XNAS:FBRC FBR & Co Quarterly Report 10-Q Filing - 6/30/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number: 001-33518

 

 

FBR & CO.

(Exact name of Registrant as specified in its charter)

 

 

 

Virginia   20-5164223

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1001 Nineteenth Street North

Arlington, VA

  22209
(Address of principal executive offices)   (Zip code)

(703) 312-9500

(Registrant’s telephone number including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  ¨    No  x

The number of shares outstanding of the registrant’s common stock, $0.001 par value per share, as of July 31, 2012 was 48,936,241 shares.

 

 

 


Table of Contents

FBR & CO.

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2012

INDEX

 

          Page  

PART I—FINANCIAL INFORMATION

  

Item 1.

  

Financial Statements

  
  

Consolidated Financial Statements and Notes—(unaudited)

  
  

Consolidated Balance Sheets—June 30, 2012 and December 31, 2011

     1   
  

Consolidated Statements of Operations—Three and Six Months Ended June 30, 2012 and 2011

     2   
  

Consolidated Statements of Comprehensive Income—Three and Six Months Ended June 30, 2012 and 2011

     3   
  

Consolidated Statements of Changes in Shareholders’ Equity—Six Months Ended June 30, 2012 and Year Ended December 31, 2011

     4   
  

Consolidated Statements of Cash Flows—Six Months Ended June 30, 2012 and 2011

     5   
  

Notes to Consolidated Financial Statements

     6   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     20   

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

     30   

Item 4.

  

Controls and Procedures

     33   

PART II—OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

     34   

Item 1A.

  

Risk Factors

     35   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     35   

Item 4.

  

Mine Safety Disclosures

     36   

Item 6.

  

Exhibits

     36   
  

Signature

     37   


Table of Contents

PART I

FINANCIAL INFORMATION

 

Item 1. Financial Statements

FBR & CO.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

(Unaudited)

 

     June 30,
2012
    December 31,
2011
 

Assets

    

Cash and cash equivalents

   $ 145,534      $ 135,792   

Receivables:

    

Due from brokers, dealers and clearing organizations

     11,665        6,048   

Customers

     4,492        3,937   

Other

     2,757        6,854   

Financial instruments owned, at fair value

     70,763        100,634   

Other investments, at cost

     27,674        25,744   

Intangible assets, net

     1,890        2,121   

Furniture, equipment, software and leasehold improvements, net of accumulated depreciation and amortization

     5,275        6,162   

Prepaid expenses and other assets

     9,318        10,791   
  

 

 

   

 

 

 

Total assets

   $ 279,368      $ 298,083   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Liabilities

    

Securities sold but not yet purchased, at fair value

   $ 36,195      $ 35,496   

Accrued compensation and benefits

     11,535        15,760   

Accounts payable, accrued expenses and other liabilities

     14,214        15,280   

Due to brokers, dealers and clearing organizations

     7,781        6,250   
  

 

 

   

 

 

 

Total liabilities

     69,725        72,786   
  

 

 

   

 

 

 

Commitments and Contingencies (Note 6)

    

Shareholders’ Equity

    

Preferred stock, $0.001 par value, 100,000,000 shares authorized, none issued and outstanding

     0        0   

Common stock, $0.001 par value, 300,000,000 shares authorized, 48,920,117 and 54,981,135 shares issued and outstanding, respectively

     49        55   

Additional paid-in capital

     401,219        413,224   

Employee stock loan receivable, including accrued interest (75,950 and 103,450 shares, respectively)

     (489     (673

Restricted stock units

     24,298        29,013   

Accumulated other comprehensive (loss) income, net of taxes

     (22     19   

Accumulated deficit

     (215,412     (216,341
  

 

 

   

 

 

 

Total shareholders’ equity

     209,643        225,297   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 279,368      $ 298,083   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Table of Contents

FBR & CO.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012      2011     2012      2011  

Revenues:

          

Investment banking:

          

Capital raising

   $ 16,841       $ 22,925      $ 31,015       $ 38,035   

Advisory

     2,118         7,074        4,124         8,534   

Institutional brokerage:

          

Principal transactions

     3,753         5,139        10,255         10,975   

Agency commissions

     8,567         15,953        18,117         33,208   

Net investment income (loss)

     1,090         (7,209     2,991         (1,630

Interest income, dividends and other

     1,363         1,392        2,175         2,249   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total revenues

     33,732         45,274        68,677         91,371   
  

 

 

    

 

 

   

 

 

    

 

 

 

Expenses:

          

Compensation and benefits

     16,880         27,792        34,728         54,960   

Professional services

     3,759         2,783        6,591         6,637   

Business development

     2,444         3,186        5,004         6,483   

Clearing and brokerage fees

     1,900         3,314        4,284         5,988   

Occupancy and equipment

     3,499         5,553        7,541         10,461   

Communications

     3,063         3,964        6,608         8,169   

Other operating expenses

     1,865         1,852        3,626         4,207   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total expenses

     33,410         48,444        68,382         96,905   
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) from continuing operations before income taxes

     322         (3,170     295         (5,534

Income tax provision (benefit)

     15         (213     22         (290
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) from continuing operations, net of taxes

     307         (2,957     273         (5,244

Income from discontinued operations, net of taxes

     184         230        656         612   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 491       $ (2,727   $ 929       $ (4,632
  

 

 

    

 

 

   

 

 

    

 

 

 

Basic income (loss) per share:

          

Income (loss) from continuing operations, net of taxes

   $ 0.01       $ (0.05   $ 0.01       $ (0.08

Income from discontinued operations, net of taxes

     0.00         0.01        0.01         0.01   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 0.01       $ (0.04   $ 0.02       $ (0.07
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted income (loss) per share:

          

Income (loss) from continuing operations, net of taxes

   $ 0.01       $ (0.05   $ 0.01       $ (0.08

Income from discontinued operations, net of taxes

     0.00         0.01        0.01         0.01   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 0.01       $ (0.04   $ 0.02       $ (0.07
  

 

 

    

 

 

   

 

 

    

 

 

 

Basic weighted average shares outstanding (in thousands)

     55,495         62,726        55,938         63,116   
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted weighted average shares outstanding (in thousands)

     57,254         62,726        57,225         63,116   
  

 

 

    

 

 

   

 

 

    

 

 

 

See notes to consolidated financial statements.

 

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Table of Contents

FBR & CO.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

(Unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Net income (loss)

   $ 491      $ (2,727   $ 929      $ (4,632

Other comprehensive income, net of tax:

        

Change in unrealized gain (loss) on available-for-sale investment securities, net of taxes

     (40     2,510        (41     75   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 451      $ (217   $ 888      $ (4,557
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Table of Contents

FBR & CO.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars and shares in thousands)

(Unaudited)

 

     Common
Stock
Shares
    Common
Stock
Amount
    Additional
Paid-in
Capital
    Employee
Stock
Loan
Receivable
    Restricted
Stock
Units
    Accumulated
Other
Comprehensive
(Loss) Income
    Accumulated
Deficit
    Total  

Balances at December 31, 2010

     61,718      $ 62      $ 424,641      $ (706   $ 34,239      $ (53   $ (166,692   $ 291,491   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     —          —          —          —          —          —          (49,649     (49,649

Issuance of common stock, net of forfeitures

     1,505        1        10,242        33        (12,070     —          —          (1,794

Repurchase of common stock

     (8,242     (8     (23,230     —          —          —          —          (23,238

Stock compensation expense for options granted to purchase common stock

     —          —          1,571        —          —          —          —          1,571   

Issuance of restricted stock units

     —          —          —          —          6,844        —          —          6,844   

Other comprehensive income:

                

Change in unrealized gain (loss) on available-for-sale investment securities, net of taxes

     —          —          —          —          —          72        —          72   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2011

     54,981      $ 55      $ 413,224      $ (673   $ 29,013      $ 19      $ (216,341   $ 225,297   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     —          —          —          —          —          —          929        929   

Issuance of common stock, net of forfeitures

     1,024        1        6,421        184        (7,403     —          —          (797

Repurchase of common stock

     (7,085     (7     (19,549     —          —          —          —          (19,556

Stock compensation expense for options granted to purchase common stock

     —          —          1,123        —          —          —          —          1,123   

Issuance of restricted stock units

     —          —          —          —          2,688        —          —          2,688   

Other comprehensive income:

                

Change in unrealized gain (loss) on available-for-sale investment securities, net of taxes

     —          —          —          —          —          (41     —          (41
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at June 30, 2012

     48,920      $ 49      $ 401,219      $ (489   $ 24,298      $ (22   $ (215,412   $ 209,643   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Table of Contents

FBR & CO.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

     Six Months Ended
June 30,
 
     2012     2011  

Cash flows from operating activities:

    

Net income (loss)

   $ 929      $ (4,632

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Depreciation and amortization

     1,365        2,359   

Stock compensation

     3,941        4,790   

Net investment (income) loss from investments

     (3,066     1,616   

Securities received in lieu of cash

     (810     0   

Other

     904        1,411   

Changes in operating assets:

    

Receivables:

    

Brokers, dealers and clearing organizations

     (5,617     9,446   

Customers

     (1,305     (3,298

Interest, dividends and other

     4,087        2,274   

Trading securities

     25,209        (48,348

Prepaid expenses and other assets

     1,473        (1,436

Changes in operating liabilities:

    

Trading securities sold but not yet purchased

     (646     38,540   

Accrued compensation and benefits

     (3,975     (36,157

Accounts payable, accrued expenses and other liabilities

     (2,481     (10,849

Brokers, dealers and clearing organizations

     1,531        (4,784
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     21,539        (49,068
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of investments

     (22,514     (25,001

Proceeds from sales of and distributions from investments

     28,885        22,467   

Securities sold but not yet purchased, net

     1,291        0   

Purchases of furniture, equipment, software, and leasehold improvements

     (379     (741

Payments for other investing activities

     0        (500
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     7,283        (3,775
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Repurchases of common stock

     (19,556     (6,904

Proceeds from sales of common stock

     302        554   

Proceeds from repayment of employee stock purchase plan

     174        60   
  

 

 

   

 

 

 

Net cash used in financing activities

     (19,080     (6,290
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     9,742        (59,133

Cash and cash equivalents, beginning of period

     135,792        236,077   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 145,534      $ 176,944   
  

 

 

   

 

 

 

Supplemental Cash Flow Information:

    

Cash payments for taxes

   $ 80      $ 100   

Non-cash investing activities:

    

Securities received in exchange for services provided, at fair value at receipt date

   $ 810      $ 0   

See notes to consolidated financial statements.

 

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Table of Contents

FBR & CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

(Unaudited)

 

1. Basis of Presentation:

The consolidated financial statements of FBR & Co. and subsidiaries (collectively, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Therefore, they do not include all information required by accounting principles generally accepted in the United States of America for complete financial statements. The interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the results for the periods presented. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three and six months ended June 30, 2012 and 2011 are not necessarily indicative of the results for the entire year or any subsequent interim period. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although the Company bases its estimates and assumptions on historical experience and market information (when available) and on various other factors that it believes to be reasonable under the circumstances, management exercises significant judgment in the final determination of its estimates. Actual results may differ from those estimates.

In June 2012, the Company entered into a definitive agreement to sell the assets related to the management of the entire family of ten FBR Funds. The transaction is expected to close in the fourth quarter 2012, subject to regulatory and fund shareholder approval. As a result of the Company’s decisions during the second quarter and this agreement to sell these assets, the Company now reports the results of its asset management operations as discontinued operations. As a result of this change, certain previously reported amounts in the consolidated financial statements and notes have been reclassified to conform to the current period presentation. These reclassifications had no effect on the results of operations of the Company.

 

2. Financial Instruments and Long-Term Investments:

Fair Value of Financial Instruments

The Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 820 “Fair Value Measurements and Disclosures” (“ASC 820”) defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, not adjusted for transaction costs. ASC 820 also establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels giving the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3) as described below:

 

Level 1 Inputs     Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible by the Company;
Level 2 Inputs     Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly;
Level 3 Inputs     Unobservable inputs for the asset or liability, including significant assumptions of the Company and other market participants.

The Company determines fair values for the following assets and liabilities:

Equity securities, listed options and warrants—The Company classifies marketable equity securities and listed options within Level 1 of the fair value hierarchy because quoted market prices are used to value these securities. Non-public equity securities are classified within Level 3 of the fair value hierarchy if enterprise values are used to value these securities. In determining the enterprise value, the Company analyzes various financial, performance and market factors to estimate the value, including where applicable over-the-counter market trading activity. Warrants to purchase non-public equity securities are classified as Level 3 as both enterprise value and Black-Sholes valuation are used to value these securities.

 

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Convertible and fixed income debt instruments—The Company classifies convertible and fixed income debt instruments within Level 2 of the fair value hierarchy as they are valued using quoted market prices provided by a broker or dealer, or alternative pricing services that provide reasonable levels of price transparency.

Other—The Company invests in proprietary investment funds that are valued at net asset value (“NAV”) determined by the fund administrator. Investments in mutual funds are classified within Level 1 of the fair value hierarchy because investments within the funds are primarily exchange-traded securities and no restrictions exist on the redemption of the amounts invested by the Company. For investments in non-registered investment companies (private equity and debt funds and fund of funds), the Company classifies these investments within Level 3 as the underlying securities held by these investment companies are primarily private-equity and debt securities and restrictions exist on the redemption of amounts invested by the Company.

As a practical expedient, the Company relies on the NAV of these investments as their fair value. The NAVs that have been provided by investees are derived from the fair values of the underlying investments as of the reporting date.

Fair Value Hierarchy

The following tables set forth, by level within the fair value hierarchy, financial instruments accounted for under ASC 820 as of June 30, 2012 and December 31, 2011. As required by ASC 820, assets and liabilities that are measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Items Measured at Fair Value on a Recurring Basis

 

     June 30,
2012
     Level 1      Level 2      Level 3  

Financial instruments owned, at fair value:

           

Financial instruments held for trading activities at broker-dealer subsidiaries:

           

Marketable and non-public equity securities

   $ 10,779       $ 9,595       $ 0       $ 1,184   

Listed options

     1,342         1,342         0         0   

Convertible and fixed income debt instruments

     35,892         0         35,892         0   
  

 

 

    

 

 

    

 

 

    

 

 

 
     48,013         10,937         35,892         1,184   

Financial instruments held for investment activities:

           

Designated as trading:

           

Marketable and non-public equity securities

     12,243         4,991         0         7,252   

Listed options and warrants

     849         39         0         810   

Fixed income debt instruments

     2,095         0         2,095         0   

Designated as available-for-sale:

           

Marketable equity securities

     124         124         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 
     15,311         5,154         2,095         8,062   

Other

     7,439         794         0         6,645   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 70,763       $ 16,885       $ 37,987       $ 15,891   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities sold but not yet purchased, at fair value:

           

Marketable equity securities

   $ 23,443       $ 23,443       $ 0       $ 0   

Listed options

     907         907         0         0   

Convertible and fixed income debt instruments

     11,845         0         11,845         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 36,195       $ 24,350       $ 11,845       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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As of June 30, 2012, financial assets measured and reported at fair value on a recurring basis and classified within Level 3 were $15,891, or 5.7% of the Company’s total assets at that date. Regarding these Level 3 financial assets, in determining fair value, the Company analyzes various financial, performance and market factors to estimate the value, including where applicable over-the-counter market trading activity. The following table provides the valuation technique and unobservable inputs primarily used in assessing the value of these securities as of June 30, 2012:

 

Valuation Technique

   Fair Value     

Unobservable Input

   Range   Weighted
Average
 

Market approach

   $ 3,400      

Over-the-counter trading activity

   $3.75 - $20.25/share   $ 11.10   

Discounted cash flow

   $ 5,036      

Liquidation proceeds estimates

   $9.25 - $9.75/share   $ 9.25   
     

Discount rate

   10%     10

Black-Scholes

   $ 810      

Volatility

   39%     39
     

Dividend Yield

   0%     0
     

Interest Rate

   2%     2
     

Discount Rate

   50%     50

For those non-public equity securities valued using a market approach, adverse industry market conditions or events experienced by the underlying entities could result in lower over-the-counter trading prices for the securities. Such lower trading prices would result in a decline in the estimated fair value of these securities. For those non-public equity securities valued using discounted cash flows, a reduction in the liquidation proceeds estimate provided by the management of the corresponding entity or the use of a higher discount rate could result in a lower estimated fair value of these securities.

 

     December 31,
2011
     Level 1      Level 2      Level 3  

Financial instruments owned, at fair value:

           

Financial instruments held for trading activities at broker-dealer subsidiaries:

           

Marketable and non-public equity securities

   $ 24,043       $ 20,966       $ 0       $ 3,077   

Listed options

     4,930         4,930         0         0   

Convertible and fixed income debt instruments

     45,282         0         45,282         0   
  

 

 

    

 

 

    

 

 

    

 

 

 
     74,255         25,896         45,282         3,077   

Financial instruments held for investment activities:

           

Designated as trading:

           

Marketable and non-public equity securities

     25,107         20,358         0         4,749   

Designated as available-for-sale:

           

Marketable equity securities

     165         165         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 
     25,272         20,523         0         4,749   

Other

     1,107         591         0         516   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 100,634       $ 47,010       $ 45,282       $ 8,342   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities sold but not yet purchased, at fair value:

           

Marketable equity securities

   $ 24,414       $ 24,414       $ 0       $ 0   

Listed options

     7,062         7,062         0         0   

Convertible and fixed income debt instruments

     4,020         0         4,020         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 35,496       $ 31,476       $ 4,020       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of December 31, 2011, financial assets measured and reported at fair value on a recurring basis and classified within Level 3 were $8,342, or 2.8% of the Company’s total assets at that date.

 

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Level 3 Gains and Losses

The tables below set forth a summary of changes in the fair value of the Company’s Level 3 financial assets that are measured at fair value on a recurring basis for the three months ended June 30, 2012 and 2011. As of June 30, 2012 and 2011, the Company did not have any net unrealized gains (losses) included in accumulated other comprehensive income on Level 3 financial assets.

 

     Trading
Securities
    Other     Total  

Beginning balance, April 1, 2012

   $ 7,585      $ 505      $ 8,090   

Total net gains (losses) (realized/unrealized)

      

Included in earnings

     417        27        444   

Included in other comprehensive income

     0        0        0   

Purchases

     46,129        6,150        52,279   

Sales/Distributions

     (44,885     (37     (44,922

Transfers out of level 3

     0        0        0   
  

 

 

   

 

 

   

 

 

 

Ending balance, June 30, 2012

   $ 9,246      $ 6,645      $ 15,891   
  

 

 

   

 

 

   

 

 

 

The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date

   $ 328      $ 27      $ 355   
  

 

 

   

 

 

   

 

 

 

 

     Trading
Securities
    Other     Total  

Beginning balance, April 1, 2011

   $ 4,171      $ 650      $ 4,821   

Total net gains (losses) (realized/unrealized)

      

Included in earnings

     1,153        (4     1,149   

Included in other comprehensive income

     0        0        0   

Purchases

     325,632        0        325,632   

Sales/Distributions

     (321,108     0        (321,108

Transfers out of level 3

     (1,623     0        (1,623
  

 

 

   

 

 

   

 

 

 

Ending balance, June 30, 2011

   $ 8,225      $ 646      $ 8,871   
  

 

 

   

 

 

   

 

 

 

The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date

   $ 344      $ (4   $ 340   
  

 

 

   

 

 

   

 

 

 

There were no transfers of securities in to, or out of, Level 1, 2, and 3 financial assets during the three months ended June 30, 2012.

There were no transfers of securities in to, or out of, Level 2 financial assets during the three months ended June 30, 2011. One transfer was made out of Level 3 and into Level 1 during the three months ended June 30, 2011 for an equity security that was previously a non-public equity security and during the period became publicly traded.

 

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The tables below set forth a summary of changes in the fair value of the Company’s Level 3 financial assets that are measured at fair value on a recurring basis for the six months ended June 30, 2012 and 2011.

 

     Trading
Securities
    Other     Total  

Beginning balance, January 1, 2012

   $ 7,826      $ 516      $ 8,342   

Total net gains (losses) (realized/unrealized)

      

Included in earnings

     665        29        694   

Included in other comprehensive income

     0        0        0   

Purchases

     142,762        6,150        148,912   

Sales/Distributions

     (142,007     (50     (142,057

Transfers out of level 3

     0        0        0   
  

 

 

   

 

 

   

 

 

 

Ending balance, June 30, 2012

   $ 9,246      $ 6,645      $ 15,891   
  

 

 

   

 

 

   

 

 

 

The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date

   $ 454      $ 29      $ 483   
  

 

 

   

 

 

   

 

 

 

 

     Trading
Securities
    Other     Total  

Beginning balance, January 1, 2011

   $ 4,462      $ 555      $ 5,017   

Total net gains (losses) (realized/unrealized)

      

Included in earnings

     1,135        (59     1,076   

Included in other comprehensive income

     0        0        0   

Purchases

     474,916        150        475,066   

Sales/Distributions

     (470,665     0        (470,665

Transfers out of level 3

     (1,623     0        (1,623
  

 

 

   

 

 

   

 

 

 

Ending balance, June 30, 2011

   $ 8,225      $     646      $ 8,871   
  

 

 

   

 

 

   

 

 

 

The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date

   $ 137      $ (59   $ 78   
  

 

 

   

 

 

   

 

 

 

There were no transfers of securities in to, or out of, Level 1, 2, and 3 financial assets during the six months ended June 30, 2012.

There were no transfers of securities in to, or out of, Level 2 financial assets during the six months ended June 30, 2011. One transfer was made out of Level 3 and into Level 1 during the six months ended June 30, 2011 for an equity security that was previously a non-public equity security and during the period became publicly traded.

Gains and losses from Level 3 financial assets that are measured at fair value on a recurring basis, included in earnings for the three and six months ended June 30, 2012 and 2011, are reported in the following line descriptions on the Company’s statements of operations:

 

     Three Months Ended
June  30,
    Six Months Ended
June  30,
 
     2012     2011     2012     2011  

Total gains and losses included in earnings for the period:

        

Principal transactions

   $ 72      $ 750      $ 192      $ 732   

Net investment income (loss)

     372        399        502        344   

Change in unrealized gains or losses relating to assets still held at the end of the respective period:

        

Principal transactions

   $ (17   $ (59   $ (19   $ (266

Net investment income (loss)

     372        399        502        344   

 

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Financial Instruments Held for Investment—Designated as Trading

As of June 30, 2012, the Company has certain investments in marketable equity securities held by other than the Company’s broker-dealer subsidiaries that are classified as trading securities. These investments are designated as trading based on the Company’s intent at the time of designation. In accordance with ASC 320, these securities are carried at fair value with resulting realized and unrealized gains and losses reflected as net investment income (loss) in the statements of operations. Net gains and losses on these securities as of the dates indicated were as follows:

 

    Three Months Ended
June  30,
    Six Months Ended
June  30,
 
    2012     2011     2012     2011  

Net gains (losses) recognized on trading securities

  $ 1,068      $ (562   $ 2,967      $ (433

Less: Net (gains) losses recognized on trading securities sold during the period

    (748     (39     (2,145     (56
 

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains (losses) recognized on trading securities still held at the reporting date

  $ 320      $ (601   $ 822      $ (489
 

 

 

   

 

 

   

 

 

   

 

 

 

Financial Instruments Held for Investment—Designated as Available-for-Sale

As of June 30, 2012 and December 31, 2011, the Company has certain investments in marketable equity securities held by other than the Company’s broker-dealer subsidiaries that are classified as available-for-sale securities. These investments are designated as available-for-sale due to the Company’s intent at the time of designation to hold these securities for investment purposes over an extended period. However, these investments are available to be sold should economic conditions warrant such a transaction. In accordance with ASC 320, these securities are carried at fair value with resulting unrealized gains and losses reflected as other comprehensive income or loss. Gross unrealized gains and losses on these securities as of the dates indicated were as follows:

 

     June 30, 2012  
     Cost
Basis
     Unrealized     Fair Value  
      Gains      Losses(1)    

Marketable equity securities

   $ 146       $ 0       $ (22   $ 124   

 

     December 31, 2011  
     Cost
Basis
     Unrealized      Fair Value  
      Gains      Losses(1)     

Marketable equity securities

   $ 146       $ 19       $ 0       $ 165   

 

(1) Duration of unrealized losses is less than 12 months

The Company evaluates its portfolio of marketable equity securities for impairment as of each reporting date and more frequently when economic or market concerns warrant such evaluation. For the securities with unrealized losses, the Company will review the underlying cause for the impairments, as well as the severity and duration of the impairments. If the impairment is determined to be other-than-temporary, the Company will recognize an other-than-temporary impairment loss in its statement of operations. During the three and six months ended June 30, 2012, the Company did not record any other-than-temporary impairment losses in the statements of operations relating to marketable equity securities. During the three and six months ended June 30, 2011, the Company recorded other-than-temporary impairment losses of $7,499 in the statement of operations relating to two marketable equity securities. The Company recognized the impairment losses in 2011 due to the severity of the decline in the fair value of these securities below its cost basis during the second quarter of 2011. These results include an impairment loss of $7,416 related to an entity operating in the maritime transportation industry. This entity completed a secondary public offering in June 2011 that significantly diluted previous shareholders and severely impacted the market value of the entity’s shares. The carrying value of the security after the recognition of the impairment loss was $8,054. Subsequent to the recognition of this impairment loss, based on the increased liquidity of the shares resulting from the offering and the Company’s intentions with respect to the investment, the Company elected to transfer the security from designated as available-for-sale to designated as trading.

 

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There were no sales of marketable equity securities during the three and six months ended June 30, 2012. During the three and six months ended June 30, 2011, the Company received $6,360 from sales of marketable equity securities resulting in gross gains of $1,386.

Other Investments, at Cost

Other investments consisted of the following as of the dates indicated:

 

                                             
     June 30,
2012
     December 31,
2011
 

Non-public equity securities

   $ 27,357       $ 25,427   

Note receivable

     317         317   
  

 

 

    

 

 

 
   $ 27,674       $ 25,744   
  

 

 

    

 

 

 

The Company evaluates its portfolio of investments, carried at cost, for impairment as of each reporting date. Based on its evaluations, including consideration of the severity and duration of factors affecting the fair values of the Company’s investments, the Company recorded no impairment losses during the three and six months ended June 30, 2012 and 2011.

During the three and six months ended June 30, 2012, the Company received proceeds of $52, from sales of, or distributions from, non-public equity securities, resulting in gross gains of $52. During the three and six months ended June 30, 2012, there were redemptions of investments in investment funds of $37 and $59, respectively. During the three and six months ended June 30, 2011, the Company received proceeds of $2,785 and $8,285, respectively, from sales of non-public equity securities, resulting in gross gains of $-0- and $5,500, respectively and gross losses of $(22) and $(22), respectively. During the three and six months ended June 30, 2011, there were no redemptions of investments in investment funds.

 

3. Income Taxes:

During the three and six months ended June 30, 2012, the Company recorded a tax provision from continuing operations of $15 and $22, respectively. During the three and six months ended June 30, 2011, the Company recorded a tax benefit from continuing operations of $(213) and $(290), respectively. The Company’s effective tax rates for continuing operations for the three and six months ended June 30, 2012 were 4.7% and 7.5%, respectively. The Company’s effective tax rates for continuing operations for the three and six months ended June 30, 2011 were 6.7% and 5.2%, respectively. These tax rates differed from statutory tax rates primarily due to the effects of recording a full valuation allowance on the Company’s net deferred tax assets. The effective tax rate for three and six months ended June 30, 2012 also incorporates a projected tax liability related to domestic operations and the benefit of net operating losses expected to be utilized during 2012.

As of June 30, 2012, the Company continues to provide a full valuation allowance against its net deferred tax assets since, based on the application of the criteria in ASC 740 “Income Taxes” (“ASC 740”), it is more likely than not that the benefits of these assets will not be realized in the future.

 

4. Net Capital Requirements:

FBR Capital Markets & Co. (“FBRCM”), the Company’s principal U.S. broker-dealer subsidiary, is registered with the Securities and Exchange Commission (“SEC”) and is a member of the Financial Industry Regulatory Authority, Inc. (“FINRA”). As such, it is subject to the minimum net capital requirements promulgated by the SEC. As of June 30, 2012, FBRCM had net capital of $62,940, which was $59,768 in excess of its required net capital of $3,172.

 

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5. Earnings Per Share:

Basic earnings per share includes no dilution and is computed by dividing net income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share includes the impact of dilutive securities such as stock options, unvested shares of restricted stock and restricted stock units (“RSUs”), all of which are subject to forfeiture. Due to the Company’s reported net loss for the three and six months ended June 30, 2011, all stock options, unvested shares of restricted stock and unvested RSUs were considered anti-dilutive for these periods. The following table presents the computations of basic and diluted earnings per share for the periods indicated:

 

     Three Months Ended
June 30, 2012
     Three Months Ended
June 30, 2011
 
     Basic      Diluted      Basic     Diluted  

Weighted average shares outstanding:

          

Common stock (in thousands)

     55,495         55,495         62,726        62,726   

Stock options, unvested restricted stock and unvested RSUs (in thousands)

     0         1,759         0        0   
  

 

 

    

 

 

    

 

 

   

 

 

 

Weighted average common and common equivalent shares outstanding (in thousands)

     55,495         57,254         62,726        62,726   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) applicable to common stock

   $ 491       $ 491       $ (2,727   $ (2,727
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) per common share

   $ 0.01       $ 0.01       $ (0.04   $ (0.04
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     Six Months Ended
June 30, 2012
     Six Months Ended
June 30, 2011
 
     Basic      Diluted      Basic     Diluted  

Weighted average shares outstanding:

          

Common stock (in thousands)

     55,938         55,938         63,116        63,116   

Stock options, unvested restricted stock and unvested RSUs (in thousands)

     0         1,287         0        0   
  

 

 

    

 

 

    

 

 

   

 

 

 

Weighted average common and common equivalent shares outstanding (in thousands)

     0         57,225         63,116        63,116   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) applicable to common stock

   $ 929       $ 929       $ (4,632   $ (4,632
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) per common share

   $ 0.02       $ 0.02       $ (0.07   $ (0.07
  

 

 

    

 

 

    

 

 

   

 

 

 

The following table presents the number of anti-dilutive stock options, unvested restricted stock and unvested RSUs for the periods indicated (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Stock Options—Employees and directors

     6,838         7,976         6,838         7,976   

Stock Options—Non-employee

     3,669         3,424         3,669         3,424   

Restricted Stock, unvested

     10         287         10         287   

Restricted Stock Units, unvested

     5,174         7,177         5,297         7,177   
  

 

 

    

 

 

    

 

 

    

 

 

 
     15,691         18,864         15,814         18,864   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

6. Commitments and Contingencies:

As of June 30, 2012, except as described below, the Company was neither a defendant nor plaintiff in any lawsuits or arbitrations nor involved in any governmental or self-regulatory organization matters that are expected to have a material adverse effect on its financial condition, results of operations or liquidity. The Company has been named as a defendant in a small number of civil lawsuits relating to its various businesses. In addition, the Company is subject to various reviews, examinations, investigations and other inquiries by governmental agencies and self regulatory organizations. There can be no assurance that these matters individually or in aggregate will not have a material adverse effect on the Company’s financial

 

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condition, results of operations, or liquidity in a future period. However, based on management’s review with counsel, resolution of these matters is not expected to have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

Many aspects of the Company’s business involve substantial risks of liability and litigation. Underwriters, broker-dealers and investment advisers are exposed to liability under Federal and state securities laws, other Federal and state laws and court decisions, including decisions with respect to underwriters’ liability and limitations on indemnification, as well as with respect to the handling of customer accounts. For example, underwriters may be held liable for material misstatements or omissions of fact in a prospectus used in connection with the securities being offered and broker-dealers may be held liable for statements made by their securities analysts or other personnel. FBRCM has been named as a defendant in a small number of securities claims involving investment banking clients of FBRCM as a result of FBRCM’s role as an underwriter. In these cases, the underwriting agreement provides, subject to certain conditions, that the investment banking client is required to indemnify FBRCM against certain claims or liabilities, including claims or liabilities under the Securities Act of 1933, as amended (the “Securities Act”), or contribute to payments which FBRCM is required to make as a result of the litigation. There can be no assurance that such indemnification or contribution will ultimately be available to the Company or that an investment banking client will be able to satisfy its indemnity or contribution obligations when due.

In May 2008, the lead plaintiff in a previously filed and consolidated action filed an amended consolidated class action complaint that, for the first time, named Friedman, Billings, Ramsey & Co., Inc. (now FBRCM) and eight other underwriters as defendants. The lawsuit, styled In Re Thornburg Mortgage, Inc. Securities Litigation and pending in the United States District Court for the District of New Mexico, was originally filed in August 2007 against Thornburg Mortgage, Inc. (“TMI”), and certain of its officers and directors, alleging material misrepresentations and omissions about, inter alia, the financial position of TMI. The amended complaint included claims under Sections 11 and 12 of the Securities Act against nine underwriters relating to five separate offerings (May 2007, June 2007, September 2007 and two offerings in January 2008). The allegations against FBRCM related only to its role as underwriter or member of the syndicate that underwrote TMI’s total of three offerings in September 2007 and January 2008—each of which occurred after the filing of the original complaint—with an aggregate offering price of approximately $818,000. The plaintiffs sought restitution, unspecified compensatory damages and reimbursement of certain costs and expenses. Although FBRCM is contractually entitled to be indemnified by TMI in connection with this lawsuit, TMI filed for bankruptcy on May 1, 2009 and this likely will decrease or eliminate the value of the indemnity that FBRCM receives from TMI. On June 2, 2011 the Court granted FBRCM’s motion to dismiss the consolidated class action complaint as to FBRCM and then entered final judgment for FBRCM on July 25, 2011. Plaintiffs filed a timely notice of appeal to the 10th Circuit Court of Appeals, challenging the District Court’s findings; briefing on the appeal is ongoing and currently expected to be complete in August 2012. On July 20, 2012, Plaintiffs filed a motion to voluntarily dismiss with prejudice the claims relating to the January 2008 offering; that motion is pending at the Court of Appeals. The claims against FBRCM relating to the September 2007 offering remain on appeal.

FBRCM has been named as a defendant in a case relating to its role as an underwriter in residential mortgage-backed securities (“RMBS”) offerings. FBRCM is among dozens of underwriter, securitization trust and depositor defendants in an individual action filed by Cambridge Place Investment Management, Inc. in Massachusetts state court (Cambridge Place Investment Management Inc. v. Morgan Stanley et al). Cambridge’s complaint relates to the more than $2,400,000 in RMBS purchases it made in numerous underwritten offerings (of which the claims concerning FBRCM are limited to Cambridge’s purchases of a combined $22,000 of RMBS in two separate offerings) and alleges that each of the defendants made misrepresentations and omissions relating to, among other things, loan-to-value ratios, appraisals, and underwriting standards, in violation of state securities laws. FBRCM has contractual indemnification claims against the RMBS issuers and contribution claims against co-underwriters involved in the two offerings for which claims have been made against it.

FBRCM has been named a defendant in the putative class action lawsuit MHC Mutual Conversion Fund, L.P. v. United Western Bancorp, Inc., et al. pending in the United States District Court for the District of Colorado. The complaint, filed in March 2011 against United Western Bancorp, Inc. (the “Bank”), its officers and directors, underwriters and outside auditors, alleges material misrepresentations and omissions in the registration statement and prospectus issued in connection with the Bank’s September 2009 offering. The complaint alleges claims under Sections 11 and 12 of the Securities Act against the lead underwriter of the offering and FBRCM as a member of the underwriting syndicate. Although FBRCM is contractually entitled to be indemnified by the Bank in connection with this lawsuit, the Bank filed for bankruptcy on March 5, 2012 and this likely will decrease or eliminate the value of the indemnity that FBRCM receives from the Bank.

FBRCM has been named a defendant in four putative class action lawsuits all alleging substantially identical claims against Imperial Holdings, Inc. (“Imperial”), its officers and directors and underwriters for material misrepresentations and omissions in the registration statement and prospectus issued in connection with Imperial’s February 2011 initial public offering. The cases of Martin J. Fuller v. Imperial Holdings, Inc., et al. and City of Roseville Employees Retirement System

 

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Table of Contents

v. Imperial Holdings, et al, filed in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida, have been removed to the United States District Court, Southern District of Florida. Subsequently, two additional complaints, alleging substantially identical claims, have been filed in the Southern District of Florida (Sauer v. Imperial Holdings, et al. and Pondick v. Imperial Holdings, et al.). The complaints, alleging claims under Sections 11 and 12 of the Securities Act against the lead underwriters of the offering will likely be consolidated. Imperial has assumed its contractual obligation to indemnify the underwriters.

Although these cases involving FBRCM are at a preliminary stage, based on management’s review with counsel and present information currently known by management, resolution of such matters is not expected to have a material effect on the Company’s financial condition, results of operations, or liquidity.

In certain circumstances, broker-dealers and asset managers may also be held liable by customers and clients for losses sustained on investments. In recent years, there has been an increasing incidence of litigation and actions by government agencies and self regulatory organizations involving the securities industry, including class actions that seek substantial damages. The Company is also subject to the risk of litigation, including litigation that may be without merit. As the Company intends to actively defend such litigation, significant legal expenses could be incurred. An adverse resolution of any future litigation against the Company could materially affect its financial condition, operating results and liquidity.

 

7. Shareholders’ Equity:

Share Repurchases

In June 2012, the Company completed a tender offer to repurchase shares of its stock. Pursuant to the modified “Dutch auction” tender offer, the Company repurchased 5,107,000 shares of its common stock at a weighted average share price of $2.75 per share for a total cost, including transaction costs, of $14,202.

During the three and six months ended June 30, 2012, in privately negotiated or open market transactions the Company repurchased 1,478,575 and 1,978,077 shares, respectively, of its common stock at a weighted average share price of $2.75 and $2.71 per share, respectively, for a total cost, including transaction costs, of $4,081 and $5,354, respectively. See Note 12 regarding an increase in the Company’s share repurchase authorization subsequent to June 30, 2012.

Employee Stock Purchase Plan

Under the Company’s Employee Stock Purchase Plan (the “Purchase Plan”), eligible employees may purchase common stock through payroll deductions at a price that is 85% of the lower of the market value of the common stock on the first day of the offering period or the last day of the offering period. The Company recognizes compensation expense relating to shares offered under the Purchase Plan. For the three and six months ended June 30, 2012, the Company recognized compensation (credit) expense of $(2) and $86, respectively. For the three and six months ended June 30, 2011, the Company recognized compensation (credit) expense of $(27) and $171, respectively.

Stock Compensation Plans

FBR & Co. 2006 Long-Term Incentive Plan (“FBR & Co. Long-Term Incentive Plan”)

Under the FBR & Co. Long-Term Incentive Plan, as amended, the Company may grant options to purchase stock, stock appreciation rights, performance awards, restricted and unrestricted stock and RSUs for up to an aggregate of 22,069,985 shares of common stock, subject to increase under certain provisions of the plan, to eligible participants. Participants include employees, officers and directors of the Company and its subsidiaries. The FBR & Co. Long-Term Incentive Plan has a term of 10 years and options granted may have an exercise period of up to 10 years. Options may be incentive stock options, as defined by Section 422 of the Internal Revenue Code, or nonqualified stock options. The Company grants options to purchase stock, restricted shares of common stock and RSUs to employees that vest based on meeting specified service conditions of three to five years and in certain cases achievement of specified market conditions. The following table presents compensation expense related to these awards for the periods indicated:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Stock options

   $ 396       $ 652       $ 797       $ 845   

Restricted shares

   $ 104       $ 100       $ 130       $ 407   

RSUs

   $ 1,338       $ 1,617       $ 2,688       $ 3,155   

 

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Table of Contents

The following table presents issuance activity related to grants of these awards for the period indicated:

 

     Three Months Ended June 30, 2012      Six Months Ended June 30, 2012  
     Stock
Options
     Restricted
Shares
     RSUs      Stock
Options
     Restricted
Shares
     RSUs  

Stock-based award issuances

     0         0         192,905         0         0         2,868,276   

Grant date fair value per share

   $ 0.00       $ 0.00       $ 2.68       $ 0.00       $ 0       $ 2.41   

The following table presents the unrecognized compensation related to unvested options to purchase stock, restricted shares of common stock, and RSUs and the weighted average vesting period in which the expense will be recognized:

 

     As of June 30, 2012  
     Stock
Options
     Restricted
Shares
     RSUs  

Unrecognized compensation

   $ 1,390       $ 23       $ 12,489   

Unvested awards

     3,238,595         27,336         6,827,600   

Weighted average vesting period

     1.1 years         0.6 years         2.5 years   

 

8. Related Party Transactions:

Professional Services Agreement

Under the professional services agreement, as amended, with Crestview Partners, L.P (“Crestview”), the Company agreed to pay Crestview Advisors, L.L.C. a $1,000 annual strategic advisory fee plus reimbursement of reasonable out-of-pocket expenses as long as Crestview continues to own at least 50% of the shares purchased by certain Crestview affiliates in our 2006 private offering. In June 2012 and 2011, Crestview elected to receive a portion of the management fee in options to purchase shares of the Company’s common stock as allowed for under the agreement. Based on Crestview’s election, the Company issued 244,898 and 168,067 options, respectively, to Crestview Advisors, L.L.C. valued at $240 and $200, respectively. During the three and six months ended June 30, 2012, the Company recognized $250 and $500, respectively, of expense associated with this agreement. During the three and six months ended June 30, 2011, the Company recognized $250 and $500, respectively, of expense associated with this agreement.

 

9. Discontinued Operations:

In accordance with a definitive agreement to sell the assets related to the management of the entire family of ten FBR Funds, discussed in Note 1, the sale will include an initial payment upon closing and a subsequent payment upon the first anniversary of closing, in each case based on a percentage of assets under management for the applicable funds. Specifically, the Company’s proceeds will include an initial payment equal to 60% of the sales price as calculated on the closing date and the remaining 40% of the sales price as calculated on the first anniversary of the closing. Based on the value of the assets under management as of June 30, 2012, the Company would realize aggregate proceeds of approximately $30,000 from this sale, although the actual amount paid to the Company will vary based on assets under management for each fund at the applicable measurement dates. The transaction is expected to close in the fourth quarter 2012, subject to regulatory and fund shareholder approval. Upon completion of the transaction, the family of FBR Funds will be managed and distributed by the third party buyer.

The results related to the asset management operations reflected in the consolidated statements of operations are presented in the following table.

 

     Three Months Ended
June  30,
     Six Months Ended
June  30,
 
     2012      2011      2012      2011  

Revenues

   $ 4,157       $ 3,908       $ 8,290       $ 7,909   

Expenses

     3,954         3,676         7,599         7,283   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from discontinued operations before income taxes

     203         232         691         626   

Income tax provision

     19         2         35         14   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from discontinued operations, net of taxes

   $ 184       $ 230       $ 656       $ 612   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

As of June 30, 2012 and December 31, 2011, the Company had $1,890 and $2,121, respectively, of intangible assets assigned to its asset management operations. The intangible assets underlying these values will be transferred upon the close of the sale and therefore, will be eliminated from the Company’s balance sheet at that time. The carrying value of these assets at the closing date will be netted against the expected proceeds from the sale in determination of the gain on sale.

 

10. Segment Information:

The Company considers its capital markets and principal investing operations to be separate reportable segments. The capital markets segment includes the Company’s investment banking and institutional sales, trading and research operations. These businesses operate as a single integrated unit to deliver capital raising, advisory and sales and trading services to corporate and institutional clients. Principal investing includes investments in merchant banking and other investments.

The Company has developed systems and methodologies to allocate overhead costs to its business units and, accordingly, presents segment information consistent with internal management reporting. Revenue generating transactions between the individual segments have been included in the net revenue and pre-tax income of each segment.

In prior periods, the Company included the results of its fee-based asset management operations in continuing operations and reported these operations as a separate reportable segment. However, due to the transaction described in Note 9 and the reclassification of asset management’s results as discontinued operations, the Company no longer includes the results of its asset management operations in its segment information. Corporate overhead costs that have been allocated to the asset management operations are included in the segment disclosure as these costs will remain part of the Company’s continuing operations upon the disposal of the asset management operations.

Prior to December 2011, the Company’s subsidiary FBR Capital Markets International, Ltd. (“FBRIL”) located in the United Kingdom was an introducing broker-dealer registered with the Financial Services Authority (“FSA”) of the United Kingdom. In the fourth quarter of 2011, the Company initiated the process to cease activities at FBRIL and terminate FBRIL’s registration with the FSA. The Company’s revenues from foreign operations totaled $0 and $843 for the three months ended June 30, 2012 and 2011, respectively, and $0 and $2,671 for the six months ended June 30, 2012 and 2011, respectively. The following tables illustrate the financial information for the Company’s segments for the periods indicated:

 

     Three Months Ended June 30, 2012  
     Capital
Markets
    Principal
Investing
    Other1     Total  

Revenues:

        

Investment banking

   $ 18,959      $ 0      $ 0      $ 18,959   

Institutional brokerage

     12,320        0        0        12,320   

Net investment income

     0        1,090        0        1,090   

Net interest income, dividends and other

     1,186        177        0        1,363   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     32,465        1,267        0        33,732   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Expenses:

        

Variable

     8,783        (1     7        8,789   

Fixed

     24,164        100        357        24,621   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     32,947        99        364        33,410   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pre-tax income (loss)

   $ (482   $ 1,168      $ (364   $ 322   
  

 

 

   

 

 

   

 

 

   

 

 

 

Compensation and benefits:

        

Variable

   $ 3,091      $ (2   $ 2      $ 3,091   

Fixed

     13,566        39        184        13,789   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 16,657      $ 37      $ 186      $ 16,880   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

1 

Included in “Other” are net revenues and operating expenses related to the Company’s continuing operations that are allocated to the Asset Management segment.

 

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Table of Contents
     Three Months Ended June 30, 2011  
     Capital
Markets
     Principal
Investing
    Other1     Total  

Revenues:

         

Investment banking

   $ 29,999       $ 0      $ 0      $ 29,999   

Institutional brokerage

     21,092         0        0        21,092   

Net investment (loss) income

     0         (7,210     1        (7,209

Net interest income, dividends and other

     919         472        1        1,392   
  

 

 

    

 

 

   

 

 

   

 

 

 

Total

     52,010         (6,738     2        45,274   
  

 

 

    

 

 

   

 

 

   

 

 

 

Operating Expenses:

         

Variable

     13,092         0        5        13,097   

Fixed

     34,869         97        381        35,347   
  

 

 

    

 

 

   

 

 

   

 

 

 

Total

     47,961         97        386        48,444   
  

 

 

    

 

 

   

 

 

   

 

 

 

Pre-tax income (loss)

   $ 4,049       $ (6,835   $ (384   $ (3,170
  

 

 

    

 

 

   

 

 

   

 

 

 

Compensation and benefits:

         

Variable

   $ 7,952       $ 0      $ 0      $ 7,952   

Fixed

     19,599         48        193        19,840   
  

 

 

    

 

 

   

 

 

   

 

 

 

Total

   $ 27,551       $ 48      $ 193      $ 27,792   
  

 

 

    

 

 

   

 

 

   

 

 

 

 

1 

Included in “Other” are net revenues and operating expenses related to the Company’s continuing operations that are allocated to the Asset Management segment.

 

     Six Months Ended June 30, 2012  
     Capital
Markets
    Principal
Investing
     Other1     Total  

Revenues:

         

Investment banking

   $ 35,139      $ 0       $ 0      $ 35,139   

Institutional brokerage

     28,372        0         0        28,372   

Net investment income

     0        2,991         0        2,991   

Net interest income, dividends and other

     1,649        526         0        2,175   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total

     65,160        3,517         0        68,677   
  

 

 

   

 

 

    

 

 

   

 

 

 

Operating Expenses:

         

Variable

     16,673        115         20        16,808   

Fixed

     50,627        188         759        51,574   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total

     67,300        303         779        68,382   
  

 

 

   

 

 

    

 

 

   

 

 

 

Pre-tax income (loss)

   $ (2,140   $ 3,214       $ (779   $ 295   
  

 

 

   

 

 

    

 

 

   

 

 

 

Compensation and benefits:

         

Variable

   $ 5,465      $ 113       $ 11      $ 5,589   

Fixed

     28,664        85         390        29,139   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 34,129      $ 198       $ 401      $ 34,728   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

1 

Included in “Other” are net revenues and operating expenses related to the Company’s continuing operations that are allocated to the Asset Management segment.

 

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Table of Contents
     Six Months Ended June 30, 2011  
     Capital
Markets
    Principal
Investing
    Other1     Total  

Revenues:

        

Investment banking

   $ 46,569      $ 0      $ 0      $ 46,569   

Institutional brokerage

     44,183        0        0        44,183   

Net investment (loss) income

     0        (1,631     1        (1,630

Net interest income, dividends and other

     1,553        693        3        2,249   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     92,305        (938     4        91,371   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Expenses:

        

Variable

     27,002        4        18        27,024   

Fixed

     68,867        222        792        69,881   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     95,869        226        810        96,905   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pre-tax loss

   $ (3,564   $ (1,164   $ (806   $ (5,534
  

 

 

   

 

 

   

 

 

   

 

 

 

Compensation and benefits:

        

Variable

   $ 14,910      $ 1      $ 4      $ 14,915   

Fixed

     39,497        120        428        40,045   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 54,407      $ 121      $ 432      $ 54,960   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

1 

Included in “Other” are net revenues and operating expenses related to the Company’s continuing operations that are allocated to the Asset Management segment.

 

11. Recent Accounting Pronouncements:

In December 2011, the FASB amended its guidance for disclosure of assets and liabilities netted for financial statement purposes. The amendment is designed to enhance disclosures by requiring improved information about financial instruments and derivative instruments that are either offset in accordance with current standards or subject to an enforceable master netting arrangement or similar agreement. The disclosure enhancements include providing in the notes to the financial statements the gross assets and gross liabilities recognized on the balance sheet, those amounts netted in accordance with current standards, those net positions subject to an enforceable master netting arrangement or similar agreement, and the net positions presented on the balance sheet. This information should be presented in a tabular format. This amendment is effective for annual reporting periods beginning January 1, 2013 and interim periods within those annual reporting periods.

 

12. Subsequent Events:

In July 2012, the Board of Directors of the Company approved a 5,000,000 share increase to the number of shares of the Company’s common stock that the Company is authorized to repurchase. This directive increased the total number of shares authorized to repurchase to 6,146,644 shares.

 

19


Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the consolidated financial condition and results of operations of FBR & Co. and its subsidiaries (collectively, “we”, “us”, “our” or the “Company”) should be read in conjunction with the unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report on Form 10-Q and the audited consolidated financial statements and notes thereto appearing in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

The discussion of the Company’s consolidated financial condition and results of operations below may contain forward-looking statements. These statements, which reflect management’s beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of the risks and uncertainties that may affect the Company’s future results, please see “Forward-Looking Statements” immediately preceding Part I of, and other items throughout, the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Please also see “Risk Factors” in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year fiscal ended December 31, 2011.

Business Environment

The capital markets have been affected by the global economic challenges facing the U.S. and many nations in the Eurozone and instability in investor confidence. In particular, weak flows into equity mutual funds, a reticence among investors to put capital at risk through new investments, and a decrease in trading volumes for both equity and fixed income securities have resulted in significantly diminished volume of equity capital markets activity. We expect the remainder of 2012 to continue to be marked by significant risks, including; high levels of unemployment, world-wide sovereign debt challenges, and uncertainty regarding both the statutory expiration of certain tax regulations that reduce the individual tax obligation of U.S. citizens, and the potential for significant reductions in government spending.

Executive Summary

Our net income for the second quarter of 2012 was $0.5 million as compared to a net loss of $2.7 million in the second quarter of 2011. For the six months ended June 30, 2012, our net income was $0.9 million as compared to a net loss of $4.6 million in the comparable period in 2011.

In June 2012, we entered into a definitive agreement to sell the assets related to the management of the entire family of ten FBR Funds. The transaction is expected to close in the fourth quarter 2012, subject to regulatory and fund shareholder approval. As a result of the Company’s decisions during the second quarter and this agreement to sell these assets, the Company now reports the results of its asset management operations as discontinued operations.

For second quarter of 2012, our total revenues from continuing operations were $33.7 million, our pre-tax income from continuing operations was $0.3 million and our net income from continuing operations was $0.3 million, compared to total revenues from continuing operations of $45.3 million, a pre-tax loss from continuing operations of $3.2 million and a net loss from continuing operations of $3.0 million for the three months ended June 30, 2011. In addition, our income from discontinued operations, net of taxes, was $0.2 million in the second quarters of both 2012 and 2011.

For the six months ended June 30, 2012, our total revenues from continuing operations were $68.7 million, our pre-tax income from continuing operations was $0.3 million and our net income from continuing operations was $0.3 million, compared to total revenues from continuing operations of $91.4 million, a pre-tax loss from continuing operations of $5.5 million and a net loss from continuing operations of $5.2 million for the six months ended June 30, 2011. In addition, for the six months ended June 30, 2012, our income from discontinued operations, net of taxes, was $0.7 million compared to income from discontinued operations, net of taxes, of $0.6 million for the six months ended June 30, 2011.

The improvement in our operating results in the three and six months ended June 30, 2012 as compared to 2011 was primarily the result of the restructuring activities that we initiated in the fourth quarter of 2011 and the resulting reductions to our fixed costs that we realized during the six months ended June 30, 2012. These cost reductions were primarily achieved through reductions in our workforce as our headcount in our continuing operations as of June 30, 2012 is down approximately 39% since June 30, 2011.

The following is an analysis of our operating results by segment for the three and six months ended June 30, 2012 and 2011.

 

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Table of Contents

Capital Markets

Our capital markets segment includes investment banking and institutional sales, trading and research. These business units operate as a single integrated segment to deliver capital raising, advisory and sales and trading services to corporate and institutional clients. Our investment banking and institutional brokerage businesses are focused on the consumer, diversified industrials, energy and natural resources, financial institutions, insurance, real estate, and technology, media and telecommunications sectors. By their nature, our capital markets business activities are highly competitive and are subject to general market conditions, volatile trading markets, and fluctuations in the volume of market activity, as well as to the conditions affecting the companies and markets in our areas of focus. As a result, our capital markets revenues and profits are subject to significant volatility from period to period. The following tables provide a summary of our results within the capital markets segment (dollars in thousands).

 

     Three Months Ended
June 30,
 
     2012     2011  

Revenues:

    

Investment banking

   $ 18,959      $ 29,999   

Institutional brokerage

     12,320        21,092   

Net interest income, dividends and other

     1,186        919   
  

 

 

   

 

 

 

Total

     32,465        52,010   
  

 

 

   

 

 

 

Operating Expenses:

    

Variable

     8,783        13,092   

Fixed

     24,164        34,869   
  

 

 

   

 

 

 

Total(1)

     32,947        47,961   
  

 

 

   

 

 

 

Pre-tax (loss) income

   $ (482   $ 4,049   
  

 

 

   

 

 

 

 

(1) For the three months ended June 30, 2012 and 2011, total operating expenses includes the allocation of corporate overhead costs of $6,311 and $8,708, respectively.

The pre-tax loss from our capital markets segment was $0.5 million for the second quarter of 2012 compared to pre-tax income of $4.0 million for the second quarter of 2011. This pre-tax loss in 2012 is attributable to decreases in both investment banking and institutional brokerage revenues. However, the impact that the decrease in revenues had on pre-tax results was partially offset by a decrease in fixed expenses of $10.7 million or 31% in 2012. This decrease is attributable to a reduction in employees since June 30, 2011 and the impact of other non-compensation cost reduction initiatives.

Investment banking revenues decreased $11.0 million to $19.0 million during the second quarter of 2012 from $30.0 million during the second quarter of 2011. In the second quarter of 2012, we completed 12 investment banking transactions, including two sole-managed private placements and four advisory assignments. Our investment banking revenues for the second quarter of 2011 were generated from 20 transactions, including three sole-managed private placements and four advisory assignments.

Our institutional brokerage revenues decreased $8.8 million to $12.3 million for the second quarter of 2012 from $21.1 million for the second quarter of 2011. This decrease was primarily due to the continuing decrease in equity trading volumes being experienced industry-wide during the second quarter of 2012 resulting from lower volatility in the market and net outflows from domestic equity funds.

 

21


Table of Contents
     Six Months Ended
June 30,
 
     2012     2011  

Revenues:

    

Investment banking

   $ 35,139      $ 46,569   

Institutional brokerage

     28,372        44,183   

Net interest income, dividends and other

     1,649        1,553   
  

 

 

   

 

 

 

Total

     65,160        92,305   
  

 

 

   

 

 

 

Operating Expenses:

    

Variable

     16,673        27,002   

Fixed

     50,627        68,867   
  

 

 

   

 

 

 

Total(1)

     67,300        95,869   
  

 

 

   

 

 

 

Pre-tax loss

   $ (2,140   $ (3,564
  

 

 

   

 

 

 

 

(1) For the six months ended June 30, 2012 and 2011, total operating expenses includes the allocation of corporate overhead costs of $12,865 and $16,902, respectively.

The pre-tax loss from our capital markets segment decreased to $2.1 million for the six months ended June 30, 2012 from $3.6 million for the six months ended June 30, 2011. With revenues decreasing $27.1 million or 29% in 2012, the decrease in our pre-tax loss is attributable to decreases in both fixed and variable costs. Fixed expenses decreased $18.2 million, or 26%, in 2012 as a result of a reduction in employees since June 30, 2011 and the impact of other non-compensation cost reduction initiatives. Variable expenses decreased $10.3 million, or 38%, in 2012 reflecting a decrease in variable compensation and a decrease in clearing and brokerage costs. The decrease in variable compensation was attributable to the decrease in revenues and the reduction in our headcount. The decrease in clearing and brokerage costs is directly related to the decline in institutional brokerage activity in 2012.

Investment banking revenues decreased $11.5 million to $35.1 million during the six months ended June 30, 2012 from $46.6 million during the six months ended June 30, 2011. In the six months ended June 30, 2012, we completed 29 investment banking transactions, including two book-run initial public offerings and four sole-managed private placements. Our six months ended June 30, 2011 investment banking revenues were generated from 35 transactions, including one book-run initial public offering and seven private placements.

Our institutional brokerage revenues decreased $15.8 million to $28.4 million for the six months ended June 30, 2012 from $44.2 million for the six months ended June 30, 2011. This decrease was primarily due to the continuing decrease in equity trading volumes being experienced industry-wide during the six months ended June 30, 2012 resulting from lower volatility in the market and net outflows from domestic equity funds.

 

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Table of Contents

Principal Investing

As of June 30, 2012, our principal investing activity consists of investments in merchant banking and other equity investments and investment funds. The following tables provide a summary of our results within the principal investing segment (dollars in thousands):

 

     Three Months Ended
June 30,
 
     2012     2011  

Revenues:

    

Net investment income (loss)

   $ 1,090      $ (7,210

Net interest income, dividends and other

     177        472   
  

 

 

   

 

 

 

Total

     1,267        (6,738
  

 

 

   

 

 

 

Operating Expenses:

    

Variable

     (1     —     

Fixed

     100        97   
  

 

 

   

 

 

 

Total(1)

     99        97   
  

 

 

   

 

 

 

Pre-tax income (loss)

   $ 1,168      $ (6,835
  

 

 

   

 

 

 

 

(1) For the three months ended June 30, 2012 and 2011, total operating expenses includes the allocation of corporate overhead costs of $77 and $97, respectively.

The pre-tax income from our principal investing segment of $1.2 million for the second quarter of 2012 compares to a pre-tax loss of $6.8 million for the second quarter of 2011. Net investment income for the second quarter of 2012 includes net realized and unrealized gains of $1.1 million on trading securities held for investment purposes compared to second quarter of 2011 net investment loss which includes other-than-temporary impairment losses of $7.5 million related to two equity investments and $0.6 million in net unrealized losses on trading securities held for investment purposes, offset partially by $0.9 million in net realized gains from the sale of several investments during the second quarter of 2011. The net realized and unrealized gains of $1.1 million for the second quarter of 2012 include net gains of $0.7 million on securities sold during the period.

 

     Six Months Ended
June 30,
 
     2012      2011  

Revenues:

     

Net investment income (loss)

   $ 2,991       $ (1,631

Net interest income, dividends and other

     526         693   
  

 

 

    

 

 

 

Total

     3,517         (938
  

 

 

    

 

 

 

Operating Expenses:

     

Variable

     115         4   

Fixed

     188         222   
  

 

 

    

 

 

 

Total(1)

     303         226   
  

 

 

    

 

 

 

Pre-tax income (loss)

   $ 3,214       $ (1,164
  

 

 

    

 

 

 

 

(1) For the six months ended June 30, 2012 and 2011, total operating expenses includes the allocation of corporate overhead costs of $169 and $226, respectively.

The pre-tax income from our principal investing segment of $3.2 million for the six months ended June 30, 2012 compares to a pre-tax loss of $1.2 million for the six months ended June 30, 2011. Net investment income for the six months ended June 30, 2012 includes net realized and unrealized gains of $3.0 million on trading securities held for investment purposes compared to six months ended June 30, 2011 net investment loss which includes other-than-temporary impairment losses of $7.5 million related to two equity investments and $0.5 million in net unrealized losses on trading securities held for investment purposes, offset partially by $6.4 million in net realized gains from the sale of several investments. The net realized and unrealized gains of $3.0 million for the six months ended June 30, 2012 include net gains of $2.1 million on securities sold during the period.

 

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Investments

The total value of our investment portfolio was $50.4 million as of June 30, 2012. Of this total, $27.7 million was held in non-public investments recorded at cost associated with our merchant banking portfolio, $15.3 million was held in marketable and non-public equity and fixed income securities, at fair value, and $7.4 million was held in investment funds.

The following table provides additional detail regarding our merchant banking and other long-term investments as of June 30, 2012 (dollars in thousands):

 

     Number
of Shares
     Carrying Value/
Fair  Value
 

Investments, at cost:

     

American Residential Properties, Inc.

     75,000       $ 1,403   

NBH Holdings Corp.(1)

     1,049,906         20,472   

Capital Bank Corp.(1)

     248,529         4,802   

Other

     n/a         997   
     

 

 

 

Total

      $ 27,674   

Marketable and non-public equity securities and warrants, at fair value

        15,311   

Investment funds, at fair value

        7,439   
     

 

 

 

Total investments

      $ 50,424   
     

 

 

 

 

(1) As of June 30, 2012, these shares represent investments in non-public securities in which the sale of these shares was subject to restrictive covenants.

 

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Results of Operations

Three months ended June 30, 2012 compared to three months ended June 30, 2011

We recognized net income of $0.5 million in the second quarter of 2012 compared to a net loss of $2.7 million in the second quarter of 2011. This change in net income was primarily the result of the effects of cost reduction initiatives that were implemented during the fourth quarter of 2011, including an approximate 39% reduction in our headcount since the second quarter of 2011. Our net income for the second quarter of 2012 also includes a $15 thousand tax provision as compared to a $213 thousand tax benefit in the second quarter of 2011.

The pre-tax loss in our capital markets segment was $0.5 million for the second quarter of 2012 compared to pre-tax income of $4.0 million for the second quarter of 2011. This pre-tax loss in 2012 is attributable to decreases in both investment banking and institutional brokerage revenues. However, the impact that the decrease in revenues had on pre-tax results was partially offset by a decrease in operating expenses. Offsetting these results was an increase in pre-tax income from our principal investing segment to $1.2 million during the second quarter of 2012 from a loss of $6.8 million during the second quarter of 2011, reflecting an increase in net investment income for the second quarter of 2012 as compared to the same period in 2011. Our income from discontinued operations, net of taxes was $0.2 million in both the second quarters of 2012 and 2011.

Our revenues decreased 25.6% to $33.7 million during the second quarter of 2012 from $45.3 million during the second quarter of 2011 due to the changes in revenues discussed below.

Capital raising revenues decreased 26.6% to $16.8 million in the second quarter of 2012 from $22.9 million in the second quarter of 2011. In the second quarter of 2012, we completed eight capital raising transactions including two sole-managed private placements. Our capital raising revenues for the second quarter of 2011were generated from sixteen transactions including three sole-managed private placements.

Advisory revenues decreased 70.4% to $2.1 million in the second quarter of 2012 from $7.1 million in the second quarter of 2011. We completed four assignments in both the second quarters of 2012 and 2011, however, our 2011 results include one significant merger and acquisition transaction that generated a majority of the advisory revenues for this period. Our results in 2012 do not include a comparable transaction.

Institutional brokerage revenues from agency commissions and principal transactions decreased 41.7% to $12.3 million in the second quarter of 2012 from $21.1 million in the second quarter of 2011. This decrease is primarily a result of a decrease in overall industry-wide trading volume during the second quarter of 2012 as compared to 2011.

Net investment income was $1.1 million in the second quarter of 2012 compared to net investment losses of $7.2 million in the second quarter of 2011. Net investment income for the second quarter of 2012 includes net realized and unrealized gains of $1.1 million on trading securities held for investment purposes compared to second quarter of 2011 net investment loss which includes other-than-temporary impairment losses of $7.5 million related to two equity investments and $0.6 million in net unrealized losses on trading securities held for investment purposes, offset partially by $0.9 million in net realized gains from the sale of several investments during the second quarter of 2011. The net realized and unrealized gains of $1.1 million for the second quarter of 2012 include net gains of $0.7 million on securities sold during the period.

Interest income, dividends and other revenues was $1.4 million in the second quarters of 2012 and 2011. These revenues include interest from convertible and fixed income securities held on our trading desks as well as interest and dividends generated from our investment activities.

Total expenses decreased 31.0% to $33.4 million in the second quarter of 2012 from $48.4 million in the second quarter of 2011. This decrease was caused by the changes in expenses described below.

Compensation and benefits expenses decreased 39.2% to $16.9 million in the second quarter of 2012 from $27.8 million in the second quarter of 2011. Fixed compensation decreased $6.0 million in 2012 reflecting the effects of an approximate 39% reduction in our headcount since the end of the second quarter of 2011. Variable compensation decreased $4.9 million during the second quarter of 2012 as compared to second quarter of 2011 due to a decrease in revenues and a reduction in our headcount.

Professional services expenses increased 35.7% to $3.8 million in the second quarter of 2012 from $2.8 million in the second quarter of 2011 primarily due to an increase in transaction costs related to investment banking activity.

 

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Business development expenses decreased 25.0% to $2.4 million in the second quarter of 2012 from $3.2 million in the second quarter of 2011. This decrease is primarily the result of decreased travel costs associated with the overall reduction in our workforce.

Clearing and brokerage fees decreased 42.4% to $1.9 million in the second quarter of 2012 from $3.3 million in the second quarter of 2011. This decrease is primarily due to a lower volume of trading activity, in particular related to our equity trading desk.

Occupancy and equipment expenses decreased 37.5% to $3.5 million in the second quarter of 2012 from $5.6 million in the second quarter of 2011. The decrease in occupancy costs is primarily the result of reductions in depreciation expense associated with reduced capital expenditures over the past several years and reductions in our leased office space. Also, the results for the second quarter of 2011 include a $1.0 million charge associated with the consolidation of office space in our Arlington, Virginia headquarters.

Communications expenses decreased 22.5% to $3.1 million in the second quarter of 2012 from $4.0 million in the second quarter of 2011. The decrease in these expenses is primarily due to decreased costs related to market data and customer trading services as a result of the reduction in our workforce.

Other operating expenses were $1.9 million in the second quarters of 2012 and 2011. The 2012 activity reflects decreased corporate insurance costs, business licensing taxes and regulatory agency fees as a result of the reduction in our workforce and revenues offset by a bad debt expense in 2012 that is not comparable to 2011.

We recognized a tax provision of $15 thousand in the second quarter of 2012 compared to a tax benefit of $213 thousand in the second quarter of 2011. Our quarterly tax provision is determined pursuant to ASC 740, which requires using an estimated annual effective tax rate based on the forecasted taxable income for the full year. Based on this approach, our effective tax rate was 4.7% in the second quarter of 2012. This rate differed from statutory tax rates due to the effects of recording a full valuation allowance on the Company’s net deferred tax assets and the projected liability related to domestic operations in 2012 after accounting for the benefits of net operating losses expected to be utilized during the year. In comparison, our effective rate was 6.7% in the second quarter of 2011. This rate differed from statutory tax rates due to a full valuation allowance on the tax benefits of book losses incurred and as a result of the benefit of tax losses realized or expected to be realized.

The Company believes there is potential for volatility in its 2012 effective tax rate from quarter-to-quarter due to the impact of any prospective changes in its forecasted earnings for the year.

Income from discontinued operations, net of taxes, was $0.2 million for the second quarters of 2012 and 2011. These results reflect an increase in asset management fees as a result of the increase in our average assets under management offset by $0.4 million in costs associated with the pending sale transaction in 2012 that are not comparable to 2011. Our mutual fund assets under management increased 18% to $2.0 billion at June 30, 2012 from $1.7 billion at December 31, 2011 and increased 25% from $1.6 billion at June 30, 2011. The increase in mutual fund assets under management during the six months ended June 30, 2012 is primarily the result of net inflows of $223 million and a 6% increase in market value.

Six months ended June 30, 2012 compared to six months ended June 30, 2011

We recognized net income of $0.9 million in the first six months of 2012 compared to a net loss of $4.6 million in the first six months of 2011. This change in net income was primarily the result of the effects of cost reduction initiatives that were implemented during the fourth quarter of 2011, including an approximate 39% reduction in our headcount since the second quarter of 2011. Our net income for the first six months of 2012 also includes a $22 thousand tax provision as compared to a $290 thousand tax benefit in the first six months of 2011.

The pre-tax loss in our capital markets segment decreased to $2.1 million during the first six months of 2012 from $3.6 million during the first six months of 2011. While capital markets revenues decreased in 2012, the reduction in our loss is due to a decrease in our operating expenses reflecting the impact of cost reduction initiatives. Offsetting the loss in our capital markets segment in 2012 was an increase in pre-tax income from our principal investing segment to $3.2 million during the first six months of 2012 from a loss of $1.2 million during the first six months of 2011. The improvement in these results is due to a increase in net investment income for the first six months of 2012 as compared to the same period in 2011. Our income from discontinued operations, net of taxes was $0.7 million in the first six months of 2012 which is relatively consistent with $0.6 million recognized in the comparable period in 2011.

 

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Our revenues decreased 24.8% to $68.7 million during the first six months of 2012 from $91.4 million during the first six months of 2011 due to the changes in revenues discussed below.

Capital raising revenues decreased 18.4% to $31.0 million in the first six months of 2012 from $38.0 million in the first six months of 2011. In the first six months of 2012, we completed two book-run initial public offerings and four sole-managed private placements compared to the first six months of 2011 in which we completed one book-run initial public offering and seven private placements.

Advisory revenues decreased 51.8% to $4.1 million in the first six months of 2012 from $8.5 million in the first six months of 2011. We completed 10 assignments in the first six months of 2012 as compared to seven assignments in the first six months of 2011, however, our 2011 results include one significant merger and acquisition transaction that generated a majority of the advisory revenues for this period. Our results in 2012 do not include a comparable transaction.

Institutional brokerage revenues from agency commissions and principal transactions decreased 35.7% to $28.4 million in the first six months of 2012 from $44.2 million in the first six months of 2011. This decrease is primarily a result of a decrease in overall industry-wide trading volume during the first six months of 2012 as compared to 2011.

Net investment income was $3.0 million in the first six months of 2012 compared to net investment losses of $1.6 million in the first six months of 2011. Net investment income for the first six months of 2012 includes net realized and unrealized gains of $3.0 million on trading securities held for investment purposes compared to six months ended June 30, 2011 net investment loss which includes other-than-temporary impairment losses of $7.5 million related to two equity investments and $0.5 million in net unrealized losses on trading securities held for investment purposes, offset partially by $6.4 million in net realized gains from the sale of several investments. The net realized and unrealized gains of $3.0 million for the six months ended June 30, 2012 include net gains of $2.1 million on securities sold during the period.

Interest income, dividends and other revenues were $2.2 million in the first six months of 2012 and 2011. These revenues include interest from convertible and fixed income securities held on our trading desks as well as interest and dividends generated from our investment activities.

Total expenses decreased 29.4% to $68.4 million in the first six months of 2012 from $96.9 million in the first six months of 2011. This decrease was caused by the changes in expenses described below.

Compensation and benefits expenses decreased 36.9% to $34.7 million in the first six months of 2012 from $55.0 million in the first six months of 2011. Fixed compensation decreased $10.9 million in 2012 reflecting the effects of an approximate 39% reduction in our headcount since the end of the second quarter of 2011. Our fixed compensation costs in the first six months of 2011 included severance costs of $0.8 million that are not comparable to the first six months of 2012. Variable compensation decreased $9.3 million during the first six months of 2012 as compared to first six months of 2011 due to a decrease in revenues and a reduction in our headcount.

Professional services expenses were $6.6 million in the first six months of both 2012 and 2011, reflecting a decrease of $0.2 million in transaction costs related to investment banking activity offset by a comparable increase in costs related to corporate activities.

Business development expenses decreased 23.1% to $5.0 million in the first six months of 2012 from $6.5 million in the first six months of 2011. This decrease is primarily the result of decreased travel costs associated with the overall reduction in our workforce.

Clearing and brokerage fees decreased 28.3% to $4.3 million in the first six months of 2012 from $6.0 million in the first six months of 2011. This decrease is primarily due to a lower volume of trading activity, in particular related to our equity trading desk.

Occupancy and equipment expenses decreased 28.6% to $7.5 million in the first six months of 2012 from $10.5 million in the first six months of 2011. The decrease in occupancy costs is primarily the result of reductions in depreciation expense associated with reduced capital expenditures over the past several years and reductions in our leased office space. Also, the results for the first six months of 2011 include a $1.0 million charge associated with the consolidation of office space in our Arlington, Virginia headquarters.

Communications expenses decreased 19.5% to $6.6 million in the first six months of 2012 from $8.2 million in the first six months of 2011. The decrease in these expenses is primarily due to decreased costs related to market data and customer trading services as a result of the reduction in our workforce.

 

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Other operating expenses decreased 14.3% to $3.6 million in the first six months of 2012 from $4.2 million in the first six months of 2011. The decrease in expenses is primarily due to decrease in corporate insurance costs, business licensing taxes and regulatory agency fees as a result of the reduction in our workforce and revenues.

We recognized a tax provision of $22 thousand in the first six months of 2012 compared to a tax benefit of $290 thousand in the first six months of 2011. Our income tax provision is determined pursuant to ASC 740, which requires using an estimated annual effective tax rate based on the forecasted taxable income for the full year. Based on this approach, our effective tax rate was 7.5% in the first six months of 2012. This rate differed from statutory tax rates due to the effects of recording a full valuation allowance on the Company’s net deferred tax assets and the projected liability related to domestic operations in 2012 after accounting for the benefits of net operating losses expected to be utilized during the year. In comparison, our effective rate was 5.2% in the first six months of 2011. This rate differed from statutory tax rates due to a full valuation allowance on the tax benefits of book losses incurred and as a result of the benefit of tax losses realized/expected to be realized in the period.

The Company believes there is potential for volatility in its 2012 effective tax rate from quarter-to-quarter due to the impact of any prospective changes in its forecasted earnings for the year.

Income from discontinued operations, net of taxes, was $0.7 million for the second quarter of 2012 compared to income of $0.6 million for the second quarter of 2011. The change in income reflects an increase in asset management fees as a result of the increase in our average assets under management offset by $0.4 million in costs associated with the pending sale transaction in 2012 that are not comparable to 2011.

Liquidity and Capital Resources

Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing funding for investments, and for other general business purposes. Regulatory requirements applicable to our broker-dealer subsidiaries require minimum capital levels for these entities. The primary sources of funds for liquidity consist of existing cash balances (i.e., available liquid capital not invested in our operating businesses), proceeds from sales of securities, internally generated funds, dividends on equity securities that we own, and credit provided by margin accounts, banks, clearing brokers, and affiliates of our principal clearing broker. Potential future sources of liquidity for us include internally generated funds, borrowing capacity through margin accounts, corporate lines of credit and other credit facilities which we may enter into in the future, and future issuances of common stock, preferred stock or debt securities.

Cash Flows

As of June 30, 2012, our cash and cash equivalents totaled $145.5 million representing a net increase of $9.7 million for the first six months of 2012. The increase is primarily attributable to cash provided by operating activities of $21.5 million which primarily resulted from a $24.6 million reduction in our trading desk positions. Cash provided by investing activities of $7.3 million was associated with the sale of $28.9 million in equity investments offset partially by the purchase of $22.5 million of equity and fixed income investments and investment funds. Cash used in financing activities of $19.1 million was the result of repurchases of our common stock. Due to the cyclical nature of our industry and the industries in which we provide services, we maintain liquid capital to cover potential cash outflows in periods of decreased revenues and earnings.

Net cash provided by operating activities of $21.5 million during the first six months of 2012, compares to $49.1 million used during the first six months of 2011. The cash provided by operating activities during the first six months of 2012 primarily reflects the decrease in our trading positions. The first six months of 2011 cash used in operating activities reflects increased capital investment in our trading desk positions.

Net cash provided by investing activities of $7.3 million during the first six months of 2012 compares to net cash used in investing activities of $3.8 million during the first six months of 2011. The activity for both periods reflects the purchase and sale of equity and fixed income investments and contributions to investment funds.

Net cash used in financing activities of $19.1 million during the first six months of 2012 compares to $6.3 million used during the first six months of 2011. The 2012 activity primarily represents the repurchase of 7.1 million shares of our common stock for $19.6 million. The 2011 activity reflects the repurchase of 1.9 million shares of our common stock for $6.9 million.

 

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Sources of Funding

We believe that our existing cash and cash equivalents balances (totaling $145.5 million at June 30, 2012), cash flows from operations, borrowing capacity, other sources of liquidity and execution of our financing strategies will be sufficient to meet our cash requirements. We have obtained, and believe we will be able to continue to obtain, short-term financing, such as margin financing and temporary subordinated financing, in amounts and at interest rates consistent with our financing objectives. We may, however, seek debt or equity financings, in public or private transactions, to provide capital for corporate purposes and/or strategic business opportunities, including possible acquisitions, joint ventures, alliances or other business arrangements which could require substantial capital outlays. Our policy is to evaluate strategic business opportunities, including acquisitions and divestitures, as they arise. There can be no assurance that we 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 our needs ever exceed these sources of liquidity, we believe that most of our investments could be sold, in most circumstances, to provide cash.

We monitor and manage our leverage and liquidity risk through various committees and processes we have established. We assess our leverage and liquidity risk based on considerations and assumptions of market factors, as well as factors specific to us, including the amount of our available liquid capital (i.e., the amount of our cash and cash equivalents not invested in our operating business). At June 30, 2012, we had no outstanding borrowings.

Asset Management Sale

In accordance with the definitive agreement to sell the assets related to the management of the entire family of ten FBR Funds that we entered into in June 2012, (see Note 9 to the financial statements), the sale will include an initial payment upon closing and a subsequent payment upon the first anniversary of closing, in each case based on a percentage of assets under management for the applicable funds. Specifically, our proceeds will include an initial payment equal to 60% of the sales price as calculated on the closing date and the remaining 40% of the sales price as calculated on the first anniversary of the closing. Based on the value of the assets under management as of June 30, 2012, we would realize aggregate proceeds of approximately $30 million from this sale, although the actual amount paid to us will vary based on assets under management for each fund at the applicable measurement dates. The transaction is expected to close in the fourth quarter 2012, subject to regulatory and fund shareholder approval.

Assets

As of June 30, 2012, our principal assets consisted of cash and cash equivalents, receivables, trading securities and investments. As of June 30, 2012 and December 31, 2011, liquid assets consisted primarily of cash and cash equivalents of $145.5 million and $135.8 million, respectively.

The decrease in our total assets to $279.4 million as of June 30, 2012 compared to $298.1 million as of December 31, 2011, was primarily the result of a decrease of $27.9 million in financial instruments partially offset by a $9.7 million increase in cash and cash equivalents discussed previously.

Our due from and to brokers, dealers, and clearing organizations balances primarily represent unsettled trades associated with our credit sales and trading platform and also include unsettled equity and convertible securities trades. Such credit transactions include corporate bond and syndicated loan trades. An increase in unsettled credit transactions was the primary reason for the increase in the receivable from brokers, dealers and clearing organizations as of June 30, 2012. The total amount of outstanding unsettled trade receivables and payables related to these instruments was $8.2 million and $7.8 million, respectively, as of June 30, 2012 compared to $5.0 million and $6.3 million, respectively, as of December 31, 2011. Due to the extended settlement nature of most par and distressed bank loan transactions, we are subject to certain market and counterparty credit risks. See our discussion related to these risks included in the Quantitative and Qualitative Disclosures about Market Risk.

As of June 30, 2012, our $50.4 million of investments primarily consists of investments in non-public equity securities, marketable equity securities and investment funds. These investments are funded in cash and are not financed with debt. Accordingly, a decline in value of these assets, should it occur, would impact our return on our investment, however, it would not impact our current liquidity requirements.

 

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Regulatory Capital

FBRCM, our principal U.S. broker-dealer, is registered with the SEC and is a member of the FINRA. As such, FBRCM is subject to the minimum net capital requirements promulgated by the SEC. As of June 30, 2012, FBRCM had total regulatory net capital of $62.9 million, which exceeded its required net capital of $3.2 million by $59.7 million. Regulatory net capital requirements increase when the broker-dealer is involved in underwriting activities based upon a percentage of the amount being underwritten.

Share Repurchases

In June 2012, we completed a tender offer to repurchase shares of our common stock. Pursuant to the modified “Dutch auction” tender offer, we repurchased 5,107,000 shares of our common stock at a weighted average share price of $2.75 per share for a total cost, including transaction costs, of $14.2 million.

During the six months ended June 30, 2012, we repurchased 1,978,077 shares of our common stock through privately negotiated or open market transactions at a weighted average share price of $2.71 per share for a total cost, including transaction costs, of $5.4 million.

In July 2012, our Board of Directors approved a 5,000,000 share increase to the number of shares of our common stock that we are authorized to repurchase. This directive increased the total number of shares authorized to repurchase to 6,146,644 shares.

Off-Balance Sheet Arrangements

Through indemnification provisions in agreements with clearing organizations, customer activities may expose us to off-balance sheet credit risk. Financial instruments may have to be purchased or sold at prevailing market prices in the event a customer fails to settle on a trade on its original terms or in the event cash and securities in customer margin accounts are not sufficient to fully cover customer obligations. We seek to manage the risks associated with customer activities through customer screening and selection procedures as well as through requirements on customers to maintain margin collateral in compliance with various regulations and clearing organization policies.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Overall Risk Management

We monitor market and business risk, including credit risk, operations, liquidity, compliance, legal, and reputational risk through a number of control procedures designed to identify and evaluate the various risks to which our business and investments are exposed. We have established various committees and processes to assess and to manage risk associated with our investment banking, trading, and merchant banking activities. We review, among other things, business and transactional risks associated with potential investment banking clients and engagements as well as our capital subjected to risk through our trading activities. We seek to manage the risks associated with our investment banking and merchant banking activities by review and approval of transactions by the relevant committee, prior to accepting an engagement or pursuing a material investment transaction.

Market Risk

Market risk is the risk that a change in the level of one or more market prices, rates, indices, or other market factors, such as market liquidity, will result in losses for a position or portfolio. Our activities as an underwriter, market maker and principal investor, as well as our activities as a financial intermediary in customer trading transactions, expose us to market risk.

We use a number of quantitative measures to manage our exposure to market risk in our trading businesses. These measures include:

Inventory position limits—we establish inventory position limits on gross and net positions, at both the trading desk and individual position level, and we monitor exposures against limits on a daily basis.

Scenario analysis—we apply stress tests and scenario analysis to estimate the potential impact on our trading revenues of highly stressful market environments in both the credit and equity markets.

Value at Risk—we utilize a statistical measure of potential trading loss, called Value at Risk (“VaR”), to estimate the potential loss from adverse market moves in an ordinary market environment. We also establish VaR limits, as appropriate.

 

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Value at Risk. We calculate VaR for our trading businesses using a historical simulation model that isolates various risk elements associated with each of our trading positions over a one-day time horizon and at a 95% confidence level. The simulation is based on data for the previous twelve months. This approach assumes that historical changes in market values are representative of future changes.

Using the results of this simulation, VaR measures the potential gains and losses on net trading positions at a 95% confidence level over a one-day time horizon. A 95% confidence level implies that, on average, we anticipate that 5% of the time we may realize trading losses in excess of our VaR amount. Our one-day 95% VaR at June 30, 2012 was approximately $320 thousand.

 

LOGO

VaR is a model that quantifies potential losses using historical data. We could incur losses greater than the reported VaR because the historical market prices used may not be an accurate measure of future market events and conditions, especially in highly stressful market environments. In addition, the VaR model measures the risk of the current net trading positions and does not take into account future position changes arising from transaction and/or hedging activity. Our VaR includes positions actively managed and held by our trading desks and does not include positions associated with investment banking transactions that may be held on our trading desk in order to facilitate distribution. In most instances, these positions are held only for a short period and sold at or above our costs. To the extent we hold these positions on a long-term basis, they are reflected as long-term investments and risk related to these positions are discussed below under Equity Price Risk.

The comparison of actual daily trading revenue fluctuations with a daily VaR estimate is the primary method used to test the reasonableness of the VaR measure. The following table provides the distribution of daily trading revenues and losses during the six months ended June 30, 2012. The table shows data reflecting that the average lowest 5 percentile daily trading revenues during the six months ended June 30, 2012 was net losses of $25 thousand. Over the same period, the worst one-day trading revenues were net losses of $207 thousand which is less than the $357 thousand daily trading loss implied by the average one-day VaR for the six months ended June 30, 2012.

 

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LOGO

Equity Price Risk. Equity price risk represents the potential loss in value of a position due to adverse changes in the level or volatility of equity prices. We generally attempt to limit exposure to equity price risk on securities held as a result of our daily equity trading activities by limiting our intra-day and overnight inventory of trading securities to that needed to provide the appropriate level of liquidity in the securities for which we are a market maker. We also seek to manage these risks by diversifying exposures, controlling position sizes, and establishing economic hedges in related securities, principally through short sale transactions.

While it is impossible to project exactly what factors may affect the prices of equity securities and how much the effect might be, the impact of a ten percent increase and a ten percent decrease in the price of equities held by us would be as follows as of June 30, 2012. The fair value of the $10.8 million of trading equity securities held at our broker-dealer subsidiaries would increase or decrease to $11.9 million and $9.7 million, respectively, and the fair value of the $40.0 million of other equity investments would increase or decrease to $44.0 million and $36.0 million, respectively.

Except to the extent that we sell our equity securities designated as available-for-sale or our cost method equity investments, or a decrease in their fair value is deemed to be other-than-temporary, an increase or decrease in the fair value of those assets will not directly affect our earnings. However, an increase or decrease in the value of trading securities held by broker-dealer subsidiaries, investment securities designated as trading, or investment funds will directly affect our earnings.

Credit Risk. Our broker-dealer subsidiaries clear all of their securities transactions through a clearing broker on a fully disclosed basis. Pursuant to the terms of the agreements between our broker-dealer subsidiaries and the clearing broker, the clearing broker has the right to charge us for losses that result from a counterparty’s failure to fulfill its contractual obligations. As the right to charge us has no maximum amount and applies to all trades executed through the clearing broker, we believe there is no maximum amount assignable to this right. At June 30, 2012 and December 31, 2011, we have recorded no liabilities with regard to this right. During the six months ended June 30, 2012 and 2011, amounts paid to the clearing broker related to these guarantees have been immaterial. In addition, we have the right to pursue collection of performance from the counterparties who do not perform under their contractual obligations. We monitor the credit standing of the clearing broker and all counterparties with which we conduct business.

We attempt to limit our credit spread risk by offsetting long or short positions in various related securities, but may also hedge credit risk exposure through the use of credit derivatives such as credit default swaps.

Our due from and to brokers, dealers and clearing organizations balances primarily represent unsettled trades associated with our credit sales and trading platform. These transactions include corporate bonds and syndicated loan trades. As part of this activity, we incur market and counterparty credit risk due to the extended settlement nature of most par and distressed bank loan transactions. Par loan and distressed bank loan trades have extended settlement periods due to the administrative and legal requirements associated with transferring title of such instruments. During this period whereby a

 

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trade has been executed but not settled, we are at risk if one of our counterparties defaults on a trade obligation and we have to meet this obligation at market prices that are adverse relative to the original trade. We manage this exposure by calculating the current and potential default exposure on each trade and maintaining risk limits for each counterparty with whom we have outstanding bank loan trades.

The securities industry is subject to numerous risks, including the risk of loss associated with the underwriting, ownership, and trading of securities, and the risk of reduced revenues in periods of reduced demand for security offerings and activity in secondary trading markets. Changing economic and market trends may negatively impact the liquidity and value of our investments and the level of security offerings underwritten by us, which may adversely affect our revenues and profitability.

Our equity and debt investments include non-investment grade securities of privately held issuers with no ready markets. The concentration and illiquidity of these investments expose us to a higher degree of risk than associated with readily marketable securities.

Interest Rate Risk. Interest rate risk represents the potential loss in value of a position or portfolio from adverse changes in market interest rates. We are exposed to interest rate risk through our trading activities in convertible and fixed income securities, however, based on our daily monitoring of this risk, we believe we currently have limited exposure to interest rate risk in these activities.

 

Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

As of the end of the period covered by this report on Form 10-Q, our management carried out an evaluation, with the participation of our Chief Executive Officer, Richard J. Hendrix, and our Chief Financial Officer, Bradley J. Wright, of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) pursuant to Rule 13a-15(b) under the Exchange Act. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures, as of June 30, 2012, are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure.

Changes in Internal Controls over Financial Reporting

During the six months ended June 30, 2012, we have not made any changes that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act).

 

33


Table of Contents

PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings

As of June 30, 2012, except as described below, the Company was neither a defendant nor plaintiff in any lawsuits or arbitrations nor involved in any governmental or self-regulatory organization matters that are expected to have a material adverse effect on its financial condition, results of operations or liquidity. The Company has been named as a defendant in a small number of civil lawsuits relating to its various businesses. In addition, the Company is subject to various reviews, examinations, investigations and other inquiries by governmental agencies and self regulatory organizations. There can be no assurance that these matters individually or in aggregate will not have a material adverse effect on the Company’s financial condition, results of operations, or liquidity in a future period. However, based on management’s review with counsel, resolution of these matters is not expected to have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

Many aspects of the Company’s business involve substantial risks of liability and litigation. Underwriters, broker-dealers and investment advisers are exposed to liability under Federal and state securities laws, other Federal and state laws and court decisions, including decisions with respect to underwriters’ liability and limitations on indemnification, as well as with respect to the handling of customer accounts. For example, underwriters may be held liable for material misstatements or omissions of fact in a prospectus used in connection with the securities being offered and broker-dealers may be held liable for statements made by their securities analysts or other personnel. FBRCM has been named as a defendant in a small number of securities claims involving investment banking clients of FBRCM as a result of FBRCM’s role as an underwriter. In these cases, the underwriting agreement provides, subject to certain conditions, that the investment banking client is required to indemnify FBRCM against certain claims or liabilities, including claims or liabilities under the Securities Act of 1933, as amended (the “Securities Act”), or contribute to payments which FBRCM is required to make as a result of the litigation. There can be no assurance that such indemnification or contribution will ultimately be available to the Company or that an investment banking client will be able to satisfy its indemnity or contribution obligations when due.

In May 2008, the lead plaintiff in a previously filed and consolidated action filed an amended consolidated class action complaint that, for the first time, named Friedman, Billings, Ramsey & Co., Inc. (now FBRCM) and eight other underwriters as defendants. The lawsuit, styled In Re Thornburg Mortgage, Inc. Securities Litigation and pending in the United States District Court for the District of New Mexico, was originally filed in August 2007 against Thornburg Mortgage, Inc. (“TMI”), and certain of its officers and directors, alleging material misrepresentations and omissions about, inter alia, the financial position of TMI. The amended complaint included claims under Sections 11 and 12 of the Securities Act against nine underwriters relating to five separate offerings (May 2007, June 2007, September 2007 and two offerings in January 2008). The allegations against FBRCM related only to its role as underwriter or member of the syndicate that underwrote TMI’s total of three offerings in September 2007 and January 2008—each of which occurred after the filing of the original complaint—with an aggregate offering price of approximately $818.0 million. The plaintiffs sought restitution, unspecified compensatory damages and reimbursement of certain costs and expenses. Although FBRCM is contractually entitled to be indemnified by TMI in connection with this lawsuit, TMI filed for bankruptcy on May 1, 2009 and this likely will decrease or eliminate the value of the indemnity that FBRCM receives from TMI. On June 2, 2011 the Court granted FBRCM’s motion to dismiss the consolidated class action complaint as to FBRCM and then entered final judgment for FBRCM on July 25, 2011. Plaintiffs filed a timely notice of appeal to the 10th Circuit Court of Appeals, challenging the District Court’s findings; briefing on the appeal is ongoing and currently expected to be complete in August 2012. On July 20, 2012, Plaintiffs filed a motion to voluntarily dismiss with prejudice the claims relating to the January 2008 offering; that motion is pending at the Court of Appeals. The claims against FBRCM relating to the September 2007 offering remain on appeal.

FBRCM has been named as a defendant in a case relating to its role as an underwriter in residential mortgage-backed securities (“RMBS”) offerings. FBRCM is among dozens of underwriter, securitization trust and depositor defendants in an individual action filed by Cambridge Place Investment Management, Inc. in Massachusetts state court (Cambridge Place Investment Management Inc. v. Morgan Stanley et al). Cambridge’s complaint relates to the more than $2.4 billion in RMBS purchases it made in numerous underwritten offerings (of which the claims concerning FBRCM are limited to Cambridge’s purchases of a combined $22.0 million of RMBS in two separate offerings) and alleges that each of the defendants made misrepresentations and omissions relating to, among other things, loan-to-value ratios, appraisals, and underwriting standards, in violation of state securities laws. FBRCM has contractual indemnification claims against the RMBS issuers and contribution claims against co-underwriters involved in the two offerings for which claims have been made against it.

 

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Table of Contents

FBRCM has been named a defendant in the putative class action lawsuit MHC Mutual Conversion Fund, L.P. v. United Western Bancorp, Inc., et al. pending in the United States District Court for the District of Colorado. The complaint, filed in March 2011 against United Western Bancorp, Inc. (the “Bank”), its officers and directors, underwriters and outside auditors, alleges material misrepresentations and omissions in the registration statement and prospectus issued in connection with the Bank’s September 2009 offering. The complaint alleges claims under Sections 11 and 12 of the Securities Act against the lead underwriter of the offering and FBRCM as a member of the underwriting syndicate. Although FBRCM is contractually entitled to be indemnified by the Bank in connection with this lawsuit, the Bank filed for bankruptcy on March 5, 2012 and this likely will decrease or eliminate the value of the indemnity that FBRCM receives from the Bank.

FBRCM has been named a defendant in four putative class action lawsuits all alleging substantially identical claims against Imperial Holdings, Inc. (“Imperial”), its officers and directors and underwriters for material misrepresentations and omissions in the registration statement and prospectus issued in connection with Imperial’s February 2011 initial public offering. The cases of Martin J. Fuller v. Imperial Holdings, Inc., et al. and City of Roseville Employees Retirement System v. Imperial Holdings, et al, filed in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida, have been removed to the United States District Court, Southern District of Florida. Subsequently, two additional complaints, alleging substantially identical claims, have been filed in the Southern District of Florida (Sauer v. Imperial Holdings, et al. and Pondick v. Imperial Holdings, et al.). The complaints, alleging claims under Sections 11 and 12 of the Securities Act against the lead underwriters of the offering will likely be consolidated. Imperial has assumed its contractual obligation to indemnify the underwriters.

Although these cases involving FBRCM are at a preliminary stage, based on management’s review with counsel and present information currently known by management, resolution of such matters is not expected to have a material effect on the Company’s financial condition, results of operations, or liquidity.

In certain circumstances, broker-dealers and asset managers may also be held liable by customers and clients for losses sustained on investments. In recent years, there has been an increasing incidence of litigation and actions by government agencies and self regulatory organizations involving the securities industry, including class actions that seek substantial damages. The Company is also subject to the risk of litigation, including litigation that may be without merit. As the Company intends to actively defend such litigation, significant legal expenses could be incurred. An adverse resolution of any future litigation against the Company could materially affect its financial condition, operating results and liquidity.

 

Item 1A. Risk Factors

As of June 30, 2012, there have been no material changes to our risk factors as previously disclosed in Item 1A, “Risk Factors”, in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table provides information on the Company’s share repurchases during the second quarter of 2012:

 

    Total Number of
Shares  Purchased
    Average Price Paid
per Share
    Total Number of  Shares
Purchased as Part of
Publicly Announced
Plans or Programs(1)
    Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs
 

April 1 to April 30, 2012

    —        $ —          —          2,625,219   

May 1 to May 31, 2012

    —          —          —          2,625,219   

June 1 to June 30, 2012

    6,585,575       2.75        1,478,575       1,146,644   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

    6,585,575     $ 2.75        1,478,575       1,146,644   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) On July 27, 2010, the Board of Directors of the Company approved a 5,000,000 share increase to the number shares of common stock that the Company is authorized to repurchase. This directive increased the total number of shares authorized to repurchase to 5,650,500 shares of which 1,146,644 shares remain authorized to be repurchased as of June 30, 2012. As announced on July 18, 2012, on July 17, 2012, the Board of Directors of the Company approved a 5,000,000 share increase to the number shares of common stock that the Company is authorized to repurchase. This directive increased the total number of shares authorized to repurchase to 6,146,644 shares.

 

35


Table of Contents
Item 4. Mine Safety Disclosures

Not applicable.

 

Item 6. Exhibits

 

Exhibit
Number

  

Exhibit Title

    3.1    Amended and Restated Articles of Incorporation of the Registrant.*
    3.2    Amended and Restated Bylaws of the Registrant.**
  31.01    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.02    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.01    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.02    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101    The following financial information from the Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to the Consolidated Financial Statements.

 

* Previously filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (Registration No. 333-175088), which was filed with the SEC on June 23, 2011, and incorporated herein by reference.
** Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K, which was filed with the SEC on June 23, 2011, and incorporated herein by reference.

 

36


Table of Contents

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  FBR & Co.
Date: August 9, 2012   By:  

/S/    BRADLEY J. WRIGHT        

    Bradley J. Wright
    Executive Vice President, Chief Financial Officer
    (Principal Financial Officer)
Date: August 9, 2012   By:  

/S/    ROBERT J. KIERNAN        

    Robert J. Kiernan
   

Senior Vice President, Controller and

Chief Accounting Officer

    (Principal Accounting Officer)

 

37

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