23.3 million and unrealized gains of $0.3
million. As of December 31, 1998, the Company's equity investments had an
aggregate cost basis of $81.2 million, fair value of $71.0 million, unrealized
losses of $12.3 million, realized losses of $6.6 million, and unrealized gains
of $2.1 million.
At June 30, 1999, the Company's equity investments had an aggregate cost basis
of $86.7 million, a fair value of $73.5 million, unrealized losses of $14.8
million and unrealized gains of $1.6 million.
<TABLE>
<CAPTION>
Amount of Market Value at Market Value at
Equity Investments Investment(1) December 31, 1998 June 30, 1999
- ------------------ ------------- ----------------- ---------------
<S> <C> <C> <C>
Anthracite Capital, Inc. $18,334,496 $12,358,170 $10,380,864
Capital Automotive REIT 25,000,000 26,657,711 23,745,524
Chastain Capital Corporation(2) 3,150,000 3,150,000 4,637,500
Imperial Credit Commercial Mortgage
Inv. Corp. 13,050,230 8,437,500 9,731,250
Imperial Credit Industries, Inc.(3) 10,000,000 - 10,000,000
Prime Retail, Inc. 1,201,317 1,211,844 1,072,906
Prime Retail, Inc., pfd(3) 1,454,320 - 1,553,104
Resource Asset Investment Trust 5,292,516 3,790,325 4,350,259
Building One Services Corporation(4) 4,053,180 10,437,500 2,811,894
East-West Bank 5,200,000 4,940,000 5,232,500
----------- ----------- -----------
Total $86,736,059 $70,983,050 $73,515,801
=========== =========== ===========
</TABLE>
(1) As of June 30, 1999
(2) Reflects realized loss of $6.6 million recorded in 1998 for other than
temporary impairment in the value of Chastain Capital Corporation
(3) Purchased in 1999.
(4) In April 1999, FBR Asset sold 297,341 shares of Building One Services
Corporation and realized a gain of $743,353.
F-15
<PAGE>
Imperial Credit Commercial Corporation ("ICMI")
FBR Asset purchased 900,000 shares of ICMI common stock in December 1997. ICMI
is a Maryland corporation that has elected REIT status. It invests primarily in
performing multifamily and commercial term loans and interests in commercial and
residential mortgage-backed securities. ICMI also invests in various classes of
non-investment grade mortgage-backed securities. ICMI's common stock is publicly
traded.
Building One Services Corporation ("BOSS")
FBR Asset purchased 500,000 shares of BOSS (formerly Consolidated Capital
Corporation) common stock in December 1997. BOSS is a Delaware corporation that
was founded in February 1997 to build consolidated enterprises through the
acquisition and integration of multiple businesses in one or more fragmented
industries. BOSS has undertaken to consolidate facilities management companies
and may select companies in this or related industries in which to make future
investments. BOSS's common stock is publicly traded. Pursuant to BOSS's tender
offer, which expired in April 1997, FBR Asset sold 297,341 of its BOSS common
shares for a price of $22.50 per share, or $6.7 million in April 1999.
Capital Automotive REIT ("CAR")
On February 13, 1998, FBR Asset acquired 1,792,115 shares of common stock in CAR
in a private transaction, concurrent with CAR's initial public stock offering at
a price of $13.95 per share. CAR is a self-administered and self-managed
Maryland REIT formed to invest in the real property and improvements used by
operators of multisite, multifranchised motor vehicle dealerships and motor
vehicle related businesses located in major metropolitan areas throughout the
United States. CAR primarily acquires real property and simultaneously leases
back this property for use by dealers. CAR's common stock is publicly traded.
Resource Asset Investment Trust ("RAS")
On February 19, 1998, FBR Asset acquired 300,000 shares of common stock in RAS,
a Maryland REIT, for a cost of $4,599,000 or $15.33 per share. RAS's principal
business activity is the acquisition and/or financing of loans secured by
mortgages on real property (or interests in such loans) in situations that,
generally, do not conform to the underwriting standards of institution lenders
or sources that provide financing through securitization. RAS believes that its
anticipated financing activity provides it with an underserved niche market in
the real estate industry. RAS's common stock is publicly traded.
On June 24th and 25th, 1998, FBR Asset acquired an additional 44,575 shares of
RAS for a cost of $693,516 or $15.55 average cost per share.
Anthracite Capital, Inc. ("AHR")
On March 27, 1998, FBR Asset purchased 716,846 shares of common stock in AHR, a
Maryland REIT, for a cost of approximately $10 million or $13.95 per share. AHR
was organized in November 1997 to invest in a diversified portfolio of
multifamily, commercial and residential mortgage loans, mortgage-backed
securities, and other real estate related assets in the United States and
non-U.S. markets. AHR seeks to achieve strong investment returns by maximizing
the spread of investment income earned on its
F-16
<PAGE>
real estate assets over the cost of financing and hedging these assets and/or
liabilities. AHR's common stock is publicly traded.
During September and October, 1998, FBR Asset purchased an additional 865,000
shares of AHR for $8,334,496 or $9.64 average cost per share.
Chastain Capital Corporation ("CHAS")
On April 29, 1998, FBR Asset purchased 700,000 shares of common stock in CHAS, a
Georgia REIT, for a cost of $9,765,000 or $13.95 per share. CHAS was organized
in December 1997 to invest in commercial and multifamily mortgage and real
estate related assets located in major metropolitan markets throughout the
United States. CHAS emphasizes, in particular, origination of commercial
mortgage loans for the purpose of securitizing and the retainage of subordinated
interests in these loans.
In 1998, FBR Asset recorded a charge to operations in the amount of $6,615,000
to reflect management's determination that the decline in the market value of
the stock was more than temporary. On May 14, 1999, CHAS announced that its
Board of Directors had voted to sell all of CHAS' assets, either through a plan
of liquidation or through a sale of the company.
East-West Bancorp ("EWB")
On June 30, 1998, FBR Asset purchased, through a private placement offering,
520,000 shares of EWB, a Southern California commercial bank, for a cost of
$5,200,000 or $10.00 per share. EWB's strategy is to become the premier
commercial bank in California serving the unique personal and business banking
needs of customers engaged in business and having family ties with or origins
from the Asia Pacific region, with experienced personnel having the language
capability and cultural sensitivity appropriate for the region.
Prime Retail, Inc. ("PRT")
In September 1998, FBR Asset purchased an aggregate of 122,300 shares of PRT,
for a total of $1,191,832, or $9.74 average cost per share. On October 18, 1998,
FBR Asset purchased an additional 1,200 shares of PRT's common stock for $9,485
or $7.90 per share. PRT is a Maryland REIT that is engaged primarily in the
ownership, development, construction, acquisition, leasing, marketing and
management of factory outlet centers. PRT's common stock is publicly traded.
On April 22, 1999, FBR Asset purchased 78,400 shares of PRT's preferred stock
for a cost of $1,454,320 or $18.55 average cost per share. PRT's preferred stock
is publicly traded.
Kennedy-Wilson, Inc. ("KWIC")
FBR Asset owns warrants to acquire 131,096 shares of Kennedy-Wilson common stock
at a price of $7.5526 per share. The warrants expire in June 2003.
Imperial Credit Industries, Inc. ("ICII")
On June 30, 1999, FBR Asset privately purchased 400,000 shares of ICII's
preferred stock for $25.00 per share. ICII is a commercial and consumer finance
holding company specializing in non-conforming residential mortgage banking,
business and consumer lending and commercial leasing.
F-17
<PAGE>
<TABLE>
<CAPTION>
========================================================================================
<S> <C>
We have not authorized any dealer, salesperson or any
other person to give any information or make any
representations in connection with this offering other
than those contained in this prospectus, and, if given
or made, such information or representations must not
be relied upon as having been authorized by the company
or the selling stockholders. This prospectus does not
constitute an offer to sell or a solicitation of an
offer to buy any security other than the shares offered FBR Asset Investment
by this prospectus nor does it constitute an offer to Corporation
sell or a solicitation of an offer or to buy the shares
offered hereby in any jurisdiction in which such offer
or solicitation is not authorized or in which the
person making such offer or solicitation is not
qualified to do so, or to any person to whom it is
unlawful to make such offer or solicitation. Neither
the delivery of this prospectus nor any sale made
hereunder shall, under any circumstances, create any
implication that the information herein is correct as
of any time subsequent to the date hereof or that there
has not been a change in the affairs of the company
since the date hereof.
--------------- Common Stock
5,767,750 Shares
SUMMARY TABLE OF CONTENTS
Page
----
Summary...........................................1
Risks of Investing in FBR Asset...................4
Organization & Relationships.....................17
FBR & FBR Management.............................18
FBR Asset's Business.............................27
Selected Financial Data..........................43
Management's Discussion & Analysis...............44 ---------------
FBR Asset's Directors & Officers.................65 PROSPECTUS
FBR Asset's Capital Stock........................72 ---------------
Common Stock Available For Future Sale...........77
Principal Shareholders...........................78
Federal Income Tax Consequences of FBR Asset's
Status as a REIT ................................79
ERISA Considerations.............................97
Selling Shareholders.............................99
Use of Proceeds.................................102
Plan of Distribution............................103
Other Matters...................................105
For a period of 25 days after the registered securities
are first offered to the public pursuant to this
prospectus, all dealers effecting transactions in the
registered securities, whether or not participating in
this distribution, may be required to deliver a
prospectus. September 27, 1999
========================================================================================
</TABLE>
